Saving the American Dream: The Heritage Plan to Fix the Debt, Cut Spending, and Restore ProsperitySaving the American Dream is The Heritage Foundation’s plan to fix 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 half. It eliminates government-mandated health care and fully funds our national defense. It squarely confronts Social Security, Medicare, and Medicaid, the three so-called entitlement programs, which together account for 43 percent of federal spending today. To encourage Americans to become more fiscally responsible, the Heritage plan redesigns our entire tax system into an expenditure tax that will have a single, flat rate. This is a structure that will promote savings, therefore benefiting individual Americans, our body politic, and the economy.At the end of the day our plan, while economic in nature, has a higher moral purpose. If entitlements are not reformed, the next generation and future ones will have to pay punitive tax rates that will end liberty as we have known it. Our proposal, which was funded by a grant initiative set up by the Peter G. Peterson Foundation, aims to preserve America’s promise bequeathed to us by past generations.The Heritage FoundationTHF_6268d39a-39a4-11e2-ae5e-9147cf2fd515Edwin J. FeulnerPresident, The Heritage FoundationPeter G. Peterson FoundationOur proposal, which was funded by a grant initiative set up by the Peter G. Peterson Foundation, aims to preserve America’s promise bequeathed to us by past generations.Stuart M. Butler, Ph.D.Author -- Distinguished Fellow and Director, Center for Policy Innovation, Center for Policy Innovation -- Stuart M. Butler, a nationally recognized architect of public policy, directs the Center for Policy Innovation. This new division of The Heritage Foundation is charged with designing the next generation of breakthrough ideas. Butler envisioned the Center for Policy Innovation, or CPI, as the “iPod division” of Heritage--a small, loosely structured group assembled to research and develop radically innovative solutions to some of America’s toughest challenges. “Think of CPI as a think tank within a think tank,” Heritage President Edwin J. Feulner said in announcing the division. “It will be a freewheeling research laboratory dedicated to thinking ‘outside the box’ to devise landmark policy recommendations consonant with time-tested, conservative principles.” Before taking the helm of CPI in August 2010, Butler guided Heritage’s domestic policy research for almost 30 years. As vice president for domestic and economic policy studies, he helped shape the debate on critical issues from health care and Social Security to welfare reform and tax relief. Butler, who remains on Heritage’s senior management team, sees the Center for Policy Innovation as a mechanism for assembling “virtual think tanks,” each dedicated to addressing a seemingly intractable problem...Alison Acosta FraserAuthor -- Director, Thomas A. Roe Institute for Economic Policy Studies -- As Director of the Roe Institute for Economic Policy Studies, Alison Acosta Fraser oversees Heritage Foundation research on a wide range of domestic economic issues including federal spending, taxes, energy and environment, retirement savings and regulation. One of the Roe Institute's priorities is reform of the federal retirement programs – Medicaid, Medicare and Social Security. Under Fraser's leadership, Heritage research has helped define and communicate the long-term fiscal threats from spending and taxes and identify solutions and proposals for reforms. Fraser is a member of the Fiscal Wake-Up Tour, designed to educate Americans about the nation's true long-term financial condition and large and growing fiscal imbalance and to encourage Americans to demand action. The tour conducts of town hall forums, business roundtables and editorial board briefings across the country. By uniting with analysts from across the political spectrum on the Fiscal Wake-Up Tour, Heritage hopes to encourage the spirit of bipartisan honesty and discussion that will be necessary to preserve the strength of the American economy for posterity. Unless Congress fundamentally recasts Medicaid, Medicare and Social Security, Americans within two generations will be saddled with European levels of taxation and economic stagnation...William W. BeachAuthor -- Director, Center for Data Analysis and Lazof Family Fellow -- As Director of The Heritage Foundation's Center for Data Analysis, William W. Beach is the think tank's chief "number cruncher." He oversees Heritage's original statistical research on taxes, Social Security, energy, crime, education, trade and a host of other issues, ensuring it is both rigorous in technical scholarship and produced in time to help inform public debate. Under Beach's leadership, Heritage has acquired one of the largest collections of privately held public-policy databases in the United States, as well as a variety of peer-reviewed analytical models. Together, these acquisitions allow the Center for Data Analysis (CDA) to produce some of the most sophisticated calculations done anywhere in the world. Because of his ability to boil down complicated data into plain language and real-world examples, Beach is a reliable source for news reporters and a frequent guest on television and radio talk shows. He serves on the Economics Advisory Panel for ABC News...... the American Dream._6268d778-39a4-11e2-ae5e-9147cf2fd515To fix the debt, cut spending and, above all, restore prosperity._6268d8ea-39a4-11e2-ae5e-9147cf2fd515Balance BudgetBalance the federal budget and keep it balanced forever at no more than 18.5 percent of GDP._6268d9e4-39a4-11e2-ae5e-9147cf2fd5151American TaxpayersBalances the federal budget within a decade and keeps it balanced forever at no more than 18.5 percent of GDP. Americans have made very clear to Washington over many decades the limits of how much they are willing to pay for government. That historical average figure is approximately equal to 18.5 percent of GDP, so we balance spending and revenue at that level._6268dae8-39a4-11e2-ae5e-9147cf2fd515Debt ReductionReduce the debt to 30 percent of GDP within 25 years and put it on track to continue falling thereafter._6268dbf6-39a4-11e2-ae5e-9147cf2fd5152InvestorsLendersReduces the debt to 30 percent of GDP within 25 years and puts it on track to continue falling thereafter. Our national debt now is nearly 70 percent of GDP and on track to hit 185 percent within 25 years. Lower debt will remove the threat of financial crisis and restore the confidence of investors and lenders. It will also sharply reduce the debt burden on future generations, relieve the pressure on interest rates, and help to secure our prosperity._6268dcf0-39a4-11e2-ae5e-9147cf2fd515Size of GovernmentCut the size of the federal government by about half._6268de12-39a4-11e2-ae5e-9147cf2fd5153Cuts the size of the federal government by about half within 25 years. By achieving balance at this level, we stop the federal government from growing to over one-third of the entire U.S. economy. Left unchecked, it would reach that size by the time a baby born today graduates from college._6268df20-39a4-11e2-ae5e-9147cf2fd515Tax CodeStop scheduled tax increases and replace the tax code._6268e038-39a4-11e2-ae5e-9147cf2fd5154TaxpayersStops scheduled tax increases and replaces the complex and unfair tax code with a completely new tax system. In addition to holding revenues at no more than their historical average, we replace the current Byzantine tax system with a much simpler system that minimizes tax distortions and perverse incentives._6268e16e-39a4-11e2-ae5e-9147cf2fd515Defense FundingEnsure full funding for national defense._6268e290-39a4-11e2-ae5e-9147cf2fd5155Protects America and its interests around the globe by ensuring full funding for national defense. Defense is a core constitutional responsibility, a fundamental duty of the federal government, and essential to preserving American liberty and prosperity. Waste and inefficiency in defense spending should be rooted out, but we use the savings to meet defense needs._6268e3b2-39a4-11e2-ae5e-9147cf2fd515Health CareEliminate Obamacare and create a health care system that is affordable._6268e506-39a4-11e2-ae5e-9147cf2fd5156IndividualsFamiliesEliminates Obamacare and creates a health care system that is affordable both for the nation and for individuals and families. This system fosters the individual choice, competition, and state-level innovation needed to control underlying health costs while assuring continuous and portable coverage. By overhauling subsidies and tax breaks for health care, we ensure that Americans can afford adequate coverage._6268e646-39a4-11e2-ae5e-9147cf2fd515Social Security & MedicareRedesign Social Security and Medicare._6268e790-39a4-11e2-ae5e-9147cf2fd5157SeniorsChiildrenGrandchildrenRedesigns Social Security and Medicare as sustainable programs that truly protect seniors and will be around for our children and grandchildren. The current system will soon be running massive deficits and unable to pay in full for all of its promised benefits. Accordingly, we redesign these defined-benefit entitlement programs as budgeted “real insurance” programs that focus on those who need them and are phased out by income for those who do not really need them. In contrast with those who argue for raising taxes on current and future Americans, the Heritage plan eliminates the need to raise taxes._6268e916-39a4-11e2-ae5e-9147cf2fd515Savings & InvestmentProvide incentives for working Americans to save and invest._6268ea7e-39a4-11e2-ae5e-9147cf2fd5158Working AmericansProvides powerful incentives for working Americans to save and invest so that they will be less dependent on these programs. Our tax and Social Security reforms provide new ways for Americans to save for their future security and to create capital for enterprise._6268ebe6-39a4-11e2-ae5e-9147cf2fd515Social SecurityStrengthen the Social Security system._6268ed62-39a4-11e2-ae5e-9147cf2fd5159Heritage proposes to ... strengthen the Social Security system by tightening its benefits and returning it to its original purpose: a guarantee that older Americans won’t fall into poverty. Heritage proposes to make Social Security “real insurance” for Americans as they reach retirement.BenefitsTransition to a flat benefit._6268eede-39a4-11e2-ae5e-9147cf2fd5159.1A Predictable Benefit That Provides Economic Security. The centerpiece of the new Social Security system involves a gradual transition to a flat benefit that pays retirees who qualify for a full Social Security check. This amount is well above the income level that the Census Bureau says an American over the age of 65 needs to avoid poverty. Thus, the new system will guarantee that no retiree falls into poverty because of insufficient income. Under today’s system, retirees can pay Social Security taxes for 35 years and still receive a benefit that is below the poverty level. Some of these seniors are forced to go on welfare. The new system corrects this serious flaw. The flat benefit will be the equivalent of about $1,200 per month in 2010 dollars when the reform is complete. This is both higher than today’s average Social Security retirement benefit payment ($1,164 per month) and well above the 2009 poverty level for a single adult over age 65 ($857 per month). To ensure that future retirees do not slip back into poverty, the flat benefit level will be indexed for wage growth. Slow Transition to the New Flat Benefit. The new flat benefit will be phased in slowly. Current retirees and those who are close to retirement will see only a minimal change in the basic design of their benefits. Those with a significantly longer time before retirement, who have more flexibility in planning their future, will see larger changes in their benefits. Workers born after 1985 will come under the new flat Social Security benefit system when they retire.Need BasisLimit Social Security to Those Who Actually Need It._6268f0aa-39a4-11e2-ae5e-9147cf2fd5159.2Limiting Social Security to Those Who Actually Need It. In addition to moving to a flat benefit over time, the plan makes Social Security a properly financed, true insurance program. It starts to do that immediately. This means that the program will concentrate on protecting the economic security of retirees rather than following the current approach of promising unaffordable benefits to all without regard to need. This new approach means that retirees with substantial non–Social Security retirement income will start receiving a lower benefit on a sliding scale that gradually reduces Social Security checks to zero for those with the highest non–Social Security incomes. This transparent mechanism will apply to benefits received by affluent Americans under both the current system and the flat-rate system. This transparent, sliding-scale approach is a major improvement on today’s taxation of Social Security benefits. Under the plan, income-adjusted benefits start in 2012 as individual retirees with non–Social Security incomes above $55,000 start to see a slight reduction in benefit payments. Those with higher non–Social Security income will see larger reductions in their checks. Individuals with more than $110,000 in non–Social Security income will receive no Social Security payments. Married couples who file taxes jointly would be subject to higher thresholds, with benefits beginning to phase out at a joint non–Social Security income of $110,000 and ending when income reaches $165,000. Married couples can decide whether they want to qualify for benefits as individuals or jointly as a couple. The income thresholds will be indexed for inflation. Income-adjusting benefits is not new. It occurs in today’s Social Security system. But it is largely hidden today and hits lower-income seniors, not just the affluent. Seniors with as little as $15,000 in non–Social Security income, or even less in some cases, must pay tax on part of their benefits. Seniors with more income than that pay steadily higher rates of tax on more of their Social Security benefits. The Heritage approach, when fully phased in, would income-adjust benefits transparently and not tax the benefits a senior receives. It also would start income-adjusting at a much higher income. Today, about half of seniors have their checks eroded by taxation. Under the Heritage plan, only about 9 percent of seniors would see their checks reduced and only just over 3.5 percent of seniors would receive no check. Real insurance also protects seniors from poverty if their financial situation changes. Retirees who suffer a sudden and permanent drop in non–Social Security income would find their benefits rapidly restoredCOLAsBase annual cost of living adjustments (COLA) on the Chained Consumer Price Index (C-CPI-U)._6268f24e-39a4-11e2-ae5e-9147cf2fd5159.3More Accurate Inflation Protection. The annual cost of living adjustment (COLA) for Social Security, which protects retirees against inflation, will be based on the Chained Consumer Price Index (C-CPI-U), a measure of inflation that is more accurate than the index used currently. The Bureau of Labor Statistics specifically designed this inflation measure to better reflect the way that consumers buy different items as the prices of various products fluctuate.Retirement AgeAdjust the retirement age to reflect increases in life expectancy._6268f3fc-39a4-11e2-ae5e-9147cf2fd5159.4A More Reasonable Retirement Age. The plan adjusts the retirement age to reflect increases in life expectancy and those anticipated in the future. Under the plan, these changes are phased in gradually. Those nearing retirement are affected only slightly. Over the next 10 years, the age for full benefits rises to 68 for workers born in or after 1959. Over the next 18 years, the early retirement age rises to 65 for workers born in or after 1964. After that, both early and normal retirement ages will be indexed to longevity, which will add about one month every two years according to current projections. The plan recognizes that a small proportion of workers will be physically unable to work until these ages. It therefore includes an improved disability system to protect them. The reformed disability system ensures that those who are unable to work longer receive a quick and accurate decision on their benefit application rather than facing today’s long delays, and improves today’s often arbitrary decision-making process.Work IncentivesProvide incentives for working longer._6268f5b4-39a4-11e2-ae5e-9147cf2fd5159.5Incentives to Work Longer. Starting immediately, those who work past their full-benefit age receive a special annual tax deduction of $10,000, regardless of income level. For instance, once the new system is completely phased in, a worker earning $50,000 per year who delays Social Security payments will see a $200 per month increase in spendable income.SavingsCreate better ways for workers to build savings for retirement._6268f7a8-39a4-11e2-ae5e-9147cf2fd5159.6An Improved Savings Plan to Supplement Social Security. As Social Security is transformed into a real insurance system that focuses scarce resources on those who need them most, the plan also creates better ways for workers to build savings for retirement. Beginning in 2014, a new savings plan will be introduced over two years. Under this plan, 6 percent of each worker’s income is placed in a retirement savings plan that the worker owns and controls unless he or she explicitly declines 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 retirement standard of living. Savings are invested through an improved version of the IRA/401(k) employment-based retirement savings system already familiar to Americans. The money put into these savings accounts will not be double-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 for retirement. First, under the reformed tax system detailed below, all savings (without limit) will no longer be double-taxed. Savings remain completely free of taxation until they are actually spent. Second, as benefit reforms drive the costs of Social Security below the level of taxes collected, those savings will go into the workers’ accounts.MedicareTransform Medicare from a defined-benefit entitlement to focus subsidies on those who need them most._6268f974-39a4-11e2-ae5e-9147cf2fd51510Medicare must be reformed to solve this huge financing problem, to improve access to quality care, and to ensure that health care will be available for younger Americans when they retire. The Heritage plan accomplishes this by transforming Medicare from an open-ended and unsustainable defined-benefit entitlement into a properly budgeted program that focuses Medicare subsidies on those who need them most. The new Medicare program would look much more like the Federal Employees Health Benefits Program (FEHBP), the health care system for Members of Congress and federal employees. Over a five-year period, the plan transforms Medicare into a defined-contribution system, with stronger health security for the poor and less healthy, and guarantees new protections against catastrophic costs for all enrollees. Today’s traditional fee-for-service Medicare program provides no such protections. Because of this gap, nine out of 10 seniors feel compelled to buy supplemental private health insurance, including Medigap, to cover themselves against the financial devastation of catastrophic illness. This means that seniors pay an extra set of premiums and often incur high out-of-pocket costs for both premium and non-premium medical expenses. Finally, the plan establishes a true long-term budget for Medicare.Defined Contributions[Provide for] defined contributions adjusted by income._6268fb54-39a4-11e2-ae5e-9147cf2fd51510.1A Defined Contribution Adjusted by Income. Five years after enactment, all new retirees receive a contribution (premium support) from the government, just as federal employees and retirees do today. They can use this contribution to choose Medicare’s premium-based FFS plan or one of the other health plans. After one year of operation, Medicare enrollees in the traditional Medicare FFS program are free to join the new Medicare premium-support program. They can then choose a premium-based FFS plan or an alternative. During the first five years of the premium-support program, the government’s contribution is based on the weighted average premium of the regional bids of competing health plans. After the first five years, the government contribution is based on the lowest bid of competing plans in a region. The bidding system will be phased in and will include the bids of the competing managed care plans, other private plans, and the Medicare premium-based FFS plans offering an approved range and quality of services. Under the Heritage plan, low-income enrollees receive the full Medicare defined contribution. The amount of the defined contribution starts to phase out for 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 full, unsubsidized premiums. As with Social Security, married couples can decide whether they want to qualify for benefits as individuals or jointly as a couple. The phaseout income levels will be inflation-indexed. However, Medicare remains a valuable program for higher-income seniors because they retain access to a guaranteed-issue and community-rated insurance program. Under the Heritage plan over 90 percent of seniors would receive the full defined contribution. Only just over 3.5 percent have such high incomes that they would pay the entire premium without any contribution from the government.Medicare Budget & Financing System[Institute] a Medicare budget and financing system._6268fd84-39a4-11e2-ae5e-9147cf2fd51510.2A Medicare Budget and Financing System. During the first five years of the new Medicare program, the government’s annual contributions to enrollees’ plans are based on the weighted average premium of participating health plans’ bids on a regional basis. The plans bid to provide Medicare benefits plus catastrophic coverage and, just like the FEHBP, are weighted on plan enrollment. Thereafter, the government contribution is based on the premium bid of the lowest-cost health plan that meets the required level of quality and provides an adequate range of benefits. In both cases, the per capita government contribution on the basis of the plan bidding is set at 88 percent of the bids. By comparison, the FEHBP contribution is set at 72 percent of the national average weighted premium, and the original Medicare Part B premium contribution was set at 50 percent in 1965. The Heritage plan also caps total Medicare spending. The spending cap is indexed annually for inflation using the Consumer Price Index plus 1 percent and Medicare population growth. If Medicare spending exceeds the cap, the government’s contribution declines from 88 percent to the percentage that complies with the Medicare spending cap, thereby pressuring the competing plans and providers to control costs more tightly.Dual-Eligibles[Give] States the option to “top up” the Medicare defined-contribution amount for dual-eligibles who choose to enroll in a private health plan._6268ff8c-39a4-11e2-ae5e-9147cf2fd51510.3Additional Assistance for Dual-Eligibles. Medicaid, the federal–state program for the poor and the indigent, provides supplemental coverage for about 8 million Medicare beneficiaries. These are poor people, and most qualify for full Medicaid benefits, including long-term care services in nursing homes. They receive subsidies for Medicare premiums and cost-sharing and for the Medicare Part D drug coverage. Beginning five years after enactment, states have the option to “top up” the Medicare defined-contribution amount for dual-eligibles who choose to enroll in a private health plan. Dual-eligible enrollees who stay with the revamped Medicare FFS plan continue to receive Medicaid coverage as they do today.Catastrophic CostsIntegrate traditional Medicare into the system and add catastrophic cost protection._626901a8-39a4-11e2-ae5e-9147cf2fd51510.4Integrating Traditional Medicare into the System and Adding Catastrophic Cost Protection. Under the Heritage plan, all senior citizens have the option of keeping their current health plans or choosing better health plans. Five years after enactment, traditional Medicare FFS begins to compete directly with private plans on a level playing field. Seniors can remain in Medicare FFS if they wish. However, the previous organizational and benefit distinctions within Medicare FFS (Medicare Parts A, B, C, and D) disappear because Medicare becomes a single, unified program with a unified trust fund that is financed by a defined contribution. A single stated premium incorporates today’s multiple Medicare FFS premiums plus the cost of a new catastrophic benefit. Cost-sharing parameters are adjusted to ensure that the Medicare benefit package is actuarially equivalent to the package provided under current law. In the first year of competition with private health plans, the initial value of the catastrophic benefit will need to equal the average of such benefits currently provided in the Medicare Advantage program, but it may be adjusted thereafter by the Secretary of Health and Human Services.Transitional ChangesMake changes in Medicare FFS during the transition._62690414-39a4-11e2-ae5e-9147cf2fd51510.5Changes in Traditional Medicare FFS During the Transition -- During the transition, the Heritage plan:SubsidiesReduce subsidies and phases them out for upper-income enrollees._6269064e-39a4-11e2-ae5e-9147cf2fd51510.5.1Reduces subsidies and phases them out for upper-income enrollees. For upper-income seniors, the premium subsidies for Part B and Part D are phased out and a premium for Part A is phased in. For upper-income seniors, the subsidy implicit in their premiums is phased out over the same range as for Social Security ($55,000 to $110,000 for individuals and $110,000 to $165,000 for couples). Under the changes in traditional Medicare, these subsidy reductions and phaseouts also apply to government subsidies for those who are enrolled in Medicare Advantage plans.Part A PreimiumPhase in a new income-related Part A premium for retirees to cover the full cost of Part A_626908a6-39a4-11e2-ae5e-9147cf2fd51510.5.2A new income-related Part A premium for retirees is phased in to cover the full cost of Part A services during the transition and to cover any deficit in the Hospital Insurance trust fund. The premiums are phased in for individuals with annual incomes between $55,000 and $110,000 and couples with annual incomes between $110,000 and $165,000. Individuals with an annual income of $110,000 and couples with an annual income of $165,000 pay full, unsubsidized premiums.Part A DeductibleIndex the deductible for Part A to an average of the Consumer Price Index (CPI) and the Medical CPI._62690b30-39a4-11e2-ae5e-9147cf2fd51510.5.3Changes co-payments. Medicare Part A, which covers hospitalization, has a deductible. During the transition, the deductible is indexed annually to an average of the Consumer Price Index (CPI) and the Medical CPI. A co-payment of 10 percent is added for the total cost of each home health care episode (defined as 60 days of service). Today, there is no such co-payment in spite of heavy utilization of this costly benefit.Part B & Part D PremiumsRaise premiums for Part B and Part D._62690d92-39a4-11e2-ae5e-9147cf2fd51510.5.4Raises the premiums for Part B and Part D. The Part B and Part D premium percentage for most beneficiaries is gradually raised from 25 percent to 35 percent in increments of 2 percentage points per year over the five-year transition. The existing “hold harmless” provisions are retained for low-income seniors.Other Changes & Rules[Make] other changes and rules in the current Medicare program._62690ff4-39a4-11e2-ae5e-9147cf2fd51510.6Other Key Changes in Medicare -- The Heritage plan envisions other important changes and rules in the current Medicare program:Doctor–Patient ContractingEliminate restrictions on doctor–patient contracting._6269129c-39a4-11e2-ae5e-9147cf2fd51510.6.1DoctorsPatientsEliminating restrictions on doctor–patient contracting. Beginning immediately, the plan eliminates the statutory and regulatory restrictions on private contracting outside of Medicare that were enacted in the Balanced Budget Act of 1997. There were no such statutory restrictions before 1997. This means that Medicare enrollees can enter into private agreements for medical services with the physicians of their choice with no statutory or regulatory restrictions. For reasons of privacy, or for whatever reasons seem good to them, they can go outside of the Medicare program without being required to submit a claim to the Medicare bureaucracy for the physician’s service. This restoration of the right of private contracting will also encourage the treatment of Medicare patients by more physicians who otherwise might not participate in the program.Medicare SavingsRetain Medicare savings for Medicare alone._62691512-39a4-11e2-ae5e-9147cf2fd51510.6.2Retaining Medicare savings for Medicare alone. Beginning immediately, any savings in the Medicare program are prohibited from being credited to the cost of current or future “health care reform” provisions that fund Medicare benefits or subsidize those who are not enrolled in the program. Five years after enactment, any remaining savings from traditional Medicare are deposited into the new unified Medicare trust fund.Doc FixEnact a permanent “doc fix” and make physician pricing fully transparent._626917e2-39a4-11e2-ae5e-9147cf2fd51510.6.3DoctorsPhysiciansEnacting a permanent “doc fix” and making physician pricing fully transparent. Beginning immediately, a permanent “doc fix” is implemented using any Medicare savings from legislation, including savings from this proposal. From this point forward, physician payments are adjusted for inflation, measured by the CPI (not the Medical CPI). However, the law is changed to permit balanced billing in combination with a price disclosure requirement for Medicare physicians’ services. Thus, for traditional Medicare FFS during the transition, the government determines Medicare reimbursement, while physicians determine patient fees. This change will encourage doctors who otherwise might drop out of Medicare to continue to treat Medicare patients. Moreover, the required transparency in physician fees guarantees price competition in physician services, thus helping to lower Medicare costs. Allowing new retirees to keep their existing plans. Surveys show that the vast majority of working Americans are satisfied with and, if possible, want to keep their existing health plans. The Heritage plan expands the opportunities for Americans to keep their existing plans into retirement. Even before the five-year transition to a full premium-support program, Medicare provides a risk-adjusted defined contribution for 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.Health CareUse a consumer-centered, market-based approach to reduce health care costs and give patients and their families a greater say in health care spending and decisions that affect their lives._62691ac6-39a4-11e2-ae5e-9147cf2fd51511FamiliesHealth Care for Families -- Summary: Health care costs are rising at an alarming rate, while individuals and families have less control over their health care dollars or decisions. Worse still, the recently enacted Patient Protection and Affordable Care Act (PPACA, or Obamacare) is accelerating these problems. In sharp contrast to the centralized government approach of the Obama legislation, the Heritage plan uses a consumer-centered, market-based approach to reduce health care costs and give patients and their families a greater say in health care spending and decisions that affect their lives. This begins by repealing Obamacare. The Heritage Foundation has already proposed major health care reform to create an affordable health care system in America. The reform is based on consumer choice and ownership of coverage, together with an infrastructure for competitive private plans and state-led innovation. The Heritage plan includes key budget and tax components of the overall Heritage health care reform, including reform of the tax treatment of health expenses and assistance for health insurance for lower-income families. Other features of the health care reform are developed in other studies and reports.Tax CreditEnd the tax exclusion for employee compensation in the form of employer-sponsored health insurance and introduce a new uniform, nonrefundable federal tax credit to assist families in their purchase of health insurance._62691d64-39a4-11e2-ae5e-9147cf2fd51511.1EmployeesFamiliesA New Health Tax Credit. The Heritage plan ends the existing tax exclusion for employee compensation in the form of employer-sponsored health insurance. This means that the value of employer-paid health insurance premiums is included in the employee’s total taxable compensation. Today’s system excludes this compensation from income and payroll taxes, effectively giving upper-income workers in high-tax brackets a large tax benefit. In return for ending this tax break, the plan introduces a new uniform, nonrefundable federal tax credit to assist families in their purchase of health insurance. Employers and employees could decide whether to have the employer continue to buy coverage or to cash out the existing coverage in the form of higher cash income. Either way, the tax break for coverage would change from an exclusion to a credit. The net value of the credit is $2,000 for an individual and $3,500 for a couple or family. Under the Heritage plan, this credit can be used either to offset the cost of coverage offered through the workplace or to buy insurance outside the workplace. For most middle-income working families, the value of the credit is similar to the tax relief that they receive for health insurance today. For upper-income households, the new credit is typically less and is reduced as income rises. The phaseout begins at $50,000 for an individual and $100,000 for a family. The credit is fully phased out at $90,000 for an individual and $170,000 for a family. The credit is advanceable, assignable, and available on a prorated basis. This means that the credit is available when premiums are due, enabling families to claim the credit for premiums already paid before the end of the tax year. An assignable credit allows a family to assign their tax credit to a health plan in return for a dollar-for-dollar lower premium, eliminating the need to claim it on their own tax forms. It is important to note that health care benefits are a form of worker compensation directed by the employer and are not “paid for” in any charitable sense by the employers. Therefore, in the labor market, employers would likely adapt to the tax reform either by increasing the wages for their employees instead of offering health insurance or by continuing to offer coverage to their employees. Either way, we know from research that the employee’s overall compensation should stay the same in most cases. There is no mandate on individuals to obtain insurance, but if they did not obtain coverage, they would have to forgo the credit or assistance for insurance. Importantly, the Heritage plan envisions much wider use by employers of auto-enrollment mechanisms in the future, with employees automatically enrolled in a plan as the default option. Research suggests that such an auto-enrollment approach, combined with tax incentives or subsidies, is likely to result in high rates of enrollment under the credit system.Low-Income AssistanceMake available financial assistance for purchasing insurance, equivalent to the tax credit, to households with no tax liability and prorated to those with a tax liability less than the value of the available credit_62692020-39a4-11e2-ae5e-9147cf2fd51511.2Lower-Income Working FamiliesAssistance for Lower-Income Working Families. Financial assistance for purchasing insurance, equivalent to the tax credit, is made available to households with no tax liability and prorated to those households with a tax liability less than the value of the available credit. This money can be used only for purchasing health insurance and typically would be sent directly to the chosen plan in return for a dollar-for-dollar reduction in the premium to the family. This is like the way the government’s contribution to a federal employee’s FEHBP reduces the employee’s premium. Thus, if a family’s tax liability is less than the value of the credit, the family receives assistance partly in the form of a credit (up to its tax liability) with the rest in the form of direct assistance for insurance. If this family’s income rises in subsequent years, the amount it receives as assistance is phased out and the credit amount is phased in, maintaining the same full credit/assistance amount throughout the income change. In contrast to the current patchwork health care model, the Heritage plan streamlines federal assistance to ensure that no families fall through the cracks. For very-low-income families with children earning less than 200 percent of the federal poverty level (FPL), the Heritage plan provides an additional federal subsidy worth $5,500. The full additional subsidy would be available to families up to 133 percent of the FPL and would gradually phase out between 133 percent and 200 percent of FPL. This enhanced subsidy is intended for the traditional, “mandatory” Medicaid populations—the groups that states are required by federal law to include in Medicaid—and the eligibility phaseout is designed to minimize work disincentives, unlike current law, in which Medicaid has a very sharp eligibility cutoff. In 2011, a family of three with an income below $37,000 would meet this threshold. Again, this is paid for with reductions in federal spending. Of course, states may provide additional assistance to low-income families and individuals.Health Savings AccountsReplace health savings accounts with a new Roth IRA savings system._99f74f48-39aa-11e2-9ea8-7d9dcf2fd51511.3Health Savings Accounts. Health savings accounts are replaced by the new Roth IRA savings system under the tax reform features of the Heritage plan. Existing HSAs are grandfathered, meaning that current HSA balances are not taxed when withdrawn, but account owners may make no further deposits in the accounts. However, under the Heritage tax reform, money saved for future health care needs or for any other purpose is no longer double-taxed. In addition, any health credit or health assistance amount not used for premiums and any unused supplemental subsidies can be deposited into a Roth IRA–style savings account and can be used for out-of-pocket health care expenses, including deductibles, co-pays, and other medical expenses. Under the plan, withdrawals from these accounts are not taxed. (See the tax reform proposal.)Medicaid Safety-NetCover low-income nondisabled individuals and families through the credit/assistance._99f756a0-39aa-11e2-9ea8-7d9dcf2fd51511.4Low-Income Nondisabled IndividualsNew Medicaid Safety-Net Program. In the Heritage plan, low-income nondisabled individuals and families currently on Medicaid, are covered through the credit/assistance. Low-income disabled and elderly continue to receive care and assistance through Medicaid. For the Medicaid-eligible elderly and the disabled, federal Medicaid acute and long-term care spending is converted into a capped federal allotment to the state. Total federal Medicaid spending is set at its 2007 levels beginning in 2014, after the recovery is solid and unemployment at a normal level, and is adjusted for medical inflation thereafter. In exchange for the capped federal allotment, states are granted considerable new flexibility to manage and administer the restructured Medicaid program to meet its mutual federal and state objectives. This means that states are granted broad discretion and authority to meet general objectives and outcome measures. States that wish to try very different approaches to better serve and improve health care quality for these key populations would have additional authority beyond the normal waiver process. While states receive an allotment from the federal government, they still need to use their own funds to achieve agreed goals for providing care and services for the elderly and disabled on Medicaid. However, if states use innovative approaches that require less state spending than is now the case under the current Medicaid formula that determines the state share (known as FMAP), they can keep the savings and spend them on state priorities or provide tax breaks to their citizens.Discretionary & Small Entitlement ProgramsTake action on discretionary programs and smaller entitlement programs to reach a balanced budget and ensure that federal spending is smaller, more effective, and more efficient._99f75a1a-39aa-11e2-9ea8-7d9dcf2fd51512Additional Major Spending Reforms -- Summary: Over the past decade, Congresses and Presidents have undertaken a surge of spending that has accelerated America’s speed along the road to economic ruin. Since 2000, non-defense discretionary outlays have expanded 50 percent faster than inflation. Antipoverty spending has risen 83 percent faster than inflation, and other programs have grown rapidly. Despite multiple government audits that have shown many programs to be duplicative or ineffective, no significant federal program has been eliminated in more than a decade. Government continues to grow, financed by taxes on Americans and an explosion of borrowing that is imposing huge additional burdens on future generations. Thus, although the major entitlement programs are the primary driver of long-term spending and debt, Congress must take tough action on discretionary programs and smaller entitlement programs to reach a balanced budget and ensure that federal spending is smaller, more effective, and more efficient. Under the Heritage plan, non-defense discretionary spending—appropriated programs such as foreign aid, K–12 education, transportation, health research, housing, community development, and veterans health care, which account for 4.5 percent of GDP—is reduced to 2.0 percent of GDP by 2021. These reforms will reduce the burden of government, thereby empowering families and entrepreneurs and promoting economic prosperity. In addition, antipoverty spending is reformed. Obamacare is repealed, as noted earlier, and replaced with an alternative solution to uninsurance and high costs. Agriculture and education programs are structurally reformed. The central goal for defense is to guarantee national security as prudently and economically as possible. With improvements in efficiency, we estimate that defense needs will require spending approximately 4 percent of GDP for the foreseeable future. Rather than across-the-board spending reductions, which would not set true priorities for government, the Heritage plan follows six guidelines in designing reforms: * The federal government should focus on performing a limited number of appropriate governmental duties well while empowering state and local governments, which are closer to the people, to address local needs creatively in such areas as transportation, justice, job training, the environment, and economic development. * Functions that the private sector can perform more efficiently should be transferred to the private sector. * Duplicative programs should be consolidated both to save money and to improve government assistance. * Federal programs should more precisely target those who are actually in need, which means reducing aid to large businesses and upper-income individuals who do not need taxpayer assistance and enforcing program eligibility rules better. * Outdated and ineffective programs should be eliminated. * Waste, fraud, and abuse should be cleaned up wherever found. By following these six guidelines, the Heritage plan produces a more effective and efficient government and promotes stronger economic growth.Non-Defense Discretionary SpendingReturn most non-defense discretionary spending to 2008 levels. _99f75cd6-39aa-11e2-9ea8-7d9dcf2fd51512.1Returning Most Non-Defense Discretionary Spending to 2008 Levels. Non-defense discretionary spending has expanded 21 percent faster than inflation over the past three years. Returning to 2008 levels still leaves typical programs nearly one-third larger than they were in 2000 (adjusted for inflation). Freezing this spending at 2008 levels through 2015 and then capping subsequent growth at the inflation rate would save more than $2 trillion in the first decade and even more thereafter. Many of these savings are achieved by reducing the size of the federal bureaucracy, overhauling the federal pay system, permanently eliminating many earmarked accounts, and consolidating duplicative functions. Yet not all programs are affected equally. For example, Coast Guard and other important security spending rises under the plan, while lower-priority spending, such as subsidies to public broadcasting, AmeriCorps, the National Endowment for the Arts, and the National Endowment for the Humanities, is left to the private sector.Transportation SpendingDevolve or Privatize most transportation spending._99f760dc-39aa-11e2-9ea8-7d9dcf2fd51512.2Devolving or Privatizing Most Transportation Spending. Under the federal highway program, Washington collects the 18.3 cents-per-gallon gas tax from states, subtracts a large administrative fee, and returns the remaining funds to the states with numerous strings attached, including many requirements to spend the dollars on congressional earmarks and for specific uses that may not coincide with local needs. The Heritage plan reforms this inherently wasteful system by devolving the highway program and gas tax to the states, thereby eliminating the federal middleman and allowing states to retain the gas tax revenues and spend them on their own highway priorities, provided they maintain a minimum standard of interstate highway maintenance. The Heritage plan ends federal funding for passenger rail, saving money on projects that invariably have ridership that is far below projections and costs that far exceed initial budgets. Amtrak subsidies are phased out over three years, the President’s costly high-speed rail program is terminated, and subsidies to for-profit freight railroads are ended. This relieves states of the upkeep and maintenance burdens associated with rail programs that Washington is currently pressuring them to undertake. The private sector and state governments can either take over or terminate these rail programs as they see fit. Finally, all non-safety functions of the Federal Aviation Administration (FAA) are transferred to the private sector, and most FAA fees are eliminated. The air traffic control system will be transferred to the private sector, where it belongs, and financed by flight ticket user fees. The airport improvement program is also terminated, with airlines, state government, and private investment taking the place of the federal taxpayer.Education SpendingScale back K–12 education spending and reform higher education spending. _99f763f2-39aa-11e2-9ea8-7d9dcf2fd51512.3Scaling Back K–12 Education Spending and Reforming Higher Education Spending. Federal spending on K–12 education has grown 192 percent faster than inflation since 2000, yet this sharply increased federal spending and federal micromanagement of school districts has not improved student performance. Under the Heritage plan, total federal K–12 spending is reduced to 2000 levels (adjusted for inflation), in part by eliminating many of the numerous small education programs that Washington uses to micromanage school districts. This will allow states and school districts to manage and meet the needs of their students more effectively. Higher education reforms, including the new deduction for college tuition in the Heritage tax reform, ensure that students receive enough financial assistance to attend college. Shifting from grants to student loans ensures that most college costs will be financed by the college graduates themselves, who benefit the most from their degrees, and not by other Americans. However, thanks to a key provision in the Heritage plan’s tax reform, higher education costs are partially defrayed through the simplified and generous tax deduction for higher education tuition. Families whose incomes are too low for them to benefit fully from this tax deduction are eligible for a Pell Grant with a value up to the tax deduction. The direct student loan program is retained with loan limits high enough to guarantee college access but with rates set to ensure that there are no budgetary costs, including the costs associated with deferred repayment until graduation as well as the costs of loan forgiveness programs. Thus, all Americans will have access to financial aid in attending college, but it will not be a free ride at the taxpayers’ expense.Public Health Service SpendingMake public health service spending more efficient._99f766c2-39aa-11e2-9ea8-7d9dcf2fd51512.4Public Health ServiceMaking Public Health Service Spending More Efficient. Public health service spending has grown 56 percent faster than inflation since 2000. While health research is vital, the Heritage plan eliminates waste and inefficiencies that have accumulated. For example, by consolidating redundant facilities and laboratories, the Heritage plan saves the National Institutes of Health $1 billion annually. States take over the financing and operation of health centers, health professions programs, and the substance abuse block grant. The Centers for Disease Control and Prevention sees savings over $2 billion annually by reducing travel, ending questionable public campaigns, and focusing its role on interstate coordination. Finally, converting Indian Health Service aid into a premium-support system (where possible) and reforming the Food and Drug Administration save a combined $1 billion annually.Defense SpendingFund an adequate defense. _99f76ae6-39aa-11e2-9ea8-7d9dcf2fd51512.5Funding an Adequate Defense. The most important core function of the federal government is ensuring America’s national security, but it needs to be accomplished as economically and efficiently as possible. The Defense Department will focus on identifying and addressing its significant levels of wasteful spending and initiating significant reforms and efficiencies in logistics and acquisition processes so that those funds can be reprioritized into the most important uses to protect America and our allies by maintaining a strong, modern, and effective military. The war on terrorism has increased defense spending to approximately 5 percent of 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 plan recognizes that predicting precise funding requirements for overseas contingency operations is impossible, it is reasonable to expect that the phasedown in those efforts will permit reducing defense spending to approximately 4 percent of GDP and maintaining it at that level. Ultimately, of course, defense spending will have to be whatever it takes to protect America and its interests around the globe. While this proposal for maintaining sufficient levels of defense spending assumes that future military personnel will be brought under the broader proposals for health care and retirement reform outlined in this report, it also provides for tailored transition options for current military personnel and retirees. Importantly, reforms in compensation and benefits must maintain effective recruitment and retention of, and honor reasonable commitments to, members of the armed forces.Obamacare.Repeal Obamacare._99f76e06-39aa-11e2-9ea8-7d9dcf2fd51512.6Repealing Obamacare. If fully implemented, Obamacare will add trillions of dollars in long-term government spending to a health care system that is already unaffordable. It also increases federal controls and mandates and will impose heavy costs on states, businesses, and households. As noted earlier, the Heritage plan repeals Obamacare and replaces it with the improved, consumer-centered health care system.Farmer Savings AccountsReplace farm subsidies with farmer savings accounts._99f7734c-39aa-11e2-9ea8-7d9dcf2fd51512.7FarmersReplacing Farm Subsidies with Farmer Savings Accounts. Intended to remedy low crop prices and farmer poverty, the current farm subsidy system does neither. Farm subsidies encourage overplanting, which drives prices down further, necessitating even more subsidies. Moreover, rather than focusing on low-income farmers, most farm subsidies go to commercial farmers who report an average annual income of nearly $200,000. Claims that the agriculture industry could not survive without large subsidies are contradicted by the fact that nearly all subsidies go to growers of just five crops (wheat, cotton, corn, soybeans, and rice), while fruit, vegetable, livestock, and poultry operations thrive with almost no government aid. The real problem—yearly income fluctuations due to crop and weather unpredictability—can be solved inexpensively with farmer savings accounts. Under the Heritage plan, growers of all crops, not just the “big five,” can save money during boom years in tax-deductible IRA-style accounts and withdraw those funds during bust years as taxable income, thus smoothing out their yearly income fluctuations. An improved no-net-cost crop insurance system will assist when major disasters deplete most farmers’ accounts. All farmers can participate in the new system regardless of income or crop grown and at a fraction of the current cost to taxpayers.Antipoverty SpendingCap and reform antipoverty spending._99f777ac-39aa-11e2-9ea8-7d9dcf2fd51512.8Capping and Reforming Antipoverty Spending. Since 1990, federal antipoverty spending, including Medicaid, has expanded 236 percent faster than inflation, from $190 billion to $639 billion (an increase of 2.2 percent of GDP). Antipoverty spending has grown as much as Social Security, Medicare, defense, and education spending combined. Overall, the federal government spends approximately $28,000 per family with children in the bottom third of the income table without encouraging independence. Many of the programs do not include enforced work requirements and continue to reward illegitimacy and other destructive behaviors that block the road to independence. Once the unemployment rate drops back to normal levels (projected in 2014), the Heritage plan returns total federal antipoverty spending to its 2007 level (adjusted for inflation) and then caps total spending growth at the inflation rate (using the medical inflation rate for the health care portion). Congress or states could shift spending among antipoverty programs to increase effectiveness as long as total spending does not exceed the cap. This cap and flexibility will force lawmakers at all levels to reexamine the size and goals of the welfare state and tailor assistance more efficiently to help families escape poverty and dependence and achieve independence.State & Local ProgramsReturn federal programs to the state or local levels._99f77af4-39aa-11e2-9ea8-7d9dcf2fd51512.9State GovernmentsLocal GovernmentsOther Spending Reforms. Multiple federal programs should be returned to the state or local levels. For instance, there is no compelling reason for Washington to finance local job training, justice, environmental, or community and economic development programs. Therefore, the plan eliminates these federal grant programs with the expectation that state and local governments will determine whether to address these local issues with local funds and be held accountable by local voters. Energy research and development spending that is commercial in nature is moved to the private sector. Lawmakers are also expected to pare $15 billion in costs associated with the estimated $125 billion in annual federal payment errors. Asset SalesSell at least a portion of the federal assets, especially those that are currently generating revenue below market levels._99f77e00-39aa-11e2-9ea8-7d9dcf2fd51512.10Asset Sales. The federal government currently owns and controls vast assets, including huge swaths of commercial land, especially in the West; power generation facilities; valuable portions of the electromagnetic spectrum; underutilized buildings; and financial assets. Given the federal government’s huge debt, it makes sense to sell at least a portion of these assets, especially those that are currently generating revenue below market levels (in which case the sale value would be above the present value of the current income on the assets). Sales of assets would immediately reduce the government’s operating deficit and debt, reducing future interest costs. The Heritage plan includes a program of asset sales totaling approximately $260 billion over 15 years. This includes partial sales of federal properties, real estate, mineral rights, the electromagnetic spectrum, and energy-generation facilities.Federal Budget ProcessReform the federal budget process._99f7826a-39aa-11e2-9ea8-7d9dcf2fd51512.11Reforming the Federal Budget Process. When Congress established its current budget process in 1974, the United States was in debt by about a half-trillion dollars; it is now in debt over $14 trillion. Regrettably, for any proposal to deal with the nation’s fiscal problems, the budget process does little to help and in many ways impedes good and bold policy. For one thing, its focus on just 10 years diverts lawmakers from dealing with the mounting long-term challenges, such as retirement programs. For another, the lack of firm budget controls and enforcement procedures makes fiscal discipline very difficult. Reforming the budget process is therefore an implicit part of reforming the budget itself. In the Heritage plan, we change the budget process to impose enforceable caps to reduce total federal spending to 18.5 percent of GDP by 2021 (including entitlement programs) and then keep spending at that level. Within those overall caps we also cap non-defense discretionary spending at 2.0 percent of GDP. Anti-poverty spending is also capped, as described above. These statutory restrictions on future spending are to be no higher than the modern historical level of federal revenues. We also propose amending existing federal laws that provide permanent or indefinite appropriations for federal agencies or programs (including and especially entitlement programs), or that allow agencies or programs to spend funds they receive from fees or other sources, rather than depositing them in the U.S. Treasury, so as to retrieve congressional control of spending for those agencies and programs. Within our specific reforms for Medicare and Medicaid we also include a fixed budget amount for each program. To make the budget process more visible, understandable, and accountable to the American people, we require Congress to estimate and publish the projected cost over 75 years of any proposed policy or funding level for each significant federal program. Any major policy change should also be scored over this long-term horizon. Finally, in addition to calculating the costs of proposed congressional actions without regard to the response of the economy to those actions (known as “static” scoring), we require a parallel calculation that takes account of that response (known as “dynamic” scoring) so as to make more practical and useful cost information available to Congress when it decides whether to pursue the actions.Tax ReformReplace the individual income tax with a new flat-rate tax applied to income after deducting all savings and replace the business tax code with a flat business tax on domestic sales of goods and services._99f785d0-39aa-11e2-9ea8-7d9dcf2fd51513Tax Reform -- Summary: The existing tax system is manifestly indefensible, especially in its complexity and its drain on economic vitality. The complexity of the tax system plagues taxpayers in all walks of life. Low-income citizens must navigate the enormously complex Earned Income Credit. Those who save must sort through multiple tax rates and tax regimes for different kinds of returns on those savings, and there is a multitude of phaseouts of various credits, exemptions, and deductions. As if this were not bad enough, Congress created a parallel income tax called the Alternative Minimum Tax, so millions of taxpayers must figure their taxes two different ways before they can know what to pay. Yet these difficulties suffered by taxpayers are relatively minor compared to some of the tortuous rules and exceptions inflicted on businesses large and small. The drain inflicted on economic vitality is even worse than the tax code’s complexity. High marginal rates discourage all manner of productive activity. The U.S. corporate income tax rate is the second-highest in the industrialized world and much higher than the average tax rate of our international competitors. The current tax system actively discourages citizens from saving enough for retirement, emergencies, or the large purchases in life, thus driving them toward consumer debt. In turn, it artificially depresses the level of national savings and makes domestic investment more dependent on foreign investment. For decades, Congresses have tweaked and twisted a fundamentally flawed system into knots, each time creating two new problems while attempting to solve one old one. The income tax was a poor choice from the outset, and Congress after Congress has consistently made it worse. The federal tax system need not be so complex or damaging to our economy, nor should it be. A stronger economy means higher wages for American workers and better returns for America’s savers. A stronger economy means better opportunities for college graduates and better economic security for families. It means that American companies and workers can compete more effectively in the global economy. And a stronger economy is a more resilient economy, able to withstand and overcome the inevitable economic shocks of tomorrow. A stronger economy also plays a vital role in improving federal finances. It means sustained, normal levels of tax revenues and a lower level of spending to meet the needs of those who are temporarily distressed because of unemployment. A stronger economy offering better wages and better job opportunities is also the most powerful antidote to persistent poverty, and less poverty reduces the demands for anti-poverty spending. Without a stronger economy, we will not solve our long-term problems of federal overspending and overborrowing. Thus, tax reform to spur economic growth is a critical component of the Heritage plan. In broad terms, to promote growth, the federal tax system must be: * A single, low rate system to collect needed revenues without unnecessarily distorting economic decision making. * Simpler and far more transparent. A simple, transparent tax is needed so that taxpayers can anticipate and plan for the tax consequences of their actions and easily understand the full extent of their tax burden. It also provides greater confidence that other taxpayers are not exploiting tax complexities to underpay their taxes. * Neutral between savings and investment. Unlike the current system, it must not impose multiple levels of taxation on saved income. Treating savings neutrally gives individuals greater control of their economic futures while ensuring that the economy has the raw financial material to grow and encourages Americans to invest their savings in the most productive ventures. * Levied in a way that minimizes tax distortions and perverse incentives. This allows prices and market forces—not intentional or inadvertent government meddling—to decide how best to grow the economy. It also helps to keep the tax system simple. * Capable of collecting revenues equivalent to 18.5 percent of the economy. The modern average of tax revenue under normal economic conditions is approximately 18.5 percent of GDP. This is the upper 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 strong economy and to restrain the growth of government. Using these essential elements, the Heritage plan will transform the current tax system into a modern flat tax that taxes individual income only once and replaces all federal income taxes, all payroll taxes, the death tax, and virtually all excises. Specifically, for individuals, the current system will be replaced with a new flat-rate tax applied to income after 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 that individuals pay taxes only on what they withdraw from the economy and not on savings that they make available for investment in the economy by others. Today’s business tax code will be replaced by a flat business tax on domestic sales of goods and services with deductions for labor costs and purchases from other businesses, including expensing of capital purchases. All business activity, including corporate, will be taxed under the new flat business tax.Single RateInstitute a simple, single-rate tax on individuals and businesses._99f788f0-39aa-11e2-9ea8-7d9dcf2fd51513.1A Unified Single Tax Rate. The Heritage tax reform plan is far more comprehensive than previous well-known tax reform proposals. Typical of many tax reform proposals, our plan replaces today’s individual and corporate income tax systems and eliminates the death tax. In lieu of the current motley collection of taxes, this plan institutes a simple, single-rate tax on individuals and businesses. It also folds today’s federal payroll taxes financing Social Security and Medicare into the new system, establishing a single tax rate for all taxpayers. In addition, it replaces all federal excise taxes except those dedicated to specific trust funds, such as the gasoline tax, which would be retained until that tax and its associated highway program are devolved to the states.Revenue StreamRaise a permanent revenue stream of up to 18.5 percent of the economy as measured by GDP._99f78d8c-39aa-11e2-9ea8-7d9dcf2fd51513.2Tax Rate. The tax system is designed to raise a permanent revenue stream of up to 18.5 percent of the economy as measured by GDP. With the design characteristics of this new tax system, we estimate that the statutory individual and business tax rate will likely eventually be between 25 percent and about 28 percent under traditional scoring methods. This is comparable to or significantly below the typical rate facing an individual or family today. Most working families today are subject to a 15.3 percent payroll tax rate on wages and salaries plus a 10 percent, 15 percent, 25 percent, or 28 percent individual income tax rate for a combined rate of 25.3 percent, 30.3 percent, 40.3 percent, or 43.3 percent.SimplificationTax uniformly all income sources that are spent on consumption._99f7911a-39aa-11e2-9ea8-7d9dcf2fd51513.3 A Simplified System. The basic structure of this tax plan is simple. With its single rate, it taxes uniformly all income sources that are spent on consumption. This means that taxable income includes all labor compensation and all net borrowings. The net amount put aside in savings is then subtracted to determine net taxable income. Thus, the more individuals or families save, the lower their taxes; they pay tax on savings only when savings are used to pay for goods and services. However, the new tax system does not tax government transfers explicitly associated with low-income citizens, such as welfare, health care assistance, and similar programs. Ultimately, when the Social Security and Medicare programs are fully reformed, the Social Security checks and premium support that seniors receive will not be taxed either. In the Social Security and Medicare transition periods, a portion of the benefits of some seniors will be taxed if their income is above a certain amount, just as many seniors’ Social Security is taxed today. Thus, the new tax system offers individuals and families a comparable or lower tax rate and vastly improves their savings incentives to build wealth and ensure their own financial security. It simultaneously improves the ability of the economy to raise wages and provide more job opportunities. And filling out tax forms will be a lot simpler.After-Tax Dollar SavingsPermit taxpayers to contribute after-tax dollars to an account, contributing as they choose until the account balance reaches $100,000._99f7946c-39aa-11e2-9ea8-7d9dcf2fd51513.4TaxpayersAn Alternative Option for Savings. For some purposes, many taxpayers today prefer to save after-tax dollars as permitted through the current-law Roth IRA rather than paying tax when funds are withdrawn as under today’s traditional IRA. This Roth-style alternative maintains the principle of a single incidence of taxation but may result in further increased saving by giving savers an additional option. To allow such accounts for those who feel they need them, the plan permits taxpayers to contribute after-tax dollars to an account, contributing as they choose until the account balance reaches $100,000, with a limit of one account per adult taxpayer. The income earned on the account is tax-free, and disbursements from the account are tax-free for any purpose.Deductions & CreditsAllow only three types of deductions._99f7998a-39aa-11e2-9ea8-7d9dcf2fd51513.5Few Deductions or Credits. Under the Heritage tax plan, the individual income tax has only three deductions instead of the legion of deductions under current law: * Higher education. Recognizing the role of higher education as a form of saving and investment in human capital, a deduction is allowed for tuition and expenses for higher education up to the average annual cost at a four-year public college or university. * Charitable donations and other gifts. Since the tax is levied on consumption, gifts are not taxable until they are spent by the recipient. Thus, per current law, gifts to nonprofit organizations are tax deductible if the organization is recognized as tax-exempt for tax purposes. Gifts to individuals and transfers through inheritance are deductible and become taxable to the recipient only when spent on consumption. And there is no death tax. * Mortgage interest. As under current law, homeowners can deduct mortgage interest while the lender continues to be taxed on mortgage interest income. Homeowners are also given the option of forgoing the deduction, in which case the lender is not taxed on mortgage interest income and market pressure would encourage the lender to offer a lower mortgage interest rate. Tax ReliefProvide substantial tax relief to low-income workers and families._99f79d36-39aa-11e2-9ea8-7d9dcf2fd51513.6Low-Income WorkersProtections for Low-Income Working Households. Current law hits low-income workers and others with the full weight of today’s payroll taxes, whatever their wage and salary income may be. The Heritage tax plan folds all payroll taxes—or FICA—into the single tax system. It then eliminates all income tax on low-income workers through the health insurance tax credit described above (a $3,500 nonrefundable tax credit for families and $2,000 credit for individuals). In addition, the Earned Income Credit is retained as part of the overall system of financial support for low-income Americans. Further, the calculation of taxable income excludes all other cash and noncash benefits provided by the federal government through its anti-poverty programs, such as food stamps. The net effect is that, compared to current law, this plan provides substantial tax relief to low-income workers and families.Low-Income SeniorsProtect low-income seniors._99f7a092-39aa-11e2-9ea8-7d9dcf2fd51513.7Low-Income SeniorsProtecting Low-Income Seniors. For Medicare-eligible senior citizens, the measure of taxable income is modified to ensure that the flat benefit amounts for Social Security and the Medicare defined contribution are tax-free. Thus, lower-income seniors will not be pushed back into poverty by the tax system after Social Security and Medicare have lifted them out of poverty. As noted earlier, during the lengthy transition period for the Heritage plan’s Social Security reform, some seniors above certain incomes with relatively high benefits will pay tax on part of those benefits, but they will pay less than many do today. Thus, this tax plan includes three important senior-specific features: * During the transition to the new Social Security and Medicare systems, all seniors have a “senior’s standard exclusion” amount equal to the sum of the flat Social Security benefit amount plus the value of the Medicare defined contribution. This exemption amount will be approximately $22,500 per senior in 2015. This provision ensures that seniors protected from poverty by the Social Security and Medicare reforms are not again placed at risk by losing some benefits through taxation. As explained earlier, when the benefits reforms are fully implemented, the amount received by a senior will not be taxed. * Encouraging seniors to stay in the workforce longer is important both for their own financial security and for the health of the economy. To achieve this, the first $10,000 of a senior’s wages and salary is excluded from tax. This provision is especially important for low-income and middle-income seniors. * Because they are on Medicare and have the seniors’ standard exclusion to protect low-income seniors from tax, seniors do not qualify for the health insurance tax credit described above.Social Security and Medicare Trust FundsProtect the Social Security and Medicare trust funds._99f7a786-39aa-11e2-9ea8-7d9dcf2fd51513.8Protection for the Social Security and Medicare Trust Funds. The tax system leaves in place the existing wage income reporting systems. Even though the existing payroll taxes are eliminated, the revenues they would have raised are credited appropriately to the Social Security and Medicare trust funds as per current law.Business TaxTax businesses by a levy on domestic net cash flow._99f7ab82-39aa-11e2-9ea8-7d9dcf2fd51513.9Taxation of Businesses. The tax on businesses is a simple levy on domestic net cash flow so that all compensation provided to employees and all purchases from other businesses are deducted from gross domestic receipts. In addition to its great simplification compared to the current income tax, this means that businesses can immediately deduct purchases of new productive equipment, thus eliminating a tax bias against business investment. All other special provisions and credits in existing law are repealed except for the Alternative Simplified R&D tax credit, which is retained in its current form. Family businesses in particular are able to grow without the uncertainty or burden of dealing with the death tax, which is repealed. After a brief transition period, the tax rate on businesses matches the rate for individuals. During the transition period, the tax rate on businesses declines from current law, 35 percent, a percentage point per year until the business tax rate matches the individual rate. From that point forward, individual and business rates will be the same The business tax base includes only income generated by domestic sales of goods and services. It excludes all foreign-source income, which is taxed in the foreign jurisdictions according to their laws and systems. The tax is also border-adjustable, which means that the federal taxation of exports and imports is adjusted to level the playing field between foreign and domestically produced goods and services. Specifically, the domestic tax is lifted from exports and levied on imports, normalizing tax levels between countries much as a series of locks on a canal raises or lowers boats so they can travel from point to point.TransitioningTransition taxpayers from the old tax system._99f7afe2-39aa-11e2-9ea8-7d9dcf2fd51513.10TaxpayersTransition Arrangements. Special care is needed in transitioning taxpayers from the old tax system to this Heritage tax plan. For example, it is important that taxpayers are not subject to an extra tax burden solely because of the transition. This would amount to retroactive taxation because the higher tax burden would arise from actions taken before tax reform. Thus, all current-law accrued tax “assets”—such as interest on pre–tax reform debt, including existing home mortgages, depreciation, and accrued tax credits—are applicable to taxable income or tax liability under the new tax system until the tax assets are exhausted. As noted above there will be a period over which the business tax rate declines until it matches the individual rate. The shift to taxing only what businesses earn domestically is an important simplification and an important step toward improving international competitiveness. However, many businesses have accrued foreign tax credits under current law that would be inapplicable under the new tax system. To provide adequate time to adjust, businesses will have the option of being taxed under the current system of worldwide taxation for up to 10 years after the enactment of tax reform. It is important to avoid retroactive taxation, but it is equally important to avoid creating tax windfalls caused merely by transitioning from one tax system to another. This would occur especially with respect to savings prior to tax reform (“old savings”), which are invested in various assets generating income streams and capital gains that are subject to immediate taxation at current rates. These tax windfalls, which would be similar to winning a tax lottery, would tend to benefit the wealthiest taxpayers and erode the tax base, thus necessitating a higher tax rate. Thus, a transition system is provided to prevent tax windfalls by ensuring that old savings remain subject to current levels of taxation. In the transition to the new tax system, employers will furnish their employees with a statement on how they will handle that part of the employee’s compensation that currently takes the form of the “employer’s share” of payroll taxes paid to the Treasury. The options in the statement could include, among others, an adjustment in the employee’s cash compensation, a contribution to the employee’s savings or retirement account, or an allocation of the money to the employee’s income tax withholdings. The Department of Labor would make template forms available on its Web site for employers to use. After the transition, when compensation and tax withholdings are fully adjusted, no further statements would be necessary.2011-05-102012-11-28http://www.heritage.org/research/reports/2011/05/saving-the-american-dream-the-heritage-plan-to-fix-the-debt-cut-spending-and-restore-prosperityOwenAmburOwen.Ambur@verizon.net