The Bottom Line
Secretary of State Hillary Clinton spoke yesterday about the importance of taking action soon to ensure future fiscal sustainability, calling the mounting federal deficit a threat to our national security in two ways:
“It undermines our capacity to act in our own interest, and it does constrain us where constraint may be undesirable. And it also sends a message of weakness internationally. It is very troubling to me that we are losing the ability not only to chart our own destiny, but to have the leverage that comes from having this enormously effective economic engine that has powered American values and interests over so many years. So I don’t think we have a choice – it is a question of how we decide to deal with this debt and deficit…. There is no free lunch, and we cannot pretend that there is without doing grave harm to our country and our future generations.”
Secretary Clinton's statement reflects the growing number of our nation's leaders (listed here are the members of the Announcement Effect Club) who recognize that our current unsustainable fiscal path will have ripple effects beyond just our federal budget. Our skyrocketing national debt will impact not only America at home but also our global economic and political relationships -- making it more important than ever to enact a plan now that will outline how we will bring down future deficits, before it's too late.
The knives are out, and they’re pointing at Social Security reform.
There is no one “right” way to fix the fiscal problems facing the country, but if there is one thing experts from all ideological perspectives tend to agree on, it is that with Americans living longer, we should raise the retirement age. Just ask House Majority Leader Steny Hoyer or House Minority Leader John Boehner. Or ask any member of the American Academy of Actuaries, for that matter.
So why then the slew of recent attacks on raising the retirement age? Sure, some are depressingly predictable made by groups determined to prevent any changes to Social Security benefits – actuaries’ warnings be damned. But others show that the pushback against raising the retirement age is gaining momentum even by those who previously supported it. If fixing the budget is a one-step-forward three-steps-back kind of process, markets are going to lose patience sooner than we were expecting.
Working longer is probably the single best thing people can do for their retirement security. The stock market’s plunge left savings pummeled and companies have pulled back from providing defined benefit plans. Staying in the workforce allows workers to save more money before retiring and go without wages for a shorter period of time. Importantly, it also improves the overall fiscal picture through higher income tax revenues and improved labor market incentives, helping to grow the economy, which benefits everyone.
When Social Security began, the retirement age was 65. Today, 75 years later, it is 66, moving up to 67. The good news is that life expectancy has improved greatly since then – by 17 years for men and 20 for women. In his recent piece in the Washington Post, Ezra Klein points out that these numbers are influenced in part by improvements in infant mortality. Yet even life expectancy at age 20 has increased by 9 years for men and 10 years for women.
||At Age 20||At Age 65|
In light of continued increasing longevity, it only makes sense that individuals would work longer. Raising the normal retirement age would serve as an important signal to encourage them to do so, and raising the early retirement age would go even further to promote longer working lives.
So why all the pushback on turning to the retirement age as part of the problem?
There are concerns that it would be regressive and unfair. Not so.
Even reform-opponent Dean Baker admits that “an increase in the NRA reduces benefits by the same percent for all workers” – and that analysis doesn’t account for disability benefits, which are completely protected from changes to the retirement age. When looking at the entire Social Security system, the Urban Institute finds that raising the NRA is in fact a progressive option and “benefit reductions from an increase in the [NRA] would increase with lifetime earnings.”
Benefit Reductions by Quintile in 2050 (percent relative to scheduled benefits)
Then there is the concern that some individuals may be physically unable to continue working past the current early retirement age of 62. This is a legitimate concern for about a fifth of young retirees today, but we shouldn't design the entire retirement piece of program around them since they can largely be assisted through the disability program, SSI, or other means. We need to be targeting benefits toward the old-old who have outlived their savings and really can’t work. Maintaining unaffordable benefits for 100 percent of people in order to protect 20 percent of people is like putting out a match with a fire extinguisher.
Back in 1950, the average retirement age was over 67, and more than 70 percent of 65 year olds worked. Today, the average retirement age is 62 and only 30 percent of 65 year olds work (this was true before the recession as well). Are we really going to argue that jobs are more physically intensive and people less able to work than back in 1950?
The barrage of arguments against Social Security reform aren't limited to the retirement age.
In his article, Ezra also argues that the Social Security gap isn’t that large -- and that we are better off letting the Bush tax cuts expire on high income earners than we are going after Social Security.
Yet Social Security and the higher-income tax cuts don’t actually have the same impact on the debt at all though there have been repeated attempts to equate them. From about 2021 on, the Social Security cash shortfall will grow larger than the value of those cuts – much larger as time goes on. (We’ll discuss this more in a future blog). Realistically, we should be talking about letting the tax cuts for the well off expire AND reforming Social Security. We’re going to have to do both, and much, much, more, if we really want to stabilize the debt.
Finally, Ezra makes the argument against Social Security changes in general because of the high level of efficiency, which he argues would make changes a zero-sum game. Ezra uses the low administrative costs of the system to make his case. But saying Social Security is efficient because SSA can cut checks on the cheap is like saying dropping money from a helicopter is efficient as long as we get a good price on the helicopter.
The real measure of efficiency should be how effectively Social Security meets its goal of improving retirement security, and at what cost to society. It’s an open question as to whether a program which gives some seniors more than $30,000 a year and leaves others in poverty is efficient, especially if it encourages under-savings and premature retirement in the process.
Done right, Social Security reform need not be zero-sum at all. If we can encourage people to work longer and save more, we can improve their personal retirement security, increase income tax revenue, and (by increasing labor and capital supply) improve overall economic growth, all while preserving Social Security for future generations.
This approach to shooting down all possible changes to strengthen Social Security presents a serious danger to our nation’s fiscal sustainability. Instead, it would be helpful for those who don’t want to touch Social Security benefits to show how they would fix the program on the tax side, and for those who don’t want to address it at all to show how they would fix the budget without changes to Social Security. There are ways to do both (though probably not ones most people would like when presented with the facts), but this effort at shooting arrows at all ideas is not the way to succeed in putting the program back on sound footing.
An interesting exchange was recently published on progressive ways to think about deficit reduction, especially when it comes to the “big three entitlement programs”. Isabel Sawhill and Greg Anrig debated on how to go about medium- and long-term debt reduction in a manner that would be amenable to many progressives.
Anrig emphasized deficit reduction not taking place until after the economic recovery. Beyond that, he went through a plan that would hit a large swath of government programs and revenue sources, but would leave much of the big three untouched. He proposed a public option for the health insurance exchange as the "next round" of health care reforms (which he claims are crucial to the nation's fiscal future), and suggested looking deeply at the defense budget. On the tax side, he suggested a broad overhaul of the tax system, along the lines of the 1986 Tax Reform Act. He -- like many others -- also wants to go after tax expenditures, specifically mentioning the preferential rates for capital gains.
Sawhill argued that savings must be found within the big three; otherwise, the government would risk losing the people’s trust as deficits and debt exploded. On health care, she suggested setting a per-capita spending limit on Medicare while reforming provider payments to reward quality and not quantity. With regard to Social Security, she proposed slowing the growth of benefits for the more affluent -- presumably along the lines of progressive price indexing -- and raising the retirement age. She agreed with Anrig on the need for tax reform, citing tax expenditures like the mortgage interest deduction and the exclusion of fringe benefits from taxable income as items that should be addressed.
CRFB is always glad to hear about people presenting specific ways to bring down future deficits and debt. Check out the full debate here, and as always feel free to submit your own ideas for reducing the debt using either our Contact page or by submitting your choices on our Stabilize the Debt budget simulator.
Today, former OMB Director Peter Orszag debuted his new column in the New York Times and he sure made a splash. He tries to thread the needle of propping up the economy in the immediate-term and helping right the budget imbalances in the medium-term by suggesting that the tax cuts should be temporarily extended for all income brackets until 2013 and then allowed to expire. While this is not his ideal plan--he states that extending the tax cuts for only middle-income earners would be--he notes that “getting a deal in Congress, though, may require keeping the high-income tax cuts, too. And that would still be worth it.”
Orszag's opinion has spurred a great deal of discussion. The White House felt it necassary to state that it disagrees with its former budget chief's view. CRFB’s president Maya MacGuineas wrote a response today in Politico to Orszag as part of a lively debate on Politico.com. MacGuineas called Orszag's solution to extend the cuts to 2013 and subsequently let them all expire “clever”. While agreeing with the idea of a temporary extension, she further suggests that the tax cuts be used as a “budget hammer” in order to get broader budget reform through and only made permanent if they are fully offset. MacGuineas also notes that the then impending tax cut expiration should spur serious tax reform that could include replacing the income tax with an energy tax and broadening the tax base through tax expenditure reform.
Yesterday, the President announced two new plans for economic growth. Responding to pressure to deliver more job creation in a critical election year, Obama announced a plan to spend $50 billion next year on transportation and infrastructure—from roads to railways to airports. The proposal also includes plans for the creation of a national ‘infrastructure bank’ to attract private funding for further infrastructure improvement projects. If approved, this $50 billion in spending would be the first part in a six-year series of infrastructure spending bills, supposedly to be paid for by an increased tax on oil and gas companies.
Additionally, Obama will announce tomorrow his proposal for two new tax write-offs for businesses—a permanent extension of the research tax credit and a tax break that would allow companies to write off 100 percent of any new investments this and next year. It’s expected that these combined tax proposals would cost about $130 billion over the next ten years. This bill would be the tenth stimulus bill since the beginning of 2008, and would not be extremely large on the scale of the original Economic Stimulus Act passed in February of that year (see our recent blog on Stimulus Calculus for a rundown of the bills and their costs).
In the wake of Obama’s new ‘stimulus’ proposals, it’s imperative to remember the need to pay, over the longer-term, for any tax cuts or new spending we implement now. As we face an increasingly grim fiscal future, the need for economic growth in the short-run must be balanced with budgetary sustainability in the long-run.
As CRFB President Maya MacGuineas stated in Politico's Arena today:
"While more stimulus may well be in order in the short run, a budget plan to bring down future deficits and debt also needs to be put in place as quickly as possible, and phased in gradually as the economy recovers, in order to reassure global credit markets and keep interest rates low. Focusing on the relatively easy part of what taxes to cut and spending to increase--which makes up stimulus--may be politically desirable, but it will not get the job done."
Follow Stimulus.org for a complete look at how policymakers have addressed the economic downturn.
A Lot of Work Ahead – The end of the long Labor Day weekend heralds the effective end of summer: the pools are closed, the kids are back at school, and summer vacations are over. Congress goes back to work in Washington next week. Members of Congress may be hard at work back home campaigning now, but tough tasks wait for them in DC as well.
Spurring the Economy Still a Work in Progress – With little improvement in the jobs picture, the White House is rolling out new proposals to stimulate the economy. On Monday the president announced a plan to improve the nation’s infrastructure, including a swift $50 billion dollar federal infusion to fund improvements to roads, rail lines and airport runways and a new infrastructure bank to finance longer term projects. Reportedly, higher taxes on the oil and gas industry will pay the costs of the plan. Tomorrow he is expected to call for a permanent extension of the corporate research and development tax credit, which will reportedly cost $100 billion and be paid for by closing other corporate tax loopholes. He will also propose allowing businesses to deduct the full cost of equipment purchases through 2011. Plans for paying for such policies over the longer term need to be fleshed out more. A White House statement on the infrastructure plan states that “As with other long-run policies, the Administration is committed to working with Congress to fully pay for the plan.” That is a hopeful sign that long-term offsets will be found to pay for the short term stimulus, as CRFB recommends.
Small Business Bill Awaits Big Break – The Senate plans to resume work next week on legislation (HR 5297) to aid small business that already has cleared the House. The package creates a $30 billion lending fund for small businesses and includes numerous tax breaks. It is ostensibly paid for, but one of the offsets involves allowing people to roll over their individual retirement accounts into Roth IRAs. Although the change will increase revenues in the next ten years, it will cost more afterwards. This is no more than a timing gimmick that increases long-term debt.
Much Laboring to Do Over Tax Cuts – One of the biggest policy debates is over what to do with the 2001/2003 tax cuts that will expire at the end of the year. The debate will become more intense as the Senate is expected to take up the issue this month. President Obama wants to permanently extend the tax cuts for the middle class while Republicans in Congress argue for extending all the cuts, even those for the wealthy. Many economists argue that a permanent extension is not feasible in light of the nation’s long-term debt issue. Some propose a compromise to extend the tax cuts temporarily, as in a year or two. CRFB wants any extension to be paid for in the longer term.
Orszag at Work in New Job – Former OMB director Peter Orszag published his first piece as a columnist with the New York Times yesterday. He writes that a permanent extension of the tax cuts is not fiscally feasible while letting them expire now could harm the economy. He offers a two-year extension as a compromise. He also argues that we cannot expect the bond market to ignore our mounting debt indefinitely and that market sentiment could change swiftly, and painfully, for the U.S. The problem will become more prevalent as the economy recovers.
We are heading into the Labor Day weekend with persistent labor market weakness and great uncertainty over the direction of the economy. This is a tough situation for policymakers and taxpayers.
An IMF paper released today details the long-run fiscal outlook for the G7 nations. Authors Carlo Cottarelli and Andrea Schaechter wrote about the need for fiscal adjustment in order to ensure long-term sustainability and prevent any defaults on national debt. Yet they tempered this call for reform with the acknowledgement that it “cannot be too abrupt”—as we emerge from the recent global financial crisis, our economic recovery is too precarious for excessively sudden or dramatic change. Cottarelli and Schaechter argue for a “downsizing of government, but without preventing it from playing a key role in the provision of basic services.”
Now is the time, they argue, to tackle the public debt problem that has been growing around the world for decades—and even though it will be difficult to do, if we don’t, we run the risk of a far worse financial crisis than what we’ve recently witnessed. G7 economies will face the challenge of “reducing debt ratios at a time when aging-related spending will put additional pressure on public finances.” In order to put the focus on long-term fiscal sustainability, Cottarelli and Schaechter advocate “growth-friendly structural reforms, a fiscal strategy involving gradual but steady fiscal adjustment, stronger fiscal institutions, expenditure and revenue reforms, and an appropriate degree of burden sharing across all stakeholders.”
Furthermore, Cottarelli and Schaechter argue that right now is a good time to implement these reforms because of the “current environment of low interest rates,” which has kept debt service payments relatively low despite ballooning debt principal levels. The time for action is now, they say, because interest rates may not stay low much longer, and the additional fiscal burden placed on G7 economies by steadily increasing debt service payments might be too much to bear, increasing the risk of default.
CRFB board member Laura Tyson makes the argument for additional economic stimulus in a recent New York Times op-ed. At the same time she mirrors CRFB in also proposing that policymakers “should enact a credible multiyear plan now to stabilize the ratio of federal debt to gross domestic product gradually as the economy recovers.” Additionally, she renews her membership in CRFB’s “Announcement Effect Club” by arguing that announcing a credible plan now would ease capital market concerns.
But Andrew Samwick at Capital Gains and Games disputes her counting of stimuli. What she argues would be a second stimulus Samwick labels as a third, also counting the $150 billion package in early 2008 while George W. Bush was president. Actually, there have been multiple attempts to stimulate the economy since the beginning of the current economic slowdown.
Fortunately, CRFB has a great tool in Stimulus.org for keeping track of economic stimuli. It is a comprehensive database of government reactions to the economic and fiscal crisis. It is a good resource for staying on top of the complex stimulus calculus. According to Stimulus.org, there have been 9 stimulus bills (or extensions of provisions in previous stimulus bills) enacted into law since the beginning of 2008.
|Date||Name||Gross Cost (billions)||Deficit Impact|
|Feb. 2008||Economic Stimulus Act of 2008||$147||$114|
|Feb. 2009||American Recovery and Reinvestment Act||$814||$814|
|Nov. 2009||Worker, Homeownership, and Business Assistance Act||$24||$0|
|Dec. 2009||Provisions in Defense Appropriations Bill||$17||$17|
|Mar. 2010||Temporary Extensions Act||$8||$8|
|Mar. 2010||Hiring Incentives to Restore Employment Act||$13||-$1|
|Apr. 2010||Continuing Extension Act of 2010||$18||$18|
|Aug. 2010||Unemployment Compensation Extension Act||$34||$34|
|Aug. 2010||State Aid Bill||$26||-$1|
Many are sounding alarms over news that the White House fiscal commission is considering changes to Social Security as a part of a possible debt reduction proposal. Progressive members of Congress are demanding that Social Security be taken off the table. At the same time the commission is being similarly pressured from the right to take tax increases off the table. All this goes directly against the president’s charge that nothing be left off the table in considering how to improve the long-term fiscal outlook.
The sirens have been especially loud regarding raising the retirement age. The Economic Policy Institute has put forth the top ten reasons not to raise the retirement age. CRFB board member Gene Steuerle rebutted many of these arguments in a recent commentary. We would like to add to the excellent points Gene made.
The argument that raising the retirement age will be a benefit cut is misleading. As Gene points out, even if the retirement age is increased to 70, projected benefits will still increase substantially for beneficiaries.
The fact is that people are living longer and Social Security must adjust to that reality. While it is true some people can't work longer, many retire way earlier now than they did in the 1950s and 60s—despite a significant decrease in the number of physically demanding jobs. A 2008 study by the Rand Corporation for the AARP Public Policy Institute suggests that less than 20% of 62 year olds are truly believed to be unable to work. That number will likely continue to go down further over time. That said, increases to the retirement age should (as pretty much everyone acknowledges) go hand-in-hand with protections for those who cannot work longer.
As it is with dealing with the larger budget picture, spending cuts and revenue increases must both be considered in shoring up Social Security’s long-term finances. The revenue-only options that EPI proposes to raise the taxable earnings cap and the cap on employer’s taxes would not be adequate. If phased-in completely by 2019, the proposal would close only about 85% of the actuarial shortfall; and about 40% of the gap in the 75th year. The problem grows so large, there are no easy fixes.
Furthermore, there are only so many tax increases the budget can sustain. So the question must be asked: what is the best use of new tax dollars—supporting larger Social Security benefits than what are paid today, other investments that could do more to fuel economic growth, or keeping taxes closer to historical levels? Whatever one’s answer—and there is no “right” answer—it should not be a given that Social Security trumps all other budgetary priorities without considering the nation’s full host of needs.
As with the overall budget picture, some tough choices will have to be made to strengthen Social Security so that future generations can be secure in retirement with adequate annual benefits. We need a constructive dialogue on what can be done to improve the important program’s long-term finances. We agree with Congressman Paul Ryan’s call for a real conversation without partisan attacks. Impractical demands to ignore potential solutions will not get us there.
The FDIC has just released its Quarterly Banking Profile (QBP) for the second quarter of 2010, showing improvement in bank balance sheets since last quarter and at the same point last year.
After the collapse of the subprime mortgage market, many banks were hemorrhaging money as many of those loans and the mortgage-backed securities attached to them went south. The financial collapse in September 2008 greatly worsened the problem and sent the number of bank failures in the following year skyrocketing. In 2009, 140 banks failed at a cost to the FDIC of $36 billion.
But in 2010, with an economic recovery seeming to take hold, banks have gotten out of a two year tailspin. The QBP reported that among FDIC-insured institutions, profits were about $22 billion in the second quarter of this year, compared to a $4 billion loss in the same period last year and an $18 billion profit in the first quarter of this year. The 2010 Q2 profit total represents the highest mark in three years.
With banks doing better in the aggregate, the cost of bank failures this year has gone down as well. As of August 27, bank failures have cost the FDIC about $20 billion in 2010; if this pace keeps up, the total cost for the year should come in much lower than the cost in 2009. However, the total still completely dwarfs the total cost of bank failures from 2000-2007, a reminder of how deep the financial crisis and recession were.
|Year||Number of Bank Failures||Cost to FDIC (billions)
*The FDIC did not provide cost estimates for nine of the 24 closings during this period. Still, the total should not come close to approaching the costs of bank closings froom 2008 through 2010 since most of these banks were smaller.
In somewhat contrasting news, though, on August 20, Chicago's ShoreBank failed, at a cost to the FDIC of almost $400 million. This represents the largest cost by a single bank failure in four months.
Remember, you can check the FDIC cost of bank failures, along with any other government actions to help the economy at Stimulus.org.
While a great deal of attention has been given to Federal Reserve Chairman Ben Bernanke’s address in Jackson Hole, Wyoming on Friday, the remarks provided that day by his trans-Atlantic counterpart, European Central Bank President Jean-Claude Trichet, deserve equal, if not more, attention. Trichet highlighted the need for “ambitious” fiscal consolidation in promoting the global economic recovery.
Trichet said that the debt overhang among families, the public and private sectors is primarily responsible for the slowing down of the economic recovery. He argued against using inflation to solve the debt overhang, saying that such a policy “has been disastrous everywhere.” He also dismissed “living with the debt” in order to pursue economic stimulus in the short term. He pointed out Japan’s “lost decade” in the 1990s as an example of the failure of ignoring imbalances. Trichet contended that addressing the debt will promote growth and that strong growth will, in turn, make it easier to reduce the debt.
He acknowledged that reaching the target of a 60 percent debt-to-GDP ratio (as the Peterson-Pew Commission on Budget Reform also recommended in the report, Red Ink Rising) will require sizable decreases in debt, but said that such reductions “are not uncommon and quite feasible.” He provided post-war United Kingdom, Belgium in the late 1990s and 2000’s, Ireland, Spain, the Netherlands and Finland in the mid 1990s as examples. He also made it clear that he was “skeptical” of arguments that fiscal consolidation could severely harm the fragile economy. Rather, Trichet maintained that timely fiscal consolidation would strengthen the economy, while delay would be costly.
He reaffirmed the ECB’s membership in CRFB’s “Announcement Effect Club” by reasoning that announcing a credible fiscal plan now would aid the economy by removing uncertainty that debt will be addressed.
Timeliness does not necessarily mean that all measures are implemented immediately. Rather, it implies that a credible long-term plan is announced in time. Although fiscal adjustment itself may be gradual, it is important to announce a credible road-map for fiscal consolidation as soon as possible. With a credible road-map, and a consistent step-by-step implementation of the consolidation measures that it involves, the uncertainty diminishes or perhaps even vanishes completely. As a consequence, fiscal consolidation pushes the economy towards a durable recovery.
We completely agree.
From Red Carpet to Red Ink – The Emmy Awards last night celebrated the best in TV. In Washington, the plotlines are still being written for this fall, but fiscal issues are sure to get star treatment.
No “Glee” from S&P – A senior executive with rating agency Standard & Poor’s last week warned the U.S. that its AAA credit rating was at risk down the road if action is not taken to address mounting national debt. The official specifically mentioned that they would closely follow the recommendations of the White House fiscal commission later this year and how Congress reacts.
“Mad Men” (and Women) of CRFB Release Realistic Baselines – Last week CRFB released its Medium- and Long-Term Baselines, which forecast a bleak budget outlook based on realistic assumptions about future policy. CRFB calculates that, absent significant policy action to change course, debt will reach 75 percent of GDP in 2015, 89 percent in 2020, and 127 percent in 2030.
A “Modern Family” Get-Together in Jackson Hole – Economists and central bankers descended upon Jackson Hole, Wyoming for an annual economic symposium where monetary and fiscal policy were hot topics. In his address, Federal Reserve Chairman Ben Bernanke admitted that the U.S. economy was sluggish and that the Fed stood ready to make sure the recovery continued. European Central Bank President Jean-Claude Trichet told the gathering that now that the worst of the financial crisis is over, governments must aggressively reduce their debt. CRFB President Maya MacGuineas was there and talked to CNBC about fiscal policy and the need for a credible debt reduction plan.
Presidential Panel Seeks “Big Bang Theory” for Tax Reform – On Friday the President’s Economic Recovery Advisory Board submitted a report on tax reform options. The report offers several ideas for improving the tax code, along with pros and cons of each. Hopefully, the report will initiate a much-needed discussion on fundamental tax reform that modernizes the inefficient tax code and broadens the tax base.
Boehner Seeks to be “The Closer” – House Republican Leader John Boehner (R-OH) gave a much-publicized speech on the economy last week that is seen as a part of his effort to provide the closing campaign argument for control of the House of Representatives. He devoted significant time to fiscal policy in his remarks. Of particular importance were his statements on the need for tax reform. His acknowledgement that some tax breaks need to be reexamined and the tax code simplified are welcomed and could open the door for bipartisan reform.
Are Unemployment Numbers Still “Breaking Bad”? – Observers are eagerly awaiting the August unemployment report due Friday as an indicator of the strength of the recovery.
At the Federal Reserve meetings in Jackson Hole, CRFB President Maya MacGuineas, commented on fiscal policy and the need for a credible debt reduction plan.
Watch a video of the interview below, or click here to go to CNBC.
Today the President’s Economic Recovery Advisory Board issued a report on tax reform options. The report should encourage and inform a vital discussion on the need for fundamental tax reform and hopefully will broaden the current narrow debate over extending the 2001/2003 tax cuts.
PERAB was created by the president last year “to ensure the availability of independent, nonpartisan information, analysis, and advice as he formulates and implements his plans for economic recovery and enhancing the strength and competitiveness of the Nation’s economy.” It is chaired by former Federal Reserve chairman, and CRFB board member, Paul Volcker.
The report is in response to a request from President Obama to provide options for changing the tax system to achieve three goals: simplifying the tax system, improving taxpayer compliance with existing tax laws, and reforming the corporate tax system. The president stipulated that the options presented could not raise taxes on families earning less than $250,000. The panel took this as meaning that the options taken together had to be revenue neutral for this cohort.
The report does not make specific policy recommendations, but offers a detailed list of options with pros and cons for each. A multitude of options are offered, including simplifying tax filing; raising the standard deduction and reducing itemized deductions; simplifying or eliminating the AMT; broadening the corporate tax base; and eliminating or reducing tax expenditures.
Offering a detailed list and providing pros and cons of each option opens a much-needed conversation on improving the antiquated and inadequate tax code. Focusing on simplification and efficiency, closing the tax gap and corporate tax reform are important and must be part of the conversation. But the dialogue will also have to include broadening the tax base as part of larger efforts to reduce fiscal imbalances.
The section on tax expenditures is particularly insightful, stating,
Many of these provisions distort economic activity, increase the complexity of the tax code, and violate principles that businesses with similar characteristics should be treated equally. Eliminating specific expenditures would thus improve efficiency while simplifying the tax code.
Options discussed are eliminating the domestic production credit; eliminating or reducing accelerated depreciation; and eliminating special rules for employee stock ownership plans. In light of recent remarks from House Republican Leader John Boehner regarding tax expenditures, a genuine opportunity exists for action.
PERAB has provided policymakers with a good reference; now it is time for them to work together to fundamentally improve the tax code.
An op-ed in the New York Times yesterday featured Rep. Earl Blumenauer (D-OR) and his unorthodox approach to fiscal sustainability. Unlike many of his peers on the Hill, Rep. Blumenauer does not believe in extensive federal program cuts to balance the budget—but he has advocated extensively for the need to balance the budget, somehow, and soon. Pushing aside the traditional conservative vs. liberal debate that seems to always center on the continuation of major federal programs like Social Security—with no room for compromise between leaving them unchanged to help those who rely on them and reducing benefits to help decrease the deficit—Blumenauer instead puts the focus on their efficacy, arguing that if their supporters really want to protect them in the long term, they must “bring their costs in line with reality” and figure out how to realistically pay them.
Credibility, he argues—of both individual programs’ longevity and of the sustainability of the federal budget as a whole—is crucial, and is in fact the only way to protect individual Americans’ investments in our systems. Programs like Social Security, for example, simply can’t exist on “make-believe money,” and if its long-term credibility problem was fixed—in other words, if young Americans today believed that the program they’re paying into today will still exist upon their retirement—they will be more willing to pay, because “they’re convinced their getting their value,” says Blumenauer. Along these lines, Blumenauer encourages liberals to seriously consider changing the benefit structure of Social Security, including “progressive price indexing,” or pegging more Americans’ benefits to the consumer price index rather than their wages and reducing overall government payouts.
Whatever way it’s done, we agree wholeheartedly with Blumenauer that fiscal reform is critical to the future success of our government and the programs that Americans rely on. For our projections on Social Security's fiscal path and recommendations for reform, see CRFB's report here.
Today, CRFB released a new policy paper showing a more probable fiscal outlook over the coming decade than what baseline budget projections would predict. Late last week, CBO released its updated current law budget and economic assumptions. While current law projections show debt continuing to grow over the next ten years, it is highly likely that actual deficits and debt will be much worse over both the medium- and long-term.
Under current law, debt is projected to grow from 62 percent of GDP this year to 69 percent by 2020. However, this current law baseline assumes that a number of policies that are scheduled to expire actually actually do, when in all likelihood many of them will be extended. There are four main assumptions in current law projections that are unlikely to materialize and will push deficits and debt even higher:
- The 2001/2003 tax cuts will fully expire at the end of this year;
- Lawmakers will stop "patching" the Alternative Minimum Tax (AMT) to keep it from hitting middle-income earners;
- Medicare physician payments will fall by about 30 percent over the next few years;
- Discretionary spending will grow in line with inflation over the next ten year, declining as a share of GDP.
Incorporating these changes (and a few other small ones) on top of baseline deficits will drastically increase out borrowing needs over the medium- and long-term.
|Current Law Deficits||$6,246|
|Extend 2001/2003 Tax Cuts for All but Top Earners||$1,727|
|Index AMT to Inflation||$583|
|Interaction Between Tax Cuts and AMT||$683|
|Medicare Pay Patch||$276|
|Faster Discretionary Growth||$1,273|
|Reduce Troops in Iraq and Afghanistan||-$914|
|CRFB Realistic Baseline Deficits||$10,683|
Under CRFB's Realistic Baseline, debt would reach 89 percent of GDP in 2020 - much higher than the 69 percent projected under current law.
CRFB also developed a more realistic long-term baseline (click here to read about all of our long-term assumptions). Instead of debt rising to 85 percent of GDP by 2040, to 94 percent by 2060, and to 114 percent by 2080 (note: long-term baseline figures adjusted by CRFB to include CBO's updated medium-term projections from last week), debt would rise to 127 percent of GDP by 2030, to 182 percent by 2040, and to 246 percent by 2050 under more realistic assumptions. Surely, no economy could ever sustain such enormous debt levels.
In the policy paper, CRFB argues that policymakers should decide which policies are most important to continue, and then they should offset the costs of whichever policies they keep.
Credit-rating agency Standard & Poor’s has a message to U.S. policymakers: We are watching you on the growing national debt.
In an interview today in Dow Jones Newswire, the chairman of S&P’s sovereign rating committee said that the U.S. government will need to take steps to protect its cherished AAA credit rating. He specifically referenced the White House fiscal commission and indicated that the agency would closely watch how lawmakers deal with its recommendations due to be issued after the November elections.
"It is very important for the credit standing of the United States that the Congress considers very carefully what the fiscal commission proposes," John Chambers, chairman of S&P's sovereign rating committee, was quoted as saying.
"It is very important for Congress to take the required steps."
While the article indicates that there is not much chance of the U.S. credit rating being downgraded very soon, S&P has been making it clear recently that the country won’t be given slack indefinitely for its mounting debt. New baseline projections released today by CRFB underscore how unsustainable the current course is. CRFB forecasts that U.S. debt will reach 75 percent of GDP in 2015, 89 percent in 2020, and 127 percent in 2030 if no action is taken.
The remarks indicate that the markets are watching for signs that policymakers will confront the mounting long-term debt and that they will look at the fiscal commission as a bellwether. This gives new emphasis to the work of the National Commission on Fiscal Responsibility and Reform.
The bipartisan panel is being pressured from all sides not to recommend cutting certain programs or to deal with the revenue side of the equation, making it more difficult to find solutions. The comments from S&P illustrate that the inability of the commission to issue recommendations or the failure of Congress to act on the proposal could be seen by markets and creditors as a sign that the country is not able to change course, which could have severe repercussions for the U.S. economy.
If the credit rating of the country is lowered and U.S. debt is no longer attractive to investors, interest rates will rise – restraining economic growth. Developing a credible plan to deal with the debt will be essential to maintaining our credit worthiness. That is why CRFB has been calling for a fiscal plan now that can be implemented as the economy recovers. Many experts believe that the announcement of a credible plan would reassure markets and allow the U.S. to continue to enjoy low interest rates, which will aid the fragile recovery. We have formed the “Announcement Effect Club” to highlight prominent individuals that share this view.
We cannot afford to ignore these warnings. We need to develop a credible plan now. And the fiscal commission is a good springboard for action.
If lawmakers extended various current policies, as opposed to letting them expire as they are set to under current law, what would happen to economic growth over the coming decade?
In its most recent Long Term Outlook, CBO presented an Alternative Fiscal Scenario (AFS) with current policies that are expected to be extended in the near future—the biggest component of which being a full extension of the 2001/2003 tax cuts. Other assumptions in the AFS include faster discretionary spending growth, AMT patches, and annual "doc fixes" to prevent scheduled cuts in Medicare payments to physicians. The effects of these policies on the alternative baseline show alarming spending growth and comparatively slower revenue growth in the long-run (click here to read our newest policy paper on more realistic medium- and long-term projections). As for their affect on economic growth, in the recent Budget Update CBO states:
"Under those alternative assumptions, real GDP would be higher in the first few years of the projection period but lower in subsequent years than under CBO’s baseline forecast."
So, despite the seemingly positive short-term effects on GDP that tax cuts and other policies may have, growth will be slower later on as a consequence—and federal debt would balloon to 185 percent of GDP by 2035. CBO reports that despite higher growth in the near-term:
"Over time, the negative consequences of very high federal borrowing build up....real GDP would fall below the level in CBO’s baseline projections later in the coming decade because the larger budget deficits would reduce or 'crowd out' investment in productive capital and result in a smaller capital stock."
Interest rates under the AFS would rise to nearly 4 percent of GDP by 2020 -- much higher than the current level of 1.4 percent. The AFS would also improve unemployment in the short-term, estimating that:
“[T]he unemployment rate would be lower by 0.3 to 0.8 percentage points at the end of 2011—that is, 8.0 percent to 8.5 percent.”
Focusing just on the tax cuts, CBO's newest estimates give us an idea just how costly it would be to extend all or parts of them over the coming decade. Since the debate in Washington has been centered on either extending them fully or for those earning less than $200,000 ($250,000 for couples), we have included those costs in the table below.
||2011-2020 Budgetary Impact|
Fully Extend the Tax Cuts (without AMT)
Fully Extend the Tax Cuts (with AMT)
|Extend the Tax Cuts for All but Top Earners (without AMT)||$1.7 trillion|
Extend the Tax Cuts for All but Top Earners (with AMT)
The cost of extending the 2001/2003 tax cuts for all but high earners (and even if they were fully extended) would be even larger if lawmakers continue patching the Alternative Minimum Tax (AMT)—in fact, almost $700 billion more over ten years—and this is very likely to occur. CBO estimates that the tax increases for all but high earners combined with AMT patches would result in $2.4 trillion more in deficits over 10 years, $2.7 trillion if just all the 2001/2003 tax cuts are extended, and a whopping $3.9 trillion more in deficits over 10 years if the AMT patch and all of the 2001/2003 tax cuts are extended.
Clearly, the larger projected debts must be taken into account in any policy debate on tax cut issue. More broadly (and as we argue in our newest policy paper), lawmakers should decide which policies are the most important for the country going forward, and then they should find way to pay for the policies they choose.
Debate over the 2001/2003 tax cuts is centered on its economic and budgetary aspects and effects. The President has proposed extending the tax cuts only for individuals earning less than $200,000 and couples earning less than $250,000, while letting the tax cuts for individuals and couples above the designated income bracket expire. CBO reports that extending all of the 2001/2003 tax cuts would cost $2.7 trillion over the 2011-2020 period (excluding AMT patches and added interest payments), using the CBO current law baseline as the starting point. The public is also weighing in and is divided. An August 20th CNN Poll found that 51 percent of Americans are in favor or letting the tax cuts expire for families making more than $250,000 while 31 percent oppose such a measure. The Senate is reported to be taking this issue up when it reconvenes in September. In the meantime, many questions have been raised—and opinions have been asserted—about the feasibility, benefits, and consequences of these tax cuts.
Here's what some lawmakers and economists have been saying:
- CBO wrote in its most recent Budget and Economic Outlook Update that while the tax cut extentions would be beneficial for short-term economic growth, longer-term growth would suffer.
- Mark Zandi recently wrote an op-ed for the New York Times in which he argues that some of the tax cuts should be extended through 2011, but be only made permanent for the middle class and working poor while slowly phasing back in tax increases in 2012, after the economy recovers.
- Paul Krugman recently weighed in on the debate. Krugman makes the point that the benefits of the tax cuts, if fully extended, would "nearly all...go to the richest 1 percent of Americans, people with incomes of more than $500,000 a year." He claims that the political culture is "dysfunctional and corrupt" and wonders why Congress claims it lacks revenue to pay for funds "protecting the jobs of schoolteachers and firefighters" yet many are willing to extend all of the 2001/2003 tax cuts.
- Merrill Lynch chief North American economist Ethan Harris is quoted as writing a report saying that the expiration of the 2001/2003 tax cuts would result in a 1.3 percent annual GDP hit.
- William G. Gale wrote about what he refers to as five myths about the Bush tax cuts.
CRFB believes that if lawmakers and economists agree that any or all of the tax cuts should be extended, the costs of doing so should be fully offset. Otherwise, their long-term cost to the nation’s debt and the resulting drag on economic health could far outweigh any short-term gains.