The Washington Post has a story today saying that ending retirement savings tax expenditures would save little money. The argument is a familiar one, and one that requires an understanding of how tax expenditures are scored.
The article cites a study by the American Society of Pension Professionals and Actuaries, which finds that limiting tax expenditures for retirement saving would not save very much, despite large yearly estimates in lost revenues for the federal government. Because 401(k)s have only been around for a few decades, tax-free contributions to these plans significantly exceed taxable withdrawals, making the tax expenditure appear larger than it will save.
This may be true, but the article makes this point--that tax expenditures don't save as much as we think--for the cutting of other tax breaks as well (the title in the print version reads "Ending tax breaks won't fix budget, study says"). As the article states:
For example, if the mortgage interest deduction were eliminated, people would probably shift their investments to other tax-preferred vehicles, thereby denying the tax man a portion of his expected rewards, said Ed Kleinbard, a former director of the congressional Joint Committee on Taxation, which, along with the Treasury, estimates the value of federal tax expenditures.
It's likely that eliminating an individual tax expenditure would save less than it currently costs the government, since taxpayers could shift towards other tax preferred activities. The $1 trillion estimate that we see from Treasury or JCT simply measures how much revenue we forgo each year by having these breaks in place. It says little about how much we save from doing away with individual tax breaks.
Regardless, though, even when we talk about individual tax expenditure changes, it is clear that they will save a significant chunk of change. For example, eliminating the deduction for state and local taxes would save $97 billion in 2016 (according to CBO's Budget Options), while the estimate for the size of the deduction in 2016 is $98 billion. Or consider the charitable deduction, as we did on Friday. Simply putting a two percent of income floor on the deduction would raise $23 billion in 2016, or one-third of the size of the deduction in that year. Also, note that these are actual cost estimates, which account for the effects of taxpayers responding to these changes.
However, we know that comprehensive reform of tax expenditures would minimize the differences between static cost estimates for various expenditures and the savings potentially achieved by reducing or eliminating them. Simply put, the fewer preferences there are in the tax code, the fewer places there are for taxpayers to put their money in an effort to lower their tax burden. Thus, the shifting that might occur if we eliminate only one large tax expenditure would be less pronounced if we get many of them in one fell swoop, as some fiscal plans have proposed.
And even if potential savings don't quite reach the sum of the current cost estimates for various expenditures, the totals would still be significant, as we showed in a paper looking at some potential reforms to certain tax expenditures. Revenues will have to be part of the equation if there is to be a bipartisan deal on a long-term debt reduction package. Raising revenue by scaling back or eliminating tax expenditures would have the added benefit of simplifying the tax code. Cleaning up the code would help make our tax system fairer and more efficient, especially if the tax breaks on the chopping block are poorly targeted, overly generous, or distributionally upside-down.
Though recent discussion about "spending in the tax code" has brought fresh attention to tax expenditures, much of the discussion has been about how to deal with them comprehensively. For example, CRFB President Maya Macguineas recently put out a plan with Martin Feldstein and Daniel Feenberg to limit how much an individual could collect in tax expenditures, and the Fiscal Commission proposed a Zero Plan to wipe out most of the tax expenditures and use a portion of the money for rate reduction. However, it is also useful to break down some of the bigger tax breaks and examine them individually. Fortunately, CBO provides us with a new report outlining options for changing the charitable deduction.
The charitable deduction, for donations to qualified nonprofit organizations, is one of the larger tax expenditures in our tax code -- OMB estimates that it will cost over $300 billion in the next five years. And although the goal of promoting charitable giving is certainly a noble one, a number of policies have the potential to reduce the cost of the deduction while continuing to promote charitable giving.
CBO's options break down into four categories:
- Adding a floor to the current deduction
- Making the deduction available to taxpayers who don't itemize
- Replacing the deduction with a 25 percent non-refundable credit
- Replacing the deduction with a 15 percent non-refundable credit
Each of the latter three options come in three variations: no floor, a $500 floor ($1,000 for families), or a two percent of income floor. The floor would make it so the tax benefit would not be available on the first dollar of charitable giving, and instead would only be available on giving above that floor (for example, an individual who gives $600 under the 25 percent credit/$500 floor scenario would recieve a tax subsidy of $25 -- 25 percent of their last $100). Many economists see a floor as a very efficient way to limit the subsidy, since it would be unlikely to impact incentives on the margins but could still limit the "windfall subsidy" for charitable giving which would have been done anyway.
For each option, CBO estimates the savings/costs and the impact on charitable giving in 2006. The budget impact ranges from increasing the 2006 cost by $7 billion (25 percent credit, no floor) to reducing the cost by $25 billion (15 percent credit, two percent floor).
We've attempted to roughly re-estimate those savings if the policy were to be in effect over the next decade.
|Charitable Deduction Options|
|Option||2012-2021 Savings (billions)
||Percent Change in Subsidy||Percent Change in Giving
|Two Percent of AGI Floor||$220||-38.5%||-1.5%|
|Extend Deduction to All Filers||-$70||12.8%||1.0%|
|Extend Deduction With $500/$1000 Floor||$30||-6.1%||0.4%|
|Extend Deduction with Two Percent Floor||$180||-32.1%||-0.9%|
|Convert to 25 Percent Credit||-$100||17.4%||1.3%|
|25 Percent Credit With $500/$1000 Floor||$30||-5.8%||0.7%|
|25 Percent Credit With Two Percent Floor||$170||-29.2%||-0.5%|
|Convert to 15 Percent Credit||$190||-32.6%||-3.9%|
|15 Percent Credit With $500/$1000 Floor||$270||-46.5%||-4.2%|
|15 Percent Credit With Two Percent Floor||$340||-60.1%||-4.9%|
CBO's numbers bear out the fact that limiting the charitable deduction, especially through the use of a floor, would have a very limited effect on giving compared to the savings. For example, enacting a 25 percent credit with a 2 percent of income floor would reduce charitable giving by $1 billion but would save $12 billion. Note that two of the deficit-reducing options, both involving the $500/$1,000 floor, would actually increase charitable giving. And even for the options that reduce charitable giving, the government could, for example, directly spend on causes that are typically supported by charitable organizations--offsetting, and then some, the decrease in donations--and still have money left over to reduce the deficit.
Two of the major bipartisan plans out right now, the Bowles-Simpson Fiscal Commission plan and the Domenici-Rivin Debt Reduction Task Force plan, would both make changes to the charitable deduction along these lines. The Fiscal Commission's illustrative tax plan would replace the deduction with a 12 percent credit with a floor at two percent of AGI, for savings similar to the most stringent option. The Domenici-Rivlin tax reform plan would simply replace the deduction with a 15 percent refundable credit with no floor. Both of these options would limit the subsidy for high earners and make it available to non-itemizers while significantly reducing the expenditure's cost.
In addition, our Let's Get Specific paper on tax expenditures recommends instituting a floor at two percent of AGI for the current deduction.
The charitable deduction is just one of many tax expenditures that need to be scrutinized in any serious budget debate. Many of these tax breaks are poorly targeted, regressive, and costly. They must be on the table as part of any tax reform or deficit reduction discussion.
Trading of credit default swaps (CDS) insuring U.S. treasuries has doubled in the last year in response to fears over our inability to deal with our debt and deficit problems in addition to fears about lawmakers not raising the statutory debt ceiling to avoid a U.S. default.
Credit default swaps act as an insurance policy against a default on a loan. Just like other types of insurance, the purchaser of a credit default swap makes a series of payments to the insurer, and in exchange receives a payout if the borrower defaults on the (now insured) debt or loan. In the case of U.S. Treasuries, those who hold our debt may choose to purchase credit default swaps as a protection against a potential U.S. default this summer or down the road.
Increased trading suggests a higher level of fear over U.S. default on its debt obligations. As of May 20, 819 contracts insuring $4 billion in U.S. debt were outstanding, up from 449 insuring $2 billion of U.S. debt last year, according to Depository Trust & Clearing Corp (DTCC). Average daily trading just jumped to $490 million last week from $10 million the week prior, putting the U.S. at fourth most traded among those tracked by DTCC -- up from 633rd!
This is certainly an unsettling sign for the U.S. Our creditors will not lend to us indefinitely, and appear to be waking up to our unsustainable fiscal path and our rapidly approaching August deadline when Treasury estimates we'll hit our debt limit.
We need to responsibly raise the debt ceiling and put our debt on a downward path.
Today's editorial in the Washington Post, "The Chained CPI, an easy way to save money," endorses switching to the chained CPI for indexation of all inflation-indexed federal programs and provisions in the tax code -- a change CRFB has long supported. We even included the change in our recent list of common-ground deficit reduction measures that could be a foundation for a long-term debt reduction plan.
The editorial cites the recent paper "Measuring Up: The Case for the Chained CPI," published by the Moment of Truth (MOT) project -- a project of CRFB -- and written by MOT and CRFB analysts Adam Rosenberg and Marc Goldwein. The paper explains the problems with the current measure used to estimate inflation (the CPI-W and CPI-U), the improvements made under the chained CPI (the C-CPI-U), and the budgetary effects of making the switch.
We recently estimated that changing to the chained CPI would save $255 billion over ten years by reducing Social Security outlays by $112 billion, reducing other spending by $56 billion, and increasing revenue by $87 billion. Including interest savings, the switch would achieve roughly $300 billion in savings over 10 years.
Hopefully, this and other common-ground proposals get enough traction to be a part of bipartisan budget negotiations in Congress, perhaps as a down payment toward a larger long-term budget deal.
Yesterday, the Senate voted on four budget resolutions (Sen. Rand Paul (R-KY), Sen. Pat Toomey (R-PA), Rep. Paul Ryan (R-WI)/ House Passed Budget and President Obama's Febuary Budget) and all failed to meet the 60 vote threshold. This was done in part to show that none of the current budget plans will be able to garner the bipartisan support necessary to pass the Senate, signaling that more negotiation will be needed to agree on a budget for FY 2012.
|Sen. Rand Paul (R-KY)||7/90|
|Sen. Pat Toomey (R-PA)||42/55|
|Rep. Paul Ryan (R-WI)/ House Passed Budget||40/57|
|President Obama's Febuary Budget*||0/97|
*The President's February Budget is different from and not to be confused with the President's new Budget Framework offered in April.
Both parties have affirmed that a budget plan will only be passed if it can garner bipartisan support. We hope bipartisan negotiations on the budget and debt can produce a plan that can meaningfully address our nation's fiscal challenges. CRFB has identified over $1 trillion in common ground deficit reduction measures, which suggest that negotiations should continue to move forward.
Yesterday at the Peterson Foundation's 2011 Fiscal Summit, six think tanks--Heritage, AEI, EPI, Center for American Progress, Bipartisan Policy Center, and the Roosevelt Institute--released their plans to cut our medium- and long-term deficits and debt. We won't get into the details of each plan (you can check them out here), but we will quickly compare the metrics for each of them.
First, debt as a percent of GDP. Heritage is the most aggressive here, getting debt down to 58 percent of GDP by 2021 and 30 percent by 2035. Also, with the exception of EPI, debt is lower in 2035 than in 2021 in all of these plans.
Next up are spending levels. Once again, Heritage is the most aggressive, getting spending down to 17.7 percent of GDP in 2035. Every other plan would also cut spending below current law to varying degrees, ranging from 20.9 percent to 24.5 percent in 2021 and 23 percent to 27.8 percent in 2035.
And finally, revenue levels. Four of the plans raise as much or more revenue than CBO's extended baseline, with the most in 2021 being CAP at 22.3 percent of GDP and the most in 2035 being EPI at 24.1 percent. Two plans, by Heritage and AEI, hold revenue at or below 20 percent through 2035.
It was great to see all of these plans released yesterday. Together, they present a wide variety of very interesting ideas to push the current debate forward. Lawmakers certainly would do themselves a favor by reading through these plans in their search to find at least $4 trillion in savings.
With all the ideas out there now, it's time for lawmakers to come together and enact a fiscal plan.
Now, as we argued last September in a post titled "It Depends What You Mean by 'Equal'" after suggestions that the costs of both the upper-income tax cuts and Social Security shortfall were equal, we're again discussin claims that we could finance our Social Security shortfall by letting the upper income tax cuts expire at the end of 2012.
This suggestion comes out of a graph from the Center on Budget and Policy Priorities which shows that "the revenue loss just from extending the tax cuts for people making over $250,000 — the top 2 percent of Americans — would itself be almost as large as the Social Security shortfall over the 75-year period." (Note that while CBPP does not suggest this means one should be used to pay for the other, others have made this suggestion.)
CBPP makes this claim by taking the present value of Social Security's 75-year shortfall (0.8 percent of GDP) and comparing it to their present value projections of extending the upper income tax cuts over the next 75 years (0.7 percent of GDP).
Unfortunately, as we did last year, we think this methodology has a few flaws.
First, the measure of Social Security's 75-year shortfall includes the assets it currently holds in its trust funds. To be comparable to the cost of the tax cuts, it may be preferable to look at it's future shortfall. Viewed that way, we estimate an imbalance of about 1 percent of GDP rather than 0.8 percent.
Secondly, while present value matters, cash flow matters too. Attempting to replicate CBPP's methodology, we find that the Social Security (OASDI) shortfall exceeds the cost every year after 2020 -- quite substantially in most years. This is not reflected well in a present value estimate since it weights the earliest year (and the trust fund balance) most heavily. But looking at this chart, it is hard to argue that the costs are equal:
Third, even this chart may overstate the case somewhat. As we pointed out last year, "projecting forward the value of the tax cuts... appears to be highly sensitive to a few uncertain assumptions...tiny changes in some of the numbers they use can drastically alter this number." We haven't aimed to re-project the numbers, but here is what we projected the long-term costs of the upper-income tax cuts to be last year, under a variety of scenarios:
As you can see, our estimates from last September show that the difference between the cost of the tax cuts and the shortfalls could be even larger than shown in the top graph.
And finally, it is important to understand just what it takes to actually bring the fiscal situation under control. We face an enormous fiscal gap which would not be closed even if we let all the tax cuts expire and we make Social Security sustainably solvent. We're going to need a combination of Social Security reform, new revenue, discretionary spending cuts, and other mandatory cuts to even start to address this problem -- and ultimately that will have all been for nothing if we cannot slow the long-term growth of federal health spending.
Everything has to be on the table.
The Biden group of debt negotiations resumed on Tuesday with the fourth meeting of the bipartisan group of lawmakers chaired by Vice President Biden. The talks continued to focus on forging a debt reduction deal that will facilitate an increase in the statutory debt limit.
The negotiators are looking for $1 trillion in spending cuts as a “down payment” towards larger debt reduction. So far the group has only agreed to between $150-$200 billion in cuts. CRFB has identified between $1-$2.5 trillion in common-ground deficit savings through an analysis of recent budget plans from both parties. Much of the discussion reportedly focused on finding savings in healthcare. CRFB offered some ideas for health care reform that can reduce the debt here.
The group will meet again on Thursday, where they are poised to discuss “trigger” mechanisms to get the rest of the $4 trillion in deficit reduction that is the goal of many. Triggers can play a major role in meeting debt reduction goals, though they are no substitute for specific debt reduction policies. The Peterson-Pew Commission on Budget Reform (a project of CRFB) has been a leader in formulating debt targets and triggers that would effectively complement strong fiscal policies in significantly reducing the national debt. The Commission recently provided ideas for making targets and triggers work as part of a fiscal plan.
Revenues will be a key sticking point in the negotiations. Biden says that taxes must be on the table, while House Majority Leader Eric Cantor (R-VA), one of the negotiators, says that is not going to happen. Eliminating or reducing tax expenditures, which are really just spending through the tax code, are an area of possible compromise. See here, here, and here for how tax expenditure reform can simplify the dysfunctional tax code while broadening the tax base so that tax rates can be lowered with more revenue available to reduce the debt.
As CRFB has pointed out, the debt ceiling will have to be raised because the economic consequences would be disastrous otherwise. However, refusing to confront the mounting debt will also have grave economic effects, only more drawn out. The ideas, and agreement in many cases, are there; what is needed now is the political will among lawmakers to make the tough choices together in a bipartisan manner.
Fiscal policy experts and policymakers gather today for the second annual Fiscal Summit in Washington, DC, convened by the Peter G. Peterson Foundation. In addition to speeches from luminaries such as former President Bill Clinton, former Senator Alan Simpson, and several sitting members of Congress, the event will also feature new fiscal plans from groups spanning the political spectrum, including the American Enterprise Insitiute, Center for American Progress, and the Bipartisan Policy Center. CRFB will live-tweet highlights of the proceedings at http://twitter.com/budgethawks and it can also be followed at twitter.com/fiscalsummit. The event will also be webcast here. The live feed is embedded below. The event starts just after 9 am eastern time.
Attempting not to replicate last year's/this year's FY 2011 appropriations debacle, the House is moving the FY 2012 process in a relatively timely manner. After passing the budget resolution on April 15, the various subcommittees and the full Appropriations Committee are busy trying to adhere to Chairman Hal Rogers's (R-KY) schedule for mark-ups. The Appropriations Committee met today to officially approve of the 302(b) allocations for each subcommittee, based on the $1.019 trillion cap contained in the budget resolution, which is $30 billion below the negotiated FY 2011 levels for new budget authority. A "deeming resolution" is expected on the floor of the House next week to lock in the $1.019 trillion marker since Senate adoption of the budget resolution is not likely.
The full House Appropriations Committee today also marked up the first FY 2012 spending bills -- Homeland Security and Military Construction-VA. An amendment was added to the Homeland Security bill adding $1 billion in disaster funding to ensure that Federal Emergency Management Agency (FEMA) accounts don't run dry. In addition, the Agriculture bill was marked up in its respective subcommittee today. Full committee action on the Ag bill will probably come next week, assuming that they adhere to Chairman Rogers's schedule. And the Homeland Security and MilCon-VA bills likely will see action on the House floor next week.
All of the 302(b) allocations are presented below.
|House 302(b) Allocations (billions)|
|Subcommittee||FY 2011 Actual||FY 2012 Proposed||Change||Percentage Change
|Energy and Water||$31.7||$30.6||-$1.0||-3%|
Source: House Appropriations Committee
The Defense Authorization Act is also on the horizon, with debate on the bill expected to start this week in the full House. The bill would set the Pentagon's base budget at $553 billion ($29 billion more than last year) but the total including funding for the wars would be $690 billion ($15 billion less than last year, due to a $40 billion decrease in funding for the wars). The CBO estimates that certain provisions of the bill include "implicit authorizations" that would put the total price tag over $700 billion though 2016 if they are appropriated.
Meanwhile, the Senate by no means intends to keep pace with the House. No budget resolution is currently in the works in the Senate, as they are waiting to see if there is a successful bipartisan budget deal that the resolution could serve as a legislative vehicle for. Symbolic votes are expected next month on budgets that have no chance of passing, specifically on the President's original budget and the House-passed budget. Sen. Pat Toomey's (R-PA) budget and Sen. Rand Paul's (R-KY) budget may also get a vote -- under a Senate rule allowing any senator to bring a budget to the floor if there is no budget resolution by April 1.
Regardless of the tempo being set by the House, the FY 2012 process likely will not go smoothly or swiftly. The Democratic-controlled Senate will not easily go along with anything passed by the Republican-controlled House. So, just as the current fiscal year process demonstrated that our budget process is badly in need of reform, the FY 2012 proceedings will likely only confirm that view. We have some great suggestions on how to fix the process in our Peterson-Pew Commission report Getting Back in the Black.
And we'll continue to keep our eye on the current appropriations process.
Donald Marron, director of the Tax Policy Center, has a good piece over at the Christian Science Monitor on how tax expenditures should be part of any deficit reduction plan and subject to the same scrutiny that direct spending is.
As Marron says:
The ethanol subsidy thus looks like a tax cut, but it's really government spending in disguise. The Department of Energy could accomplish the same thing by sending out subsidy checks. The same is true for dozens of other tax provisions, such as the business credit for research and development and personal tax breaks for mortgage interest, health insurance, and charitable giving.
As a way to find a middle ground, cutting tax expenditures are a great way to raise revenue without necessarily having to raise marginal tax rates -- as long as everyone recognizes that they are simply spending by another name.
The graphic compares deficit reduction and the resulting deficits and debt under the President's budget, the President's framework, the House Republican budget, and the Fiscal Commission plan. The graphic allows users to see a description and the magnitude of changes made in each area of the budget.