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Deficit Reduction Proposals: What They Could Mean for You

This article was updated on November 17, 2010
Raising the Social Security age to 69, cutting Medicare outlays, limiting the mortgage interest deduction to loans under $500,000, getting rid of the Alternative Minimum Tax, and tossing out preferential tax rates for capital gains and dividends -- these are just some of the federal deficit reduction suggestions floated last week by the co-chairs of President Obama's bi-partisan deficit reduction commission. And yet another group -- the Bipartisan Policy Center's (BPC) Debt Reduction Task Force, chaired by former Senator Pete Domenici and former Congressional Budget Office director Alice Rivlin -- released its deficit reduction proposals this week that included instituting a national sales tax of 6.5 percent and suspending the Social Security payroll tax for a year to boost economic growth.

"A Starting Point"
If the $3.8 trillion in cuts recommended by the Obama commission's Alan Simpson and Erskine Bowles were enacted, they would reduce the deficit to 2.2 percent of GDP by 2020; currently we're at 9 percent. The biggest suggested cuts would come from reducing outlays for defense, reducing the size of the federal workforce, and paring back a whole host of discretionary spending initiatives. (Check out the duo's $200 billion in "illustrative savings" for a sampling of proposed cuts.)

But the whole structure of the commission is a bit nebulous. The 18-member bipartisan group of legislators, former legislators, a couple of titans of industry and a policy wonk has a limited mandate; all that it can do is send deficit-cutting proposals to Congress, and even that will only happen if at least 14 of the 18 members vote for it. Yet what we got last week was not from those 18 members. Or 14. It was the work of just Simpson and Bowles, who must now cat-herd the other 16 into a final proposal and vote by President Obama's December 1st deadline. The two have positioned their proposal as a "starting point" for further deficit-cutting conversations, though Simpson also dryly noted that "we'll both be in a witness protection program when this is all over, so look us up."

Meantime, the plan put forth by the Bipartisan Policy Center would reduce projected deficits by almost $5.9 trillion from 2012 through 2020, largely by cutting spending on defense and domestic programs, and instituting a national sales tax. The Center was established in 2007 by four former Senate Majority leaders with the goal of coming up with solutions for major national issues.

Here are some of the proposals from each group that would have a direct impact on your personal finances:

Simpson and Bowles included three different tax proposals for the commission to chew on. Among their proposals for dealing with individual taxes:

  • Cut back to just three tax rates; the highest rate among the three proposals is 35 percent.
  • Reduce deductions. In one plan, state and local taxes are no longer deductible, and the mortgage interest deduction would be limited to primary-home mortgages of less than $500,000. No write off for vacation home mortgage interest or home equity loans and lines, either.
  • Get rid of the AMT: this one is included in all three proposals.
  • Tax capital gains and dividend income as ordinary income. Depending on what tax rates would be enacted, that rate could be as high as 35 percent. At the moment -- pending Congress deciding what to do about the expiring Bush tax cuts -- the top long-term capital gains rate and dividend income rate is 15 percent.
The Domenici-Rivlin plan contains some similar proposals for simplifying the tax code, but with some important differences. Specifically it would:
  • Reduce the number of individual tax brackets from the current six to just two (15 percent and 27 percent), and decrease the corporate tax rate from 35 percent to 27 percent.
  • Replace the deductions for mortgage interest and charitable contributions with 15 percent refundable tax credits
  • Establish a new 6.5 percent national "Debt Reduction" sales tax. The tax would be phased in, starting at 3 percent in 2012 and rising to the full 6.5 percent the next year.
The Simpson-Bowles plan calls for the following:
  • Raise the normal retirement age from 67 (for those born after 1959) to 68 by 2050 and age 69 by age 2075, but simultaneously provide a "hardship exemption" for people deemed unable to work beyond age 62.
  • Calculate the annual cost of living adjustment using a different metric --the chained CPI -- which would effectively reduce the adjustments.
  • Raise the upper limit for income that's subject to the Social Security payroll tax (the current cutoff is $106,800). Right now, the formula for setting the upper limit means that about 86 percent of earnings are taxed; under the proposal, the formula would be tweaked to set the upper limit to capture 90 percent of earnings.
  • Give retirees the choice of collecting half their benefits early and the other half at a later age. The idea here is to help folks ease into a phased-retirement.
The BPC plan would not raise the retirement age, but would make similar changes to the limits on income that are subject to the Social Security payroll tax. The proposed one-year Social Security tax holiday in 2011 would create between 2.5 million and 7 million jobs, according to the BPC, and would be paid for, in part, by the new national sales tax.

The Simpson-Bowles plan would implement the following:

  • Shift more cost onto beneficiaries ("expanding cost sharing" is the artful phrase) but impose an annual catastrophic cap to limit total out of pocket costs. Estimated savings from 2011-2020: $85 billion.
  • Require drug companies to offer rebates on more drugs as a condition of participating in Part D (estimated $59 billion in savings from 2011-2012).
  • Push through tort reform to reduce medical insurance costs (estimated savings of $64 billion over the same stretch)
The BPC plan would also shift costs onto beneficiaries, and would encourage people to purchase private health insurance by charging higher premiums for Medicare if costs rise faster than certain pre-determined limits, starting in 2018.

The Simpson-Bowles plan would cut $100 billion each from both defense and domestic programs by 2015.

The Domenici-Rivlin plan would freeze additional spending on domestic programs for four years, and on defense for five years. After that time, the growth in spending for each would be limited to overall GDP growth.

The Simpson-Bowles plan also calls for the following taxes and cuts:

  • Add another 15 cents to the current 18.4 cents per gallon federal gas tax to pay for all transportation and highway programs directly, rather than through Treasury appropriations.
  • Eliminate the in-school interest payment for subsidized Stafford loans.
  • The Smithsonian Museum, currently free to all visitors, would be required to cover 25 percent of its operating budget ($225 million) by charging an entrance fee that Simpson and Bowles estimate would come to about $7.50 per person.
  • The National Park Service would increase its use of visitor fees (not all parks charge them.) Simpson and Bowles are calling for an extra $75 million to be raised by park fees, a cost they estimate will amount to about $0.25 more per visitor.
As I said, those are just a few of the highlights, or low-lights depending on your point of view, of each group's proposals. It will be interesting to see what, if anything, gains traction in the coming weeks, and whether the Obama Commission can get to a 14-vote consensus. Even if that happens, it's a lot of heavy lifting just to land at Congress' doorstep, where the real debate would begin. As I said, stay tuned -- this could get interesting.

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