The Best Plan Yet? A Summary of the New Bipartisan Deficit Reduction Scheme

Stimulus now and austerity later might be an appropriate five-word summation of the latest deficit reduction plan to hit the press. And it's good.

Sponsored by the Bipartisan Policy Center and led by former Senate Budget Committee Chairman Pete Domenici and former White House Budget Director and Federal Reserve Vice Chair Alice Rivlin, it might be my favorite plan released yet. Let's take a quick look at the plan, comparing it to the liberal proposal from deficit commission member Rep. Jan Schakowsky (my review here) and the bipartisan chairmen's plan from Erskin Bowles and Alan Simpson (my defense here).

MORE ON Rescuing the US Budget:

Derek Thompson:The Liberal Deficit Reduction Plan

Center for a Responsible Federal Budget: A 50/50 Plan to Stabilize the Debt

Megan McArdle: How I Over-Balanced the Budget

First, like Schakowsky and unlike Bowles-Simpson, this plan puts a big stimulus upfront to help the struggling economy: a one-year payroll tax holiday costing $650 billion. More than three times the size of Schakowsky's stimulus and six times the size of the Making Work Pay tax cut in the president's 2009 Recovery Act, this would give employers and employees each a 6.2 percent tax cut on all wages up to $107,000. Employers would have thousands of dollars to spend on new equipment and workers, and employees would have a couple thousand dollars to spend on food and furniture.

So far, the White House has resisted this option for a few reasons: (1) it costs a lot of money; (2) without capping the payroll tax cut, a lot of this money will end up in wealthy people's pockets and they might not spend it quickly; and (3) it's unclear how well a one-year tax cut will stimulate growth if people know that taxes will rise significantly two years later. Still, this is a bold and worthy idea -- the CBO esimates it could create up to 7 million jobs in 2011 -- that would draw both liberal and conservative support. Point: Rivlin-Domenici.

Second, on discretionary budget cuts, this plan, like the chairmen's proposal, calls for freezing domestic discretionary spending and defense spending -- except it starts cutting immediately rather than allow a one-year grace period. This would yield 2015 savings of more than $200 billion, like the chairmen's plan. Many of the items nominated for the chopping block are also on the chairmen's list. The liberal proposal, by contrast, would seek similar cuts in defense but it would hardly touch domestic discretionary spending.

I feel uncomfortable evaluating the wisdom of domestic discretionary cuts. (Is it wiser to seek $500 million in cuts from the Educational Technology State Grants or the Hollings Manufacturing Extension Partnership and Baldrige National Quality Program? I really cannot say.) So I'm going to chalk this up to a tie. But I will say that I prefer the Bowles-Simpson proposal to wait a year before enacting cuts, and also I prefer the Schakowsky plan to cut defense more than domestic. Three-way tie.

Third, on health care, the Rivlin-Domenici plan looks more similar to the chairmen's proposal than the liberal proposal. It caps Medicare to GDP-plus-1 percent, about 40% below current projections. It reforms medical malpractice laws, increases cost-sharing in Medicare, includes a permanent "doc fix," strengthens the Affordable Care Act, and includes plans to "incentivize providers to seek more efficient delivery systems." All of these ideas look similar to the chairmen's proposal. I'll take a longer look at all of the health care plans later this, but for now I like prefer the the more fleshed out Rivlin-Domenici approach to health care. Point: Rivlin-Domenici, barely.

Fourth, on taxes, today's new plan broadens the base and lowers the rate on personal income and corporate income (like Bowles-Simpson) but it also adds a key new variable: a tax on consumption specifically designed to reduce the debt. It simplifies the tax code into two rates -- 15 and 27 percent -- lowers the corporate income tax to 27 percent from 35, taxes investment income as ordinary income (raising effective rates on the rich), increases and simplifies the child tax credit and earned income tax credit (lowering effective rates on the low-income), and changes the mortgage interest deduction to a tax credit to make it less regressive. All told, it dramatically simplifies the tax code and makes it more progressive than both our current system and the chairmen's plan (according to initial Tax Policy Center estimates).* Point: Rivlin-Domenici.

Fifth, on Social Security, today's plan mimics the chairmen by (1) gradually raising the amount of wages subject to payroll tax to 90 percent of all wages, (2) slowing the growth of benefits by tweaking the cost-of-living adjustment, and (3) increasing the minimum benefit. Rather than very slowly raise the retirement age, this plan would very slowly shrinks the "replacement rates" used to calculate benefits each year for new beneficiaries to reflect an aging population receives more Social Security checks as we live longer.

Surprisingly, the most significant Social Security saver in this plan would be the slow elimination of the employer health care subsidy until 2028. This would encourage employers to put more money toward taxable wages, which would raise lots of money for Social Security. In any case, this is a much more balanced approach to Social Security reform than Schakowsky's plan to nearly eliminate the taxable ceiling and make no spending cuts. Tie: Rivlin-Domenici/Bowles-Simpson.

This might be the best deficit reduction plan I've seen yet. In the short term, the combination of a looming consumption tax and a payroll tax might get consumers spending quickly. (If most products will be 6.5% more expensive tomorrow, and you have a one-year tax break right now, your incentive might be to rush some big purchases this year, stoking short-term aggregate demand.) In the long term, it makes sensible changes to the tax code, strengthens the best parts of the Affordable Care Act, sets its eyes on a pay-for-care health system, and shores up Social Security on the spending and taxing side. I've only taken one read through the plan, so I reserve the right to completely change my mind tomorrow. But for today, this plan looks like a winner to me -- even though it's still probably a non-starter with today's Congress.


* I'll be coming back to this tax plan later this week, especially to look at how the addition of a sales tax could hurt businesses who will be paying a similar effective corporate income tax rate.