Now or never

Unless the GOP’s pledges of fiscal responsibility are sincere, they won’t enjoy power for long

The Republicans are going to take back the House of Representatives. With a little luck, and some defections by moderate Democrats (both “R-Nelson” and “R-Lieberman” have a certain je ne sais quoi about them), they could assume control of the Senate as well.

A question making its way around the beltway is whether the party should put forward a set of explicit policy aspirations now, so that it returns to power with a mandate, or if it should avoid giving anything for Democrats to attack, so as to improve the chances of victory. In the “we need a mandate” category are men like Paul Ryan, author of the bold (if uninspiringly titled) “Roadmap for America’s Future.” In the other corner are have much of the GOP’s official leadership, authors of the insipid “Pledge to America.”

Regardless of how the roadmap vs. pledge debate settles out, everyone in the GOP should be put on notice: there will be no second chances. If they fall off the wagon again, if they belie their fiscally conservative rhetoric and return to Bush-era profligacy, they will be cast out into a political wilderness deeper than they can imagine.

Fortunately, in the zeitgeist of this day and age, voters want their politicians to make the tough decisions. From New Jersey to Britain, the politicians taking a hard-nosed look at state spending are being rewarded in the polls.

So what should Republicans do on November 3rd?

First and foremost, the GOP must tackle the biggest problem in the U.S. budget: the entitlement programs of Social Security, Medicare, and Medicaid. All three face insolvency as the baby boom retires — the two health programs particularly so because of decades of above-inflation escalation in health care costs.

For Social Security, the growing consensus that the retirement age must be raised is the correct one. The debate over whether it is efficient for the government to supply old-age insurance is moot — if the average citizen thinks there’s only a coinflip chance that the insurance program will be there for them when they retire, then it simply isn’t insurance. By gradually raising the retirement age, Republicans will retain the part of Social Security that gets the most bang for its buck (the very-old-age insurance) while returning the program to a state of solvency that will reduce uncertainty in retirement planning.

For Medicare and Medicaid, there are three options that are attractive. The first option is to turn Medicare and Medicaid into voucher programs. By giving our citizens the choice of how to use their health care dollars, we may be able to avoid the wastefulness that comes from subsidizing patients into consuming care they are indifferent towards, while retaining the safety net that our values demand we keep.

The second option is to significantly raise the deductibles of Medicare and Medicaid, in particular Medicare Part D passed under the Bush Administration. You may remember Medicare Part D from the “fill the donut hole” pledge given by Democrats during the health care debate. In reality the economically sensible policy was not to fill the donut hole, but to cut out the bottom half of the donut, where the cost was greatest and the benefit least. Like raising the retirement age, restricting our health care entitlements to cover extreme events saves the most impactful portions even as we tighten spending.

Lastly, as much as Republicans have railed against ObamaCare, by mending the non-group health insurance market, the recent reforms allow the federal government to raise more revenue by ending the employer health care tax credit, and over time substitute individual insurance subsidies with penalties on those who do not purchase insurance. The GOP should work to squeeze savings out of this new system, not repeal it.

Entitlement spending is the biggest challenge, but also important is reigning in runaway discretionary spending. Last year we spent roughly $1.4 trillion in discretionary spending: $900 billion on military and national security, and $500 billion on non-military programs. We may wish to postpone cutting this spending for Keynesian reasons, but this does not mean we should postpone the planning of the cuts; the goal of the GOP, if not now, then on day one of taking back the office of the Chairman of the House, should be to identify $90 billion of annual military spending and $50b of non-military spending that can be cut without overly harming our economy, social equality, or national defense.

Some reductions will come easy — no one really thinks the U.S. Census Bureau is going to need its $7.4b budget next year — while some will require more abstract thinking — is it really strategically necessary to spend $3.7 billion on military financial assistance to Israel and Egypt for a peace they signed 30 years ago?

But make no mistake, the cuts are there to be had. Democrats like to have it both ways. They rail against a political process they claim has been hijacked by special interests, but as soon as it comes to cutting any of the goodies that special interests have obtained, they defend each dollar as sacrosanct. Republicans will have to show a little more principle.

I’ve made my own list of programs I’d like to shave (the JSF, the V-22, the F-35, the F-22, missile defense... NASA), and I’m sure many Congressmen have done the same. But the process should not be dominated by any one individual’s list of priorities. Republicans need to build a consensus, to engage in serious discussion that identifies what spending is really necessary to meet our national goals, and what spending has merely been shoe-horned in over the years by underhanded lobbying and bureaucratic sprawl.

The trickiest problem for Republicans will be taxes. Given our fiscal predicament, major tax cuts are simply not in the cards — indeed, it is more likely that at least modest tax increases will prove necessary. What Republicans do have an opportunity to do is re-orient our tax system from one which seeks to re-distribute income to one which maximizes economic growth and efficiency. The Republican sense of fairness is libertarian, and wants to let a man keep that which he has rightfully earned. The Democratic sense of fairness is more Rawlsian in nature, and wants to equalize income across society. With new power, the Republicans will have the ability to tilt the balance back.

Because taxes induce individuals to change their behavior, they can lead to suboptimal behavior and create economic inefficiencies. Some taxes, like capital income taxes, produce relatively high inefficiencies, while others, like estate taxes, produce relatively low losses.

Where Republicans have the budgetary leeway to introduce tax cuts, they should focus them on capital gains. In the long run, capital gains taxes are among the most inefficient and should be among the first to go. The trouble is that slashing all capital gains taxes immediately would surrender a great deal of revenue in the form of a windfall profit to capital holders — having already paid the price of the inefficiency (less saving and investment due to expectation of a future tax), we would lose the revenue it was expected to yield. Republicans should focus on phasing out the capital gains tax by maintaining it on all existing assets, but not applying it on any capital investments henceforth.

For the most part however, Republicans will be faced with the choice of where to raise taxes, not lower them. If their libertarian sense of fairness prevails, they will raise them where they will do the least damage to economic growth — on the lower income tax brackets that hit all tax payers equally.

The elasticity of taxable income, and thus the inefficiencies created by a tax, get higher as both income and marginal tax rates increase. It polls well to tax the income of just the rich, but more often than not, the rich respond by working less, shrinking the economic pie.

A tax on a lower income bracket takes money from a broader base, and only distorts the decision making of those for whom that tax bracket represents their marginal tax rate, individuals who are much less likely to deprive society of their labor in response. “Taxing everybody” doesn’t make as good a soundbite as taxing the rich, but when nearly half the country pays no income tax, even as they enjoy the benefits that income tax provides, Republicans should feel compelled to brave the storm and make a stand for their core philosophy.

None of these are easy problems to solve — that is why they have been left festering for so long. But if Republicans are to scrub off the image they gained during the Bush years, they need to prove to the American people that they are capable of making the hard choices, that policy positions and value judgments aside, they offer something the Democrats do not possess: courage.