Want to know why caps on federal spending will never work? Just take a look at proposed Medicare vouchers that are included in the House-passed 2012 budget framework.  Faced with an arbitrary ceiling on spending, a determined Congress could easily turn those subsidies into tax credits. They’d  be exempt from spending limits but still add billions of dollars to the deficit.  

Here is the story: The House Republicans want to convert Medicare from an entitlement program into a direct government subsidy—sometimes described as a voucher or, in polite society, “premium support.”  Either way, instead of directly paying for the health care of seniors as it does today, Washington would cut a check for everyone 67 or older (the new age of eligibility in the GOP plan). Seniors would use the money to buy insurance on the private market.

So what does all this have to do with spending caps? It is simple. If the Department of Health & Human Services cuts the checks, these vouchers would be considered spending and thus subject to a spending cap such as the one proposed by senators Claire McCaskill (D-MO) and Bob Corker (R-TN).

But government doesn’t have to spend money directly to fund senior health care. Instead, could subsidize health insurance another way—through refundable tax credits.  And if that happens—if, in effect, the IRS writes the checks instead of HHS—a big chunk of the subsidy would morph into a tax cut. And, lo and behold, hundreds of billions of dollars in federal subsidies would be exempt from a spending cap.

Yet, the deficit would be exactly the same whether Congress chose to provide that assistance through direct spending or through a refundable credit. A subsidy of, say, $300 billion, would add $300 billion to the deficit no matter where it lived on the fiscal ledger.   

Under current budget conventions, the refundable portion (that is, the piece of the credit that goes to recipients who already pay no tax) is considered spending.  But there is no way to know today how much of the credit would be refundable, or even whether budget process reform would change those rules.      

We do know that the consequences of running a voucher program through the tax code could be enormous. McCaskill and Corker would cap spending at 20.6 percent of Gross Domestic Product by 2023. Medicare spending alone would exceed one-third of that, or more than 7 percent of GDP. Thus, shifting even part of Medicare from the spending side of the budget to the tax side would be a very big deal for fiscal politics even though it would not matter one bit when it comes to actual deficits.      

Such a step would have all sorts of very weird consequences, however. For example, while many conservatives express outrage at the number of households who pay no income tax, subsidizing seniors’ health insurance premiums through the tax code would drive more people off the tax rolls. At a time when politicians are, rhetorically at least, dialing up their criticism of tax expenditures, operating vouchers as refundable credits would create a massive new one. Most perverse of all, to the degree these vouchers are treated as tax cuts, they could even free up more spending dollars–even under an outlay cap.  This, of course, is why Democrats would likely insist on using a tax mechanism as their price for supporting such big Medicare changes.

Would a Medicare subsidy program be run through the tax code? I have no idea, although it is worth noting that the U.S. has some history here. See, for instance, the exclusion for employer-sponsored health insurance premiums as well as many provisions of the 2010 health law. 

I do know, however, that a refundable senior health care tax credit could well be the poster child for what is wrong with spending, as opposed to deficit, caps.

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