It appears both sides are quite close to a deal that would avert (or at least quickly reverse) the fiscal cliff. Although negotiations remain ongoing and not all the information is public, here is what we know -- or think we know -- would be included in the deal as it has been negotiated so far:
- A permanent extension of most of the 2001/2003/2010 income tax cuts for incomes below $400,000/$450,000 include lower rates on ordinary income, capitals gains, and dividends.
- A top ordinary rate of 39.6% on ordinary income above $400,000/$450,000 and 20% on capitals gains and dividends for those earning above those thresholds.
- The reinstatement of the PEP and Pease provisions to limit exemptions and deductions for income above $250,000/$300,000.
- A five-year extension of various refundable tax credits established in 2009 and extended in 2010, including the American Opportunity Tax Credit (AOTC) as well as expansions to the Child Tax Credit and Earned Income Tax Credit.
- An extension of current policy on the estate tax (include a $5+ million exemption indexed for inflation) but with a rate of 40% instead of 35%
- A permanent patch to the Alternative Minimum Tax
- An extension of various "tax extenders" for 2012 and 2013
- A one-year extension of 50% Bonus Depreciation
- A one-year "Doc Fix" to prevent a 27% cut in physician payments
- A 2-month delay of sequestration
- Still unspecified spending cuts to finance the cost of the doc fix and sequester delay
- A one -year extension of unemployment benefits
- A one-year extension of the farm bill
Although no costs have yet been reported, we have made some very rough estimates based on our understanding of the deal. Note that numbers could be off somewhat from estimating differences and could be off substantially if any agreed-to policy are different from how we understand them currently.
Relative to current law, we estimate this plan by itself would increase the deficit by roughly $4.6 trillion including interest. Relative to current policy, we estimate it would reduce the deficit by $550 to $600 billion.
How this plan effects the debt depends on what happens in future stages. Assuming policymakers continue current policy -- including by errantly delaying the sequester and avoiding SGR reductions in physician payments without offsets -- we estimate the plan would result in debt levels of between 79 percent of GDP (CRFB realistic, which assumes war drawdown and no extenders) and 86 percent of GDP (CBO AFS, which assumes no war drawdown and continued tax extenders).
Importantly, though, the plan would leave in place both the sequestration and the SGR -- which could serve to encourage further deficit reduction. If policymakers were able to identify the roughly $1.2 trillion in offsets necessary to pay for those measure (while also paying for or letting expire "tax extenders" and drawing down war spending) then the debt could fall to as low as 73 percent of GDP.
Even this might be insufficient to stabilize the debt, and would require substantial new revenue or spending cuts to be identified. Presuming our numbers are right, such a plan would likely represent the absolute minimum amount of savings which could have the potential to stabilize the debt.
For that reason, whatever happens to this package in 2012, more work will be necessary in 2013.
While most of the country is focused on the fiscal cliff, The New York Times is reporting on another cliff, this one involving the farm bill. Unlike the fiscal cliff, this one involves policies that will increase spending and deficits. If Congress is unable to agree on a farm bill before the end of the year, we would revert back to 1949 law, the last time the government made a permanent farm law. As a result, Washington would be required to purchase milk at more than twice the current market price to set a price floor for producers.
According to the article, milk prices are estimated to double as a result of the price floor. Producers are not happy about this because even though they will benefit significantly from the government's purchases, the hit to consumer demand would be huge. Obviously, consumers would lose big as well and the government would have to increase spending unnecessarily. It's a situation that no one wants. One interesting side note -- if we go over both the fiscal cliff and the farm cliff, the sequester will cut farm programs across the board by about eight percent. It's unclear how this interaction would affect the milk program, but it could dampen some of the negative effects.
So where are we with the farm bill? The Senate passed a farm bill in June that would save $23 billion. The House has not yet brought the farm bill to the floor, but one version that would save $35 billion passed the Agriculture Committee later this summer. Both bills would replace direct payments with a shallow loss program, which would guarantee farmers a certain amount of gross revenue. Although the two bills have slight differences in the design of this new crop insurance program, the combined effect of these policies would save roughly $20 billion over the next decade. One major difference between the two bills is in nutrition programs. In particular, the House Agriculture Committee version restricts categorical eligibility in food stamps--where recipients of benefits in other low-income programs automatically qualify for the program--to cash assistance programs only, saving an additional $12 billion over the Senate version. Overall, these bills are a step in the right direction, but more savings could be gotten in farm programs, and lawmakers should be vigilant that the shallow loss programs do not become overly expensive.
|Ten-Year Savings/Costs (-) in the Farm Bills (billions)|
|Crop Insurance Programs||-$5||-$10|
|Subtotal, Farm Programs||$19||$19|
Ultimately, the change to food stamps is a major barrier to passage. The measure is seemingly unable to pass the House because Democrats object to those changes, and enough Republicans object to the level of spending in the bill that it cannot pass on strict party lines. House Speaker John Boehner (R-OH) has said that he would not include the farm bill in a fiscal cliff deal, another barrier to its passage. Given the focus on that deal and the limited time until the end of the year, a farm bill will probably not pass in the remaining days of this Congress. That leaves the liklihood of a stop-gap measure for the milk program, thereby pushing off the farm bill to the new Congress and adding it to the growing list of to-do items.
Usually around this time, we say we wish this was the year a fiscal planis enacted. But with the ongoing negotiations between the White House and Republicans along with the looming fiscal cliff, 2012 is not completely in the books yet.
2012 was certainly a year when our national fiscal issues came front and center. Whether it was the 330,000 citizens signing a petition to Fix the Debt, the budget being prominently featured during the Presidential and Vice Presidential debates, or a number of new budget proposals and legislation that were introduced, fiscal policy was a big part of the political and policy discussion this year.
If a bipartisan debt agreement comes together before the new year, as we hope, The Bottom Line will be on the job, breaking down the details of any agreement and how it affects our debt path in the next ten years and beyond. However, our regular blogging will slow until the new year, as we focus our attention on the fiscal cliff negotiations.
Keeping with tradition, we've created a word cloud from Wordle of The Bottom Line for 2012. Among the top words were budget, tax, spending, deficit, fiscal, and cliff (no surprise). Hopefully, the words "deal" and "bipartisan" get a little bit larger in our next word cloud.
We've enjoyed participating in the conversation this year. We wish our readers a safe and happy holiday season.
We've talked before about the rational behind implementing the chained CPI, that the current index (CPI-W) does not incorporate substitution effects and therefore overstates inflation. And it turns out a good number of economists agree with us.
A new survey from the University of Chicago's Booth School finds that a great number of economists believe the current measure of CPI used to index Social Security benefits leads to greater benefits that under a true cost-of-living index. This survey indicates implies the use of a slower growing index for COLAs, perhaps the chained CPI.
It's not surprising then that policy experts and lawmakers from both sides of aisle have indicated support for chained CPI. Just today Senator Mark Warner (D-VA) spoke on the floor of the Senate today in support of the chained CPI. He noted that many groups along the political spectrum from the Heritage Foundation, to the Center of American Progress, to the Fiscal Commission has supported chained CPI. Said Warner:
Why do economists support the chained CPI? Because it honors a commitment to maintain the purchasing power of spending and revenue policies. It provides savings across the budget -- not just in entitlement programs but across other areas.It raises revenues and it contributes meaningfully to the long-term fiscal sustainability of the programs that we want to protect.
Because across the government we have indexed things to inflation - the tax code, entitlement programs, all are indexed -- their rise and decrease is based on inflation. So again, this tool while not perfect, all these groups have said it needs to be part of any reform.
Warner is not the only influential lawmaker to declare support for the policy maker. Chained CPI has appeared in the most recent proposals from both the White House and Congressional Republicans. House Minority Leader Nancy Pelosi (D-CA) said today that chained CPI would strengthen Social Security. With support building for the proposal, we hope it will be found in the final deal.
Click here to see a speech from Warner on the chained CPI.
Because there has been a lot of talk about the chained CPI lately, CRFB has created a brand new "Chained CPI Resource Page" to give readers one place to see all that information.
The page has background on the current consumer price index and the chained CPI. It also shows analyses from a variety of sources about the effects of the chained CPI on the budget, taxes, and Social Security in addition to links to outside experts and organizations who support using the chained CPI for inflation calculations.
As a reminder, the chained CPI would replace the current CPI for inflation calculations for cost-of-living adjustments for retirement programs and for various provisions of the tax code. The chained CPI is widely considered to be a more accurate measure of inflation since it more comprehensively accounts for the ability of consumers to substitute goods to avoid the full brunt of relative price increases.
Click here to view the chained CPI resource page.
While Speaker Boehner and President Obama attempt to bridge their differences in the fiscal cliff negotiations, you can try your hand at creating a plan using the "Choose Your Own Fiscal Cliff Adventure" simulator from Wonkblog. The simulator offers users a chance to come up with their own plan to avoid the fiscal cliff while reducing the deficit in the long run to stabilize the debt.
The simulator allows users to choose among various policy options dealing with the fiscal cliff components, additional stimulus, and deficit reduction. The deficit reduction options include changes to federal health programs, Social Security, discretionary spending, and the tax code. The simulator then displays the effect your choices have on GDP growth over the next three years and deficits over the next ten years.
Wonkblog's simulator is helpful in showing the trade-offs between short-term growth and longer-term deficit reduction. Lawmakers could look to these options and many others, such as those we list in our recently released "Revenue and Health Care Savings Options" report, as they figure out how to navigate the fiscal cliff and the mountain of debt.
The Internal Revenue Service has continued to warn Congress of the administrative consequences of going over the fiscal cliff. In another letter to the chairs of both the Senate Finance Committee and House Ways and Means Committee, IRS Tax Commissioner Steven Miller estimates that between 80 million and 100 million tax returns could be delayed if Congress fails to pass a deal that includes an Alternative Minimum Tax patch due to computer reprogramming issues. In his letter, Miller writes:
In my previous letter, I estimated that more than 60 million taxpayers might be prevented from filing their tax returns while we are reprogramming our computers. This figure includes those who would be subject to additional tax as well as those who would be required to perform the calculation to determine if the changes in thresholds and credit ordering rules affect their tax liability. As we consider the impact of the current policy uncertainty on the upcoming tax filing season, it is becoming apparent that an even larger number of taxpayers - 80 to 100 million of the 150 million total returns expected to be filed - may be unable to file.
This number results from the need to limit filing by those who may be potentially impacted. The IRS cannot process the returns of any taxpayers whose return characteristics do not allow us to differentiate them from those whose tax liability would be altered by the AMT expiration. This means that there are certain forms and schedules we could not accept from any taxpayer - even those who ultimately may not have additional AMT liability. Similarly, returns of any taxpayers whose income levels may subject them to the AMT could not be processed.
Furthermore, it may not be possible even to process some returns that are clearly not subject to or affected by the AMT. Allowing only some taxpayers to file as we reprogram could substantially increase the risk of fraud and error in initial filings as well as create the potential for a large number of amended returns.
There is no question the delay in processing tax returns would be a huge problem for federal government and taxpayers alike. Even worse, if the AMT patch is not retroactively reinstated, then 28 million more taxpayers are expected to pay the tax (and current AMT taxpayers would be hit as well). The distribution table below shows that this is a relatively harsh burden that not only hits upper-middle class households, but those in the middle class as well. Clearly, this is not desirable tax policy for either Republicans or Democrats.
Distribution of the Expiration of the AMT
Source: Tax Policy Center
The expiration of the AMT patch, along with many other provisions in the tax code, make it clear that at the very least the fiscal cliff negotiations should fix the current temporary nature of the tax code. We need more revenue, but it is also important that we reform the tax code to promote longer-term growth and reduce uncertainty for businesses and individuals. Failing to fix the AMT is not the answer, and we need a plan if we are going to deal with it.
Click here to read IRS Commissioner Miller's letter.
UPDATE: The Joint Committee on Taxation has scored Plan B as costing $4.1 trillion over ten years, savings of $400 billion over a full extension. Both the text and the graph have been updated to reflect this score. Tax Policy Center has also produced distribution tables of Plan B.
There has been much speculation in these last few days about where the fiscal cliff negotiations might be heading. One piece that has added to the conversation is House Speaker John Boehner's (R-OH) so-called "Plan B."
The plan includes a partial extension of the 2001/2003/2010 tax cuts and Alternative Minimum Tax patch. From the tax cuts, Plan B leaves out:
- The extension of the 35 percent rate for people making more than $1 million. It will instead revert to 39.6 percent.
- The extension of the 15 percent rates on capital gains and dividends for people making more than $1 million. Those will instead rise to 20 percent, consistent with the Senate Democrats' tax cut extension but with a lower tax rate on dividends than President Obama calls for (39.6 percent for millionaires).
- The extension of the 2009 refundable tax credit expansions that were previously extended in 2010. These expansions would shrink the earned income tax credit and child tax credit, while replacing the American Opportunity tax credit with the non-refundable Hope credit.
The Joint Committee on Taxation has estimated that Plan B would cost $4.14 trillion over ten years. Compared to a full extension of the tax cuts, this would save about $400 billion.
All of the other tax cuts for income below $1 million, the estate tax parameters from the 2010 tax cut, and the repeal of the personal exemption phaseout (PEP) and Pease limitation would be continued. Importantly, Plan B does nothing about the other parts of the fiscal cliff beyond the tax cuts and AMT patch. Clearly, as its name indicates, it is not intended to be a cliff replacement plan, but rather an if-all-else-fails option. Lawmakers would have to come back to the issue to address the other parts of the fiscal cliff and the additional deficit reduction necessary for sustainability.
The graph below is our estimate of what Plan B would do to public debt. We show different scenarios assuming that literally nothing else is done with the cliff (current law), the doc fix is extended and the sequester is repealed without being offset, and current policies are extended one year at a time and offset over ten years. These scenarios are compared to the CRFB Realistic Baseline. These figures could be slightly higher depending on what was done with the payroll tax cut and unemployment insurance benefits.
Source: JCT, CRFB calculations
We will provide further analysis as more information comes out.
The chained CPI has been receiving much attention lately after being included in the latest offers from both the GOP and White House. Some critics of the policy have been voicing their concerns, and yesterday, CRFB chimed in again to clear up the misconception that moving to the chained CPI would be regressive. Today, Robert Greenstein, president of the Center on Budget and Policy Priorities, clarified his view on the merits of including the chained CPI, thoughtfully addressing some of the criticisms of the policy. Below is a segment of his reaction:
So what is my thinking? I share concerns about the effects of the chained CPI on beneficiaries. But I think that some benefit cuts in Social Security are inevitable sooner or later. The program needs some changes to make it solvent for the long term, and the chances that policymakers will restore solvency entirely through tax increases — with no benefit-reduction component — are essentially zero. That didn’t happen in 1983, and it almost certainly won’t happen now or in the foreseeable future.
Furthermore, as in 1983, benefit changes won’t be limited to high-income beneficiaries. There are limits to how far one can cut benefits at the top without breaking Social Security’s link between payroll-tax contributions and benefits, and thereby risking undermining public support for the program. I see these factors as basic political realities, whether we like them or not.
That brings me to the key point: the chained CPI is the only Social Security benefit change that brings an increase in general tax revenues with it. Eventually, about half of the savings from the chained CPI come from revenues, and about half from Social Security and other benefit programs. The more that we raise in revenues, the less that policymakers will slash programs generally. So, this — and the fact that the chained CPI is a more accurate measure of inflation (although not necessarily for the elderly) — leads me to conclude that if policymakers can build appropriate protections into the chained CPI to protect both the oldest and the poorest beneficiaries, it’s worth considering.
Finally, I hope people reading Bob’s article don’t think I’m the sole liberal who’s open to the chained CPI. The late, revered Bob Ball — the former Commissioner of Social Security who led efforts to defend the program for half a century and was a hero and beacon on social insurance issues to so many of us — put forth several Social Security plans that included the chained CPI as a way to help restore Social Security solvency. Indeed, I first looked at the proposal after I saw that Bob Ball had included it in one of his plans. The Center for American Progress also embraced the chained CPI several years ago and included the proposal in its Social Security solvency plan.
The full blog post from Robert Greenstein can be found here.
With time running out for a deal, the U.S. credit rating may be in jeopardy if lawmakers don't reach a compromise to replace the fiscal cliff. Fitch is the latest credit rating agency to warn that failure to come to an agreement would likely lead the U.S. to lose its AAA status. From Fitch's Global Sovereign Review (login required):
In Fitch's opinion, the tax increases and spending cuts implied by the fiscal cliff would not address the long-term drivers of higher public spending and the narrow and volatile tax base. Many of the measures would probably be partially reversed if the economy slowed and unemployment began to rise, perpetuating the uncertainty over government tax and spending policies that is weighing on the economic recovery. Failure to avoid the fiscal cliff would not, in Fitch's opinion, place US public finances on a long-term sustainable path. It would exacerbate rather than diminish the uncertainty over fiscal policy, and tip the US into an avoidable and unnecessary recession that could erode medium-term growth potential and financial stability. In such a scenario, there would be an increased likelihood that the US would lose its "AAA" status.
This statement from Fitch echoes comments made last week from Federal Reserve Chairman Ben Bernanke that both avoiding the cliff and having a sizeable deficit reduction plan are equally important. In terms of the latter, Fitch says that after a few years of kicking the can down the road, the U.S. needs to adopt a credible medium- to long-term fiscal consolidation plan.
The credibility of any deficit reduction plan would be greatly enhanced by specific measures and targets reflected in legislation with a significant down payment in 2013. Agreement on a multi-year deficit reduction plan to stabilise government indebtedness and secure the sustainability of public finances would be likely to lead to Fitch affirming the US "AAA" rating and revising the Rating Outlook to Stable. Conversely and in the absence of positive economic and fiscal shocks, failure to put in place a credible fiscal consolidation strategy during 2013 would be likely to result in the US losing its "AAA" status.
Fitch is not the only agency with a current "Negative" outlook on the U.S. Here is a reminder of where the other credit agencies stand:
|U.S. Credit Rating By Agency|
|Standard & Poor's||AA+||Negative|
|Japan Credit Rating Agency||AAA||Stable|
|Rating and Investment Information||AAA||Stable|
Source: Agency Outlooks
Hopefully, the White House and Republican leaders will take the final steps toward a deal over the next few days. While decent progress has been made in recent weeks, there is still a long ways to go.
The recent offers from the White House and Republican House leadership have shown that both parties appear to be committed to finding a compromise. But lawmakers still have a long ways to go. Not only must Congress and the President find a way to replace the fiscal cliff, but they should do so with a plan that adequately addresseses our unsustainable debt problem. To do this, all ideas must be on the table.
To show the many options that lawmakers could choose from, CRFB has compiled two menus of revenue and health care options that could be considered in the fiscal cliff negotiations. The health care list includes roughly 100 options such as reforming Medicare cost-sharing, restricting Medigap coverage, equalizing payments between skilled nursing facilities and inpatient rehabilitation facilities, requiring drug rebates in Medicare, and expanding hospital penalties for re-admissions, among many others.
On the revenue side, there are roughly 70 options, which include taxing dividends as ordinary income, capping itemized deductions at various dollar amounts, limiting the value of tax expenditures for higher earners, getting rid of the mortgage interest deduction for second homes, or implementing a surtax.
Although these are not the only policies out there, these lists give a sampling of what policymakers have to work with in these negotiations. If we are going to agree on a significant bipartisan plan that will stabilize debt and put it on a downward path as a share of the economy, we need to consider all of the ideas out there.
Click here to read the full report.
After being included in both the most recent White House and Republican offers, the "chained CPI" has been front and center as a potential piece of any compromise to avoid the fiscal cliff. A number of critics of the policy (see here, here, and here) have voiced concern about the chained CPI, attacking the option as a regressive Social Security cut and tax increases. To address these concerns, we explored the distributional impact of chained CPI in the most recent update of our report, "Measuring Up: The Case for Chained CPI."
On Social Security, cost-of-living adjustments offer the same percentage increase for all their beneficiaries, therefore a COLA that grows more slowly would be distributional neutral in theory. Differences due to other factors, including a greater cut for those who receive benefits for a longer time, actually make the change slightly progressive. This table from the Social Security Administration show that the benefit cut would be greater for those in the top two quintiles.
On the tax side, switching to chained CPI would affect tax brackets, the standard deduction, personal exemptions, and other features of the tax code. Other than those who have a negative tax burden, most everyone would be affected - with TPC finding each quintile on average receiving a 0.2 percent reduction in their after tax income over the next decade. On average, the chained CPI's effects are roughly distributionally neutral -- though those at the very very very bottom and very very top would bear a smaller relative burden.
Standing alone, switching to chained CPI is more or less distributionally neutral. But policymakers may want to achieve an outcome more progressive than the current system and may want to protect certain vulnerable populations. With regards to Social Security, the best way to do that is to enact a comprehensive package which makes the system solvent in the context of modifying the benefit formula and offering other features such as a minimum benefit. Short of that, however, policymakers could protect the old-old by combining chained CPI with a benefit bump-up for the very old. As an example, the Simpson-Bowles plan included a flat dollar increase equal to 5 percent of the average benefit available phased in beginning 20 years after eligibility.
Whereas by itself benefit reductions are equal by income group in the same cohort, the change is quite progressive when combined with such a policy. The graph shows the benefit change at age 86, since that is when the bump-up would be fully phased-in under a Simpson-Bowles type policy.
Source: Social Security Administration, CRFB Calculations
Likewise, switching to the chained CPI on the tax side has clearly not prevented major bipartisan plans from being substantially more progressive than the current code.
It makes no sense to continue overstate inflation if the most vulnerable can be protected with additional policies.
Click here to read our updated Measuring Up report.