The Bottom Line

August 27, 2010

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.



August 27, 2010

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.

August 27, 2010

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.

August 26, 2010

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.

  2011-2020 (billions)
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
Interest $810
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.



August 26, 2010

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.

August 26, 2010

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)

$2.7 trillion

Fully Extend the Tax Cuts (with AMT)

$3.9 trillion
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)

$3.0 trillion


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.

August 25, 2010

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.

August 25, 2010

Yesterday, CBO released an update on the American Recovery and Reinvestment Act’s (read our analysis of it here) impact on unemployment and job growth for the second quarter of 2010. It reported that ARRA funded almost 750,000 jobs in the U.S. this quarter, yet this positive report was accompanied by the cautionary note that the number of jobs created cannot alone paint a picture of the bill’s impact, primarily because some of those jobs might have existed regardless of the stimulus.

CBO’s analysis says that the economic stimulus package raised real GDP by between 1.7 and 4.5 percent in the second quarter of 2010, while lowering the unemployment rate by between 0.7 and 1.8 percentage points (the range illustrates the inherent uncertainty in estimating the effects of the stimulus). CBO reports that, from its implementation through the second quarter of 2010, the ARRA increased the number of people employed by between 1.4 million and 3.3 million, and increased the number of full-time-equivalent jobs by 2.0 million to 4.8 million compared with what would have otherwise occurred. The chart below compares CBO's most recent findings with those of CEA, published a month ago.

Measure 2009 Q2 2009 Q3 2009 Q4 2010 Q1 2010 Q2 2010 Q3 2010 Q4

CEA and CBO Estimates of ARRA's Economic Impact

CBO GDP Increase 0.8 - 1.3% 1.2 - 2.4% 1.4 - 3.3% 1.7 - 4.1% 1.7 - 4.5% 1.5 - 4.2% 1.1 - 3.6%
CBO Employment Increase (millions) 0.3 - 0.5 0.6 - 1.1 0.9-  1.9 1.2 - 2.7 1.4 - 3.3 1.4 - 3.6 1.3 - 3.5
CEA GDP Increase (multiplier model) 0.8% 1.7% 2.1% 2.5% 2.7% n/a  n/a
CEA Employment Increase (millions) 0.4 1.1 1.7 2.2 2.5 3.0* 3.5*

*For CEA Employment Increases (millions) in Q3 2010 and Q4 2010, the numbers were derived from the CEA Report by taking note that they project 3.5 millions jobs to be created/saved by Q4 2010, and then splitting the difference between Q3 and Q4 2010 columns.

However, CBO also warns that the ARRA’s effects on output will be gradually diminishing during the second half of 2010 and beyond, with its effects on unemployment lagging slightly behind, beginning a more noticeable decline in 2011.

Type of Activity Low Estimate Output Multiplier High Estimate Output Multiplier Total 10-year Budgetary Cost
Purchases of Goods and Services by the Federal Government 1.0 2.5 $95 billion
Transfer of Payments to State and Local Governments for Infrastructure 1.0 2.5 $139 billion
Transfer of Payments to State and Local Governments for Other Purposes 0.7 1.8 $215 billion
Transfer of Payments to Individuals 0.8 2.1 $100 billion
One-Time Payments to Retirees 0.3 1.0 $20 billion
Two-Year Tax Cuts for Low and Middle Income Earners 0.6 1.5 $168 billion
One-Year Tax Cut for High Income Earners  0.2 0.6 $70 billion
Extension of First Time Homebuyer Credit             0.3 0.8 $7 billion


The ARRA, signed into law in February 2009, included about $814 billion in spending and tax cuts over a ten year period (the latest number from CBO), among them a $400 per person "Making Work Pay" tax credit, a patch of the Alternative Minimum Tax, substantial infrastructure investment, an expansion of unemployment benefits, and significant state and local aid. Follow the bill's continued deficit impact at

August 24, 2010

House Republican Leader John Boehner (R-OH) gave an economic speech today that was billed as setting the policy table if Republicans gain control of the House in November. If so, the table needs some more place settings.

The speech got headlines because Boehner blasted the policies of the Obama administration and called for Treasury Secretary Tim Geithner and National Economic Council Director Larry Summers to resign. But the address also touched on fiscal issues; illustrating why it is so hard for policymakers to address the debt but also offering a glimmer of hope for some progress.

Boehner hammered at Obama and Democrats over “irrational” federal spending, calling to return non-defense discretionary spending to 2008 levels. He said with Republicans in charge, they would do things different and confront the national debt.

Listen, we need to have an honest conversation with the American people about the scope of our fiscal challenges – that means everything from short-term commitments to long-term commitments.

Sounds great, but then he ensures the conversation will be one-sided by taking the 2001/2003 tax cuts off the table, saying if they aren’t all permanently extended, it will be a “jobs-killing” tax increase. This unwillingness to consider all options is a key reason why Washington has yet to come close to developing a serious plan for putting the country on a sustainable fiscal course. The lack of direction is reflected in a recent poll underscoring that Americans are split over extending the tax cuts for the wealthy or just the middle class – with voters professing to support deficit reduction at the same time. A truly open and honest conversation on the fiscal situation and how to fix it must include both spending and revenues.

Yet Boehner does provide an opening for bipartisan agreement when he turns to tax expenditures – the myriad of targeted tax breaks in the tax code.

We need to take a long and hard look at the undergrowth of deductions, credits, and special carveouts that our tax code has become.

And, yes, we need to acknowledge that what Washington sometimes calls ‘tax cuts’ are really just poorly disguised spending programs that expand the role of government in the lives of individuals and employers.

It was the late Jack Kemp who said, ‘not all tax cuts are created equal.’ We need to bring simplicity and certainty to our tax code so we can make it a vehicle for sustainable pro-growth policies, not transfer payments to the favored few.

This call for tax reform and serious examination of tax expenditures that are usually extended without any review is very encouraging and welcome. Fundamental tax reform can play an important role in improving the fiscal outlook, but in addition to simplifying the tax code reform must also broaden the tax base in order to be effective. Resistance to any increases in revenues will make real reform impossible.

Boehner called for a “fresh start” in the speech. Putting everything on the table in order to encourage sensible solutions to our fiscal problems would be something fresh and useful.

August 23, 2010

Back to School – For many kids, parents and teachers today is the first day of school. Congress is still out until after Labor Day, but policymakers have plenty of homework.

CBO Report Tops the Reading List – The Congressional Budget Office released its update on the budget and economic outlook last week. The revised figures project debt now reaching just over $16 trillion in 2020, which is $1 trillion above the forecast from earlier this year. See here and here and here for analysis and commentary from CRFB on the report.

Social Security is Popular Subject News last week that the White House fiscal commission is considering changes to Social Security has generated the kind of buzz usually reserved for when the football team captain and head cheerleader break up. Some are trying to get lawmakers to promise to oppose any changes that include benefit cuts in any form. CRFB sent them to the principal’s office last week in a blog post and recently did a blog series on the subject in the Bottom Line.

August 21, 2010

Since economic assumptions have such a big effect on fiscal projections, we have compared their new assumptions in the Updated Budget and Economic Projections to their previous assumptions and to OMB's projections in the Mid-Session Review (click here for an analysis of the MSR).

In light of more recent economic data, CBO is now projecting slightly higher growth this year and next year compared to its previous projections. Growth is now expected to reach 3.0 percent this year and 2.1 percent next year, above the 2.2 and 1.9 percents, respectively, projected earlier. CBO and OMB projections diverge significantly next year, where CBO sees growth slipping and OMB assumes growth of 4.0 percent. In order to explain some of the variation between CBO’s and OMB’s economic projections, it should be noted that CBO incorporates different assumptions. As CBO explains:

“Differences between the projections of CBO and those of other forecasters probably stem primarily from a difference in assumptions about fiscal policy. Most forecasters appear to assume that the Congress will extend at least some of the tax cuts enacted in 2001 and 2003 as well as some relief from the AMT. In contrast, CBO’s forecast is predicated on the assumption that current law is maintained.”

This highly important factor must be taken very seriously as we agree with CBO that it is highly unlikely that there will be no extension of the 2001/2003 tax cut or the annual AMT fix. Thus, larger potential deficits from extensions of “current policies” would also yield different economic outcomes going forward. CBO states that under an alternative fiscal path, growth would be higher in the short-term but lower by the end of the decade as larger deficits would hamper growth. This is an important trade-off to take note of.

CBO also projects an improved unemployment rate from its earlier estimates. Unemployment is now expected to average 9.5 percent this year, down from CBO’s previous 10.1 percent. CBO’s unemployment estimates are now more in line with those from OMB. A lower unemployment rate will put less pressure on safety-net spending and increase tax receipts as the number of people in the workforce and wages rise, helping to reduce future deficits and debt. CBO has also lowered its inflation estimates in the near-term, but raised them in the long-term, citing the expectation that the Federal Reserve will “attempt to maintain an inflation rate for consumer prices near the top end of the central tendency of the long-range forecasts for inflation.”


CRFB believes that policymakers should begin work now on developing a fiscal plan. But when they do so, we also believe that they should pursue the best possible mix of policies to encourage growth – as a stronger economy will reduce future deficits and our borrowing needs via imrpvoed automatic stabilizers (such as lower unemployment benefits and higher government revenues). A stronger economy would also increase the denominator in debt-to-GDP calculations, making a return to sustainable fiscal paths much easier.


August 20, 2010

In the wake of its fiscal crisis, Greece has taken sufficient definitive steps to reduce its budget deficit that it is in line to receive another $11.5 billion in aid from the EU, the Wall Street Journal reported yesterday. The nation's deficit has fallen by almost half -- 46 percent -- since the beginning of 2010, with spending also reduced by 17 percent compared with 2009. The EU Fiscal Commission called these impressive reductions "faster than planned," and applauded them for initiating and achieving significant structural reforms within their government. EU leaders seem to agree with the Greeks in saying that the prospects for stability, reform, and a surging economic recovery are strong thanks to their efforts at fiscal reform and long term sustainability.

Also, in the UK, numbers were released showing that the nation's budget deficit shrank at a faster rate than was expected during the month of July, and retail sales increased significantly as well, indicating a stronger British economic recovery. The news of the shrinking deficit comes in the wake of the nation's recently announced new budget plan, which includes dramatically reduced government spending and increased taxes in an attempt to decrease their ballooning deficit. In an attempt to find ways to even further reduce spending and get the most out of the policies and programs that do exist, the British government has reached out to its citizens, asking for their input on the best ways to cut spending. The British Treasury website has received over 45,000 submissions so far, ranging from the elimination of the monarchy altogether to putting British prisoners to work at government jobs.

The positive retail sales numbers, however, seem to disprove some economists' fears that the slashed government spending would cripple the burgeoning economic recovery in Britain -- providing even more ammunition behind the argument that economic growth and fiscal sustainability can be pursued at the same time and can actually reinforce each other (see our blog on the academic basis for this). Allan Meltzer's op-ed in the Wall Street Journal last week reflected this idea: that clear plans to reduce government spending and to get on sustainable fiscal paths actually helps economic recovery and growth, especially in the long-run. Reminiscent of the Announcement Effect Club, we maintain that a strong commitment to restore fiscal sustainability gradually as the economy recovers can actually encourage growth now because it reassures investors of our economic and fiscal solvency. So it makes sense that, in fact, the pound rose against the dollar after Britain recently released its new budget that is meant to significantly reduce government spending over the coming decades.

August 19, 2010

Today, CBO released an update to its economic and budget projections for the coming decade, originally reached in February and March. Under its current law baseline, debt projections have increased to $16.1 trillion by 2020, up a trillion dollars from the previously projected $15 trillion amount. Although projections for the next few years remained mostly the same, CBO’s projections for the cumulative deficit over the next ten years have increased by about $300 billion, from $5.9 trillion predicted in March to more than $6.2 trillion now expected today.

The graph below shows that deficits will decline over the next few years due to the effects of the economic recovery, which will increase revenues from taxation and decrease outlays (especially with the end of spending on recent stimulus packages and the drawdown in Iraq and Afghanistan).

CBO’s newest forecasts only reaffirm that even under the most conservative, baseline projections, debt and the deficit will continue to grow in the coming years—and even more quickly if policymakers follow current policy, instead of current law. As the economy takes slow steps on the road to recovery, growing debt and deficits could hamper this—so we must make a sustainable fiscal plan our priority now. Stay tuned for CRFB’s more detailed analysis of the August update soon.

August 19, 2010

Many Americans lament the state of U.S. education; they fear that low standards and expectations are impairing the ability of our children to prepare for the challenges ahead. Now some want to bring that same curriculum for failure to Social Security.

The Campaign for America’s Future and other groups are pushing for candidates to promise to oppose any Social Security reforms that include benefit cuts. The group will issue a report card for Members of Congress and candidates: those that oppose all benefit cuts will get an “A” while those that support plans that include cuts in any form will get an “F.”

Talk about grading on a curve—or more like an upside down curve. These standards make it much, much, harder to put Social Security back on sound footing.

The recent annual report from the Social Security Trustees lays out plainly that the program faces a future shortfall. It will run cash flow deficits in all future years but three and will no longer be able to pay benefits in full by 2037. It is obvious that changes will have to be made to strengthen the program and as the program’s own Trustees say—the sooner the better.

When a student is not performing to his/her potential the key is to identify the problem and develop a plan to help them. Rigging the grading scale does not help—in fact it allows the problem to persist, ultimately, making it harder to fix. Reading the Trustees report would be a good homework assignment for those who are truly interested in protecting Social Security.

The group is also circulating a pledge for candidates to sign promising not to support any Social Security benefit cuts in any form. Another pledge of what policymakers will not do to fix the nation’s fiscal challenges is exactly what we don’t need. Much like the “no new taxes” pledge, it is harmful to the public discourse and finding sensible solutions to our country’s fiscal problems. Revenue increases and spending cuts must both be part of the discussion in reducing our long-term debt. Strengthening Social Security—much like fixing the rest of the budget—will require compromises and tradeoffs. All options must be on the table and constructively discussed. Demagoging the issue without presenting alternatives for improving its long-term outlook will not preserve Social Security.

If we want to ensure that Social Security will be able to help future generations, then our grading needs to be more objective and our pledges more inclusive.

We suggest a more appropriate grading scale. Those who demagogue Social Security to avoid making necessary changes get an F. Those who acknowledge the need for changes to strengthen the program get a passing grade. Those who present credible options to bring Social Security into balance—be they on the tax or on the spending side—get a B. And those who support comprehensive plans to bring the program into balance get an A.

If Campaign for America's Future really wants to help the program they profess to care about so much, they would put together a detailed plan to save it; right now, based on a balanced grading scale, they risk getting a failing grade.

August 18, 2010

The Obama Administration held a conference yesterday discussing how to fix federal housing programs, with the goal of submitting a comprehensive Fannie Mae and Freddie Mac reform proposal by January. Many reform options were presented by the financial and economic minds present at the conference, and each would have significant implications for the federal budget -- especially because they each seem to necessitate the government's increased involvement in Fannie and Freddie, and even more federal money spent on them in turn. But Treasury Secretary Geithner maintained that the reform plan will focus largely on improving the current system, rather than implementing massive changes, and he reaffirmed the U.S. government's role in supporting American mortgages.

In September 2008, just a week before the collapse of Lehman Brothers kicked the financial crisis into high gear, the Treasury Department placed Fannie and Freddie into a government conservatorship in response to their growing losses in the mortgage market, thanks to the Housing and Economic Recovery Act of 2008. Before their federal takeover, Fannie and Freddie were not considered part of the federal budget by either CBO or OMB, even though the GSEs were considered to have an implicit guarantee backed by the government's financial resources (as proven by their relatively low borrowing costs and lax regulations). But the government's acquisition of Fannie and Freddie's mortgage guarantees in 2009 cost $291 billion according to CBO's initial risk-adjusted present value method of inclusion (which counted all of the GSEs' loans as if they were indeed made by explicitly federal agencies, a la the TARP legislation). This method converts the estimated net cash flows of the GSEs' mortgage commitments into present values and estimates the risk they face in the same way a private corporation would over ten years. CBO expects an additional $100 billion to be added to our federal deficit in paying for Fannie and Freddie over that period, with the stabilizing of the mortgage market accounting for the lower annual costs relative to 2009.

By contrast, OMB has kept Fannie and Freddie off-budget, counting only the federal government's cash infusions to them (excluding the costs of providing current and future guarantees on their assets). Where do these amounts come from? Beginning in September of 2008, the U.S. Treasury also committed itself to buying up to $200 billion in preferred stock and mortgage-backed securities from the former GSEs in a further attempt to stabilize them. So far, Treasury purchases have totaled about $95.6 billion in cash outlays to Fannie and Freddie, with an additional $65 billion expected over the 2010-2019 period--and it is this sum which OMB tallies as the direct costs to the federal government. Since its initial projections, CBO has changed its method to a cash basis looking backward, while keeping its risk-adjusted present value estimations for the future, in an attempt to measure the burden placed on the federal budget by Fannie and Freddie.

Reform of the GSEs should affect not only how much they could cost taxpayers (by ensuring that they aren't so exposed in the future), but also how they are treated in the budget, something we discussed in our previous blog on Fannie and Freddie. Treatment of less straightforward aspects of the federal budget -- like loans and guarantees -- is referred to as "budget concepts." Here's what we argued for back in February regarding GSEs and budget reform:

Budget reform needs to look at the subsidies conveyed by government sponsorship of large financial enterprises such as the Federal Home Loan Banks and the Farm Credit System. The budget should not shy away from recording the real cost of government commitments to the stability of such quasi-private entities. The subsidies are real, taking the form of lower funding costs than would be demanded of such risky entities if the Government were not behind them. The budget should record the costs of such federal commitments when they arise, not just when the bills are due. If the budget recognizes the potential costs of these programs as subsidies are conveyed, policymakers can act ahead of time to limit or offset the cost of the government subsidy and reduce the risk of a future bailout of other housing funds or programs.

As the Peterson-Pew Commission finishes up work on its second report -- focusing specifically on budget reform and to be released this fall! -- we will have more to say about this topic very soon.

August 17, 2010

Looks like even after 8 months, our Red Ink Rising report is still inspiring a significant amount of discussion. Take for example another fine work (published by Deloitte), also conveniently entitled Red Ink Rising. Not to be confused with our 2009 report Red Ink Rising that outlines a series of specific steps (such as committing to a 60 percent debt to GDP ratio by 2018) that Congress and the President should implement to ameliorate our dangerous and growing national debt, Deloitte reports on what they refer to as “The Gap”: the problem of the growing difference between what governments (localities, states, provinces, and nations) are bringing in with revenues and what they are spending in outlays. Deloitte points out that this gap cannot be solved as just an economic issue, but is “a challenge to the entire democratic government.”

Deloitte sees the road to fiscal reform passing through three distinct phases: a conceptual phase, political blueprint phase, and the transformation phase. Let’s hope that we are nearing the conclusion of the first stage, with policymakers and the public understanding that there is a problem and a need for reform, and entering into the second phase of working on a plan to get our fiscal house in order.

We commend Deloitte for not only bringing to light the problems of fiscal irresponsibility, but for choosing an excellent title as well.

August 16, 2010

Washington Empties Out – With both houses of Congress in recess and the president traveling, Washington feels deserted. The biggest news in DC is whether the Nats will sign Bryce Harper. Congress will return after Labor Day.

They’re Here (for a day) – The House did return briefly on Tuesday to approve $26.1 billion in state aid. The president signed the bill, which is fully offset, shortly afterwards.

Specter of Taxes Looms – Congress is poised to take up the heated debate over tax cuts that expire at the end of the year. The Joint Committee on Taxation estimated last week that extending the tax cuts for the wealthy would add $36 billion to the deficit next year. President Obama has proposed extending the tax cuts only for families making less than $250,000. The upcoming debate must also include the need for fundamental tax reform that addresses the country’s future fiscal needs.

Filling the Empty Seat at OMB – The Senate is expected to take up the nomination of Jacob Lew to replace Peter Orszag as OMB director shortly after it returns from recess.

Appropriations Apparitions? – A seat on the Appropriations Committee was once considered a plum assignment, allowing legislators to send pork back home. But now the ghosts of past practices may be coming back to haunt appropriators. The New York Times reports that in a time when voters are deeply concerned about the rising federal budget deficit, earmarks are decidedly unpopular and lawmakers are no longer being rewarded for steering federal money back home.

Will New CBO Numbers be Ghastly? – The CBO will release its summer update of its budget and economic outlook on Thursday.

Social Security Not Ready for the Graveyard Yet – Social Security celebrated its 75th Anniversary on Saturday. While the recent Trustees report indicates that the long-term outlook is bleak without action, the Bottom Line dedicated a blog series on the importance of the program and what can be done to strengthen it for future generations.

August 14, 2010

Social Security turned 75 today! While the program remains vigorous after all these years, it is beginning to show its age. Unlike those that depend on it, retiring Social Security is not an option, which means that action will be required. Whether it continues to thrive 75 years from now and beyond is up to us and the decisions we make in the near future.

Social Security recently had its yearly check up, in the form of the annual report from the trustees overseeing the program (see our analysis of the report here). The results indicate that its health is in decline. It will run a cash flow shortfall this year and next and run increasing deficits from 2015 onward. In 2037 the Social Security trust fund will be exhausted and the program will no longer be able to pay full benefits.

Although the long-term prognosis is not so good, there is no need to pull the plug. Drastic action is not required, as long as we act reasonably now. With some relatively minor adjustments, Social Security can be restored and strengthened to serve future generations. The sooner the changes are made, the easier the medicine will be to swallow. Ignoring the diagnosis will only result in more painful measures down the road.

Over the past week and a half The Bottom Line’s Social Security blog series has examined the program, where it stands, and what needs to be done to ensure its future. We have explored topics such as its long-term outlook, how it affects the overall budget picture, options for reform and the international perspective. CRFB’s analysis of the trustees report offers a comprehensive look at Social Security.

The purpose of the paper and blog series is to start a constructive conversation about Social Security and its future. We need to move beyond the false choices presented by some and to take a hard look at how Social Security can remain the vital program that it has been. Only through thoughtful discourse and sensible solutions can we guarantee that it will be around another 75 years and beyond.

Happy Birthday Social Security. While our gift may not be shiny, we hope it helps ensure many more birthdays.

August 13, 2010
Countdown to Social Security's 75th

We've spoken a lot about Social Security reform the last few days, in the context of solvency, sustainability, and direct effects on the budget. But we haven't yet talked about reform in the context of our overall fiscal and economic picture. On the fiscal side, our fundamental problem is the growth of entitlement spending, and this is driven by both health care cost growth and by population aging. Aging effects not only Social Security's costs, but Medicare's and Medicaid's as well.


We've written many times on the importance of bending the health care cost curve - putting measures in place which exert downward pressure on economy-wide health care costs can make other hard choices at least a little bit easier. What we don't talk about, enough, is trying to "bend the aging curve" -- or to put it more accurately, deal with our decreasing dependency ratio.

Given the consequences of an aging society, though, we should be thinking hard about these issues. Population aging will not only drive up entitlement costs by creating new retirees, but it will also undermine the revenue base by decreasing the relative number of (tax-paying) workers. An older society is also a slower growing society, as there are less workers (labor) and less net savers (investors) in the economy.

But all is not lost, we can both mitigate and address the consequences of population aging -- and can do so through Social Security reform. Of course one option is to just change the demographic factors: fertility, immigration, and mortality -- though we can't imagine these changes would be very popular, especially in the context of Social Security reform. Check out the book Boomsday, which gives a whole new meaning to the word "death panel."

More seriously, we can change the dependency ratio by getting people to work longer. In this way, we could turn would-be retirees into workers, improving income tax revenue, labor supply, savings and investments (and therefore capital stock), and individual retirement security.

Getting people to work longer is not an impossible venture. Since Social Security was established, there have been tremendous gains in life expectancy at birth -- yet average retirement age has continued to fall. As of 2008, the average retirement age was about 62, (not so) conicidentally the same age that Social Security begins offering benefits.



Social Security has many levers which can be pulled to reverse this trend. The most commonly cited option, here, is to raise the Normal Retirement Age (which is currently 66 and scheduled to increase to 67). This age serves as a powerful signal for retirement, and gradually increasing it would likely encourage longer work and help reduce Social Security's shortfalls at the same time. An even more powerful lever is the Earliest Eligibility Age, the first age at when beneficiaries can begin to collect benefits (currently 62). Raising this age would not only encourage longer work, but would protect retirees from recieving permanantly lower benefits by accepting the full downward actuarial adjustment that comes with retiring early. (Of course policymakers would need to think through how to protect those who truly cannot work beyond 62 -- perhaps by strengthening the disability system).

Other Social Security reform option could also help encourage longer working lives. For example, we could increase the number of years used to compute benefits, offer a payroll tax cut for individuals who have worked more than 45 years, increase the penalty for early retirement, or change the way we distribute benefits -- perhaps through something like Jed Graham's Old Age Risk Sharing.

Of course, we can't count on longer working lives to solve all of our fiscal and economic problems. We also can't count on Social Security to force these changes by itself. In fact, we should also be looking at changes to Medicare, pension rules, certain tax and regulatory policies, etc; and we need to change the culture to allow people more flexibility to work at old age and phase into retirement as they would like and are able to.

But as we do reform Social Security, we should be thinking about the broader fiscal and economic issues -- especially those revolving around work.

See CRFB Policy Director Marc Goldwein debating this issue here.

Click here to read our Celebrating Social Security's 75th series.


August 12, 2010

With heated public debate and growing uncertainty about the momentum of the economic recovery, all eyes turned to the scheduled meeting of the Federal Reserve's monetary policy body (the FOMC) this week. Press reports that the Fed was reconsidering its exit strategy of unwinding its balance sheet had already come out on the heels of recent disappointing government reports (a disappointing slowdown in GDP growth from 3.7% the first quarter to 2.4% in the second quarter; weak labor market numbers in June and July; continuing signs of trouble in housing; plus persistent tight credit). Global recovery news has also been disappointing, with the eurozone fiscal crisis playing a role. Moreover, inflation has been coming in below the Fed's target range, according to some measures.

So, at Tuesday's FOMC meeting, the Fed changed its assessment of the outlook. In contrast to earlier in the year (and to some more hopeful economic commentators and politicians), its view now is that the recovery is slowing - not gaining traction- and that the risks are on the downside. Concern is more about the risks of deflation than inflation for the time being.

With increased concern about economic weakness, the FOMC announced that it would halt its plan to let its balance sheet shrink. More specifically, to maintain rather than withdraw support for the economy, it will reinvest the money from otherwise maturing mortgage-backed securities and agency debt in long-term Treasury securities. The move is intended to continue holding down long-term interest rates, which should help the mortgage market. These actions will also mean that the Fed is changing the composition of its holdings, back toward a greater relative weight in Treasury instruments - its more traditional holdings. While indicating only a modest change in support for the economy (only about 3.5% of Fed holdings of agency debt and MBSs will mature within a year), the FOMC also quietly indicated that it would be prepared to step in with additional resources if necessary. How much quantitive easing it would be willing to use, though, is unknown.

Financial markets responded yesterday with a reassessment of risk based on the Fed's statement and announced actions. Stocks took a hit and bonds rallied, presumably due to profit worries, safe haven interest and deflation concerns.

For fiscal policy wonks - whether you are taxpayers or politicians, the Fed's views and its even modest change in policy direction should give us food for very serious thought indeed. We have many challenges before us, many of which appear to go in a different direction - and at the same time. It is time to focus on the big picture for our country. An important part of this must be to try to get the fiscal and monetary policy mix right for the near future - but also beyond.

For the near term, we need a strong economic recovery - and there are signs that our financial sector-driven recovery may take more time than a "normal" recovery to gain its footing. Our labor markets continue to show signs of distress, which risk undermining economic momentum and even persisting into the future as more structural - not temporary - problems, which are very costly to a government and a society. Housing problems persist, which makes economic adjustment to a new normal growth path difficult to say the least. Fiscal tightening at the state and local level remains a drag on the economy.

Yet our fiscal house is out of whack. We face rising debt into the future as far as the eye can see. Events in Greece and other eurozone countries should be taken as a warning to the United States that markets eventually reach their limits of the amount of sovereign debt they'll finance - even if for the time being, having the dollar as the world's reserve currency might give us more running space. Like other countries, the United States needs to put our nation on a reasonable debt path - and we need a plan soon.

A fiscal package that supports the economy now but over time gets our fiscal house credibly in order, making the sorts of structural adjustments that encourage long-run economic success. The timing and composition of any package is important, with adjustment to our new fiscal path done gradually when the economy is on firmer footing. Putting high quality/growth friendly policies in place for the longer run can help boost standards of living for generations to come. We can do it smartly - or we can just cross our fingers and hope that this whole nightmare will just go away. Let's opt for the former.

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