heritage fiinancial plan

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SR-xx

March XX, 2011

Heritage

Special ReportPublished by The Heritage FoundationSR-91

May 10, 2011

Saving the American Dream

The Heritage Plan to Fix the Debt, Cut Spending,and Restore Prosperity



Tis paper is part o the Entitlements and Health Care Initiatives, two o 10 ransormational

Initiatives making up Te Heritage Foundation’s Leadership or America campaign. For more

products and inormation related to these Initiatives or to learn more about the Leadership or

American campaign, please visit heritage.org .

Te Heritage Foundation is a research and educational institution—a think tank—whose mission

is to ormulate and promote conservative public policies based on the principles o ree enterprise,

limited government, individual reedom, traditional American values, and a strong national deense.

Our vision is to build an America where reedom, opportunity, prosperity, and civil society ourish.

As conservatives, we believe the values and ideas that motivated our Founding Fathers are worth

conserving. As policy entrepreneurs, we believe the most efective solutions are consistent with

those ideas and values.



Edited by Stuart M. Butler, Ph.D., Alison Acosta Fraser, and William W. Beach

Saving the American DreamThe Heritage Plan to Fix the Debt,

Cut Spending, and Restore Prosperity



2

About the Editors

Stuart M. Butler is Distinguished Fellow and Director o the Center or Policy Innovationat The Heritage Foundation.

Alison Acosta Fraser is Director o the Thomas A. Roe Institute or Economic PolicyStudies at The Heritage Foundation.

William W. Beach is Director o the Center or Data Analysis at The Heritage Foundation.

The editors are grateul to the team leaders who worked with policy experts throughout TheHeritage Foundation to develop this report: J. D. Foster, Ph.D., Norman B. Ture Senior Fellow inthe Economics o Fiscal Policy; Rea S. Hederman, Jr., Assistant Director and Research Fellow inthe Center or Data Analysis; David C. John, Senior Research Fellow in Retirement Security and

Financial Institutions; Robert E. Moft, Ph.D., Senior Fellow in the Center or Policy Innovation;Nina Owcharenko, Director o the Center or Health Policy Studies; and Brian M. Riedl, GroverM. Hermann Research Fellow in Federal Budgetary Aairs.

_______

This plan was developed as part o the Solutions Initiative and unded by the Peter G. PetersonFoundation.

The Peterson Foundation convened organizations with a variety o perspectives to develop plansaddressing our nation’s scal challenges. The American Enterprise Institute, Bipartisan PolicyCenter, Center or American Progress, Economic Policy Institute, The Heritage Foundation, andRoosevelt Institute Campus Network each received grants. All organizations had discretion andindependence to develop their own goals and propose comprehensive solutions. The PetersonFoundation’s involvement with this project does not represent endorsement o any plan. The nalplans developed by all six organizations will be presented as part o the Peterson Foundation’ssecond annual Fiscal Summit in May 2011.

© 2011 by The Heritage Foundation214 Massachusetts Avenue, NE Washington, DC 20002–4999(202) 546-4400 • heritage.org

This paper, in its entirety, can be ound at:http://report.heritage.org/sr0091

Nothing written here is to be construed as necessarily refecting the views o The Heritage Foundationor as an attempt to aid or hinder the passage o any bill beore Congress.

http://heritage.org/

http://report.heritage.org/sr0088

http://report.heritage.org/sr0088

http://heritage.org/



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Foreword

Fellow Americans:

We have come to a time o decision. For ar too long, Congress has been on an unsustainable binge o spending,taxing, and borrowing. Our nation is going broke, and we are passing the costs o these misguided policies to ourchildren and their children.

Over time, our national government has become bloated, overextended and unrestrained, oblivious o its coreunctions, operating ar beyond its means and vastly outside o its proper constitutional bounds. Unchecked, thecourse we are on now will cripple our economy, undermine our prosperity, and lead to scal insolvency. By robbingthe uture o opportunity and reedom, it will destroy the American Dream or uture generations.

Already, we are living through the shame o being publicly lectured by our Communist Chinese creditors, whohave contempt or our profigacy. The day it was announced that Standard & Poor’s had lowered the outlook on

our economy, a collective gasp went through the international community. I our elected leaders keep it up, we arecertain to ace nancial crises like Greece or Portugal.

America is on the verge o becoming a country in decline—economically stagnant and permanently debt-bound, heavily regulated and bureaucratic, less sel-governing and less ree.

But this ate does not have to be our uture. We can get spending under control, balance the budget, and shrinkour debt. We can limit the size o government and set ree once again the unlimited genius o Americans to createwealth and jobs. We can turn the tide and change our nation’s course.

Saving the American Dream is our plan to x the debt, cut spending and, above all, restore prosperity.It balances the nation’s budget within a decade—and keeps it balanced. It reduces the debt and cuts

government in hal. It eliminates government-mandated health care and ully unds our national deense.In order to get our scal house in order, we must address Social Security, Medicare, and Medicaid, the three so-calledentitlement programs which together account or 43 percent o ederal spending today. Far too many seniors still lackenough help to avoid poverty. Saving the American Dream thereore does not end these programs; instead it ocusesthem on those who need them.

Our plan also encourages Americans to become more scally responsible themselves. It redesigns our entiretax system into an expenditure tax that will have a single fat rate. This is a structure that will promote savings,thereore beneting individual Americans, our body politic, and the economy. Greater savings mean stronger capitalormation and thus a more robust economy, which means real jobs or Americans.

This plan substantially reduces the size and scope o the ederal government, undamentally increases

the role o the states in choosing their own practices, and brings decision-making closer to the people ratherthan unelected administrators. These are crucial steps that will get our nation on a path o scal, political, andconstitutional responsibility. It is part o our larger eort to get our country back on track, reclaim its truths,conserve its liberating principles, and build an America where reedom, opportunity, prosperity, and civil societyfourish.

At the end o the day our plan, while economic in nature, has a higher moral purpose. I entitlements are notreormed, the next generation and uture ones will have to pay punitive tax rates that will end liberty as we haveknown it. Our proposal aims to preserve America’s promise bequeathed to us by past generations.

iii



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Edmund Burke reminds us to think o our time on this earth not as an individual and temporary event, butrather as a partnership “between those who are living, those who are dead and those who are yet to be born.”Keeping aith with this partnership is what we aim to do with Saving the American Dream.

We have been here beore, and every time the American people have always risen to the occasion and seizedthe moment. In 1776 we were told that no upstart colonists could deeat the strongest nation in the world, and wedecided to change the course o history. In 1860 we were told the Union could not hold and that America was over,

and we brought orth a new birth o reedom. In 1980 we were told that the American century was at an end, andwe launched a great economic expansion, rebuilt our military, and revived our national spirit.

Hard times demand tough choices. The uture o our nation is at stake.

All that is required, as my hero Ronald Reagan once said, is “our best eort, and our willingness to believe inourselves and to believe in our capacity to perorm great deeds; to believe that together, with God’s help, we can andwill resolve the problems which now conront us.”

Together, let us seize the moment, change our country’s course, and save the American Dream.

—Edwin J. Feulner President, The Heritage Foundation

iv



1

Introduction

There Is Only One Choice

America must change course. We ace a staggering scal problem that threatens the very uture o our nation.Not only will we continue to struggle with huge ederal decits into the near uture, but the problem will becomeever larger and ever deadlier in the decades to come. Unless we act wisely, massive government spending and surg-ing public debt will destroy the oundations o our economy and darken the American Dream or our children and

grandchildren.But this is not inevitable. We can in act preserve the American Dream. With bold and decisive action, we can

reduce spending and solve our debt problem. We can saeguard our legacy o reedom, opportunity, and prosper-ity, and we can do it in such a way that shrinks the government to a manageable size, invigorates our economy,and ensures basic economic security to younger and older Americans alike. We can save ourselves rom a sea o red ink while doing better or our seniors and the poor than the current programs that have gotten us into thepresent mess.

The Heritage Foundation has come up with such a plan.

The underlying problem that it addresses is simple: The government is doing things it should not be do-ing and spending ar more than we can aord to pay or should be paying. It is time to start moving decisivelytoward a ederal government that is limited and carries out its appropriate unction. As a result o the govern-ment’s doing ar too much, spending since World War II is at record levels as a proportion o the U.S. economy(in terms o gross domestic product, or GDP1) and is growing. The ederal government is borrowing 40 centso every dollar that it spends. The accumulated national debt caused by this and past borrowing already standsat nearly 70 percent o the country’s annual economic output and is set to climb to at least 100 percent by theend o this decade.

According to some international comparisons, the U.S. economy is already in worse shape than the stumblingeconomies o most European nations, and it is only a matter o time until our nancial house collapses. We are liv-ing on borrowed time and risk an economic catastrophe unless somebody in government exercises real leadershipto reduce spending and borrowing. We can and must do better.

What i we ail to act beore domestic and oreign lenders lose condence that America and Americans will

ever act responsibly? What i a crisis enguls us? To see our grim uture, we need only look at countries likeGreece that are experiencing stringent and disruptive austerity and sudden drops in living standards. Yet we canstill avert such a catastrophe in America with real leadership and bold action. A growing number o states in America are conronting similar challenges with creative remedies to return to scal discipline.

However, i we do nothing, spending will continue to surge. Past Congresses made utterly unaordable prom-ises to Americans that are now coming due. These promises will continue to come due in the next decades.

1. The gross domestic product is the measure o the value o the total output o goods and services within the United States in a year.



2


In particular, Washington promised expensive Medi-care and Social Security benets to the baby-boomgeneration,2 but the money to pay or these programsis running out.

These programs promise benets or one set o Americans that are being paid through taxes and bor-rowing. The way this is done needs some explaining.Many Americans believe that the taxes and premiumsthey pay into Social Security and Medicare go into realtrust unds where they will be used to cover promiseduture benets. That’s not the case. Instead, the moneytaken rom one set o Americans today just goes outthe door to pay or benets or others. Any “surplus”is not kept in a und either, but rather is spent im-mediately by the government or other purposes andreplaced with an IOU that is nothing more than a taxlien that uture taxpayers will be orced to repay. And

that means obligations against the uture incomes o unsuspecting Americans, many o whom have yet tobe born.

Pay-as-you-go schemes can work only as long asenough people are paying into the system. Yet withthe leading edge o the enormous baby-boom genera-tion now reaching retirement, these programs are nolonger cash cows covering other government spending.Instead, they are rapidly deepening seas o red ink. Fityyears ago, there were ve workers paying the benetso each retiree. Today, there are only three workers per

retiree, and in 20 years, there will be just two. Simplemath shows that this cannot continue.

We are acing the consequences o generations o politicians rom both political parties having promisedmillions o Americans certain services without regardto cost or how we will pay or them. The three majorentitlements—Social Security, Medicare, and Medic-aid—account or 43 percent o ederal spending, or10.3 percent o GDP. These three programs will surgerom 10.3 percent o the economy to almost 20 per-cent in just 40 years. To pay these promised benets inull or just Social Security and Medicare, the govern-ment would need to set aside and invest almost $40trillion o our tax dollars today to cover this long-termshortall.

With the baby-boom generation now reaching re-tirement, the nances o these programs are in direcrisis, and they are placing an increasing burden on

2. Baby-boom generation reers to people born in the years 1946to 1964.

heritage.orgChart 1 • SR 91

The Current and Future Crisis:Runaway Federal Spending Will Resultin Huge Budget Deficits

Source: Heritage Foundation calculations based on data fromCongressional Budget Office, Alternative Fiscal Scenario.

Revenue and Spending as a Percentage of GDP

Surplus/Deficit as a Percentage of GDP

10%

15%

20%

25%

30%

35%

2010 2015 2020 2025 2030 2035

2010 2015 2020 2025 2030 2035

-20%

-15%

-10%

-5%

0%

SPENDING

DEFICIT

REVENUE

35.2%

19.3%

–15.9%



3

The Heritage Plan to Fix the Debt, Cut Spending, and Restore Prosperity

Americans. These entitlement programs consume a large and rapidly growing proportion o the nation’s eco-nomic output.

Politicians and policymakers have put orward three visions o how to respond to this, but only one o thesechoices would deal with the budget and economic threat while beginning to restore the ederal government to itsproper, limited role and not passing on a huge nancial burden to our children and grandchildren.

Choice #1: Cross our ngers and hope or the best.

Many politicians either finch rom taking the necessary action or delude themselves into believing that some-how things will magically turn out okay. Others seem to believe that the ederal government is somehow just“too big to ail”—something many Greeks once believed o their government—and that the Chinese and otherlenders will trust in our ability to pay them back and sell o their holdings o Treasury securities, thereby sendinginterest rates skyrocketing. The ederal government would then need to make savage cuts to restore internationalcondence.

Even beore such a crisis, growing concern among oreign and domestic lenders about our willingness to takethe necessary long-term action will push up interest rates, hurting American businesses, investors, homebuyers, and

borrowers. But even i this crisis never occurs, the only way we can continue to pay or the promised entitlementsis to pass tens o trillions o dollars o debt onto our children and grandchildren. In this scenario, our children andgrandchildren will pay the bill. And it is a huge bill: Each working American and each o his or her children nowowes more than $200,000.

Perhaps the biggest danger is that when Washington sees this mounting debt, it will choose the most dangerous,“easy-way-out” strategy: printing money to pay the bills. This leads to rampant infation. America and many othercountries have experienced high infation beore. It devastates economies and perniciously eats away at the hard-earned savings o working and retired Americans.

This is not a real choice. Global capital markets will demand action at some point. Moreover, doing nothing is achoice that Americans emphatically rejected in the 2010 elections. They do not want an ever-growing ederal gov-ernment. They want the ederal government to be limited and to operate in line with its constitutional unctions.

And they do not want Congress to continue spending and making promises that we cannot keep without undermin-ing our prosperity and burdening uture generations with debt.

Choice #2: Raise taxes.

Some argue that the proper approach is to continue our spending and entitlement binge and simply raise taxesuntil we balance the books. But i we did this, spending and taxes would rise over the next ew decades to levelsmore like those endured in Europe than those we expect in America.

For instance, nancing promised entitlement spending solely by raising tax rates would require doubling themarginal tax rates or all income brackets over the next 30 years, reaching a 66 percent ederal income tax rate ormany middle-income Americans, on top o payroll taxes or state and local income taxes. Corporate taxes—already

among the highest in the industrial world—would also need to double. America cannot possibly compete economi-cally at that level o spending and taxation.

And who would pay the bulk o these taxes? Those in retirement or near retirement today would not, eveni rates were raised immediately. The Americans who would pay the lion’s share are those just starting out inlie. They would bear this staggering tax burden or decades while still trying to provide or their own needs.Indeed, this second choice would simply substitute taxes on young Americans or borrowing on the sameyoung Americans.



4


Some argue that even i spending commitments are trimmed, tax increases will still be needed because Ameri-cans are not willing to cut spending enough. Yet Americans have awakened to the spending problem. They aredemanding spending cuts, not more taxes. They also realize rom experience that i more o their money is sent to

Washington to “deal with the decit,” Congress will likely spend it rather than use it to reduce the long-term debt.Moreover, raising taxes will hit younger generations longer and will still shit much o the burden onto the peoplewho did not cause the problem.

This, too, is not a real choice. Imposing any new taxes or increasing current taxes—or example, by raisingrates—would erode American competitiveness and discourage entrepreneurship and investment, slowing growthand job creation and dimming uture prosperity. Even more important, it would lock in a vision o government thatrefects the European tradition ar more than it does the American tradition. It would uel an ever-growing ederalgovernment that continues to engage in activities that should be handled by the states or the people themselves,with programs that are nancially unsound and that cause more and more Americans to become dependent ongovernment.

Choice #3: Actually x the spending and debt problem and begin to restore the ederalgovernment to its proper unctions.

The third choice is to recognize that the U.S. government has gone well beyond its proper unctions. It has beenliving beyond the means o the American people, and Congress ater Congress has made unwise and unaordablepromises. Americans must return to the basic truths and values o our vision o limited government and reshapeour ederal government accordingly.

Marginal Income Tax Rates

The cost of Medicare, Medicaid, and Social Security is rising substantially. Paying for this spending solely through federalincome tax increases would require more than a twofold increase of current tax rates, even for the lowest tax bracket.

Hiking Taxes to Pay for Entitlements Would Require Doubling Tax Rates

0%

20%

40%

60%

80%

100%

Lowest Bracket

2010 2050 2082

Middle Bracket

2010 2050 2082

Highest Bracket

2010 2050 2082

Corporate Taxes

2010 2050 2082

10%

19%25% 25%

47%

63%

35%

66%

88%

35%

66%

88%

Source: Congressional Budget Office.




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To ensure prosperity and growth or ourselves andour children, we must reduce the ederal governmentso that it is closer to its proper size and ocus it on per-orming its core responsibilities. This will mean deepand sustained reductions in ederal spending. We mustalso hold down taxes while reorming our needlessly

complex, burdensome, and highly unair tax systemto sharpen incentives and reward saving i we want America to be prosperous once again. We must re-en-ergize entrepreneurs and workers to restore America’sprosperity powerhouse. We can best solve our spend-ing and debt problem through the growth, opportunity,and prosperity that come with low tax rates and limitedgovernment.

This choice requires that we tackle the root o thespending problem by squarely addressing the unsus-tainable entitlement promises that are overwhelming

us. I we act soon rather than waiting until the prob-lem is too urgent and too big to x prudently, we canx the problems in ways that actually strengthen eco-nomic security.

To deal with entitlements, we must ask parents andgrandparents to think not just o the promises pastCongresses have made to them, but also o the con-sequences their children and grandchildren will su-er i these promised benets remain untouched. Torepeat, the money that Americans have paid into theseprograms has already been spent. It is no longer avail-

able to pay or all o the promised benets. That is anindictment o Washington, but it is also a act—and one that we must address.

Today, we must ask ourselves tough questions about how we can allocate public unds in the most eective way. We must acknowledge that everyone will need to pitch in to solve the problem.

The good news is that we can do this. We can guarantee economic security to middle-aged and older Ameri-cans even as we reduce the crippling debt that we have piled onto the shoulders o the young.

However, xing these programs is only hal o the economic equation. The other hal is to oster the Ameri-can spirit o sel-reliance to fourish and to cast o the growing and dispiriting dependence on government thathas characterized recent decades. Faster growth through greater economic reedom will enable more and more Americans to build both a solid and secure lie and retirement or themselves and the means, as a community, tohelp those who worked hard but do not have the means to support themselves in retirement.

This third choice is the only one that upholds the vision o government shared by the vast majority o Americans.It is the only real choice. That is why The Heritage Foundation made this vision the basis o our plan to x America’sspending and debt crisis.

$159.3billion

GlobalWar on

Terrorism

$28.6billion

ForeignAid

$19.5billion

NASA

$2.4 trillion

Entitlements

(Medicare, Medicaid,Social Security, andother mandatory

programs)

Note: Figure for entitlements includes net interest. Without netinterest, the total is $2.2 trillion.

Discretionary Spending Cuts Alone Are Not an Adequate Substitute forEntitlement Reform

Annual spending on entitlement programs is massive

compared to other federal spending priorities.Cutting discretionary spending is a necessary step,but cuts to foreign aid alone or pulling out of Afghanistan will not close the deficit. Entitlementspending must be reined in.

Source: White House Office of Management and Budget.

Spending in 2011




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What the Heritage Plan Will Achieve

The Heritage plan will solve America’s twin crises o debt and spending with reorms that are consistent with theprinciples o democratic governance and deeply held American values.

Our plan does this by cutting government down to size, re-energizing American enterprise through undamentaltax reorm, and transorming entitlement programs to provide real economic security without passing a crushing

fnancial burden onto younger generations.Specically, the Heritage plan:

• Balances the ederal budget within a decade and keeps it balanced orever at no more than 18.5percent o GDP. Americans have made very clear to Washington over many decades the limits o howmuch they are willing to pay or government. That historical average gure is approximately equal to18.5 percent o GDP, so we balance spending and revenue at that level.

• Reduces the debt to 30 percent o GDP within 25 years and puts it on track to continue allingthereater. Our national debt now is nearly 70 percent o GDP and on track to hit 185 percent within25 years.3 Lower debt will remove the threat o nancial crisis and restore the condence o investorsand lenders. It will also sharply reduce the debt burden on uture generations, relieve the pressure oninterest rates, and help to secure our prosperity.

• Cuts the size o the ederal government by about hal within 25 years. By achieving balance at thislevel, we stop the ederal government rom growing to over one-third o the entire U.S. economy. Letunchecked, it would reach that size by the time a baby born today graduates rom college.

• Stops scheduled tax increases and replaces the complex and unair tax code with a completelynew tax system. In addition to holding revenues at no more than their historical average, we replace thecurrent Byzantine tax system with a much simpler system that minimizes tax distortions and perverseincentives.

• Protects America and its interests around the globe by ensuring ull unding or national de-ense. Deense is a core constitutional responsibility, a undamental duty o the ederal government, andessential to preserving American liberty and prosperity. Waste and ineciency in deense spending

3. Congressional Budget Oce, “The Long-Term Budget Outlook,” June 2010, at http://www.cbo.gov/ftpdocs/115xx/doc11579/06-30-LTBO.pdf (May 3, 2010).

Heritage Plan Curbs Revenue, Spending, and Debt

Sources: Current projections: Heritage Foundation calculations based on data from Congressional Budget Office, Alternative Fiscal Scenario. Heritage Plan:Calculations by the Center for Data Analysis, The Heritage Foundation, based on baseline data in the current projections, data provided by the Peter G. PetersonFoundation, and CDA policy models.

Table 1 • SR 91 heritage.org

REVENUE AND SPENDING PUBLICLY HELD DEBT

HeritagePlan

CurrentProjections Heritage Plan

CurrentProjections

Revenue OutlaysSurplus/ Deficit Revenue Outlays

Surplus/ Deficit

2011 14.8 24.7 –9.8 16.9 24.5 –7.6 69.4 67

2012 16.1 22.1 –6.0 17.6 22.9 –5.3 72.9 69

2021 18.3 18.1 0.2 19.3 26.3 –7.0 58.2 91

2035 18.5 17.7 0.8 19.3 35.2 –15.9 30.0 185

Figuresare % of GDP

http://www.cbo.gov/ftpdocs/115xx/doc11579/06-30-LTBO.pdf

http://www.cbo.gov/ftpdocs/115xx/doc11579/06-30-LTBO.pdf



7


Current Projections Heritage Plan

The Alternative—Saving the American DreamBy rapidly lowering total federal spending, the Heritage plan would balance the budget by 2021 and keep it therepermanently, without raising taxes.

SURPLUS


Sources: Current projections: Heritage Foundation calculations based on data from Congressional Budget Office, Alternative Fiscal Scenario. Heritage Plan: Calculationsby the Center for Data Analysis, The Heritage Foundation, based on baseline data in the current projections, data provided by the Peter G. Peterson Foundation, andCDA policy models.



10%

15%

20%

25%

30%

35%

2010 2015 2020 2025 2030 2035

2010 2015 2020 2025 2030 2035

-20%

-15%

-10%

-5%

0%

SPENDING

DEFICIT

REVENUE

35.2%

19.3%

–15.9%



10%

15%

20%

25%

30%

35%

2010 2015 2020 2025 2030 2035

2010 2015 2020 2025 2030 2035

-20%

-15%

-10%

-5%

0%

SPENDING

DEFICIT

REVENUE17.7%

18.5%

0.8%



8


should be rooted out, but we use the sav-ings to meet deense needs.

• Eliminates Obamacare and creates ahealth care system that is aordableboth or the nation and or individualsand amilies. This system osters the indi-vidual choice, competition, and state-levelinnovation needed to control underlyinghealth costs while assuring continuous andportable coverage. By overhauling subsi-dies and tax breaks or health care, we en-sure that Americans can aord adequatecoverage.

• Redesigns Social Security and Medicareas sustainable programs that truly pro-tect seniors and will be around or ourchildren and grandchildren. The cur-

rent system will soon be running massivedecits and unable to pay in ull or all o its promised benets. Accordingly, we re-design these dened-benet entitlementprograms as budgeted “real insurance” pro-grams that ocus on those who need themand are phased out by income or thosewho do not really need them. In contrastwith those who argue or raising taxes oncurrent and uture Americans, the Heritageplan eliminates the need to raise taxes.

• Provides powerul incentives or work-ing Americans to save and invest so thatthey will be less dependent on these pro-grams. Our tax and Social Security reormsprovide new ways or Americans to save ortheir uture security and to create capital orenterprise.

2010 2015 2020 2025 2030 2035

0%

50%

100%

150%

200%

CURRENTPROJECTIONS

HERITAGEPLAN

185%

2023:100%

30%


The Heritage Plan Would ReverseTrajectory of Unsustainable Debt

Without significant spending reforms, the nationaldebt is projected to reach 185 percent of GDP by2035. Under the Heritage plan, federal spending

would be reduced by about half, which woulddramatically lower our debt to 30 percent.

Sources: Current projections: Heritage Foundation calculations basedon data from Congressional Budget Office, Alternative Fiscal Scenario.Heritage Plan: Calculations by the Center for Data Analysis, The HeritageFoundation, based on baseline data in the current projections, dataprovided by the Peter G. Peterson Foundation, and CDA policy models.

Publicly Held Debt as a Percentage of GDP



9

Social Security

Summary

Social Security is the largest single ederal program, paying out about $700 billion per year to some 60 million Americans. It is a major source o retirement income or millions o Americans. Yet Social Security went into the redin 2010, paying out more in benets than people paid in as payroll taxes. The Congressional Budget Oce says thatthese decits will continue or at least the next 75 years and probably indenitely.

What Is Social Security?

Social Security, today’s largest single ederal program, provides (1) retirement income to workers andtheir spouses, (2) survivors benets to the amily members o deceased workers, and (3) disability ben-ets or workers who have been injured and are unable to work and to the amilies o those workers. Theprogram is unded by a 12.4 percent payroll tax that is paid equally by both the worker (6.2 percent) andhis or her employer (6.2 percent). Employers correctly see their contribution as a part o the employee’stotal compensation.

In 2009, the most recent year or which data are available, Social Security spent a total o $685.8 bil-lion providing these benets. That was also the last year that Social Security collected more in payrolltaxes than it paid out in benets. Starting in 2010, the program started to run cash-fow decits that theCongressional Budget Oce says are unlikely ever to end. The annual Social Security decit will increaseevery year until about 2030, when it will reach about $350 billion annually in 2010 dollars (without in-cluding any infation), and stay at approximately that level permanently.

Social Security does have a $2.5 trillion trust und rom the surpluses that it collected between 1983and 2009—but that money isn’t there. Rather than build up real assets in a real trust und, Congressactually spent that money on everything rom roads to corporate welare. That trust und is lled withspecial-issue Treasury bonds that the U.S. Treasury is required to nance when they are needed to undSocial Security’s decits. As they are bonds not backed by any real assets, the government will have toeither borrow or raise taxes to pay or them.

In essence, then, these bonds are really a demand on uture tax collections—a lien. In 2010, the Trea-sury started to redeem these bonds, or tax liens, by tapping into other tax sources in order to cover Social

Security’s decits. Around 2037, even those special-issue bonds will run out. From that time on, underthe provisions o current law, every retiree—no matter how wealthy or how poor—will have his or herSocial Security benets cut by about 22 percent.

Over the next 75 years, the program has promised to pay $7.8 trillion more in benets than it will receive in pay-roll taxes. The only way that uture retirees can collect all o the benets promised to them is to make their childrenand grandchildren pay massive amounts o additional taxes.



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Heritage proposes to solve these problems and strengthen the Social Security system by tightening its benetsand returning it to its original purpose: a guarantee that older Americans won’t all into poverty. Heritage proposesto make Social Security “real insurance” or Americans as they reach retirement.

This reorm means that Social Security’s promises in the uture will change in several ways:

• Social Security will gradually be transormed rom an “income replacement” system back to its originalpurpose o guaranteeing seniors reedom rom ear o poverty and assuring a decent retirement income.This means that Social Security benets will evolve over time into a fat payment to those who workmore than 35 years—a fat payment that is sucient to keep them out o poverty throughout theirretirement.

• Because the new Social Security is a real insurance system, designed to protect seniors rom poverty, re-tirees with high incomes rom sources other than Social Security will receive a smaller check, and veryafuent seniors will receive no check. This transparent way o income-adjusting benet checks will replacethe method used today, whereby the checks o even modest-income seniors are taxed and thus reduced.

• To help make up the dierence between the new Social Security benet and what workers may desire or

a more comortable retirement, our plan will create greater incentives or workers o all income levels tosave more or retirement. These savings will supplement their Social Security and create a more secureretirement.

• Americans live much longer than they used to. While this is good news, it means that they are spendinga much higher proportion o their lives in retirement. Regrettably, these longer retirements play a majorrole in Social Security’s nancial problems. For this reason, the Social Security retirement ages will beraised gradually and then indexed to lie expectancy. This will create a more reasonable balance betweenthe number o years a person works and the number o years one receives Social Security benets.

Tax Revenue and Entitlement Spending as a Percentage of GDP

Without Reforms, Entitlements Will Consume All Tax Revenues

0%

5%

10%

15%

20%

25%

Tax Revenue

1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080

Social

Security

Medicaid,ObamacareSubsidyProgram

Medicare

Source: Congressional Budget Office.




11


• To encourage people to stay in the workorce longer, those who work beyond ull retirement age willreceive a higher level o ater-tax income during the period when they are not claiming benets.

This new Social Security system is reasonable, predictable, and aordable. It ocuses resources on those whoneed the most help while providing complete protection against poverty or all seniors who qualiy or ull benets.

The Details

A Predictable Benet That Provides Economic Security. The centerpiece o the new Social Security sys-tem involves a gradual transition to a fat benet that pays retirees who qualiy or a ull Social Security check. Thisamount is well above the income level that the Census Bureau says an American over the age o 65 needs to avoidpoverty.

Thus, the new system will guarantee that no retiree alls into poverty because o insucient income. Under to-day’s system, retirees can pay Social Security taxes or 35 years and still receive a benet that is below the povertylevel. Some o these seniors are orced to go on welare. The new system corrects this serious faw.

The fat benet will be the equivalent o about $1,200 per month in 2010 dollars when the reorm is complete.

This is both higher than today’s average Social Security retirement benet payment ($1,164 per month) and wellabove the 2009 poverty level or a single adult over age 65 ($857 per month). To ensure that uture retirees do notslip back into poverty, the fat benet level will be indexed or wage growth.

Slow Transition to the New Flat Benet. The new fat benet will be phased in slowly. Current retirees andthose who are close to retirement will see only a minimal change in the basic design o their benets. Those with asignicantly longer time beore retirement, who have more fexibility in planning their uture, will see larger changesin their benets. Workers born ater 1985 will come under the new fat Social Security benet system when theyretire.

Limiting Social Security to Those Who Actually Need It. In addition to moving to a fat benet over time,the plan makes Social Security a properly nanced, true insurance program. It starts to do that immediately. Thismeans that the program will concentrate on protecting the economic security o retirees rather than ollowing the

current approach o promising unaordable benets to all without regard to need.This new approach means that retirees with substantial non–Social Security retirement income will start receiv-

ing a lower benet on a sliding scale that gradually reduces Social Security checks to zero or those with the highestnon–Social Security incomes. This transparent mechanism will apply to benets received by afuent Americansunder both the current system and the fat-rate system. This transparent, sliding-scale approach is a major improve-ment on today’s taxation o Social Security benets.

Under the plan, income-adjusted benets start in 2012 as individual retirees with non–Social Security incomesabove $55,000 start to see a slight reduction in benet payments. Those with higher non–Social Security incomewill see larger reductions in their checks. Individuals with more than $110,000 in non–Social Security income willreceive no Social Security payments. Married couples who le taxes jointly would be subject to higher thresholds,with benets beginning to phase out at a joint non–Social Security income o $110,000 and ending when income

reaches $165,000. Married couples can decide whether they want to qualiy or benets as individuals or jointly asa couple. The income thresholds will be indexed or infation.

Income-adjusting benets is not new. It occurs in today’s Social Security system. But it is largely hidden todayand hits lower-income seniors, not just the afuent. Seniors with as little as $15,000 in non–Social Security income,or even less in some cases, must pay tax on part o their benets. Seniors with more income than that pay steadilyhigher rates o tax on more o their Social Security benets. The Heritage approach, when ully phased in, wouldincome-adjust benets transparently and not tax the benets a senior receives. It also would start income-adjustingat a much higher income. Today, about hal o seniors have their checks eroded by taxation. Under the Heritage



12


plan, only about 9 percent o seniors would see their checks reduced and only just over 3.5 percent o seniors wouldreceive no check.

Real insurance also protects seniors rom poverty i their nancial situation changes. Retirees who suer a sud-den and permanent drop in non–Social Security income would nd their benets rapidly restored.

More Accurate Infation Protection. The annual cost o living adjustment (COLA) or Social Security, which

protects retirees against infation, will be based on the Chained Consumer Price Index (C-CPI-U), a measure o infa-tion that is more accurate than the index used currently. The Bureau o Labor Statistics specically designed this infa-tion measure to better refect the way that consumers buy dierent items as the prices o various products fuctuate.

A More Reasonable Retirement Age. The plan adjusts the standard retirement age to refect increases in lieexpectancy and those anticipated in the uture. Under the plan, these changes are phased in gradually. Those near-ing retirement are aected only slightly. Over the next 10 years, the age or ull benets rises to 68 or workers bornin or ater 1959. Over the next 18 years, the early retirement age rises to 65 or workers born in or ater 1964. Aterthat, both early and normal retirement ages will be indexed to longevity, which will add about one month every twoyears according to current projections.

The plan recognizes that a small proportion o workers will be physically unable to work until these ages. Itthereore includes an improved disability system to protect them. The reormed disability system ensures that those

who are unable to work longer receive a quick and accurate decision on their benet application rather than acingtoday’s long delays, and improves today’s oten arbitrary decision-making process.

Incentives to Work Longer. Starting immediately, those who work past their ull-benet age receive a spe-cial annual tax deduction o $10,000, regardless o income level. For instance, once the new system is completelyphased in, a worker earning $50,000 per year who delays Social Security payments will see a $200 per monthincrease in spendable income.

An Improved Savings Plan to Supplement Social Security. As Social Security is transormed into a realinsurance system that ocuses scarce resources on those who need them most, the plan also creates better ways orworkers to build savings or retirement.

Beginning in 2014, a new savings plan will be introduced over two years. Under this plan, 6 percent o eachworker’s income is placed in a retirement savings plan that the worker owns and controls unless he or she explicitlydeclines to have such an account. (This approach is known as automatic enrollment.)

This new, additional retirement security system gives Americans another tool with which to secure their retire-ment standard o living. Savings are invested through an improved version o the IRA/401(k) employment-basedretirement savings system already amiliar to Americans. The money put into these savings accounts will not bedouble-taxed, unlike today’s Social Security payments and many other savings mechanisms.

In addition to this new savings plan, workers have two other important ways to save or retirement.

First, under the reormed tax system detailed below, all savings (without limit) will no longer be double-taxed.Savings remain completely ree o taxation until they are actually spent.

Second, as benet reorms drive the costs o Social Security below the level o taxes collected, those savings willgo into the workers’ accounts.

The Bottom Line

The Heritage plan reorms Social Security to create a retirement security system that will be available or uturegenerations. It will be one that provides a reasonable, predictable, and aordable benet that ensures that no retireewho has worked or 35 years or more aces poverty or economic insecurity. At the same time, this new system pro-tects our children and grandchildren rom the massive tax increase that would be necessary to pay all o the SocialSecurity benets that Washington has irresponsibly promised.



13

Medicare

Summary

The Medicare program aces a 75-year ununded liability in excess o $30 trillion even as it is plagued by seri-ous gaps in coverage, an increasing number o demoralized doctors reusing to accept new Medicare patients, asluggish and outdated system o infexible governance, and tens o billions o dollars in annual losses to waste,raud, and abuse.

What Is Medicare?

Medicare is the ederal government’s health insurance program or all Americans age 65 and olderand or the disabled. In 2010, the program covered 47 million enrollees. Almost hal (47 percent) haveannual incomes below 200 percent o the ederal poverty level ($21,660 in 2010 dollars or individualsand $29,140 or couples). An estimated 45 percent have three or more chronic medical conditions, and17 percent are non-elderly people with disabilities. Medicare is projected to spend $549 billion in 2011,increasing to $891 billion per year by 2019.

Medicare has our parts.

• Part A covers in-patient hospitalization, hospice care, and some home health care. It is undedby a 2.9 percent payroll tax, but projected spending will ar exceed uture tax revenue.

• Part B is voluntary and covers physician services, outpatient hospital services, preventive care,and some home health services. Beneciary premiums cover just 25 percent o Part B costs. Tax-payers pay or the remaining 75 percent. Federal Insurance Contributions Act (FICA) payrolltaxes contribute nothing to Part B. Premiums are income-related.

• Part C, the Medicare Advantage program, is also voluntary. It consists o private plans that al-ready compete in the Medicare program. They are unded by a combination o enrollee premi-ums and taxpayer subsidies, including Part A unds.

• Part D is the voluntary Medicare prescription drug program. FICA payroll taxes do not und thispart o Medicare. Enrollees pay income-adjusted premiums, but the costs or all beneciaries aresubsidized by taxpayers, with greater subsidies or low-income enrollees. While beneciary pre-miums account or approximately 10 percent o Part D nancing, 82 percent comes rom gen-eral ederal revenues, and approximately 8 percent o the unding comes rom states and othersources. As with Medicare Part B, wealthy retirees pay higher premiums, up to 80 percent o thecosts o the drug benet.

Medicare Part A and Part B together are sometimes reerred to as traditional Medicare or Medicareee-or-service (FFS). This means that doctors, hospitals, and other medical proessionals are paid or theindividual services that they provide to patients as opposed to being paid salaries or given “capitated”payments as payment or all o the care provided to a senior. The ees are governed by government eeschedules or payment ormulas or specic medical services.



14


Medicare must be reormed to solve this huge nancing problem, to improve access to quality care, and to ensurethat health care will be available or younger Americans when they retire.

The Heritage plan accomplishes this by transorming Medicare rom an open-ended and unsustainable dened-benet entitlement into a properly budgeted program that ocuses Medicare subsidies on those who need themmost. The new Medicare program would look much more like the Federal Employees Health Benets Program(FEHBP), the health care system or Members o Congress and ederal employees.

Over a ve-year period, the plan transorms Medicare into a dened-contribution system, with stronger healthsecurity or the poor and less healthy, and guarantees new protections against catastrophic costs or all enrollees.Today’s traditional ee-or-service Medicare program provides no such protections. Because o this gap, nine out o 10 seniors eel compelled to buy supplemental private health insurance, including Medigap, to cover themselvesagainst the nancial devastation o catastrophic illness. This means that seniors pay an extra set o premiums andoten incur high out-o-pocket costs or both premium and non-premium medical expenses.

Finally, the plan establishes a true long-term budget or Medicare.

The Reormed System. When the changes are ully phased in, seniors will enroll in the health plans o theirchoice and receive a dened contribution (known as premium support) toward the cost o their plans, much asMembers o Congress and millions o ederal employees and retirees do through the FEHBP. Unlike today, all plans

will include catastrophic protection. Thanks to the structure and insurance rules in Medicare, the premium supportwill be sucient or seniors to aord an adequate level o benets, regardless o age or health care condition.

Current Projections Heritage Plan

The Heritage Plan Would Rein in Mandatory Entitlement Spending


Spending as a Percentage of GDP

0%

5%

10%

15%

20%

2010 2015 2020 2025 2030 2035

Spending as a Percentage of GDP

0%

5%

10%

15%

20%

2010 2015 2020 2025 2030 2035

9.1%

17.1%

SOCIAL SECURITY

MEDICARE, MEDICAID,EXCHANGE, CHIP


SOCIAL SECURITY

MEDICARE, MEDICAID,EXCHANGE, CHIP



15


The range o choices in the transormed system includes Medicare premium-based ee-or-service insurance aswell as other ee-or-service plans, Medicare Advantage plans, managed care plans, association plans, and Tat–Hart-ley Act and employer-based plans. Existing health savings accounts (HSAs) can also be carried into retirement.

Medicare’s basic rules or insurance are retained, together with an improved risk-adjustment mechanism tooset the impact o any adverse selection. Under the reormed system, Medicare’s Center or Drug and Health PlanChoice, whose mission today is to identiy abuse and oversee marketing rules or Medicare Advantage and Medicaredrug plans, carries out that unction or all plans.

Beyond retaining the Medicare insurance rules, the reorm provides or scal solvency and reserve requirementsor all health plans to ensure that plans have the nancial resources to pay insurance claims. It also provides market-ing rules to protect consumers against raud and a requirement that benets be described in plain English withoutsurprises or denials in ne print. By increasing choice and competition, the reormed Medicare program will deliverbetter care and provide true health care security or less money than under current projections.

The cash value o premium support is reduced or upper-income seniors and eventually phased out or thosewith the highest incomes. However, all seniors will have access to the same Medicare system with no need to buya separate plan to cover catastrophic expenses. Poor seniors remain eligible or Medicaid assistance. Like the SocialSecurity adjustments in retirement age, Medicare’s eligibility age becomes 68 in 10 years and is indexed thereater

or increases in longevity.During the ve-year transition period, Medicare’s traditional ee-or-service system also changes. Part A costs are

oset by a new premium payment system or upper-income retirees. The premiums or Parts B and D rise accord-ing to income. The highest-income seniors pay an unsubsidized premium or Parts B and D during the transition.

The Details

A Dened Contribution Adjusted by Income. Five years ater enactment, all new retirees receive a con-tribution (premium support) rom the government, just as ederal employees and retirees do today. They can usethis contribution to choose Medicare’s premium-based FFS plan or one o the other health plans. Ater one year o operation, Medicare enrollees in the traditional Medicare FFS program are ree to join the new Medicare premium-support program. They can then choose a premium-based FFS plan or an alternative.

During the rst ve years o the premium-support program, the government’s contribution is based on theweighted average premium o the regional bids o competing health plans. Ater the rst ve years, the governmentcontribution is based on the lowest bid o competing plans in a region. The bidding system will be phased in andwill include the bids o the competing managed care plans, other private plans, and the Medicare premium-basedFFS plans oering an approved range and quality o services.

Under the Heritage plan, low-income enrollees receive the ull Medicare dened contribution. The amount o thedened contribution starts to phase out or Medicare enrollees with annual non–Social Security incomes between$55,000 and $110,000 and couples with incomes between $110,000 and $165,000. Enrollees with incomes over$110,000 and couples with incomes over $165,000 receive no government contribution and pay ull, unsubsidized

premiums. As with Social Security, married couples can decide whether they want to qualiy or benets as indi-viduals or jointly as a couple. The phaseout income levels will be infation-indexed. However, Medicare remains avaluable program or higher-income seniors because they retain access to a guaranteed-issue and community-ratedinsurance program.

Under the Heritage plan over 90 percent o seniors would receive the ull dened contribution. Only just over3.5 percent have such high incomes that they would pay the entire premium without any contribution rom thegovernment.

This income-adjustment o Medicare is not new. Today, or instance, Medicare Part B and Part D premiums arechanged signicantly according to income. For single retirees, Part B premiums can range widely, rom $96.40 per



16


month to as much as $369.10 per month, depending ontheir income. Upper-income retirees can pay as much as$69.10 per month more or the same Part D coverage as alower-income senior. What the Heritage plan does is ratio-nalize the income adjustment o Medicare so that it ulllsthe true insurance purpose o the program while assuring

that the program will be available or uture generations.

A Medicare Budget and Financing System.Dur-ing the rst ve years o the new Medicare program, thegovernment’s annual contributions to enrollees’ plansare based on the weighted average premium o partici-pating health plans’ bids on a regional basis. The plansbid to provide Medicare benets plus catastrophic cov-erage and, just like the FEHBP, are weighted on planenrollment. Thereater, the government contributionis based on the premium bid o the lowest-cost healthplan that meets the required level o quality and pro-

vides an adequate range o benets. In both cases, theper capita government contribution on the basis o theplan bidding is set at 88 percent o the bids. By com-parison, the FEHBP contribution is set at 72 percent o the national average weighted premium, and the origi-nal Medicare Part B premium contribution was set at 50percent in 1965.

The Heritage plan also caps total Medicare spending. The spending cap is indexed annually or infation usingthe Chained Consumer Price Index and Medicare population growth. I Medicare spending exceeds the cap, thegovernment’s contribution declines rom 88 percent to the percentage that complies with the Medicare spendingcap, thereby pressuring the competing plans and providers to control costs more tightly.

Additional Assistance or Dual-Eligibles. Medicaid, the ederal–state program or the poor and the indigent,provides supplemental coverage or about 8 million Medicare beneciaries. These are poor people, and most qualiyor ull Medicaid benets, including long-term care services in nursing homes. They receive subsidies or Medicarepremiums and cost-sharing and or the Medicare Part D drug coverage.

Beginning ve years ater enactment, states have the option to “top up” the Medicare dened-contributionamount or dual-eligibles who choose to enroll in a private health plan. Dual-eligible enrollees who stay with therevamped Medicare FFS plan continue to receive Medicaid coverage as they do today.

Integrating Traditional Medicare into the System and Adding Catastrophic Cost Protection. Underthe Heritage plan, all senior citizens have the option o keeping their current health plans or choosing better healthplans. Five years ater enactment, traditional Medicare FFS begins to compete directly with private plans on a levelplaying eld. Seniors can remain in Medicare FFS i they wish. However, the previous organizational and benet

distinctions within Medicare FFS (Medicare Parts A, B, C, and D) disappear because Medicare becomes a single,unied program with a unied trust und that is nanced by a dened contribution.

A single stated premium incorporates today’s multiple Medicare FFS premiums plus the cost o a new catastroph-ic benet. Cost-sharing parameters are adjusted to ensure that the Medicare benet package is actuarially equivalentto the package provided under current law. In the rst year o competition with private health plans, the initialvalue o the catastrophic benet will need to equal the average o such benets currently provided in the Medicare Advantage program, but it may be adjusted thereater by the Secretary o Health and Human Services.

Percent of Defined Benefit Contribution for Medicare Beneficiaries, by Income

Sources: Calculations by the Center for Data Analysis, The HeritageFoundation.


SINGLES % of Contribution

$0–$55,000 100%

$56,000–$57,000 98%$75,000–$76,000 64%

$82,000–$83,000 49%

$100,000–$101,000 18%

$109,000–$110,000 2%

More than $110,000 0%

MARRIED COUPLES % of Contribution

$0–$110,000 100%

$111,000–$112,000 98%

$130,000–$131,000 64%

$137,000–$138,000 49%

$155,000–$156,000 18%

$164,000–$165,000 2%

More than $165,000 0%



17


Changes in Traditional Medicare FFS During the Transition

During the transition, the Heritage plan:

• Reduces subsidies and phases them out or upper-income enrollees. For upper-income seniors, thepremium subsidies or Part B and Part D are phased out and a premium or Part A is phased in. Forupper-income seniors, the subsidy implicit in their premiums is phased out over the same range as or

Social Security ($55,000 to $110,000 or individuals and $110,000 to $165,000 or couples). Underthe changes in traditional Medicare, these subsidy reductions and phaseouts also apply to governmentsubsidies or those who are enrolled in Medicare Advantage plans.

A new income-related Part A premium or retirees is phased in to cover the ull cost o Part A servicesduring the transition and to cover any decit in the Hospital Insurance trust und. The premiums arephased in or individuals with annual incomes between $55,000 and $110,000 and couples with annualincomes between $110,000 and $165,000. Individuals with an annual income o $110,000 and coupleswith an annual income o $165,000 pay ull, unsubsidized premiums.

• Changes co-payments. Medicare Part A, which covers hospitalization, has a deductible. During thetransition, the deductible is indexed annually to an average o the Consumer Price Index (CPI) and theMedical CPI. A co-payment o 10 percent is added or the total cost o each home health care episode

(dened as 60 days o service). Today, there is no such co-payment in spite o heavy utilization o thiscostly benet.

• Raises the premiums or Part B and Part D. The Part B and Part D premium percentage or mostbeneciaries is gradually raised rom 25 percent to 35 percent in increments o 2 percentage points peryear over the ve-year transition. The existing “hold harmless” provisions are retained or low-incomeseniors.

Other Key Changes in Medicare

The Heritage plan envisions other important changes and rules in the current Medicare program:

• Eliminating restrictions on doctor–patient contracting. Beginning immediately, the plan eliminatesthe statutory and regulatory restrictions on private contracting outside o Medicare that were enacted inthe Balanced Budget Act o 1997. There were no such statutory restrictions beore 1997. This means thatMedicare enrollees can enter into private agreements or medical services with the physicians o theirchoice with no statutory or regulatory restrictions. For reasons o privacy, or for whatever reasons seem

good to them, they can go outside o the Medicare program without being required to submit a claim tothe Medicare bureaucracy or the physician’s service. This restoration o the right o private contractingwill also encourage the treatment o Medicare patients by more physicians who otherwise might notparticipate in the program.

• Retaining Medicare savings or Medicare alone. Beginning immediately, any savings in the Medicareprogram are prohibited rom being credited to the cost o current or uture “health care reorm” provi-

sions that und Medicare benets or subsidize those who are not enrolled in the program. Five yearsater enactment, any remaining savings rom traditional Medicare are deposited into the new uniedMedicare trust und.

• Enacting a permanent “doc fx” and making physician pricing ully transparent. Beginning im-mediately, a permanent “doc x” is implemented using any Medicare savings rom legislation, includ-ing savings rom this proposal. From this point orward, physician payments are adjusted or infation,measured by the CPI (not the Medical CPI). However, the law is changed to permit balanced billing incombination with a price disclosure requirement or Medicare physicians’ services.



18


Thus, or traditional Medicare FFS during the transition, the government determines Medicare reim-bursement, while physicians determine patient ees. This change will encourage doctors who otherwisemight drop out o Medicare to continue to treat Medicare patients. Moreover, the required transparencyin physician ees guarantees price competition in physician services, thus helping to lower Medicarecosts.

• Allowing new retirees to keep their existing plans. Surveys show that the vast majority o working Americans are satised with and, i possible, want to keep their existing health plans. The Heritageplan expands the opportunities or Americans to keep their existing plans into retirement. Even beorethe ve-year transition to a ull premium-support program, Medicare provides a risk-adjusted denedcontribution or any retirees who want to remain in their pre-existing health plan, including employer-based coverage. Subsidies will also be adjusted by the new income rules.

The Bottom Line

By moving to a premium-support program, Congress can introduce the powerul orces o consumer choice andcompetition into Medicare, orcing health plans and providers to deliver value or taxpayer and beneciary dollars.

Similar approaches to health care nancing and delivery have been used in Medicare Part D and the FEHBP, theprogram that covers Members o Congress. The record shows that this approach can successully control and slowthe growth o health care costs while increasing patient satisaction.

Medicare today is less a traditional social insurance program, in which beneciaries pay or their benets, and isbecoming more o an income transer program. Today’s enrollees are not, in act, “paying or” their Medicare ben-ets, since it is really a “pay as you go” system with today’s workers paying or today’s beneciaries. Even so, payrolltaxes pay or just a portion o one part o Medicare, and the premiums that seniors pay or the other parts cover lessthan a quarter o those costs.

Taxpayer subsidies account or 85 percent o total Medicare program costs. I Medicare is let unreormed, ourchildren and grandchildren will pay those higher taxes even as they work and save to provide or their own amilies.

By reducing the level o tax subsidies or seniors with higher incomes, the Heritage plan reduces both the bur-den on uture taxpayers and dependence on government. By adding catastrophic protection against serious illnessand targeting unding to those who are most in need, the plan strengthens Medicare as saety-net insurance or all Americans and guarantees them better health and economic security. Finally, by reducing the role o bureaucracyand red tape in the delivery o medical care, the Heritage plan makes the practice o medicine more attractive,thereby encouraging dedicated and talented individuals to join the health proessions.



19

Health Care for Families

Summary

Health care costs are rising at an alarming rate, while individuals and amilies have less control over their healthcare dollars or decisions. Worse still, the recently enacted Patient Protection and Aordable Care Act (PPACA, orObamacare) is accelerating these problems. In sharp contrast to the centralized government approach o the Obamalegislation, the Heritage plan uses a consumer-centered, market-based approach to reduce health care and give pa-tients and their amilies a greater say in health care spending and decisions that aect their lives.

This begins by repealing Obamacare.

The Heritage Foundation has already proposed major health care reorm to create an aordable health care sys-tem in America. The reorm is based on consumer choice and ownership o coverage, together with an inrastructureor competitive private plans and state-led innovation. The Heritage plan includes key budget and tax componentso the overall Heritage health care reorm, including reorm o the tax treatment o health expenses and assistanceor health insurance or lower-income amilies. Other eatures o the health care reorm are developed in other stud-ies and reports.

The Heritage Foundation health care proposal assumes numerous other policy initiatives that accom-pany the budget design elements in the Heritage plan. These include:

• Removing consumer barriers to the purchase o health insurance, such as existing limits oninterstate purchase;

• Developing mechanisms, such as risk-adjustment and high-risk pools, to address access issuesor the hard-to-insure;

• Making available new pooling arrangements, such as individual association plans; and

• Supporting strong state-led initiatives to promote innovation and experimentation withconsumer-centered, market-based reorms.

These and other insurance reorms are intended to augment the Heritage plan, to promote competition,drive down cost, and advance stability, portability, and personal ownership.

In conjunction with the plan’s tax reorms, the current individual tax exclusion or employer-sponsored healthinsurance and other tax mechanisms are replaced with a nonreundable xed tax credit or households to purchasehealth coverage. The credit is phased out as income rises and eliminated or upper-income households. The switchrom the exclusion to the credit system is revenue-neutral to the ederal government.

This change is needed because under today’s system, the tax code provides unlimited tax breaks only to thoseworkers who receive coverage through their employers. Workers cannot use this tax break i no plan is oeredthrough their employers or i they simply preer a plan other than their employer’s. Moreover, while upper-incomeworkers obtain a very large tax break, the exclusion provides little or no help to lower-income workers who arestruggling to aord coverage or their amilies.



20


Through tax reorm and other measures, the Heritage plan ensures that everyone, regardless o job situation, iseligible or a tax credit or other help in purchasing health insurance. This means that people can buy, own, and keepthe health care plans o their choice.

For poor Americans, the plan provides assistance or coverage, paid with reductions in other ederal spending.Under this reorm, low-income able-bodied adults and their children who are currently on Medicaid would no lon-ger participate in the costly and ailing Medicaid program; instead, they would be able to enroll in private coverage.

In addition, under the Heritage plan, low-income individuals who are not currently eligible or Medicaid wouldreceive nancial assistance toward a plan. This ensures that everyone who needs assistance receives assistance inpurchasing health insurance. Like those who receive the tax credit, individuals and amilies receiving assistance havethe same health care plan choices as those with the tax credit and can buy, own, and keep their health insurance.

The Heritage plan transorms the remainder o today’s Medicaid program—or the rail elderly and disabled—into a health care saety-net program rather than today’s catch-all, patchwork program. In addition, the Heritageplan replaces the open-ended ederal–state nancing arrangement that is crippling state and ederal budgets witha more consistent and sustainable capped allotment. In exchange or the capped allotment, states are given muchmore fexibility to redesign health services or the disabled and the elderly poor so that they can provide better andmore integrated services at lower cost. This new arrangement enables states not only to provide better care or the

neediest in our society, but also to keep to their budgets without cutting other state priorities or raising taxes.

The Details

A New Health Tax Credit.The Heritage plan endsthe existing tax exclusion or employee compensation inthe orm o employer-sponsored health insurance. Thismeans that the value o employer-paid health insurancepremiums is included in the employee’s total taxablecompensation. Today’s system excludes this compensa-tion rom income and payroll taxes, eectively giving

upper-income workers in high-tax brackets a large taxbenet.

In return or ending this tax break, the plan intro-duces a new uniorm, nonreundable ederal tax creditto assist amilies in their purchase o health insurance.Employers and employees could decide whether to havethe employer continue to buy coverage or to cash outthe existing coverage in the orm o higher cash income.Either way, the tax break or coverage would changerom an exclusion to a credit.

The net value o the credit is $2,000 or an in-

dividual and $3,500 or a couple or amily. Underthe Heritage plan, this credit can be used either tooset the cost o coverage oered through the work-place or to buy insurance outside the workplace. Formost middle-income working amilies, the value o the credit is similar to the tax relie that they receiveor health insurance today. For upper-income house-holds, the new credit is typically less and is reducedas income rises. The phaseout begins at $50,000 or

Health Care Credits and Subsidies

Sources: Calculations by the Center for Data Analysis, The HeritageFoundation.


FAMILY OF FOUR

Income (% of Poverty Level) 2011 Income Credit

EnhancedFederalSubsidy

0%–133% Less than $29,727 $3,500 $5,500134%–200% $29,727–$44,700 $3,500 $2,750

201%–400% $44,701–$89,400 $3,500 $0

401%–500% $89,401–$111,750 $3,340 $0

501%–700% $111,751–$156,450 $1,789 $0

701%–1,000% $156,451–$223,500 $68 $0

1,001%+ $223,501+ $0 $0

SINGLE

Income (% of Poverty Level) 2011 Income Credit

0%–133% Less than $14,485 $2,000

134%–200% $14,485–$21,780 $2,000

201%–400% $21,781–$43,560 $2,000

401%–500% $43,561–$54,450 $1,954

501%–700% $54,451–$76,230 $1,231

701%–1,000% $76,231–$108,900 $145

1,001%+ $108,901+ $0



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an individual and $100,000 or a amily. The credit is ully phased out at $90,000 or an individual and$170,000 or a amily.

The credit is advanceable, assignable, and available on a prorated basis. This means that the credit is availablewhen premiums are due, enabling amilies to claim the credit or premiums already paid beore the end o the taxyear. An assignable credit allows a amily to assign their tax credit to a health plan in return or a dollar-or-dollarlower premium, eliminating the need to claim it on their own tax orms.

It is important to note that health care benets are a orm o worker compensation directed by the employer andare not “paid or” in any charitable sense by the employers. Thereore, in the labor market, employers would likelyadapt to the tax reorm either by increasing the wages or their employees instead o oering health insurance orby continuing to oer coverage to their employees. Either way, we know rom research that the employee’s overallcompensation should stay the same in most cases.

There is no mandate on individuals to obtain insurance, but i they did not obtain coverage, they would have toorgo the credit or assistance or insurance. Importantly, the Heritage plan envisions much wider use by employerso auto-enrollment mechanisms in the uture, with employees automatically enrolled in a plan as the deault option.Research suggests that such an auto-enrollment approach, combined with tax incentives or subsidies, is likely toresult in high rates o enrollment under the credit system.

Assistance or Lower-Income Working Families. Financial assistance or purchasing insurance, equivalentto the tax credit, is made available to households with no tax liability and prorated to those households with a taxliability less than the value o the available credit. This money can be used only or purchasing health insuranceand typically would be sent directly to the chosen plan in return or a dollar-or-dollar reduction in the premium tothe amily. This is like the way the government’s contribution to a ederal employee’s FEHBP reduces the employee’spremium.

Thus, i a amily’s tax liability is less than the value o the credit, the amily receives assistance partly in the ormo a credit (up to its tax liability) with the rest in the orm o direct assistance or insurance. I this amily’s incomerises in subsequent years, the amount it receives as assistance is phased out and the credit amount is phased in,maintaining the same ull credit/assistance amount throughout the income change. In contrast to the current patch-work health care model, the Heritage plan streamlines ederal assistance to ensure that no amilies all through the

cracks.For very-low-income amilies with children earning less than 200 percent o the ederal poverty level (FPL), the

Heritage plan provides an additional ederal subsidy worth $5,500. The ull additional subsidy would be availableto amilies up to 133 percent o the FPL and would gradually phase out between 133 percent and 200 percent o FPL. This enhanced subsidy is intended or the traditional, “mandatory” Medicaid populations—the groups thatstates are required by ederal law to include in Medicaid—and the eligibility phaseout is designed to minimize workdisincentives, unlike current law, in which Medicaid has a very sharp eligibility cuto. In 2011, a amily o threewith an income below $37,000 would meet this threshold. Again, this is paid or with reductions in ederal spend-ing. O course, states may provide additional assistance to low-income amilies and individuals.

Health Savings Accounts. Health savings accounts are replaced by the new Roth IRA savings system underthe tax reorm eatures o the Heritage plan. Existing HSAs are grandathered, meaning that current HSA balances

are not taxed when withdrawn, but account owners may make no urther deposits in the accounts.However, under the Heritage tax reorm, money saved or uture health care needs or or any other purpose

is no longer double-taxed. In addition, any health credit or health assistance amount not used or premiums andany unused supplemental subsidies can be deposited into a Roth IRA–style savings account and can be used orout-o-pocket health care expenses, including deductibles, co-pays, and other medical expenses. Under the plan,withdrawals rom these accounts are not taxed. (See the tax reorm proposal.)

New Medicaid Saety-Net Program. In the Heritage plan, low-income nondisabled individuals and amiliescurrently on Medicaid, are covered through the credit/assistance. Low-income disabled and elderly continue toreceive care and assistance through Medicaid.



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For the Medicaid-eligible elderly and the disabled, ederal Medicaid acute and long-term care spending is con-verted into a capped ederal allotment to the state. Total ederal Medicaid spending is set at its 2007 levels begin-ning in 2014, ater the recovery is solid and unemployment at a normal level, and is adjusted or medical infationthereater.

In exchange or the capped ederal allotment, states are granted considerable new fexibility to manage and ad-minister the restructured Medicaid program to meet its mutual ederal and state objectives. This means that statesare granted broad discretion and authority to meet general objectives and outcome measures. States that wish totry very dierent approaches to better serve and improve health care quality or these key populations would haveadditional authority beyond the normal waiver process.

While states receive an allotment rom the ederal government, they still need to use their own unds to achieveagreed goals or providing care and services or the elderly and disabled on Medicaid. However, i states use innova-tive approaches that require less state spending than is now the case under the current Medicaid ormula that de-termines the state share (known as FMAP), they can keep the savings and spend them on state priorities or providetax breaks to their citizens.

The Bottom LineHealth care is a major cost or several important ederal spending programs and or households and businesses.

Thus, in addition to redesigning the programs, health care reorm is needed to slow down rising costs in the publicand private sectors. The Heritage approach to this challenge o rising health care costs and uncertainty over cover-age is to transorm the current government and employer-based models into a consumer-centered, market-basedsystem in which individuals own and control health care dollars and decisions and the health industry competesor their business.



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Additional Major Spending Reforms

Summary

Over the past decade, Congresses and Presidents have undertaken a surge o spending that has accelerated America’s speed along the road to economic ruin. Since 2000, non-deense discretionary outlays have expanded 50percent aster than infation. Antipoverty spending has risen 83 percent aster than infation, and other programshave grown rapidly. Despite multiple government audits that have shown many programs to be duplicative or ine-ective, no signicant ederal program has been eliminated in more than a decade. Government continues to grow,nanced by taxes on Americans and an explosion o borrowing that is imposing huge additional burdens on uture

generations.

Thus, although the major entitlement programs are the primary driver o long-term spending and debt, Congressmust take tough action on discretionary programs and smaller entitlement programs to reach a balanced budget andensure that ederal spending is smaller, more eective, and more ecient.

Under the Heritage plan, non-deense discretionary spending—appropriated programs such as oreign aid, K–12education, transportation, health research, housing, community development, and veterans health care, which ac-count or 4.5 percent o GDP—is reduced to 2.0 percent o GDP by 2021. These reorms will reduce the burden o government, thereby empowering amilies and entrepreneurs and promoting economic prosperity.

In addition, antipoverty spending is reormed. Obamacare is repealed, as noted earlier, and replaced with analternative solution to uninsurance and high costs. Agriculture and education programs are structurally reormed.

The central goal or deense is to guarantee national security as prudently and economically as possible. With im-provements in eciency, we estimate that deense needs will require spending approximately 4 percent o GDP orthe oreseeable uture.

Rather than across-the-board spending reductions, which would not set true priorities or government, the Heri-tage plan ollows six guidelines in designing reorms:

• The ederal government should ocus on perorming a limited number o appropriate governmental du-ties well while empowering state and local governments, which are closer to the people, to address localneeds creatively in such areas as transportation, justice, job training, the environment, and economicdevelopment.

• Functions that the private sector can perorm more eciently should be transerred to the private sector.

• Duplicative programs should be consolidated both to save money and to improve governmentassistance.

• Federal programs should more precisely target those who are actually in need, which means reducingaid to large businesses and upper-income individuals who do not need taxpayer assistance and enorcingprogram eligibility rules better.

• Outdated and ineective programs should be eliminated.

• Waste, raud, and abuse should be cleaned up wherever ound.



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By ollowing these six guidelines, the Heritage plan produces a more eective and ecient government and pro-motes stronger economic growth.

The Details

Returning Most Non-Deense Discretionary Spending to 2008 Levels. Non-deense discretionaryspending has expanded 21 percent aster than infation over the past three years. Returning to 2008 levels still leavestypical programs nearly one-third larger than they were in 2000 (adjusted or infation). Freezing this spending at2008 levels through 2015 and then capping subsequent growth at the infation rate would save more than $2 trillionin the rst decade and even more thereater.

Many o these savings are achieved by reducing the size o the ederal bureaucracy, overhauling the ederal paysystem, permanently eliminating many earmarked accounts, and consolidating duplicative unctions. Yet not allprograms are aected equally. For example, Coast Guard and other important security spending rises under theplan, while lower-priority spending, such as subsidies to public broadcasting, AmeriCorps, the National Endow-ment or the Arts, and the National Endowment or the Humanities, is let to the private sector.

Devolving or Privatizing Most Transportation Spending. Under the ederal highway program, Wash-ington collects the 18.3 cents-per-gallon gas tax rom states, subtracts a large administrative ee, and returns theremaining unds to the states with numerous strings attached, including many requirements to spend the dollarson congressional earmarks and or specic uses that may not coincide with local needs. The Heritage plan reormsthis inherently wasteul system by devolving the highway program and gas tax to the states, thereby eliminating theederal middleman and allowing states to retain the gas tax revenues and spend them on their own highway priori-ties, provided they maintain a minimum standard o interstate highway maintenance.

The Heritage plan ends ederal unding or passenger rail, saving money on projects that invariably have rider-ship that is ar below projections and costs that ar exceed initial budgets. Amtrak subsidies are phased out overthree years, the President’s costly high-speed rail program is terminated, and subsidies to or-prot reight railroadsare ended. This relieves states o the upkeep and maintenance burdens associated with rail programs that Wash-ington is currently pressuring them to undertake. The private sector and state governments can either take over or

terminate these rail programs as they see t.

Finally, all non-saety unctions o the Federal Aviation Administration (FAA) are transerred to the private sector,and most FAA ees are eliminated. The air trac control system will be transerred to the private sector, where itbelongs, and nanced by fight ticket user ees. The airport improvement program is also terminated, with airlines,state government, and private investment taking the place o the ederal taxpayer.

Scaling Back K–12 Education Spending and Reorming Higher Education Spending. Federal spend-ing on K–12 education has grown 192 percent aster than infation since 2000, yet this sharply increased ederalspending and ederal micromanagement o school districts has not improved student perormance. Under the Heri-tage plan, total ederal K–12 spending is reduced to 2000 levels (adjusted or infation), in part by eliminating manyo the numerous small education programs that Washington uses to micromanage school districts. This will allowstates and school districts to manage and meet the needs o their students more eectively.

Higher education reorms, including the new deduction or college tuition in the Heritage tax reorm, ensurethat students receive enough nancial assistance to attend college. Shiting rom grants to student loans ensures thatmost college costs will be nanced by the college graduates themselves, who benet the most rom their degrees,and not by other Americans.

However, thanks to a key provision in the Heritage plan’s tax reorm, higher education costs are partially de-rayed through the simplied and generous tax deduction or higher education tuition. Families whose incomesare too low or them to benet ully rom this tax deduction are eligible or a Pell Grant with a value up to the taxdeduction. The direct student loan program is retained with loan limits high enough to guarantee college access but



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with rates set to ensure that there are no budgetary costs, including the costs associated with deerred repaymentuntil graduation as well as the costs o loan orgiveness programs.

Thus, all Americans will have access to nancial aid in attending college, but it will not be a ree ride at the tax-payers’ expense.

Making Public Health Service Spending More Ecient. Public health service spending has grown 56

percent aster than infation since 2000. While health research is vital, the Heritage plan eliminates waste and ine-ciencies that have accumulated. For example, by consolidating redundant acilities and laboratories, the Heritageplan saves the National Institutes o Health $1 billion annually. States take over the nancing and operation o health centers, health proessions programs, and the substance abuse block grant. The Centers or Disease Controland Prevention sees savings over $2 billion annually by reducing travel, ending questionable public campaigns, andocusing its role on interstate coordination. Finally, converting Indian Health Service aid into a premium-supportsystem (where possible) and reorming the Food and Drug Administration save a combined $1 billion annually.

Funding an Adequate Deense. The most important core unction o the ederal government is ensuring America’s national security, but it needs to be accomplished as economically and eciently as possible. The DeenseDepartment will ocus on identiying and addressing its signicant levels o wasteul spending and initiating sig-nicant reorms and eciencies in logistics and acquisition processes so that those unds can be reprioritized into

the most important uses to protect America and our allies by maintaining a strong, modern, and eective military.The war on terrorism has increased deense spending to approximately 5 percent o GDP, yet it remains well

below the 9 percent spent during in the 1960s and the 6 percent spent during the 1980s. While the Heritage planrecognizes that predicting precise unding requirements or overseas contingency operations is impossible, it isreasonable to expect that the phasedown in those eorts will permit reducing deense spending to approximately 4percent o GDP and maintaining it at that level. Ultimately, o course, deense spending will have to be whatever ittakes to protect America and its interests around the globe.

While this proposal or maintaining sucient levels o deense spending assumes that uture military personnelwill be brought under the broader proposals or health care and retirement reorm outlined in this report, it alsoprovides or tailored transition options or current military personnel and retirees. Importantly, reorms in compen-sation and benets must maintain eective recruitment and retention o, and honor reasonable commitments to,

members o the armed orces.Repealing Obamacare. I ully implemented, Obamacare will add trillions o dollars in long-term government

spending to a health care system that is already unaordable. It also increases ederal controls and mandates and willimpose heavy costs on states, businesses, and households. As noted earlier, the Heritage plan repeals Obamacareand replaces it with the improved, consumer-centered health care system.

Replacing Farm Subsidies with Farmer Savings Accounts. Intended to remedy low crop prices and arm-er poverty, the current arm subsidy system does neither. Farm subsidies encourage overplanting, which drivesprices down urther, necessitating even more subsidies. Moreover, rather than ocusing on low-income armers,most arm subsidies go to commercial armers who report an average annual income o nearly $200,000. Claimsthat the agriculture industry could not survive without large subsidies are contradicted by the act that nearly allsubsidies go to growers o just ve crops (wheat, cotton, corn, soybeans, and rice), while ruit, vegetable, livestock,

and poultry operations thrive with almost no government aid.The real problem—yearly income fuctuations due to crop and weather unpredictability—can be solved inex-

pensively with armer savings accounts. Under the Heritage plan, growers o all crops, not just the “big ve,” cansave money during boom years in tax-deductible IRA-style accounts and withdraw those unds during bust yearsas taxable income, thus smoothing out their yearly income fuctuations. An improved no-net-cost crop insurancesystem will assist when major disasters deplete most armers’ accounts. All armers can participate in the new systemregardless o income or crop grown and at a raction o the current cost to taxpayers.

Capping and Reorming Antipoverty Spending. Since 1990, ederal antipoverty spending, including Med-icaid, has expanded 236 percent aster than infation, rom $190 billion to $639 billion (an increase o 2.2 percent



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o GDP). Antipoverty spending has grown as much as Social Security, Medicare, deense, and education spendingcombined. Overall, the ederal government spends approximately $28,000 per amily with children in the bottomthird o the income table without encouraging independence. Many o the programs do not include enorced workrequirements and continue to reward illegitimacy and other destructive behaviors that block the road to indepen-dence.

Once the unemployment rate drops back to normal levels (projected in 2014), the Heritage plan returns totalederal antipoverty spending to its 2007 level (adjusted or infation) and then caps total spending growth at theinfation rate (using the medical infation rate or the health care portion). Congress or states could shit spendingamong antipoverty programs to increase eectiveness as long as total spending does not exceed the cap. This capand fexibility will orce lawmakers at all levels to reexamine the size and goals o the welare state and tailor assis-tance more eciently to help amilies escape poverty and dependence and achieve independence.

Other Spending Reorms. Multiple ederal programs should be returned to the state or local levels. For in-stance, there is no compelling reason or Washington to nance local job training, justice, environmental, or com-munity and economic development programs. Thereore, the plan eliminates these ederal grant programs with theexpectation that state and local governments will determine whether to address these local issues with local undsand be held accountable by local voters. Energy research and development spending that is commercial in nature ismoved to the private sector. Lawmakers are also expected to pare $15 billion in costs associated with the estimated

$125 billion in annual ederal payment errors.

Asset Sales. The ederal government currently owns and controls vast assets, including huge swaths o com-mercial land, especially in the West; power generation acilities; valuable portions o the electromagnetic spectrum;underutilized buildings; and nancial assets. Given the ederal government’s huge debt, it makes sense to sell atleast a portion o these assets, especially those that are currently generating revenue below market levels (in whichcase the sale value would be above the present value o the current income on the assets). Sales o assets would im-mediately reduce the government’s operating decit and debt, reducing uture interest savings.

The Heritage plan includes a program o asset sales totaling approximately $260 billion over 15 years. Thisincludes partial sales o ederal properties, real estate, mineral rights, the electromagnetic spectrum, and energy-generation acilities.

Reorming the Federal Budget Process. When Congress established its current budget process in 1974,the United States was in debt by about a hal-trillion dollars; it is now in debt over $14 trillion. Regrettably, or anyproposal to deal with the nation’s scal problems, the budget process does little to help and in many ways impedesgood and bold policy. For one thing, its ocus on just 10 years diverts lawmakers rom dealing with the mountinglong-term challenges, such as retirement programs. For another, the lack o rm budget controls and enorcementprocedures makes scal discipline very dicult. Reorming the budget process is thereore an implicit part o re-orming the budget itsel.

In the Heritage plan, we change the budget process to impose enorceable caps to reduce total ederal spendingto 18.5 percent o GDP by 2021 (including entitlement programs) and then keep spending at that level. Withinthose overall caps we also cap non-deense discretionary spending at 2.0 percent o GDP. Anti-poverty spending isalso capped, as described above. These statutory restrictions on uture spending are to be no higher than the mod-ern historical level o ederal revenues.

We also propose amending existing ederal laws that provide permanent or indenite appropriations or ederalagencies or programs (including and especially entitlement programs), or that allow agencies or programs to spendunds they receive rom ees or other sources, rather than depositing them in the U.S. Treasury, so as to retrievecongressional control o spending or those agencies and programs. Within our specic reorms or Medicare andMedicaid we also include a xed budget amount or each program.

To make the budget process more visible, understandable, and accountable to the American people, we requireCongress to estimate and publish the projected cost over 75 years o any proposed policy or unding level or eachsignicant ederal program. Any major policy change should also be scored over this long-term horizon.



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Finally, in addition to calculating the costs o proposed congressional actions without regard to the response o the economy to those actions (known as “static” scoring), we require a parallel calculation that takes account o that response (known as “dynamic” scoring) so as to make more practical and useul cost inormation available toCongress when it decides whether to pursue the actions.

The Bottom Line

Runaway ederal spending threatens to drown the nation in taxes and debt or generations to come. Promoting eco-nomic prosperity requires streamlining government, cutting spending, and empowering amilies and entrepreneurs.

The Heritage plan achieves those objectives by ocusing Washington on perorming a limited number o appro-priate duties well rather than a wider range o questionable duties poorly. It transers more power to state and localgovernments, which are closer and more responsive to the people; transers unctions to the private sector that themarket can perorm better; targets ederal spending more precisely to those in need; and eliminates wasteul, un-necessary, and duplicative spending.

These steps will unleash the power o the private sector to meet market demands, create jobs, and raise livingstandards. Taking these steps, combined with entitlement and tax reorm, means that Americans can look orwardto opportunity and prosperity rather than a uture o debt and economic decline.



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Tax Reform

Summary

The existing tax system is maniestly indeensible, especially in its complexity and its drain on economic vital-ity. The complexity o the tax system plagues taxpayers in all walks o lie. Low-income citizens must navigate theenormously complex Earned Income Credit. Those who save must sort through multiple tax rates and tax regimesor dierent kinds o returns on those savings, and there is a multitude o phaseouts o various credits, exemptions,and deductions. As i this were not bad enough, Congress created a parallel income tax called the Alternative Mini-mum Tax, so millions o taxpayers must gure their taxes two dierent ways beore they can know what to pay. Yet

these diculties suered by taxpayers are relatively minor compared to some o the tortuous rules and exceptionsinficted on businesses large and small.

The drain inficted on economic vitality is even worse than the tax code’s complexity. High marginal rates dis-courage all manner o productive activity. The U.S. corporate income tax rate is the second-highest in the industrial-ized world and much higher than the average tax rate o our international competitors.

The current tax system actively discourages citizens rom saving enough or retirement, emergencies, or the largepurchases in lie, thus driving them toward consumer debt. In turn, it articially depresses the level o national sav-ings and makes domestic investment more dependent on oreign investment.

For decades, Congresses have tweaked and twisted a undamentally fawed system into knots, each time creatingtwo new problems while attempting to solve one old one. The income tax was a poor choice rom the outset, and

Congress ater Congress has consistently made it worse. The ederal tax system need not be so complex or damagingto our economy, nor should it be.

A stronger economy means higher wages or American workers and better returns or America’s savers. A strongereconomy means better opportunities or college graduates and better economic security or amilies. It means that American companies and workers can compete more eectively in the global economy. And a stronger economy isa more resilient economy, able to withstand and overcome the inevitable economic shocks o tomorrow.

A stronger economy also plays a vital role in improving ederal nances. It means sustained, normal levels o taxrevenues and a lower level o spending to meet the needs o those who are temporarily distressed because o unem-ployment. A stronger economy oering better wages and better job opportunities is also the most powerul antidoteto persistent poverty, and less poverty reduces the demands or anti-poverty spending.

Without a stronger economy, we will not solve our long-term problems o ederal overspending and overborrow-

ing. Thus, tax reorm to spur economic growth is a critical component o the Heritage plan.

In broad terms, to promote growth, the ederal tax system must be:

• A single, low rate system to collect needed revenues without unnecessarily distorting economic deci-sion making.

• Simpler and ar more transparent. A simple, transparent tax is needed so that taxpayers can antici-pate and plan or the tax consequences o their actions and easily understand the ull extent o their taxburden. It also provides greater condence that other taxpayers are not exploiting tax complexities tounderpay their taxes.



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• Neutral between savings and investment. Unlike the current system, it must not impose multiplelevels o taxation on saved income. Treating savings neutrally gives individuals greater control o theireconomic utures while ensuring that the economy has the raw nancial material to grow and encour-ages Americans to invest their savings in the most productive ventures.

• Levied in a way that minimizes tax distortions and perverse incentives. This allows prices andmarket orces—not intentional or inadvertent government meddling—to decide how best to grow theeconomy. It also helps to keep the tax system simple.

• Capable o collecting revenues equivalent to 18.5 percent o the economy. The modern average o tax revenue under normal economic conditions is approximately 18.5 percent o GDP. This is the up-per limit that Americans have over many decades indicated to politicians they are prepared to accept.Thus, the tax system should be capped at collecting no more than this amount both to ensure a strongeconomy and to restrain the growth o government.

Using these essential elements, the Heritage plan will transorm the current tax system into a modern fat taxthat taxes individual income only once and replaces all ederal income taxes, all payroll taxes, the death tax, andvirtually all excises. Specically, or individuals, the current system will be replaced with a new fat-rate tax appliedto income ater deducting all savings. Taxable income will be reduced by the net amount contributed to savings,

and savings will be taxable only when spent. This eliminates the current-law bias against saving and ensures thatindividuals pay taxes only on what they withdraw rom the economy and not on savings that they make availableor investment in the economy by others.

Today’s business tax code will be replaced by a fat business tax on domestic sales o goods and services withdeductions or labor costs and purchases rom other businesses, including expensing o capital purchases. All busi-ness activity, including corporate, will be taxed under the new fat business tax.

The Details

A Unied Single Tax Rate. The Heritage tax reorm plan is ar more comprehensive than previous well-known tax reorm proposals. Typical o many tax reorm proposals, our plan replaces today’s individual and cor-porate income tax systems and eliminates the death tax. In lieu o the current motley collection o taxes, this planinstitutes a simple, single-rate tax on individuals and businesses. It also olds today’s ederal payroll taxes nancingSocial Security and Medicare into the new system, establishing a single tax rate or all taxpayers. In addition, it re-places all ederal excise taxes except those dedicated to specic trust unds, such as the gasoline tax, which wouldbe retained until that tax and its associated highway program are devolved to the states.

Tax Rate. The tax system is designed to raise a permanent revenue stream o up to 18.5 percent o the economyas measured by GDP. With the design characteristics o this new tax system, we estimate that the statutory individualand business tax rate will likely eventually be between 25 percent and 28 percent under traditional scoring methods.This is comparable to or signicantly below the typical rate acing an individual or amily today. Most working amiliestoday are subject to a 15.3 percent payroll tax rate on wages and salaries plus a 10 percent, 15 percent, 25 percent, or28 percent individual income tax rate or a combined rate o 25.3 percent, 30.3 percent, 40.3 percent, or 43.3 percent.

A Simplied System. The basic structure o this tax plan is simple. With its single rate, it taxes uniormly allincome sources that are spent on consumption. This means that taxable income includes all labor compensation andall net borrowings. The net amount put aside in savings is then subtracted to determine net taxable income. Thus,the more individuals or amilies save, the lower their taxes; they pay tax on savings only when savings are used topay or goods and services.

However, the new tax system does not tax government transers explicitly associated with low-income citizens,such as welare, health care assistance, and similar programs. Ultimately, when the Social Security and Medicareprograms are ully reormed, the Social Security checks and premium support that seniors receive will not be taxed



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either. In the Social Security and Medicare transition periods, a portion o the benets o some seniors will be taxedi their income is above a certain amount, just as many seniors’ Social Security is taxed today.

Thus, the new tax system oers individuals and amilies a comparable or lower tax rate and vastly improves theirsavings incentives to build wealth and ensure their own nancial security. It simultaneously improves the abilityo the economy to raise wages and provide more job opportunities. And lling out tax orms will be a lot simpler.

An Alternative Option or Savings. For some purposes, many taxpayers today preer to save ater-tax dollarsas permitted through the current-law Roth IRA rather than paying tax when unds are withdrawn as under today’straditional IRA. This Roth-style alternative maintains the principle o a single incidence o taxation but may result inurther increased saving by giving savers an additional option. To allow such accounts or those who eel they needthem, the plan permits taxpayers to contribute ater-tax dollars to an account, contributing as they choose until theaccount balance reaches $100,000, with a limit o one account per adult taxpayer. The income earned on the ac-count is tax-ree, and disbursements rom the account are tax-ree or any purpose.

Few Deductions or Credits. Under the Heritage tax plan, the individual income tax has only three deduc-tions instead o the legion o deductions under current law:

• Higher education. Recognizing the role o higher education as a orm o saving and investment in hu-man capital, a deduction is allowed or tuition and expenses or higher education up to the average an-

nual cost at a our-year public college or university.• Charitable donations and other gits. Since the tax is levied on consumption, gits are not taxable until

they are spent by the recipient. Thus, per current law, gits to nonprot organizations are tax deduct-ible i the organization is recognized as tax-exempt or tax purposes. Gits to individuals and transersthrough inheritance are deductible and become taxable to the recipient only when spent on consump-tion. And there is no death tax.

• Mortgage interest. As under current law, homeowners can deduct mortgage interest while the lendercontinues to be taxed on mortgage interest income. Homeowners are also given the option o orgoingthe deduction, in which case the lender is not taxed on mortgage interest income and market pressurewould encourage the lender to oer a lower mortgage interest rate.

Protections or Low-Income Working Households. Current law hits low-income workers and others withthe ull weight o today’s payroll taxes, whatever their wage and salary income may be. The Heritage tax plan oldsall payroll taxes—or FICA—into the single tax system. It then eliminates all income tax on low-income workersthrough the health insurance tax credit described above (a $3,500 nonreundable tax credit or amilies and $2,000credit or individuals). In addition, the Earned Income Credit is retained as part o the overall system o nancialsupport or low-income Americans. Further, the calculation o taxable income excludes all other cash and noncashbenets provided by the ederal government through its anti-poverty programs, such as ood stamps. The net eectis that, compared to current law, this plan provides substantial tax relie to low-income workers and amilies.

Protecting Low-Income Seniors. For Medicare-eligible senior citizens, the measure o taxable income ismodied to ensure that the fat benet amounts or Social Security and the Medicare dened contribution are tax-ree. Thus, lower-income seniors will not be pushed back into poverty by the tax system ater Social Security andMedicare have lited them out o poverty. As noted earlier, during the lengthy transition period or the Heritage

plan’s Social Security reorm, some seniors above certain incomes with relatively high benets will pay tax on parto those benets, but they will pay less than many do today.

Thus, this tax plan includes three important senior-specic eatures:

• During the transition to the new Social Security and Medicare systems, all seniors have a “senior’s stan-dard exclusion” amount equal to the sum o the fat Social Security benet amount plus the value o theMedicare dened contribution. This exemption amount will be approximately $22,500 per senior in2015. This provision ensures that seniors protected rom poverty by the Social Security and Medicarereorms are not again placed at risk by losing some benets through taxation. As explained earlier, whenthe benets reorms are ully implemented, the amount received by a senior will not be taxed.



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• Encouraging seniors to stay in the workorce longer is important both or their own nancial securityand or the health o the economy. To achieve this, the rst $10,000 o a senior’s wages and salary isexcluded rom tax. This provision is especially important or low-income and middle-income seniors.

• Because they are on Medicare and have the seniors’ standard exclusion to protect low-income seniorsrom tax, seniors do not qualiy or the health insurance tax credit described above.

Protection or the Social Security and Medicare Trust Funds. The tax system leaves in place the existingwage income reporting systems. Even though the existing payroll taxes are eliminated, the revenues they wouldhave raised are credited appropriately to the Social Security and Medicare trust unds as per current law.

Taxation o Businesses. The tax on businesses is a simple levy on domestic net cash fow so that all compensa-tion provided to employees and all purchases rom other businesses are deducted rom gross domestic receipts. Inaddition to its great simplication compared to the current income tax, this means that businesses can immediatelydeduct purchases o new productive equipment, thus eliminating a tax bias against business investment.

All other special provisions and credits in existing law are repealed except or the Alternative Simplied R&D taxcredit, which is retained in its current orm.

Family businesses in particular are able to grow without the uncertainty or burden o dealing with the death tax,which is repealed.

The business tax base includes only income generated by domestic sales o goods and services. It excludes alloreign-source income, which is taxed in the oreign jurisdictions according to their laws and systems. The tax isalso border-adjustable, which means that the ederal taxation o exports and imports is adjusted to level the playingeld between oreign and domestically produced goods and services. Specically, the domestic tax is lited romexports and levied on imports, normalizing tax levels between countries much as a series o locks on a canal raisesor lowers boats so they can travel rom point to point.

Transition Arrangements. Special care is needed in transitioning taxpayers rom the old tax system to thisHeritage tax plan. For example, it is important that taxpayers are not subject to an extra tax burden solely becauseo the transition. This would amount to retroactive taxation because the higher tax burden would arise rom actionstaken beore tax reorm. Thus, all current-law accrued tax “assets”—such as interest on pre–tax reorm debt, includ-ing existing home mortgages, depreciation, and accrued tax credits—are applicable to taxable income or tax liabilityunder the new tax system until the tax assets are exhausted.

The shit to taxing only what businesses earn domestically is an important simplication and an important steptoward improving international competitiveness. However, many businesses have accrued oreign tax credits undercurrent law that would be inapplicable under the new tax system. To provide adequate time to adjust, businesseswill have the option o being taxed under the current system o worldwide taxation or up to 10 years ater theenactment o tax reorm.

It is important to avoid retroactive taxation, but it is equally important to avoid creating tax windalls causedmerely by transitioning rom one tax system to another. This would occur especially with respect to savings prior totax reorm (“old savings”), which are invested in various assets generating income streams and capital gains that aresubject to immediate taxation at current rates. These tax windalls, which would be similar to winning a tax lottery,

would tend to benet the wealthiest taxpayers and erode the tax base, thus necessitating a higher tax rate. Thus, atransition system is provided to prevent tax windalls by ensuring that old savings remain subject to current levelso taxation.

In the transition to the new tax system, employers will urnish their employees with a statement on how theywill handle that part o the employee’s compensation that currently takes the orm o the “employer’s share” o payroll taxes paid to the Treasury. The options in the statement could include, among others, an adjustment in theemployee’s cash compensation, a contribution to the employee’s savings or retirement account, or an allocation o the money to the employee’s income tax withholdings. The Department o Labor would make template orms avail-able on its Web site or employers to use. Ater the transition, when compensation and tax withholdings are ullyadjusted, no urther statements would be necessary.



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The Bottom Line

Economic growth is one o the undamental underpinnings o xing America’s budget problems, so any changesin the tax system must ensure that growth is a primary objective.

The Heritage tax plan xes the labyrinth o complexities and inequities that taxpayers must endure in today’s sys-tem by replacing it with a new system that is fat, simple, and transparent. It encourages ar greater economic growth

by lowering rates and removing multiple layers o taxation on the same income. One low rate replaces today’s arrayo income and payroll tax rates, treats all businesses the same, and allows them to compete better globally. We endtoday’s disincentives to build savings—whether or retirement or or buying a house—by taxing only income that isspent on consumption, so Americans can build better economic security or themselves and their amilies. And wedo all this without raising taxes by injecting every dollar saved back into lower rates, not so-called decit reduction.

The Heritage plan will raise no more than the level o taxes Americans historically have been willing to pay: 18.5percent o the economy. Under our tax plan, Americans will have ar greater economic reedom, more opportunities,more jobs, and higher wages.



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Economic and Fiscal Results

Scoring Fiscal Plans

The Heritage plan produces strong economic growth by reducing burdens on taxpayers and businesses, re-ducing the government debt, increasing investment, and encouraging competition. It also brings ederal spend-ing into balance and maintains revenues over the next decade at the average historical level o 18.5 percent o GDP, which as noted earlier is the upper limit that Americans have indicated a willingness to pay. The economytypically has grown quite well under this average level o taxation. Taxes above this level oten have had a nega-tive impact on the economy.

With the expansion o the ederal government not just slowed but reversed, the economy grows switly, creatingnew jobs and raising incomes or Americans. A stronger economy strengthens the tax base and helps to achieve theplan’s revenue targets. When combined with sharp reductions in spending, the Heritage plan’s revenues are su-cient to reduce decits and, thus, the debt.

As a part o its Solutions Initiative,4 the Peter G. Peterson Foundation asked Heritage and the ve other organiza-tions to prepare their own solutions to the long-term budget crisis and to score their plans using the same baseline.Thus, The Heritage Foundation’s Center or Data Analysis (CDA) modeled the Heritage plan using a “static” scoringagainst a close approximation o the Congressional Budget Oce’s (CBO) extended baseline that was developed bythe Peterson Foundation.5

A static score assumes some behavioral changes by individuals and markets, but leaves the overall economy

unchanged. A dynamic model assesses the economic eects o policy changes, and the CDA will separatelypublish a dynamic scoring o the Heritage plan, using the CBO’s alternative scal scenario as the baseline.6 This alternative scenario, widely used in budget discussions and comparisons, assumes that Congress will con-tinue its current policy and thus practices, such as adjusting the unindexed Alternative Minimum Tax (AMT)threshold, suspending payment reductions to Medicare physicians (the “doc x”), and extending the 2001 and2003 tax relie.

When available, the CDA used and updated reorm proposals analyzed by the CBO, such as the eect o some policy changes to Medicare. For analysis o the impact o tax changes, the CDA used its tax and health caremodels.

A number o important insights into the scal eects o the Heritage plan can be obtained by examining thestatic, or conventional, changes in ederal revenues and outlays resulting rom ully implementing the Heritage plan

under this Peterson/CBO baseline. However, the methodology or static scoring does not account or macroeco-

4. In addition to The Heritage Foundation, ve other organizations are participating in the Peter G. Peterson Foundation’s SolutionsInitiative. Peter G. Peterson Foundation, “Peter G. Peterson Foundation Announces Grants to Six Institutions to Develop Solutions to America’s Fiscal Challenges,” January 20, 2011, at http://www.pgpf.org/Issues/Fiscal-Outlook/2011/01/20/PGPF-Announces-Grants-to-Six-Institutions-to-Develop-Solutions-to-Americas-Fiscal-Challenges.aspx (May 2, 2011).

5. The extended baseline is based on current law extended beyond the normal 10-year CBO window to 2035. The exact extendedbaseline used by the CDA was created by analysts at the Peterson Foundation. This CBO baseline builds on the CBO’s 10-year currentlaw orecast published in January o this year

6. For a description o the Alternative Fiscal Scenario, see Congressional Budget Oce, “The Long-Term Budget Outlook,” June 2010, athttp://www.cbo.gov/ftpdocs/115xx/doc11579/06-30-LTBO.pdf (April 29, 2011).



36


nomic changes that result rom changes such as higher tax rates or lower spending. These economic changes cansignicantly aect scal items, including revenue, because in reality more economic growth will increase the taxbase. Thus, policies that create more economic growth also generate more tax revenue than a static model wouldindicate. To show the ull benets o the Heritage plan, the CDA will publish a separate dynamic analysis o the planto supplement the static analysis presented in this report.

The Bottom Line:Static Analysis and CBO Current Law Baseline

On the revenue side,7 the Heritage plan reorms the tax code as described in the Tax Reorm section by creat-ing a new labor and business tax system. The static estimates o tax changes were developed by introducing thesechanges into the CDA tax models. The resulting estimates show revenues reaching approximately 16.9 percent o GDP in 2013 and increasing to 18.5 percent in 2022, where they remain throughout the remaining orecast period.The Peterson/CBO baseline, on the other hand, shows revenues rising rom 18.8 percent o GDP in 2013 to 23.3percent in 2035.

On the outlay side, changes to nearly every major spending category sharply reduce the spending estimates un-

der the Heritage plan. The plan starts with spending at 22.1 percent o GDP in 2012—roughly $188 billion lowerthan the baseline—by assuming some cuts in discretionary spending. Outlays drop signicantly thereater. By 2021,spending stands at 18.1 percent o GDP and ends the orecast period in 2035 at 17.7 percent o GDP. In contrast,the baseline projects outlays at 24 percent o GDP in 2021 and 28.3 percent in 2035.

Given this much lower spending path and steady revenue growth, the Heritage plan achieves low decits andthen scal balance during the orecast period. A balanced budget appears in 2021 and 2022 and the budget remainsbalanced in each subsequent year through the simulation. The baseline shows worsening decits throughout theorecast period. By 2035, the scal decit stands at a 5 percent o GDP in the current law baseline.

Taxes. Under the Heritage plan, the tax system is reormed, and revenue is capped at its historical level o 18.5percent o GDP. The plan replaces the current six tax brackets and payroll taxes with one simple fat rate that appliesto all corporate, small business, and personal income, excluding savings and a ew other deductions, and produces

that needed level o revenue (18.5 percent o GDP).

The Heritage tax model estimates that these reorms will save taxpayers an average o almost $280 billion an-nually over the next 10 years compared with the current law baseline. By 2021, total tax savings will exceed $3.1trillion. Many taxpayers will immediately see a signicant reduction in their tax burden. For example, those withsmall business income will see an average tax reduction o about $8,000 in 2012, rising to $11,000 by 2014. By2014, households ling jointly will see an average tax reduction o about $4,000, while college students will seean average reduction o about $3,000. In 2014, seniors with Social Security income will on average owe about hal what they currently owe ($5,500 down rom $11,000).

Many tax provisions have strong eects on other elements o the budget. For example, health care benets are nolonger excluded rom taxation, but are replaced by a health care tax credit. This change will make total compensationmore transparent and in most cases quickly lead employers to provide more compensation in the orm o cash, whichwill encourage employees to make more ecient purchases o health insurance. The credit is available to all taxpayers,regardless o insurance oering by their place o work, thereore promoting tax equity and limiting “job lock.”8

7. Estimates reported in the section have been taken rom the Peter G. Peterson Foundation, “PGPF Fiscal Solutions Reporting Template,”March 18, 2011.

8. “Job lock” reers to a common diculty that workers ace when thinking about changing jobs or starting a business. I workers believethat changing jobs might mean losing their health insurance, they are less likely to make the change. Thus, employer-provided healthinsurance has the eect o locking workers into their current jobs. This job lock clearly is economically inecient. It requentlytraps workers in jobs where their talents are not applied in the best way. It discourages the ormation o new businesses, reducingentrepreneurship and innovation. Reductions in innovative activities slow economic growth below its potential.



37


Health Care. Heritage’s plan makes important changes at all levels o the health care system. The Heritage planencourages consumer choice and increased competition to reduce health care costs. Signicantly, some o the keyHeritage reorms alter the price o health care, which will aect consumer decisions. This demand side reorm willreduce some health care spending by encouraging consumers to make more ecient choices on plans and services,thereby reducing health care outlays across the board. Some o the health care proposals, such as the Medicare re-orms, will also shit the cost curve o health care.

The Heritage plan will also aect the supplier side o health care providers. With increased competition, sup-pliers will be encouraged to improve their business models and reduce their costs to consumers. When highlyregulated markets are more ree and subject to competitive pressures, costs can drop quickly and substantially.For example, the deregulation o the airline industry reduced airares by more than 20 percent in only 20 years. 9 Regulatory policy changes and increased competition have prompted sharp price reductions in other industries,such as communications.

This undamental downward shit in the cost curve o health care is anticipated, but not modeled in thisstatic analysis o the Heritage plan. We expect the prices o certain health care goods and services to all. Theseeects will be included in the dynamic analyses, but our static score modeling o the proposal, including theMedicare reorms, does not model a scenario in which the change in prices would undamentally change thegrowth path o the cost curve. Instead, we model the price changes as a change in the level o spending. Some

o the price changes will likely spill over into the non-Medicare market, but modeling those eects were out-side the scope o the analysis because the cost o the health care tax credit and Medicaid are not tied to theprice o health care.

Health Care or the Working-Age Population. The Heritage plan undamentally reorms the Americanhealth care system beginning with a critical change in the tax treatment o health insurance. The plan replacesthe current tax exclusion or employer-sponsored health insurance with premium assistance or most Americanhouseholds. This policy change eliminates the current inequity in which only individuals with access to employer-sponsored insurance receive avorable tax treatment and the additional inequity generated by the subsidies inPPACA. This will reduce labor market distortions, such as “job lock,” and remove the incentive created in thePPACA or individuals to stop working to qualiy or a generous subsidy or health insurance. The Heritage pre-mium support model will reduce the dominance o employers in selecting one or two plans or their workers and

allow individuals greater reedom to shop or an insurance plan that will provide the best health care at the bestvalue or their amilies.

To best preserve public unds, the Heritage plan begins phasing out the tax credit at $100,000 in income ora amily and $50,000 or an individual. The tax credit is completely phased out at $170,000 or a amily and$90,000 or an individual. The current Medicaid eligibility structure as well as the subsidy cli in the PPACA dis-courages people near the upper income limit rom pursuing better job opportunities or ear o losing Medicaidcoverage or themselves or their children. Importantly, the Heritage plan alleviates this disincentive or upwardmobility. The tax credit is also available to individuals well into the middle class. For instance, individuals andamilies earning well over 400 percent o the ederal poverty line (about $90,000 or a amily o our), the levelat which the health insurance subsidies in PPACA phase out, will be eligible or a tax credit.

Families with children and incomes below 200 percent o the ederal poverty line qualiy or an additional sub-

sidy under the plan. This subsidy can be used to pay insurance premiums or other health-related expenses. Theadditional subsidies phase out slowly to prevent eective marginal tax rates rom being too high or eligible low-income workers.

Medicare. The Heritage plan changes Medicare by moving to a dened contribution premium-support systemsubject to competitive bidding. The CDA projects that the Heritage plan will save almost $2.3 trillion by 2021 com-

9. Steven A. Morrison and Winston Cliord, “The Remaining Role or Government Policy in the Deregulated Airline Industry,” in SamPeltzman and Cliord Winston, eds., Deregulation of Network Industries: What’s Next? (Washington, D.C.: American Enterprise InstitutePress, 2000).



38


pared with the current law baseline and 10.7 trillion by 2035. Overall, ederal health care spending is 40 percentless under the Heritage plan.

Premium support and competitive bidding are not new ideas and have been analyzed beore. In December 2006,the CBO estimated that a premium-support program with competitive bidding could reduce Medicare expendituresby 8 percent to 11 percent, although it would not signicantly aect underlying spending growth.10 Another studyon the benets o consumer choice through such approaches ound that Medicare spending would all by 8 per-cent as a result o choice and competition.11 The CDA assumes that, when the Heritage plan is ully implemented,Medicare spending will all by 10 percent annually because o the budgeted dened contribution and competitivebidding. However, there are reasons to believe that Medicare cost growth would all by much more as seniors aregiven a reason to be cost-conscious consumers o health care. Thereore, the 10 percent decrease that we estimaterom the competition reorm is likely a lower bound.

Wealthier seniors contribute more toward their health care under the Heritage plan. The CDA used the Cur-rent Population Survey to estimate how many seniors have adjusted gross income in excess o the phaseoutthresholds. Under the plan the value o the premium contribution is reduced by 1.82 percent or each $1,000 inexcess o the phaseout level. The CDA estimates that just over 9 percent o seniors have income in excess o thephaseout threshold.

Other changes in Medicare include increasing the eligibility age and requiring higher Part B premiums or thosecontinuing to participate in the traditional Medicare ee-or-service program. The CDA scoring o these changesclosely matches CBO scoring estimates o various budget options.12

Medicaid and the Working-Age Population. The Medicaid reorms in the Heritage plan will signicantlystrengthen the economy by slowing down health care costs and ederal spending on health care, reducing barriersto economic mobility, and encouraging work and savings.

The Heritage plan makes several reorms to Medicaid, reshaping the program to ocus on the disabled andelderly with very low incomes and providing able-bodied adults and their amilies with assistance to buy privateinsurance instead o Medicaid. This is an especially important component o the plan because it will reduce barriersor many non-disabled adults to return to work. Today, many lose coverage i they take a job with an employer thatdoes not oer insurance. By introducing stricter eligibility requirements or the program (with the alternative assis-

tance or certain current enrollees) and capping spending growth, the Heritage plan will bring Medicaid spendingand its growth path under control, saving taxpayers $1.1 trillion compared with the baseline in the rst 10 yearsand $8.2 trillion by 2035.

The Heritage plan replaces Medicaid coverage or non-disabled adults and children with a tax credit and voucheror purchasing health insurance in the private market.

Social Security Modernization. The Heritage plan works to protect seniors rom poverty, but also transpar-ently reduces checks to more afuent seniors. Today, the benets o more afuent seniors are taxed, and the taxesreduce checks at much lower income levels than the phasedown threshold in the Heritage plan. The Heritage planalso adjusts the retirement age to take into account increased lie expectancy.

With modeling assistance rom the American Enterprise Institute, the CDA estimates that the Heritage reormswill reduce ederal spending by $1.7 trillion rom 2012 to 2021 and $10.9 trillion cumulative by 2035. This is a

reduction o almost 4 percent in annual Social Security outlays by 2035 while ensuring that no eligible senior allsbelow the poverty line.

10. Congressional Budget Oce “Designing a Premium Support or Medicare,” December 2006.

11. Robert F. Coulam, Roger Feldman, and Bryan E. Dowd, Bring Market Prices to Medicare (Washington, D.C.: American EnterpriseInstitute Press, 2009).

12. Congressional Budget Oce, Budget Options, Vol. 1, Health Care, December 2008, at http://www.cbo.gov/doc.cfm?index=9925 (April 29, 2011).



39


Achieving Fiscal Balance

The Heritage plan achieves scal balance by ensuring that tax receipts will match government expenditures.I no action is taken, the decit in the current law baseline is 3.2 percent o GDP in 2021 and 5 percent in 2035.The Heritage plan balances the ederal budget by 2021, with spending and revenues each reaching 18.5 percent o GDP. The budget stays balanced without exceeding those levels through the entire time rame. This leads to a sharp

reduction in debt as a percentage o GDP. In the extended baseline scenario, debt climbs to 91.5 percent o GDPby 2035. The Heritage plan reduces the debt by two-thirds to 30 percent o GDP. A smaller national debt resultsin savings to taxpayers as interest payments all sharply rom an annual share o 4.6 percent o GDP to 1.7 percentin the Heritage plan, a savings o more than $1 trillion each year. Reduced interest payments on the national debtaccount or almost one-third o the reduced government spending, which is a result o the strong budget reormscontained in the Heritage plan.

Comparing the Heritage Plan to Current ProjectionsFigures are in Percentages of GDP



REVENUE AND SPENDING PUBLICLY HELD DEBT

HeritagePlan

CurrentProjections Heritage Plan

CurrentProjections

Revenue OutlaysSurplus/ Deficit Revenue Outlays

Surplus/ Deficit

2010 14.9 23.8 –8.9 14.9 24.3 –9.4 62.1 62

2011 14.8 24.7 –9.8 16.9 24.5 –7.6 69.4 67

2012 16.1 22.1 –6.0 17.6 22.9 –5.3 72.9 69

2013 16.9 20.3 –3.4 18.2 22.6 –4.4 73.7 70

2014 17.4 19.3 –1.9 18.7 22.8 –4.1 72.3 71

2015 17.5 19.0 –1.5 18.7 23.3 –4.6 70.5 72

2016 17.5 18.6 –1.1 18.9 23.9 –5.0 68.5 75

2017 17.8 18.4 –0.6 19.0 24.4 –5.4 66.5 77

2018 17.9 18.3 –0.4 19.1 24.9 –5.8 64.5 80

2019 18.0 18.3 –0.3 19.1 25.4 –6.3 62.5 84

2020 18.1 18.3 –0.2 19.3 25.9 –6.6 60.5 87

2021 18.3 18.1 0.2 19.3 26.3 –7.0 58.2 91

2022 18.5 18.4 0.1 19.3 26.8 –7.5 56.2 95

2023 18.5 18.4 0.1 19.3 27.6 –8.3 53.9 100

2024 18.5 18.5 0.0 19.3 28.4 –9.1 52.0 106

2025 18.5 18.5 0.0 19.3 29.1 –9.8 49.9 112

2026 18.5 18.5 0.0 19.3 29.7 –10.4 47.9 118

2027 18.5 18.5 0.0 19.3 30.4 –11.1 46.0 125

2028 18.5 18.5 0.0 19.3 31.1 –11.8 44.2 131

2029 18.5 18.4 0.1 19.3 31.7 –12.4 42.4 138

2030 18.5 18.3 0.2 19.3 32.2 –12.9 40.4 1462031 18.5 18.2 0.3 19.3 32.8 –13.5 38.4 153

2032 18.5 18.0 0.5 19.3 33.4 –14.1 36.3 161

2033 18.5 18.0 0.5 19.3 34.0 –14.7 34.3 169

2034 18.5 17.8 0.7 19.3 34.6 –15.3 32.1 177

2035 18.5 17.7 0.8 19.3 35.2 –15.9 30.0 185

heritage fiinancial plan

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