The Bottom Line

February 28, 2014

Along with its analysis of the conventional revenue impacts (summarized here by CRFB), the Joint Committee on Taxation (JCT) analyzed the potential economic impacts of Chairman Camp's proposal, also known as a macro-dynamic estimate. Overall, JCT expects that this bill would increase the size of the economy over the next decade by anywhere from 0.1 percent to 1.6 percent, largely caused by two things: reduced marginal tax rates on labor and the boost to consumption from increases in after-tax income. Those increases in real GDP translate to increases of roughly $200 billion to $3.4 trillion of additional economic activity through 2023.

Before we review the details of JCT's analysis, it's important to understand dynamic scoring and its role in the current budget process. Scoring agencies like JCT and CBO incorporate micro-dynamic changes from proposals in their conventional estimates -- covering changes in behavior, supply and demand, and the timing of certain decisions, to name a few. What the conventional scoring process does not do is incorporate the the effects of any changes in macroeconomic variables -- things like GDP, inflation, and employment -- and how those might alter the cost estimate. As CRFB discussed in 2012, dynamic scoring can offer valuable information that conventional estimates do not provide. However, dynamic scoring is extremely sensitive to the assumptions used, and there is no consensus on what some of those assumptions should be. Therefore, supplementing conventional estimates with some additional dynamic estimates on major pieces of legislation, such as Camp's tax reform draft, can help give lawmakers and the public more information, but the default score should be used for budgetary purposes. 

In its estimates of the discussion draft, JCT shows that lower effective marginal tax rates improve work incentives and overall labor supply, and in some years would stimulate higher levels of business investment. The proposal would also increase the after-tax income of many individuals, which would in turn increase private demand, especially when the economy has not yet fully recovered. However, JCT also notes that the cumulative effect of other parts of the proposal would hold back the economy. Specifically, reductions or eliminations of some tax preferences -- like accelerated depreciation -- would increase effective marginal tax rates on business investment. On net, JCT expects that the after-tax return to investment would fall and multinational companies would likely see their tax liability increase. Yet JCT expects the overall economic impact to be positive because of the individual income tax provisions.

2014-2023 Economic Effect of the Tax Reform Act

  Low Estimate
High Estimate Average of All Estimates
% Change in Real GDP +0.1% +1.6% +0.65%
$ Change in Real GDP +$0.2 trillion +$3.4 trillion +$1.4 trillion
% Change in Labor Supply +0.3% +1.5% +0.6%
% Change in Private Employment
+0.4% +1.5% +0.8%
Change in Employment +0.5 million +1.8 million +1 million
% Change in Business Capital Stock 0% -0.6% -0.25%
Change in Revenues (Dynamic Score) +$50 billion +$700 billion +$300 billion

Note: Estimates for changes in economic output and labor force participation are rounded to the nearest $100 billion and 100,000 people, respectively.

If enacted, JCT estimates that Camp's discussion draft would increase labor force participation by an average of between 0.3 and 1.5 percent each year this decade, and increase private sector employment by between 0.4 and 1.5 percent. In addition to the improved incentives for workers to find jobs and higher after-tax incomes, businesses would also seek to employ more workers as the return on capital fell slightly, incentivizing some substitution of capital for more labor. JCT expects that business investment would likely fall later in the decade, as the repeal of accelerated depreciation in 2016 and the longer amortization of intellectual property expenses begin to outweigh the positive effects of lower tax rates on business income.  

For a complete overview of Chairman Camp's draft, see CRFB's analysis here

February 28, 2014

The Tax Reform Act of 2014, House Ways and Means Chairman Dave Camp's (R-MI) discussion draft, is a sizeable document touching almost all parts of the tax code. However, one fiscally concerning piece of the legislation that we brought up in our analysis of the draft has to do with transportation spending: the transfer of general revenue to the Highway Trust Fund (HTF). In short, the bill double counts temporary revenue from taxation of foreign earnings held overseas to both extend the life of the HTF—a variation of which has been proposed in Congress and by President Obama—and to meet the goal of revenue neutrality over ten years.

To understand this proposal, one must first understand the international tax system and how the draft reforms it. Currently, foreign earnings of U.S. multinational companies are not taxed by the federal government until their profits are repatriated into the U.S., although certain financial income is taxed in the year it is earned. This "deferral" encourages companies to retain trillions of dollars of earnings overseas that are not subject to U.S. taxation. The draft proposes to move to a territorial system, which would essentially exempt foreign earnings from taxation that would under current law be taxed upon repatriation. To prevent companies from reaping a significant tax windfall on previous earnings, the draft enacts a 8.75 percent tax on foreign earnings held since 1986, payable over eight years. Because much of these earnings would have likely never been taxed by the U.S., JCT scores this transition tax as increasing revenue by $170 billion through 2023 and devotes $126.5 billion of it to the HTF.

Because the tax is payable over eight years, this revenue stream would disappear beyond the ten-year window. The draft decides to dedicate this temporary revenue to the Highway Trust Fund, with 80 percent going to the Highway Account and 20 percent going to the Mass Transit Account. According to the summary released by the Ways and Means Committee, these revenues would allow the Highway Trust Fund to cover projected spending through 2021.

Source: CBO, JCT

CBO projects that the HTF will be exhausted in 2015 and the Department of Transportation may be required to begin slowing reimbursements to limit spending from the HTF as early as the latter half of 2014. The highway account of the HTF faces a cumulative shortfall of $129 billion in projected spending above revenues through 2024, and the mass transit account faces a cumulative shortfall of $43 billion. The looming "funding cliff" facing highway programs has placed pressure on Congress to act this year to avoid reductions in highway spending by closing the HTF funding shortfall. But increasing the gas tax faces intense opposition, and proposals for alternative funding sources for the HTF are similarly controversial, so exploiting trust fund accounting and scoring conventions to bail out the HTF without increasing revenues or reducing spending becomes a tempting option for lawmakers. 

The budgetary impact of trust funds can be complicated. We've discussed this issue previously in general and as it related to the Affordable Care Act and Medicare Part A. CBO treats different trust funds in different ways, in some cases not counting savings that improve trust fund solvency, in some cases counting savings but not trust fund solvency improvement, and in some cases counting both. Like Part A, the Highway Trust Fund falls in the latter category. CBO assumes in its baseline that lawmakers will always act to fund the HTF, so transferring general revenue has no budgetary effect. Lawmakers can also claim to extend the life of the HTF without being charged a cost for doing so or identifying new revenues or spending cuts to cover the shortfall. Legally, the HTF is not allowed to run a negative balance and does not have authority to borrow money to cover obligations in excess of revenues after the trust fund has been exhausted, so transferring money to the HTF to extend trust fund solvency allows spending to be greater than it otherwise would have been.

In reality, though, money can only be used once. By transferring the revenue raised from the repatriation tax to the HTF, lawmakers allow the HTF to spend $126.5 billion more through 2023 than it otherwise would. But the proposal does not generate net new revenues to cover the HTF shortfall; it essentially reallocates a portion of corporate tax revenues to the HTF.

Critically, the increased revenues from the repatriation provision are also used to offset other provisions that reduce revenues to maintain the proposal's revenue-neutrality. In essence, the revenue from taxation of accumulated overseas earnings and profits can be used to make the Tax Reform Act revenue-neutral over ten years, or it can be used to close the HTF shortfall. It cannot do both.

There is merit in dedicating temporary revenues from repatriation to cover a portion of the HTF shortfall instead of using them to offset permanent revenue losses. However, this bill has no room to spare to be diverting revenue for specific purposes. If Congress were to enact the repatriation provision as part of a highway bill reauthorization in order to close the HTF funding shortfall, the tax reform proposal would no longer be revenue neutral. President Obama has made a similar proposal to cover HTF shortfalls with revenues generated by repatriation of overseas earnings as part of corporate tax reform, but with the key difference that the money dedicated to the HTF would come from the net increase in revenues over the ten year window from his corporate tax reform proposal, and the tax reform proposal would still be revenue-neutral without those revenues.

While increasing transportation spending by closing the HTF shortfall is a worthy goal, it should be done within the program by increasing the gas tax or other dedicated revenues and/or reducing projected spending levels. If lawmakers want to dedicate revenues from outside of the program to shore up the trust fund, they should do so with new revenues and not simply reallocate existing revenues.

February 28, 2014

On Wednesday, House Ways & Means Chairman Dave Camp released a detailed tax reform discussion draft, which we summarize and analyze here. On its own, the draft is an impressive piece of legislation: it is nearly 1000 pages of legislative text and addresses tax rates and preferences in both the individual and corporate tax code. But how does it stand up to other major tax reform proposals?

The comparison chart below - also found in our longer analysis paper - stacks up Chairman Camp's proposal against the Simpson-Bowles proposal, the Dominici-Rivlin proposal, and the Wyden-Coats proposal. In terms of revenue impact, both Simpson-Bowles and Domenici-Rivlin intended to raise revenue while Wyden-Coats intended to be revenue-neutral.

Comparison of Tax Reform Plans

This tax reform draft is a good jumping off point as we enter into budget season. In releasing their budgets, we hope that President Obama and the Senate and House budgets will address tax reform - in addition to entitlement reform - as a way of addressing the long-term drivers of our debt.

February 27, 2014

To understand Rep. Dave Camp's (R-MI) tax reform discussion draft, you could read the 194-page section-by-section summary of the bill. Or you could read the 5-page summary that we have just published, detailing the provisions, budgetary impact, and potential economic effects. As a whole, Chairman Camp deserves a lot of credit for producing a reform which makes many hard choices, but we are concerned that the bill could increase deficits over the longer term when reform should be contributing to deficit reduction.

Click here to read our analysis of the Tax Reform Act of 2014.

The paper details the numerous reforms contained in the draft. Individual tax rates are consolidated from seven to three brackets with rates of 10, 25, and 35 percent. The 10 percent bracket is phased out for high earners and the 35 percent bracket is applied to a wider swath of income, effectively limiting the value of tax expenditures like the health and municipal bond exclusions and the mortgage interest deduction to 25 percent. The standard deduction and child tax credits are significantly increased and also phased out for high earners while personal exemptions are eliminated. Capital gains and dividends are taxed as ordinary income but with a 40 percent exclusion, which makes an effective top rate of 21 percent. The state and local tax deduction is eliminated while the mortgage interest deduction and charitable deduction are limited, and a number of other provisions are reformed or eliminated. The Alternative Minimum Tax is also eliminated.

On the corporate side, the top rate is lowered from 35 to 25 percent, and the corporate AMT is eliminated. Preferences like accelerated depreciation, LIFO accounting, and R&E expensing are eliminated. Half of the advertising deduction is required to be written off over ten years. The R&E credit is reformed and permanently extended. The international tax system is transitioned to a territorial system where income is only taxed in the country where it is earned with certain "base erosion" protections to prevent income shifting. The one-time revenue from this transition is dedicated to the Highway Trust Fund.

In addition, the bill repeals the medical device tax and enacts a .035 percent quarterly tax on assets over $500 billion for large financial institutions.

Overall, the legislation increases revenue by $3 billion over ten years, with an almost $25 billion gain in the first five years and a $20 billion loss in the last five years. Judging by the later years of the score, it is possible that the bill would increase deficits over the longer term since there are a number of provisions that provide front-loaded or temporary revenue used to pay for permanent rate cuts. However, there are also a few provisions, such as the Chained CPI, where the revenue would grow over time.

The JCT also evaluated the potential economic benefits of tax reform, finding that it could increase real GDP by between 0.1 to 1.6 percent over ten years, translating to additional revenue gains of between $50 billion and $700 billion. If these gains materialized, the 2023 debt-to-GDP ratio could be lowered by between 0.3 and 4.0 percentage points.

Net Revenue in the Tax Reform Act (Percent of GDP)

 Notes: hypothetical revenue with dynamic scoring assumes $375 billion of additional revenue (the mid-point of JCT’s estimates) distributed from 2015 through 2023. Revenue levels compared to pre-reform GDP. Current law with expiring provisions assumes the extension of the normal tax extenders and expiring refundable tax credits. Net revenue refers to revenue minus refundable credits.

Chairman Camp's draft is an impressive piece of legislation, making many hard choices and demonstrating the tradeoffs inherent in tax reform. It can be a good starting point for a bipartisan reform effort. However, the fiscal impact remains a concern; hopefully, a longer-term analysis of the bill can be produced to see if its revenue-neutrality would hold up beyond 10 years. Still, the draft is an important contribution to the tax reform debate and hopefully will help push the conversation forward.

Click here to read our analysis of the bill.

February 27, 2014

A few weeks ago, we talked about the Senate veterans bill proposed by Senator Bernie Sanders, which would increase spending on veterans and pay for it by extending some expiring savings provisions and by using the war gimmick. That bill is now set to move forward in the Senate this week.

Only one thing has changed since we first wrote about it: the military cost-of-living adjustment reduction repeal has already taken place for current service members as enacted in the debt ceiling bill. This repeal eliminates the savings from the COLA reduction for at least 20 years, so repealing it entirely no longer has a cost in the ten-year CBO score (although it would have longer-term costs). As a result the bill now reduces mandatory spending -- the spending that would occur without further action by Congress -- by slightly more than $1 billion rather than increasing mandatory spending by approximately $5 billion. 

The bill does authorize an additional $21.7 billion for discretionary programs, but spending on those programs are subject to appropriations. Under budget rules, the costs of discretionary programs are scored to appropriations bills that actually provide spending authority and are subject to the discretionary caps in law. The discretionary authorizations in the bill do not by themselves affect actual spending or the deficit; only the provisions affecting mandatory spending would do so. Thus, enactment of the bill would reduce the deficit by more than $1 billion.

The problematic part of the bill is that it still maintains the war gimmick by putting in caps in 2018-2021 that are $5 billion lower per year than in CBO's baseline for Overseas Contingency Operations (OCO). While the gimmick no longer necessary to offset the military COLA reduction, it still leaves open the possibility -- and makes more likely -- the future use of war savings as an offset. Since the war spending caps the bill would put in place are barely a drawdown from CBO's baseline, it would not restrain war spending but would formalize OCO as a slush fund.

Congress could provide funding for base defense spending that could not fit within the existing defense caps through the OCO category and justify it by saying the spending was still below the OCO caps. Moreover, establishing caps well above anticipated future war spending would create a mechanism that would allow Congress to claim hundreds of billions of future "savings" to offset mandatory spending increases by continually lowering the caps to more realistic levels that Congress would likely abide by anyways. Essentially, this would legitimize the use of war spending caps as a slush fund to circumvent budget rules without placing any meaningful restraint on war spending.

We've pointed out many times that using war spending as an offset is a gimmick since the caps are simply meant to reflect plans already in place. To quote CBO (emphasis added):

The proposed limits on appropriations are $20 billion below the $409 billion projected for such operations over the 2018-2021 period in CBO's baseline. That $409 billion figure, however, is just a projection; such funding has not yet been provided, and there are no funds in the Treasury set aside for that purpose. As a result, reductions relative to the baseline might simply reflect policy decisions that have already been made and that would be realized even without such funding constraints. Moreover, if future policymakers believed that national security required appropriations above the capped amounts, they would almost certainly provide emergency appropriations that would not, under current law, be counted against the caps.

Creating this slush fund is unnecessary for the underlying bill itself and opens the door for fiscally irresponsible legislation that use the war gimmick as offsets. To be sure, repealing the reduction in military retirement COLAs for future enrollees will have a long term cost that will place pressure on the defense budget and should be replaced by other long term savings, ideally from other reforms of defense entitlements. Likewise, increasing discretionary authorizations places increased pressure on appropriations, and identifying savings in other discretionary authorizations can reduce that pressure. But setting a cap on OCO spending does not serve either of these purposes, particularly one set at a such a high level that will have no practical effect.

If lawmakers are to put caps on war spending, they should set them at levels to reflect the drawdown underway to lock should in those savings already expected to occur and prevent the OCO category from being used to circumvent restraints on other parts of the budget without taking credit for achieving new savings. Otherwise, they are simply playing games with it.

February 27, 2014

Yesterday, House Ways & Means Chairman Dave Camp released a tax reform discussion draft, and we commended him for the level of detail and consideration provided. We'll continue to cover the interesting aspects of the draft throughout the week.

Our partners at Fix the Debt yesterday released an overview of the Tax Reform Act of 2014 in which they provided summary information of the Camp proposal's many provisions, budgetary impacts, and revenue effcts.

 

Click Here to Read the Paper

 

Overview of the Draft

Individual Tax Reform:

  • Replaces seven brackets from 10% to 39.6% with three brackets of 10%, 25%, and 35%; phases out the 10% bracket for higher earners.
  • Repeals the Alternative Minimum Tax and Pease provisions.
  • Taxes capital gains and dividends as ordinary income with a 40% exclusion (effective rates of 6%, 15%, and 21%); leaves 3.8% ACA surtax in place.
  • Eliminates state and local tax deduction, limits mortgage interest deduction to $500,000 of loans, puts 2% of AGI floor on charitable deduction.
  • Limits value of various tax preferences (including mortgage interest deduction, employer health exclusion, retirement contributions, and municipal bond interest exclusion) to 25% bracket.
  • Repeals personal exemptions but expands standard deduction and child tax credit; phases out these provisions at higher income levels.
  • Indexes elements of the tax code to the more accurate chained CPI.
  • Reforms and makes permanent higher education tax credits.
  • Limits tax-deferred 401(k) contributions to half current level w/ Roth-style contributions allowed up to current limits.
  • Reduces or repeals various other tax expenditures and loopholes.

Business Tax Reform:

  • Reduces corporate tax rates from top rate of 35% to a flat 25%.
  • Lengthens depreciation schedules to approximate economic depreciation.
  • Requires companies to amortize research and development and certain advertising expenses rather than expensing them in first year.
  • Phases out domestic production activities deduction.
  • Moves to a territorial tax system with base erosion protections and a one-time deemed repatriation tax.
  • Reduces or repeals various other tax expenditures and loopholes.

Other Changes:

  • Imposes a .035% tax on large financial institutions.
  • Repeals medical device tax.

Impact of Reforms:

  • Roughly revenue neutral over ten years but adds to the deficit in 2023, and would likely do so over the long run under conventional scoring.
  • Roughly maintains distribution of the tax code over ten years.
  • Reduces taxpayers needing to itemize from one-third to 5%.
  • Increases the size of real GDP by between 0.1% to 1.6% by 2023, according to JCT, largely driven by increases in labor supply and consumption.
  • With macroeconomic feedback (or “dynamic”) effects, would raise an additional $50 billion to $700 billion in revenues over ten years.

Messaging Points on the Draft

Top Line Messaging:

  • Importantly, Chairman Camp’s draft would move the ball forward on comprehensive tax reform.
  • The draft recognizes the tough choices and trade-offs involved in tax reform, and Chairman Camp shows true leadership in taking on the special interests in favor of a better tax code.
  • Tax reform is vital to long-term fiscal and economic sustainability.
  • Tax reform should: reduce and reform tax preferences, lower rates, improve simplicity, promote competitiveness, protect the most vulnerable, encourage economic growth, and contribute to medium and long-term deficit reduction.
  • Chairman Wyden, President Obama, and other lawmakers and stakeholders should engage with Chairman Camp and work toward comprehensive tax reform.

What We Like:

  • The draft is an important step in moving the tax reform process forward, representing the first comprehensive proposal from a tax-writing committee in a number of years.
  • The draft significantly reduces the number and size of credits, deductions, and other tax preferences in the current code.
  • The draft would promote growth and increase the size of the economy by 0.1 to 1.6 percent.
  • The draft finds permanent solutions to expiring tax provisions without adding to the deficit, meaning it generates $560 billion more in revenues than if lawmakers were to continue various tax extenders and refundable credit expansions without offsets.
  • Chairman Camp dedicates dynamic revenue gains to deficit reduction rather than using uncertain revenues for further rate reduction before the growth has actually occurred.
  • The draft incorporates the chained CPI, a more accurate measure of inflation – a promising sign of support for measures than can save significant sums from across the federal budget.

Our Concerns:

  • Tax reform should help to reduce deficits in order to slow the growth of our ever-rising national debt. This draft uses all of the revenue from base broadening to provide rate reduction, and none to improve our overall budgetary situation.
  • The discussion draft generates some revenue from timing shifts and temporary revenue provisions to offset permanent rate reductions; given this, we are concerned the draft would add to the deficit over the long-term.
  • The draft dedicates about $125 billion to the highway trust fund, removing the need to close that fund’s financial gap without providing any net new resources. Effectively, the same money is used twice to shore up the highway trust fund and achieve deficit-neutrality.

Summary Charts

Summary of Tax Reform Act of 2014

Area Current Law Tax Reform Act of 2014
Individual Income Tax  
Tax Rates 10% | 15% | 25% | 28% |33% | 35% | 39.6% 10% | 25% | 35%
(10% rate phases out at high incomes)
Standard Deduction $6.2k/$12.4k $11k/$22k (phases out at high income)
Personal Exemptions $3,900, phased out at higher incomes Eliminated
AMT Alternative tax w/ 26% and 28% rates Eliminated
Child Tax Credit $1,000/child not indexed for inflation - phased out at higher incomes; more refundable through 2017 Credit increased to $1,500 and indexed for inflation, refundability rate increased; phased out at higher incomes
Earned Income Tax Credit $500-$6,000 credit, phased out at higher incomes; higher for families with 3 children through 2017 Reduced credit rates to $100-$4,000, phase-outs begin at higher income levels; marriage penalties lessened
Mortgage Interest Deduction Available to itemizers for up to $1 million of debt Available to itemizers up to $500,000 of debt; value limited to 25% bracket
Charitable Deduction Available to all itemizers Subject to 2% of AGI floor
Health Insurance Exclusion Available w/ 40% tax on high-cost plans Value limited to 25% bracket
State & Local Tax Deduction Available to all itemizers Eliminated
Municipal Bond Exclusion Available for public and private bonds Value limited to 25% bracket; exclusion eliminated for certain private activity bonds
401(k) Retirement Accounts Up to $17,500 of employee contributions on a tax-deferred or Roth-style basis Contributions above $8,750 allowed only in Roth-style accounts
Capital Gains and Dividends Taxed at 0%, 15%, 20% with 3.8% surtax for income above $250K Taxed as ordinary income w/ 40% exclusion (effective rates of 6%, 15%, and 21%); 3.8% surtax retained
College Tax Credit $2,500 American Opportunity Tax Credit through 2017 ($1,000 is refundable); additional tax benefits available AOTC extended permanently, refundability increased to $1,500, income eligibility range reduced; other benefits eliminated
Other Tax Provisions Various credits, deductions, exclusions, and other preferences available Dozens of preferences repealed or reformed. Numerous loopholes closed.
Corporate Income Tax  
Rates Top Rate of 35% Flat Rate of 25%
Accelerated Depreciation Accelerated Depreciation (MACRS) Economic depreciation, basis adjusted to account for inflation
Advertising Deduction Costs fully expensed Half of costs amortized over 10 years
Domestic Production Deduction 9% of income deduction generally available Deduction phased out by 2017
Research & Experimentation Costs fully expensed Costs amortized over 5 years
Inventory Accounting Last-in-First-Out Accounting allowed Last-in-First-Out Accounting phased out
R&E Credits 4 credits, all expired in 2013 Alternative simplified credit reformed and permanently extended, others repealed
International Tax Worldwide w/ deferral Territorial w/ base erosion protections and one-time transition tax
Other Tax Provisions Various credits, deductions, exclusions, and other preferences available Dozens of preferences repealed or reformed.
Excise Taxes  
Medical Device Tax 2.3% tax on sale of certain medical devices Tax repealed
Bank Tax N/A .035% quarterly tax on assets over $500 billion

 Source: JCT

 

Budget Impact of Tax Reform Act of 2014
Provision 2014-2018 2014-2023
Individual Reforms  
Reduce rates to 10%, 25%, and 35%, limit certain tax preferences to 25% bracket, phase out 10% rate, and index brackets to chained CPI -$232 billion -$544 billion
Tax Capital Gains/Dividends with 40% Exclusion $15 billion $45 billion
Consolidate, reform, and extend personal exemptions, standard deduction, CTC, and EITC $18 billion -$16 billion
Modify various itemized deductions $309 billion $858 billion
Require 401(k) contributions above half of current limit be placed in Roth-style accounts $56 billion $144 billion
Reform education tax preferences $27 billion $19 billion
Enact other changes $76 billion $237 billion
Repeal Alternative Minimum Tax -$443 billion -$1,332 billion
Subtotal, Individual Reforms* -$174 billion
 -$589 billion
Business Reforms  
Reduce corporate rate to 25% and repeal AMT -$234 billion -$791 billion
Reform accelerated depreciation schedules $59 billion $270 billion
Modify net operating loss deduction $30 billion $71 billion
Amortize R&E and advertising expenses $152 billion $362 billion
Phase out domestic production deduction $44 billion $116 billion
Repeal LIFO accounting rules $6 billion $79 billion
Reform international tax system $20 billion $68 billion
Enact other changes $103 billion $359 billion
Subtotal, Business Reforms* $180 billion $533 billion
Excise Taxes  
Impose .035% tax on large banks $30 billion $86 billion
Repeal medical device tax and other changes -$12 billion -$28 billion
Subtotal, Excise Taxes $18 billion $58 billion
Total Budgetary Impact $24 billion $3 billion
Addendum #1: Total impact w/ economic growth Unknown $50 to $700 billion

 Source: JCT
* For pass-throughs, the rate reductions are captured in individual reforms while base-broadening is captured in business reforms.
Other corporate tax changes include revenue from tax-exempt entities and tax administration and compliance.

 

Net Revenue under Tax Reform Act of 2014

Notes: hypothetical revenue with dynamic scoring assumes $375 billion of additional revenue (the mid-point of JCT’s estimates) distributed from 2015 through 2023. Revenue levels compared to pre-reform GDP. Current law with expiring provisions assumes the extension of the normal tax extenders and expiring refundable tax credits. Net revenue refers to revenue minus refundable credits.

February 26, 2014

Earlier today, House Ways and Means Chairman Dave Camp (R-MI) released the Tax Reform Act of 2014, which would drastically restructure the U.S. tax code. We took an initial look at the draft and will follow-up with an in-depth paper later this week. Camp has stated that his goal for reform was to close loopholes and lower rates, not to raise revenue. The chart below shows the trajectory of the new proposal in comparison to current law and current policy.

The Joint Committee on Taxation estimates that the proposal would be roughly budget neutral over the 10 year window, but add to the deficit in 2023. Notably, the discussion draft generates some revenue from timing shifts and temporary revenue provisions to offset permanent tax rate reductions, which raises concerns that it will add to the debt over the long-term.

Notes: hypothetical revenue with dynamic scoring assumes $375 billion of additional revenue (the mid-point of JCT’s estimates) distributed from 2015 through 2023. Revenue levels compared to pre-reform GDP. Current law with expiring provisions assumes the exclusion the extension of the normal tax extenders and expiring refundable tax credits. Net revenue refers to revenue minus refundable credits.

The graph above also illustrates what revenues would be if a host of temporary tax provisions set to expire were extended permanently without offsets. Compared to that possibility, Camp's draft reform would actually generate approximately $560 billion of new revenue over 10 years.

The Joint Committee on Taxation additionally provided a dynamic score of the draft. The dynamic score considers projected economic growth anticipated as a result of this reform, which JCT says could increase revenue over 10 years by between $50 and $700 billion (for the above graph, we show the central estimate of $375 billion). JCT explains their assumptions:

“The extent of both supply and demand effects depends on the sensitivity of individual labor choices to changing effective marginal rates, the responsiveness of individual savings choices to changes in the after-tax return on earnings from investment, and the responsiveness of businesses to changing incentives for overall investment and the location of investment and taxable profits in the United States. In addition, the projected impacts of the proposal on the economy depend on assumptions about the monetary policy response by the Federal Reserve Board. In general, under most modeling assumptions, the proposal is projected to increase overall economic activity as measured by changes in gross domestic product (“GDP”) relative to the present law baseline over the 10-year budget period.”

We're encouraged that Chairman Camp's draft relies on conventional scoring and the current law baseline to achieve his fiscal goals. However, it can be useful to consider a proposal's dynamic effects and how it compares to current policy.

February 26, 2014

In a widely anticipated move in the tax world, House Ways and Means Chairman Dave Camp (R-MI) has released a comprehensive tax reform discussion draft after both tax-writing committees had released a number of discussion drafts dealing with specific sections of the tax code. There is a lot to analyze in the bill: a quick summary of the bill's major reforms is below, and a more detailed analysis will follow later in the week.

In an editorial published in the Wall Street Journal preceding the discussion draft's release, Camp said: "If Congress doesn't take action, the U.S. risks falling further behind. The tax code should make it easier for American companies to bring back profits earned overseas so they can be invested here. It should not hinder small businesses from growing into large businesses. And the individual income tax needs to be simpler, fairer and flatter for everyone." Chairman Camp addressed both the corporate and individual tax systems in his discussion draft released today.

The reform reduces individual tax rates and consolidates tax brackets from seven to three: 10, 25, and 35 percent. These tax brackets – and other income thresholds – will be indexed to chained CPI. The 10 percent bracket also phases out for higher earners, and the top bracket does not apply to business income.

Meanwhile, personal and dependent exemptions are eliminated in favor of a larger standard deduction and child tax credit, both of which phase out for the highest earners. Capital gains and dividends are taxed as ordinary income with a 40 percent exclusion, leading to effective rates of 6, 15, and 21 percent before counting the 3.8 surtax currently in place.

These changes would be paid for in a number of ways. The state and local tax deduction would be eliminated, the mortgage interest deduction limited to $500,000 of debt (down from $1 million), and the charitable deduction subject to a 2-percent-of-AGI floor. A number of other tax preferences would be reduced or repealed, and many of those remaining – including the employer health exclusion, mortgage interest deduction, and exclusion of municipal bond interest – would be limited in value to the 25 percent bracket.

Comparison of Tax Reform Act of 2014 with Current Law
Area Current Law Tax Reform Act of 2014
Individual Income Tax  
Tax Rates 10% | 15% | 25% | 28% |33% | 35% | 39.6% 10% | 25% | 35%
(10% rate phases out at high incomes)
Standard Deduction $6.2k/$12.4k $11k/$22k (phases out at high income)
Personal Exemptions $3,900, phased out at higher incomes Eliminated
AMT Alternative tax w/ 26% and 28% rates Eliminated
Child Tax Credit $1,000/child not indexed for inflation - phased out at higher incomes; more refundable through 2017 Credit increased to $1,500 and indexed for inflation, refundability rate increased; phased out at higher incomes
Earned Income Tax Credit $500-$6,000 credit, phased out at higher incomes; higher for families with 3 children through 2017 Reduced credit rates to $100-$4,000, phase-outs begin at higher income levels; marriage penalties lessened
Mortgage Interest Deduction Available to itemizers for up to $1 million of debt Available to itemizers up to $500,000 of debt; value limited to 25% bracket
Charitable Deduction Available to all itemizers Subject to 2% of AGI floor
Health Insurance Exclusion Available w/ 40% tax on high-cost plans Value limited to 25% bracket; 40% tax on high-cost plans
State & Local Tax Deduction Available to all itemizers Eliminated
Municipal Bond Exclusion Available for public and private bonds Value limited to 25% bracket; exclusion eliminated for certain private activity bonds
401(k) Retirement Accounts Up to $17,500 of employee contributions on a tax-deferred or Roth-style basis Contributions above $8,750 allowed only in Roth-style accounts
Capital Gains and Dividends Taxed at 0%, 15%, 20% with 3.8% surtax for income above $250K Taxed as ordinary income w/ 40% exclusion (effective rates of 6%, 15%, and 21%); 3.8% surtax retained
College Tax Credit $2,500 American Opportunity Tax Credit through 2017 ($1,000 is refundable); additional tax benefits available AOTC extended permanently, refundability increased to $1,500, income eligibility range reduced; other benefits eliminated
Other Tax Provisions Various credits, deductions, exclusions, and other preferences available Dozens of preferences repealed or reformed. Numerous loopholes closed.
Corporate Income Tax  
Rates Top Rate of 35% Flat Rate of 25%
Accelerated Depreciation Accelerated Depreciation (MACRS) Economic depreciation, basis adjusted to account for inflation
Advertising Deduction Costs fully expensed Half of costs amortized over 10 years
Domestic Production Deduction 9% of income deduction generally available Deduction phased out by 2017
Research & Experimentation Costs fully expensed Costs amortized over 5 years
Inventory Accounting Last-in-First-Out Accounting allowed Last-in-First-Out Accounting phased out
R&E Credits 4 credits, all expired in 2013 Alternative simplified credit reformed and permanently extended, others repealed
International Tax Worldwide w/ deferral Territorial w/ base erosion protections and one-time transition tax
Other Tax Provisions Various credits, deductions, exclusions, and other preferences available Dozens of preferences repealed or reformed.
Excise Taxes  
Medical Device Tax 2.3% tax on sale of certain medical devices Tax repealed
Bank Tax N/A .035% quarterly tax on assets over $500 billion

 Source: JCT

On the business side, the corporate income tax rate would be reduced from 35 to 25 percent. This reduction would be paid for by repealing accelerated depreciation, moving away from Last in First Out (LIFO) accounting, requiring partial amortization of advertising and research and experimentation, phasing out the domestic production activities deduction, and making numerous other changes. The draft also calls for moving to a territorial tax system with base erosion protections and a temporary repatriation tax.

Finally, the legislation calls for repealing the medical device tax and imposing a new .035 percent quarterly tax on assets over $500 billion in large financial institutions.

Budget Impact of the Tax Reform Act of 2014
Provision 2014-2018 2014-2023
Individual Reforms  
Reduce rates to 10%, 25%, and 35%, limit certain tax preferences to 25% bracket, phase out 10% rate, and index brackets to chained CPI -$232 billion -$544 billion
Tax Capital Gains/Dividends with 40% Exclusion $15 billion $45 billion
Consolidate, reform, and extend personal exemptions, standard deduction, CTC, and EITC $18 billion -$16 billion
Modify various itemized deductions $309 billion $858 billion
Require 401(k) contributions above half of current limit be placed in Roth-style accounts $56 billion $144 billion
Reform education tax preferences $27 billion $19 billion
Enact other changes $76 billion $237 billion
Repeal Alternative Minimum Tax -$443 billion -$1,332 billion
Subtotal, Individual Reforms* -$174 billion
 -$589 billion
Business Reforms  
Reduce corporate rate to 25% and repeal AMT -$234 billion -$791 billion
Reform accelerated depreciation schedules $59 billion $270 billion
Modify net operating loss deduction $30 billion $71 billion
Amortize R&E and advertising expenses $152 billion $362 billion
Phase out domestic production deduction $44 billion $116 billion
Repeal LIFO accounting rules $6 billion $79 billion
Reform international tax system $20 billion $68 billion
Enact other changes $103 billion $359 billion
Subtotal, Business Reforms* $180 billion $533 billion
Excise Taxes  
Impose .035% tax on large banks $30 billion $86 billion
Repeal medical device tax and other changes -$12 billion -$28 billion
Subtotal, Excise Taxes $18 billion $58 billion
Total Budgetary Impact $24 billion $3 billion
Addendum #1: Total impact w/ economic growth Unknown $50 to $700 billion

 Source: JCT
* For pass-throughs, the rate reductions are captured in individual reforms while base-broadening is captured in business reforms.
Other corporate tax changes include revenue from tax-exempt entities and tax administration and compliance.

As shown above, Chairman Camp's discussion draft would be roughly revenue neutral over the decade. However, because several of the bill's revenue sources represent one-time gains or revenue shifted from the far future into the near future, we are concerned that the legislation would add to the deficit in future decades. We will continue to analyze the legislation and provide further information in the coming days.

* * *

Overall, Chairman Camp deserves a lot of credit for producing a full tax reform proposal; the first such proposal to come out of a Congressional committee in recent years. The plan identifies the trade-offs needed in order in lower tax rates and broadening the tax base while also bringing in new revenue sources. Making many hard choices, as this plan does, is praiseworthy, and the draft represents a starting point for a bipartisan tax reform deal. However, there is concern that the reform would add to the deficit over the long run, when we will need to raise revenue from tax reform to meet the nation's fiscal challenges. Still, the draft is one that lawmakers can build on and use along with entitlement reform to put debt on a downward path.

February 26, 2014

In a somewhat atypical move, Defense Secretary Chuck Hagel previewed in a speech yesterday the Department of Defense's (DoD's) budget request for FY2015, which will be a part of the President's Budget submitted to Congress next week. The budget shows the types of cuts necessary to comply with congressionally mandated budget cuts that transition DoD from an era of wars in Iraq and Afghanistan and real growth in the defense budget to a new era of discretionary spending restraint.

According to the Bipartisan Budget Act, defense spending next year is set to rise by $1 billion to $521 billion, which is lower than either party called for in their original budget proposals last year and represents $75 billion in cuts over this year and next compared to pre-sequester levels agreed to in the Budget Control Act.

While the President's Budget will abide by the agreed-upon spending levels for 2015, the President will propose five-year spending for the Defense Department that is $115 billion more than sequester levels. The budget will also propose an additional $26 billion of defense funding to be offset by cutting other spending and closing tax loopholes. Secretary Hagel argued that the increase strikes a balance between protecting national security and a realistic assessment of future fiscal levels, warning that "[s]equestration requires cuts so deep, so abrupt, so quickly, that we cannot shrink the size of our military fast enough."

Looking into the future, defense spending over the 2015-2024 period has been reduced by hundreds of billions of dollars as a result of several measures adopted over the past few years, including spending freezes, the Budget Control Act spending caps, and sequestration. As a result, defense spending will continue to fall as a share of the economy.

However, when looking at inflation-adjusted spending since World War II, defense spending will remain at historically elevated levels even after falling gradually over the next few years. 

Hagel's speech illustrates the types of choices that DoD is making to simultaneously live within smaller future budgets and to modernize its force to fight more advanced adversaries.

The largest cost reductions proposed are in the growing area of personnel costs, which currently make up roughly 50 percent of DoD's budget. Hagel said, "Given the steps already taken to reduce civilian personnel costs – including a three-year pay freeze – no realistic effort to find further significant savings can avoid dealing with military compensation. That includes pay and benefits for active and retired troops, both direct and in-kind." (emphasis added) As shown recently by CBO, military personnel indeed does make up a large portion of DoD's budget and shows no signs of abating down the road.

The budget will propose a 13 percent reduction in the size of the active duty force and a 5 percent reduction in the size of National Guard and reserve units, while the number of Special Operations forces would increase by 6 percent.

Hagel stressed the need for holistic changes, and proposed reductions beyond trimming troop numbers. Civilian and military personnel will be limited to a 1 percent pay raise this year, while pay for generals and other top officers will be frozen. Servicemembers will gradually be asked to pay for 5 percent of their housing, rather than 0 percent today. The Defense Department will stop reimbursing for renters' insurance, and trim the direct subsidies given to military commissaries by $1 billion (over 70 percent).

Similar to last year, this year's budget recommends modernizing TRICARE, so servicemembers use the most affordable means of care, such as using generic drugs. The budget asks servicemembers to pay a little more in copays and deductibles, but Hagel assures servicemembers that "benefits will remain affordable and generous…as they should be."

However, the FY2015 budget does not recommend any changes to the military retirement system, which has been debated recently in Congress. (In December, Congress approved a 1 percentage point reduction in annual cost-of-living increases for working-age retirees. It undid the change for current servicemembers two months later.) No recommendations will be made until the Military Compensation and Retirement Modernization Commission completes its work, due to be presented in February 2015.

Hagel also called for several other reforms, including eliminating an entire class of Air Force attack jets that were scheduled to be replaced within a decade, as well as eliminating the U-2 spy plane. He called for a new round of base closures under the BRAC Commission (even though Congress has not agreed to BRAC requests for the last two years) and will announce cuts to bases in Europe, where BRAC authority is not needed. In the navy, Hagel will reduce the number of the new Littoral Combat Ships constructed from 52 to 32.

Hagel closed his discussion of military compensation by noting the necessity of reform:

"Although these recommendations do not cut anyone’s pay, I realize they will be controversial. Congress has taken some important steps in recent years to control the growth in compensation spending, but we must do more...Our proposals were carefully crafted to reform military compensation in a fair, responsible, and sustainable way. We recognize that no one serving our nation in uniform today is overpaid for what they do for our country. But if we continue on the current course without making these modest adjustments now, the choices will only grow more difficult and painful down the road. We will inevitably have to either cut into compensation even more deeply and abruptly, or we will have to deprive our men and women of the training and equipment they need to succeed in battle. But, either way, we would be breaking faith with our people.  And the President and I will not allow that to happen."

February 26, 2014

In a new and informative series on Reforming the Budget, the Brookings Institution looked at challenges facing the budget process and proposed strategies to improve its shortfalls. Given the frequent breakdown and tardiness in the process and the limitations of federal budget data, there are a number of ways to improve budget process and accounting in order to facilitate better decision making.

The Brookings series presents articles from a number of budget community experts. Our recent blog covered the first two pieces in the series by Phillip Wallach and Elaine Kamarack. Picking up where the first left off, this blog covers the final five installments in the series. Overall, the experts clearly send the message that budget reform is badly needed to incorporate a review of all parts of the federal budget and to become a more manageable process. Bipartisan cooperation will be integral to the success of any reform effort.

* * *

Former CBO director and CRFB board member Alice Rivlin presents her ideas for reforming the currently broken budget process in 'How to Fix the Congressional Budget Process'. She makes a number of points about what an ideal budget process would look like -- noting that it should contain three central elements. First, the process should consider all spending and revenues. Currently, tax expenditures and mandatory spending are not given proper annual consideration like discretionary spending. Secondly, the process should be easy to understand and complete on time. Rivlin writes that since the Budget Reform Act of 1974, it has been too elaborate to be workable and its numerous demanding deadlines are regularly missed. Lastly, Rivlin proposes turning the budget into a law passed by Congress and signed by the president (it is currently a resolution passed by Congress, not signed by the president, and does not have the force of law). Additionally, she proposes that the membership of the Budget Committees include Congressional leadership and chairs of the program and revenue committees.

Linda Bilmes' article, Four Steps to Restore Fiscal Discipline, states that the current budgeting system is broken. For one thing, it consumes far too much time. Each year across the government, thousands of officials prepare their agencies' budgets, but increasingly often, Congress ignores these proposals and estimates. Rather, Congress has fallen into a pattern of enacting budgets based on the previous year's spending levels, not based on current need. To improve the budgeting system, Bilmes suggests four reforms: transitioning to biennial budgeting to lessen the time burden, adopting managerial cost accounting and capital budgeting, rewarding managers for efficiency gains, and simplifying the budget process.

Paul Posner, Steven Redburn, and Jonathan Breul address the absence and relative invisibility of tax expenditures in the budget process in their article, The Mysterious Case of Tax Expenditures. They argue tax expenditure consideration should be added to the budget process for multiple reasons. First, their relative lack of transparency and accountability means other parts of the budget assume disproportionate shares of deficit reduction. Second, to hold revenues constant, tax rates have to be higher to cover the costs of subsidies provided through the tax code. Finally, tax provisions often subsidize activities taxpayers would undertake anyway, so they are not efficient. We have repeatedly called for tax reform and emphasized the great need for a close examination of tax expenditures.

Philip A. Wallach, in his article The Still-Useless Debt Ceiling, calls for the repeal of the debt ceiling and replacement with another measure aimed at fiscal restraint. His reasons are that the debt ceiling incited budget standoffs of recent years have been economically damaging. He links to a previous post of his suggesting a few ways to replace the debt ceiling, including with counter-cyclical spending controls or a "No Budget Agreement, No Pay" type provision.

In Thomas E. Mann's article, Budget Process Blues, he blames Congressional hostility and failure to make timely and reasoned decisions as a fatal impediment to the budget process. He states budget process reforms such as biennial budgeting and instituting caps on spending and revenue are an ill-suited match for Congress' recent failures.

* * *

We agree with several of the authors that the budget process contains plenty of room for improvement. The current system is flawed and does not adequately serve the public. However, budget process reforms alone cannot solve our nation’s fiscal challenges. Still, they can help make budget decisions be made more efficiently and perhaps pave the way for a major budget deal. The Peterson-Pew Commission has provided extensive in-depth analysis of options for budget process reform. Take a look at our analysis of the Commission's work.

February 25, 2014

Tomorrow, House Ways and Means Chairman Dave Camp (R-MI) is expected to release his comprehensive tax reform proposal after a series of discussion drafts. The tax code is in significant need of an overhaul, and reform can to improve fairness and simplicity, make U.S. businesses more competitive, and reduce the deficit. Over the years, CRFB has produced extensive analysis of previous proposals and the need for tax reform.

Click Here to Visit Our Tax Resource Page

To get a better idea of how Chairman Camp's proposal would compare to previous reform efforts, take a look at this chart summarizing several bipartisan tax reform plans from recent years.

Comparison of Bipartisan Tax Reform Plans

Area Simpson-Bowles Illustrative Plan Domenici-Rivlin 2005 Tax Panel Growth and Investment Plan Wyden-Coats
Individual Income Tax    
Tax Rates 12% | 22% | 28% 15% | 28% 15% | 25% | 30% 15% | 25% | 35%
Standard Deduction Increased 10% Replaced with work and family credits Replaced with work and family credits Roughly Tripled
Personal Exemptions Retained Retained
Child Tax Credit & EITC Retained Retained
AMT Repealed Repealed Repealed Repealed
Mortgage Interest Deduction Converted to 12% credit; capped at $500K mortgage Converted to 15% credit; limited to $25K of interest Converted to 15% credit; limited to average price of housing No change
Charitable Deduction Converted to 12% credit; 2% of AGI floor Converted to 15% credit Retained with 1% of income floor No change
Employer Sponsored Insurance Exclusion Capped, phased out from 2018 to 2038 Capped, phased out from 2015 to 2025 Capped at average premium Cafeteria Plans Preference Eliminated
State & Local Tax Deduction Eliminated Eliminated Eliminated No change
Misc. Itemized Deductions Eliminated Floor increased to 5% of AGI Unspecified Eliminated
Muni Bond Exclusion Phased out for new bonds Private Activity bonds repealed Retained Replaced with a credit
Retirement Savings Consolidated and capped at $20K or 20% of AGI Consolidated, replaced with 15% credit up to $20K or 20% of AGI Replaced with “Save for Retirement” accounts with $10K limit Consolidated into new Retirement Savings Accounts and Lifetime Savings Accounts
Capital Gains and Dividends Taxed as ordinary income (top rate 28%) Taxed as ordinary income (top rate 28%) Taxed at 15% top rate Taxed as ordinary income with 35% exclusion (top rate 22.75%)
Step-up Basis for Capital Gains Eliminated Eliminated Retained No change
Other Tax Expenditures Most other tax expenditures eliminated Most other tax expenditures eliminated Most other tax expenditures modified or repealed Several dozen tax expenditures eliminated, including various exclusions for employee benefit
Corporate Income Tax    
Rates 28% 28% 30% (consumption base) 24%
Depreciation Economic depreciation No change Full expensing Alternative Depreciation Schedule
Domestic Production Deduction Eliminated Eliminated Unspecified Eliminated
Inventory Accounting LIFO eliminated No change All purchases immediately deductible LIFO and LCM eliminated
Other Tax Expenditures Eliminated Mostly eliminated Mostly eliminated Mostly eliminated
Interest Deduction No change No change Disallowed; interest income is not taxed Deduction in excess of inflation disallowed
International Tax Territorial No change Destination-based Worldwide

 Visit Our Tax Resource Page for More Information

Check back tomorrow and later this week for more analysis of Camp's tax reform draft.

February 24, 2014
Weekly Update on Budget and Fiscal Policy Developments and a Look Ahead

Closing the Ceremony – The Winter Olympics ended in Sochi, Russia on Sunday with the closing ceremony. The eye-catching spectacle put an exclamation point on two weeks of intense drama and competition. Another ceremonial closing occurred back in Washington as it was reported that the president’s forthcoming budget would not include any offers of compromise as last year’s budget did. Not only did the announcement put an end to some two years of jockeying to reach a broad fiscal deal, but it also effectively closed the door on any bipartisan action this year on any matter. The ritual of governing from crisis to crisis has been concluded, as has any pretense of finding agreement on a comprehensive deficit reduction plan. In this election year, there is little hope for substantive action on the critical issues facing the country. As Congress returns from its Presidents Day recess this week, don’t expect any golden moments for a while.

Budget Ends Hopes for Solutions —The president will unveil his Fiscal Year 2015 budget request on March 4, with more detailed numbers coming the following week. In previewing the budget, it was revealed that the proposal that was in last year’s budget submission to switch to a more accurate measure of inflation, the chained CPI, will not be included. The White House did say the offer remains on the table if Republicans agree to close some tax loopholes. Check out our Chained CPI Resource Page for more on chained CPI. The budget proposal will call for increased public investment to boost the economy that will be paid for by some tax and spending changes. But it is likely to be more of an election-year political statement than a feasible fiscal blueprint that can attract broad support in Congress. 

Mobilizing Defense Savings – On Monday, Defense Secretary Chuck Hagel unveiled a Pentagon budget proposal that would shrink the armed services to its smallest size since before World War II. The plan also calls for eliminating some costly weapons systems. Defense spending represents a considerable share of the overall federal budget, and there is growing pressure to cut back due to military action in Afghanistan winding down and spending caps.

The Never Ending Tax Reform Debate – Amid skepticism that fundamental reform of the tax code can be achieved this year, House Ways and Means Chairman Dave Camp (R-MI) plans to release a comprehensive tax reform discussion draft on Wednesday. Tax reform is critical to addressing our fiscal challenges. Our partners at the Campaign to Fix the Debt make the case for fundamental tax reform and offer some principles to guide the process. Check out our Tax Break-Down series for a look at areas of the tax code ripe for reform. Meanwhile, the G-20 nations agreed to strengthen international tax rules to clamp down on multinational firms using loopholes to avoid paying taxes.

Still Looking for Closure on Unemployment Insurance Extension – Work continues on extending emergency Unemployment Insurance benefits. Republican senators are reportedly working on an approach that would pay for the extension and could gain bipartisan support. Sticking to PAYGO principles is critical as policymakers consider new policies. We cannot afford to backslide on the deficit reduction achieved so far.

Doc Fix Still Open Ended – Lawmakers still aren’t able to seal the deal on permanently repealing the Sustainable Growth Rate (SGR) formula to prevent a sharp cut in payments to Medicare physicians. The main barrier to the “doc fix” remains finding a way to cover the estimated $150 billion price tag. Last week, a group of health experts offered a potential solution in Health Affairs that would offset the costs with some Medicare reforms. 

Budget Gimmicks Still a ConcernRoll Call warns that lawmakers are still eyeing gimmicks as they seek to avoid budget tradeoffs in considering new policies. We identify the key gimmicks to be on the lookout for in our chartbook.

 

Key Upcoming Dates (all times are ET)

 

February 28

  • Bureau of Economic Analysis releases second estimate of 4th quarter GDP growth.

 

March 4

  • White House releases topline numbers for Fiscal Year 2015 budget request.

 

March 7

  • Bureau of Labor Statistics releases February 2014 employment data.

 

March 18

  • Bureau of Labor Statistics releases February 2014 Consumer Price Index data.

 

March 27

  • Bureau of Economic Analysis releases third estimate of 4th quarter GDP growth.

 

March 31

  • "Doc fix" expires.

 

February 24, 2014

CBO's recent budget projections show a much deteriorated budget outlook, with debt now rising faster over the coming decade than previously anticipated. Their projections, of course, are based a number of assumptions, including assumptions about future policy. Were Congress to make different policy choices than CBO assumes, debt numbers could change significantly.

Typically, CRFB makes certain adjustments to CBO's current law baseline to establish the CRFB Realistic Baseline, but this year the CBO baseline may represent a reasonable approximation of that. Differences between "current law" and "current policy" have been narrowed dramatically as a result of the 2012/2013 fiscal cliff deal - which extended $4 trillion of expiring tax cuts - and the 2013 Ryan-Murray deal, which created a glide path to the sequester-level spending caps.

With these changes in place, our view is that the CBO baseline represents a reasonable approximation of where the debt is currently headed (reasonable, but by no means definitive). After all, the CBO baseline assumes lawmakers continue to spend at current law levels on the wars abroad, allow doctors in Medicare to take an 25 percent payment cut, let a host of expired or expiring tax provisions disappear, and provide no additional sequester relief. 

For that reason, CRFB has contructed two alternatives to the CBO baseline. On the low end (the PAYGO Scenario), we assume that Congress fully abides by PAYGO rules (by fully offsetting any spending or tax cuts) while we draw down troop levels in Afghanistan from 38,000 to 30,000 by 2017, and that spending will decrease consistent with that plan.

On the high end (the No-Offset Scenario), we continue to assume the troop drawdown but also assume that lawmakers enact annual doc fixes, extend the refundable tax credit expansions after 2017, reinstate and continue the currently-expired "normal tax extenders," and repeal future sequestration cuts. Essentially, this is the scenario if lawmakers do not adhere to PAYGO at all. In both scenarios, we correct for some minor timing issues.

Bridge from Current Law to Alternate Scenarios (Billions of dollars)

Source: CBO, CRFB calculations
All numbers are rounded to the nearest $5 billion.

Not surprisingly, deficits and debt differ substantially depending on the assumptions made. Under CBO's baseline, debt will remain at about 72 percent of GDP through 2017, and then rise to 79 percent of GDP by 2024. After accounting for the war drawdown in our PAYGO Scenario, debt levels grow modestly slower -- reaching 77 percent of GDP by 2024 as opposed to 79 percent.

On the other hand, if policymakers choose the fiscally irresponsible route assumed in our No-Offset Scenario, debt would rise to 84 percent of GDP by 2024, and would be on a much faster upward path. 

The graph above illustrate that without real policy changes, debt will remain at its record high levels and begin to grow rapidly later in the decade. Yet, taking steps backward by failing to abide by pay-as-you-go rules will substantially worsen the fiscal situation.

In addition to the debt implications, the scenarios we laid out also have different implications for spending and revenues. The table below shows how other budget metrics fare under each scenario.

Budget Metrics (Percent of GDP)

Source: CBO, CRFB calculations

Clearly, the federal budget continues to be on an unsustainable path. Lawmakers should work on a bipartisan basis to take advantage of the upcoming Congressional and President's budget proposals to put forward responsible fiscal policies that reduce the debt as a share of the economy this decade and over the long term. At the very minimum, they should not be passing measures that make the situation worse, and should abide by PAYGO rules.

Click here or on either table for an Excel version of the tables.

February 21, 2014

Next week, House Ways & Means Chairman Dave Camp is set to release a draft of a bill to revamp the U.S. tax code, according to press reports. It was unclear whether Camp would release a tax reform draft at all, as House Republican leadership remains skeptical of tax reform, and Camp's Senate taxwriting counterpart Max Baucus was recently confirmed as Ambassador to China. While details about the bill are still scarce, Camp's decision to release a draft represents a positive step forward for the tax reform debate.

We applaud Chairman Camp's decision to release a draft. It is one thing to talk in generalities about the need to lower tax rates and make the tax code simpler, but the debate does not move forward until legislators get specific. Simplifying the tax code and reducing rates will require eliminating or significantly scaling back some popular tax breaks. For instance, making changes necessary to reduce the corporate tax rate (currently at 35 percent) below 30 percent without increasing the deficit almost requires changing accelerated depreciation and Section 199, which both provide significant tax breaks to manufacturers. On the individual side, reducing rates will require eliminating or scaling back popular deductions, such as the deductibility of state and local sales taxes which Camp held a hearing on last year. A serious effort to reform the tax code will require numerous tradeoffs, but if done properly, the economic and fiscal benefits of tax reform will justify the tough choices that will be necessary.

Tax reform has the potential to improve the fairness of the tax code, make U.S. business more competitive, and improve the deficit. Our partners at Fix the Debt summed up nicely the case for comprehensive tax reform, arguing that many of the $1.3 trillion of tax preferences are:

Many of these preferences are expensive, regressive, and economically distorting; they increase complexity, reduce fairness, and let the government pick winners and losers. The higher than necessary rates, narrow base, and sheer complexity in the tax code hurt economic growth by driving up compliance costs and reducing incentives to work, save, and invest.

Similar to the analyses we provided of the Baucus discussion drafts released last year, we will eagerly wait to see what is in Camp's tax reform draft and provide analysis of the draft when it is released. Although tax reform efforts may be temporarily stalled, Chairman Camp's has done a great deal of work on the nuts and bolts of tax reform in his four years as Chairman, and he can make a valuable contribution to the debate before he steps down as Ways & Means chairman at the end of this year by putting forward a comprehensive proposal based on that work.

* * * * *

Looking for more info? Check out Fix the Debt's case for comprehensive tax reform and our blog series "The Tax Break-down" that examines the tax breaks under discussion as part of reform and options for reforming them.

February 20, 2014

Today, the White House announced that the President will not propose adopting the “chained CPI” in the President’s Budget this year, as he did last year (though the White House commented today that they are open to the provision as part of a bipartisan deficit reduction deal).

We argued yesterday that this would be a mistake, explaining that the chained CPI is not only a much more accurate measure of inflation but would also result in several hundred billion dollars of savings in the first decade and more than $1 trillion in the second.

For those interested in learning more about the chained CPI, CRFB and its partner – the Moment of Truth Project – have published a large amount of material on the topic. Their paper, Measuring Up: The Case for the Chained CPI, explains the interaction between the inflation measure and the budget, makes the technical case for chained CPI, and shows the budgetary and distributional impact of adopting it.

In addition to this paper, we have published answers to frequently asked questions about the chained CPI, corrections to some common myths, explanations of the distributional impact, pushback on misleading claims, and dozens of blog posts discussing various facets of chained CPI.

Our chained CPI resource page compiles numerous resources on chained CPI from CRFB and from government agencies, think tanks, and economists from across the ideological spectrum. Our resources page also links to a brief summary of the issue, which can be viewed below:

As we’ve explained many times before, chained CPI is a common-sense proposal with broad bipartisan support that would not only improve the way we measure inflation but also raise additional revenue, slow the growth of government spending, and help to shore up Social Security.

Although we are glad the President remains open to the policy, we are disappointed he has removed it from his budget. As CRFB President Maya MacGuineas said today in a statement from our partner Fix the Debt:

We are incredibly disappointed to learn that the President has decided to drop his proposal to correct the way in which the federal government measures inflation…Reaching agreement on a comprehensive debt deal will require consideration of all policy options and compromises by both sides. While we welcome today’s statements from the administration indicating they remain open to supporting chained CPI in the context of a bipartisan deficit reduction agreement, the nation needs the President to lead on this issue. The clear pullback on his part is a disturbing sign that he will not.

To learn more about chained CPI, visit our chained CPI resource page here

February 19, 2014

At the beginning of the month, the Congressional Budget Office released its annual report on the federal budget, which showed that the deficit is expected to fall by $166 billion from last year to this year, but increase by $1.7 trillion over the next ten years compared to previous projections.

The next day, we released an analysis of the reasons why the deficit dropped since last year. Three-quarters of the drop, or $120 billion, could be attributed to "expected" changes that had been predicted in last year's report. Higher collections from Fannie Mae and particularly Freddie Mac also improved the deficit, while legislation increasing discretionary spending above sequestration amounts in exchange for cuts in future years increased the 2014 deficit. In this post, we look into the other changes to the 2014 deficit, those included as "expected" changes, particularly the automatic stabilizers that increase deficits when the economy is operating below potential.

There are several large factors which will reduce the deficit in 2014. Perhaps most fundamentally, government revenues increase along with the economy. As payrolls, personal incomes, and corporate profits increase, so does tax revenue. The economy is projected to grow by nearly 4 percent, and income tax revenue will grow by nearly 5 percent.

Yet revenues still have a long way to recover from the recession. During a recession, certain "economic stabilizers" automatically increase the deficit by lowering tax revenue and raising safety net spending. At their height in 2010, these stabilizers increased the deficit by $373 billion, nearly 30 percent of the total deficit.

The high deficits of the last few years are falling; however, the deficits from automatic stabilizers are projected to continue for several more years. The automatic stabilizers only fell by $16 billion between 2013 and 2014, a drop caused by $6 billion in higher revenues and $10 billion in lower safety net spending. In 2014, stabilizers will cost $261 billion, over half of this year's $514 billion deficit. The automatic stabilizers will continue to drop in future years, but are not expected to reach zero based on a change in how CBO projects future growth: they no longer expect the economy to reach full potential within ten years or the unemployment rate to fall to levels projected in past forecasts.

Other factors contributed to the changes to the deficit. The new taxes in the fiscal cliff deal, such as a new top rate of 39.6 percent and a 5 percent higher rate on capital gains and dividends, raised approximately $47 billion. While they were in effect for all of calendar year 2013, they did not apply to the entire fiscal year 2013, which includes 3 months of 2012, before the tax increases were enacted.

Other factors increase the deficit. The Affordable Care Act's new coverage provisions have begun, costing the federal government $41 billion in exchange subsidies and expanding health coverage to low-income populations. Finally, with every passing year, more of the population ages into retirement – Social Security outlays will increase by $38 billion and net Medicare spending is expected to increase by $13 billion. 

As Congress wrestles with how to achieve deficit reduction, they would be wise to consider the various factors pulling the deficit in different directions – particularly over the long term. The newest deficit projections were slightly rosier in the short-term, but that was largely as a result of factors outside their control. Later this decade and over the long term, there will almost surely be no conversations about why the deficit is falling. The focus will instead be on why the deficit is growing because of health care costs and an aging population. However, waiting until that happens before we take action will risk higher debt levels, forgoes time when reforms could be gradually phased in, and places a larger share of the population at risk by being either in or near retirement. Falling deficits this year should be an opportunity to create lower deficits in the future too.

February 19, 2014

Last Friday, 16 Senate Democrats sent a letter to President Obama, but it wasn't for Valentine's Day. Rather, the letter warned the President against including cuts to Social Security, Medicare, or Medicaid benefits in his FY 2014 budget, due out in two weeks. Although it did not specifically mention any policies, it was clearly addressed at the inclusion of the chained CPI in last year's budget and certain modest Medicare cost-sharing reforms. Today, House Democrats sent a letter more specifically opposed to the chained CPI. There has been much speculation about what this budget will contain, particularly with regards to the chained CPI.

However, given the recent deterioration in budget projections, though, this is the wrong time to turn our back on entitlement reforms. With health care, there are significant savings that can be had from health care providers and drug companies -- and the President has those -- but beneficiaries will ultimately need to contribute as well. There are ways to achieve savings that will actually help beneficiaries and make the health care system more efficient, such as cost-sharing reforms. And on Social Security, the system's finances demand that we find solutions, or else beneficiaries will receive a one-quarter cut to benefits in 2033, according to the program's trustees.

As we have said many times before, the chained CPI is the most accurate measure of inflation and should be used where inflation calculations are relevant, whether that be in Social Security or other programs. Chained CPI achieves significant savings across the budget on both the spending and revenue side by more accurately implementing the policy of adjusting benefits and provisions in the tax code to reflect inflation. Overestimating inflation is not a targeted or wise way to increase benefits; other ways exist to boost benefits, particularly for the most vulnerable.

Switching to chained CPI has been a key element of comprehensive deficit reduction plans such as Simpson-Bowles, Domenici-Rivlin and the President's budget and backing away from chained CPI now will make it harder to reach an agreement in the future which puts the debt on a sustainable path while replacing sequester with smarter savings. But chained CPI could also be part of smaller packages such as the proposal put forward by CRFB President Maya Macguineas to use the non-Social Security savings from chained CPI to offset the costs of temporary spending for unemployment benefits and job creation measures, with savings in Social Security going to improve the program's solvency.

Another issue with taking entitlement reforms off the table is the squeeze unchecked growth of entitlement programs will put on the rest of the budget. Deficit reduction efforts on the spending side in recent years have focused almost entirely on discretionary spending, which contains defense spending and non-defense spending like education, infrastructure, and research. That category has fallen significantly in recent years and will continue to be constrained in future years if policymakers do not act to restrain the growth of mandatory spending. With mandatory programs contributing little to deficit reduction so far, discretionary spending has felt the brunt.

In short, we hope that President Obama not only maintains the reforms he proposed last year and in previous years but builds on them. The recent uptick in debt projections should bring a new focus on the drivers of the long-term debt.

February 18, 2014

Last week, the relevant Congressional committees released a bipartisan, bicameral proposal to replace the Sustainable Growth Rate (SGR) formula for Medicare physician payments, which has repeatedly been modified or delayed before taking effect since 2003. Despite this agreement, much less work has been done concerning how to pay for the cost of the replacement. To fill that void, Mark McClellan, Keith Fontenot, Alice Rivlin, and Erica Socker published a proposal in Health Affairs to offset the $130–$170 billion ten-year cost of a replacement system.

Their proposal aims to use this opportunity to create better incentives to provide and use care more efficiently through rewards for coordinated care and the use of cost-sharing changes, shared savings, and other means. Their package includes a mix of savings from both providers and beneficiaries, many of which have been highlighted in the Congressional Budget Office's (CBO's) Budget Options report. Many have also received support from the President's budget, Simpson-Bowles, Domenici-Rivlin, and the Medicare Payment Advisory Commission (MedPAC). They describe their list of policies as follows:

If Congress can come up with off-sets for physician payment reform that support improvements in care as well as lower costs, the whole package could have a more meaningful effect on beneficiary care than the physician payment reforms alone.  This could assure beneficiaries and other health care providers that these savings are not just payment cuts that must be absorbed, but steps to help reduce spending through reforms that improve care.

The reforms they propose would be sufficient to pay for the cost of a reasonable permanent doc fix.

McClellan-Table-1

This package is just one way lawmakers could choose to offset the cost of a doc fix. There are many options from CBO and others that would also do the trick while also encouraging higher-quality, higher-value care. Legislators working on the SGR replacement simply need to find the political will to agree on offsets.

February 18, 2014
Weekly Update on Budget and Fiscal Policy Developments and a Look Ahead

Cold Reality – The Winter Olympics are in full swing in Sochi, Russia, but Washington saw its own share of winter games before Congress adjourned for yet another break. Lawmakers played with the debt limit and considered virtually every idea under the sun before agreeing to put it off for another year. Legislators also fooled around with various budget gimmicks as they seek to game the system. There are a lot of issues that Americans want their representatives to tackle, but there isn’t much hope of that happening in this political climate. Avoiding debt ceiling disaster may end up being one of the biggest achievements out of Washington this year. Not really the stuff of Olympic glory.

Tough Sledding on the Debt Limit – Congress managed to avert going to the brink of a national default by agreeing to suspend the debt limit once again. The suspension lasts until March 15, 2015. House leaders had floated a wide range of proposals to pair with raising the debt ceiling, but in the end gave the president the clean increase he wanted. The Senate quickly followed suit and it was signed by President Obama on Saturday. The suspension means there will be no more major fiscal fights until at least October 1, when government funding expires. However, it does nothing to improve the debt outlook, which the latest projections from the Congressional Budget Office (CBO) show is now even worse than previously forecast. A statement from the Campaign to Fix the Debt urges, “It’s critical that lawmakers not take steps backwards or undermine this progress by considering legislation that has the ability to add to the deficit or worsen the country’s already strained fiscal outlook.” The recent debt limit fights have led to increased calls to improve the mechanism so that it can more effectively be used to put the country on a sustainable fiscal path without threatening the economy.    

Gimmick Olympics Produce No Winners – Lawmakers are facing heightened pressure not to add to the deficit, but some proposals they are offering to offset the costs of new policies are not medal caliber. A host of budget gimmicks have popped up that technically pay for new policies but, in reality, add to the deficit. Republicans in the House considered the “pension smoothing” gimmick to pay for rolling back recent military retirement reforms while Democrats in the Senate offered it to offset the cost of a three-month extension of expanded unemployment insurance benefits. The Senate proposal to reverse the military retirement changes used another gimmick – “war savings” – as an offset. We urged rejecting these gimmicks in a statement, and fortunately they were not used. However, gimmicks are still an attractive avenue. We created a chartbook identifying gimmicks to watch out for using helpful charts that illustrate how they work and why they add to the deficit.     

Skating Around Reform – On Saturday, the president also signed into law legislation rolling back the reduction in the cost-of-living adjustment (COLA) for working-age military retirees that was included in the Ryan-Murray budget deal. The House and Senate passed the change as they worked on the debt ceiling legislation separately. Now, only service members who start this year and afterwards will be impacted. The original version was a modest reform of a military retirement system in need of change that has now been diluted. As pressure mounts to find more savings from defense, it will be impossible to exclude military compensation, which is accounting for more and more of the Pentagon budget. The military COLA change is also a rare instance of entitlement reform that policymakers have been able to achieve. Although it is positive that lawmakers rejected blatant budget gimmicks to offset the change, it is still a step backwards because it replaces savings that would be realized far beyond the ten-year budget window with extending the cleaver of the mandatory spending sequester for an additional year. As a CNN article put it, “in reality the measure to reverse most military retirement cuts is the legislative equivalent of a cocaine hit: a feel-good high that obscures current problems, makes future issues worse (for the Pentagon and taxpayers) and sends one of the best signals yet that Congress is nowhere near making the tough decisions needed to avoid the financial storm set to crash on the federal budget in just a few years.”   

Downhill from Here for Doc Fix? – The military COLA bill also contained a provision creating a $2.3 billion "Transitional Fund for Sustainable Growth Rate Reform," which could be used to pay for a permanent repeal of the Sustainable Growth Rate (SGR). The relevant congressional committees recently jointly introduced “doc fix” legislation that didn’t include an offset.

Tax Reform an Olympian Task – The prospects for changes to the tax code remain cloudy. New Senate Finance Committee Chair Ron Wyden (D-OR) says that major reform won’t happen this year because of the partisan divide in Congress. Wyden hopes to take action on the “tax extenders” this year as a "bridge" to broader reform. Meanwhile, Wyden’s House counterpart, Ways and Means Committee Chair Dave Camp (R-MI), may go ahead with introducing comprehensive tax reform legislation. Also, the economic plan proposed by House Republicans has a tax reform component. However, the Olympic spirit has indeed gripped legislators as a bipartisan push has gained steam to exclude the value of Olympic winnings from income.  

A Golden Opportunity for Budget Reform? – The budget dysfunction of recent years is bolstering calls to reform the budget process. Last week the House Budget Committee approved of two budget process reform bills. One would introduce fair value accounting for federal credit programs and the other would institute biennial budgeting, which would move from yearly budgets to a two-year process. Advocates say two-year budgeting would allow more time for oversight of government spending and cut down on annual budget battles. For more budget reform ideas, visit budgetreform.org. Meanwhile, the Office of Management and Budget (OMB) confirmed that the White House Fiscal Year 2015 budget request will be released in two parts, with the topline numbers released March 4 and more detailed information following the next week.

 

 

Key Upcoming Dates (all times are ET)

 

February 20

  • Bureau of Labor Statistics releases January 2014 Consumer Price Index data.


February 28

  • Bureau of Economic Analysis releases second estimate of 4th quarter GDP growth.

 

March 4

  • White House releases topline numbers for Fiscal Year 2015 budget request.

 

March 7

  • Bureau of Labor Statistics releases February 2014 employment data.

 

March 18

  • Bureau of Labor Statistics releases February 2014 Consumer Price Index data.

 

March 27

  • Bureau of Economic Analysis releases third estimate of 4th quarter GDP growth.

 

March 31

  • "Doc fix" expires.

 

February 14, 2014

Earlier this week, Congress moved quickly on a bill to repeal the military cost-of-living adjustment (COLA) reduction for working age retirees that was included in the Ryan-Murray budget deal. The bill repeals the reduction for all service members who started before 2014, effectively delaying any part of the reform for 20 years and delaying its full phase in until 2058. The new spending from repeal is offset by extending the mandatory spending sequester an additional year to 2024, and it also designates $2.3 billion (the savings from the sequester extension in excess of the 10-year cost of repealing the COLA reform) to help pay for the next needed "doc fix," whether temporary or permanent. The bill passed with dissent from only 90 members of the House and 3 Senators.

Although the bill is technically offset over ten years, it is a step backward for fiscal responsibility. It partially repeals one of the few entitlement reforms in the budget deal and offsets it with an extension of a policy that cuts spending across the board in a ham-handed manner. Moreover, the modest COLA reduction repeal has costs over the longer term whereas the sequester extension only produces savings in two years. Also, the higher accrual payments the Department of Defense (DoD) must put away to pay the higher COLAs will put a squeeze on other defense priorities, given the tight spending caps already in place.

This last fact is why the bill would make a good candidate for a longer-term scoring technique, even if it has a relatively small budgetary impact. For one, repealing the COLA for current service members means that the policy does not apply to anyone for 20 years (because military pensions do not vest for 20 years). However, the cost of repeal will phase out over time, eventually reaching zero once all retirees face the COLA reduction. The extension of the sequester, alternatively, produces savings in the tenth year and the year immediately following, but it does not produce any savings in subsequent years. Thus, both the cost and the offset have different effects over time.

For the first decade, the primary effect (not including interest costs) of the bill is almost exactly deficit-neutral. However, accounting for interest costs, the bill increases the debt by about $2 billion. Looking over the next twenty years, the bill with interest could cost about $15 billion. Another thing to account for, however, is accrual payments by the federal government. When retirement benefits are increased, agency pre-funding contributions (which are effectively monies paid to ourselves on paper to highlight future costs) also increase. With discretionary caps in place, because those pre-funding contributions count toward the caps, that additional spending is ultimately taken out of other programs, so the net effect is to reduce deficits. After accounting for the effect of accrual payments and related interest savings, the bill is actually roughly deficit-neutral over twenty years.1

Note that since there are no official CBO numbers beyond the first ten years, the two-decade estimates are rough.

Budgetary Impact of the Military COLA Bill (Billions of Dollars)

Source: CBO, CRFB calculations
Note: Second decade estimates are very rough and rounded calculations.

Regardless of the fiscal impact, though, the bill is a step backward for responsible budgeting in that it shows a lack of commitment to entitlement reform, and feeds the notion that similar reforms may not take effect. As House Budget Committee chairman Paul Ryan (R-WI), who voted against the bill, said, "Rather than making the tough choices, it sidesteps them. I’m open to replacing this reform with a better alternative. But I cannot support kicking the can down the road." Sen. Jeff Flake (R-AZ) asked, "How do we convey to the nation the seriousness about solving the debt crisis when at the first sign of political pressure, we repeal one of the deficit reduction measures?" House Armed Services Committee ranking member Adam Smith (D-WA) noted, "By repealing the COLA provision that was just agreed to a month ago in this very body, we are forcing the Department of Defense to focus on personnel costs...forcing cuts to readiness and procurement."

Granted, military retiree pensions are a particularly politically sensitive topic, but if lawmakers are unwilling to stick with a modest reform, it speaks poorly to their ability to agree to the reforms that will be needed for health care programs, Social Security, and the tax code. The bill's impact is deficit-neutral on paper over the next twenty years, but its portent is much worse.


1 Although CBO notes the size of changes to accrual payments, they do not include these in their estimate of the bill's effect on direct spending because the final amount of discretionary appropriations are still subject to annual appropriations bills not yet enacted.

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