The Bottom Line
At 11 AM Eastern time, the Social Security and Medicare trustees will release their respective reports on the finances of the two programs over the next 75 years. The release will be done at a press conference with Treasury Secretary Jacob Lew, Health and Human Services Secretary Kathleen Sebelius, Acting Labor Secretary Seth Harris, and public trustees Charles Blahous and Robert Reischauer. You can watch the webcast of the press conference here. We will embed the stream below if it becomes available.
Earlier today, CRFB took a look at two of the biggest "fiscal speed bumps" remaining for the year, the exhaustion of extraordinary measures to advert the debt ceiling and the expiration of the continuing resolution funding the government, as well as how to deal with the ongoing sequester. But these are not the only speed bumps on the horizon.
Also upcoming is the expiration of lower interest rates on student loans on July 1, which the House and Senate have begun to address. January 1 will bring another scheduled Sustainable Growth Rate cut to Medicare provider payments, expiration of extended unemployment insurance benefits, and expiration of many tax extenders. Not too far down the road are the exhaustion of the highway trust fund in 2015 and the Social Security Disability Insurance trust fund in 2016.
Not all of these "fiscal speed bumps" are necessarily bad policy, but this outlook shows how the budget is constantly in flux. Instead of waiting until the last minute to fix policies that might not be working, lawmakers should instead take a proactive approach to the budget and its problems. In that sense, these "fiscal speed bumps" are very similar to our federal debt problem, which will only become more difficult to solve the further we kick the can down the road.
In our paper, "What We Expect From the Upcoming Fiscal Discussions," we referenced our latest official CRFB Realistic baseline. Although we have cited new Realistic projections prior to this paper, those estimates were "rough cuts" which did not fully incorporate all the changes in CBO's latest budget projections.1
For background, CBO produces a current law baseline which is generally based on the law as it is written, and they produce an alternative fiscal scenario (AFS) baseline which assumes policymakers extend a number of deficit-increasing current policies. Yet there is a case to be made that the current law scenario is too optimistic about the future in some areas, and the AFS too pessimistic in other areas.
The CRFB Realistic baseline is an effort to construct what we think is a more likely portrayal of current policy. Of course, as we have discussed before, different observers may interpret current policies in different ways. Our baseline, which is the same as the baseline used by the Center on Budget and Policy Priorities (CBPP), differs from current law by assuming:
- Repeal of the sequester after 2013, with the sequester remaining in place for FY 2013
- A permanent extension of several tax credit expansions scheduled to expire in 2017
- Permanent repeal of the Sustainable Growth Rate, which requires a 25 percent reduction to Medicare physician payments in 2014, a patch which is often referred to as the “doc fix"
- A drawdown of war spending closer in line with current plans, instead of having funds grow with inflation from current levels
- A correction of the CBO current law projection of disaster relief, removing the assumption that temporary Hurricane Sandy relief spending will grow annually with inflation
Debt under these more realistic projections is projected to drop to a low of 71.9 percent of GDP in 2018 before rising to 75.5 percent by 2023; this is somewhat lower than and certainly an improvement from our prior projections of at 79 percent, though as we've explained before roughly half the difference is due to one-time rather than structural effects. Compared to CBO current law, which assumes sequestration remains in effect among other policy changes, the CRFB realistic outlook is slightly worse, although debt is on an upward trajectory at the end of the decade under both baselines.
The graph below shows the CRFB Realistic baseline and a few variants. The lower bound of the shaded area (71 percent of GDP in 2023) represents debt under CRFB Realistic assuming the sequester remains in place, and the upper bound (78 percent in 2023) represents CRFB Realistic debt assuming the temporary "tax extenders" are also extended.
Debt Under CRFB's Realistic Baseline
Our most recent CRFB Realistic projection uses a slightly different treatment of sequestration than in February: the cuts remain in effect for 2013, since they have been allowed to take effect already, while the sequester is repealed for 2014 and beyond (see here for a discussion of how to treat the sequester). Although this is by no means an obvious choice, it is meant to reflect the reality that both parties have more-or-less conceded spending at post-sequester levels for 2013 but have made no such agreement for 2014. In fact, as we explained in today's paper, both the House and the Senate are currently writing appropriations bills which would violate the sequester law, though in very different ways.
The table below shows a bridge of the policy differences between CBO's current law baseline and CRFB's Realistic baseline and the resulting Realistic budget metrics. Spending would fall from 22 percent of GDP in 2014 to 21.5 percent in 2017 before rising to 22.7 percent of GDP by 2023. Revenues would rebound as the economy continues to recover, from 18.3 percent to roughly stabilizing around 19 percent.
|CRFB Realistic Baseline Deficits (billions)|
|Current Law Deficit||-$560||-$378||-$432||-$482||-$542||-$648||-$733||-$782||-$889||-$895||-$6,340|
|Enact "Doc Fix"||-$9||-$13||-$13||-$13||-$13||-$14||-$15||-$16||-$17||-$17||-$139|
|Reduce Troops in Afghanistan||$15||$34||$46||$54||$57||$61||$62||$64||$66||$67||$526|
|Draw Down Disaster Spending||$2||$10||$18||$26||$31||$36||$39||$41||$43||$45||$291|
|CRFB Realistic Deficit||-$611||-$436||-$480||-$521||-$579||-$707||-$791||-$838||-$935||-$938||-$6,836|
|Spending (% of GDP)||21.9%||21.7%||21.7%||21.5%||21.6%||21.9%||22.2%||22.3%||22.8%||22.7%||22.1%|
|Revenues (% of GDP)||18.3%||19.3%||19.2%||18.9%||18.8%||18.7%||18.7%||18.8%||19.0%||19.1%||18.9%|
|Deficits (% of GDP)||-3.7%||-2.5%||-2.6%||-2.6%||-2.8%||-3.2%||-3.5%||-3.5%||-3.8%||-3.6%||-3.2%|
|Debt (% of GDP)||76.5%||75.2%||73.6%||72.2%||71.9%||72.3%||73.0%||73.7%||74.7%||75.5%||N/A|
The trajectory of debt at the end of the decade in our most recent CRFB realistic baseline and the one produced in February are similar, even though levels may be lower. As we said in our analysis of the new budget outlook, the majority of changes affect the first two years, but do not leave us much closer to putting debt on a downward path. The short-term budget outlook has improved, but our long-term debt problem is still far from solved and additional savings will be needed.
1 A special thanks to Richard Kogan of the Center on Budget and Policy Priorities who helped us work through some particularly difficult technical issues related to this baseline.
On May 19, the debt ceiling was reinstated as the Treasury Department began to use extraordinary measures to prevent running up against the debt limit. Extraordinary measures are expected to be exhausted sometime this fall, also when the current continuing resolution (CR) funding the government is due to expire. In addition, both parties are looking to alter the sequester in some form for future years and will have to figure out what to do with it then. In a new paper, "What We Expect From the Upcoming Fiscal Discussions," we lay out what we expect from the upcoming fiscal discussions surrounding both the debt limit and the FY 2014 budget.
The last debt ceiling debate lead to the Dow Jones Industrial Average falling by over two thousand points and a credit rating downgrade by S&P from AAA to AA+. While some deficit reduction was achieved in the Budget Control Act, most address the short-term deficit with little progress made on the long-term problem. Instead of the increasing uncertainty that comes with an eleventh hour effort, we favor a proactive approach that:
- Raises the debt ceiling well before extraordinary measures run out
- Addresses the sequester by agreeing to defense and nondefense levels for 2014 and sustainable levels thereafter, without increasing long-term debt
- Agrees to a comprehensive fiscal framework which sets future discretionary spending levels and calls for mandatory spending and revenue changes sufficient to put the debt on a clear downward path relative to the economy
- Enacts some combination of specific changes and a credible process to implement the agreed-to framework
There is no question that waiting to make changes until the last minute will do unneccessary harm to the economy and lead to hastily designed deficit reduction measures, like sequestration. The debt ceiling and expiration of the continuing resolution will require Washington to turn its attention to the budget, and while waiting until then might be a tempting option for some lawmakers, it would be a major mistake. As we conclude in our paper:
In many ways, the approaching debt ceiling and appropriations deadlines represent a microcosm for the larger long-term fiscal issues. The longer we wait to address these issues, the harder it will be to do so, and the more economic risks we will be taking in the process.
Click here to read the full report.
The CBO released a paper today analyzing the distributional impact of major tax expenditures on the individual side of the tax code. Considering the tax reform efforts underway, the report is particularly timely as lawmakers take a look at the myraid of preferences in the law. The new analysis estimates that the 10 largest tax expenditures will cost the federal government $900 billion in revenue in fiscal year 2013 alone and $12 trillion from 2014-2023. That amounts to an estimated 5.7 percent and 5.4 percent of GDP, respectively.
Specifically, the CBO's paper considered exclusions from taxable income like employer-sponsored health insurance, retirement account and pension contributions, step-up basis for capital gains at death, and exclusion of Social Security benefits; itemized deductions like the mortgage interest deduction, state and local tax deduction, and charitable contribution deduction; preferential tax rates on capital gains and dividends; and tax credits like the earned income tax credit and the child tax credit.
The tax expenditures CBO analyzed are quite large, all of them reducing revenue by more than $30 billion each in 2013 alone and by as much as $250 billion in the case of the exclusion for employer-paid health insurance premiums. Furthermore, many of the larger tax expenditures, particularly the deductions and provisions related to capital gains and retirement savings, confer disproportionate benefits on higher earners, as seen in the chart below.
The distributional picture changes when measured as a percentage of after-tax income, with the largest benefit by quintile going to the lowest one. These households mainly benefit from the earned income tax credit and child tax credit, so the picture changes significantly when looking at the other provisions. Tax expenditures benefit the top quintile to the tune of 9 percent of after-tax income, and they equal 13 percent for the top 1 percent, the largest benefit to any of the income groups CBO provided. It should be noted that since CBO's analysis only shows the benefit in 2013, it excludes tax credits for purchasing health insurance in the exchanges created in the Affordable Care Act that will be in effect starting in 2014. These expenditures will mainly benefit the lower and middle quintiles and could amount to 0.4 percent of GDP from 2014-2023.
Different types of tax provisions have different distributional impacts. As shown by the graph below, lower-income earners benefit most from the credits because credits phase out at higher incomes, they are less likely to be able to benefit from the other preferences, and the benefit of a deduction or exclusion rises with one's marginal tax rate. This is one reason why bipartisan plans like Simpson-Bowles and Domenici-Rivlin proposed converting a few of the deductions they did choose to keep into credits: to make those tax breaks more progressive while raising revenue.
This new analysis is further proof that many tax provisions overwhelmingly benefit more well-off taxpayers. As we have said before, tax expenditures have an outsized impact on the budget, necessitate higher individual rates, and further complicate our already inefficient tax code. Certain tax expenditures may be worthwhile, but Congress certainly has a lot of room to raise revenue from them and simplify the code.
Today, in a Project Syndicate piece, Laura Tyson examines the state of retirement saving in the U.S. and argues that many retirement saving tax expenditures are failing to achieve their goals. Many tax expenditures are designed to encourage actions that many lawmakers would argue are useful, like charitable donations and homeownership. The problem is that many of those provisions could be better designed, often serving as a windfall for upper-income taxpayers and unnecessarily costing the government tax revenues.
Personal retirement savings, another pillar of the US retirement system, are woefully inadequate for most households, partly because the decades-long stagnation in median wages has made it difficult to save. According to a recent study, one-third of Americans aged 45-54 have nothing saved specifically for retirement. Meanwhile, three-quarters of near-retirees – those aged 50-64 – have annual incomes below $52,201 and average total retirement savings of less than $27,000.
The United States relies on generous tax incentives to encourage personal retirement savings, but these incentives are poorly targeted and yield limited returns. More than 80% of the value of these incentives goes to the top 20% of taxpayers, who earn more than $100,000 a year. Moreover, while the incentives cost the US Treasury nearly $100 billion annually, they induce little new saving; instead, they cause high-income taxpayers to shift their savings to tax-advantaged assets – a major reason why President Barack Obama proposes capping the tax deduction for retirement saving.
A more radical proposal would convert the tax deduction into a means-tested and refundable matching government contribution – deposited directly into a taxpayer’s individual retirement account (IRA). Taxpayers are more responsive to matching incentives than they are to tax incentives, because the former are easier to understand and more transparent.
Tyson argues that reforms like automatic enrollment would be more effective than the retirement tax expenditures.
Lack of coverage in employer-based plans and insufficient personal savings leave more than one-third of all households (and more than 75% of low-income households) entirely dependent on Social Security for their retirement income. And, because Social Security replaces only about 40% of pre-retirement income for low-wage workers and less than a third for median-wage workers, those who rely on it as their sole source of income live at or below the poverty line. (Replacement rates in other developed countries are in the 70% range, compared to a benchmark of 80% recommended by retirement experts.
Addressing the looming retirement crisis in the US requires increasing worker coverage in employer-based plans. Here, automatic enrollment, unless workers opt out, has proved effective, boosting employee participation to more than 90%. Indeed, recent research indicates that automatic enrollment is much more effective than tax incentives for increasing retirement saving.
But many employers do not offer retirement plans, while almost all workers are eligible for tax-advantaged IRAs. As Obama has proposed, employers that do not offer retirement plans should be required to offer automatic contributions to their workers’ IRAs through regular payroll deductions. Matching government contributions should be used in lieu of, or in addition to, tax deductions to encourage low-income workers to participate.
Lawmakers may decide that retirement tax expenditures justify their cost or might choose to use alternative methods to promote retirement saving. Either way, these tax expenditures should at least be reviewed in comprehensive tax reform, as the House Ways and Means Committee and Senate Finance Committee have begun to do. With an overly complex and inefficient tax code, not all tax expenditures need to be eliminated, but all should be examined to see if they justify their costs.
Notwithstanding the recent short-term progress in reducing the deficit, our long-term debt outlook remains a problem. Although additional revenue will be needed, long-term success in making the debt sustainable will hinge on the ability of policymakers to slow the growth of entitlement spending. In the May 25th edition of The Economist, the magazine puts forward a "briefing" to President Obama on the financial sustainability of entitlement programs and the need for reform.
The federal government clearly has a long-term debt problem, and The Economist argues that the problem is unlikely to be solved without reforming our entitlement programs, due to the pressures of an aging population and rising health care costs.
You declared from your first days in office that Social Security and Medicare have to be fixed. We must not, you said, leave American children a “debt they cannot pay”. But how? You got the rich to pay more taxes, and you rightly want them to pay a bit more. But you have never asked for tax rises on a scale that would finance this sort of growth in entitlements, and for good reason: neither Congress nor the voters would tolerate them for a minute.
The solution will need to be a "grand bargain," argues The Economist, as a bipartisan effort will be needed to produce a plan that has a chance of staying in effect.
Source: The Economist
To get there, The Economist lays out a few principles for entitlement reform, similar to the principles of bipartisan plans like Simpson-Bowles and Domenici-Rivlin:
- No steep cuts in the next five years. The recovery is fragile enough as it is. And you can’t spring big changes on people who are about to retire.
- Any reforms should boost the economy’s supply side. Millions of working-age Americans have left the labour force, sapping the country’s economic potential. Most have quit because they cannot find jobs; but too many entitlements give them an incentive to leave.
- The rich should bear the lion’s share of the adjustment, simply because their incomes have grown so much faster than the average in recent decades.
- Don’t be deterred by the political difficulty. Democrats don’t want to touch benefits, and the only thing Republicans hate more than higher taxes is Obamacare. But action is necessary.
Of course, while guiding principles are a start, the entitlement reform effort will not move far without effective policies. Fortunately, The Economist goes on to describe many specific policies to reform Social Security, disability insurance, Medicaid, and Medicare. It also explores the idea of premium support, strengthening the Independent Payment Advisory Board (IPAB), and other reforms to make the health care system as a whole more efficient. The Economist doesn't list all of possible options available to lawmakers, but many of the options they propose have been featured in bipartisan plans and should at the very least be on the table for consideration.
Overall, The Economist thoroughly describes one of the great challenges lawmakers will face in a comprehensive debt deal, reforming our entitlement programs. These reforms, along with revenue-raising tax reform and other spending cuts, will be needed if we are to put debt on a truly sustainable, downward path as a share of the economy.
Click here to read the full article.
Today, the House Energy and Commerce Committee took a small step in the process to replace the Sustainable Growth Rate (SGR) formula -- Medicare's physician payment "system" -- with a more stable and efficient alternative by issuing draft legislation. Passed in 1997, the SGR formula is a backstop for Medicare spending which adjusts physician payments based on whether the program meets certain spending targets. However, those targets have consistently been missed for the past decade and the SGR's mandated cuts have grown to almost 25 percent for 2014. Temporary "doc fixes" have staved off cuts since 2003, which have only made them bigger over time, although the recent health care cost slowdown has reversed that trend slightly by requiring smaller cuts.
Permanently repealing the SGR and instead freezing physician payments is the "default" option to replacing the SGR, and CBO revised its estimate of such a policy down by about $100 billion this year, thus opening the door wider for a permanent fix. As it stands, a permanent freeze would cost roughly $140 billion over ten years (estimates of other replacement options are available here). While Energy and Commerce's draft legislation is silent on how to pay for their proposal, it takes the first step in replacing the SGR with a payment system that better takes into account quality metrics. The Committee is currently soliciting input on how to fill in some of the blanks of the policy, but broadly the measure would require the Secretary of Health and Human Services to develop a new payment system that better aligns payments away from the current quantity-driven system and towards a new model that encourages efficiency and quality. Other details, such as exactly when and how a transition to the new system would happen, still need to be filled in by members of the Committee. The Committee will have a hearing to discuss the legislation next Wednesday, June 5.
Although there are important details which still need to be worked out, the legislation is a good start and signals that Congress may finally be ready to address this long-standing budget dilemma. But the challenge, assuming the design of the new system will largely be left up to the HHS Secretary, will be the pay-fors. One way to make that factor easier would be to make the interim replacement schedule less costly than the standard payment freeze. This could involve targeted cuts or a broader small clawback of payments over the next few years. As for specific pay-fors, there are many health savings options to choose from. Since the SGR's original purpose -- however flawed the mechanism for achieving it was -- was to constrain unnecessary utilization, it may make sense to focus on replacement policies that do the same thing, whether through restraining federal spending on providers, beneficiaries, or both.
Overall, lawmakers should pass a fiscally responsible and permanent physician payment system this year. The moment has never been better to replace the SGR formula.
On Friday, the Social Security and Medicare Trustees will issue their latest report, showing the finances of the two programs and their related trust funds over the next 75 years. The following Tuesday, June 4 at 8 AM Eastern time, the Committee for a Responsible Federal Budget, the Mercatus Center, and Third Way will hold an event discussing the implications of the report for the future of Social Security. The event will be held at the Hyatt Regency in Washington, DC.
The action will kick off at 8 with a preview of CRFB's interactive tool "The Reformer" which will give users the ability to make their own Social Security reform plan and show the effect on revenue, outlays, and the trust fund. Then, Social Security trustee and Mercatus Center research fellow Charles Blahous will "decode" the latest Trustees' report. Blahous will join a panel moderated by CNNMoney writer Jeanne Sahadi for a discussion including Jim Kessler of Third Way, Virginia Reno of the National Academy of Social Insurance, and Nick Troiano of The Can Kicks Back.
Given the names involved, the event should be a lively and informative discussion about the future of Social Security and how the latest Trustees' report has changed that outlook.
8:00 a.m. Breakfast and "Reformer" Interactive Tool Preview
8:30 a.m. Decoding the 2013 Trustees Report
Charles Blahous, Social Security Public Trustee; Senior Research Fellow, Mercatus Center
9:00 a.m. Panel: What's Next for Social Security?
- Charles Blahous, Social Security Public Trustee; Senior Research Fellow, Mercatus Center
- Jim Kessler, Senior Vice President for Policy, Third Way
- Virginia Reno, Vice President for Income Security, National Academy for Social Insurance
- Nick Troiano, Co-founder, The Can Kicks Back
- Moderator: Jeanne Sahadi, CNNMoney
Click here to RSVP.
In recent weeks, a number of competing proposals from the parties in each chamber of Congress to reform the interest rates charged on student loans have come to the forefront. CBO has scored four of them, including one from President Obama, so let's take a look at each one. You can also see some of the other proposals in a New America Foundation blog post here.
First, a little background. There are four main different types of student loans that these proposals deal with. Subsidized Stafford loans are the loans that currently are set at 3.4 percent and are set to go back to 6.8 percent on July 1. Unsubsidized Stafford loans are currently 6.8 percent and are not scheduled to change. GradPLUS and parent loans are set at a rate of 7.9 percent.
The proposals generally deal with Stafford loans but may make changes to the others. Many of them encouragingly deal with the interest rate permanently by pegging the rate to the ten-year Treasury note rate, which currently sits at two percent, an approach that would generally keep rates lower in the short term and higher in the long term. Here's what each plan does:
- President's Budget: The President's budget sets the subsidized loan rate at the ten-year Treasury note rate plus 0.93 percent, thus likely making the rate lower than 3.4 percent upfront. The unsubsidized loan rate would be two percentage points higher than that. There is no cap on how high either interest rate could go. CBO scored this provision as saving $6.7 billion over ten years, with $30 billion of costs through 2018 and $36.5 billion of savings in the next five years. Also see our discussion of this provision here.
- House Republicans: The House Republicans' plan, which just passed the House on a party line vote, would adjust all four types of loans to be linked to the ten-year Treasury rate. They would equal the ten-year Treasury rate plus 2.5 percentage points with a cap of 8.5 percent for subsidized and unsubsidized loans and a 10.5 percent cap for GradPLUS and parent loans. This would likely mean that the subsidized loan rate for the upcoming year would be somewhere between 3.4 percent and 6.8 percent. This is the only proposal that would have variable-rate loans as opposed to fixed-rate loans, meaning that each loan's rate would vary from year to year, rather than the rates being set in stone once the loan is issued. This reform would save $3.7 billion over ten years.
- Senate Democrats: In contrast to other proposals which set a permanent rate for subsidized loans, the Senate Democrats' plan would extend the 3.4 percent subsidized loan rate for two years. The plan would pay for this extension, which costs $8 billion, with three tax changes. One would change the tax treatment of tax-exempt pension plans, the second would further limit the deductibility of interest for expatriated businesses, and the final one would expand the definition of "crude oil" for the excise tax that funds the Oil Spill Liability Trust Fund. Overall, the bill slightly reduces deficits by $330 million over ten years.
- Senate Republican: The Senate minority's bill would result in the highest interest rates of the three proposals that link student loan rates to the ten-year Treasury rate. It would set the rate for all four types of loans to the ten-year rate plus three percent, which would likely put the rate about halfway between 3.4 percent and 6.8 percent for next year. The proposal would save about $16 billion over ten years.
The chart below shows how each plan would affect the deficit. Each plan has an upfront cost since it reduces rates relative to the current law rates on student loans but raises them later on or makes up the money elsewhere in the budget.
Source: CBO, CRFB calculations
Note: Year refers to second year of academic year. CBO interest rates are calendar year rates.
There are a number of other proposals outside of these ones, such as:
- The "Bipartisan Path Forward" plan to peg interest rates for student loans to an unspecified market-based rate
- Rep. Joe Courtney's (D-CT) plan to also extend the 3.4 percent rate for two years
- Sen. Elizabeth Warren's (D-MA) plan to set the subsidized loan rate for the next year equal to the Federal Reserve's discount rate
- Sen. Jack Reed's (D-RI) plan to have the Secretary of Education set a rate annually that cannot exceed the cost of administering the loans
Encouragingly, the four major proposals described in the first part of this blog (along with the Bipartisan Path Forward proposal) would all prevent the sharp student loan increase in a fiscally responsible way which would not add to the deficit over the next decade. However, the Senate Democrat approach represents a band-aid solution to a problem in need of something more permanant. Under that solution, interest rates would be scheduled to double in July 2015, and the issue would need to be re-visited. The better approach is to permanantly peg student loan rates to market rates, so that they stay low now but gradually rise as interest rates grow in order to avoid future cliffs and help reduce long-term deficits.
Ideally, policymakers would follow the example of the Bipartisan Path Forward and also use this opportunity to make further reforms to the entire higher education funding system. Permanantly addressing the interest rates issue, though, would represent a good start.
The revenue debate in DC is one that is often focused on the individual income tax system. But one option to raise revenue is to use new taxes that tax "economic bads," reducing the social costs while raising revenue. CBO explores one of these taxes, a carbon tax, in a recently released report.
CBO assumes that a carbon tax priced at $20 per metric ton of carbon dioxide would raise a similar level as a corresponding cap and trade auction, or $1.2 trillion over ten years according to a 2011 estimate. This would be equivalent to the revenue raised by all other federal excise taxes. Like many other consumption taxes, a carbon tax would be relatively regressive. CBO has estimated the distributional effects of a $28 per metric ton tax on carbon dioxide would reduce after-tax income by 2.5 percent for the bottom quintile and by less than 1 percent for the top quintile.
There would be a question on how to use the revenue. One option would use the revenues to reduce the long-term budget deficit. While a carbon tax could hurt growth somewhat on its own, a rising debt path is also expected to constrict growth. While CBO has not estimated a tradeoff between the tax and a reduced deficit, they do point to an earlier study which estimated that repealing the 2001/2003 tax cuts would increase growth, with the lower debt burden outweighing the effects of higher marginal rates.
Another option would be to lower economically distorting taxes. Tax swaps -- using a carbon tax to lower other tax rates -- have been investigated, but evidence on the growth effect is mixed. The regressivity of the tax could also be addressed by lowering taxes or increasing spending to low income groups. Of course, lawmakers could decide to use some combination of deficit reduction and "give-backs" if a carbon tax was enacted.
As for the environmental effects, CBO estimates that a $20 carbon tax would reduce emissions by 8 percent by 2021. One problem CBO identifies is the difficulty of estimating the social cost of carbon (SCC) to which the tax should be set. While $20 per metric ton is the tax CBO has explored, the SCC could be higher or lower, and experts differ on the appropriate tax rate.
Given the sentiment in Congress on a carbon tax right now, a carbon tax is unlikely to be enacted. But the CBO report does show that the tax code can be used to change market behavior. However, it is important that our code is reviewed and reformed and all that options be explored for making sure it raises the necessary revenue and accomplishes the appropriate policy goals.
Click here to read the full report.
Yesterday, the CBO released its latest estimate of the subsidy cost of the Troubled Asset Relief Program (TARP). The estimate serves as a demonstration of how little of TARP is still operating in a major fashion, as most of the cost has not changed since the last score in October 2012. The overall cost of TARP dropped from $24 billion (the previous estimate in October 2012).
The main movement comes from the auto industry assistance, which dropped from an estimated cost of $20 billion to $17 billion. This movement is not particularly surprising since GM's share price has risen significantly -- about 40 percent -- since October 2012. Thus, the federal government's gains on its remaining holdings in GM will be greater than previously expected.
|Subsidy Cost Estimate (billions)|
|Area||March 2012||October 2012||May 2013||Maximum Amount Disbursed|
|Capital Purchase Program||-$17||-$18||-$17||$205|
|Citigroup and Bank of America||-$8||-$8||-$8||$40|
|Community Development Capital Initiative||$0||$0||$0||$1|
|Assistance to AIG||$22||$14||$15||$68|
|Subtotal, Financial Institutions||-$3||-$11||-$10||$313|
|Auto Company Assistance||$19||$20||$17||$80|
Most of the rest of TARP has largely stayed the same. The net gain from financial institutions -- the net of the Capital Purchase Program (the original centerpiece of TARP), support for Citigroup and Bank of America, and the cost of supporting AIG -- fell by $1 billion while the gain from investment partnerships went up by $1 billion.
Estimates for TARP continue to fall from the original score and it looks as if the loss to the federal government will be small, an unexpected but welcomed development.
Today, the House Ways and Means Subcommittee on Social Security held a hearing on bipartisan proposals to reform Social Security. Members of the subcommittee and the witnesses all agreed that now is the time to reform Social Security, which is currently projected to be unable to pay full benefits by 2033. Testifying once again before the subcommittee was CRFB Senior Advisor and Executive Director of the Moment of Truth Project Ed Lorenzen. In his testimony, Lorenzen provided an overview of the original Simpson-Bowles plan's recommendations to reform Social Security.
Lorenzen explained that the Commission's plan relied on a mix of changes in benefits and revenues, with the net reduction in costs from benefit changes accounting for about 54 percent of the savings over 75 years and a net increase in revenues responsible for roughly 46 percent of the savings. As a result, the Trustees projected at the time that the Commission’s plan would fully close the shortfall over 75 years and in the 75th year. The shortfall projection has increased in recent years, so the plan may have to be tweaked some to achieve the same result.
His testimony highlighted the Commission’s recommendation for progressive changes in the benefit formula to slow benefit growth for higher earners and enhanced benefits for low-wage workers, such as creating a new special minimum benefit to provide stronger poverty protections. Lorenzen also explained that some tweaks to the benefit enhancements outlined in the Commission’s 2010 report will be necessary in order to fully achieve the intent of Commission members who supported the final recommendations regarding protecting benefits for workers in the bottom quintile of earnings. These include making the formula change even more progressive by increasing the 90 percent bottom replacement factor and phasing up the minimum benefit more rapidly for retirees with less work history.
The other major element of the Commission’s proposal which Lorenzen underlined was indexing the normal retirement and early retirement eligibility ages to increases in longevity to account for increasing life expectancy. This would result in increasing the retirement ages by one month every two years after the retirement age reaches age 67 under current law, and would include certain hardship exemptions. He also discussed the distributional and economic impacts of raising the age:
Indexing the retirement age to longevity as opposed to setting a fixed schedule for increasing the retirement age provides additional robustness to ensure that the program remains on a fiscally sustainable course even if actual outcomes differ from projections...the actual effects of an increase in the retirement ages are slightly progressive because it is a benefit cut that exempts those who first collect through the disability system – who tend to be lower income.
By making the program sustainably solvent, the Simpson-Bowles framework would prevent a 25 percent across-the-board benefit reduction in 2033 under current law. Additionally, the SSA’s Chief Actuary found that for some low-income beneficiaries, the Commission’s plan would be more beneficial than scheduled benefits (ignoring trust fund solvency), and in some cases much better.
Distribution of Simpson-Bowles Plan for Social Security by Illustrative Earner (Percent of Scheduled Benefits)
Source: Social Security Administration
The hearing included additional testimonies by Bill Hoagland, Senior Vice President, Bipartisan Policy Center; Dr. Jason Fichtner, Senior Research Fellow, Mercatus Center; Leticia Miranda, Senior Policy Advisor, National Council of La Raza; Donald Fuerst, Senior Pension Fellow, American Academy of Actuaries; and CRFB board member Gene Steuerle, Institute Fellow, Urban Institute.
Gene Steuerle’s testimony echoed the potential benefits that raising the normal retirement age would have for the Social Security program. He described reforms that would ensure that Social Security meets its primary purpose of "providing greater protections for those truly old or with limited resources" while helping to improve the program's long-term solvency. Specifically, he recommended that policymakers:
Further adjust minimum benefits and the rate schedule and indexing of that schedule over time to achieve final cost and distributional goals. For instance, for those with higher incomes, cap benefits or use limited wage indexing; for middle-income workers, add another rate or extend the length of a rate bracket. The extent of these adjustments will also depend upon the tax rate and base structure agreed upon.
Overall, today’s hearing was a reminder of the various proposals which are available to policymakers to address the solvency issues with Social Security. Beyond the Simpson-Bowles plan, there are also many other plans which would improve the finances of the program. When asked by the Chairman when Social Security reform needs to happen, all six witnesses responded with very soon, and that we've already waited too long. Lorenzen noted that he had been working on Social Security reform for over fifteen years and that choices had only become more difficult over time.
There is no reason for delay; numerous options are available for policymakers to fix the program. In fact, the Committee for a Responsible Federal Budget will soon release an interactive tool called "The Reformer" to enable policymakers and the public to estimate the effects of a range of Social Security reforms on the finances of the program. It will be released at an event with a discussion about the challenges facing Social Security. While much of the recent budget debate in Washington has often evaded the issue of reforming Social Security, it's time for a bipartisan solution to put the program on a more sustainable path to ensure its promise for future generations.
As we have written before, the CBO recently released updated projections that show an improvement in the fiscal climate. Based on CRFB’s realistic baseline, the new data suggests that the debt will rise to 76 percent of GDP in 2023 as opposed to 79 percent. Some commentators have held up this rosier outlook as proof that the deficit reduction battle is over, at least for the next decade or so. This is a misreading of the CBO’s report, since as we pointed out the projections reflect largely short-term improvements that impact the debt level as opposed to its trajectory (although there were also encouraging downward revisions to health care and Social Security spending).
A recent blog by the Committee for Economic Development underscores the fact that the better numbers from CBO do not mean that our debt problem is solved. As we did, they point out that most of the improvement is transitory in nature:
Of the $203 billion improvement in the 2013 deficit, $95 billion comes from a unexpected payment to the Treasury from Fannie Mae and Freddie Mac. CBO reports that those payments will occur because of “accounting changes,” and assigns a probability of zero to any further payments at anything like that magnitude over the next 10 years. Another $105 billion (that is, essentially the remainder) of the improvement comes from higher revenues. Those revenues apparently arose because upper-income households shifted an unexpectedly large portion of their income from calendar year 2013 to calendar year 2012 to head off the increase in upper-bracket tax rates, and because corporate tax payments snapped back to normal from their depressed recession percentage of profits somewhat faster than CBO had anticipated in February.
CED’s blog notes that "CBO now expects the deficit to improve through only 2015, and then to begin to rise again. And by 2019, the deficit is again large enough that the public debt grows faster than the economy – that is, the debt-to-GDP ratio begins to rise again." Instead of declaring victory, policymakers should be focused on putting the debt on a sustainable downward path over the long term as a percentage of GDP.
The blog also points out that while projections are uncertain, there is not necessarily a strong reason to believe that they will improve on their own.
Still, admitting uncertainty, it is hard to see a lot of upside in these numbers. Might there be still more revenues? Sure – but CBO already has raised its projection of revenues as a percent of GDP above their long-term average. And that is after the income tax rate cuts for the vast majority of the population were made permanent at the beginning of this year, making further revenue improvement less likely. And outlays could be lower, too; but CBO (as noted above) already has reduced its estimates for Medicare, Medicaid and Social Security.
While this honest assessment of the CBO’s projections may seem bleak, it is by no means a riddle without a solution. Our analysis has estimated that under the new projections, $2.2 trillion in additional deficit reduction would put our debt on a sustainable downward trajectory by 2023. There are numerous ways to get there -- for instance, Erskine Bowles and Alan Simpson’s new plan would save $2.5 trillion -- but the political will to do it will be needed.
Tune in as the House Committee on Ways and Means Subcommittee on Social Security will hold a hearing on bipartisan proposals to reform Social Security benefits and their impact on beneficiaries, the budget, and the economy. CRFB's Senior Advisor and Moment of Truth Director Ed Lorenzen will testify on possible reforms to entitlement programs. CRFB board members William Hoagland and Eugene Steuerle will also be testifying tomorrow. The hearing is scheduled to begin at 9:30 am.
This morning, Federal Reserve Chairman Ben Bernanke testified before the Joint Economic Committee regarding the current economic climate. He noted that the economy has begun to show signs of life, attributing the accelerating pace of GDP growth to gradual improvements in credit conditions and the housing market. He also argued that the Fed should continue its quantitative easing at its current pace until the labor market improves sufficiently.
At the same time, Chairman Bernanke warned of more bumps on the road to recovery, particularly short-term fiscal consolidation, mainly from the sequester. He cautioned against using the short-term improvement in CBO’s latest fiscal projections as evidence that we are out of the woods in terms of our debt problems and argued that the best way for policymakers to sustain economic growth over the long term is to enact comprehensive deficit reduction legislation. In short, he concluded that under sequestration, lawmakers are doing perhaps too much in the short term while leaving the long-term deficit issue inadequately addressed.
Although near-term fiscal restraint has increased, much less has been done to address the federal government's longer-term fiscal imbalances. Indeed, the CBO projects that, under current policies, the federal deficit and debt as a percentage of GDP will begin rising again in the latter part of this decade and move sharply upward thereafter, in large part reflecting the aging of our society and projected increases in health-care costs, along with mounting debt service payments.
To promote economic growth and stability in the longer term, it will be essential for fiscal policymakers to put the federal budget on a sustainable long-run path. Importantly, the objectives of effectively addressing longer-term fiscal imbalances and of minimizing the near-term fiscal headwinds facing the economic recovery are not incompatible. To achieve both goals simultaneously, the Congress and the Administration could consider replacing some of the near-term fiscal restraint now in law with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run.
Congress should heed Chairman Bernanke’s advice and pass comprehensive legislation to put the debt on a sustained downward path that will foster future economic growth. Importantly, enacting a deficit reduction plan today is not the same thing as implementing deficit reduction today. As Chairman Bernanke recommends and we have noted before, deficit reduction can and should be phased in gradually to protect the fragile economic recovery. But that is no excuse for Congress to ignore the budget indefinitely.
In light of the recent controversy over the findings from economists Carmen Reinhart and Ken Rogoff on the relationship between debt and growth, there has been much speculation about what the critiques of those findings mean for what we know about that correlation. Former Council of Economic Advisors chair Michael Boskin writes in Project Syndicate that the economic context of debt accumulation matters, but the longer-term risks of not paying attention to the debt are clear:
We should adopt policies that benefit the economy in the short run at reasonable long-run cost, and reject those that do not. That sounds simple, but it is a much higher hurdle than politicians in Europe and the US have set for themselves in recent years.
I estimated the impact on GDP of America’s recent and projected debt increase (in which the explosive growth of public spending on pensions and health care looms largest), using four alternative estimates of the effect of debt on growth: a smaller Reinhart/Rogoff estimate from a more recent paper; a widely used International Monetary Fund study, which finds a larger impact (and which deals with the potential reverse-causality problem); a related CBO study; and a simple production function with government debt crowding out tangible capital. The results were quite similar: unless entitlement costs are brought under control, the resulting rise in debt will cut US living standards by roughly 20% in a generation.
Corroborating statistical evidence shows that high deficits and debt increase long-run interest rates. The effect is greater when modest deficit and debt levels are exceeded and current-account deficits are large. The increased interest rates are likely to retard private investment, which lowers future growth in employment and wages.
Numerous studies show that government spending “multipliers,” even when large at the ZLB, shrink rapidly, then turn negative – and may even be negative during economic expansions and when households expect higher taxes beyond the ZLB period. Permanent tax cuts and those on marginal rates have proved more likely to increase growth than spending increases or temporary, infra-marginal tax rebates; successful fiscal consolidations have emphasized spending cuts over tax hikes by a ratio of five or six to one; and spending cuts have been less likely than tax increases to cause recessions in OECD countries.
It is true that the design and timing of a comprehensive deficit reduction plan will matter a great deal in its economic benefit. But that is why working toward an agreement is so important. Putting debt on a sustainable path will be difficult, and it will take both parties to achieve a deal that will be better in both the short and long run for the economy than the sequester. Boskin agrees that we can't put the budget on the back-burner:
Nonetheless, the evidence clearly suggests that high debt/GDP ratios eventually impede long-term growth; fiscal consolidation should be phased in gradually as economies recover; and the consolidation needs to be primarily on the spending side of the budget. Finally, the notion that we can wait 10-15 years to start dealing with deficits and debt, as economist Paul Krugman has suggested, is beyond irresponsible.
Click here to read to full op-ed.
Taking It to the Limit – The statutory debt ceiling is back. The temporary suspension of the debt limit enacted earlier this year was lifted on May 19. The Treasury Department has begun extraordinary measures to hold off a default. Treasury Secretary Jacob Lew says the measures should last until after Labor Day, though he urged quick action. The Hill notes these so-called "extraordinary measures" have become commonplace in recent years as the debt limit has become a political hot potato. The latest deadline sparked little action from policymakers as budget talks remain stalled. Waiting until another debt ceiling crisis is directly in front of us is not a good idea. Standard & Poor’s, the credit rating agency that downgraded the U.S. credit rating after the last debt limit fight, warns that another such episode could result in another downgrade. Our leaders should be working now on a comprehensive plan that would make raising the debt limit more palatable. Keep track of debt limit developments here and get familiarized with the debt ceiling with our primer.
Sequester Replacement Bill Introduced – House Democrats on Monday introduced legislation to replace sequestration for two years with a package of roughly equal spending cuts and revenue increases. This is a positive step towards replacing the sequester, although we would prefer a comprehensive plan that addresses the long-term drivers of the debt. Learn more about sequestration with our Sequestration Resource Page.
Appropriations Process Moves Forward – Even without a concurrent budget resolution Congress is moving forward with spending bills for the fiscal year beginning October 1. Predictably, the House and Senate are far apart. The Senate is using topline spending numbers $91 billion higher than the House because the Senate does not include the sequestration cuts. The House assumes the sequester is maintained but includes defense and security spending beyond the caps, making up for the increase with further cuts to domestic spending such as education. The House Appropriations Committee approved of the Military Construction and Veterans Affairs spending bill on Tuesday.
CBO Scores President’s Budget – On Friday the Congressional Budget Office (CBO) released its score of the President’s fiscal year 2014 budget. CBO says the budget will reduce deficits by $1.1 trillion over ten years relative to its baseline. The score confirms that the budget is a step in the right direction in putting the debt on a downward path as a share of the economy. But CRFB noted in a statement that more would be needed to be done to ensure adequate long-term debt reduction. Read our full analysis here.
Confirmation Hearing for OMB Deputy – The Senate Budget Committee held a confirmation hearing on Tuesday for the designee to be Deputy Director of the Office of Management and Budget (OMB), Brian Deese. In his testimony, Deese mentioned his commitment to crafting a sound fiscal policy. “Much of my professional work has focused on the role that fiscal policy can play in promoting stronger and more durable economic growth. I believe that sound fiscal policy requires all of us to not shy away from our long-term fiscal challenges and to work diligently to reduce our deficits to strengthen the economy for both current and future generations. If confirmed, I will work closely with Director Burwell to build on the progress we have made and to help find common ground on the kind of comprehensive deficit reduction plan that will achieve these vital objectives.”
Hearings Expose Need for Tax Reform – High-profile congressional hearings on the IRS scandal over tax-exempt 501(c)4 organizations and efforts by Apple Inc. to lower its tax burden have spotlighted the need for tax reform. Bipartisan, bicameral efforts to fundamentally reform the tax code continue. Try your hand at corporate tax reform with our interactive calculator.
Key Upcoming Dates (all times are ET)
- Joint Economic Committee hearing on "The Economic Outlook" with Federal Reserve Chair Ben Bernanke at 10 am.
- Senate Budget Committee hearing on "Supporting Broad-Based Economic Growth and Fiscal Responsibility through Tax Reform at 2:30 pm.
- House Committee on Ways and Means Social Security Subcommittee hearing on the President's and other bipartisan entitlement reform proposals at 9:30 am.
- Bureau of Economic Analysis releases second estimate of 2013 1st quarter GDP.
- Bureau of Labor Statistics releases May 2013 employment data.
- Deadline for estimated quarterly individual and corporate tax payments.
- Dept. of Labor's Bureau of Labor Statistics releases May 2013 Consumer Price Index data.
- Bureau of Economic Analysis releases third estimate of 2013 1st quarter GDP.
- The date Treasury Department expects a nearly $60 billion payment from Fannie Mae, which will help delay the time by which lawmakers will need to raise the debt ceiling.
- Bureau of Labor Statistics releases June 2013 employment data.
- Dept. of Labor's Bureau of Labor Statistics releases June 2013 Consumer Price Index data.
- Bureau of Economic Analysis releases advance estimate of 2013 2nd quarter GDP.
Although efforts to replace the sequester have been on hold for a while, the House Democrats, led by House Budget Committee ranking member Chris Van Hollen (D-MD), have come out with a bill to replace the remaining 2013 and part of the 2014 sequester with $181 billion of savings over ten years. The bill is similar to one Rep. Van Hollen produced last year and one that Senate Democrats introduced this year.
The bill includes a roughly equal mix of tax increases and spending cuts, according to The Hill. The bill contains elements of both the House effort last year and the Senate effort this year. It includes the Buffett Rule ("Fair Share Tax") as its main revenue-raiser along with disallowing the domestic production deduction, expensing for intangible drilling costs, and the use of last-in first-out (LIFO) accounting for major oil companies.
As with last year's bill, the spending cuts include the elimination of direct commodity payments for farmers, a provision that has been included in the competing Congressional farm bills. It also reduces the defense spending caps in years 2017-2021, a similar provision to one included in the companion Senate sequester replacement bill.
Ideally, lawmakers would replace the sequester on a permanent basis with a comprehensive deficit reduction plan that makes much more gradual and smarter cuts and has savings in many different areas of the budget. However, the House Democrats' plan is positive in that it responsibly pays for a two-year repeal of the sequester.
The CBO has now spoken on how the President's budget would affect the fiscal outlook. Debt would fall to 70 percent of GDP by 2023, compared to 73 percent under current law and 76 percent under our latest iteration of the CRFB Realistic baseline (though we are still working on the precise number as we get new information). But what about the Bipartisan Path Forward proposed last month by Fiscal Commission co-chairs Erskine Bowles and Al Simpson?
The plan's "Step 3," included $2.5 trillion of ten years relative to the February CRFB Realistic Baseline, was originally estimated to get debt down to 69 percent of GDP by 2023. Assuming the savings remain the same*, save a small adjustment in our new baseline, the debt would be on even lower than previously estimated, and on a slightly sharper downward path. Specifically, debt would fall from 76.5 percent of GDP in 2014 to about 66 percent by 2023.
Source: CBO, CRFB calculations
Over the 2014-2023 period, spending would total 21.3 percent of GDP and revenue would total 19.2 percent, resulting in average deficits of 2.1 percent. This compares to the 2.4 percent ten-year deficit in the President's budget and the 3.0 percent and 3.2 percent deficits in current law and CRFB Realistic, respectively. In 2023, the final year of the projection window, spending would be 21.3 percent of GDP and revenue would be 19.7 percent, resulting in a 1.6 percent deficit.
|Bipartisan Path Forward Budget Metrics (Percent of GDP)
|Bipartisan Path Forward|
|President's Budget (CBO Estimate)|
Source: CRFB calculations
The Bipartisan Path Forward shows that policymakers can indeed put together a package which puts the debt on a clear downward path. That's true even before accounting for the plans "Step 4" reforms to Social Security and federal health spending. Clearly, a comprehensive fiscal package can be done if lawmakers are willing to put all parts of the budget on the table.
*A number of policies may save different amounts due to changes in CBO's baseline. In particular, the health savings may be less due to downward revisions in health spending, although other policies may save more. The document does include additional savings options to meet the targets if necessary.