What's Next? Reforming Corporate Taxes and Entitlements

We've raised taxes. Eventually we'll have to close the deficit from the other side.

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Nancy Pelosi, of all people, got it right Thursday morning. In an interview broadcast on National Public Radio, the liberal House Minority Leader agreed that spending cuts and entitlement reforms are necessary.

"The size of our deficit is an immorality, we should not be heaping those responsibilities onto the future," Pelosi said, sounding oddly Republican. "Finding reductions, subjecting every federal dollar spent to harsh scrutiny as to whether the taxpayer is getting full value for the dollar, is very important. And that holds true in defense as well as on the domestic side."

Pelosi, of course, could simply be spouting rhetoric. In the same interview, she called for Republicans to "take back your party" from "anti-government ideologues," praised Tuesday's last-minute budget deal for creating "more fairness in our tax code," and said the goal of entitlement reform must be to "strengthen" Medicare and Social Security, not slash them.

But give Pelosi credit for at least admitting that spending cuts are necessary. Since President Barack Obama's re-election, some on the left have argued that entitlement programs do not need major reform. That alone won't suffice; like or loathe this week's tax compromise, it does not create nearly enough revenue to fund our current spending.

The Congressional Budget Office found that the U.S. will amass roughly $4 trillion in deficit over the next decade if current spending levels remain in place. Even with a drawdown of American troops in Afghanistan, the Committee for a Responsible Federal Budget estimates that the U.S. debt will remain at 79 percent of GDP through 2022.

Democrats, of course, can and should call for deep cuts in defense spending. But they must recognize the need to reform Medicare, the country's fastest growing government program. The rise in health care costs is the single largest fiscal threat the government faces. McSweeney's and The New York Times, two publications embraced by the left, have both published prescient pieces on the vast scope of the problem.

Ezekiel J. Emanuel, a professor and health care expert at the University of Pennsylvania, and the older brother of Democratic Chicago Mayor Rahm Emanuel, starkly summed up the problem in the Times in May.

"By 2025, tax revenue will be able to pay for Medicare, Medicaid, Social Security, interest on the debt and nothing else," Emanuel wrote. "The rest -- defense, medical research, highways, education, energy -- will have to be financed by deficits. Social Security's funding is predicted to run short in 2033, Medicare's trust fund in 2024."

Emanuel called for "graduated eligibility," a reform that would result in wealthier people receiving Medicare and Social Security later in life. The reform reflects the reality that the rich outlive the poor.

"People in the bottom half of the lifetime earnings distribution would become eligible for normal retirement benefits at age 65 for Medicare and 66 for Social Security, just as they are today," Emanuel wrote. "But people in the next quarter of the lifetime earnings distribution would become eligible for the respective programs at 67 and 68, and those in the top quarter would become eligible at 70 and 71. All eligibility ages would increase over time, as they are scheduled to now."

This is just one proposal that should be considered by Democrats. Over the long term, a refusal by the left to embrace any type of major reforms to Medicare and Social Security is fiscal and political suicide.

At the same time, Republicans should embrace the need for corporate tax reforms that increase revenues, not decrease them. One of the worst aspects of the "fiscal cliff" compromise was that, yet again, corporate America won.

Congress ended a 2 percent payroll tax holiday that helped middle class Americans but extended $46.1 billion in tax breaks and credits for American corporations. That includes a $78 million subsidy to NASCAR for racetrack construction over the next 10 years. Separately, the wind industry gained a whopping $12 billion over the next decade.

The biggest problem, though, is a corporate tax system that allows companies to avoid vast amounts of taxes by hiding profits overseas. In an excellent piece in Quartz Thursday morning, Tim Fernholz argued that there was a larger reason CEOs embraced higher income taxes for wealthy Americans in recent White House meetings: the promise of corporate tax reform. Two vast tax breaks that CEOs wanted as part of corporate tax reform, according to Fernholz, were in this week's final deal.

"A provision allows U.S. companies operating overseas to convert 'passive' profits like interest payments and rents into lower-tax 'active' investment vehicles, largely benefitting financial services companies or industrials, like GE, with major financial units," Fernholz wrote. "Another provision allows tech and pharmaceutical companies to move intellectual property to subsidiaries in low-taxed or no-tax countries. These are the kinds of rules that allow companies like Pfizer and Google to pay low taxes, and recently attracted public censure for Starbucks in the United Kingdom."

In recent years, corporations have set records for profitability as a share of the economy, according to Fernholz.  At the same time, the share of revenue that the government is collecting from corporations has declined due to tax breaks and the increasing ability of companies to keep profits overseas.

In a perfect world, Republicans would accept a stricter corporate tax system in exchange for Democrats agreeing to entitlement reform. That's a fantasy, of course, but it is what taxpayers deserve.

This post also appears at Reuters.com, an Atlantic partner site.