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The Sharp Pencil Test

Time for a real growth agenda

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The problem should be fixed at the federal level: Rather than pay half the cost of whatever states decide to cover, give the states a fixed allowance called a block grant. Couple that with a sharp reduction in federal regulations so that states can design and administer programs as they see fit. This rewards innovation and thrift. It is a major principle of the Ryan budget. One can debate the amount of the block grant, but to pass any Sharp Pencil Test, block-granting Medicaid is the only way to go.

President Obama and the Democrats oppose this. One reason is that some of their special interest groups like the service-employees union are major beneficiaries of the current system. But the main reason is that Obamacare needs the matching-grant system to depress its apparent price tag. It dumps millions of people onto the Medicaid rolls, forcing states to pick up half the cost. This is a central objection of the 26 states that have sued to have Obamacare declared unconstitutional. And it is one of the gimmicks that allows Obamacare to appear relatively “low cost” at the federal level: Half the costs of an expanded Medicaid are shifted to the states.

Medicare has its own structural problem. The federal government pays 80 percent of whatever seniors spend. That includes needless tests to protect doctors from malpractice suits, end-of-life care that often goes well beyond keeping patients comfortable, and unnecessary use of scarce medical resources by beneficiaries without any incentive to economize. The Obama administration intends to curb costs by rationing care. A federal panel will prioritize procedures and deny funds for any medical procedure that doesn’t make the cut. That arrangement might work at the budgetary level, and it is used to ration care in a number of countries with socialized medicine. But the one-size-fits-all approach is crude and unappealing and brings to mind the unfortunate phrase “death panel.”

A better approach, contained in the Ryan budget and advocated by some thoughtful Democrats like Alice Rivlin, who served as director of the Office of Management and Budget and was vice chair of the Fed in the Clinton administration, is the “premium support” concept. This would provide seniors with a program similar to the prescription drug part of Medicare, and similar to the arrangement now enjoyed by members of Congress, who choose among competing health care plans that are subsidized up to a fixed amount. The plans would vary in their coverage; they might be more or less generous in their coverage of, say, end-of-life care. But the key is that the patient would choose, not a panel of federal bureaucrats. As with Medicaid, it is fair to debate the precise level of assistance, and the Rivlin and Ryan plans differ on this. But at the structural level, premium support is by far the best sharp pencil reform we can make.

Social Security, with nearly $10 trillion in spending over the next decade, is also a program that needs to be addressed. Changing benefits for those now receiving them or expecting to receive them soon is unnecessary. Drastic changes in the rules, moreover, are not needed if change is enacted now. One very progressive plan to save Social Security was put together by the Bowles-Simpson commission. Other plans, including some developed by President Bush’s Social Security Commission, would also solve the problem. What is essential is to act now, while reforms that would save the system can be introduced gradually.

Finally, taxes must be part of any broad-based solution. But the evidence is overwhelming that to continue our current highly inefficient and distorted tax system is antithetical to growth, and simply to raise rates under that system would make matters worse. Because taxes distort people’s decisions, taxpayers are worse off by $1.70 for every extra dollar of government revenue. At modestly higher tax rates than we have now, this effect would become even more severe. Taxpayers in high-tax states could be up to $4 worse off on every extra dollar the government collects.

One approach, used by both the Bowles-Simpson commission and the Ryan budget, is to broaden the base and lower the rates. Bowles-Simpson does this with rates that would raise substantial revenue, Ryan does it on a break-even basis. But the structure of both plans is the same. Broadening the base with a top rate of 25 to 27 percent would both enhance revenue and enhance the country’s growth prospects, a quintessential sharp pencil approach.

Even more dramatic would be to replace our income tax system with a system based on cash-flow. Administratively it would be far simpler to collect a single tax on business. It would also minimize avoidance based on the definition of income. As we learned in the financial crisis, “Cash is a fact, income is an opinion.”

What all of these structural changes have in common is efficiency. Ultimately that is what generates economic growth and balanced budgets. If a program that produces just a 1 percent return for the economy is funded from tax dollars taken from individuals and businesses that may get a 6 percent return on their investment, then the economy is poorer by 5 cents for each dollar spent. And if $100 million is spent on a program whose objectives could be met with an outlay of $70 million, the nation is poorer by $30 million. That is true no matter how well-intentioned the program may be, how neatly it fits into a political speech, or how much it may appease a special interest group. We must stop equating the spending of dollars with “stimulus.” Wasted dollars make us poorer, not richer. Taking a sharp pencil to the federal budget is the way both to restore growth and to lessen the burden of government debt we are leaving to our children.


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