Beware the “Grand Bargain”

Barack Obama really does have a plan for the next four years. When he thought he was speaking off the record to the Des Moines Register the other day, he said he wanted to negotiate a “grand bargain” with the congressional Republicans. It would include spending reductions and tax increases to reduce forecasted federal deficits.

About the same time that the president was giving his interview, more than 80 CEOs of some of the nation’s largest companies were making a similar announcement. To get the country’s fiscal house in order, they said, we need both spending reductions and tax increases.

The idea of a grand bargain is very much on the minds of Washington, D.C., insiders these days. I frequently see it mentioned in news reports and on public policy blogs. So be forewarned. The inside-the-Beltway crowd is gearing up for a very large scale budget deal.

Let’s Make a Deal

Here’s the problem for Republicans: this could easily be a trap. By that I mean we are likely to see tax increases immediately and permanently, while the spending cuts may never occur.

Why is that? Because the only way to get substantial spending reductions is to cut outlays for entitlement programs, including Social Security, Medicare and Medicaid. And although the Democrats have said they are willing to do that, there are two conditions: (1) the spending cuts must come in future years and (2) they must not — repeat, not — involve fundamental reform.

Fundamental reform is what President Bush tried to do with Social Security. He wanted to replace the Ponzi scheme finance of the current system, under which each generation expects future generations to pay for its benefits, with a private, funded system, under which each generation would save and invest and pay their own way.

Fundamental reform of Medicare and the elderly portion (which is most of the total) of Medicaid needs to proceed in much the same way. Young people need to start saving right now to pay for their health care and their nursing home needs during the years of their retirement. We also need to create more private sector options so that seniors have access to the same kind of health insurance the rest of the nation has access to (a la Paul Ryan).

The Democrats, however, will have none of this. Their idea of Social Security reform is raising the retirement age, reducing the rate of growth of benefits, raising the maximum wage subject to the payroll tax, etc. In other words, they want to tinker around the edges. And while they are perfectly willing to allow increasing the payroll tax on higher-income taxpayers immediately, all the spending reductions must only apply to future retirees, not current ones.

You see the problem? Tax increases get legislated now. Spending cuts take place at a time when some future Congress will have the opportunity to rescind them.

Reform of government health care programs follows much the same pattern for the Democrats. No fundamental reform. Only tinkering. Tax increases are immediate. Spending reductions get phased in in future years — but only if future representatives can withstand the political pressure.

One way to appreciate how the Democrats approach entitlement reform is to consider the way they chose to fund the Affordable Care Act (ObamaCare). Over the next 10 years, a new health insurance entitlement for young people is to be paid for by reducing Medicare spending by $716 billion. There is also a hefty increase in the Medicare payroll tax for higher income taxpayers.

However, the new Medicare payroll tax kicks in 2013, while the spending reductions phase in slowly, over time. Further, in their campaign rhetoric, the Democrats claim that seniors won’t even be harmed at all, since the spending reductions will come at the expense of doctors, hospitals and insurance companies.

Of course, when the doctors stop seeing senior patients (or start converting to concierge care), when the hospitals leave the market (as one in seven will in the next eight years, according to the Medicare Actuary) and when the insurance plans cut back on the benefits they are providing, there will be enormous pressure on Congress to reverse all of this. And most inside-the-Beltway folks are firmly convinced they will be reversed.

What would structural change look like? NCPA Senior Fellow Andrew Rettenmaier and NCPA Senior Fellow and former Medicare Trustee Thomas R. Saving explain how to reform Social Security with a system of private savings accounts — requiring a contribution equal to 5% of payroll during the working years. Rettenmaier and Saving propose a similar approach to Medicare reform that requires contribution of 4% of payroll to a health retirement account. I expand on Medicare reform in this study.

Comments (21)

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  1. Ken says:

    You are right, John. A grand bargain would be a trap.

  2. Cindy says:

    I appreciate that this blog is committed to proposing alternate solutions instead of just pointing out the problems with healthcare — one of the reasons why I enjoy reading it!

  3. Lloyd says:

    Sounds like more gridlock on the beltway, no “grand bargain” for the president.” We can only hope that the Democrats and Republicans will someday work together in the right direction again.

  4. Praktika says:

    A “grand bargain” is like a game of mouse trap, in the end someone gets tricked and others get caught in the game.

  5. Cindy says:

    It’ll be interesting to see what the actual policies will look like. Could be that this is just more of the same from both sides — I agree with Lloyd that gridlock will continue to be a problem barring some kind of unlikely massive overhaul.

  6. Jordan says:

    Bipartisanship will go away if Romney wins, that’s the way it works. The incumbent party always sounds magnanimous until they lose — then the cycle starts all over again.

  7. Kyle says:

    This is one of those train wrecks that makes me want to leave the country and watch from afar.

  8. Buster says:

    It was a Grand Bargain that eliminated half of all wage earners from the tax rolls. Once liberated from paying taxes (like the rest of us), they had little incentive to curtail their demands more government services that actual taxpayers (and their descendants) are expected to pay for.

  9. Jennie Fiedler says:

    I think long term savings is really the key here. It would however mean a huge shift in how Americans use their money. On average about 35% to 40% of our income goes to housing. I see a huge drop in not only home ownership but consumer spending and borrowing as well. Hopefully there will also be a shift towards personal responsibility for good health which helps prevent large outlays of money for medical treatment.

  10. Joe S. says:

    You have the right word: BEWARE.

  11. Earl Grinols says:

    History does seem to teach that trading future spending cuts for immediate tax increases leads to tax increases but not the cuts.

    Franklin Roosevelt style entitlement programs fail modern economics in two ways: they provide aid to everyone (even those who do not need it) and they funtion wastefully. We now know that targeted income aid is the efficient way.

    How to make the transition? An example using Social Security: Make payments as under current law until a recipeint receives what he is entitled to based on what was put into the system on his behalf plus interest. Then terminate payments, but if this causes hardship allow the recipient to apply for extension on welfare needs grounds.

  12. David Alexander says:

    I think any fundamental reform of government programs has to involve a fundamental reform of our system of taxation. The idea of taxing income and capital make no sense unless the goal is to give politicians an endless opportunity to create perverse incentives for just about any interest group. Ultimately we must obtain the broadest base for taxation and leave taxpayers with more disposable income for individual consumption choices, savings and investment. Something along the lines of the Fair Tax would be a good place to start.

  13. seyyed says:

    i think the current system of taxation can remain as long as policymakers are willing reach across the aisle and not only make difficult cuts but also be willing to make fundamental reforms to many entitlement programs

  14. Robert says:

    I’m very curious about this banding together of CEOs in favor of this plan, especially Goldman Sach’s.

  15. Spencer says:

    Sounds like a big ol’ mess, if you ask me.

  16. August says:

    I doubt spending can be re-balanced to proper levels without fundamental reform. Here is the Economist on that spending balance

    “On the spending side of the budget, America allocates far less than other rich countries to cash transfers, such as unemployment insurance or income support. But it does spend a large and growing share of its budget on social services, particularly health care for the poor and the old. The result is a welfare state that is skewed rather than skimpy. America’s government raises revenues inefficiently and redistributes them oddly: too much from young to old, too much in the form of health care, and ever less from rich to poor.”

    “According to the Centre on Budget and Policy Priorities, over half of all entitlement spending flows to the elderly and around 40% is spent on health care. The poor do not get much of a look-in. Around 10% of the total goes to the richest fifth of Americans, almost 60% to the middle three-fifths and only 30% to the poorest fifth.”

  17. Alex says:

    There’s no way any sort of bargain would get passed in today’s polarized atmosphere.

  18. Paul says:

    Once a tax is on the books it never really goes away.

  19. wanda j. jones says:

    John and Gentle Commenters:

    John and Colleagues: As long as I have been politically conscious, some 4 decades out of my 7, I have been aware that the root cause of poor national policy is not just partisanship, but basic ignorance of economics on the part of the body politic. That ignorance leads to over-use of credit cards, buying houses above one’s income, and supporting social programs that seem to be paid for from a printing press in Washington, instead of our of local payroll checks.

    When trying out the various permutations of saving social programs, or reducing the budget or the debt, it is pointless to explain it in text, which would not be read and comprehended by half of the population or more, not even by the supposedly educated members of the senior press and commentators. [To no one’s surprise, our local liberal paper just endorsed Obama.]

    There is no long term view of personal responsibility in the head of young people whose brains have not matured. What if they continue to want pleasure, food and children over saving 5% of what may be a very small salary. It will take generations of training to make them not only econ-literate, but willing to be personally responsible, as well.

    The Democrats are incapable of cutting social programs as they see those as political glue. Republicans must elect more Republicans. The annual US budget should be changed from a cash budget to an accrual budget with a futurity of an expected Presidential term or terms so it shows the impact of future expenditures on the present. It should also be ordered by seriousness of the expenditure or tax. Or in reverse by those line items that are optional vs those that are necessary.

    [For example, the military budget includes payment for over 700 military stations across the world. WHY?)

    [And everyone, everywhere, should be aware that 40% of our national debt is owned by China.

    People who do not submit tax returns do tend to perceive all public programs as “free.” Does that tell you something?

    The Medicare reductions are not “cuts” but limits in expected rates of growth. And the $700+ billion is over a ten year period, or about 71 million per year. As we have 5,000+ hospitals and about a million health practitioners of various kinds, that impact will be spread fairly thin, if done across the board. [And, yes, if those limits are put in place it will have an impact on hospital survival and physician participation in the medical work force.] I am as much concerned with the multiple impacts of the taxes in Obamacare, the ones that will raise the price of everything medical. So, revenue reduction, increases in production costs…a great recipe for a deteriorating balance sheet.

    There are some glaring mis-allocations that, if ended, could save a lot:

    1. Close rural hospitals under 50 beds (half the total) that have less than 10 patients per day. Convert to health stations with distance medicine connections to the nearest large medical center, with good transportation. Currently, the government pays them on the basis of their cost of operation, not fee for service, as they are pork for rural politicians. For the most part, the employed and retired populations travel to the nearest medical center, leaving the agricultural workers to use the local hospital.

    2. Add “hostels” to hospital campuses to house people who come from a distance, so they won’t have to stay in a hotel or in the hospital if the service is essen-tially ambulatory.

    3. Develop a model physician/nurse practice acts to enable nurses in every state to take on some physician roles. Incorporate language that clarifies traditional “corporate practice of medicine” restrictions to not forbid contract employment by not for profit healthcare systems.

    4. Agree to arrange memberships with provider organizations in parallel to enrollment in health plans, so members would use a sponsored social network to communicate with their health teams, could be seen in groups according to their conditions, and could be trained to care for their own relatives or friends so as to reduce the use of long term care or rehab facilities. Hospitals should have demonstration patient rooms so a relative or friend could be trained in what to do for the patient during admission and at home. Labor is our biggest cost and one with the most political pressure not to mess with.

    [ In the San Francisco Bay Area as we speak, the California Nurses’ Association is planning a one day strike of several community hospitals belonging to Sutter Health, something it routinely does against provisions in their own contracts. They react like a stuck pig when the hospital then hires registry nurses, which only come with a one-week guarantee, saying” you are locking us out!” The San Francisco Business Times had an editorial this past Friday on how unprofessional they are. Also, they are picketing the homes of Board members of these hospitals, something considered dangerous and unsupportable.]

    5. Publicize and encourage the use of modular construction of health facilities, both inpatient and ambulatory, after the practice of Aspen Street Architects of Angel’s Camp, California, and as produced by Walden structures. They did a new hospital for Joplin, MO, to replace one taken down by their hurricane two years ago–get this: 8.5 months and $350.00 per square feet. Stick built construction would have been 3 – 5 years and $1500 per square foot.

    In other words, for a relatively small amount of capital, lots of it supplied by developers who are accustomed to developing sets of structures in multiple locations, our healthcare system could move rapidly much of inpatient care to cheaper ambulatory settings, plus adding the capacity needed by our aging and growing population without adding a commensurate amount of hospital capacity. I’m working on this right now.

    There are dozens of things that can be done to strip extraneous costs our of the system. But whether there can be a clear enough picture of what is actually the nature of healthcare and its costs to make good policy decisions that will only come to fruition a generation from now is a profound question. It can’t hurt, however, to have a visual model of the healthcare system, and run scenarios on it very frequently, until people get used to seeing the relationships between earnings, taxes, policy, delivery of services, resources used, and results.

    We have the computer capability and we have a fairly large army of people who have learned simulation modeling. But it has not been used much because once people get to Washington, it is not data and economic principles that count, it is the political equation. The ONLY thing to do about that is to have the maximum number of decisions made locally, and as privately as possible.

    This is a very good topic, but beware, all commentators, that it can’t be settled with quips and slogans and Krugman-like scolding. And not even with reasoned arguments that depend on good will and rationality for success!

    Happy Fall! (Giants won!)

    —Aging in place as a more or less frustrated Medicare Member, getting a cardioversion tomorrow at 8AM.


    Wanda J. Jones President
    New Century Healthcare Institute
    San Francisco

  20. Arnie Poutala says:

    I always appreciate Wanda’s contributions. She is a model we all should strive for, being so productive at an age when many others in our country feel we all owe them a comfortable retirement and unlimited healthcare.

  21. Jimmy says:

    Most of the time when politicians say “spending cuts”, they are referring to more of a “spending freeze”. Instead of budgeting more money for next year, keep spending at the previous years level for an amount of time.