The False Messiah: Pete Peterson's Revelations Are Not Gospel

Peter G. Peterson, as he cheerfully admits, is not a member of the middle class. He's a rich Republican Wall Street investment banker. But in his crusade against deficits and entitlements, he adroitly poses as a champion of the middle class.

Given his circumstances, it's not entirely surprising that Peterson is an outspoken opponent of the federal government's two most progressive (and successful) programs: the graduated income tax and Social Security. What is odd is that his pose as a friend of the common American succeeds; that he publishes in liberal journals like the Atlantic and the New York Review; and that he enjoys a largely uncritical press.

Even odder is the fact that Bill Clinton, after presiding over the most progressive tax reform in two decades, would name Peterson as one of his ten appointments to the newly formed Bipartisan Commission on Entitlement and Tax Reform. Peterson is at the epicenter of a growing network dedicated to demonizing entitlements.

In order to squeeze his 1993 budget plan through the Senate last year, Clinton had to appease Nebraska Democrat Bob Kerrey, who in an emotional, late-night speech on the Senate floor complained bitterly that the plan was not tough enough on the middle class. To secure Kerrey's reluctant vote, Clinton agreed to form a commission to study possible cuts in entitlement programs and new taxes. Congress was awarded 22 of the 32 seats on the commission, 12 Senators and 10 Representatives, each split evenly between Democrats and Republicans. The remaining 10 choices were reserved for the President.

But when it came time to make appointments, House Republicans, led by GOP Whip Newt Gingrich, refused to fill their five designated positions unless Clinton conceded some of his slots as well. After months of delay and with his promise to Kerrey on the line, Clinton caved in and named several Republicans, including Pete Peterson. Although Peterson's views are antithetical to much of the Clinton agenda, he will fit in well with several other members of the commission, including the two co-chairmen, Senators Kerrey and Republican John Danforth, who want both big cuts in federal transfer payments and major tax changes that encourage savings and investment.

The 67-year-old Peterson, who served Richard Nixon as a White House staffer and then Secretary of Commerce, has emerged as perhaps the leading spokesman for what remains of the anti-deficit wing of the Republican Party. For example, Peterson is the founding president of the nominally bipartisan Concord Coalition, chaired by former Senators Warren Rudman and Paul Tsongas. Senator Tsongas, who began his electoral career as a Republican, declared in 1992, "Of all the Democratic candidates, I have the strongest appeal among Republicans." The Coalition wants to eliminate the deficit by the year 2000 by cutting entitlements and raising consumption taxes. Peterson has helped fund "Lead . . . or Leave," a group with a similar entitlement-bashing agenda that claims to represent Generation Xers. He and his staff have written a number of books and articles, most recently Facing Up (1993), excerpted in the Atlantic under the same title and adapted in a New York Review article called "Entitlement Reform: The Way to Eliminate the Deficit."

Kerrey and Danforth apparently hope their Entitlements Commission will provide a quasi-official endorsement for the Peterson program. Most GOP leaders fear that calling directly for entitlement cuts, namely in Social Security, is political suicide; they have instead stuck with vague recommendations for less "wasteful spending." Likewise, while they may favor lowering taxes on the wealthy, they are reluctant to call directly for higher taxes on middle- and low-income families to replace the lost revenue. Peterson is more forthright. Along with tax cuts for the rich, he explicitly endorses tax increases for the poor and the middle class as well as sharp reductions in what average families receive from the government.


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But because Peterson cloaks his goals in the rhetoric of progressivity, the press has fawned over him. The misleading notions that entitlements are running up the deficit, stealing from future generations, and maintaining the elderly in affluence while young people suffer, have become received wisdom for many. Much like Tsongas, Peterson has cultivated a reputation as someone who is above politics and willing to face the hard truth.


Seductive Rhetoric

As outlined in his 1993 book, Facing Up, Peterson would tinker with various federal spending programs from defense to welfare, with little net change in the total spent. The heart of his agenda is the following:

  • Cut Social Security and Medicare by $135 billion a year by the year 2000 -- a reduction of 21 percent that year and more thereafter. Both the Concord Coalition and "Lead . . . or Leave" endorse similar proposals.
  • Enact vast new federal taxes on consumption. Initially, Peterson would generate $220 billion in additional annual revenue (in the year 2000) by imposing a national sales tax and a stiff tax on employee health benefits, as well as tripling or quadrupling selected federal excise taxes. He would use part of the money to pay for $30 billion or so in new loopholes for corporations and the wealthy. Eventually, he hopes to raise about a trillion dollars in new consumption taxes, so that he can eliminate personal and corporate income taxes entirely. The Concord Coalition endorses the same plan.

Peterson's bottom line is that the middle class gets too much from government and pays too little for it, while corporations and the rich deserve a break. Curiously, that's not how he sells his program.

Peterson frames his case by contending that well-off people get too much from government. "Counting both direct benefits and the value of entitlements conveyed through the tax code, the aggregate amounts received by people above the national median are simply staggering," he complains. "In 1991 nearly half of all entitlements went to households with incomes over $30,000. One quarter went to households with incomes over $50,000." Peterson takes into account all direct-benefit outlays and tax expenditures, then concludes that "On average, a household with an income under $10,000 collected roughly $5,700 in 1991. On average, a household with an income over $100,000 collected $9,300. This distribution of benefits by income . . . clearly . . . has nothing to do with economic equality."

To be a bit churlish, these figures don't necessarily seem all that bad. By Peterson's arithmetic, the lowest income group he cites gets almost its entire $6,000 average income from government assistance, while the high-income group's "benefits," mainly tax breaks, amount to only about 4 percent of its $200,000-plus average income.

But Peterson continues his populist rhetoric. "Middle-class Americans today feel hard pressed and beleaguered -- and they are." Peterson promises to wring revenue from the "genuine upper class" through higher tax rates, lower tax subsidies, and greatly reduced entitlement benefits.

Alas, having piqued middle-class interest, Peterson switches his message. Stripping the big fish of federal benefits won't do much for the budget, he asserts, because the rich don't really get much in the way of government subsidies:

As for direct entitlement benefits, . . . not much help is available from the rich. The maximum entitlement savings obtainable from the 1 percent of households enjoying incomes of more than $200,000 are . . . about $5 billion if we took away all their benefits (something that even Bill Clinton . . . has never dreamed of suggesting).

Nor, he claims, can we get much from eliminating the tax breaks of the rich. "For all the subtle subsidies that help the wealthy borrow huge sums for home mortgages and take unlimited health-care deductions," he says, "just 7 percent go to the Americans whom the President calls `rich.'"

In truth, the wealthy get far more in tax breaks than Peterson admits. Hence, the bait-and-switch. Despite his rhetoric, Peterson apparently doesn't want the wealthy to relinquish anything. On the contrary, he would have the middle class suffer and the rich get tax cuts to more than offset any reductions in their direct federal benefits.


Rich Ironies

"Unlike some of my Wall Street colleagues," Peterson wrote in the October 1993 Atlantic, "I see absolutely nothing wrong with imposing higher tax burdens on the wealthiest in our society." That may be, but Peterson's tax program is about the most pro-rich approach imaginable.

Peterson harps on the "shocking" regressivity of various federal income tax breaks that he says provide an unfair advantage to the wealthy. Yet his ultimate goal is to repeal all personal and corporate income taxes. He is enamored of the so-called "progressive consumption tax," which would be levied on incomes after a deduction for money saved. By definition, corporations would pay no tax at all.

Since rich people can save a far higher share of their income than average families, a tax limited to spending would require extraordinarily high rates at the top to avoid providing huge tax cuts to the wealthy. Indeed, only consumption tax rates of more than 100 percent for the very highest earners could approximate the progressivity of the current system. Enacting such rates would, of course, be impossible; as a result, Peterson's consumption tax would almost certainly cut taxes for the rich and raise taxes for most others.

Because a progressive consumption tax has unsolvable technical problems, Peterson offers a more practical, albeit hugely regressive, alternative: a 5 percent national retail sales tax, a 50-cent-a-gallon gasoline tax hike, sharply increased taxes on alcohol and tobacco, and a stiff tax on employee health benefits. Together, these taxes are supposed to raise $220 billion a year by the year 2000.

Distributionally, the Peterson tax package would take about five times as large a share of income from median income families as from the rich, and an even higher percentage from the poor. But that's not all. It would also give corporations new tax breaks and the wealthy a capital gains loophole. So, far from "higher burdens on the wealthiest in our society," Peterson would grant himself and his high-rent neighbors a tax cut.

To be fair, Peterson does offer a rationale for so tilting the tax code. In his book, he says, "By taxing consumption (as opposed to income), we of course create incentives that favor household savings." In addition, he argues that "Every other major industrial country relies more heavily -- typically, much more heavily -- on consumption taxes than the United States does. Not coincidentally, these other countries have higher rates of private saving than we do."

The underlying premise of these contentions -- that higher savings would be an unmitigated boon for our economy -- can be debated. But even conceding that point, Peterson's assertions simply do not hold up under scrutiny.

Start with Peterson's contention that "every other major industrial country" relies more on consumption taxes. Yes, most do -- but not all. In fact, Japan, our biggest competitor, relies considerably less on consumption taxes and far more on income taxes than we do. And Japan leads the world in savings. Moreover, the rest of the industrial world does not agree that higher consumption taxes are the key to economic growth. On the contrary, 19 out of the 23 OECD countries have reduced their relative reliance on consumption taxes in recent years.

But why isn't it simply common sense that tax breaks for saving -- or tax penalties for consumption -- must lead to increased saving and less spending? Well, suppose that tomorrow the price of everything you buy went up by 5 percent but your income remained the same. It's unlikely that your first reaction would be to eat less, drive less, and move to a cheaper apartment so that you could save more. If anything, you'd cut back on your savings so you could consume just as before.

Alternatively, suppose you are trying to save money for retirement, a new car, or whatever. And suppose that the rate of return on your savings goes up, perhaps because the government gives savings a tax break. Would you rush to save more? Or, now that you could put less money aside and still meet your saving goal, would you choose to save less?

As a matter of economic theory there's no way to tell for sure, but the experience during the Reagan administration suggests Peterson is indeed wrong. In Reagan's 1981 tax act, new tax breaks were showered on savings, through deductible IRAs, capital gains tax breaks, a 30 percent cut in the top personal tax rate on investment income and a plethora of new corporate loopholes. Yet thereafter, savings plummeted. Conversely, when Congress repealed many of the tax breaks in 1986, savings eventually rebounded. Most experts who study these issues find no correlation between taxes on savings and savings rates, either in the United States or among the major countries of the world.

In 1992 when Peterson and I served on a "capital formation" subgroup of a Presidential commission exploring these issues, the assembled experts overwhelmingly concluded that the relative level of taxation on savings versus consumption has little or no effect on saving behavior. That experience may help explain Peterson's reluctance to cite serious evidence for his assertions that consumption taxes would increase savings. But it does not excuse his clinging to the notion of regressive, unfair taxes at the core of his deficit reduction program. One wonders whether he isn't pushing consumption taxes precisely because they are so regressive.


Is Social Security Unfair?

The other half of Peterson's program -- the part that carries the most weight in public debate -- is the notion that excessive federal "entitlements" are at the root of our deficit problem. Entitlements are federal programs not subject to annual appropriations. They are simply paid to whomever qualifies. Entitlements are expected to cost more than $800 billion in the upcoming fiscal year -- more than half the entire federal budget.

Just under a quarter of mandatory spending goes for low-income programs such as Medicaid, food stamps, and welfare. Another sixth represents veterans benefits, federal employee retirement pensions, unemployment compensation, and several smaller items. (Farm price supports are less than 1 percent of total entitlements.) That leaves Social Security and Medicare, which currently account for about 60 percent of total entitlements.

To Peterson, the Concord Coalition, "Lead . . . or Leave," and others, Social Security is an expensive scandal. "We will no longer be able to afford a system that equates the last third or more of one's adult life with a publicly subsidized vacation," Peterson wrote in the Atlantic, hyperbolically implying that the average Social Security recipient lives to be 100. "Unfair and unsound . . . Social Security is a generational scam," Jon Cowan and Rob Nelson of "Lead . . . or Leave" wrote last year in the New York Times. "The Concord Coalition believes that reducing [Social Security] payments to people with mid-level and higher incomes is not only fair but also the only realistic way to get control of the deficit."

Is any of this true? Well, no.

Sure, Medicare is out of control -- just like the rest of the health care system. But the only solution is comprehensive health care reform. Clinton's program, for example, seeks to stabilize outlays for Medicare's hospital insurance program as a share of GDP, cutting them by 20 percent below current projections by the year 2000, a goal the generally skeptical Congressional Budget Office says the Clinton plan could achieve. In the past Congress has tried to trim Medicare without broader reform. But the main effect was that hospitals and other health providers shifted costs to other patients in order to make up the difference. That's why we need a more comprehensive approach such as Clinton proposes. Peterson agrees that health costs ought to be cut, but says he is "more than a bit skeptical" about the possibility of doing so.

What about the Social Security retirement system? "It's an outrage," Ross Perot liked to say in 1992, "that somebody like me is entitled to Social Security benefits from the government." Well actually, Ross, there aren't many billionaires like you. More to the point, Social Security is not a windfall to the wealthy, it is not out of control, and it is not contributing to the deficit.

From the mid-1970s to the early 1980s, Social Security benefits were growing rapidly as a share of the gross domestic product, due in large part to an error in the benefits calculation formula that was double-counting inflation for making cost-of-living adjustments. In 1977 and then in 1983, Congress increased payroll taxes and cut benefits to address the problem. Last year, Congress again effectively reduced benefits by making a larger portion subject to personal income taxes for better-off retirees (in the case of couples, primarily affecting those making more than $60,000). As a result, after peaking at 5.1 percent of GDP in 1983, Social Security retirement benefits have declined to about 4.6 percent of the GDP. They are expected to remain at that level for at least the next two decades as well.

Meanwhile, the increased payroll taxes have produced a large investment fund for the Social Security system, a fund that is now growing by $70 billion a year. By the decade's end, it will be growing by $100 billion a year. This investment fund has been lent to the Treasury, thereby reducing the apparent budget deficit by corresponding amounts. In other words, far from contributing to the budget deficit, the Social Security system's surplus has been reducing the government's consolidated deficit for the past decade, and should do so for at least the next 15 years.

Peterson acknowledges as much, but says he is concerned that the surplus will evaporate once baby boomers retire in large numbers -- a scenario that is quite likely. After 2013, Social Security expenditures are projected to increase. By 2015, they should return to their 1983 level of 5.1 percent of GDP. Ten years later, they are expected to exceed 6 percent of GDP, after which they should stabilize. In other words, 30 years from now, Social Security may cost 1 percent more of the GDP than it did in 1983. That's not a problem to be sniffed at; 1 percent of the GDP is a lot of money. But to put that in perspective, health care outlays have been growing by one percent of GDP every 35 months since 1980.

As time goes by, it probably will be necessary to adjust Social Security benefits and taxes to keep the system working. But it's disingenuous for those who focus on budget-balance by the year 2000 to complain about the problems of Social Security two generations in the future. Social Security is the one government program (besides the IRS budget) that makes the current deficit smaller than it otherwise would be.

But shouldn't the rich still forfeit most or all of their Social Security benefits, merely on principle? The Concord Coalition has gotten a lot of mileage out of its revelation that in 1990 retired people with annual incomes of more than $100,000 got $8 billion in gross Social Security benefits. It may sound like a lot, but after taxes (under current tax law) that amounts to less than $6 billion annually -- about 2 percent of total benefits.

In fact, the number is so small it cannot provide the revenue Peterson says is needed. To slash Social Security and Medicare by a fifth to a quarter, as Peterson proposes, benefit reductions would affect more than just the affluent. Under the Peterson plan, benefit cuts would affect elderly couples making as little as $12,200 a year and elderly singles making just $7,100.

To be sure, under the Peterson plan those seniors making the most money would lose the largest percentage of their Social Security and Medicare benefits. The richest retirees would see their benefits cut by as much as 85 percent. But since benefits are a declining share of total income, rich retirees would lose a smaller share of total income than middle-income elderly people. Over the past decade, Congress has already reduced Social Security benefits by about a fifth for the wealthiest 10 percent of retirees, and by a third for those with the very highest retirement incomes.

But Congress made these changes primarily to assure the long-term financial viability of the Social Security system. It's a different story to propose benefits cuts to pay for general spending. The only reason the public tolerates a payroll tax capped at $60,600 in wages is that Social Security is rather like a pension plan. What people get out of the system is loosely based on what they put in (although unlike private pensions, Social Security gives a much better return to lower-income workers than to those who contribute at the maximum.) Absent a need to shore up the Social Security system, any reduction in benefits should logically and morally be accompanied by a reduction in payroll taxes.

In an Oct. 25, 1993 New Republic column praising parts of the Peterson plan, the usually estimable Michael Kinsley, echoing economist Milton Friedman, criticized Social Security for "transferring money from poorer people to richer ones." That's a harsh indictment, if true. But it's not. Despite the cap on taxable wages, the best-off fifth of all families (incomes above $55,000) pays almost half the Social Security taxes. But the best-off fifth of Social Security recipients (incomes above $39,000) gets only about 20 percent of the after-tax benefits. In other words, taxes paid by the better off cover not only retirement benefits for higher-income people but a large share of the benefits that go to lower-income people as well. That hardly looks like "redistributing income upward."

Pundits such as Kinsley like to point out that if one analyzes the Social Security tax and the Social Security retirement benefit structure in isolation from one another, each seems bad. The financing of social security -- a capped payroll tax -- is indeed regressive; the average retiree benefits are close to a flat $8,000 a year (after-tax), regardless of income group. But put the two aspects together and you find a progressive retirement system that's lasted for more than half a century, and has dramatically reduced poverty among the elderly. FDR was right: structuring Social Security on a quasi-pension model has ensured its political longevity.

No doubt we could imagine a Social Security system that's even more progressive. If Social Security were like welfare, then the best-off fifth would pay about two-thirds of the taxes, but get none of the direct benefits. But would such an aggressively means-tested system really work? The poor political fortunes of welfare over the years suggest otherwise.

In theory we could take wealthier people out of the Social Security system entirely, on the ground that they don't need the government's help to plan for retirement. That would satisfy people like the Concord Coalition who are scandalized that better-off retirees get Social Security checks. But Social Security would be in big trouble if it lost the wealthy's tax payments as a trade-off for cutting their benefits. Indeed, Social Security would be running far in the red, rather than enjoying a surplus. Were that the case, Peterson, Kinsley et al. could more reasonably blame Social Security for our budget deficit problem. Until then, we should respect Social Security as the very progressive retirement system that it is. If we want the wealthy to pay their fair share, there is a far better remedy than undermining Social Security. We can simply increase the progressivity of the tax system.


Beyond Regressive Reform

Unlike some of my friends, I don't begrudge Peterson's expression of concern about escalating budget deficits. As a matter of macroeconomics, one can debate what level of deficits and the ratio of debt to GDP are sustainable. With the 1993 budget accord, that ratio, which rose steadily during the Reagan-Bush years, is starting to come down. But the deficit is a problem because chronic structural deficits threaten the ability of the government to do its job. Devoting an ever larger percentage of the budget to debt service, as we saw over in the Reagan-Bush years, means less money to build roads, educate children, protect the poor, and all the other important tasks that only government can undertake well. President Clinton now finds there is little revenue available to spend on genuine public needs because of the deferred task of deficit reduction.

Those who complain about the supposed staggering growth of "entitlements" usually target Social Security simply because it's big. Shame on them. As noted, Social Security has actually declined as a share of GDP over the past decade; it is expected to remain stable for the next 15 years. Our real problem with entitlement spending, the one major area that has been growing rapidly, is health care. There, the solution is not to restrict entitlements, but to reform the system once and for all by joining a new entitlement -- universal health coverage -- with comprehensive cost containment.

Whatever happens with health care, tax reform remains the most promising strategy of reducing the long-term budget deficit. With total U.S. taxes now the lowest in the industrialized world, certainly there is room for higher taxes here. But whose taxes?

Rather than repeating the "trickle-down" approach of the early 1980s, as Peterson proposes, we could increase revenues through further progressive tax reforms. Clinton's 1993 budget act took back about 43 percent of the tax cuts granted the wealthiest Americans in the late 1970s and early 1980s. It did so primarily by increasing the top marginal personal income tax rate to 39.6 percent. But there is still more to do.

Future efforts to improve tax fairness should focus on closing loopholes that allow some corporations and high-income people to avoid paying their fair share, while harmfully distorting investment decisions. These are precisely the loopholes that Peterson either ignores or would expand in his proposed program.

Numerous economically sound, fair, and needed tax reforms are available. They range from restructuring the way we tax the profits of multinational corporations, to clamping down on corporate buying and selling of tax breaks, to closing loopholes for capital gains (rather than expanding them, as Peterson proposes). Changes such as these -- a long list is available from Citizens for Tax Justice -- could cut the deficit by huge amounts without crippling Social Security or loading new burdens on those least able to pay.

Deficits do matter, both to the economy and to the government's ability to respond to the needs of the nation. But "entitlements" are the wrong demon, and regressive solutions like Pete Peterson's fail the test of both fairness and economic soundness. He and his allies should stop pretending otherwise.

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