A tough road to fiscal prudence

Erskine Bowles and Alan Simpson, co-chairmen of the National Commission on Fiscal Responsibility and Reform, have accomplished something politicians rarely achieve: Their plan to cut the federal government’s deficit to a sustainable 2% of gross domestic product over a number of years includes something distasteful to virtually everyone.

Almost every section of society takes a hit — federal employees, the military, doctors, lawyers, taxpayers and retirees. No doubt the politically savvy chairmen realized they were kicking over many hornets’ nests. They did so deliberately.

As a bipartisan duo, the co-chairmen realize that the uglier their proposals, the more political cover they provide for the senators and representatives who will have to craft the harsh spending cuts and tax increases to bring our runaway spending under control. Viewed less cynically, they wanted their proposals to stimulate discussion. And that they certainly have done.

So far, the discussion mainly has been about the parts various groups dislike. There hasn’t been much thought and discussion about the overall thrust of their recommendations — which aim to cut spending while raising revenue and making the tax system more efficient — and whether they make sense for the U.S. economy.

It is time for all groups that will be affected by these proposals to examine them to see if they make sense for the country as a whole. Then they should examine if the parts that affect their interests make sense as part of the overall plan. If they believe they don’t, they should propose alternatives that will provide the cost savings or the additional revenue required to balance the federal budget.

For example, several proposals would affect the financial services industry. Mr. Bowles and Mr. Simpson have proposed eliminating virtually all tax expenditures — provisions in the tax code that provide incentives for particular kinds of activities or give special or selective tax relief to certain groups of taxpayers.

Such tax expenditures include the tax deferrals on contributions to 401(k) plans and individual retirement accounts, and on the inside buildup in life insurance policies.

The deficit commission, which estimated that tax expenditures cost the government $1.1 trillion annually, proposed using part of the sum recouped to reduce the deficit. It recommended using the remainder to reduce federal income tax rates to just three brackets: 8%, 14% and 23%.

Sectors of the financial services industry are likely to resist efforts to remove the tax preferences for life insurance and contributions to 401(k)s and IRAs because that is likely to mean fewer people buying insurance products and a decrease in retirement plan contributions.

They may argue that ending these tax preferences will harm the U.S. savings rate, which until the 2008 financial crisis was abysmal but has now recovered to a healthier level.

A 1999 study by the Joint Economic Committee of Congress noted: “Saving occurs after the payment of income taxes, and the earnings on those savings are then taxed again, resulting in the same income stream being taxed twice. By taxing the returns to saving, the price of saving increases relative to consumption. As the relative cost of saving rises, people reduce the amount they save. Economic research indicates that this bias is a partial explanation of the low saving levels in the United States.”

But reducing income tax rates significantly also could reduce the cost of saving relative to consumption and might lead to taxpayers’ saving more than they do now.

Further, simplifying the tax code could free up time and money currently spent by individuals, corporations and organizations to calculate taxes owed to the government.

The financial services industry, and every other segment of society, should consider not only what is in its short-term best interests but also what is in the long-run best interests of the economy when its leaders take their stances on the ultimate reform proposals from the commission.

Ultimately, a healthy economy is in everyone’s best interests.

Mr. Bowles and Mr. Simpson have laid out possible pathways to a healthier economy. Theirs is not the only way to solve the deficit crisis, but it is an excellent starting point for discussion and negotiation.