Pay (Through the Nose) As You Go

Wall Street Journal ^ | October 15, 2004 | JAGADEESH GOKHALE and KENT SMETTERS

[OESY]

...During the debate, Sen. Kerry... said that he would adopt a "pay-as-you-go" approach to ensuring financial solvency to Social Security. President Bush's response, though apt, needs amplification.

...[P]ay-as-you-go is effective when... we are concerned with surging discretionary spending.... defense, roads and highways, judicial services, and homeland security.... Under pay-as-you-go rules discretionary spending can be increased only if Congress is willing to finance it 100% out of other spending cuts and tax increases. The political undesirability of both financing methods serves to check both higher deficits and growth in the size of the government.

On the other hand, the pay-as-you-go approach has proved ineffective in imposing fiscal discipline in our entitlement programs. Pay-as-you-go in this context usually implies benefit increases -- for which retirees obviously don't pay -- and tax increases for workers and future generations. The taxpayers' higher future benefits never make up for their earlier payroll tax hikes in present value -- and future benefits remain subject to changes. Consequently, today's retirees (who vote in larger numbers) receive windfalls, but workers and future generations lose out.

Pay-as-you-go, therefore, is precisely the approach that has created a financial mess in Social Security and Medicare. Our future benefit commitments now far exceed our ability to pay. The financial imbalance is now estimated by Social Security's independent actuary to equal $10.4 trillion. For Medicare, the overall shortfall is even larger -- $62 trillion.... [R]ejecting an attempt to control the growth rate of costs implies an immediate and permanent tax hike of 17.4 percentage points. That would more than double the current payroll tax rate of 15.3%. Inaction over another four years will increase the required hike to 19.7 percentage points. A recent study by the latest Nobel laureate for economics, Ed Prescott, points out that higher tax rates will slow economic growth....

[OESY]

Mr. Gokhale is a senior fellow at Cato. Mr. Smetters is an associate professor at Wharton.

[gridlock]

Pay-as-you-go is a public policy disaster, and here's why.

It encourages the government to think up new programs that can be "sold" to public and new taxes on unpopular things that will be tolerated without much public opposition. So you wind up with, "My proposal will fund fluffy puppies for orphans, and we'll pay for it through a tax on cigarette sales to crack whores..." Never mind that the fluffy puppies aren't wanted or needed, and that cigarette taxes are already 95% of the cost of the product. The proposal passes, and the government grows incrementally bigger. Twenty years later, you have 5000 bureaucrats in Washington to manage the puppy distribution program, and cigarettes cost $250 a pack.

Pay-as-you-go means that the government does not prioritize spending by a rational means. It also creates advocates for certain taxes, eliminating the quite correct perception that all taxation is evil, but some is necessary. You can bet all 5000 employees of the US Orphan Puppy Administration will vote to support their dedicated tax, come what may. There should be no built-in constituency for any tax.