The Bottom Line

September 24, 2013

Congress faces a number of looming fiscal crises this fall, and the first obstacle is just around the corner -- if lawmakers fail to pass legislation to fund federal programs before September 30, the government will shut down.  Today, CRFB released a new Q&A for understanding government shutdowns and related issues, including continuing resolutions and the federal appropriations process.  This new resource also provides a historical and legislative background to the upcoming fiscal debates.

A few of the questions we answer are summarized below. Click here to read the full Q&A.

What is a government shutdown?

Many federal government agencies and programs rely on annual funding appropriations made by Congress. Since the government’s fiscal year starts on October 1, a government shutdown will occur if Congress has not passed appropriations bills for next fiscal year by September 30. In a “shutdown,” federal agencies must discontinue all non-essential discretionary functions until new funding legislation is passed and signed into law. Essential services continue to function, as do mandatory spending programs.

What services are affected in a shutdown and how?

Each federal agency develops its own shutdown plan, following guidance from previous cases and coordinated by the Office of Management and Budget (OMB). The plan identifies which government activities may not continue until appropriations are restored, requiring furloughs and the halting of many agency activities. However, “essential services” – mainly those related to public safety – continue to receive funding. In prior shutdowns, border protection, medical care of inpatients, air traffic control, law enforcement, and power grid maintenance have been among the services classified as essential, while legislative and judicial staff have also been largely protected. Mandatory spending on programs like Social Security, Medicare and Medicaid also continue.

Does a government shutdown save money?

While estimates vary widely, evidence suggests that shutdowns tend to cost, not save, money. OMB official estimates of the 1996 government shutdown found that it cost the taxpayer $1.4 billion (over $2 billion in 2013 dollars), and some estimates have put an even greater price tag on a shutdown.

How does a shutdown differ from a default?

In a shutdown, government temporarily stops paying employees and contractors who perform government services, whereas the list of parties not paid in a default is much broader. In a default, the government exceeds the statutory debt limit and is unable to pay its creditors (or other obligations). Without enough money to pay its bills, any of its payments are at risk—including all government spending, mandatory payments, interest on our debts, and payments to U.S. bondholders. Whereas a government shutdown would be disruptive, a government default could be disastrous.

While we hope that this Q&A will serve as a resource for those wanting to learn more about government shutdowns, we believe that lawmakers must come together on a bipartisan compromise to fund the government before the September 30th deadline. Ideally, that compromise would include entitlement and tax reforms and help put the debt on a sustainable long-term trajectory. 

September 24, 2013

Yesterday, the Washington Post Editorial Board published an editorial urging lawmakers to use the looming shutdown as an impetus to come up with a serious response to the long-term debt picture rather than another short-term stopgap.  As we have written many times before, the consequences of failing to deal with the long term are dire, a point that the editorial makes clear:

President Obama and his team talk as if they’ve gotten the deficit more or less under control, because the short-term trend has brightened. The federal debt, having soared from 39 percent of the gross domestic product at the end of 2008 to 73 percent this year, is on track to decline to 68 percent by 2018. Thereafter, though, it will begin to rise again, reaching 100 percent of GDP 20 years later. Only one other time in U.S. history has debt exceeded 70 percent of the national economy— around the end of World War II.

The editorial goes on to say that both sides are to blame for the lack of focus on the long-term debt, because neither the Democrats nor the Republicans have been talking about the real root of the problem.

Democrats like to say the country has a “revenue problem,” but the CBO assumes that revenues will rise to 19.7 percent of GDP by 2038, compared with an average of 17.4 percent over the past 40 years, and the deficit widens anyway. Republicans are fixated on Obamacare...[when] the aging population and the relentless growth in health-care costs overall — even accounting for the recent deceleration in that growth — are the main culprits.

Congress can't continue to operate the way that it has over the past three years -- barely averting fiscal catastrophe with last-second short-term compromises. The time has come for real solutions that address the long term. Otherwise, as the Post notes, things will only get more difficult:

Just to keep pace, the government would have to tax more and more, or cut more and more, or both. The longer policymakers wait to address these issues, the harder it will be.

September 23, 2013

Update: The second graph has been corrected to show the correct year for each line.

It is no secret that the growth of federal health care spending is key to the government’s long-term fiscal outlook. With evidence growing that at least some portion of the recent slowdown in health care cost growth represents structural changes in the health care system, the Congressional Budget Office (CBO) revised downward their estimates of health care spending over the coming years from their last Long-Term Budget Outlook in 2012. Despite improved projections in the near term, however, CBO’s projected long-term growth rates remain nearly unchanged and still far in excess of per capita economic growth. Moreover, the short-term gains actually erode over time due to increased projections of longevity.

In fact, while spending on Medicare is now estimated to be 4 percent lower over the next decade than it was last year, CBO actually increased its projections of program growth after 2023 (from an average annual rate of 6.4% from 2023-2050 to 6.5%). Even within a decade, though excess cost growth (the per beneficiary growth above economic growth per capita) for Medicare is expected to average only 0.3 percent (in part due to the effects of the 24 percent physician payment cut dictated by the Sustainable Growth Rate formula), it is expected to rise back to 1.4 percent by 2023, which has been a more typical level in the past.

Part of the explanation is that CBO now expects higher per beneficiary spending growth in the 2020s and only slightly lower growth thereafter. Looking at the causes of the recent slowdown, CBO explains that “even the portion of the recent slowdown that reflects structural changes in payment mechanisms or in how care is delivered may represent [a] one-time downward shift in costs rather than a persistent reduction in the growth rate.”

On a more positive note, CBO now also predicts that Americans will live longer than previously anticipated. While increased longevity would be great news, it also means higher spending on programs to support older Americans, particularly Medicare and Social Security.

Therefore, as you can see in the graph below, Medicare spending in CBO’s latest projections actually slowly catches up to last year’s estimates, surpassing them in 2054. This also happens when looking at all major federal health care programs, although the catch up would not be complete until 2076.

Importantly, even if the recent health care slowdown did continue in full, a significant portion of the growth in federal health care programs over the next couple of decades is driven by demographics rather than health costs. In fact, the retirement of the baby-boom population and growing life expectancy are projected to account for 35 percent of the growth of major health care programs by 2038, with the remainder attributed to excess health care cost growth (40 percent) and the Affordable Care Act’s coverage expansions (26 percent).

CBO’s updated projections are an important reminder that controlling health care cost growth over the long-term remains arguably the most critical challenge facing the federal budget. While the recent slowdown is encouraging, more almost certainly must be done. To change the spending trajectory over the long-term, reforms will likely need to be made to the way we deliver and pay for care. Fortunately, as a recent paper from the Moment of Truth Project shows, a consensus appears to be building on the types of reforms that can help bend the health care cost curve while also improving the patient experience.

September 23, 2013

On September 18, CRFB hosted "Defining Moments in Debt," a panel discussion at the Captial Visitor Center about the many impending "fiscal speed bumps," approaching this fall. There was widespread agreement about the severity of the upcoming debt limit and potential shutdown, as well as the unsustainablity of the budget in the long term. The panel was moderated by CNNMoney writer Jeanne Sahadi, and featured:

  • Jared Bernstein from the Center on Budget and Policy Priorities
  • Diana Furchtgott-Roth from the Manhattan Institute
  • Jim Kessler from Third Way
  • Maya MacGuineas from CRFB
  • Derrick Morgan from the Heritage Foundation

The discussion focused on both problems and solutions to our looming economic problems. Derrick Morgan and Jared Bernstein talked about the causes of our current fiscal situation. Morgan stressed the threats of a large federal debt - as it hinders economic growth and restricts the options of the government in a crisis. In order to combat this threat, Morgan thinks long-term health care spending should be on the table, as it will grow rapidly in the coming years.

Jared Bernstein cautioned against too much austerity in the near term, arguing that we should be focusing on job creation right now. However, he agreed that in the medium-term, debt stabilization is essential, and in the long-term, a sustainable budget path must include a reduction in the rate of health care spending growth.

Jim Kessler, Diana Furchtgott-Roth, and Maya MacGuineas discussed possible solutions, and what they expect to see in the next few weeks. Jim Kessler argued that the key to solving this situation in the short-term is Social Security reform, which he states is the only way to obtain revenue that Republicans will support. Once Social Security is made solvent, there will be room to discuss other reform and budget discussions. Diana Furchtgott-Roth focused on growing the economy and cutting spending as a way to move forward. She cited several specific potential drivers of economic growth, including tax reform and energy and regulatory reform. She also illustrated many ways to reduce spending, including reforming Social Security, Medicare, and eliminating some government programs.

Maya MacGuineas emphasized the breakdown of budget process in talking about the current dysfunction. Instead of prudent discussions about budgetary priorities, legislators are hopping from crisis to crisis with temporary fixes. She was also dismayed at the lack of any real discussion between Democrats and Republicans as the risk of default and shutdown grows larger. MacGuineas remains supportive of a comprehensive plan that would address our long-term challenges now. She believes there is still some room to "go medium" and make some changes to the sequester and other areas to address our current crisis.

There was widespread agreement among the panelists that our country faces long-term drivers of debt that must be addressed, the sooner the better. All were dismayed at the lack of progress and foresight on Capitol Hill, and concerned that there has been a lack of serious focus on how to address these upcoming deadlines. Encouragingly, the panelists described plans that they believed could get support and address both short- and long-term concerns. There was agreement that a plan for fiscal sustainability should be reached as soon as possible, even if spending cuts and revenue increases were phased in later. Even with some disagreement over the size and scope of revenue and spending changes, the entire panel concurred that shifting from crisis to crisis placed too much emphasis on short-term challenges, and not enough on the long-term changes we need in order to ensure the health of the economy going forward.

September 23, 2013
Weak Leaders Fumble the Public Purse

It's the first week of fall, and that means the end of the fiscal year is drawing to a close. Unfortunately, we still do not have a bill funding the government for FY 2014 or even a path forward laid out at this point. In today's Washington Times, Former U.S. Comptroller General and CRFB board member David Walker lays out what he expects for the government funding negotiations. Should they fail to reach a compromise on a comprehensive plan, they should at least partly take advantage of this opportunity:

Congress and the president should work together to replace the senseless sequestration with alternative mandatory and discretionary spending cuts for at least the next two years. They should also set targets for additional spending reductions through social-insurance reforms and additional revenues through comprehensive tax reform. The relevant congressional committees should be charged with coming up with related legislation by a specified date.

To ensure more timely and informed actions moving forward, Congress should also enact biennial budgeting, a meaningful no-budget-no-pay bill, the recently introduced Inform Act, and a substantive Government Transformation Commission that can recommend cost-control measures. Finally, the individual mandate under Obamacare should be delayed, because the government is not ready to implement it effectively.

We must change the way the federal government keeps score. Right now, policymakers focus on annual deficits and 10-year baselines. A more comprehensive and credible approach should take into consideration all our unfunded promises and liabilities, including Social Security, Medicare and civilian and military retirement obligations, and a much longer time frame. Importantly, that figure can go down if we achieve a responsible grand bargain — unlike the amount shown on our National Debt Clock. We also need to focus our fiscal reform efforts on the ratio of debt to gross domestic product, and not the budget deficit. In fact, we should ultimately replace the debt ceiling with a debt-to-GDP limit.

We previously set our expectations for the negotiations in a recent paper that included a grading scale for how lawmakers deal with appropriations and sequestration. Some of Walker's additional measures would be welcomed. Ultimately, if Congress is not able to use this opportunity to achieve a "grand bargain," they must at least keep their commitment to fiscal responsibility, and the American people must demand it in these coming months. Writes Walker:

We must address our biggest deficit — the leadership deficit. Our elected officials have shown too little backbone when we need the courage and conviction that goes with true leadership. This will take both the emergence of nontraditional leaders and political reforms that will encourage more qualified people to seek office.

Ultimately, however, it is “We the People” who must take the lead. Independent-minded Americans of all political affiliations and diverse groups need to come together to focus on common concerns and goals. My travels across the country have convinced me that a significant majority of Americans would rally behind specific economic and political reforms, as long as they are deemed to be comprehensive and fair. In the end, the prescription we need is a consensus for action, and a voting public that says “enough” to politicians who refuse to be part of the solution.

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.

September 20, 2013

With the debt limit approaching and another showdown looming, the focus of some policymakers may naturally turn to how to avoid a similar potentially damaging impasse in the future. In that vein, Rep. Scott Peters (D-CA) has introduced a bill which addresses both the need to raise the debt limit and the need to put the debt on a sustainable path. The bill's reforms are similar to the reforms proposed by the Bipartisan Path Forward from Erskine Bowles and Al Simpson. As a result, the duo has endorsed Peters's package of process reforms.

Peters' plan consists of two bills. The first bill indexes the debt limit to GDP to ensure that lawmakers only need to raise the limit when debt is growing faster than the economy. The second bill requires lawmakers to consider policies to put the debt on a stable or downward path if it were projected to be growing. If a budget resolution does not contain instructions to fix the debt, any Member of Congress would be empowered to call up a vote on a budget proposal that has a minimum level of support.

In essence, the package changes the "pressure points" for deficit reduction built into the budget process. The debt limit would be less prominent, and the focus would be shifted to this new enforcement mechanism requiring Congress to address the sources of growth in the debt well in advance of a deadline. Congress would only need to vote to raise the debt limit if it had failed to stabilize the debt as a percentage of GDP, making the vote on raising the debt limit more meaningful as a reflection of fiscal policy.

In a press release, Peters' office explained the rationale for both bills:

The prolonged national debate over the debt ceiling two years ago led to a credit downgrade, added $18 billion dollars to future borrowing costs, and incited a 2,000 point drop in the New York Stock Exchange over a two month period. This ineffectual solution harmed and extended an already weak economic recovery. The package introduced today by Rep. Peters builds on his consistent advocacy to find an alternative to the current mechanism for raising the debt ceiling, which in recent years has led to paralysis on Capitol Hill.

As mentioned above, Erskine Bowles and Al Simpson released a statement of support for the package, saying:

The political fights over the past two years about raising the debt limit have severely harmed confidence in our government and created tremendous uncertainty. At the same time, debt cannot continue to grow faster than the economy without risking a fiscal crisis. The legislation introduced by Representative Peters would not only help avoid the dangerous political brinksmanship surrounding the debt limit, but also establish a mechanism to ensure Congress and the President act in advance of a crisis if the debt is projected to begin growing faster than the economy.

The Peters plan is a good mechanism for avoiding the kind of unnecessary brinksmanship that sometimes accompanies the debt limit while ensuring that lawmakers keep their eye on the path of debt. It is certainly a constructive budget process reform to help make the process less chaotic.

September 20, 2013

Last week, we laid out our expectations for the government funding negotiations, outlining grades for lawmakers based on how responsibly they handled the issue. With the deadline fast-approaching on October 1, it’s helpful to take a step back and understand where the numbers are coming from in the various continuing resolution (CR) proposals.

House-passed CR – $986 billion

The recently House-passed CR at $986 billion ($518 billion for defense / $468 billion for non-defense) is being billed as a continuation of Fiscal Year (FY) 2013 post-sequester levels, but if you look at the Congressional Budget Office’s analysis, you’ll notice that discretionary spending was actually $1.002 trillion last year ($518 billion for defense / $484 billion for non-defense). So why were FY2013 appropriations actually $16 billion higher than those in the House bill?

The answer gets complicated fast, even to people familiar with the budget, but here’s a quick explanation:

Bridge from FY 2013 to House-passed CR Discretonary Levels (billions)
Adjustment Budgetary Effect
FY 2013 Post-Sequester $1,002
CHIMPS ~ -$19
Extra Federal Housing Administration Receipts ~ +$5
Small Adjustments Made by House CR, Remove Some Sandy Funding  ~ -$1.7
House-passed CR for FY 2014
$986.3

 

First, each year, appropriators use a little-known tool that allows them to “offset” some higher spending on discretionary programs with certain cuts to mandatory spending – called “Changes in Mandatory Programs,” or CHIMPS for short. Under tight budgets due to the sequester in FY 2013, lawmakers used roughly $19 billion of these CHIMPS in order to maintain relatively higher spending on discretionary programs. Therefore, the $1.002 trillion level of discretionary spending is actually achieved by appropriating $983 billion ($1.002 trillion minus $19 billion), before CHIMPS are considered.

Additionally, receipts from the Federal Housing Authority (FHA) – which count as negative discretionary spending – were about $5 billion higher than anticipated in FY 2013. Removing the unanticipated extra receipts brings us to $988 billion ($983 + $5 billion), which would be the amount for a “clean” CR at 2013 levels.

As with all CRs, though, the House made a few other small adjustments (the biggest of which is not extending a small piece of Hurricane Sandy funding that was not counted as disaster nor emergency spending) to bring the total funding in their bill to $986 billion. Importantly, if a CR at these levels were signed into law, with defense funded $20 billion above the statutory cap ($518 bn vs. $498 bn), a sequester would take effect in January to cut defense spending in an across-the-board fashion in order to remove the additional $20 billion.

Van Hollen Proposal – $1.058 Trillion

The Budget Control Act (amended by the American Taxpayer Relief Act) actually created two sets of discretionary caps – those that would occur in the event the Super Committee succeeded and those imposed under “sequestration” if the Super Committee failed.

Congressman Chris Van Hollen, the ranking Democrat on the House Budget Committee, has proposed a continuing resolution at pre-sequester levels. Specifically, his CR would fund the government at $1.058 trillion, with $552 billion devoted to defense and $506 billion for non-defense. Encouragingly, Congressman Van Hollen’s legislation would more than fully offset the difference between the pre- and post-sequester caps through a combination of mandatory spending cuts, further defense cuts, and new revenue.

Current Law – $967 Billion

Current law, under sequestration, calls for funding levels of $967 billion for 2014 – including $498 billion for defense funding and $469 billion for non-defense funding. These levels are $91 billion lower than the pre-sequester caps supported by Van Hollen and about $20 billion lower than those in the house-passed CR. Notably, this entire $20 billion difference comes from the defense side.

Funding the government at $967 billion would be the most consistent with current law, and in fact without legislative change, any funding above that level will ultimately be cut through a second sequestration to occur in January.

The Path Forward

The ultimate, agreed-upon funding levels to keep the government open should be based on a conversation and negotiation about what the government should and shouldn’t do and at what cost. Given the apparent lack of support for truly appropriating at sequester levels, lawmakers would ideally replace at least a portion of sequestration with a broader set of policies sufficient to put debt on a downward path or at least improve our long-term fiscal situation.

Abiding by current law levels of $967 billion – or else offsetting spending above that amount – would at least be a demonstration that policymakers are willing to stick to the deficit reduction they have already agreed to. Congressman Van Hollen's proposal, for instance, would at least more than offset the one year of sequester being replaced with other savings. Violating sequestration without a plan to offset it could be viewed as an unfortunate demonstration that Congress is not serious about putting our fiscal house in order.

September 20, 2013

Politicians and economists have long talked about the negative effects of an accumulating national debt, but cannot always quantify their position. This week's report on the long-term budget outlook from the Congressional Budget Office (CBO) attempts to put some hard numbers behind the consequences of high debt. 

As we reported earlier this week, CBO found that debt will continue to climb over the coming decades, reaching 100 percent of GDP by 2038, and twice the size of our economy by 2076. But incorporating the negative effects of accumulating debt on our economy makes the picture worse.

CBO's standard estimates account for historical norms of economic growth, inflation, and other variables. They do not, however, incorporate the effects of changing levels of debt or different spending and tax policies on these economic variables, often called the “feedback effects” or “dynamic effects." 

CBO finds four major consequences of rising debt that are not directly incorporated into their standard assumptions:

  • Increased borrowing by the federal government would eventually reduce private investment in productive capital, because the portion of total savings used to buy government securities would not be available to finance private investment. The result would be a smaller stock of capital and lower output and income in the long run than would otherwise be the case [...]
  • Federal spending on interest payments would rise, thus requiring larger changes in tax and spending policies to achieve any chosen targets for budget deficits and debt.
  • The government would have less flexibility to use tax and spending policies to respond to unexpected challenges, such as economic downturns or wars.
  • The risk of a fiscal crisis—in which investors demanded very high interest rates to finance the government’s borrowing needs—would increase.

Because of these effects, CBO included alternative scenarios that account for the negative effects of rising debt, which makes the budget picture a little bleaker. The first scenario keeps the same baseline assumptions about the deficit, but includes economic feedback effects. This model shows the economy would be roughly 4 percent smaller in 2038, interest rates would be a half point higher, and the debt would increase to 108 percent of GDP by 2038, instead of 100 percent without feedback effects. 

Because it may not be realistic to assume no changes in law, CBO projected three more alternatives, all incorporating economic feedback effects. The first is an Alternative Fiscal Scenario with deficits roughly $2.4 trillion higher than current law over the next ten years. CBO also projected two scenarios in which spending is reduced and/or revenue is increased by $2 trillion and $4 trillion over the next ten years. These packages exclude interest spending, so the total figures would be higher.

If those same savings continue into the future, the budget picture dramatically changes.  It takes a savings package of $2 trillion to keep our debt near current levels, at 67 percent of GDP. On the other hand, if lawmakers spend an additional $2.4 trillion beyond current law, our debt could reach 190 percent of GDP by 2038.

Source: CBO, 2013 Long-term Budget Outlook

These different budget packages will also affect economic growth. A savings package of $2 trillion is needed just to keep the economy on its current course, roughly offsetting the negative impacts of including economic feedback. Under the Alternative Fiscal Scenario, annual economic growth is projected to be 0.35 percentage points lower than it would otherwise be, resulting in an economy nearly 7 percent smaller in 2038. The scenario with $4 trillion in additional savings would have the opposite effect, where annual growth is estimated to be 0.31 percentage points higher and the economy is 7 percent larger after 25 years.

Source: CBO, 2013 Long-term Budget Outlook
 

 

September 20, 2013

This is the eighth 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 tax-free municipal bonds and cafeteria plans that help employers offer fringe benefits.

Accelerated depreciation is the largest corporate tax break, allowing companies to deduct the costs of assets faster than their value actually declines. The preference is the largest in the corporate tax code and is broadly enjoyed by most businesses. 

To understand accelerated depreciation, one must first understand that U.S. businesses are taxed on profits – that is, their revenues minus their expenses. Yet because many large expenses (for example, purchases of buildings or equipment) are used over a number of years to produce income, they must be “depreciated” over the life of the asset. Because it is impossible to know the actual life of every asset, the tax code groups types of assets into categories of “class lives” and gives each a “schedule” – a number of years over which it must be depreciated for tax purposes, as opposed to deducting the full cost when purchased. Accelerated Deprecation allows assets to be depreciated faster than their economic life.

To take advantage of accelerated depreciation, most companies rely on something called the modified accelerated cost recovery system (MACRS), which was adopted in 1986. MACRS is thought of as accelerated depreciation for two reasons: the system shortened class lives so depreciation happens more quickly, and also allows companies to deduct more of an item’s cost in the first years. By comparison, the Alternative Depreciation System – which more accurately reflects economic depreciation – uses longer class lives and relies on a straight-line method, where an item must be depreciated equally over its lifetime.

Although there are over 100 categories, the table below lists a few of the asset classes treated differently under accelerated depreciation.

Source: Internal Revenue Service

With a quicker depreciation schedule, companies can claim higher expenses and thus lower their short-term taxable income. Although over time a company theoretically pays the same amount of tax, an earlier deduction allows companies to take advantage of “the time-value of money” to reap higher interest savings or investment returns.

How Much Does It Cost?

Accelerated depreciation is the largest corporate tax expenditure. The Office of Management and Budget (OMB) estimates that accelerated depreciation for machinery and equipment cost nearly $70 billion in 2012 and $274 billion over the next five years. 

The Joint Committee on Taxation does not provide an isolated estimate for accelerated depreciation under MACRS; however in 2011 they estimated that a full repeal would save $724 billion between 2012 and 2021.

 

According to our Corporate Tax Reform Calculator, if the deduction were repealed, the revenue from C-corporations could finance a corporate rate cut of 4.3 percentage points over ten years. If the deduction were also repealed for pass-throughs, the rate could decrease 6.2 percentage points. If the pass-through revenue were instead used to reduce individual tax rates, the Tax Foundation estimates it could pay for a 0.7 percent cut (the 39.6 percent rate would fall to 39.3 percent).

Importantly, much of the revenue from depreciation comes from a timing shift that increases tax payments now but reduces them later. As a result, legislation that eliminated accelerated depreciation and lowered tax rates could run the risk of paying for a permanent rate cut in part with temporary revenue. Thus a proposal which was revenue-neutral over the first ten years could lose revenue in subsequent years.  A paper by Treasury officials James Mackie and John Kitchen estimates that eliminating accelerated depreciation would raise aboout four-fifths of the revenue in the second decade as it did in the first, and only two-thirds of the first-decade revenue over the long-term. Other studies suggest even lower revenue levels over the long run; Congressional Research Service economist Jane Gravelle found that the long term revenue gained from repealing accelerated depreciation is only 54 percent of the revenue gained in the first ten years.

Who Does It Affect?

Accelerated depreciation is used by most businesses, but because it sets out different schedules for different types of assets, the effective tax rates on investment varies widely. A 2011 study by CRS economist Jane Gravelle found that effective tax rates due to accelerated depreciation vary widely on different types of assets, as shown in the table below. Accelerated depreciation provides much more tax benefit to investments in equipment, which benefit from effective tax rates between 4 and 15 percent lower. The effective tax rate on buildings, on the other hand, generally drops by 4 percent or less. 

Source: Jane Gravelle, 2011

What are the Arguments For and Against Accelerated Depreciation?

Proponents of accelerated depreciation argue that it is an important incentive to spur business investment and keep effective marginal tax rates on capital investment low. For instance, the Institute for Research on the Economics of Taxation estimated in 2010 that repealing accelerated depreciation would reduce GDP by 3.2 percent. Proponents argue that trading accelerated deprecation for lower rates would still mean higher rates on new investment — at the expense of lower rates on old investments and on non-investment business activity. Many defenders of accelerated depreciation would prefer to go further toward “full expensing," which accounts for the actual expenses businesses face each year. 

Opponents of accelerated depreciation argue that it is a clear preference — allowing companies to deduct expenses faster than assets actually wear out — and that it not only distorts businesses decisions of when and how much to invest but also what to invest in. Opponents also cite a JCT study that found any negative macroeconomic effects for accelerated depreciation would be more or less wiped out by the benefits of rate reduction, and the allocative microeconomic benefits could be substantial. Finally, opponents argue the current system is needlessly complex and tremendously outdated.

Corporate tax reformers have another reason for targeting accelerated depreciation, independent of its merits. Without accelerated depreciation, it is virtually impossible to reduce the corporate tax rate below 30 percent in a revenue neutral way through eliminating corporate tax expenditures alone. On the other hand, many worry that using accelerated depreciation to reduce the corporate tax rate would present the opportunity for a timing gimmick because the provision raises much less in the long-term than in the first decade.

What are the Options for Reform and What Have Other Plans Done?

Most corporate tax reform proposals would address accelerated depreciation in some way. Both the Simpson-Bowles plan and the Wyden-Gregg proposal would repeal accelerated depreciation entirely in favor of the Alternative Deprecation Schedule. President Bush's 2005 Tax Reform Panel recommended two plans, one that would overhaul the depreciation system and replace it with a simple system with four asset categories, and one that would repeal all depreciation in favor of full expensing, which would accelerate depreciation to top speed and allow all expenses to be deducted in the first year. In either case, small businesses would be able to fully expense items.  The Heritage Foundation and the American Enterprise Institute also move to full expensing, the latter through a consumption tax.

More recently, the President's Framework for Business Tax Reform calls for "addressing depreciation schedules," but does not specify how other than by eliminating accelerated depreciation for corporate jets. 

The Domenici-Rivlin plan and the Center for American Progress explicitly retain accelerated depreciation.

If accelerated depreciation were repealed, it could be repealed only for C-Corporations or for all businesses, which would raise either $550 or $775 billion over ten years. Another option would be to retain some amount of accelerated depreciation, but update the schedule of class lives. These schedules have not been updated since 1986 and are calibrated based on the assumption that 25-year interest rates would be 5 percent. Adjusting schedules to a newer estimate of inflation (like 2.5 percent projected in CBO’s recent long-term outlook), would also equalize effective tax rates between equipment and structures, ending the implicit subsidy for equipment, and raise $260 billion over ten years.

Depreciation could also be increased further by switching to full expensing, either for small businesses or for all businesses, which would cost hundreds of billions over the next ten years.

Revenue from Reform Options on Accelerated Depreciation
Policy Savings (2014-2023)
Repeal accelerated depreciation, returning to the Alternative Depreciation Schedule $775 billion
Repeal accelerated depreciation, for C-Corps only $550 billion
Reduce accelerated depreciation for C-Corps by half $275 billion
Retain accelerated depreciation. but lengthen class lives to equalize effective tax rates between equipment and structures and account for today's lower level of inflation $270 billion
Repeal accelerated depreciation for corporate jets $4 billion
Update class lives to adjust for changes in technologies unknown
Allow businesses with incomes up to $1 million to fully deduct expenses - $40 billion
Permanently extend increased expensing for small businesses - $70 billion
Allow companies to fully expense capital assets in the first year unknown

*All estimates are CRFB calculations based on available estimates

Importantly, the revenue raised from most of these options in the first decade is substantially higher than the second decade, or over the long term. For instance, fully repealing accelerated depreciation would raise approximately $775 billion over the first decade—approximately 0.36 percent of GDP. By the second decade, it would raise more like 0.30 percent of GDP, 0.27 percent of GDP by the third decade, and 0.24 percent of GDP once new depreciation changes are fully in place. If policymakers wish to enact corporate tax reform that was revenue-neutral over the long-term, this differential must be taken under consideration.  One option to reduce the differential would be to gradually phase in changes in the deprecation schedule rather than imposing the shift immediately.

Where Can I Read More?

* * * * *

As the largest corporate tax break, accelerated depreciation will play a central role in any corporate tax reform plan. Although there are strong arguments that it plays a helpful role in spurring investment, it can distort business decision-making and is extremely expensive. In fact, retaining this break would make it close to impossible to bring the corporate rate below 30 percent from corporate tax expenditure reform alone without losing revenue. If policymakers are unwilling to repeal accelerated depreciation entirely, there are a number of options to reduce its costs. In all cases policymakers must remain aware of the long-term fiscal implications and how they differ from those in the first decade. Failing to address depreciation schedules at all, however, will make corporate tax reform quite difficult to achieve.

Read more posts in The Tax Break-Down here.

September 19, 2013

Recently, Congressman Reid Ribble (R-WI) sent a letter to his colleagues in Congress calling for them to use the upcoming fiscal discussions to push for comprehensive Social Security reform to make it solvent  for future generations. Ribble writes the expiration of the government funding bill and the debt ceiling present possible danger for the country, but also a chance to improve the nation's finances - and lawmakers need to take advantage. Writes Ribble:

I believe we should utilize this unique time and begin undertaking entitlement reform. Specifically, I believe we should save and secure Social Security.

We, as sons and daughters of Social Security recipients - and parents of future recipients as well - have an obligation not to simply focus on the next election, but to ensure this vital safety net is in place for the next generation and for generations to come. We espouse fiscal responsibility but we need to be honest with ourselves: do we want to solve this problem or not? And while our conference is conflicted on what paths to pursue in the coming weeks I would present this as an option we could unify behind and actually get enacted into law.

I've heard countless times during my short period in Congress, "Social Security's the easy one to solve." ...and yet we do not step forward to fix it. Instead we kick the can down the road and allow the problem to grow worse. If this is the "easy one," where the problem and the potential solutions are readily clear, then we should not delay. Let's actually fix it for the American people.

As we've written before, the Social Security is trust funds will run out of money by 2033 or earlier, at which point all beneficiaries -- regardless of age or income - will face an across-the-board 23 percent cut. And as we showed in our recently released report, "Social Security Reform and the Cost of Delay," the closer we get to the insolvency date, the harder it will be to solve the problem. For example, a gap that could be closed with a 20 percent cut for new beneficiaries or 2.7 point payroll tax increase would require a 30 percent benefit cut or 3.3 point tax increase in only ten years. Moreover, the longer we wait the less time workers will have to plan and adjust.

As Congressman Ribble explains, delay is unwise. We might go further and call it unacceptable. Congressman Ribble lays out several options that could close the funding gap, all of which have at times received bipartisan support. They include:

  • Continuing and expanding the phase-in of raising the retirement age
  • Adjusting the inflation formula used for calculating future growth
  • Means-testing benefits for high income recipients of Social Security
  • Gradually restoring the cap on wages subject to FICA to its Reagan-era levels

Of course, these aren't the only options to reform Social Security. Indeed, our interactive Social Security Reformer shows the wide range of options that lawmakers have available to them. Ribble notes this, challenging his colleagues to propose alternatives that would achieve the goal of Social Security solvency.

Ribble should be credited for putting options on the table, but his openness to other solutions is particularly helpful.  Lawmakers should follow this example and maintain flexibility as they propose their favored options that would reform Social Security. There might not be complete agreement on every individual policy, but the final result of saving this vital program that will be more than work it.

We can't help but agree with the Congressman when he argues that "Acting now will show the American people once again that we are serious about protecting the most vulnerable in our communities, tackling our nation's problems in a responsible way, and getting our fiscal house in order. We should not delay."

Click here to read about the cost of delay and click here for our Social Security Reformer.

September 19, 2013

On Tuesday, Senator Mike Lee (R-UT) presented his Family Fairness and Opportunity Tax Reform Act, which will be introduced in the coming days.

Senator Lee described his plan as a new, simple tax structure to address this country's inequality of opportunity and as a way to correct a tax penalty for being a parent.  He claims parents contribute to the economic system twice, once by paying taxes, and another time by bearing the costs of raising children, who will grow up to be the next generation of taxpayers.

Lee's tax reform plan has the following components:
  • Replace the current seven income tax brackets with two brackets, at 15 percent and 35 percent
  • Begin the higer bracket at $87,850 for individuals, which is the current breakpoint between the 25 percent and 28 percent brackets, but at double that amount ($175,700) for couples, therefore eliminating the so-called "marriage penalty"
  • Eliminate most deductions and credits not related to children, including the state & local deduction, the standard deduction, and the personal exemption
  • Create an additional $2,500 per child tax credit
  • Replace the personal exemption and standard deduction with a $2,000 personal credit
  • Reform the charitable deduction so it is available to all taxpayers
  • Reform the mortgage interest deduction so it is available to all homeowners, but limit it to the first $300,000 of a mortgage
  • Repeal the AMT and two taxes associated with the Affordable Care Act, the 3.8 percent surtax on high investment income and the 0.9 percent Medicare payroll surtax on high-earners

The Senator's tax proposal alters the tax code in a few important ways. Individuals in the current 25 percent tax bracket would see a nominal marginal rate reduction to 15 percent, while those in the 28 percent bracket would see a nominal marginal rate increase to 35 percent (some couples in the current 28 percent bracket, however, would have their marginal rate reduced to 15 percent due to the elimination of marriage penalties). Individuals making more than $400,000, currently paying a marginal income tax rate of 39.6 percent, would also see a nominal rate reduction. The fact that the brackets are double for married couples eliminates any sort of marriage penalty and increases marriage bonuses.

The centerpiece of Senator Lee’s plan is a new child tax credit. If taxpayers do not owe enough income tax to take advantage of the credit, the credit can offset payroll taxes paid by the employee and the employer. He would also maintain existing tax benefits for children, including the child tax credit, Earned Income Tax Credit, the child and dependent care credit, and the exemption for dependents.

Although the top rate decreases, there are several progressive elements of this plan. Replacing the personal exemption and standard deduction with his proposed credit equates to a larger effective "zero percent bracket," in which taxpayers would pay zero income tax. Under the current system, individuals earning $10,000 or less automatically pay no income taxes (because these two provisions equal taxable income), but this figure rises to $13,333 under Lee's plan. The plan would also repeal repeal regressive itemized deductions like the state and local tax deduction. Finally, the reformed charitable and mortgage interest deduction would be available to all filers, not just those who itemize, who tend to have higher incomes.

Lee presented his tax reform bill both as a way to correct penalties in the tax code, and as a way for Republican legislators to rally around an agenda responsive to the inequality crisis. Senator Lee has no official cost estimates of this bill, but expects to see a small reduction in revenue, though consistent with historical averages.

We applaud this new addition to the tax reform discussion. As Congress discusses tax reform this fall, they will benefit from having more ideas on the table, not less. We look forward to a more detailed look at his proposals when legislative language is released.
September 19, 2013

Update: CBO has now released its official Alternative Fiscal Scenario estimates (tab 6 of the Excel). They find that debt reaches 165 percent of GDP in 2039, one year later than we estimated.

As we prepared for CBO's Long-Term Outlook to be released Tuesday, we anticipated two sets of projections: the Extended Baseline Scenario (EBS), which approximates current law, and the Alternative Fiscal Scenario, which includes current policies that were set to expire. This has been normal practice by CBO in recent years, and has allowed them to demonstrate the fiscal consequences of continuing current actions even if new laws were technically required to see them through. This year, CBO focused only on their Extended Baseline Scenario, a choice which will be the topic of the first post of in our Long-Term Outlook series.

So why did CBO virtually abandon the Alternative Fiscal Scenario in this report? We can’t know for sure, but we do have some ideas. Most importantly, major differences in the past between current law and the Alternative Fiscal Scenario – the expiration of the 2001/2003/2010 tax cuts and of “AMT patches” – were resolved permanently in the fiscal cliff deal. As a result, there is no longer a question as to whether we will update the AMT each year or let it snap back to 2000 levels, or whether we will continue current tax rates – most (though not all) tax law is now permanent. That change alone closed about $5 trillion of the gap between current law and the AFS through 2023.

Of course, a number of differences between current law and the AFS still remain. Unlike the AFS, current law assumes sequestration continues, physicians accept a 24 percent payment cut, and a number of temporary tax cuts expire as scheduled. While a realistic baseline might correct for these assumptions, it would also make offsetting corrections, assuming that disaster spending on Hurricane Sandy relief will not continue at current levels and war spending will continue to drawdown. Taking these all together, the difference between CRFB's Realistic baseline and CBO's current law baseline in 2023 is only 2 percent of GDP.

Still, the AFS does provide some useful (and large) long-term assumptions which may (or may not) be more realistic than CBO’s Extended Baseline. Specifically, it freezes revenue as a percent of GDP after 2023, increases other mandatory and discretionary spending to their historical averages, and assumes some Medicare provider reductions will not continue to be sustainable beyond 2023.

Below, we make an effort to replicate CBO’s Alternative Fiscal Scenario using data about the current policies involved. Under these projections, debt would pass 150 percent of GDP by the mid-2030s and 400 percent by the early 2060s. CBO suggests that when economic effects are included, debt would reach 200 percent of GDP by 2040 or so.

Source: 2013 CBO Long-Term Outlook and 2012 CBO Long-Term Outlook with GDP Revisions

What is interesting about these projections is how similar they look to last year’s AFS. Though there have been changes in the levels of debt as a share of the economy, it remains on a clear upward trajectory. While the exact "crisis point" is unknown, it would be unlikely that the U.S. could continue on this path without seeing some kind of fiscal crisis. Last year, CBO stopped projecting numbers after 250 percent of GDP as it did not believe it could reliably forecast the certain parts of the budget with such high interest levels.

The Alternative Fiscal Scenario may not be the most likely scenario going forward, but instead could be thought of as the most pessimistic of the possible scenarios. Next week, we will publish the newest CRFB Realistic baseline, which will fall somewhere between current law and the AFS (although closer to current law). Importantly, all three scenarios show that we are on an unsustainable fiscal path.

September 18, 2013
How The Millenial Generation Will Pay the Price of Washington's Paralysis

Given the impact of Medicare and Social Security on our fiscal path, seniors are given a lot of attention whenever Congress debates deficit reduction. Another group often given rhetorical attention is the unborn, as politicians promise to address the debt before handing it off to the next generation. But a new report highlights one demographic group that's often ignored—young people between 18 and 30. 

On Monday, The Can Kicks Back released a new report entitled "Swindled: How The Millenial Generation Will Pay the Price of Washington's Paralysis, " which analyzed the effect our nation's unaddressed fiscal challenges will have on the millenial generation.  The report examines the fiscal gap: an estimate of the unfunded responsibilities that must be paid by future generations.

The report had five major takeaways:

  1. The true size of the nation’s debt problem is $200 trillion when you take into account all the future promises government has made but has not funded. That's the full tab millenials are going to inherit. 
  2. The longer our country waits to address its long-term budget imbalance, the greater the burden will be on young people –– in part because of compounding interest payments. 
  3. Millennials and future Americans have a higher net tax burden than any other generation. Unlike older Americans who will collect more in benefits than they've paid in taxes over the course of their lifetime, millenials will be stuck with a giant bill. 
  4. Changes in government spending have resulted in a shift from investment in the future to consumption in the present. Seniors' share of the pie is growing, while millenials' share is shrinking. 
  5. Millennials cannot bear the burden being handed to them due to the economic challenges they are already facing, including unemployment, underemployment, falling wages, and massive student loans.

One of the report's most interesting graphs shows generational payments, which highlight the amount each age cohort is expected to pay in taxes, if the fiscal gap is going to be closed. While children under 18 and those over 35 are net recipients of money from the government—the burden of addressing the nation's debt will fall squarely on the Millenial generation, born between 1980 and 1995. These individuals will be forced to bear the burden of debt, either through tax increases or reduced government services from spending cuts. 

 

Read the full report here.

September 18, 2013
Reason to Hope for Fiscal Sanity

Many are pessimistic about whether Congress will be able to meaningfully address our countries debt challenges this fall, especially with the possiblity of a government shutdown looming in a few short days, and a need to raise the debt ceiling shortly thereafter. Yesterday, former Comptroller General and CEO of the Comeback America Initiative David Walker argues in an op-ed in The Hill that despite the great challenge that lies ahead, public will indicates some reason for hope.

The task ahead will be challenging, but based on what I’ve seen and heard, especially in my travels to all 50 states, we have more reason for hope than despair. Here’s why:

We the People are in charge.

Today we have a government that is neither representative of nor responsive to the American people. That can change if Americans insist on accountability and punish unduly partisan and ideological politicians in the voting booth.

Walker sees a disconnect right now between elected officials and voters. We've seen in polling before that most Americans favor a budget compromise that would put us on a sustainable path. In fact, even when presented the details, most Americans are willing to compromise so long as the principles seemed fair, according to Walker's experience on his national tour:

More than anyone else, I have gauged the will of my fellow citizens when it comes to fixing our government’s financial mismanagement—most recently in a nationwide bus tour through 27 states last fall. Their verdict could not be clearer. In gatherings across the country, with participants of every political stripe, we obtained 92 percent agreement on six key principles to guide a fiscal “grand bargain.” The reforms should lead to economic growth, and be socially equitable, culturally acceptable, mathematically accurate, politically feasible, and able to achieve meaningful bipartisan support.  When we discussed specific reforms, most conservatives and liberals were willing to put aside ideology as long as proposals were deemed to be fair and part of a comprehensive plan.

That tells us that politicians in Washington can gain the public support they need for bold reforms as long as they explain our urgent need to act and then lay out responsible positions. I am convinced that over time political courage and leadership will be rewarded—and cowardice will be punished.

Walker sees this impact of raised public awareness in many ways. More politicians are concerned about the issue, including President Obama and Speaker of the House John Boehner (R-OH), as the fiscal cliff negotiations clearly showed. More organizations have joined the fight, like the Campaign to Fix the Debt, No Labels, and The Can Kicks Back. So while fiscal responsibility is tough work, Walker believes momentum is on our side. Writes Walker:

Clearly the hole we have dug ourselves is deep, and getting deeper, and our political system is badly broken. But I am hopeful about our ultimate prospects for success. We the People have awakened, and Washington is slowly waking up, too.  If we act boldly and responsibly, our best days will surely lie ahead.

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.

September 18, 2013

This morning, at 9 AM Eastern time at the Capitol Visitors Center, CRFB will host "Defining Moments for the Debt," an event which will discuss the many "fiscal speed bumps" that are coming in the next month. The event will be highlighted by a heavy-hitting and diverse panel discussion, moderated by CNNMoney writer Jeanne Sahadi and featuring:

  • Jared Bernstein, Center on Budget and Policy Priorities
  • Diana Furchtgott-Roth, Manhattan Institute
  • Jim Kessler, Third Way
  • Maya MacGuineas, The Committee for a Responsible Federal Budget
  • Derrick Morgan, The Heritage Foundation 

You can watch the event live below.

September 17, 2013

CBO's Long-Term Budget Outlook is a sizeable 126-page document with tons of facts and figures, and an accompanying spreadsheet with even more data. In order to help people pull out the key findings and takeaways from the report, we've condensed the document down to a concise 7-page analysis of the key facts and figures. As we anticipated, it shows that despite some short- and medium-term deficit improvements, both from enacted legislation and from broader changes in the economy, the long-term fiscal outlook still has a long way to go to be sustainable.

Under CBO's current law baseline (and Extended Baseline Scenario over the long term), debt will stay relatively stable over the next decade before increasing dramatically. It will rise from 71 percent of GDP in 2023 to 93 percent by 2035, 129 percent by 2050 and 233 percent by 2085. Deficits will also increase over the 75-year outlook. These totals are much higher than were projected in last year's outlook, of course, due to the fiscal cliff deal which averted much of the deficit reduction that was previously incorporated into CBO's current law baseline (though not incorporated into more realistic projections at the time).

As has been the case for a long time, the drivers of the increased deficits and debt are increases in health care and interest spending, along with (to a lesser extent) Social Security spending. While CBO has revised its long-term projections of health care cost growth down slightly, those gains are ultimately wiped out by increases in CBO's projected life expectancy, so health spending is still expected to increase rapidly from 4.7 percent this year to 7.6 percent by 2035, 9.4 percent by 2050, and 13.5 percent by 2085. Social Security spending will also rise over the next few decades from 4.9 percent of GDP today to 5.3 percent in 2023, 6.0 percent in 2030, and 6.2 percent in 2040. Finally, revenue will rise, but not nearly as quickly as spending, going from from 17.0 percent of GDP in 2013 to 18.5 percent in 2023, 19.0 percent of GDP in 2030, and 20.8 percent in 2050.

Spending by Category and Revenue as a Percent of GDP Through 2050

Source: CBO

Although CBO has traditionally publishes an Alternative Fiscal Scenario showing the fiscal impact of continuing a number of current policies, the fiscal cliff deal eliminated a significant source of that difference -- the 2010 tax cut and AMT patches. Instead of publishing a detailed alternative scenario, CBO has instead expanded on its analysis of the economic impact of its current law baseline and the potential impacts of three other alternatives. The analysis shows that the high debt in the baseline would dampen economic growth, causing real per capita GNP to be 4 percent lower in 2038 than it would be if debt was held stable at current levels. On the flip side, two scenarios show additional deficit reduction this decade, and one scenario assumes savings roughly in line for what CRFB has said is the minimum needed to control the debt. Not surprisingly, additional deficit reduction would notably strengthen the economy in subsequent decades. We concisely discuss these details, and others, in our report. We will also have much more analysis in the next few weeks on many different aspects of the report, so stay tuned.

The deadlines coming up this fall may have lawmakers focused on just next year's spending levels, but clearly the economy would benefit from a longer-term view. As we conclude in the paper:

Naturally, lawmakers may be focused on the budget issues that need to be resolved in the next few months (the expiration of the FY 2013 continuing resolution, the debt ceiling, and the ongoing sequestration), but lawmakers cannot forget about the long-term problem and must take advantage of these upcoming opportunities to relieve the debt burden being left to future generations.

Click here to read the full report.

September 17, 2013

It's here — CBO has released its updated long-term baseline. Since December, many commentators have attempted to see where we stand since the fiscal cliff deal and recent slowdown in health care cost growth, coming to very different conclusions. But while CBO's projections show the outlook has improved somewhat since last year's Long-Term Outlook, it’s clear the country is still on an unsustainable path.

Debt is projected to decline in the near-term in the Extended Baseline Scenario (EBS), from 73 percent of GDP in 2013 to 68 percent in 2018, but permanently reverses course thereafter. Debt will rise on a clear upward path, reaching 73 percent of GDP by 2025, 93 percent by 2035, 129 percent by 2050, and 233 percent by 2085. It's a sharp contrast to last year's Extended Baseline prior to the fiscal cliff that showed debt on a steadily declining path. While that scenario would have involved going over the fiscal cliff and making unwise policy decisions, lawmakers can no longer rely on letting current law to take effect in order to put the budget on a sustainable path — instead, lawmakers will need to be proactive.

Source: CBO Long-Term Outlook

While in the past CBO has produced a more pessimistic Alternative Fiscal Scenario baseline, that highlighted the high debts associated with continuing current policy, they have not presented a full Alternative Fiscal Scenario this year. The scenario they do present assumes that policymakers continue to allow the cuts from sequestration, do not enact yearly "doc fixes," do not extend various tax provisions, and allow revenue to grow indefinitely as a share of the economy. Without these assumptions, the fiscal situation could be significantly worse (though importantly, the current projections continue disaster and war spending at current levels which would partially offset the costs described above).

Source: CBO Long-Term Outlook
 
Lawmakers will need to take significant action to put the budget on a sustainable path. Despite claims that lawmakers may have time before needing to address the budget, CBO's projections show that debt is still a pressing concern. Today, we have the chance to agree upon a comprehensive plan, with slowly phased-in, smart policies. We will not have that luxury as the problem grows bigger. As CRFB President Maya MacGuineas concluded in a press release:

It is time for lawmakers to look at the tough choices that are before them and work toward a bipartisan agreement. Jumping from crisis to crisis with one short-term solution after another is not going to change the skyrocketing trajectory of our debt. Instead of focusing on the next month and the next election, policymakers should focus on the next decade and the next generation.

Later today, we will be releasing our full analysis of CBO's new long-term outlook in a report and we will be following up with a series on the long-term report in the following two weeks. Stay tuned for more analysis.

September 17, 2013

The Congressional Budget Office, on Friday, estimated that the Energy & Commerce Committee’s (E&C) bill to permanently replace the flawed Sustainable Growth Rate (SGR) formula is expected to cost $175.5 billion from 2014-2023, $36 billion higher than the cost of a permanent freeze in Medicare physician payments.

 

Congress must address the SGR by year’s end to avoid a 24 percent automatic cut in physician payments – and there has been increased interest this year in a permanent fix to take advantage of the unusually low costs in light of the recent slowdown in health care cost growth.

 

Congress must address the SGR by year’s end to avoid a 24 percent automatic cut in physician payments – and there has been increased interest this year in a permanent fix to take advantage of the unusually low costs in light of the recent slowdown in health care cost growth.

As we’ve said before, we are glad to see Congress working proactively to enact a long-term fix, rather than the usual temporary patch. Critically, the E&C bill seeks to use this opportunity to incentivize higher quality, more coordinated care through quality-measurement and the development of “alternative payment models,” and Congress has committed to find offsets for any SGR replacement. (You can read a full description of E&C’s proposal here).

Medicare's Payments to Physicians: Budgetary Impact of SGR Replacements (billions, per fiscal year)

  2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2014-2023
Frozen Through 2023 $8.6 $13.4 $13 $12.7 $12.7 $13.8 $15 $15.8 $16.9 $17.2 $139.1
1% Annual Update $8.8 $14.3 $14.6 $14.9 $15.6 $17.6 $19.8 $21.8 $24.4 $25.9 $177.7
E&C Bill $9.0 $13.5 $13.5 $13.5 $14 $16.5 $19.5 $22.0 $25.5 $28.5 $175.5

Source: CBO

However, while the aims of the bill to encourage higher-quality care and desire to find offsets are commendable, the plan could be improved to do more to control long-term health spending and provide stronger incentives for providers to move away from fee-for-service (FFS) reimbursement. The administration, for example, has called for SGR reform at the cost of a pay freeze ($139 billion over 10 years). Proposals from the Simpson-Bowles Fiscal Commission and MedPAC were estimated to cost roughly 10 and 33 percent less, respectively, than a freeze.  And by extending penalties to all Medicare providers (not just physicians) who don’t join a more organized delivery model, the Bipartisan Policy Center’s SGR replacement is likely able to more than pay for itself. By comparison, the E&C bill costs 26 percent more than a freeze – including 66 percent more in 2023.

The relatively high expense in 2023 indicates that while costs are only moderately higher than those of a freeze this decade, costs could be substantially higher thereafter. Moreover, even if the costs of the E&C bill are offset, the more health care savings that are used in this process, the less we’ll have for much-needed debt-reduction.

The key features that sets these more cost-effective recommendations apart is that they rely more heavily on sticks, rather than predominantly on carrots, and rely less heavily on physicians to set their own payment rates. MedPAC’s proposal, for instance, would actually reduce physician payments for services other than primary care by about 3 percent annually for 3 years, while freezing primary care payments. BPC’s recommendation would reserve payment updates only for providers (including hospitals and post-acute facilities) who join or contract with an enhanced, enrollment-based version of Accountable Care Organizations (ACOs). And the Fiscal Commission would demand that an improved payment system save at least as much as a rebased SGR.

A recent report from the Moment of Truth Project and the National Coalition on Health Care, Achieving Real Savings through Better Care, which focuses on the potential of delivery and payment system reforms to control costs, can serve as a guide to both formulating an SGR replacement and offsets (and even more offset ideas can be found here). The report recommends “policymakers consider policy changes that create similar incentives encouraging coordinated care for all providers rather than just physicians … reimbursed through the physician fee schedule.” To move large numbers of providers away from the status quo of fee-for-service reimbursement, strong incentives, including penalties for lower quality, less coordinated care, will be needed. A bill could also benefit from a more precise definition of what will qualify as an “alternative payment model.”

By focusing on incentives to deliver higher-quality, higher-value care, the E&C reform proposal is an encouraging start. It includes important penalties for the substandard provision of care in addition to bonuses for high-quality care, but continuing efforts could draw lessons from other, more cost-effective approaches. But regardless of the form that a potential SGR replacement takes, Congress must soon turn its attention to the more contentious task of finding offsets.

September 16, 2013
Government Shutdown? A Leap of Trust Can Seal a Budget Deal

We are now another week closer to a possible government showdown, and still no viable solution has emerged. But while a deal may have not come together yet, Fiscal Commission co-chairs and CRFB board members Erskine Bowles and Alan Simpson still see an opening for a comprehensive budget deal.

In today's Christian Science Monitor, Bowles and Simpson write that despite the rhetoric, the two sides were very close to a deal in the past, which could form a basis for a compromise:

Budget talk in Washington is again dominated by nonnegotiable demands and a potential government shutdown – or even an unprecedented default on US debt in October. Despite the heated rhetoric, we believe that a bipartisan agreement is still possible on a meaningful budget deal that puts America on the path to fiscal responsibility.

We believed this in 2010, when we co-chaired a bipartisan national commission to fix the debt, and we still believe it. The country simply can’t afford to keep lurching from one fiscal crisis to the next. True, some fiscal progress has been made, but the underlying problem remains: In just a decade, the debt will be equal to 77 percent of our economy – draining resources to pay interest on the debt, and negatively affecting American jobs, consumer credit, and the country’s competitiveness.

Still, we’re hopeful about a fiscal deal, in part because of our experience in revising a deficit-reduction plan based on last winter’s negotiations between President Obama and House Speaker John Boehner. In the process of splicing that plan together, it became clear to us that the two sides had been quite close to reaching an agreement and that the remaining policy differences could be bridged if both sides were willing to go a little further and come to a principled compromise without compromising their principles.

If lawmakers are looking for a model, they have to go no further that the Bipartisan Path Forward, which attempted to build on the fiscal cliff negotiations and provide a roadmap for a more ambitious deal:

Our revised plan, The Bipartisan Path Forward, would go further than many Democrats have been willing in reforming costly entitlement programs that are driving long-term debt, particularly health care. It would, for instance, move away from Medicare’s fee-for-service delivery system and gradually increase the eligibility age. Our plan would also require Republicans to accept more revenues beyond the expiration of the 2001 upper-income tax cuts agreed to in January.

Our plan would implement entitlement reform in a way that provides important protections for the most vulnerable. And it would raise revenue through tax reform that repeals or reforms various deductions, exclusions, and credits; lowers rates; and ultimately reduces the deficit. Both sides would have to go beyond their political comfort zones to reach a real budget deal. But the end result would put the debt on a downward trajectory for the long term.

Bowles and Simpson have seen many encouraging signs in recent months such as the President offering the chained CPI as part of his budget, a growing number of Republicans indicating that they would be willing to support a plan with additional revenues if it included entitlement reform, and the proposal from Finance Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT) to use a "blank slate" approach for tax reform. If lawmakers are willing to take the courageous stand, there is are many opportunities in the next few months. Write Simpson and Bowles:

It is going to take political courage on both sides to come together on fiscal common ground. The problem is real, the solutions are painful, and there is no easy way out. But there is room for a solution. We must find it for the sake of our grandchildren, ourselves, and our country.

Click here to read the full op-ed.

September 16, 2013

Beginning tomorrow, the Federal Open Market Committee, the Fed's interest rate setting and deliberative body that meets eight times a year -- will meet for two days to make decisions about the future path of U.S. monetary policy. In particular, many are looking to see whether the Fed will begin a "taper" and slow the rate of asset purchases, signaling the beginning of an unwind of the Fed's expanded balance sheet. Whatever the Fed decides is likely to have a significant impact on interest rates. Changes in interest rate then have substantial impacts of the federal budget and on debt projections going forward, the focus of CRFB's latest analysis: Interest Rate Risk and the U.S. Debt. With interest rates likely to return to historical levels at some point, it will significantly increase spending on interest on the debt. As debt rises, we risk further increases in interest rates that will put greater pressure on the budget. Ultimately, the best way to guard against interest rate risks is to put debt on a downward path to lessen the negative effect of interest rate increases.

We show that even under CBO's modest projected interest rates, interest spending will by far become the fastest growing part of the budget this decade and beyond as interest rates return to more normal levels and as the nation's stock of debt continues to grow. Under the CRFB Realistic Baseline, interest payments are projected to increase from 1.3 percent of GDP in 2013 to 3.1 percent by 2023 and 6.4 percent by 2050.

To put that in perspective, interest payments will exceed federal spending on all non-defense discretionary programs, food stamps, and federal retirement spending by 2025, and those programs plus defense spending by 2045. Interest payments will also roughly equal the size of Social Security in 2045. If the challenges posed by rising interest payments -- namely that they will reduce the resources available for other important priorities and will take years to bring under control -- is not reason enough for lawmakers to take action to control the debt, the risk that interest rates could rise even higher than projected should add further concern. Even small interest rate changes could have profound effect on the federal budget.

Source: Rough CRFB calculations based on CBO data

If interest rates were 1 percentage point higher than expected, debt would rise by $1.2 trillion over ten years – enough to wipe out all of the savings from sequestration. And as the table below shows, the impact higher interest rates would have is greater than what lower interest rates might save, in part due to the "zero bound" on interest rates.

Whereas interest rates can change quickly, even overnight, debt usually takes a long time to turn around. We have talked before of the importance of slowly phasing in policies to give households and businesses time to adjust, but that might not be an option if the country faces a unexpected interest rate increase. Furthermore, as the paper points out:

Not only do lower levels of debt reduce a country's risk of and exposure to changes in interest rates, but lower-debt economies have added fiscal flexibility to absorb unexpected increases in debt. For these reasons and more, it would be prudent for policymakers to enact further deficit reduction today to phase in gradually as the economy recovers and begin to bring debt levels down as a share of the economy.

There are clear benefits to being proactive and agreeing upon a comprehensive plan, and that remains the best way to protect against interest rate risk. Hopefully lawmakers can use the upcoming fiscal negotiations as an opportunity to do just that.

Click here to read the full report.

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