A proposal to form a bipartisan commission to address the nation’s mounting long-term debt just fell short of the 60 votes needed for approval in the Senate. The vote on the Conrad-Gregg amendment to the debt limit increase was 53 in favor to 46 opposed. The vote tally detailing how Senators voted is available here.

Just before the vote, the co-sponsor of the proposal, Senate Budget Committee Chairman Kent Conrad (D-ND), called the vote “A defining moment for this Congress.” President Obama gave his backing to the legislation over the weekend.

A bipartisan group of Senators supported the measure as the best means of confronting the country’s growing fiscal imbalance. CRFB supports a statutory commission.

A group of Senate moderate Democrats led by Sen. Conrad have signaled they will not vote to increase the nation’s debt limit without a fiscal commission. They have been working with the White House on a fall back plan if the legislation failed in which the President would appoint a commission. The moderates are seeking firm assurances that Congress will vote on the recommendations of a presidential commission. Congress would have been required to vote on a fast-track basis on the commission’s proposals under the Conrad-Gregg legislation.

Debate will continue this week and perhaps next week on raising the debt ceiling. The Senate is seeking to raise the limit to nearly $14.3 trillion. See CRFB's recent paper, "Raising the Debt Ceiling."

 The federal deficit in FY10 is expected to be $1.35 trillion--a slight drop from the $1.41 trillion in FY09--but still the second largest in our nation's history, CBO says in its "Budget and Economic Outlook: Fiscal Years 2010-2020," released this morning. But CBO warns that if, as expected, Congress enacts legislation that will increase spending or reduce revenue, the deficit in 2020 will remain the large share of GDP that it is now and that debt held by the public would equal close to 100 percent of GDP. The $1.3 trillion deficit represents 9.2 percent of GDP, slightly smaller than the 9.9 percent last year. CBO also forecasts that that next year's deficit could drop to $980 billion, but only if all tax cuts passed during the administration of George W. Bush were allowed to expire--an unlikely scenario. This year's deficit is expected to remain close to last year's because spending on stimulus legislation and income support programs will climb, while assistance to the financial sector will drop. In August, CBO predicted that the FY09 deficit would reach $1.59 trillion and that the deficit in FY10 would be $1.38 trillion.

The large deficits will result in federal debt continuing to climb. At the end of 2009, debt held by the public was $5.8 trillion or 53 percent of GDP. By the end of 2020, that debt is expected to climb to $1.5 trillion, or 67 percent of GDP. As the debt increases and interest rates climb, interest payments on the debt will soar. CBO projects that spending on net interest will more than triple between 2010 and 2020 in nominal terms, going from $207 billion to $723 billion and will more than double as a share of GDP.

And CBO warns that its projections understate likely political scenarios, including extension of the tax cuts, changes to the alternative minimum tax and larger-than-inflation increases in appropriations. For instance, baseline projections show ;revenues rising to 20.2 percent of GDP by 2020, with almost half of that increase attributed to an assumption that tax cuts will be allowed to expire. The Committee for a Responsible Federal Budget will release its analysis of the CBO report later today.

The Senate will vote this week on key fiscal measures as it attempts to increase the nation’s debt ceiling. The debt limit is expected to be reached next month absent action by legislators to increase it.

On Tuesday Senators will vote on an amendment by Senate Budget Committee Chairman Kent Conrad (D-ND) and Ranking Member Judd Gregg (R-NH) to create a Bipartisan Task Force for Responsible Fiscal Action that would offer recommendations to improve the long-term fiscal condition of the country. The panel would be empowered to propose tax increases and cuts in entitlement spending. Its proposals would be subject to an up-or-down vote in Congress after the mid-term elections.

Although the Conrad-Gregg commission plan has bipartisan support, it also faces opposition from special interests on both sides of the political spectrum. Groups like AARP oppose it because they are against reducing Social Security and Medicare benefits while organizations like Americans for Tax Reform fear tax increases.

Underscoring the sway of such interests in Congress, just before the vote on the Conrad-Gregg commission amendment, the Senate will vote on an amendment from Senate Finance Committee Chairman Max Baucus (D-MT) to exempt any changes to Social Security recommended by such a commission from being considered under a fast-track process. And Senate Minority Leader Mitch McConnell (R-KY) is expected to offer an alternative proposal with a commission that only considers spending cuts, not tax increases. The politics surrounding the upcoming fiscal commission vote serves to highlight the need for a special process that confronts the nation’s fiscal challenges.

On Saturday President Obama officially endorsed the Conrad-Gregg proposal. Moderate Democrats in the Senate had been pressuring him to publicly support the idea. The presidential support may not improve prospects for the vote on Tuesday, but may make it easier for the moderate Democrats to support Obama’s preferred approach, a commission created by the White House, if the Conrad-Gregg amendment fails to garner the 60 votes needed for approval.

After Tuesday’s votes, several more amendments await Senate consideration. On Friday Senate Majority Leader Harry Reid (D-NV) offered an amendment to reinstate statutory pay-as-you-go (paygo) rules. Senators Jeff Sessions (R-AL) and Claire McCaskill (D-MO) have an amendment instituting discretionary spending caps and Senator Tom Coburn (R-OK) is sponsoring an amendment rescinding at least $120 billion in federal spending. Last week an amendment from Senator John Thune (R-SD) that would have ended the TARP program and mandated unused TARP funds go towards reducing the debt fell short of the 60 vote threshold, garnering 53 votes.

The debt limit debate has become politically charged as voters signal their frustration with mounting federal budget deficits and national debt. The Democratic leadership in Congress is trying to raise the limit enough to avoid further action until after the midterm elections while Republican leaders would like to force a series of debt limit votes throughout the year and use each vote as an opportunity to paint Democrats as fiscally reckless. The White House would like to point to some concrete steps on the debt ahead of the president’s State of the Union address Wednesday night and the release of its budget proposal on February 1. The Senate will consider raising the limit a record $1.9 trillion to $14.3 trillion.

CRFB supports a budget commission that places all options for stabilizing the debt on the table, as well as paygo rules without exemptions (except for emergency spending) and discretionary spending caps. Now is the time for developing a credible fiscal plan, not for political posturing and finger-pointing.

We recently invited folks to take the spending challenge and show how they would close the budget gap without raising taxes (or alternatively, take the tax challenge and show the inverse). Our first contestant suggested cutting bureaucracy --  a good idea but one that doesn't get us too far.

Bob Williams, Rosanne Altshuler, Katie Lim of the Tax Policy Center took this challenge without even knowing it recently, in a  paper measuring what we would need to do on personal income tax rates in order to stabilize the debt.

So can we fix our budget problems with income tax increases? The short answer is no.

This is especially true if we only tax the rich. The authors looked at how high the top two rates would need to be to bring the deficit down to 2 or 3 percent of GDP if we kept other rates at their current levels -- as per the pledge that taxes not be raised for those making under $250,000 a year. In that case the top tax rate would need to increase to as high as 90 percent.

^{Chart Created With Data From The Altshuler, Lim, and Williams, "Desperately Seeking Revenue."}

And in reality, such high rates would almost certainly influence behavior and negatively imapct the economy; as a result, they would raise much less revenue than the authors' static analysis reflects.

So what about moving passed the $250,000 tax pledge? Well, if we raised each rate proportionally they would each have to go up by 40 to 50 percent -- so the bottom rate would have to increase from 10% to as much as 15%, and the top rate from 35% to around 50%. And again, these assume no behavior responses. 

And still, these taxes only get you to 2019. As the population ages and health care costs grow, the costs of Social Security, Medicare, and Medicaid are expected to rise considerably in the following decades. So tax rates would have to keep rising. 

Income tax rates can surely be part of the solution, but they fall short of being able to fix the budget problem on their own. An excelent place to look for new revenue would be the income tax base, which could be broadened by reducing the multitude of tax credits, deductions, exemptions, and exclusions.

Even then, depending on how much policy makers are willing to cut on the spending side, there may very well have to be a new source of revenue: likely contenders are an energy tax, transactions tax, or consumption tax.

If these taxes are considered, one of the most heated debates is likely to be over whether they should be introduced in place of the income tax, on top of it, or some combination. We'll surely write more on this in the future.

^{Chart Created With Data From The Congressional Budget Office}

Nobel Laureate Joseph Stiglitz stopped by New America this week to discuss his new book "Freefall", about our economic and financial crisis.

For the fiscal hawks among us, he warns: "Our economic growth has been based … on borrowing from the future: we have been living beyond our means."

But, he has other worries for the immediate future:

• He’s still more worried about deflation than inflation, given the continuing weakness of the economy.
• He argues that it is very important now for additional stimulus resources to go to state and local governments to help offset state tightening to satisfy their balanced budget requirements. State and local fiscal tightening had made the Great Depression worse, he noted.
• He proposes a Chapter 11 bankruptcy framework for households, particularly since otherwise record high home foreclosures will perpetuate the vicious cycle keeping job creation down.

But much of his talk and his book were/are devoted to fixing the financial sector - provocative and important reading in the wake of this week's Volcker Rule announcement by President Obama. His proposed financial sector fixes seem along the lines of the Volcker Rule proposals.

For us, however, there are important fiscal issues to be raised. Going forward, the taxpayer costs of not getting the fix right for the financial sector could be high. And we've already spent massive amounts of money to stop the economy’s freefall caused by the financial sector crisis. Taxpayer anger has been increasingly visible - and understandable.

But, with all due respect to one of the foremost thinkers of our time, does it make sense to make changes so that the financial sector will consist of, on the one hand, low return, plain vanilla banking, but, on the other hand, high risk, high return, essentially unregulated activity? Didn't the banks get into trouble in the first place because of their desire/need to compete with the high flyers? And, isn’t it significant that the major firms precipitating the collapse (AIG, Lehman Brothers, Bear Sterns) and costing us the most taxpayer dollar (most notably AIG) were not commercial banks and were not within the fold of the formal safety net?

Just think about it a bit more: as the economic situation improves, will you give your money to a taxpayer-insured low yield bank or would you search for a better return - especially if you need additional income?

And aren't we still begging the critical question of how to manage risk at a time of global capital liberalization and technological change (not to mention structural shifts in industry and global markets)? Can we stuff only one hand of the genie back into the bottle? Although done in the name of the taxpayer, won't this ultimately diminish the viability of the financial sector that would be covered by the deposit insurance safety net, and therefore potentially cost the taxpayer in the end - however well intentioned? Why is no one talking about "smart regulation" any more?

For more on the Volcker position, see the report he headed last year from the Group of Thirty ("Financial Reform: A Framework for Financial Stability"); and for more on concerns about this approach, see the most recent piece by Douglas Elliott of Brookings ("More Nuance Needed in Bank Regulations").

Update: The debate between Maya MacGuineas and Brad Delong is about to begin. See the live tweets here: http://twitter.com/BudgetHawks

Maya MacGuineas, President of the Committee for a Responsible Federal Budget, joined three other budget experts testifying today before the House Budget Committee.  MacGuineas was discussing the Peterson-Pew Commission's recent report Red Ink Rising.  We will post more on that hearing later today.

Also, at 12:30 this afternoon, MacGuineas will participate in a debate sponsored by the National Academy of Social Insurance at the National Press Club.  The topic is How Should We Think About the Public Debt?  Should be a lively debate with Brad DeLong, an economist at the University of California, Berkeley.  Follow our live Tweet of the debate this afternoon.

As the Senate continues its consideration of the debt ceiling today, it will consider at least three important budgetary amendments - a deficit commission supported by Senators Conrad and Gregg, statutory pay-as-you-go rules to be introduced by Senator Reid, and discretionary budget caps supported by Senators Sessions and McCaskill. We've voiced our support for the deficit commission, and comprehensive PAYGO (without exemptions) before; but just as important is the implementation of discretionary spending caps.

Along with PAYGO, these types of caps are a valuable and co-necessary tool to stop the debt situation from getting any worse.

For all our talk about entitlements and mandatory spending, it is important to remember that discretionary spending makes up nearly 40 percent of the budget. And historically -- over the past decade, especially -- this area of the budget has grown tremendously, at a faster pace than entitlement spending, in fact.

If regular (non-war, non-stimulus) discretionary spending were to simply grow with the economy over the next decade (a slower pace than its historical average, by the way), we calculate it would cost an extra $1.7 trillion plus interest, relative to the CBO baseline. As we wrote recently in a paper on discretionary spending:

"Over the past decade, discretionary spending has grown faster than mandatory. Between 1999 and 2008, mandatory spending grew by an annual average of 6.4 percent, from about $900 billion to almost $1.6 trillion. Discretionary spending grew annually, on average, by 7.5 percent – from less than $570 billion to over $1.1 trillion... Although the CBO baseline makes it appear as if discretionary spending will grow only modestly, more realistic assumptions tell a different story"

"Just holding discretionary spending growth to inflation – with strong enforceable spending caps – would be a positive step. In the 1990s, it was these types of caps, along with pay-as-you-go rules, strong economic growth, slower-than-usual health care cost growth, and a commitment to deficit reduction that led to budget surpluses."

That is why the amendment proposed by Senator Sessions and Senator McCaskill is so important.

Generally speaking, they would cap defense and non-defense discretionary spending at the levels in the President's Budget for the next five years. There would be some exceptions for war spending, program integrity adjustments (spending designed to save money by cutting waste, fraud, and abuse), and emergency spending, but the caps would be relatively rigid. Absent a new law, waiving the caps would require a two thirds majority.

These caps, of course, will not be nearly enough to stabilize our debt. We need to reform Social Security, Medicare, Medicaid, and the tax code (all things which we hope the commission will consider). But discretionary spending caps -- especially if accompanied by statutory PAYGO --  can slow the bleeding. And they would signal,  for the first time in a long time, that the United States is committed to getting its fiscal house in order.

Roll out the red carpet and velvet rope, CRFB’s new list of prominent economists, organizations, and opinion leaders that have joined us in suggesting we create a viable fiscal plan now to be implemented as the economy recovers is quickly becoming the hot club to be seen in.

Soon after we unveiled the “Announcement Effect Club” last week, Donald Marron applied for membership, offering this post from October as his creds. He cites the example of Sweden in recovering from fiscal crisis and identifies one of the key lessons of that experience is to “[s]et clear, easily communicated budget goals (e.g., specific deficit targets that get the government debt under control).” He goes on to say that “clear, credible commitments will be rewarded by world capital markets through lower interest rates, which can help offset some of the contractionary effects of tightening the budget.” We are happy to welcome him into the club and apologize for not including him in the original list.

Len Burman of Syracuse University has also earned admission to the club, along with his co-authors, Jeffrey Rohaly, Joseph Rosenberg, and Katherine Lim of a recent paper presented at a conference last week on the looming fiscal crisis. In a footnote they contend, “if corrective policies were adopted early enough that either the size of outstanding debt was “modest” or most of the adjustment could take the form of credible commitments to reduce future government deficits, the macroeconomic effects could be manageable.”

Underscoring the international flavor of this group, Nick Clegg, leader of Liberal Democrats in the UK, joined the group with a Financial Times piece describing the need for his country to set forth a credible fiscal plan in order to reassure jittery markets. He writes,

“The consequences of failure to bring the deficit under control could be very damaging for Britain… Significant cuts are necessary. But the hawks must accept that cuts should come only once tests confirm the resilience of the recovery: jobs, growth, credit availability, international conditions and the cost of government borrowing. The timing of fiscal contraction should be governed by economics, not political dogma… To maintain confidence, it is vital that steps are taken now, before the election, to demonstrate clear commitment.”

Who will be next to join this trendy club? View the complete list here.

Even though they're sending a self-proclaimed deficit hawk to the Senate, Massachusetts voters don't see the budget as a major problem, if two recent public opinion polls are to be believed. Republican Sen.-elect Scott Brown railed against government spending in his campaign. But it appears that his upset win can be attributed to voter unrest on other issues , such as health reform rather than government spending.

Only 9 percent of the 554 likely voters surveyed by the University of New Hampshire Survey Center between Jan. 2 and Jan 6  identified taxes and the budget as the most important issue or problem facing the state's new senator. Health care, jobs and the economy and "other" finished ahead of taxes and the budget.  And ironically, more of those polled said they would trust Democratic candidate Martha Coakley to handle spending issues than the budget hawk Brown. Coakley beat Brown 42 percent to 37 percent when voters were questioned who they would trust the most to handle their checkbooks.

Another poll also showed the budget wasn't on voters' minds. Only 3 percent of the 500 likely voters polled by Suffolk University on Jan. 11-13 identified the budget and spending as the most important job facing the state's next senator. They rated health care and overall economic issues as the top problems. But voters also may be unsure of the impact of government spending. A poll of 1,000 likely voters by Rasmussen Reports on Jan. 11 found that 54 percent of the likely voters believed that increased government spending hurt or had no impact on the economy, while 38 percent said it helped.