The Bottom Line
In her testimony before the President’s Fiscal Commission last week, CRFB President Maya MacGuineas presented the following plan as an option to stabilize the federal debt at the popularly considered maximum, 60 percent of GDP, in response to the request for specific policies to deal with the debt. Her plan (shown in the below table) is meant to achieve the 60 percent goal in a balanced manner, while protecting the most vulnerable and promoting economic growth. What follows is only one option for stabilizing the debt—but regardless of the plan we ultimately choose, it’s time to get specific in determining exactly how we are going to fix this grave problem.
A PLAN TO STABILIZE DEBT AT 60% OF GDP
Savings in 2018 (Billions)
Here are the highlights from this weekend’s editorials on fiscal and budget policy:
The Denver Post said that although they opposed a large stimulus package, they did not believe that Congress should penny pinch on the unemployed in the current economic situation. Noting the recent upward trends in unemployment claims, they believed that it was important to extend benefits in an economic climate where "even the most talented and ambitious job-seekers" cannot find a job. The Post believed that the benefits of extending unemployment benefits outweighed the costs of not paying for them.
The Kansas City Star also called for unemployment benefits to be extended, criticizing Congress for playing political games at the expense of the unemployed. They pointed out that unemployment benefits have a high multiplier effect, since recipients have to spend almost all of the money on living expenses. As with the Denver Post, they used the current state of the job market as justification for the extension of benefits.
On the news that TARP could end sooner than expected in order to pay for the financial reform legislation, The Washington Post wrote a eulogy of sorts for the program, noting that its relative economic success may be obscured by its political unpopularity. They pointed to the modest cost of $105 billion of TARP and said that "it arguably saved the U.S. economy." However, they also said that there were many "TARP martyrs": Congressional incumbents who lost their seats partially because they voted for TARP.
The New York Times praised a bill in the House that would provide states with $10 billion to prevent teacher layoffs but said that the cost should not be offset by cutting $500 million from the Race to the Top program, which provides grants to states to implement school reforms. Although they said that preventing teacher layoffs was important, they thought that cutting a program that had spurred school reform plans in almost every state would be very counterproductive. They wanted Congress to find offsets elsewhere.
Last Friday, CBO released a report on 30 options for changing the Social Security system, analyzing both the savings and distributional effects of the options. After CBO released such dismal long-term budget projections last Wednesday (see our analysis here) showing that population aging is set to become the largest driver of entitlement spending through 2035, surely any real reform to our country's finances over the medium- and long-term must make changes to the largest single government program.
The report first focuses in the imbalance between projected revenues and outlays (actually, CBO even expects Social Security deficits to begin this year). While outlays are expected to increase from about 4.8% of GDP currently to 6.2% in 2040 and 6.3% in 2080, revenues are projected to mostly stay flat at around 5%. This leaves a program imbalance that grows from 0.3% of GDP in 2020 to 1.3% in 2040, staying in the 1%-1.5% range throughout the rest of the projection. The total imbalance over the next 75 years is 0.6% of GDP or 1.6% of taxable payroll.
In discussing the reform options, CBO groups the 30 Social Security options into five broad categories:
- Increases in the Social Security payroll tax
- Reductions in people's initial benefits
- Increases in benefit for low earners
- Increases in the full retirement age
- Reductions in COLA's that are applied to continuing benefit
CBO measures each option by how much of a change in the 75-year outlook an option would make, both as a percentage of GDP and payroll. They also find out when the trust fund would be exhausted under each option, but we generally find it more helpful to look at the cash flows of the program. This way, we can see the effects on the budget, as well as if gradually phased-in changes (such as changes in indexing) would put the program on balance when their effects start to accumulate.
It is also worth noting, as CBO does, that different changes to Social Security can affect the future economy in different ways and should be taken into consideration. As they note, raising taxes either through the existing FICA tax or by raising the tax cap would give workers incentives to shift more of their wages into tax-free fringe benefits, especially high income workers who have more flexibility in choosing their compensation. Considering that the excise tax enacted in the health care legislation was designed to do the opposite (or at least reduce the amount of fringe benefits taken in the form of health insurance), this incentive would probably be considered counterproductive. Additionally, CBO notes that benefit reductions might incentivize workers to save more for their retirement, and the increased savings rate would help economic growth. This case is especially true of middle- and high-income workers, which have more after-tax income to save in the first place.
The tax increases come in two forms: changes in the current payroll tax rate or changes in some way involving the FICA tax cap (set at $106,800 currently). CBO offers rate increases of one, two, and three percent, phased in at different rates. None of these options would eliminate the cash flow deficit, although the three percent increase would cut the 2080 cash flow deficit significanly, down to 0.2% of GDP. Eliminating the payroll tax cap without providing new benefits would eliminate the program deficits in the near-term but it would fail to completely close the gap in the years beyond 2040, raising a flat 0.9% of GDP through all those years. Raising the cap to $250,000 without providing new benefits would improve cash flow in 2080 by 0.6% of GDP, cutting the program deficit in half. A more politically realistic option (similar to one proposed by Rep. Robert Wexler) that would tax income above the cap at 4% would improve cash flow by 0.1% of GDP in 2080.
To understand the myriad of benefit reduction options, one must first understand exactly how Social Security benefits are calculated (the CBO report also explains it). Basically, the Social Security Administration (SSA) takes a worker's average monthly earnings over his top 35 earning years and indexes that for wage growth. This number is the AIME (average indexed monthly earnings). The number that SSA comes up with is used to determine the benefit, referred to as the Primary Insurance Amount (PIA). The PIA is determined in 2010 by multiplying the first $761 of the AIME by 0.9, then multiplying the next $3,825 by 0.32, then any amount after that minus the first $4,586 by 0.15 (see here for an example). The points where the multipliers change, $761 and $4,586, are referred to as "bend points" and the multipliers are referred to as "PIA factors." After the initial benefit is determined, SSA then indexes the benefits semi-annually based on price growth; these are "COLAs."
Because there are a lot of moving parts to the calculation of benefits, there are also many ways to reduce benefits, both initially and in the indexing of benefits thereafter. For reductions in initial benefits, CBO offered many options, whether it was increasing the number of earning years included in the calculation, reducing the PIA factors, changing the indexing of lifetime wages in the calculation of benefits, or indexing the PIA factors differently.
The biggest change from the initial benefits options came from the option to reduce the PIA factors by the amount of real wage growth. This would immediately start reducing benefits from current law (by 1.3 percent each year in CBO estimates). The change would improve the cash flow in 2080 by a whopping 2.6% of GDP and the savings would continue to grow over time. Such a drastic option is probably overkill though, and it would be politically unfeasible to cut benefits by 40 percent, which is what this option would do by 2080 relative to current law.
In fact, many of the big options that would eliminate cash flow deficits in one fell swoop are politically difficult. It is more likely that Congress will enact a combination of smaller options on both the revenue and benefit sides that together would put Social Security in balance. Here are some smaller options on the benefit side:
|Option||Improvement in 2080 Cash Flow (% GDP)||75 Year Improvement (% GDP)||75 Year Improvement (% Taxable Payroll)|
|Index AIME to Prices||0.5||0.2||0.5|
|Reduce Top PIA Factor By One-Third||0.1||0.1||0.2|
|Index Initial Benefits to Changes in Life Expectancy||0.6||0.2||0.6|
|Raise Normal Retirement Age to 68||0.2||0.1||0.4|
|Index Retirement Age to Life Expectancy||0.5||0.2||0.5|
|Base COLAs on Chained CPI-U||0.2||0.2||0.5|
|Increase AIME Computational Period to 38 Years||0.1||0.1||0.2|
CBO has done a good job of laying down the options here. Unlike Medicare, which is a more difficult and complex problem to solve, Social Security's options are clear and stir up less disagreement on the technical estimates of reform options. Most importantly, if we enact a plan now, the options can be less painful and they can be phased in more gradually.
After the Fireworks – The Independence Day celebrations have concluded. The fireworks have fizzled and most of us are back to work. Capitol Hill is quiet after its own pyrotechnics last week as lawmakers tried to finish work on some contentious issues before its recess this week. It failed to get many of its tasks fully completed as disagreements on how to fund legislation continued to bog down the agenda.
War Supplemental Still Smoking on the Grill – Congress had hoped to adopt a supplemental spending bill to fund operations in Afghanistan and Iraq before the Fourth of July, as requested by the Pentagon. But the debate over stimulating the economy in the short term and addressing the long term debt problem that is stalling much action in Washington has affected this bill as well. The House finally approved a bill late last week that in addition to the war funding adds some $21 billion in domestic spending. Although the additional money is offset, the bulk of the bill is not paid for. It is unclear if the Senate will approve of the House version next week amid concerns around some of the offsets in the House bill and growing debate over whether such spending should be undertaken at this time.
No Long Term Budget This Year – Like the adventurous father who prefers to load up the family car and take off for vacation without making reservations or mapping out a route, Congress has decided to forgo the customary multi-year budget blueprint for a one-year spending cap. Legislators could not agree on how to address medium term deficits and did not want to highlight the bleak long term outlook in an election year. The one-year discretionary limit was narrowly deemed by the House without any debate as part of the rule for considering the war supplemental. The Senate could conceivably choose a different limit, setting up an even more dysfunctional appropriations process than normal. This episode provides further proof that significant budget process reform will be required to deal with our longer term budget issues. The Peterson-Pew Commission on Budget Reform is working on a set of recommendations to release later this year.
Financial Overhaul Sees Finish Line – Financial regulatory reform needs at least one more dip in the pool to become law. Lawmakers thought they could get a bill before the president before the Fourth, but Senator Scott Brown (R-MA) and a few others raised questions about the bank tax used to offset the cost of the legislation. So negotiators axed the tax and replaced it with a combination of ending TARP early and using the savings towards financial reform along with increasing the fees larger banks pay to the FDIC Deposit Insurance Fund. CRFB has previously raised concerns about effectively double-counting TARP money.
White House Deficit Commission Listens to Public Comments – The President’s National Commission on Fiscal Responsibility and Reform held a wonky picnic and invited everyone to bring a dish last week. At its monthly public hearing commissioners heard comments from Americans on what to do to improve the fiscal picture. CRFB president Maya MacGuineas was one of those to testify.
CBO Rains on the Festivities – The nonpartisan Congressional Budget Office presented some gloomy numbers last week in its Long Term Budget Outlook. While it found that health care reform will help improve the long run budget picture, much more still needs to be done to put the country on a sustainable fiscal course. CRFB offered an analysis of the report here. CBO also released last week a report on options to improve the fiscal situation for Social Security as reform is being increasingly viewed as not only essential for its own long term sustainability, but for that of the federal budget as a whole.
Late last night the House passed a supplemental appropriations bill ostensibly to fund military operations in Iraq and Afghanistan. However, lawmakers supplemented the supplemental with plenty of funds that will never get anywhere near the Middle East.
Before adopting the legislation the House added more than $21 billion in domestic spending to the measure. This includes $10 billion to cash-starved states to stave off teacher layoffs, $1 billion for youth summer jobs, $4.95 billion for Pell Grants (see our take on that money here), around $4.5 billion to settle two class action lawsuits against the government and $701 million for border security.
The extra spending is offset through $11.7 billion in rescissions and $4.7 in projected savings through changes to mandatory spending programs. But it is not too hard to see some of those rescissions getting rolled back. The White House is displeased that $800 million has been rescinded from its signature “Race to the Top” education reform initiative, and has even threatened to veto the bill over it. Another $2 billion on the chopping block comes from the pandemic preparedness fund of the Department of Health and Human Services. There is no doubt that money would be quickly restored, likely as unpaid-for emergency appropriations, in the case of a pandemic.
The bulk of the bill’s cost is not offset, considered as “emergency” spending that is not subject to pay-as-you-go rules. CRFB previously has warned against treating the wars in Iraq and Afghanistan as emergencies and not budgeting for them.
In conjunction with the supplemental the House also passed it’s so-called “budget enforcement resolution.” While there was a great deal of debate over the war last night, there was no debate over the measure that will control how much the House spends in the next fiscal year. The deeming resolution, which was only released earlier in the day, was simply deemed as passed when the chamber narrowly approved the rule for debating the supplemental on a 215-210 vote. It sets a discretionary spending cap of $1.121 trillion for FY 2011. While this is $7 billion below what the White House requested in its budget, it falls far short of the traditional resolution that sets targets for at least 5 years and includes projections of future deficits.
There was a lot of song and dance last night, but not enough substance when it comes to fiscal responsibility.
As expected, the House came out today with its "budget enforcement resolution." What's the difference between a budget enforcement resolution and a traditional budget resolution? A lot of things, as it turns out.
The one blatant difference is that this resolution only applies to the House, whereas the typical concurrent budget resolution applies to both chambers. The Senate has yet to pass a counterpart resolution, although the Senate Budget Committee passed a budget blueprint in April. Another difference is that a typical budget resolution sets out spending and revenue levels for the next five years, as did the resolution adopted by the Senate Budget Committee. But the House resolution only deems the spending level that the Appropriations Committee must follow for one year. Setting out multiyear spending and revenue levels are essential to dealing with the medium- and long-term fiscal imbalances.
Granted, the resolution does set out a few medium-term goals, one good one and one extremely vague one. The former is the adoption of the White House fiscal commission's goal of primary balance (revenues equaling spending excluding interest payments) by 2015. The latter states that "the debt-to-GDP ratio should be stabilized at an acceptable level once the economy recovers." Of course, there has already been and will continue to be plenty of debate about what an "acceptable level" is and there is no date specified as to when this should be accomplished by. Once again, the lack of outyear budget numbers also hinders the ability to create a path to reach these goals.
On a side note, the resolution also states that the recommendations of the fiscal commission would be brought to a vote before the House and that any recommendations enacted would specifically be used for deficit reduction. This codifies the commitment House leaders have already made.
But overall, the relative lack of teeth of the resolution and lack of multiyear planning shows why passing a real budget resolution is needed. Without it, lawmakers will have a harder time finding a path back to fiscal responsibility. This underscores the need for a comprehensive fiscal plan now to implement as the economy recovers as well as budget process reforms to ensure that the plan stays on track.
CRFB just released its analysis of the long term outlook. The analysis noted that while the debt picture has improved somewhat under CBO's extended baseline scenario, there is still much work to be done to prevent debt from reaching unsustainable levels. CRFB has already commented on the outlook in the blog (see posts on the debt outlook and spending and revenue levels), and we will have more analyses throughout the next week, especially on the scoring of health care.
Erskine Bowles, co-chairman of the National Commission on Fiscal Responsibility and Reform, joined the Announcement Effect Club yesterday during the Commission's third meeting. Read Erskine's membership-affirming statement below:
We have to put forth a realistic plan, and if you put forth a realistic plan, people will believe it, and it will have a positive effect on the markets.
He also said "for that plan to be realistic, we have to be as specific as we possibly can," a statement we certainly agree with.
Bowles said that he didn't think any sort of cutback should happen until 2012 and that he thought we should be bolstering the recovery with more stimulus, so being part of the Club is not at odds with wanting to stimulate the economy. That is a point we can't stress enough. In fact, pairing short-term stimulus with medium-term deficit reduction is alot of what the Announcement Effect Club is about.
We're glad to have Co-Chairman Bowles on board.
This afternoon, CRFB President Maya MacGuineas testified before the National Commission on Fiscal Responsibility and Reform, offering several suggestions for the commission's work leading up to the December report. She argued that:
- The Commission needs both a medium- and long-term fiscal goal. (As we've argued for here)
- It's time to get specific.
- Focus on policies that are conducive to growth.
- Process reforms can be used to both help force changes and enforce a plan.
In the vein of getting specific, MacGuineas offered her own specific plan on how to stabilize the debt at 60 percent of GDP by 2018, proposing a package of $650 billion in savings in 2018. Included were savings from revenue changes, defense, Social Security, health care, and some other discretionary changes. Click here to read her testimony and see her plan.
As for her last point, the Peterson-Pew Commission on Budget Reform is currently working on its second report focusing on comprehensive budget process reform. Stay tuned for its release this fall.
After much anticipation, the CBO has released its Long Term Budget Outlook, which gives the first glimpse at the long-term effects of the recently-enacted health care legislation. In the report, which was released at the third meeting of President Obama's fiscal commission, the extended-baseline scenario (current law) shows drastic improvement from last year's outlook, but the alternative scenario, which is composed of policies more likely to occur, shows a shocking amount of debt.
First, the good news. The extended baseline scenario shows health care spending coming down from levels in the 2009 outlook. By 2083, health spending is about 2 percent of GDP lower than it was projected last year. This decrease is due to both the effects of the health care legislation and to a methdological change by CBO in which they assume lower health cost growth.
Total spending in 2083 is about nine percentage points lower in the 2010 extended baseline outlook compared to last year. About 85 percent of that drop is due to a decrease in spending on interest, which stems mainly from drastically higher revenues that hold debt down compared to the 2009 outlook. Revenues were projected to reach about 26 percent of GDP by 2083 in the 2009 outlook, but this year's outlook projects revenues to reach 30 percent mostly due to tax increases in the health care legislation. The higher revenue obviously decreases the debt, which significantly decreases interest paid on the debt.
Ironically, the biggest driver of the decreased spending in the 2010 extended baseline scenario is higher taxes.
|Spending Category||Extended Baseline Scenario (% GDP)||Alternative Fiscal Scenario (% GDP)|
Now the bad news.
While the extended baseline presents a much rosier scenario compared to last year, the alternative scenario paints a fiscal nightmare. Debt held by the public threatens to break into the quadruple digits (though we would surely never get there), and spending on interest takes up more than half the entire budget by the end of the outlook.
The alternative fiscal scenario assumes that the 2001/2003 Bush tax cuts are made permanent, the AMT and Medicare physician payments continue to be patched, and most importantly, the Medicare spending cuts and slowing of the growth rate of the health insurance subsidies do not occur after 2020.
Under this scenario, primary spending is at 35 percent in 2083, only about 3.5 percentage points higher than current law. However, interest spending is at an astounding 45 percent of GDP, meaning we will be paying more to our creditors than for every government program combined. This leaves total spending at an unbelievable 80 percent of GDP. Revenues don't contribute to debt reduction in this scenario because CBO assumes that lawmakers will change the tax code to keep them at a constant 19.3 percent of GDP after 2020.
The main lessons to draw from this report is that there is still serious work to be done on the spending side. We must be vigilant to make sure health are cost-cutting measures stick, and we will also need to raise sufficient revenues. Even under the rosy scenario of current law, debt is above 100% of GDP and government is spending is 37 percent of GDP. Those levels are well above historical averages and approaching records. Also, it is unlikely that lawmakers would have the political will to raise anywhere close to 30 percent of GDP in revenues to keep the debt in check. The long term outlook underscores that we have to get to work now to solve our future fiscal problems.
This morning, CBO Director Doug Elmendorf released CBO's long-term outlook at the third public meeting of The National Commission on Fiscal Responsibility and Reform. The commissioners are also holding a public listening session right now. We will provide more information on the long-term outlook after it comes out.
Beginning at 9:30, you can watch the video here:
CBO’s Long Term Budget Outlook, released today (see our press release here), paints a more alarming picture of the U.S. debt path than had been previously expected. Under its extended-baseline scenario—assuming the closest approximation of current law to continue in the future—CBO’s 2009 Outlook predicted that our debt held by the public would hit 56 percent of GDP in 2020, and would skyrocket to 128 percent by 2050. Its 2010 revised baseline scenario shows debt-to-GDP at 66 percent by 2020—surpassing the commonly-considered 60 percent sustainable debt level—and reaching 90 percent by 2050.
Yet even more alarming are the numbers predicted under CBO’s alternative fiscal scenario, which is generally considered to be a more likely picture of our future fiscal path, and includes the extension of various tax provisions and other programs set to expire soon. The 2009 Outlook predicted that our debt held by the public would hit 87 percent of GDP by 2020 under these projections, and would more than triple to a whopping 321 percent by 2050—far, far beyond any common benchmark of sustainability. But 2010’s outlook seems even worse: we are now expected to hit the 100 percent of GDP mark by 2023, only a little over a decade from now, and in 2050, our public debt will be almost 350 percent of GDP. In 2084, CBO projects our debt to reach an unfathomable 947 percent.
CBO’s report reflects the importance of acting soon to change the prospects for our fiscal future. With these projected numbers rising year after year while we stay on our current fiscal path, it is clear that we should expect the debt to rise exponentially in the coming decades as well. Unless something is done soon to adjust our growing deficit, it will reach critical and unmanageable levels. It will become harder year after year to return to a sustainable path, and it is thus critical to act now.
Watch for CRFB’s more detailed analysis of CBO’s report soon.
The CFR has a paper out called "How Dangerous is US Government Debt?", looking at the possibilities of a spike in interest rates in the future. They noted that there were many domestic factors that pointed to such possibility, and potential volatility with regards to foreign inflows.
On the domestic front, they talked about the deterioration of short-term/medium-term fiscal outlook. In particular, they brought up an analysis by Thomas Laubach that linked each percentage point increase in the projected deficit-to-GDP ratio to a 0.25 percent increase in "longer-term" interest rates. If you combine that correlation with the current deficit projections, CFR claimed that the fiscal situation would lead to a one percentage point increase in long term rates.
Otherwise, they noted that the Federal Reserve has been purchasing long-term Treasury securities since March 2009, a move that has helped ease the enormous strain that the current huge deficits have had on the Treasury markets. Although these purchases appear to have no sign of slowing down soon, when the Fed does pull out, it will put extra pressure on the bond markets. Another factor that could put upward pressure on long term interest rates is inflation expectations, which were on a "post-crisis upward march" and which they expected to accelerate once the recovery got a stronger hold.
In terms of foreign inflows, obviously the US is very much dependent on them to finance its public sector debt. Currently, foreigners own about half of all Treasuries, so a move away from bonds could mean significant increases in interest rates. The CFR said that the US got a bit of good luck with the timing of the European financial turmoil, since foreign inflows were headed clearly in the direction of the eurozone and away from the US before then. According to CFR, the eurozone crisis, and the flight-to-quality that followed, might just be masking an underlying lack of confidence in US debt like the one we saw in early 2009.
Finally, they warned that this "respite" might be an excuse to run up the debt even further. That obviously should not be the case. Regardless of where the market is this moment, we should develop a plan to deal with our debt in the medium-term. And no, this is not saying we should cut back now while the economy is weak, just because bad things might happen if we don't. We're saying the US should try to minimize the chance that interest rates could jump in the future by cutting back when the economy has recovered. Low interest rates are no excuse not to act.
Major legislation reforming the financial regulatory process hit a snag today as Senator Scott Brown (R-MA) said he would not support the bill because it relies primarily on a $19 billion levy on large financial institutions and hedge funds to pay for its costs. At least a couple of Republicans will need to vote for the bill in order to overcome a Senate filibuster and Brown was one of the few GOPers to vote for a previous version of the measure.
It looks like, once again, the matter of offsets has, at least temporarily, derailed major legislation. Leaders in Congress will have to reopen the House-Senate conference process to consider changes to the bill. One option being discussed is to replace the bank tax with bringing the Troubled Assets Relief Program to an early conclusion. Terminating TARP ahead of the scheduled October 3 end date could save $11 billion to use towards the financial overhaul, but we oppose the use of this since it is essentially double-counting savings. A better option is to institute another increase in the fees banks pay to the FDIC.
Congress is still feeling its way through this whole paying-for-legislation thing.
Extenders Put on Hold – Legislation to extend some tax breaks and expanded unemployment insurance has been put on the back burner because senators could not agree on how to finance the package. Senate leaders decided to move on after they failed to end debate on the latest version in a 57-41 cloture vote.
Temporary “Doc Fix” Makes it Through – Congress did manage to enact a fully paid-for extension of the so-called “doc fix” that delays a 21 percent cut in Medicare payments to physicians until the end of November. The measure was broken out from the extenders bill after it became apparent that agreement could not be reached on the larger package.
Appropriations Begins – The appropriations season began last week with the first spending bill clearing a subcommittee. The Homeland Security appropriations bill was marked up for the full House Appropriations Committee. As we pointed out last week, conditions could cause the process to be even more unwieldy than usual. Many of the measures could wait for a lame duck session after the November elections.
No Budget Blueprint This Year – Leaders in Congress finally confirmed last week what had been long expected, that there will be no budget resolution this year. They will instead opt for what they are calling a “budget enforcement resolution” that will “deem” spending caps for one year, not the five year blueprint that the budget resolution usually provides. The lack of a resolution underscores the need for serious budget process reform.
Decisions Loom for War Supplemental – With the Pentagon pressuring Congress to provide funds to continue operations in Afghanistan and Iraq ASAP, leaders must decide what else they will try to attach to the bill. Such must-pass legislation often attracts riders and House leaders are considering adding $10 billion to prevent teacher and other public employee layoffs and nearly $5 billion for Pell Grants. As has been pointed out, the Pell Grant money may be important, but it is not an emergency as the fund has enough to cover expenses for the coming school year. In the quest to avoid offsets, leaders are playing a game of chicken with our troops.
Unbeknownst to the public, Olivier Blanchard and Carlo Cottarelli ascended Mt. Sinai at some point earlier this year. Last week, they came down with the Ten Commandments for Fiscal Adjustment. In their IMF blog post, they make recommendations for how G-20 countries can have successful and productive fiscal consolidations. The commandments are below:
Commandment I: You shall have a credible medium-term fiscal plan with a visible anchor.
Commandment II: You shall not front-load your fiscal adjustment, unless financing needs require it.
Commandment III: You shall target a long-term decline in the public debt-to-GDP ratio, not just its stabilization at post-crisis levels.
Commandment IV: You shall focus on fiscal consolidation tools that are conducive to strong potential growth.
Commandment V: You shall pass early pension and health care reforms as current trends are unsustainable.
Commandment VI: You shall be fair. To be sustainable over time, the fiscal adjustment should be equitable.
Commandment VII: You shall implement wide reforms to boost potential growth.
Commandment VIII: You shall strengthen your fiscal institutions.
Commandment IX: You shall properly coordinate monetary and fiscal policy.
Commandment X: You shall coordinate your policies with other countries.
Commandments I and III are especially central to CRFB's message, and we are working on VIII with the Peterson-Pew Commission on Budget Reform. Commandment II is an important one in the context of the current debate about the timing of cutbacks, and the two took a page out of the Announcement Effect Club when they said "while front-loading fiscal tightening is, in general, inappropriate, front-loading the approval of policy measures...will enhance the credibility of the adjustment." Interestingly, they also took a page out of Paul Krugman's book with the ninth commandment, stating that "if fiscal policy is tightened, interest rates should not be raised as rapidly as in other phases of economic recovery."
However, the crux of the success of fiscal adjustments will be in Commandments IV-VII. Unfortunately, these commandments can sometimes conflict with each other. Generally, economists agree that spending cuts are less harmful to economic growth, which complies with the fifth commandment, but may violate the sixth. Also, the seventh commandment, which emphasizes the promotion of investment, may require new spending or tax cuts that would be at odds with a fiscal consolidation plan. The fifth commandment is an absolute must, but how they do it requires walking a tightrope between growth and equity. Either way, the IMF's Ten Commandments show that HOW you consolidate is important along with IF you consolidate.
In his Sunday Wonkbook post, Ezra Klein highlighted CRFB’s Stabilize the Debt interactive online game, which allows visitors to pick and choose for themselves the policies and programs to cut in order to balance the budget and reduce the federal debt at 60 percent of GDP.
The national debt and how it should be reduced is a topic too easily weighed down by complex and confusing vocabulary, and Klein says that the Stabilize the Debt game helps to clarify and “bring discipline and realism” to a persistently difficult-to-answer question. “’Debt' isn’t a buzzword, it’s a math problem,” says Klein, and the Stabilize the Debt game can help us learn how to solve it. Thanks, Ezra.
Ezra’s column addresses the magnitude of the changes necessary to bring our debt to a sustainable level, the same changes we illustrate in the interactive game on our (according to Ezra) “sexed up” website. We encourage everyone to check it out for themselves at http://crfb.org/stabilizethedebt.
The declaration from the G20 meetings in Toronto this past weekend sounds, at first, to be taking a strong stance on fiscal consolidation.
“There is also a risk that the failure to implement consolidation where necessary would undermine confidence and hamper growth. Reflecting this balance, advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016.”
Ok, that sounds pretty good, but wait a second. Halve deficits? This is that old game started in the Bush years and taken up by the Obama administration of halving something from a completely nutso starting point and calling it a victory. It’s like setting a goal of losing half your pregnancy weight.
The projected deficit for 2010 is 10.3% of GDP. It would drop to 4.5% by 2013 under the President’s budget. Under a current law scenario, it is projected to be 3.1% of GDP that year—so significantly better. Economic improvements alone are easily expected to cut the deficit in half by 2013 – this requires no change in policy in the U.S. So not exactly a heavy lift.
But then again, what happens in 2013 is probably less important than thereafter. The goal of stabilizing the debt by 2016 is a big deal. Keeping the debt-to-GDP ratio stable requires that the long-term deficit problems—driven by healthcare costs and aging—are addressed. You can’t get there any other way. This would be a huge accomplishment.
Not allowing the debt to grow faster than the economy is necessary to get control of the situation, as is getting debt levels back down to a manageable level where fiscal flexibility is preserved. We have recommended 60% by 2018 and lower thereafter. Anything higher would leave the U.S. without the fiscal firepower to respond to future crises.
As we have said before, we need both a medium-term goal and a long-term goal, both of which are included in the G20’s Declaration this weekend.
An important question is whether these G20 targets are credible. President Obama did not emphasize the fiscal targets in his remarks, and his administration is currently more focused on stimulus measures than specific measures to get the budget under control. But there needs to be a credible commitment to budget reform to reassure financial markets and keep our interest rates from rising. Also, given the political environment, it appears there will be little appetite for further stimulus measure unless important measures are taken that will get the debt under control.
The best path forward—something recognized in the G20’s Declaration—is an emphasis on necessary short-term stimulus along with putting in place medium-term budget plans. The U.S. needs to focus on both. Rather than pairing back stimulus measures, the key here is to craft effective short-term stimulus while putting in place the medium-term budget changes. Other countries are ahead of us on this piece, and the U.S. should step up the emphasis on policy changes to get the budget under control. Without growth and a credible consolidation plan, our fiscal situation will remain precarious.
Here they go again. As they have for years, lawmakers are attempting to tuck billions of dollars for unrelated programs into the war supplemental spending bill. The House version of the $61.5 billion appropriations bill, likely to go to the floor this week, contains funding for a variety of non-war programs, including some $5.7 billion for the Pell Grant program.
As our New America Foundation colleague Jason Delisle recently pointed out, education advocates view this funding as crucial because Pell funding provided under the American Recovery and Reinvestment Act of 2009 soon will be depleted. If the funding is approved, Congress would only have to provide $17.5 billion in Fiscal 2011 rather than $23.2 billion to keep the maximum grant funded at $5,550 for future years. It should also be noted that the Pell Grant program is in surplus right now due to a supplemental $13.5 billion appropriation in the Health Care and Education Reconciliation Act signed into law in March. Given this funding surplus, there is no need to fund the Pell Grant as an emergency – there is absolutely no risk that a student would be denied his or her Pell Grant under the maximum award level of $5,550 for the 2010-11 academic year.
It appears that it's business as usual on Capitol Hill. War supplementals often are considered must-pass bills, so members hang unrelated funding they consider essential onto the bills. In addition, providing funding for Pell in the supplemental would loosen up more money in the upcoming Labor-Health and Human Services-Education appropriations bill--another favorite practice. The Pell charade has gone on for years. Congress divides up money for the program among several spending bills and does not fund Pell where it should be funded--in the Labor-HHS-Education appropriations measure. However, some members are complaining about the overall cost of the bill and the cost of the war effort, so the fate of the measure remains somewhat unclear. Domestic spending in the bill may be considered in separate legislation.
Meanwhile, is it any wonder that the federal debt continues to soar? Congress continues to use backdoor funding to pay for priorities. If the Pell program is the priority it appears to be, it should be funded through the normal appropriations process. At the very least, if money is to be included in a supplemental, offsetting cuts should be found elsewhere. CRFB warned previously of slipping in programs in the stimulus that are intended to be permanent, now we are sadly seeing that come about.
This is another instance of the failure of the budget process. That is why the Peterson-Pew Commission on Budget Reform is studying the process and will issue recommendations for an improved budget process later this year.