May 2012

CBO Director Lays Out Six Criteria for Evaluating Fiscal Plans

May 7, 2012

The non-partisan Congressional Budget Office (CBO) doesn't make recommendations for, or against, any fiscal plan, but that doesn't mean they can't help others do so. To that end, CBO director Doug Elmendorf recently suggested six criteria with which to evaluate the many plans out there. Of course, these criteria are not necessarily co-equal, but each are important. They are:

  • Magnitude of Changes: Simply put, this criterion is about hitting a certain debt target, usually as defined by the debt-to-GDP ratio. Elmendorf states that "policymakers will need to make judgments about how much federal debt is acceptable" and choose a baseline to work off of. Moving from the clearly unsustainable "Alternative Fiscal Scenario"--in which current tax and spending policies are maintained--to current law would require $8 trillion of savings, but lawmakers could target a more modest goal of stabilizing debt to GDP or a more aggressive goal of getting debt back to its approximate average in recent decades of 40 percent of GDP. Whatever the goal, they will need to have enough deficit reduction to get there.
  • Specificity: We have long extolled the virtues of being as specific as possible with budget plans, and the CBO director agrees, at least for the purposes of being able to evaluate the plan. Beyond that, he reiterates the announcement effect idea that "credible policy changes that would substantially reduce deficits later in the coming decade and beyond could boost the economic expansion in the next few years by holding down interest rates and increasing people's confidence in the nation's long-term economic prospects." Being specific is one of the key aspects to policy changes being credible in the eyes of the public.
  • Amount and Composition of Federal Spending: Assuming that revenue will have to be kept roughly in line with spending (or at least close), a fiscal plan must make a decision about how large government is and what its priorities are as reflected in spending. Elmendorf notes that Social Security and health care programs are automatically set to rise in the coming decades due to demographic shifts and health care cost increases, but policymakers must decide how much of that increase they will tolerate when weighed against spending on the rest of the budget, or whether they will simply allow spending to rise as a percent of GDP. (We would add that politicians should also be concerned about the composition of the tax code -- how much it spends on tax expenditures, and to what end.)
  • Short-Term Economic Impact: Considering the current economic environment, Elmendorf notes that policymakers must be careful with the timing of deficit reduction policies. He notes that these policies would be a drag on the economy in the short term through their effects on aggregate demand, but also that waiting too long to implement deficit reduction would result in higher debt. Still, in another nod to the announcement effect, he says, "despite those trade-offs, however, I am not aware of any benefit to delaying decisions about future changes in tax and spending policies. Indeed, as I noted above, credible policy changes that put the debt on a sustainable long-term path could boost the economy in the near term." Well said, Doug.
  • Longer-Term Economic Impact: Policymakers should also consider the effects on the economy over the longer-term. Unlike with the short term, this criterion is more about the composition of policies rather than the timing. Reducing deficits, all else equal, will increase national savings and investment and thus grow the size of the nation's capital stock. But the composition of policy changes could boost or dampen the effect on long-term growth. For example, rate-reducing tax reform or an increase in the retirement age could encourage more work and investment, while raising tax rates or cutting infrastructure spending could partially mute the positive economic effects of deficit reduction.
  • Distributional Effects: The policy composition of a fiscal plan determines who bears the burden of tax and spending changes. Elmendorf points out that this entails not only looking at the direct effects of policy changes, but also the indirect effects via the economy and its consequences for different people. Distributional analysis is most often associated with effects on people with different incomes, but could also be done by occupation, family/marriage status, or other distinctions that are relevant for policymakers.

Director Elmendorf's six criteria serve as a very useful checklist in evaluating the many fiscal plans that are floating around in the current debate. Check out our interactive comparison grid and apply the criteria yourself.

MY VIEW: Judd Gregg

May 7, 2012

Today in The Hill, former Senator Judd Gregg (R-NH) penned an Op-Ed analyzing the French elections (where France yesterday elected Mr. Hollande of the French Socialist Party) and notes what America can learn from France and their current employment situation. Gregg says that the United States should not model itself after France's labor laws or retirement system. Sen. Gregg writes:

"It has been a long time getting there, but France now seems to be on the final leg of this journey of self-delusion and self-destruction. The world is becoming more and more competitive, with no time for the self-indulgent as nations seek better lifestyles for their people. The politics of envy and the real reduction in competitiveness of the French society is clearly placing France and many nations in Europe at a tipping point. They have dealt themselves a losing hand. We should simply observe, note it and hopefully choose not to play the same cards."

Click here to read the full op-ed.

"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.

Dimon: "We Know the Way, It's Called Bowles-Simpson"

May 4, 2012

At an event at the University of Rochester's Simon School yesterday, JPMorgan Chase CEO Jamie Dimon made a direct call for the Simpson-Bowles recommendations. Dimon stated that the debt challenges facing the United States are "the opposite of Europe" because we see the crisis coming and know how to solve it. He pointed to Simpson-Bowles is the answer, but that right now our elected official don't have the political courage to make it happen.

Dimon is just one of a few prominent people to recently endorse the plan. Former Federal Reserve chairman Alan Greenspan called it an "ideal vehicle" for deficit reduction because it would start the country on the right path of taking large chucks out of deficits and debt, even if it didn't turn out to be the full solution, while offering an opportunity for compromise. He also said that President Obama should have embraced the plan immediately. General Electric CEO Jeffrey Immelt has also made high supportive statement about the Simpson-Bowles plan in recent weeks and months, citing how we need to take a hard look at every part of the budget and need to start thinking about where there's bipartisan support.

A Social Solution for Social Security

May 3, 2012

Last week’s report from the Social Security Trustees laid out the challenges facing the vital program. The largest federal program began running annual deficits in 2010 and will continue to do so each year through 2033, when the trust fund is projected to become exhausted. At that point, recipients will see a 25% cut in benefits, absent any action.

Our analysis made clear the need for some kind of change in order to bolster Social Security’s finances. And the sooner action is taken, the more the reforms can be phased-in and the better beneficiaries can plan for the changes.

While politicians in Washington have disagreed over what to do and have delayed action even though the problem has been foreseen for years, Americans across the country have been making the tough choices necessary to strengthen the program for the future. The results of CRFB’s budget simulator pertaining to Social Security challenge the notion that it is still the third rail of American politics and instead shows the fast track to reform.

Several Social Security options received majority support from the over 8,000 users who completed the simulator and voluntarily submitted their results for analysis (although note that our results are not scientific). In particular, two ideas that have received a great deal of attention as of late, and also have been the subject of heated opposition, received overwhelming support. Seventy-four percent of the group opted to gradually raise the Social Security retirement age from 67 to 68, including 71 percent of Democrats and 74 percent of Independents. [Read more on the topic here and here.] Switching to the chained Consumer Price Index (CPI) to measure inflation for cost-of-living adjustments (COLAs) was supported by 71 percent of participants, including 68 percent of Democrats and 71 percent of Independents. [Learn more about the chained CPI here, here, here and here.]

Increasing the number of years used to calculate a retiree’s benefits from the highest 35 years to 40 years was chosen by 53 percent of participants, including 48 percent of Democrats and 53 percent of Independents. Including all new state and local workers in Social Security was one of the most popular choices in the simulator, garnering support of 77 percent. And three options to gradually reduce scheduled benefits while protecting at least some earners received a combined 81 percent of support. Finally, either raising the Social Security cap to 90 percent of earnings was or enacting a two percent surtax above the cap was chosen by 76 percent of the sample, including 69 percent of Republicans and 74 percent of Independents.

Social Security Options Supported by Majority of Users
Option Savings (Percent of 75-Year Shortfall) Savings (billions) % Users % Dem % Ind % GOP
Raise Retirement Age to 68 ~20% $110 74% 71% 74% 82%
Gradually Reduce Scheduled Benefits, Protecting Some Earners* ~65% $80 51% 42% 52% 64%
Use a More Accurate Measure of Inflation for COLAs ~20% $100 71% 68% 71% 77%
Increase Years Used to Calculate Benefits ~15% $40 53% 48% 53% 63%
Include New State and Local Workers ~10% $80 77% 76% 76% 82%
Raise Payroll Taxes On Income Above Social Security Cap ~35% $420 55% 61% 53% 49%
Total Savings ~165% $830        

Note: Social Security shortfall is 2011 projected shortfall in this table, which is smaller than 2012 projected shortfall

*This assumes the "Progressively Reduce Scheduled Benefits, Protecting Low Earners" is enacted since it is the first option to receive majority support. Reducing benefits by 30% received 31 percent support while reducing benefits while protecting low earners received 20 percent support.

The options that received majority support would result in debt savings of $830 billion through 2018. In addition, the options chosen would eliminate the Social Security 75-year shortfall and then some, closing about 165 percent of the shortfall.

Just as simulator users supported a combination of spending cuts and increased revenue to shore up the budget as a whole, so too did they for fixing Social Security.

Full results of the simulator.

Read the summary.

Do the simulator.

Brookings Institution Comments on Tax Reform

May 3, 2012

As the topic of tax reform will be heating up this year, five analysts from the Brookings Institution's Hamilton Project have released a paper called "A Dozen Economic Facts About Tax Reform." It is certainly a useful primer on how the tax system has changed over time and the promise and difficulties involved in changing it.

Those dozen facts are:

  1. America collects lower revenue than other industrialized countries.
  2. Tax expenditures represent a large share of total government spending.
  3. The tax code subsidizes some activities and penalizes others.
  4. The tax system has become less progressive over time.
  5. Virtually all American families, even low-income families, pay taxes.
  6. There is a limit to what tax reform can accomplish.
  7. Individuals and the economy will feel every approach to tax reform.
  8. The benefits from tax expenditures are not equally shared.
  9. Cutting individual income tax rates would modestly increase the earnings of the typical American family while substantially increasing the federal budget deficit.
  10. Deficit-financed tax cuts do not spur economic growth in the long run.
  11. Corporate tax reform can improve U.S. competitiveness in several different ways—but not necessarily all at once.
  12. Addressing the deficit will require policy solutions equal to the size of the problem.

First, the paper provides context by showing how the size of our revenue compares to other countries and how the system has changed over time. It also talks about the size of tax expenditures in the context of the federal budget (spoiler alert: they're huge). Interestingly, they quantify what the top marginal tax rate could be if different reform options were taken with different revenue targets. For example, converting the mortgage interest deduction to a 15 percent credit, eliminating the state and local tax deduction, and capping the value of the health care exclusion would allow the top to be lowered from 39.6 percent to 38 percent while increasing revenue by $100 billion in 2015.

The paper is accompanied by an event this morning with multiple all-star panels, including former Treasury secretary Lawrence Summers, former CBO and OMB director (and CRFB board member) Alice Rivlin, and former Council of Economic Advisers chair Martin Feldstein. You can watch the event on C-SPAN here and read the paper here.

Different Approaches to the Simulator

May 2, 2012

David Lawder of Reuters has featured our recently updated budget simulator in an excellent piece about the challenges of cutting the debt. The simulator offers a menu of tax and spending options with the ultimate goal of reducing debt below 60 percent of GDP. As many of our users are finding out, debt reduction is possible but not without considering some difficult options.

Lawder tries his hand at the simulator, using four hypothetical approaches. A conservative attempt that keeps the entire Bush tax cuts and leaves alone defense spending but cuts entitlement and other domestic programs leaves debt at 73 percent of GDP. Adding defense cuts in the second attempt is an improvement but still stabilizes debt above 60 percent of GDP. On the other hand, a liberal effort succeeds in lowering debt to a level below 60 percent of GDP, but goes very heavy on tax increases that would hurt the economy in the short-term. Finally, Lawder considers a balanced approach:

No hard-core gamer would tolerate this, but let's do the bipartisan thing and mix some revenue increases with spending cuts. We'll start with Obama's plan to raise taxes on those earning over $250,000 and impose a millionaire’s surtax. We cut troop levels and shrink the Navy but the F-35 lives.

Americans must be slightly older before qualifying for Medicare and Social Security and some benefits are shrunk. There are further savings from repealing portions of Obama's healthcare reforms, which the Supreme Court may do anyway. We phase out the mortgage interest deduction while keeping the research and development funding increase.

Result: The pain is spread all around by picking and choosing from a menu of liberal and conservative options: raising taxes, giving up the moon base, cutting school breakfasts and arts funding. But we still are $750 billion short. "Nice try. You reduced the debt to 60 percent of GDP, but not until 2023. Hopefully, you will have done enough to avert a fiscal crisis."

Reducing the federal debt is difficult and only when policymakers are willing to put all options on the table will there be an effective solution. CRFB President Maya MacGuineas is quoted in the article arguing that Congress should look at the numbers and seriously consider what is best for the country rather than partisan interests:

The best thing we can do is ask every politician to run through the simulator themselves. Put them into a quiet, dark room with the shades drawn so they can figure out what it really takes.

MY VIEW: Marc Goldwein

May 1, 2012

CRFB's Senior Policy Director Marc Goldwein has a message to policymakers in an op-ed in The Hill: don't overlook the disability insurance (DI) program. The latest Trustees report projecting the DI trust fund to run out in only four years, but people often overlook that deadline, since they assume money would be transferred from the old age portion of the program. 

However, Goldwein says that simply making that transfer would be poor policy.

The Social Security disability system is broken in many ways. Not only is the program financial insolvent, but the system is wrought with fraud, needlessly complex, difficult to navigate, inconsistent and unfair in determining eligibility, inflexible to changes in the structure of the workforce, administratively overburdened, almost completely uncoordinated with other government policies, and unable to help or reward those who are interested in reentering the workforce.

Making the disability system solvent simply by taking money from the already-underfunded old-age system would represent a double policy failure by committing a disservice to both programs. Instead, policymakers should use the fast-approaching insolvency date in the same way they did when the trust funds ran low in 1983 – come together and fix both programs for this generation and the next.

Goldwein goes on to suggest ways to reform the program. Options include pushing tougher anti-fraud measures, limiting retroactive benefits, and eliminating the payroll tax cap for the 1.8 percent tax that is dedicated specifically to the DI trust fund. He also encourages lawmakers to take the opportunity of shoring up a program with immediate funding problems to address the broader Social Security program. As he says:

Ideally, we wouldn’t need a looming insolvency to force action on this important issue. But if politicians need the threat of a crisis in order to act responsibly, there is no shortage of these in the months and years ahead. Hopefully they will act in time to avoid them.

Click here to read the full op-ed.

"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.

Yes, Actually, We Should Pay for the Tax Cuts

May 1, 2012

An article in The Hill today notes that House Republicans do not plan to offer offsets for the extension of the 2001/2003 tax cuts that expire at the end of the year. The tax cuts are the largest part of the fiscal cliff, representing a $435 billion hit to the economy over the next two years (although we have noted previously that the policy is not a particularly cost-effective form of stimulus).

Still, short-term economic concerns should not be an excuse to simply add to the deficit. Just as we said two weeks ago, the tax cuts should be paid for if not dealt within the context of an overall deficit reduction plan. Unlike the small business tax cut, not paying for this one would have huge implications for fiscal policy. Of course, the House majority is not alone in wanting to extend the tax cuts: the Democrats' main position is to extend them for everyone making less than $250,000. Either way, the tax cuts should be dealt with in a responsible manner.

Extending the tax cuts by themselves will cost $2.8 trillion over ten years, while extending only the "middle class" tax cuts will cost $1.9 trillion. Assuming that Alternative Minimum Tax patches were already in place, the extensions would cost $3.8 trillion and $2.8 trillion, respectively, due to interactions with the AMT.

For context, we have graphed what debt as a percent of GDP would be under different policies. If the tax cuts were extended, the AMT was patched, physician payments were frozen instead of cut, war spending was drawn down as scheduled, and the sequester was repealed, debt would be 85 percent of GDP in 2022. If all of those policies happened except the tax cuts for people making more than $250,000, debt would be 81 percent in 2022. If all the tax cuts expired but the other policies were kept, debt would be 67 percent in 2022. Finally, if all of those policies expired, debt would be at the current law level of 61 percent.

 

One House member is quoted in the article as saying "It's not a pay-for situation. It's just a strong policy that needs to be adopted." We think the opposite is true: if it's such a strong policy, it should be easy to find a way to offset the costs in a responsible way.