Health Reform Fight Will Raise Questions About Our Tax System

Posted October 13, 2009 at 3:41pm

First, a shout-out to Rep. Jeff Flake (R-Ariz.), who chronicled his extraordinary “district work period— adventure in the Washington Post on Monday. I don’t know many people who could survive a week alone on a desert island — much less write about it so compellingly.

[IMGCAP(1)]Flake can drive his colleagues on both sides of the aisle to distraction — but that is because he has strong principles, ideological and ethical. His integrity was on display, as usual, after his August island adventure when he voted to reprimand Rep. Joe Wilson (R-S.C.) — and let me belatedly commend his Republican colleagues, Reps. Jo Ann Emerson (Mo.), Bob Inglis (S.C.), Anh “Joseph— Cao (La.), Walter Jones Jr. (N.C.), Tom Petri (Wis.) and Dana Rohrabacher (Calif.), for their own courage to stand for the integrity and comity of the House.

It could not have been easy for any of them to buck their leaders and partisan pressure in this climate. If we had more of that on both sides of the aisle, we would have both a better House and better policy emerging from the true give-and-take that the process was designed to produce.

Now back to that policy process. As health care reform moves to a new stage of negotiation and action, it is clear that the funding side has at least as many issues to resolve as the substantive side. The public insurance option has become the most visible flash point, of course. But there are multiple ways to compromise or strike a balance there. There are other major issues, too, on the substance side, including Medicare payments to physicians, the size and breadth of subsidies for those given access to insurance on the exchanges, the range of people given access to the exchanges, and the penalties for those who fail to get mandated insurance. But resolving many of these controversies requires more money to pay for reforms.

Let’s face it: A large slice of the money needed is going to come on the tax side, and here there is no easy consensus. Whether it is the president’s original proposal to reduce marginal rate levels for charitable and other itemized deductions for wealthier taxpayers, additional levies on providers such as medical device manufacturers, a surtax on the wealthy, limits on the tax-free status of “Cadillac— high-end health insurance plans, or a “windfall profits— tax on insurers, there are strong opponents who are key parts of a necessary majority or 60-vote margin for success.

I actually like the president’s plan to give the same itemized deduction rates to middle-income and wealthier taxpayers; there is no inherent reason why those at the upper end should get more proportional advantage than those in the middle. In general, I believe that credits are a better way to go than deductions, for just that reason, and that evidence suggests the proposed change would not significantly alter the charitable inclinations of the well-to-do. And for conservatives who were upset at the notion of having a 28 percent rate for deductions — saying it would harm charities — would any have objected to an overall reduction in marginal rates to a maximum of 28 percent?

I also favor a limit on the Cadillac plans, which load up on health services and benefits and reduce or eliminate co-payments or out-of-pocket costs for recipients. I believe, as most economists do, that having unlimited tax-free status for these plans encourages overuse and waste in the health care system — why not get more tests, do more things, if they are free to the recipients? We should not be encouraging things we want to discourage.

This raises a larger point. While we will have in the next weeks an intense focus on some elements of our tax system, we need a much larger and broader debate about the system. That is never easy to do, but it is so much harder in this hyperpartisan era, where the one thing that most unites Republicans is no new taxes.

The need to discuss taxes was especially underscored at a panel at the Urban Institute I participated in last week on our coming debt and deficit crisis, which will explode into economic catastrophe in a decade or so without significant action. The action has to start on the spending side, to be sure, but the difficulty of restraining spending growth in the big-ticket areas of Medicare and Medicaid will only grow as more baby boomers begin to hit 65 and receive benefits directly (and as an older generation increasingly relies on Medicaid for long-term care). The bonehead move by Republican National Committee Chairman Michael Steele to put his party behind defending and protecting every dime of Medicare spending now and in the future surely doesn’t help.

So realistically, we also have to grapple with the tax side, not just by raising revenue but ideally by rethinking what kind of tax system we want — how can we raise enough revenue to pay for the government voters demand, without harming the economy? How can we find ways to tax the things we want to discourage and reduce or remove taxes on things we want to encourage? My smart Urban Institute co-panelists, including former Congressional Budget Office Director Rudy Penner and Syracuse University Moynihan professor Len Burman, talked a lot about the inevitability of a value-added tax. There are other options, too.

Next year is actually the ideal time to consider the options, with the scheduled expiration of many of the Bush tax cuts. I was dismayed when the Obama administration gave in early on many of these, since the expiration offers the perfect dynamic to force bipartisan cooperation — the minority cannot use delay in the same way if delay brings about a highly undesirable outcome.

We should be thinking about fundamentally changing the base of our tax system. A VAT to replace a major portion of the income tax is one way to go. A carbon tax to replace the payroll tax — tax the use of undesirable pollutants, stop taxing work — is an intriguing idea. Given the intense disagreements we are seeing over marginal changes to finance health reform, it may be that the only way to get things done is to think, and move globally. That sure would make for an interesting 2010.

Norman Ornstein is a resident scholar at the American Enterprise Institute.