The Bottom Line
Yesterday, CBO put out a new report on the system for taxing U.S. multinational corporations, a somewhat complex but important topic when it comes to corporate tax reform. The report both describes the current system and its shortcomings, while presenting options for reform.
In short, our current international tax system works as follows:
- Active Income: U.S. multinational corporations are taxed on their worldwide income, but much of their foreign income ("active income") is not taxed until it is repatriated back to the U.S.
- Passive Income: Other income, known as "passive income" (investment income or other easily mobile income), is generally taxed in the year it is earned regardless of where it is earned.
In both cases, any foreign income that is taxed by the U.S. government may also get a credit for taxes paid to foreign governments. This credit, though, cannot exceed the U.S. tax liability on that income. Prior to 1976, the foreign tax credit was individually calculated for each foreign country, limiting companies ability to "cross credit," or using the excess credits from foreign revenue earned from high tax countries to cover additional taxes owed to the U.S. government for revenue in low tax countries - thereby reducing a business's total tax liability.
The combination of deferral and cross crediting creates a number of problems. The report notes that deferral can lead to tax-motivated investment decisions and shifting of income, which detracts from economic efficiency. This may be further exacerbated by the way the foreign tax credit is calculated, which may further discourage investment in high-tax countries and shifting of income and/or production to low-tax countries.
The two major ways to reform international taxes are to move towards either a pure worldwide system or a territorial system. Under a worldwide system, the U.S. would tax all income earned both domestically and overseas, but with the foreign tax credit to avoid double taxation. Under a territorial system, active income earned overseas would not be taxed. The choice of either system has implications revenue, but also incentives for investing abroad.
A "pure" worldwide system could be achieved by eliminating deferral but continuing to keep the foreign tax credit, which CBO says would raise $114 billion. However, this would dramatically reduce incentives to invest in foreign countries, especially those with lower corporate tax rates.
Moving toward a territorial system could gain or lose revenue, depending on the design. One option CBO puts forward would be to exempt active dividends earned overseas from U.S. taxes, which would raise $76 billion according to CBO over the next ten years. This option would raise revenue by restricting companies from deduction expenses from overseas operations and reduce foreign tax credits that were used to exempt other forms of taxable foreign income such as royalties. CBO cautions that countries with territorial systems tend to have lower foreign corporate tax revenues, however, whether it would lower or raise revenues depends how it is structured.
To prevent companies from moving profits to tax havens to escape corporate taxation, many other OECD countries that use a territorial system have also created anti-abuse rules like minimum taxation levels or the use of blacklists. House Ways and Mean's Chairman David Camp (R-MI) has proposed something to this effect, calling for a revenue neutral territorial system which pays for revenue losses through a combination of anti-abuse provisions and a temporary transition tax on foreign-earned income.
Alternatively, CBO also presents other ways to reform the corporate tax system including making changes to the foreign tax credit or changing the rules by which different entities are taxed. These reforms could reduce cross-crediting and profit shifting between high-tax and low-tax countries and raise a significant amount of revenue.
The CBO report shows that there are many ways to make the current system more effective with reform, but that there are no easy choices to be made with international taxation.
Click here to read the full report.
Recently, former Senator Chuck Hagel (R-NE) was nominated to succeed Leon Panetta as the Secretary of Defense. He would likely be presented a challenge faced by his predecessors Panetta and Robert Gates: how to find savings in the Defense Department and help make it more fiscally responsible. Admiral Mike Mullen has called the national debt "the greatest national security threat" to the U.S., and it will be crucial for the Pentagon to make smart and targeted reforms that can help rein in defense spending.
Lawmakers made significant progress under the Budget Control Act's caps on discretionary spending, which saved $350 billion compared to CBO's baseline at the time or nearly $500 billion relative to the FY 2012 President's budget. The Defense Department has proposed changes to help meet those caps, including slowing procurement of the F-35 fighter, withrawing two of four brigades in Europe, limiting military pay raises to private sector wage inflation, and introducing fees for TRICARE, among others. But given our fiscal path, more reforms may be needed.
To do this, the Defense Department is going to have to make some tough choices. A report from Carl Conetta of the Project on Defense Alternatives, Reasonable Defense: A Sustainable Approach to Securing the Nation, presents $560 billion that could be saved over the next ten years, putting defense spending at post-sequester levels but through more targeted changes.
The plan use a mix of personnel and procurement reductions, including:
- Reducing the active military force to 1.15 million personnel, a decrease of 19 percent from 2012 levels.
- Reducing Reserve and National Guard forces to 755,000 personnel, a decrease of 11 percent from 2012 levels.
- Having a peacetime overseas force of 115,000 personnel, a reduction of 40 percent from planned levels.
- Reducing the number of aircraft carriers from 11 to 9 and reducing the Navy's fleet from 290 to 230 ships.
- Reducing the number of aircraft by 9 percent.
- Canceling the Marine and Navy versions of the F-35 Joint Strike Fighter.
- Reducing the nuclear arsenal from 1970 to 900 warheads and cancelling the bomber leg of the nuclear triad
One of the notable features of the Reasonable Defense plan is that it does not reduce military pay or benefits like has been proposed by the White House/Pentagon and some other fiscal plans. The report says that doing so could add an additional $40 billion to $130 billion in savings over ten years.
The total savings and many of the policies in the Reasonable Defense approach are similar to ones contained in the 2010 report from the Sustainable Defense Task Force, of which Conetta was a member. Both of these reports show the that while it will not be easy -- requiring a re-thinking and/or downsizing of U.S. strategy -- there are certainly models of restraint out there that can achieve significant military savings.
This report, and others, show it’s possible to have well-thought and gradual reforms to DoD, unlike the sequester which would be abrupt and untargeted. We hope lawmakers can replace the sequester with a smarter plan that addresses all areas of the budget, including defense.
The full report from the Project of Defense Alternatives can be found here.
With health care spending a central topic in budget discussions, the actuaries at the Centers for Medicare and Medicaid Services (CMS) have released a timely report on the growth of National Health Expenditures (NHE). In the report, published in Health Affairs, CMS finds that total health care spending (both private and public spending) in the U.S. in 2011 reached $2.7 trillion, or about 17.9 percent of GDP. This comes out to roughly $8,700 per person.
Compared to the prior year, this is an increase of 3.9 percent and the third year in a row that health care cost growth has not increased above this level. This increase is also in line with the growth of GDP -- about 4 percent in 2011 -- meaning that the NHE as a share of GDP has remained the same. While lawmakers debate rising health care costs, this report would appear to suggest health care costs are actually slowing relative to the previous decades which averaged increases of 7.8 percent per year. But will this slowdown last?
Last summer, we discussed this question when the actuaries released their projections for the next decade on health care cost growth. At that time, they projected health care cost growth would increase on average 5.7 percent annually from 2011-2021, but only about 0.9 percentage points faster than GDP. For context, the Independent Payment Advisory Board's target growth rate for Medicare spending is GDP plus 1 percent, and health care spending growth has often well exceeded this target in the past. This week’s report sheds more light on some of the reasons for this slower growth, and provides some more clues as to whether this trend is a temporary consequence o the recession or whether it will continue over the long term.
While the recession ended in June 2009, its effect persisted into 2011 with continued levels of high unemployment, and therefore a decline in health insurance coverage. The CMS actuaries point out this is typical of economic downturns, although was more pronounced than prior economic cycles. The impact on insurance coverage was one of the biggest contributors to the slower growth in NHE. When people lack coverage they tend to seek less medical care, resulting in a reduction in use and intensity of services. Together with a decline in the amount and mix of investment in structures and equipment, this decrease has been a major factor in slower health care cost growth. As the economy recovers and unemployment trends downward, it is unclear how much longer this will continue to affect the growth rate.
Some have pointed to the Affordable Care Act as a source of slower growth, potentially even having a longer term effect. However, the actuaries find that the ACA’s influence on NHE was minimal and had no discernible impact in 2011. Other factors in the CMS report include slower growth in the use of hospital services and physician and clinical services in the volume of prescription drugs dispensed. What remains uncertain is how new cost containment pilots will have an impact and how providers will respond to them. Richard Foster, Chief Actuary for CMS, remains optimistic:
The jury is still out whether all the innovations we’re testing will have much impact…I am optimistic. There’s a lot of potential. More and more health care providers understand that the future cannot be like the past, in which health spending almost always grew faster than the gross domestic product.
This is not the first time we’ve seen this kind of slowdown in health care cost growth. Most recently in the 1990s, the expansion of managed care and Health Maintenance Organizations (HMOs) along with Medicare provider cuts slowed the average annual growth of NHE slightly. However, this was short-lived as the backlash against managed care produced a reversal in this pattern in the latter part of the decade.
The 2011 growth rate is a sign of an encouraging trend, but history shows us that trends can easily reverse in the years ahead. Over the next two decades, CBO forecasts that the overall aging of the population will account for the majority of the growth in major health programs, but thereafter health care cost growth will become the lead driver of federal health care spending. Already, despite slower growth for other payers, the federal government’s share of NHE has increased to 28 percent of total health spending compared to 23 percent in 2007.
If the current NHE trend continues to slow, this may improve projections for federal health expenditures, but the experience of the 1990s teaches us we cannot take it for granted. Lawmakers should not use the current trend as a reason for complacence. Long-term reforms to federal health programs and health care spending more broadly will be needed to not only bring down future deficits, but to ensure the sustainability of these programs for generations to come.
Over the past week, CRFB has examined the composition, budgetary effects, and economic effects of the American Taxpayer Relief Act (ATRA), which replaced most of the fiscal cliff.
While ATRA represents a tremendous missed opportunity to replace the fiscal cliff with a gradual and intelligent plan to put the debt on a clear downward path relative to the economy, the package will nonetheless have a notable impact on the budget in the medium and long term. Our analysis of the plan was meant to answer a number of important questions, summarized below.
What Was in the Fiscal Cliff Deal?
In The Good, the Bad, and the Ugly in the Fiscal Cliff Package, we show what there is to like and dislike in the fiscal cliff agreement, as well as our estimates of the package broken down into its various components. The bill avoids most of the economic harm of the fiscal cliff, raises $620 billion in revenue compared to current policy, and leaves in place an opportunity for lawmakers to discuss debt reduction further in negotiations to avoid sequestration in March. However, the bill did not address larger reforms to either the tax code or entitlement programs and falls short of what is needed to stabilize the debt and put it on a downward path as a shared of the economy -- the bare minimum of what is needed. We pointed out last week that kicking the can is a common trend in recent years when lawmakers have had an opportunity to enact a big deal. Instead, they have often passed legislation that has increased deficits dramatically or only had minor savings.
We estimated that including interest, the package would increase deficits by $4.6 trillion relative to current law (all the fiscal cliff policies take effect) and reduce deficits by $650 billion relative to current policy (most of the fiscal cliff policies do not take effect). ATRA extended most of the 2001/2003/2010 tax cuts for those below $400k for individuals and $450k for households, permanently patched the AMT, delayed the sequester for two months, extended temporary "tax extenders," and extended the "doc fix," among other changes.
Beside the headline provisions, ATRA contained many other items, a few of which we highlighted in Eight Things You Didn't Know Were In the Fiscal Cliff Deal. Some of these things include a one-year extension of the farm bill, reductions in discretionary spending caps, the repeal of the CLASS Act, establishment of a long-term care commission, and a tax break for racetracks.
Most glaring among these is the biggest budget gimmick of the bill, a provisions that allows individuals to more easily convert 401(k)s and 403(b)s to Roth retirement accounts, which was scored as raising $12 billion in revenue over the next ten years but will likely cost the government revenue in the long term.
How Does the Fiscal Cliff Deal Change Budget Projections?
Ten-year budget projections look markedly different after the passage of ATRA, which we detail in How Does the Budget Look Now? As the graph below shows, current law has converged sharply with current policy, with much of the deficit reduction that was to take place under the fiscal cliff being averted.
Under the new current law scenario, which would allow the sequester to go off in March and several temporary extensions under ATRA, including the "doc fix" and extended unemployment benefits to expire at the end of the year, debt would be 73 percent of GDP in 2022. Under a more realistic scenario that permanently waives the sequester and continues annual "doc fixes" and the refundable tax credits, debt would rise to nearly 79 percent of GDP by 2022. If tax extenders are also continued in perpetuity without being offset, debt would rise to 80 percent.
The deal also dramatically changes budget projections beyond the ten-year window, which we discuss in The Post-Deal Long Term Outlook. Our analysis showed that under three different budget baselines -- CBO's current law, CRFB Realistic, and CBO's Alternative Fiscal Scenario -- debt would be on a clear upward path and would rise well above the size of the economy over the coming decades. In particular, the extension of most of the 2001/2003/2010 tax cuts and permanent patch of the AMT will cause the current law projection to converge upward toward current policy. Our realistic projection of debt in the long-term shows a slight improvement as a result of ATRA, but much more clearly needs to be done for our fiscal path to be sustainable.
What Was the Economic Impact of the Fiscal Cliff Deal?
In The Economic Effects of Avoiding (Much of) the Fiscal Cliff, we look at the economic effects of ATRA compared to the fiscal cliff. According to our prior analysis based on CBO, the fiscal cliff would have represented a 2.9 percent hit on the economy by the end of 2013 (more in the first quarter). This plan, as written into law, would reduce that hit to about 1.3 percent. If we continue to delay sequestration beyond March 1, the hit would be further reduced to 0.7 percent. Note that these numbers are in line with what CBO estimated the economic effect of the deal would be.
The deal may have avoided much of the economic harm that would have occurred with the drastic and sudden tax increases and spending cuts of the fiscal cliff, but budget projections show that the agreement fell far short of putting our fiscal house in order.
To read more, see:
- The Good, the Bad, and the Ugly in the Fiscal Cliff Package (http://crfb.org/blogs/good-bad-and-ugly-fiscal-cliff-package)
- Washington’s Gift for the New Year: Another Kicked Can (http://crfb.org/blogs/washington%E2%80%99s-gift-new-year-another-kicked-can)
- Eight Things You Didn't Know Were In the Fiscal Cliff Deal (http://crfb.org/blogs/eight-things-you-didnt-know-were-fiscal-cliff-deal)
- How Does the Budget Look Now? (http://crfb.org/blogs/how-does-budget-look-now)
- The Post-Deal Long Term Outlook (http://crfb.org/blogs/post-deal-long-term-outlook)
- The Economic Effects of Avoiding (Much of) the Fiscal Cliff (http://crfb.org/blogs/economic-effects-avoiding-much-fiscal-cliff)
- Credit Rating Agencies and IMF Say More Needs to Be Done (http://crfb.org/blogs/credit-rating-agencies-and-imf-say-more-needs-be-done)
Last week, as reported on our "Debt Ceiling Watch" blog, the U.S. reached the statutory debt limit, and the Treasury Department began using extraordinary measures to postpone defaulting on our debt. Secretary Geithner has warned there is approximately $200 billion in headroom using these measures until we default on our debt. With the clock ticking, the Bipartisan Policy Center has released a very detailed and timely analysis of the debt limit and when the so-called “X Date” (or default date) could occur. The report is authored by Steve Bell, Loren Adler, Shai Akabas and Brian Collins .
In their report, the authors highlight examples of the current extraordinary measures which the Treasury is currently taking to delay default. As we’ve discussed in great detail before, these include borrowing from the Federal Employees’ Retirement System G-Fund, the Exchange Stabilization Fund, interest payments and cash receipts to the Civil Service Fund and Postal Fund, and maturing securities in the Civil Services Fund and Postal Fund. BPC notes that these measures will not last as long as they did during the debt ceiling standoff in the summer of 2011. At that time, the Treasury was able to delay by over two and a half months. Unfortunately, the timing of this debt limit falls in the beginning of the year, which is a worse month for government finances than the summer.
After the Treasury depletes its extraordinary measures, the authors explain that the government will only be left with daily cash revenue and cash on hand. The BPC concludes that the “X date” -- when both extraordinary measures, daily revenue, and cash on hand are all exhausted -- will occur sometime between February 15 and March 1. This means the US will default on its outstanding obligations around the same time that the sequester is scheduled to take effect (March 1) and less than a month before the current Continuing Resolution funding the government expires (March 27).
Since there is no precedent for defaulting on our debt, the BPC walks through several scenarios for what could happen if lawmakers cannot agree to raise the debt ceiling. Under one scenario, the Treasury might choose to pay some bills and not others, causing a great deal of uncertainty and questions of fairness. This would lead to prioritizing some payments over others, and could even mean not making Social Security payments, Medicare payments, and taxpayer refunds. Under another scenario, the Treasury might wait until it has collected enough daily revenue to pay off a day’s worth of payments. The report goes into further detail, analyzing daily expenditures and revenue during the projected default time frame. The breakdown demonstrates how much more the U.S. will have in obligations each day than they will have in revenue, making it difficult to even pay off one day’s worth of spending with two days’ worth of revenue.
Above all, the most serious risk of these sudden cuts to spending obligations will be the impact on the economy. BPC’s analysis warns of high interest rates, additional credit rating downgrades, and the potential for serious harm to the entire global financial system. Last year, the Government Accountability Office found that higher interest rates caused by the debt ceiling debate and last-minute solution cost $1.3 billion in 2011. As lawmakers continue to delay a deal on raising the debt ceiling, we face a repeat of incurring unnecessary borrowing expenses while jeopardizing the economy. What’s even more detrimental this time is that the potential debt ceiling breach will coincide with the sequester going into effect. The BPC report assumes the sequester will not go off, but should lawmakers not act on both issues, that would add insult to injury in terms of the economic impact and uncertainty of federal payments.
To get us through the next few years, the BPC projects the debt limit will need to be raised by $1.1 trillion through the end of this year or $2.1 through the end of 2014. After yet another disappointing round of budget negotiations last week, the BPC analysis reminds us why it is critical that lawmakers use the next few weeks wisely to come together in a bipartisan manner to raise the debt ceiling and enact a plan to bring down deficits in the future.
For more information, you can find our primer on the debt ceiling here.
While the American Taxpayer Relief Act has put off worries about the fiscal cliff for a month, it is clear that we missed a clear opportunity to do something about our unsustainable fiscal path. Fiscal Commission co-chairs and Fix the Debt co-founders Al Simpson and Erskine Bowles made it clear that more will need to be done on the debt after missing a "magic moment" in these fiscal cliff negotiations.
Appearing on Meet The Press this Sunday, Simpson and Bowles argue that lawmakers are now left with the really tough decisions because most of the low-hanging fruit are already gone, having been picked during previous negotiations. Further, when both also also said that the sequester is not good policy for reducing the debt; rather, lawmakers should look toward reforming our tax code and entitlement programs if we are going to be able to stabilize the debt and put it on a downward path as a share of the economy. Said Bowles:
First of all, we've done all the easy stuff. All of the hard decisions lay ahead of us. We have got to reform the tax code to make it more globally competitive. We have got to reduce entitlement spending, particularly as it relates to health care. We have to slow the rate of growth of health care to the rate of growth of the economy or it will eat the rest of the budget alive. And we've got to make Social Security sustainably solvent. If we do these things, we can go a long way to stabilizing the debt and keeping it on a downward path as a percentage of GDP. But it's got to be growth. It's got to have some revenue. But the big part going forward has got to be spending cuts.
Simpson was also disappointed lawmakers did not go further with the fiscal cliff compromise. While we may have avoided some of the short-term harm of the fiscal cliff, Simpson argued that there were roadmaps for a bipartisan solution should both sides put everything on the table:
Well, the sad part of it is that the mountain roared and gave birth to a mouse. This thing isn't going to do anything really. Erskine is so correct. And don't forget in our commission we got five Democrats, including Dick Durbin, five Republicans, including Tom Coburn, and one Independent, how do you do any better than that? And the President ignored it, and the Congress has ignored it, because they won't do the big stuff. And the big stuff has to get done. This other stuff is nothing.
We may breathe a sigh of of relief that a deal has been reached to avert a cliff, but this can only be temporary. Projections of debt in both the medium term and the long term show that the fiscal cliff package did not go nearly far enough in terms of deficit reduction. Hopefully, lawmakers listen to the Fiscal Commission co-chairs and start new negotiations now. The full video is below.
Click here for a statement from Simpson and Bowles on the fiscal cliff deal.
Should Old Reluctance Be Forgot? – A new year and a new Congress have been ushered in. However, hopes for putting behind the fighting and foot-dragging of the past are fading as quickly as the Redskins playoff hopes. The stage is set for a series of budget battles this year with both sides already laying down their markers. While the players and owners in the NHL may have settled their differences, the fiscal cliff deal did little to settle the budget disputes in Washington. Be prepared for more budget drama in 2013.
Fiscal Cliff Avoided, but Issues Remain – Washington briefly went over the fiscal cliff on New Year’s Day, but Congress approved of an agreement pulling the country back from the cliff, if only temporarily. While the deal addressed the tax components of the equation, renewing tax cuts for families earning under $450,000 and extending a series of tax breaks, it put off the across-the-board spending cuts known as the sequester for two months, guaranteeing yet another budget battle. At the same time, the deal did little to address the country’s fiscal problems, as we pointed out, saving only $650 billion over ten years compared to current policy and actually costing $4.6 trillion over that same period according to the official current law baseline that assumed all the tax cuts would expire. While the deal lessened the short-term economic impact of the cliff by more than half, the unsustainable long-term debt trajectory was barely dented. Former Fiscal Commission co-chairs Alan Simpson and Erskine Bowles called the deal a “missed opportunity” to get a comprehensive plan to address the debt even though the cliff was set up to compel both sides to forge such a plan. The fiscal cliff is the latest in a long line of missed opportunities to seriously deal with the national debt. The Fix the Debt Campaign advises everyone to “Hold Your Applause” for the deal since there is still much work to be done.
Debt Ceiling Déjà Vu? – The U.S. officially hit the statutory debt limit as the new year dawned. The Treasury Department is using “extraordinary measures” to stave off a default. Such actions should be sufficient until around the end of February, at which time the debt ceiling will have to be raised in order to prevent a national default. Republicans want to use the debt limit to enact spending cuts at least equal to the amount of the debt ceiling increase while President Obama has said he will not negotiate over the debt limit, expecting a clean increase to avoid an economic calamity. Keep track of debt ceiling developments here, and read our primer for a refresher on the topic.
Dropping the Budget Ball – Even though we are a quarter of the way through fiscal year 2013, the spending picture for the year is not yet fully resolved. A stopgap measure funding the federal government expires on March 27. While House and Senate lawmakers are working to craft a spending package for the remainder of the year, a government shutdown may be threatened over the issue of spending cuts. On top of that, debate over the FY 2014 budget will soon begin. The White House has already said that it has delayed the budget process because of the fiscal cliff and the upcoming negotiations, meaning it could miss the standard deadline of the first Monday in February to present its proposal. Fixing the dysfunctional budget process remains a necessity. On a somewhat related note, the House approved continuing the ban on earmarks.
Tax Reform on the Agenda – The fiscal cliff deal was not the last word on taxes. Congress plans to take up a fundamental rewrite of the tax code this year. Democrats want to raise additional revenue by limiting or eliminating deductions and other preferences known as tax expenditures, while Republicans want reform to be revenue-neutral. CRFB shows how fundamental tax reform can reduce rates and the deficit by dealing with tax expenditures.
Sandy Aid Moves – Last week, Congress approved legislation authorizing $9.7 billion in additional flood insurance for victims of Hurricane Sandy. Next week the House is expected to take up a larger $51 billion package that includes funding for Sandy recovery and rebuilding efforts as well as projects to mitigate the effects of future disasters. Whether any of the funding should be offset will be a matter of some dispute. This is yet another example of the need for Congress to improve how it budgets for disasters.
Key Upcoming Dates (all times are ET)
- Dept. of Labor's Bureau of Labor Statistics releases December 2012 Consumer Price Index data.
- President Obama publicly sworn in for his second term (a private swearing in will occur on Sunday the 20th, the technical inauguration date).
- Bureau of Economic Analysis releases advance estimate of 2012 4th quarter and annual GDP.
- Dept. of Labor's Bureau of Labor Statistics releases January 2013 employment data.
- By law, the President's budget must be submitted by the first Monday in February, occurring February 4 this year.
- Dept. of Labor's Bureau of Labor Statistics releases January 2013 Consumer Price Index data.
- Bureau of Economic Analysis releases second estimate of 2012 4th quarter and annual GDP.
- Across-the-board cuts to defense and non-defense discretionary spending prescribed in the Budget Control Act, known as "sequestration," will take effect.
- Dept. of Labor's Bureau of Labor Statistics releases February 2013 employment data.
- Current continuing resolution (CR) funding the federal government expires.
- Bureau of Economic Analysis releases third estimate of 2012 4th quarter and annual GDP.
The American Taxpayer Relief Act has been discussed at length in the news and on this blog, but much of the discussion has been focused on the big provisions in the law like the extension of most of the 2001/2003/2010 tax cuts on income below $400,000/$450,000, the extension of unemployment benefits, or the delay of the sequester.
But the bill also contained a number of smaller changes that you may have not heard about with the various offsets and tax extenders. While the budgetary impact of these provisions is much smaller than the main tax changes, they do add up.
Here are a few of the less talked about provisions in the bill:
Allowing Conversion of 401(K)s to Roth Accounts: In what is probably the most notable budget gimmick in the bill, the two month delay of sequestration is partly paid for with a provision that makes it easier to convert traditional retirement accounts (i.e. 401(k)s) into Roth accounts. The essential difference between the two is that traditional retirement accounts allow pre-tax contributions (with withdrawals taxed), while Roth accounts allow tax-free withdrawals (with contributions made with after-tax income). By allowing individuals to convert, this provision essentially gives workers the option of paying taxes now that they otherwise would have paid later. This is the reason why CBO estimates the provision will reduce the deficit over the next five years, though by decreasing amounts. At best, the provision is a revenue-neutral one masquerading as revenue-increasing, but in reality those who take advantage of it are likely to be better off as a result, since they would often pay a lower tax rate now than they will in the future. Thus, the net effect could be substantial revenue loss over the long term.
Farm Bill Extension: Unknown to most observers, the fiscal cliff deal actually included an extension of the 2008 Farm Bill for 2013, preventing the so called "milk cliff" that would occur as many agricultural policies reverted back to 1949 law. The extension ended up costing about $110 million relative to CBO's baseline, which is paid for by reducing spending for nutrition education programs.
Lower Discretionary Caps in 2013 and 2014: To help pay for a two-month delay of the sequester -- which would have reduced 2013 discretionary spending (BA) by about $95 billion -- the cliff bill actually reduced the base discretionary caps under the Budget Control Act. For 2013, the legislation restores the security/non-security caps in effect before the failure of the Super Committee and reducing each cap by $2 billion ($4 billion in total) -- which essentially is the equivalent of a freeze from 2012. For 2014, the legislation allows the defense/non-defense caps go into effect and reduces each side by $4 billion ($8 billion in total), essentially allowing 1.4 percent growth from 2013.
Repeal of the CLASS Act and Create a Long-Term Care Commission: Included in the "Doc Fix" offsets was a repeal of the Community Living Assistance Service and Support (CLASS) Act, a program created under PPACA in order to provide long-term care insurance. Last year, the Department of Health and Human Services opted not to implement the CLASS Act due to design flaws which left the program structurally unsound, so in many ways this repeal is simply codifying a policy already in effect. In addition to wiping the program from the books, the legislation also establishes a blue ribbon commission to study financing and delivery of long-term care services and report its recommendations. The 15 members of the commission must be appointed by early February.
Rebased End Stage Renal Disease (ESRD) Payments: Another offset for the "doc fix" extension was $4.9 billion in savings from adjusting Medicare bundled payments for End Stage Renal Disease (ESRD) treatment. In early December, the GAO came out with a report recommending that bundled payments for ESRD be re-priced to take into account changes in behavior and utilization of drugs for dialysis. In their report, the GAO found that Medicare was paying $650-$880 million more than necessary for dialysis care in 2011 because utilization rates that year were 23 percent lower than in 2007, the year off which the payment rates were based. The ATRA takes GAO's recommendations and corrects this overpayment to better align program costs with actual utilization.
Extension of 50 Percent Bonus Depreciation: In order to match up income with its associated costs, businesses write off the cost of equipment used to produce income in future years over time using depreciation schedules. As part of the Economic Stimulus Act of 2008, businesses are allowed to deduct 50 percent of the value of the property immediately. This was designed to be a temporary stimulus policy, but has been extended, expanded, retrenched, and now as part of the cliff bill has been extended for an additional year.
Tax Giveaway for Hollywood Films: The fiscal cliff legislation retroactively extends for 2012 and through 2013 a provision to allow television and film producers to expense the first $15 million of costs incurred within the U.S. and the first $20 million if incurred in "economically depressed areas" of the U.S.
NASCAR Racetrack Subsidy: The bill retroactively extends for 2012 and through 2013 a provision that allows a seven-year cost recovery period for racetracks, a much quicker recovery period than would likely be warranted if a normal depreciation schedule were applied. This tax break is commonly known as the NASCAR loophole.
To see how the provisions in the bill add up, read our analysis in "The Good, The Bad, and The Ugly in the Fiscal Cliff Package."
So far, we have analyzed the fiscal cliff deal by looking at the good, the bad, and the ugly in the package, showing what the deal does to the budget, and estimating the short-term economic impact of the deal. This blog will look at the potential impact of the deal over the long term.
Just as it did in the medium term, the American Taxpayer Relief Act will significantly increase deficits and debt relative to current law. Previously, the drastic amount of deficit reduction in the fiscal cliff combined with the ever-increasing reach of the Alternative Minimum Tax and health insurance excise tax over the long term had debt actually being paid off by 2070 under current law (2060 including a drawdown of war spending). Now, debt is stabilized in the medium term but on a clear upward path over the long term, since most of the tax cuts have been extended and the reach of the AMT has been limited. Relative to current policy, the expiration of some of the tax cuts will slightly reduce deficits and debt.
As you can see below, under both current law (including the war drawdown) and the two versions of current policy presented (CRFB Realistic and CBO's Alternative Fiscal Scenario), debt as a share of GDP would rise significantly over the long term, well exceeding the size of the economy by the 2030s in all three scenarios.
Source: CBO, CRFB calculations
Note: Both current law scenarios include a drawdown of war spending.
Please note that these estimates are based off of CBO's economic assumptions from their August baseline, which include both the severe short-term impact of the fiscal cliff and the mildly positive longer-term impact of the deficit reduction in current law. Both aspects would likely change when CBO updates these assumptions in their next baseline.
The deal has made current law and current policy converge greatly, but there are still some differences in assumptions. They include:
- Tax Cuts: While most of the tax cuts in the deal are permanent, the 2009 refundable tax credit expansions and "tax extenders" are set to expire after five years and one year, respectively. Current law assumes that they expire as scheduled while the other two scenarios assume they are permanently extended.
- Health Care Spending: The "doc fix" that prevented a 27 percent cut to Medicare physician payments will only last for a year. Current law assumes that there will be no extension of the doc fix, while the other two scenarios assume that it is extended permanently. Over the long term, health care cost growth in current law basically assumes that the Affordable Care Act is successful in achieving its cost containment goals through 2030. The AFS assumes that it is only successful through 2022. CRFB Realistic assumes a growth path in between current law and the AFS.
- Discretionary and Other Mandatory Spending: While current law assumes that the sequester will go off in two months as scheduled, both AFS and the CRFB Realistic scenario assume that it is permanently repealed. Also, while this version of current law and CRFB Realistic assume that war spending is drawn down as planned, the AFS assumes that it increases with inflation. Over the long term, both current law and CRFB Realistic assume that these categories of spending (discretionary and other mandatory) stay constant as a percent of GDP after 2022, while the AFS assumes that they increase over five years and stay at their 40-year historical average beyond 2022 (an annual difference of about 2.4 percent of GDP).
- Long-Term Revenue: Both current law and CRFB Realistic allow certain features of the tax code--particularly, the health insurance excise tax applying to more and more insurance plans over time and the tendency for wages to increase faster than prices (to which tax brackets are indexed)--to push up revenue as a percent of GDP over time. By contrast, the AFS freezes revenue at its 2022 share of GDP. This difference becomes quite substantial over the long term.
The new estimates of the long-term budget outlook show that our fiscal path is unsustainable, regardless of the assumptions. We will need to do much more, especially on health care spending, to change that reality.
Today, CRFB put out a release, "Washington's Gift for the New Year: Another Kicked Can," on the fiscal cliff deal and previous missed opportunities to fix the debt. While the American Taxpayer Relief Act prevented most of the sharp and poorly targeted spending cuts and tax increases that were part of the fiscal cliff, it wasted an opportunity to put the debt on a sustainable fiscal path in the long term.
Unfortunately, lawmakers are beginning to display a pattern. As we show in our release, leaders in Washington have promised at the beginning of the last three years to seriously address our unsustainable budget path. But presented with a tremendous opportunity to act, they have consistently come up short, whether it was the Fiscal Commission in 2010, the Super Committee in 2011, or negotiations to advert the fiscal cliff in 2012.
This week's fiscal package was more of the same. While the agreement did enact $650 billion in savings relative to current policy, it also waived $4.6 trillion that was scheduled to occur under current law. However, the sequester was only delayed two months, setting up another hurdle that could be the next opportunity for more deficit reduction.
CRFB President Maya MacGuineas urged lawmakers to break the cycle and keep their New Year's resolutions on fiscal responsibility:
At the beginning of every year, policymakers of both parties pledge to reduce our deficit and bring the country’s finances under control. But instead of abiding by their past New Year’s resolutions, policymakers have forgone many opportunities to tackle the debt – often making things worse instead of better.
End-of-the-year irresponsibility is not for a lack of opportunity, but rather a lack of political will. In the last three years we’ve had the Fiscal Commission, the Super Committee, the Obama-Boehner talks leading up to the fiscal cliff. Instead of coming together on a bipartisan basis to make hard choices, our leaders seem to find it easier to come together and horse-trade over how to make things worse or further delay the necessary changes.
Stumbling over self-imposed hurdles month after month may be what it takes to ultimately make the changes that are needed, but I am confident lawmakers can come together to embrace a big deficit reduction package. It’s time to start expecting more from our elected leaders. Let’s make 2013 the year we hold our leaders to their New Year’s resolutions.
Hopefully, 2013 will finally be the year we go for a bigger and bolder deal.
Click here to read the full release.
Update: CBO confirmed our numbers today, finding a remaining fiscal contraction of about 1 1/4 percent.
The American Taxpayer Relief Act which President Obama just signed into law has averted much of the fiscal cliff while enacting a small amount of deficit reduction. Of course, the short-term purpose of avoiding the cliff was to prevent immediate austerity measures from damaging the economy. We have already described how ATRA would affect the budget, but how did it do on softening the economic harm?
Remember that the fiscal cliff had several components -- some of which were fully addressed and others which were not or only partially addressed. The components of the cliff were:
- The 2001/2003/2010 tax cuts
- The Alternative Minimum Tax (AMT) patch
- The across-the-board spending sequester
- The 27 percent scheduled cut in Medicare physician payments
- The payroll tax cut and unemployment benefits beyond 26 weeks
- The various "tax extenders"
- The taxes from the Affordable Care Act that were scheduled to go into effect in 2013
The first two items were extended permanently, with the exception of tax cuts for essentially the top one percent of earners. The physician payment cuts, unemployment benefits, and tax extenders were all extended for a year. The sequester was delayed for two months. The payroll tax cut, or some equivalent, was discussed as a possibility, but ultimately was allowed to expire. Finally, the ACA taxes went into effect as scheduled.
CBO's pre-deal estimate of the economic effect of the fiscal cliff through 2013 was 2.9 percent of GDP. Using the numbers in that same report, we estimate that the ATRA will reduce the amount of fiscal drag by slightly more than one-half to about 1.3 percent of GDP. Most of the remaining economic impact comes from the ten months of remaining sequestration and the expiration of the payroll tax cut.
But both parties have indicated that they would prefer to repeal the sequester for at least 2013, if not longer. Of course, it remains to be seen how lawmakers plan to replace the sequester. Assuming that they replace it with cuts that take place beyond 2013, the fiscal cliff related drag would be further reduced to 0.7 percent of GDP, the remaining drag being mostly from the payroll tax cut expiration.
Source: CBO, CRFB calculations
There are a few things to note about these calculations. One is that this only looks at 2013, thus ignoring the potential effect of the unemployment benefit/tax extender/doc fix cliff now scheduled for the end of the 2013. That cliff would be much more mild overall than this cliff, but would still have an effect in 2014. The second is that the 1.3 percent number does not represent the total fiscal drag or stimulus from the federal government in 2013, since it does not take into account policies outside of what we label the fiscal cliff (other stimulus in effect or winding down, the discretionary spending caps, or other deficit reduction previously put into place, for example). Finally, this does not account for any increased or reduced uncertainty as a result of the deal or effects related to the failure to adequately tackle our long-term debt problem.
In short, out of a 2.9 percent of GDP economic impact in 2013, lawmakers have permanently averted 1.6 percent of the harm and have the potential to avoid an additional 0.6 percent of it.
With President Obama's signing of the American Taxpayer Relief Act (ATRA), lawmakers have avoided most of the upfront hit of the fiscal cliff but have made only slight progress on addressing deficits and debt. More will have to be done to control the debt, but it's not just CRFB saying this. Moody's and Standard & Poor's, two of the top credit rating agencies, and the IMF are also saying more needs to be done.
Yesterday, Moody's issued a statement that warned that lawmakers needed to do more in the coming months if the U.S. is going to be able to maintain its Aaa rating. We've talked about the need to put the debt on a downward path as a share of the economy at the end of the decade, and Moody's establishes this goal as critical to retaining the U.S.'s Aaa rating:
Moody's Investors Service said that the fiscal package passed by both houses of Congress yesterday is a further step in clarifying the medium-term deficit and debt trajectory of the federal government. It does not, however, provide a basis for a meaningful improvement in the government's debt ratios over the medium term. The rating agency expects that further fiscal measures are likely to be taken in coming months that would result in lower future budget deficits, which are necessary if the negative outlook on the government's bond rating is to be returned to stable. On the other hand, lack of further deficit reduction measures could affect the rating negatively. Notably, yesterday's package does not address the federal government's statutory debt limit, which was reached on December 31. The need to raise the debt limit may affect the outcome of future budget negotiations.
The Congressional Budget Office (CBO) estimates that the net increase in budget deficits from the fiscal package when compared to its baseline scenario (which assumes taxes on all income levels would increase) is about $4 trillion over the coming decade, excluding higher interest costs on the resultant higher debt. Based on that estimate, a preliminary calculation by Moody's shows that the ratio of government debt to GDP would peak at about 80% in 2014 and then remain in the upper 70 percent range for the remaining years of the coming decade. Stabilization at this level would leave the government less able to deal with future pressures from entitlement spending or from unforeseen shocks. Thus, further measures that bring about a downward debt trajectory over the medium term are likely to be needed to support the Aaa rating.
S&P, which downgraded the U.S. after the 2011 debt ceiling debate, also did not indicate that their outlook would change to stable. Many of the reasons for the downgrade, which we covered in our report "Understanding the S&P Downgrade," still remain. The agency released a statement that cautioned Congress that there was still more work to do to avoid another downgrade:
While Congressional compromise designed to avoid the 'fiscal cliff' may support the still-fragile U.S. economic rebound, the compromise doesn't affect our view of the country's credit outlook, given that we believe yesterday's agreement does little to place the U.S.'s medium-term public finances on a more sustainable footing.
Fitch has yet to comment on the fiscal cliff deal but it is unlikely that their view differs too much from Moody's and S&P. All three major credit agencies have the U.S. on a negative outlook, making it critical that the lawmakers take up more reforms in the next two months leading up to the scheduled activation of the sequester on March 1st.
|U.S. Credit Rating By Agency|
|Standard & Poor's||AA+||Negative|
|Japanese Credit Rating Agency||AAA||Stable|
|Rating and Investment Information||AAA||Stable|
Source: Agency Outlooks
The IMF has also released a statement about the deal, saying that more needed to be done to put the budget on a sustainable path. From the release:
We welcome the action by the U.S. Congress to avoid sudden tax increases and spending cuts, including through an extension of unemployment benefits during 2013. In the absence of Congressional action the economic recovery would have been derailed.
However, more remains to be done to put U.S. public finances back on a sustainable path without harming the still fragile recovery. Specifically, a comprehensive plan that ensures both higher revenues and containment of entitlement spending over the medium term should be approved as soon as possible. In addition, it is crucial to raise the debt ceiling expeditiously and remove remaining uncertainties about the spending sequester and expiring appropriation bills.”
We hope policymakers heed these warnings and work toward enacting a big and bold package that produces a sustainable debt path. With a clearly communicated and sustainable budget path, the public, businesses, credit agencies, and markets can have the certainty they need to have confidence in the strength of the short-term and long-term economy. We need to take advantage of the upcoming opportunities to go further on deficit reduction.
After a tense few days, or weeks for that matter, lawmakers have enacted a fiscal cliff package -- the American Taxpayer Relief Act. With budget negotiations likely laying low for a few days, we turn our attention to where the deal leaves the budget. We previously analyzed the budgetary effect of each provision of the deal relative to both current law and current policy. In this blog, we will go into more detail on what the budget will look like after the deal.
Where the bill leaves the budget, however, depends heavily on assumptions made about the future. We look at two scenarios in detail: new current law projections and CRFB Realistic projections. The graph below shows debt under each scenario pre- and post-deal, while the text and tables further down go into more detail.
Source: CBO, CRFB calculations
As we said yesterday, though this package will avert much of the short-term economic effects of the fiscal cliff as a result of temporarily waiving the sequester and renewing most of the tax cuts, it will not halt the longer-term trend of rising debt and the associated economic threats. The 2001/2003/2010 tax cuts and AMT patch will be permanently extended, while the sequester, unemployment benefits, tax extenders, and doc fix will be at least temporarily extended (see a table of the provisions and their budgetary impact here). The deal will add about $4.6 trillion to the debt relative to current law, although it does save $650 billion relative to current policy.
Debt under Current Law Projections
The current law scenario which previously had debt on a downward path now has converged significantly toward the unsustainable current policy path, since current law now includes an extension of most of the 2001/2003/2010 tax cuts and a permanent AMT patch. The current law scenario, however, still allows the sequester to take effect in two months; the tax extenders, Medicare doc fix, and unemployment benefits to expire in one year; and the 2009 refundable tax credit expansions to lapse in five years. Our estimate of what current law projections (including a drawdown of war spending) would show is presented in the table below.
Under current law with a war drawdown, debt would reach a size equal to 73 percent of the economy by 2022, about where it was at the end of 2012, and likely higher levels over the long term.
|Current Law w/ Drawdown Budget Parameters After Deal
|Nominal Dollars (billions)|
|Percent of GDP|
Source: CBO, CRFB calculations
Debt Under CRFB Realistic Projections
This picture is worse if you look at the CRFB Realistic Baseline. In contrast to current law, this baseline assumes the sequester is permanently repealed, annual doc fixes continue, the refundable tax credits are extended permanently, and war spending draws down as scheduled rather than increasing with inflation. Our Realistic Baseline also assumes that the tax extenders and unemployment benefits expire as scheduled at the end of 2013.
Under CRFB Realistic, debt will likely reach a size equal to 79 percent of the economy by 2022, and much higher levels over the long-term.
|Budget Parameters for CRFB Realistic After Deal
|Nominal Dollars (billions)|
|Percent of GDP|
Source: CBO, CRFB calculations
One could also argue that the tax extenders could realistically be extended in perpetuity (as their name indicates) without being offset. If that happens, revenue would fall, and spending would increase due to higher interest payments on the debt. Under this scenario, debt will likely reach a size of more than 80 percent of the economy by 2022, and much higher levels beyond that.
It is clear that none of these scenarios are very favorable for the economy over the long term. Stabilizing the debt within a decade is the bare minimum for achieving fiscal sustainability, since changing demographics and rising health care costs will swamp the budget over the next few decades.
Still, there is further opportunity for action, especially given that some parts of the deal are temporary. This package is just the first phase of fiscal negotiations that will pick up again very soon to deal with these outstanding issues. Hopefully, lawmakers will agree on a sufficient and long term deal to stop reckless last-minute deal making.
Stay tuned for more analysis of the fiscal cliff deal throughout the week!
Last night, the House passed the fiscal cliff package already agreed upon by the Senate, by a 257-167 vote. Now the bill is headed to the White House, where it is expected to be signed by President Obama.
As we covered in our blog yesterday, "The Good, the Bad, and the Ugly in the Fiscal Cliff Package," the bill replaces the fiscal cliff with $650 billion in deficit reduction compared to current policy. The bill resolves many of the tax expirations that were part of the fiscal cliff. However, the sequester is only delayed for two months and the debt ceiling looms, requiring Washington to return to the issue of debt reduction in February and March.
As a reminder, below is our rough estimate of the provisions of the deal.
It certainly wasn't the "Grand Bargain" many had hoped for, but it is a small step toward fiscal responsibility. Fiscal Commission co-chairs and founders of the Fix the Debt Campaign Erskine Bowles and Al Simpson gave their thoughts on the bill yesterday in a statement:
The deal approved today is truly a missed opportunity to do something big to reduce our long term fiscal problems, but it is a small step forward in our efforts to reduce the federal deficit. It follows on the $1 trillion reduction in spending that was done in last year’s Budget Control Act. While both steps advance the efforts to put our fiscal house in order, neither one nor the combination of the two come close to solving our Nation's debt and deficit problems. Our leaders must now have the courage to reform our tax code and entitlement programs such that we stabilize our debt and put it on a downward path as a percent of the economy.
Washington missed this magic moment to do something big to reduce the deficit, reform our tax code, and fix our entitlement programs. We have all known for over a year that this fiscal cliff was coming. In fact Washington politicians set it up to force themselves to seriously deal with our Nation’s long term fiscal problems. Yet even after taking the Country to the brink of economic disaster, Washington still could not forge a common sense bipartisan consensus on a plan that stabilizes the debt.
It is now more critical than ever that policymakers return to negotiations that will build on the terms of this agreement and the spending cuts in the Budget Control Act. These future negotiations will need to make the far more difficult reforms that bring spending further under control, make our entitlement programs sustainable and solvent, and reform our tax code to both promote growth and produce revenue. We take some encouragement from the statements by the President and leaders in Congress that they recognize more work needs to be done. In order to reach an agreement, it will be absolutely necessary for both sides to move beyond their comfort zone and reach a principled agreement on a comprehensive plan which puts the debt on a clear downward path relative to the economy.
They may have missed this opportunity, but with so much still needed to be done in fiscal policy in 2013, lawmakers will have the chance to put debt on a sustainable path. It's an encouraging first step, but there is still much more to be done in reaching a truly adequate fiscal agreement.
The statement from Fix the Debt co-founders Erskine Bowles and Al Simpson can be found here.
Last night, the Senate voted on and approved a package to avert most components of the fiscal cliff, which we took a preliminary review of last night. Today, however, there are many more details to review now that the legislation is available and JCT has estimated the revenue effects.
In short, the package would permanently extend most of the 2001/2003/2010 tax cuts for incomes below $400,000/$450,000 while letting the ordinary rate above that threshold rise to 39.6 percent and the capital gains and dividends rates to 20 percent; it would increase the estate tax rate from 35 to 40 percent; it would permanently patch the AMT; and it would extend various “tax extenders” for 2012 and 2013. On the spending side, the package would delay the sequester for two months, enact a doc fix for a year, extend unemployment benefits for a year, extend the farm bill for a year, and enact about $50 billion in spending and revenue offsets to pay for the sequester delay and doc fix.
Based on more recent estimates, CRFB estimates that the entire package would increase deficits by about $4.6 trillion over the next ten years compared to current law projections (assuming everything expires or activates as called for) but would decrease deficits and debt by about $650 billion compared to more realistic current policy projections. These revised estimates continue to show that debt would remain on a upward path over the next ten years -- reaching 79 percent of GDP by 2022 – if policymakers are unable to offset a repeal of the sequester and Sustainable Growth Rate. That would be a slight improvement over the CRFB Realistic Projections, which show debt rising to over 81 percent by 2022. Clearly, lawmakers will need to go further, however, to put in place much more savings.
Below is our effort to roughly estimate the parameters of the deal.
Savings and Costs in the Fiscal Cliff Package
So what’s to like and dislike about the deal? Below we explain:
- Avoids most of the abrupt economic harm from the fiscal cliff by extending or delaying most provisions
- Raises $620 billion in gross revenues relative to current policy, which would contribute to reducing the deficit compared to current policy
- Sets the precedent that extending the sequester has to be paid for and strengthens the precedent that the doc fix should be waived only along with offsetting health provisions
- Leaves in place the ability for lawmakers to discuss further and more meaningful deficit reduction measures in the coming weeks in order to avoid sequestration in the beginning of March
- Does not put in place the measures necessary to stabilize the debt as a share of the economy, let alone reduce it
- Does not include any serious entitlement reforms or set up a clear process for considering such reforms even though rising health costs remain our largest single fiscal challenge on Social Security is on a road toward insolvency
- Does not include a process to enact pro-growth and revenue generating tax reforms
- Does not specifically offset the costs of the tax extenders or UI benefits, setting a bad precedent for future extensions
- Uses a tax timing gimmick to pay for part of the sequester. Specifically, it raises $12 billion by allowing people to convert certain retirement accounts to "Roth" accounts so that they can pay their taxes now instead of later
- Cuts taxes by almost $4 trillion relative to current law projections, with a permanent resolution to the 01/03/10 tax cuts and AMT enacted on a deficit-financed basis even when deficit reduction needs have not been met
- Represents an incredible failed opportunity by missing what Erskine Bowles calls a “magic moment” to put in place a comprehensive plan that would simultaneously avoid the fiscal cliff and more importantly enact the spending cuts, tax reforms, and entitlement reforms necessary to truly control rising debt
CRFB hopes that lawmakers will return the table very quickly in the new year to enact savings sufficient in size and scope to solve the country's debt problems.
It appears both sides are quite close to a deal that would avert (or at least quickly reverse) the fiscal cliff. Although negotiations remain ongoing and not all the information is public, here is what we know -- or think we know -- would be included in the deal as it has been negotiated so far:
- A permanent extension of most of the 2001/2003/2010 income tax cuts for incomes below $400,000/$450,000 include lower rates on ordinary income, capitals gains, and dividends.
- A top ordinary rate of 39.6% on ordinary income above $400,000/$450,000 and 20% on capitals gains and dividends for those earning above those thresholds.
- The reinstatement of the PEP and Pease provisions to limit exemptions and deductions for income above $250,000/$300,000.
- A five-year extension of various refundable tax credits established in 2009 and extended in 2010, including the American Opportunity Tax Credit (AOTC) as well as expansions to the Child Tax Credit and Earned Income Tax Credit.
- An extension of current policy on the estate tax (include a $5+ million exemption indexed for inflation) but with a rate of 40% instead of 35%
- A permanent patch to the Alternative Minimum Tax
- An extension of various "tax extenders" for 2012 and 2013
- A one-year extension of 50% Bonus Depreciation
- A one-year "Doc Fix" to prevent a 27% cut in physician payments
- A 2-month delay of sequestration
- Still unspecified spending cuts to finance the cost of the doc fix and sequester delay
- A one -year extension of unemployment benefits
- A one-year extension of the farm bill
Although no costs have yet been reported, we have made some very rough estimates based on our understanding of the deal. Note that numbers could be off somewhat from estimating differences and could be off substantially if any agreed-to policy are different from how we understand them currently.
Relative to current law, we estimate this plan by itself would increase the deficit by roughly $4.6 trillion including interest. Relative to current policy, we estimate it would reduce the deficit by $550 to $600 billion.
How this plan effects the debt depends on what happens in future stages. Assuming policymakers continue current policy -- including by errantly delaying the sequester and avoiding SGR reductions in physician payments without offsets -- we estimate the plan would result in debt levels of between 79 percent of GDP (CRFB realistic, which assumes war drawdown and no extenders) and 86 percent of GDP (CBO AFS, which assumes no war drawdown and continued tax extenders).
Importantly, though, the plan would leave in place both the sequestration and the SGR -- which could serve to encourage further deficit reduction. If policymakers were able to identify the roughly $1.2 trillion in offsets necessary to pay for those measure (while also paying for or letting expire "tax extenders" and drawing down war spending) then the debt could fall to as low as 73 percent of GDP.
Even this might be insufficient to stabilize the debt, and would require substantial new revenue or spending cuts to be identified. Presuming our numbers are right, such a plan would likely represent the absolute minimum amount of savings which could have the potential to stabilize the debt.
For that reason, whatever happens to this package in 2012, more work will be necessary in 2013.
While most of the country is focused on the fiscal cliff, The New York Times is reporting on another cliff, this one involving the farm bill. Unlike the fiscal cliff, this one involves policies that will increase spending and deficits. If Congress is unable to agree on a farm bill before the end of the year, we would revert back to 1949 law, the last time the government made a permanent farm law. As a result, Washington would be required to purchase milk at more than twice the current market price to set a price floor for producers.
According to the article, milk prices are estimated to double as a result of the price floor. Producers are not happy about this because even though they will benefit significantly from the government's purchases, the hit to consumer demand would be huge. Obviously, consumers would lose big as well and the government would have to increase spending unnecessarily. It's a situation that no one wants. One interesting side note -- if we go over both the fiscal cliff and the farm cliff, the sequester will cut farm programs across the board by about eight percent. It's unclear how this interaction would affect the milk program, but it could dampen some of the negative effects.
So where are we with the farm bill? The Senate passed a farm bill in June that would save $23 billion. The House has not yet brought the farm bill to the floor, but one version that would save $35 billion passed the Agriculture Committee later this summer. Both bills would replace direct payments with a shallow loss program, which would guarantee farmers a certain amount of gross revenue. Although the two bills have slight differences in the design of this new crop insurance program, the combined effect of these policies would save roughly $20 billion over the next decade. One major difference between the two bills is in nutrition programs. In particular, the House Agriculture Committee version restricts categorical eligibility in food stamps--where recipients of benefits in other low-income programs automatically qualify for the program--to cash assistance programs only, saving an additional $12 billion over the Senate version. Overall, these bills are a step in the right direction, but more savings could be gotten in farm programs, and lawmakers should be vigilant that the shallow loss programs do not become overly expensive.
|Ten-Year Savings/Costs (-) in the Farm Bills (billions)|
|Crop Insurance Programs||-$5||-$10|
|Subtotal, Farm Programs||$19||$19|
Ultimately, the change to food stamps is a major barrier to passage. The measure is seemingly unable to pass the House because Democrats object to those changes, and enough Republicans object to the level of spending in the bill that it cannot pass on strict party lines. House Speaker John Boehner (R-OH) has said that he would not include the farm bill in a fiscal cliff deal, another barrier to its passage. Given the focus on that deal and the limited time until the end of the year, a farm bill will probably not pass in the remaining days of this Congress. That leaves the liklihood of a stop-gap measure for the milk program, thereby pushing off the farm bill to the new Congress and adding it to the growing list of to-do items.
Usually around this time, we say we wish this was the year a fiscal planis enacted. But with the ongoing negotiations between the White House and Republicans along with the looming fiscal cliff, 2012 is not completely in the books yet.
2012 was certainly a year when our national fiscal issues came front and center. Whether it was the 330,000 citizens signing a petition to Fix the Debt, the budget being prominently featured during the Presidential and Vice Presidential debates, or a number of new budget proposals and legislation that were introduced, fiscal policy was a big part of the political and policy discussion this year.
If a bipartisan debt agreement comes together before the new year, as we hope, The Bottom Line will be on the job, breaking down the details of any agreement and how it affects our debt path in the next ten years and beyond. However, our regular blogging will slow until the new year, as we focus our attention on the fiscal cliff negotiations.
Keeping with tradition, we've created a word cloud from Wordle of The Bottom Line for 2012. Among the top words were budget, tax, spending, deficit, fiscal, and cliff (no surprise). Hopefully, the words "deal" and "bipartisan" get a little bit larger in our next word cloud.
We've enjoyed participating in the conversation this year. We wish our readers a safe and happy holiday season.
We've talked before about the rational behind implementing the chained CPI, that the current index (CPI-W) does not incorporate substitution effects and therefore overstates inflation. And it turns out a good number of economists agree with us.
A new survey from the University of Chicago's Booth School finds that a great number of economists believe the current measure of CPI used to index Social Security benefits leads to greater benefits that under a true cost-of-living index. This survey indicates implies the use of a slower growing index for COLAs, perhaps the chained CPI.
It's not surprising then that policy experts and lawmakers from both sides of aisle have indicated support for chained CPI. Just today Senator Mark Warner (D-VA) spoke on the floor of the Senate today in support of the chained CPI. He noted that many groups along the political spectrum from the Heritage Foundation, to the Center of American Progress, to the Fiscal Commission has supported chained CPI. Said Warner:
Why do economists support the chained CPI? Because it honors a commitment to maintain the purchasing power of spending and revenue policies. It provides savings across the budget -- not just in entitlement programs but across other areas.It raises revenues and it contributes meaningfully to the long-term fiscal sustainability of the programs that we want to protect.
Because across the government we have indexed things to inflation - the tax code, entitlement programs, all are indexed -- their rise and decrease is based on inflation. So again, this tool while not perfect, all these groups have said it needs to be part of any reform.
Warner is not the only influential lawmaker to declare support for the policy maker. Chained CPI has appeared in the most recent proposals from both the White House and Congressional Republicans. House Minority Leader Nancy Pelosi (D-CA) said today that chained CPI would strengthen Social Security. With support building for the proposal, we hope it will be found in the final deal.
Click here to see a speech from Warner on the chained CPI.
Because there has been a lot of talk about the chained CPI lately, CRFB has created a brand new "Chained CPI Resource Page" to give readers one place to see all that information.
The page has background on the current consumer price index and the chained CPI. It also shows analyses from a variety of sources about the effects of the chained CPI on the budget, taxes, and Social Security in addition to links to outside experts and organizations who support using the chained CPI for inflation calculations.
As a reminder, the chained CPI would replace the current CPI for inflation calculations for cost-of-living adjustments for retirement programs and for various provisions of the tax code. The chained CPI is widely considered to be a more accurate measure of inflation since it more comprehensively accounts for the ability of consumers to substitute goods to avoid the full brunt of relative price increases.
Click here to view the chained CPI resource page.