February 2014

Drawing a Realistic Baseline

CBO's recent budget projections show a much deteriorated budget outlook, with debt now rising faster over the coming decade than previously anticipated. Their projections, of course, are based a number of assumptions, including assumptions about future policy. Were Congress to make different policy choices than CBO assumes, debt numbers could change significantly.

Typically, CRFB makes certain adjustments to CBO's current law baseline to establish the CRFB Realistic Baseline, but this year the CBO baseline may represent a reasonable approximation of that. Differences between "current law" and "current policy" have been narrowed dramatically as a result of the 2012/2013 fiscal cliff deal - which extended $4 trillion of expiring tax cuts - and the 2013 Ryan-Murray deal, which created a glide path to the sequester-level spending caps.

With these changes in place, our view is that the CBO baseline represents a reasonable approximation of where the debt is currently headed (reasonable, but by no means definitive). After all, the CBO baseline assumes lawmakers continue to spend at current law levels on the wars abroad, allow doctors in Medicare to take an 25 percent payment cut, let a host of expired or expiring tax provisions disappear, and provide no additional sequester relief. 

For that reason, CRFB has contructed two alternatives to the CBO baseline. On the low end (the PAYGO Scenario), we assume that Congress fully abides by PAYGO rules (by fully offsetting any spending or tax cuts) while we draw down troop levels in Afghanistan from 38,000 to 30,000 by 2017, and that spending will decrease consistent with that plan.

On the high end (the No-Offset Scenario), we continue to assume the troop drawdown but also assume that lawmakers enact annual doc fixes, extend the refundable tax credit expansions after 2017, reinstate and continue the currently-expired "normal tax extenders," and repeal future sequestration cuts. Essentially, this is the scenario if lawmakers do not adhere to PAYGO at all. In both scenarios, we correct for some minor timing issues.

Bridge from Current Law to Alternate Scenarios (Billions of dollars)

Source: CBO, CRFB calculations
All numbers are rounded to the nearest $5 billion.

Not surprisingly, deficits and debt differ substantially depending on the assumptions made. Under CBO's baseline, debt will remain at about 72 percent of GDP through 2017, and then rise to 79 percent of GDP by 2024. After accounting for the war drawdown in our PAYGO Scenario, debt levels grow modestly slower -- reaching 77 percent of GDP by 2024 as opposed to 79 percent.

On the other hand, if policymakers choose the fiscally irresponsible route assumed in our No-Offset Scenario, debt would rise to 84 percent of GDP by 2024, and would be on a much faster upward path. 

The graph above illustrate that without real policy changes, debt will remain at its record high levels and begin to grow rapidly later in the decade. Yet, taking steps backward by failing to abide by pay-as-you-go rules will substantially worsen the fiscal situation.

In addition to the debt implications, the scenarios we laid out also have different implications for spending and revenues. The table below shows how other budget metrics fare under each scenario.

Budget Metrics (Percent of GDP)

Source: CBO, CRFB calculations

Clearly, the federal budget continues to be on an unsustainable path. Lawmakers should work on a bipartisan basis to take advantage of the upcoming Congressional and President's budget proposals to put forward responsible fiscal policies that reduce the debt as a share of the economy this decade and over the long term. At the very minimum, they should not be passing measures that make the situation worse, and should abide by PAYGO rules.

Click here or on either table for an Excel version of the tables.

Camp to Release Tax Reform Draft Next Week

Next week, House Ways & Means Chairman Dave Camp is set to release a draft of a bill to revamp the U.S. tax code, according to press reports. It was unclear whether Camp would release a tax reform draft at all, as House Republican leadership remains skeptical of tax reform, and Camp's Senate taxwriting counterpart Max Baucus was recently confirmed as Ambassador to China. While details about the bill are still scarce, Camp's decision to release a draft represents a positive step forward for the tax reform debate.

We applaud Chairman Camp's decision to release a draft. It is one thing to talk in generalities about the need to lower tax rates and make the tax code simpler, but the debate does not move forward until legislators get specific. Simplifying the tax code and reducing rates will require eliminating or significantly scaling back some popular tax breaks. For instance, making changes necessary to reduce the corporate tax rate (currently at 35 percent) below 30 percent without increasing the deficit almost requires changing accelerated depreciation and Section 199, which both provide significant tax breaks to manufacturers. On the individual side, reducing rates will require eliminating or scaling back popular deductions, such as the deductibility of state and local sales taxes which Camp held a hearing on last year. A serious effort to reform the tax code will require numerous tradeoffs, but if done properly, the economic and fiscal benefits of tax reform will justify the tough choices that will be necessary.

Tax reform has the potential to improve the fairness of the tax code, make U.S. business more competitive, and improve the deficit. Our partners at Fix the Debt summed up nicely the case for comprehensive tax reform, arguing that many of the $1.3 trillion of tax preferences are:

Many of these preferences are expensive, regressive, and economically distorting; they increase complexity, reduce fairness, and let the government pick winners and losers. The higher than necessary rates, narrow base, and sheer complexity in the tax code hurt economic growth by driving up compliance costs and reducing incentives to work, save, and invest.

Similar to the analyses we provided of the Baucus discussion drafts released last year, we will eagerly wait to see what is in Camp's tax reform draft and provide analysis of the draft when it is released. Although tax reform efforts may be temporarily stalled, Chairman Camp's has done a great deal of work on the nuts and bolts of tax reform in his four years as Chairman, and he can make a valuable contribution to the debate before he steps down as Ways & Means chairman at the end of this year by putting forward a comprehensive proposal based on that work.

* * * * *

Looking for more info? Check out Fix the Debt's case for comprehensive tax reform and our blog series "The Tax Break-down" that examines the tax breaks under discussion as part of reform and options for reforming them.

Chained CPI Not in President's FY2015 Budget

Today, the White House announced that the President will not propose adopting the “chained CPI” in the President’s Budget this year, as he did last year (though the White House commented today that they are open to the provision as part of a bipartisan deficit reduction deal).

We argued yesterday that this would be a mistake, explaining that the chained CPI is not only a much more accurate measure of inflation but would also result in several hundred billion dollars of savings in the first decade and more than $1 trillion in the second.

For those interested in learning more about the chained CPI, CRFB and its partner – the Moment of Truth Project – have published a large amount of material on the topic. Their paper, Measuring Up: The Case for the Chained CPI, explains the interaction between the inflation measure and the budget, makes the technical case for chained CPI, and shows the budgetary and distributional impact of adopting it.

In addition to this paper, we have published answers to frequently asked questions about the chained CPI, corrections to some common myths, explanations of the distributional impact, pushback on misleading claims, and dozens of blog posts discussing various facets of chained CPI.

Our chained CPI resource page compiles numerous resources on chained CPI from CRFB and from government agencies, think tanks, and economists from across the ideological spectrum. Our resources page also links to a brief summary of the issue, which can be viewed below:

As we’ve explained many times before, chained CPI is a common-sense proposal with broad bipartisan support that would not only improve the way we measure inflation but also raise additional revenue, slow the growth of government spending, and help to shore up Social Security.

Although we are glad the President remains open to the policy, we are disappointed he has removed it from his budget. As CRFB President Maya MacGuineas said today in a statement from our partner Fix the Debt:

We are incredibly disappointed to learn that the President has decided to drop his proposal to correct the way in which the federal government measures inflation…Reaching agreement on a comprehensive debt deal will require consideration of all policy options and compromises by both sides. While we welcome today’s statements from the administration indicating they remain open to supporting chained CPI in the context of a bipartisan deficit reduction agreement, the nation needs the President to lead on this issue. The clear pullback on his part is a disturbing sign that he will not.

To learn more about chained CPI, visit our chained CPI resource page here

Why Did the Deficit Drop in 2014? Part 2

At the beginning of the month, the Congressional Budget Office released its annual report on the federal budget, which showed that the deficit is expected to fall by $166 billion from last year to this year, but increase by $1.7 trillion over the next ten years compared to previous projections.

The next day, we released an analysis of the reasons why the deficit dropped since last year. Three-quarters of the drop, or $120 billion, could be attributed to "expected" changes that had been predicted in last year's report. Higher collections from Fannie Mae and particularly Freddie Mac also improved the deficit, while legislation increasing discretionary spending above sequestration amounts in exchange for cuts in future years increased the 2014 deficit. In this post, we look into the other changes to the 2014 deficit, those included as "expected" changes, particularly the automatic stabilizers that increase deficits when the economy is operating below potential.

There are several large factors which will reduce the deficit in 2014. Perhaps most fundamentally, government revenues increase along with the economy. As payrolls, personal incomes, and corporate profits increase, so does tax revenue. The economy is projected to grow by nearly 4 percent, and income tax revenue will grow by nearly 5 percent.

Yet revenues still have a long way to recover from the recession. During a recession, certain "economic stabilizers" automatically increase the deficit by lowering tax revenue and raising safety net spending. At their height in 2010, these stabilizers increased the deficit by $373 billion, nearly 30 percent of the total deficit.

The high deficits of the last few years are falling; however, the deficits from automatic stabilizers are projected to continue for several more years. The automatic stabilizers only fell by $16 billion between 2013 and 2014, a drop caused by $6 billion in higher revenues and $10 billion in lower safety net spending. In 2014, stabilizers will cost $261 billion, over half of this year's $514 billion deficit. The automatic stabilizers will continue to drop in future years, but are not expected to reach zero based on a change in how CBO projects future growth: they no longer expect the economy to reach full potential within ten years or the unemployment rate to fall to levels projected in past forecasts.

Other factors contributed to the changes to the deficit. The new taxes in the fiscal cliff deal, such as a new top rate of 39.6 percent and a 5 percent higher rate on capital gains and dividends, raised approximately $47 billion. While they were in effect for all of calendar year 2013, they did not apply to the entire fiscal year 2013, which includes 3 months of 2012, before the tax increases were enacted.

Other factors increase the deficit. The Affordable Care Act's new coverage provisions have begun, costing the federal government $41 billion in exchange subsidies and expanding health coverage to low-income populations. Finally, with every passing year, more of the population ages into retirement – Social Security outlays will increase by $38 billion and net Medicare spending is expected to increase by $13 billion. 

As Congress wrestles with how to achieve deficit reduction, they would be wise to consider the various factors pulling the deficit in different directions – particularly over the long term. The newest deficit projections were slightly rosier in the short-term, but that was largely as a result of factors outside their control. Later this decade and over the long term, there will almost surely be no conversations about why the deficit is falling. The focus will instead be on why the deficit is growing because of health care costs and an aging population. However, waiting until that happens before we take action will risk higher debt levels, forgoes time when reforms could be gradually phased in, and places a larger share of the population at risk by being either in or near retirement. Falling deficits this year should be an opportunity to create lower deficits in the future too.

Entitlement Reform Should Be in the President's Budget

Last Friday, 16 Senate Democrats sent a letter to President Obama, but it wasn't for Valentine's Day. Rather, the letter warned the President against including cuts to Social Security, Medicare, or Medicaid benefits in his FY 2014 budget, due out in two weeks. Although it did not specifically mention any policies, it was clearly addressed at the inclusion of the chained CPI in last year's budget and certain modest Medicare cost-sharing reforms. Today, House Democrats sent a letter more specifically opposed to the chained CPI. There has been much speculation about what this budget will contain, particularly with regards to the chained CPI.

However, given the recent deterioration in budget projections, though, this is the wrong time to turn our back on entitlement reforms. With health care, there are significant savings that can be had from health care providers and drug companies -- and the President has those -- but beneficiaries will ultimately need to contribute as well. There are ways to achieve savings that will actually help beneficiaries and make the health care system more efficient, such as cost-sharing reforms. And on Social Security, the system's finances demand that we find solutions, or else beneficiaries will receive a one-quarter cut to benefits in 2033, according to the program's trustees.

As we have said many times before, the chained CPI is the most accurate measure of inflation and should be used where inflation calculations are relevant, whether that be in Social Security or other programs. Chained CPI achieves significant savings across the budget on both the spending and revenue side by more accurately implementing the policy of adjusting benefits and provisions in the tax code to reflect inflation. Overestimating inflation is not a targeted or wise way to increase benefits; other ways exist to boost benefits, particularly for the most vulnerable.

Switching to chained CPI has been a key element of comprehensive deficit reduction plans such as Simpson-Bowles, Domenici-Rivlin and the President's budget and backing away from chained CPI now will make it harder to reach an agreement in the future which puts the debt on a sustainable path while replacing sequester with smarter savings. But chained CPI could also be part of smaller packages such as the proposal put forward by CRFB President Maya Macguineas to use the non-Social Security savings from chained CPI to offset the costs of temporary spending for unemployment benefits and job creation measures, with savings in Social Security going to improve the program's solvency.

Another issue with taking entitlement reforms off the table is the squeeze unchecked growth of entitlement programs will put on the rest of the budget. Deficit reduction efforts on the spending side in recent years have focused almost entirely on discretionary spending, which contains defense spending and non-defense spending like education, infrastructure, and research. That category has fallen significantly in recent years and will continue to be constrained in future years if policymakers do not act to restrain the growth of mandatory spending. With mandatory programs contributing little to deficit reduction so far, discretionary spending has felt the brunt.

In short, we hope that President Obama not only maintains the reforms he proposed last year and in previous years but builds on them. The recent uptick in debt projections should bring a new focus on the drivers of the long-term debt.

A Proposal to Pay for the Doc Fix

Last week, the relevant Congressional committees released a bipartisan, bicameral proposal to replace the Sustainable Growth Rate (SGR) formula for Medicare physician payments, which has repeatedly been modified or delayed before taking effect since 2003. Despite this agreement, much less work has been done concerning how to pay for the cost of the replacement. To fill that void, Mark McClellan, Keith Fontenot, Alice Rivlin, and Erica Socker published a proposal in Health Affairs to offset the $130–$170 billion ten-year cost of a replacement system.

Their proposal aims to use this opportunity to create better incentives to provide and use care more efficiently through rewards for coordinated care and the use of cost-sharing changes, shared savings, and other means. Their package includes a mix of savings from both providers and beneficiaries, many of which have been highlighted in the Congressional Budget Office's (CBO's) Budget Options report. Many have also received support from the President's budget, Simpson-Bowles, Domenici-Rivlin, and the Medicare Payment Advisory Commission (MedPAC). They describe their list of policies as follows:

If Congress can come up with off-sets for physician payment reform that support improvements in care as well as lower costs, the whole package could have a more meaningful effect on beneficiary care than the physician payment reforms alone.  This could assure beneficiaries and other health care providers that these savings are not just payment cuts that must be absorbed, but steps to help reduce spending through reforms that improve care.

The reforms they propose would be sufficient to pay for the cost of a reasonable permanent doc fix.

McClellan-Table-1

This package is just one way lawmakers could choose to offset the cost of a doc fix. There are many options from CBO and others that would also do the trick while also encouraging higher-quality, higher-value care. Legislators working on the SGR replacement simply need to find the political will to agree on offsets.

Line Items: Winter Games Edition

Cold Reality – The Winter Olympics are in full swing in Sochi, Russia, but Washington saw its own share of winter games before Congress adjourned for yet another break. Lawmakers played with the debt limit and considered virtually every idea under the sun before agreeing to put it off for another year. Legislators also fooled around with various budget gimmicks as they seek to game the system. There are a lot of issues that Americans want their representatives to tackle, but there isn’t much hope of that happening in this political climate. Avoiding debt ceiling disaster may end up being one of the biggest achievements out of Washington this year. Not really the stuff of Olympic glory.

Tough Sledding on the Debt Limit – Congress managed to avert going to the brink of a national default by agreeing to suspend the debt limit once again. The suspension lasts until March 15, 2015. House leaders had floated a wide range of proposals to pair with raising the debt ceiling, but in the end gave the president the clean increase he wanted. The Senate quickly followed suit and it was signed by President Obama on Saturday. The suspension means there will be no more major fiscal fights until at least October 1, when government funding expires. However, it does nothing to improve the debt outlook, which the latest projections from the Congressional Budget Office (CBO) show is now even worse than previously forecast. A statement from the Campaign to Fix the Debt urges, “It’s critical that lawmakers not take steps backwards or undermine this progress by considering legislation that has the ability to add to the deficit or worsen the country’s already strained fiscal outlook.” The recent debt limit fights have led to increased calls to improve the mechanism so that it can more effectively be used to put the country on a sustainable fiscal path without threatening the economy.    

Gimmick Olympics Produce No Winners – Lawmakers are facing heightened pressure not to add to the deficit, but some proposals they are offering to offset the costs of new policies are not medal caliber. A host of budget gimmicks have popped up that technically pay for new policies but, in reality, add to the deficit. Republicans in the House considered the “pension smoothing” gimmick to pay for rolling back recent military retirement reforms while Democrats in the Senate offered it to offset the cost of a three-month extension of expanded unemployment insurance benefits. The Senate proposal to reverse the military retirement changes used another gimmick – “war savings” – as an offset. We urged rejecting these gimmicks in a statement, and fortunately they were not used. However, gimmicks are still an attractive avenue. We created a chartbook identifying gimmicks to watch out for using helpful charts that illustrate how they work and why they add to the deficit.     

Skating Around Reform – On Saturday, the president also signed into law legislation rolling back the reduction in the cost-of-living adjustment (COLA) for working-age military retirees that was included in the Ryan-Murray budget deal. The House and Senate passed the change as they worked on the debt ceiling legislation separately. Now, only service members who start this year and afterwards will be impacted. The original version was a modest reform of a military retirement system in need of change that has now been diluted. As pressure mounts to find more savings from defense, it will be impossible to exclude military compensation, which is accounting for more and more of the Pentagon budget. The military COLA change is also a rare instance of entitlement reform that policymakers have been able to achieve. Although it is positive that lawmakers rejected blatant budget gimmicks to offset the change, it is still a step backwards because it replaces savings that would be realized far beyond the ten-year budget window with extending the cleaver of the mandatory spending sequester for an additional year. As a CNN article put it, “in reality the measure to reverse most military retirement cuts is the legislative equivalent of a cocaine hit: a feel-good high that obscures current problems, makes future issues worse (for the Pentagon and taxpayers) and sends one of the best signals yet that Congress is nowhere near making the tough decisions needed to avoid the financial storm set to crash on the federal budget in just a few years.”   

Downhill from Here for Doc Fix? – The military COLA bill also contained a provision creating a $2.3 billion "Transitional Fund for Sustainable Growth Rate Reform," which could be used to pay for a permanent repeal of the Sustainable Growth Rate (SGR). The relevant congressional committees recently jointly introduced “doc fix” legislation that didn’t include an offset.

Tax Reform an Olympian Task – The prospects for changes to the tax code remain cloudy. New Senate Finance Committee Chair Ron Wyden (D-OR) says that major reform won’t happen this year because of the partisan divide in Congress. Wyden hopes to take action on the “tax extenders” this year as a "bridge" to broader reform. Meanwhile, Wyden’s House counterpart, Ways and Means Committee Chair Dave Camp (R-MI), may go ahead with introducing comprehensive tax reform legislation. Also, the economic plan proposed by House Republicans has a tax reform component. However, the Olympic spirit has indeed gripped legislators as a bipartisan push has gained steam to exclude the value of Olympic winnings from income.  

A Golden Opportunity for Budget Reform? – The budget dysfunction of recent years is bolstering calls to reform the budget process. Last week the House Budget Committee approved of two budget process reform bills. One would introduce fair value accounting for federal credit programs and the other would institute biennial budgeting, which would move from yearly budgets to a two-year process. Advocates say two-year budgeting would allow more time for oversight of government spending and cut down on annual budget battles. For more budget reform ideas, visit budgetreform.org. Meanwhile, the Office of Management and Budget (OMB) confirmed that the White House Fiscal Year 2015 budget request will be released in two parts, with the topline numbers released March 4 and more detailed information following the next week.

 

 

Key Upcoming Dates (all times are ET)

 

February 20

  • Bureau of Labor Statistics releases January 2014 Consumer Price Index data.


February 28

  • Bureau of Economic Analysis releases second estimate of 4th quarter GDP growth.

 

March 4

  • White House releases topline numbers for Fiscal Year 2015 budget request.

 

March 7

  • Bureau of Labor Statistics releases February 2014 employment data.

 

March 18

  • Bureau of Labor Statistics releases February 2014 Consumer Price Index data.

 

March 27

  • Bureau of Economic Analysis releases third estimate of 4th quarter GDP growth.

 

March 31

  • "Doc fix" expires.

 

Backtracking on Military Retirement Bodes Poorly for the Budget

Earlier this week, Congress moved quickly on a bill to repeal the military cost-of-living adjustment (COLA) reduction for working age retirees that was included in the Ryan-Murray budget deal. The bill repeals the reduction for all service members who started before 2014, effectively delaying any part of the reform for 20 years and delaying its full phase in until 2058. The new spending from repeal is offset by extending the mandatory spending sequester an additional year to 2024, and it also designates $2.3 billion (the savings from the sequester extension in excess of the 10-year cost of repealing the COLA reform) to help pay for the next needed "doc fix," whether temporary or permanent. The bill passed with dissent from only 90 members of the House and 3 Senators.

Although the bill is technically offset over ten years, it is a step backward for fiscal responsibility. It partially repeals one of the few entitlement reforms in the budget deal and offsets it with an extension of a policy that cuts spending across the board in a ham-handed manner. Moreover, the modest COLA reduction repeal has costs over the longer term whereas the sequester extension only produces savings in two years. Also, the higher accrual payments the Department of Defense (DoD) must put away to pay the higher COLAs will put a squeeze on other defense priorities, given the tight spending caps already in place.

This last fact is why the bill would make a good candidate for a longer-term scoring technique, even if it has a relatively small budgetary impact. For one, repealing the COLA for current service members means that the policy does not apply to anyone for 20 years (because military pensions do not vest for 20 years). However, the cost of repeal will phase out over time, eventually reaching zero once all retirees face the COLA reduction. The extension of the sequester, alternatively, produces savings in the tenth year and the year immediately following, but it does not produce any savings in subsequent years. Thus, both the cost and the offset have different effects over time.

For the first decade, the primary effect (not including interest costs) of the bill is almost exactly deficit-neutral. However, accounting for interest costs, the bill increases the debt by about $2 billion. Looking over the next twenty years, the bill with interest could cost about $15 billion. Another thing to account for, however, is accrual payments by the federal government. When retirement benefits are increased, agency pre-funding contributions (which are effectively monies paid to ourselves on paper to highlight future costs) also increase. With discretionary caps in place, because those pre-funding contributions count toward the caps, that additional spending is ultimately taken out of other programs, so the net effect is to reduce deficits. After accounting for the effect of accrual payments and related interest savings, the bill is actually roughly deficit-neutral over twenty years.1

Note that since there are no official CBO numbers beyond the first ten years, the two-decade estimates are rough.

Budgetary Impact of the Military COLA Bill (Billions of Dollars)

Source: CBO, CRFB calculations
Note: Second decade estimates are very rough and rounded calculations.

Regardless of the fiscal impact, though, the bill is a step backward for responsible budgeting in that it shows a lack of commitment to entitlement reform, and feeds the notion that similar reforms may not take effect. As House Budget Committee chairman Paul Ryan (R-WI), who voted against the bill, said, "Rather than making the tough choices, it sidesteps them. I’m open to replacing this reform with a better alternative. But I cannot support kicking the can down the road." Sen. Jeff Flake (R-AZ) asked, "How do we convey to the nation the seriousness about solving the debt crisis when at the first sign of political pressure, we repeal one of the deficit reduction measures?" House Armed Services Committee ranking member Adam Smith (D-WA) noted, "By repealing the COLA provision that was just agreed to a month ago in this very body, we are forcing the Department of Defense to focus on personnel costs...forcing cuts to readiness and procurement."

Granted, military retiree pensions are a particularly politically sensitive topic, but if lawmakers are unwilling to stick with a modest reform, it speaks poorly to their ability to agree to the reforms that will be needed for health care programs, Social Security, and the tax code. The bill's impact is deficit-neutral on paper over the next twenty years, but its portent is much worse.


1 Although CBO notes the size of changes to accrual payments, they do not include these in their estimate of the bill's effect on direct spending because the final amount of discretionary appropriations are still subject to annual appropriations bills not yet enacted.

CBO: The Deficit Will Be About $45 Billion Lower This Year But $1.7 Trillion Higher over Ten Years

In May of last year, CBO expected the 2014 deficit to fall to $560 billion from 2013's total of $680 billion. Now, CBO is estimating a deficit of $514 billion this year, a reduction of $46 billion compared to May. By contrast, CBO revised its estimates of ten-year deficits up by about $1.4 trillion over the 2014-2023 period and nearly $1.7 trillion over the 2015-2024 period on an apples-to-apples basis that removes non-recurring disaster costs.*

Ironically, most economists would have preferred exactly the opposite: somewhat higher deficits today, when the economy is weak, and lower deficits in future years to allow the debt to fall as a share of GDP. In fact, had the opposite occurred, it would have boosted GDP both this year and the end of the decade by about 0.35 percent, using CBO rules of thumb (Appendix D of the report).

Many articles (here and here and here) have reported the lower deficits that CBO now projects in the short term. Less attention, however, has focused on the far worse projections over the rest of the ten-year window (and likely beyond). As we explained in recent blog posts on CBO's new report, falling deficits in the near term are being driven by higher revenues and lower spending as a result of the economic recovery, along with payments to the Treasury from Fannie Mae and Freddie Mac, but higher deficits of about $1.7 trillion than previously thought over the decade are being driven by slower economic growth, a slower recovery of the labor market, and lower levels of labor participation.

Unfortunately, it would have been far better if CBO had said the opposite was occurring. Luckily, lawmakers can adopt measures to control long-term debt and improve the country's growth potential.

 

The Short Term

CBO's updated projections show slower economic growth over the next few years than previously thought – growth in 2016 only reaches 3.4 percent in 2016 instead of 4.4 percent – and a slower recovery in the labor market. Such information could prompt lawmakers and economists to call for additional temporary short-term investments to aid the recovery, should they deem it necessary. According to CBO, short-term relief in form of emergency unemployment benefits and/or additional sequester relief could boost near-term GDP growth and employment. Using rough rules of thumb from CBO, an additional $45 billion in deficits this year from aid for the jobless and/or additional sequester relief could boost 2014 inflation-adjusted GDP by between 0.30 and 0.35 percentage points (raising real growth from 2.7 percent to about 3.0 percent) and boost full-time equivalent employment by between 350,000 and 400,000.

Importantly, however, CBO also cautions that higher federal borrowing for short-term measures "would eventually reduce the nation's output and income slightly below what would occur." When presented with the option of providing additional relief to the economy in the near term while offsetting the costs over the long-term, CBO would say it would be a net positive for the economy (as would most economists), especially if the offsets continued to hold down deficits over the long term.

The Long Term

Higher expected deficits after 2015 will come at a time when population aging, health care costs, and rising interest payments will place even larger demands on the government to borrow. As CRFB and CBO continue to stress, increased federal borrowing when debt is already at elevated levels poses serious risks to economic growth, investment, budgetary flexibility, and financial stability.

In addition to the reasons cited for lower projected growth this decades, which include lower labor force participation and lower productivity growth, CBO cites higher levels of debt as a central component. As a result of higher debt levels than in previous projections, CBO now forecasts that the nation's capital stock (the cumulation of current and past investments in physical capital) will grow more slowly each year – 3.1 percent, down from an average of 3.4 percent.

Using CBO's rough rules of thumb over the longer term, an additional $1.5 trillion in primary deficit reduction (which is what would occur if CBO's deficit increases from the May baseline became downward revisions) could increase the size of the economy by between 0.35 and 0.40 percentage points by 2024 as a result of a larger capital stock. Greater deficit reduction, and particularly pro-growth tax and spending reforms, could produce additional economic gains.

Combining the Short Term and Long Term into One Strategy

A far better strategy than short-term austerity or elevated deficits in later years would be to reverse the trends simultaneously. Such a strategy could allow for slightly higher deficits in the near term, something than many economists have suggested, while at the same time paying for these measures over the ten-year window and undertaking far-reaching reforms to the tax code, entitlement programs, and other spending to put the debt on a downward path relative to the economy. The upfront measures could help encourage the recovery, while entitlement and tax reforms would put downward pressure on the debt over the long term, enhancing overall growth. Most economists would call that a win-win, plain and simple.

If the changes since the May baseline had been in the opposite direction – lowering ten-year deficits by about $1.7 trillion instead of increasing them – debt would have been on a roughly stable path later this decade instead of an upward path. Importantly, however, lawmakers would have to do far more in order to put the debt on a downward path – an outcome that should be the ultimate goal.

Many bipartisan deficit reduction plans have allowed for slightly higher near-term borrowing in exchange for much lower borrowing down the road. For example, the original Domenici-Rivlin plan coupled an upfront payroll tax holiday for both employees and employers along with trillions of dollars in health care reforms, tax reforms, spending reforms, and Social Security reform. In addition, the recent Simpson-Bowles proposal called for repealing a larger portion of the sequester than lawmakers were able to agree on and combine those near-term measures with more than $2.5 trillion in savings through 2023. President Obama's deficit reduction offer to Speaker Boehner in the fiscal cliff negotiations included $50 billion of immediate infrastructure investments coupled with $1.8 trillion in savings through 2023.

Let's hope that the FY2015 budget season focuses attention on CBO's worsened projections and produces proposals to improve the economy and guide the budget toward long-term sustainability.


 

*The $46 billion change in FY2014 deficits would change only slightly when correcting for the differences in Sandy aid between the baselines.

Everything You Need to Know About Budget Gimmicks, in 8 Charts

Last week's report by the Congressional Budget Office showed that our debt remains on an unsustainable path, (see our ongoing blog series) and is projected to be $1.7 trillion higher by 2024 than we previously thought.

Despite the dismal fiscal picture, Congress may be considering measures to worsen the deficit, and covering their tracks with so-called "budget gimmicks."

Today, we released a chartbook, "Avoiding Budget Gimmicks," which explains and illustrates several of the tricks and slights of hand that policymakers may use to avoid identifying genuine offsets and payfors.

We encourage our readers to share these charts and graphs and to hold policymakers accountable for efforts to worsen the long-term fiscal situation.

A pdf version of this chartbook is available here. The individual charts, with descriptions, are also posted below.


 

Chart 1: The National Debt is High and Growing

Debt is currently at its highest level since World War II, and is expected to continue to grow later this decade. Assuming the wars in Iraq and Afghanistan continue to unwind and policymakers abide by current law, debt is projected to rise from 72 percent of GDP in 2013 to 77 percent by 2024.  

 

Chart 2: Deficit-Financed Extensions Would Make the Debt Much Worse

While abiding by current law will allow debt to grow to 77 percent of GDP, continuing expiring (or expired) provisions without legitimate offsets could make the situation far worse. Extending the current doc fix, the recently expired tax extenders, and certain refundable tax credits would increase debt levels to 80 percent of GDP by 2024. Adding a repeal of future sequestration cuts would increase it to 84 percent. Additionally reinstating and extending unemployment benefits and "bonus depreciation" could drive the debt to 86 percent of GDP.

Chart 3: The War Gimmick May Allow Policymakers to Avoid Tough Choices

Under current budget conventions, uncapped discretionary spending, like war spending, is assumed to grow with inflation in the CBO baseline regardless of future plans. Some have suggested taking advantage of this quirk to cap war spending below the CBO baseline but well above the levels consistent with the drawdown currently underway. Yet capping spending above what current policy dictates and what Congress intends to spend will not result in lower future spending, and will generate only phantom savings.

 

The Congressional Budget Office, as well as budget experts on the left and right, all warn that war savings are illusory:

 

Chart 4: Using the War Gimmick Can Create a Slush Fund to Further Worsen the Debt

If war spending is capped at levels in excess of expected costs, these caps will create a slush fund for future spending. Specifically, lawmakers could further lower the caps to offset new priorities, or could sneak normal defense costs under the war spending caps if they are still elevated above drawdown levels. For example, if lawmakers set war spending caps $50 billion (over ten years) below the CBO baseline, it would create a $600 billion slush fund to avoid paying for future initiatives.

 

Chart 5: Policies Which Save Now and Cost Later Don't Really Save At All

Some policies take advantage of the ten-year budget window by taking credit for alleged savings that only represent a timing shift. For instance, a provision called pension smoothing would increase tax revenues in the first six years, but lose revenue beyond that and have no significant budgetary impact over the long-run.


Similarly, budget experts from across the political spectrum warn that this sort of timing shift is a gimmick:


Chart 6: Moving Savings from Year 11 to Year 10 Doesn't Reduce the Deficit

Another timing gimmick takes savings which would have occurred in the 11th year – just outside the ten year budget window – and moves them into the 10th. This shift may appear to reduce ten-year deficits, but in fact results in no net savings. Policymakers used this gimmick when approving a 3-month "doc fix" in December 2013.

Chart 7: Offsetting Permanent Costs with Temporary Savings Results in Permanent Costs

Some policy changes have largely temporary deficit impacts, while others have largely permanent impacts. Using a temporary policy to pay for a permanent one may appear to add up over ten years, but would worsen the fiscal outlook over the long-run. For example, adopting LIFO accounting in the tax code would generate mostly temporary revenue; using that revenue to pay for a permanent rate reduction would increase long-term deficits and debt.

Chart 8: Waiting Ten Years to Start Paying May Be Unwise

Although it may not be considered a gimmick, waiting until the end of the decade to pay for new spending can be both risky and costly. First, an offset far in the future may not be viewed as credible. Even if it were, however, substantial interest costs would accrue over the decade. In the example below, waiting ten years to pay a $25 billion bill results in interest costs equal to one-third of the primary budget impact.

 


 

The long-term debt problem is daunting enough, and it will be worse if lawmakers continue to suggest using budget gimmicks to hide or obscure the costs of new policies. We encourage readers to use these tools to hold lawmakers accountable for their efforts to worsen the long-term fiscal situation. Our whole chartbook is available here, or as a printer-friendly PDF. You can read more detail about these and other gimmicks in our paper Beware of Budget Gimmicks.

Related Blogs:


Note: The last chart was updated on February 12 to include estimates from CBO's newest interest projections.

 

Mixed News on the House Military COLA Bill

With the debt ceiling having been reinstated last Friday, lawmakers are scrambling to come up with legislation to lift or suspend it again before extraordinary measures likely run out by the end of the month. Originally, House Republicans had planned on attaching a repeal of the military retirement cost-of-living adjustment reduction for people who joined the service prior to 2014 to a debt ceiling suspension through March 15 of next year. Now it appears they will pursue the "beware the ides of March 2015" strategy separately from the military COLA change, opting to vote on a clean debt limit suspension instead.

Avoiding default on the national debt is, of course, a good thing. The military COLA bill is more of a mixed bag.

As we have said before, the reduction in COLAs for working age military retirees in the Ryan-Murray deal is a modest change in the military retirement system that is need of reform.  Funding the obligations for health and pension benefits for military retirees is placing an increasing burden on the defense budget. Repealing or limiting application of the COLA provision in Ryan-Murray without offsetting it with other changes reducing obligations for pension or health benefits for military retirees will require further cuts in other defense programs to accomodate higher accrual payments to fund these obligations.

The bill the House is considering would exempt current service members and retirees from the COLA reduction and apply the reduction to service members who enlisted after January 1, 2014. As a result, the policy would not achieve any savings for at least twenty years, which is the vesting period for military pensions. Grandfathering current enlistees and retirees would cost $7 billion over the next ten years. These costs would be offset by extending the mandatory spending sequester through 2024 (it had previously been extended to 2022 and 2023 in the Ryan-Murray deal).

The good news is that unlike the legislation currently being considered by the Senate, which would completely repeal the military COLA reduction without offsetting the costs, the bill the House will consider would be fully offset within the ten-year window, and it would at least maintain the COLA policy for new service members. The less good news is that it partially rolls back one of the few entitlement reforms in Ryan-Murray, and it offsets the cost with savings in the tenth year, meaning that interest costs will accrue on higher debt in the years prior. Also, it will be replacing a targeted cut with the across-the-board cuts from the mandatory sequester. Moreover, it accelerates the timing of the sequester cuts in 2024 to move some of the savings that would have otherwise occurred in FY 2025 (outside the ten year budget window) into FY 2024. Finally, the COLA reduction repeal has costs over the longer term whereas the sequester extension only produces savings in two years.

As a side note, the legislation also contains $2.3 billion for a "Transitional Fund for Sustainable Growth Rate Reform," which would provide funds for the Secretary of Health and Human Services to supplement Medicare physician payments in 2017. Most likely, though, the fund will be rescinded and used as an offset in SGR reform legislation.

The military COLA bill at least complies with PAYGO on paper but just barely clears the bar. While it is encouraging that the legislation the House will be considering offsets the costs, replacing savings from a specific reform of an entitlement program with one-time savings from an across-the-board spending cut is a step back from responsible budgeting.

Debt Ceiling Watch 2014

In order to avoid bumping up against the statutory debt ceiling, the Department of the Treasury has begun undertaking a number of so-called "extraordinary measures." The current debt limit is $17.211 trillion.

Keep checking back as we update this table (and click here for last year's Debt Ceiling Watch 2013, here for the 2012 watch, and here for the 2011 watch).

Date Extraordinary Measure

Headroom Given

Debt (Gross / Subject to Limit)
2/10/2014

Debt Issuance Suspension Period for CSRDF and Suspension of Investment in G-Fund

The Treasury Department will enter into a "debt issuance suspension period" from 2/10/2014 through 2/27/2014 and will suspend additional investments to the Civil Service Retirement and Disability Fund (CSRDF). Additionally, The Treasury Department has suspended investments of the Government Securities Investment Fund (G-Fund) of the Federal Employee's Retirement System in interest-bearing securities.

Measures like this have been used in 1996, 2002, 2003, 2004, 2006, 2011, 2012, and 2013. Read more here.

CSRDF: $50-$75 billion

G-Fund: $175 billion

 
2/7/2014

Debt Limit Reinstated

The debt limit was temporarily suspended through February 7th under the Continuing Appropriations Act. With its reinstatement, Treasury will begin undertaking "extraordinary measures" to continue paying the nation's bills. However, Treasury was not confident that extraordinary measures would last past February 27th. Read more here.

 

$17,258,482/
$17,211,181

2/4/2014

Treasury Suspends Sales of State and Local Government Series Securities

The Treasury Department announced that it will suspend the sales of State and Local Goverment Series (SLGS) securities on February 7th when the debt ceiling is reinstated. The move does not create any headroom, but it does preserve existing headroom by preventing additional sales that would have counting toward the debt limit. Read more here and here.

  $17,263,040/
$17,215,738
1/22/2014

Treasury Department Warns Extraordinary Measures Will Not Last as Long as Previous Uses

Secretary Lew warned that extraordinary measures will not be able to extend the nation's borrowing authority as long as in 2011 and 2013, as February is a month with high net outflows due to tax refunds. In addition, there will be less headroom created than in 2013 as some extraordinary measures can only be used at certain times. About $200 billion in headroom can be freed up in February, compared to the $330 billion that was created in 2013. Read more here.

   $17,276,127/
$17,227,861