The Bottom Line

August 1, 2013

The talk of the town in recent days has been President Obama's new plan to combine corporate tax reform with public investments in what President Obama calls a "grand bargain for middle class jobs." From a growth perspective, there is a lot to like about this proposal. But there is also a lot we find discouraging about a plan which would decouple corporate tax reform from any broader deficit reduction effort. In our view, the best and most productive way to achieve corporate tax reform and boost public investment is through a comprehensive plan that also includes individual tax reform and entitlement reform in the context of medium- and long-term deficit reduction.

The Nuts and Bolts of the President's Proposal

For the most part, the President's new bargain is a rehashing of various investments in his budget, coupled with his business tax reform framework, which calls for the corporate tax rate to be reduced to 28 percent, many corporate tax preferences be eliminated, and incentives for manufacturers and small businesses to be increased.

At the time the framework was released last year, the President called for his tax reform to be revenue-neutral. However, corporate tax reform which is cost-neutral over the first decade is likely to lose revenue over the long-run because, as the Center on Budget and Policy Priorities explains, "many corporate tax subsidies are structured in such a way that scaling them back would generate much larger savings in the first ten years than over the long run."

To ensure corporate tax reform doesn't add to the deficit over the long-run, the President is now calling for reform where base broadening exactly pays for rate reduction over the long run but generates new net revenue in the ten-year period. That net new revenue would go to temporary investments such as those in the President's FY 2014 budget proposal for direct infrastructure investment, a national infrastructure bank, new infrastructure bonds, and various job training and community college initiatives.

The exact source of the ten-year revenue need not be specified since it can come from a combination of reforms, but one option which has been floated is to use revenue from a temporary transition tax on foreign income that could accompany broader international reform. Another possibility is to use the portion of the revenue from repealing or reducing accelerated depreciation schedules which represents a timing shift in tax payments, while leaving the portion which represent a permanant change in tax burden for rate reduction. 

Overall, the plan includes some encouraging aspects but also many negative aspects.

The Good News

In the past, we've called on policymakers to "go smart" and "go long" by focusing on economic growth and looking beyond the ten-year budget window. The President's proposal would, to some extent, do both.

As we've explained before, corporate tax reform can be an important part of an economic growth strategy to make United States businesses more competitive. For example, a 2005 Joint Committee on Taxation (JCT) study concluding that even a deficit-financed reduction in the rate to 28 percent would raise GDP by 0.2 to 0.4 percent. Using base broadening to reduce rather than increase the deficit and removing various distortions in the tax code could have additional economic benefit.

On top of the benefits from corporate tax reform, the President's proposed investments in infrastructure and job training initiatives could help to increase employment in the short run by boosting aggregate demand and could increase the productive capacity of the economy over the long run by boosting the supply of physical and human capital.

In addition to his plan likely being pro-growth, it is encouraging to see the President focus on the long-term deficit impact of corporate tax reform rather than just the first ten years. A number of perfectly sensible reforms will have the effect of raising more revenue in the first decade than over the long-run. By demanding that corporate tax reform look beyond the first decade, the President is ensuring the plan won't add to the debt over the long-term, when population aging and growing health care costs will present us with enough fiscal challanges as is. This focus will also discourage explicit timing gimmicks, such as the Roth IRA provision included in the fiscal cliff agreement.

The Bad News

Although there is some economic virtue to the President's plan, there is also much to be concerned about.

Reasonable people can disagree on whether corporate tax reform should be a revenue-generating or revenue-neutral part of a broader fiscal plan, but the President's proposal to make corporate tax reform revenue-positive and put none of that money toward deficit reduction seems to us a mistake.

The political challenges of generating an agreement which includes new net revenues are substantial. With $2.2 trillion of further deficit reduction needed to put the debt on a clear downward path, using none of that revenue for deficit reduction would be a significant missed opportunity in our view.

It would also be a mistake to divorce corporate tax reform from individual tax reform. The two codes are intertwined, with most businesses filing as "pass-through entities", paying on the individual side and with many corporate tax expenditures available to those businesses. Decoupling corporate and individual reform will mean either accepting a large divergence between the rates and/or tax base paid by C-Corps and pass-through entities or else devising a complicated and costly work-around.

Even if a solution for pass-through entities could be worked out, abandoning individual reform would be a fiscal and economic mistake. The individual tax code suffers from substantial complexity and costly distortions and should be addressed in ways that will lower rates, broaden the base, promote economic growth, and contribute to deficit reduction.

The Disappointing News

Failing to use new revenue for deficit reduction and seperating corporate from individual tax reform are problematic in our view. But our biggest concern is the President's decision to decouple corporate tax reform from the broader deficit reduction effort.

With few sweeteners left available for deficit reduction, the Administration had previously conditioned corporate tax reform on a broader set of changes to both raise revenue from high earners and slow the growth of entitlement programs. Although the President has not abandoned his call for deficit reduction, that he has decoupled it from tax reform and seemingly deprioritized it relative to tax reform is quite discouraging.

Indeed, any "grand bargain" for middle-class jobs is not complete without a plan to bring the debt under control. As it currently stands, sequestration is hurting short term growth, and our large debt burden will hurt long-term growth potential. New investments and corporate tax reform can make improvements on the margins. But absent a comprehensive plan to address the sequester, reform the individual tax code, reform entitlement programs, and put the debt on a clear downward path, it isn't clear that sustained growth will be achieved over the long term.

Now isn't the time to think small, it is time to think big. We are big fans of corporate tax reform which our corporate tax calculator shows can be designed a number of ways. But what the President has proposed is a mini-bargain. What we need is a grand bargain.

August 1, 2013

Yesterday, the House Transportation-Housing and Urban Development (THUD) appropriations bill was removed from floor consideration, showing a lack of consensus in Congress regarding how to live within the existing caps. The question of how the Congress should replace sequestration in a fiscally responsible manner is becoming increasingly important with this decision.

Both the House and Senate have both been pursuing appropriations bills that would violate sequestration in some way for FY 2014. The Senate has set overall funding levels at the pre-sequester levels, while the House has chosen to keep the sequester caps, but reallocate funding so that defense spending is funded at the pre-sequester mark, requiring further cuts to nondefense discretionary spending. The House's THUD bill would have required a $4.4 billion cut from post-sequester levels, with an overall funding total not seen since 2006. Pulling the bill from the floor shows that abiding by the steep cuts to discretionary spending required by the sequester for 2014 will be difficult.

House Appropriations Chairman Hal Rogers (R-KY) expressed his disappointment in a statement and argued that yesterday's actions were evidence that the sequester needed to be replaced with a comprehensive plan:

I am extremely disappointed with the decision to pull the bill from the House calendar today. The prospects for passing this bill in September are bleak at best, given the vote count on passage that was apparent this afternoon. With this action, the House has declined to proceed on the implementation of the very budget it adopted just three months ago. Thus, I believe that the House has made its choice: sequestration – and its unrealistic and ill-conceived discretionary cuts – must be brought to an end. And, it is also clear that the higher funding levels advocated by the Senate are also simply not achievable in this Congress.

This Congress must now deal in a productive way to address the nation’s crippling deficits and debt to put our budget back on a sustainable and responsible path. This means that all government programs – not just those on the discretionary side of the ledger – must be reduced. Spending reductions in mandatory and entitlement programs, which are the drivers of our deficits and debt, are the most effective way to enact meaningful change in the trajectory of federal spending. The House, Senate and White House must come together as soon as possible on a comprehensive compromise that repeals sequestration, takes the nation off this lurching path from fiscal crisis to fiscal crisis, reduces our deficits and debt, and provides a realistic topline discretionary spending level to fund the government in a responsible – and attainable – way.

We agree with Chairman Rogers that sequestration should be replaced with a comprehensive package that puts debt on a downward path in the long term. Rogers aptly points out that spreading the savings throughout the budget is much more achievable than the sequester approach, and additional mandatory and entitlement reforms must be part of the package. As should comprehensive tax reform that simplifies the code and reduces the deficit. But even if a sequester is not replaced with a comprehensive plan, any smaller scale replacement must at minimum be fully offset with equal or greater savings. Waiving the sequester without offsets would be a clear failure on the part of Congress.

Given yesterday's actions, it is clear that the current approach the Senate and House are both taking for appropriations is not working. Ideally, lawmakers will begin negotiations toward a comprehensive fiscal framework before the September 30 deadline, as we described in our report on what we expect in the upcoming fiscal discussions. But at the very least, lawmakers should begin to find offsets for a sequester replacement.

July 31, 2013

The 2008 recession substantially altered the enrollment and operations of many government programs, particularly those providing financial benefits. The Urban Institute further explored one of these programs in a recently released report analyzing the recession's effects on Social Security claiming.

As the report states, Social Security benefits upon retirement are in part determined by the full retirement age (FRA), currently at age 66 and scheduled to be 67 for people born in 1960 and later. While benefits can be claimed as early as 62, benefits are adjusted depending on how much earlier or later than the retirement age they are claimed. The paper notes that the recession and resulting unemployment levels forced many low and middle-income elderly workers into early retirement. Retired worker claims increased 12 percent in 2008 and an additional 20 percent in 2009.

Yet, the Urban Institute finds that this surge in early retirement claims was far from permanent. As the unemployment rate began to fall from it's 2009 peak levels, so did claims. What ultimately fueled the reversal from dangerous early retirement trends was a change in government policy: increase in the retirement age. 

Perhaps the most important change to Social Security was the increase in the FRA, which had been age 65 since the program began. The FRA was raised to 65 years and two months for those born in 1938. It increased another two months for each successive birth cohort until it reached 66 years for those born in 1943. It is scheduled to remain at 66 until it begins increasing two months per year again for those born in 1955 through 1960. Current law sets the FRA at 67 years old for everyone born in 1960 or later.

Increasing the retirement age, as the Urban Institute argues, allowed for the transition from the short-term increases in Social Security claims to a decreasing trajectory as the average retirement age taken by beneficiaries gradually increased. The graph below illustrates the correlation between a gradually increasing FRA and a gradually increasing age of retirement  for those born in between 1937 and 1943. The second spike at which many beneficiaries begin collecting Social Security strongly correlates with the gradual scheduled increase in the FRA.

Source: Urban Institute (Survey of Income and Program Participation)

By increasing the FRA, as Urban argues, policy makers have the ability to "influence retirement decisions by signaling an 'appropriate' time to begin collecting retirement benefits." While claiming benefits later has a muted effect on the Social Security Trust Fund (as those benefits are actuarially-adjusted), the decision to retire later will boost economic growth by increasing the size of the labor force, increase retirement savings, and reduce the longevity risk of beneficiaries outliving those savings. There may be some who are not physically able to work longer, but many solutions have been proposed to address this problem, and the retirement age should not be adjusted based on that minority.

Social Security as it currently stands needs reform, with the trust fund's expected depletion in 2033. We know that we will have to act on Social Security, and an increase in the retirement age should be on the table. Not only will it help the Trust Fund, but it will help increase labor participation among the elderly when Americans are living longer, helping both the budget and the economy. Social Security is in need of reform and changes will be neccessary; raising the retirement age is a good place to start.

July 30, 2013

Early this month, the Obama Administration announced that it would delay enforcement of the employer mandate penalty in the Affordable Care Act for 2014. The employer mandate would have required employers with 50 or more full time workers to pay $2,000 to $3,000 per employee if any of their workers did not receive an affordable offer from the employer and instead obtained subsidized health insurance coverage through a health insurance exchange. The first 30 workers are exempted in calculating the penalty.

At the time, we estimated that the delay would increase spending in the exchanges by about $3 to $5 billion, in addition to revenue losses from fewer penalties of about $10 billion. All-in-all, we estimated about $13 to $15 billion in costs. Now, CBO has put its official score out, estimating that the action would increase the net cost of the ACA's coverage provisions by $12 billion over ten years -- very close to what we roughly estimated!

CBO also estimated the effect for delaying the implementation of an additional layer of income verification for exchange subsidy applicants but found that the effect would be almost negligible.

The bulk of the $12 billion difference, $10 billion to be precise, comes from the lack of employer penalties themselves as 1 million fewer people would receive coverage through their employer. About half of those people would then receive coverage through the exchanges or through Medicaid. As a result, CBO estimated that a $3 billion increase in exchange subsidies. CBO also estimates a $1 billion revenue gain from the lessening employer coverage as employees make up for their loss of health insurance coverage by increasing their taxable compensation.

July 30, 2013

Last week at Knox College, President Obama gave the first of a series of speeches on the economy. He called on Washington to pass policies that would give middle class families a "better shot" in the global economy, emphasizing education, investments, and research. But in a piece today, the Washington Post editorial board notes that President Obama left out a major piece in making the nation more competitive: entitlement reform.

The country's debt path is unsustainable and the problem is unlikely to be resolved without reforms to entitlement programs. If nothing is done, the nation's debt will grow and weigh down growth:

By the tendentious standards of politics, it was okay for the president to challenge Republicans to come up with better ideas than his, while simultaneously portraying most of them as mindlessly bent on a government shutdown. What’s rather less forgivable, however, is that, even though the president of the United States is well into a highly promoted series of major addresses on the future of the U.S. economy, searching the text of his speeches for “entitlement reform” or “entitlement” yields nothing but “phrase not found."

Yes, Mr. Obama told Democrats that they “can’t just stand pat and just defend whatever government is doing.” Addressing Republicans, he pronounced himself “ready to work” on tax reform, or a “balanced, long-term fiscal plan that replaces the mindless cuts currently in place.”

But that’s a far cry from leveling with the public about the fact that Social Security, Medicare and the rest are crowding out other domestic priorities — including those that the president emphasized in his speeches — and that these programs are at the heart of the country’s long-term fiscal challenges, which have still not been addressed even as the deficit has declined in the short term.

Six months into President Obama's second term, there is the question of what the President's legacy will be. The economy is a good place to start. But if the President and Congress want to have a major long-term impact, they should turn to the tough decisions that need to be made on these programs. Writes the editorial board:

As president, Mr. Obama is the one player in the capital’s drama best positioned to represent the national interest on entitlement reform; as a second-term president, he is also in the best position to take the political heat for doing so. It is still possible that he will do so in his remaining speeches. Until then, though, Mr. Obama’s vision for the country can only be described as incomplete.

Click here to read the full editorial.

July 29, 2013

Today, the Center for American Progress (CAP) hosted a panel discussion featuring Center on Budget and Policy Priorities Senior Fellow Jared Bernstein, CAP President Neera Tanden, Concord Coalition Executive Director Robert Bixby, and President of the Committee for a Responsible Federal Budget Maya MacGuineas. 

As a follow up to the Center for American Progress's paper by the same name (that we have responded to here, here, and here) -- which suggested that short-term improvements in budget projections could allow lawmakers to put aside deficit reduction for the next couple of years -- the participants gathered to discuss and debate the urgency of dealing with the national debt, the effectiveness of current policies, and what they believe our future should hold. Although each panelist had different perspectives, they all agreed that policy changes must ultimately be made to create a long-term, fiscally sustainable future.

CRFB President Maya MacGuineas began by explaining the necessity for long-term solutions. She argued that recent deficit reduction measures, most notably the sequester, have not changed our long-term debt outlook as they focus almost exclusively on discretionary spending, a category of spending that is not a key driver of the country's long-term debt. She argued that much more work is needed before the debt is put on a sustainable long-term path, and that true fiscal sustainability will only be achieved when policymakers address the structural drivers of debt including health care, population aging and the tax code.

By enacting such long-term oriented reform, she explained, not only will we begin accumulating savings today, but many of the savings associated with these policies (the chained CPI, for one) will compound in the medium and long run. Furthermore, many of the long-term policies produce little savings in the first few years, making them much better than frontloaded approaches like sequestration. Moreover, MacGuineas showed that although the recovering economy has resulted in lower deficits, our long-term problems are far from solved. Many structural problems that existed before the recession continue to threaten our economy today. It is not the current deficits that are the problem, she concluded, but the ballooning debt that threatens our economy if we choose not to act.

In regards to the other outstanding panelists, Bixby echoed and reinforced very similar concerns, placing an emphasis on the structural problems that continue to exist in many of our institutions while both Tanden and Bernstein had a different focus. Tanden noted that the Center for American Progress had put out many plans to address our long-term debt problem but did not believe a compromise could be acheived with Republicans. Bernstein, while concerned about the long-term outlook was more concerned with the negative affects associated with the policies currently in place - especially sequestration. They both argued that the administration's number one concern should be the current economic weakness, with Bernstein asking not whether our short-term deficits are too big, "but whether they are big enough?"

Despite the differences in opinion, in the final minutes of the discussion, MacGuineas asked the other panelists whether, disregarding politics, they would support long-term deficit reduction along with Social Security, Medicare, and tax code reform. They all answered "yes". This response suggests that securing a sustainable fiscal future is not necessarily the biggest source of disagreement. Instead, it is a question of whether Congress can achieve while aiding short-term economic growth. Neither Tanden nor Bernstein were against long-term deficit reduction and reform, but they did not believe that Congress had what Bernstein called the "political oxygen" to deal with both issues simultaneously. Yet, with continued progress on tax reform and increasing pressure for longer-term entitlement reforms -- with both policies being talked about as replacements for the sequester -- the policy foundation is there for Congress to do just that.

July 29, 2013

The tax reform debate is heating up and many groups are weighing in on what tax provisions should be kept and what the broad revenue and distributional goals of tax reform should be. But Paul Weinstein of the Progressive Policy Institute, a former senior advisor to the Fiscal Commission reminds in a new report that lawmakers should not forget about the opportunity to make the code drastically simpler for taxpayers.

In the paper, Simplify, Simplify, Simplify: The First Principle of Tax Reform, Weinstein argues that focusing on simplification will in turn achieve many other policy goals that are important to lawmakers and prevent special interest groups from disrupting the process. In her annual report to Congress, the IRS Taxpayer Advocate Nina Olson estimated that businesses and individuals spent 6.1 billion hours complying with the tax system. 60 percent relied on paid preparers, while another 30 percent used a tax filing software. Besides the tax code's complexity costing taxpayers their time, tax expenditures also lead to substantial forgone revenue, estimated at $1.3 trillion in 2013 for both individuals and corporations.

Some have suggested return-free filing, where the government fills out the tax form for taxpayers, as a way to make the tax filing process simpler. However, Weinstein points out that this move does not address the underlying complexity and opacity of the code, may be very administratively difficult, and presents a conflict of interest with tax authorities who may view maximizing revenue as the goal over accuracy.

Therefore, Weinstein focuses on simplification of the code itself first and foremost, eliminating or redesigning many of the tax preferences currently in place. Weinstein recommends achieving six goals with comprehensive tax reform:

  1. Promote economic efficiency and growth
  2. Reduce the number of tax incentives to lower rates and rebuild the nation's revenue base
  3. Maintain progressivity
  4. Reduce errors and avoidance
  5. Better align state and federal rules

There are many benefits that can come with tax reform: the opportunity to raise needed revenue, lower marginal rates and promote growth, and better target tax preferences to benefit those who need them. But focusing too much on the distributional effect or marginal rates distracts from the benefit of making the code simpler and more efficient. Concludes Weinstein:

Simplicity and its many benefits are often overlooked in the tax reform debate, which typically centers on economic and redistributive issues. Simplification should be considered a goal of equal importance and should be made a fundamental test of comprehensive tax reform. A democracy should strive to make tax policy transparent and user-friendly to ordinary citizens, so that it becomes an instrument for promoting common prosperity rather than special privilege.

Fortunately, the good news is that policymakers do not have to choose among economic growth, progressivity, and simplification when it comes to tax reform. There are a number of plans that would incorporate all three principles and would put our nation on a path to prosperity for everyone, not just a select few. There is a moment of opportunity in this Congress and this Administration to do great good in making our tax system more rational and understandable and effective. We need to seize the moment.

Click here to read the full report.

July 29, 2013
Weekly Update on Budget and Fiscal Policy Developments and a Look Ahead

Heading for the Exits – This is the final week before Congress begins its five-week August recess. Lawmakers have a lot baggage to pack up before they leave town. As such, there is a flurry of activity to wrap up work on items such as student loans and spending bills before lawmakers head home. The stage is also now being set for the fights that will begin as soon they return as the budget battles are set to be revived with a potential government shutdown, the need to lift the statutory debt limit, and further work on tax reform.

House Set to Vote on Student Loan Bill – The House of Representatives could end the drama over student loans this week when it votes on the bipartisan student loan legislation approved by the Senate. We applauded the compromise for dealing with the problem in a permanent and fiscally responsible way and also noted that it isn’t a bad deal for students. We also took issue with some of the criticisms The New York Times had against the bill. 

Appropriations Move...Towards Government Shutdown? – Both the House and Senate are busy marking up fiscal year 2014 spending bills before the recess, yet no progress is being made to bridge the more than $90 billion gap between the spending levels in the two chambers. The difference centers around the fact that the Democrats who control the Senate want to get rid of the sequester, while Republicans who control the House want to leave it in place. The full House last week passed the Defense spending bill, while the Senate Appropriations Committee approved spending bills for Financial Services and State-Foreign Operations. Both the full House and Senate are expected to pass the Transportation-Housing and Urban Development spending bill this week, though the two measures are $10 billion apart, which is indicative of the deep divide in Congress on discretionary spending overall. Lawmakers will have only three weeks from when they return to approve all appropriations bills and avoid a federal government shutdown when the current fiscal year ends on September 30. Both sides appear to be digging in for a confrontation.

Laying Down Markers for Upcoming Fiscal Battles – Last week, President Obama began setting the stage for this fall’s fiscal battles by kicking off a series of speeches across the country on the economic challenges facing the country and his vision for addressing them. On Tuesday he continues the tour in Chattanooga, Tennessee. The White House is staking its position ahead of potentially nasty fights over government funding and raising the statutory debt ceiling. While neither side publicly seems to be giving any ground, eight Republican senators met twice last week with the White House to discuss a deal that could diffuse the situation. The talks reportedly involve changes such as implementing the chained CPI and making wealthier Medicare beneficiaries pay higher premiums. These changes could be part of a package changing the sequester. Check out the other fiscal speed bumps ahead with our infographic

Tax Reform Looks for Brotherly Love – Senate Finance Committee Chair Max Baucus (D-MT) and House Ways and Means Committee Chair Dave Camp (R-MI) take their tax reform tour to Philadelphia today as they move forward with fundamental reform of the tax code. Several senators submitted ideas for what tax breaks to maintain under the blank slate" approach ahead of the Friday deadline imposed by Baucus. Meanwhile, in the House, the New Democrats Coalition is looking to get involved in the effort. And Baucus said he plans for his committee to mark up reform legislation this fall. The Tax Foundation begins a series of case studies looking at different tax expenditure reform ideas, starting with the mortgage interest deduction. We offered some ideas for tax reform beyond tax expenditures in a recent Tax Notes article. In addition, the Campaign to Fix the Debt made the case for fundamental tax reform and offered principles in a brief last week.

CBO Looks at Economic Impact of Sequester – On Friday, the Congressional Budget Office (CBO) released a study estimating that repealing sequestration would improve the economy in the short term, but growth would be reduced in the longer term because of increased debt. CBO also notes that "boosting debt above the amounts projected under current law would diminish policymakers’ ability to use tax and spending policies to respond to unexpected future challenges and would increase the risk of a fiscal crisis." As we point out, the better approach would be to replace sequestration with a comprehensive fiscal plan with targeted cuts in all areas of the budget that are much more gradual than sequestration. 

New Bill Will Better INFORM the Consequences of Fiscal Decisions – Last week, Sens. John Thune (R-SD), Tim Kaine (D-VA), Rob Portman (R-OH), and Chris Coons (D-DE) introduced the Intergenerational Financial Obligations Reform (INFORM) Act, which aims to improve the budget process by providing analysis on how budgets and major legislation would affect younger generations further down the road. The legislation calls for extending the window in which the fiscal impact of legislation is measured beyond the usual ten years.

 

Key Upcoming Dates (all times are ET)

 

July 30

  • Senate Budget Committee hearing on containing health care costs at 10:30 am.

July 31

  • House Appropriations Committee mark-up of the Fiscal Year 2014 Interior and Environment appropriations bill at 11 am.
  • Joint Economic Committee hearing on how tax reform can boost economic growth at 2 pm.

August 1

  • Senate Appropriations Committee mark-up of the Fiscal Year 2014 Defense appropriations bill at 10:30 am.

August 2

  • Bureau of Labor Statistics releases July 2013 employment data.

August 16

  • Dept. of Labor's Bureau of Labor Statistics releases June 2013 Consumer Price Index data.

August 31

  • Bureau of Economic Analysis releases advance estimate of 2013 2nd quarter GDP.

 

July 26, 2013

Today, the Congressional Budget Office released a report detailing the projected economic effects of repealing the sequester starting August 1. The report is timely considering the big role the sequester will play in the 2014 appropriations process which is now heating up.

In the report, CBO finds that repealing the sequester starting in August would increase spending by $14 billion in fiscal year 2013 and by $90 billion in fiscal year 2014. CBO concludes that such changes would increase real GDP by 0.7 percent and increase the level of employment by 0.9 million in the third quarter of 2014 relative to the levels CBO currently projects. The full range of possible changes are between 0.2 and 1.2 percent for growth and between 0.3 million and 1.6 million for employment. The central tendencies of their estimates are similar to what the agency found the total effect of the sequester would be in 2013.

Economic Effect of the Sequester
  2013 Q4 2014 Q3
Real GDP -0.6% -0.7%
Employment -750,000 -900,000

Source: CBO

However, CBO notes that growth over the longer term would be harmed if the repeal was done by itself since it would lead to greater federal debt that would eventually reduce the nation's output and income below what would occur under current law. Furthermore, as they say, "boosting debt above the amounts projected under current law would diminish policymakers’ ability to use tax and spending policies to respond to unexpected future challenges and would increase the risk of a fiscal crisis." Although the sequester is mostly a short- and medium-term solution policy for the debt, repealing it would be a step in the wrong direction in absence of a better plan to deal with longer-term deficits.

The sequester represents a poor way to reduce the deficit. Rather than relying on gradual and intelligent changes focused on the drivers of the debt, the sequester results in abrupt, across-the-board, and economically harmful cuts which leaving growing entitlement programs longly unscathed and come to an end after 2021.

Therefore we and many others have advocated that policymakers should replace the sequester on a more permanent basis with a comprehensive deficit reduction plan that makes more gradual and smarter cuts and finds savings in all parts of the budget. Recent CBO numbers show that this would be a win-win for the economy, creating jobs in the short-run and accelerating growth over the long-run while putting our debt on a more sustainable long-term trajectory.

July 25, 2013

Is Social Security a distributionally regressive system overall? Some people may have this conception due to a few features of the program: higher-income people retire later and therefore qualify for larger annual benefits than if they retired earlier, they live longer and so collect more Social Security checks, and some of their income is exempt from the payroll tax, which is capped at $113,700. When considering only this evidence, there might appear to be some credibility to the claim that Social Security is a regressive program. However, a report from Third Way by Jim Kessler and David Brown dispels this notion, demonstrating through the Brady Bunch that the return on investment in the system is inversely correlated with income. 

Third Way's report tackles the debate by telling the story of three siblings as they work through four different scenarios to figure out whether or not Social Security is an inherently regressive system. To determine this, they approach it from a pure investment standpoint by calculating and comparing the real return on investment each individual would require if they invested their Social Security contributions in the market as opposed to receiving the benefits through the system. For comparison purposes, the characters in the report hail from three different income classes: Marcia earns the taxable maximum of $113,700, Greg makes half the tax max, while Peter makes one-fourth the tax max.

The authors evaluate four scenarios:

  • Scenario one takes into account only the contributions employees make to Social Security, which are equal to the 6.2 percent payroll tax all employees pay.
  • Scenario two adds the employer portion of the tax into the equation, which many economists believe is ultimately borne by employees. When incorporating this assumption, the rate of return for all three siblings decreases.
  • Scenario three involves the employer contribution and different retirement ages. Because lower-income jobs are often more physically demanding, it is expected that they will often have to retire early. Conversely, those in upper-income groups have more access to healthcare and less physically strenuous jobs, which result in a longer work history. Thus, it is assumed in this scenario that Peter retires at age 62, Marcia at 70 and Greg retires at the same age as the other scenarios at 67. 
  • Scenario four includes all of the above in addition to different life expectancies where Marcia's is above average and Peter's is below average.

The results of Third Way's work show that the less a worker earns over the course of their lifetime, the better a return they can expect from Social Security. Even when differences in retirement age and life expectancy are brought into the debate, the progressive nature of the program is still evident in the real return on investment each income group received. There are many reasons for this ranging from the progressive nature of the benefit formula to the fact that wealthier people have to pay taxes on some of their benefits.

Real Return on Investment for Different Earners
  Low Earner (Peter) Middle Earner (Greg) High Earner (Marcia)
Scenario 1
(Employee Contributions Only)
5.2% 4.5% 3.3%
Scenario 2
(Employer and Employee)
2.9% 2.2% 0.8%
Scenario 3
(Scenario 2 Plus Retirement Ages)
3.0% 2.2% 0.6%
Scenario 4
(Scenario 3 Plus Life Expectancies)
2.5% 2.2% 1.1%

Source: Third Way

Nonetheless, just because Social Security is a progressive system doesn't mean it has the distributionally proper outcome -- this in itself is a question of values. Some plans to reform the program, such as those submitted by Simpson-Bowles and Domenici-Rivlin, would in fact make the program more progressive than it is today by making the benefit formula more progressive and raising the payroll tax cap. There are countless ways to reform the system that either keep or increase its current level of progressivity while also ensuring its long-term sustainability.

July 25, 2013
CRFB Releases Paper in Tax Notes on Non-Tax-Expenditure Base Provisions

Readers of The Bottom Line know that we talk frequently on the subject of tax expenditures, the deductions, credits, and other tax preferences which cost us $1.3 trillion a year relative to what a clean tax code would look like. Reducing or reforming these preferences are vital to achieving tax reform, which is why we are enthused about the "blank slate" approach moving forward in the Senate Finance Committee.

However, not all deductions, credits, and related provisions are tax expenditures; some are structural parts of the tax code, including many that are  used to help calculate net income. Although they are not deviations from a "clean" tax code, these provisions can be quite costly relative to a code that excluded them and are the topic of a new Tax Notes paper by CRFB's own Marc Goldwein, Adam Rosenberg, and Jessica Stone*.

In "Beyond Tax Expenditures," Goldwein, Rosenberg, and Stone discuss what they call Non-Tax-Expenditure Base Provisions (NTEBPs) and suggest that many of these NTEPs could and should be modified in the context of comprehensive tax reform. The paper argues that while it is technically possible to achieve sweeping tax reform that reduces tax expenditures and tax rates while raising revenue, political and administrative difficulties may make that task tough to meet without looking at another source of revenue such as NTEBPs. This should be no surprise, as the last sweeping tax reform in 1986 actually raised about 40 percent of its gross revenue from sources other than tax expenditures.

Most NTEBPs, the paper argues, are integral parts of the tax system that should not be modified or removed. However, a subset of them may be quite ripe for reform. The authors lay out five criteria for evaluating NTEBPs that could be reformed.

1. Improperly defined income. Some expenses may be immediately deductible as a normal expense when an argument can be made that they should either not count against income at all or not count against current-year income alone. Principles of taxation dictate that expenses used to produce income over several years should be deducted over that same period (the useful life of that expense). While the current code attempts to depreciate those income-generating assets when appropriate, there may be times when it fails in that goal.

2. Dual-purpose provisions. A pure income tax allows for the deduction of normal business expenses in order to calculate net income for the purpose of taxation. However, some expenses may simultaneously have a businesspurpose for generating income and an individual benefit promoting personal welfare. In that case, policymakers may want to consider modifications such as a partial deduction.

3. Abused provisions. Some NTEBPs may be justifiable adjustments to income in theory but in practice be heavily abused. This is especially true for dual-purpose provisions, where the line between personal and business expenses is blurred. To reduce the incentive for abuse, policymakers could tighten eligibility for, restructure, or eliminate some of these provisions.

4. Provisions in conflict with public policy goals. Some provisions in the code may actually work against important policy goals by encouraging undesirable behavior and creating undesired income distribution outcomes, in addition to lowering potential tax revenue. Policymakers could alter specific NTEBPs that they believe conflict with other public policy goals.

5. Tax expenditure proxy provisions. Some tax expenditures may be difficult to eliminate directly but possible to address indirectly. For example, some forms of compensation are both excludable for individuals and deductible for employers. Technically, the exclusion is the tax expenditure and the deduction is a normal feature of the tax code (as a normal business expense). However, it may prove politically or administratively difficult to address the exclusion or other tax expenditure itself, in which case the parallel NTEBP could be modified as a proxy. Although this article does not address tax expenditure proxy provisions, more research should be conducted in this area.

In addition to explaining how NTEBPs differ from tax expenditures and laying out a criteria for judging NTEBPs, the authors present a number of  examples of specific NTEBPs that could be reformed based on the criteria. Examples of NTEBPs on the individual side include the standard deduction and personal exemptions, the deferral of taxes on capital gains until they are realized, and deductions for moving expenses. Examples on the business side include deductions for interest expenses, meals and enertainment expenses, and full expensing of advertising costs which may have benefits over a number of years. We've previously discussed a number of these provisions on our blog.

The list the authors put forward is far from exhaustive, but rather a starting point from which the academic and tax community can build.

Tax expenditures can and should be the focus of tax reform since there are serious revenue implications and plenty justification to eliminate or reduce many of the provisions that are there. However, policymakers should not ignore opportunities to improve the tax code through alternate forms of base-broadening. Reforming both tax expenditures and certain NTEBPs are complementary steps to make the tax system more efficient and raise revenue.

Click here to read the full paper.

*Note: Jessica Stone was a policy analyst at the time the analysis was written, but currently works in a congressional office.

July 24, 2013

A recent New York Times editorial gets it wrong by opposing a bipartisan student loan deal that would lower interest rates for all new students today while permanently addressing student loan rates in a sensible and fiscally responsible way.

The deal, as we've explained before, will replace the current system of fixed nominal rates which can only be changed through an act of Congress with a system that links new fixed-rate loans to the ten-year Treasury bond rate. Specifically, undergraduate Stafford loans would be set at 2.05 percentage points above the Treasury rate (with a 8.25 percent cap), graduate Stafford loans would be 3.6 percentage points above Treasuries (with a 9.5 percent cap), and GradPLUS and parent loans would be set at 4.6 percentage points above with a 10.5 percent cap. In practical terms, this means a 20-40 percent rate cut compared to rates that are currently in place for most new students this year, with rates gradually rising over time as the economy recovers.

The New York Times opposes this deal, arguing that the government should not be "making money off the backs of struggling student borrowers," that rates for "loans in future years could rise as high as 8.25 percent," and that the legislation requires "future college students to pay for the financial break enjoyed by students who precede them." Unfortunately, all of these claims are misleading, as are many other claims in the NYT editorial.

Student Loan Profits

The Times claims that the government will earn $184 billion in profit over the next decade from its student loan programs to make the case that the government should not be profiting on students.

They cite a Congressional Budget Office estimate, but get their numbers a bit wrong by looking over an eleven (rather than ten) year period and failing to account for administrative costs. In reality, the mandatory cost of direct loan programs is more like $137 billion. And it is quite important to understand where that $137 billion comes from.

About half of the $137 billion in alleged profit is due to the fact student loans are not currently linked to Treasury bonds, which means that they have thus far been unable to take advantage of low economy-wide interest rates.  The New York Times suggests that the current law method for setting rates is "sensible" since they provide certainty to families. But the flip side is that they provide a benefit to the lender (the government) relative to the borrower (the student) when interest rates are low, a problem which would more or less be fixed under the Senate bill.

The other half of the alleged profit comes from a decision by Congress and the President to re-allocate funds from student loans to Pell grants for low-income students. Specifically, both the Budget Control Act and the reconciliation portion of the Affordable Care Act reduced spending by ending subsidized loans for new graduate students and by eliminating the guaranteed loan program in favor of direct loans, respectively. In both cases, the savings were used to finance Pell Grants and other education programs. One can argue about the relative merits of Pell Grants versus student loans, but it is a net wash for students on the whole and was a conscious choice that we cannot ignore in making future policy.

When one removes the effect of the lower rates and the legislative reallocations, the profit disappears (seen in the solid blue line in the graph below).

Net Outlays of Direct Student Loans, FCRA Method and Fair Value Method (billions)

Source: CBO, CRFB
Note: Fair-value estimate of BCA change is estimated to be the same as the traditional estimate, although in reality it may differ slightly.
"Steady State" estimate assumes the 2018-2023 subsidy rate applies for all years.

More fundamentally, it is not at all clear there was any "profit" there in the first place. By law, Congressional Budget Office estimates of loan programs aim to measure the lifetime value of the loan in the year it is made after accounting for defaults and adjusting future spending to the "present value." But current law does not charge the government for market risk, even though many experts believe calculations should include a risk premium which accounts for changes in macroeconomic conditions. CBO itself has made the case for this "fair-value accounting" before, and under this approach the $137 billion in profit becomes about $114 billion of government cost.

Rates as High as 8.25 percent?

One reason the New York Times opposes the student loan bill is because it would eventually allow subsidized student loan rates to rise beyond the 6.8 percent rate under current law to "as high as 8.25 percent." This is true in a technical sense -- if ten year Treasury rates rise to 6.2 percent then student loan rates could rise to 8.25 percent (due to the cap, they could not rise higher).

Of course, the New York Times fails to mention the flip side -- that if ten-year bonds are below 4.75 percent (they are at 2.6 today), then students would face a lower interest rate than under current law. They also fail to mention that neither budget agency is projecting student loan interest rates to be near the 8.25 percent cap. CBO's projections suggest a rate of 7.25 percent in 2023, and OMB a rate of 7.05 percent in that year. Note that neither are far from the 6.8 percent rate under current law.

As rates in the rest of the economy rise, however, it only makes sense that student loan rates rise. This approach keeps the subsidy roughly constant, rather than offering huge windfalls to some cohorts of students and generating profits from other cohorts.

Future College Students Paying for Current Students?

The Times claims that the Senate "bill pits students against one another, requiring future college students to pay for the financial break enjoyed by students who precede them."

CRFB is among the biggest advocates for future generations, but on this issue the Times has it backwards. Under current law, current students are subsidizing future students. That's why of the $137 billion of claimed profits over the next ten years, about $95 billion are in the first four years. When interest rates in the rest of the economy are low, those borrowing at 6.8 percent are being punished relative to those borrowing at 6.8 percent when interest rates are high.

Under the Senate bill, current and future students will pay interest rates based on the government’s cost of borrowing. This doesn't pit students against each other any more than today's  new homebuyers are pitted against those who take out mortgages in future years. The Senate bill instead starts to even out the government subsidy over time, rather than having it fluctuate as Treasury rates change.

Estimates of Direct Student Loans With Senate Deal, FCRA Method and Fair Value (billions)

Source: CBO
Note: Proposal Fair Value line may be slightly off due to differences in the estimate of the bill under fair value accounting. 

*****

The bipartisan student loan agreement being considered by the Senate a sensible solution for solving the current impasse on loan rates by allowing those rates to respond to market conditions. The nominal rate will go up and down, of course, but the government subsidy will remain stable. As currently constructed, the proposal is also fiscally responsible, paying for itself over the next ten years and getting policymakers out of the position of governing by crisis on student loans one year at a time. Yet the New York Times suggestions that the bill is profiting off of students, pitting those cohorts of students against each other, and driving rates to unaffordable levels are just plain wrong.

We welcome a debate on the future of higher education funding. But it should be an honest debate.

July 24, 2013

Senators John Thune (R-SD), Tim Kaine (D-VA), Rob Portman (R-OH), and Chris Coons (D-DE) have introduced the Intergenerational Financial Obligations Reform (INFORM) Act, a bill that would encourage responsible budgeting by increasing the scope of federal budget analysis. The bill would incorporate fiscal gap analysis and generational accounting into CBO analyses of budget bills and at the request of House or Senate Budget Committee Chairmen and Ranking Members for significant non-budget legislation; to the OMB's analysis of Presidential budget proposals; and for the GAO's long-term fiscal outlook. It is very encouraging to see a bipartisan group of lawmakers focus on the long-term impacts of our unsustainable budget path. This proposal would help our elected leaders better understand the consequences of our current trajectory and the effect that proposals could have on future generations. The INFORM Act was initially championed by The Can Kicks Back, a millennial advocacy organization affiliated with the Campaign to Fix the Debt.  Fix the Debt released a statement in support of the bill today.

These new analyses would serve two important purposes: issuing a public reminder that unsustainable budgets will leave future generations with an unfair debt burden that will threaten their quality of life and requiring budget agencies to provide Congress and the White House with a tangible and valuable tool for considering the outyear impact of immediate budget decisions. The second point is also important because while the ten-year budget window does matter, it is the longer term that has a much more troubling picture.

Fiscal gap analysis is already a widely-used metric for looking at the long term. Simply put, the analysis calculates the discrepancy between projected revenues and outlays over a longer timeframe, usually up to 75 years, in order to determine the long-term impact of today's budgetary decisions. Fiscal gap projections are used by the Social Security Trustees to predict the outyear fiscal health of the Social Security program and the implications of proposed policy changes.

Generational accounting looks at the net revenue impact of the fiscal gap by comparing what living and future generations will pay in net taxes, or taxes less benefits. This analysis is also not a new concept; the Clinton and George H.W. Bush administrations both used generational accounting in budget proposals.

Sens. Thune, Kaine, Portman, and Coons should be commended for introducing the INFORM Act. The bill demonstrates that Congress has an appetite for increased transparency and accountability in the budget process and understands the importance of a sustainable debt trajectory over the long term.

July 24, 2013
Credible Debt Plan Would Boost the US Economy

In the midst of our slow economic recovery, both the public and our Congressional leaders alike can too easily narrow their field of vision to solely short-term concerns, like our 7.6 percent unemployment rate and modest economic growth, or focus solely on long-term problems like our debt path. Some fear that Congress will ultimately end up choosing one or the other, improving today's economy or our long-term prospects. 

In response, former New Hampshire Governor and Senator, Chairman of the Senate Budget Committee, and Co-Chair of the Fix the Debt Campaign, Judd Gregg, recently authored a piece in the Financial Times explaining that not only are both these short and long-term goals accomplishable, but they can also be compatiable. Building a financially sustainable government for our future through smart entitlement and tax code reform will boost investor confidence and our economic outlook today and can be done in a way that does not harm short-term growth. 

Implications that addressing the debt versus the economy is a zero-sum game is false. There’s no reason why we can’t do both. In the commission report and the plan they recently put forward, Mr. Simpson and Mr. Bowles stress the importance of phasing in deficit reduction gradually to avoid harming the economic recovery. Indeed, that is the reason to act now to replace the immediate austerity from sequestration with policies that will reduce the deficit over time. In fact, putting in place a smart, credible debt plan would likely boost the economy by showing markets we are serious about dealing with the long-term debt.

Gregg also underscores that although the growing debt-crisis is often considered a long-term issue, it must be addressed today, even if the changes don't take effect right away.

The threat to Social Security’s solvency is not as hypothetical or as far off as Mr. Luce argues. The trustees who oversee the vital programme have been warning for years that the retirement of the baby boomers will put a strain on the programmed as more workers receive benefits and fewer contribute to it. As the saying goes, “demography is destiny”. The choices facing policy makers will become increasingly unpleasant the longer action is delayed. Waiting until a crisis is imminent will require harsh solutions such as across-the-board cuts for all beneficiaries, including the poorest seniors. In addition, Social Security’s Disability Insurance Program Trust Fund will be exhausted in just three years, underscoring the fact that this is not a distant concern.

Click here to read the full op-ed.

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

July 23, 2013

After releasing a broad physician payment reform draft, the House Energy and Commerce Committee has released a more fleshed out framework to replace the Sustainable Growth Rate (SGR) formula with a new payment system that better takes into account quality. This draft is also an improvement on the previous one in that it has bipartisan co-sponsors, including Committee Chairman Fred Upton (R-MI) and Ranking Member Henry Waxman (D-FL).

As we have mentioned before, the recent lowering of the cost for repealing the SGR has given lawmakers a sense of urgency to replace it with a new system that rewards quality rather than quantity of services. Although the SGR intended to penalize overutilization of services by physicians, it was a very blunt tool, setting overall Medicare spending targets and punishing or rewarding all physicians based on that aggregate goal. The Committee's initial replacement draft intended to give physician payments an interim period of stable payment increases or freezes and an eventual transition to a new payment system. It was largely silent on the specifics of what the payment updates would be, when the transition would happen, or what the new system would be. The latest draft fills in a lot of these details.

Instead of the SGR's 25 percent cut to payments in 2014, physicians would receive payment increases of 0.5 percent annually through 2018. In 2019, the new payment system would kick in, allowing the underlying 0.5 percent update to be adjusted based on how physicians score in a composite quality measure. The measure would be developed by the Secretary of Health and Human Services and must include at least scores of clinical care, safety, care coordination, patient and caregiver experience, and population health and prevention. Other measures to be included and the weighting of each aspect would be up to the HHS Secretary. Physicians in the top one-third, middle one-third, and bottom one-third of the measure would receive additional payment updates of a one percent increase, no increase, and a one percent decrease, respectively. The legislation also allows physicians to use alternative payment reform models to better deliver care.

While many details have been filled in on the SGR replacement, one key detail remains: pay-fors. Although there is no official CBO score, the budgetary effect would most likely be somewhere in between a permanent freeze in payments and a permanent one percent annual increase, which have been estimated to cost about $140 billion and $175 billion over ten years, respectively. Luckily, there are plenty of options to offset that cost that could also work in conjunction with the physician payment reform to make the health care system more efficient.

It is encouraging to see a bipartisan effort to reform Medicare's physician payment system. While they do so, lawmakers should easily be able to make an SGR repeal bill fiscally responsible. 

July 23, 2013

Today, the Campaign to Fix the Debt released a memo making the case for the “blank slate” approach to tax reform proposed by Senate Finance Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT). The “blank slate” process would eliminate all of the $1.3 trillion in tax expenditures and put the burden of proof on lawmakers to justify adding them back at the cost of higher rates.

Getting rid of all tax expenditures would allow for a top individual tax rate of 23 percent and a corporate rate of about 27 percent. Re-introducing tax expenditures in the code will require higher rates or larger deficits and should encourage lawmakers to look for more efficient designs or do away with some tax expenditures entirely.

Some lawmakers may support overall tax reform but express concern when the conversation turns some of the more politically popular provisions in the code. But while some tax expenditures promote worthwhile goals, many could be redesigned to be better targeted and less costly. The memo goes through a few of the largest tax expenditures -- the mortgage interest deduction, the charitable deduction, the exclusion for employer-provided health insurance, education tax provisions, and corporate tax preferences -- listing their costs and possible ways to redesign these tax provisions.

The memo highlights many of the redesigns we put forward in our recent blog, Retargeting Tax Expenditures. The mortgage interest deduction will cost more than $1 trillion over the next decade, but it could be redesigned to be less costly by putting a limit on the value of the deduction, turning it into a credit, preventing it from being used for second homes or home equity loans, or phasing it out entirely. The charitable deduction will cost over $600 billion over the next ten years, and the health exclusion will cost $2 trillion ($3.4 trillion including payroll tax), and they could also be replaced by less costly provisions. As the table below shows, overall tax expenditures tend to be regressive so the blank slate approach should encourage lawmakers to design these provisions to be more efficient and better targeted.


Source: CRFB

The memo also discusses a few tax expenditures not included in our previous blog. Education tax credits will cost about $400 billion over ten years and in 2012 rivaled Pell Grants in size but are much less targeted towards those who need them.

In addition, there are roughly 80 corporate tax expenditures, totaling about $2 trillion in forgone revenues. Corporate tax reform could lower marginal rates if many of those tax preferences are eliminated, and other aspects of the corporate tax code are examined as well.

The opportunity to redesign or reduce these tax expenditures is one of the advantages of the "blank slate" approach. By putting the burden on lawmakers to justify "add-backs," lawmakers may be more careful about how tax preferences are reintroduced into the code. The table below shows how different tax reform plans handled major provisions of the tax code. In many cases, they did not simply choose to eliminate or keep them but rather modified them to make them more effective in achieving their goals.


Source: CRFB

The Fix the Debt memo should be useful as lawmakers move forward with the tax reform process. Hopefully, lawmakers will take advantage of this opportunity to make a tax code that better serves our revenue and economic needs.

Click here to see the full memo.

July 23, 2013
Weekly Update on Budget and Fiscal Policy Developments and a Look Ahead

Heat Is On – The heart of the summer is upon us and Washington is feeling the heat in more than one way. In addition to record temperatures, policymakers are also feeling the heat of impending deadlines. Lawmakers have less than two weeks until their month-long August recess. Some believe that recent bipartisan deals on student loans and presidential nominations may pave the way for more breakthroughs, such as a comprehensive fiscal deal. Will they turn up the temperature to get things done or throw cold water on everything?

Budget Back on the Front Burner – On Wednesday, President Obama will begin setting the stage for the upcoming fiscal discussions by kicking off a series of economic speeches in Illinois. This comes as the White House and Senate Republicans continue their talks to achieve a comprehensive debt deal. Last week, the Campaign to Fix the Debt (a project of CRFB) hosted a national fly-in with supporters from 19 states to urge lawmakers to work together and address the national debt. The Washington Post editorial board also urges action now. Meanwhile, the Peterson Foundation made the case for “Why Long-Term Debt Matters.” Read our recent reports “Our Debt Problems Are Still Far from Solved,” and “What We Expect From the Upcoming Fiscal Discussions.”    

Burning the Appropriations Candle At Both Ends...To What End? – The House and Senate are both working on appropriations bills for the next fiscal year, but it isn’t clear that they will be able to meet in the middle. The Senate is pushing a topline spending number of $1.058 trillion while the House plans on spending a total of $967 billion. The difference between the two chambers for Transportation-HUD funding alone is $10 billion. As we point out, differences in how to deal with sequestration are the root of the split. CQ Roll Call reports (subscription required) that impasse could well result in yet another continuing resolution when the current fiscal year ends September 30, meaning that many agencies may be operating at FY 2013 levels. The full House recently approved the Energy & Water Development spending bill and the Financial Services, Transportation-HUD and Agriculture bills are likely next up for floor consideration. The Defense spending bill has been slowed by threatened amendments. Meanwhile, the Senate Appropriations Committee marked up spending bills for the Legislative Branch; Labor, Health and Human Services and Education; Homeland Security and Commerce, Justice and Science in recent weeks. The Transportation-Housing and Urban Development appropriations bill is expected to be the first taken up on the Senate floor.  

Immigration Reform Debate Continues to Be a Scorcher – While the Senate overwhelmingly passed legislation to overhaul the immigration system, its fate is still uncertain in the House. CBO produced a new estimate based on amendments to the bill projecting that it would reduce deficits by about $158 billion over ten years. The savings were reduced from a previous estimate because an amendment was approved increasing border security costs. CBO points out that all of the deficit savings produced by the legislation results from increased payroll tax revenues that are dedicated to funding Social Security. Excluding Social Security, the bill slightly increases deficits and violates PAYGO rules. We have argued for offsetting the non-Social security deficit increase and warned against using the Social Security savings as a reason to add more spending.

Entitlement Reform a Hot Topic – In light of the recent reports from the Trustees overseeing Social Security and Medicare warning of the long-term financing problems facing the vital programs (see charts illustrating the problems here), there is a renewed push to strengthen their finances so that they will be there for future generations. The House Ways and Means Committee jumped into the issue and released a discussion draft on switching to the chained CPI to calculate Social Security benefit increases that also mentions ideas for bumping up old-age benefits to mitigate the effect of the chained CPI for older, more vulnerable beneficiaries. CRFB’s Marc Goldwein explains that economists across the spectrum support this change. In addition, the U.S. Chamber of Commerce launched an effort to promote reform that includes busting some myths. The Moment of Truth Project released a paper on reforming Medicare’s inefficient and complicated cost-sharing rules and bipartisan legislation was introduced in the Senate to increase Medicare premiums for some higher-income participants. The Medicare Advisory Payment Commission (MedPAC) offered some ideas for Medicare reform and Fred Hiatt of the Washington Post made the progressive case for entitlement reform. Go ahead and devise your own Social Security reform plan with our interactive “Reformer” tool.      

Tax Reform Continues to Sizzle – The two chairmen of the congressional tax-writing committees, Max Baucus (D-MT) and Dave Camp (R-MI) believe that tax reform has a better than 50 percent chance of passing and they continue to push for an overhaul both inside and outside the Beltway. They recently hosted a bipartisan get-together at a Washington pub and kicked off their national roadshow with a stop in Minnesota highlighting the need for tax reform. Camp is also seeking Democratic support in the House and Baucus and Sen. Orrin Hatch (R-UT) are pursuing a “blank slate” approach in the Senate where the deductions, exemptions and other tax breaks known as tax expenditures will be eliminated and lawmakers have until July 26 to justify saving certain tax expenditures. This is essentially the “Zero Plan” proposed in the Simpson-Bowles deficit reduction plan. Simpson & Bowles praised the idea in an op-ed. The Business Roundtable also supports tax reform and lays out its priorities in a letter to Baucus and Hatch. There will be pressure to exclude popular tax breaks like the employer-based health insurance exclusion, which we argued against taking off the table and we offered some options for reforming it and two other popular tax expenditures. Relatedly, the Tax Policy Center looked at other ideas for limiting tax expenditures. Meanwhile, former Treasury Secretary Larry Summers is calling for corporate tax reform. This comes as recent polling shows support for reforming corporate taxation as a part of comprehensive tax reform and a Government Accountability Office (GAO) study found that the current corporate tax system has a lot to be desired. Try your hand at reforming the corporate tax system with our simulator.      

Senators Finally Felt the Heat Over Student Loans – The interest on student loan rates doubled on July 1 because lawmakers could not agree on how to fix the situation. On Thursday a bipartisan group of senators reached an agreement that would tie student loan rates to Treasury bond rates. The deal reduces deficits by $715 million over the decade, which is an encouraging sign that lawmakers can deal with problems in a fiscally responsible way. Hopefully lawmakers will keep this in mind as they deal with the other upcoming fiscal speed bumps.   

Both Sides Warming Up for Debt Ceiling Fight – It is estimated that the “extraordinary measures” being undertaken by the Treasury Department and an improving economy will delay reaching the statutory debt ceiling until this fall. But both sides are starting to gear up for the debate. House Republicans are drafting a menu of spending cuts, mainly on the mandatory spending side, that would be acceptable in exchange for raising the debt limit. Democrats are holding to the position that the debt ceiling increase should not be held hostage because a default could lead to economic catastrophe. Follow debt ceiling developments here.  

Still No Fire Over Going to Budget Conference – Although both the House and Senate passed fiscal year 2014 budget resolutions months ago, no effort has been made to reconcile differences and put a budget in place for the first time in four years. Democrats are trying to push for repealing sequestration to be a focal point of the talks. House Minority Leader Nancy Pelosi (D-CA) tried to force action on a budget conference by appointing members to take part. Senate Budget Committee chair Patty Murray (D-WA) wrote an op-ed on the need for a budget deal to avoid the next fiscal speed bump when the fiscal year ends on September 30. House Majority Leader Eric Cantor (R-VA) said he’s not sure there ever will be a conference. Budget talks could be an avenue for negotiating a larger debt deal. Both sides need to come together and start talking.  

Roasting Congressional Inaction – Last week the nonpartisan No Labels movement unveiled its Make Government Work agenda, which prominently features many budget reform ideas. Proposals include “No Budget, No Pay” legislation withholding lawmaker’s pay if they don’t pass a budget and spending bills; moving to biennial budgeting; and getting rid of duplicative and overlapping programs as identified by GAO.

Interest Rates Rising – Markets heated up when Federal Reserve chair Ben Bernanke announced that the Fed would dial back its stimulus as the economy improves, slowing the pace of quantitative easing. Although markets eventually stabilized and Bernanke has since clarified his statement, rates are already beginning to naturally rise as the economy recovers. Rising interest on the national debt will crowd out important investments in areas such as education, infrastructure and research unless action is taken to address our fiscal challenges. 

Budget Process Reform Still a Hot Potato – The House Budget Committee approved two bills to change how federal budgeting is done on party-line votes. One bill would require the Congressional Budget Office (CBO) to use dynamic scoring in assessing the budgetary impact of major legislation. The other would eliminate automatic inflation adjustments in CBO baseline budget projections. The dysfunctional federal budget process needs serious reform and it must be done on a bipartisan basis. See more ideas at budgetreform.org.

 

Key Upcoming Dates (all times are ET)

 

July 24

  • House Appropriations Committee mark-up of spending bill for State Departmant and Foreign Operations at 10 am.

July 25

  • House Appropriations subcommittee mark-up of spending bill for Labor, Health and Human Services and Education at 9 am.
  • Senate Appropriations Committee mark-up of spending bill for State Departmant and Foreign Operations at 10 am.

August 2

  • Bureau of Labor Statistics releases July 2013 employment data.

August 16

  • Dept. of Labor's Bureau of Labor Statistics releases June 2013 Consumer Price Index data.

August 31

  • Bureau of Economic Analysis releases advance estimate of 2013 2nd quarter GDP.
July 22, 2013
"Blank Slate" Key to Tax Reform

Today, Fiscal Commission co-chairs and CRFB board members Erskine Bowles and Alan Simpson published an op-ed in Politico reiterating their support for the Senate Finance Committee's "blank slate" proposal for tax reform.  As we have explained before, the "blank slate" approach would start by removing all specific tax preferences from the tax code and require lawmakers to justify adding them back on a case-by-case basis.

In their op-ed, Bowles and Simpson praise Senate Finance Committee Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT) for introducing the blank slate, a similar approach to the "zero plan" for tax reform that was the framework included in the Fiscal Commission proposal.

Starting from scratch, as Sens. Baucus and Hatch propose, provides the single best chance to accomplish fundamental tax reform, which could be one of the best ways to get the economy moving. On the Fiscal Commission (known colloquially as Simpson-Bowles), our decision to take a similar approach — we called it the “zero plan” — was a turning point that truly broke the partisan logjam. This was a true game changer that made it possible for us to put forward tax reform that accomplished the Republican goal of substantially reducing rates and the Democratic goal of raising new revenue.

Bowles and Simpson note that many popular tax preferences could be added back in the blank slate process, but lawmakers would have to prove that these provisions were cost-effective and achieved desirable public policy objectives.

Importantly, starting from scratch doesn’t mean that all tax preferences will be eliminated. Instead, it puts the onus on advocates of tax preferences to justify their existence and it requires policymakers to pay for those add-backs with higher rates. We believe most will not pass the cost-benefit analysis and will either be eliminated or phased out. Those deemed to serve important public policy purposes can be added back more efficiently and cost-effectively — for example, by using credits instead of deductions.

While the recent progress on tax reform is encouraging, Bowles and Simpson caution that overhauling the tax code is not sufficient; rather, it must be part of a comprehensive plan our nation's fiscal house in order. But the blank slate tax reform process -- if lawmakers embrace it -- can serve as an important starting point for a broader deficit reduction compromise that will make our government more efficient and effective:

Of course, tax reform can’t do all the work on its own. Any successful effort to truly unlock the U.S. economy’s potential must bring our rapidly expanding national debt under control, which means slowing the growth of our unsustainable entitlement programs to match revenues from tax reform, along with other cuts in spending.  Combining tax reform with a broader package, one that also replaces the mindless sequester cuts with larger and smarter spending cuts and entitlement reforms, would represent a tremendous accomplishment.

Combining tax reform with a broader package, one that also replaces the mindless sequester cuts with larger and smarter spending cuts and entitlement reforms, would represent a tremendous accomplishment.

...

Starting with a blank slate doesn’t allow us to avoid the hard choices. But it does make them just a little bit easier. It lets us build the Tax Code we want, rather than chip away from the Tax Code we have. If members of Congress and the administration rise to the challenge, this country’s future will be a whole lot brighter.

Click here to read the entire op-ed.

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

July 19, 2013

Yesterday, CRFB praised the recent bipartisan agreement to enact a permanent fix for student loans instead of another temporary and costly solution. The agreement would reduce interest rates for all borrowers in 2013 and then permanently peg future rates to those of government bonds in a way that will not add to ten-year budget deficits. The deal would be a permanent and fiscally responsible solution -- not something we see everyday.

Some critics, however, are unhappy with the deal, arguing that it will ultimately place a high burden on students. Many have argued for simply continuing the 3.4 percent interest rate under current law. In our view, the solution put forward in the Senate is much better.

As a starting point, it is important to understand what the bill would do for new borrowers. For 2013, all students will see reductions in their loan rates compared to what is currently in place -- more than a 40 percent reduction for undergraduate and 20 percent reduction for everyone else. Compared to last year,  subsidized Stafford loans will see a very modest rate increase (from 3.4 to 3.85) while other loan rates will fall quite dramatically (from 6.8 to 3.85 for unsubsidized Stafford loans, as an example).

It is true that nominal student loan interest rates will increase over time, as economy-wide interest rates recover. By our calculations, undergraduate loans in 2023 will offer an interest rate of roughly 7.25 percent (though that number could be lower if a deficit-reduction plan were enacted). Importantly, though, the fact that student loan interest rates adjust over time is a feature of the deal, not a flaw.

Under prior law, nominal interest rates stayed fixed regardless of interest rates, inflation rates, or broader economic conditions. Meanwhile, returns on bank accounts and interest rates on mortgages and all other loans adjust as the economy does. Critics see the fixed rate as protection against high interest rates in the rest of the economy, but they forget that it is also punishment against low rates -- a situation that the country faces today. Indeed, this fixed rate is the reason for the $10 to $40 billion profit some have criticized the government for making off of student loans in 2013. This profit for the government is the result of fixed nominal student loan rates contrasted to constantly moving government bond rates.

The right way to measure how much the government is subsidizing borrowers (outside of non-rate subsidies) is not by where nominal rates are, but how they compare to the rate at which the government is borrowing. Of course, student loans will necessarily have higher rates than government bonds to finance administrative costs, collections, and the risk of default, forgiveness, and delinquency.

Over the last few years, the subsidy has swung wildly. The bipartisan legislation that will be considered by the Senate would very slightly reduce the subsidy for subsidized Stafford loans, and would increase the subsidy quite significantly for all other types of loans. After that, it would hold the subsidy constant by fixing interest rates to the ten year bond -- with downside risk to students born entirely by the government through nominal caps on how high the interest rates could go.

Difference Between Student Loan Rates and Ten-Year Treasuries

Source: CRFB

But what about the 3.4 percent rate? It's important to understand that this rate was arbitrary, temporary, and never really affordable. Jason Delisle at the New American Foundation offers a useful history of the 3.4 percent rate. While House Democrats in 2006 campaigned on cutting student loan rates in half, they found after taking the House that doing so would be quite costly -- $133 billion over ten years. Instead, they reduced rates on only a small subset of loans (subsidized Stafford loans), did so gradually over five years, and allowed the reduction to expire in the sixth year. In total, the 3.4 percent rate stayed in effect for only two years. Due to the coincidentally low interest rate environment in the rest of the economy, this low interest rate ended up making some sense. Continuing it over the long-run, however, would be unsustainable.

The Senate agreement on student loans shows that policymakers can come together on a bipartisan basis to find lasting solutions to our problems. It would have been easy to kick the can down the road for another year. Instead, they found a fiscally responsible solution that reduces costs for all borrowers in 2013 and then locks in place the effective subsidy in order to protect future taxpayers from excessive liability. Now that a solution has been identified, it's time for policymakers to put this issue behind us and transfer some of the bipartisan spirit generated on this agreement for lingering challenges still facing the budget.

July 19, 2013

In a recently released IMF working paper, economists Salvatore Dell’Erba, Todd Mattina, and Agustin Roitman looked into the precursors of fiscal consolidations across 17 OECD countries during the 1980 to 2011 time frame. The report finds that market pressures -- as evidenced by changes in government interest rates, currency values, and credit ratings -- under roughly a third of fiscal consolidations. Within the scenarios with market pressure, larger fiscal consolidations were generally taken.

The larger than typical consolidations under market pressure is particularly relevant to our country's financial position. With public debt elevated and facing an upward long-term trajectory, a downgraded Standard & Poor's credit rating, and no agreement on how to control future deficits and debt, the U.S. is exposed to risks. The relevant question remains: whether significant deficit reduction will be the result of an economic shock (be it rising interest rates, reduced appetite for holding U.S. Treasuries, or another form of market pressure) or result from our own foresight and leadership.

The working report ultimately concludes that approximately one-third of fiscal consolidations occurred under market pressure. This suggests that market pressure does play a significant role in spurring action to reduce a nation's deficits, although this is not the majority of all cases. The second point should provide some hope; based on history, lawmakers may be successful in pushing for reform before the markets force their hand. The paper closely resembles the conclusion that George Mason Professor Paul Posner found in his report, Will It Take a Crisis? Posner writes:

...Democratic nations are not doomed to be reactive to market pressures alone. Rather, the record shows that policy makers and publics alike can be summoned to fiscal sacrifice and longer-term vision by compelling ideas presented in ways designed to mobilize broader publics traditionally unengaged in budget decision-making. Elected leaders at times are rewarded by publics that are persuaded to view sacrifices as necessary for the broader public good. While leaders may indeed attempt to justify their actions based on what they define as a “crisis”, often these actions are taken to head off a serious exogenous crisis, as we have defined it in this paper.

Lawmakers can enact deficit reduction plans by communicating the issue, even if market forces have not yet taken hold. This is to the country's benefit - if inaction ultimately leads to increasing market pressures that force consolidation, the resulting backlash is much more dangerous. As the IMF working paper suggests, "market based and market forced fiscal consolidations will be much larger than non-market forced consolidations." This is largely in line what we have often warned - making changes now will allow for smart, phased-in policies that might not be available further down the road. The kick the can approach is much more risky.

The IMF paper leaves us with a simple conclusion: we must act soon. By dealing with our debt now, we can get our fiscal house in order under our terms. If we wait too long, we won't have that luxury.

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