The Bottom Line

November 2, 2010

Our Stabilize the Debt budget simulator, which allows users to try their hand at deficit reduction, has become an important tool for understanding the magnitude of our fiscal challenges and considering potential solutions. We recently worked with the Dallas Morning News in encouraging its readers to try their hand at our simulator and in analyzing the results of those who voluntarily submitted their choices. The results were quite interesting.

From early August to early September we had 823 separate attempts (from 758 different e-mail addresses) from Dallas Morning News readers using a special link to the simulator. Sixty percent of those respondents were able to reach the Peterson-Pew Commission recommended goal of 60 percent debt-GDP by 2018. Overall, there was broad support for raising the Social Security retirement age (74 percent), less support for raising the eligibility age for Medicare (60 percent) and disagreement on defense cuts and what to do on the revenue side.

Democratic and Republican respondents both favored eliminating earmarks and outdated programs. Democrats were more in favor of some specific weapons cuts such as missile defense systems, while Republicans were in favor of extending most, if not all, of the 2001/2003 tax cuts.

This exercise involves very tough choices. Getting rid of earmarks and outdated programs alone will not solve our fiscal problem. The article summarizing the results of the exercise notes:

One big lesson is that cutting the deficit solely through tax hikes, or solely through spending cuts, makes the task particularly challenging. The better solution may require both.

As CRFB President Maya MacGuineas says in the article, "The less likely people are to support revenue increases, the less likely they are to get to the goal." And with regard to spending, "Don't think about earmarks, think about reforming entitlements. Think about energy taxes and discretionary spending freezes, instead of clinging to the hope that we can all make this magically go away."

The lessons learned from the exercise can be helpful to policymakers who campaigned on reducing the budget deficit. Schools and other groups are using the simulator as a tool for education and conversation. Try it yourself, and get your friends to try it and compare results.

November 1, 2010
Questions to Ask the Candidates

The Bottom Line today concludes its blog series highlighting our Ten Questions to Ask the Candidates on fiscal responsibility.

9. Rejecting Pledges. Rather than saying what you would not do, will you focus on what you would do to fix the problem? Committing to pledges—whether to oppose tax increases, or not to touch Medicare or Social Security benefits—reduces lawmakers’ ability to properly evaluate solutions and budget tradeoffs and govern effectively. No candidate should make promises about what solutions should be “off the table” without explaining how they would fix the problem.

A common tactic on the campaign trail is to get candidates to sign pledges. In this election familiar pledges have involved promising not to raise taxes or cut Social Security benefits. Such pledges are not constructive in finding solutions to our fiscal challenges; on the contrary, taking possible solutions off the table poisons the collaborative process. Instead of promising what they won’t do, candidates should be encouraged to stress what policies they could support.

10. Considering Proposals from the Fiscal Commission. When the White House Fiscal Commission makes its recommendations, will you consider the proposals and suggest alternatives for those you do not support? The fiscal commission has been tasked with developing a plan to fix the nation’s fiscal problems, to be released in early December. The recommendations can be the first step in a national dialogue about how to fix the nation’s budget problems. Lawmakers must help the process by either supporting the Commission’s ideas or proposing alternatives that would be at least as helpful in reducing the national debt.

The White House created the National Commission on Fiscal Responsibility and Reform earlier this year to identify policies “to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run.” The bipartisan panel is charged with presenting recommendations for Congress to consider by December 1. Since its inception many special interests have derided the commission and tried to prevent it from considering various options. The fiscal commission represents an opportunity to address our fiscal challenges in a thoughtful, bipartisan manner. Any recommendations presented by the commission should be seriously considered by policymakers.

Make sure you vote tomorrow if you haven’t already. Information on your voting location can be found here.

November 1, 2010

Tricks and Treats Not Done Yet – Halloween was celebrated last night and Election Day is tomorrow. Which day is scarier likely depends on your political view, but Tuesday will be filled with plenty of tricks and treats for political junkies. The election results will significantly influence the fiscal policy agenda.

Really Scary Times Could Be Ahead – With Republicans poised to gain a significant number of seats in tomorrow’s mid-term election, the likelihood of confrontation in Washington over the budget is greatly increased. Some are already suggesting a government shutdown in order to push for deeper federal spending cuts. A more perilous showdown could occur over raising the debt limit next year. According to CQ (subscription required) House Republican Whip Eric Cantor (R-VA) last week called for an up or down vote on increasing the limit when the time comes, which will probably be in the middle of next year, and suggested that his caucus would want to see major progress on spending cuts and deficit reduction before supporting an increase. Failure to increase the debt limit would likely lead to a U.S. default and could trigger a financial crisis.

Fiscal Issues a Big Factor in Mid-Term Elections – There is no denying that fiscal policy has been a key focus during this campaign season. The deficit/debt has consistently ranked just behind the economy/jobs as the top issue for voters in polls. Federal spending and taxes are primary talking points for candidates. Whether that focus will result in more fiscal responsibility in Washington and solutions to our fiscal challenges remains to be seen. CRFB provided 10 Questions to Ask the Candidates on fiscal responsibility in order to move beyond the campaign rhetoric towards discussing solutions. Don't forget to vote tomorrow if you haven't already.

More Are Getting Specific – Last week saw more specific ideas for reducing our fiscal imbalances. The National Taxpayers Union and U.S. Public Interest Research Group teamed up on a proposal that would save around $600 billion by 2015. The Heritage Foundation followed suit by detailing some $343 billion in spending cuts that could be enacted in the coming fiscal year. CRFB has said it’s time to get specific, hosting an event in September highlighting specific ideas and releasing detailed proposals for health care, Social Security, and tax expenditures, with more to come. CRFB president Maya MacGuineas also devised a fiscal plan with Bill Galston of the Brookings Institution.

Lame Duck on the Menu After Election – Congress will convene for a lame duck session starting November 15 that will address several pending fiscal issues, including the expiring 2001/2003 tax cuts, extensions of expired tax breaks like the research and development tax credit, and FY 2011 federal funding. On the tax cuts, Senator John Cornyn (R-TX) hinted there may be room for compromise that extends all the tax cuts temporarily and the White House reportedly is considering a permanent extension of the tax cuts for families making less than $250,000 and a temporary extension for those above the threshold. 

Some Intel on Intelligence Funding – Last week the federal government disclosed that just over $80 billion was spent on intelligence in FY 2010, a more complete accounting than is usual for the intelligence budget. This comes as the two chairs of the committees overseeing the intelligence community in Congress signaled they will target the intelligence budget for waste and duplication, looking for significant savings.

November 1, 2010

The Heritage Foundation recently came out with a detailed paper with over $300 billion in spending cuts that can be put in place in FY 2012. Their proposal is broken up into six general categories: eliminating federal programs so the task can be taken up by the states, consolidating duplicative programs, privatizing some government functions, aligning spending programs more closely with national priorities, eliminating outdated and ineffective programs and eliminating waste, fraud and abuse. Breaking their proposals up further, they go into direct government departments from Agriculture to Justice to Veteran’s Affairs.

The following are their proposed cuts with their projected savings amounts.

Proposal
Spending Cut ($ Millions)
Agriculture 19,500
Commerce 500
Community Development 8,000
Energy and the Environment 11,800
Government Reform 91,800
Health Care 16,600
Homeland Security 2,700
Income Security 500
Interior 1,700
International 4,000
Justice 7,800
Labor 6,800
National Science Foundation 1,800
Transportation 48,600
Treasury 26,700
Veterans 4,400
Cross-Agency and Other 80,600
Total 343,000

Note: Figures may not add up due to rounding.

Some of their proposals, since they rescind money going to the states, would put additional pressure on cash-strapped states if they keep the programs funded. This is not to say that some of the programs should not be cut, but a reminder that devolving is not so much a money-saver than a funding-shifter. Some of the programs that Heritage poposes to devolve to the states are eliminating most homeland security grands to the states ($2.7 billion), eliminating many justice grants to the states ($7.3 billion) and devolving transportation funding ($45 billion).

The Heritage plan joins a growing list of specific deficit reduction plans--see here, here, here and here for others and try our budget simulator. We are glad to see more groups getting specific and hope that more policymakers will join the trend.

October 31, 2010
Questions to Ask the Candidates

The Bottom Line presents the next installment in our series highlighting our Ten Questions to Ask the Candidates leading up to Election Day.

7. Controlling Health Care Costs. Will more have to be done to control federal health care costs? If so, what? Health care costs remain the biggest threat to our fiscal health in the long run and are set to continue growing faster than the economy. The Congressional Budget Office projects direct federal health care costs will total 9.7 percent of GDP by 2030 and 13.7 percent by 2050.

Health care costs are a key driver behind our bleak fiscal outlook. The recently enacted health care reform bill may be a start, but the Congressional Budget Office has analyzed the law and still finds that health care costs will continue to spiral upwards, driving up our long term debt through increased costs in Medicare, Medicaid, Children’s Health Insurance Program and other federal health programs such as TRICARE (a military health program).

Pointing to the health care reform law is not enough of an answer for a candidate on this question. It alone will not slow the spiraling growth rate of health care costs, nor will repealing the law fix the problem. A candidate must therefore give a full and credible plan to address this crucial issue. Political slogans will not work. See our health care reform proposal here.

8. Raising Taxes. Will we need to raise taxes to gain control of the federal debt? If not, and you think it can be done all through spending cuts, which ones? It is very difficult to lay out a credible deficit plan that would not increase taxes. It is also very difficult to develop a comprehensive plan that would not raise taxes on families making less than $250,000 per year. If a candidate is willing to raise taxes, which ones? If not, what spending cuts would they support instead? Tax expenditures, the tax breaks that are often narrowly targeted and benefit relatively few taxpayers, also must be addressed. They are spending by another name; with little oversight by policymakers or analysis of their effectiveness.

No one wants higher taxes. Yet any candidate that proposes to close our enormous fiscal gap without raising revenues must detail the massive spending cuts required. The Center for American Progress has put together a report entitled “A Thousand Cuts” which illustrates the magnitude of the cuts required if taxes are not increased. Even so, they used tax expenditures to cover part of this plan.

Tax expenditures are little more than spending programs labeled as tax breaks. They are designed so that targeted groups have more money in their pockets if they meet certain criteria. They function no differently than spending in their incentives, yet receive little Congressional oversight or analysis of their benefits. This year alone, the federal government lost over $1 trillion in revenue due to tax expenditures. Broadening the tax base and simplifying the tax code by reforming these programs would contribute significantly to improving our budget outlook. See our ideas for reforming tax expenditures here.

October 30, 2010
Questions to Ask the Candidates

The Bottom Line continues its blog series highlighting our Ten Questions to Ask the Candidates ahead of the mid-term elections.

5. Strengthening Social Security. Do you believe that Social Security is in financial trouble? If so, what should be done to strengthen it? The Social Security Trustees’ most recent report says that Social Security will run a cash-flow deficit of more than $40 billion this year, $100 billion by 2020, and more than $450 billion by 2030. As the Trustees state, “The projected trust fund shortfalls should be addressed in a timely way so that necessary changes can be phased in gradually and workers can be given time to plan for them. Implementing changes sooner will allow the needed revenue increases or benefit reductions to be spread over more generations.”

Social Security is the largest program in the federal government. Every candidate running for office should have an understanding of this program, its problems, its strengths and a plan to strengthen its long-term finances. We cannot afford to ignore the tough choices needed to ensure the sustainable solvency of this essential program.

It is not enough to promise solvency over the standard 75-year period. Voters should ask of any plan, what happens after the 75th year? CRFB advises a focus on cash flow--any reform plan must eventually bring revenues and expenses in line. See CRFB's proposals for Social Security reform here.

6. Finding Savings in Defense. Do you think we should pay for any additional war costs by cutting other programs or raising taxes, instead of continuing to borrow to fund them? Do you believe that defense cuts should be one way to decrease the federal debt? This is the only time in our nation’s history when we have not increased taxes during a prolonged war. Thus far, approximately $1 trillion has been appropriated for military operations in Iraq and Afghanistan. Total defense spending was $692 billion this year, or 4.7 percent of GDP. This spending is a post-World War II high when measured in constant dollars.

Defense and security spending represent around 20% of the budget. The Sustainable Defense Task Force has come out with a plan that would achieve nearly $1 trillion in defense savings. The report and efforts by Defense Secretary Gates underscore the point that there is significant savings to be found in defense without threatening U.S. security. As we have stated previously, “done thoughtfully and prudently, changes to the security budget can lead to significant savings in the nation’s budget.”

October 29, 2010

Yesterday was a big day for getting specific as the National Taxpayers Union and the United States Public Interest Research Group, as well as the Heritage Foundation, came out with their own specific fiscal plans!

The NTU/USPIRG report offers a specific plan to cut $600 billion by 2015. This plan goes beyond the low-hanging fruit and tackles important areas like tax expenditures, Medicare and defense.

This plan is also noteworthy in that it brings together two organizations that often don't see eye-to-eye in supporting specific proposals to stabilize our national debt. Not only does the proposal offer hope that specific ideas can be put forth and debated, but that it can be done in a bipartisan manner. The report uses ideas from a variety of sources such as the Congressional Budget Office, the Joint Committee on Taxation and the Government Accountability Office. Their plan focuses on four main areas; eliminating wasteful spending, improving contracting and assets acquisition, improving government operations and addressing outdated or ineffective military programs.

Their plan offers the following proposals:

Plan

Savings by 2015  ($  millions)

Eliminate the Overseas Private Investment Corporation 154
Eliminate the Market Access Program 1,000
Eliminate subsidies to trade assocations for marketing abroad 175

Eliminate subsidies to "big agribusiness"

35,497
Eliminate refundable tax credits for ethanol 22,640
Eliminate insurance subsidies for repeatedly-flooded homes 891
Eliminate ultra-deepwater natural gas and petroleum research program 158
Reduce funding for public timber sales that lose money 279
Sell Southeastern Power Administration and related assets 1,220
Implement acquisititon reforms identified by Defense Acquisition Panel 135,000
Eliminate 32 already-identified wasteful Department of Homeland Security projects 34,300
End orders for obsolete spare parts and supplies for the Defense Logistics Agency 35,500
End orders for obsolete spare parts and supplies for the Army 18,000
End orders for obsolete spare parts and supplies for the Navy 37,500
End orders for obsolete spare parts and supplies for the Air Force 93,500
Remove ceiling on the collection of overpayments for the SSI 580
Reduce by 25 percent the backlog of federal-owned buildings "not utilized or underutilized" 24,000
Recalibrate Medicare payments to cover actual costs for its graduate education program 20,500
Recalibrate Medicare reimbursement rates in high-cost regions 11,700
Eliminate overpayments for housing subsidies 4,480
Eliminate the Leveraging Educational Assistance Partnership 272
Return unallocated funds from TARP 15,000
Eliminate National Drug Intelligence Center 223
Cancel production of the V-22 Osprey 6,164
Cancel F-35 Joint Striker Fighter and replace with cheap and reliable alternatives 22,500
Alternativly, reduce F-35 procurements by cancelling Navy and Marine Corps Joint Striker Fighters 7,400
End spending for high-risk satellites and replace with lower cost alternatives 5,000
Align nuclear arsenal with current needs and threats 56,750
Cancel Expendtionary Fighting Vehicle 16,309
Change military depots' pricing structure for repairs to be more cost effective 1,030
Total 600,322

 

The Heritage Foundation also came out with a spending cut program of their own. This plan details over $343 billion in spending cuts that can be implemented this coming fiscal year. We will analyze their proposal in a separate blog.

Overall, we commend NTU, US PIRG and the Heritage Foundation for following our Let's Get Specific call and coming out with specific ideas on fiscal responsibility. The more realistic plans introduced by credible organizations designed to fix our budget, the better. For a comparison, see Congressman Paul Ryan’s Roadmap, Esquire’s own plan and CRFB President Maya MacGuineas and Bill Galston’s plan. And devise your own plan using our budget simulator.

October 29, 2010
Questions to Ask the Candidates

Continuing in our discussion of (what we believe to be the most important!) Ten Questions to Ask the Candidates leading up to this coming Tuesday's mid-term elections, let's take a look at questions 3 and 4.

3. Paying As You Go. If you support new spending programs or tax cuts, will you offset the costs so they don’t add to the deficit? The current pay-as-you-go requirement has so many exemptions it still will allow trillions of dollars to be added to the debt. But the principle is still an important one in budgeting, and should be strengthened. Candidates who suggest new spending programs or tax cuts need to specify how they would pay for those policies so they don’t add to the deficit.

As we've said many times before, current PAYGO rules have loopholes so big you could fly a jumbo jet through them. These exemptions include:

  • The costs of any extension of the 2001/2003 tax cuts for individuals and couples earning less than $200,000 and $250,000, respectively, for the next 10 years from having to be paid for.
  • The costs of an extension of the 2009 estate tax parameters.
  • The costs of annual freezes in Medicare payments to physicians, or "doc fixes", through 2014, which are scheduled to drastically decrease under current law.
  • The costs of annual AMT patches through 2011.
  • The costs of legislation deemed as "emergency" requirements by Congress.

These exemptions could add trillions to the debt, and policymakers need to do better. PAYGO rules are an important principle to abide by and proved to be helpful in leading to budget surpluses during the late 1990s. Lawmakers must have specific proposals for how they would pay for, over the medium-term, any new spending increases or tax cuts.

4. Extending the Tax Cuts. Do you support extending some or all of the tax cuts? Permanently extending all of the expiring 2001/2003 tax cuts, along with continuing to patch the Alternative Minimum Tax, would cost nearly $4 trillion over the next ten years. Even allowing the tax cuts for families making over $250,000 to expire, as the President has proposed, would still increase the deficit by over $3 trillion over the next ten years. The director of the non-partisan Congressional Budget Office recently testified that financing the extension of the tax cuts through borrowing would crowd out private investment, damaging the economy by as much as 11 percent of GNP by 2040.

Representing the largest portion of PAYGO exemptions, what to do with the upcoming expiration of the 2001/2003 tax cuts at the end of this year will be a critical question in coming months. As we've written about here, any non-paid for extension of the tax cuts--whether full, partial, permanent, or temporary--will negatively affect the economy by the end of the decade, despite the short-term benefits.

Let's hope the candidates are taking note of these important issues, and we encourage them to be specific about what they support.

October 29, 2010

Fixing the Nation's Four-Tranche Universal Health System

U.S. citizens soon will be participating in a four-part, nearly universal, health care system. Medicare, Medicaid, employer-provided health, and the new exchange insurance policies all come with different government subsidies. Medicare is tied to age or disability and provides roughly the same amount of insurance to all recipients. Medicaid (and a related children's health insurance program) also provides more or less equal coverage to all who get it, though it pays providers less for that coverage and, cliff-like, often cuts off beneficiaries who cross an earnings line. Subsidies for employer-provided health insurance are largest for those with the highest incomes and the most expensive policies. Meanwhile, the new exchanges created under health care reform would phase out subsidies for households as their income increased.

I find myself in that minority that is uncomfortable with both sides of the current health care debate. I support a more universal health care system but think this four-stream subsidy system is unworkable and unfair. I don't want to go back to having tens of millions of uninsured people, and that could happen if some Republicans fighting health reform prevail by simply restoring the former three-tranche system. But it doesn't help when some Democrats put all their political eggs in the new, still-unworkable exchange subsidy basket.

Both would be taking paths to dead ends—no surprise since neither party is looking hard at the whole crazy quilt system we have created, much less at how the numbers add up, how taxes cover costs, who pays and receives, and how the four subsystems interact.

Of course, you have to start somewhere. How the new exchange policies interact with employer-provided health insurance and, to some extent, Medicaid gets my vote because right now it's where the rubber hits the road. Also, at some level it should appeal to Democratic concerns about extending coverage and Republican concerns about trying to use a market for health insurance.

First, some simple math that's at the heart of health reform. Health spending now averages about 21 percent of households' personal income (17 percent of GDP). Few believe we can afford to pay this much, yet we do. And, the percentage of income spent on health care is rising. We are already financing part of our health care costs by borrowing from China and limiting cash wage growth substantially. Meanwhile, the new health care legislation presumes that those in an exchange shouldn't have to pay more than 10 percent of their income for a health insurance policy. The trouble is, we're already paying a lot more than that to support the three-, soon-to-be four-, tranche system.

This decision to ignore the math has created far-reaching consequences:

  • Those in the exchanges will get substantially higher subsidies than will many households that remain in the less subsidized employer-provided insurance market, as well as those on Medicaid.
  • To prevent too many employees from getting the new subsidy, employer penalties and other tactics try to keep people within the less subsidized employer network. Even so, droves of employees—potentially tens of millions—are likely to shift out of employer-provided insurance over the next decade or two, especially as newer firms and their employees find it more profitable to get the exchange subsidies than the subsidies for health insurance provided by the employer.
  • To try to prevent small employers from bearing the burden of the new system, yet more subsidies and exemptions from employer penalties were created but not distributed fairly according to need.
  • To prevent states from shifting from Medicaid, which they help fund, to the exchanges, which they don't, still more restrictions and incentives were designed.
  • If, despite all these provisions, these incentives cause too many people to shift to the new, most generously subsidized tranche (the exchange), the four-stream system becomes even more unsustainable from a budget perspective. After all, every person who receives a higher subsidy will impose additional cost on government
  • The exchanges don't just handle health insurance. Rather, they are expected indirectly to operate an entirely new "tax" system that collects another 9 or 10 cents from most insured household for every additional dollar earned and a new "welfare" system that tries to determine in advance and at various later stages households' eligibility for different subsidies.
  • It may not be possible for various employers, exchanges, Medicaid systems, and the IRS (which is expected to verify income statements to the exchanges on initial applications, but not later amendments) to share all the data needed to enforce the new subsidies. Think about the logistics of updating the information every time an individual becomes eligible for a higher subsidy because he or she marries, divorces, gains a dependent, moves, changes jobs, and earns less over a stretch of time.

Clearly, to create an administrable system, we need some certainty about the size of the subsidy; to be fair, we need to make the subsidy about the same for all those with equal incomes. This suggests that we must give households throughout the middle-income range (and perhaps those in some Medicaid and higher-income ranges too) about the same level of premium support, while eliminating discrimination against workers with employer-provided insurance. Rather than clawing back the subsidy indirectly with a new, hard-to-administer tax, we must use the current tax system to provide fewer subsidies, on net, to those with higher incomes.

True, health care is now so expensive that it's hard to provide a subsidy high enough to cover most of the cost of insurance. Therefore, we must turn to other alternatives to encourage people to buy insurance. That is one purpose of the new law's so-called mandate—which is not really a mandate at all but a penalty for not buying insurance.

A penalty serves a second and related purpose. It deters people from avoiding insurance purchase when healthy on the expectation that they can buy it cheaply, relative to their costs, when sick. Otherwise, it will not be possible to maintain the popular health reform that prevents insurers from excluding those with preexisting conditions. If current "mandates" are considered unacceptable, a perfectly constitutional and partial fix that both parties could accept might be simply denying other tax and welfare benefits to those who don't buy health insurance.

Concerned about administrative ease and fairness, few Democrats should like subsidizing some families more than others in the same income range or seeing enrollments in employer-sponsored insurance drop. And few Republicans should like the higher subsidies and state cost-shifting that cloud the true tax rates and mandates required to support the system.

The fundamental dilemma for both liberals and conservatives is that we simply can't achieve a more universal health system without charging people for it, enforcing it, admitting to the explicit or implicit tax rates involved, and avoiding very large incentives (for individuals, employers, and state governments) to shift from one tranche of the system to another. Once both sides accept these basic facts and the fundamental arithmetic that drives them, they must turn to the types of amendments suggested here. Neither side is served well by the wishful thinking that pervades the debate over simply maintaining or abandoning the new health care legislation.

Gene Steuerle is a member of the board of directors of the Committee for a Responsible Federal Budget. He also is a senior fellow at The Urban Institute, co-director of the Urban- Brookings Tax Policy Center, and a columnist for Tax Notes Magazine.

"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.

 

Note: This article was originally published as a Government We Deserve column at the Urban Institute.

 

October 29, 2010

All eyes are on next week’s meeting of the Fed’s Open Market Committee (FOMC), the monetary policy setting body of the Fed. As priced in by the markets, the FOMC is widely expected to agree at its meeting November 2-3 to start on a second phase of quantitative easing (ie, the purchase of long-term assets, which have been government securities – primarily Fannie and Freddie instruments) in order to support the economy. The public case for a new round of monetary easing made by Fed Chairman Bernanke and others is based on the weakness of the economy and inflation that is below the Fed’s target floor, raising concerns about increased risks of deflation. Throughout the week, traders have tried to parse Fed officials’ comments, which may point to internal discussion, or disagreement, over the appropriate size and timing of the new round of liquidity. Critical questions include: Will the Fed move massively in a shock and awe approach, will it gradually supply liquidity in a predictably measured way, or will it just shock?

For the time being, monetary policy is seen to be the only policy game in town to increase support for demand. The Fed’s QE2, as it is dubbed, perhaps can also be seen as an attempt to counteract the tightening of fiscal policy now underway. In the absence of a budget for the fiscal year which started this month, the broad outlines of fiscal policy are not even in place and there are few signs whether the fiscal stalemate will be resolved by the end of the year, after the mid-term elections. Fiscal stimulus resulting from last year’s ARRA law (the administration’s major stimulus package) is waning because most of the provisions were temporary and expiring. Plus, if the Bush tax cuts are allowed to expire, as currently scheduled, then fiscal policy will tighten dramatically and abruptly starting January 1st.

In the meantime, today’s news on the economy confirms views of continuing economic weakness. According to today’s first estimate of the 3rd quarter, the economy grew at a 2 percent annualized rate, a slight pickup from the first quarter’s 1.7 percent but low for this stage of the recovery (we are still waiting for that “V” shaped recovery) and too slow to improve the job market. Inflation was below what is regarded as the Fed’s target floor.

October 28, 2010
Fiscal Questions for the Candidates

Last week CRFB provided Ten Questions to Ask the Candidates on fiscal policy as a way to help voters gauge how serious a candidate truly is regarding fiscal responsibility. While the federal budget deficit has been prominently featured during this election season, it has been little more than a talking point for most candidates as they have avoided discussing specifics. In the run up to Election Day The Bottom Line will highlight these questions in a blog series to move beyond the campaign rhetoric towards discussing potential solutions. This blog post covers the first two questions.

1. Picking a Fiscal Goal. Do you believe the country has a serious fiscal problem? If so, do you think the country needs a “fiscal goal?” What particular fiscal goal would you support? The current fiscal path is unsustainable. Public debt is on course to pass 100% of GDP in the 2020s and 500% in the 2080s. The Peterson-Pew Commission on Budget Reform has argued for a fiscal goal of 60% debt-GDP by 2018 to reassure credit markets that the United States is on course to gradually bring its debt back to sustainable levels.

It’s difficult to measure our progress towards fiscal sustainability if we don’t have benchmarks guiding us. We discussed the merits of setting a fiscal target here. It’s not enough for a candidate to simply say they will reduce the deficit and cut federal spending; having a goal indicates that a candidate is serious about addressing our fiscal challenges. We don’t suggest that the 60 percent debt-GDP target is the only viable goal, but we need to establish a credible, yet ambitious, goal now.

2. Going Beyond the Budget Myths. Eliminating waste, fraud, abuse, earmarks, and tax evasion will not solve our fiscal problem. What other specific cuts are you willing to accept? Yes, wasteful government spending should be eliminated, earmarks are bad process, and we should collect all the taxes that are owed—thereby closing the “tax gap.” But that is not enough. The largest drivers of the debt are aging, growing health care costs, and the imbalances between how much we spend and what we pay in taxes. It is hard to imagine a credible budget plan that does not include changes to these areas of the budget as well as defense, domestic discretionary spending…and…well, pretty much all areas of the budget.

Candidates often fall back on these items when asked to name the budget issues they will address. While these low-hanging fruit should be picked, much more will need to be done to address our fiscal imbalances. Defense and security, entitlements, and interest on our debt account for roughly two-thirds of our budget as opposed to the old stand-bys such as waste, fraud and abuse, which represent only a tiny fraction.

Candidates must get specific! We offer some ideas in our new Lets’ Get Specific series of papers. We've already looked at Social Security, Health Care, and Tax Expenditures. Doing our “Stabilize the Debt” online budget simulator can also help in determining the magnitude of the changes we must make to reach the goal and put us on a sustainable fiscal course.

October 28, 2010

“Virtually all advanced economies are likely to conduct fiscal consolidation at some point in the future to put their fiscal positions back on a sustainable footing.” - International Monetary Fund, World Economic Outlook, October 2010, p.21

The United States, like a number of other countries, needs to figure out how to best design a fiscal recovery package that will not derail a lackluster recovery, while at the same time, phases in debt reduction policies soon enough and aggressively enough to reassure credit markets.

Helpfully, the International Monetary Fund’s chapter “Will it Hurt? Macroeconomic Effects of Fiscal Consolidation” in the most recent World Economic Outlook provides some answers.

The benefits of fiscal consolidation. For a start, the Fund confirms the bulk of research that shows that fiscal consolidation in high-debt countries will be beneficial and likely increase output over the long-run. A reduction in government debt will reduce the crowding out of private investment as the economy approaches full employment. In fact, the reduction in government debt will “crowd in” private investment - which ultimately raises underlying growth - by lowering inflation-adjusted interest rates and reducing debt service payments. This lesson is clearly relevant for the United States.

But what about the short-run? Fund economists also take a close look at the mixed evidence on short-run costs to the economy from fiscal consolidation. The IMF identifies two things that are likely to help mitigate contractionary effects in the short run and over time: focusing on policy changes that are conducive to growth, including what many refer to as structural policy changes (we have suggested, for example, fundamental tax reform including broadening the tax base significantly, in our paper on reforming tax expenditures, and shifting from a consumption-focused to an investment-focused budget), and increased coordination with other nations.

For advanced economies as a group, policies that have relied on spending cuts, particularly cuts in transfers, have tended to be less contractionary than tax-based adjustments—in part because central banks often have responded to spending cuts by lowering interest rates. Given how low rates are in the U.S., though, this may be less relevant now than it would be normally. Moreover, it is not clear how relevant these findings are to the US now – most of the other advanced economies have started with far higher spending and taxes as a share of the economy, which can reduce the scope for adjustment on the tax side and increase incentives to have spending-heavy programs. It is also not at all clear what motivated the central banks to act in response to spending shifts. These points are critical for the US – and it is important to get them right.

The IMF also found that the contractionary effects are worse when many nations engage in debt reduction all at once. This is why, while we watch what is going on in Britain with admiration and awe and keep our fingers crossed it will work, we realize it may well make our own job even more difficult. If the shaky global economy is a table with each country serving as a stabilizing leg, the risk is that the U.S. will be left as one of the only support systems for demand as other countries engage in debt reduction more aggressively. This is, in part, because they have to, since they do not have our dollar and safe-haven advantages, which our creditors perceive as lowering our sovereign risk (at least for the time being – history shows that confidence can shift suddenly). Under these circumstances, competitive currency devaluation can get nasty, as countries try to boost their exports as much as possible to help their economies when fiscal adjustment is underway. More global coordination would be wise, and it can take many forms.

The IMF finds that even in the bulk of the cases in which fiscal consolidation had a contractionary effect on the economy in the short-run, the negative effects on aggregate demand were often offset through stronger growth in net exports and the easing of monetary policy by the central bank. In the current environment however, there may be limits to these offsets: many major trade partners have fiscal adjustment under way simultaneously and not everyone can boost exports through a depreciating currency at the same time; and because interest rates are near zero, central banks may not be able to provide monetary stimulus as they did in the past.

Luckily, the Fund suggests policy actions to increase fiscal adjustment credibility, which could help limit negative short-run effects: strengthening fiscal institutions, reforming pension entitlements and reforming public health systems. “To the extent such measures improve household and business confidence and raise expectations about future income, they could help support activity during the process of fiscal adjustment”. No question, this won’t be easy and it will not be painless, but there are steps we can take to make the transition easier.

October 27, 2010

Nine months since the creation of the Fiscal Commission, we are now just one month away from the scheduled release of its report/recommendations. For the past nine months the Commission has been pelted with letters and requests to keep off of Social Security. So when the American Academy of Actuaries sent a letter to the Commission arguing for raising the retirement age, it was something worth noting.

The letter addresses many points that have been raised by opponents of making changes to Social Security. The Academy basically lumps such arguments into two categories: one challenging the view that raising the retirement age is a de facto benefit cut, and one addressing many "specific concerns" over an increased retirement age (such as people in physically demanding jobs and unequal distributional effects of gains in life expectancy).

First, they combat the "benefit cut" view specifically. They point out that for all the years that the retirement age remained fixed (and even after adjustments included in 1983 legislation), retirees have been getting a de facto benefit increase, since they will spend more years collecting benefits in the system than previous generations. This increase comes on top of the fact that initial benefits grow with wage inflation and retirees have (for the most part) recevied annual COLAs.

In addition, the Academy says that raising the retirement age creates a "signaling effect" that people should work longer and delay retirement. They explain it below:

For example, if the retirement age is raised by one year, and a worker retires a year later, the worker’s annual benefit is approximately the same as if he or she retired a year earlier and the retirement age had not been raised. The combination of the change in retirement age and the change in behavior leaves the retiree with approximately the same degree of retirement security as without those changes. That is the intended effect, which is very different from a direct cut in the benefit formula.

Basically, raising the retirement age--and specifically indexing it to life expectancy--reduces the "benefit increase" associated with longer life expectancy, rather than actually cutting benefits. And even with an increase in the retirement age, benefits would still be growing as they always do.

After addressing the benefit cut view, the Academy discusses the myriad concerns involving the view that raising the retirement age would allow more Americans to slip through the cracks. These concerns include the unequal distribution of gains in life expectancy (the rich have generally seen larger gains in life expectancy than the poor) and the hardship an increased retirement age could create for people who simply cannot work, like those in physically demanding jobs.

The Academy states that the concerns are legitimate, but that is no reason to leave the retirement age unchanged for the whole population. These targeted concerns could be addressed in other ways, for example, by reforming disability programs or making the PIA formula more progressive.

Remember that an increase in the retirement age should come in the context of an overall reform plan. It is not a stand-alone policy. While we often present Social Security reform as a choice of different levers, the choices made should be part of a coherent plan. So, categorically rejecting a raise in the retirement age without the context of a reform plan is not constructive.

We appreciate the Academy's constructive addition to the Social Security debate.

October 26, 2010

Today, Standard and Poor’s reaffirmed their rating of the U.K.'s AAA debt instruments in response to the UK’s recently devised fiscal consolidation plan that is projected to reduce their deficit from around 11 to 3 percent of GDP in 2014. Within the AAA credit rating, S&P raised their outlook of U.K. debt from "negative" to "stable". Their ratings improvement comes as a result of the increased economic growth (by 0.8 percent) that has followed the coalition-implemented new budget and the expectations of future growth to come.

The positive results of the British fiscal consolidation prove the importance of fiscal sustainability for the U.S. as well—we must focus on similar deficit reduction planning if we want to ensure long-term economic growth. Furthermore, this shows that devising plans now for future fiscal consolidation can have positive economic effects in the short-run too, increasing consumer and investor confidence in the overall health of the economy.

October 26, 2010

CRFB President Maya MacGuineas has another commentary on CNN Money, discussing Britain's fiscal austerity plan, setting the right place and the importance of political courage in confronting our fiscal challenges. You can check it out here.

 

"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

 

October 25, 2010

With the November elections just two weeks, demagoguing has reached a fever pitch. So, predictably, when the SSA sent a letter to Rep. Earl Pomeroy about how different reform provisions would affect benefit levels, reform opponents (or at least spending side reform opponents) took aim at the most notorious reform plan in Washington right now: Paul Ryan's Roadmap.

The letter estimated the effect of instituting progressive price indexing, raising the retirement age, and switching to the chained CPI-U for COLAs (which by the way, are the proposals we include in our Let’s Get Specific on Social Security paper). All the proposals showed cuts in average benefits, leading CBPP and Pomeroy (who you might recognize from the ad-hoc COLA debacle) to go on the offensive against Ryan's plan, which includes progressive indexing and an increase in the retirement age.

There are a few problems with the attacks. Let's go through them.

  • Comparisons to promised benefits: SSA compared benefit levels under different reform options to scheduled benefits. Scheduled benefits assume that all the current benefit calculations remain the same. The problem with this is that the system doesn't have the money to pay these benefits. If no changes are made to Social Security, scheduled benefits won't happen: once the Trust Fund runs out, the SSA will only be able to pay less than 80% of scheduled benefits (and that assumes immediate cuts for all those already retired, which no reform plan would do).
  • Using wage-indexed dollars: SSA also used wage-indexed 2010 dollars to measure benefit levels. If you don't look closely enough to realize this, the letter makes it look like these provisions drastically cut the nominal benefit level over time when, in fact, that's not the case. Even if progressive price indexing and an increased retirement age were implemented, nominal benefits and real benefits would still increase over time, since real benefits by definition account for price inflation. The only people who might see their real benefits decrease would be the highest earners. Reform plans merely slow the growth of benefits relative to the scheduled benefits baseline.
  • Attacking (and misrepresenting) Ryan's plan specifically: Even though CBPP claims the Goss letter "allows one to calculate the size of the benefit reductions that Rep. Paul Ryan’s budget plan would generate" that is not true. This only measures some of the benefit reduction  provisions of the Roadmap plan, but doesn't include many of the benefit increases, such as the low earner enhancement or the benefits from private accounts. It’s like attacking your company for cutting health insurance benefits while ignoring a big wage increase they also gave you. Listen, Social Security is unsustainable. Just about any credible plan is going to show a reduction in benefits. Critics need not stack the deck against reform—the reality is that benefits will have to be lower than what we have promised.
Roadmap Benefits Compared to Payable Benefits
  10 Year Birth Cohort Starting in Year Total Benefits as Percentage of Payable Benefits
10th Percentile of Earnings 1970 130%
1980 145%
1990 145%
2000 145%
50th Percentile of Earnings 1970 100%
1980 105%
1990 95%
2000 95%
90th Percentile of Earnings 1970 80%
1980 75%
1990 70%
2000 90%

Source: Congressional Budget Office

  • How about producing a plan instead of throwing stones: It's perfectly fine to disagree with a reform plan, but then provide an alternative.. For those who have not, we have to assume the plan is to drain the budget of resources over the next few decades to repay the Trust Funds and then abruptly cut benefits across the board by more than 20% in 2038, when the Trust Funds run out. That must be little comfort to those who will be depending on Social Security for the bulk of their retirement income. Pomeroy to his credit points out that "a cut in benefits after 2037 can be avoided if steps are taken by Congress before that time to improve the financial status of the program over the long-term" but the longer he and others delay action of any kind, the more drastic the "steps" need to be.

On a more positive note, though, an alternative plan was just recently scored by the SSA from Rep. Ted Deutch. Basically, it's a no-benefit-cut scenario. Deutch would eliminate the payroll tax cap (currently at $106,800) and he would provide a small benefit credit--an "AIME+" for the earnings above the cap. Also, it would use the CPI-E for COLAs--which is about 0.2 percentage points higher than the CPI-W--and provide a $250 payment whenever there is no COLA (you know our thoughts on this). 

We applaud Deutch for getting specific on how he thinks we should fix the program. That said, his plan does not do nearly enough to put the system on a sustainable track. Though it technically makes the system solvent through the 75-year period, it does not achieve sustainable solvency since it doesn't get to permanent (near) cash balance. Beginning in 2024, under the Congressman's plan, costs exceed revenue and the system draws on the trust fund (meaning the rest of the budget has to pay for it) until the point when it empties in the 2080s. Keeping the system solvent and achieving cash-flow balance would require eventually raising payroll taxes by another 2 percentage points or so. Effectively, looking to the 75th year, Congressman Deutch's plan would only solve about half the problem.

Nonetheless, we very much appreciate Deutch's willingness to get specific on Social Security. It is certainly more constructive than election year demagoguery and is exactly the type of specific plan we need to start the comparison between different approaches to reform. Thank you, Congressman Ryan and Deutch. Anyone else ready to step up?

 

October 25, 2010

In an op-ed in today’s Wall Street Journal, Alan Blinder discusses his frustrations with what he dubs the “fiscal policy paradox”: that the economy-boosting “policies that might work won’t be tried,” due to partisan infighting, and the “policies that will be tried might not work.” He laments that fiscal policy has largely been on the sidelines while monetary policy undertaken by the Federal Reserve has done most of the heavy lifting to spur the economy. He argues for the reverse and contends that while monetary policy is close to being out of bullets, there is plenty of fiscal artillery left. Blinder goes on to detail just a few of the ways in which fiscal policy could help speed up economic growth.

  • A sustained, large-scale new jobs tax credit would offer tax incentives for firms to increase employment above a certain level;
  • Increased government hiring, like that done by FDR during the New Deal, would also put more people back to work and increase growth;
  • Third, a sales tax cut to encourage consumer spending.

These three options are only a few of the myriad possibilities out there, says Blinder, but partisan paralysis and demagoguery are preventing any comprehensive response. Blinder is correct in pointing out that political factors are hindering the formulation of rational fiscal policy at a critical time. He is also right in arguing that stimulative measures, coupled with credible future deficit reduction, could pack a potent punch. We wish he would have provided his best deficit reduction proposals along with his stimulus ideas.  

This argues for a credible fiscal plan to be implemented as the economy gains strength. The deficit should not be an excuse for blocking all stimulative measures, but medium- and long-term debt concerns dictate that any stimulus be well-crafted to have the most bang for the buck and be devised in a way that it does not add to the debt in the longer run.

October 25, 2010

David Chavern of the Chamber of Commerce and Christina Romer, former chair of the Council of Economic Advisors (CEA), both joined the Announcement Effect Club this month. Interesting that two people on very different sides of the economic debate have something in common.

First, Romer in a New York Times article on Sunday:

Such backloaded deficit reduction would not hurt growth in the short run — and could raise it. If uncertainty about future budget policy is harming confidence, as some business leaders suggest, spelling out future spending and tax changes could be helpful. More important, showing that policy makers can come together and make essential decisions about our fiscal challenges would reassure all Americans that our economic future is better than the current grim reality.

She notes that backloaded plans have been done before with regards to Social Security and taxes, with some changes not taking effect until years or even decades (think 1983 Social Security changes) after the plans were passed.

It's also important to note that Romer makes this point in an article in which she calls for more stimulus (the title of the article is "Now Isn't the Right Time to Cut the Budget Deficit"). It cannot be stressed enough that short-term stimulus and deficit reduction are not mutually exclusive; in fact, pairing them can make each separate component more effective.

Now on to Chavern, who takes a little different approach to the AEC:

Now, imagine if you will, that we took our biggest and most politically intractable domestic problem - long term deficits and entitlement reform - and solved it!  Not solved it completely or immediately, but adopted a reasoned compromise plan that gave high assurance that long-term deficits would be dramatically reduced over next several decades. All of the sudden, the future of the U.S. doesn't look so bleak. We would have a reasonable fiscal outlook (unlike Europe), a favorable demographic outlook (unlike Europe or China), some of the best creative talent and entrepreneurs in the world and continued access to tremendous natural resources. Where would you want to put your money then?  Maybe, in fact, the pain of long-term deficit reduction could lead to a large short-term economic gain.

While many Club members have advocated for medium-term deficit reduction, few have put solving our long-term problem as a way to stimulate growth. Certainly it would need to be backloaded, since the twin problems of aging and health care cost growth can't be solved overnight. And as reducing medium-term deficits would reduce pessimism about the outlook of the next decade, so would alleviating our long-term imbalances reduce pessimism about the next half-century or so. Imagine: no more of those ubiquitous exponentially growing debt projection charts! Obviously, it's easier said than done.

For a full list of members in the Announcement Effect Club, see here

October 25, 2010

Surprises We Want to See – With pivotal mid-term elections next week that will decide control of Congress, observers are awaiting this year’s “October surprise” – the breaking news that could change the course of the election. We at The Bottom Line have our own ideas for surprises we would like to see.

Candidates Move Beyond Rhetoric – Those running for office have been quick to decry the large federal budget deficit, but few have offered detailed plans on how they will address the mounting debt and put the country on a sustainable fiscal course. CRFB has endeavored to move the campaign rhetoric from sound bites to solutions by providing ten questions voters should ask their candidates on fiscal responsibility last week. We also are leading the way with a Let’s Get Specific series of papers and recent event. Our Stabilize the Debt budget simulator provides everyone the opportunity to see how numerous specific ideas can contribute to closing the fiscal gap.

U.S. Devises a Fiscal Plan – CRFB has been calling for the creation of a credible plan now to be implemented as the economy recovers. Some recent events provide hopeful signs this may occur. U.S. Treasury Secretary Tim Geithner sent a letter to G-20 ministers supporting the setting of medium-term fiscal targets consistent with sustainable debt levels. The Peterson-Pew Commission on Budget Reform recommended a goal of a 60 percent debt-GDP ratio by 2018 in the report, Red Ink Rising. The United Kingdom also announced a comprehensive plan to reduce its debt.

A Rational Budget Process is Created – Congress will return for a lame duck session beginning November 15. One of the reasons it must reconvene is to complete its work funding government operations. The new fiscal year began on October 1 without any of the annual appropriations bills enacted, requiring a stopgap funding measure to prevent a government shutdown. Congress was also unable to adopt a budget blueprint this year, for the first time since the 1974 Budget Act the House was unable to approve of a budget resolution. The U.S. cannot properly address its fiscal challenges with a dysfunctional budget process. The Peterson-Pew Commission on Budget Reform will soon unveil its recommendations for creating a more effective, transparent, and accountable budget process.

Fundamental Tax Reform is Tackled – Congress will also address the matter of the expiring 2001/2003 tax cuts as well as other expiring tax provisions in the lame duck. The debate over extending all or a portion of the tax cuts has overshadowed the need for comprehensive reform of the tax code. Creating a simpler tax system with a broader base will be essential to tackling our fiscal challenges. CRFB made some recommendations for reforming tax expenditures in a recent paper.

October 22, 2010
It's Not All Just About China

We at CRFB applaud Treasury Secretary Tim Geithner’s support of medium-term fiscal targets, in the run-up to this weekend’s meeting of G-20 finance ministers. In the context of correcting external imbalances, Treasury Secretary Geithner sent a letter (excerpts from the Financial Times) indicating three steps that he believes G20 countries should commit to:

  1. Reduce external imbalances. Countries "should boost national savings by adopting credible medium-term fiscal targets consistent with sustainable debt levels and by strengthening export performance."
  2. Don't undervalue currencies. Countries should commit to refraining from weakening their currencies, or preventing undervalued currencies from appreciating.
  3. IMF Involvement. The IMF should monitor progress on these commitments.

As budget wonks, we find the first goal especially important – although history shows that the importance of avoiding competitive currency devaluations should not be underestimated.

Credible medium-term fiscal targets are a way to begin signaling to markets that we are serious about deficit reduction. With a reasonable target path agreed to (a sort of budget constraint), the challenge will be for policymakers to work together with taxpayers to figure out how the U.S. can sensibly meet our fiscal goals so that we can bring our debt back down to sustainable levels. The Peterson-Pew Commission has argued for a fiscal target of a 60 percent debt-GDP ratio by 2018, and other groups have argued for similar goals.

For why fiscal goals are important and how they can help bring down future debt, see CRFB president Maya MacGuineas's testimony from July before the Fiscal Commission. We hope other policymakers join the Treasury Secretary in supporting fiscal goals.

Photo Credit: Chip Somodevilla / Getty.

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