The Bottom Line
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.
This week, Senate Finance Committee Chairman Max Baucus (D-MT) is moving ahead with tax reform, starting with the release of discussion drafts on reforming the international tax system, tax administation, and cost recovery. Today, Baucus released the draft on international taxes.
Baucus’ international tax reform draft moves toward a hybrid territorial/worldwide system—setting up a minimum tax on overseas income that in many cases now goes untaxed or near untaxed until it is repatriated into the United States. Companies would pay tax when the income is earned, and wouldn’t owe any additional tax when it is brought back to the U.S.
By taxing income as it is earned, this draft is intended to help address two of the biggest problems of the international tax system—the current incentive to hold cash overseas in order to avoid taxation and the ability to pursue tax evasion schemes that allow many companies to structure their subsidiaries to entirely avoid tax.
The draft appears intended to be revenue neutral in the long-term, with a one-time infusion of over $200 billion from a 20% tax on all previous-earned foreign profits, paid over 8 years.
Elements of a hybrid worldwide/territorial system with a minimum tax
In all cases, Baucus would tax overseas income as it is earned, completely ending the deferral system we have now. If it is passive or mobile income without a clear source (like investment income), it would be taxed at the full U.S. corporate income tax rate. The draft does not specify what the corporate rate is, but Baucus has said that he hopes to lower the top U.S. corporate income tax rate to less than 30 percent. In this post, we use a 28% top rate as an example, but the actual rate could be higher or lower.
If the income is from operations of a business abroad, the draft presents two alternative options:
- Tax the income at 80% of the full rate (22.4%, assuming a 28% top rate), which is close to the OECD average effective tax rate of 20.6%; or
- Split the income into two categories: active income taxed at 60% of the full rate (16.8%, assuming a 28% top rate) and passive income taxed at the full rate.
The minimum tax would apply to subsidiaries with low effective tax rates. For instance, a subsidiary in Ireland would be taxed at Irish rates of 12.5% and would have to pay an additional 9.9% to the U.S., assuming a top U.S. rate of 28% (under the first option). However, a subsidiary in Germany would already pay German rates of 29.5% and would therefore not owe any U.S. tax, assuming a top U.S. rate of 28%, because the 29.5% paid to Germany is larger than the 22.4% minimum tax. Neither would owe any additional tax if they bring the money back to the U.S.
|Income Earned in Example Countries Under Hypothetical Mininum Tax
(Assumes 28% top rate and the first option "Option Y")
|Company Earnings||$1 billion||$1 billion||$1 billion||$1 billion|
|Minimum Tax Rate||22.4%||22.4%||22.4%||22.4%|
|Foreign Country’s Statutory Tax Rate||24.0%||29.5%||12.5%||0%|
|Taxes paid to foreign country||$240 million||$295 million||$125 million||$0|
|Taxes owed to U.S. due to minimum tax||0%||0%||9.9%||22.4%|
|U.S. Tax Paid||$0||$0||$99 million||$224 million|
|Additional Tax When the Income is Repatriated||$0||$0||$0||$0|
|Total Taxes Paid||$240 million||$295 million||$224 million||$224 million|
In contrast, Chairman Dave Camp’s draft would move to a 95% territorial system for active income, so companies would only pay the tax of the other country. If the income was repatriated, a company would pay at a 1.25% rate (5% subject to tax x 25% corporate tax rate). Passive income would be subject to a 10% minimum tax. Camp offered various options to deal with intangible income, taxing it at a 15% minimum rate or a 25% normal rate.
One-time charge on profits parked overseas
The draft includes a one-time charge of 20% on all outstanding earnings of foreign subsidiaries that have not yet been subject to U.S. tax, regardless of whether they are repatriated or not, which would likely raise over $200 billion. In contrast, Camp’s draft would charge 5.25% on all foreign earnings, and an additional 1.25% if the income is repatriated, for a total charge of 6.5%
Elements to end tax evasion
A common tax evasion tactic under the current system is that U.S. companies can set up foreign subsidiaries, which sell into the American market, but are taxed under another country's jurisdiction. The Baucus draft would tax income from such activities at the full U.S. corporate rate.
The draft would also eliminate the international portion of “check the box,” which some companies use so that their cash transfers between subsidiaries are disregarded by the IRS. If the two subsidiaries are in countries with very different levels of taxation (Germany and Bermuda, for instance), the check-the-box rules allow the company to shift profits and in some cases avoid tax entirely.
Similar to "thin capitalization" rules in Camp's draft, new rules would limit the interest deduction to borrow in the U.S. if the resulting foreign income is not subject to U.S. tax, or if the U.S. parent company is over-leveraged compared to its subsidiaries.
|Overview of International Tax Reform Plans|
|Corporate Tax Rate||25%||28%||unknown|
|Transition||5.25% tax on all foreign earnings||N/A||20% tax on all foreign earnings|
|Intangible Income||Options: Tax excess low-taxed intangible income in Subpart F, or all intangible income at minimum of 15%,||Include excess low-taxed (<15% ETR) intangible income in Subpart F||N/A|
|Low-Taxed Income||Non-active business income w/ ETR*<10% taxed in Subpart F||Global minimum tax (details not specified)||Global minimum tax of 80% or 60% of corporate rate|
|Foreign Tax Credit (FTC)||No FTC for 95% exempted dividends; only directly allocable deductions for foreign income||New limit determined on a “pooling” basis; defer interest deduction for deferred foreign income||Generally limits opportunities for cross-crediting.|
|Subpart F (excluding base erosion)||Repeals exclusion for previously taxed income if eligible for dividend exemption||No changes||Adds “United States related income” as a category of Subpart F earnings, covering sales in the U.S.|
|Interest Deductibility||Thin Capitalization rules tighten tests for leverage and adjusted taxable income||Disallows interest deductions greater than 25% of adjusted taxable income||Limits interest deductions for domestic companies if the associated foreign income is exempt from tax|
|Other||Election to treat 10/50s as CFCs||Disallow deduction for reinsurance premiums to exempt affiliates||Eliminates check-the-box and CFC lookthrough|
Update: Blog updated on 11/20 to clarify several descriptions of elements of the discussion draft.
Historic Moment – On this day 150 years ago, President Abraham Lincoln delivered the Gettysburg Address dedicating the new national cemetery at the site of the epic Civil War battle. We observe that historic moment at a time when the “government of the people, by the people, for the people” that Lincoln defended appears at a low ebb. Congressional approval ratings are at record lows and other institutions are also suffering. One of the reasons for the lack of confidence is the seemingly endless crises created by policymakers as they continuously kick the can on addressing our fiscal challenges. It seems like it’s been fourscore and seven years since we had a federal budget and there is little optimism that the conference committee charged with negotiating one will have much success. We’ll see how our leaders address the task before them.
Budget Conference Talks Continue; Little Progress Seen – The Gettysburg Address was a very short speech that has had significant impact over time. The conference committee trying to establish a budget at least for the rest of the fiscal year has featured a lot of talk so far with no results as of yet. The committee convened its second formal meeting last week where it heard from Congressional Budget Office (CBO) director Douglas Elmendorf, who made it clear that long-term budget challenges still remain despite deficits coming down in the near term. While committee member Sen. Angus King (I-ME) served up a compromise “Grande Plan” for fellow conferees to consider, there has been no noticeable progress towards a budget deal. The panel has until December 13 to report to the full Congress but appropriators want agreement on a topline spending number before that so they can get to work drafting spending bills.
Will Tax Reform Have Its Moment? – The Battle of Gettysburg was a chance encounter. Advance units of the North and South converged just outside of the town, eventually drawing their larger forces into a three day battle. For the past year Senate Finance Committee chair Max Baucus (D-MT) and House Ways and Means Committee chair Dave Camp (R-MI) have been attempting to create a similar set of circumstances. The bipartisan duo has been working within their respective committees on a fundamental rewrite of the tax code and toured the country together to promote tax reform in the hopes that their efforts would converge at the right moment. On Tuesday Sen. Baucus continued his work by releasing the first tax reform discussion draft – a proposal to change international taxation to encourage American companies to stop keeping profits offshore in order to avoid higher U.S. taxes. He promised more drafts would come later this week. Meanwhile, Rep. Camp had promised that his committee would mark up a comprehensive tax reform bill this year, but that plan may be pushed back until next year as the debate over the Affordable Care Act is taking up much of the oxygen. Follow our “Tax Break-Down” series as we continue to examine tax expenditures that could be included in tax reform.
No Lack of Ideas – While policymakers continue to struggle to devise a fiscal plan for moving the country forward, it is not for a lack of ideas. In fact, CBO provided over 100 ideas last week in its updated “Options for Reducing the Deficit: 2014 to 2023.” The ideas cover all areas of the budget. Our “Build Your Own Budget” tool allows you to choose from many ideas to create your own budget plan.
Addressing Health Care – Health care has received a lot of attention as of late, but beyond website problems and questions over who gets to keep their health insurance is the larger concern of reducing the growth of health care spending. Health care is one of the largest drivers of the national debt moving forward. Last week the CBO’s Doug Elmendorf gave a presentation substantiating the view that significant long-term deficit reduction cannot be achieved without addressing health care costs. Our partners at the Moment of Truth project recently collaborated with the National Coalition on Health Care to examine how payment and delivery reforms can contribute significantly to driving down cost growth.
Key Upcoming Dates (all times are ET)
November 20, 2013
- Bureau of Labor Statistics releases October 2013 Consumer Price Index data.
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.
The year is rapidly coming to a close, with only 11 days left that the House plans to be in session. Before the year's end, Congress is supposed to hear from the budget conference committee on the results of their negotiations, but lawmakers also have a few other year-end events to handle.
Among them is consideration of the tax extenders, dozens of temporary provisions that expire annually. Extending these tax breaks has become something of an annual holiday tradition for Congress. Although these costs may be traditional in the recent past, policymakers should not assume that they are automatic. Any budget deal should not count "savings" from letting a provision expire as scheduled, and any extended tax provision should be treated with a "pay as you go" principle — lawmakers either need to find savings elsewhere to offset the cost of an extension, or let the provision expire.
The Joint Committee on Taxation lists 64 provisions in the tax code that will expire at the end of the year. Although estimates for most of the provisions are one year old, the normal extenders would increase the ten-year deficit by approximately $40 billion if they were extended for one more year. The vast majority of the money, about 85 percent, is for business or energy provisions. One additional extender, bonus depreciation, represents a timing shift that would cost $5 billion overall, $50 billion in upfront costs over the next two years that are mostly offset in the following eight.
Not all of these extenders are equally sized. Most of them cost under a billion dollars; approximately 50 small provisions make up 30 percent of the total cost. The larger extenders are the wind production tax credit, which gives wind farms a per-cent credit for every kilowatt-hour of electricity they produce, the credit for research and experimentation expenses, an "active financing exception" that allows U.S. financial institutions to defer taxes on some of their overseas income, and the deduction for state sales taxes paid.
Recent reports suggest that some lawmakers are considering letting some of these provisions expire and counting the savings as new revenue, which could then be paired with targeted spending reductions to reach a budget deal. There's a big problem with this plan: lawmakers would set an artificially low bar. They would be assuming that all temporary tax breaks are extended forever and then give themselves credit for letting a provision expire on schedule. That's certainly not how the budget scorekeepers would treat a bill, nor should they. Both JCT and CBO treat current law as the norm: extending a tax break costs money, and letting it expire on schedule has no effect. Following this agreed-upon budget convention is the most responsible thing to do. If lawmakers want to extend a provision beyond its current expiration, they should acknowledge the additional costs and offset them.
And lawmakers would be wrong to assume that every tax break is routinely extended. Many are, but the fiscal cliff legislation at the end of 2012, for example, let almost a third of the provisions (21 of 76) that expired in 2011 and 2012 lapse. Some of the ones that were extended, such as special breaks for film and television production or special depreciation schedules for racetracks and race horses, attract negative media attention every year. Furthermore, Senate taxwriters Max Baucus (D-MT) and Orrin Hatch (R-UT) have said that the Finance Committee will not issue a separate bill for tax extenders, choosing to address the provisions within tax reform. But as noted by the Congressional Research Service, "With tax reform efforts unlikely to be completed in 2013, it seems likely that the tax provisions scheduled to expire at the end of 2013 will lapse, at least temporarily." Even if the provisions lapse, lawmakers have sometimes passed them retroactively; for example, most of the provisions that expired at the end of 2011 were not extended until the end of 2012.
Hopefully, tax reform will end the uncertainty surrounding many tax extenders, either extending them permanently or letting them expire. But if lawmakers are interested in preserving the provisions before 2014, they could be considered in the normal process. If lawmakers paid for extending some of these provisions with new revenue, they would have a bill that scores as revenue-neutral, but actually enhances the long-term deficit picture by exchanging a temporary short-term cost for permanent long-term deficit reduction. Further, dealing with extenders now provides an opportunity to consider each provision instead of waiting until the end of next year, when the sense of urgency would pressure lawmakers to extend them en masse in a deficit-financed year-end package.
With tax reform unlikely to tackle extenders by the end of the year, lawmakers will need to tackle them in a separate bill in order to keep them from expiring. If they choose to extend the provisions, they should abide by PAYGO, paying for the additional costs of an extension.
Though the government shutdown ended a little over a month ago, its effects still linger on. In an editorial published today in The Hill, former Senator Judd Gregg (R-NH) reviews the aftermath of the shutdown and debt ceiling debacle, to try and determine what it accomplished.
Gregg points out that these self imposed crises had negative consequences that extend beyond the federal worker furloughs and loss of government services. They imposed harm on the economy and had negative fiscal ramifications.
The cost of short-term borrowing for the government went up 9 basis points during this period of artificially induced crisis over paying the debt. The six-month treasury notes went up 22 points.
This may not sound like much but it actually represented a totally unnecessary increase in spending to pay for these higher interest charges. The added expenditure totaled close to $400 million.
Now, not only do the American taxpayers have to pay for this additional debt, they have to pay interest on the funds borrowed to pay the debt.
At a time when our elected officials should be focused on addressing the challenges posed by our nation's mounting long-term fiscal problems, these crises added to our debt:
Standard & Poor’s estimates the hit to the economy to have been around $24 billion. This also translates into lost tax revenues for the government.
Those tax revenues would have paid for obligations which the government has incurred. Now, without those revenues, these obligations will have to be paid for by more borrowing.
Congress should learn from this experience and stop playing politics with the debt ceiling and the fiscal future of this country. The budget conference committee is an opportunity to forge a compromise on spending levels in a responsible manner. Hopefully, they can take full advantage.
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.
In addition to CBO director Doug Elmendorf's testimony, yesterday's budget conference committee meeting produced another notable moment: a proposal from Sen. Angus King (I-ME) to replace part of the sequester with targeted and permanent reforms. The plan is an archetype of what a modest solution from the conference committee could look like, as it would replace the sequester responsibly. In fact, King referred to it as the "grande" plan, named after the medium size at Starbucks.
Specifically, King's proposal would replace about half the sequester through 2021 -- at a cost of $455 billion -- with $200 billion of revenue from corporate tax base-broadening and $255 billion of savings from mandatory programs. It would also reduce another $325 billion from eliminating or reforming many corporate tax expenditures to finance a reduction in the top corporate tax rate from 35 percent to 32.5 percent and a $50 billion of which would go to new infrastructure spending. After repealing half of the sequester, King would "smooth" the caps so there were fewer cuts in the earlier years and slower growth in the caps over time. We said that this could be a sensible approach yesterday while warning that if it's taken too far or done on its own, it could easily amount to a budget gimmick.
|Parameters of the King Plan (Billions)|
|Ten-Year Savings/Costs (-)|
|Half Sequester Replacement||-$455|
|Subtotal, Sequester Policies||$0|
|Additional Corporate Base-Broadening||$325|
|Corporate Rate Cut to 32.5%||-$275|
|Subtotal, Additional Policies||$0|
|Total Budget Impact Against Current Law
The King plan is a solid approach to the sequester. It does no harm to future debt levels compared to current law, replaces the mindless sequester with more targeted and gradual reforms, and would likely enhance economic growth in the short-term by providing some relief from the sequester (the effect on long-term growth would depend on the details). Senator King has presented a compelling plan that deserves serious attention. Ideally, lawmakers would go even further in finding targeted savings to truly put the debt on a downward path over the long-term, but Senator's King would be a good step in the right direction.
We welcome any additional details about the mandatory or tax savings involved, since filling in those details will be key to a potential agreement. For an idea of how the tax expenditure savings could be achieved, check out our corporate tax reform calculator.
As the conferees met yesterday, any doubt that we can afford to wait on the long-term debt problem should have quickly been erased after CBO Director Doug Elmendorf's testimony to the conference committee. While the budget outlook has improved somewhat in the short term, little progress has been made on the long-term problem. And fixing the long term will likely require greater reforms to entitlement programs and the tax code.
In another presentation yesterday, Elmendorf explained that if we want to make real progress on our fiscal problem, we will have to address health care. Elmendorf's presentation to the Public Policy Institute at the Wharton School at the University of Pennsylvania shows that health care by far has outpaced the growth of other programs, and the projections look even starker over the long term.
He attributes the growth of health care spending to three factors: population aging, the expansion of health insurance coverage in the Affordable Care Act, and health care cost growth.
A lot of the growth in health care spending can be tied to the retirement of the Baby Boom generation and population aging. But as Elmendorf notes, it is difficult to do much on population aging because most policies to improve the health care system should also increase longevity. That is especially the case now that CBO has revised down its estimate for increasing the Medicare retirement age. This is not to say that there aren't many other ways to address population aging - Social Security reform is a great way to tackle that driver of the debt.
Alternatively, many health policy experts have stressed delivery and payment reforms, which could reduce health care cost inflation while ideally not affecting or improving quality of care. Over the past few decades, health care costs have growth much faster than inflation, and if history is any indication, this trend is likely to continue unless significant changes are made. There has been some slowdown in health care cost growth over the past few years, but it is still too early to conclude how much of the slowdown is permanent and how much is due to temporary factors like the poor economy.
Delivery and payment reforms are particularly promising, but lawmakers must also use caution in the same way that they do with eligibility reforms. As Elmendorf notes:
Restructuring federal payments for health care holds the promise of encouraging greater efficiency in the delivery of care or better choices about the use of care—but it also would present risks of the same shifting of costs and loss of access to insurance and care.
That being said, lawmakers have many different options available to them that could substantially improve the health care system. Reforming federal health spending to make it sustainable will be an ongoing process, but lawmakers should begin as soon as possible. The longer we wait, the less time we will have to phase in changes slowly and the larger the debt problem will grow to be.
Click here to see Elmendorf's full presentation.
On Monday, we took a look at the breakdown of federal spending and taxes by the type of household, particularly between elderly and non-elderly households. But CBO's recent analysis of 2006 household data also contains valuable information on the income distribution of the budget as well. CBO excludes elderly households from this analysis as market income is not a good measure of their resources -- they rely instead mostly on retirement savings, Social Security benefits and pensions -- but the report still provides useful insight into the effect of taxes and transfers on the overall income distribution.
For non-elderly households, the lowest income quintile receives about $13,000 in net transfers after taxes, while the top three quintiles, particularly the top quintile, paid more taxes than they received in transfers. When government spending other than transfers is included, the bottom two quintiles are shown to benefit, the 3rd and 4th quintiles roughly break even, and the highest quintile pays more in taxes than it receives in benefits.
One noticeable finding from CBO's report is how much of the progressivity of the federal budget is the result of the tax code. For nonelderly households, transfers are progressive, with lower income households receiving a larger share, but the tax code's effect on distribution is far larger. Of course, including elderly households would again change the distribution, as would including the activities of state and local governments. Internationally, America has a very progressive tax code since most other industrialized nations have some form of sales tax, but transfers are less progressive than in many other industrialized nations.
Lawmakers ultimately need to decide what combination of taxes and transfers is best for achieving the progressivity they desire. But one myth that is counterproductive is the idea that deficit reduction plans will hurt low income households and make income distribution more regressive. As we've shown on this blog, many plans have adopted the Fiscal Commission's principle of instituting reforms that protect low-income households. The Bipartisan Path Forward, a plan Erskine Bowles and Al Simpson released in March, contained many low-income protections, such as a repeal of sequestration and an including old age "bump up" with their chained CPI proposal, similar to the policy included in the President's Budget.
Tax reform can also be progressive, as many of the tax expenditures in the code disproportionately benefit wealthier households. Many of these provisions, if not eliminated, could be redesigned to be more progressive and cost less, for example, by turning deductions into credits.
Protecting the disadvantaged in a comprehensive deficit reduction is one of the enduring legacies of the Fiscal Commission and one that the budget conferees should follow. Not all of the budget options released in CBO's report may hold lower-income households harmless, but they can easily be modified to do so. Morever, what ultimately matters is the overall effect of a plan, and a comprehensive plan is better positioned to make lower-income people better off overall. Lawmakers will need to make tough choices, but if they are committed to protecting the disadvantaged, it is definitely achievable.
Yesterday, the Congressional Budget Office released its budget options paper, a biannual report that provides over 100 suggestions of specific things that could be done to reduce the deficit. We explained yesterday how important the report, Options for Reducing the Deficit: 2014 to 2023, actually is: it provides updated estimates and descriptions for the current 10-year budget window, because their last report in 2011 was published before the recent changes to the budget picture. In early 2011, the budget did not yet include the Budget Control Act that limited discretionary spending, the sequester that cut it further, or the fiscal cliff deal that raised tax rates for upper-income Americans. Since CBO serves as the official scorekeeper for the Congress, its estimates can affect how a bill is treated. For example, any reconciliation instructions issued by the budget conference committee cannot increase the deficit.
In light of the new numbers from CBO, we've adjusted our estimates and added new options to the Tax Break-Down series, which for the past couple months has been examining each tax break one at a time, listing some of the arguments for and against it, and listing several options for reform. We'll treat the Tax Break-Down series as an evolving set of documents, updating it whenever a relevant option is released, including when a tax reform bill is released this fall.
* * *
See the entire CBO report on Options for Reducing the Deficit: 2014 to 2023 here.
Read the (updated) posts in the Tax Break-Down series here.
As the budget conference committee works to develop a plan to offset some of the sequester, they may be tempted to use budget gimmicks in place of hard choices (last week we warned against use of the war gimmick). One such gimmick would be to repeal most or all of the sequester now and pay for it by increasing the sequester later.
Doing so would be an irresponsible way to offset the sequester, and it would lack credibility. From a policy standpoint, offsetting the temporary cuts of sequester now with deeper temporary cuts later would do nothing to improve the fiscal situation; the sequester was meant to be a backstop to encourage permanent deficit reduction policies.
But more troubling, repealing the sequester now by deepening the sequester in future years would lack credibility would likely be seen as a pure budget gimmick. After all, if we are unwilling to live under the sequestration cuts now, what evidence is there that we can bear even deeper cuts later?
Imagine that policymakers repealed two thirds of the discretionary sequester this year -- $60 billion -- shrinking a 8.5 percent cut (relative to pre-sequester caps) to a 2.8 percent cut, and then paid for it by reducing future caps $6.6 billion per year over the next nine years. Under that scenario, next year's cut would by 8.9 percent -- something they are unlikely to accept if they couldn't allow for a 8.5 percent cut this year.
Instead, they might repeal $66 billion of the sequester next year, paid for with $7.5 billion of annual cuts over the following nine years. And then they might repeal $82 billion the following year, and so on and so on. Taken to its logical conclusion, policymakers would face an 12.6% ($125 billion) cut in 2021 -- one which they would be quite unlikely to accept -- and in the process would have only allowed one-third of the sequestration's original cuts to actually go to deficit reduction.
The chart below illustrates the scenario described above – offsets share the same color as the sequester relief provided. As you can see, sequester relief that costs only $60 billion in 2014 will rise to $90 billion by 2018 and $130 billion by 2021. And those cuts are on top of the $30 billion in cuts that are continually retained.
Anyone who doubts that Congress will repeatedly kick the can on actually making discretionary cuts need only look at the experience of the Medicare Sustainable Growth Rate (SGR) formula in which Congress has consistently canceled cuts scheduled for the upcoming year and required deeper cuts in future years. Eventually, the cuts snowballed to the point where doctors now face a 24% cut that no one ever thinks will occur. Turning the sequester into another SGR would be a grave mistake.
To be sure, not all adjustments in discretionary cap levels would be gimmicky in nature. A much more modest plan to "smooth" the sequester cuts in concert with other reforms could help make what is left of the sequester easier to bear by phasing it in more gradually. This smoothing wouldn't solve our fundamental budget problem or make the necessary hard choices, but if realistic it could be part of a more complete budget plan.
Yet there is a slippery slope between reasonable smoothing and unreasonable gimmicks. Reducing the amount of cuts that need to be made in the appropriations bills for the upcoming fiscal year by promising to make greater savings in later years creates a dangerous precedent that could easily be abused. To be credible, smoothing must be part of a larger plan which agrees to a full set of caps which policymakers intend to and are able to abide by. Any reductions in the sequester now paid for by increases in future-year sequester cuts which will be difficult to enact or which policymakers intend to modify later would qualify as a gimmick. And any significant sequester relief not accompanied by permanent deficit reduction would likely be non-credible and certainly a missed opportunity.
Backloading sequester will not solve our fundamental budget challenges, and declaring that we cannot accept cuts now so we will impose a deeper version of those cuts later does not pass the laugh test.
Congress should take the steps necessary to replace mindless, temporary, anti-growth sequester cuts with sensible, targeted, permanent, long-term reforms. But as Congressional Budget Office Director Doug Elmendorf explained today, "no steps at all are better than steps backwards." Congress must not gimmick it's way to sequester relief.