The Bottom Line
CRFB encourages you to check out our budget simulator: Stabilize the Debt!
It's no secret that America's finances are a mess. The problem of our mounting debt can't be solved overnight, but we need to start addressing it now. In this online simulator, visitors get to make the hard choices themselves in order to stabilize the debt at 60% of GDP by 2018.
With a new government in place, the UK is moving fast to trim their budget deficit. Treasury head George Osborne is expected to announce £6 billion in spending cuts (about $9 billion) next week to cut into their £163 billion deficit ($235 billion, 12.6% of GDP). It seems that the financial market turmoil in Greece has spooked the government into taking action immediately, rather than waiting for the economy to be in full swing. The cuts are relatively modest, bringing the deficit down by only 0.5% of GDP, but they should at least help assuage investors, and The Financial Times suggests that more cuts will be coming in the future. They will be necessary, considering that Britain's debt-to-GDP ratio will hit 90% next year. Just to demonstrate the volatility of European markets and their sensitivity to debt-hiding as Greece did, The Times said that sterling fell just based on an accusation by the new government that the old Labour government had fixed fiscal forecasts.
The UK government should be applauded for moving quickly to get their deficits and debt under control before the markets force severe action on them (we must also note that Nick Clegg, now Deputy Prime Minister of the U.K. is a member of the Announcement Effect Club) . Our own government should take note of the steps that Britain is taking. Although it would be unwise for us to start reducing deficits immediately, we can enact a deficit-reduction plan now that will take effect slowly as the economy recovers. The longer we wait, the more severe our actions must be, and if we wait until crisis, the actions will need to be draconian.
Over the past few weeks, passage of an "extenders" bill has become the top priority of Congress. The bill, HR 4213, finally seems to have a definitive shape to it after both Houses of Congress considered a laundry list of provisions for inclusion. The core of the bill includes many extensions on social spending, such as unemployment benefits, COBRA subsidies, and temporarily increased Medicaid reimbursement rates to states. In addition, a five-year "doc fix" has been included in the bill. It also includes the extension of many temporary tax provisions, such as the research and development tax credit and the state sales tax deduction. A fix to the estate tax was also talked about being added to the bill, but it appears that may not be happening.
Overall, the bill's cost is estimated in the $200 billion neighborhood, with a significant chunk of that coming from the social spending. Extensions for unemployment benefits, COBRA, and Medicaid reimbursements will cost about $80 billion, and the doc fix has a price tag of $88.5 billion. The total cost of the tax extenders comes in at about $50 billion.
The bigger problem with this bill is the offsets. So far, House and Senate Democrats have only committed to offsetting the cost of the tax provisions, with the main offset being the taxation of "carried interest" as ordinary income instead of at the lower capital gains rates. Obviously, this is not enough: only paying for the tax provisions would leave about 75% of the bill unpaid for, with the costs of much of it being deemed "emergency spending."
We've seen this move since the passage of statutory PAYGO back in February. In a press release today, CRFB blasted the use of the "emergency spending" tag in relation to stimulus measures, and argued that statutory PAYGO should be strengthened to close the loopholes that allow fiscally irresponsible measures to be pushed through. Using the emergency spending crutch may be politically convenient, but ultimately PAYGO exists so that we don't continue to add to our long term debt.
Fortunately, Republicans and some moderate Democrats are concerned about the lack of offsets, so Congress may need to pay for the whole bill before it gets passed. We obviously encourage lawmakers to work together to find the offsets necessary to do so. As we have said many times before, if Congress wants to enact a short-term stimulus measure, they would make it more effective by paying for it in the long term.
Little Resolve for Budget Resolution – Leaders in the House have yet to make a final decision on moving forward with a FY2011 budget resolution. But every day that goes by makes it less likely Congress will adopt a budget blueprint this year. House Democrats are split between moderates who want cuts in discretionary non-security spending along with longer-term deficit reduction targets and others who fear social program cuts and think defense spending should also be subject to limits. Limiting discretionary spending and setting deficit reduction goals are critical to putting the country on a sustainable fiscal course. The goal recommended by the Peterson-Pew Commission on Budget Reform of stabilizing the debt at 60 percent of GDP by 2018 is a good place for lawmakers to start.
A Broken Process – If the House does not agree on a budget resolution, it would be the first time since the current budget process was created that the chamber has failed to produce an initial budget. The difficulty in adopting a budget blueprint at a time when leadership on fiscal matters is most needed underscores the need for serious budget process reform. The Peterson-Pew Commission is currently developing budget reform proposals that will be released later this year.
“Deeming” Likely – Under House rules, appropriations bills can now be considered without a budget resolution in place. Congress is now likely to adopt a “deeming” resolution that will set spending figures for appropriators to work under. Such a resolution can simply be attached to other legislation and avoid a floor debate that will highlight the bleak fiscal situation and the inability of politicians to confront it so far.
CRFB Dream Team Set for Budgetball – The CRFB Budget Hawks are set to take their fiscal responsibility message to the field this coming Friday, May 21 for the second annual “Budgetball on the Mall.” The tournament will be played in the shadow of the Washington Monument on the National Mall and will pit college squads against teams representing the Washington “establishment.” Budgetball is a unique sport that promotes physical, and fiscal, fitness by combining athletic activity with sound budget strategy. We won’t try to explain how exactly the oven mitts, life preservers, masks and hats come in; visit http://www.budgetball.org/crfb to learn more about the game and tourney.
Voting on Cuts – Last week House Republicans introduced “YouCut” which will allow people to vote each week on government programs to cut towards reducing the deficit. They promise to push for a floor vote for the top-voted idea. In that same vein of promoting more public engagement in finding fiscal solutions, stay tuned for an announcement this week from CRFB on a new interactive initiative to get Americans thinking and talking about the tough decisions that will be required to stabilize the debt.
Voting and Cutting – Congress wants to finish work on financial regulatory reform and “extenders” legislation that will expand tax breaks like the research and development tax credit as well was social spending such as expanded unemployment benefits and COBRA subsidies for the unemployed before lawmakers cut out of DC for the Memorial Day recess. Financial reform will likely pass by the end of this week. Legislators are still working out the extenders package. The main stumbling point is the cost, which may reach up to $200 billion, with little of it paid for. CRFB has been tracking the proposed spending and related items such as a possible estate tax extension and calling for them to be fully offset over the longer term.
Feldstein Favors Two-Year Extension Over Permanent Tax Cuts – Supply-side icon Martin Feldstein last week argued against permanently extending the 2001/2003 tax cuts in the present environment due to the excessive U.S. debt. Instead he recommends a two-year extension as part of a grand bargain that includes spending cuts. This mirrors an idea that CRFB president Maya MacGuineas has put forward. Feldstein concludes, “The inherent uncertainty about the out-year deficits means that it would be unwise to enact tax cuts that stretch beyond the next two years. Congress should move quickly to reassure taxpayers and financial markets that the current tax rates will be preserved for two years but that further tax cuts will depend on the future fiscal outlook.”
Robert Samuelson has a blunt message for the American public in today's Washington Post: WAKE UP! In his op-ed Samuelson pans the lack of urgency by lawmakers and the public alike, particularly in light of the recent financial turmoil in Europe. He questions whether anyone is serious about reducing our deficits and debt. He also questions the goal set for President Obama's fiscal commission to reduce the deficit to 3% of GDP by 2015, saying that targets such as these don't usually pan out.
In a classroom, limiting government debt in relation to GDP can be defended. The idea is to reassure investors (a.k.a. "financial markets") that the debt burden isn't becoming heavier so they will continue lending at low interest rates. But in real life, the logic doesn't work. Governments inevitably face deep recessions, wars or other emergencies that require heavy borrowing. To stabilize debt to GDP, you have to aim much lower than the target in good times, meaning that you should balance the budget (or run modest surpluses) after the economy has recovered from recessions.
In criticizing debt-to-GDP stabilization goals, he points out that they did not work at all for the European Union.
The 16 countries using the euro were supposed to adhere to a debt target of 60 percent of GDP. Before the financial crisis, the target was widely breached. From 2003 to 2007, Germany's debt averaged 66 percent of GDP, France's 64 percent and Italy's 105 percent of GDP. Once the crisis hit, debt-to-GDP ratios jumped; by 2009, they were 73 percent for Germany, 78 percent for France and 116 percent for Italy.
Thus, he states if any target is to be set, it should be to balance the budget. By aiming high during good times, the government can then have a greater ability to respond to crises without shattering the original stabilization goal. Certainly, there is merit to budgeting for a rainy day.
However, as frequenters of our blog already know, CRFB has been pushing a goal of stabilizing the debt at 60% of GDP by 2018. We believe that setting a realistic fiscal goal is a helpful first step to fiscal responsibility. The EU's main problem is that it did not have an effective way of enforcing fiscal discipline on its member countries. This just shows the importance of pairing a fiscal goal with a strong enforcement mechanism.
But even the strongest enforcement will inevitably have some cracks in it. Most fiscal processes and fiscal goals make exceptions for emergencies like wars or recessions; not doing so would simply be unrealistic. Unfortunately, this definition is often stretched, as we have seen in the wake of the recently enacted PAYGO law. Even when enforcement is not breached, depending on automatic across-the-board spending cuts and tax increases avoids a discussion about what our nation's priorities should be.
Thus, the point to be taken is that fiscal goals are a good start, but detailed plans are imperative to putting our nation back on a sustainable fiscal path. The problem is that there are very few plans out there, with the notable exception of Congressman Paul Ryan's Roadmap. He deserves credit for coming up with a plan to solve our long term fiscal issues, but few lawmakers are jumping on board or coming up with their own comprehensive plans. Our politicians need the courage to propose detailed solutions to put our fiscal house back in order. A fiscal goal is a start, but follow-through with a plan is crucial.
Here are the highlights from this weekend’s editorials on fiscal and budget policy:
The Chicago Tribune noted that for all the attention paid to bank bailouts, the most costly government action during the 2008 financial crisis will be the takeover of Fannie Mae and Freddie Mac. Pointing to CBO numbers that suggested the cost of the move would be a total of $389 billion by 2019, they criticized the defeat of an amendment that would have cut the government's ties to both entities. They also said that the Democrats were "so busy hammering the banks," that they weren't willing to deal with Fannie and Freddie yet.
The Washington Post also brought up Fannie and Freddie, stating that while they both need serious reform or perhaps elimination, the amendment "was too vague about who or what would provide liquidity after they were gone." Nonetheless, The Post praised the amendment for putting the spotlight on the issue of the cost to the taxpayer of the two big housing market players. They also said that the flaws in the old structure, such as weak capital standards and the propensity for Fannie and Freddie to take on too much risk, should not be repeated.
The New York Times praised Defense Secretary Robert Gates for trying to achieve savings, albeit modest ones, in the Defense Department. Characterizing the defense budgets of the last decade as a "feeding frenzy", the paper applauded Gates' desire to look over the entire defense budget and determine what is necessary and what is not. They noted Gates' questioning of the need for certain military vehicles and his desire for savings even in military health care, obviously a politically sensitive issue. The Times praised this move nonetheless, stating that with the current and future budget troubles, "everyone must share the burden."
The Boston Globe supported President Obama's choice of Donald Berwick to run Medicare and Medicaid. Noting Berwick's important role in finding savings in the two programs, The Globe stated that he has been "a leader in promoting innovative ways to improve the quality of care, thereby cutting the costs of medicine." They also criticized Senate Republicans for going after Berwick politically, saying that they were picking the wrong target to re-start the debate about the recently passed health care law.
U.S. markets continued to be dominated this week by the continuing roller coaster ride from the Greek (and eurozone) debt crisis. More positive U.S. economic news appeared to be less important. The cause of last week’s stunning drop and subsequent recovery in the U.S. stock market is still not well-understood.
U.S. bond markets (and, stock markets today) have continued to be buffeted by safe haven ups and downs, as global markets continue to assess the situation in Europe. At the beginning of the week, European authorities were able to finally get ahead of the curve. For the U.S., positive global market reactions to the surprisingly massive ($1 trillion) EU and IMF rescue package diminished the safe haven effects that had boosted Treasury prices and lowered yields the previous week. So we saw Treasury yields on the 10 year note reverse direction and head upwards again, although yields did not return to higher rates which had prevailed this year prior to the Greek sovereign debt “shock”. However, on Thursday, the initial positive global market reaction to the Greek situation appeared to have shifted, most likely reflecting fears over the impact of the announced fiscal austerity package on eurozone growth (with Portugal and Spain’s new austerity packages now part of the mix), plus concerns over Greece’s ability to sustain a tough austerity program. More fundamental fears over the eurozone’s fiscal management capabilities reappeared, as well. By mid-day Friday (May 14), interest rates on medium and long-term Treasury instruments were declining again as investors increased safe haven holdings by turning more to U.S. Treasury assets.
Next week, House Democrats intend to introduce a package of aid to states, extended unemployement benefits, and tax break extensions. This "must-pass" bill is also seen as a possible vehicle for other difficult pieces of legislation -- namely a five-year doc fix and/or a solution to the currently expired estate tax (the Bush tax cuts called for the estate tax to sunset in 2010 before returning in 2010 at pre-2001 levels, which have fairly widespread bipartisan opposition).
The statutory PAYGO law passed in February 2010 technically would exempt this doc fix for five years or about $88.5 billion, even as PAYGO rules do not. CRFB, of course, strongly opposes these exemptions, and believes we'll pay a price of them in the bond markets. As CRFB President Maya MacGuineas said, “Considering that we face untenable levels of borrowing, an obvious first step would be to stop adding to the debt by paying for any and all policies. Many of these priorities are critical—but no more critical than the need to pay for them.”
The House, last year, did pass a permanent extension of the doc fix. And though that specific vote is now not possible thanks to the PAYGO law enacted in February, some Congressmen are stating that this fix should be a generous one. Others, particularly some Blue Dogs, are growing increasingly uneasy about an expensive and un-offset doc fix.
The estate tax is also affected by statutory PAYGO law as well, which only allows a two year fix to be deficit-financed. According to the JCT, the 10-year cost of extending the estate tax at 2009 levels is just over $250 billion; and the estate tax reform currently being considered is even more generous than that.
While we have yet to see whether the extenders bill will include a five year doc fix or a change to the estate tax, we do know that it will include a number of other provisions, including between $30-35 billion of tax relief, as well as an extension of unemployment benefits, COBRA health subsidies, Medicaid reimbursements to states, and other provisions. Below is a chart of some of the provisions that could potentially be included in this extenders bill. Sander Levin, Chairman of the Ways and Means Committee, has expressed interest in a number of revenue-raiser options to offset the costs of the bill. These include changes to the biofuel tax credit and changes to the way we tax the “carried interest” earned by private equity managers and venture capitalists and real estate investors.
According the reports, Senators Kyl and Lincoln are working on finding offsets to cover the costs of estate tax reform.
|Potential Provisions within Tax Extenders Bill
|Tax Extenders||$31 billion|
|Doc fix||$88.5 billion|
|Unemployment benefits, COBRA, and Medicaid reimbursements||$80 billion|
|Settlement for African American farmers and American Indians||$4 billion|
|Estate tax reform*||$300-$400 billion|
*Details of the Lincoln-Kyl plan may have changed somewhat recently. Our estimate of $300-$400 billion is based both upon looking at the CBO Options and Tax Policy Center estimates.
Along with the extenders bill, Congress is working on a war and disasters supplemental funding bill, to be completed at the end of this month. Because this is discretionary spending, it is not subject to PAYGO. And although they should, we doubt Congress will make any effort to pay for these costs. The breakdown is below:
|Provisions within Supplemental Spending Bill||Cost|
|Funding for Iraq and Afghanistan||$33 billion|
|FEMA Disaster Relief||$5.1 billion|
|State Department and Foreign Aid||$4.5 billion|
|Aid for Haiti||$2.8 billion|
|Summer jobs programs||$600 million|
Inspiration can come from the most surprising places.
Take Portugal, for instance. (Granted, there are major differences between the U.S. and Portuguese economic and fiscal situations.)
Yet, the crisis fiscal package announced today by Portugal’s Prime Minister may suggest a way forward to U.S. political leaders, so far unwilling to make the tough choices needed for our fiscal future and under pressure from citizens who do not appear to appreciate the gravity of our situation.
In announcing Portugal’s new fiscal package of tax increases and spending cuts, Prime Minister Socrates said, according to the Financial Times:
"The world has changed – and how – over the past two weeks," Mr Sócrates said, explaining why he had decided to break recent pledges not to increase taxes.
For the U.S., too, the world has changed – and how. Still emerging from our economic crisis, with unemployment so painfully high and our financial system continuing to move between boom and bust, we cannot “return to normal” – nor should we. Yet what the heck do we do now? We face increasing fiscal pressures as far as the eye can see. Without enough domestic savings, we need foreign creditors to fill the gap. We are living well beyond our means – and have been for awhile. Baby Boomer retirement is about to accelerate, which will put even greater pressure on our precious fiscal resources. Plus, there are basic fairness issues that still need to be addressed. Despite the impressive (and so important) increase in wealth here, many people are looking at a drop in their standard of living. (That may be at least some of what Tea Party supporters are telling us.) And, as the Baby Boom generation warily eyes its prospects for retirement and the youth of America looks at limited job prospects, it is indeed not the world we had expected.
But there is a way forward. We need to come up with a new fiscal path that will allow us to have sustainable growth. In the absence of a solid fiscal (and, by the way, financial) framework underlying growth, we will most likely go from one crisis to another over the next generation. But, politicians will need to put everything on the table to achieve a fiscal recovery package that will be credible – credible to markets but also credible to the American taxpayer. A fiscal recovery package should not be put in place until the economy is on firmer footing (we made that mistake in the 1930s), but its adoption and announcement in the very near future would put us back on course. Because of the magnitude of our problems, it must involve shared sacrifice – but also shared hope. In the end, it is about higher living standards for all Americans.
So, Portugal provides an important lesson here for both the President (who is so far sticking to his campaign tax pledge) and those who have taken the “no new tax” pledge: that an understandable and compelling case should and can be made to the American public that new tax measures must be included in a broader bipartisan fiscal consolidation package.
Our politicians should also take note that the main political parties in Portugal were able to negotiate and agree on the contents of the package. (It does however appear that some parts of the political spectrum were left out, which could make implementation of the package more difficult. For a package to be politically credible, it is always better to include as much of the political arena as politically achievable.)
Inspiration can come from the most surprising places.
Yesterday, House Minority Whip Eric Cantor (R-VA) launched a new project - YouCut. YouCut allows people to vote online or from their cell phones on spending cuts, from a list of several options -- to be updated weekly, that they would like to see the House act on. House Republicans will then offer an up-or-down vote on the winning spending cut from the previous week.
CRFB is encouraged that lawmakers are reaching out to the public to begin finding specific changes we can make to start curbing the growth of future deficits. We share their desire to curb federal spending.
This week, YouCut is featuring the following spending cuts:
- Presidential Election Fund ($260 million over 5 years)
- Federal union activities ($600 million over five years)
- HUD support for certain doctoral dissertations ($1 million over 5 years)
- New non-reformed welfare program ($2.5 billion each year)
- Eliminate wealthier communities from Community Development Block Grant program ($2.6 billion over 5 years)
Watch Congressman Cantor's introductory video:
Today in the Washington Post, Steven Pearlstein took the "Deficit Challenge", proposing his own plan on how to reduce future deficits through a combination of spending and tax changes. He's right on the mark when he says that there's no lack of commentary and reports on where our future deficits and debt are headed if we don't change course, but that what has been missing "is a framework for tackling the budget challenge in a way that is economically coherent and politically viable." (See Red Ink Rising for a refresher on the extent of our budget challenges, and here for an illustration of the kinds of changes necessary to stabilize the debt at 60 percent of GDP by 2018.)
Here's what Pearlstein proposes on the spending side:
- Hold federal health spending increases to GDP growth plus 1 percentage point a year.
- Raise Social Security and Medicare eligibility age by one month for each two-month increase in life expectancy.
- Slowly reduce COLAs on Social Security benefits and slowly increase Medicare premiums for wealthy seniors.
- Limit growth of discretionary spending to inflation, excluding funding for wars, natural disasters, and safety-net spending.
Pearlstein also offers several ways to increase revenues:
- Impose a VAT of 6 percent, with rebates for lower-income households.
- Reduce corporate tax rate from 35 percent to 25 percent (and close enough loopholes to increase corporate revenue by 5 percent).
- Increase the standard deduction and personal exemptions.
- Tax wages, salaries, and capital gains at only three rates: 17 percent for income from $50,000 to $150,000, 27 percent for income from 150,000 to $250,000, and 37 percent for income above that.
- Tax interest, dividends, and long-term capital gains at 20 percent (up from the current 15 percent).
- Reduce Social Security payroll tax slightly to 12 percent, and over time impose it on wages up to $150,000, up from current cap of $100,000
- Raise Medicare payroll tax slightly to 3 percent and apply it to all income.
- Replace gas tax with carbon-based transportation fuels tax at a rate that would raise $25 billion more each year.
- Eliminate the inheritance tax, but require all estates to pay any deferred and unpaid capital gains taxes on all assets before distribution to heirs.
Pearlstein admits that he is not sure whether the additional savings and revenues from these options would be enough to "[fill] the budget 'hole". We're not exactly sure either about how much this all would save, but we're also working on some back-of-the-envelope calculations to get an idea for how much deficit reduction he's talking about.
Pearlstein is arguing that reducing future deficits doesn't require "the wisdom of a blue-ribbon panel [or] the end of American life as we know it," it just requires that policymakers have "an open mind, some common sense, and a health dose of political courage."
CRFB whole-heartedly agrees that if we implement a plan now that would take effect as the economy recovers, the required changes will be much less harsh than if we wait for markets to force changes on us. But it will still take some pretty tough decisions, as Steven illustrates in his article. CRFB would like to congratulate Pearlstein for getting specific - he now joins Congressman Paul Ryan in putting out a proposal for how to get our federal finances back on a sustainable course.
Click here for a list of all previous "Deficit Challenge" posts.
In a release late Sunday night, the Fed announced that it has agreed with other major central banks to reopen foreign currency swap lines in order to provide them with dollar liquidity through January 2011. While currency swap lines have been a frequent feature of central banks’ global activities, special swap facilities – like those announced on Sunday – are expected to be particularly useful to ease interbank liquidity pressures overseas at a time when the massive ($1 trillion) IMF-EU stabilization was announced.
At the start of the financial crisis in December 2007, special currency swaps between the Fed and other central banks were adopted "to address elevated pressures in short-term [U.S. dollar] funding markets" and operated until February 2010. Markets had responded very similarly to the Greek crisis as they did in the fall of 2008, when interbank funding costs rose because banks were unsure of each other's exposure to risk.
In essence, the Fed is trying to maintain global liquidity. Since the dollar is the world's reserve currency, it is critical that the Fed sends more dollars into the mix. The process works as follows: the Fed lends dollars to other central banks in exchange for foreign currencies as collateral at current exchange rates (so there is no exchange rate risk), the central banks then provide the dollars to financial firms in their jurisdiction as needed, and then central banks eventually repay the Fed the dollars they originally borrowed. The loans range in duration from one day to three months.
A Wall Street Journal article today has a helpful graphic showing how these swap lines work.
Fed officials and some policymakers have justified reinstituting the swap lines as a way to help prevent financial spillover effects from increasingly jittery financial markets. By limiting a potential rise in the cost of funding for US and other countries’ financial firms due to worry over risk, the Fed and its counterparts hope to minimize the impact of higher interest rates on the global recovery. The Fed points out that there is little risk to the taxpayer since the Fed’s swap contracts is with the other central banks alone. Some lawmakers, however, have been expressing opposition to the swap lines, arguing that the U.S. is taking part in yet another bailout. The administration has responded that providing additional dollar liquidity in the early stage of a crisis will be a cost-effective way to limit the crisis, as it was during the global economic and financial crisis which started several years ago.
Since the swap lines have the potential to add liquidity if drawn upon, there may be some small up-side risks for inflation over time, although this will importantly depend on the evolution of the economic and financial situation in Europe and the United States.
From Sophisticated to Sophocles – The untangling of the complex web of financial manipulation and deceit arising from the “hidden debts” controversy in Greece has exposed the mythology of its finances and is now playing out like something written by the ancient playwright, Sophocles. As the Greek economy becomes the latest tragic tale to emerge from that country, many are wondering if the woe will spread elsewhere and what lessons the U.S. can learn from the drama. The Bottom Line explored some morals to the story in posts today and Friday. A timely CRFB conference last week examined how a fiscal crisis could play out in the U.S. and a subsequent statement warned that the Thursday stock plunge could foreshadow trouble for the U.S. because of mounting debt and called for policymakers to develop a credible fiscal plan now. Meanwhile CRFB board member David Walker argued in testimony before the House Financial Services Oversight and Investigations Subcommittee that we must learn the lessons of Greece so that we don’t repeat them. In the same hearing, Federal Reserve Bank of Kansas City President Thomas Hoenig echoed statements that he made before a Peterson-Pew Commission on Budget Reform conference in February that he fears if action isn’t taken to reduce the debt, there will be increasing pressure on the Federal Reserve to monetize it, causing hyperinflation. Will warnings from experts and Moody’s be enough for the U.S. to avoid its own tragedy?
Titans of Business Fear Debt Above All – Even as they see reasons for optimism about economic growth, a poll last week from the Business Council and the Conference Board found that top CEOs see the federal budget deficit as the most important policy issue facing the U.S. Caterpillar CEO Jim Owens said the country is in for “a train wreck” if nothing is done.
Gates Calls for Herculean Task at DOD – Defense Secretary Robert Gates over the weekend called for restraint in the Pentagon budget, saying that it is growing at an “unsustainable” rate. While acknowledging that efforts to find savings of 2-3 percent of the budget would anger powerful interests, he said that "Given America's difficult economic circumstances and parlous fiscal condition, military spending on things large and small can and should expect closer, harsher scrutiny." We applaud Secretary Gates for his courageous stand and hope others will follow him into this battle.
House Agrees to Pay for Cash for Caulkers – While Congress has avoided offsetting the costs of stimulus bills as if they were Medusa’s gaze, a small victory was achieved last week. Before passing the Home Star Energy Retrofit Act, House leaders agreed to Republican demands that the program not go forward unless appropriators pay for it. The “cash for caulkers” legislation is designed to spur the economy by providing rebates to homeowners who improve their homes to make them more energy efficient.
Feingold Seeks to Preserve PAYGO – While not quite the quest for the Golden Fleece, Senator Russell Feingold (D-WI) has set off to protect Senate PAYGO rules. In the “Minority Views” document that accompanied the Senate Budget Committee’s report on the FY 2011 Budget Resolution it passed, Feingold -- the lone Democrat to vote against the budget blueprint in committee -- argues against a provision that would drop Senate PAYGO rules in favor of statutory PAYGO requirements that contain huge exemptions for policies such as the Medicare “Doc fix” and extension of the 2001/2003 tax cuts for the middle class. He states, “As we start the difficult task of cleaning up the fiscal mess left to us by the last Administration, weakening our budget rules is precisely the wrong thing to do.” He’s right; PAYGO must be strengthened, not weakened.
Congress Looks to Pass Tax Extenders Before Memorial Day – Before succumbing to the Siren call of recess and campaigning, legislators want to pass a large package of extensions for tax breaks and social programs until the end of the year. Many of the policies are exempt from PAYGO requirements and lawmakers in both chambers are haggling over how to pay for the rest. In a statement last week CRFB called for longer-term offsets so that the legislation does not add to the long-term debt.
The EU and IMF just recently agreed to provide a nearly $1 trillion rescue fund for European countries facing troubled fiscal waters. Meetings over the weekend between European finance ministers lasted until early today, after which the EU announced it would provide $560 billion in new loans and an additional $76 billion to existing lending programs to struggling countries. The IMF is prepared to supplement this with $321 billion in financial support, bringing the total size of the rescue package to $957 billion.
The purpose of these funds will be to help stabilize the market as Greece and others make necessary fiscal adjustments. The loans come with strict conditions, though, so as not to let countries like Greece completely off the hook.
Although the announcement of the rescue package has already appeared to improve European and global markets (as shown by the halving of Greece's 10-year borrowing costs and the rebound in global stock indices), it is not a cure for future fiscal woes. Overall debt levels remain very high throughout Europe, and market uncertainty over countries' abilities and/or willingness to reign in borrowing could prompt another crisis down the road.
Robert Samuelson has a great op-ed in today's Washington Post on how a dire fiscal outlook is not just Greek's problem, but most "every advanced nation, including the U.S., faces the same prospect." He argues that advanced economies have promised huge health and retirement benefits for which they have not fully budgeted. With a debt level at about 115 percent and a deficit of about 13 percent of the economy, Greece has run into its fiscal wall. Given enough time, most other advanced economies will meet Greece's fate if current policies are left unchanged.
In reality, Greece's recent experiences are somewhat different than ours. Their current crisis was prompted by the misrepresentation of fiscal data and a subsequent deficit-driven shock, not just by growing entitlement costs. Even so, the Greek experience shows us the dangers of having markets lose faith in sovereign debt.
Carmen and Vincent Reinhart clear up some other misconceptions about Greece's crisis in yesterday's Washington Post:
- This is a new type of crisis (actually, governments have borrowed beyond their means for centuries)
- Small economies such as Greece can't launch major financial turmoil (remember Thailand in 1997?)
- Fiscal austerity will solve Europe's debt difficulties (reduced borrowing now could threaten the recovery)
- The euro is to blame for Greece's financial woes (not true - the real question is why did investors facilitate overborrowing?)
- It can't happen here (we've heard that before -- but guess what, it can!)
As Greece illustrates, countries (including the U.S.) are in a bind right now. Cutting back on spending and raising more revenue now could undermine recoveries in a way that not only hurts the economy, but makes fiscal goals much harder to achieve (slower growth means lower revenue, increasing automatic stabilizer spending, and a smaller denominator in debt-to-GDP ratios). Yet, waiting too long to make fiscal adjustments can also lead to economic havoc and have many of the same consequences -- along with higher interest payments to boot.
There is a solution though: announce a fiscal plan now, which delays most fiscal adjustments until after the economy has recovered. Since markets are (at least somewhat) forward looking, such a strategy can help to avoid a hard landing.
And as CRFB argued in this policy paper, it's always better for a country to make fiscal adjustments on its own terms.
The sheer number of countries facing future budgetary difficulties is daunting and could spark a worldwide economic collapse if nothing is done to curb the growth of debt. As Samuelson says, this is "why dawdling is so risky."
The Congressional Budget Office (CBO) issued its Monthly Budget Review late last week. CBO reports that the federal government incurred a deficit of $800 billion for the first seven months of fiscal year 2010, about the same level as the deficit recorded for this same period last year.
Expenditures through April were at about $56 billion (or 3 percent) higher for the same timeframe last year. Outlays for unemployment benefits were about $41 billion (or 69 percent) higher and Medicaid outlays were about $15 billion higher (or 10 percent.).
Revenues were about 4 percent lower than in the 2009 timeframe, primarily due to lower wages and the effects of the Making Work Pay tax changes. This decline was about twice what CBO had projected in its baseline.
But the report also hints that receipts changes might be a sign of hope. CBO indicates that receipts in March and April indicate that tax revenues may be on the upswing over the coming months. CBO estimates that the growth in the receipts from withheld income and payroll taxes over last year’s levels may hint at a “rebound in wages and salaries.” And net corporate receipts (which were below last year’s levels through February) are now $6 billion above last year’s receipts during the same timeframe.
In addition, CBO estimates that the April deficit was, at $85 billion, $64 billion higher than it was last April (about $25 billion of which can be attributed to calendar timing shifts in certain payments.)
Here are the highlights from this weekend’s editorials on fiscal and budget policy:
The Chicago Tribune criticized both parties for reckless spending in the area of health care policy. Noting both the Democrats' recent health care bill and the 2003 Medicare expansion, they suggested that there was a "health care arms race" going on that would destroy the future outlook of the federal budget. They also pointed out similarities in the passing of the two measures, such as the close, generally party-line votes and the use of budgetary gimmicks.
The Indianapolis Star called on Congress to rein in its spending, even for ostensibly good causes. They used incentives for energy efficiency as an example of something that may be a worthwhile objective, but should be put off while the US government reins in its deficits. They also believed that further stimulus would do little for job creation at this point, and that the accumulation of debt related to it could actually be hurtful to the economy in the long run.
The Kansas City Star criticized the federal government's farm subsidy program for both their cost and their lack of transparency. They pointed to numbers by the Environmental Working Group that showed that the program has not cut back payments to wealthy farmers as intended when the 2008 farm bill was passed. Also, they criticized the fact that the 2008 bill prevents some information from being released about which farmers/businesses receive how much in subsidies. Noting our fiscal situation, The Star stated that the subsidies should have been cut a long time ago, especially those that go to wealthy farmers.
The New York Times published a whirlwind editorial that touched on many economic subjects. In it, they called on Congress to pass a broad jobs package, even with the positive employment numbers that came out last Friday. The package they wanted would include state fiscal aid, unemployment benefit extensions, infrastructure programs, and summer youth job programs. They also touched on the Greek debt crisis, noting how dangerous overly expansionary fiscal policy can be, and lamenting the economic bind that Greece and potentially many other European countries may be in.
It wasn’t enough that we had a lot of impressive economic news this week (including today’s solidly positive employment numbers – even though structural unemployment remains a huge problem). It appears that the recovery is finally on track, although perhaps subpar compared to other recoveries. Moreover, structural unemployment will remain a tough nut to crack for awhile.
But US markets did not on balance reflect the good economic news.
Instead, they were dominated by the spillover from the eurozone crisis. (It also appears that a possibly unrelated and destabilizing technical problem gave markets the extra kick yesterday that sent the Dow down nearly 100 points very briefly. The sharp drop of the Dow is not yet well-understood, with possibilities ranging from a typo to a computer glitch from program trading.)
Investors once again bought US debt as a safe haven, as investor fears about the Eurozone’s ability to manage the Greek crisis surged. The dollar strengthened and the US stock market fell as investors poured into US government bonds. Treasury bond yields fell sharply, as a result.
But a return of safe haven effects on US financial markets may not be the best thing for the United States. (We saw this during the first phase of our economic and financial crisis.) In addition to the volatility such large and rapid short-term capital movements may have, they may also lull us into a false sense of security that interest rates will be low forever. When people – and governments – have interest rate illusion, they tend to take on more debt. (This was certainly a lesson of the subprime crisis.) However, when interest rates rise to more normal levels (and they most certainly will), we will not be able to as easily carry the amount of debt (both government and private) that we have taken on when interest rates are so low.
As Fred Bergsten, director of the Peterson Institute for International Economics, recently warned in a Foreign Affairs article, while we have long worried that foreigners might eventually not finance our external deficits, it might be even worse if they do.
European leaders are meeting tonight to talk about Greece and the eurozone crisis. According to press reports, they will likely agree upon and announce steps to strengthen the eurozone’s fiscal framework. (We may read the steps described as improving the eurozone’s “economic governance”.)
Although these matters may seem minor and sleep-inducing to many, they are among the most critical that Europe can do right now to show the markets the eurozone crisis can be contained and managed – and for the right reasons that should give investors comfort.
The eurozone woes reflect several key challenges, but one of the most critical is that Europe did not (does not) have a strong enough fiscal framework. For all the Maastricht Treaty work, there were large gaps. The institutional speed bumps to prevent a Greece from ever occurring didn’t work for Greece. The government appears to have substantially misrepresented its fiscal situation at least twice, maybe more, to its fellow EU country members. It is important to have fiscal goals, but a country must have a sensible budget path that can be followed and communicated. However, without sufficiently strong or workable rules to back up fiscal goals, a country is vulnerable to many of the type of problems Greece is experiencing.
The bodies charged with enforcing the fiscal goals of the Maastricht Treaty (the European Commission on the policy side, Eurostat on the statistical side) were not given sufficient authority (including an audit function or any corrective authority) and the EU country political leaders did not want to rock the boat in what appeared to be good times.
To move forward, Europe must strengthen its fiscal framework. We wish the EU leaders well this weekend.
There are important lessons coming from the other side of the “pond” for Americans. Although there are fundamental differences in the sovereign debt situations of the United States and Greece, there is a common lesson: it is crucial for countries to have not only a fiscal framework but also a credible fiscal framework. Without one, a country can is very easily be under fire, especially in tough economic times.
Policymakers will soon be focusing on passing a new package of extenders and tax breaks that – at a potential cost of around $200 billion over ten years – may get pushed through Congress before Memorial Day. Among other things, the bill would prevent a 21 percent cut in Medicare reimbursements to physicians, scheduled to take effect June 1st, from occurring for five years.
This fix, which is exempt from statutory pay-as-you-go requirements, would cost more than $80 billion over the next five years, but would do nothing to repair the Sustainable Growth Rate (SGR) formula which calls for these cuts in the first place. As a result, when this fix expires, physician payments will have to be cut by 30% -- a scenario future Congress’s will most likely avoid through further deficit financing. Extending the ‘Doc Fix’ through 2020 could cost nearly $200 billion beyond the original $80 billion in the first give years. Technically, updates to physician payments through 2015 are considered current policy exemptions to the statutory PAYGO law. However, such patches are not exempt from House and Senate PAYGO rules.
Other details that have emerged about the bill indicate that it could include:
- $5 billion towards minority farmers' discrimination claims, as well as settlement on the mismanagement of funds for American Indian tribes.
- A $35 billion tax package that would revive provisions such as the research and development tax credit and the state sales tax deduction. This would not be exempted from PAYGO rules.
- Around $80 billion for doc fix, which would be exempted from PAYGO under current policy exemptions.
- Around $80 billion for extending unemployment insurance, COBRA health subsidies for laid-off workers and Medicaid reimbursements to states. This would be exempt from PAYGO under emergency fund designation.
CRFB issued a press release on this topic yesterday, which can be seen here.
Yesterday, The Committee for a Responsible Federal Budget hosted a chilling conference on “What a Fiscal Crisis Would Look Like in the U.S.” An all-star group discussed: what a tipping point might be; how a crisis might unfold; and what policies would be best to avoid a crisis. There was a clear consensus in the room that without changes, a crisis in inevitable.
Some of the possible tipping points participants mentioned included: Congress’s failure to adopt a budget resolution, policy deadlocks within the President’s fiscal commission, state budget crises, costly natural disasters, or a creditor outside the U.S. simply deciding to invest at home. The psychology of the financial markets is unpredictable, one analyst said, adding that a precipitating factor could be "anything." The biggest risk is laziness, another said, commenting that the financial markets are based on faith and that the fiscal standing of the United States will drop when people lose faith that policymakers can control fiscal matters.
Today’s market rollercoaster shows the U.S. is extremely vulnerable to debt jitters—even those that originate across the globe.
The current fiscal path of the nation is unsustainable, as the Peterson-Pew Commission on budget reform has pointed out. For the past forty years, the nation's debt-to-GDP ratio has averaged about 40 percent. This year, it's projected to reach 60 percent and by the end of the decade, it is expected to reach 90 percent, with levels continuing to rise. If investors lose confidence in the U.S., interest rates will soar, job creation will slow and the financial health of Americans will deteriorate.
The key is to make a commitment to a credible plan now. The Peterson-Pew Commission on Budget reform has recommended that policymakers make a commitment to stabilizing the debt by 2018, and to phase in policy changes beginning in 2012