The Bottom Line
Recently, several Members of Congress and outside groups have called for continuing extended unemployment benefits to allow the unemployed to collect for up to 73 weeks instead of 26. When Congress considers this extension, as with tax extenders and the sequester, they should keep PAYGO principles in mind.
CBO recently estimated the cost of a one-year extension at $25 billion and separately found that this extension would increase GDP by 0.2 percent and employment by 200,000 at the end of 2014. These gains are far from insignificant, but if a policy is important enough to extend, it’s also worth paying for.
The pay-as-you-go (PAYGO) principle ensures that policymakers face the real trade-offs of budgeting, and when abided by, it prevents policymakers from making an already unsustainable fiscal picture even worse.
Moreover, offsetting an extension of unemployment benefits would be a win-win economically. As CBO explains:
"[extending unemployment benefits] would lead to greater federal debt, which would eventually reduce the nation’s output and income slightly below what would occur under current law (unless other policy changes were made that offset the increase in federal debt from the policies analyzed here)."
Offsetting the cost of unemployment benefits with other savings will prevent them from adding to the debt and reducing economic growth, and assuming the offsets are permanent, they will eventually help to slightly accelerate the growth of the economy over the long term.
PAYGO rules are there to enforce fiscal responsibility, not to be waived whenever they become inconvenient. Policymakers should abide by PAYGO strictly, at least so long as the debt is on an unsustainable long-term path.
Deals to be Had – We survived Black Friday, Cyber Monday and Giving Tuesday. While the door buster bargains may be gone, there are still deals for the taking in Washington. Namely, lawmakers have striking deals on a budget and farm bill on their wish lists. With a Congress that is on pace to go down as the least productive in history, legislators have to be in the mood for bargains. Although progress has been very slow, there are signs of progress. The House is back from Thanksgiving break this week while the Senate is still home. The House would like to wrap things up and adjourn by December 13, the deadline for the budget conference committee to report a deal, and several deadlines loom at the end of the year. Prepare for the next big holiday rush.
Budget Blowout – The lead negotiators in the budget conference committee, Rep. Paul Ryan (R-WI) and Sen. Patty Murray (D-WA), appear to be close to an agreement that would establish a budget framework for the rest of this fiscal year and possibly next year and mitigate some of the automatic sequester cuts. The prospective deal would likely set a spending level for this fiscal year somewhere in between the $967 billion approved by the House and the $1.058 trillion passed by the Senate. Some of the sequester cuts over the next two years could be replaced by cuts elsewhere in the budget and with additional revenues by increasing fees such as those for airline security. While the committee has until December 13 to report a deal, appropriators are pushing for quicker action so they have time to produce a spending plan based on the topline numbers ahead of January 15, when the current stopgap measure funding the government expires. Appropriators wanted a deal by Monday so that they can get to work. If the committee fails to reach a deal, a bipartisan group of senators is prepared to pick up the slack and work on an agreement and House leaders say they will move another stopgap continuing resolution at the $967 billion level in that case.
Cultivating a New Farm Bill – As many of us continue to recover from excessive consumption of turkey and other foods, lawmakers are working on renewing a major farm bill. Food stamps and crop subsidies continue to be the key sticking points. As negotiators continue their talks ahead of a January 1 deadline, some are broaching the possibility that the matter could be rolled up into a budget deal.
Dealing with Medicare Physician Pay – Another January 1 deadline involves the so-called “doc fix” regarding the formula for the paying Medicare physicians. Policymakers are motivated to agree on a permanent solution to the perennial problem of avoiding a steep reduction in payments to Medicare physicians because the cost of a SGR fix has dropped dramatically. As part of this effort, the key congressional negotiators recently reached agreement on how Medicare reimburses physicians for certain services and procedures. Payments for some services would be decreased and redistributed to other services that are currently viewed as undervalued.
Extending the Tax Extenders Debate – Numerous tax provisions face yet another January 1 deadline. The so-called “tax extenders” consist of 55 tax measures, including a corporate research and development tax credit, which have been routinely extended each year. Extending them for another year would cost about $54 billion. According to CQ (subscription required) the provisions will likely not be renewed by the end of the year, but some could be extended retroactively, perhaps as part of a comprehensive tax reform package.
Getting Less Than They Bargained for – Even if the budget conference committee reaches a deal, it will be a very small one that will likely not improve the long-term fiscal outlook. As we have been pointing out, “The Longer We Wait, the Tougher the Choices Become.” The longer we wait to implement the savings necessary to put the national debt on a sustained, downward path as a share of the economy, the more severe the deficit reduction will be. We also provided some thoughts on how to assess policies effectively through disregarding temporary effects and timing shifts, particularly making sure that permanent tax rate cuts aren’t paid for with temporary revenue raisers. Timing shifts are one of the gimmicks we warn about in a new paper, along with war drawdown “savings,” ignoring policies that are routinely “patched,” double-counting, excessive back loading, shifting sequester cuts, and trust fund revenue transfers. Relatedly, we warn against the idea of applying savings from the fiscal cliff deal to repeal 60 percent of the sequester.
Key Upcoming Dates (all times are ET)
December 12, 2013
- Senate Finance Committee executive session to consider legislation to repeal the Sustainable Growth Rate (SGR) - "doc fix" - at 10 am.
December 13, 2013
- Date by which the budget conference committee must report to Congress.
- Target adjournment date for the House.
January 1, 2014
- The "doc fix," temporary tax extenders, extended unemployment insurance benefits, and the farm bill expire.
January 15, 2014
- The continuing resolution funding the federal government expires.
- 2014 sequester cuts take effect.
- First set of IPAB recommendations expected.
February 7, 2014
- The extension of the statutory debt ceiling expires.
In his recent testimony, CBO directory Doug Elmendorf argued that it would be beneficial for policymakers to make large improvements to our budgetary picture, but that small steps forward would be better than nothing, and "no steps at all would be better than stepping backwards." Budget gimmicks fall squarely into that stepping backwards category by potentially offsetting real costs with phony savings.
Today, CRFB released a paper "Beware of Budget Gimmicks" which warns against using these various tricks. The types of gimmicks the paper warns against are:
- Phony Drawdown Savings: This gimmick involves claiming savings for the drawdown of costs related to the war in Afghanistan, which is already in place, and the discontinuation of one-time Superstorm Sandy aid, which was never meant to continue. We discussed the war gimmick previously in detail.
- Timing Shifts or One-Time Savings: There are many policies which provide one-time savings, shift costs just outside or shift savings just inside the ten-year window, or save money upfront but cost money in later years. Using these policies to achieve ten-year savings provides a very incomplete and misleading picture of their effect on the budget.
- Ignoring Policies Currently in Place That Are Likely to be Extended: Policies like the "doc fix" are temporary but very likely to be continued into the future. A major gimmick would be to artificially improve budget numbers by ignoring the costs of these current policies.
- Double-Counting Savings: For technical reasons, some savings -- particularly increasing federal employee retirement contributions -- could be used both to offset the cost of repealing part of the sequester and create room under the discretionary caps for more spending. Doing both of those would result in a double-counting of savings and could lead to higher debt. Read more about this gimmick here.
- Excessively Back-Loading Savings: Policymakers may choose to enact policies late in the ten-year window that they have little intention in following through on. While starting some policies at a later date might be ideal to give people time to prepare for the changes, having a sudden "cliff-like" spending cut or tax increase take effect would not be credible.
- Shifting the Sequester Cuts: One gimmick to provide sequester relief in the short term would involve shifting those cuts to later years. While "smoothing" the sequester so there is a constant nominal dollar increase in the caps could be credible, spending up to pre-sequester levels by cutting well below sequester levels in later years without a reasonable path to get there would be a gimmick.
- Trust Fund Revenue Transfers: Because of the budgetary accounting mechanisms, transferring general revenue to trust funds that are due to be exhausted, such as the Highway Trust Fund and the Disability Insurance trust fund, are not recorded as costs even though they allow lawmakers to spend more than they would if the trust funds were exhausted. If policymakers wish to improve the financial situation of a trust fund, they should identify policy changes to do so, not rely on general revenue.
Relying on any of these budget gimmicks would be a step backward after lawmakers have taken some steps in the right direction. It would also undermine fiscal credibility by showing that lawmakers are not serious about our debt challenge and will look for easy ways out instead of making hard choices. They should instead use legitimate, targeted savings if they wish to provide sequester relief or offset other costs rather than further adding to the debt through smoke and mirrors.
Last month, Senate Finance Committee Chairman Max Baucus (D-MT) released three tax reform discussion drafts. One of the most commendable elements in these discussion drafts is Baucus’ focus on the long-term impact of reform – ensuring it will not add to the deficit in future decades.
In a recent paper, we wrote about the importance of measuring long-term fiscal impact and the many ways it could be measured. While precise estimates of a policy become increasingly uncertain beyond the ten-year budget window, several measurement tools can provide policymakers with an indication of the fiscal impact of a policy beyond the ten year window.Senator Baucus adopted one of these measures, “steady-state analysis,” as the standard for tax reform to ensure that his corporate tax reform package is revenue-neutral even after temporary effects fade. As we explained in our paper:
A steady-state analysis shows the budgetary effect of a policy, disregarding aspects that result in temporary effects or timing shifts. This type of analysis is particularly useful for policies with both permanent and temporary effects. In those cases, the steady-state analysis would measure the effect of the former while ignoring the latter. The measurement can be expressed in dollar terms or as a percent of GDP. An advantage to this approach is that it controls for the “noise” associated with timing shifts. On the other hand, it ignores the fact that these shifts can create noticeable increases or decreases in borrowing levels upfront that – though temporary – can continue to have effects in later years in the form of higher or lower debt levels and, thus, interest payments.
By focusing on the steady state, Senator Baucus can avoid the fiscal folly of paying for permanent corporate tax rate cuts with provisions which increase revenues temporarily. In particular, four sets of provisions proposed by Senator Baucus have significant temporary effects. All of these provisions generate at least a portion of their revenue from a timing shift or temporary increase in revenues that diminishes or disappears over time:
- Repealing last-in-first-out (LIFO) accounting rules (see our tax break-down on LIFO here and our write up of Baucus’s proposal here);
- Repealing accelerated depreciation in favor of a simpler schedule (see our tax break-down on accelerated depreciation here and our write up of Baucus’s proposal here);
- Repealing “full expensing” for research and experimentation, intangible drilling, and advertising (see our discussion of intangible drilling here, information on the advertising deduction here, and write up of Baucus’s proposal here); and
- Imposing a one-time transition tax on corporate profits being held overseas, (see our write up of Baucus’s proposal here)
Most of these measures would continue to raise revenue over the long-run, but the revenue will fall as a percentage of GDP after the first decade. For example, repealing LIFO rules is likely to raise less than one quarter as much in the second decade as it does in the first. And studies suggest that revenue from repealing accelerated depreciation will modestly decline early in the second decade, and eventually begin to grow in nominal dollars, but still decline as a share of the economy. A steady-state analysis clears away these temporary revenue effects and measures whether the long-term revenue will increase or decrease.
It is also important to remember that some types of policies operate in the opposite direction. New “expensing” provisions (Baucus proposes a few for small businesses) cost more in the short-run than in the long-run, as does most transition relief. Policies that broaden the tax base that are phased in or grandfather existing property (for example, changing the deductibility of interest for new loans only), will raise more in the long-run than in the first decade. Temporary revenue gains could be used entirely to offset temporary revenue losses and still meet the goal of steady-state neutrality.
Steady-state analysis is not the only method to ensure that temporary revenue is not used to pay for permanent rate cuts that ultimately add to the deficit. Policymakers have a number of options for looking beyond the standard 10-year scoring window. As an example, they could look at the second decade impact – when most (though not all) of the timing shifts will have faded. Or they could use present-value analysis to determine revenue-neutrality over a long period of time – say 50 years.
Of all these approaches, steady-state analysis is the strictest way to approach reform that temporarily raises money – erring the most on the side of fiscal responsibility. All temporary revenue and the interest it produces represent permanent gains for the government that is never returned in the form of lower corporate rates.
This is not to say that the “steady state” measure is the absolute right one. Like every other measure, it has many flaws. This is also not to say that corporate tax reform has to meet this target if part of a broader plan – what matters most is the package as a whole, not each individual part. However, this measure does help ensure fiscal responsibility over the long-term.
The importance of a long-term focus should not be understated. As we’ve explained, our long-term debt problems are very far from solved. Whether talking about tax reform, sequester replacement, or entitlement reform, policymakers should focus their efforts beyond the next 5-10 years in order to put us on a sustainable fiscal path.
A recent CNN Money article suggests that budget conferees are likely to propose an increase in aviation security fees. When added to an increase in federal retirement contributions and other changes being floated, these higher fees could help pay for a reduction in the 2014 and 2015 sequester.
For background, the federal government has played an increased role in airport security since the 9/11 terrorist attacks. To help fund TSA security costs, the federal government charges a ticket fee of $2.50 per non-stop flight and $5 per indirect flight. In 2012, the fee raised $2 billion, covering only 40 percent of the $5 billion aviation security budget.
One option would be to charge a flat $5 fee, regardless of the number of stops. This proposal would raise $11 billion over ten years if it started in 2015, or $13 billion if it began in 2014. If in place today, this increase would allow TSA fees to cover 60 percent of costs. Most of these proposals would not increase the total amount of money going toward aviation security but increase the share paid by air passengers rather than taxpayers. The House budget resolution uses this option, although it is not clear when the policy takes effect.
Of course, policymakers could go further. A $6 flat fee would raise close to $20 billion over ten years and cover about 70 percent of costs. The President's budget and the Senate budget resolution would go further still, gradually increasing the flat fee from $5 to $7.50 by 2019 and allowing the Homeland Security Secretary to increase it further as necessary. This would save $26 billion over ten years, with $8 billion dedicated go toward a higher aviation security budget for net savings of $18 billion. This approach would allow TSA fees to cover about 85 percent of the costs.
There are other options as well, such as indexing a $5 flat fee to inflation (it would reach about $6.10 by 2023) or requiring the fee cover a certain percentage of the aviation security budget. Policymakers could also keep the current fee structure while raising the rates.
The below table includes a number of potential options:
|Savings from Aviation Security Fee Increases|
|Increase to $5 flat fee in 2014||$13 billion|
|Increase to $6 flat fee in 2014||$20 billion|
|Increase to $7.50 flat fee in 2014||$31 billion|
|Increase to $5 flat fee in 2014, then gradually increase to $7.50 by 2019||$26 billion|
|Increase to $7.50 flat fee by 2019 and increase aviation security budget by $8 billion||$18 billion|
|Increase to $5 flat fee in 2014 and index for inflation||$17 billion|
|Increase to $7.50 flat fee in 2014 and index for inflation||$36 billion|
|Require fee to be adjusted to cover 75% of aviation security budget||~$23 billion|
|Increase current direct and indirect flight fees by 50% (to $3.75 and $7.50)||~$15 billion|
Source: CBO, OMB, rough CRFB calculations
Raising the aviation security fee would not be a significant entitlement reform, but replacing temporary sequester cuts with permanent mandatory savings would be a small step forward for the budget.
In our recent paper, "Our Long-Term Debt Problems are Very Far From Solved," we showed that while the debt problem may be long-term, solutions need to start today. Similar to our analysis of the cost of delaying reform to Social Security, the cost of closing our fiscal shortfall rises over time as we lose the ability to take advantage of compounding interest savings and the ability to spread the adjustment over more years.
In our analysis, we modeled the minimum changes necessary to bring debt down to historical levels of GDP by 2088, as in our "Minimum Path," to put the debt on a clear downward path as a share of the economy.
In order to put debt on a clear downward path through 2088, policymakers would need to enact immediate and permanent spending cuts and tax increases (excluding interest) equal to 3.1 percent of GDP. However, if lawmakers were to wait 10 years before acting, an adjustment of 3.7 percent would be needed; if they waited 20, an adjustment of 4.5 percent would be required. If savings were slowly phased in over 50 years, which is far more likely than a massive immediate adjustment, spending cuts and tax increases (excluding interest) would need to reach 5 percent of GDP. Keeping the sequester in place only reduces the necessary deficit reduction by 0.4 percent - still leaving large adjustments to be made down the road if lawmakers delay additional deficit reduction policies.
As the above graph makes clear, the longer we wait the deeper any cuts or tax increases must be. This is doubly true given that fewer cohorts of people will be able to share in the burden of these adjustments (meaning more cuts per person).
Our paper showed estimates over a 75-year timeframe. But what about a shorter timeframe? Over a 25-year time horizon, our Minimum Path suggests that debt levels should fall from 73 percent of GDP today to just below 60 percent – dropping by about 0.6 percent of GDP per year. To close this gap, an immediate 1.9 percent of GDP adjustment would be necessary. Yet this rises dramatically to 3.3 percent if lawmakers wait ten years before starting and to a virtually unachievable 8.3 percent of GDP if they wait for 20 years.
Note: The "Starting in 20 Years" has been excluded from the chart for comparability, but would require an adjustment of 8.3 percent
There is a cost to waiting regardless of which budget window lawmakers decide is appropriate; and it is important lawmakers keep that cost in mind when contemplating further delay in action.
It is preferable to phase in changes and adjustments gradually rather than begin them immediately, but even that phase in is not free. And while the benefits of phasing in a policy may outweigh the costs, it is hard to say the same about the benefits of delaying legislative action. The longer we wait to begin making changes, the larger and more abrupt any tax increases and spending cuts will have to be, the fewer people will be able to share in the burden of those cuts, and the less warning individuals and businesses will have to prepare.
A new report from the Center for American Progress argues that roughly 60 percent of the sequester should be waived in light of the savings from the fiscal cliff deal in January, which allowed taxes to rise on the top 1 percent or so of Americans.
CAP argues that the $737 billion in savings (relative to a current policy baseline) from the fiscal cliff package were not applied to the sequester but should have been. They suggest retroactively using this savings to reduce the future savings from sequester from $1.2 trillion (including interest) to $463 billion.
As we’ve explained before, a plan like this would represent a serious step backward for responsible budgeting. Not only would the CAP plan increase deficits by almost $750 billion over the next decade compared to current law, but it would undermine the country’s fiscal credibility by violating pay-as-you-go (PAYGO) principles, which say that policymakers must fully pay for any new tax cuts or spending increases, and proving that policymakers cannot stand by agreed-upon deficit reduction. Waiving those cuts without any replacement savings would increase current law debt projections by roughly three percentage points a decade from now, though keeping part of the sequester would reduce the debt slightly compared to the CRFB Realistic Baseline.
In addition to these broader concerns, CAP’s argument for applying $737 billion against the sequester makes little sense. Below, we walk through a number of reasons why.
The Fiscal Cliff Deal Didn’t Reduce Current Law Deficits, It Increased Them
The Center for American Progress claims that the fiscal cliff deal produced substantial deficits reduction that could have been applied to reduce the sequester. Yet, compared to a current law baseline, the fiscal cliff deal did not reduce the deficit by raising taxes, it increased the deficit by renewing tax cuts and spending increases slated to expire. At the time, CBO estimated the deal would add nearly $4 trillion to deficits through 2022, excluding interest effects.
It’s true that the deal did raise revenue relative to a current policy baseline, like CRFB’s Realistic Baseline. But pay-as-you-go rules do not and should not apply relative to current policy. The idea of PAYGO is to prevent an unsustainable current law fiscal situation from being made worse. As we explained at the time, policymakers should not have renewed the tax cuts and waived the sequester outside of PAYGO rules unless they were replacing the provisions with a plan to put the debt on a sustainable long-term path.
As we explained in July 2012:
Gradually phasing in well thought-out entitlement and tax changes would be far preferable to large, blunt, and abrupt savings upfront…However, the worst case scenario would be for lawmakers to repeal the sequester and once again extend expiring debt-expanding policies without offsetting their costs.
The fiscal cliff deal, although it included some savings relative to current policy, violated this principle by adding to the deficit and leaving an unsustainable fiscal path. Further increasing the deficit and worsening the fiscal outlook would be a huge step in the wrong direction.
There Has Only Been About $325
$275 Billion of Deficit Reduction from Current Policy, Not $737 Billion
The idea that the fiscal cliff deal could cover 60 percent of the sequester is based on fuzzy math that compares $737 billion of gross savings through 2022 to a $1.2 trillion savings target through 2021.
Those savings are apples to oranges in a number of ways. Correcting the fiscal cliff time frame to be through 2021, for starters, reduces the savings from the fiscal cliff from $737 billion to about $615 billion.
The savings number CAP quotes also includes about $20 billion through 2021 that, though deficit reduction relative to current policy, was clearly earmarked for a “doc fix”. But we still give CAP credit for this relative to most current policy baselines.
$40 billion (through 2021) that was earmarked at the time to pay for a “doc fix” and sequester extension. It also excludes the roughly $75 billion cost of extending various business tax cuts. When these factors are taken into account, including interest effects too, total “savings” from the fiscal cliff deal are not $737 billion, but rather $525 $475 billion.
On top of this, the CAP numbers cherry pick the supposed savings from the fiscal cliff deal but ignore other legislation since August 2011 that has added to the deficit. Including interest, we’ve added over $200 billion to the deficit (through 2021) between the extension of the payroll tax holiday, the hidden discretionary spending increases from higher federal retirement contributions, and relief for Hurricane Sandy.
If one accounted for all major deficit-changing measures since the Super Committee and counted the savings relative to the CRFB Realistic Baseline, the total savings would be closer to $325
$275 billion, not $737 billion.
|Ten-Year Savings and Costs (Including Interest)|
|Claimed Fiscal Cliff Savings Through 2022||$737 billion|
|Adjustment from 2013-2022 window to the sequester’s 2012-2021 window||-$125 billion|
|Incorporated costs of fiscal cliff extenders package||-$90 billion|
|Subtotal, Fiscal Cliff Savings (2012-2021)||$525 billion|
|Costs of other notable legislation since late 2011 (payroll tax extensions, Sandy aid, etc.)||-$200 billion|
|Total, Net Budgetary Impact
Note: Estimates are rounded to the nearest $5 billion.
Enacted “Deficit Reduction” Plus Sequester Savings Still Fall Short of Super Committee Target
CAP claims that the $737 billion in "savings" from the fiscal cliff deal would justify a 60 percent reduction in the sequester. Yet, with only $325
$275 billion of deficit reduction actually enacted since the Super Committee relative to a current policy baseline with the sequester (and massive deficit increases from current law), the most that could be justified is a 1/3 32 percent reduction in the total sequester through 2021 and a 35 percent reduction going forward (the sequester would have saved about $1 trillion through 2021, including about $925 billion from the 2014-2021 sequester). But applying any of these savings to sequester relief would ensure far fewer savings than the original Super Committee was charged with recommending.
As CRFB has explained before, the Super Committee was charged with identifying $1.5 trillion of deficit reduction through 2021. For a variety of reasons, however, the sequester is now expected to generate just above $1 trillion of deficit reduction over that time period. Even crediting the supposed enacted deficit reduction of about $325
$275 billion to that total would still result in only $1.3 trillion, still short of the Super Committee target by a little over 11 13 percent (and only 11 8 percent in excess of the original sequester target). If we exclude the cost of deficit-increasing legislation over the past two years, the total would just about meet the original Super Committee target.
CAP Proposal Would Worsen the Unsustainable Fiscal Picture
The main purpose of pay-as-you-go principles is to keep Congress from worsening the already-bleak fiscal situation. Instead, the CAP proposal adds nearly $750 billion to the deficit over the next decadeand allows the debt to grow continuously as a share of GDP (though if the remaining sequester from the proposal remained in place, debt could be more than $400 billion lower through 2023 than under the CRFB Realistic Baseline).
It’s true that under the proposal debt levels will decline between 2014 and 2018 – just as under current policy. But under our projections, the debt would still rise from 68 percent of GDP in 2018 to 71 percent if 2023, 94 percent in 2035, and nearly 140 percent by 2050.
CAP Proposal Would Undermine Fiscal Credibility
Replacing the sequester with more sensible and permanent deficit reduction would likely improve the economy and long-term fiscal situation. But repealing parts of the sequester on a deficit-financed basis would undermine fiscal credibility at a time when it is needed most.
First, as mentioned before, it violates pay-as-you-go principles. This violation would be especially egregious since it would be justified using so-called revenue that came from violating PAYGO principles and a much more lenient statutory PAYGO law.
Even more troubling, waiving the sequester would demonstrate that policymakers cannot stick to agreed-upon deficit reduction. Sequestration was explicitly put forward, on a bipartisan basis, as an enforcement mechanism to ensure policymakers identified at least $1.2 trillion (with a target of at least $1.5 trillion) of deficit reduction through 2021. That the Super Committee and subsequent fiscal cliff negotiations failed to result in this deficit reduction is bad enough, but cancelling the enforcement could undermine the credibility of all future deficit reduction promises. With debt at twice its historic average and the highest it has been since World War II, faith that the U.S. will make good on its debt promises is as important as ever.
* * * * *
There is no question that the sequester is the wrong way to reduce the deficit – it is mindless, anti-growth, poorly targeted, and does very little to improve the long-term fiscal picture. But these flaws suggest the sequester should be replaced with more permanent, better targeted, longer-term savings, not waived altogether. As the chairman of the President’s Council of Economic Advisers Jason Furman has said recently, replacing the sequester with smarter savings is not only good politics but sensible economic policy as well.
Conversely, reducing the sequester cuts without paying for them is not only politically unpalatable but poor economic policy as well. The plan to deficit-finance a 60 percent reduction in sequester cuts is based on selective math, has no real justification, adds roughly three percentage points to the debt by the end of the decade, and undermines the country’s fiscal credibility.
Just because you get closer to the finish line doesn’t mean you lay off the gas, and it certainly doesn’t justify putting the car in reverse. Lawmakers should pursue long-term deficit reduction measures because we still face unsustainable levels of debt and the sooner we act the easier it will be.
 Coincidentally, the actual cost of repealing the sequester through 2023 will also be about $1.2 trillion, including extrapolated discretionary costs – smaller than originally intended.
 The payroll tax holiday and discretionary retirement adjustments would likely have been incorporated as costs had the Super Committee reached agreement.
Note: This blog has been updated since original posting based on new information provided to us from CAP on the elements of their $737 billion estimate. All additions have been made in green and deletions changes have been marked with
We hope all of our readers enjoyed their Thanksgiving holiday. The long weekend brought some fantastic rivalry games, Michigan-Ohio State, Auburn-Alabama, Ravens-Steelers, and many more. Coaches often had to decide whether to punt or to go for it and keep the drive alive. But in Washington, where Congress has had clear opportunities to get our fiscal house in order, a new Fix the Debt infographic shows lawmakers have been doing much more punting than solving.
Giving Thanks...and Little Else – As we prepare to spend time with family and celebrate Thanksgiving, Congress gave itself a head start on the holiday rush and left town. While lawmakers may be giving thanks this week, there is little they can say they have offered. Much work remains on a budget and farm bill and there is some pessimism in Washington that anything more will be accomplished before the end of this year. As the New York Times and Washington Post both point out, it is politics, not policies, that are preventing a comprehensive fiscal plan from being agreed to. We made clear in a paper last week that “Our Long-Term Debt Problems Are Very Far from Solved,” and only a comprehensive approach will adequately address our long-term fiscal challenges. The report points out that: 1.) the federal debt is growing unsustainably over the long run due to health care cost growth and population aging; 2.) little has been done to change the long-term trajectory of the debt; 3.) we’ll need around $13 trillion of deficit reduction over the next two decades to put the debt on a clear downward path relative to the economy; 4.) economic growth alone cannot solve our long-term debt problems; and 5.) starting now will allow more gradual and less distressing changes to be phased in over time. Another recent paper provides guidance on how to look beyond the short term, including identifying long-term deficit reduction; replacing short-term cuts with long-term savings; and evaluating the long-term impact of policies.
Talking Turkey on the Budget – The leaders of the budget conference committee – Sen. Patty Murray (D-WA) and Rep. Paul Ryan (R-WI) – are negotiating towards a small-scale deal that could provide a budget framework for the rest of the fiscal year and next and replace a small portion of the sequester. Talks are revolving around a possible $85 billion deal. About $65 billion of the automatic cuts of sequestration over two years would be replaced by cuts elsewhere, along with some non-tax revenues. Revenue options include increased user fees such as airline security fees and proceeds from selling government assets, such as auctioning broadband spectrum. Spending reduction possibilities include cuts in farm subsidies and decreased federal contributions to civilian employee pensions. We warn against double-counting when it comes to the pension issue. Murray and Ryan will continue their talks over the Thanksgiving break.
“Smooth” Sailing for Sequestration? – Black Friday sales aren’t the only place to watch out for gimmicks. Legislators may resort to gimmicks as they seek to at least loosen the noose of the sequester. The back-up plan if a budget deal cannot be reached appears to be spreading some of the 2014 sequester cuts among the remaining years of sequestration, referred to as “smoothing.” We previously warned that simply canceling sequestration for one year and increasing it down the road was a gimmick. Lawmakers must be careful to not cross the line between adjusting sequestration to make it more bearable and continually kicking it down the road and not making real changes. Have more questions about sequestration? We have lots of answers here.
A Heaping Serving of Tax Reform – Senate Finance Committee chair Max Baucus (D-MT) continued his effort to fundamentally rewrite the tax code by releasing three discussion drafts last week and indicating more are to come. The drafts tackle specific tax topics – international taxation, tax administration, and cost recovery and tax accounting rules. The international tax draft proposes a hybrid territorial/worldwide system designed to discourage corporations from keeping profits overseas. The tax administration draft offers ideas to reduce fraud, close the “tax gap” by collecting more taxes that are owed and making the filing process simpler. The cost recovery draft recommends ways to simplify how businesses treat expenses. For example, Baucus consolidates some 40 accelerated depreciation rates into 5; see our “Tax Break-Down” for more on the topic. He also proposes repealing the “last-in first-out” (LIFO) accounting method for measuring profits on inventory; see our LIFO “Tax Break-Down” to learn more about one of the biggest corporate tax breaks. Meanwhile, Baucus’ counterpart, House Ways and Means Committee chair Dave Camp (R-MI) is continuing his parallel tax reform effort. He is meeting with business groups and plans to mark-up comprehensive tax reform legislation by early next year. His efforts have bore some fruit as members of one of the tax reform working groups he formed in his committee introduced bipartisan legislation to reform education tax incentives. The Student and Family Tax Simplification Act, introduced by Reps. Diane Black (R-TN) and Danny K. Davis (D-IL), consolidates four tax breaks into one tax credit - simplifying education tax breaks, increasing the benefits for lower-income families and likely saving money. Follow our “Tax Break-Down” series to learn more about various tax expenditures that could be a part of tax reform.
Debt Ceiling Takes a Break – The statutory debt ceiling may not be home for the holidays, but it won’t be far from policymaker’s minds. Although the suspension of the debt limit expires on February 7, 2014, the Congressional Budget Office predicts that “extraordinary measures” could hold off a breach of the debt ceiling until as late as June. But policymakers no doubt will not want to go to the brink of a national default in an election year. Keep up with debt ceiling developments here.
Will Farm Bill Be a Cornucopia of Savings? – In addition to the budget conference committee, there is another committee working to reconcile the differences between the House and Senate on a major piece of legislation. Lawmakers are working to overcome differences on the farm bill. Savings generated by the bill, such as by cutting direct payments to farmers, if an agreement is reached, could contribute to deficit reduction. But many differences still exist, especially in regards to funding for food stamps.
Stuffing with Mushroom Cloud – Last week the Senate voted to change its rules to prohibit filibusters against nominations to federal office, except for Supreme Court justices – the dreaded “nuclear” option. While the filibuster is still an option for legislation and won’t have any direct impact on budget policy, the change could further sour already tense relations between the two parties on Capitol Hill. That could make reaching a budget deal even more difficult.
Key Upcoming Dates (all times are ET)
December 13, 2013
- Date by which the budget conference committee must report to Congress.
January 1, 2014
- The "doc fix," temporary tax extenders, extended unemployment insurance benefits, and the farm bill expire.
January 15, 2014
- The continuing resolution funding the federal government expires.
- 2014 sequester cuts take effect.
- First set of IPAB recommendations expected.
February 7, 2014
- The extension of the statutory debt ceiling expires.
As budget conference committee chairs Patty Murray and Paul Ryan appear to be moving closer to a partial sequester-replacement deal, reports suggest such a deal could include an increase in federal civilian retirement contributions. Increasing the amount federal workers pay toward their retirement benefits to more closely align with the private sector would be a sensible reform that could improve the fiscal situation. But there is a risk that policymakers would double-count the saving, in which case such reform would actually increase the deficit. This double-counting is highly technical, easily hidden, and perhaps unintentional. But it must be avoided.
|The Cost of Double-Counting Retirement Savings|
|Saving from Increasing Worker Contributions from 0.8 to 2.0||+$20 billion|
|Cost of Reducing the FY2014 Sequester by $20 billion||-$20 billion|
|Cost of Replacing Intragovermental Transfers with Discretionary Spending*||-$20 billion|
|Total Net Budgetary Impact
*This would take place through a three step process. First, retirement contributions owed by the federal agencies would fall, saving $20 billion. This in would lead to $20 billion in lower offsetting receipts into the retirement trust funds, costing $20 billion. Finally, the $20 billion of "headroom" created from the lower contributions would allow more direct spending from the discretionary budget, costing an additional $20 billion.
Three Ways to Avoid Double-Counting
- Keep the Discretionary Headroom, but Ignore the New Receipts. Policymakers could allow higher worker contributions to create headroom within the budgetary caps for agencies. With workers contributing more toward their retirement, agencies could contribute less and could therefore spend more for other important purposes. From a policy standpoint, this approach (assuming the President’s policy of $20 billion) would be virtually identical to reducing the sequester cuts by $2 billion per year. To avoid double-counting, the new receipts could not be used to directly reduce the size of the sequester nor counted toward any deficit reduction goal.
- Count the New Receipts, but Adjust the Discretionary Caps. If policymakers wanted to use the new receipts from increasing federal retirement contributions to reduce sequestration cuts or reduce deficits, they could prevent additional unintended discretionary spending by reducing budgetary caps in an amount equal to the value of the increased discretionary headroom. In our example using the President’s policy, policymakers would reduce the pre- and post-sequester budgetary caps by $2 billion per year and not count any savings from that reduction for any purpose. This approach could be taken in concert with short-term sequester relief, though any reducing in the size of those cuts must come after the cap adjustment described above.
- Count the New Receipts, but Hold Agency Contributions Constant. Rather than making an adjustment to budgetary caps, lawmakers could simply prevent agencies from reducing their contributions in order to create headroom in the first place. Under this approach, new government receipts could be used for sequester relief or deficit reduction and no unintended additional discretionary spending (beyond that sequester relief) would be allowed to take place. To avoid “overfunding” the FERS program, agencies could be allowed to reduce their contributions toward FERS but required to pay the difference toward the CSRS program, which is currently underfunded by over $750 billion.
With Congress is in recess, it's likely we won't see a deal this week, but the December 13th deadline for the budget conference committee is fast approaching. Expectations for an agreement are mixed, but in an article in this weekends's U.S. News and World Report, CRFB board member and former CBO Director Alice Rivlin and former Senator Pete Domenici (R-NM) believe that there is a significant opportunity to do something about our long-term fiscal problems.
A budget resolution is limited in what it can achieve, but Rivlin and Domenici argue that it can form the foundation for significant legislation:
Conventional wisdom about the outcome of the Budget Conference Committee – co-chaired by House Budget Chairman Paul Ryan, a Republican, and Senate Budget Committee Chairwoman Patty Murray, a Democrat – is that nothing much will happen. At best, they will cut a small-bore deal to avoid another government shutdown or debt crisis before the congressional elections in November. They will fail to enhance near-term growth or tackle the tax and entitlement reforms needed to stabilize future debt increases. The excuses are: the challenges are too big, time is too short and conferees don’t have the legislative tools to do anything substantial.
Time for the conferees is short, but they have the option of buying more time for the big decisions. The challenges are huge, but the consequences of failure are even worse. Most important, the conferees have a legislative tool – reconciliation – at their disposal that enables them to find a lasting solution, if they have the will to do so.
We called for the conferees to push for budget reconciliation in our report, What We Hope to See From the Budget Conference Committee, particularly to achieve significant entitlement and tax reforms. Of course, this will inevitably require tough decisions to be made, but Rivlin and Domenici argue that it will ultimately be necessary.
Both sides fear reconciliation. Republicans fear it will lead to higher revenues. Democrats fear it will lead to future reductions in Medicare, Medicaid and Social Security benefits. In other words, both are afraid to even discuss the changes needed to grow the economy faster and start the nation’s debt accumulation on a downward path. Both are afraid to do more than kick the proverbial can down the road one more time.
But fear is not a strategy. All of the bipartisan budget strategy groups, including the Debt Reduction Task Force that we co-chaired at the Bipartisan Policy Center, have proposed reforming income taxes to enhance economic growth and raise more revenue without raising tax rates. They also recommended slowing the growth of health care entitlements by making care delivery more efficient and preserving Social Security for future retirees by making the program solvent.
We've shown before that budget reconciliation can be a powerful tool in achieving deficit reduction. There is still time for the budget conference to develop the framework for a comprehensive deficit reduction plan and we shouldn't dismiss the opportunity that the conferees have right now.
Click here to read the full op-ed.
"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.
Efforts to reform the tax code are picking up steam, with several tax plans introduced in the last month. In the House, Ways & Means Chairman Dave Camp (R-MI) created 11 tax reform working groups to deal with different parts of the tax code. Last month, one of these working groups released a bipartisan discussion draft which would reform tax incentives for education.
The Student and Family Tax Simplification Act, introduced by the chairs of the working group, Representatives Diane Black (R-TN) and Danny K. Davis (D-IL) consolidates four education incentives into a better-targeted credit. This bill will most likely save money, while increasing payouts to low-income individuals, increasing the progressivity of the tax code, and simplifying a confusing set of education incentives.
Representatives Black and Davis penned an editorial in Roll Call last week explaining why they took on the task of reforming tax benefits for education:
Today’s broken tax code does little to ease that financial burden or provide a sense of security that education will be a reality in the future. In fact, because it is such a complex and confusing system, more than 80 percent of Americans say that dealing with the tax code makes them frustrated and angry.
Representatives Black and Davis said they could imagine parents overwhelmed by the various tax incentives for education - 15 in all. The Representatives explain that "our desire to provide at least some relief from that frustration led the two of us to work even further to see how we could clean up the code and actually help students and families in their struggles to finance education costs."
The four education incentives changed by the bill are the American Opportunity Tax Credit (AOTC), its predecessor the Hope Credit, the Lifetime Learning Credit, and a deduction for tuition and fees.
Source: Office of Management and Budget, 2013
The AOTC offers up to $10,000 to qualifying students or parents during the first 4 years of college (up to $2,500 per year). Up to 40% of the yearly credit ($1,000) is refundable for taxpayers who have no income tax liability. Instead of claiming the AOTC, a taxpayer can also choose to claim the Lifetime Learning Credit, a smaller credit available beyond the first 4 years of college, or a deduction for up to $4,000 for tuition and fees.
The Black-Davis education bill would combine these four provisions into a single, reformed American Opportunity Tax Credit.
How It Works
When the AOTC was enacted as part of the 2009 stimulus legislation, it increased the award amount of the existing Hope credit, made it available for 4 years of college (instead of two), made 40% of the credit refundable, and made it available to upper-middle income taxpayers. Previously, the Hope credit phased out for taxpayers earning over $57,000 ($107,000 for joint filers), while the expanded AOTC now phases out for taxpayers making between $80,000 and $90,000 ($160,000 and $180,000 for joint filers).
Black and Davis propose altering the AOTC by extending it permanently (under current law, it is set to expire at the end of 2017). Currently, the AOTC's benefit is spread relatively evenly across the income distribution. Black and Davis's proposal would increase the benefit to low-income individuals by increasing the maximum refund available to $1,500 (previously $1,000). They would additionally reduce the benefit to high-income taxpayers by lowering the phaseout levels. This bill would decrease the income phaseout levels to individuals making between $43,000 and $63,000 ($86,000 and $126,000 for joint filers), slightly less than Hope credit levels.
In addition to an increased refund, the formula for calculating refunds change so that a higher refund is available to people with fewer expenses. Under the current system, where a person must spend at least $4,000 on tuition to claim the full $1,000 refund. The proposal would make the first $1,500 of expenses eligible for a refundable credit.
Finally, this bill would index all components of the credit – including the total amount, refundable amount, and phaseout levels – to inflation after 2018 and change the way that Pell grants are counted against tuition.
Potential Costs of Proposals
Although this bill has not yet been scored by the Joint Committee on Taxation, it is still possible to get an idea how much revenue it will raise. While extending the AOTC permanently and increasing its refundable portion would cost money, these provisions are mostly paid for by eliminating the credit for upper-middle income individuals. Extending the AOTC permanently would cost around $60 billion over the next 10 years, and increasing its refundability about $20 billion. We estimate that reducing the phaseout threshold would raise enough to roughly offset these costs.
Changing the refund formula of the credit to increase refunds to low-income filers would cost roughly $5 billion, and indexing the provisions to inflation starting after 2018 would cost another $5 billion.
Most of the savings in this proposal come from repealing the Lifetime Learning Credit and allowing the tuition and fees deduction to expire, which would save between $20 and $30 billion over the next 10 years.
There are two ways to measure the bill. In official score estimates, CBO will measure the bill against current law, which assumes the AOTC will expire on schedule. However, the President's Budget and the CRFB Realistic Baseline assume the plausible scenario that the AOTC is extended permanently (a "current policy" baseline). From our rough estimates, it appears the working group set a goal of making an education credit that was more generous than current policy without costing any more than current law.
|Estimated Revenue Effects of the Student and Family Tax Simplification Act|
Current Law (billions)
Realistic Baseline (billions)
|Extend the AOTC permanently||-$60||$0|
|Increase refundability to $1,500||-$20||-$20|
|Change refund formula||-$5||-$5|
|Decrease phaseout range||$70||$70|
|Index to inflation after 2018||-$5||-$5|
|Repeal the Lifetime Learning Credit||$30||$30|
|Repeal the Tuition and Fees Deduction||$1||$1|
|Total, Education Discussion Draft
*Note: Estimates are very rough CRFB estimates based on available JCT scores and CLASP.
The bill does not change any other education incentives that currently exist – including the deductibility of student loan interest, the fact that scholarships are excluded from income, and several smaller exclusions. These provisions combined cost $130 billion per year.
The education proposal by Black and Davis simplifies the complex set of tuition tax incentives and makes it more progressive, eliminating a tax credit for graduate students and reducing the amount given to high-income taxpayers. It redirects the savings towards maintaining and enhancing the existing tax credits for college, particularly for low-income taxpayers. While it's far from final, this discussion draft released by the House Ways & Means bipartisan working group is an example of how tax reform can cut tax expenditures, raise revenue for deficit or rate reduction, and increase tax progressivity at the same time.
This week, Senate Finance Chairman Max Baucus (D-MT) has been moving forward with tax reform, releasing three discussion drafts. On Tuesday, he released a draft of international tax reform intended to make the U.S. more competitive with other developed countries. On Wednesday, he released a draft on tax administration, intended to fight fraud and simplify the filing process. Yesterday, he released a draft changing how businesses treat their expenses, most notably by dramatically simplifying depreciation.
This final draft was intended to achieve a "modern, simpler, and fairer" system that "promotes tax neutrality," equalizing the treatment of different industries and different types of investments. Currently, different industries pay wildly different tax rates. According to the Treasury Department, these rates range from 14 percent for utilities to 31 percent for construction or retail sales.
As with the draft on international taxation, this draft is intended to be revenue-neutral for corporations over the long term, using revenue raised from corporations to lower the corporate tax rate. Some of the revenues raised from small business would be given back to them in better-targeted incentives, which are not all discussed in this draft. Many provisions appear to generate a one-time infusion of revenue since many of the provisions involve a shift in the timing of tax liability rather than an increase. We applaud Senator Baucus for taking the fiscally responsible step of not using temporary revenue for permanent tax cuts, which would increase the deficit in later years.
Because many large expenses (for example, purchases of buildings or equipment) are used over a number of years to produce income, they must be "depreciated" over the life of the asset. The tax code currently groups assets into over 100 categories with over 40 different rates – the number of years over which the asset must be depreciated.
The current system is called "accelerated" because it allows assets to be written off faster than their economic life; companies can claim higher expenses upfront and thus lower their taxable income. Because of these different rates on assets, accelerated depreciation gives an implied subsidy to certain assets and penalizes others. See our Tax Break-Down on accelerated depreciation for a table showing effective tax rates for various types of equipment.
The draft repeals the current depreciation systems and simplifies more than 40 depreciation rates into 5. The draft dramatically simplifies accounting: rather than tracking depreciation for each asset, companies would group their purchases into 4 pools and calculate depreciation once for the entire pool.
Under the current system, a business owner that wants to properly account for a purchase has to consult pages of tables from the IRS, determine when during the year an item began to be used, and find how many years that particular category of item is allowed to be depreciated. For instance, when a store owner buys a $300 cash register and a $1,000 carpet, the IRS tables dictate that both have a 5-year life. The tables then specify what percentage of the cost that can be claimed in each year. In this case, the store owner can deduct $60 of the cost of the cash register and $200 of the carpet in the first year. If the owner buys a desk, which has a 7-year life, the next year, the deductions become even more complicated to track. As a business buys more and more items, tracking deductions for each one becomes increasingly complex.
The Baucus draft would dramatically simplify this system. Instead of calculating deductions for each item individually, the cost of every item with a similar life is combined into the same "pool." In our example case, both the $300 cash register and the $1,000 carpet are combined in the same pool for everything with a life between 5 and 8 years. The pool is $1,300, and the business owner can claim 18 percent as a deduction every year. For the next year, the pool is 18 percent smaller, but increases when future purchases are added.
Finance Committee staff asked CBO to calculate economic lives of assets based on economic data from the Bureau of Economic Analysis. By setting depreciation schedules roughly equal to economic lives, the draft removes implied subsidies from the depreciation schedules. It makes the tax code more transparent, implying that incentives should be given directly through credits or deductions, rather than indirectly through faster depreciation schedules.
Certain assets would still be depreciated asset-by-asset, but the time periods would increase to reflect economic life. The time period for intangibles (copyrights, patents, customer lists, etc.) would increase from 15 to 20 years while the time period for real property (real estate) would lengthen to 43 years.
Earlier this year, we estimated repealing accelerated depreciation in favor of the so-called Alternative Depreciation Schedule would raise roughly $775 billion, including $550 billion from C-Corporations. Once temporary revenue from timing shifts were excluded, those numbers would fall to close $520 billion and $350 billion, respectively. It is not clear whether the Chairman’s plan would raise more or less than this policy. According to our Corporate Rate Calculator, raising $350 billion from this provision would be enough to reduce the corporate rate by approximately 3 percentage points.
Generally, spending that generates income over time must be amortized over the time that the income will be earned. However, several types of spending are exempt from the general rule under the current system. Money spent on research and experimentation, natural resource extraction, or advertising can be deducted immediately, even though they generate income over time. Under this plan, expenses for research and natural resource extraction must be deducted over five years. Half of advertising expenses can still be deducted immediately, but the other half must also be deducted over five years.
The treatment of research expenses is a tax expenditure, or a deviation from a "normal" income tax code. Several tax expenditures make up the special treatment of natural resource extraction. The ability to deduct advertising expenses, however, is considered a normal part of the income tax code, and amortizing advertising expenses is a non-tax expenditure base provision (NTEBP) that has been considered for decades. Even though it's not officially a tax expenditure, changing the treatment of advertising expenses can still broaden the tax base and equalize treatment of similar long-term investments that build brand loyalty.
Completely repealing the expensing of research and experimental expenditures, which make them be depreciated over the same time period as the benefits, would raise $160 billion, nearly all from C-Corporations. The draft allows expenditures to be expensed over 5 years, which would raise less money than completely repealing expensing. As we estimated in our Tax Break-Down, repealing drilling cost expensing would raise $18 billion (the Baucus draft would raise less). And we previously estimated that amortizing one quarter of the advertising deduction over 15 years would raise $20 billion per year. It is not clear whether amortizing one-half the deduction over five years would raise more or less money.
The majority of the money raised from small businesses would be spent to allow them to immediately deduct costs. Currently, a temporary provision allows small businesses to deduct $500,000 of expenses immediately, regardless of whether they normally have to be depreciated over time. The $500,000 amount phases out for businesses that buy over $2 million of property in a year. Baucus' draft would make the provision permanent and double it to $1 million of property (indexed to inflation). In contrast, Chairman Dave Camp's draft would revert the deduction to 2012 levels of $250,000. The bill extends some smaller expensing provisions, such as the inclusion of computer software, and lets others expire.
The deduction is currently set to shrink at the end of the year. Extending the deduction at the lower levels proposed by Chairman Camp would cost approximately $35 billion, while extending at the deduction at current levels would cost approximately $65 billion. It is unknown how much more the expanded Baucus version would cost.
The draft also allows small businesses with under $10 million in receipts to use cash accounting, which eliminates the need to account for inventories and depreciate property. This draft also includes a provision from Camp's small business draft, doubling the deduction for start-up expenses, which costs less than $1 billion.
Repealing certain tax expenditures
The draft repeals last-in, first-out accounting (LIFO), a special system available to U.S. companies that is not available under international accounting standards. LIFO allows certain companies that have held inventories over long periods of time to claim smaller profits (and pay less tax) than they otherwise would. We described LIFO in detail in our Tax Break-down series, including more information on the types of companies affected. The draft also repeals another preferential method for measuring inventories, the "lower of cost or market" rules.
Several smaller tax expenditures are repealed like percentage depletion rules, which allow oil and gas companies to deduct drilling costs faster than otherwise, and like-kind exchanges, which let taxpayers avoid capital gains tax from selling an asset if they use a gain to buy a similar ("like-kind") asset.
Repealing LIFO will generate between $90-$110 billion, of mostly temporary revenue as companies are forced to revalue their existing inventories. Repealing the lower-of-cost-or-market rules will raise $5 billion, repealing percentage depletion will generate $10 billion, and repealing like-kind exchanges will raise $20 billion.
The draft released by the Finance Committee today would dramatically change the way that businesses claim expenses. It would reduce economic distortions between different types of investment, creatively improve simplicity, and recognizes the types of hard choices that will have to be made in tax reform. Some industries will lose the indirect subsidies of current system; however, every business will benefit from the lower rates and simpler accounting system under the new bill. We look forward to seeing the comments and responses around this new bill. The bill is a large step moving the process forward towards responsibly reforming our tax code.
This post corrected on November 25, 2013 to clarify the expanation on intangible expensing.
The New York Times is reporting that the Treasury Department will sell its remaining shares in General Motors, bringing to an end its five-year involvement in the company. Treasury's holdings of GM stock have been quietly dwindling throughout the year, falling from about one-third of the company's stock in late 2012 to 2 percent after a sale two days ago. The proceeds from the sale will likely be around $1 billion assuming GM's stock price doesn't change drastically.
According to the NYT, Treasury will take a $10 billion loss on its investment in GM, which included a series of loans made in 2008 and 2009 and an infusion of common stock purchases that at its peak had Treasury owning three-fifths of GM's stock. In May, CBO estimated that total auto industry assistance, including Chrysler and GMAC (now Ally Financial), would cost $17 billion. GM's stock has risen somewhat since May, though, so that total may be lower.
|Estimated TARP Subsidy Costs (Billions)|
|Area||March 2012||October 2012||May 2013||Maximum Amount Disbursed|
|Capital Purchase Program||-$17||-$18||-$17||$205|
|Citigroup and Bank of America||-$8||-$8||-$8||$40|
|Community Development Capital Initiative||$0||$0||$0||$1|
|Assistance to AIG||$22||$14||$15||$68|
|Subtotal, Financial Institutions||-$3||-$11||-$10||$313|
|Auto Company Assistance||$19||$20||$17||$80|
With Treasury's exit from GM, that leaves housing programs as the main remaining part of TARP, which CBO estimates will end up costing the federal government $16 billion. In total, CBO latest estimates from May peg the entirety of TARP at a cost of $21 billion to U.S. taxpayers. The higher stock price from GM compared to May could push that total lower, although of course other portions of TARP could change as well.
Most of the action left in TARP will be in housing, where the federal government continues to provide assistance.
Every year, CBO analyzes the Department of Defense's Future Years Defense Program (FYDP), most recently done last March. As has been the case over the past few years, CBO's analysis showed that DoD's plans would exceed the caps called for by the Budget Control Act, and far exceed those under sequestration. While the Administration and many in Congress have been looking to replace sequestration, they have not been able to do so yet. Lawmakers should replace sequestration with permanent, long-term savings, but it is becoming increasingly likely that the sequestration caps might be here to stay. Even if the sequester were eliminated, DoD's plans may be unrealistic.
But while the challenge over the next five years is significant, a new report from CBO shows that this gap will grow further over the long term. Under both CBO's and DoD's projections, defense spending will exceed sequester caps by between $60 billion to $90 billion per year, for the entire time sequestration would be in effect. After the 5-year projection of the FYDP, CBO believes that under either projection, defense spending will begin to rise much more quickly than the caps.
The report details projections for operations and support costs, acquisition costs, and military construction and family housing costs. But one of the most dramatic projections by CBO is for the military health system. CBO estimates that DoD will spend around $49 billion in 2014 on military health care, $54 billion in 2018, and $70 billion in 2028. While these projections are lower than last year's, the growth of health care spending is definitely an issue for the military that needs to be addressed.
We warned before that lawmakers might attempt to use a "sequester delay" gimmick, partially delaying part of the sequester by lowering future sequester caps even further. Besides the compounding effect we mentioned, CBO's report shows that the Defense Department may have an equally difficult time meeting the discretionary caps under sequestration in later years, as they will for next year. Reasonable defense savings can be implemented, but there are clearly already tough choices to be made on defense without reducing future spending even farther.
Over the long run, DoD will have to carefully plan and be realistic about the funding it is likely to receive. Lawmakers may be focused on discretionary levels for FY 2014, but to be at all effective, they will have to think next year. Perhaps they should read our papers on the long-term problem and different ways to evaluate policies over the long term as a start.
Our paper released yesterday detailed how our long term debt problems are far from solved, making clear the unsustainability of federal debt over the long term and how much deficit reduction remains to fix it. As policymakers consider how to achieve long term deficit reduction, they must make sure they effectively evaluate policy options available to them, and have better information on the long term impact of different policies.
Today CRFB released a paper, "Looking Beyond the Ten-Year Budget Window" which describes why it is important for lawmakers to focus on policies that achieve long term savings, even if those policies do not achieve substaintial savings in the 10 year budget window. The paper also provides information on what types of policies have savings that tend to grow or shrink over time. It also explains how replacing the sequester with equivalent mandatory cuts would be very good for the long term, and provides a variety of methods to measure savings beyond the traditional 10 year budget window.
The paper explains that not all ten-year deficit reduction is created equal, since policies could have significantly different effects over the long term. There are policies whose savings grow over time, including those that address a fast-growing area of the budget, are phased in over time, that start later in the decade, or that exempt new beneficiaries from changes. There are also policies which shrink over time as well, including temporary policies, ones which address a shrinking area of the budget, or policies which produce one-time revenue.
A well known temporary policy is the sequester, whose cuts technically end in 2021. The report shows that replacing the sequester with equivalent ten-year savings would actually be a boon to the budget over a longer time frame. For example, replacing half the sequester for five years with the chained CPI would be neutral over ten years but would save about $1.2 trillion in the second decade, excluding interest.
Replacing a Portion of the Sequester with Permanent Savings (billions)
Measuring savings over the second decade is not the only way to take a longer-term view of policies. The paper lays out six other ways which policymakers can measure fiscal effects. Some of them, including the second decade analysis and long-term actuarial analysis, have already been used by agencies like the Congressional Budget Office and Social Security Administration. Others include generational accounting, fiscal gap analysis, and steady state analysis. A description of these methods, their pros and cons, and the appropriate use of each can be found in the full paper.
Although debt levels may be stabilized in the short term, achieving deficit reduction over long term remains necessary to address the deficits and debt that are projected to rise to unprecedented levels. Thus it is critical that lawmakers are evaluating options appropriately and utilizing the full wealth of information that budget estimators produce to see the long term effects of policies.
Given the nature of debt ceiling politics lately, estimating when the federal government will start defaulting on obligations has become a common, multiple-times-a-year occurrence.
With the debt ceiling scheduled to be re-instated on February 8 by the terms of the agreement reached last month, the Congressional Budget Office (CBO) has again tried to estimate how much breathing room Treasury will have before it will exhaust all borrowing authority. The actual X date is not February 8 since the Treasury Department can use "extraordinary measures" to temporarily avoid hitting the limit, which CBO predicts will most likely push the X date to sometime in March, but potentially as late as early June or as early as February.
CBO highlights that deficits tend to be very high in February in March as income tax refunds are paid out, but that the government is actually likely to run a surplus in April when tax receipts come due. The latter is the reason why CBO thinks there is a small possiblity that the X date could slip as late as June.
Analysts at the Bipartisan Policy Center, however, do not anticipate this happening. Shai Akabas and Brian Collins of the BPC, who have been very accurate historically, project that the X date will fall between late February and mid-March. A Treasury official also confirmed BPC's estimated timeframe to the Washington Post's Brad Plumer.
Needless to say, until further notice, lawmakers shouldn't plan on seeing the cherry blossoms before having to deal with the debt ceiling. Particularly given that the delayed tax filing season will likely move some income tax refunds past February 8, it appears that lawmakers will have to address the debt limit by mid-March at the latest.
This week, Senate Finance Chairman Max Baucus (D-MT) is moving forward with tax reform, releasing three discussion drafts. Yesterday, he released a draft of international tax reform intended to make the U.S. more competitive with other developed countries. Today, he released a draft on tax administration, intended to improve the way taxes are collected and make it easier for taxpayers to file. Tomorrow, he will release a draft changing how businesses claim costs from their expenses.
Today's draft may not be headline-grabbing material, but it is filled with many ideas to reduce the complexity of the tax code and make it easier for taxpayers to file. The bill is not likely to be controversial and many provisions have bipartisan support. Much of the draft could be enacted outside of tax reform.
Closing the Tax Gap
This draft makes steps towards closing the "tax gap," or the amount of taxes that are owed but not collected either due to purposeful evasion or accidental mistakes. According to a 2011 IRS study, the tax gap was $385 billion – approximately 14 percent of all taxes owed, a rate that was essentially unchanged from the previous study. Assuming the same rate applies today, the annual amount of uncollected taxes is more than $430 billion.
IRS studies show that requiring information to be reported to the IRS, via W-2s for example, dramatically enhances compliance. If information is not reported, the amount eventually claimed on tax returns is underreported by 56 percent, but the percentage drops to 8 percent when information is reported. The Baucus draft enhances reporting concerning bank accounts, mortgages, life insurance sales, college tuition, and sole proprietorships. In these cases, some information is already required to be reported, but is missing key pieces. For instance, taxpayers claiming a deduction for mortgage interest include a form showing the amount of interest they paid, but the form does not include the total balance of the mortgage, which would help the IRS know if the mortgage is in excess of the $1 million eligible for the deduction.
In order to pursue delinquent tax filers, the bill allows overdue taxes to be subtracted from the Medicare payments to delinquent providers. It would also deny passports to people owing at least $50,000 in delinquent taxes.
Within the last few years, tax refund fraud has become increasingly prevalent. Last year, an investigation found a potential of 1.5 million fraudulent returns costing as much as $5.2 billion. The bill would combat fraud by limiting the public dissemination of Social Security numbers. Currently, the Social Security Agency keeps a list of public deaths in the United States, which agencies use for the purpose of stopping benefits after death. The public can also buy a truncated copy of the list that includes Social Security numbers and addresses of the deceased; insurance companies and banks use the list to discover deaths and combat fraud, and genealogists use the list for research. However, IRS Taxpayer Advocate Nina Olson found that the list promotes fraud, by making private data available immediately. The bill puts a 3-year time limit on public access to the list, unless the user can prove a legitimate interest in fraud prevention. The bill would also discontinue using full Social Security numbers on W-2 forms.
Currently, there is a $500 penalty for paid preparers that do not make reasonable efforts to insure their clients actually qualify for the Earned Income Tax Credit, to prevent preparers from knowingly helping to get a fraudulent refund. The penalty would be expanded to include the Child Tax Credit. The draft would allow the IRS to regulate paid tax preparers, an issue currently being litigated. Finally, the IRS could verify employment and salary information against the National Directory of New Hires, a database of current employment information maintained for child support reasons.
Making the Process of Filing Taxes Less Cumbersome.
The draft also changes the filing schedule so it proceeds more logically. Currently, calendar year corporations have to file taxes on March 15, but they often need information from partnerships, who do not have to file taxes until a month later. The bill would reorganize the filing schedule so it proceeds more logically from partnerships to corporations to individuals. The filing day for individuals would still be April 15.
Taxpayers would no longer be required to file corrections to their information returns (like W-2s) for small errors less than $25.
Enable IRS to Verify Information in Real Time
The IRS currently deals with a veritable flood of information: over 150 million returns are filed each year, and an additional 1.4 billion information returns. In addition, technology has greatly improved since the tax code was last rewritten in 1986. The draft would take advantage of new technologies to help IRS process information faster and more accurately. People submitting more than 25 returns would have to file electronically, as would all paid preparers. The draft would require tax returns prepared with software to include a scannable barcode, so the IRS can scan the information instead of manually typing it in.
The bill also makes a host of smaller changes: technical corrections to 38 provisions dating back to 2004 and removing 108 "deadwood" provisions no longer necessary. It improves access to the Tax Court and reduces the Joint Committee on Taxation's workload reviewing smaller corporate refunds.
Today, CRFB has released a new paper, Our Long-Term Debt Problems Are Very Far from Solved, which shows while recent improvements may have benefited our budget outlook over the short and medium term, we have made little progress on the long term and sizable challenges still remain. Or to quote CBO Director Doug Elmendorf "the fundamental budgetary challenge has hardly been addressed."
Specifically, we highlight five important points about the long-term outlook.
- Despite projections of historically low discretionary spending levels and historically high revenue levels, the federal debt is growing unsustainably over the long run due to health care cost growth and population aging.
- Deficit reduction enacted to date has helped reduce current and future levels of debt (though levels are still at historical highs) but done little to change the long-term trajectory of debt.
- While we need $2.2 trillion in savings over the next decade to get control of the debt, those policies will need to yield closer to $13 trillion of deficit reduction over the next two decades to put the debt on a clear downward path relative to the economy.
- No plausible rate of economic growth can reverse growing debt levels.
- Acting now can allow policymakers to make smaller and more gradual changes spread over more generations.
Since the enacted savings so far has focused mostly on discretionary spending, which is not a driver of our debt, there has not been a similar improvement in the long-term outlook. We estimate that to get debt back to its historical average of around 40 percent over the next 75 years would require the equivalent of non-interest savings of three percent of GDP each year (the fiscal gap).
In order to stick to our minimum sustainable debt path, lawmakers would have to enact growing savings (including interest) over time: 1 percent of GDP in the first ten years, 3.5 percent in the next ten years, and 6 percent in the ten years after that. The graph below shows the divergence between the minimum debt path and CRFB Realistic over time.
Debt as a Percent of GDP, 2010-2080
While the budget conferees may be focused on setting discretionary levels for 2014 and sequester-replacement, the paper is an important reminder of the need to focus on the long-term debt problem along with our analysis of CBO's Long Term Outlook report. The longer we wait, the harder it will be to solve.
Click here to read the full paper.