The Bottom Line

April 7, 2014

Although the primary purpose of a budget resolution is to set spending and revenue levels to govern the consideration of legislation by Congress, it can also contain provisions regarding budget rules and scoring procedures for legislation. The budget resolution reported by the House Budget Committee contains two particularly significant provisions dealing with accounting for costs of credit programs and general revenue transfers to the highway trust fund. While these provisions are technical and arcane, they could have a significant impact on legislation if they are adopted.

Section 507 of the budget resolution would require the Congressional Budget Office to provide a supplemental fair value estimate of legislation regarding loan programs at the request of the Chairman or Ranking Member of the Budget Committee. It also provides for fair value estimates of legislation regarding housing or residential mortgage programs. In general, fair value accounting incorporates market risks into estimates of the cost of legislation, which generally results in a higher estimated cost for legislation. Importantly, these fair value estimates of legislation may be used in determining whether legislation complies with budget allocations and other budgetary rules.

As we've written before, proposals regarding fair value accounting are very arcane and controversial. The Federal Credit Reform Act  of 1990 (FCRA) required credit programs to discount the future expected cash flows to a present value estimate, a process which requires an interest rate. Under those reforms, federal programs would use the interest rate on U.S. Treasuries. In recent years, some organizations and experts have argued that the rules under FCRA are not a comprehensive measure of the cost the government incurs when it enters into loans and loan guarantees. They argue that using the Treasury discount rate does not fully account for the market risk the government is taking on and does not accurately portray the costs to policymakers. The Congressional Budget Office has stated that in its view "adopting a fair value approach would provide a more comprehensive way to measure the costs of federal credit programs and would permit more level comparisons between those costs and the costs of other forms of federal assistance."

Budgetary Treatment of $100 Million Loan under the Three Approaches
  Cash Accounting FCRA Fair-Value
Year 1 $100 million -$1.6 million $1.3 million
10-Year Period -$3 million -$1.6 million $1.3 million

Note: See CBO's detailed version of this example in this report.

A "fair-value" approach to estimating the costs of federal credit programs would assign a "market risk premium" to bridge the gap between Treasury interest rates and the discount rate that private lending institutions would assign when assessing the costs of a loan. This approach is intended to  measure the costs of those program at market prices. Fair-value accounting has been used for some government programs, including payments to the IMF and spending in the Troubled Asset Relief Program, but it is not widespread practice.  CBO has applied the concept of reflecting market risk into estimates in other areas, most significantly for Social Security reform proposals for which CBO estimates and analysis provided risk-adjusted returns for individual accounts.

Opponents of switching to fair value accounting point out that these loans are funded through the issuance of Treasury debt, which means there is very little or no market risk, so it is appropriate to use the FCRA rules. They also argue that the additional cost that fair-value accounting records does not actually occur, requiring real offsets for costs which do not occur. Further, they argue that using this method would apply inconsistent budgetary treatment to credit programs versus other programs.

The valuation of federal credit programs can be an arcane topic. But at the same time policymakers need to decide what is the best way to reflect the costs or profits of the operations of the federal government. The Congressional Budget Office estimates that the $635 billion of loans and loan guarantees issued in 2013 alone would generate budgetary savings of $43 billion under current FCRA accounting but would have a cost of $11 billion under fair value accounting.

Section 508 of the budget resolution provides that transfers from the general fund to the Highway Trust Fund should be scored as a cost equal to the amount of the general revenue transfer. The Highway Trust Fund is afforded many special protections in the budget process because it is supposed to be a self-funded program financed by a dedicated revenue source, the gas tax. But gas tax revenues have not kept pace with increased spending on highway programs, resulting in the trust fund repeatedly coming close to exhaustion. Legally, the Highway Trust Fund is not allowed to run a negative balance and does not have authority to borrow money to cover obligations in excess of revenues after the trust fund has been exhausted. Therefore, transferring money to the Highway Trust Fund to extend trust fund solvency allows spending to be greater than it otherwise would have been.

But under current scoring conventions, CBO assumes in its baseline that spending on highway programs will continue at current levels regardless of the status of the Highway Trust Fund. As a result, general revenue to trust funds that are due to be exhausted, such as the Highway Trust Fund, are not recorded as costs even though those transfers allow lawmakers to spend more than they would if the trust funds were exhausted. This loophole, among the budget gimmicks we identified in a paper last year, allows lawmakers to take credit for extending the life of the Highway Trust Fund without being charged a cost for doing so or identifying new revenues or spending cuts to cover the shortfall.

Requiring general revenue transfers covering shortfalls in the Highway Trust Fund to be offset would have a significant impact given the $172 billion cumulative shortfall facing the Highway Trust Fund over the next decade.
 

The budget resolution does not provide for any general revenue transfers to the Highway Trust Fund and assumes that the entire shortfall is made up by reducing spending from highway trust fund by $172 billion over the next decade, including no new contract authority in 2015. However, the resolution does include a reserve fund allowing highway spending levels to be increased as part of deficit-neutral legislation which either increases dedicated revenues into the trust fund or provides a general revenue transfer to the trust fund that is offset.

Congress has enacted four general revenue transfers to the Highway Trust Fund totaling $53.3 billion to avoid trust fund exhaustion since 2008. Only one of these transfers, an $18.8 billion transfer in the 2012 highway bill was (mostly) offset. Despite these transfers, the Highway Trust Fund is once again facing exhaustion. The Congressional Budget Office estimates projects that the HTF will be exhausted in 2015 and the Department of Transportation may be required to begin slowing reimbursements to limit spending from the HTF as early as the latter half of 2014 without additional revenues into the trust fund. House Speaker John Boehner has publicly rejected another bailout of the trust fund, which suggests that he would oppose any general revenue transfers to the Highway Trust Fund even if they were offset by savings elsewhere in the budget.

But the tax reform discussion draft released by Ways and Means Committee Chairman Dave Camp relied on current scoring rules to direct revenues from the tax repatriation provision in his bill to the highway trust fund while also using those revenues to offset the lower rates in his proposal. Under the rule proposed in the budget resolution, depositing revenues into the HTF would be scored as a cost, and those revenues could not be used to offset other costs in the bill as well.

While Congress is not expected to adopt a budget resolution conference report this year, the House could deem all or parts of the House budget resolution to be in effect in the House for enforcement of budget rules. If either of these provisions are included in such a deemer, the impact on legislation regarding highway spending and credit programs would be significant.

April 7, 2014

House Budget Committee Chairman Paul Ryan's budget would substantially reduce deficits and debt over ten years, but one remaining question is what the budget would look like over the long term. The same day the budget was released, CBO produced an analysis of the budget that runs through 2040. Of course, CBO deputy director Bob Sunshine noted in an accompanying blog post that "CBO does not analyze or prepare estimates of budget resolutions because they are targets for the Congress and its committees and do not contain legislative language for specific proposals whose budgetary effect we could estimate." This means that the numbers CBO produces are simply based on the targets in the budget resolution, not the policies it specifies.

CBO's report shows that including the positive economic effects of the budget's deficit reduction, debt would continue to decline from 56 percent of GDP in 2024 to 18 percent by 2040. Using supplemental data in the CBO analysis, we estimate that excluding the economic effects, the debt path would be largely similar, declining from 57 percent of GDP in 2024 to 24 percent by 2040. Both of these compare very favorably to the budget's baseline -- CBO's current law baseline with a drawdown of war spending -- which has debt rising to about 110 percent of GDP by 2040.

Over the long term, the Ryan budget would significantly shrink the size of government compared to current law as it shrinks debt. The budget would adhere to current law revenue, but it would cap revenue at 19 percent of GDP so it would diverge in the long run from current law, under which revenue continues to rise above that level by the 2030s due to "bracket creep." For spending, the budget would get it down to almost 18 percent of GDP by 2024, and it would ultimately fall below that level. By contrast, current law would have spending rising to close to 30 percent of GDP by 2040, largely driven by growing interest costs to service the growing debt.

While CBO analysis is not an actual score of the Ryan budget, there are a number of policies that would produce significant savings over the long term, in particular from health policies. The highest profile one would transform Medicare into a premium support system starting in 2024 for new beneficiaries and tie the federal government's premium contribution to the average bid amongst insurers in each region. Because the competition would bring down premiums and the federal contribution, and more and more people over time would enter the new system, the policy would produce growing savings over time. In addition, the budget would institute cost-sharing reforms and raise the Medicare eligibility age starting in 2024, so those policies would have higher savings over the longer term than what shows up for one year within the ten-year window. Finally, the Medicaid block grant would save increasing amounts over time as the annual increase in the block grants would fall short of current projected growth each year.

It is no surprise given how the Ryan budget looks over ten years that it would continue to put debt on a downward path over the long term.

April 4, 2014

Update: The House passed the Pro-Growth Budgeting Act by a 224-182 vote. Also, CBO posted a letter to Chairman Paul Ryan examining the feasibility of conducting the analyses required by some of the proposed amendments to the Pro-Growth Budgeting Act.

The House of Representatives is scheduled today to consider legislation introduced by Congressman Tom Price (R-GA), H.R. 1874, The Pro-Growth Budgeting Act, which would require the CBO to prepare an analysis of the effect that major legislation would have on the U.S. economy. The macroeconomic-impact analysis would be supplemental information in addition to the official congressional cost estimate of the legislation. This legislation is very similar to an amendment by Senator Rob Portman that was adopted by the Senate during consideration of the budget resolution last year.

The issue of dynamic scoring has come up often recently, with Ways and Means Committee Chairman Camp (R-MI) providing a supplemental macro-dynamic analysis of his tax reform legislation and Budget Committee Chairman Paul Ryan (R-WI) including the budgetary effects of the “fiscal dividend” from macroeconomic effects of deficit reduction in his budget resolution.

Background

Under current procedures, CBO's scores of legislation do not take into account macroeconomic responses, changes to variables like GDP, employment, or inflation. They do, however, account for microeconomic responses such as the timing of economic activity, the shifting of income between taxable and nontaxable categories, effects on supply and demand, and interactions with other taxes. Estimates of lower income tax rates, for example, would show an increased tax base as people shift more compensation from nontaxable benefits, such as employer provided health care and retirement plans, to taxable wages. Estimates of spending programs also take microeconomic effects into account. For example, while CBO already takes into account a tax rate increase's effect on how much income a person receives in taxable versus non-taxable form under conventional scoring rules, a macro-dynamic estimate would also take into account the rate increase's effect on variables like GDP or inflation.

The Pro-Growth Budgeting Act

The legislation being considered today would require CBO to provide a macro-dynamic analysis for all major revenue or spending legislation, except for appropriations bills, regarding the impact on real GDP, business investment, capital stock, employment, interest rates, and labor supply. This analysis would also include an estimate of the legislation’s potential fiscal impact, including any changes in tax revenues resulting from changes in GDP. This requirement would apply to legislation with a budgetary effect of at least 0.25% of GDP in any year in the ten year budget window. Importantly the macro-dynamic estimates would be provided as supplemental information rather than as a replacement for the traditional CBO scoring and would not be used for determining whether legislation complies with budget allocations, PAYGO or other budget rules.

There are a number of arguments both for and against adopting or relying on macro-dynamic scoring, which we summarized in a report in 2012.

Arguments in favor include:

  • It provides lawmakers with more information about legislation
  • It reduces bias against pro-growth policies in scoring.
  • It takes advantage of advances in economic modeling and new research about the effects of various policies

Arguments against it include:

  • The score would be highly sensitive to the assumptions CBO makes or the model they use
  • Requiring  CBO to make certain assumptions about future policy changes could render an estimate meaningless
  • The impracticality of constantly having to update CBO's baseline economic projections for new legislation

The Bottom Line

As we said in our letter commenting on Chairman Camp’s tax reform legislation, we believe legislation should be designed to add up without the effects of economic growth. At the same time, we believe that legislation promoting the growth should be pursued to the greatest extent possible, and policymakers should have as much information about the potential economic impact of legislation as possible.

Dynamic scoring can offer valuable information about growth effects that conventional estimates do not provide, and the analysis required by H.R. 1874 would provide important information to help lawmakers and the public evaluating the merits of legislation. However, there are significant challenges to incorporating macro-dynamic estimates into the official cost estimate for legislation. For one, dynamic estimates of legislation are subject to considerable uncertainty. Dynamic scoring is extremely sensitive to the assumptions used and there is no consensus on what some of those assumptions should be. In addition, dynamic estimates often require making assumptions about future legislative actions and monetary policy – a practice which is understandably counter to current scoring conventions.

Given the uncertainty in dynamic estimates and the magnitude of the fiscal challenges we face, the responsible course of action would be to rely on conventional scoring of legislation and treat the potential dynamic effects of legislation as a “bonus” to help further reduce the deficit and put the debt on a sustainable path. Relying on projected revenues from dynamic effects to meet fiscal goals creates an undue risk that the deficit will exceed projections if the hoped for dynamic effects don’t materialize as projected.

Regardless of what is and isn’t measured, we would encourage Congress and the President to pursue policies which both promote economic growth and put the debt on a clear downward path.

April 4, 2014

The Senate Finance Committee met yesterday to consider the fate of the 50-plus tax breaks that expired last year known as "tax extenders." Unfortunately, they chose to extend almost all of them for two years by adding the costs of the tax cuts to the national debt.

However, lawmakers had many options to pay for these tax breaks, if they were so inclined. Below we've compiled a list below of some of the commonly discussed revenue ideas, including those endorsed by both House Ways and Means Committee Chairman Dave Camp (R-MI) and President Obama.

Earlier this week, we gave some credit to Chairman Ron Wyden (D-OR) and Ranking Member Orrin Hatch (R-UT) for releasing draft legislation that would have allowed a quarter of the provisions to expire. We also criticized lawmakers for not paying for any of the remaining tax breaks. However, it was clear that many of the popular provisions missing from the initial draft were likely to be restored. The largest was the renewable energy production tax credit, an incentive that Wyden has praised many times. The second-largest, dealing with payments between overseas corporate subsidiaries, would have changed the way multinational corporations do business and was unlikely to be considered outside of international tax reform.

Between the modifications made by Chairman Wyden and the amendments passed by the Finance Committee, nearly every provision that had been allowed to expire was restored. In addition to the two mentioned above, the committee added back incentives for energy-efficient buildings, special breaks for film production and NASCAR racetracks, and others. The total cost of the bill increased by almost $20 billion, to $86 billion, while amendments only added $1 billion worth of savings to pay for the added extensions.


Numbers do not add to the $86 billion total due to rounding.

Congress has not usually paid for the extenders, choosing to pass these tax cuts every year by adding to the deficit. Given our unsustainable debt situation, it is important that lawmakers abide by PAYGO and ensure that any extension is paid for with savings elsewhere, following the example set by both Chairman Camp and President Obama. As it was, Senators submitted over 90 amendments, ranging from tax breaks for bike-sharing programs to beer production. This type of logrolling – loading up legislation with special interest provisions – results when legislation is not subject to the discipline of PAYGO. Many of these provisions would not be considered a high enough priority to include if their advocates had to propose offsets.

If lawmakers were interested in taking a fiscally responsible approach and either reducing the size of the extenders or offsetting the costs, they had a number of options. The Finance Committee extended them for two years, but lawmakers could also get creative by modifying some, making them permanent, or choosing to keep some expired. For instance, the package of education reforms in Camp's discussion draft let one education break expire and repealed several other permanent ones to pay for a permanent extension of the American Opportunity Tax Credit, which is scheduled to expire in 2017. As another example, Camp's discussion draft shrank the expiring renewable energy production tax credit back to its original pre-inflation level, which pays for the credit to be extended and phased out over the next ten years.

Importantly, the $85 billion two-year cost to extend all of these provisions is deceptive. In reality, if lawmakers continue the current trend of extending all the provisions year after year, the cumulative cost would sum to approximately $750 billion (or almost $930 billion with interest) over the next ten years. One provision alone, bonus depreciation, accounts for two-fifths of the cost of the entire package.

If lawmakers want to consider paying for the provisions, there are many options, including more than $60 billion worth of options that have been suggested both by President Obama (in his most recent budget) and Chairman Camp (in his tax reform draft).

Possible Revenue Offsets for the Tax Extenders Bill

Policy Ten-Year Savings
Offsets Proposed By Both President Obama and Chairman Camp 
Close the carried interest loophole $15 billion
Tax derivative contracts on a “mark-to-market” basis $15 billion
End the "John Edwards/Newt Gingrich" loophole $15 - $35 billion
Repeal select tax preferences for oil and gas companies $10 billion
Require inherited pensions to be distributed over 5 years $5 billion
Close the corporate jet loophole $3 billion
Close estate tax loophole about reporting the value of property $2 billion
Offsets Proposed by President Obama 
Limit tax benefit for large retirement accounts $30 billion
Close other estate tax loopholes $10 billion
Impose surcharge for air traffic services $8 billion
Enact spectrum license user fees $5 billion
Offsets Proposed by Chairman Camp 
Enact a package of education reforms $20 billion
Extend, reduce, and phaseout the wind Production Tax Credit over 10 years $10 billion
Repeal tax exemption for advance refunding bonds $8 billion
Eliminate "divorce subsidy" - equalize treatment of payments between married and divorced individuals $6 billion
Equalize payroll taxes for employees and the self-employed $5 billion
Repeal credit for plug-in electric vehicles $5 billion
Prevent nonprofits from avoiding tax on their business income by using losses from one business to offset gains in another $3 billion
Other Revenue Offsets
Eliminate mortgage interest deduction for yachts and second homes $15 billion
Extend GSE fees $12 billion
Treat companies managed and controlled in the U.S. as U.S. companies $7 billion
Extend customs fees that expire in 2023 $4 billion
Extend mandatory receipts from TSA fees that expire in 2023 $2 billion
Allow taxpayers to voluntarily pay more taxes to pay down the national debt $0.2 billion

Source: CBO, JCT, OMB

April 3, 2014

Much of the focus in House Budget Committee chair Paul Ryan's (R-WI) budget inevitably falls on the changes it it would make to mandatory spending, of which there are many. However, much of the budget's deficit reduction comes through further cuts (beyond the sequester currently in place) to non-defense discretionary spending.

For FY 2015, the year that the budget resolution has to specifically lay out its discretionary spending allocations, the budget adheres to the Bipartisan Budget Act's discretionary spending cap of $1.014 trillion and its division of spending between defense and non-defense functions. That amounts to a slight increase in budget authority -- the money that is newly obligated to be spent each year -- from FY 2014 levels.

After that, the budget diverges from the spending caps in current law in a few different ways. First, it reduces total discretionary spending caps by $308 billion below sequester levels from 2016-2024, with all the cuts coming on the non-defense side. Second, as in last year's budget, it shifts $483 billion of defense sequester cuts to the non-defense side. As a result, defense spending is restored to pre-sequester levels while non-defense discretionary spending is about $1.15 trillion below pre-sequester levels. NDD spending would also be about $1 trillion lower than in the President's budget. In 2024, alone, non-defense funding would be 22 percent below post-sequester levels, effectively almost quadrupling the sequester cut. Even in nominal dollars, non-defense spending in 2024 under Ryan's budget would be below 2008 levels.  In terms of its impact on the deficit, on net, these changes to both caps will save $287 billion compared to the sequester.

Note: Totals only include base spending (i.e., war spending is excluded)

The repeal of the defense sequester means that defense funding in 2016 will jump from $521 billion to $566 billion, increasing gradually from there to $696 billion by 2024. Non-defense spending by contrast will fall from $492 billion in 2015 to $450 billion in 2016 and $443 billion in 2017, before increasing slightly to $467 billion by 2024.

As a percent of GDP, the budget would accelerate the pre-existing trend of declining resources going to discretionary spending. Base discretionary budget authority would decline from 5.6 percent of GDP in 2015 to 4.3 percent by 2024, somewhat less than the 4.6 percent of GDP in 2024 called for under current law and 4.7 percent in the President's budget.

Of course, the comparisons are starker if one looks at non-defense spending. In the Ryan budget, NDD spending declines from 2.8 percent of GDP in 2015 (which already matches the 50-year historical low) to 1.7 percent in 2024, a steeper decline than the paths projected under current law and in the President's budget, which reach 2.2 and 2.3 percent in 2024 respectively. Note that the 50-year historical average is 3.8 percent, so all scenarios point to well-below average levels of NDD spending going forward.

Note: Totals only include base spending (i.e., war spending is excluded)

Defense spending follows a similar trend, although there is less variation among the different paths. The Ryan budget keeps defense spending constant at around 3 percent of GDP through 2018 before it declines to 2.6 percent by 2024, consistent with the pre-sequester cap. Meanwhile, the President's budget reduces spending to 2.4 percent by 2024, just slightly above current law.

Since the discretionary portion of the budget has been the predominant focus of deficit reduction since 2011, it is no surprise that the two most prominent budget proposals and current law projections show discretionary spending as a share of GDP falling to historically low levels. Of course, undertaking entitlement and tax reform could help ease the burden being placed on this portion of the budget right now. The agreement last year between Budget Chairmen Patty Murray and Paul Ryan showed how this could be done in small steps, but a larger deal would be needed to truly change course.

April 2, 2014

One of the recurring themes of recent budget debates has been partisan differences over the appropriate level of revenues, with Republicans rejecting any increased revenue proposed by Democrats in budget negotiations. But in separate releases yesterday, Senate Democrats proposed reducing revenues below the levels proposed by House Republicans. While this may seem like an April Fool’s joke, the numbers don’t lie. 

In a strange twist of timing, Senate Finance Committee Chairman Ron Wyden (D-OR) and Ranking Member Orrin Hatch (R-UT) released a chairman’s mark of legislation addressing tax extenders that would reduce revenues below current law by $108.5 billion in fiscal year 2015 and $67 billion over ten years the same day that House Budget Committee Chairman Paul Ryan (R-WI) released a budget resolution which would maintain revenues at current law levels. As a result, total revenues under the Senate Finance Committee mark would be $108.5 billion below the revenue levels proposed in Chairman Ryan’s budget resolution for fiscal year 2015. 

The difference becomes even more dramatic if the tax extenders in the Senate Finance Committee legislation were extended through the end of the decade. In that case, revenues under the Senate Finance Committee policies would be $679 billion lower than the revenue levels in the budget resolution put forward by Chairman Ryan. 

We should note that Senate Democrats are not solely responsible for the Senate Finance Committee's proposal; the chairman's mark has the support of Hatch, the Committee's ranking Republican. And lawmakers of both parties have already offered up numerous amendments that would increase the final cost of the Senate proposal. 

It is true that Chairman Wyden has said that this is the last tax extenders package he intends to enact, and that he plans on dealing with extenders as part of tax reform. But how Congress deals with tax extenders now will affect the baseline used to score tax reform proposals. Passing tax extenders without offsets could lead to a much lower revenue baseline as the starting point for tax reform. For that reason, it is essential that policymakers offset the costs of a temporary extension of expiring provisions and permanently address tax extenders as part of comprehensive tax reform. If not, the joke will be on the American people in the form of higher debt.

April 2, 2014

Update: Two days later, the Senate Finance Committee amended the legislation to extend nearly all of the provisions that had been allowed to expire. See our blog post for analysis of the final package.

The Senate Finance Committee released draft legislation yesterday that would extend some of the tax provisions that expired last year. Over 50 provisions expired on December 31, 2013, but Congress has often extended these provisions retroactively, which is possible because most people do not pay their 2014 taxes until 2015.

The package extends nearly three-quarters of these provisions for 2014 and 2015. The provisions that are extended also represent about three-quarters of the total cost of extending all of the expired provisions. Of the draft's $67 billion cost, over two-thirds goes to extending business provisions. The largest business provisions extended are the research and experimentation credit ($15 billion) and a provision on active financing that allows financial companies to defer taxation on their overseas income ($2 billion).

Despite Chairman Wyden's statement that this is the last time a tax extenders bill will be considered, many of these provisions have been extended year after year. One of the most prominent, the research and development tax credit, has been extended at least 15 times since 1981. (See our "Tax Break-Down" on the extenders for the history of many of the others.) If the 45 provisions extended by Wyden's draft are extended permanently, costs dramatically increase. This phenomenon is due to several provisions, mostly bonus depreciation, which cost money upfront but regain it after the provision expires. For instance, a two-year extension of bonus depreciation costs less than $3 billion, but a permanent extension costs about $300 billion over the next ten years. Bonus depreciation was enacted as temporary stimulus in response to the Great Recession and should not be treated as a normal tax extender, but it risks becoming one if it is extended again.

The table below lists some of the more costly provisions included and excluded from the extenders legislation, but some of the most heavily reported on tax breaks are not very large. The draft extends the special depreciation schedule for racehorses for two years, while it allows special provisions for film production and NASCAR tracks expire.

The bill does not extend about a dozen provisions, shaving about $19 billion off the cost of the bill. However, some of these provisions are likely to be reinserted during the Finance Committee’s markup tomorrow. For instance, Chairman Wyden has spoken many times about the need to extend the renewable energy credit, while a provision dealing with payments between overseas corporate subsidiaries is unlikely to be considered outside of international tax reform. Adding these two provisions back to the bill will increase the bill's cost by $15 billion, eliminating four-fifths of the savings from letting some provisions expire. Committee members have already filed amendments to add back most of the provisions that had been removed.
 
For descriptions of many of these provisions, see our recent "Tax Break-Down" on the extenders.
 

Major Extenders In and Out of the Finance Committee Draft

Policy 2014-2024 Cost of a Two-Year Extension (Billions)
Business Provisions in the Draft
Credit for Research and Experimentation $15
Subpart F for Active Financing Income $10
Special Depreciation for Leased and Restaurant Equipment $5
Small Business Expensing $3
Bonus Depreciation $3
22 Other Business Provisions $10
Subtotal, Business Provisions in the Draft
$47
Individual Provisions in the Draft
Deduction for Sales Taxes $6
Tax Relief for Mortgage Debt Forgiveness $5
Tax-free Donations from IRAs $2
Five Other Individual Provisions $3
Subtotal, Individual Provisions in the Draft $17
Energy Provisions in the Draft
Tax Credits for Renewable Diesel Fuel $3
Incentives for Other Alternative Fuels $1
Credit for Energy Efficient Homes $0.6
Six Other Energy Provisions $0.25
Subtotal, Energy Provisions in the Draft $4
Total, All Provisions
$67
Provisions Allowed to Expire
Renewable Energy Production Tax Credit $13
Payments Between Corporate Subsidiaries $2
Credit for Energy-Efficient Home Upgrades $2
Nine Other Expired Provisions $2
Total, provisions allowed to expire
$19

Source: JCT. Numbers do not add to totals due to rounding.

The bill deserves credit for allowing some provisions to expire. Unfortunately, the Finance Committee is not offsetting the approximate $67 billion cost of the provisions it continues, so the price of the extenders package will add to the federal debt. The Senate Finance Committee's approach of charging these tax breaks to the nation's credit card is less responsible than the approach taken by Ways & Means Chairman Dave Camp and President Obama, who both pay for the tax provisions they choose to extend.  Lawmakers should not add back provisions and further increase the bill's costs without proposing offsetting savings.

Further, this bill continues a disturbing trend of Congress repeatedly extending these provisions without paying for them. If Congress continues extending these provisions without offsets, they will cost almost $700 billion over the next decade (or almost $850 billion with interest).

The best approach to the tax extenders was taken by Chairman Camp: comprehensive tax reform which evaluates the merits of each provision. The next best option would be for Congress to at least pay for the extenders package and avoid making our current unsustainable fiscal situation even worse.
 

April 2, 2014

A new feature of House Budget Committee Chairman Paul Ryan's (R-WI) FY 2015 budget is assumption of a "fiscal dividend," which reflects the economic impact of the deficit reduction in the budget. Policy changes have both direct and indirect budgetary impacts. Directly, increases in revenue or cuts in spending lower the deficit. Indirectly, deficit reduction can produce economic effects which, in turn, contribute to additional deficit reduction.

Chairman Ryan's FY 2015 budget relies on $175 billion in deficit reduction from fiscal dividends, or "macroeconomic fiscal impacts," to achieve a balanced budget by FY 2024. CBO's accompanying analysis details how the changes in the budget would affect the economy, similar to their analysis of illustrative deficit reduction packages last year. CBO caveats that it only looks at differences in deficits and debt, so it assumes that other factors such as marginal tax rates or spending on public investments would remain the same, even though Ryan's budget would change both significantly.

CBO projects that economic output will be lower relative to their baseline under Chairman Ryan's budget from FY 2015-2017, then increase relative to the baseline beginning in FY 2018. Lower deficits lead to lower output in the short term as a result of decreased aggregate demand. Over the longer term, when the economy (at least by CBO projections) has returned to full capacity, lower deficits reduce "crowding out" of private investment – when savings that would otherwise fund private investment instead purchase government debt – leading to higher domestic investment, national savings, and economic output.

In 2025, real per capita GNP would be 2 percent higher under the Ryan budget than it would be under current law. By 2040, that effect would grow to 9 percent. Under the Ryan budget, nominal GDP would be almost 5 percent higher in 2040 than under current law.

The economic effects of the deficit reduction feed back into the budget as well. Higher economic growth boosts revenue, and lower interest rates from less crowding out result in lower interest spending. Also, higher GDP means that the ratios of debt and deficits to GDP shrink. The Ryan budget quantifies these effects with the fiscal dividend. The Ryan budget, to its credit, includes both the negative and positive economic effects.

As we explained yesterday, the fiscal dividend results in a slight improvement in the debt situation and allows the budget to be balanced in 2024. Debt in 2024 would be 56 percent of GDP, or 57 percent without the fiscal dividend. The budget would have a deficit of about one-quarter of a percent of GDP without the fiscal dividend rather than a small surplus.

Source: House Budget Committee, CBO, OMB, CRFB calculations
Note: President's budget uses OMB GDP, which differs from the GDP used in the other debt paths

Although this is the first Ryan budget to incorporate dynamic scoring into its budget totals, it is not entirely unprecedented in budget resolutions. In particular, the budget resolution included with the 1997 balanced budget agreement incorporated a fiscal dividend into its projections to get the budget to balance by 2002. As it turns out, that projection was overly pessimistic, as the budget balanced the next year instead.

As a general rule, we believe that dynamic analysis should be provided as a supplement to formal budget scoring to provide policymakers with additional information about the economic effects of legislation but should not be incorporated into the official score or used to meet fiscal goals. However, Chairman Ryan’s budget sets an extremely ambitious fiscal goal and would still put the debt on a downward path and bring it below 60 percent of GDP within the decade without including the effects of the fiscal dividend. By itself, the inclusion of this effect is not a big deal, but it creates a troubling precedent. As the Concord Coalition said:

It is one thing to give an illustrative estimate of the effects that a particular path of deficit reduction may have on the economy, as the Congressional Budget Office (CBO) has done at Ryan’s request. But it is quite another to count that as a year-by-year score.

This is particularly true when specific policy details are absent, as they are in a congressional budget resolution. One set of policy details could have a much different feedback effect than another.

Chairman Ryan has proposed significant levels of deficit reduction through policy changes, and that deficit reduction is likely to have a longer-term economic benefit given the high levels of debt projected in current law. However, as CBO notes, their estimates of the economic and budgetary effects of deficit reduction are "highly uncertain." Evaluating the economic effects of proposals is helpful, but policymakers should avoid banking any deficit reduction from these effects because of the inherent uncertainty in the estimates. Still, even without the fiscal dividend, the Ryan budget would clearly put debt on a downward path.

See our other analyses of the Ryan budget here.

April 2, 2014
A Guide to Congress' Gimmicks

Elected officials in Congress often hide new spending or tax cuts by taking advantage of the rules followed by the Congressional Budget Office (CBO). Marc Goldwein, Senior Policy Director at the Committee for a Responsible Federal Budget, recently highlighted four examples of this budget trickery in a piece published in The AtlanticWith debt at historical levels and set to rise over the next decade even under current law, policymakers need to avoid using these budget gimmicks and instead face the reality that new tax and spending measures have real costs. Goldwein writes:

"Last night, the Senate passed legislation sent over from the House to avoid a deep cut to physician payments through a 12-month “Doc Fix.” Later this week they will likely pass a bill restoring and extending emergency unemployment benefits. These proposals have two things in common. First, they both would cost money and add to the deficit. And second, their proponents claim they would not add to the deficit, and they use data from the non-partisan Congressional Budget Office to support this claim.

How do you spend more without adding to the deficit on paper? Budget gimmicks, that's how.

Under current law, “pay as you go” rules require legislators to find $1 in savings for every $1 in new spending (or cut taxes) over 10 years. This rule is meant to control the debt and prevent frivolous new tax and spending plans. But budget gimmicks offer an escape hatch for policymakers to evade the rule. My organization, the Committee for a Responsible Federal Budget, released a chartbook explaining many of these gimmicks. Here’s how they work:..."

Goldwein explains four gimmicks in detail, with accompanying charts. They include:

  • Using the Magic Window to Hide Spending
  • Shifting Savings Inside the Budget Window
  • Payment for Permanent Costs with Temporary Savings
  • Using Phony War Savings to Finance Real Costs

Click here to read the full article at The Atlantic.

"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.

April 1, 2014

With the medium-term economic and budget outlook weaker than last year, House Budget Chairman Paul Ryan's (R-WI) goal of reaching a balanced budget by the end of the decade has become much more difficult. Despite this, Ryan's FY2015 budget does achieve balance in 2024, just as last year's budget did in 2023. It does so through a combination of faster phase-ins, lower war spending, larger discretionary spending cuts, and the assumption of a “fiscal dividend.” Below, we explain these changes in more detail.
 
Adjusted to remove one-time Hurricane Sandy relief funding, CBO’s baseline last year projected $5.9 trillion in deficits from 2014 to 2023, and over $800 billion in 2023 alone. This year, however, CBO projects $6.8 trillion over that same ten-year window ($7.2 trillion from 2015-2024), and about $975 billion in 2024. In other words, this year’s projection of 2024 deficits is about $150 billion higher than last year’s projections for 2023.


Source: CBO, CRFB calculations
Note:
Extrapolated Hurricane Sandy relief spending is removed for February 2013 numbers

Although $150 billion is a large difference, it could have been worse. Luckily for Congressman Ryan, 2024 has a timing issue that makes that year's deficit appear to be $50 billion smaller: the beginning of the fiscal year falls on a weekend, so the year only includes 11 monthly payments (as opposed to 12) from mandatory programs that send out monthly payments. In addition, many policies save more money in 2024 than 2023 due simply to inflation, growth, and the passage of time.

Nevertheless, the budget proposal must identify an additional $150 billion in the final year of the budget window, relative to last year’s budget, to balance the budget – and it does. That money comes mainly from three sources. First, the budget adopts President Obama’s assumption on war spending, which results in roughly $25 billion less spending in the final year than in last year's budget. Second, this year's budget assumes a “fiscal dividend” of growth-induced deficit reduction, based on CBO’s estimates of what lower deficit levels would do to the economy and debt. This generates about $75 billion of deficit reduction in 2024. Finally, the budget further reduces discretionary levels compared to last year’s budget. Including interest, this lower discretionary spending is responsible for about $50 billion of the difference in the last year of the budget window.

Other changes move in both directions. On the one hand, the budget saves less from the Medicaid program. On the other hand, it saves more in the other mandatory category. On the whole, fully half of the needed additional deficit reduction comes from the "fiscal dividend," and most of the remaining cuts come from the discretionary budget. We'll be writing more on both of these changes in the coming days.

April 1, 2014

House Budget Committee Chairman Paul Ryan (R-WI) released his FY 2015 budget today, outlining a series of changes that promise to reduce the debt as a share of the economy and balance the budget by 2024. Our initial analysis of the budget took a look at the impact it will have on the deficit and debt. This post examines spending and revenue levels in the Ryan budget. 

Ryan's budget would significantly reduce both discretionary and mandatory spending. Some of the largest cuts include repealing the coverage provisions in the Affordable Care Act, block granting Medicaid and food stamps, and reducing the federal contribution for civilian pensions. The budget proposal would also cut future non-defense discretionary spending to well below-sequester levels, while restoring most of the defense cuts in the sequester. As a result, outlays would fall from 20.5 percent of GDP in 2014 to about 18.4 percent by 2024 (or 18.6 compared to CBO's GDP projections). 

House Budget Committee FY 2015 Proposal (Percent of GDP)
  2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Ryan Budget
Outlays 20.2% 19.5% 18.9% 18.7% 18.8% 18.9% 18.9% 19.0% 18.7% 18.4%
Revenues 18.3% 18.4% 18.2% 18.0% 17.9% 17.9% 17.9% 18.0% 18.1% 18.2%
Fiscal Dividend 0.1% 0.2% 0.1% 0.0% 0.0% -0.1% -0.2% -0.2% -0.2% -0.3%
Deficit 2.1% 1.2% 0.9% 0.7% 0.9% 0.9% 0.8% 0.8% 0.4% 0.0%
Debt 73.0% 71.0% 69.0% 66.0% 64.0% 63.0% 61.0% 60.0% 58.0% 56.0%
Ryan Budget Without Fiscal Dividend*
Outlays 20.2% 19.3% 18.9% 18.7% 18.9% 19.0% 19.0% 19.1% 18.9% 18.6%
Revenues 18.2% 18.2% 18.1% 18.0% 18.0% 18.0% 18.1% 18.1% 18.2% 18.4%
Deficit 2.0% 1.0% 0.8% 0.7% 0.9% 1.0% 1.0% 1.0% 0.6% 0.3%
Debt 72.8% 70.0% 68.4% 65.8% 64.1% 63.1% 61.4% 60.5% 58.9% 57.2%
Current Law
Outlays 20.9% 21.1% 21.0% 21.1% 21.4% 21.7% 21.9% 22.3% 22.3% 22.4%
Revenues 18.2% 18.2% 18.1% 18.0% 18.0% 18.0% 18.1% 18.1% 18.2% 18.4%
Deficit 2.6% 2.8% 2.9% 3.1% 3.4% 3.7% 3.8% 4.2% 4.1% 4.0%
Debt 73.2% 72.6% 72.3% 72.6% 73.3% 74.2% 75.3% 76.8% 78.0% 79.2%

Source: House Budget Committee
*This section represents CRFB calculations if Ryan's budget were measured using GDP projections from CBO, without the bonus from economic growth that Ryan includes in his projections.

Meanwhile, the budget would leave total revenues unchanged, instead calling for revenue-neutral tax reform with a goal of achieving a top individual rate of 25 percent and eliminating the Alternative Minimum Tax while eliminating or reducing tax expenditures. Revenue as a share of GDP would rise, as under current law from 17.5 percent in 2014 to 18.2 percent in 2024 (or 18.4 percent relative to CBO's GDP projections). As a result, spending and revenue levels would be nearly in line by 2024 -- with the difference made up for by a "fiscal dividend".
 

 Source: House Budget Committee and CRFB calculations
Note: All numbers use CBO GDP

Spending levels in this year’s budget are higher than those in Ryan’s FY2014 budget proposal, while revenues are lower. However, this difference is is largely due to changes in CBO’s baseline, rather than major policy changes within the budget. Spending and revenue levels in last year's budget would also appear slightly different due to the Bureau of Economic Analysis's new methodology for calculating GDP -- though we've accounted for that adjustment in the graph below.   


Source: House Budget Committee and CRFB calculations
Note: All numbers use CBO GDP

In the end, the budget proposal is able to reduce spending significantly as a share of GDP, while allowing revenue to climb slowly as it would under current law.

We will continue to analyze other aspects of Chairman Ryan's budget proposal in the coming days.

April 1, 2014

This morning, House Budget Committee Chairman Paul Ryan released his FY 2015 budget proposal, "The Path to Prosperity." The budget reaches balance in 2024 by cutting over $5.1 trillion of spending over ten years (relative to a "PAYGO baseline"), and it assumes an additional $175 billion in deficit reduction from a "fiscal dividend" which incorporates the longer-term economic benefits (and short-term economic drawbacks) of the deficit reduction contained in the budget.

Importantly, the budget puts debt on a clear downward path as a share of the economy, falling from about 73 percent of GDP today to 56 percent by 2024. Even excluding the higher revenue and higher GDP created from the fiscal dividend, debt would still fall to just above 57 percent by 2024 and would still be on a clear downward path.

 


Source: House Budget Committee, CBO, OMB, CRFB calculations
Note: President's budget uses OMB GDP, which differs from the GDP used in the other debt paths

Given the deteriorations in CBO's underlying projections, Ryan's current budget is somewhat more aggressive and creative than last year's. For one, the budget no longer delays the start date for adopting a premium support system for Medicare to outside the budget window, and instead maintains last year’s start date of 2024. In addition, the budget calls for somewhat deeper discretionary cuts and faster phase-ins of various policies. Finally, the budget assumes the fiscal dividend would generate $75 billion of savings in 2024.

This last assumption is based on CBO's estimate about the economic benefits of the budget's deficit reduction, though we would caution against banking these uncertain savings. Still, even without the fiscal dividend, the 2024 deficit would only be $70 billion, or about one-quarter of one percent of GDP.

 
Source: House Budget Committee, CBO, OMB, CRFB calculations
Note: President's budget uses OMB GDP, which differs from the GDP used in the other deficit paths

The deficit reduction in the budget causes deficits to fall from the 2014 level of 3 percent of GDP to zero in 2024. This is a large improvement over the 3.6 percent of GDP deficit in 2024 in the PAYGO baseline. By the end of the ten-year window, both spending and revenue would equalize at just over 18 percent of GDP.

As in previous budgets, the Ryan budget would achieve all of its deficit reduction on the spending side. The largest savings, $2.1 trillion, come from repealing the coverage expansions in the Affordable Care Act while leaving the bulk of the Act's Medicare reductions and additional tax revenues in place. The budget also banks about $730 billion of savings by block granting and capping the growth of Medicaid. It abides by the discretionary spending limits in the Murray-Ryan deal for FY 2015, but lowers discretionary budget authority after that to $310 billion below sequester levels through 2024 -- the net effect of $791 billion in non-defense cuts and $483 billion in defense increases. The budget gets sizeable savings from other mandatory programs, with policies such as block granting food stamps, increasing federal employee retirement contributions, and reducing fraud and abuse throughout government.

Policy Proposals in the Ryan Budget (Billions of Dollars)
Policy  2015-2024 Savings
Repeal Coverage Provisions of Affordable Care Act $2,066
Block Grant Medicaid $732
Enact Tort Reform and Premium Support, and Increase Means-Tested Medicare Premiums $129
Increase Federal Retirement Contributions $125
Block Grant Food Stamps $125
Reduce Farm Subsidies $23
Fund Program Integrity Measures $27
Enact Other Mandatory Spending Cuts $665
Repeal Sequester for Defense and Increase Cuts for Non-Defense Discretionary Spending $287
Limit Transportation Spending to Dedicated Revenue $173
Interest Savings $783
Total Deficit Reduction $5,135
"Fiscal Dividend" $175
Total Deficit Reduction with Fiscal Dividend $5,310

Source: House Budget Committee
Note: Savings estimates are based on illustrative policy options.

Over the course of the week, we will continue to analyze the Ryan budget and any alternative budget resolutions on our blog. You can also read more about developments with the FY 2015 budget here.

March 31, 2014
Senate-Passed Doc Fix Includes Multiple Serious Medicare Reforms

The Senate voted 64-35 today to approve a 12-month temporary “doc fix” to push back the impending nearly 25 percent cut to Medicare physician payments dictated by the Sustainable Growth Rate (SGR) formula.

After the bipartisan, bicameral agreement on how to replace the SGR, hopes were elevated that lawmakers could acheive a  permanent fix. Once again, though, a permanent replacement proved elusive due to disagreements over how, or even whether, to pay for the $180 billion cost of providing payment updates and making permanent a host of temporary programs.

While a full replacement would have been ideal, this temporary patch continues the SGR’s tradition of prompting serious, if small, health care reforms (although one-fifth of the bill is offset through a timing gimmick).

The largest savings in the bill, from allowing the Department of Health and Human Services (HHS) to collect and use data on values of physician services to more accurately set Medicare payments, is a variant of a direct recommendation from MedPAC the last two years.

Reducing Medicare lab test payments to bring them in line with those from private payors jumps right off a recent study and recommendations from HHS’ Office of Inspector General (OIG). And basing payment rates for skilled nursing facilities (SNFs) in part on measures of avoidable readmissions has been recommended by MedPAC and been included in President Obama’s last three budgets.

CBO Estimate of One-Year Doc Fix Bill (billions of dollars)
Policy 2014-2024 Savings/Costs (-)
Spending Increases
-$20.9
Extend doc fix for one year -$15.8
Extend health extenders and certain other provisions for one year -$4
Create demonstration program for community mental health services -$1.1
Offsets $17.2
Re-arrange Medicaid DSH payments and extend ACA reduction through 2024 $4.4
Revise payments for over-valued physician services $4.0
Set clinical lab payments equal to private payor rates $2.5
Eliminate SGR transition fund $2.3
Implement value-based purchasing program for SNFs $2.0
Update prospective payment system for end-stage renal disease $1.8
Other provisions $0.2
Subtotal, Excluding Gimmicks
-$3.7
Shift Medicare sequester in FY2025 into FY 2024 $4.9
Total $1.2

Source: CBO

In total, now, lawmakers have offset 132 out of 135 months of doc fixes since 2004 with equivalent savings, or 98 percent of the time. Even disregarding the few times small gimmicks were used, policymakers still paid for these delays 94 percent of the time – with almost all of those savings coming from health care programs.

Although the SGR clearly has not functioned as intended, it has served as an action forcing mechanism to prompt targeted health reforms in place of its prescribed blunt, across-the-board cuts. Once the president signs this patch into law, the need to offset the costs of repeated doc fixes will have resulted in $165 billion of deficit reduction from 2003 through 2025.

Although replacing the SGR altogether would offer an opportunity to pursue more structural Medicare reforms instead of tinkering on the margins, the one-year patch in this bill illustrates that continuing to paying for temporary patches can also have positive effects. Without the annual SGR exercise, many of these MedPac recommendations and proposals from the President's Budget may not have ever been enacted.
 


 

Methodology Notes: To calculate the cumulative savings resulting from policies enacted to offset delays to the Medicare Sustainable Growth Rate (SGR) formula ($140 in total from 2003-2024), we analyzed Congressional Budget Office (CBO) scores of the relevant legislation. We allocated savings to costs based both on the score and our understanding of legislative history. For instance, although the American Taxpayer Relief Act of 2012 increased the debt in total, lawmakers explicitly designated requisite health care savings to offset the costs of the "doc fix" included. In the multiple cases where deficit-reducing reforms were intended to offset both an SGR delay and a temporary extension of the various so-called "health extenders," we only counted the percentage of savings necessary to offset the SGR delay, and ignored the additional savings for the purposes of this analysis. The analysis does not incorporate the effects of doc fixes on federal interest costs. To estimate deficit savings beyond the 10-year windows estimated by CBO, we analyzed each policy separately, but for most we assumed that annual savings continued as the same percentage of their respective baseline. The estimates in this blog do not include either the savings achieved by the SGR reduction when it took effect in 2002 or the extrapolated costs of the deficit-financed SGR delay in 2003, due to a lack of data. Additionally, this analysis does not account for potential behavioral effects beyond those incorporated in CBO estimates that lower Medicare physician payment rates may have had in increasing the volume of physician services.

March 31, 2014

In a letter to the Ways & Means Committee, CRFB President Maya MacGuineas states that Chairman Dave Camp's tax reform draft made the right choices in choosing how to deal with the tax extenders and potential revenue from economic growth. The full letter can be seen here.

In response to Chairman's request for comments on his tax reform draft, the letter commends Camp for taking the responsible approach towards two issues. First, Chairman Camp asked if it was correct in scoring the legislation against a current law baseline which assumes the expensive package of tax extenders will expire as scheduled, or whether the draft should alternatively assume that the provisions are extended without being paid for, as Congress has often done. Second, the draft asked about the treatment of additional federal revenues arising out of economic growth. On both issues, CRFB believes the draft takes the "proper and fiscally responsible postion."

MacGuineas lays out several of the reasons why the budget baseline used to score tax reform should assume the expiration of the various tax extenders. First, reinstating an expired tax break counts as a tax cut and should be paid for. Second, many of these provisions were intended to be temporary stimulus in response to the Great Recession, such as bonus depreciation rules intended to boost business investment and tax relief for mortgage debt forgiveness. Finally, it is wrong to assume that every tax provision will always be extended: the fiscal cliff legislation at the end of 2012 let almost one-third of the tax provisions set to expire permanently lapse.

Finally, and most importantly, enacting tax reform from a baseline that includes extenders would make an unsustainable debt situation even worse – adding between $460 and $960 billion to the debt. Under current law with a war drawdown, debt levels will grow slowly from about 73 percent of GDP today to 77 percent by 2024, which still leaves debt at unacceptably high levels and will require additional deficit reduction to stabilize the debt. Enacting tax reform relative to a baseline that assumes the extension of expiring tax provisions will increase the debt by 3 to 4½ percent of GDP – to as much as 81 percent if bonus depreciation is included.

 

The second issue concerns how to address additional revenue that may materialize from economic growth. The draft lowers rates and increases fairness in a pro-growth way, and is estimated to produce $50 to $700 billion of new "dynamic" revenue that could come from a healthier economy. The draft devotes this new revenue to reducing deficits, rather than cutting tax rates. MacGuineas' letter affirms that this is the responsible position.

These new revenues are extremely uncertain and fall in a wide cost range. Given this uncertainty, it is better to "treat the potential dynamic effects of legislation as a 'bonus' to help further reduce the deficit and put the debt on a sustainable path."

Although the draft is not perfect – it did not devote any revenue to tackling our large and growing national debt – Camp took the most fiscally responsible positions on two critical issues: not automatically assuming that the extenders will be charged to the nation's credit card and not counting dynamic revenue before it materializes.

See CRFB's full letter to Chairman Camp here.

A post in the same vein, Camp Makes Responsible Choices on Tax Extenders, commended Chairman Camp for his decision to pay for the extenders which he chose to continue.

March 31, 2014

Last week, we made the case that an expired provision known as bonus depreciation be treated separately from the other tax extenders, both because it was intended as temporary stimulus and because the small cost of a one-year extension masks the huge cost of making it permanent. Specifically, extending bonus depreciation for one year would cost about $5 billion (before interest) while extending it year after year would cost $300 billion.

In fact, bonus depreciation has already added significantly to the current debt. The policy was first enacted in the 2008 stimulus and has been extended four times prior to its lapse at the end of last year.

The costs of these extensions, between 2008 and 2013, is a full $200 billion before interest, or $220 billion when interest is included. If it remains expired, the net costs will fall over time as businesses are no longer able to take accelerated deductions for equipment they previously purchased. By 2024, the primary cost of bonus depreciation will have fallen to $30 billion. However, that number excludes the substantial interest costs that accrue as businesses take advantage of the time value of money.

When including interest, bonus depreciation will have added $120 billion to the debt by 2024, even if lawmakers allow it to expire after one year. The costs would be somewhat higher if bonus depreciation were phased out over several years, but much higher if policymakers continue to extend it every year. If the practice of extending bonus depreciation continues for the next decade, the revenue that is set to be recovered in later years will never materialize, resulting in a total cost of $325 billion before interest, or $500 billion when interest is included.

Cost of Bonus Depreciation
  2008-2013 Cost 2008-2024 Cost w/ Expiration 2008-2024 Cost w/ Extension
Revenue Loss $200 billion $30 billion $325 billion
Total Cost w/ Interest $220 billion  $120 billion  $500 billion

 Source: CBO, JCT, CRFB calculations
Note: Numbers are rounded to nearest $5 billion.

The bottom line is that a permanent or long-term extension of bonus depreciation is extremely expensive. Policymakers shouldn't simply lump it in with the other tax extenders because its effect is larger and its intent is different than many of the other provisions. They should instead evaluate the need for bonus depreciation based on the economic situation. Then they should let it expire, phase it out, or make it a permanent part of the tax code while acknowledging its full costs. In any case, lawmakers should abide by PAYGO for the expiring provisions and fully pay for any policies they choose to extend. 

March 28, 2014

A recent Department of Defense white paper takes a close look at what reforms to the military retirement system might look like, even though the Commission on Military Compensation and Retirement Modernization will not make its recommendations in 2015. The white paper does not make any formal recommendations, but it does analyze two possible design concepts for a reformed military compensation system that would include both a defined benefit and defined contribution component.

Currently, members of the military become eligible for retirement benefits after 20 years of service, with some receiving retirement benefits as early as their late 30s. The formula used to determine benefits is based on the average of the beneficiary’s highest 36 months of pay, and an increase of 2.5 percent for every year of service beyond 20. This retirement system offers very generous benefits to those who qualify, but provides nothing to the more than 85 percent of servicemembers who do not remain in the military for 20 years. As a group of retired generals recently wrote, growing retirement payments currently threaten to crowd out other defense priorities.

The first reform concept would offer only partial monthly payments during a former service member’s working-age years before shifting to full benefits once the individual reaches retirement age. The second option would resemble the existing retirement system, but would use a lower multiplier for years of service beyond 20.

Both concepts would complement the current defined benefit system with a 401(k)-style Thrift Savings Plan account available to all service members who serve at least six years, continuation bonuses for active duty members, and a lump-sum transition payment provided upon retirement to those with 20 or more years of service. Current military members would be grandfathered into the current retirement system, while new recruits would be covered under the new design.

These reforms would lead to accrual savings to the Military Retirement Trust Fund, allowing the DoD and Treasury to reduce their annual contributions to the Fund. The DoD estimates that once fully implemented, the first idea would allow contributions of $1.8 to $4.1 billion less to the Military Retirement Trust Fund each year, depending on the multiplier used to calculate benefits. The second would save the DoD and the Treasury between $1.4 and $3.7 billion per year, again depending on the benefit multiplier chosen.

In addition to reducing the amount of contributions necessary, both reform concepts would also lead to savings in the form of reduced benefits. Under both options, outlays would initially increase due to contributions made to the Thrift Savings Plan and more generous continuation and transition payments. In the long run, however, these reforms would save money as service members grandfathered in to the old pension system retire and the share of beneficiaries covered by the reformed system grows. Eventually, the first concept would reduce outlays by between $5.5 and $7.9 billion per year, while the second would reduce outlays by between $6.5 and $10.2 billion per year.

While Congress has shown that it is reluctant to make changes to military pensions, several defense officials have called for reforms to set the military retirement system on a more sustainable path. Smart reforms would help the Pentagon address rising personnel costs without negatively effecting retention and recruitment. As the white paper concludes:

While these concepts do realize savings, they are about more than achieving efficiencies or fiscal savings. These design concepts look to the future to help ensure that military service remains attractive to today’s youth and tomorrow’s service member. At the same time, they reflect the importance of balancing the needs of the member, the taxpayer, and the uniformed services. We believe the framework represented by these concepts will sustain the All-Volunteer Force, foster recruiting and retention, ensure an appropriate standard of living for our members, and maintain fiscal sustainability—as set forth in the guiding principles established at the outset of this paper.

March 28, 2014

Senate Budget Committee Chair Patty Murray (D-WA) introduced legislation yesterday to cut taxes for low- and middle-income workers in a few different ways. The legislation is intended to be fully paid for, and although there is no official CBO or JCT score, it appears to accomplish that goal.

The tax cuts include one that has been prominent in recent years and one that has not been part of the tax code for nearly 30 years. The former is an increase in the Earned Income Tax Credit for childless workers. The policy in this bill is somewhat more generous than the President's proposed expansion, nearly tripling the maximum credit from about $500 to $1,400 in 2015 and extending the income at which the credit fully phases out to 133 percent of the full-time earnings of a minimum wage worker, or about $19,000 in 2014. Like the President's expansion, it would also reduce the age at which someone can qualify to 21 (as long as they are not a student or a dependent). To cut down on fraudulent payments, the bill would double the penalty (from $500 to $1,000) for tax preparers who fail to comply with due diligence requirements when preparing returns which claim the credit.

The second tax cut would bring back a form of the two-earner deduction, which existed in the tax code prior to the Tax Reform Act of 1986. The pre-1986 version provided a deduction to married couples equal to 10 percent of the second earner's first $30,000 of income (for a maximum deduction of $3,000). The Murray version, based on a proposal by the Hamilton Project, would instead provide a 20 percent deduction of the second earner's first $60,000 of income (for a maximum deduction of $12,000) but would restrict it to families with a child under the age of 12. It would also phase out the deduction between the income ranges of $110,000 and $130,000, coinciding with when the child tax credit phases out.

According to Murray's office, these tax cuts would cost $145 billion over ten years. They would be paid for with two variants on policies that were included in the tax reform discussion draft produced by House Ways and Means Committee Chair Dave Camp (R-MI). The first would end exceptions to the $1 million limit on the deductibility of executive compensation. Currently, performance bonuses and stock options are generally not subject to the limit. The policy would also broaden the limit to apply to all current and former employees, not just the CEO and the four other highest-paid employees. A similar policy introduced last year in the Senate was estimated to raise $50 billion over ten years.

The second policy would tax multinationals with low overseas tax rates. Currently, multinationals can defer taxation on profits earned abroad until the money is returned to the United States. The proposal would tax profits in the year they are earned if the profits are subject to a foreign tax rate less than 15 percent (effectively creating a 15 percent minimum tax). The Camp discussion draft included a similar provision, raising $115 billion over ten years, but set a rate of 12.5 percent and only included it in the context of switching to a territorial system (which would eliminate U.S. taxation on active foreign income). The Murray version could raise somewhat more.

It is good to see lawmakers finding offsets for new proposals at a time when that has often not been the case. Some version of these proposals could be components of comprehensive tax reform as well.

March 27, 2014

Congress is considering another 12-month doc fix, averting a 24 percent cut in Medicare physician payments scheduled for April 1. While the SGR patch contains several serious reforms that would reduce future health care costs, it contains one big accounting gimmick that accounts for about one-fifth of the bill's savings. The gimmick takes advantage of CBO's ten-year budget window to essentially move savings from 2025 (outside the window) into 2024. Though the bill is scored as saving $1 billion, the legislation would actually cost about $4 billion through 2024, after removing the fake savings from this gimmick.

A little background: due to the 2011 Budget Control Act, the 2013 Ryan-Murray deal and a 2014 bill affecting military COLAs, certain mandatory programs are subject to sequestration through 2024, and Medicare providers and plans are subject to a 2 percent payment cut. Some of the 2024 cuts, however, actually occur in Fiscal Year (FY) 2025 (FY 2025 runs from October 1, 2024 through September 30, 2025).

The recent SGR legislation would replace a 2 percent payment cut for the whole year in 2024 with a 4 percent payment cut for the first half of the year.  The effect of this would be to reduce Medicare spending in FY 2024 – a year which CBO measures in its ten year budget window – but increase Medicare spending by almost the exact same amount in FY 2025. This produces no savings overall, but by shifting cuts that would otherwise occur in FY 2025 into CBO's ten-year window, it appears to save $5 billion, offsetting approximately one-fifth of the bill's cost. This timing shift is rightly likely prohibited by PAYGO rules.

We've warned about this type of gimmick before, because it undermines fiscal responsibility.

Luckily, there is still time to replace this gimmick with real savings. Any number of relatively modest health care changes could replace the $5 billion cost (see the table below). Alternatively, the duration of the doc fix could be shortened – enacting a doc fix through the end of December instead of the end of March would reduce the cost of the legislation so it is roughly budget-neutral.

Possible Offsets to Replace the Gimmick in the Protecting Access to Medicare Act of 2014

Policy 2015-2024 Savings (Billions)
Means-Testing
Impose Part A premium on people making above $200K/$250K beginning in 2020 $5
Extend freeze for means-tested Part B and D premium thresholds for one year $4
Post-Acute Care
Freeze home health payments for one year $8
Freeze Skilled Nursing Facility (SNF) payments for one year $4
Freeze Inpatient Rehabilitation Facility (IRF) and Long-Term Care Hospital (LTCH) payments for one year $3
Implement 75% rule for IRFs $1
Equalize certain payments in IRFs and SNFs $1
Hospitals
Make site-neutral payments for evaluation and management $10
Equalize payments for certain procedures conducted in hospital outpatient departments and freestanding physician's offices $10
Better align graduate medical education with costs $7
Reduce Medicare coverage of bad debts from 65% to 55% $5
Reduce Critical Access Hospital (CAH) payments to 100% of reasonable costs $1
Prohibit CAH designation for facilities within 10 miles of nearest hospital $1
Medicare Advantage
Align employer group waiver plan payment with average MA plan bids $6
Taxes
Increase levy authority for payments to Medicare providers with delinquent tax debt $1
Move up Cadillac tax start date to 2017 $6
Drugs
Change ASP+6% reimbursement for Part B drugs to flat fee equivalent of ASP+3% $5
Accelerate brand drug discounts in closing Part D donut hole $5
Ban "pay-for-delay" agreements $4
Change payment formula for biosimilars in Part B and modify exclusivity available under approval pathway $3
Medicaid
Increase prescription drug rebates for Medicaid $10
Limit Medicaid durable medical equipment reimbursement $4
Reduce provider tax threshold to 2011 levels $10
Reduce duplicative administrative funding already covered by TANF $3
Reduce waste, fraud, and abuse in Medicaid $2
Other
Increase TRICARE enrollment fees and pharmacy copayments $6
Exclude certain services from in-office ancillary services exception $2
Freeze Prevention and Public Health Fund at current level $4
Cap rental period for oxygen concentrators at 13 months $10
Offer an FEHBP+Self One option and domestic partner benefits $1

Source: OMB, CBO, MedPAC, CRFB calculations

For all the problems with the current SGR, it has at least led Congress to enact real health care reforms over the years. In fact, lawmakers have enacted $140 billion of deficit reducing policies, almost entirely health savings, while paying for the cost of the annual doc fixes. Partially relying on gimmicks instead of real savings represents a step backwards, and one that should be avoided.

 

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March 31: 2014: The graph in this post was updated to show only savings sequestered from Medicare sequester. A previous version showed sequestered from all mandatory programs.

March 26, 2014
Patch Includes Many Serious Reforms and One Big Gimmick

(Updated to incorporate new information from the Congressional Budget Office's score of the doc fix bill)

In lieu of a permanent agreement and with the deadline approaching in five days, new legislation has emerged in the House to extend the "doc fix" and other health extenders for a year. This legislation would avert a 24 percent cut in Medicare physician payments due in April from the Sustainable Growth Rate (SGR) formula, instead freezing physician payments through March 2015.

The end goal remains a permanent replacement of the SGR formula, but with no agreement reached on pay-fors and three of the four proposals either offsetting the costs with gimmicks or simply ignoring its costs altogether, lawmakers appear ready to move a host of smaller Medicare reforms to pay for another temporary patch.

The one-year doc fix and health extenders package would cost about $21 billion, according to the Congressional Budget Office (CBO), but on paper, these costs would paid for with $22 billion of savings from more targeted health care reforms. Notably, though, $5 billion of the $22 billion is the result of a timing gimmick that was also used in the previous three-month doc fix for some of its savings. The other $17 billion, however, consists of a host of legitimate offsets through health care reforms, some of which are structural changes, if small, including:

  • Establishing a value-based purchasing program in Medicare for Skilled Nursing Facilities that would take into account re-admission rates ($2 billion);
  • Setting Medicare payments for clinical lab tests equal to the median payment from private insurers, in place of the current uncompetitively high, administratively set rates ($2.5 billion);
  • Allowing the Department of Health and Human Services to use data on values of physician services to more accurately set Medicare payments, with a target reduction in spending of 0.5 percent per year ($4 billion);
  • Undertaking a number of steps to encourage quality and appropriate use of imaging in Medicare, including requiring prior authorization for physicians who order an unusually high number of advanced imaging tests ($200 million);
  • Updating the Medicare end-stage renal disease prospective payment system ($1.8 billion);
  • Eliminating limits on deductibles for small group health plans; and
  • Extending the Medicaid Disproportionate-Share Hospital (DSH) payment reductions first passed in the Affordable Care Act for an additional year to 2024 ($4.4 billion).

The gimmick, though, damages the fiscal credibility of the bill. Rather than having the Medicare sequester cut payments by 2 percent uniformly in 2024, the bill increases cuts in the first half of the year to 4 percent and eliminates them in the second half. The bill, therefore, would result in lower spending in FY 2024 that would be completely offset by higher spending in FY 2025, effectively shifting spending outside the ten-year budget window. This produces no savings overall, but by shifting cuts that would otherwise occur in FY 2025 back into CBO's ten-year window, it makes the bill ostensibly deficit-neutral over ten years.

This gimmick is problematic because it simply uses a deficit-neutral timing shift to pay for real costs. Even more problematic is the fact that the gimmick is larger this time: whereas the three-month doc fix set the payment cuts at 2.9 percent and 1.1 percent in the first half and second half of 2023, respectively, this bill would make the payment cuts in 2024 4 percent and 0 percent in the first and second half of the year, respectively. This makes the size of the gimmick much larger and enables lawmakers to pay for a more expensive or longer doc fix.

This gimmick also likely runs the bill afoul of PAYGO rules, as it appears to fall under statutory PAYGO's prohibition of "timing shifts." Specifically, the PAYGO statute states that "The Director shall not count timing shifts, as that term is defined at section 3(8) of the Statutory Pay-As-You-Go Act of 2010, in estimates of the budgetary effects of PAYGO Legislation." Without the "savings" from sequester realignment, the bill would not be offset for purposes of PAYGO, adding roughly $4 billion to deficits through 2024. To avoid this problem, the bill includes special language to exclude its effects from counting on the PAYGO scorecard.

Obviously, a permanent doc fix would be ideal, especially given the bipartisan, bicameral agreement on the replacement payment system. A permanent replacement can encourage care coordination and help move the health system further toward paying for quality and value rather than just the quantity of services provided. And plenty of options exist to offset its costs.

One-year patches can be useful, though, and this bill importantly follows in the tradition of past doc fixes by including some legitimate reforms to improve health care policy, but the $5 billion gimmick means that the bill falls short of being paid for.

CBO Estimate of One-Year Doc Fix Bill (billions of dollars)
Policy 2014-2024 Savings/Costs (-)
Spending Increases
-$20.9
Extend doc fix for one year -$15.8
Extend health extenders and certain other provisions for one year -$4
Create demonstration program for community mental health services -$1.1
   
Offsets $17.2
Re-arrange Medicaid DSH payments and extend ACA reduction through 2024 $4.4
Revise payments for over-valued physician services $4.0
Set clinical lab payments equal to private payor rates $2.5
Eliminate SGR transition fund $2.3
Implement value-based purchasing program for SNFs $2.0
Update prospective payment system for end-stage renal disease $1.8
Other provisions $0.2
   
Subtotal, Excluding Gimmicks
-$3.7
   
Shift Medicare sequester in FY2025 into FY 2024 $4.9
   
Total $1.2

Source: CBO

March 26, 2014

This is the sixteenth post in our blog series, The Tax Break-Down, which analyzes and review tax breaks under discussion as part of tax reform. Previously, we wrote about the Charitable Deduction, which lets itemizers deduct the amount they donate to charity. Read more posts in the Tax Break-Down here. This blog examines the provisions that expired at the end of 2013.

Among the unfinished business that Congress did not address in 2013 was a collection of over 50 tax provisions that expired at the end of the year. Most of these "tax extenders" have been extended before, usually a year or two at a time. The perennial use of these extenders creates unnecessary uncertainty for individuals and business, obscures their true budgetary cost, and will likely push debt levels higher going forward. If Congress chooses to extend any of these provisions, they should be fully offset by savings elsewhere in the budget. Ideally, Congress would resolve the quasi-permanent status of these extenders as part of tax reform, evaluating each one and either making it permanent or letting it expire.

The provisions that expired in 2013 contain a hodgepodge of different types of tax breaks. Some are not normal tax extenders but meant to be temporary stimulus efforts, such as the ability of underwater homeowners to write off forgiven mortgage debt or bonus depreciation allowing business to write off new capital spending. Others are relatively longstanding elements of the tax code, like a credit for research or a deduction for teachers who spend their own money on school supplies. Some are broadly available, like a deduction for sales taxes paid, while some are narrow tax breaks for specific industries, such as the wind production credit or special depreciation for NASCAR tracks and racehorses. The appendix below describes the biggest and most often discussed extenders.

The last time the extenders expired was at the end of 2011, but they were not addressed until the fiscal cliff legislation at the beginning of 2013. At that time, several provisions were allowed to expire, including ethanol credits and energy grants, and other provisions like bonus depreciation were scaled back. As a result, the total size of the extenders package decreased by about one-third. The others were extended for one year (and retroactively for 2012). Retroactive extensions up to a year are possible because most individuals do not file their tax returns until the next year. However, some provisions that are taken throughout the year (like the monthly transit benefit taken out of paychecks) are difficult to claim retroactively.

Over the last 15 years, Congress has increasingly relied upon temporary provisions, with the number of expiring provisions annually quadrupling between 1998 and 2010. The number decreased after 2010, when the 2001/2003 tax cuts were first scheduled to expire.

Source: Joint Committee on Taxation documents, American Enterprise Institute

What Are The Drawbacks of Having Provisions That Expire?

In theory, there may be good reasons to enact a tax provision on a temporary basis. For instance, a provision could be enacted briefly to measure its effectiveness. A short-term provision may be appropriate in response to a natural disaster or economic downturn. Unfortunately, most extenders are not reviewed regularly and are often extended one year at a time simply to hide their budgetary cost.

Many critics argue that tax extenders are not meaningfully evaluated, create unnecessary uncertainty, and are less effective than a permanent provision. Although temporary provisions theoretically force Congress to look at the costs and benefits of each measure before deciding to extend it, critics argue that “no real systematic review ever occurs,” since the extenders are grouped and passed as a “package of unrelated temporary tax benefits.” Further, the uncertainty whether a provision will be extended diminishes its usefulness as an incentive. Retroactive extensions complicate financial accounting and are much less effective at incentivizing behavior, mostly providing a windfall to reward behavior that has already occurred. In several cases, such as the tax credit for research and experimentation, the uncertainty makes it difficult for companies to engage in long-term planning.

Further, classifying these quasi-permanent provisions as tax extenders distorts the budget picture. Under the law used to make budget projections, the Congressional Budget Office assumes that temporary tax provisions are just that—temporary. However, Congress almost always extends these provisions by adding to the deficit. (Past years have also included the expensive AMT patch, which has since been enacted permanently.) The extensions therefore make the budget picture worse than CBO’s official budget projections shows. If Congress extends these provisions without paying for them, the debt at the end of the decade would be nearly 4 percent of GDP larger.

Not Paying for Tax Extenders Increases Long-term Debt 

How Much Do They Cost?

If all of the expired tax provisions were extended for one year, it would cost approximately $35 billion over the next ten years, or $40 billion when bonus depreciation is included. The vast majority of the money, about 85 percent, is for business or energy provisions. Not all of these extenders are equally sized; most of them cost under a billion dollars. Five provisions, less than a tenth of them, make up two-thirds of the total cost of a one-year extension.

If the provisions were extended for two years (retroactively for 2014 and forward for 2015), the bill would cost about $75 billion, or almost the same as the fiscal cliff deal last year. Permanently extending the provisions would cost approximately $470 billion through 2024, or $770 billion including bonus depreciation. Business extenders make up two-thirds of the total cost.

Cost of Extending the Tax Extenders (2014-2024)
Policy One-Year Extension Two-Year Extension Permanent Extension
Individual Tax Provisions
Sales Tax Deduction $3 billion $6 billion $35 billion
Mortgage Forgiveness Exclusion $1 billion $2 billion $15 billion
Charitable Donations of IRAs $0.5 billion $1 billion $10 billion
Tuition and Fees Deduction $1 billion $2 billion $2 billion
Other individual tax provisions $1 billion $1 billion ~ $20 billion
Total, All Individual Provisions $6 billion $12 billion ~ $80 billion
Business Tax Provisions  
Research and Experimentation Tax Credit $7 billion $15 billion $80 billion
Active Financing Income $6 billion $10 billion $70 billion
Section 179 Expensing $1 billion $2 billion $70 billion
Other Business Tax Provisions $5 billion $10 billion ~ $90 billion
Total, All Business Provisions $20 billion $35 billion ~ $310 billion
Energy Tax Provisions
Renewable Energy Production Tax Credit $6 billion $12 billion $30 billion
Biodiesel Blending Credits $1 billion $2 billion $20 billion
Other Energy Tax Provisions $3 billion $4 billion ~ $30 billion
Total, All Energy Provisions $9 billion $18 billion ~ $80 billion
Grand Total, Traditional Tax Extenders
$36 billion ~ $65 billion ~ $470 billion
Bonus Depreciation $5 billion $10 billion $300 billion
Grand Total, All Expired Provisions
$41 billion ~ $75 billion ~ $770 billion

Source: CBO Expiring Tax Provisions, and JCT revenue estimate from the American Taxpayer Relief Act of 2013, CRFB calculations. Totals may not add due to rounding. Estimates are based on available scores or very rough CRFB estimates.

What Have Other Plans Done?

Various tax reform plans make different decisions about which extenders to extend and which to let expire. For instance, the Domenici-Rivlin plan keeps an extender dealing with the international income of financial firms while eliminating most other tax breaks. The Center for American Progress would extend the research & experimentation credit permanently, while assuming the rest expire or are offset with other revenue. And the Simpson-Bowles plan assumes most of the extenders are allowed to expire (though only a few are mentioned explicitly).

The President's Budget permanently extended some provisions while remaining silent on many others. Among the extended provisions were the research & experimentation tax credit, a credit for renewable energy production, incentives for energy efficiency, and certain hiring incentives. Encouragingly, the President paid for all the extensions he included in the budget. The provisions he did not mention are implicitly assumed to either expire or be paid for in the context of business tax reform.

Ways & Means Chairman Dave Camp's tax reform draft makes a responsible choice to evaluate each of the extenders and pay for the ones it retains. The draft repeals dozens of extenders, but permanently extends a modified research credit and a write-off for small businesses making capital investments, as well as several of the smaller provisions. The few provisions that he temporarily extends persist for several years. A provision allowing financial firms to defer taxation on overseas income continues until 2019, when a lower corporate rate takes effect. The renewable energy production tax credit is reduced, but continues until 2024.

What Happens Now?

Though the tax extenders have been expired for over three months, Congress can restore them retroactively through at least the end of the year. Last year, the chairmen of the tax-writing committees did not address tax extenders, wanting to include them as part of an effort to reform the tax code. However, with tax reform efforts stalled, both the Senate Finance and House Ways & Means Committees seem prepared to address extenders on a separate track.

In late December, Senate Majority Leader Harry Reid (D-NV) proposed a bill (which was never voted on) that would have extended all the provisions en masse, including the costly bonus depreciation, without paying for any of them. At the time, we called it an irresponsible tax extender package, and the Center on Budget and Policy Priorities also stated the bill should be fully paid for.

More recently, new Senate Finance Chairman Ron Wyden (D-OR) has suggested that he would address these provisions "sooner rather than later," and is expected to consider the extenders as early as next week. While Wyden has not yet detailed his specific approach, we expect that most but not all expired provisions will be included in the initial package. Chairman Wyden has spoken favorably about the need to extend renewable energy provisions. Meanwhile, House Ways & Means Chairman Dave Camp (R-MI) is proposing to move forward on permanently extending certain provisions as “incremental progress towards full reform.”

The tax extenders are one of the few pieces of legislation that Congress is expected to consider in 2014. It will be an important test of fiscal responsibility to see which tax preferences are extended and whether the costs are offset or if the provisions are added to the nation's credit card.

Where Can I Read More?

* * * * *

Policymakers should take a careful look at each and every expiring provision – preferably as part of tax reform – rather than simply rubberstamping the continuation of all the extenders. Many of the provisions would not pass a cost-benefit analysis and should be reformed, phased out, or allowed to expire; other provisions may indeed be merited and should be made permanent; and there may even be some provisions where a temporary extension is warranted. In any case, whatever is continued should be fully offset with new revenue or spending cuts so as not to add to the national debt.
 


 

Appendix: Explanation of Select Extenders

Although there are over 50 provisions that expired at the end of 2013 (a full list is available here), below we describe some of the biggest, most popular, or most discussed provisions. Some of these provisions are the "normal tax extenders," provisions that have been enacted year after year and are almost a fixture in the tax code, while others are temporary stimulus measures passed in 2007 and 2008.

Tax Credits for Individuals

Sales Tax Deduction - One of the largest permanent tax breaks is the state and local tax deduction, which allows filers who itemize to deduct the amount paid in state or local income tax. However, people who live in states with no income tax cannot take advantage of this deduction. This provision created a deduction for sales tax states by allowing an individual to deduct either the amount they paid in sales tax or income tax since 2004.

Charitable Donations from an IRA - Under this provision created in 2006, retirees age 70.5 and older could donate up to $100,000 tax-free from their IRA each year to charity. Normally, the donation would be eligible for a charitable deduction, but this provision converts the deduction to a complete exclusion, which allows retirees to make their required IRA withdrawals without triggering a tax a Social Security benefits for retirees with income other than Social Security.

Tuition and Fees Deduction - This deduction, in place since 2001, allows filers with incomes less than $65,000 a year ($130,000 if filing jointly) to deduct up to $4,000 of tuition and fees paid for higher education. This provision was for filers who did not claim one of the other educational credits, and it phased out entirely for filers with incomes over $80,000 ($160,000 if filing jointly).

Educators' Out-of-Pocket Expenses - With this provision, originally enacted in 2002, teachers could deduct up to $250 of out-of-pocket expenses for classroom materials.

Parity for Commuter Transit Benefit - Before this provision expired, commuters could spend up to $245 a month of tax-free income for either transit or parking. After the expiration, the amount for transit has dropped to $130 a month, while the amount for parking rose with inflation to $250 a month, meaning that those who drive to work are now subsidized more than those who use public transit. The transit benefit originated in 1993 and became equal to the parking benefit in 2009.

Mortgage Debt Forgiveness - Normally, forgiven debt counts as taxable income. In response to the housing crisis, homeowners could exclude up to $2 million of canceled debt ($1 million if married filing separately) on their principal residence. The forgiveness must be directly related to a decline in the home’s value or the taxpayer’s financial condition. This provision was passed as temporary stimulus measure in 2007.

Tax Credits for Businesses

Research and Experimentation Credits - The R&E credit is one of the longest lasting tax extenders, having been extended 15 times since 1981. Currently, there are four separate credits. The main credit allows companies to claim a 14 percent credit for research expenses that are more than half of their three-year average, or 6 percent if the company had no research expenses for the past three years. The idea behind comparing a company's research spending with previous years is to only subsidize incremental research that would not already be undertaken by the company. This credit can also be carried forward 20 years.

Active Financing Exception for Subpart F - Normally, business income earned overseas is not taxed until it is repatriated to the United States, but "passive" income like rents, interest, and dividends are taxed immediately. The active financing exemption, in place since 1999, allows banks and financial institutions to treat the interest and dividends they receive like business income and not pay tax until they bring the money back to the United States.

Small Business Expensing (Section 179) - Generally, companies that make large capital purchases must deduct the cost over several years according to a set of depreciation schedules. Section 179 allows small business owners to immediately write off most depreciable assets, up to a certain limit. Section 179 has been allowed since 1958, but the limit has changed over time. In 2013, small businesses could write off up to $500,000 of purchases, an amount that phased out when total purchases exceeded $2.5 million. When this extender expired, total deductible expenses dropped to $25,000 (phasing out after $200,000 of purchases).

Special Depreciation Schedule for Motor Tracks - This provision, in place since 2004, allowed motor sport complexes to be depreciated over seven years, the same as amusement parks. Without this extender, these structures would be written off over 39 years, like most other buildings.

Special Depreciation Schedule for Racehorses - Without this extender, racehorses had different depreciation schedules depending when they started training: seven years if they started training before age two and three years otherwise. Under this tax provision, all racehorses have been depreciated over three years since 2009.

Immediate Expensing for Film & Movie Production - Since 2004, movie production studios had been able to deduct up to $15 million in expenses if more than 75 percent of the production occurred in the United States, or up to $20 million if produced in a low-income community.

Bonus Depreciation - Bonus depreciation (different from permanent accelerated depreciation) allows companies to immediately write off a certain percentage of their purchases. It is not one of the normal tax extenders, but has been enacted frequently as a stimulus measure, most recently as part of the 2008 Economic Stimulus Act, when it was reinstated at a level of 50 percent. It was increased to 100 percent (also known as immediate expensing) in 2010, and reduced again to 50 percent for 2012 and 2013. Because bonus depreciation is largely a timing shift, a one year extension would have substantial immediate costs that would be largely recovered over time – though a permanent extension would be quite costly.

Tax Credits for Energy

Renewable Energy Production Tax Credit - The federal renewable electricity production tax credit has been in place since 1992, but it has sometimes lapsed and been later extended. Sellers of renewable energy can claim a credit for every kilowatt-hour of energy produced. The most used is for wind energy, which receives a credit of 2.3¢/kWh. The credit has been partially responsible for the rise of new wind energy in the United States, as illustrated by the reductions in construction when the credit lapsed in 2000, 2002, and 2004. Former Senate Finance Chairman Baucus recently released a tax reform discussion draft focused on energy policy which would extend this credit, make it available to all types of clean energy, and phase out once the average unit of electricity is 25% cleaner than it is today.

Biodiesel Blending Credits - There are a number of different biodiesel credits, depending on whether the fuel is sold pure or blended, and whether it is made by a small producer. Generally, this provision provided $1.00 per gallon of pure biodiesel (or other renewable diesel fuels). These biodiesel credits have been in place since 2003 and 2005.

Energy Efficiency Credits - Several different energy efficiency credits expired, including a $2,000 credit for contractors building an energy-efficient home and a credit for each energy-efficient appliance manufactured. Some of these credits had existed since 2007, but many were created or expanded in 2009.

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