The Bottom Line
Regular readers of The Bottom Line are probably familiar with our goal of putting the debt on a downward path as a share of the economy over the long term. Much of the conversation on fiscal policy recently has centered around arguments against "austerity," but smart deficit reduction is different. By taking into consideration the short-term economic effects of deficit reduction, budgets may be able to achieve most of the necessary savings when the economy has recovered while providing relative stability and confidence in the future fiscal outlook.
IMF Chief Economist Oliver Blanchard and Daniel Leigh of the IMF's Research Department show in a VOX blog post that there are many different factors in play when determining the timing of a fiscal consolidation plan:
When fiscal multipliers are large, government spending cuts and tax hikes have a large adverse effect on output in the short run, and a small initial effect on the ratio of debt to GDP (Eyraud and Weber, 2013). Indeed, as GDP may initially decline by more than debt, it may lead to an initial increase in the debt-to-GDP ratio, something we have seen in a number of countries in this crisis. (All that is needed, for example, is a multiplier above 1 and the sum of the ratio of revenue-to-GDP and the debt-to-GDP ratio above 100 per cent).
Large multipliers do not necessarily affect the optimal timing of fiscal consolidation, however. If they remain just as large in the future, the adjustment will be as painful later. But, if they are larger now than later, this tilts the adjustment toward doing more later: Less pain now, less pain later. And there are at least three reasons to believe that multipliers are larger now.
A second argument in favour of backloading is that, when growth is low, the economy is more vulnerable to “stalling” and slipping into recession (Nailwaik, 2011, Sheets, 2011, and others). Tightening fiscal policy when growth is low is thus riskier than when growth is near normal. (A more accurate statement would probably replace “low growth” by “large output gap” as it is really the level of activity that matters here. But the literature has focused on growth rather than on the gap.)
In this sense, the large fiscal consolidation taking place in the United States this year is not as bad, given relatively strong private demand, as the same fiscal consolidation would be in countries where private demand is very weak.
A third argument in favor of backloading is that fiscal consolidation carries the risk of causing long-term economic damage through hysteresis effects. DeLong and Summers (2012) have argued that a process of “hysteresis” links the short-term cycle to the long-term trend, implying more persistent fiscal policy effects.
Just like large multipliers, however, hysteresis does not necessarily have implications for the timing of fiscal consolidation. The adjustment will be just as painful in the future as it is today. What is needed to tilt the desirable adjustment path is for hysteresis to be stronger today than in the future.
As in the case of multipliers, there are indeed good reasons to think that hysteresis is stronger now.
Note that none of these arguments support the idea that we should ignore the debt entirely; rather, they complement the notion of a fiscal consolidation package that should be phased in over time. Blanchard describes the two risks of high debt: a "debt overhang," or an extended period of high debt that may be difficult to get out of, and an increased risk of a fiscal crisis. The question before lawmakers is how to best reduce debt, in particular, how quickly deficit reduction should proceed to simultaneously protect the economy in the short term and reduce the risks of a debt overhang over the longer term.
So, how do countries get out of the danger zone? Even with a large and steady fiscal consolidation, decreasing the debt-to-GDP ratio from, say, 100 per cent to 60 per cent is a slow process, likely to take decades. So the bad news is: Debt will be high for a long time. There is, however, some good news as well: The evidence shows that markets, to assess risk, look at much more than just current debt and deficits. In a word, they care about credibility. The danger zone is not defined by a magic threshold for the debt-to-GDP ratio, but by a much more complex set of characteristics of the fiscal and economic situation.
How best to achieve credibility? A medium-term plan is clearly important. So are fiscal rules, and, where needed, retirement and public health care reforms which reduce the growth rate of spending over time. The question, in our context, is whether frontloading increases credibility.
If one measures credibility by the size of the sovereign spread, the econometric evidence from the crisis is ambiguous. Smaller deficits appear to reduce spreads, but lower growth increases them (Cottarelli and Jaramillo, 2012). Thus, whether or not faster fiscal consolidation decreases spreads depends on whether the effect of a smaller deficit dominates the effect of lower growth. This, in turn, depends on the size of fiscal multipliers. And, for a plausible range of multipliers, the answer can go either way.
To put it another way, it is unclear whether front-loaded deficit reduction is necessary to establish credibility and with the economy still recovering, front-loaded deficit reduction may be less effective by harming growth. While Blanchard argues that each case must be considered individually, a credible medium-term deficit reduction plan might be preferred.
In a Financial Times op-ed, Larry Summers takes a stronger stance against front-loaded deficit reduction, but cautions against forgetting about debt and deficits entirely:
On all but the most optimistic forecasts, further actions will be necessary almost everywhere in the industrial world to assure that debt levels are sustainable after economies recover.
This is not the time for austerity, but we forget at our peril that debt-financed spending is not an alternative to cutting other spending or raising taxes. It is only a way of deferring those painful acts.
Lawmakers need to get the timing right in order for deficit reduction to be most effective. Immediate austerity is the worst way to go about deficit reduction, and it is not representative of what a deficit reduction plan has to be. For example, the new Simpson-Bowles plan contains less deficit reduction in 2014 and 2015 than sequestration, while achieving greater ten-year deficit reduction. Policymakers should see the "why" on deficit reduction and turn their focus to the "how" and "when."
As lawmakers gear up to debate immigration reform in the weeks and months ahead, it will likely coincide with the ongoing budget debate in Washington, meaning that there will be heightened attention paid to the legislation's economic impact and budgetary impact. While CBO has not yet analyzed the immigration legislation recently introduced in the Senate, they have released a report outlining the methods used to estimate the effects of immigration reform legislation in 2006 that illustrates how an immigration bill may be scored.
How CBO Scores Immigration Reform
While CBO’s conventional scoring methods do not incorporate macroeconomic changes in legislation, the anticipated change in the U.S. labor force from the Comprehensive Immigration Reform Act of 2006 would have been significant enough that JCT and CBO relaxed their usual assumptions, thus partially using an approach known as dynamic scoring. They incorporated the direct effect of a large increase in the labor force of 3.4 million workers by 2016 and therefore assumed greater employment, total wages, and tax revenues. CBO also incorporated the expected increase in population (7.8 million by 2016) into its spending projections. While cost estimates differed from normal scoring conventions, not all macroeconomic effects of the immigration bill were accounted for, only the dynamic effects of an increased labor force and population.
Left out of the 2006 estimate was the full range of dynamic effects, such as changes to private savings, capital flows, and interest rates. To show these other possible macroeconomic effects from the bill, CBO produced a separate analysis that relaxed even more assumptions and provided two alternative estimates: a high investment assumption and a low investment assumption. Under both assumptions, CBO estimated the legislation would increase GDP – by 1.3 percent on average under the high investment scenario, and by 0.8 percent under the low investment scenario from 2012 through 2016.
In 2007, the last time Congress considered comprehensive immigration reform, a large part of the debate centered on the cost estimate of the bill. CBO’s analysis of the Comprehensive Immigration Act of 2007 estimated it would increase the deficit by about $18 billion from 2008-2017. Outside of that window, CBO estimated the legislation would increase the deficit by “several billion dollars a year.” While CBO notes that analysis for new legislation will likely build upon the improvements CBO has made to its estimating techniques, the general approach will be similar.
Until the new legislation is scored, we can gain a better understanding from experts across the political spectrum who have examined the potential economic impact of immigration reform. Since reform efforts failed in 2006 and 2007, several studies have looked at the economic impact, many of which argue immigration reform could reduce future deficits if full dynamic scoring were used. A 2012 study by Raul Hinojosa-Ojeda found that under one scenario, comprehensive immigration reform could lead to a 0.84 percent annual increase in GDP growth, amounting to $1.5 trillion in additional GDP over 10 years. Hinojosa-Ojeda bases his estimates on the experience of legalization under the 1986 Immigration Reform and Control Act, which raised wages and spurred increases in educational, home, and small business investments by newly legalized immigrants. Another study by experts at the Center for American Progress found that, depending on the parameters, immigration reform could result in $0.8-$1.4 trillion in GDP growth over 10 years.
Additional research suggests that immigration reform could have a positive impact on wages and employment. One paper by economist Giovanni Peri found that immigration from 1990 to 2006 increased real wages by almost 3 percent. Several other economic analyses have also found that immigration may increase wages and have a net positive impact on employment for native workers in the long run. More recently, Peri published another study that looked at the impact of highly-skilled immigrants and found that foreign scientists and engineers in the H-1B visa program contributed to 10 to 20 percent of the yearly productivity growth in the U.S. during the period 1990-2010, enabling GDP per capita to be 4 percent higher than it otherwise would have been.
A 2007 research review by CBO found most efforts to estimate the fiscal impact of immigration in the United States have concluded that, in aggregate and over the long term, tax revenues generated by immigrants, legal and unauthorized, exceed the cost of the government services they use. This is in large part because many immigrants pay payroll taxes, but most of those who are unauthorized are prohibited from receiving federal benefits from programs like Social Security, food stamps, Medicaid (other than emergency services), and Temporary Assistance for Needy Families (TANF). CBO estimates that half to three-quarters of unauthorized immigrants pay taxes. According to Stephen Goss, chief actuary for the Social Security Administration, undocumented workers contribute about $15 billion a year to Social Security through payroll taxes, but only take out $1 billion. Goss also says that undocumented workers have contributed up to $300 billion, or more than 10 percent, of the $2.7 trillion Social Security Trust Fund.
Source: The Hamilton Project
Scoring the 2013 Legislation
Still, a lot still remains uncertain about the effects of comprehensive immigration reform in the current Congress. Many unauthorized immigrants who currently do not pay taxes work in the cash economy and will not begin to pay taxes, even if given legal status. Depending on the timing of the path to citizenship, spending will increase in the long term as immigrants who become citizens would be entitled to government benefits such as Social Security and Medicare. The current Senate bill would offer a 13-year pathway to citizenship for the 11 million unauthorized immigrants currently in the U.S. and therefore push much of the spending increase into the second decade and beyond. That said, immigrants tend to be younger and healthier and can help to offset some of the effects of our aging population in the next few decades. And by the time they are using Medicare and Social Security benefits, their children will be working and paying into these programs. Another important (and new) element in an analysis of the 2013 legislation’s budget impact will be the number of legalized immigrants who become eligible for health insurance subsidies under the Affordable Care Act.
For many of these reasons, outside estimates of the Senate framework have ranged. One new study by the Heritage Foundation's Robert Rector and Jason Richwine argues that the net cost to taxpayers of new legal immigrants over the course of their lifetimes would be $6.3 trillion, due to their ability to benefit from Medicare, Medicaid, health insurance subsidies, and Social Security. However, this is an update to Rector's 2007 study that faced criticism from experts on both the right and the left for exaggerating estimates with faulty assumptions and failing to account for inflation. On the other hand, former CBO Director Doug Holtz-Eakin estimates immigration reform can reduce the federal deficit by $2.5 trillion.
While much of the debate on immigration reform will focus on other issues related to the policy goals of the proposed legislation, it’s important that lawmakers be mindful of the intersection these reforms might have with any potential deficit reduction proposals. Although much is uncertain about the future of immigration reform, it's likely that reform will have a significant economic impact in the long term.
Harvard professors Carmen Reinhart and Kenneth Rogoff’s (R&R) 2010 paper, Growth in a Time of Debt, has been all over the news in the past few weeks due to a critique of their methodology by a team of University of Massachusetts-Amherst economists. Since the R&R study has been frequently cited as an argument in support of fiscal responsibility, we reviewed the critique of the paper, the two authors' response, implications of high debt levels, and other studies that examine the relationship between government debt and the economy.
The Reinhart and Rogoff Paper
For those who haven’t followed the controversy, R&R used an extensive data set of advanced economies to show that countries with gross government debt levels above 90 percent experienced a sharp drop off in economic growth rates. Their analysis grouped data into four "buckets" – instances with debt levels less that 30 percent of GDP, between 30 percent and 60 percent, between 60 percent and 90 percent, and greater than 90 percent – and then determined mean growth rates (as well as median growth rates), with the findings showing a strong negative correlation between debt and GDP growth rates. The study proved particularly influential not only for finding a relationship but for finding a nonlinear relationship: a sharp drop-off in growth rates at 90 percent.
However, a recent critique from Thomas Herndon, Michael Ash, and Robert Pollin (HAP) of the University of Massachusetts-Amherst had two methodological concerns in the report along with an Excel coding error that R&R have since acknowledged as a clear mistake. R&R accidentally excluded five countries from their calculation of the mean and one of these countries, Belgium, contributed to the high debt category. But the coding error wouldn't change the findings significantly; the HAP authors calculate that fixing the Excel error would raise the mean growth rate of high debt countries by 0.3 percentage points. The main dispute is with the other two methodological concerns, which R&R have defended.
First, the HAP authors argue that the R&R paper did not include data for three countries – Australia, New Zealand, and Canada – for the first five years of the study. Second, they take issue with R&R's use of average growth rates for each country over pooling the data and then taking average – which could potentially make the result susceptible to outliers or countries with small data samples. The HAP authors find that after adjusting for their three concerns (and a minor transcription error), average growth rates for the 90 percent category would be 2.2 percent, instead of the -0.1 percent average in the R&R paper.
The duo has responded to these concerns in an email response and in a New York Times op-ed and technical appendix. They write that the excluded data had just been recently acquired and had not been vetted. As it turns out, some of that recently acquired data may have had serious flaws, and a later R&R study used revised data. Other gaps in the data set were also present due to inconsistencies among data sources, including debt and growth rates Spain in the 1960's, which would have strengthened R&R's argument with debt levels below 30 percent and economic growth over 6 percent. This is a familiar problem with using old historical data as sources may greatly differ on estimates and possible inaccuracies may require judgment calls about what to include.
On the weighting issue, they defend their methodology as an attempt to reduce the excessive effect of countries like Japan and Greece, which have persistently had high debt levels, on the study's results. The R&R method would reduce impact of country-specific characteristics (like structural problems or high savings rates) on the relationship between debt and economic growth. As Reinhart and Rogoff argue, "Our approach has been followed in many other settings where one does not want to overly weight a small number of countries that may have their own peculiarities." In reality, no weighting mechanism is perfect and the choice of the mechanism will depend on what the author is trying to investigate as well as potential biases in the data.
R&R also present two additional defenses of their conclusion. First, they point out that they generally rely on median rather than mean change – which would reduce the effect of the HAP concerns on the paper’s results – since this approach corrects for potential outliers. Second, as they demonstrate in the graph below, the HAP methods and results actually lead to the same conclusion as the R&R paper – that countries with higher debt levels experience slower economic growth.
Source: New York Times (Reinhart and Rogoff)
The Reality of High Debt Levels
With the Reinhart and Rogoff paper now in question, what does this new information mean? While the HAP report finds no evidence of a 90 percent "debt cliff" after making their adjustments, it does find a negative correlation between debt and GDP. This conforms with the standard theory in normal economic times -- as debt rises, economic growth slows as debt "crowds out" private investment. This was the central point behind a recent post from former OMB Chief Economist Joe Minarik, on his "Back in the Black" blog. Minarik gave four reasons why a nation would be better off with a smaller debt stock, then a larger one:
- I’d rather spend my scarce tax dollars on something other than debt service.
- I want flexibility to respond to problems like the financial crisis.
- I don’t like to worry about a financial meltdown.
- There is a relationship – not a cliff, but a meaningful slope – between debt and growth.
Some have taken the HAP paper as a victory for Keynesians and a loss for so-called "austerians." But there is no need to divide the policy world into opposing camps. The original paper's findings should not have done that, and neither should the review of the study. As Holman Jenkins writes in The Wall Street Journal:
As much as some try to invent a fierce debate between "austerians" and advocates of stimulus, the policy consensus, in fact, has been strikingly solid. Michael Kinsley nicely demonstrates in a Los Angeles Times column that even Paul Krugman and his bête noire, deficit hawk Pete Peterson, have been saying the same thing: NO to immediate fiscal stringency, YES to long-term reform.
The U.S.'s long-term fiscal outlook is troubling, but engaging in austerity would largely be counterproductive and likely wouldn't address the drivers of our long-term problem anyway. Lawmakers need to strike a careful balance between these two concerns and this can easily be lost if the takeaway is either that we shouldn't worry about debt or that austerity would do no harm - sequestration is evidence of that. Smart deficit reduction plans often reduce short-term austerity while making progress on long-term fiscal sustainability, the recently released Simpson-Bowles plan is such an example.
Other Research and Studies Confirm Risk of High Debt
Regardless of the criticism of the R&R study, there is still strong evidence from many other studies that shows a negative relationship between debt levels and economic growth, using more sophisticated econometric techniques than "Growth in a Time of Debt." Economists from the CBO, IMF, OECD, and academic institutions have investigated the relationship between debt and growth, generally coming to the consensus that higher debt slows growth due to crowding out effects.
- The Congressional Budget Office: Economists at the CBO have warned of both slower growth and an increasing probability of a fiscal crisis with high debt levels. In one simulation, the Macroeconomic Effects of Alternative Budget Paths, CBO projected that a $2 trillion deficit increase package would slow output (measured by GNP) by nearly 1 percent by 2023, although it would boost in the short term.
- Manmohan Kumar and Jaejoon Woo of the International Monetary Fund: In a study of advanced economies from 1970 to 2007, economists at the IMF found that a 10 percentage point increase in countries debt level corresponds with a 0.15 percent lower growth rate of GDP, largely due to "crowding out" and a reduced capital stock.
- Stephen Cecchetti, M S Mohanty, and Fabrizio Zampolli of the Bank of International Settlements: Using data for 18 OECD countries from the last three decades, economists at the Bank of International Settlements found thresholds for corporate, household, and government debt, beyond which increased debt is associated with slower growth. For government debt, this threshold is roughly around 85 percent of GDP, beyond which a 10 percentage point increase is associated with a 0.1 percentage point reduction in growth rates.
- Jorgen Elmeskov and Douglas Sutherland of the OECD Economics Department: This study focuses on "debt overhangs," long periods of persistently high debt levels. Debt levels are associated with higher interest rates, and at higher debt levels dramatic fiscal consolidation may be needed to put debt on a stable or downward path, which could further reduce growth.
- David Greenlaw, James Hamilton, Peter Hooper and Frederic Mishkin: Similar to the OECD study, this paper also estimates a tipping point for debt at around 80 percent, at which point an interest rate and interest payment spiral may quickly cause the fiscal outlook of a country to become unsustainable.
Reinhart and Rogoff's famous paper should be re-examined in light of the new critique, but the established relationship between debt and economic performance has not changed. Economic growth is expected to slow as debt levels rise higher, and although evidence of a key threshold may be hard to find, current projections for the federal government show that debt is on an unsustainable upward path.
Although it is impossible to know the “tipping point,” there is no question that increasing debt cannot be sustained forever. As Reinhart and Rogoff say, “Debt is a slow-moving variable that cannot – and in general should not – be brought down too quickly. But interest rates can change rapidly." Importantly, the longer we delay to enact changes to right our course, the tougher and more abrupt those changes will need to be. For these reasons, it would be far preferable to enact changes today which phase in very slowly (even reversing much of the immediate austerity currently in place) and are designed on a whole to promote rather than inhibit overall economic growth.
A recent article in The New York Times entitled "The Corporate Tax Game" details the tricky politics of corporate tax reform, especially when it comes to deciding how to pay for a rate reduction. With a variety of interest groups out there, businesses may be divided over the tax preferences that should be on the chopping block. The article in particular draws attention to the international tax code and the debate over how to treat foreign-source income, a debate which got another contribution from Rosanne Altshuler and Harry Grubert evaluating many different international tax reforms.
Our corporate tax calculator is a useful tool for demonstrating the trade-offs that are inherent with corporate tax reform. Users are able to choose a revenue target and then pick revenue-raising or revenue-losing options. The calculator then shows the statutory rate that satisfies these criteria. It makes quite explicit what it could take to produce the kind of tax reform the user wants to see.
In light of the NYT article, the calculator is a good preview of what would be involved in navigating both interest group politics and policy concerns.
Click here to try the corporate tax calculator.
This week, Senator Orin Hatch (R-UT), Ranking Member of the Senate Finance Committee, and Rep. Fred Upton, Chairman of the House Energy and Commerce Committee, released a blueprint for Medicaid reform centered on a per capita cap and reforms to increase flexibility for state Medicaid programs. The Upton-Hatch proposal is really the first time in recent years we’ve seen a truly comprehensive plan to reform Medicaid enter the discussion on reforming federal health spending, which is usually dominated by Medicare policy. Their proposed framework offers a valuable contribution to the debate and many of their options can be implemented independently or easily adjusted in a number of ways to reduce Medicaid costs and improve quality of care.
Earlier this year, Senator Hatch proposed several reforms to federal health entitlement programs that could be considered in a bipartisan deficit reduction package. Among them was a proposal to apply a per capita cap on Medicaid to slow spending growth in the program. The idea of a per capita cap, or a limit on the amount of federal dollars spent on each Medicaid beneficiary, has been around since the mid-1990s. It emerged as a compromise between the current federal matching scheme and a switch to block grants for Medicaid.
Under the Upton-Hatch Medicaid plan, a cap would be placed on each of the four major beneficiary groups – aged, blind and disabled, children, and adults – and based on the product of the state’s number of enrollees in each of the categories and the per capita amount for each category. Caps would grow by a “realistic exogenous and appropriate growth factor” for each state and rebased every 5 years if average per capita costs grow slower than the target growth rate. States in the top quartile of per capita spending would have a slower growth rate while those in the bottom quartile would have a faster growth rate to account for geographic spending variation.
The proposal would also require CMS to project aggregate federal Medicaid expenditures and states would not receive additional funding unless they can demonstrate higher than projected enrollment. While the blueprint does not include any savings estimates, this policy has the potential to significantly slow and reduce future Medicaid spending. However, excluded from the cap are certain dual eligibles whose Medicaid expenses are limited to cost-sharing and premiums, DSH payments, GME payments, CHIP payments, Indian Health Service enrollee payments, other partial Medicaid benefit enrollees.
In addition to the per capita cap, the Upton-Hatch proposal includes a number of other Medicaid reforms to help increase flexibility for state Medicaid plans and slow cost growth. Some of these include:
- Allowing flexibility in benefit design: The Upton-Hatch blueprint would offer states a menu of options from which to design Medicaid benefits, similar to those currently available to them under CHIP. It would also allow states to offer value-based insurance design plans with lower cost sharing for higher-value services and higher cost sharing to discourage low value services. Other reforms would give states the ability to reward beneficiaries with incentive payments and/or lower cost-sharing to encourage the use of higher value services.
- Increasing transparency and value-based purchasing: The proposal would encourage health providers to make pricing data more widely available by requiring states to release Medicaid claims data to certified entities. Upton and Hatch also recommend aligning provider incentives to encourage care coordination by allowing states to implement value-based payment methods with financial and performance accountability measures
- Improving care coordination: The Upton-Hatch plan would increase access to coordinated care by allowing states to passively enroll high-cost and high-need beneficiaries in managed care plans. It would encourage managed care through budget-neutral waivers, evaluate best practices in managed care payment determination and quality measurements, and exempt state contracts with managed care plans from federal medical loss ratio (MLR) requirements.
- Requiring CMS to give a final decision on Section 1115 Medicaid waivers within 120 days and approving any waiver similar to one approved for another state.
- Repealing maintenance of effort (MOE) requirements that restrict states from changing eligibility and giving states greater flexibility in verifying eligibility.
- Building on successful outcomes from demonstrations currently in place that improve quality care and reduce costs for the dual-eligible population.
- Allowing states to choose a defined funding allotment with enhanced flexibility to build on successful long-term care reforms.
- Guaranteeing current law benefits for individuals with disabilities.
- Requiring states to report on achievement measures on access to care, patient outcomes, patient experience and health care costs. Bonus payments could be tied to achieving certain benchmarks.
- Implementing program integrity measures such as reducing the provider tax threshold from 6 percent to 5.5 percent to limit a common state gimmick used to draw down more federal Medicaid dollars.
The policies in the Upton-Hatch blueprint represent some of the many options available to lawmakers to reform the Medicaid program, such as those we highlighted in our Health Care and Revenue Savings Options report. Several of the policies in the plan overlap with those in other health spending reform proposals. For example, the Simpson-Bowles Bipartisan Path Forward also promotes waiver flexibility, reducing the provider tax threshold, increasing price transparency, and encouraging care coordination for dual eligibles. More importantly, many of the ideas presented in this plan, particularly those on benefit design and state flexibility, can be included in alternative approaches to reforming the financing of the Medicaid program. Upton and Hatch deserve credit for reintroducing Medicaid back into the debate and putting together a thoughtful and comprehensive package of policies to put future Medicaid spending on a sustainable path.
The entire blueprint can be found here.
Sometimes, the timing of things can really work out in Washington. Yesterday, President Obama nominated Rep. Mel Watt (D-NC) to be the head of the Federal Housing Finance Agency (FHFA), the agency in charge of Fannie Mae and Freddie Mac. If confirmed, he would replace current chief Ed DeMarco in a move that could signal a policy shift at the FHFA.
One issue that has received attention in recent years is "principal forgiveness" for mortgages backed by Fannie and Freddie, which would involve writing down the balance of mortgages where payments are delinquent or default is a possibility rather than reducing monthly interest payments or making other loan modifications. Although President Obama supports allowing principal forgiveness in Fannie and Freddie-backed mortgages, DeMarco has not, and thus the policy has not been implemented. If Watt is confirmed, that could change.
Coincidentally, the CBO released a report the same day as the Watt nomination, analyzing different possibilities for principal forgiveness for FHFA mortgages. The three different options they detailed for principal forgiveness would all reduce the deficit slightly by avoiding defaults on mortgages and, consequently, Fannie and Freddie-incurred losses that would be greater than the cost of the writedown.
First, the report goes into a little background on the housing situation. Within the Troubled Asset Relief Program (TARP) is the Home Affordable Modification Program (HAMP), a centerpiece in the government's effort to assist struggling homeowners. CBO's report describes how HAMP has evolved to include principal reductions:
In 2010, the Treasury Department expanded the program to include the possibility of principal forgiveness, a reduction in the amount the borrower owes. Before then, the program had been limited to other ways of reducing payments. (This report refers to HAMP without principal reduction as “standard HAMP.”) For the borrower, principal forgiveness provides not only a lower monthly payment, but also, unlike standard HAMP, an improved equity position as a result of the lower loan balance. Having equity (the difference between the value of the home and what the borrower owes) allows a borrower to more easily refinance or sell the home to avoid default and strengthens his or her incentive to continue to pay off the mortgage.
Principal reduction, though, has been limited to non-Fannie/Freddie mortgages. The FHFA has cited moral hazard -- that homeowners would be intentionally delinquent on mortgage payments to qualify for assistance -- and implementation concerns, as well as potential adverse effects on future borrowers.
CBO analyzed three options for introducing principal writedowns for FHFA mortgages, allowing the FHFA in all options to choose between two programs for each borrower based on which they expect would cost the federal government the least. These options are:
- Option 1: The FHFA chooses between the current HAMP and HAMP with principal reductions, the latter involving a reduction of monthly payments to 31 percent of the borrowers' gross income and a reduction of the loan balance to as low as 115 percent of the home's value.
- Option 2: The FHFA chooses between the current HAMP and HAMP with principal reductions, which would reduce the loan balance to equal the home's value.
- Option 3: The FHFA chooses between the current HAMP and HAMP with principal reductions, which would reduce the loan balance to equal the home's value.
Overall, Option 1 is the most modest option, Option 3 has the largest effect for homeowners, and Option 2 has the largest amount of deficit reduction. There would be 18,000 fewer defaults with Option 1, 43,000 fewer defaults with Option 2, and 95,000 defaults with Option 3. Savings would be $0.2 billion, $2.8 billion, and $2.2 billion under Options 1, 2, and 3, respectively. These deficit reduction figures are generated using fair-value accounting. CBO also expects a small but positive boost to the economy. CBO notes that their estimates are subject to variability in the financial situation of those who participate and, of course, the actual design of a principal writedown program (eligibility criteria, etc.).
It will be interesting to see how Rep. Watt's confirmation process will play out. If confirmed, we may have an idea of where the FHFA will head in terms of policy and its effects on homeowners and the budget.
Over the last two weeks, the Committee for a Responsible Federal Budget has been analyzing the new proposal from former Fiscal Commission co-chairs Erskine Bowles and Alan Simpson, “A Bipartisan Path Forward to Securing America’s Future.” The new proposal contains $2.5 trillion of additional savings over ten years, enough to put debt on a clear downward path and falling below 70 percent of GDP by 2023. Below we present our analysis on the CRFB’s blog, The Bottom Line.
Simpson and Bowles Release "A Bipartisan Path Forward": Simpson and Bowles presented their framework for the plan earlier in February, but the new report contains all of the policies needed to meet their savings target. In this post, CRFB features a table containing all of the policy changes as well as ten-year deficit reduction estimates.
Comparing the Bipartisan Path to Other Budget Proposals: In addition to “A Bipartisan Path Forward,” the House, Senate, and White House all presented new budgets in April that were able to put debt on a downward path. However, these proposals achieve their deficit reduction in different ways. In this post, CRFB estimates savings compared to our realistic baseline, in order to allow for a direct comparison of the new Simpson-Bowles plan to the other major budget proposals. We also show how each proposal would affect debt, revenues, and spending as a share of the economy.
"A Bipartisan Path Forward" and the Long Term: The goal of lawmakers should be to put debt on a downward path in the long term and not just temporarily. In this post we show that the new Simpson-Bowles plan succeeds in achieving this goal, using the report’s long-term estimates.
New Simpson-Bowles Plan Would Boost Economic Growth, Not Slow It: Some commentators have dismissed deficit reduction plans as austerity, but “A Bipartisan Path Forward” would actually reduce short-term austerity. By waiving sequestration and phasing in cuts slowly, economic output would likely be greater under the Simpson-Bowles plan than under sequestration in the next few years. In this post, CRFB also shows how the plan would boost economic growth in the medium term through a lower debt burden and tax reform. We analyze several supporting studies that suggest that the plan could increase economic output by over 1 percent by 2023.
How Simpson and Bowles Protect the Disadvantaged: One of the core principles of the Fiscal Commission’s recommendations was that the truly disadvantaged should be protected as much as possible in deficit reduction. In this post, CRFB shows that “A Bipartisan Path Forward” places particular emphasis on protecting low-income and vulnerable populations through a number of policies, including repealing sequestration, proposing benefit enhancements along with the chained CPI, strengthening the Pell Grant program, and leaving many means-tested programs untouched. Most importantly, the plan would fix the country’s fiscal problem and ensure that the burden of higher debt does not fall on the most vulnerable.
How Simpson and Bowles Plan to Bend the Health Care Cost Curve: The projected rise in health care spending is the primary driver of debt in the long-term, and the Simpson-Bowles plan includes many policies to “bend” the health care cost curve. In this post, we describe many of the plan’s structural health care reforms to provider payments, beneficiary, cost-sharing, and Medicaid. In addition, the blog describes the cap on the growth rate of the federal budgetary commitment to health care and the mechanism used to enforce it.
The Bipartisan Path Forward's Medicare Buy-in: The Simpson-Bowles plan includes a new take on raising the Medicare age. This post further describes the plan's Medicare buy-in proposal combined with its retirement age increase. Specifically, it describes the progressive premium assistance system that intends to protect lower-income beneficiaries from potential adverse effects from raising the age.
Tax Reform in A Bipartisan Path Forward: This blog talks about the plan's proposed tax reform, including its broad framework and an example of how the original Simpson-Bowles plan accomplished it. It also discusses the plan's proposed enforcement mechanism to ensure that the revenue from tax reform actually materializes.
Budget Enforcement Provisions in the Bipartisan Path Forward: Along with specific policies, A Bipartisan Path Forward also contains many budget reforms in the plan intended to either enforce those policies or ensure that fiscal responsibility is maintained overall. The blog talks about the requirement that Congressional and President's budget put debt on a stable or downward path, the 67-vote threshold for rolling back certain aspects of the plan, and indexing the debt ceiling to GDP.
Discretionary Savings in the Bipartisan Path Forward: While much of the deficit reduction achieved by lawmakers has used savings from the discretionary budget, there are still areas where greater efficiency could be achieved. In this blog, we break down the $385 billion of discretionary savings along with other enforcement changes to the discretionary spending caps.
Education Reforms in A Bipartisan Path Forward: In this blog, we talk about education reforms contained in the plan. The blog mainly focuses on how the plan reduces the implicit Pell Grant funding shortfall and how it permanently solves the Stafford student loan interest rate issue, when rates are scheduled to double on July 1.
User Fees in the Bipartisan Path Forward: In this blog, we show how the new Simpson-Bowles plan achieves $50 billion in savings through reforms to user fees in order to recoup the cost of some government services that benefits particular groups or industries.
Among the many proposals in Alan Simpson and Erskine Bowles's new plan, “A Bipartisan Path Forward,” is the increased presence of user fees for many government services. With some spending only benefiting select groups, the beneficiaries of those programs could better pay for the services they use, rather than having the funds come out of general revenue. As they write in their report:
The federal government subsidizes a large number of industries or individuals either through direct payments, discounted services, or direct provision of various activities. In some cases, it would be sensible for the government to reduce its role and leave more to the private sector. In other cases, however, the government could charge (or increase) user fees in order to recoup its costs.
The plan identifies $15 billion in savings from making the Fannie Mac and Freddie Mae Mortgage Guarantee Fees permanent, making the U.S. Customs merchandizing fees permanent, and indexing all government user fees to inflation, using the plan's preferred measure, the chained CPI. Indexing user fees was one of the recommendations proposed by the original Fiscal Commission report, which Simpson and Bowles co-chaired.
Another $20 billion in savings is achieved from increasing Transportation Security Administration (TSA) fees and adding a new fee to for air traffic control services. Currently, the user fee structure for TSA services is complicated and fails to reflect the cost of services. The House budget proposes a $5 flat fee per flight (raising over $15 billion), while the President’s budget proposes both a flat per flight fee (begin at $5 and to rise to $7.50 by 2019) and well as an air traffic control fee per flight. While the Senate budget does not list specific user fee changes, some of these changes are likely included in the $76 billion in other mandatory savings.
The rest of the savings could come from a combination of new fees or reforms, among which Simpson and Bowles list subsidized public utilities, receipt sharing for energy minerals, fees for health and food inspection, and assessments on nuclear utilities as possibilities.
There are many opportunities to pay for government subsidies or services through user fees and given our fiscal outlook, they may be one of the easier choices lawmakers will have to make. By dedicating a revenue stream to these programs, harmful cuts that could limit effectiveness can be avoided.
In a piece for Project Syndicate, former Council of Economic Advisers chair and CRFB board member Laura Tyson discusses the recent slowdown in health care spending growth and its potential implications for the budget outlook. Noting that some slowdown is to be expected given the recent economic weakness, she talks about a few studies -- one of which we reviewed last week -- that try to pinpoint exactly how much of the slowdown is economically related:
A new study by Drew Altman, a respected health-care expert and President of the Henry J. Kaiser Family Foundation, concludes that slower growth in real GDP, along with a lower inflation rate, accounts for more than three-quarters of the slowdown in health-care spending in the US after 2001. The weak economy has caused people to postpone consumption of health-care services and has encouraged states and employers to restrain their spending on health.
But important cost-containing changes in the private health-care system, including more cost-sharing in private insurance plans and tighter controls in managed care, have also contributed to the slowdown. Altman conjectures that, overall, the growth in health-care spending between 2008 and 2012 was about one percentage point lower than predicted by deteriorating macroeconomic conditions alone. If this reduction continues after the economy recovers – as seems likely, given the cost-containment incentives in the Affordable Care Act (commonly known as Obamacare) – the US stands to spend $2 trillion less on health care over the coming decade.
Based on the relationship between changes in real per capita health-care spending and changes in unemployment rates at the state level, the recent Economic Report of the President concludes that the recession and lackluster recovery account for less than 20% of the slowdown in health-care spending since 2007 – and for an even smaller share of the slowdown that began in 2002. And difficult macroeconomic conditions explain little (if any) of the slowdown in Medicare spending per enrollee since 2001.
However much of the slowdown is cyclically-related as opposed to related to structural changes in the health care sector, Tyson notes that getting health spending under control would have a large impact on the federal budget, particularly over the long term.
In 2011, Medicare spending accounted for 3.7% of GDP. Based on current policies, the government forecasts that Medicare spending per beneficiary will grow at an average annual rate of 4.3% and will rise to 6.7% of GDP over the next 75 years. If, instead, Medicare spending per beneficiary grew by only 3.6% a year, the average rate of the last five years, Medicare’s share of GDP would remain unchanged. This would narrow the fiscal gap, a widely used measure of long-term budgetary imbalance, by almost one-third.
Trends in the US budget reflect an inconvenient truth: If the growth of spending on health-care programs cannot be slowed, stabilizing the federal debt at a sustainable level will require deep cuts in spending on other priorities and increases in taxes on the middle class. The recent slowdown in the growth of health-care spending is a promising sign that America’s budgetary tradeoffs may turn out to be less difficult than expected.
Click here to read the full article.
"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.
Yesterday, the Engelberg Center for Health Care Reform at Brookings released a new report on reducing health care costs called "Bending the Curve: Person-Centered Health Care Reform: A Framework for Improving Care and Slowing Health Care Cost Growth." The report is the latest in a number of plans with the goal of reforming health spending by realigning incentives to slow health care cost growth.
The authors propose an integrated set of reforms across the health care system to Medicare, Medicaid, private payers, and regulations like medical and antitrust laws. They argue the proposals in their plan illustrate consensus on reducing health care cost growth while improving care and can be used as a framework for the foundation of any reform. According to the report’s estimates, on net (after offsetting the cost of repealing the sustainable growth rate formula) these reforms could provide $300 billion in savings to the federal government over the next decade and long-term savings of $1 trillion over the next 20 years. Below are some of the key elements of this plan:
Transition to Medicare Comprehensive Care: The report calls for a transition away from traditional Medicare fee-for-service (FFS) and towards a new alternative called Medicare Comprehensive Care (MCC). Similar to the idea behind the Bipartisan Policy Center’s Medicare Networks or the Commonwealth Fund’s Medicare Essential, MCC would be an alternative payment system and benefit package to align incentives with higher value care. On the provider side, MCC would build on current payment reforms such as bundled payments, Accountable Care Organizations, and medical homes to replace FFS payments so that by the end of the decade the majority of Medicare services are reimbursed by these alternative arrangements. All Medicare payments (FFS, MCC, and Medicare Advantage) would be based on current per beneficiary spending and limited to the per capita growth rate of GDP – similar to budgetary caps called for in the Bipartisan Path Forward and other plans.
Incorporate Cost Sharing Reforms: On the beneficiary side, the MCC would offer beneficiaries the option to reduce their premiums and/or copays in exchange for choosing higher-value MCC providers. The report also proposes incorporating an out-of-pocket maximum and requiring Medigap plans to have an actuarially equivalent copay of at least 10 percent. These cost-sharing recommendations are similar to what we have seen in other plans and further demonstrate the growing support for such reforms.
Reduce Medicaid Per-Beneficiary Growth: With respect to Medicaid, the Brookings report proposes reforms that would reduce per capita cost growth and streamline the Medicaid waiver process. To encourage states to pursue reforms that lower costs and improve quality, they would allow states to share in some of the savings their plans produce. Additionally, the plan would make permanent and expand the CMS capitated Financial Alignment Demonstration for dual eligibles and allow states to benefit from their share of any savings to Medicaid.
Limit the Employer-Provided Health Exclusion: The other large source of deficit reduction in the Brookings plan comes from new revenue by limiting the employer-provided health insurance exclusion. This has been called for in several other proposals, and the authors recommend phasing in a cap on this exclusion below the current level of the Affordable Care Act’s excise tax on high-cost plans (the “Cadillac tax”), but above the caps for the subsidies in the health insurance exchanges.
Encourage System-Wide Efficiency: The plan includes a number of other recommendations such as improving cost and quality transparency, promoting effective antitrust enforcement, standardizing administrative requirements, supporting state-based medical liability reforms, and encouraging broader participation in the health insurance exchanges to lower rates.
By developing a plan centered on basic ideas that have been receiving considerable attention from both sides of the aisle, the Brookings report highlights that political differences on reforming federal health spending may not be that large. While their projected savings are lower than some other proposals, the proposal does demonstrate the great potential for common ground on a significant number of policies that could help put health care spending on a more sustainable path in the long term.
Click here to read the full report.
In the past, the Bureau of Labor Statistics has made adjustments to the Consumer Price Index without much controversy. But due to the method of calculating the chained CPI, switching to this more accurate measure of inflation requires the creation of a new index, and thus action from Congress. While receiving the support of many economists, the chained CPI has been attack by interest groups on the left and right.
Last week, Robert Romasco, the President of the AARP, argued that chained CPI was both "unfair and inaccurate," focusing on how the provisions would affect retirement benefits. On the other end of the spectrum is the American for Tax Reform, who opposed the chained CPI as a tax increase. But Committee for a Responsible Budget's Marc Goldwein and Ed Lorenzen argue in The Hill there is nothing unfair or inaccurate about the chained CPI. It is a more accurate measure of inflation, with the secondary benefit of helping to reduce our budget deficit. They write:
Economists from the left, right, and center are in broad agreement that chained CPI more accurately reflects cost-of-living increases by accounting for the small-sample and substitution biases in the current inflation measure. This view is shared by experts at the non-partisan Congressional Budget Office as well as the experts at Bureau of Labor Statistics who are responsible for measuring inflation. Adopting the chained CPI doesn’t represent a policy change, but rather would best reflect the current intent of the law to index various provisions to inflation.
And while some argue that seniors face faster cost-growth than other populations, there is little evidence of a significant difference when one accounts for the fact that seniors are more likely to own their own homes mortgage free, have different shopping habits than younger populations, are able to take advantage of senior discounts, and receive constantly improving health treatments. Indeed, according to the Congressional Budget Office, “it is unclear, however, whether the cost of living actually grows at a faster rate for the elderly than for younger people.”
Moreover, offering seniors a preferential inflation measure raises more fairness concerns than it answers. If seniors receive a higher inflation measure, should non-seniors on the Social Security program receive a lower measure? Geographic inflation disparities are far larger than alleged age disparities (inflation has averaged 2.7 percent in New York and 1.8 percent in Detroit over the last decade); why protect seniors and not New Yorkers? What about other government programs and tax provisions? Should each be indexed to costs within its population? Or only those backed by powerful interest groups?
More unfair would be ignoring our fiscal and retirement challenges and leaving the job to a future politicians. According to the left-leaning Center on Budget and Policy Priorities, the President’s chained CPI proposal would result in benefit levels 1 to 2 percentage points lower than under current law – and it accompanies the switch with benefit enhancements for the old that actually reduce poverty among that group. By comparison, there is a 25 percent cut scheduled to occur under current law when the trust funds dry up in 2033. The greatest unfairness would be allowing this across-the-board benefit cut to hit every beneficiary regardless of age or income – when this cut could be easily avoided through a balanced package of revenue and benefit adjustments.
In the original Fiscal Commission plan, the chained CPI was included as part of a comprehensive Social Security reform. There is no doubt including chained CPI along with other policies to make Social Security solvent would be the preferred approach, and recently released "Bipartisan Path Forward" included an additional step to strengthen Social Security. But the failure of the political system to address this program is no reason to continue using an inaccurate measure of inflation. Argue Goldwein and Lorenzen:
Mr. Romasco is right, we need a national conversation on improving retirement security, including how to make Social Security sustainably solvent in order to avoid abrupt benefit cuts and ensure the system is better protecting those who rely on it. Ideally, we’d have this conversation now. However, the overheated reaction to a technical correction in cost of living adjustments suggests that the political system may not be ready to tackle comprehensive Social Security reform. Continuing to index benefits improperly while we wait for this reform to materialize would be a costly mistake that will only make future Social Security changes more painful.
Click here to read the full op-ed.
"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.
Although most discussion of Erskine Bowles' and Al Simpson's Bipartisan Path Forward has focussed on its health and tax reforms, the plan also includes changes in discretionary spending as well as $265 billion of other mandatory savings. Of that, a small but significant $35 billion comes from reforming higher education spending.
Importantly, that $35 billion isn't just cuts; rather, it is the net effect of a number of policies meant to improve higher education financing while fulfilling many of the Bipartisan Path Forward principles includling "cut spending we cannot afford," "replace dumb cuts with smart reforms," "protect the disadvantaged," and "make America better off tomorrow than it is today."
The centerpiece of the education reforms is fixing two issues in higher education programs: (1) the imminent doubling of Stafford loan interest rates in July of this year and (2) the implicit $50 billion shortfall facing the Pell Grant program. The plan addresses both of these issues in a permanent fashion by reallocating and retargeting spending within the higher education budget.
To address the interest rate spike, the plan proposes a solution we've talked about before, one that was part of the President's budget: linking the interest rate to a market-based rate like Treasuries. That would enable the interest rate to stay low in the short term and rise more gradually in the longer term than the quick jump that would happen in July. The budgetary result: larger deficits in the short term -- though not as large as continuing current interest rates indefinitely -- and smaller deficits over the longer term once interest rates return to normal levels. The proposal in the President's budget is estimated to save about $15 billion over ten years, though the proposal from Simpson and Bowles would be modestly more generous and save a little bit less.
To address the shortfall in the Pell Grants program which offers college aid to low-income students, the plan would reform the student loan program enjoyed by many middle-class students. Most significantly, it would repeal the in-school interest subsidy for undergraduate student loans (it has already been eliminated for graduate students), which defers accrual of interest on loans until after a student graduates. According to Bowles and Simpson, "this subsidy is neither well-targeted to those who need it nor effective in encouraging higher education." Additional savings could come from a number of smaller reforms described in detail in the report.
A portion of these savings would go to deficit reduction, but the majority would go to closing roughly 80 percent of the Pell Grants shortfall (the report calls for the remaining shortfall to be closed through savings and efficiencies within the Pell program).
The New America Foundation's Education Policy Program has an excellent write-up of the plan worth reading. In their own proposal Rebalancing Resources and Incentives in Federal Student Aid, they propose many of the same savings but reallocate all of those savings to higher education spending rather than setting aside a portion for deficit reduction. As they explain:
Our proposal included a broad array of reform proposals, covering loans, grants, tax expenditures, transparency, and other federal aid issues, and it is meant to be seen as an entire package, not a menu of options, because each component of aid affects the others. We stand by that belief, but we are pleased to see other groups arrive at the same conclusions that we did in reforming the federal student aid system: Policymakers can better spend the significant resources they have already committed to federal student aid programs to benefit students, taxpayers, and other education stakeholders.
Today is the last day of April, and Peter G. Peterson Foundation has released the latest result of its Fiscal Confidence Index. The Fiscal Confidence Index attempts to measure public opinion on fiscal sustainability based on polling data in three areas -- concern, priority, and expectations -- to produce a fiscal confidence index value between 0 and 200, with a "100" being neutral.
April's mark was a "44," showing that Americans feel very concerned about the state of our nation's finances. The index has remained in the low to mid 40s since January, where the index plummeted from December's 50 to 40, likely due to the failure of both parties to reach a significant fiscal cliff deal.
Source: Peter G. Peterson Foundation
Besides the index, polling revealed some concern with important programs like Social Security and with the resources that would be available for education and high-value added research. From the report:
- With the future of Social Security at the center of public discussion, only 42% of Americans believe Social Security will have the money to provide benefits for their retirement. 47% believe Social Security will not be able to provide benefits.
- Views of Social Security’s ability to fund benefits vary significantly by age. Americans 65 and over are most confident (72%) that Social Security will provide for them. Americans 18-44 are least confident—just 25% believe Social Security will be able to provide for their retirement.
- 86% of Americans are concerned that, without reforms, Social Security and Medicare benefits will put too much of a financial burden on future generations.
- Voters place particularly high value on having resources to invest in education (75% important, 36% extremely important).
- Americans want to see the country build a strong foundation for future economic growth (77% important, 32% extremely important).
- Improving national security also rates highly (70% important, 32% extremely important).
We've seen time and time again that those outside of Washington would like our budget problems to be resolved, but in the nation's capital, progress has proceeded much more slowly. Hopefully, lawmakers will be able to put aside their differences and find a compromise that can put the nation's budget on a sustainable path.
Click here for the full results and more on the methodology.
With the chained CPI becoming a frequent topic among commentators, CRFB has put together a great deal of new analysis, which may be helpful in clarifying a number of facts about the measure of inflation.
Recently, the Moment of Truth Project’s Ed Lorenzen testified at the House Ways and Means Subcommittee on Social Security, where he presented the merits of switching to the more accurate measure of inflation. We blogged on the hearing here and his full testimony is also available in writing, but now you can either watch the full hearing or highlights of Lorenzen’s testimony.
We have also updated our one-stop resource page for the chained CPI, which now contains a one-page summary of MOT's "Measuring Up" report, answers to some frequently asked questions about the chained CPI, and a correction of some common myths about the index. As before, it contains some of the most useful CRFB blogs on the chained CPI as well as outside analysis and resources.
CRFB's chained CPI resource page can be found here.
Over the past few years, lawmakers have made the most progress in discretionary spending in the deficit reduction effort. Additional opportunities for finding efficiencies in the discretionary budget exist for defense and nondefense, but right now cuts are being done through sequestration, which imposes blunt, across-the-board reductions instead of targeting areas where resources could be allocated better. Simpson and Bowles seek to improve upon this approach in their new plan as evidenced by their principle, Replace Dumb Cuts with Smart Reforms. In their words:
The mindless, across-the-board cuts from sequestration would reduce the deficit, but represent the wrong approach to budgeting. These cuts should be replaced with targeted reforms that focus on the drivers of the debt while eliminating redundant, wasteful, ineffective, or unwarranted federal spending while preserving high-value investments.
In particular, Simpson and Bowles propose four changes to discretionary budgeting:
- Replace sequestration with tight discretionary caps through 2025 to require real but gradual spending controls.
- Establish a 67-vote point of order to enforce caps so future lawmakers cannot easily reverse the spending controls.
- Cap spending on overseas contingency operations to end the “war gimmick” and prevent policymakers from classifying normal defense spending as war spending
- Stop the abuse of emergency spending by adopting a formal definition of emergency and justifying disaster spending against that definition.
Of most significance, from a fiscal respective, is the replacement of sequestration with more gradual discretionary caps. Specifically, Simpson and Bowles would repeal 70 percent of the sequester cuts for FY2013 and then cap defense and non-defense spending levels through 2025 to grow at the rate of inflation (as measured by chained CPI). Because this change would build off of the levels under sequestration, this change would result in about $220 billion of defense savings and $165 billion of non-defense savings -- $385 billion total. This compares to the $690 billion of direct discretionary savings ($870 billion if levels are extrapolated) from the sequestration.
Source: Bipartisan Path Forward
These caps will not be easy to abide by. Capping spending growth to the rate of inflation will require continuing to identify efficiencies and make tough decisions about what government should and shouldn’t be doing. However, using hard spending constraints to require these changes over time is far superior than allowing an abrupt across-the-board meat axe to cut spending indiscriminately in 2013 and require no efficiencies after 2021.
As we have written before, key elements of the Bipartisan Path Forward focus on reducing the debt as a percentage of GDP over the long term. Bowles and Simpson’s proposal notes that getting to a sustainable and stable level of debt will require lawmakers to make tough decisions, a sentiment that has been echoed by many leading economists including former Fed Chairman Alan Greenspan. But recent debate on Capitol Hill about replacing the sequester – such as Senate Majority Leader Harry Reid’s proposal to use a budget gimmick to eliminate or delay many of the most painful cuts – begs the question: how can a plan make sure that its deficit reduction isn't simply washed away? Bowles and Simpson’s new plan would enforce debt stabilization in several important ways, some of which have been put forward in other budget reform proposals.
Putting Debt on a Downward Path
Beyond 2015, A Bipartisan Path Forward would ensure that Presidential budget requests and congressional budget resolutions put the debt on a stable or declining path as a share of GDP. Likewise, if debt is projected to be growing as a percentage of GDP, Congress and the President would be required to consider legislation to reverse the trend. Legislation to put the debt back on a stable or declining path would be fast-tracked to enable easier enactment. Congress would also be restricted from considering any legislation increasing the deficit if the debt is on an unsustainable path.
Source: CBO, CRFB, MOT
Note: Graph of BPF's debt path shows only "Step 3," Scenario 1. For a fuller discussion of the plan's long-term debt, see here.
Having a 67-Vote "Escape Valve"
The plan would establish a 67-vote point of order for any legislation that would exceed the enacted proposal’s discretionary spending caps, circumvent statutory PAYGO requirements, or delay the tax reform enforcement mechanism. This provision would ensure that there be a very good reason to turn off any of these backstops, accounting for unforeseen economic circumstances while also encouraging Members to stay the course on keeping the debt on a sustainable trajectory.
Indexing Debt Ceiling to GDP
In an effort to avoid the need to regularly vote to raise the debt ceiling, which caused great economic uncertainty in 2011, Bowles and Simpson have proposed indexing the debt limit to GDP growth. That means if the debt does not remain on a stable path as a percentage of GDP -- whether because of an emergency, war, or other reason -- Congress will once again have to raise the debt ceiling.
It is important to note that Simpson and Bowles recommend suspending these enforcement provisions under turbulent or uncertain economic conditions. Congress could exempt certain situations as part of a comprehensive plan, including but not limited to stagnant GDP growth or an unforeseen major economic downturn.
The Bipartisan Path Forward's recommendations are another contribution to a number of other budget process reform proposals. The Peterson-Pew Commission proposed having lawmakers set a longer-term debt target with a glide path to hit it, enforced by across-the-board spending cuts and revenue increases which could not exceed one percent of GDP in any given year. Previous budget proposals from President Obama included a debt failsafe to hit a longer-term debt target enforced by automatic spending and tax expenditure cuts. Both of these proposals have escape valves in case of a recession or other emergency.
Similar to the intent of other budget reform proposals, the Bipartisan Path Forward's reforms will help ensure that a deficit reduction plan sticks, when there will be a lot of pressure for lawmakers to renege.
Erskine Bowles and former Senator Alan Simpson (R-WY), the two former co-chairs of the Fiscal Commission, have spent the last two and a half year talking to American citizens about the need to put our budget on a sustainable path and the recommendations put forward by the Fiscal Commission. But while the political landscape has changed over the last couple years, our debt problem remains far from solved.
In today's Washington Post, Bowles and Simpson offer their take on our fiscal outlook, what progress has been made, and what lawmakers need to do going forward:
Unfortunately, in Washington, the past two years have been defined by fiscal brinksmanship. Policymakers have lurched from crisis to crisis, waiting until the last moment to do the bare minimum to avoid catastrophe without addressing the fundamental drivers of our long-term debt.
To be sure, some progress has been made the past two years. Policymakers have enacted about $2.7 trillion in deficit reduction, primarily through cuts in discretionary spending and higher taxes on wealthy individuals. Yet what we have achieved so far is insufficient. Nothing has been done to make our entitlement programs sustainable for future generations, make our tax code more globally competitive and pro-growth, or put our debt on a downward path. Instead, we have allowed a “sequestration” to mindlessly cut spending across the board — except in those areas that contribute the most to spending growth.
But there are seeds of hope that a bipartisan agreement might be achievable.
Our fiscal problem will not be solved unless Congressional leaders and the President can guide their parties to a principled compromise. Political reality dictates that Democrats and Republicans cannot stick to their preferred positions wholeheartedly. Bowles and Simpson recently released a new plan, "A Bipartisan Path Forward to Securing America's Future," showing where a possible "grand bargain" might lie. Bowles and Simpson break down the details of their plan.
The plan we propose would achieve $2.5 trillion in deficit reduction through 2023, replacing the immediate, mindless cuts of the sequester with smarter, more gradual deficit reduction that would avoid disrupting a fragile economic recovery while putting the debt on a clear downward path relative to the economy over the next 10 years and beyond. Importantly, the plan would achieve this deficit reduction while respecting the principles and priorities of both parties.
Our proposal contains concrete steps to reduce the growth of entitlement programs and make structural changes to federal health programs, such as reforming the health-care delivery system to move away from the fee-for-service model and gradually increasing the eligibility age for Medicare. At the same time, it would provide important protections and benefit enhancements for low-income and vulnerable Americans, such as an income-related Medicare buy-in for seniors affected by the increase in Medicare’s eligibility age and greater protections against catastrophic health-care costs for low-income seniors.
Our proposal recognizes that additional revenue must be part of a comprehensive deficit-reduction plan for both substantive and political reasons. Our plan raises revenue through comprehensive tax reform that lowers rates, improves fairness and promotes more vibrant economic growth.
These structural reforms are accompanied by spending cuts in all parts of the budgets put forward by both parties, including cuts to defense and non-defense programs. The plan also includes a shift to the chained consumer price index to provide more accurate indexation of provisions throughout the budget, with a portion of the savings devoted to benefit enhancements for low-income populations. Together, these policies would put the debt on a downward trajectory as a share of gross domestic product — and would keep it declining for the long term.
The "Bipartisan Path Forward" is not intended to be a replacement for the original Fiscal Commission plan but rather a guide showing where a possible compromise may be if both parties are willing to put aside their sacred cows. Write Bowles and Simpson:
Our proposal is not our ideal plan, and it is certainly not the only plan. It is an effort to show that a deal is possible in which neither side compromises its principles but instead relies on principled compromise. Such a deal would invigorate our economy, demonstrate to the public that Washington can solve problems and leave a better future for our grandchildren.
Click here to read the full op-ed.
"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.
This week, Senator Tom Harkin (D-IA) introduced a concurring resolution that would establish a sense of Congress that chained CPI should not be used to index cost-of-living adjustments or provisions in the tax code. The Campaign to Fix the Debt responded, saying:
Reaching agreement on a comprehensive debt deal will require consideration of all options and compromises by both sides, and taking proposals off the table makes a deal harder. Chained CPI is a technical change that would help improve the budget situation and strengthen Social Security, and it has the support of President Obama as well as experts across the country. It is irresponsible and counterproductive to take a common sense and bipartisan option off the table.
As we've talked about many times on the blog, there are many merits to switching to the chained CPI, a more accurate measure of inflation. We have also written a paper discussing in full the technical and budgetary merits of the measure. Below, we walk through the entire legislative language and fact check some myths and misperceptions:
"Whereas the Social Security program was established more than 77 years before the date of agreement to this resolution and has provided economic security to generations of Americans through benefits earned based on contributions made over the lifetime of the worker;"
This is true.
"Whereas the Social Security program continues to provide modest benefits, averaging approximately $1,156 per month, to more than 57,000,000 individuals, including 37,000,000 retired workers in March 2013;"
True, although the initial benefit for someone retiring at age 65 this year is $1,493 per month. That will increase to $1,581 by 2020 and $1,804 by 2035 in real terms (2012 dollars). In nominal terms, monthly benefits would be $1,905 and $3,292, respectively.
"Whereas the Social Security program has no borrowing authority, has accumulated assets of $2,700,000,000,000, and, therefore, does not contribute to the Federal budget deficit;"
This is only one way of looking at the program, where the program has dedicated funding and its own trust fund. But this approach also assumes that lawmakers would allow benefits to be cut if funds were exhausted. Another view is that Social Security is part of the federal budget, and outlays in excess of revenue would contribute to the deficit.
"Whereas the Board of Trustees of the Federal Old-Age and Survivors Insurance Trust Fund projects that the Trust Fund can pay full benefits through 2032;"
True, but the Trust Fund will run out in 2033 and beneficiaries will face a 25 percent benefit cut.
"Whereas the Social Security program is designed to ensure that benefits keep pace with inflation through cost-of-living adjustments (referred to in this preamble as ‘‘COLAs’’) that are based upon the measured changes in prices of goods and services purchased by consumers that is currently published by the Bureau of Labor Statistics as the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI–W);
Whereas the Bureau of Labor Statistics publishes a supplemental measure of inflation, the Chained Consumer Price Index for all Urban Consumers (C–CPI–U), or ‘‘Chained CPI’’, which adjusts for projected changes in consumer behavior resulting from price fluctuations known as the ‘‘substitution effect’’;
Whereas the substitution effect occurs when consumers buy more goods and services with prices that are rising slower than average and fewer goods and services with prices that are rising faster than average;"
True, the incorporation of substitution effect is the primary reason why the chained CPI would be a more accurate measure of inflation.
Whereas studies indicate that typical Social Security beneficiaries spend a significantly higher percentage of their budget than other consumers on health care, health care prices have increased at higher than average rates, and consumers, including seniors, may not be able to substitute health care easily;
While it is true that seniors spend more on health care, there is no evidence they have different substitution habits overall, and there is little evidence they experience higher inflation. As the CBO explains "It is unclear, however, whether the cost of living actually grows at a faster rate for the elderly than for younger people, despite the fact that changes in health care prices play a disproportionate role in their cost of living."
Whereas the current COLAs, based on the CPI-W, fail to reflect that Social Security beneficiaries spend more of their income proportionally on expenses such as health care as compared to a regular wage earner, and therefore underestimate increases in the cost of living of Social Security beneficiaries;
This is uncertain. In a recent CBO analysis of the CPI-E, CBO pointed out that many analysts believed that the Bureau of Labor Statistics (BLS) may underestimate the improvement in quality of care and therefore overstated the price increase of health care. Even putting that point aside, setting the precedent of having population-specific price indices for programs is problematic, especially since many Social Security beneficiaries are not elderly and variations by criteria such as geography are much larger than those by age.
Whereas reductions in Social Security benefits from using the Chained CPI to calculate Social Security COLAs would continue to compound over time, and the AARP Public Policy Institute estimates that the reductions would grow to 3 percent after 10 years and 8.5 percent after 30 years;
Whereas Social Security Works estimates that using the Chained CPI to calculate Social Security COLAs would reduce annual Social Security benefits of the average earner by $658 at age 75, $1,147 at age 85, and $1,622 at age 95;
Actually, according to an analysis by the Center on Budget and Policy Priorities, the President’s chained CPI proposal would only change current law benefits by an average of 1 to 2 percent. And as we show, benefits for an 85 year old 20 years from now will actually be 25 percent higher than current law allows and 8 percent higher in real terms than today’s 85 year olds. We write more about this here.
Whereas reductions in Social Security benefits would harm some of the most vulnerable populations in the United States;
Using the wrong measure of inflation represents an expensive and poorly-targeted way to offer relief to the most vulnerable. Both the President’s budget and "A Bipartisan Path Forward" instead propose targeted benefit enhancements. The White House proposal was found to reduce projected poverty for elderly seniors.
Whereas adopting the Chained CPI would cause tax brackets and the standard deduction to rise more slowly, disproportionately raising the tax burden on low- and middle-income taxpayers;
"Disproportionately" is a stretch. Analysis from the Tax Policy Center has shown that the chained CPI would be a roughly distributionally neutral tax change, including a very small change for the very poorest. Even so, any undesired revenue increase for low- or middle-income taxpayers could be dealt with in the context of comprehensive reform. For example, the Simpson-Bowles illustrative tax plan included both the chained CPI and a gas tax increase and still cut taxes slightly for the bottom quintile.
Whereas the Department of Veterans Affairs provides more than 3,200,000 veterans with disability compensation benefits as a result of injuries or illnesses sustained during, or as a result of, military service;
Whereas Social Security Works estimates that using the Chained CPI to calculate veterans disability COLAs would reduce benefits for 100 percent-disabled veterans who started receiving benefits at age 30 by $1,425 at age 45, $2,341 at age 55, and $3,231 at age 65; and
Whereas adopting the Chained CPI would also cut the benefits of more than 350,000 surviving spouses and children who have lost a loved one in battle by cutting Dependency Indemnity Compensation benefits that average less than $17,000 per year:
Benefits would grow more slowly than scheduled, but at the more accurately measured rate of inflation, which reflects the intent of cost-of-living adjustments in these programs. If benefits are considered to be too low for certain populations after switching to the new index, adjustments could be made to compensate, rather than continuing to use an inaccurate measure of inflation for indexing purposes.
Click here to read some common myths about the chained CPI.
Among the principles outlined by former Fiscal Commission co-chairs Senator Al Simpson and Erskine Bowles in their new plan A Bipartisan Path Forward is that a reasonable debt reduction plan must protect the disadvantaged. They argue that while additional spending cuts and reforms of entitlement programs will be necessary as part of a plan to put the budget on a fiscally sustainable course, low income programs should not harmed and entitlement reforms should include protections for vulnerable populations who rely on those programs most.
We must ensure that our nation has a robust, affordable, fair, and sustainable safety net. Benefits should be focused on those who need them the most, and low-income programs should not be cut simply for the sake of deficit reduction. Broad-based entitlement reforms should either include protections for vulnerable populations or be coupled with changes designed to strengthen the safety net for those who rely on it the most.
Importantly, the specific policies in their plan demonstrate that it is possible to meet the principle of protecting low-income and vulnerable populations in developing a comprehensive deficit reduction plan. The plan protects low-income programs by including a number of targeted benefit enhancements and low-income protections to accompany the entitlement reforms in the plan while still improving the solvency of Medicare and Social Security and achieving significant deficit reduction.
- Sequester repeal: The plan repeals most of the sequester, which calls for across-the-board cuts in discretionary spending, which disproportionately affects programs in housing, education, child care, nutrition, and energy assistance. Instead, it has discretionary spending caps which allow appropriators to target cuts where they deem most appropriate.
- Means-tested programs and UI benefits untouched: The plan does not make any direct changes to means-tested programs like Supplemental Security Income, food stamps (SNAP), and cash welfare (TANF). In addition, unemployment insurance is left untouched. The only changes are anti-fraud measures and the chained CPI switch, both of which reflect the intentions of current law rather than a new policy.
- Medicaid benefits untouched: A Bipartisan Path Forward leaves Medicaid alone for the most part. One exception is a change that phases out the gimmick of states taxing medical providers to pay for Medicaid expansions, which then leads to higher federal government spending.
- Benefit enhancements for the chained CPI: To protect vulnerable populations who would be affected by the chained CPI switch, the plan would provide a flat dollar benefit bump-up to those receiving Social Security, Supplemental Security Income (SSI), and veterans benefits and have been in these programs for 20 years. Within the SSI program, they propose indexing the $20 income disregard and asset limits to inflation measured by the chained CPI.
- Income-related catastrophic protections: The Medicare cost-sharing proposal provides for the first time an income-related out-of-pocket maximum, thus concretely limiting beneficiaries' potential exposure to health care cost-sharing. In addition, the cost-sharing reforms include an income-related deductible, lowering the deductible for lower-income seniors. While the exact level of out-of-pocket caps and reduced deductibles of the proposal would need to be fleshed out to hit the savings target, the plan would seek to hold average out-of-pocket costs constant from year to year and would likely reduce out-of-pocket costs for the poorest and sickest seniors and offer much greater protection from financial risk.
- Medicare buy-in with income-related premiums: The plan's gradual raising of the Medicare eligibility age is combined with a Medicare buy-in to ensure that low and moderate income seniors affected by the increase in Medicare eligibility age have access to affordable health insurance through Medicare. As we discussed on Tuesday, Simpson and Bowles would offer seniors affected by the age increase the option to buy into Medicare with an income-related premium. The biggest assistance would be for those below 100 percent of poverty who would receive a full subsidy for their Medicare premium. Seniors between 100 and 400 percent of poverty would pay an income-related premium similar to the way the subsidies work in the Affordable Care Act’s health insurance exchanges.
- Strengthening Pell Grants: A Bipartisan Path Forward eliminates the Pell Grant funding shortfall through savings from reforms of provisions that do not target education resources nearly as well. Without new funding to fix the shortfall, Congress would be forced to either reduce the Pell grant award amount and eligibility for assistance or cut other discretionary programs more deeply to cover the shortfall in future appropriations bills.
- Progressive tax reform: The proposal calls for tax reform that makes the code at least as, if not more, progressive. The original Simpson-Bowles Illustrative plan, which is one of the models the proposal cites, included a small tax cut for the bottom quintile.
- Social Security protections: The original Simpson-Bowles plan would have increased benefits for low-income workers and reduced poverty among seniors by making the benefit formula more progressive, including a hardship exemption from their proposal to index the retirement age to longevity, establishing a new minimum benefit of 125 percent of poverty for those with 25 years of work, and establishing a flat dollar bump up for beneficiaries who have received benefits for twenty years and are at greater risk of poverty. Simpson and Bowles now recommend further strengthening the Commission’s low-income protections to eliminate any benefit reduction in the bottom quintile by increasing the bottom replacement factor from 90 percent to 95 percent and phasing up the minimum benefit faster for those with less work history.
- Fixing the fiscal situation: The Bipartisan Path Forward puts the debt on a sustainable path over the medium and long term, thus precluding the possibility of a debt crisis. Such a debt crisis would likely involve severe and immediate cuts, and low-income programs would likely have to be a part of those cuts. Making targeted changes that protect the most vulnerable while putting the debt on a downward path avoids this possibility.
As the reforms in their plan show, Simpson and Bowles follow the principle of protecting the disadvantaged by including numerous protections for low-income individuals who depend the most on certain entitlement programs. Any responsible plan for deficit reduction must include significant spending cuts and reforms to control the growth of entitlement programs. Simpson and Bowles have made a valuable contribution to the debate by demonstrating that it is possible to slow the growth of entitlement programs through smart, targeted reforms that preserve the safety net and protect low-income individuals and other vulnerable beneficiaries.
Putting debt on a sustainable path has been a key issue in Washington ever since the Fiscal Commission showed that a bold compromise would be needed to secure the nation's future prosperity. And while the previous 112th Congress made some progress by enacting $2.7 trillion in savings, much of it was low hanging fruit in the budget and did not get us all the way towards a sustainable fiscal future. The truly tough choices will need to be made by this Congress.
Today, CRFB President Maya MacGuineas writes in The Hill that the legacy of President Obama's second term might be defined on how he handles the budget debate. In the first year of his second term, the President has already made some progress in showing that Washington is serious about the issue, but it is only a start. Argues MacGuineas:
So how is he doing in the first 100 days on this front? He is off to a good start, and it is certainly a lot better than he did in his last four years.
The budget President Obama offered was more serious than many of his other recent proposals. By including the chained CPI — a technical improvement to how we measure inflation that would help to extend the life of Social Security and increase revenue for the federal government — he sent a real signal that he is willing to discuss the kinds of more serious entitlement reforms that will have to be part of any deal.
And his so-called “charm offensive” seems to be going well. It is nothing short of absurd how little the president has interacted with members of Congress — including those from his own party — on these issues in the past. And the dinner series he initiated seems to be helping to start a real discussion. It’s hard to solve problems when no one is even talking.
But the real question is where this goes in the next 100 days. There isn’t much time; we need to get a deal hammered out before the country hits the debt ceiling late this summer or early fall.
But history will remember actions, not just intent. We are going to need to enact additional savings, likely close to the $2.4 trillion that would be required to put debt on a downward path, in order to get our fiscal house in order. That will be much more difficult. Writes MacGuineas:
Next up: the tough stuff.
All told, we have achieved about half of the savings we need to reach a minimum target. Now in the next tranche, we have to tackle the much harder parts: entitlement and tax reform. The good news is that the tax committees are making impressive progress on moving forward with tax reform, which would broaden the base; lower rates; simplify the system; make it far more equitable and competitive; and raise revenue for the federal government in a much better way.
Where the president is going to have to really use his leadership is to help make the case for entitlement reform and why we have to make the needed changes to control healthcare costs and adjust the nation’s retirement system for growing life expectancies. He should make the case to Democrats on why they should prefer Social Security and Medicare reform under his presidency, and he needs to make the case to the nation as a whole about why putting a fiscal deal in place is so important and how the economic recovery will not take off without one.
President Obama made a small down payment on his legacy in his first 100 days. Now he must invest a lot more political capital to make sure it pays off.
Click here to read the full op-ed.