The Bottom Line
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.
Sugar Crash – Another Halloween has come and gone. Many kids (and adults) have been quickly going through their sugar-filled loot. Eventually, the candy always runs out and everyone is left with a severe letdown and an empty bag. The thrill of trick-or-treating and the subsequent sugar rush are gone. It feels that way in Washington now. There are no more treats left, though there is still potential for tricks. The budget conference committee has begun deliberations on the right foot, but lots of obstacles remain. Lawmakers are spooked by low approval ratings and lingering voter resentment over the government shutdown, but they are still wary of giving any treats to the other side in order to accomplish anything substantive. The House is out this week and the Senate is out next week. Are there any goodies left in the bag on Capitol Hill, or just stomach aches?
Budget Conference Treats Itself to Positive Start – The budget conference committee formed by the deal ending the government shutdown began formal deliberations last week. The first meeting consisted of opening statements from the 29 committee members. The rhetoric was mostly positive and there was a great deal of common ground in the statements, but the real work is just beginning to get a budget deal. In a hopeful sign, CQ (subscription required) reports that there may be an opening to achieve some bipartisan Social Security reforms, with some Republicans expressing an openness to raising the cap on incomes subject to the payroll tax in exchange for other reforms, such as chained CPI, raising the eligibility age and means testing. The next public meeting is November 13, where the committee will hear from expert witnesses. The committee must report to the full Congress by December 13. CRFB board member Jim Nussle provided his ideas for ground rules in an op-ed. We offer our own thoughts on “What We Hope to See from the Budget Conference Committee.” Need to learn more? Take a look at “Everything You Need to Know About a Budget Conference.”
On the Lookout for Budget Tricks – With agreement difficult to come by between the two parties, the potential for gimmickry is there. It’s happened before. We get out in front by warning against the use of the “war savings gimmick,” which uses the savings from the military drawdown in Iraq and Afghanistan, which is already happening, to offset another policy, such as repealing sequestration.
Don’t Be Fooled, Deficits Are Still a Problem – It was announced last week that the federal budget deficit for fiscal year 2013 was $680 billion, significantly less than the trillion-dollar-plus deficits of the previous four years. While the smaller deficit was heralded by Administration officials, we point out that deficits will begin rising again in a few years because of an aging population. The longer-term fiscal outlook remains troubling and requires thoughtful action. Relatedly, Wall Street Journal economics editor David Wessel responded to the contention of former Treasury Secretary Lawrence Summers that the deficit is not an issue. We made a similar argument earlier. Americans don’t need convincing. A recent poll sponsored by our partners at the Campaign to Fix the Debt shows that the deficit is the top issue (tied with the economy) for voters. And another poll corroborates the finding that Americans support a comprehensive approach to addressing our fiscal challenges.
Will Congress Pull a Doc Fix Out of the Bag? – Last week the House Ways and Means and Senate Finance Committees released a discussion draft of a bipartisan proposal to replace the sustainable growth rate (SGR) formula and make other reforms. The so-called “doc fix” will prevent a 25 percent cut in Medicare physician payments on January 1. Lawmakers still have to find a way to offset the cost of the fix, but plenty of ideas have been presented by bipartisan plans like Simpson-Bowles.
Tax Reform is Tricky, But Could Offer Treats – Efforts to fundamentally reform the tax code continue on Capitol Hill. Senate Finance Committee chair Max Baucus (D-MT) said that next week he will release discussion drafts with specific tax reform ideas. This comes as several members of the budget conference expressed support for creating a fast-track process for enacting tax reform at the first meeting. Other members seem to prefer a piecemeal approach where some tax breaks known as “tax expenditures” are eliminated in order to offset changes to the sequester. Follow our “Tax Break-Down” series to learn more about many of these tax expenditures. There is also talk that the conference committee may target user fees as a means to generate revenue as part of a budget deal without raising taxes. At the same time, several tax breaks, known as “tax extenders” will lapse on January 1. With the focus on comprehensive tax reform, getting another extension is questionable unless part of larger reform. Addressing tax reform is key to getting a smart budget deal.
Key Upcoming Dates (all times are ET)
November 7, 2013
- Senate Armed Services Committee hearing on the impact of sequestration on national defense at 9:30 am.
- Bureau of Economic Analysis releases advance estimate of 3rd quarter GDP.
November 8, 2013
- Bureau of Labor Statistics releases October 2013 employment data.
November 13, 2013
- Joint Economic Committee hearing on the economic outlook 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
Yesterday was the 5th of November, also known Guy Fawkes Day in the UK. But in the US, this date also has special significance for being the day upon which President Bush signed the bipartisan Omnibus Budget Reconciliation Act (OBRA) of 1990 into law, the largest deficit reduction package (in real dollars) ever achieved through reconciliation. The reconciliation legislation contained nearly $750 billion (in 2013 dollars) of deficit reduction over 5 years, through a combination of revenue increases and spending cuts. It included the Budget Enforcement Act, which created caps on separate categories of discretionary spending and the pay-as-you-go (PAYGO) rule for taxes and mandatory spending that requires that any legislative changes that increase mandatory spending or reduce revenue are fully offset. The combination of those changes in policies and rules, as well as the following reconciliation bills, played a large role in acheiving budget surpluses at the end of the decade.
Budget reconciliation is a "fast-track" process that makes it easier for Congress to make changes to spending and revenues that would bring them in line with levels dictated by a budget conference agreement. Reconciliation legislation is given expedited consideration, including passage by a simple majority (a filibuster can be prevented with 51 votes instead of 60) and strict rules for debate and amendments. As we explained in our Q&A, a budget resolution cannot enact policy changes that would affect mandatory spending or revenue, but can set targets for the reconciliation process. The committees of jurisdiction then can decide what policy changes should be made to achieve those targets. Budget reconciliation bills cannot include policies that are not related to the budget and cannot increase the deficit outside the budget window. It was first used in 1980 to reduce the deficit by $8 billion in 1981 through some small changes to entitlement programs and taxes.
The 1990 bill is one of 20 budget reconciliation bills enacted into law, although an additional three bills were passed by Congress but vetoed by the White House. Of those 20, 16 reconciliation bills have reduced the deficit, with the most successful being the 1990 bill and the Omnibus Reconciliation Act of 1993. The graph below shows the 5-year deficit impact of every bill passed in part or in whole through reconciliation since the 1990 OBRA in 2013 dollars.
Source: Congressional Budget Office, Congressional Research Service
Note: Above figures are in 2013 dollars and are approximate
We argued in our recent report, "What We Expect from the Budget Conference Committee," that the conferees should use this opportunity to direct the committees of jurisdiction to achieve significant savings through the budget reconciliation process. History shows that lawmakers can be very successful when they use this tool in its intended way. Hopefully, Democrats and Republicans in Congress can use this moment to pass the largest reconciliation bill in the nation's history.
The Senate Finance and House Ways & Means Committees, last week, released a bipartisan, bicameral discussion draft of a proposal to permanently replace Medicare’s sustainable growth rate (SGR) formula, which is set to cut physician payments by nearly 25 percent next year. The new system would instead freeze physician payments through 2023, but also create a performance-based incentive payment program beginning in 2017 and provide additional bonus payments to health care professionals who join Alternative Payment Models (APMs) that take two-sided financial risk subject to quality metrics, such as some forms of Accountable Care Organizations (ACOs). The 10-year budget cost of the proposal is unclear, though it would likely be slightly above the $140 billion cost of a 10-year payment freeze.
The proposed framework primarily consists of 5 substantial delivery and payment system reforms:
1) SGR Repeal and Annual Update (Cost = $139 billion)
The proposal would permanently repeal the SGR mechanism and freeze base payment updates through 2023 (before any other bonuses or penalties). After 2023, health care professionals (including individual physicians, physician assistants, nurse practitioners, and clinical nurse specialists) participating in an advanced APM(s) would receive annual updates of 2 percent, while all others would receive annual updates of 1 percent. Beginning payment updates after the 10-year Congressional Budget Office (CBO) budget window will help to minimize the cost that must be offset through pay-as-you-go (PAYGO) rules, but lawmakers should be cognizant of the effects of policies over a longer-term horizon when our debt problems will become more severe. Offsetting policies, therefore, should be chosen with an emphasis on those with effects that grow over time.
2) Value-Based Performance (VBP) Payment Program (Cost ≈ $10 billion)
The plan would introduce a new, single budget-neutral program – the Value-Based Performance (VBP) Payment Programs – in 2017 to adjust Medicare payments to professionals based on performance, in place of three penalty programs currently in law. At the end of 2016, the proposal would sunset penalties based on the Physician Quality Reporting System (PQRS) and “meaningful use” of Electronic Health Record (EHR) technology, and the budget-neutral Value-Based Payment Modifier (VBM). The roughly $10 billion, according to the Committees’ estimate, that these would have saved would instead be added to the base off which the budget-neutral VBP adjustments would be made, therefore increasing the cost of the proposal.
The VBP program would adjust payments based on a composite score developed according to success on 1) quality; 2) resource use; 3) clinical practice improvement activities; and 4) EHR meaningful use. Professionals would be given the option to have their quality performance judged at the group level.
The VBP program would apply to: physicians beginning with payment year 2017; physician assistants, nurse practitioners, and clinical nurse specialists beginning with payment year 2018; and all others paid under the physician fee schedule (as the Secretary determines appropriate) beginning with payment year 2019.
3) Encouraging Alternative Payments Models (Savings/Cost = Unknown)
In order to further foster the formation of Alternative Payment Models, such as ACOs, starting in 2016, professionals who earn a significant share of their revenues from an APM(s) that involves two-sided financial risk and meets quality standards would receive a 5 percent bonus payment each year through 2021. The revenues thresholds to receive the bonus payment would increase every two years until 2020, at which point professionals would have to 1) receive at least 75 percent of their Medicare revenue through an advanced APM or 2) receive at least 75 percent of their total, all-payer revenue through an advanced APM, including at least 25 percent of their Medicare revenue. Any professional qualifying for the bonus would be excluded from the VBP payment adjustment program.
The budgetary effect of this incentive program is unclear. On the one hand, the 5 percent bonus payments will cost money, although they do stop after 2021, which should depress the added cost in the second decade. If APMs are able to provide quality care for less money, however, the government would share in those savings and be partially protected against losses since the APMs must take two-sided risk.
Tying the incentives to an APM’s penetration system-wide may also generate additional federal savings if such models are able to offer lower cost health plans on exchanges and in the employer market. It also shouldn’t be overlooked that APMs have the potential to greatly improve the quality and coordination of care, even if the cost savings aren’t as significant as we hope (which is what occurred in the first year of the Pioneer ACO program).
Importantly, though, many details are still unclear from the discussion draft, which are critical to estimating this element’s budgetary effects. How exactly will the shared savings/losses be structured? Will there be a path to partial and/or full capitation? How will the benchmark payment rate be determined? Will APMs be given any tools to steer care to more efficient providers? What level of beneficiary engagement will there be?
4) New Payment Code for Chronic Care Management (Savings/Cost = Unknown)
The proposal would establish one or more payment codes for complex chronic care management services, beginning in 2015, similar to a rule that was recently proposed by the Centers for Medicare and Medicaid Services (CMS). Payments for these new codes could be made to professionals practicing in a patient-centered medical home or “comparable specialty practice.”
5) Reform the Relative Value Scale Update Committee (RUC) Process (Savings = Unknown)
In the wake of negative media attention this year, the Committees’ proposal would begin to reform the opaque AMA/Specialty Society RUC process and establish checks against its findings.
First, it would set targets starting in 2016 for identifying and revaluing misvalued services in a budget-neutral manner, allow for the collection of additional information to better determine the value of services under the physician fee schedule, and also task the Government Accountability Office (GAO) to study the RUC process. It would also “direct the Secretary to ensure that the global payment for the work component of surgical procedures accurately reflects the average number/type of visits following surgery,” which should produce modest budget savings.
This discussion draft is an important step on the path to finally replacing the flawed SGR formula with a long-term fix that focuses on paying for value and quality, rather than volume, of care. Over the long term, this proposal’s aim to move reimbursement away from fee-for-service can be an integral part of bending the health care cost curve, which is essential to reining in our debt.
Comments on the draft are due to the committees by November 12, after which they would release a more detailed proposal.
As the committees’ consider ways to improve the bill, they should weigh whether the final bill provides strong enough incentives for providers to form and participate in APMs and how best to structure incentives to produce improvements in quality and efficiency of care. Given that the current discussion draft would begin positive payment updates after the ten-year budget window, lawmakers may want to condition those updates on the APMs, chronic care management, and other delivery system reforms achieving certain benchmarks for cost savings.
As the SGR replacement continues to take shape, lawmakers must soon also turn to the more politically difficult task of crafting reforms to offset the added costs. First and foremost, they must avoid using gimmicks such as counting savings from the in progress war drawdown or timing gimmicks such as the “pension smoothing” provision that was considered in the recent government funding debate.
Thankfully, numerous bipartisan health reform proposals have been put forth over the past few years, from the Simpson-Bowles Bipartisan Path Forward, to the Bipartisan Policy Center, to the National Coalition on Health Care, to a recent collaboration between the National Coalition on Health Care and the Moment of Truth Project. Lawmakers should ideally focus on structural reforms that improve incentives and have the potential to “bend the cost curve.”
With conference committee meetings underway, many are weighing in with their take on what should be accomplished. On Friday, Fareed Zakaria at CNN compiled a wishlist for Congress, with the help of commentators, analysts, and policy makers. The 12 contributors all had different takes on what the conference committee should address.
- Create a national infrastructure bank: "This would create a mechanism by which you could have private sector participation in raising money, investing, and operating roads, trains and airports." – Fareed Zakaria, CNN
- Put the sequester on hold: "Turn off the destructive sequester for a year or two, without insisting all of it be paid for in the same time period. Set realistic spending caps, mandatory spending adjustments, and revenues consistent with that objective." – Thomas E. Mann, Brookings Institution
- Jobs, jobs, jobs!: "Cancel the sequester cuts that are set to destroy up to 1.6 million jobs for teachers, police, medical researchers, national security personnel, construction workers and others across the country. Include training programs to close the skills gap and needed upgrades to infrastructure, education, and energy systems." – Rep. Frederica Wilson (D-Fla.)
- Give our military resources it needs: "Reversing disastrous cuts and providing our military with the resources it needs to execute its missions should be the paramount objective of any budget negotiation." – Rep. J. Randy Forbes (R-Va.)
- Fix the budget process: "Everything should be on the table, including repealing or replacing the debt limit, redesigning the structure of congressional committees, and rethinking the ban on earmarks." – Donald Marron, Urban Institute
- Invest in basic research: "It’s time to reverse the March sequester, which will cut federal spending on R&D by $95 billion by 2021." – Bhaskar Chakravorti, Fletcher School, Tufts University
- Reform Social Security and Medicare: "Let seniors keep current benefits, but alter the programs for those who retire in 2023. Medicare needs to be reformed through competition. The retirement age for Social Security therefore needs to be gradually raised, and the indexing of benefits changed to reflect a more accurate level of prices in the economy rather than wages." – Diana Furchtgott-Roth, Manhattan Institute
- Drop the high stakes showdowns: "Any agreement that showed an ability of Congress to compromise, and provided some degree of automaticity to the debt limit extension, even for a period of time would be an important achievement." – Robert Kahn, Council on Foreign Relations.
- Major tax reform: "Tax reform should include family-friendly reforms and severe curtailment of popular tax breaks; corporate tax reform which significantly lowers the corporate rate (down to zero, ideally); and an increase in discretionary spending on socially valuable infrastructure, basic research, and other public goods." – Michael R. Strain, American Enterprise Institute
- Invest in high quality preschool: "Modernizing our deteriorating infrastructure and delivering high-quality preschool to all children are two of the best investments we can make in our future." – Harry Stein, Center for American Progress
- Slash farming ‘welfare’: "The current Direct Payments program and a related shallow loss program known as ACRE should be terminated. Crop insurance subsidies should be rolled back to pre-2001 levels and capped at $40,000 per farm." – Vincent Smith, Montana State University
- Tackle short and long term together: "For the short run, return government spending to pre-sequester levels and provide a modest level of additional stimulus by raising infrastructure spending. For the long run, take serious steps to reform Medicare and Social Security. Reform the tax code but also bring marginal rates to the vicinity of Clinton era levels." – Mark Gertler, NYU
- Put the debt on a downward path as a share of GDP
- Set sustainable and responsible discretionary spending levels
- Use reconciliation to produce real deficit reduction and reform
- Focus on the long term
- Fix Social Security on a separate track
- Avoid budget gimmicks
The Obama Administration made an administrative change today to rules regarding Flexible Spending Accounts (FSAs) that could cost taxpayers hundreds of millions or even billions of dollars over the next 10 years. The rule change permits employers to allow employees to now roll over up to $500 of unused funds from year to year, in contrast to the "use it or lose it" rule that previously prevailed, which was intended to prevent people from sheltering income in FSAs even if they had no intent of using the money that year.
Our recent Tax Break-Down on FSAs took an in depth look. Only some employers offer them, but contributions to FSAs avoid taxation and are used for medical expenses that are not covered by insurance or dependent care. The Affordable Care Act reduced the maximum amount that could be contributed to FSAs from $5,000 to $2,500 starting this year. That change apparently prompted the Administration to make this rule change, since the tax benefits of FSAs have been reduced significantly.
Still, the change does not come without a cost. Last year, CBO scored a bill with a similar but more expansive policy as costing $4 billion over ten years, with $3 billion coming from income taxes and $1 billion from payroll taxes. Our FSA blog shows that allowing unlimited rollovers would cost $10 billion. Repealing FSAs entirely would save $60 billion over ten years.
Proponents of FSAs argue that they strengthen federal support for health care by providing more complete insurance coverage, and treating contributions as pre-tax dollars puts their treatment in line with other fringe benefits. Opponents of FSAs, however, highlight that the subsidy is regressive since its tax benefit depends on a person's tax rate, and that they encourage higher and perhaps wasteful health care spending. On the latter point, this change would have offsetting effects -- people would contribute more to FSAs, but it would limit the amount of wasteful spending at the end of the year to draw down their funds -- but it would likely on net increase health care utilization. Most major bipartisan fiscal proposals, such as Simpson-Bowles and Domenici-Rivlin, would eliminate the tax-preferred status of FSAs altogether.
As lawmakers look to replace the sequester with smarter deficit reduction, it may be tempting to look for easy ways out. Unfortunately in recent months and years, that has led some elected leaders to turn to the war gimmick because of the sheer size of the phony savings. Both lawmakers and outside groups have suggested using the war gimmick to "pay for" sequester repeal, a permanent "doc fix," and transportation spending. Any such efforts to use the war gimmick this fall and winter as the budget conference committee works toward a bipartisan agreement must be avoided at all costs (or actually, at no cost to the budget).
What Is the War Gimmick?
Funding for the wars in Iraq and Afghanistan is treated in its own budget category known as "overseas contingency operations," which are not subject to spending caps like the non-war defense budget and domestic discretionary spending programs are. In making its budget projections, CBO is required to assume that un-capped discretionary funding, such as war spending or emergency aid provided in response to Superstorm Sandy last year, will grow each and every year based on the rate of inflation.
However, it has been anticipated for years -- and already happening -- that the U.S. will draw down its commitments in Iraq and Afghanistan. Thus, the difference between the drawdown war spending path and the higher spending projections in CBO's current law baseline lead some people to incorrectly claim "savings" from the drawdown. All three major budgets this year -- from the House, Senate, and the President -- called for a continued drawdown of the wars, albeit with different paths. What is very worrying, however, is that some budget proposals actually count this toward their savings totals.
Source: CBO, OMB, SBC
It could be potentially argued that the initial change in plans by the Obama Administration several years ago to speed up the drawdown of the wars, compared to existing plans at the time, could be considered as savings. However, saying that just because we're spending less on wars which were always going to be temporary and which were unpaid for in the first place somehow qualifies as savings is a bit of a leap at best. CRFB president Maya MacGuineas analogized this perfectly in a press release on the President's budget last year:
Drawing down spending on wars that were already set to wind down and that were deficit financed in the first place should not be considered savings. When you finish college, you don’t suddenly have thousands of dollars a year to spend elsewhere – in fact, you have to find a way to pay back your loans.
Why It Reflects Irresponsible Budgeting
The very concerning problem with the war gimmick is that some lawmakers try to count the phony savings toward a deficit reduction target or (more worrying) try to count it as an offset for other costs.
- Counting the war gimmick toward a deficit reduction target: The first method was particularly concerning during the Super Committee discussions, when using the war gimmick would have reduced the need for finding other legitimate savings to reach its $1.5 trillion target. But the Super Committee was unable to find any savings. Additionally, as lawmakers look to enact another $2+ trillion in savings to put the debt on a downward path as a share of the economy, in order to reach a total of $4-$5 trillion in cumulative savings, the war gimmick could detract from finding real savings. Unfortunately, the President's budget claimed $508 billion in "savings" through 2023 by reducing war spending. We let him know loud and clear that this was very irresponsible.
- Using the war gimmick to offset new tax cuts or spending: Even more worrying would be for lawmakers to use phony war savings to offset new tax cuts or spending -- thereby making future deficits and debt worse. Again, unfortunately the President's budget would set aside $167 billion of war "savings" to fund new surface transportation projects. Also, the Senate unveiled a proposal earlier in the year to replace parts of the sequester with war "savings". Again, we called it out as irresponsible. And in the past, some have called for using the war gimmick to offset the costs of replacing the Medicare SGR. This would again be a terrible gimmick, especially given the many health care options out there to offset the SGR with.
Note: Numbers are based on January 2012 baseline, so they are not up to date for the current baseline.
* * * * *
Using the war gimmick to offset other costs or to count toward deficit reduction would send a message to the American public and our investors that we are not serious about controlling the debt. In fact, it would send the message that not only are we not serious, but we are going to try to trick everyone that we're actually doing something productive on the deficit. That's the height of irresponsibility.
We encourage lawmakers to put a cap on war spending to better reflect actual policy and prevent defense budget gimmickry but not to claim savings for it.
Update: This blog has been updated to clarify how war spending is accounted for in the budget.
As if we needed more proof that the country is ready to deal with our debt problem, the Peterson Foundation today released the results of a new poll that showed both Democrats and Republicans would support a bipartisan solution for the debt. Of the over 1,000 registered voters that were sampled, 95 percent wanted to see Democrats and Republicans work together to solve the country's fiscal problems.
Also notable was the support for a long-term plan for dealing with the country's debt problem. Among the findings:
- 94 percent of voters believed that lawmakers needed a long-term plan to deal with the debt instead of relying on short-term fixes in times of crisis
- 90 percent of voters believed that the lack of a long-term plan was creating uncertainty and having a negative effect on the economy
- 88 percent of voters believed that the budget conference committee must reach an agreement and 89 percent of voters believe the conferees should focus on the long-term problem
The results are encouraging and not surprising. Just one week ago, the Campaign to Fix the Debt released a poll with findings showing that Americans are supportive of a comprehensive debt deal. When included in a comprehensive deal, entitlement and tax reform received strong support. This is even true for specific policies that have often been suggested for a bipartisan deficit reduction package, with the chained CPI, Medicare means-testing, caps on tax expenditures for higher earners, and raising the taxable maximum for Social Security all receiving support from a majority of those polled.
The Peterson Foundation and Fix the Debt polls should send a strong message to the budget conferees, who began meeting this week. Said President and COO of the Peterson Foundation Michael Peterson:
Despite Congress’ inability to reach bipartisan compromise, a majority of Americans in both parties are willing to agree to difficult policy changes to achieve a long-term plan on our national debt...The Committee should use this opportunity to put America’s fiscal and economic future above politics, and move our great nation past these short-term fire drills once and for all.
The American people support compromise. It's up to lawmakers to see it through.
Click here to see the topline numbers from the Peterson Foundation/Global Strategy Group poll.
Two weeks ago, we responded to a Larry Summers op-ed calling for a focus on growth rather than deficits. Yesterday, Wall Street Journal economics editor David Wessel also responded, breaking down the arguments into three and taking them on one by one. He agrees with us that the short-term deficit isn't the issue, but the long-term deficit is. It cannot be hand-waved away, and it would be wise to take action sooner rather than later even if the changes in the legislation don't take effect right away. Wessel outlines his piece as follows.
Summers Argument 1: The deficit isn't an immediate problem; growth is.
Wessel agrees with the main thrust of this point, that the short-term deficit is not a concern. He points out that the deficit is coming down for now, and the federal government currently can borrow at low interest rates. And given that the economy is far from reaching full employment and potential GDP, measures like the sequester do harm to short-term growth right now.
Summers Argument 2: We've done enough.
An argument that essentially flows from Summers' argument one is the fact that just by increasing growth, we can make the long-term fiscal picture sustainable. Summers claimed that additional annual growth of 0.2 percentage points would do so, a calculation that we disagreed with. Wessel also points out that ignoring the debt because debt would be on a downward path for the next five or so years is problematic. The debt could actually be a problem sooner than one might think:
The CBO also says government debt is now higher than at any time in U.S. history except for World War II. It's nearly double what it was before the recession. That gives the U.S. much less maneuvering room were it to be hit by another financial crisis or terrorist attack. Mr. Summers says we can, as he puts it, "reload the fiscal cannon" later when the economy is stronger. But "later" to elected politicians often turns out to be "too late" or "never."
And consider this: interest accounts for 6% of federal spending today. If the economy does as well as White House economists expect and if Congress takes every spending and tax suggestion the president has made, the White House says it'll be 14% of federal spending in 2023. That threatens the very investment spending Mr. Summers prizes.
Summers Argument 3: The future is so uncertain that acting now is unwise.
Summers made this point in his op-ed, arguing that we were within the margin of error of sustainability given the magnitude of the error in CBO's budget projections. We have addressed this point before, noting that projections could easily be much worse as well as much better -- a point that Summers acknowledged himself. His response is that we should wait until the evidence is clear that we need to act to put the debt on a sustainable path. We, of course, think that at that point it would be too late, and factors like demographics are relatively predictable over a long period of time. Wessel agrees, saying:
But there are risks of waiting, too. We've promised health, retirement and other benefits that will cost more than today's tax code is projected to produce. If we're very lucky, the economy will do so surprisingly well that those two lines will meet.
What if we aren't lucky? That'd make for some pretty abrupt and painful changes to Social Security, Medicare and Medicaid later. As with climate change, there's a case for taking precautions by legislating money-saving changes today that take effect when the economy is stronger.
Wessel concludes by saying that the only way we will be able to get right-minded fiscal policy which eases up now and makes our fiscal path sustainable over the long run is to do what we have been calling for: enact a large deficit reduction agreement. Not only would that be a good growth strategy for the short term, but it would also be a boon for the long term.
Update: This blog has been updated to include the Mid-Session Review and CBO projections for the 2013 deficit.
Yesterday, the Treasury Department and the Office of Management and Budget released final budget results for Fiscal Year 2013, which ended on September 30. The deficit fell to $680 billion - a drop of more than $400 billion from the $1.1 trillion deficit posted in 2009. Last year's deficit also came in substantially under the President's budget projections from April, which had projected the year-end deficit would be $919 billion, and the Mid-Session Review projection of $735 billion. It was also $40 billion above CBO's projection in May. Although this year's deficit has shrunk, deficits are projected to start growing again as a percentage of the economy after 2018 and the long-term debt problem driven by health care costs and an aging population has barely budged.
Treasury Secretary Jack Lew said in a statement that the deficit has fallen faster over the last four years than any period since World War II, but it's not coincidental that the fall comes off of the highest deficit since WWII, driven by the 2008 recession and stimulus spending. The deficit fell from 10.1 percent of GDP in 2009 to 4.1 percent of GDP in 2013, a drop of 6 percentage points. There was actually a larger drop in the deficit in the 1990s over a longer time period, from a 4.7 percent deficit in 1992 to a 2.4 percent surplus in 2000.
More to the point, this drop in deficits was largely a predictable result of a recovering economy. The year-end deficit of 4.1 percent was nearly the exact 4.2 percent deficit that the Congressional Budget Office predicted in May, or the 4.3 percent deficit predicted in January 2011 before any deficit-reduction agreements or sequestration. The new caps on discretionary spending enacted in the 2011 Budget Control Act saved money, but the savings were wiped out by additional spending and tax cuts enacted as part of the fiscal cliff deal last January.
Source: Congressional Budget Office
Even though our deficit is projected to shrink over the next few years, the predictions for the future decades have not gotten any rosier. Unlike World War II, when budget deficits were projected to decline dramatically due to a combination of ending the war, US global dominance, an expanding labor force, and decades of close-to-balanced budgets, our debt is now projected to rise unsustainably for the foreseeable future. Health care cost growth, an aging population, and rising interest costs all threaten to increase the debt, which is projected to rise to World War II levels by 2040. This rising path will be difficult to reverse unless lawmakers are willing to look at all parts of the budget, in particular entitlement and tax reform.
Source: Congressional Budget Office
The solution should not myopically focus only on short-term spending cuts like the sequester, which cut indicriminately, hurt economic growth, and only produce savings over the next few years without addressing the long-term drivers of our debt: health care costs and population aging. The solution should be focused on responsible, targeted, long-term savings, even if the short-term savings are more modest. The budget conference committee began negotiations yesterday, and hopefully will begin to tackle these issues. Along with agreeing to a budget for FY 2014, we hope they will focus on policies that can produce long-term savings to address our long-term debt challenges.
To see more of CRFB's recommendations, see our paper What We Expect From the Budget Conference Committee.
This is the thirteenth post in our blog series, The Tax Break-Down, which will analyze and review tax breaks under discussion as part of tax reform. Our last post was on the Foreign Earned Income Exclusion, which benefits U.S. citizens living abroad.
The FICA Tip Credit allows restaurants and bars to receive an income tax credit for employer-paid payroll taxes on employee tips. By eliminating the amount of payroll tax that employers pay, the credit theoretically eliminates an employer’s incentive to hide or underreport tip income. As a result, more revenue is likely to be collected from the employee’s portion of the payroll tax and larger wages are counted for the purpose of calculating Social Security benefits.
Currently, employers and employees each pay payroll taxes on wages to fund Social Security and Medicare (generally 6.2 percent each for Social Security and 1.45 percent each for Medicare). In the restaurant industry, where much of the employee’s compensation is in the form of cash tips, it is harder to determine and report wages. Workers who receive more than $20 in tips per month are required to report these tips to their employer, who reports this income and withholds FICA taxes.
Before the credit in 1982, the IRS estimated that only 15% of tip income was reported. After the credit was enacted, the IRS still estimated that fewer than 40% of all tips were reported in 1998; roughly $9-$12 billion in unreported income. In 2010, the IRS estimated it received only a quarter of the tip disclosure forms it was supposed to receive.
In the seven states where tipped workers must be paid equally to non-tipped workers, the credit is simple: employers get a credit equal to the amount of FICA tax they paid on tips, essentially making the FICA tax free. In the other 43 states where tipped employees can be paid less than minimum wage, employers cannot claim the credit for the portion of tips that are needed to bring a server’s wage up to $5.15, the minimum wage that prevailed prior to 2007.
Prior to 1987, restaurant employers were responsible ofor FICA taxes on tips up to the minimum wage, while employees were taxed on all wages and tips. After 1987, the minimum wage ceiling for employers was removed, but the restaurant industry demanded concessions for this tax increase. The FICA tax credit was enacted six years later, in 1993. Because Congressional budget rules make it difficult to reduce Social Security revenues, the credit was structured as it is today: employers pay full payroll taxes on tips above the then-current minimum wage ($5.15) and receive a dollar-for-dollar credit on their income taxes. When Congress raised the minimum wage in 2007, they left the minimum at $5.15 for the purpose of calculating the FICA credit.
The credit is not refundable, so employers must owe some taxes in order to claim it, but unused FICA credits may be carried back one year or carried forward up to 20 years.
How Much Does it Cost and Who Benefits from It?
According to the Joint Committee on Taxation (JCT), the credit for employer-paid FICA taxes on tips will cost $1.3 billion in 2013, which would be the equivalent of nearly $17 billion over the next ten years. About 60% of the tax benefit goes to C-corporations; the remaining 40% accrues to pass-through entities and individuals, according to JCT.
According to CRFB’s Corporate Tax Reform Calculator, eliminating the credit would allow for a 0.1 point reduction in the corporate rate.
What are the Arguments For and Against the Credit for Employer-Paid FICA Taxes on Tips?
Supporters of the FICA tip credit argue that this tax provision actively encourages accurate tip reporting, as employers are incentivized to report all tipped income in order to maximize the credit. They claim that the tax break actually raises money from increased reported tip income more than the cost of the credit, addressing a small portion of the $14 billion in FICA taxes that go uncollected each year. Further, by reporting and paying taxes on their full income, employees maximize their future Social Security benefits.
Opponents of this credit argue that no other tip-driven industry receives a similar credit, which unfairly benefits restaurants over other service industries. This credit encourages income in the form of tips rather than in the form of wages and puts downward pressure on wages for restaurant workers. They further argue that employers should not receive a tax benefit for simply complying with their legal obligation to report income. This credit can also be seen as a back-door subsidy to Social Security: the government loses income tax revenue in order to encourage higher FICA tax revenue.
What are the Options for Reform and What Have Other Plans Done?
The FICA tip credit could be maintained in its current form, repealed entirely, or modified in a number of ways. Fully repealing the credit, according to JCT, would raise about $8 billion. The revenue is about half the value of the tax expenditure, since some of the revenue gained from eliminating the credit would be lost as a result of lower reporting. Alternatively, cutting the credit in half might retain much of the reporting incentive but at a lower cost to the taxpayer.
Other options to reduce the cost of the tip credit include: raising the minimum wage for the credit ($5.15) to the current federal minimum wage of $7.25; disallowing the credit against the alternative minimum tax (as it was prior to 2007); or reducing the carry-forward period from 20 years to 15 years (as it was prior to 1997). Each of these options would save less than $1 billion over a decade.
If lawmakers instead wanted to expand the credit, they could make it available to other tip-dependent businesses such as hair salons, hotels, taxis, or tour guides.
Neither the Bowles-Simpson or Dominici-Rivlin plans include the FICA tax credit on the short list of tax breaks they would keep, choosing to repeal it in favor of lower rates and deficits. The Wyden-Gregg plan keeps the tax credit for employer-paid FICA taxes on tips.
Where Can I Read More?
- National Restaurant Association – Testimony to the Ways and Means Committee on Reforming the Internal Revenue Code
- The CPA Journal – Unreported Tip Income: A Taxing Issue
- Internal Revenue Service – Bulletin
- Internal Revenue Service – Voluntary Compliance Agreements – Restaurant Tax Tips
- Department of Labor – Minimum Wage for Tipped Employees
- Marketplace – IRS keeping Tabs on Restaurant, Bar Tips
- Wall Street Journal – IRS Rule Leads Restaurants to Rethink Automatic Tips
- SS&G – Tax Issues Specific to the Restaurant Industry
The FICA Tax Credit offers restaurants and bars an income tax credit which exactly offsets the amount paid in payroll taxes, eliminating the incentive to pay tips under the table. Although the credit may enhance tip reporting, some argue that the credit unfairly benefits restaurants over other tip-based industries and gives employers a payout for simply doing what they are supposed to do -- complying with tax law. While reforming the tax code, Congress could choose to keep this break, reform it, or repeal it in favor of lower tax rates and/or deficits.
Yesterday, the Social Security Administration announced that beneficiaries will be receiving a 1.5 percent Cost-of-Living Adjustment (COLA) this year. Although this update is below the 1.7 percent increase provided this year and the 3.6 percent increase provided for 2012, it is reflective of the relatively low inflation experienced over the past year.
Some groups and commentators have suggsted that this COLA is too small relative to growing living costs, a claim that does not account for the fact that while some prices have gone up faster than 1.5 percent (for example meat prices rose by about 2 percent), others have grown more slowly or fallen (for example, gasoline prices have fallen by about 2 percent).
Other groups have used the COLA announcement as an opportunity to blast efforts to adopt a more accurate measure of inflation, or to call for indexing Social Security with an experimental senior-specific index known is the CPI-E. Because seniors spend more on health care and housing, they argued, their COLA should be measured with a senior specific index.
As we have pointed out before, however, the case for the CPI-E is quite weak. Among our concerns with adopting the CPI-E are:
- The CPI-E is highly experimental. The Burea of Labor Statistics, who publishes the CPI-E, has explained it is not ready for prime time.
- The CPI-E suffers from substitution bias, like the traditional CPI, and also suffers from a much more significant small-sample bias.
- The CPI-E does not apprioriately account for things like mail-order shopping or for senior discounts.
- The CPI-E likely overstates the impact of growing health prices by conflating increases in value with increases in price.
- The CPI-E misstates the impact of housing on cost-of-living by imputing rental value for homeowners. 80 percent of seniors are homeowners and 70 percent of them have paid of their mortgages (compared to 60 percent and 17 percent of non-seniors). When the value of their homes go up, the CPI-E measure this as if they face higher rental prices.
For these reasons and more, the CBO has questioned whether the elderly actually face higher inflation than the general population at all. And if they do, almost all evidence suggest it is by less than the CPI-E would suggest.
Adopting the CPI-E would also raise questions of fairness. What should happen to the non-elderly portion of the Social Security population? Should they get a smaller COLA? Should each inflation-indexed program and provision in the budget and tax code get its own index? Why should we adjust for a 0.2 percent claimed difference in inflation between seniors and non-seniors but ignore the 0.9 percent difference between New York and Detroit?
Ultimately, well-intentioned efforts to make government benefits more accurate and fair through the CPI-E would do the opposite, making them less accurate and less fair. Instead, policymakers should use the most accurate measure of economy-wide inflation available -- the chained CPI -- and use that measure to meet the stated goal of inflation indexing. It is our more accurate because, as our paper "Measuring Up" explained:
Moving to the chained CPI would address [upper-level substitution] bias by using a superlative index that updates expenditure weights and formulas in order to address consumer response to substitution between categories. As the Congressional Budget Office (CBO) explains, the chained CPI "attempts to fully account for the effects of economic substitution on changes in the cost of living... [It] provides an unbiased estimate of changes in the cost of living from one month to the next by using market baskets from both months, thus 'chaining' the two months together."
Other targeted concerns should be met with targeted reforms, not across-the-board mismeasurements. For example, the risk of outliving ones savings in very old age could be addressed with a benefit bump-up for the very old. And the risk of catastrophically high health care costs among a small group of seniors -- which appears to be responsible for much of the difference in health spending between seniors and the population at large -- could be addressed through cost-sharing reform that limits out of pocket costs.
Those focused on the COLA as a vehicle for making policy often forget what it is there for: to reflect cost-of-living increases over the previous year. The chained CPI best lives up to that goal.