The Bottom Line
The blogosphere exploded last week (see here and here) when a number of Republicans suggested that Congress need not offset the costs of tax cuts. According to Senator Jon Kyl (R-AZ), "you do need to offset the cost of increased spending, and that's what Republicans object to. But you should never have to offset cost of a deliberate decision to reduce tax rates on Americans."
Senate Majority Leader Mitch McConnell actually went further than this, arguing that tax cuts don't need to be offset because they pay for themselves. According to McConnell "there's no evidence whatsoever that the Bush tax cuts actually diminished revenue. They increased revenue, because of the vibrancy of these tax cuts in the economy."
On Senator Kyl's point, we just don't buy it. Why should Congress have to fully offset the costs of extending unemployment benefits or expanding health coverage (and we think they should) but not have to offset tax reductions? If Congress makes a deliberate decision to reduce the size of government, that's great; but they should proceed by cutting spending and then taxes commensurately. Or turned the other way, feel free to cut taxes and offset the revenue losses with spending cuts rather than other tax increases, but just kicking the can down the road by adding to the debt is not an economic strategy that markets are going to tolerate much longer.
We also can't help but point out that if only spending increases needed to be offset, policy makers would just replace spending policies with equivalent tax policies. Hello, unemployment tax credit anyone?
There is a reason PAYGO applies to both sides of the budget -- both tax cuts and spending increases cause our deficits and debt to rise.
Which brings us to our next point. At current levels, it is exceedingly unlikely that tax cuts would come anywhere near to paying for themselves. Yes, tax cuts generally have a positive effect on growth, but our income tax is no where near the "wrong side of the Laffer curve" -- the place where the tax is so damaging that cutting it would raise more revenue than keeping it.
For a little background, the Laffer curve starts from the basic premise: if the income tax rate is 100% it will generate little or no revenue, since few would be willing to work for no pay. From there, a reduction in taxes is likely to strengthen revenue collection. But at the other end, the Laffer curve also shows that a tax rate of 0% would raise no revenue. The question from there becomes -- what is the revenue maximizing rate of taxation?
And of course, nobody knows for sure. But you would be hard pressed to find an economist who suggested we were at or past this point. Instead, most economists believe that a tax cut would have a moderate amount of positive feedback.
This is certainly the view of a number of conservative economists, who have affirmed this point. Andrew Samwick, former chief economist of Bush's Council on Economic Advisors, has said that while "the ultimate reduction in tax revenues can be less than this first order effect.. [but] No thoughtful person believes that this possible offset more than compensated for the first effect for these tax cuts." Henry Paulson, President Bush's Secretary of Treasury, has said that "as a general rule, I do not believe that tax cuts pay for themselves." And even the 2003 Economic Report of the President stated that "although the economy grows in response to tax reductions (because of higher consumption in the short run and improved incentives in the long run), it is unlikely to grow so much that lost tax revenue is completely recovered by the higher level of economic activity.”
According to the CBO, the feedback could range from 28 percent in one extreme, to slightly negative on the other.
The point here is that tax cuts can be good for the economy, and can result in less revenue loss than static estimates suggest, but they can't pay for themselves. We don't know how much feedback they will generate -- and whatever feedback we do get should be considered a bonus to help us pay down our debt -- but even in the best case tax cuts won't come close to paying for themselves. And if tax cuts add to the debt and lead to a crisis, they'll end up costing us far more than what CBO suggests.
Tax cuts, like spending, must be paid for.
Ben Bernanke, the Chairman of the Federal Reserve, will present his twice-yearly testimony to Congress tomorrow (the Senate) and then again on Thursday (the House), accompanied by the always must-read semi-annul monetary policy report by the Fed Board. The big questions this time (and somehow there are always big questions when the Chairman speaks to Congress) are:
- Whether we should be concerned about an economic slowdown and inflation coming in below the Fed’s lower target;
- Whether in present circumstances, the Fed’s present monetary policy stance and plans for an exit strategy from its extraordinary stimulus measures are still appropriate.
We’ll also watch for any statements by the Chairman on our fiscal challenges. Chairman Bernanke and other Fed officials have placed considerable emphasis on getting our fiscal house in order sooner rather than later, to take heat off the Fed. It is still early days, but concern has already started to surface that politicians, who might ultimately be unable to take the tough decisions needed to get our fiscal house in order, might then turn to the Fed to get them off the hook by monetizing our huge debt. We could pay a dear price through inflation.
Stay tuned to this space tomorrow.
Today, four Democratic congressmen—Reps. Gary Peters, John Adler, Jim Himes, and Peter Welch—introduced four-pronged legislation, called the REDUCE Acts, meant to reduce the national deficit by more than $70 billion over the next decade. This series of bills proposes to achieve this goal through a combination of reduced spending and the elimination of “inefficient programs and costly industry subsidies.”
Each of the four congressmen has spearheaded one of the proposals within this legislation. Rep. Peters is sponsoring the energy portion, which will most notably eliminate tax loopholes for oil giants, stop the expansion of the strategic petroleum reserve, and sell federally-owned energy facilities to private utility companies—which Peters claims will save the government almost $4 billion in 2011 and almost $60 billion over 10 years.
Rep. Adler is sponsoring the Treasury and housing component. Including the implementation of electronic payroll for Treasury employees, and the elimination of the rarely-used Advanced EIC, and the Overseas Private Investment Corporation (which subsidizes U.S. companies’ investment abroad), this is estimated to save $169 million in 2011 and $3.7 billion over 10 years. Rep. Himes focuses on agriculture, proposing cuts to private agriculture subsidies and the reduction of commodity payments to wealthy farmers. He also proposes reductions in the federal reimbursement rate for private crop insurers, saving in total about half a billion dollars in 2011 and just over $6 billion in 10 years.
Finally, Rep. Welch’s defense cuts include the termination of three systems which the Defense Department supports eliminating, saving $2.6 billion in 2011 and at least $4.1 billion over the next decade.
The hard work of these four congressmen in drafting this plan only highlights the increasing importance we must place on finding specific ways to bring down deficits as the economy recovers. Those who disagree with the specifics of these bills should step forward with their own proposals for how to reduce deficits over the medium-term.
We eagerly await the future of the REDUCE bills.
Larry Summers, the Administration's top economist (and former CRFB board member), has an op-ed in the Financial Times today, looking at why the current debate in Congress muddies the fiscal waters.
In his op-ed, he suggests a more comprehensive way of thinking about our real fiscal choices: our challenges are not a matter of a simple choice between "jobs" and "deficits"; and supporting recovery in the short-term yet calling for deficit reduction in the medium- and long-run is an appropriate rather than a "mixed" message about fiscal responsibility.
In his view, while budget deficits are unproductive, if not harmful, during economic expansions, right now with interest rates close to zero and the unemployment rate at 9.5%, expansionary fiscal policy can have a powerful, positive effect on the economy. Also, since it boosts economic growth, it will help with reducing deficits in the medium-term.
However, in his view (and ours), there is most certainly a cost. Running budget deficits (especially high budget deficits) will have a cost to the economy--and the taxpayer--through the debt channel. Budget deficits if not offset translate into debt accumulation. And our debt has to be paid for somehow, somewhere, sometime, managed normally through interest payments on debt held. And there are many ways in which our budget deficits are financed: foreigners might buy more debt (or not), our domestic bond vigilantes might buy more debt (or not). To keep buyers coming to the Treasury auction table, higher interest rates might be needed, especially if the private economy looks more appealing as the economy runs closer to the full employment of people, buildings, and machines. Our government might be tempted to inflate some of the debt away--which doesn't work for long, by the way. In this process, other government priorities might be crowded out. None of these situations can be sustained for long and we don't want to go there.
So how do we avoid the costs of higher debt? In other words, what do we do to balance our short-term needs with our need to get the budget on a sustainable track? Dr. Summers points out that deficit reduction is important when the economy is on stronger footing, and it can have positive effects on the economy:
There is a very strong presumption that there are likely to be beneficial effects from the expectation that budget deficits will be reduced after an economy has recovered and is no longer demand-constrained. Not least of these are increased confidence and reduced capital costs that encourage investment, even before the deficit is reduced. Such impacts are likely to be particularly important when prospective deficits are large and raise substantial questions about sustainability or even creditworthiness.
This statement re-affirms his membership in the Announcement Effect Club and brings us to an important point. We can't have significant medium-term deficit reduction without relatively strong economic growth, and considering our future fiscal situation, we can't have robust economic growth in the long-term without deficit reduction. By announcing a deficit reduction plan now that will take effect when the economy recovers, we can increase short term economic growth, and this increased growth will further cut into our deficit. We have expanded on this point in the past.
Alan Blinder, in an op-ed in The Wall Street Journal, suggests stimulating the economy in a deficit-neutral way by letting the upper-income tax cuts expire and using the money saved over the next two years to finance further stimulus efforts. Citing multiplier calculations by Mark Zandi, Blinder estimates that "trading" upper-income tax cuts for unemployment benefits would add $100 billion to aggregate demand and one million jobs to the economy over the next two years. Even if the numbers are high, he says, the stimulative effects of unemployment benefits would certainly be higher than those of the tax cuts, since high earners save much more of their income than unemployed workers.
Summers gives the Administration credit for making recommendations to put the U.S. on a more sustainable fiscal path in the medium-term. The policies he cites are the three year freeze on non-security discretionary spending, the expiration of upper income tax cuts, the health care law, and the formation of the fiscal commission. While these are positive steps, there is still much more to be done, especially since the President's 2011 budget would put public debt at 90 percent by 2020. The freeze is good, but it should be expanded to all discretionary spending and actual cuts should be considered. The expiration of the upper income tax cuts translates as "extending the tax cuts for everyone making under $250,000 at a staggering cost"; instead the costs should be offset. Limiting the roughly $1 trillion in individual and corporate tax expenditures would be one good approach. The jury is still out on the health care law over the longer-term (see our analysis here), though it seems that if Congress sticks to their guns, it will have quite a positive effect over the long term (though much more will still need to be done). Finally, while its work could prove to be extraordinary useful for America's fiscal future, it is far from clear whether the fiscal commission will even be able to agree on recommendations to reduce medium-term and long-term deficits -- although we certainly do hope they will succeed. It would help if the President was doing more to elevate the importance of the Commission's work.
We think that Summers has it right in terms of the timing of fiscal policy. There are certainly differences in opinion over the right mix of stimulus and deficit reduction, but it is clear that we can't get our deficits under control by mid-decade with weak growth and we won't be able to have strong growth later on if our debt is rising rapidly. The announcement effect of a deficit reduction plan takes advantage of this feedback starting this year. The Administration, and the Congress for that matter, should get working on a plan that would truly put the country on a fiscally sustainable path. Everything should be on the table and everyone should be at the table.
Opens and Tours – Americans did not fare well in sporting events across the pond this weekend; leaving us Yanks to rely on past memories of success at the British Open and Tour de France as well as the understanding that our economy is not quite as bad off as those of the countries that are beating us. Meanwhile, lawmakers in Washington continue to negotiate treacherous links and steep climbs in the quest to complete legislation.
Wall Street Reform Finally in the Clubhouse – After months of debate and deliberation, legislation reforming the regulation of the financial sector was cleared for the president’s pen with Senate approval on Thursday. The last sticking point involved offsets for the measure.
Unemployment Insurance Sees Finish Line – The Senate will vote tomorrow on a measure to extend expanded unemployment benefits, right after the replacement to the late Robert Byrd is sworn in, which will provide the 60 votes needed to move forward. The bill will restore assistance beyond the traditional 26 weeks through November that was provided initially by the Recovery Act. The extension has been languishing for months as a part of the extenders bill that senators can not reach agreement on, largely due to disagreement over offsets. Congressional leaders reluctantly decided to break off the enhanced unemployment assistance in order to get it approved. The $34 billion cost of extending the increased benefits is not offset.
Small Business Bill Teeing Up for Vote – The Senate is also looking to finish up work on legislation aiding small businesses this week. While the cost of the Small Business Jobs and Credit Act is technically offset, CRFB has taken issue with one of the offsets. Allowing workers to roll over their individual retirement accounts into Roth IRAs would raise about $5 billion in the short run because the new contributions would be taxable, but since withdrawals from Roth IRAs are not taxable, in the long run the provision is expected to cost $15 billion in lost revenue. CRFB thinks that short-term stimulus should be paid for in the longer run; this gimmick has the opposite effect, adding to the cost in the longer term. Bringing the debt under control will also aid small business, as evidenced by the results of a recent poll of small business owners illustrating that 90 percent are concerned about the effect of national debt on job creation.
Senate Appropriators Sprint to the Front of the Pack – The Senate Appropriations Committee marked-up three spending bills last week and plans to tackle up to four more this week. Meanwhile its House counterpart will begin full committee mark-ups this week. Senate appropriators also set their 302(b) allocations last week, which are the limits that can be appropriated for each discretionary spending category. The total approved by the committee is $1.114 trillion for FY 2011. That amount is $7 billion less than the cap deemed by the House of Representatives in its “budget enforcement resolution” and $14 billion below that requested by the President in his budget proposal. Adding to the confusion, Senate Budget Committee chairman Kent Conrad (D-ND) last week said he may pursue a resolution similar to that passed by the House. It is not clear what spending level he would seek and how that would play out seeing as appropriators have already moved forward. Lawmakers doubt that they will complete all action on the spending bills this year, likely depending on a continuing resolution to fund at least some parts of the government when the fiscal year begins in October and requiring an omnibus spending bill during a lame duck session after the elections. CRFB predicted fiscal chaos this year in the absence of a budget resolution and noted the need for budget process reform. A solid bill was introduced last week in the House to add more transparency and discipline to the budget process.
War Supplemental in the Rough – The Senate may attempt a cloture vote on the version of the supplemental bill to fund operations in Iraq and Afghanistan passed by the House earlier this month, but it is likely to fail. The main source of contention is nearly $23 billion in domestic spending tacked on by the House.
Lew Tapped for Yellow Budget Jersey – Jacob Lew has been nominated by the White House to replace Peter Orszag as Director of the Office of Management and Budget. Meanwhile, OMB will release its Mid-Session Review of the budget and economy this Friday. Fridays are often when administrations release bad news. This update could contain forecasts that are revised downward from what was projected in the President’s budget request earlier this year. Watch out for CRFB’s analysis of the numbers shortly after they are released.
Some Democrats Break Away from the Peloton– A group of nearly 60 House Democrats sent a letter last week to House leaders expressing their desire for more spending discipline. They specifically called for ending the abuse of the “emergency” spending designation to circumvent pay-as-you-go requirements for legislation and long-run offsets for new stimulus spending. House Speaker Nancy Pelosi said that new stimulus spending, such as aid to the states, will be paid for.
Panetta Warns of Uphill Climb for Future Intelligence Funds – The Washington Post’s blockbuster special report on the intelligence community has an interesting nugget from CIA Director Leon Panetta. Panetta, a former OMB Director and CRFB Board Member, says that he is charting a five-year plan for his agency because its post-9/11 budget is unsustainable. He is quoted, “Particularly with these deficits, we're going to hit the wall. I want to be prepared for that.”
CRFB board member Eugene Steuerle joined the Announcement Effect Club in a post on the Urban Institute's website. In the post, he talked about the need to separate the difference between our short-term deficits and our medium-term structural deficits. First, the main quote:
Finally, there's a bonus in handling the first, short-term problem by starting to solve the second, long-term problem immediately: it gives greater assurance to the markets that countries are going to get their fiscal houses in order. Many solutions to long-term fiscal problems—such as reducing powerful incentives to retire—could also be designed to boost recovery.
As he points out, there's no need to wait to develop a plan, since there obviously can be a lag between when a policy is enacted and a policy is implemented. Because of this lag, he says, "The economics always [say] we should adopt and maintain good long-term budget policy as soon as possible, even when we disagree on the timing of short-term stimulus." Since a medium-term deficit reduction plan would have little, if any, contractionary effect in the short term, enacting one now makes economic sense, especially since a credible plan would reduce upward pressure that fears of excessive debt could have on long-term interest rates.
The (brief) stock market rally had dominated trading in the earlier part of the week. However, investor interest in U.S. government bonds picked up again toward the end of the trading week with a refocus on safe haven effects and increased signs of U.S. economic weakness. As a result, yields on the benchmark 10-year Treasury bond dipped below 3 percent again and came close to lows for the past year. (Yield haves been below 3 percent a lot of the time since late June and now.) The 30-year government bond has performed similarly.
Increasing concern about the strength of the economy and signs that inflationary pressures remain extremely subdued (always the biggest plus for bonds) led investors to shift relative portfolio preferences from stocks to bonds by the end of the week. Economic news of note included disappointing second quarter profit announcements over the course of the week, a disappointing consumer sentiment report, and a low consumer inflation report.
The series of weak economic news confirmed the message put out by the Fed during the week through the release of the minutes from its late June meeting: many (although not all) Fed officials think that while forward momentum continues, the economy is slowing down and the risks may be on the downside. (See its recently released FOMC minutes--along these lines, Chairman Bernanke is expected to give his Semi-Annual Monetary Policy testimony to Congress next week.)
Concerns about the economic and fiscal outlook for the eurozone also continued to underpin trading, although the earlier near-panic has subsided. During the week, the so-called “bond vigilantes” (PIMCO, the largest private holder of bonds) announced that they had reduced their exposure to eurozone debt instruments and had increased their holdings of U.S. instruments (“the U.S. remains the flight-to-quality country in the world”).
Despite OMB's best efforts to trim waste from the government, The Onion believes it is inevitable that billions and billions of dollars will be wasted on unnecessary or absurd government expenditures. So why not make that waste awesome?
Forget bridges to nowhere and researching whether mice become disoriented when they consume alcohol. The Onion would redirect spending on all of these wasteful projects towards things that we could all use. Take the defense budget for example. They spend billions and billions on vehicles that have huge cost overruns, provide little improvement over their previous models, and most importantly, provide little entertainment value for the taxpayers. So, says activist Brian McGill, why not funnel that money into spending on a giant laser that anyone could shoot?
Among the other ideas proposed:
- eliminate farm subsidies and use the money to make the world's largest kielbasa
- eliminate oil tax preferences and use the money to either build a shopping mall in the clouds, develop an invisibility pill, triple the length of summer, or make boomerangs that actually come back to you
- stop funding new prisons until money is allocated to capture Bigfoot (idea courtesy of Rep. Saxby Chambliss)
- take money out of NASA to fund a project that would make cartoon characters come to life (Grover Norquist's idea)
Of course, CRFB supports all of these ideas (especially the kielbasa one), but we worry about how it all would work out in practice. Many of these projects could be subject to the same inefficiencies and failures as the Pentagon, making us no closer to eating a 2,000-foot sausage than we were under the old system. We must be vigilant that we are funding our wasteful spending in an efficient manner, so as to not unnecessarily cost the taxpayer.
Congressman Mike Quigley (D-IL) today introduced important legislation to create a more transparent budget regime towards putting the country on a sustainable fiscal path. The “Transparent and Sustainable Budget Act of 2010” contains several sound ideas for improving the budget process.
In addition to providing for a more accurate accounting of federal expenditures, the bill also requires the establishment of debt and deficit reduction goals. Key provisions include:
- Establishes a debt reduction target of 60 percent of Gross Domestic Product and a deficit target of three percent of GDP within 10 years.
- Calls for the prompt consideration by Congress of the recommendations from the White House fiscal commission.
- Requires OMB to produce a “Quadrennial Fiscal Sustainability Report.”
- Creates an alternative budget baseline that accounts for spending and revenues through a thirty year budget window.
- Creates a point of order against measures that would create large deficits outside the 10 year budget window.
- Develops an accrual accounting system to apply to certain budget areas including retirement benefits and environmental liabilities, as recommended by GAO.
- Seeks to have Fannie Mae, Freddie Mac, and other similar agencies included in the budget.
- Requires more transparency and evaluation of tax expenditures.
The lack of a traditional multiyear budget blueprint and the likelihood of a dysfunctional appropriations process this year underscore the need for fundamental budget process reform. Improving the budget process will be essential to enforcing and attaining the fiscal goals that policymakers must adopt now in order to get our fiscal house in order.
The bill wisely acknowledges the need for an effective budget process in dealing with rising debt. CRFB commends Congressman Quigley and the bills co-sponsors for putting forth a sensible proposal that should initiate debate and action.
The Peterson-Pew Commission on Budget Reform recommended the goal of stabilizing the debt at 60 percent of GDP by the year 2018 in the December 2009 report, Red Ink Rising. A forthcoming report will offer a comprehensive set of recommendations for reforming the budget process.
According to the Council of Economic Advisors’ (CEA) quarterly report on the continuing effects of the American Recovery and Reinvestment Act (ARRA) (see our analysis of ARRA here), the magnitude of the fiscal stimulus and its positive effect on the U.S. economy have been increasing substantially in the first half of 2010 (from $108 billion in Q1 of 2010 to $116 billion in Q2). CEA estimates that the 2009 stimulus has boosted GDP by 2.7 percent and raised employment by 2.5 million jobs since February 2009, relative to what would have occured absent the stimulus.
According to CEA, ARRA has spent $480 billion and using numbers from Stimulus.org, about $260 billion of that is spending and $220 billion is tax cuts. The amounts are further broken down into several tax and spending categories on the website.
The CEA uses two different methodologies to estimate ARRA's impact. One model they use estimates the impact on the economy based on the multiplier effects of different provisions. This methodology produces the GDP and employment numbers that you see above. The other methodology they use constructs a "statistical baseline" of what the economy would be like without the stimulus, and then measures and compares it to actual economic performance. Using this approach, they estimate a GDP boost of 3.2 percent and an employment boost of 3.5 million jobs. However, this approach doesn't account for many other factors that could affect the economy, such as unusually tight credit, loose monetary policy, TARP, and state fiscal contraction. CEA notes that it is impossible to say whether this approach understates or overstates ARRA's impact.
CEA and CBO Estimates of ARRA's Economic Impact
|Measure||2009 Q2||2009 Q3||2009 Q4||2010 Q1||2010 Q2|
|CBO GDP Increase||0.9 - 1.5%||1.3 - 2.7%||1.5 - 3.5%||1.7 - 4.2%||1.7 - 4.6%|
|CBO Employment Increase (millions)||0.3 - 0.5||0.7 - 1.3||1.0 - 2.1||1.2 - 2.8||1.4 - 3.4|
|CEA GDP Increase (multiplier model)||0.8%||1.7%||2.1%||2.5%||2.7%|
|CEA Employment Increase (millions)||0.4||1.1||1.7||2.2||2.5|
Note: CBO has not released an estimate for the second quarter yet. The numbers in the table are estimates from the 2010 first quarter report.
The CEA numbers fall within the range of CBO's low and high estimates. For GDP, the CEA estimates are towards the low end of CBO's range and for employment they are towards the high end.
This quarterly report focused on the impact of the public infrastructure investment provisions in the ARRA, and the effect they are having on the American economy. The ARRA included appropriations for $320 billion in "public investment outlays" on projects like highway improvements, improved public transit, and electrical grids (Stimulus.org shows a narrower $140 billion category that represents just infrastructure spending, and a $76 billion category for corporate tax cuts). To date, CEA finds that two thirds of these funds have been obligated and a quarter have been outlaid—spending which is estimated to have saved or created 800,000 jobs as of Q2 of 2010 and to have in turn impacted private sector spending significantly due to tax breaks and other leveraging.
Although the CEA acknowledges that it can be tricky to measure exactly how a policy has impacted macroeconomic trends, they do maintain that the results of their analysis are “strong enough and clear enough [to be] confident that the basic conclusions are solid.” So far, the ARRA seems to be having a positive effect on our economy -- but how much effect it has had is very hard to know.
To track ARRA spending and all other actions the federal government has taken to support the economy, visit Stimulus.org.
Today, former Federal Reserve Chairman Alan Greenspan said in an interview that all of the 2001 Bush tax cuts, which he had previously supported, should be allowed to expire at the end of this year, citing the need for the increased tax revenue in efforts to decrease the federal deficit. Greenspan’s comments catapulted him into a highly controversial debate going on right now, regarding whether it should be a higher priority to lessen Americans’ tax burden or the growing US debt. Greenspan acknowledged that ending the tax cuts “probably will slow growth,” but claimed that the risks stemming from a rising debt are much greater, and that our long-term economic prospects will be grim if nothing is done to decrease the debt soon.
Greenspan's statement today comes on the heels of yesterday's Senate hearing on whether the tax cuts should be extended, which we blogged about here.
According to the Joint Committee on Taxation, it would cost the government about $2.5 trillion over ten years to continue the 2001/2003 tax cuts for people earning less than $250,000 (as in the President's 2011 Budget), averaging out to about $250 billion per year.
A few days after Senate Republicans jumped on board the Sessions-McCaskill bandwagon, 58 House Democrats called for greater restraint of spending and the offsetting of new stimulus spending in the long-run.
Rep. Adam Schiff (D-CA) leads this group of Democrats, who put an emphasis on the strengthening of budget enforcement mechanisms. The letter says about PAYGO:
We recognize and understand the need for the emergency designation as narrowly defined in the statutory PAYGO law recently passed by the House and signed into law by President Obama. However, we have made a commitment to pay for our priorities. It is critical that we uphold our efforts to restore fiscal discipline to the federal government by not using this tool for anything other than it is intended – a true, unforeseen emergency.
We certainly agree, and as we saw from a definition of emergency spending pushed by Keith Hennessey, most (if not all) of the stimulus measures being talked about, such as unemployment benefit extensions or aid to states, hardly qualify as emergency spending and should be paid for. As we argued in a release:
While the “emergency” provisions may be important, they are hardly emergencies in the sense that they are not a surprise to anyone. Policymakers have known for a long time that unemployment benefits (and COBRA benefits, in the original version) would need to be extended – programs like these have undergone several rounds of temporary extensions already. Politicians have had plenty of time to think through potential offsets.
In addition to pushing strengthened PAYGO, the Democrats also called for paying for any new stimulus spending with long-run offsets. In a line that echoes what we often say, the letter stated that "extending critical economic investments is no more important than paying for them."
Unfortunately, the specifics stop there. The Democrats don't call for discretionary spending caps, as the Republicans did yesterday. Nor do they specifically call for a medium- to long-term deficit reduction plan, instead saying "we stand ready to work together with you to ensure that deficit reduction continues to be a top priority of Congress and the administration."
Granted, PAYGO and offsetting stimulus spending are very important because they can help stop us from digging our fiscal hole deeper. But even if you stop digging and let sunsetting provisions fill in the hole somewhat, we're still not in a position to climb out. Even under an unlikely current law scenario, debt still rises to the triple digits. We need to get specific on what we need to do fill the hole further. We have our simulator, which lays out plenty of options, and we have compiled the results showing the most and least popular options. Perhaps lawmakers could use that as a starting point to get specific.
Nonetheless, we obviously support these Democrats' efforts to prevent our debt situation from getting worse due to new spending. We hope that they'll take the next step in getting specific for how we will get our fiscal house back in order.
What to do about the 2001 and 2003 tax cuts that are set to expire at the end of the year has been a critical question that Congress has largely ducked so far. But a Senate hearing yesterday marked the beginning of what will likely be a contentious debate. The hearing previewed some of the messages that will be used during the upcoming debate and underscored the need for serious reform of the tax system and an eye on debt reduction.
Shaping the tax debate are rising concerns over the long-term budget picture and election-year politics. President Obama has promised to permanently extend the tax cuts for the “middle class” – classified as those individuals who make less than $200,000 a year and families that bring in less than $250,000. But leaders in Congress, looking for ways to close the fiscal gap, have signaled that they won’t necessarily follow that path.
Senate Finance Committee Chairman Max Baucus (D-MT) kicked-off the hearing by stating that the budget deficit was the “elephant in the room” in considering extending the tax cuts and questioned whether tax breaks for the wealthy could be maintained in such a fiscal environment. He urged his colleagues to proceed with “an eye on the budget picture.”
Witnesses at the hearing were CRFB board member Douglas Holtz-Eakin of the American Action Forum, Donald Marron of the Tax Policy Center, Leonard Burman of Syracuse University, CPA Carol Markman, and David Marzahl of the Center for Economic Progress. While they disagreed on what to do exactly about the tax cuts, there was broad agreement on the need for comprehensive tax reform.
Burman argued against permanent extension of the tax cuts because it would make tax reform more difficult; stating in his written testimony that “A system-wide reform along the lines of the Tax Reform Act of 1986, but with the goal of eventually raising enough revenue get the national debt out of the red zone should be a top priority for the Congress.” At the same time he asserted that allowing the middle-class tax cuts to expire now would hamper the economic recovery. He proposed a two-year extension, with Congress committing to a tax reform plan before the temporary extension expires.
Burman also advised a focus on reigning in America’s long-term debt and suggested the solution will be a combination of taxes and reduced spending. His recommended three goals for budget and tax policy:
• Do not stifle the nascent economic recovery.
• Implement a credible plan to get the debt down to a sustainable level within the next decade.
• Reform the tax system to make it simpler, fairer, and more conducive to economic growth.
Holtz-Eakin agreed with Burman on the need for deep tax reform, but contended that extending the tax cuts would ease the path to reform, not make it more difficult. He also agreed that the growth in debt must be addressed, but contended that the focus should be on reducing federal spending.
He argued for a “ruthless” focus on economic growth and claimed that extending the tax cuts would promote growth through providing tax law certainty and lower rates for small businesses, while a temporary and partial extension would not encourage sufficient growth. Burman, on the other hand, testified that a continuation of current policy would not promote growth, instead putting us on the path to being Greece. Whereas Burman argued that temporarily keeping the tax cuts affecting middle- and lower-class taxpayers would aide the economy by propping up consumer spending while higher marginal income tax rates for high-income earners would have little impact on spending or entrepreneurship, Holtz-Eakin countered that maintaining lower rates would help small businesses while some provisions like refundable tax credits and marriage tax relief have no impact on growth.
Marron concurred that fundamental tax reform and debt reduction must be pursued. He also noted that many analysts believe that the economic benefits of extending some or all of the tax cuts will be maximized if they are offset.
The House leadership is reportedly considering a one-year extension of the middle-class tax cuts and a two-year extension of the “patch” preventing the Alternative Minimum Tax (AMT) from hitting middle-class taxpayers. CRFB supports fundamental tax reform that broadens the tax base and is more efficient. We have also suggested a temporary extension of the tax cuts in conjunction with a commitment to adopt a credible plan to stabilize the debt at a reasonable level.
Today, CRFB released its report on the long-term effects of the recent health care reform package (be sure to check it out!), based on information provided in CBO's Long Term Outlook. CBO's analysis reflects the relatively inconclusive results of health reform's true budget impact. While those on the right and the left have argued that the reform package will either substantially increase or decrease the U.S. deficit, in reality, it is very difficult to predict what effect it will have in the long-run.
In the short run, the reform is projected to reduce the deficit by $143 billion as a result of tax increases and Medicare cuts which more than offset new spending on Medicaid and exchange subsidies. Beyond that, several measures -- including cuts in annual updates for provider payments, a slowing in the growth of premium subsidies, an Independent Payment Advisory Board, and a growing excise tax on high-cost plans -- are supposed to put downward pressure on the growth of the deficit.
Unfortunately, the exact impact of these changes is very difficult to measure considering the inherent uncertainty of health care projections, the untried nature of many of these changes, the fact that CBO's long-term projections alreadyassume health care cost growth will slow, and the fact that many measures in the legislation may prove politically and economically unsustainable in the long-run.
With the information they do have, CBO presents two long-term budget scenarios -- one which shows health reform significantly reducing the long-term deficit (mainly as a result of higher revenues), and one which shows it having little effect at all.
We cannot be sure which is these scenarios is a closer projection of reality, though we do know that the growth of Medicare and Medicaid remains unsustainable under either.
In our report, we not only attempt to explain CBO's analysis on the impact of health reform, but also discuss ways to maximize the chances that reform succeeds in controlling costs.
Regardless of what scenario we look at, a lot more work has to be done.
Below is a table from the report, showing the effects and CBO's assumptions of health reform on the long-term.
|Baseline-Extended Scenario||Alternative Fiscal Scenario|
|First Decade||Spending and revenue provisions play out as written in law||Spending and revenue provisions play out as written in law|
|Deficit Impact in 2020
||0.1 percent of GDP reduction|| 0.1 percent of GDP reduction
|Second Decade||Federal health spending grows at slowed rate based on estimated "broad growth rates" of provision in health legislation; tax provisions play out as written into law||Federal health spending grows at rates estimated absent reform, under the assumption that policymakers will not allow certain cost-controlling measures to continue; overall revenue levels will remain fixed percent of GDP|
|Deficit Impact in 2030
|| 1 - 1.3 percent of GDP reduction
|| 0 - 0.1 percent of GDP reduction
|Beyond Second Decade||Federal health spending grows at rates estimated absent reform (though from a lower level); tax provisions play out as written into law||Federal health spending grows at rates estimated absent reform; overall revenue levels will remain fixed percent of GDP|
|Deficit Impact in 2080
|| 4 - 5 percent of GDP reduction
|| 0.3 percent of GDP increase
Republicans on the Senate Appropriations Committee backed the discretionary spending caps proposed by Jeff Sessions and Claire McCaskill yesterday, saying they would re-propose them at some point. While the caps do not freeze discretionary spending, they do represent significant reductions from where the President's budget and both the proposed House and Senate resolutions would be.
The Sessions-McCaskill caps have been voted down by just a few votes in the past, but it is unclear if this additional enthusiastic support will put them over the top since it is a few more Democrats who will need to come on board to get them passed.
The importance of these discretionary spending caps should not be understated, even if the driver of growing deficits in the future is mandatory spending. As we noted in this policy paper, discretionary spending actually grew faster than mandatory spending over the last decade.
The graph below shows discretionary budget authority under each of the proposals. The House resolution is not shown because it only covers 2011; its level is just about the same as the Senate resolution. Note that this is budget authority, not outlays. Budget authority represents how much can be committed to be spent in the future, while outlays represent how much cash is actually spent within a given year (outlays can include budget authority from previous years). Discretionary budget authority is usually lower than the actual outlays; however, it is the only measure that the Sessions-McCaskill cap applies, so it is used here for an apples-to-apples comparison.
Note: The Senate resolution and Sessions-McCaskill estimates come directly from the bills, and the President's budget numbers come from OMB (minus war spending and adding in Pell grants).
The Sessions-McCaskill caps are significantly lower than all other major proposals out there, especially the President's budget.
It's great that the Republicans of the Appropriations Committee are getting their full weight behind the caps. In conjunction with (a more strengthened) PAYGO, discretionary caps are a proven way to get spending under control when Congress is unwilling to do so by itself. We hope that Sessions-McCaskill can finally make it over the top and get the 60 votes it needs to pass.
It’s official, budget commissions are now sexy. Esquire magazine confirmed it with the creation of its own Blue Ribbon Commission to Balance the Federal Budget.
The Esquire commission is made up of a bipartisan group of former senators – Bill Bradley, Bob Packwood, Gary Hart, and John Danforth – and will be chaired by Lawrence O’Donnell, pundit, former senate aide and “The West Wing” producer. The group will be tasked with creating “a specific, actionable plan that outlines how the government can eliminate the federal deficit by 2020.”
According to the magazine, everything will be on the table for the panel and the members will “negotiate, compromise, and forge a nonpartisan, commonsense alternative to the hyperpartisan status quo.”
If Esquire can make bipartisanship and making tough fiscal decisions hip, then it will have performed a great service. Just remember, we at CRFB were trend setters with our Peterson-Pew Commission on Budget Reform.
Under the radar due to other priorities, the Senate has taken up its version of a small business stimulus bill. The bill combines two different small business bills that passed the House last month (one that created a lending fund and one that would provide tax breaks).
As with the House bills, the Senate version would create a $30 billion small business lending fund to provide equity to community banks. The banks in turn pay varying dividends on that equity based on how much they increase their lending to small businesses. CBO estimated (for the House bill) that the lending fund itself would cost $1.4 billion, although a press release by the Senate Finance Committee expects that the Lending Fund would raise $1.1 billion over ten years. That bill also included $2 billion for a State Small Business Credit Initiative, which is cut in half in the Senate version.
The bill also provides numerous tax incentives for small business investment, which make up the bulk of the gross cost. The bill extends "bonus depreciation", which allows businesses to deduct more capital purchases faster than under normal depreciation schedules. This is the single costliest measure, reducing revenue by $5.5 billion over ten years. A few other provisions include a 100 percent tax exclusion of capital gains that are from the sale of small business stock and an increased deduction for start-up expenditures. These two would cost about $750 million over ten years.
The bill is ostensibly deficit neutral over ten years. Like with the House bill, it includes a tightening of the cellulosic biofuels credit, which will raise $2 billion. Otherwise it relies on reducing the tax gap and a timing gimmick -- not exactly a great way to offset the costs of a bill.
The timing gimmick comes from allowing people to roll over their individual retirement accounts into Roth IRAs. This provision would actually raise about $5 billion over the next ten years since the rollovers would be taxed. However, since withdrawals from Roth IRAs are tax-free and traditional retirement accounts are not, Tax Policy Center estimates this provision would reduce revenues by $15 billion (in present value) through mid-century.
The House was able to pay its small business bills in a fiscally responsible and non-gimmicky manner. We should expect no less from the Senate.
See stimulus.org for all the other measures the government has taken to stimulate the economy.
Recent fiscal performances have been a mixed bag. The troubled Greek government finally pushed through significant pension reform, but doubt still lingers over their long-term viability. At the same time, trouble on the Iberian Peninsula seems to be brewing. To top it all off, the head of a global banking giant has warned that we aren’t out of the woods just yet.
Starting with the positives, the New York Times reports that Greece has finished major legislation to improve their fiscal outlook. Changes include upping the retirement age from late 40s to a flat 65, modifying the formula used to calculate pensions, and making it easier for private companies to fire employees. The legislation was met with obvious displeasure from Greek citizens, though the protests resulted in only one injury and no arrests, a serious improvement from the previous riots. In fact, the New York Times speculates that this calmer opposition may reflect a wider acceptance amongst the Greek populace that spending cuts have become necessary.
While this is obviously a positive step for the Greek government, they are still getting hammered in the bond market, where traders cannot shake the fear of an imminent debt restructuring. As a result of these jitters, the yield on Greek long-term bonds is still an incredibly high 10 percent.
Travelling westward, Portugal got hit today with another sovereign debt downgrade. This two-notch drop by Moody’s follows S&P’s two-notch drop in early May. Citing a growing debt-to-GDP ratio and very modest projected growth, Moody’s does not seem to be forecasting a pretty future for Portugal. Moody’s view on Portugal is now much closer to that of the other two major ratings agencies, S&P and Fitch, both of which have a similarly negative outlook on Portuguese creditworthiness.
Finally, Stephen Green, the Chairman of British banking giant HSBC Holdings, has warned that, though we are “on our way out,” the fiscal crisis is not over yet. He claims that the possibility of further macroeconomic shocks from indebted nations and protectionist policies enacted by countries struggling to boost growth underscore the need for global fiscal cooperation and coordination.
Though it may be unpleasant to watch, it is quite obvious that the global fiscal dance is far from over. Intermission just ended, and the critics are still debating over whether the second act will see the dreaded double-dip or simply a slow recovery. One thing, however, is for certain: if the United States doesn’t get its fiscal policies in order, we may soon be entering stage left.
Today, President Obama has announced his intention to nominate Jacob Lew, the current Deputy Secretary of State for Management and Resources, to replace Peter Orszag as Director of OMB. Lew was previously OMB director during the Clinton administration. In a statement today Obama praised Lew’s “experience and good judgment,” saying that if confirmed, he will prove to be an “extraordinary asset” in efforts to cut the deficit and develop a sustainable fiscal path for the nation. We wish him the best of luck in this endeavor.
Running for the Exits – The “Running of the Bulls” has begun in Pamplona, Spain. Combine that with the celebrations over the country’s World Cup victory yesterday and you have quite a volatile mix. Washington has its own precarious situation, though not nearly as colorful or fun. A full agenda and little time on the Congressional calendar will make for a hectic rush, especially in the Senate. Congress returns this week from its July Fourth recess with a small window before it leaves again for a month-long August recess. Lawmakers may be running like mad, but they won’t be very bullish.
Small Business Looks to Avoid Being Gored by Tax Politics – The Senate this week will consider legislation to improve lending to small businesses (HR 5297), but other issues could get in the way of fast adoption. The bill will create a $30 billion lending poll and add $12 billion in tax incentives for small businesses. Some legislators also want to include in the measure a controversial provision to extend the estate tax at lower levels.
Seeing Red in the War Supplemental – The Senate must also consider the supplemental spending bill passed by the House just before the recess to fund operations in Iraq and Afghanistan that also includes about $23 billion in domestic funding. But many doubt that version can pass the Senate.
Mid-Session Review Lost in the Stampede? – July 15 is the deadline for the administration to produce its mid-year adjustment of budget and economic projections, but that deadline is often missed. Amid fears that the new numbers will not be as good as had been hoped, it is not clear when the update will be released. However, Congress will get a report on the economic picture Wednesday as White House Council of Economic Advisers Chair Dr. Christina Romer will testify before the Joint Economic Committee on “The Economic Outlook.”
Will Energy Reform Get a Chance to Run? – Senate Majority Leaders Harry Reid (D-NV) wants to bring energy legislation to the Senate floor this month in spite of the cramped agenda the body already faces. It is not clear if putting a price on carbon will be a part of any energy bill that comes to the floor, as agreement continues to be elusive.
Tax Cuts Are the Bull Waiting to Get in the China Shop – What to do about the 2001 and 2003 tax cuts that will expire at the end of the year remains to be a simmering debate just waiting to boil over in Washington. The Senate Finance Committee will wade into the topic Wednesday with a hearing.