December 2012

Fiscal Cliff Watch: Offers Begin to Emerge

UPDATE: Debt numbers in table have been slightly altered since the original posting.

With now less than a month before the country would go over the fiscal cliff, proposals from both sides have been put on the table. While a final deal could look different than the presented plans, they do provide a guide to where the negotiations stand and where lawmakers may head to reach a compromise.

To help follow the negotiations, we've created a comparison table of both the President's proposal last week and the Republican offer presented in a letter yesterday. The Republican offer cited a suggestion Erskine Bowles put forward as a possible middle-ground during the Super Committee hearings. Because the numbers in the Republican letter were somewhat more vague than what Bowles presented, we've included both sets of numbers; we are also assuming that the numbers presented for the 2012-2021 budget window will now be applied to the 2013-2022 window.

 

Comparison of Budget Proposals (Numbers in Billions)
Budget Category
White House Offer House GOP Offer
Savings in Letter "Bowles" Savings
(from Super Com.)
Jobs Measure and Tax Extenders -$435 billion Unspecified $0
Discretionary Spending $0 $300 billion $300 billion
Health Care $350 billion $900 billion $600 billion
Other Mandatory $250 billion $300 billion
Chained CPI $0 Unspecified $200 billion
New Revenue $1,560 trillion $800 billion $800 billion
Social Security $0 $0 $0
Interest ~$225 billion $300 billion ~$350 billion
Total New Savings $1,950 billion
$2,300 billion
$2,550 billion
Enacted Savings $1,700 billion $1,700 billion $1,700 billion
Total Savings
$3,650 billion
$4,000 billion
$4,250 billion
       

Debt in 2022

(81% Under Realistic Current Policy)

73.5% 72% 71%

 

It's worth noting that both sides have realized that a bipartisan plan will need a combination of spending reductions, increased revenue and entitlement reforms -- although there is disagreement on what the right mix of each should be and what the policies should be to achieve them.

Excluding previously enacted savings, President Obama favors a plan that would raise slightly under $1.6 trillion in new revenues and produce roughly $600 billion in spending cuts (though some of this money is returned in the form of $435 billion of spending increase and tax cuts). House Republicans, on the other hand, put forward an offer which includes $800 to $850 billion in new revenue and $1.2 to $1.35 billion in spending cuts.

In addition to differences on the "how much," there are also differences on the "how". For instance, the White House wants to raise its revenue by first allowing the upper-income tax cuts to expire and rates to go up to generate about $950 billion in revenue, and then raise an additional $600 billion through tax reform. House Republicans want to raise the revenue without raising tax rates.

While is great to see that both sides are looking to address revenue and spending, both sides should negotiate up not down. The original plans offered are likely to barely stabilize the debt or put it on a slow downward path. Negotiating to the lowest common denominator will mean missing that benchmark altogether. Going bigger, on the other hand, offers the opportunity to put the debt on a clear downward path over the medium-term and making substantial improvements on our long-term fiscal situation.

We will continue updating this comparison grid as more plans are released.

Myth Buster: Other Plans are Much Worse Than the Fiscal Cliff

We've shown that there a plenty of reasons to not go over the fiscal cliff, including that it implements fiscal consolidation in an abrupt and blunt way causing a recession and puts a great deal of strain on the poor. We also know that we cannot just repeal the cliff without any offsets, since that would be a clear signal to the markets and public that even after numerous showdowns and negotiations, lawmakers cannot make sufficient progress on solving our fiscal issues.

But some commentators have argued that for the poor, the plans that would replace the cliff would be much worse than the cliff itself. While we cannot be sure what the final terms of a deal between Democrats and Republicans would be, we can look to bipartisan proposals such as Domenici-Rivlin and Simpson-Bowles as a guide. By many measures, these plans do a much better job at protecting the most vulnerable. 

Revenue Increases are More Progressive

On taxes, most economists agree that, all else equal, having a broader base and lower marginal tax rates is preferable. The lower rates in tax reform have prompted some commentators to say that these reform plans will primarily benefit the rich, but Tax Policy Center distributional analysis of both the Domenici-Rivlin and Simpson-Bowles plans are more progressive than the fiscal cliff. That's because many of the tax expenditures that tax reform would reduce or eliminate overwhelmingly benefit the wealthy.

The graph below shows the change in after-tax income from each plan and the fiscal cliff compared to continuation of current policy.

Source: Tax Policy Center*
*Please note that the above graph presents numbers that are not fully comparable, since the baselines and years examined differ in several substantial ways.
 

As can be seen above, despite reducing tax rates from current levels the Simpson-Bowles and Domenici-Rivlin plans raise substantial net revenue and do so in a far more progressive way than under the fiscal cliff (which increases rates). Going over the fiscal cliff means letting the 10% bracket increase to 15%, the $1,000 child credit reduce to $500 and lose most of its refundability, and a host of other taxes to go up on the poor and middle class. According to Tax Policy Center, in fact, the bottom quintile will see their aftertax income fall by almost 4 percent, and the second quintile by over 4 percent.

By comparison, the Simpson-Bowles and Domenici-Rivlin plans raise only very modest amounts of money from those in the bottom half of the income spectrum, with most new revenue being raised from the top quintile and especially from the top 1 percent.

Spending Cuts Designed to Protect Low Income

We've already refuted the claim that the most vulnerable are protected from the sequester in the fiscal cliff -- indeed they are hit quite hard, especially when compared to what would occur under bipartisan deficit reduction plan. True, the fiscal cliff does exempt low-income mandatory programs from cuts, but so do the bipartisan deficit reduction plans out there. A key principle in Simpson-Bowles was to "protect the most vulnerable," and neither it nor Domenici-Rivlin touch food stamps, Supplemental Security Income, unemployment insurance, or similar programs.

Where the sequester really hits low-income programs is on the discretionary side. More than one quarter of domestic discretionary spending goes to low-income programs like section 8 housing and low-income heating assistance. That means they could take a $120 billion hit under the sequester over ten years. By comparison, any bipartisan plan which calls for additional discretionary reductions will most certainly do what Simpson-Bowles and Domenici-Rivlin did and achieve those savings with caps. Those caps are very unlikely to be as deep as the sequester, and even if they were they have the advantage of allowing appropriators to assign reductions where it makes sense rather than across-the-board.

On health care, any bipartisan plan is likely to have deeper reductions than the fiscal cliff. But as we've showed before, there are any number of health care reforms that can promote greater efficiency in Medicare and Medicaid without harming the poor.

And then there is the question of Social Security. The fiscal cliff leaves Social Security insolvent, which would lead to beneficiaries receiving a benefit cut of 25 percent in 2033 if no action is taken. On the other hand, both Simpson-Bowles and Domenici-Rivlin propose a combination of new revenue, mostly progressive benefit changes, and new minimum benefits which protect and in some cases enhance benefits for low-income beneficiaries. Indeed, compared to a no-action baseline ("payable benefits" below), both plans do quite well.

Source: Social Security Administration
Note: Benefit calculations assume longest number of years worked for each earner (30 or 44 years) since they are the most common according to SSA

Growth is Stronger under a Replacement Plan

We've shown before in this Myth Busters series how the fiscal cliff would devastate the economy in the short run. But by implementing more gradual reduction, we can have stronger economic performance compared to going over the cliff.

Macroeconomic Advisors recently modeled the fiscal cliff against a relatively modest illustrative plan. Their finding was that a plan which gradually stabilized the debt -- even at a high level -- was far better for the economy than the fiscal cliff in the short term. Over the long-run, the deficit reduction from the fiscal cliff does improve the growth trend relative to the illustrative plan, but it takes many years to catch up. Thus, the Macroeconomic Advisers data show the importance of timing in deficit reduction

Source: Macroeconomic Advisers
 

A plan with more, but equally gradual, deficit reduction than the illustrative plan they modeled would likely have similar effects in the short-term and much more positive effects over the longer term. This would be especially true for plans like Simpson-Bowles and Domenici-Rivlin, which include specific growth enhancing policies such as base-broadning rate-reducing tax reform, new initiatives to increase public investments, and incentives to encourage people to work longer.

Any bipartisan plan to gradually reduce the debt will almost certainly be better in the short and medium term for the economy than the fiscal cliff, and is likely to be better for the long term as well. Faster growth means more jobs and higher wages.

There is no question that whatever plan is enacted will have its critics. Advocates and interest groups may think a plan went too far in one area or another. But a comprehensive plan would most definitely be an improvement over the fiscal cliff.

Think Tanks Bring Ideas to the Table

Just as President Obama and the Republican leadership are trading offers, three think tanks--the Heritage Foundation, the Center for American Progress, and the Bipartisan Policy Center-- each offered ideas that could be used in the negotiations.

The Heritage Foundation's J.D. Foster and Alison Acosta Fraser outline six entitlement reforms that can help with our long-term fiscal challenges, focusing primarily on Medicare and Social Security. These reforms are less sweeping than the kinds of structural reforms they would prefer, but they believe that these policies would have a better chance of being passed by Congress. The options they propose include:

  • Increasing the Social Security retirement age to 69 by 2034 and indexing it for longevity thereafter
  • Correcting the cost-of-living adjustment (COLA) in Social Security by switching to the chained CPI
  • Raising the Medicare retirement age to align with Social Security's, which is currently higher
  • Increasing Medicare premiums for high earners, reducing the premium subsidy they get from Medicare
  • Phasing out Social Security benefits for upper-income retirees
  • Consolidating Medicare's parts into one and financing 35 percent of costs with premiums.

The Bipartisan Policy Center, following on the heels of their proposal for a two-part process for deficit reduction, propose an illustrative down-payment that could be put together to produce up-front savings. In total, the package contains about $375 billion of deficit reduction over ten years including $195 billion of spending cuts, $140 billion of tax increases, and $40 billion of interest savings. The policies they use are:

  • Increasing Medicare Part B premiums to cover 27.5 percent of program costs, up from 25 percent ($60 billion)
  • Switching to the chained CPI for COLAs in Social Security and federal retiree pensions as well as for the tax code ($210 billion)
  • Implementing a temporary income tax rebate, perhaps similar to the one in 2008 (-$120 billion)
  • Taxing carried interest as ordinary income ($20 billion)
  • Reinstating the personal exemption phase-out (PEP) and Pease limitation for high earners ($160 billion)

CAP's proposal is a full deficit reduction plan involving tax reforms to increase revenue and progressivity and some spending cuts. They address the following:

  • Marginal Tax Rates: Ordinary income would be taxed at five rates of 15, 21, 25, 35, and 39.6 percent, while capital gains would be taxed at 24.2 percent (28 percent including the Medicare surtax) and dividends would be taxed as ordinary income.
  • Standard Deductions and Personal Exemptions: These would be replaced with a standard credit of $2,500 for singles and $5,000 for couples. Dependent exemptions would be replaced by an expanded child credit of $1,600 or a $600 credit for nonchild dependents.
  • Itemized Deductions: All itemized deductions would be replaced with an 18 percent credit with the exception of the charitable deduction, whose credit would be 28 percent. Similar to now, taxpayers would have to choose to take either the standard credit or the itemized credits.
  • Health Exclusion: The authors would cap the health exclusion at 28 percent for people making more than $250,000, mirroring a proposal from the President's budget.
  • AMT, PEP, and Pease: CAP would repeal all of these provisions, presumably because they would be unnecessary (personal exemptions and itemized deductions, targeted by PEP and Pease, would no longer exist).
  • Estate Tax: The exemption for the estate tax would be set at $2 million and the top tax rate would be 48 percent.
  • Other Taxes: CAP also proposes higher taxes on alcoholic beverages, cigarettes, and carried interest. They also assume a 4 percent corporate tax revenue increase from corporate reform, particularly from addressing transfer pricing. They also would legalize and tax internet gambling and extend the R&E credit and clean energy incentives.
  • Health Spending: CAP would save $385 billion from extending Medicaid rebates to Medicare, follow the Medicare Payment Advisory Commission's recommendations for reducing payments, increase premiums for higher-earners, utilizing competitive bidding for products and services, and moving away from fee-for-service.
  • Other Spending: CAP would reduce other mandatory spending and defense spending by $100 billion each. They endorse measures from the President's budget that would achieve this but aren't more specific than that.

Finally, CAP proposes a $400 billion stimulus consisting of infrastructure spending and a $100 billion tax cut, among other things. Including the stimulus, the authors estimate the plan would save $2.6 trillion over ten years, or $4.1 trillion if already-enacted spending cuts are included. They would have debt as a percent of GDP on a downward path to 72 percent in ten years.

Areas of Savings from CAP Proposal (billions)
  Ten-Year Savings/Costs (-)
Tax Proposals $1,900
Temporary Tax Cut -$100
Subtotal, Tax Increases $1,800
   
Health Cuts $385
Defense Cuts $100
Other Mandatory Cuts $100
Stimulus Spending -$300
Subtotal, Spending Cuts $300
   
Already Enacted Spending Cuts $1,500
   
Interest Savings $500
   
Total $4,100

Source: Center for American Progress

All three groups provide valuable policies to which budget negotiators should be paying attention, particularly for ones that have bipartisan appeal. We have said it before: many great ideas have already been provided--it is simply up to lawmakers to put together a politically viable and sufficiently sized package.

Watch Live: "Fixing the Debt: Reforming the Tax Code and Federal Health Spending"

Tomorrow, the Campaign to Fix the Debt will be hosting a half-day event that will bring together tax, health, and budget experts for a series of discussions on pressing budget issues. The event will start at 8:30 AM and will feature remarks from former OMB director and current Senator Rob Portman (R-OH), Senate Finance Committee chair Max Baucus (D-MT), and National Economic Council Director Gene Sperling.

It will also feature separate panel discussions on health care spending and tax reform with former lawmakers and policy experts from across the political spectrum weighing in on each subject. Given the central role that health spending and taxes are playing in the current budget discussions, it is certainly a timely discussion and promises to be very informative.

A livestream of the event can be seen below, and you can view more details about the event including the panel participants here.

MacGuineas and Weinstein on the Fiscal Cliff

CRFB President Maya MacGuineas joined Mark Zandi of Moody's Analytics on "Face the Nation" this Sunday discussing the Fix the Debt campaign and the fiscal cliff. MacGuineas criticized the political gimmicks from both Democrats and Republicans in the current negotiations and noted that the clear solution is very straightforward: it needs to raise revenues, cut spending, and reform entitlements.

MacGuineas argued that the country could use a "Go Big" type of plan that gradually phases in cuts to take advantage of the announcement effect. She described the boost in confidence from enacting such a plan as being the cheapest form of stimulus. But waiting until the last minute is not the way to go as that creates heightened uncertainty and anxiety for businesses and consumers who are looking to see what policy will be for next year. According to MacGuineas, "it's not about the policy, but the politics," and lawmakers should find a solution quickly.

Former Senior Adviser to the Fiscal Commission and CRFB consultant Paul Weinstein also appeared on Sunday's Washington Journal to discuss the fiscal cliff and the Simpson-Bowles plan.

Weinstein explained both the politics and policy involved with the Simpson-Bowles plan and its development in 2010. He also connected that experience with the current budget debate, explaining the current political dynamics and what policies may play a role. The appearance went into many other topics and is well worth the watch.

The Tax Math of the Fiscal Cliff Discussion

In a blog post on the White House's website, National Economic Council Director Gene Sperling and Deputy Director Jason Furman argue that the math of limiting deductions for high-earners dictates that an insufficient amount of revenue will be raised. They take a $25,000 cap on itemized deductions (which would raise $1.3 trillion over ten years), apply it only to people making more than $250,000 (40 percent revenue reduction), phase it in to prevent a huge tax increase as people cross the $250K threshold (additional 20 percent revenue reduction), and take out the charitable deduction (additional 30 percent revenue reduction). What's left is only $450 billion of revenue, or slightly less than half of the upper-income tax cuts. As a result, they conclude:

Plausible tax expenditure limitations that protect middle-class families and incentives to give to charity would raise far less revenue from the well off than is needed for a major budget agreement. A budget framework that raises only these amounts from high-income tax deductions while committing to no rate increases on high-income Americans would inevitably force any tax reform designed to further reduce the deficit to raise taxes on middle-class families simply to preserve lower rates for the most fortunate.

Revenue from $25,000 Cap
  Ten-Year Revenue
Impose $25,000 Cap on Itemized Deductions $1,300
Exempt People Below $200,000/$250,000 -$500
Phase In Cap -$150
Exempt Charitable Deduction -$200
   
Final Deduction Cap $450

Source: White House

They make a good point that making these modifications will reduce the revenue available. However, a comprehensive examination of the options shows that this conclusion is much too dismissive.

First of all, any of these tax expenditure limitations is dialable. One can change the limit, the tax expenditures, or other parameters to meet the desired revenue target. Also, the income level at which it applies could not be indexed for inflation. As an easy example, the White House numbers assume the $250,000 threshold is indexed to inflation, but it could be held flat in nominal dollar terms as is the case for the Medicare surtax in the Affordable Care Act.

Second, the $25,000 cap is only one of many options to limit tax expenditures and indeed it is the smallest of the options we outlined recently, in large part because it only looks at itemized deductions and ignores other tax expenditures. We outlined two other types of limitations in a recent paper, both of which would raise more revenue than the $25,000 cap. These included:

  • A Feldstein-Feenberg-MacGuineas style cap, which would cap tax expenditures at two percent of income. It would likely bring in more revenue than the $25,000 cap, especially if additional tax expenditures were included.
  • The President's preferred policy of capping the value of itemized deductions and certain other deductions and exclusions at 28 percent. The policy was modified so the value phases down to zero for people making over $1 million.

Dealing with the charitable deduction need not be a binary choice of include or exempt. We previously discussed ways in which the charitable deduction could be limited to raise revenue while mitigating the impact on charitable giving. These options include converting the deduction into a credit, having a credit for deductions that exceed a cap, or in the case of the 28 percent limitation, not phasing down the charitable deduction to zero. One could also convert the charitable deduction to an above-the-line deduction, as opposed to an itemized deduction, with a floor which contributions must exceed to be deductible. All of these methods still raise revenue from the charitable deduction while maintaining a marginal incentive to contribute to charities.

Finally and perhaps most importantly, any limitation of deductions and other tax expenditures can and should be combined with other policies. The $950 billion in upper-income tax cut expirations comes not from one policy, but from six different ones. Expecting to finance them all with a single policy might be asking too much. Any across-the-board limitation could be combined with any number of discrete policy changes, including the potential expiration of some of the upper-income tax cuts.

The White House did an important service by showing that these broad-based limitations are no silver bullet for reforming tax expenditures. Every policy has advantages and disadvantages, and there are no easy ways to generate substantial deficit reduction, particularly when focusing on such a small portion of the population. But that policies are hard does not make them impossible, and that they may be smaller than they look at first glance does not mean they are not worth pursuing.