The Bottom Line

October 15, 2013

Yesterday, Former Treasury Secretary and director of the National Economic Council Larry Summers argued that “budget deficits are now a second-order problem” and the focus should instead be on economic growth. Although the piece is in many ways insightful, it could perpetuate the myth in Washington that our debt problems are either solved or are no longer a pressing concern. In addition, Summers’ piece suggests that deficit reduction and “growth strategies” are in conflict – when in fact they are complements. Below, we respond to a number of the arguments in the FT piece.

Our Debt Problems are Far From Solved

In his piece, Summers argues that deficits need not be a major concern given that they will fall to 2 percent of GDP by 2015. While it is true that deficits are falling and debt is projected to decline from 72.5 percent of GDP now to 69.5 percent by 2018, this decline is only temporary. After 2018, debt levels will again begin to rise – reaching the size of the economy by 2035 under CRFB's Realistic Baseline, and doubling it by the 2060s. Although these levels have fallen significantly as a result of the deficit reduction enacted over the past few years, they are nonetheless unsustainable.

Even if this unsustainable growth in debt levels were stopped, moreover, more would need to be done to reduce the debt from its extraordinarily high levels. Debt as a share of GDP is currently twice its historic average and highest they have ever been since the aftermath of World War II. Once the economy recovers, these high levels of debt are likely to “crowd out” investment and growth; and are certain to reduce our fiscal flexibility. It is not clear that, under these levels of debt, the United States would have the capacity to appropriately respond to another recession, a war, or another large-scale national emergency.

Our debt problems remain far from solved, by our estimates, and an additional $2.2 trillion in deficit reduction to put debt on a downward path as a share of the economy this decade alone.

Uncertainty is Not So Uncertain

In his piece, Summers argues that even if debt levels are projected to rise, those projections could be off as they are well within a margin of error. Yet while CBO’s estimates are certainly imperfect, there is little reason to think they are directionally wrong. While economic variables and health care costs are particularly hard to project, demographics are destiny. Over the next quarter century, 19 percent of the projected increase in entitlement spending is due to increased spending from the health law and 54 percent from population aging, which have long been baked in the cake. We've known about the retirement of baby boom generation for years now so forecasters can make better informed projections about demographics than they can about health care costs or economic growth.

Moreover, uncertainty is a double-edged sword. The fiscal situation could be far worse than projected as easily as it could be far better. And considering our high levels of debt and risk of unattainability, it would be prudent to lock in a sustainable path now and relax enacted policies later if projections are too pessimistic. This is especially true given that most of the necessary entitlement changes will have to phase in slowly, meaning they will need to start soon to have a significant impact when they are needed most.

Growth is Not Enough

One common myth surrounding the nation's debt problem is we can grow our way out of the problem. Summers, in fact, suggests that an increase of just 0.2 percent in annual growth would be enough to close the gap. Although we do not have access to Dr. Summers’ calculations, our math suggests that 0.2 percent faster growth would be far from sufficient. While it is true that economic growth would increase revenues, it would also increase spending in a number of areas such as Social Security and thus reduce the budgetary improvement. In CBO's Long-Term Outlook, a 0.5 percentage point increase in productivity growth still resulted in debt levels that debt would still be between 65 and 77 percent of GDP in 2038, and on an upward path. We used these results to roughly approximate the effect of a 0.2 percentage point increase in productivity growth, under current law, and found that debt levels would remain on a clear upward track – reaching between 89 and 94 percent of GDP by 2038. Or in other words, growth certainly helps but will not solve the problem alone.

Long-Term Deficit Reduction is a Growth Strategy

In his piece, Summers rightfully calls for pursuing “growth strategies.” Yet long-term deficit reduction is a growth strategy, and is an important complement to many other growth strategies. Because lower debt levels reduce “crowd out,” of investment, deficit reduction on its own is likely to promote growth. CBO's recent Long-Term Budget Outlook found that a $2 trillion illustrative plan would increase real GNP by 0.8 percent by 2023 and 4 percent by 2038.

In addition to this direct impact, a comprehensive plan to reduce the debt may be the best avenue for pursuing a number of other growth strategies. For example, most plan to reduce impact of sequestration – which is currently reduced GDP by 0.6 percent in the fourth quarter of 2013 alone – would rightly do so by offsetting the cost through future deficit reduction. In addition, a comprehensive debt deal offers one of the best opportunities to pursue individual and corporate tax reform, which could increase the size of the economy significantly by offering lower rates and a broader base to better encourage work and investment while reducing various distortions. On the spending side, policies which reprioritize public investment over consumption and encourage work and investment can also promote growth. And finally, just the announcement of a comprehensive plan could have some positive growth impact by offering households and businesses increased certainty, stability, and confidence in the nation's economy.

At the end of the day, deficit reduction remains a first-order concern exactly because it is the key to economic growth. Or at least it can be if it focuses on putting in place the gradual tax and entitlement reforms which are so sorely needed.

October 14, 2013

Bipartisan discussions over how to end the partial government shutdown and raise the debt ceiling are coming down to the wire as this week begins, with only three days left until October 17 -- the date that Treasury Secretary Jack Lew says the U.S. government would be left with a dangerously low amount of cash on hand and default could potentially be imminent.

There are a number of good ideas out there for breaking the impasse, but there are also a number of bad ideas. As policymakers negotiate over how to re-open the government and lift the deal celing, they should avoid the following fiscally irresponsible policies:

  • Waiving sequestration (without offsets): There is currently broad agreement in Congress to continue funding government at current levels of $986 billion on a temporary basis -- which is about $20 billion higher than what is called for under sequestration. Although ideally policymakers would work to replace the sequestration with more intelligent spending cuts, there are some rumors that they may waive sequestration without other spending cuts. As we previously explained, any reduction in the sequestration cuts not accompanied by offsets would send the message that Washington is not committed to controlling deficits and debt and that it cannot responsibly stick to already enacted savings.
  • Repealing or delaying the medical device tax (without offsets): A number of policymakers have suggested accompanying a continuing resolution with a repeal or delay of the 2.3 percent medical device tax established by the ACA ("Obamacare"). As we've explained before, repealing or delaying this tax would add to the deficit to the tune of $3 billion per year. Policymakers should avoid making any changes to the medical device tax -- or any other deficit-increasing policies -- without fully offsetting the cost of doing so.
  • Using pension smoothing as an offset: Several policymakers have suggested a change in pension contributions rules to help offset the costs of other policies. As we've explained before, this "pension smoothing provision" would represent a timing shift that would raise revenue in the short-run but lose revenue over the long-run. Using temporary revenues from a timing shift to offset a permanent reduction in revenues or increase in spending would be a budget gimmick.
  • Enacting a year-long Continuing Resolution: Some proposals have called for funding the government on a long-term basis -- for six months to a year. Yet continuing current funding levels on a long-term basis would be a mistake on a number of fronts. For one, it would lock in the mindless across-the-board sequestration cuts implemented in March of this year. It would also lead to a second $20 billion defense sequester in January. Ultimately, policymakers must agree to a sustainable level of discretionary spending and then pass appropriations bills which make the hard choices as to how to allocate funds within that level. Cuts should be focused on low-priority spending, not applied across the board.
  • Repealing IPAB: Particularly in the House, there is bipartisan support for repealing the Independent Payment Advisory Board (IPAB) established under the ACA; and some rumors suggest this could be part of a broader deal to raise the debt ceiling and open the government. Yet IPAB provider an important backstop if Medicare grows quicker than anticipated by automatically implementing targeted provider savings when costs grow too fast. Although there is plenty of room to improve IPAB, it should not be repealed unless replaced with an alternative mechanism to control long-term Medicare growth.
  • Offsetting Sequestration with a Repatriation Holiday: The idea of replacing part of sequestration with revenues from a repatriation holiday for multinational companies has been floated in recent days. While a repatriation holiday would generate more revenue in the short run, it would likely reduce revenues later in the decade and over the long term. Although a broader discussion over how to reform international taxation is long overdue, using short-term revenue from a repatriation holiday to finance spending increases would be a serious gimmick.
  • Waiting until the last possible moment to gain leverage: The country is only days away from exhausting all of our borrowing authority. After Thursday, the Treasury would only be able to pay bills with the cash it has on hand, greatly increasing the risk of a default. At the same time, the government shutdown continues to drag on and certainly is not helping give consumers and businesses the confidence they need to spend and invest and is taking money out of the economy. Taking the United States to the brink might result in a better outcome for one side over the other but at the expense of the U.S. economy. It isn't worth it.

Lawmakers need to stop the madness, start discussing responsible solutions, and solve the debt problem.

October 14, 2013

Today begins week three of the government shutdown, and we are now just days away from when the Treasury will exhaust its borrowing authority and risk a default. So far, lawmakers have yet to agree on a fiscally responsible way out of this dilemma. However, former chairman of the Council of Economic Advisors Michael Boskin chimes in today with several suggestions.

Boskin writes in The Wall Street Journal about a possible proposal that could replace part of sequestration and contain "smart" deficit reduction. From Boskin:

First, appoint a commission to propose by, say, next May 15 specific reforms to reduce and eliminate waste, inefficiency and fraud in government programs—with a minimum target of $1 trillion in the next decade. Yes, "government commission" has often been a synonym for inaction—witness the Simpson-Bowles commission on fiscal reform created by President Obama, who ignored its report. Yet several rounds of Defense Base Realignment and Closure Commissions since the 1990s have led to the closure of hundreds of military installations, most recently in 2005.

This time a commission to fix wasteful spending might work. The commission must consist of highly respected, high-ranking officials from both parties—the likes of Paul Volcker, Alice Rivlin, George Shultz and James A. Baker III who have no recent policy to defend. Then make Congress vote up or down on the recommendations (as they do on base closings), so voters can hold their officials accountable.

Second, for every $2 of savings from reducing waste and inefficiency, ease up to $1 of the sequester spending caps. Lest projected savings evaporate before they occur, the 2-for-1 rule would apply only after the fact. In other words, for every $2 of verified savings from the past year, a maximum $1 of sequester relief would be granted this year. The procedure is similar to the look-back provisions many states employ to enforce balanced budgets.

Boskin believe that both parties might accept the proposal: Democrats for reducing the size of sequestration and Republicans for sequester relief and less spending. Boskin argues that finding these savings won't be a problem, there are many good ideas out there. In particular, lawmakers could:

  • Consolidate and reform duplicative programs that are not achieving their goals
  • Curtail improper payments and fraud, improve collection of vast unpaid loans and penalties
  • Modernize and upgrade personnel and technology
  • Move government programs closer to their original intent, such as reforming Social Security's disability program and adopting the chained CPI for government programs

There are many ideas of this type in the Government Accountability Office's annual report on duplication and overlap. These ideas and others should be considered in the current debate, but Boskin acknowledges that this plan would not eliminate the need for entitlement and tax reform. Boskin's idea is worth considering and might be a helpful part of a comprehensive plan, but it's worth remembering that solving our debt problem will not be easy. Unless lawmakers are willing to look at all parts of the budget, we will have difficulty getting our fiscal house in order and undoing the sequester with more targeted reforms.

October 11, 2013

Naturally, the country has been consumed by the developments (or lack thereof) in the government shutdown and debt ceiling impasse. But there is some movement on another piece of legislation which will need to pass before the end of the year: the farm bill. Last year, the farm bill was set to expire, but the fiscal cliff deal extended it for another year to give time for lawmakers to come to an agreement. If the bill does expire (it technically has but the effects mostly aren't felt until at least January 1), the law would revert back to 1949 law, and among the many consequences, milk prices would skyrocket -- a consequence we dubbed the "farm bill cliff" -- as a result of the price floor set in that law. The actual "expiration" of the farm bill is a number of different dates, but the first significant one for commodities is dairy products on January 1 with other commodities' expiration dates not coming until their first harvest in 2014.

In the last Congress, the Senate passed a farm bill with modest bipartisan support, but the House was unable to agree on one, let alone reconcile a bill with the Senate. This Congress, the Senate has again passed a similar farm bill, and the House's bill was shot down as about one-quarter of Republicans joined all Democrats in voting against it. To make the task of passing a bill easier, House leadership splintered the farm bill, passing just the nutrition portion last month by a narrow 217-210 margin.

Now, the House appears ready to move to a conference with the Senate. The main sticking point will be nutrition programs as the broad outlines of the other parts of the bill are relatively similar. The biggest change in both bills is that they eliminate direct payments to farmers and replace them with a shallow loss program which guarantees a certain level of revenue for farmers.

On nutrition, the Senate bill's main change to the food stamp program is to the standard utility allowance, which provides extra food stamp benefits for recipients who have heating and cooling expenses. However, they are able to qualify for the allowance simply by getting as little as $1 of heating assistance. The Senate bill raises this threshold to $10, while the House bill raises it to $20.

The bigger points of contention, though, are in two other provisions the House bill includes that the Senate bill does not. The first has to do with "categorical eligibility," or the ability of people to receive food stamps by virtue of qualifying for other low-income programs, regardless of whether they meet the food stamp program's means tests. The House bill would restrict categorical eligibility to cash assistance programs only. The second provision, which was not in the full House farm bill that failed to pass, would eliminate the state waiver authority for the three-month time limit for receiving benefits for childless adults. The 1996 welfare reform law included the time limit, which applies to non-disabled adults who do not work 20 hours per week or participate in a job training program. The waiver allows states with high unemployment rates to ignore these requirements.

A conference committee would have a number of issues to settle, but the biggest would clearly be nutrition. The House's full farm bill failed in part because the food stamp cuts were not deep enough for some Republicans. Whether the committee is able to thread the needle on these differences will be a big deal come the end of the year.

October 11, 2013

As the government shutdown continues into its 11th day, the two parties have just begun having serious negotiations about reopening the government and raising the debt limit to prevent a catastrophic default in the next week or so.  According to press reports, Senate Republicans are seriously discussing a proposal that would deal with both. The plan has several promising elements: it would give federal agencies two years of flexibility to deal with the sequester cuts, in addition to funding the government and raising the debt limit. However, the proposal has one troubling element: it relies on a budget gimmick that would end up increasing deficits in later years.

Any deal struck as a part of budget negotiations should decrease the deficit, not increase it. This proposal would repeal the 2.3 percent tax on medical devices that was passed as part of the Affordable Care Act. However, it would pay for the $30 billion cost with "pension smoothing," a provision we've previously described as a budget gimmick. The provision produces one-time revenues which artificially improve the short-term budget picture while leading to greater long-term liabilities.

If the proposal is similar to one included in the 2012 transportation bill, the proposal would raise money by temporarily reducing the amount that companies are required to pay into their pension funds. Even though pension smoothing saves the government money in the short term, it increases future deficits by more than it saves. In the short term, this raises revenue because companies have higher profits (or employees have higher wages) subject to taxes since companies take fewer deductions for employee compensation (or employees have more taxable income). However, contributing less to pension plans now means that companies must make greater contributions in later years, thus increasing their deductions, reducing revenue, and increasing the deficit. Also, any seriously underfunded pensions that are unable to pay benefits would be bailed out through the Pension Benefit Guaranty Corporation.

Any bipartisan solution to end the government shutdown is a step in the right direction, and we welcome proposals that would end the fiscal showdown and allow lawmakers to turn their attention to addressing our long-term fiscal imbalance. However, Congress needs to focus on solutions that decrease, not increase, the long-term deficit.

October 10, 2013

With the recent improvement in medium-term budget projections, some are trying to advance the myth that our debt problems have been solved. But as we've shown before, lawmakers still have a great deal of work left to do to put the budget on a sustainable path. In the New America Foundation's Weekly Wonk series, CRFB Senior Policy Director Marc Goldwein writes that this couldn't be further from true. Goldwein notes:

It is true that we have made substantial progress in addressing our short- and medium-term debt. In combination with the economic recovery, a number of spending cuts and tax increases enacted over the past three years have helped to stabilize debt levels as a share of the economy for the next five years. Yet temporary stability does not suggest a permanent solution. Though growth has slowed, our debt levels are the highest as a share of the economy they have been since the aftermath of World War II. At roughly twice the historical average, our extraordinarily high debt levels put us at substantial risk if interest rates rise and leave little flexibility if new needs or emergencies arise.

More frightening, our debt levels are likely to begin growing again sooner rather than later.  As health care costs continue to grow faster than the economy and the large baby-boom population enters retirement, the costs of Social Security, Medicare, and Medicaid will balloon and revenue simply won’t keep up.

The result: debt is projected to exceed the size of the economy by 2035, double the size of the economy in the 2060s, and triple it in the 2080s.

As we've said many times before, the cure is well-known, but lawmakers will need to make hard choices. Without a plan that includes entitlement and tax reform, we are unlikely to be able to get our fiscal house in order. But despite the challenges ahead, there are some signs of hope. Writes Goldwein:

Despite the dysfunction in the halls of Congress, efforts to design and agree to these changes are already underway. The President’s budget took an important step by putting a number of entitlement changes into his budget, including the adopting of the chained CPI which would switch to a more accurate and slower inflation index for calculating Social Security COLAs, changes in the tax code, and various indexed provisions in the budget.. The relevant Committees in both Houses are taking another important step by looking at ways to reform and replace the so-called “sustainable growth rate” (SGR), which threatened to cut Medicare physician payments by about 25 percent. And perhaps most encouragingly, Republican House Ways & Means Chairman Dave Camp and Democratic Senate Finance Chairman Max Baucus are working together to enact the first comprehensive overhaul of our tax code in over a quarter century.

The true test will be whether these efforts can be joined and ultimately enacted into law. Every bipartisan effort to reduce the deficit – the Simpson-Bowles Commission, the Domenici-Rivlin Commission, the Boehner-Obama discussion – found that the best way to get a budget deal was through shared sacrifice. Everyone has to be part of the solution, and all policymakers has to be willing to put their own sacred cow on the table. The retirement age must be on the table.

Click here to read the full piece.

October 10, 2013
We Already Knew the Real Solutions

In yesterday's New York Times, the paper asks in its "Room for Debate" series what federal spending we are better off without in light of the sequester and the government shutdown. CRFB President Maya MacGuineas answers that we've always known the real fiscal solutions won't exclusively involve tackling wasteful spending but rather taking up entitlement and tax reform.

So far, lawmakers efforts during the government shutdown appear to be mostly political, rather than focused on finding a way to solve our fiscal problems. MacGuineas argues lawmakers need to think bigger if they want to get out fiscal house in order.

There definitely is plenty of wasteful and overlapping spending in Washington -- and the sequester pushes policy makers to focus on where they can get savings. The Government Accountability Office has identified dozens of areas of duplication and overlap in the federal government, like that between the Agriculture Department and the Food and Drug Administration over catfish inspections. There's still much needed oversight that is lacking. But a government shutdown isn't the way to solve it.

There is still room to cut in areas like farm subsidies. Reforms to federal retirement and health benefit programs can also achieve savings. Privatize the Tennessee Valley Authority. Charge more to cover the cost of the national parks. The list goes on. We need to do all of these and more, but it's not where the real money is.

What we’ve learned from sequestration and the shutdown is that despite the significant economic disruption caused by these efforts in the near term, they have done little to reduce the long-term debt. Under realistic assumptions, public debt is expected to reach 100 percent of the economy by 2035 and will continue increasing.

Cutting waste, fraud, and abuse, while necessary, just simply won't cut it. Even sequestration fails to put our budget on a sustainable path. Writes MacGuineas:

The budget cuts so far have come from a small sliver of the federal budget and are poorly timed, coming as the economy struggles to recover. A smarter approach deals with all parts of the budget, including tax and entitlement reform, and is phased in over a longer term, allowing for more deficit reduction without stunting growth.

A much better investment is to start bipartisan discussions to comprehensively address our longer-term fiscal challenges.

Click here to read the full piece.

"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.

October 9, 2013

In an op-ed in The Wall Street Journal, House Budget Committee chairman Paul Ryan (R-WI) presents a possible down payment on the debt as a way out of the government shutdown/debt ceiling impasse. The deal would involve entitlement reforms that have some bipartisan support and tax reform.

About the entitlement reforms, he writes:

Here are just a few ideas to get the conversation started. We could ask the better off to pay higher premiums for Medicare. We could reform Medigap plans to encourage efficiency and reduce costs. And we could ask federal employees to contribute more to their own retirement.

The president has embraced these ideas in budget proposals he has submitted to Congress. And in earlier talks with congressional Republicans, he has discussed combining Medicare's Part A and Part B, so the program will be less confusing for seniors. These ideas have the support of nonpartisan groups like the Bipartisan Policy Center and the Committee for a Responsible Federal Budget, and they would strengthen these critical programs. And all of them would help pay down the debt.

We have already discussed increasing Medicare premiums for high earners as a source of bipartisan health care savings, expanding upon that which has previously been enacted into law by both parties -- in the Medicare Modernization Act and the Affordable Care Act, for example -- and has continued to recieve bipartisan support. The Medicare cost-sharing reforms Ryan offers also have the potential for bipartisan support, as plans from both parties have included variations of similar proposals.

Ryan also calls for tax reform which broadens the tax base and lowers rates. Although he does not explicitly mention raising revenue (or not) from it, a commitment to tax reform could pave the way for more revenue as well.

We should also enact pro-growth reforms that put people back to work—like opening up America's vast energy reserves to development. There is even some agreement on taxes across the aisle.

Rep. Dave Camp (R., Mich.) and Sen. Max Baucus (D., Mont.) have been working for more than a year now on a bipartisan plan to reform the tax code. They agree on the fundamental principles: Broaden the base, lower the rates and simplify the code. The president himself has argued for just such an approach to corporate taxes. So we should discuss how Congress can take up the Camp–Baucus plan when it's ready.

Ryan notes in the op-ed that these policies would not be transformative or widespread enough to constitute a "grand bargain" but would represent a good down payment for deficit reduction. It could certainly offer a good start, and he hopes could provide a path to end the impasses that have dominated Washington the past few weeks.

October 9, 2013
A Way Out Possible

The government is still shut down, and the debt ceiling is looming around the corner. Markets are beginning to worry, and the country is facing its first ever default if action is not taken soon.

In today's The Hill, former Senator Kent Conrad (D-ND), co-chair of the Campaign to Fix the Debt and CRFB board member, captures the danger of failing to raise the debt ceiling. Conrad writes:

We are on a collision course with financial calamity. A first-time-ever failure to extend the federal debt limit would lead to higher interest rates not only for the U.S. government, but also for every business, home, car, student and personal loan in America. The looming debt ceiling — and the ongoing government shutdown — is causing harmful uncertainty around the world and here at home.

But there is a way out.

This is no doubt a difficult position for lawmakers, but the good news is that much of the work of developing a way out has already been done in bipartisan plans. The way out Conrad recommends is:

  • Extend the debt limit for at least one year, preferably two, without condition. That aligns with Obama’s position that we not negotiate on the debt limit.
  • Do the negotiating within the context of a continuing resolution to fund the government and end the shutdown.
  • Agree to the Republican funding level of $988 billion for this fiscal year.
  • Agree on a process for individual and corporate tax reform next year. The goal should be to reduce rates and raise additional revenue to go toward deficit reduction. A reasonable goal would be $300 billion to $400 billion in additional revenue over the next 10 years.
  • Agree to additional savings in Medicare and other healthcare accounts by better coordinating care, especially of the chronically ill. A reasonable target would be $300 billion to $400 billion over the next 10 years.
  • Take the savings from numbers 4 and 5 above and use them to cut in half the effects of the sequester.
  • Adopt “chained CPI” as a more accurate measure of inflation that both reduces spending and raises revenue. The combined effect is a savings of about $250 billion over the next 10 years
  • Repeal the medical device tax of 2.3 percent, about which no one seems enthusiastic.
  • Name a commission to reform Social Security to ensure its long-term solvency. The longer we wait, the more draconian the solutions will have to be.

Some lawmakers might not like all of these proposals, but Conrad feels we need everything on the table. That has been the theme of bipartisan plans so far -- each side will have to make sacrifices to get a deal. Compromise still remains the best way out for lawmakers.

Click here to read the full op-ed.

"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.

October 9, 2013
The Folly of the Debt Ceiling

As we draw ever nearer to the projected deadline for hitting the debt ceiling, Congress still has not been able to make a deal. Today, CRFB board member Rudy Penner authored an piece in CNN Money describing the folly of the debt ceiling and the possibility of a default. He compared the United States' budgeting practices to those of third world countries and criticized lawmakers for failing to resolve a self-inflicted crisis.

Penner explains that countries like Ukraine or Egypt in the past essentially did not have an option to borrow, as the marketplace refuses to buy their debt. While the U.S. does not have this problem, we are faced with lawmakers who imperil our full faith and credit because they cannot agree on a budget. Penner describes what could happen if we continue down this road and are faced with payment prioritization:

To avoid a formal default, we will likely continue to pay interest on old debt. And lacking the ability to borrow more, the Treasury Department could pay bills and make other payments only when it collected sufficient revenues from taxpayers and other sources.

The House has passed a bill that would set priorities among the government's creditors, such as ensuring that Social Security recipients get paid on time.

But the Bipartisan Policy Center has cast doubt on this strategy. It believes that it would take a very long time to reprogram government computers to make payments consistent with specific priorities.

The BPC thinks it is more practical to put bills and other required payments in a queue as they become due, then pay them when the needed funds become available.

Unfortunately, payment delays would lengthen very rapidly. Hopefully the process would remain free of political favoritism and corruption.

But as the United States starts down the road toward third-world budgeting practices, who knows what will happen next?

To read our Q&A on the debt ceiling, click here. To keep up to date with our debt ceiling watch, click here.

Click here to read the full op-ed.

"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.

October 9, 2013

Earlier this week, the Senate Committee on Homeland Security and Governmental Affairs convened a hearing addressing fraudulent behavior in the Social Security Disability Insurance System, which has already garnered significant national attention. The Chairman of the Committee, Sen. Tom Carper (D-DE) released a report on a two-year, in-depth investigation into allegations of fraud in rural Kentucky, committed by Judge David Daugherty and attorney Eric Conn. The report and hearing focused on a specific case study, and suggested that increased pressure on appellate legal judges to review cases and decrease hearing backlogs led to irresponsible behavior in this instance.

This report found evidence of collusion and policy violations by Judge Daugherty and Mr. Conn, which led to the third-highest benefit award rate in the country. In addition to a presenting a number of specific findings regarding the relationship between Judge Daugherty and Mr. Conn, the report makes a number of recommendations for reform of the SSDI system as a whole. Recommendations include: strengthening the ALJ quality review process, prohibiting the use of doctors with revoked or suspended licenses, and reform of the medical-vocational guidelines, among others.

During the hearing, Senator Coburn described these specific fraudulent measures that were undertaken by Mr. Conn and Judge Daugherty to ensure hearings would award benefits in a timely fashion. Senator Levin argued that the findings of this investigation strengthen the case for greater oversight and efficiency in the SSDI program. Senator Coburn echoed those thoughts and hopes this investigation will encourage others to take a hard look at the program and support needed reforms.

We've talked before about SSDI reform, and this latest report, though a specific case study, draws more attention to Disability Insurance and the potential for reform. While fraud is important to address, more complete reforms are needed to ensure the solvency and sustainability of disability insurance. A few months ago, CRFB's Senior Policy Director Marc Goldwein offered his thoughts on problems with SSDI:

The Social Security disability system is broken in many ways. Not only is the program financially insolvent, but the system is wrought with fraud, needlessly complex, difficult to navigate, inconsistent and unfair in determining eligibility, inflexible to changes in the structure of the workforce, administratively overburdened, almost completely uncoordinated with other government policies, and unable to help or reward those who are interested in reentering the workforce. 

SSDI is projected to become insolvent in 2016, so it is imperative that measures be taken to shore up this important program. If Congress can move past the current manufactured crises, they should take concrete steps to ensure the sustainability and solvency of SSDI, by looking at all available options.

October 8, 2013

Update: The Obama Administration has issued a veto threat for the bill, instead preferring that Congress pass a clean CR and debt ceiling increase.

As a solution to the shutdown and debt limit impasse has proved elusive, the House has begun considering a twist on one of Congress's moves back in the 2011 playbook: a bicameral working group.

Granted, there are notable differences between what's being discussed today in the House and the so-called "Super Committee" from back in 2011, but the overarching feature of a joint committee of House and Senate lawmakers discussing the budget would be similar.

According to the text of the legislation, the bill would call on a bipartisan group of 10 members of the House and 10 Senators (each composed of 6 members from the majority party and four from the minority) to begin meeting to find a resolution to the current impasse over ending the shutdown and raising the debt ceiling. With only 9 days remaining until October 17 -- the date that Treasury Secretary Jack Lew has said the government will exhaust the use of extraordinary measures to stave off default and will only have $30 billion of cash on hand -- such a bipartisan group would have only a short period within which to meet unless stopgap measures were passed. The legislation call for the group to:

  1. Recommend overall discretionary spending levels
  2. Recommend changes in the debt ceiling
  3. Recommend "reforms in direct spending programs"

The group would have to garner the support of a majority of working group members appointed by the Speaker of the House and a majority of members appointed by the Senate Majority Leader in order to make any recommendations.

Although its been about two years, readers of The Bottom Line may recall the instructions given to the Super Committee -- a bipartisan group of 18 lawmakers: identify $1.5 trillion in savings over ten years or else sequestration would go into effect.

But the proposed working group would have several key differences from the Super Committee that will make it weaker and less likely to produce a bipartisan agreement that would responsibly deal with the debt. First, the mandate of the committee is limited to discretionary spending levels, increases in debt limit and changes in direct spending, leaving revenues off the table for discussion. By contrast, the Super Committee’s mandate allowed it to consider changes in all parts of the budget. Second, unlike the Super Committee the proposal does not include a savings target or other fiscal goal. Third, the plan would only have to receive majority votes from the majority party's appointments in each chamber, rather than the majority of overall members. Finally, the recommendations of the working group would be referred to committee with no procedure to ensure they received a vote in the House or Senate like the expedited procedures for consideration of Super Committee recommendations.

The desire to work on a bipartisan bicameral basis to begin addressing some of our fiscal issues is encouraging, and some type of special process to do so could be an important element of any deal. However, smart and comprehensive deficit reduction is likely to require tackling both sides of the fiscal ledger – or at least putting both sides on the table for consideration. With time running short, it time Congress and the President work constructively to open the government and avoid default, and to also work out a deal to achieve both tax and entitlement reform.

October 8, 2013
120 Former Lawmakers Sign Open Letter To Congress and the President

Today, the Fix the Debt Campaign's Congressional Fiscal Leadership Council released an open letter signed by a group of 120 former Members of Congress, calling for the President and Congress to start addressing the nation's fiscal problems. The members express that returning to the normal budget process is essential, and recognize that while working toward a bipartisan agreement may be difficult, it is necessary:

Procedurally, we believe that a return to Regular Order—including an active slate of committee hearings, mark-ups that produce well-vetted legislation for floor debate, legitimate conference committees to resolve inter-house differences, and passage of an annual budget resolution—is central to restoring Congress’ ability to tackle difficult issues such as this. Leadership is important, but not to the exclusion of meaningful participation of all Members. We are not naïve about the politically difficult choices that real reform entails.

We have been there, fought many of these same battles and have the scars to show for it. However, we believe that, despite recent decreases in near-term projected deficits, the fundamental imbalance between long-term projected revenues and spending demand that you act now to avoid strapping future generations with an even bleaker set of options for confronting what we all know is an unsustainable debt burden.

Importantly, the members do more that just call for action. They put forward different options that they would support in the context of a comprehensive deal. Among the policies they list:

  • A careful reexamination of the subsidies provided to businesses, farmers and other interests by the federal government
  • Reforms to federal military and civilian health and retirement benefits
  • Medicare payment and delivery-system reforms that realign incentives toward quality versus quantity of care, such as expansion of bundled payments and increased penalties for readmissions
  • A redesign of the Medicare benefit that rationalizes cost-sharing and requires more first-dollar “skin in the game,” but provides great protections against catastrophic costs
  • Means testing of Medicare recipients that modifies benefits received or increases premium contributions made by the wealthiest beneficiaries
  • Retirement and eligibility age adjustments that encourage work while providing protections for workers who are not able to work longer
  • The adoption of the chained CPI as a more accurate measure of inflation, with benefit enhancements to offset impact on low income beneficiaries
  • Comprehensive tax reform that reduces tax preferences in order to lower rates, promote growth, and reduce the deficit while maintaining progressivity. These could include making changes to the mortgage interest deduction, state & local tax deduction, tax exclusion for employer-provided health care, preferential treatment for investment income and other tax expenditures benefiting both corporations and individuals

In addition to the policies above, the former lawmakers also call for the President and Congress to begin work toward making Social Security sustainably solvent. The list shows that despite all the current divisiveness in Washington right now, there is actually quite a bit of common ground. This group knows how challenging agreeing upon a solution will be, but given the stakes, it is something that this Congress and the President must do.

Click here to read the full letter and see the list of signers.

October 8, 2013

As we continue to approach the October 17 deadline when the Treasury Department estimates that extraordinary measures will be exhausted, leaving Treasury with a dangerously low cash balance to finance new government obligations, the bond market is getting more and more nervous about lawmakers' ability to avoid hitting the debt ceiling. Today, yields on one-month T-bills jumped by as much as 30 basis points (0.3 percentage points) to their highest level since October 2008 (0.46 percent), although the yield fell back below 0.3 percent later in the day.

Still, the trend for one-month bills over the past month illustrates how the lack of resolution to normally-routine budget occurrences is creating unnecessary uncertainty. The yield also jumped immediately the first day of the government shutdown from near zero to 0.1 percent, even though the shutdown doesn't directly affect Treasury's ability to pay interest on government debt. Clearly, what the shutdown represented -- government dysfunction -- was enough to increase pessimism about lawmakers' ability to raise the debt ceiling. There was a similar rise in one-month yields in the run-up to the August 2 debt ceiling deadline, which quickly evaporated after it was lifted.

Source: MarketWatch

The rise should underscore that there is a cost to waiting to raise the debt ceiling, let alone blowing past October 17. There has already been research done showing that there was a direct cost to the federal budget from the 2011 showdown, pegged at $1.3 billion in that year by the Government Accountability Office and $19 billion over ten years by the Bipartisan Policy Center. Judging by the comparative size of the interest rate rises and increases in federal debt since 2011, the cost could be even higher this time around. Notably, increased interest rates on federal borrowing can also flow through to new homebuyers, car loans, and credit card interest rates.

The rise in the T-bill yield also underscores interest rate risk in the federal budget. Even though it is effectively a self-inflicted interest rate rise, it still shows how external events can have a significant impact on how much the federal government spends on interest.

Lawmakers should be cognizant of the fact that just because we do not hit the debt ceiling does not mean that there are no negative consequences of these protracted showdowns.

October 7, 2013

Last week, we noted that the furlough of "non-essential" employees at the Congressional Budget Office due to the government shutdown could halt the release of the updated Budget Options report, depriving lawmakers of important information at a time when they would ideally be using it to create a deficit reduction package. Now, budget data is being affected as CBO announced that the Monthly Budget Review (MBR) for September will be delayed until after the shutdown.

While the MBR is normally a very micro view of the budget, looking at spending and revenue by category in each month, this month's version also would have given us the first (unofficial) look at the final deficit number for FY 2013. CBO last projected in May a deficit of $641 billion for the past fiscal year. Through August, the deficit has been $753 billion, but a significant surplus in September was expected due to quarterly tax payments coming in that month (there was a surplus of $75 billion in September 2012). This year's deficit will be down significantly from last year's $1.1 trillion.

While the short-term deficit is not the main concern, it is still interesting and informative to see how recent policy changes and events have affected the federal budget. More critically, the shutdown is not allowing policymakers -- or anyone else for that matter -- to see the current budget situation or options for how to deal with the long-term problem.

October 7, 2013
Congress Shouldn't Get Paid After Letting Down the Country With Latest Shutdown

In an op-ed in the Cleveland Plain Dealer yesterday, former Senator George Voinovich (R-OH) criticized the current Congress not just for the ongoing government shutdown but more broadly for the dysfunction of the budget process in recent years. He points out that a concurrent budget resolution has not been passed in four years, and lawmakers have relied increasingly in recent years on continuing resolutions (CRs), which is a poor way to allocate funds.

These “CRs,” as they are called, are a cop-out by our elected officials and a dereliction of one of Congress’s most sacred duties.

In fact, I felt so strongly about the negative impact of the CRs that, as ranking member on the Senate Subcommittee on Oversight of Government Management, the Federal Workforce, and the District of Columbia, I asked the Government Accountability Office (GAO) to investigate the detriment CRs had on our federal government.

GAO completed its report in September 2009, and its findings were startling. Beyond the uncertainty the CRs created, they also resulted in delays to federal contracts and grant applications, some of which were responsible for updating our prison system and Veterans Affairs hospitals. 

Additionally, GAO found that each CR that was passed caused federal agencies to waste hundreds of hours on administrative tasks, like issuing and re-issuing short-term contracts, rather than on core agency missions.

Of course, the ultimate failure of the budget process has been realized in the form of a shutdown, which has now been going on for a week. This failure, Voinovich argues, brings into question the fairness of Members of Congress continuing to get paid, while many federal employees may wait weeks to receive paychecks.

Quite simply, the actions of this Congress are cutting its own legs out from under it, all while members of Congress continue to receive their paychecks from the taxpayers.

It is criminal that after forcing these continual debt debacles on the American people, members of Congress are still able to cash their paychecks. It is unjust and unconscionable that Congress should continue getting paid while hard-working federal employees such as FBI and DEA agents, border patrol agents, National Park Service employees and other federal workers are either being furloughed or given IOUs on their paychecks.

We've been saying for months now that lawmakers should act quickly to resolve this fiscal hurdles so they can turn their attention to passing a comprehensive deal that would include entitlement and tax reform. Writes Voinovich:

The American people deserve better than they are getting from Washington. I will continue to hope and pray that our elected officials – OUR Congress – can come together, pass a budget, and begin anew to instill the confidence in our elected officials that once existed. The future of our nation depends on it.

Click here to read the full op-ed.

"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.

October 7, 2013
If Congress Won't Lead, Others Must

On Day 7 of the government shutdown, it is not surprising that we are talking about a "leadership deficit" as much as the federal deficit. While there are many options on the table that will help reduce our debt and deficits, lawmakers in Congress must first embrace these proposals, especially ones with bipartisan support.

CRFB board member and former Congressman Tim Penny (D-MN) and former gubernatorial candidate Tom Horner write in this weekend's Star Tribune that the bitterness in Washington right now is disappointing for those who care about fiscal responsibility, as too often we only hear about the partisan issues. However, there is some hope given the work of third party advocates that just want to see the country move forward. They write:

One of the great strengths of our country is the balance of power shared by families, government, businesses and nonprofits, including the faith community. When one of these institutions is failing, we should look for leadership elsewhere. Business organizations can start by no longer echoing the Republicans’ no-new-taxes mantra. Instead, they can lead on comprehensive tax reform. Sen. Mike Lee, R-Utah, has proposed a tax overhaul that would promote investment and reward people for working. Among other features, Lee offers a $2,500-per-child tax credit against either income or payroll taxes (Medicare and Social Security) owed by a working family. The proposal recognizes that those in Mitt Romney’s 47 percent still pay significant federal taxes even if they owe no income taxes. More than that, it recognizes that we can no longer pay lip service to the importance of strong families. We need to invest in the ability of families to succeed.

Lee’s proposal is far from perfect, but it’s a good start. The revenue calculations still are being done, but it’s likely that some taxes will be increased in order to reduce others. Some business leaders (particularly those active in the Fix the Debt campaign) have embraced tax reform principles similar to those embodied in the Lee plan. We need their strong voices and the voices of other business­people to lead the discussion. Otherwise, we are left to the context created by Grover Norquist and other antitax crusaders.

Similarly, let’s ask organized labor to step forward to propose new ways to address the spending side of the federal budget, starting with health care. Obamacare on its own doesn’t solve the health care crisis. It promotes broader access but offers little cost control. However, throwing it out without an alternative — as Republicans have tried to do — is the wrong approach. And, asking for an exemption, as unions have done, is also wrongheaded.

The groundwork for a labor-inspired health care solution might be in a statement four years ago issued jointly by the leaders of the Service Employees International Union and Wal-Mart, Inc. Their 2009 letter to President Obama made the case for expanding access, including an employer mandate that doesn’t act as a barrier to hiring entry-level workers. Significantly, the letter also argues for the importance of controlling health costs, rightly asserting that “health care reform without controlling costs is no reform at all.

Penny and Horner assign most of the credit for ideas like the ones above to outside organizations, though they believe Congress will eventually find its way on this matter. But who deserves recognition is a secondary matter; we need a comprehensive deal to put the federal budget on a sustainable path and it will ultimately take sacrifices from everyone to get there.

Click here to read the full op-ed.

"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.

October 4, 2013

Previously, we've voiced a number of concerns about sequestration, including that it is too abrupt, too mindless, too focused on the discretionary budget, and does nothing to improve the long term. What we've failed to mention, however, is that the sequestration also provides far less deficit reduction than what the Super Committee it was meant to back up was charged with saving.

From 2012 through 2021, the Super Committee was charged with identifying $1.5 trillion of deficit reduction, whereas the sequester would save only $1.0 trillion over that time period.

Recall that the Budget Control Act established the Joint Select Committee on Deficit Reduction (the so-called Super Committee) and established that "the goal of the joint committee shall be to reduce the deficit by at least $1,500,000,000,000 over the period of fiscal years 2012 to 2021." The enforcement mechanism to encourage a deal was the across-the-board sequestration currently in effect. Yet that mechanism only saves about two-thirds as much as the Super Committee's $1.5 trillion target over that same period.

So what explains the $500 billion difference between the savings target and what was achieved by the sequester in light of the Super Committee's failure? We identify five main reasons for the difference:

  1. While the Super Committee goal was to save $1.5 trillion, only $1.2 trillion was needed to fully waive the sequester. The additional $300 billion, had it been achieved, would have allowed for a further increase in the debt ceiling beyond the $2.1 trillion that was already allowed.
  2. The sequester was meant to save $1.2 trillion total based on a calculation which assumed interest was 18 percent of the total amount. Since the BCA passed, however, CBO's interest rate projections have fallen and interest savings have declined in turn.
  3. The sequestration cuts "budget authority" (BA), which is the amount appropriated to be spent each year. These funds are not all spent in the year they are appropriated thus resulting in ten-year "outlays," which is the number that actual counts for budgetary effect, lower than ten-year BA.
  4. Original calculations of the sequester did not account for the fact that there are some interactions with the sequester that end up reducing it's effect. For example, the automatic cuts in Medicare provider payments also result in lower premiums, since premiums are linked to the program's total spending.
  5. When Congress delayed by two months and reduced the size of the sequester in the fiscal cliff deal, they paid for half of that change with a budget gimmick that allows more people to convert their 401(k) accounts to Roth accounts in order to pay more taxes now but less later.

Together, these factors work to reduce the effect of the sequester down to only two-thirds the size of the Super Committee's savings target.

Bridge From $1.5 Trillion to $1 Trillion
  2012-2021 Savings (billions)
Super Committee Target $1,500
Intended Difference Between Target and Sequester -$300
Changes in Interest Rates -$60
BA to Outlay Differences -$80
Mandatory Spending Interactions -$35
Roth Conversion Gimmick -$15
Sequester Savings

Source: CBO, CRFB calculations
Note: Lines include interest as a result of the change where appropriate.

In other words, in August of 2011 Congress and the President agreed that they needed to save 150 percent as much as what they will actually save on our current course. 

And if policymakers did replace the sequester with 150 percent of the savings, it would go a long way towards improving our long-term fiscal problems.

October 4, 2013

As Congress negotiates a proposal to pass a continuing resolution and reopen the government, they may enact other policy at the same time.  One such proposal was offered by the House Republicans on the eve of the shutdown, to permanently repeal the medical device tax and delay other aspects of the Affordable Care Act. At the time, CRFB President Maya MacGuineas criticized them for putting forward a proposal that would increase the deficit, making the problem worse. At the very least, any additional costs should be offset with savings elsewhere in the budget, so the fiscal situation will be no worse than before the showdown.

There has been bipartisan talk of Congress reconsidering repeal of the tax on medical devices. We're encouraged that this time, there is a discussion about searching for ways to offset the $30 billion cost. However, as lawmakers consider proposals, they should be wary of budget gimmicks filled with short-term revenue that makes our long-term budget situation worse. We're concerned about reports that lawmakers were considering an change to pension funds as an offset that we've previously described as a gimmick because it only raises revenue in the first few years, costs money in subsequent years, and increases pension liabilities.

If lawmakers want to repeal the medical device tax, they should find a legitimate way to offset the costs. We mentioned previously that a policy of bundling payments for certain inpatient procedures  making one payment to both physicians and the hospital for a given procedure  would provide sufficient savings and would get much of its savings from the same place, medical devices, in a smarter way. Whether policymakers use this policy or find another, it should be one that generates actual long-term savings.

Congress needs to find a way to end this government shutdown, but there are far better options. We're encouraged by reports of bipartisan conversations, which will be the only way to move forward. The dialogue about funding the government should be focused on ending the shutdown, dealing with the sequester, and a method for turning to our larger budgetary challenges. That means finding ways to reduce the long-term deficit, not ways to increase it.


October 4, 2013

This is the tenth post in our blog series, The Tax Break-Down, which will analyze and review tax breaks under discussion as part of tax reform. Last week, we wrote about individual retirement accounts used for retirement planning. 

The American Opportunity Tax Credit (AOTC) was enacted as part of the 2009 stimulus legislation and replaced an existing tax credit for college students called the Hope credit. The AOTC enables undergraduate students or their parents to claim up to $10,000 in tax credits for education expenses over four years.

The American Opportunity Tax Credit allows parents or children to claim a tax credit for education expenses – like tuition or course materials – during the first four years of college. The taxpayer can claim 100% credit for the first $2,000 spent, and 25% credit for the next $2,000 spent, for a total credit of $2,500 per year.  Up to 40% of the credit ($1,000) is refundable for taxpayers who have no income tax liability. The AOTC also phases out for single taxpayers making between $80,000 and $90,000 and joint filers making between $160,000 and $180,000.

Under current law, the AOTC will expire in 2017 and revert back to the Hope credit, which had been available since 1998. The Hope credit is non-refundable and only available for the first two years of college. It would also provide a smaller subsidy ($1,800) and starts phasing out at a lower threshold of $57,000/$107,000 (single/joint filer).

Taxpayers can only claim one of three education benefits, although the AOTC is the most generous tax benefit for people who qualify. Taxpayers can also choose the Lifetime Learning Credit (which is smaller, but available beyond the first 4 years of post-secondary school education) or the tuition and fees deduction (which is less valuable, but available to high-income taxpayers who do not qualify for the other credits).

How Much Does It Cost?

According to the Joint Committee on Taxation (JCT), all education credits combined will cost $20 billion in lost income tax revenue in 2013, or over $125 billion over the next five years. OMB provides an estimate for just the American Opportunity Tax Credit of $14 billion this year. Slightly under half of the credit’s cost is the refundable portion given to individuals with no income tax liability.

According to the Tax Foundation, repealing all education tax credits would provide enough revenue for a 0.9 percent across-the-board rate cut (the 39.6 percent rate would become 39.2 percent) 

 Source: Office of Management and Budget, 2013

If the current provisions were extended permanently instead of expiring in 2017, the AOTC would cost an additional $11 billion per year starting in 2018, or $58 billion through 2023, according to the President’s Budget.

Who Does It Affect?

Because the AOTC is refundable and phases out for higher income individuals, its benefits are spread relatively evenly across taxpayer income levels. By comparison, the Hope credit offered a benefit much more concentrated on middle-class taxpayers. Only about a quarter of the recipients of the AOTC have incomes over $75,000, and 16% have incomes over $100,000. The AOTC can either be based on a student’s income, or that of their parents, depending on who pays tuition and claims the credit. Students claiming the credit can create a very misleading perception of the income distribution, since young people make (and spend) less and get income from sources not often reported on tax returns, like gifts. 


Source: Tax Policy Center estimates for 2011 and 2012

As we’ve written before, education tax preferences are nearly as large as Pell Grants, and these tax preferences comprise half of non-loan student aid. Benefits from Pell Grants are targeted to low-income households, while the tuition and fees deduction is the least progressive of these education subsidies with 50 percent going to households making over $100,000. The AOTC’s benefit also accrues more to higher-income households than Pell Grants, which can be seen clearer in the below graph that groups taxpayers by income levels, instead of lumped into larger quintiles as above.


Source: CLASP

What are the Arguments For and Against the American Opportunity Tax Credit?

Proponents argue that the American Opportunity Tax Credit provides financial assistance for college students struggling with the rising cost of tuition. Particularly in its expanded form, the AOTC better helps students who are lower in the income distribution than the Hope credit, and was responsible for a 90 percent increase in tax incentives for education in 2009. Proponents say that expanding the credit to cover third and fourth year students will make it easier for them to stay in school. A study predating the AOTC found that federal aid creates a small persistence effect, encouraging students to stay in school.

Opponents argue that the AOTC does nothing to encourage college attendance; rather, it is a windfall to students who planned to attend college anyway. The credit may help students with college costs, but it comes with a lag of up to 15 months, and the student likely would have already taken out loans to pay for college. Further, they argue that the credit is not well-targeted, since credits given to upper-income students could be better targeted to poor families. They argue that the complicated system of three different tax credits, various deductions for tuition expenses, and tax benefits given to universities should be dramatically simplified. Finally, federal subsidies for education may drive up the cost of tuition, either at all universities or only for-profit universities. 

What Are the Options For Reform? 

Revenue from Options to Reform the American Opportunity Tax Credit (billions, 2014-2023)
Policy Current Law Current Policy
Extend AOTC past 2017 - $60 $0
Extend the AOTC and index it for inflation - $75 - $15
Repeal the AOTC, but leave the Hope credit in place $100 $160
Repeal the AOTC, Hope, and Lifetime Learning credits, and gradually eliminate the interest deduction $155 $215
Limit the AOTC to those below 500% of poverty, extend it, and eliminate other education tax benefits $25 $85
Streamline all education benefits into a single credit, as proposed by Wyden-Gregg $60 $120
Repeal all education preferences except the AOTC $200 $140
Increase the AOTC’s refundability to 60% - $10 - $15

 *All estimates are CRFB calculations based on available estimates.

What Have Other Plans Done?

President Obama’s budget and the Senate Budget Resolution would make the AOTC permanent, extending it past 2017. Numerous other proposals would reform, consolidate, or eliminate education tax credits. The New America Foundation’s plan for education reform would eliminate all tuition tax benefits and re-direct the money to Pell Grants. The Institute for College Access and Success recommends eliminating higher education tax provisions as well, instead funneling the money into Pell Grants and incentive funds.

Many plans would streamline various education credits into one provision: Senators Wyden and Coats would create a single nonrefundable credit. Sen. Rubio and Rep. Schock would eliminate other tax incentives in favor of a version of the AOTC targeted towards low- and middle- income families. Both the National Community Tax Coalition and the American Institute of CPAs propose a simplified credit. The Heritage Foundation would create a single tuition deduction, up to the value of the average cost of college.

The Center for Law and Social Policy published recommendations that would reform the AOTC and other educational credits, simplifying tax credits and front-loading refundability so students get the credit when they pay tuition instead of much later. 

Both the Simpson-Bowles and Domenici-Rivlin plans did not include the American Opportunity Tax Credit on the short list of tax expenditures that they would keep, choosing to repeal it in favor of lower rates and higher revenue.

Where Can I Read More?

* * * * * 

The American Opportunity Tax Credit is an expanded tax credit for undergraduate tuition expenses.  It helps students and their families in most income ranges, providing up to $2,500 per student per year. However, critics complain that the AOTC does not change the number of people who go to college—it only subsidizes those who would go anyway. Some education reformers would eliminate the AOTC in favor of more funding for Pell Grants, which are targeted more heavily to low-income families and provide aid when the tuition bill comes due instead of 15 months later. Many tax reform plans have offered suggestions to consolidate and simplify the many tax preferences for higher education, in some cases incorporating features to better help students attend college without contributing to the rising cost of tuition.

Read more posts in The Tax Break-Down here.

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