The Bottom Line
In addition to CBO director Doug Elmendorf's testimony, yesterday's budget conference committee meeting produced another notable moment: a proposal from Sen. Angus King (I-ME) to replace part of the sequester with targeted and permanent reforms. The plan is an archetype of what a modest solution from the conference committee could look like, as it would replace the sequester responsibly. In fact, King referred to it as the "grande" plan, named after the medium size at Starbucks.
Specifically, King's proposal would replace about half the sequester through 2021 -- at a cost of $455 billion -- with $200 billion of revenue from corporate tax base-broadening and $255 billion of savings from mandatory programs. It would also reduce another $325 billion from eliminating or reforming many corporate tax expenditures to finance a reduction in the top corporate tax rate from 35 percent to 32.5 percent and a $50 billion of which would go to new infrastructure spending. After repealing half of the sequester, King would "smooth" the caps so there were fewer cuts in the earlier years and slower growth in the caps over time. We said that this could be a sensible approach yesterday while warning that if it's taken too far or done on its own, it could easily amount to a budget gimmick.
|Parameters of the King Plan (Billions)|
|Ten-Year Savings/Costs (-)|
|Half Sequester Replacement||-$455|
|Subtotal, Sequester Policies||$0|
|Additional Corporate Base-Broadening||$325|
|Corporate Rate Cut to 32.5%||-$275|
|Subtotal, Additional Policies||$0|
|Total Budget Impact Against Current Law
The King plan is a solid approach to the sequester. It does no harm to future debt levels compared to current law, replaces the mindless sequester with more targeted and gradual reforms, and would likely enhance economic growth in the short-term by providing some relief from the sequester (the effect on long-term growth would depend on the details). Senator King has presented a compelling plan that deserves serious attention. Ideally, lawmakers would go even further in finding targeted savings to truly put the debt on a downward path over the long-term, but Senator's King would be a good step in the right direction.
We welcome any additional details about the mandatory or tax savings involved, since filling in those details will be key to a potential agreement. For an idea of how the tax expenditure savings could be achieved, check out our corporate tax reform calculator.
As the conferees met yesterday, any doubt that we can afford to wait on the long-term debt problem should have quickly been erased after CBO Director Doug Elmendorf's testimony to the conference committee. While the budget outlook has improved somewhat in the short term, little progress has been made on the long-term problem. And fixing the long term will likely require greater reforms to entitlement programs and the tax code.
In another presentation yesterday, Elmendorf explained that if we want to make real progress on our fiscal problem, we will have to address health care. Elmendorf's presentation to the Public Policy Institute at the Wharton School at the University of Pennsylvania shows that health care by far has outpaced the growth of other programs, and the projections look even starker over the long term.
He attributes the growth of health care spending to three factors: population aging, the expansion of health insurance coverage in the Affordable Care Act, and health care cost growth.
A lot of the growth in health care spending can be tied to the retirement of the Baby Boom generation and population aging. But as Elmendorf notes, it is difficult to do much on population aging because most policies to improve the health care system should also increase longevity. That is especially the case now that CBO has revised down its estimate for increasing the Medicare retirement age. This is not to say that there aren't many other ways to address population aging - Social Security reform is a great way to tackle that driver of the debt.
Alternatively, many health policy experts have stressed delivery and payment reforms, which could reduce health care cost inflation while ideally not affecting or improving quality of care. Over the past few decades, health care costs have growth much faster than inflation, and if history is any indication, this trend is likely to continue unless significant changes are made. There has been some slowdown in health care cost growth over the past few years, but it is still too early to conclude how much of the slowdown is permanent and how much is due to temporary factors like the poor economy.
Delivery and payment reforms are particularly promising, but lawmakers must also use caution in the same way that they do with eligibility reforms. As Elmendorf notes:
Restructuring federal payments for health care holds the promise of encouraging greater efficiency in the delivery of care or better choices about the use of care—but it also would present risks of the same shifting of costs and loss of access to insurance and care.
That being said, lawmakers have many different options available to them that could substantially improve the health care system. Reforming federal health spending to make it sustainable will be an ongoing process, but lawmakers should begin as soon as possible. The longer we wait, the less time we will have to phase in changes slowly and the larger the debt problem will grow to be.
Click here to see Elmendorf's full presentation.
On Monday, we took a look at the breakdown of federal spending and taxes by the type of household, particularly between elderly and non-elderly households. But CBO's recent analysis of 2006 household data also contains valuable information on the income distribution of the budget as well. CBO excludes elderly households from this analysis as market income is not a good measure of their resources -- they rely instead mostly on retirement savings, Social Security benefits and pensions -- but the report still provides useful insight into the effect of taxes and transfers on the overall income distribution.
For non-elderly households, the lowest income quintile receives about $13,000 in net transfers after taxes, while the top three quintiles, particularly the top quintile, paid more taxes than they received in transfers. When government spending other than transfers is included, the bottom two quintiles are shown to benefit, the 3rd and 4th quintiles roughly break even, and the highest quintile pays more in taxes than it receives in benefits.
One noticeable finding from CBO's report is how much of the progressivity of the federal budget is the result of the tax code. For nonelderly households, transfers are progressive, with lower income households receiving a larger share, but the tax code's effect on distribution is far larger. Of course, including elderly households would again change the distribution, as would including the activities of state and local governments. Internationally, America has a very progressive tax code since most other industrialized nations have some form of sales tax, but transfers are less progressive than in many other industrialized nations.
Lawmakers ultimately need to decide what combination of taxes and transfers is best for achieving the progressivity they desire. But one myth that is counterproductive is the idea that deficit reduction plans will hurt low income households and make income distribution more regressive. As we've shown on this blog, many plans have adopted the Fiscal Commission's principle of instituting reforms that protect low-income households. The Bipartisan Path Forward, a plan Erskine Bowles and Al Simpson released in March, contained many low-income protections, such as a repeal of sequestration and an including old age "bump up" with their chained CPI proposal, similar to the policy included in the President's Budget.
Tax reform can also be progressive, as many of the tax expenditures in the code disproportionately benefit wealthier households. Many of these provisions, if not eliminated, could be redesigned to be more progressive and cost less, for example, by turning deductions into credits.
Protecting the disadvantaged in a comprehensive deficit reduction is one of the enduring legacies of the Fiscal Commission and one that the budget conferees should follow. Not all of the budget options released in CBO's report may hold lower-income households harmless, but they can easily be modified to do so. Morever, what ultimately matters is the overall effect of a plan, and a comprehensive plan is better positioned to make lower-income people better off overall. Lawmakers will need to make tough choices, but if they are committed to protecting the disadvantaged, it is definitely achievable.
Yesterday, the Congressional Budget Office released its budget options paper, a biannual report that provides over 100 suggestions of specific things that could be done to reduce the deficit. We explained yesterday how important the report, Options for Reducing the Deficit: 2014 to 2023, actually is: it provides updated estimates and descriptions for the current 10-year budget window, because their last report in 2011 was published before the recent changes to the budget picture. In early 2011, the budget did not yet include the Budget Control Act that limited discretionary spending, the sequester that cut it further, or the fiscal cliff deal that raised tax rates for upper-income Americans. Since CBO serves as the official scorekeeper for the Congress, its estimates can affect how a bill is treated. For example, any reconciliation instructions issued by the budget conference committee cannot increase the deficit.
In light of the new numbers from CBO, we've adjusted our estimates and added new options to the Tax Break-Down series, which for the past couple months has been examining each tax break one at a time, listing some of the arguments for and against it, and listing several options for reform. We'll treat the Tax Break-Down series as an evolving set of documents, updating it whenever a relevant option is released, including when a tax reform bill is released this fall.
* * *
See the entire CBO report on Options for Reducing the Deficit: 2014 to 2023 here.
Read the (updated) posts in the Tax Break-Down series here.
As the budget conference committee works to develop a plan to offset some of the sequester, they may be tempted to use budget gimmicks in place of hard choices (last week we warned against use of the war gimmick). One such gimmick would be to repeal most or all of the sequester now and pay for it by increasing the sequester later.
Doing so would be an irresponsible way to offset the sequester, and it would lack credibility. From a policy standpoint, offsetting the temporary cuts of sequester now with deeper temporary cuts later would do nothing to improve the fiscal situation; the sequester was meant to be a backstop to encourage permanent deficit reduction policies.
But more troubling, repealing the sequester now by deepening the sequester in future years would lack credibility would likely be seen as a pure budget gimmick. After all, if we are unwilling to live under the sequestration cuts now, what evidence is there that we can bear even deeper cuts later?
Imagine that policymakers repealed two thirds of the discretionary sequester this year -- $60 billion -- shrinking a 8.5 percent cut (relative to pre-sequester caps) to a 2.8 percent cut, and then paid for it by reducing future caps $6.6 billion per year over the next nine years. Under that scenario, next year's cut would by 8.9 percent -- something they are unlikely to accept if they couldn't allow for a 8.5 percent cut this year.
Instead, they might repeal $66 billion of the sequester next year, paid for with $7.5 billion of annual cuts over the following nine years. And then they might repeal $82 billion the following year, and so on and so on. Taken to its logical conclusion, policymakers would face an 12.6% ($125 billion) cut in 2021 -- one which they would be quite unlikely to accept -- and in the process would have only allowed one-third of the sequestration's original cuts to actually go to deficit reduction.
The chart below illustrates the scenario described above – offsets share the same color as the sequester relief provided. As you can see, sequester relief that costs only $60 billion in 2014 will rise to $90 billion by 2018 and $130 billion by 2021. And those cuts are on top of the $30 billion in cuts that are continually retained.
Anyone who doubts that Congress will repeatedly kick the can on actually making discretionary cuts need only look at the experience of the Medicare Sustainable Growth Rate (SGR) formula in which Congress has consistently canceled cuts scheduled for the upcoming year and required deeper cuts in future years. Eventually, the cuts snowballed to the point where doctors now face a 24% cut that no one ever thinks will occur. Turning the sequester into another SGR would be a grave mistake.
To be sure, not all adjustments in discretionary cap levels would be gimmicky in nature. A much more modest plan to "smooth" the sequester cuts in concert with other reforms could help make what is left of the sequester easier to bear by phasing it in more gradually. This smoothing wouldn't solve our fundamental budget problem or make the necessary hard choices, but if realistic it could be part of a more complete budget plan.
Yet there is a slippery slope between reasonable smoothing and unreasonable gimmicks. Reducing the amount of cuts that need to be made in the appropriations bills for the upcoming fiscal year by promising to make greater savings in later years creates a dangerous precedent that could easily be abused. To be credible, smoothing must be part of a larger plan which agrees to a full set of caps which policymakers intend to and are able to abide by. Any reductions in the sequester now paid for by increases in future-year sequester cuts which will be difficult to enact or which policymakers intend to modify later would qualify as a gimmick. And any significant sequester relief not accompanied by permanent deficit reduction would likely be non-credible and certainly a missed opportunity.
Backloading sequester will not solve our fundamental budget challenges, and declaring that we cannot accept cuts now so we will impose a deeper version of those cuts later does not pass the laugh test.
Congress should take the steps necessary to replace mindless, temporary, anti-growth sequester cuts with sensible, targeted, permanent, long-term reforms. But as Congressional Budget Office Director Doug Elmendorf explained today, "no steps at all are better than steps backwards." Congress must not gimmick it's way to sequester relief.
At the second meeting of the budget conference committee earlier today, CBO director Doug Elmendorf was on hand to present the budget and economic outlook and to answer (as it turned out many, many) questions from the conferees. Throughout, Elmendorf made clear that our debt problems are still far from solved and that the committee has many options before them to consider, including those illusrated today in CBO's newly released Options for Reducing the Deficit.
Elmendorf made clear to the committee that while the near-term budget outlook showed falling deficits in the coming years, that would not last for long.
Although deficits will fall to 2 percent of GDP by 2015, they will then begin to increase again reaching 3 1/2 percent of GDP or nearly $1 trillion by 2023. Moreover, under the Extended Baseline in our long-term outlook, deficits continue to increase beyond the coming decade. As a result, federal debt held by the public...would reach 100 percent of GDP 25 years from now even without accounting for the harmful economic effects from that increase in debt.
He also outlined the consequences associated with elevated debt, even at the level we have right now. We have gone through a number of these concerns while discussing why lawmakers should put debt on a downward path as a percent of GDP.
There are at least three reasons why we and other analysts are concerned about the long-term budget outlook. First, debt is already larger relative to the size of the economy than at any point in our history except for a brief period around World War II. Even if debt remains near its current 73 percent of GDP, future wages and income will be lower than they would be with less debt. Also, the government's interest costs will rise dramatically as interest rates return to more normal levels. Your ability to use fiscal policy to respond to future financial crises, recessions, and international threats will be much more constrained. And the risk of a fiscal crisis will be higher than it would be with less debt. All of those problems with keeping debt at its current share of GDP will be worse if debt rises significantly and persistently relative to the size of the economy....We project that under current law debt will rise significantly and persistently relative to the size of the economy.
Elmendorf also pointed out how the composition of federal spending will change over time. Specifically, he noted that the increases in spending on health care programs and Social Security would put pressure on other federal spending and/or necessitate higher revenue.
All other non-interest spending taken together -- everything other than Social Security and Medicare and defense -- will be roughly the same share of GDP in 2023 on average that it was in the past 40 years and that it is today. I want to make it clear that the steadiness of this GDP share of the "all other" category masks very different patterns among its subcomponents....In this other category, means-tested health care programs are taking a growing share of GDP, owing to the expansion of insurance coverage through the Affordable Care Act and rising health care costs per person. In contrast, non-defense discretionary spending is on track to be a sharply shrinking share of GDP, owing in part to the caps from the Budget Control Act....If [Social Security and Medicare] are not cut back, then we will need to collect a rising share of GDP in tax revenues relative to our history or cut back on other federal benefits and services relative to what we have been accustomed to.
He also noted that "outlays for defense and non-defense discretionary programs would be smaller relative to the size of the economy in 2017 and beyond than at any point in at least 50 years", while pointing out that non-defense discretionary spending was half made up of spending on investment and that cuts to this area would harm the economy's potential capacity.
Elmendorf's comments should highlight for the committee the need to not only replace the sequester with longer-term savings, but to also work towards a comphrensive solution that addresses our long-term debt challenges. Importantly, he also said a follow up blog post about his testimony, that while he knows the picture he paints is dire, the committee should not shy away from using this opportunity to make progress.
I finished by noting that, when I make presentations like this, I worry that my toting up of all those challenges can make the problems seem so large that it actually discourages people from tackling them. That would be unfortunate. Of course, a clear resolution of the long-term budgetary concerns would be beneficial. But even if that is not feasible right now, reallocating elements of the budget to comport better with the country’s priorities as lawmakers view them, while reducing uncertainty about fiscal policy next year and improving or at least not worsening the long-run budget outlook, would be a good thing—even if it left significant challenges to be addressed in next year’s budget process.
We may have had to wait a little longer due to the government shutdown, but CBO's new budget options report is finally here. Today, CBO released its updated Revenue and Spending Options report, containing over 100 policy options and new budgetary scores for the current ten-year window. Each option is covered in great detail with not only a full description of each and background information on how the policy fits into the budget, but also arguments for and against its implementation, how the change could affect beneficiaries, and other detailed analysis.
It had been two years since CBO's previous options report, and the report is particularly timely given budget conferees that are negotiating a potential budget agreement (their second meeting happening earlier today). Members on relevant Congressional committees may also find this useful in fulfilling savings targets they receive in any reconciliation instructions from a budget resolution.
Of course, with so many options, below we have highlighted four in each budget category to help illustrate the many savings options available for lawmakers to consider. However, the report itself is well worth a read and is a gold mine of information for anyone interested in the budget.
For more options, read the full report here.
|Eliminate Direct Payments to Farmers||$10||$25|
|Reduce Subsidies to Fannie Mae and Freddie Mac||$14||$19|
|Eliminate In-School Interest Subsidy for Student Loans||$17||$41|
|Increase Federal Insurance Premiums for Private Pension Plans||$3||$5|
|Change the Cost-Sharing Rules for Medicare and Restrict Medigap Insurance||$42||$114|
|Bundle Medicare Payments to Health Care Providers for Inpatient Care and 90 Days of Post-Acute Care||$4||$47|
|Introduce Minimum Out-of-Pocket Requirements Under TRICARE for Life||$11||$31|
|Limit Medical Malpractice Torts||$19||$66|
|Link the Growth Initial Social Security Benefits to Average Prices Instead of Average Earnings||$3||$93|
|Raise the Full Retirement Age for Social Security to 70 by 2038||$5||$58|
|Eliminate Eligibility for Starting Social Security Disability Benefits at Age 62 or Later||$2||$11|
|Require Social Security Disability Insurance Applicants to Have Worked at Least Four of the Past Six Years||$6||$35|
|Replace the Joint Strike Fighter Program With F-16s and F/A-18s||$12||$37|
|Cancel the Army’s Ground Combat Vehicle Program||$2||$11|
|Increase Fees for Aviation Security to a Flat $5 Fee Per Flight||$4||$11|
|Eliminate Subsidies for Amtrak||$6||$15|
|Convert the Mortgage Interest Deduction to a 15 Percent Tax Credit After 2019||$8||$52|
|Eliminate the Deduction for State and Local Taxes||$383||$954|
|Limit the Deduction for Charitable Giving to Contributions in Excess of 2 Percent of AGI||$84||$212|
|Eliminate the American Opportunity Tax Credit and the Lifetime Learning Credit||$95||$155|
|Increase Excise Taxes on Motor Fuels by 35 Cents and Index for Inflation||$207||$452|
|Increase All Taxes on Alcoholic Beverages to $16 per Proof Gallon||$30||$64|
|Impose a 0.01 Percent Tax on Financial Transactions||$68||$180|
|Impose a $25 Per Metric Ton Tax on CO2 Emissions||$471||$1,060|
|Apply Chained CPI to the Tax Code Starting in 2014||$30||$140|
|Apply Chained CPI to Social Security Starting in 2015||$21||$108|
|Apply Chained CPI to Other Mandatory Spending Programs Starting in 2015||$11||$54|
The budget conference committee is holding its second hearing this morning as the conferees continue to try and work out a compromise between the House and Senate budgets. Today, CRFB board member and former Senator Kent Conrad (D-ND) and former Senator Judd Gregg, both who served as Chairman of the Senate Budget Committee, stress in an article in The Hill the importance of using this opportunity to act and resolve our open budget questions.
Brinksmanship and last minute solutions have prevailed over the last few years, and it isn't hard to see why that has been the case - the Congress has been operating without a budget. We may have moved past the government shutdown and the debt ceiling for now, but those hurdles will return soon, which is why it is so important to deal with issues now:
The Constitution granted Congress the authority to tax and spend, and they have certainly exercised it. But it wasn’t until 1974 that “The Budget Act” established the House and Senate Committees on the Budget and finally created what we now refer to as regular order in order to manage these resources in a manner worthy of a great nation. Under the law, each house of Congress would draft and pass their own budget resolutions and then a conference committee would meet to work out the differences. Reconciliation legislation could also be utilized to enforce the spending and revenue levels set out in the budget resolution.
Unfortunately, this established process hasn’t always yielded results in today’s divided Washington. That is one of the reasons we came together in 2009 to introduce legislation to establish a Bipartisan Task Force for Responsible Fiscal Action to put Congress back on a path to fiscal sustainability. That effort eventually led to the Simpson-Bowles Commission which we were both privileged to serve on. Since then, there have been sporadic attempts at dealing with the debt as Congress has engaged in habitual fiscal cliff-jumping.
Now nearly 40 years after the Budget Act, Congress has once again returned to regular order and convened a budget resolution conference committee to address our growing debt. We cannot let another year pass without at least taking some common sense steps to reduce our debt, beginning with a workable federal budget.
A couple of weeks ago, CRFB called for the budget committee to meet six important criteria in the final budget agreement. Conrad and Gregg also encourage the conference commmittee to put out a budget resolution that meets three fiscal goals, all of which were also included in CRFB's list:
- Puts debt on downward path as share of economy, like the House Republican, Senate Democratic, and White House fiscal year 2014 budgets
- Replaces the across-the-board sequester cuts with targeted deficit reduction that offsets any changes
- Establishes a fast-track process for entitlement and tax reform to strengthen Social Security and Medicare and make our tax code simpler and more competitive
Finding an agreement that is acceptable to both parties and is fiscally responsible will no doubt be difficult, but it will only get harder the longer we wait. Lawmakers need to take full advantage of this chance to come together.
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.
The second meeting of the budget conference committee will happen today at 10 AM Eastern time. The conferees do not have a lot of time, as their deadline of December 13 is now exactly a month away and government funding will expire a month later on January 15. Testifying at the meeting is a familiar face in the budget world, CBO director Doug Elmendorf, whose agency will also be releasing an updated Budget Options report at noon today.
You can watch the proceedings live on C-SPAN here. Also, check back to The Bottom Line later today as we summarize CBO's latest options report.
What to do about sequestration remains one of the most important questions before the budget conference, and while replacing at least part of the sequester is popular among lawmakers, it is not clear what policies should offset that cost. Today, Nicole Woo of the Center for Economic and Policy Research (CEPR) made the case for an offset that could replace one-third of the sequester for 2014 - increasing Wall Street user fees.
Woo notes that the SEC is currently funded by a financial transaction tax that raises less than 2 cents per $1000 worth of transactions. If the tax was increased to 30 cents instead and applied to a wider set of transactions, it could raise $39 billion per year. That would be enough to pay for a partial sequester repeal while enacting permanent, long-term savings.
As lawmakers work to replace the sequester, they should look to any of a number of options to reduce spending, increase user fees, or raise revenue. Ideally, they would pursue comprehensive tax and entitlement reform, but replacing the temporary cuts from sequester with any package of permanent long-term savings would improve both our economic and fiscal outlook. These cuts are abrupt and poorly targeted, but they must be replaced in a fiscally responsible way. Kudos to CEPR for presenting another option that lawmakers could use in a replacement package.
Replacing the sequester will be an important item on the conference committee's agenda, and it may also be the most difficult. Right now, the two parties differ as to how to replace it, with Republicans advocating for only spending cuts as offsets and Democrats seeking a mix of revenue and spending cuts. When it comes to the defense sequester, which is slated to reduce the defense budget by $490 billion over the next ten years, Democrats may be particularly wary of replacing defense cuts with cuts to non-defense programs. But there could be a way out through reforms to military-related entitlement programs, like pension benefits and TRICARE (the health care program for military personnel, military retirees, and their dependents).
Just like within the full budget, health care and retirement spending are consuming more and more of the defense budget, and are far more lavish than for civilian federal employees. Many reforms could begin to slow the growth of such benefits, and allow some readjustment of priorities toward direct defense capabilities.
Policies that affect mandatory spending for military retirement benefits and TRICARE-for-Life (the Medicare supplement for military retirees and their dependents) can help lawmakers offset the defense sequester. Such reforms could include disallowing cost-of-living adjustments until a retiree turns 62, with a one-time catch-up at that age; calculating retirement benefits based off the highest-5 instead of the highest-3 years of earnings, bringing it in line with the standard in the private sector; and increasing co-payments for TRICARE drugs. If changes are made to Medicare like restricting Medigap's coverage of 1st-dollar expenses to limit unnecessary overutilization, those same reforms could also be applied to TRICARE-for-Life, the Medigap-equivalent for military retirees.
|Savings from "Defense Entitlement" Policies (billions)|
|Calculate benefits based on highest 5 earnings years||$5|
|Freeze COLAs until age 62, providing one-time catch-up||$20|
|Calculate COLAs before age 62 at CPI-1%, provide catch-up, then continue at CPI-1%||$20|
|Restrict first-dollar cost-sharing coverage in TRICARE-for-Life||$25|
|Increase pharmaceutical co-pays (mandatory savings)||$5-$20|
|Change current pension plan to defined contribution system||Unknown|
Lawmakers could also think bigger when it comes to reform. For example, the pension benefit has a vesting period of 20 years, meaning that most service members do not qualify for a pension (according to the Defense Business Board (DBB), 83 percent do not) but also that those who do can start receiving benefits as early as age 38. The DBB recommended shifting the pension to a defined contribution system with a vesting period of 3-5 years and with benefits payable only after an age more in line with civilian federal retirement and Social Security. The federal government would provide matching contributions that would be generous by private sector standards.
While reforming defense entitlements may offer a path to ease the constraints of the sequester and restore spending on our defense capabilities, lawmakers must beware not to (accidentally or intentionally) double-count the savings. For accounting purposes, the Department of Defense “pre-funds” its health and retirement programs out of its discretionary budget authority – meaning that from a technical standpoint, a reduction in benefits could produce both mandatory savings and reduce the required budget authority for these programs. These discretionary savings, however, are phantom in nature and do not result in a reduction of money going out the door. To the extent appropriators spend up to the budgetary caps, in fact, they could clear headroom for more spending.
Legislatively, this double-counting arises because reductions in mandatory spending automatically lower necessary discretionary accrual contributions, thus providing additional headroom for new discretionary spending. Policymakers could avoid this one of three ways:
- Ignore the mandatory savings for purposes of offsetting the sequester or reaching a deficit reduction target, instead allowing the lower discretionary accruals to create more headroom within the sequester caps to fund defense priorities;
- Count the mandatory savings, but freeze accrual contributions at their current levels and dedicate contributions in excess of what is needed toward other underfunded military health and retirement trust funds;
- Count the mandatory savings, but lower the discretionary caps to account for the reduced accrual contributions without crediting savings to these lower caps;
Another way to create room within the sequester limit to fund other defense priorities would be to reform the TRICARE program for those under 65, which is consuming a larger and larger portion of the Department of Defense's (DoD) annual discretionary budget.1 By lowering discretionary spending dedicated to health care benefits, DoD would have more funds available to spend on defense capabilities. Enrollment fees, deductibles, and co-pays for the TRICARE programs could be increased. Or more fundamentally, military retirees under the age of 65 could be required to take employer-sponsored insurance instead of TRICARE if the offer is available, since some military retirees retire as early as 38 and many continue to work after their military service.
Used properly, "defense entitlement" reforms may provide a path forward to restore funding on defense priorities.
|Savings from "Defense Entitlement" Policies (billions)|
|Increase pharmaceutical co-pays (discretionary savings)||$5-$15|
|Increase TRICARE enrollment fees, deductibles, and co-pays, and index to inflation||$25|
|Require retirees to take employer-sponsored coverage and use TRICARE as secondary payer||Unknown|
1 In general, TRICARE for beneficiaries over the age of 65 is counted as mandatory spending and as discretionary spending for those under the age of 65.
Last week, at a breakfast with David Wessel and Gerald Seib of The Wall Street Journal, Council of Economic Advisers chair Jason Furman made the case that not only had short-term deficits been coming down, but also that the long-term situation has improved dramatically. Specifically, Furman suggested that the 75-year fiscal gap has fallen from almost 10 percent of GDP to under 2 percent.
While improvements have occurred in recent projections, however, our analysis suggest these improvements are far smaller than what Furman suggested. The true improvement in the fiscal gap is far closer to 0.8 percent of GDP than to 8.0 percent. Furman's comparisons are largely apples and oranges.
In his talk, Furman said the following (emphasis added):
[CBO's] fiscal gap over 75 years is a little bit less than 2 percent of GDP. Now, if you look at the debt 75 years from now it spirals and goes really high but every time you have a small wedge things get very large. In contrast, I used to write things before CBO was doing the estimate with Alan Auerbach and Bill Gale and we generally had numbers that were nearly 10 percent of GDP. So the 75-year outlook is considerably better and that’s because of projections around health and some of the changes we’ve made in terms of revenue and things like the Affordable Care Act that has significant long-run deficit reductions.
Furman is correct that the fiscal gap -- the amount of non-interest deficit reduction needed each year (starting immediately) to maintain the current level of debt 75 years from now -- in CBO's current law baseline is less than 2 percent of GDP. To be exact, CBO estimates a 75-year fiscal gap of 1.7 percent of GDP (in our Realistic baseline, we estimate the gap to be somewhat higher at 2.7 percent). But the suggestion that it has come down by something like 8 percent of GDP is quite misleading for at least four reasons:
- Auerbach, Furman, and Gale (hereafter AFG) never estimated a 10 percent fiscal gap. Their 75-year fiscal gap estimates in 2007 and 2008 ranged from 2.9 to 7.3 percent of GDP, depending on the assumptions.
- The higher AFG estimates made current policy baseline adjustments, whereas CBO's fiscal gap analysis is based on strict current law.
- The AFG estimates assume long-term revenue and non-health, non-Social Security mandatory spending are frozen as a share of GDP after ten years, whereas CBO assumes they grow and shrink, respectively. Both of those AFG assumptions significantly worsen the long-term outlook.
- Debt is more than twice as high as when the AFG estimates were made, and since the "fiscal gap" measures the necessary deficit reduction to stabilize the debt at current levels, the size of the fiscal gap actually actually shrinks when current debt levels grow.
When you account for these factors, it is clear that the long-term fiscal gap has not fallen by anywhere near 8 percentage points. Even comparing the strict numbers from AFG in 2007, one could only claim a reduction of a bit more than half that amount a 4.6 point reduction from 6.3 percent of GDP down to 1.7 percent.
Yet even that reduction is overstated. The AFG baseline assumed various tax cuts were extended, the wars drew down, and discretionary spending grew faster than inflation, which if assumed today would increase CBO's 1.7 percent gap to more like 2.2 percent.
Much more significantly, AFG assumed that after the end of the decade, revenue and mandatory spending would be frozen as a share of GDP. This is in serious contrast to the CBO baseline, which projects revenue will rise by 6 percentage points of GDP between 2023 and 2088 and other mandatory spending will fall by 1.5 percentage points. This difference is responsible for about 3 points in the fiscal gap.
On top of these adjustments, if we set the goal of achieving 2007 debt levels in 2088, rather than 2013 debt levels, this would further increase the gap. All told, closing this gap would require immediate deficit reduction totaling 5.5 percent of GDP, only 0.8 points less than the 6.3 calculated by Auerbach, Furman, and Gale in 2007.
|Bridge from CBO Current Law to AFG Assumptions (Percent of GDP)|
|Assumption||75-Year Present Value|
|CBO Current Law||1.7%|
|CRFB Realistic Ten-Year Adjustments||+0.2%|
|Extend Normal Tax Extenders||+0.3%|
|Freeze Other Mandatory Spending and Revenue after 2023||+2.9%|
|Subtotal, 75-Year Fiscal Gap||5.1%|
|Set Debt Target to 2007 Levels||+0.4%|
|Total, 75-Year Fiscal Gap to Achieve 2007 Debt Levels
|Memorandum: 2007 AFG Fiscal Gap||6.3%|
Source: CBO, CRFB calculations
To be sure, our 5.5 percent estimate is not a perfect apples-to-apples comparison either. One could argue that we should only calculate the gap through 2081 as AFG originally did, for example, which would reduce the fiscal gap by 0.4 percent. Or one could argue that we should assume automatic cuts from sequestration remain in place through 2021 and continue beyond their expiration, which would reduce the gap by another 0.4 percent. Yet even combining these assumptions with an assumption that all of the tax extenders and SGR cuts will be fully offset on a same-year basis would yield a fiscal gap between 4 and 4.5 percent of GDP.
The major difference between CBO and AFG is not the policies that have been enacted or even the policies that are assumed, it is the long-term assumptions on revenue and non-health/retirement mandatory spending. Whether those categories are frozen (as in AFG) or not (as in CBO) accounts for a 3 point difference in the fiscal gap. Perhaps CBO's assumptions are too generous, or perhaps the AFG assumptions were too conservative (or perhaps both), but either way, comparing them on a like basis is a clear case of comparing apples and oranges.
So if AFG and CBO are apples to oranges, what about CBO and CBO? Unfortunately, even CBO assumptions change from year-to-year, and it is unclear when that change is truly a result of new policy versus new thinking. But if one were to compare CBO baselines over time, they’d be hard pressed to find a major improvement. Since 2007, CBO has calculated the 75-year fiscal gap every year (except for 2008) using its extended baseline scenario and its alternative fiscal scenario. Although estimated have bounced around significantly, they are nearly identical today to what they were in 2007. Under CBO’s current law scenario, the fiscal gap increased from 1.7 percent in 2007 to 3.2 percent in 2009 before falling to -1.1 percent by 2012 and then returning to 1.7 this year. Similarly in the AFS, the gap went from 6.9 percent in 2007 to 8.7 percent by 2010 to 7.1 percent this year.
Source: CBO, CRFB estimate for 2013 AFS
Furman uses CBO numbers to make the case that "the long run deficit outlook is also considerably better than it used to be." Although there have certainly been improvements, both as a result of enacted legislation and a slowdown in health care cost growth, we wouldn’t call the long-term improvements "considerable." CBO’s own budget director, Doug Elmendorf, agrees. As he explained only a few months ago (emphasis added):
The federal budget deficit has fallen faster than we expected. However, relative to the size of the economy, debt remains historically high and is on an upward trajectory in the second half of the coming decade. The fundamental federal budgetary challenge has hardly been addressed: The largest federal programs are becoming much more expensive because of the retirement of the baby boomers and the rising costs of health care, so we need to cut back on those programs, increase tax revenue to pay for them, or take some combination of those actions.
Policymakers must address our long-term fiscal challenges, not simply assume the problem away.
Saluting Service – Today we salute those who have served the United States in the military with a federal holiday. While many have a day off, lawmakers are taking an extended break from Washington ahead of some bruising budget battles. The House returns to work tomorrow from over a week of recess as the Senate enjoys its own respite this week. But policymakers can’t get away from dealing with unresolved fiscal issues. Several deadlines loom and the U.S. Government Accountability Office (GAO) put out a brief but informative video last week laying out what the national debt is and why it is important. As we pause to honor our veterans, voters aren’t in much of a mood to give much respect to lawmakers as Congress deals with approval ratings at record lows. Will budget talks provide legislators an opportunity to step up?
Budget Conference Has Tough Calls Ahead – The budget conference committee convenes its second formal meeting on Wednesday. The panel will hear from Congressional Budget Office (CBO) director Douglas Elmendorf on the budget and economic outlook. The meeting will come exactly a month before the deadline for the conference to report to Congress. Given the short time frame, the focus is on a smaller deal setting a budget and delaying sequestration for a year or two. Yet, the divisions preventing a bigger deal are still present. Democrats want additional revenue as part of any deal, while Republicans are not budging on their stance against more taxes. Democrats put out a list of tax breaks they want to limit to offset sequester changes. We examined this list of “tax expenditures” to see how much savings could be achieved. Follow our “Tax Break-Down” series looking at more tax expenditures that are potentially ripe for reform, our latest looks at the Low-Income Housing Tax Credit. There could be a less contentious path to a deal; Politico lists ideas (subscription required) that could raise revenues without increasing taxes, which could open the way to a deal.
Taxing Matters – Speaking of taxes, efforts to fundamentally reform the tax code continue. Both Senate Finance Committee chair Max Baucus (D-MT) and House Ways and Means Committee chair Dave Camp (R-MI) plan meetings with members of their respective committee next week according to Politico Morning Tax. Sen. Baucus said he plans to release his first draft of comprehensive tax reform in legislative form within two weeks. Rep. Camp could also unveil his proposal within the same time frame.
More at Stake – While the focus is on the December 13 deadline for the budget conference to report and the January 15 expiration of the continuing resolution, the beginning of the year brings several other deadlines, one of which is the expiration of expanded unemployment benefits. Renewing the benefits for another year would cost about $24 billion while letting them expire would impact some 3 million unemployed workers by the middle of the year according to recent reports. Additional expirations on January 1 include various “tax extenders”, the “doc fix” and the farm bill. See our “Fiscal Speed Bumps” infographic for more fiscal deadlines.
Big Problems Will Just Get Bigger – While the budget conference appears to have little appetite for negotiating a “grand bargain” to comprehensively address the debt, policymakers will not be able to ignore the larger problems forever. A new report from the Congressional Budget Office (CBO) finds that more federal dollars are being transferred to the elderly as opposed to younger generations. As we point out, this generational transfer means that more government funding will go to insurance programs like Social Security, Medicare and Medicaid and less will go to investments that can improve standard of living for future generations. Because of this, we urge that Social Security be a part of the budget conference discussion and suggest how that could happen.
Key Upcoming Dates (all times are ET)
November 13, 2013
- Budget Conference Committee hearing on the budget and economic outlook with Congressional Budget Office (CBO) director Douglas Elmendorf at 10 am.
- Joint Economic Committee hearing on the economic outlook with White House Council of Economic Advisers chair Jason Furman at 2:30 pm.
November 20, 2013
- Bureau of Labor Statistics releases October 2013 Consumer Price Index data.
December 13, 2013
- Date by which the budget conference committee must report to Congress.
January 1, 2014
- The "doc fix," temporary tax extenders, extended unemployment insurance benefits, and the farm bill expire.
January 15, 2014
- The continuing resolution funding the federal government expires.
- 2014 sequester cuts take effect.
- First set of IPAB recommendations expected.
February 7, 2014
- The extension of the statutory debt ceiling expires.
When talking about the debt, it is hard to avoid also talking about generational inequity. Many groups, especially the Can Kicks Back, have worked to highlight how our unsustainable debt path will especially hurt younger generations if lawmakers do not take action. But a new report released by CBO last week shows quantitatively how much of the federal government's resources go to the elderly.
In our first look at the report, we will take a look at the types of households that pay federal taxes and receive federal spending. Additional posts will dive deeper into the distribution of federal spending and revenues by income groups.
The CBO report analyzes the distribution of federal spending and transfers for FY 2006, the most recent year when comprehensive data is available. As a note of caution, however, data from 2006 will not perfectly show today's federal budget because lawmakers have enacted many notable changes to federal taxes and spending since that time and an economy that is still recovering continues to affect how revenues and spending are allocated. Nevertheless, the report is still very insightful.
Not surprisingly for regular readers of The Bottom Line, seniors disproportionately benefit from the federal government after taking into account taxes and transfers. Elderly households on average receive $14,000 more than they contribute in taxes, while tax payments exceeded transfers by $17,000 for nonelderly households with children and by $16,000 for nonelderly households without children. When including other goods and services with transfers, average spending minus taxes was nearly $20,000 for elderly households, while nonelderly households were closer to breaking even.
Of course, much of this overall transfer to the elderly is due to Social Security and Medicare. Most spending on cash transfers and health care is directed at the elderly, even though they do not represent a majority of households. Spending on other goods and services otherwise is mostly directed at nonelderly households.
After seeing the distribution of spending and taxes between elderly and non-elderly groups, some observers may ask: But haven't workers "paid for" these retirement benefits over their working lives, making this distribution of spending not surprising? It's a good question, but according to a previous analysis by Eugene Steuerle and Caleb Quakenbush of the Urban Institute, Social Security taxes largely compensate for benefits later in life for medium and higher-income households but Medicare benefits far exceed taxes paid in -- and this gap will only grow for future cohorts. For a two-earner couple both making the average wage ($44,600) that turned 65 in 2010, lifetime Social Security taxes at $612,000 exceeded lifetime benefits at $583,000, but lifetime Medicare taxes at $122,000 were far below lifetime Medicare benefits at $387,000. Other types of households differ slightly, but generally benefits are close equaling taxes for Social Security, but Medicare is significantly underfunded.
It's also worth noting that CBO's analysis only refers to federal spending, and therefore disregards most of the costs of K-12 education spending, road construction and maintenance, and other state and local spending along with state and local government financing streams. After incorporating state and local spending, the Kid's Share reports from the Urban Institute show that the overall contribution from government is much more balanced across age groups. Still, entitlement spending that mostly goes to seniors will boom in the decades ahead, when there is less indication that spending targeted to children will grow. If sequestration is continued, the proportion of spending that goes to younger generations may in fact be cut. Our post last week noted that a significant portion of the budget can be thought of going to "insurance programs," like Medicare, Medicaid, and Social Security. Over the past few decades, the "insurance conglomerate" portion of the budget has been displacing everything else, and this trend is projected to continue.
Some of the budgetary trends inevitably result from population aging and more seniors beginning to retire -- some expansion of these programs was expected. However, if entitlements continue to grow and the federal debt is not addressed -- there may be little left for key investments in the nation's future and the younger generations. How much of the federal government's resources should go to different age groups is a question for lawmakers and the public, but they should remember that tough choices will eventually need to be made and that projections show our current policies cannot continue forever. Stay tuned for a second look this week when we turn to the overall distribution of federal spending and taxes by income level.
Click here to read the full report.
It has been one week since the budget conference committee's first meeting, and many are speculating that the committee could realistically come up with a plan to replace some of the sequester's temporary cuts with permanent deficit reduction. The budget conference committee has a December 13 deadline to produce a compromise budget. The day of the first meeting, Senate Democrats proposed a list with 12 proposed "tax loopholes" to close along with "responsible spending cuts." The list would raise approximately $264 billion over the next ten years, enough money to offset replacing the sequester for roughly the next two-and-a-half years, or to replace more than 25 percent of the sequester over the next ten years. If these provisions were paired with an equivalent amount of spending reductions, it would equal half of the sequester.
The list included three tax provisions affecting multinational companies proposed by Senator Carl Levin (D-MI). The largest would eliminate the "check the box" provision, which allows multinationals to escape taxation of some of their overseas subsidiaries by taking advantages in the differences between U.S. tax law and that in other countries. The second would limit a company's ability to deduct the interest paid on money borrowed to invest overseas. Another policy would also treat a company that is based in the United States, but has a "tax headquarters" located in another country as a U.S. company. Finally, the Senate Democrats would eliminate the deduction for business moving expenses when those expenses move a business overseas.
The list also included several options that would affect stock options and capital gains: limiting a company's ability to deduct large stock options given to its employees, taxing the "carried interest" received by hedge fund managers as ordinary income rather than capital gains, and reducing incentives to swap derivatives into different forms by taxing them all under the same rules.
The list would also end the ability to deduct mortgage interest on a second home or yacht, close the "John Edwards" loophole that lets self-employed people avoid payroll taxes by setting their own salary, and eliminate the accelerated depreciation schedule for corporate jets. Finally, the Senate Democrats' list incorporates a few more changes proposed in the President's Budget, ending tax benefits for tax-preferred retirement accounts that grow above $3.4 million, and changing the rules on inherited retirement accounts and estate tax trusts.
|Senate Democrats' Proposed Policies
|Eliminate “Check-the-Box”||$80 billion|
|Defer Interest Deductions Related to Foreign Income||$50 billion|
|Limit Corporate Deductions for Excessive Executive Stock Options||$50 billion|
|Close the Carried Interest Tax Break||$17 billion|
|Tax Derivative Contracts on a “Mark-to-Market” Basis||$16 billion|
|Eliminate Mortgage Interest Deduction for Yachts and Second Homes||$15 billion|
|End the "John Edwards/Newt Gingrich" Loophole||$12 billion|
|Limit Tax Benefit for Large Retirement Accounts||$10 billion|
|Treat Companies Managed and Controlled in the U.S. as U.S. Companies||$7 billion|
|Close the Corporate Jet Loophole||$4 billion|
|Close Estate Tax Loopholes||$3 billion|
|End Moving Expense Deduction for Shipping Jobs Overseas||$0.2 billion|
If the conference committee comes to an agreement that, for instance, eliminates the sequester for two years (costing $210 billion) and repeals the same amount in tax expenditures, the official budget score would be zero, but the actual budget picture will be much improved for two reasons. First, Congress may not actually allow the full sequester to take place in future years, so its uncertain savings will be replaced by a concrete amount of new savings. Second, the replaced part of the sequester is temporary and would only save money for a few years, but it would be replaced by permanent savings that continue even after the sequester expires.
The budget conference will need to reach a bipartisan agreement, ideally to replace some of the sequester with responsible, targeted savings, at the least. Senate Democrats have put forward a proposal to generate new revenue by closing loopholes (some of which might be acceptable to Republicans). The more options that on are the table, the more likely that the conference committee will have a substantive agreement.
The Government Accountability Office, the investigative arm of Congress, posted a short educational video explaining the national debt today. In a short time period, it explains the difference between gross debt and debt held by the public, why debt is measured as a percent of GDP, and why the long-term debt situation is troubling.
The video is a good educational resource for the basics of federal debt.
It's no secret that a significant portion of the federal budget is devoted to our national defense and insurance programs like Social Security, Medicare, and Medicaid. As Ezra Klein wrote almost three years ago, the federal government can be thought of as essentially "an insurance conglomerate protected by a large, standing army." But the army's getting smaller too.
A look at our budget over time and into the future, in fact, shows that we're evolving (or devolving?) into a massive insurance conglomerate with a shrinking government on the side.1 The percentage of our budget dedicated to insurance is on pace to reach 70 percent in 10 years, a full reversal from 1970 when only 30 percent was insurance and the rest focused on investment, defense, student loans, and certain low-income transfer programs like food stamps and Supplemental Security Income (SSI).
Obviously, in 1962, many of the components of insurance today -- particularly for health care -- were not yet even in existence. As the war in Vietnam drew down, new programs like Medicare and Medicaid were enacted, and expansions were made to existing programs, insurance spending as a share of the budget ramped up in the late 1960s and early 1970s. But from the mid-1970s until the early 1990s, its share of spending actually remained relatively constant, in part due to cost-of-living-adjustment (COLA) and indexation changes to programs like Social Security and federal retirement, which minimized the practice of providing large increases during election years. With the introduction of discretionary spending caps in the 1990s and a "peace dividend" from the end of the Cold War, the shift continued. From the mid-1990s, though, the split between insurance and everything else remained relatively stable until now, when the sequester and other restraints are shrinking discretionary spending while the baby boom generation is starting to retire and join Medicare and Social Security, and the Affordable Care Act is set to begin in full next year.
Going forward, the sequester and the built-in growth of insurance programs means that an ever-increasing amount of spending will go towards insurance unless policy changes are made. Unchecked growth in these programs will continue to crowd out spending on investments, safety net programs, and defense.
When looking at outlays in constant dollars, it is clear what has happened and what will happen: growth in insurance has and will outpace growth in all other spending.
While the U.S. does indeed have a large standing army, especially in comparison to other countries, in the context of the federal budget, running an insurance conglomerate does and will represent the lion's share of spending going forward. The growth of insurance is on pace to either run up federal debt, necessitate far more in revenue, require other spending to be squeezed further, or some combination thereof. In current projections, all three happen. To halt the ongoing erosion of investment and reverse our debt's long-term trajectory, the insurance conglomerate is going to need some reform.
1 Our data go back to 1962, the earliest point which OMB provides historical data at that level of specificity in Table 3.2. For simplicity's sake, our numbers going forward reflect current law, so the sequester remains in place, war spending is not drawn down, and the refundable credit expansions and doc fix are not extended. For the purposes of this blog, we classify "insurance" as the major mandatory health care programs, Social Security, unemployment insurance, federal retirement, veterans' spending, and related offsetting receipts. That leaves an "everything else" category which includes all discretionary spending and certain other mandatory spending programs, among them non-health low-income programs like food stamps and other things like farm subsidies, student loans, and the FDIC.
The low-income housing tax credit (LIHTC) is the fourth most expensive corporate tax break, and was enacted as part of the 1986 tax code overhaul. The LIHTC is the federal government's largest tax expenditure targeting affordable rental housing and (when enacted) represented a new approach to tax expenditures, rather than relying on direct subsidization.
Under the LIHTC, the government allocates nonrefundable tax credits to state-run housing agencies, who distribute them to housing developers that agree to make a portion of their units available to low-income renters. The housing developers who receive the tax credits then sell them to independent investors to help finance the actual development of the housing units. The investors are ultimately the ones who claim the tax credit rather than the low-income residents of the rental units or the developers.
There are actually two tax credits under the program: a 9 percent credit allocated to new construction projects and a 4 percent tax credit for new construction and rehabilitation projects financed with tax-exempt private activity bonds. Under current law, the 9 percent credit is scheduled to revert back to more uncertain and fluctuating rates next year based on formulas in effect in 2008 — although this provision has a very negligible budget impact. The 9 percent credits are allocated across all 50 states based on population, about $2.20 per person in 2012, which is indexed to inflation each year. For low population states, there is an allocation floor slightly over $2.5 million.
How Much Does It Cost?
According to the Joint Committee on Taxation, the LIHTC will cost $6.7 billion in foregone revenue in 2014, or approximately $85 billion over the next ten years. Likewise, OMB estimates that the LIHTC will reduce revenues to the federal government by an average of about $8 billion each year over the next few years. Corporations claim 95 percent of the credit, with individuals and passthrough businesses claiming the remainder.
According to CRFB's Corporate Tax Reform Calculator, eliminating the LIHTC could finance a roughly 0.3 percentage point reduction in the corporate tax rate.
The costs of the LIHTC are roughly a third of the size of outlays for Section 8 housing vouchers. A large share of LIHTC credits (specifically, the 9 percent credits) are capped based on the per-capita allotment to state housing agencies each year and, therefore, provide a set amount of federal funding committed to support low-income housing, unlike support given through other programs, which can vary from year-to-year.
In terms of overall federal support for housing, including rental housing and home ownership, the LIHTC makes up only a small share of the resources. Data from 2009 from the Congressional Budget Office shows that tax expenditures for rental housing (of which the LIHTC comprises roughly half) were much smaller than federal support for homeownership and even spending on rental housing. (Note: Spending and tax expenditure costs were likely larger in 2009 than in other years as a result of temporary measures, such as the Making Home Affordable program and first-time homebuyer credit.)
Who Does It Affect?
The LIHTC affects developers seeking to build low-income housing units by affecting their access to capital, the investors who ultimately receive the tax credits, and low-income households who may ultimately have greater access to affordable rental housing as a result of the tax credits.
The final rental housing units are meant to serve households with incomes at or below 60 percent of median income in the local community.
The final investors can be individuals, corporations, or financial institutions. Since about 2001, the entities claiming of the majority of the credits shifted from individual investors to corporate investors. One dollar of tax credit allows an investor to claim the tax credit each year for a 10-year period once the project is completed.
According to some estimates, the LIHTC has helped produce 2.6 million housing units for lower-income households, creating over 3.6 million jobs and leveraging $100 billion in private capital. However, data suggests a muted impact overall on the net supply of affordable housing.
In terms of tenant data, in 2008 the government began requiring state housing agencies to provide tenant data to HUD, but HUD has not yet released the information. However, some initial studies show that the tenants of LIHTC units tend to have slightly higher incomes than other federal rental assistance programs, but that more than 40 percent of LIHTC units had occupants who earned 30 percent or less of area median income (a threshold for what's referred to as "extremely low-income" households).
Source: Moelis Institute, NYU.
What Are the Arguments for and Against the LIHTC?
Proponents of the LIHTC include a broad political coalition of developers, intermediaries, and housing advocates. Since the LIHTC brings in potential investors and developers into the low-income housing market who may otherwise not have been involved in the market, proponents argue that it creates a greater supply of housing for households facing few affordable options. The LIHTC has had a better record than other types of public assistance programs in providing affordable housing outside areas of concentrated poverty.
Also, housing experts often point to the flexibility that states have in setting regulations, responding to shifting housing trends, and administering the tax credits to developers — leading to innovations that would be more difficult at a federal level. Additionally, there may political advantages in giving broad authority to state housing authorities instead of the federal government.
Opponents of the LIHTC argue that providing credits does not guarantee affordable housing will actually be constructed, since credit prices and housing supply fluctuate with the economy. For instance, during the recent financial crisis, the market value of the tax credits among potential investors fell sharply as a result of lower risk tolerance (particularly risk that economic changes could wipe away tax liability and, thus, the benefit of LIHTCs) and investors had fewer available funds to invest. As a result, developers faced significant challenges in obtaining financing for developing low-income housing units. Low-income households faced a cutback in supply at the same time that demand for affordable rental housing was increasing as a result of increased unemployment, increased difficulties in obtaining a mortgage, and increased foreclosure rates.
Other opponents have raised efficiency concerns by noting that there are sizable transaction costs associated with the sale of the tax credits, which often flow through independent third parties that help oversee the transactions and compliance regulations, along with an overall complex system to run at all levels. Some estimates peg the total amount of initial equity provided for construction projects falling to roughly 71 percent after transaction and contract costs are factored in, though there is reason to believe competition in recent years has pushed these costs down.
According to available evidence, the LIHTC program may "crowd out" sizable shares of other unsubsidized housing and, thereby, has limited effects on the overall supply of affordable housing. But other research has argued that shortages of affordable housing will dampen this result, as can other factors.
Lastly, many residents in housing units financed in part through LIHTC's often receive other forms of public housing assistance, such as Section 8 vouchers. As a result, it is unclear whether the tax credits are successful in isolation and if subsidies alone could address the challenges of affordable housing.
What Are the Options for Reform and What Have Other Plans Done?
The two large bipartisan deficit reduction plans, the Fiscal Commission and Domenici-Rivlin proposals would both eliminate the low income housing tax credit in favor of lower rates. Stopping the credit allocations to all new projects would raise approximately $40 billion.
Many other proposals would keep the basic structure of the LIHTC in place, but make improvements around the edges. For instance, the President's budget would adjust several parameters of the LIHTC by allowing states to convert unused private activity bonds into LIHTCs that states can allocate and encouraging mixed-income occupancy projects, among a few other small reforms.
Many LIHTC reform proposals would look to replace the tax credits with a voucher program; however, vouchers typically come with a host of other challenges, including higher overall prices for housing given the federal subsidies and the potential reduced supply of affordable housing for lower income households who have limited means but do not qualify for vouchers.
There have also been calls for lawmakers retain the credit in its current form or to expand the LIHTC or other federal programs aimed at promoting affordable housing to better serve even lower-income households. However, some suggest these goals could be better met through initiatives intended to serve more at-risk households, such as the National Housing Trust Fund.
|Revenue Impact from Reform Options for the LIHTC
|Fully eliminate the LIHTC for new and existing credits||$85 billion|
|Eliminate new LIHTC allocations (but honor existing credits)||$40 billion|
|Eliminate new LIHTC allocations, for C-Corps only||$38 billion|
|Replace LIHTC with increased voucher spending for low-income renters||Dialable|
|Reduce LIHTC credit percentage to 8 percent or lower||Unknown
|Replace LIHTC with a tax reduction on rental income||$0 billion|
|Adopt a renters tax credit||
|Reallocate tax credits to states according to need||Neutral|
|Cap the number of rent-restricted households in each LIHTC property||Unknown|
|Allow LIHTC credits to be used against AMT liability||Unknown
|Adopt President's proposal (convert PAB cap to LIHTCs, encourage mixed income occupancy, formula changes, etc.)||-$1 billion|
|Increase LIHTC annual allocations by 50 percent||-$12 billion|
Where Can I Read More?
- U.S. Department of Housing and Urban Development — LIHTC Basics
- Congressional Research Service — An Introduction to the Low-Income Housing Tax Credit
- Mihir Desai, Dhammika Dharmapala, and Monica Singhal — Tax Incentives for Affordable Housing: The Low Income Housing Tax Credit
- Joint Center for Housing Studies, Harvard University — Long-Term Low Income Housing Tax Credit Policy Questions
- Len Burman and Alastair McFarlane —The low-income housing tax credit
* * * * *
The LIHTC is a substantial component of the federal goverment's effort to promote affordable housing, and is one of the larger corporate tax expenditures. But there are many federal housing programs — including public assistance programs, housing vouchers, and other housing tax incentives — and some may be more effective than others at fostering access and greater supply of affordable housing for lower-income households. As lawmakers in both the House and Senate look to overhaul and simplify the federal tax code, they will have to consider how to treat the LIHTC in the pool of hundreds of other reforms.
Read more posts in The Tax Break-Down here.
All eyes are on the budget conference committee, which has a myriad of options available to consider as it negotiates this year's budget resolution. Some advocates and lawmakers have been discussing Social Security reform as an area that might be able to get bipartisan consensus. While the budget conference committee cannot address Social Security due to procedural rules, a separate process to fix Social Security would not only make that program solvent, it would also improve the long-term budget picture.
In our recent paper, What We Hope To See From the Budget Conference Committee, we called on the conference committee to recommend fixing Social Security on a separate track. Although the program is funded by its own stream of revenues, Social Security's costs are increasing as the population ages, from 4 percent of GDP in 2006 to nearly 5 percent today, and will reach 6 percent of GDP before 2030. In fact, the program began running a cash-flow deficit in 2010, which will continue indefinitely and will require the federal government to borrow more going forward to make up the difference.
As a result of the imbalance between revenues and spending, the trust fund for the disability program is projected to run out of reserves in 2016 and the retirement program in the 2030s. If the programs are reformed soon, changes can be much more gradual than if Congress waits 20 years to address the shortfall.
According to our recent paper on the cost of delay, waiting until the program is almost insolvent will require much larger benefit cuts. In a hypothetical example shown below, closing the program's funding gap with only benefit cuts would require a cut of nearly 20 percent this year, 30 percent in a decade, and 83 percent by 2030. Restoring program solvency solely by raising taxes tells a similar story: the costs of waiting grow ever greater. An immediate increase in the payroll tax from 12.4 percent to 15.1 percent would achieve 75-year solvency. If taxes were not raised until 2023, the necessary rate would be 15.7 percent. If we waited until 2033, the necessary rate would be 16.6 percent.
Regardless whether you look at Social Security as a stand alone program or as part of the federal budget, the data unmistakably points to the need for reform. When viewed as its own program, Social Security faces abrupt spending cuts once it exhausts its assets in the 2030s — clearly a bad scenario for beneficiaries. As part of the federal budget, however, even though Social Security has dedicated trust funds and is technically "off-budget," it still pays out more annually than it takes in. Regardless of whether past surpluses were saved in an economic sense or not, the federal government will have to borrow more to make up for its cash flow deficit. If Social Security were brought into balance, the unified deficit would be 20 percent smaller by 2035.
Many think that Social Security reform might actually be easier to tackle, because the demographic trends are clear and there is a fairly short list of options that could fix the problem, which must either increase future revenue into the trust funds or decrease future benefits paid out. We've put together the most common options in the Social Security Reformer, a tool which lets you create your own plan to fix Social Security.
So what can the conference committee do?
In reality, any successful Social Security reform package will contain a mix of benefit cuts and increased revenues. Although the numbers in the budget resolution do not include revenues and outlays for the Social Security trusts funds and the conference committee is not allowed to include any changes to Social Security or issue reconciliation instructions that affect the program, it could make non-binding assumptions about changes to Social Security or call for a process for future Social Security reform separate from deficit reduction.
For instance, the budget conference committee could call for adopting the chained CPI with low-income protections, which includes approximately $230 billion in savings from all parts of government, with the $145 billion in on-budget savings incorporated into the budget resolution totals and a non-binding recommendation that the policy be applied to Social Security as well. The budget conference could include a non-binding policy statement reflecting an agreement to use the Social Security savings from the chained CPI, along with another proposal with some bipartisan support like gradually raising the maximum wages subject to the payroll tax back to its historic norm, as a down payment towards Social Security reform. According to our Social Security Reformer, these two policies together would address nearly half of Social Security's 75-year shortfall. A future Commission tasked with making Social Security solvent would already be halfway to the goal.
The budget could also include a non-binding policy statement calling for a process to restore Social Security solvency, such as a trigger requiring proposals to be submitted to restore solvency with a fast track process for legislative action, a reform commission, or a deadline for Committee markup of a Social Security reform bill. The House-passed budget resolution included such a policy statement: recommending a trigger requiring the Social Security Trustees to submit a plan to restore solvency and requiring Congress to vote on the Trustees' recommendations or an alternative package to achieve solvency.
The conference committee's primary focus should be achievable savings that improve the nation's long-term fiscal situation. The conference committee cannot directly address Social Security, but the committee should not miss the opportunity to establish a process for future Social Security reforms, which will have the side effect of contributing to deficit reduction.
To read our other recommendations to the budget conference committee, click here.
Click for our Social Security Reformer, a tool to show how to make Social Security solvent over the next 10 years.
The Treasury Department released its final estimate of the budget figures for FY 2013 last week, with a final deficit figure of $680 billion. Today, CBO followed up with a breakdown of the differences between their May estimate and the actual totals.
So, how close did CBO get? Pretty close. Overall, CBO projected a deficit of $642 billion in May, $38 billion less than the final estimate from Treasury. Revenues were $39 billion lower than expected, while outlays were $1 billion lower. Below is a full breakdown.
There are a few revisions of note. First, remittances from Fannie Mae and Freddie Mac were $15 billion lower than had been projected in May. Spending by the Department of Education was also $10 billion greater than May's estimate, largely due to the Bipartisan Student Loan Certainty Act of 2013 that increased outlays by $8 billion. These changes were offset by lower spending levels elsewhere in the budget.
There is always some margin of error in CBO's projections, though the agency does a fantastic job. But some future drivers of the long-term debt, especially the changes in demographics, are well established. CBO's longer-term projections show convincingly that without significant deficit reductions efforts, debt will be on an upward trajectory at the end of the decade and balloon in the years after. Even faster economic growth would likely not be enough to reverse course. Given the evidence, we still have a debt problem we need to solve.