U.S. Fiscal Policy: Lowering Debt, Growing the Economy, and Enhancing Social Insurance
A proposed set of policy changes from the Penn Wharton Budget Model (PWBM) shows how tax and spending reforms can reduce national debt, boost the economy, and help lower-income households. These reforms are progressive, benefiting both current and future generations. Most changes start in 2025, with Social Security reforms phased in over 20 years to avoid affecting people aged 50 and older. The reforms are based on widely accepted economic principles, not political agendas.
PWBM’s policy reforms demonstrate how to achieve sustained debt reduction while also boosting economic growth and social insurance. The reforms also reduce carbon emissions, health care coverage gaps, and poverty among retirees.
Policy design principles
- Government spending focused on the provision of public goods, addressing market failures, and risk pooling.
- The use of corrective taxes to internalize externalities.
- Tax simplification broadens tax bases with lower rates to reduce economic distortions.
- Progressive taxation implemented with the lowest possible rates to raise necessary revenue while minimizing inefficiencies.
- Mandatory savings for a portion of future health care expenses to reduce moral hazard.
- Consideration of the full incidence of taxes and spending in general equilibrium, recognizing that the true economic burden is independent of the entity legally responsible for paying the tax.
Four-pronged policy bundle
- Simplify the tax code and remove incentives to reclassify labor income to receive favorable tax treatment:
- Tax capital gains and dividends at ordinary, and not preferential, rates. Tax capital gains at death without the stepped-up basis.
- Expand the base of employment taxes to cover all pass-through income.
- Disallow all itemized deductions except for charitable deductions.
- Remove the income exclusion of employer-sponsored health insurance premiums. Plus, introduce mandatory Health Savings Accounts.
- Reduce tax distortions:
- Replace the standard deduction and personal exemptions with a partially refundable credit worth up to $3,000 per household member.
- Reduce the top ordinary income tax rate from 37% to 28%, and reduce the number of thresholds from seven to five.
- Corrective taxes to price negative externalities: Introduce a carbon tax of $50/ton on fuel suppliers in an effort to reduce carbon emissions efficiently.
- Improve the solvency of Social Security and Medicare, reduce disincentives to save and work, and promote growth:
- Raise the full-benefit Social Security retirement age from 67 to 70, phased in between 2037 and 2056.
- Flatten Social Security benefits in phases between 2037 and 2056; a new minimum Social Security benefit from 2037 could bring all retirees above the federal poverty line, and a maximum benefit that is significantly lower than it is now will help secure Social Security’s long-term solvency.
- Raise the Medicare eligibility age from 65 to 67, fully phased in by 2036.
- Convert Medicare to premium support, allowing beneficiaries to choose from competing insurance plans, with the federal government sharing the cost of premiums.
- Broad-based immigration reform would double the number of legal immigrants allowed each year, requiring new immigrants to purchase health insurance without government subsidy.
Main outcomes of illustrative reforms
- Revenue boosters:
- If enacted in 2025, these reforms would generate net revenues (deficit reduction) of $10 trillion over the 10-year budget window and $59 trillion between 2025 and 2054.
- Immigration reform would be the biggest revenue raiser, followed by the removal of tax deductions for employer-sponsored health insurance premiums. Together, these two policies would increase revenues by $13.3 trillion over the 2025-2034 period and by $66 trillion over the next 30 years.
- Revenue drainers:
- The biggest revenue losses would be from replacing standard deductions and personal exemptions with refundable credits, and from lowering the top income tax rate to 28%.
- Combined, they could reduce revenues by $5.9 trillion over the next 10 years and by $23.2 trillion between 2025 and 2054.
Outcomes over 30 Years with Reforms
What goes up:
Capital stock ▲31%
GDP ▲21%
Wages ▲7%
Future lower-income households ▲$300,000 in lifetime value
What goes down:
Federal budget deficits ▼38%
Health insurance premiums ▼27
“A common misunderstanding is that serious debt reduction must come at the expense of economic growth or the social safety net. We show that this is incorrect.”
—Kent Smetters, Faculty Director, PWBM
Carbon Dieting
A carbon tax could reduce greenhouse gas emissions by:
“Households in the bottom income quintile are among the biggest winners of this change, both in absolute terms and relative to their income.”
—Felix Reichling, Senior Economist, PWBM
Key Takeaways
Lower-income households benefit
Lower-income households generally gain from implementing the policy changes in this bundle, while those in the highest income brackets generally see their post-fiscal income decrease. Households in the bottom income quintile are among the biggest winners of this change, both in absolute terms and relative to their income. This is largely due to the replacement of the standard deduction and personal exemptions with a partially refundable credit.
Many households in the lowest-income group have very little or no income tax liability under current law after deductions and credits. For these households, the new partially refundable credit that replaces the standard deduction increases their average after-tax income by $3,760 in 2025 to nearly $5,000 in 2054.
Higher GDP and capital formation, lower debt
With the policy reforms, GDP would grow 21% by 2054, driven by a 31% expansion in the capital stock and a 14% rise in total hours worked.
Higher immigration increases the U.S. population by 12% by 2054 and expands the labor force. Immigrants contribute to capital formation through savings. Per capita output increases by 8% in 2054, reflecting gains in capital accumulation that extend beyond immigrants’ contributions.
Federal debt declines 38% by 2054. This allows households to allocate more of their savings toward productive capital rather than government bonds, thereby further expanding the capital stock. Consequently, by 2054, wages increase 7% and consumption rises 10%.
Near-universal health insurance, lower premiums
Private health insurance premiums drop 27% over 30 years. Two drivers of that: One, all immigrants enroll in private health insurance, which in turn lowers overall premiums and encourages increased enrollment among native-born citizens. Two, immigrants are, on average, younger than native-born people by about eight years. Moreover, the policy reforms not only prevent an increase in the uninsured population but also drive uninsured rates to near zero.
Health care spending shifts from the government to the private sector. Spending on Medicaid falls 41% over 30 years, and that on Medicare by 11%. Helping those will be improvements in general health and well-being by retirees who are more likely to be insured before retirement.
The calculations were produced by Kody Carmody, Jon Huntley, Felipe Ruiz Mazin, Ed Murphy, and Brendan Novak under the direction of Alexander Arnon, Felix Reichling, and Kent Smetters. Sophie Shin contributed to the analysis. Felix Reichling and Kent Smetters wrote the PWBM brief with input from others. Mariko Paulson prepared the brief for the PWBM website.
PWBM will release more details about its model over the next two years to make its framework more accessible to other academics, experts, and policy advocates. It will also release additional information on how the policy reforms discussed here improve health outcomes, productivity of the previously uninsured, and life expectancy.