The Bottom Line
That’s a Wrap – The House wrapped up its work for 2013 last week, passing the budget agreement worked out by Sen. Patty Murray (D-WA) and Rep. Paul Ryan (R-WI) and extending the “doc fix” into next year to buy some more time for negotiations on that front. The Senate is trying to finish up this week and also approved of the budget deal, sending it to the president who has promised to sign it. The budget deal is one of the few things Congress was able to leave under the tree after a year marked by partisanship, brinksmanship and general dysfunction. A lot was left undone in a Congress that is on course to be the least productive ever, and many believe that policymakers deserve nothing but coal in their stockings.
Putting A Bow on the Budget Deal – The House overwhelmingly passed the budget deal in the form of the Bipartisan Budget Act of 2013 last week on a 332-94 vote with a majority of both Republicans and Democrats supporting it. It was a rare decisive, bipartisan vote in a congressional session dominated by partisan fighting and lack of accomplishments. The Senate followed suit on Wednesday with a 64-36 vote (every Democrat and 9 Republicans voted for it), and President Obama will sign it. Although the deal does not do nearly enough to address the long-term fiscal challenges facing the country, it moves in the right direction and includes some long-term fiscal benefits. It also shows that bipartisan compromise is possible, effectively splitting the difference between the House and Senate budgets passed earlier this year on discretionary spending. Finally, it returns some order to the budget process by setting topline spending numbers for the next two fiscal years. We took a look at the good, the bad, and the ugly in the agreement. Learn all you need to know about the budget deal with our brief and read all our blog posts about the agreement and budget conference.
Appropriators Get Wrapped Up in Work – The passage of the budget deal means a whirlwind of work is just beginning for appropriators. In order to avoid a government shutdown when the current continuing resolution funding federal operations expires on January 15, 2014, spending bills must still be passed. Appropriators will be busy over the holidays divvying up the $1.012 trillion topline spending figure for fiscal year 2014 in the budget deal between the various federal departments and agencies. An omnibus spending bill wrapping up most, if not all, of the 12 annual spending measures is expected. Senate Appropriations Committee chair Barbara Mikulski (D-MD) said she wants an omnibus FY 2014 spending bill on the Senate floor by Jan. 13.
Nothing Under the Tree for Debt Ceiling – The budget deal does nothing about the statutory debt limit, which is suspended until February 7, 2014. After the suspension expires, the Treasury Department will be able to employ “extraordinary measures” to hold off a national default for an unknown period of time, but the debt ceiling will have to be increased sometime in the first half of 2014. Both sides are already drawing lines. Rep. Ryan indicated that Republicans will demand concessions in exchange for an increase, perhaps approval of the Keystone XL pipeline, while the White House says it will not negotiate. Treasury Secretary Jack Lew on Thursday urged Congress to raise the debt limit "well before" February 7. Refresh your knowledge of the debt ceiling with our primer and keep track of debt limit developments here.
Tax Reform on Layaway – Lawmakers ran out of time in 2013 to reform the tax code and prospects for 2014 are uncertain. Murray and Ryan say that fundamental tax reform could be the next area up for bipartisan collaboration, building on the work done this year by Senate Finance Committee chair Max Baucus (D-MT) and House Ways and Means Committee chair Dave Camp (R-MI). Ryan promised to work closely with Camp in 2014 and Finance Committee ranking member Orrin Hatch (R-UT) indicated he will more actively engage in the debate next year. However, the White House is indicating that it will nominate Baucus to be the next ambassador to China and the loss of his leadership could impede progress on tax reform. Yet Baucus is continuing his work for now, releasing on Wednesday a proposal for reforming energy tax policy. Recommendations on infrastructure are also said to be on the way. These are the latest in a series of discussion drafts based on over a year of work. Renewing some 55 tax breaks known as the “tax extenders” will also wait until the New Year, with reformers preferring to wrap the issue into a comprehensive tax code overhaul, but other lawmakers are hoping for faster stand-alone action. Senate Majority Leader Harry Reid (D-NV) tried to push through an extension without any offsets on Thursday but was rebuffed. Here’s why not paying for an extension is a bad idea.
New Year May Bring New Hope for Unemployment Benefits – Expanded benefits for the unemployed expire on December 28, resulting in some 1.3 million Americans losing unemployment benefits. Democrats promise to revive the issue as soon as Congress returns the week of January 6. It would cost about $25 billion to extend for another year a provision enacted in response to the economic downturn that expands the period of time the unemployed can collect benefits to 73 weeks in states with the highest unemployment rates.
Congress Presents Doc Fix with More Time – Along with the budget deal, Congress also agreed to a three-month patch of the Sustainable Growth Rate (SGR), allowing legislators more time to work out a permanent “doc fix” to avoid a steep decrease in payments to Medicare physicians. Both the House Ways and Means Committee and Senate Finance Committee advanced legislation last week, but more work needs to be done to reconcile the two approaches. Paying for the at least $116.5 billion cost over 10 years is a major remaining issue.
CBO Unwraps Social Security Scenarios – The Congressional Budget Office (CBO) released a report detailing Social Security’s finances, and a variety of scenarios that would impact them. While some argue that projections regarding Social Security’s Trust Fund becoming insolvent years from now are unreliable, the CBO study shows that even when a broad range of outcomes is considered, there is almost no chance of the Trust Fund returning to a surplus. CBO projects the Trust Fund will become exhausted by 2031, with 95 percent confidence of it being exhausted by 2037.
Wasteful Holiday Reading – Senator Tom Coburn (R-OK) doesn’t like it when the government plays Santa Claus. On Tuesday he released his annual “Wastebook” that sheds a light on questionable government spending. Highlights include $914,000 spent by the National Endowment for the Humanities on The Popular Romance Project to “explore the fascinating, often contradictory origins and influences of popular romance as told in novels, films, comics, advice books, songs, and internet fan fiction.” The good news is that there are ideas to reduce waste in government and they are coming from the inside. The finalists for the annual SAVE Award have been announced and you get to vote for the best idea. The competition allows federal employees to propose ideas for the government to save money. The winner gets to present their idea directly to the president.
Federal Reserve Gives the Gift of Taper – On Wednesday the Federal Reserve announced that it would begin the long-awaited tapering of its monetary stimulus. It will reduce the total monthly purchases of longer-term Treasury and mortgage-backed securities from $85 billion to $75 billion. But don’t expect interest rates to start shooting up anytime soon. The Fed also announced that it would keep the federal funds rate near zero for longer than previously anticipated.
Key Upcoming Dates (all times are ET)
December 28, 2013
- Extended unemployment insurance benefits expire.
January 1, 2014
- Temporary tax extenders and the farm bill expire.
January 15, 2014
- The continuing resolution funding the federal government expires.
- 2014 sequester cuts take effect.
- First set of IPAB recommendations expected.
February 7, 2014
- The extension of the statutory debt ceiling expires.
Senate Democratic leadership is reportedly considering a last minute effort to extend 55 expiring tax provisions for another year, including a large number of so-called “tax extenders” as well as the supposedly-temporary bonus depreciation. This package could cost $40 to $50 billion and includes no offsets.
As CRFB, the Center on Budget and Policy Priorities, and others have said numerous times, lawmakers should fully pay for any extensions to expiring tax provisions. CRFB recently highlighted the importance of PAYGO, and we believe it should apply to anything Congress choses to continue or waive, including sequester relief, unemployment insurance, and the doc fix, as well as the tax extenders. Ideally, lawmakers would address expiring tax provisions within the context of comprehensive tax reform. But short of that, lawmakers should carefully review the extenders, decide which ones are worth keeping, and fully pay for the cost of doing so.
CRFB recently analyzed the package of tax extenders Congress is currently considering, and found that the one-year extension of the provisions could cost between $40 and $50 billion through 2023. That's a cost of roughly twice the savings that the Bipartisan Budget Act was able to put in place this week. That may not seem like a lot, but its worth considering that deficit financing the extensions year after year would cost over $500 billion if bonus depreciation expires, or roughly $800 billion if it is continued as well (which totals up to $970 billion when including interest costs). The Center on Budget and Policy Priorities recently measured the long-term implications of deficit-financing extenders. As they wrote:
If the tax extenders are made permanent but not paid for (and no other changes in current policy are made), the debt as a percent of GDP will rise about 24 percentage points between 2013 and 2040, from 75 percent of GDP to 99 percent. We project that if the cost of continuing the extenders is offset, however, the debt ratio will rise about 16 percentage points over that period, to 91 percent of GDP. The resulting debt ratio will still be too high, and deficit-reduction action will be needed on a variety of other fronts. Nevertheless, this would represent a significant contribution. Simply paying for the tax extenders would erase about one-third of the expected climb in the debt-to-GDP ratio between now and 2040.
We couldn't agree more with CBPP on this point. Senate Democrats should take note, as should the rest of Congress if this package gains any traction. Lawmakers need to either fully offsets the costs of any tax extenders this decade with other changes to the tax code or spending programs or else let the provisions expire.
It is extremely disappointing that one day after the Senate passed a budget agreement that made a very modest step in reducing the deficit Senate Majority Leader Reid is attempting to pass a tax extenders package without offsetting the cost. If lawmakers cannot agree on a comprehensive plan to reform the tax code, strengthen entitlement programs and put the debt on a downward path, they should follow the example of the Ryan-Murray budget compromise which established the principle that the costs of short-term fixes should be fully offset while also having additional savings for deficit reduction. It would be encouraging if lawmakers were to continue this principle going forward in order to keep making incremental progress on controlling long-term federal debt.
At absolute minimum, they must not make the deficit worse.
The Murray-Ryan budget deal would mitigate some of the 2014 and 2015 sequester, but it actually still leaves the sequester’s cuts to mandatory programs entirely in place, including those to parts of the Affordable Care Act (ACA). While the subsidies to help people afford health insurance premiums at the core of the law are exempt from sequestration because they are structured as individual tax credits, little has been written about the other important aspects of the ACA that are still set to be sequestered.
This blog will focus on two of the most integral parts of the law that are likely affected: cost-sharing subsidies and reinsurance payments. Note, however, that the final determination of whether something is subject to sequestration or if a workaround exists is left to the administration’s Office of Management and Budget (OMB).
(2014 cost = $4 billion, 2014 sequester = $300 million, 2014-23 cost = $150 billion, 2014-23 sequester = $8.5 billion)
In addition to federal premium subsidies, the ACA also provides subsidies to reduce cost-sharing (copays, deductibles, out-of-pocket caps) for individuals with incomes between the federal poverty level (FPL) and 250% of the FPL. To qualify for federal cost-sharing assistance, an individual must enroll in a silver-level plan, which is intended to cover, on average, roughly 70 percent of an enrollee’s costs (in health care speak, a silver plan has an “actuarial value” of approximately 70 percent – note, however, that this is an average, so some pay more and some pay less). If your income is between 100% and 250% of FPL, federal subsidies paid directly to your insurer will lower the deductible, copays, and/or out-of-pocket expenses cap you face such that the actuarial value of the plan is increased as follows.
|Cost-Sharing Subsidy Parameters|
|Income Level||Actuarial Value|
|100-150% of FPL||94%|
|150-200% of FPL||87%|
|200-250% of FPL||73%|
The Office of Management and Budget (OMB), in charge of administering sequestration, has stated that these subsidies will be cut by an estimated 7.2 percent in 2014. How these cuts will be carried out, however, is unclear. Because the subsidies are paid directly to the insurer, most – including the Congressional Research Service (CRS) – believe that insurers will receive less money from the federal government, but will still have to offer the same lower cost-sharing to enrollees, thus forcing insurers to swallow the additional costs or make them up elsewhere. From CRS:
The impact of sequestration is unclear. ACA entitles certain low-income exchange enrollees to coverage with reduced cost-sharing and requires the participating insurers to provide that coverage. Sequestration does not change that requirement. Insurers presumably will still have to provide required coverage to qualifying enrollees but they will not receive the full subsidy to cover their increased costs.
Given that the idea of an insurance exchange is for insurers to bid what they think their costs will be to cover an average enrollee plus a profit margin, this sequestration complicates that calculation and would likely lead insurers to increase premiums in order to at least partially offset the sequester loss (which would in turn increase the federal government’s cost for premium subsidies). Potentially more damaging, this could create an incentive not to be the low-bidder for Silver plans to avoid getting a disproportionate share of enrollees who are eligible for cost-sharing subsidies (who have to choose a Silver plan to get the subsidy and may be more likely to choose the least expensive offering).
(2014 cost = $10 billion, 2014 sequester = $720 million, 2014-23 cost = $20 billion, 2014-23 sequester = $1.5 billion)
The ACA’s Transitional Reinsurance Program is geared to help insurers manage the uncertainty inherent in setting premiums for the first few years when it’s very difficult to predict the risk profile of your enrollees. To protect plans that end up with a disproportionately high share of very sick enrollees, reinsurance payments will help cover the costs of very high-cost patients (see this good explainer from Sarah Kliff of the Washington Post for more info).
Particularly given the website’s rocky rollout and growing concerns about insurers ending up with a higher proportion of sick enrollees than they were expecting, the importance of the reinsurance program has gained attention. But, with the sequestration of mandatory programs still intact, these reinsurance payments are likely to be cut by over $700 million in 2014, around $400 million in 2015, and $250 million in 2016.
Notably, it is not as clear that these payments are subject to the sequester as they are not listed in OMB’s preview report. However, it is also unclear why they would be exempt since the reinsurance payments are a mandatory spending program and are not explicitly exempted by the Budget Control Act (BCA), the legislation that mandated the current sequester. Moreover, Medicare’s prescription drug benefit (Part D) includes a similar reinsurance program, which had to be explicitly exempted by law (see here, p. 17 of the pdf).
At the end of the day, though, the final decision rests with OMB and we will find out for sure in January when they issue their final sequestration report for FY 2014.
In a move that has been discussed and anticipated for months, the Federal Reserve's Federal Open Market Committee announced that it would slightly scale back its current quantitative easing program (QE3). Specifically, it would slow its purchases of longer-term Treasury and mortgage-backed securities by $5 billion per month each, reducing the total monthly purchase from $85 billion to $75 billion. It also announced a change in its policy towards the federal funds rate.
Market reaction was generally positive following the statement, possibly seeing the scaling back of QE3 as a sign that the Fed sees improvement in the economy or reacting to the fed funds rate announcement that is described below. This was in contrast to a market slide earlier this year reacting on rumors of a tapering of QE3.
Note that while this move would represent less accomodative policy, it would not mean that the Fed balance sheet would shrink in absolute terms, just that it would not grow as fast. The Fed's $1.8 trillion holdings in longer-term securities and $1.5 trillion holdings in mortgage-backed securities will continue to grow in nominal dollars, as will the balance sheet overall, which currently sits at close to $4 trillion. The graph below shows how the balance sheet has changed and grown since the recession.
Source: Cleveland Federal Reserve
Another interesting statement came regarding the federal funds rate, which is near zero. In October 2012, the FOMC said that the low federal funds rate would likely be warranted through 2015. They changed the statement in December to say that the rate would be kept there until the unemployment rate fell below at least 6.5 percent and inflation rose above 2.5 percent, with the caveats that these were not immediate triggering thresholds and that other economic conditions would be taken into account. Apparently, the FOMC was convinced that the state of the other conditions' warranted keeping the fed funds rate near zero "well past the time that the unemployment rate declines below 6-1/2 percent."
So while many people may report this as an "unwinding" of the Fed's loose monetary policy, it is actually trading a reduction in the purchases of QE3 in exchange for an explicit lengthening of amount of time when the fed funds rate will be near zero.
CBO's Long-Term Budget Outlook contains significant amounts of helpful data on Social Security. However, a lot of the data focus on just the outlays of the program; by contrast, reformers tend to focus more on its overall finances and the state of the trust fund. Today, CBO published some additional information on Social Security, showing both the program's full finances and, importantly, the ranges of uncertainty in their projections. Their projections show the trust funded being exhausted by 2031, with 95 percent confidence of it being exhausted by 2037.
Over the next 25 years, Social Security outlays are projected to grow from 4.9 percent of GDP in 2012 to 6.3 percent of GDP in 2037. They will then increase slightly from there to 6.7 percent by 2087. Meanwhile, revenues stay relatively stable, in the 4.5 to 4.7 percent of GDP range over that entire time. As a result, cash flow deficits will increase from 0.3 percent of GDP in 2012 to 1.6 percent by 2037 and 2.1 percent by 2087. Overall, CBO predicts a 75-year actuarial deficit of 1.2 percent of GDP, or 3.4 percent of taxable payroll, and they expect the combined trust fund to be exhausted in 2031. The growing deficit over time underscores the fact that waiting longer to fix Social Security will only make the solution more difficult.
This narrative is familiar to those know the Social Security situation. However, what is often less focused on is the range of possibilities for CBO's projections. This is especially important, since one argument sometimes advanced to play down the need for Social Security reform is to emphasize this uncertainty.
First, CBO shows the 80 percent range of outcomes for spending and revenue (in other words, they exclude the 10 percent most extreme outcomes on either side). As you can see, even using the most generous outcomes for spending and revenue, the program does not appear to go back into surplus at any point in the future.
There is also an uncertainty band for the trust fund ratio -- the ratio of assets to benefits paid -- and the fund's exhaustion date. In the former case, the median projection shows the trust fund ratio falling to zero by 2031, while the 10th and 90th percentiles show the trust fund ratio falling to zero by 2029 and 2036, respectively. In the case of the exhaustion date, it comes as early as the mid-2020s or as late as beyond 2037, but most of the simulations show an exhaustion date in the late 2020s and early 2030s.
The report also shows a number of different measures of benefits and taxes paid across income quintiles and birth cohorts. In terms of distribution, benefits in absolute terms are higher for higher-income people, but replacement rates and the ratio of benefits-to-taxes are higher for lower-income people. Across cohorts, real benefits and benefits-to-taxes ratios rise over time while replacement rates stay relatively constant, assuming benefits are paid regardless of the status of the trust fund ("scheduled benefits").
In short, CBO's numbers show that there is uncertainty in their projections, but under almost all projections, Social Security's finances will need to be addressed. And as we've shown before, the longer we wait to do so, the harder it will be.
While the Final Four for the NCAA tournament is still almost four months away, another Final Four is taking place right now. Although it won't be held in a football stadium, voting for the 2013 SAVE Award is happening on the White House's website. The SAVE Award, which allows federal employees to submit ideas for reducing waste, has been held every year since 2009, with the winner being able to present their idea to the President and many other submissions also getting put into the President's budget or implemented administratively.
Yesterday, OMB director Sylvia Mathew Burwell presented the Final Four in a blog post.
Kenneth Siehr, Online Tracking of Veterans Mail Prescription Deliveries. The Department of Veterans Affairs sends the majority of outpatient prescriptions to patients via mail. Currently, in order for Veterans to track the delivery of mailed prescription medications they must call their local VA Medical Center directly. Kenneth recommends saving pharmacy staff time and enhancing customer service by making the package tracking information available to Veterans online through the Veterans Health Administration’s existing web-based portal, MyHeatheVet.
Patrick Mindiola, Electronic Passport Notification. The State Department sends thousands of Information Request Letters (IRLs) in response to passport applications via regular mail. These mailings delay the processing time for applications and result in unnecessary added costs. Patrick recommends saving time and money by responding via email first, requesting any additional information needed and asking the applicants to verify submitted information. Mail notifications would be used only when email addresses are missing or returned, or if no response is received.
Dirk Renner, Share Certifications Across Agencies. Dirk has worked for multiple federal agencies and recently found out that his USDA Forest Service All-Terrain Vehicle (ATV) training was not transferable to the Department of the Interior’s Fish and Wildlife Service, where he now works. Dirk recommends allowing comparable agency certifications to transfer from agency to agency or between departments. This change would save time and reduce duplicative training and travel costs for employees across the government.
Buyar Hayrula, Collect Custom Fines and Penalties Online. Buyar suggests creating a secure website to allow Custom and Border Protection (CBP) officers and agriculture specialists to collect payments by credit card at land ports of entry. Currently, payment requests are often sent via mail when a cashier is not available. Automating this payment process would increase revenue collections and operational efficiencies at CBP while also helping reduce wait times for individuals entering the U.S. at land ports of entry.
You can vote here on the winner until Friday at noon. Last year's winner was Frederick Winter, who suggested that federal employees receiving public transit benefits be switched from regular transit fare to the reduced senior fare as soon as they are eligible. That suggestion was implemented administratively and will save $12 million over the next five years.
For years, Senator Tom Coburn (R-OK) resisted the temptation to talk in broad generalities about "wasteful government spending" and has instead been willing to call out specific examples. Today, his office has published the fifth edition of his annual Wastebook, detailing 100 examples of what he describes as "wasteful and low-priority spending," totaling almost $30 billion. The Wastebook looks at little-used government programs, unusual research projects funded by government grants, and tax breaks given to companies in order to identify these examples.
As Dr. Coburn explained,
The nearly $30 billion in questionable and lower-priority spending in Wastebook 2013 is a small fraction of the more than $200 billion we throw away every year through fraud, waste, duplication and mismanagement. There is more than enough stupidity and incompetence in government to allow us to live well below the budget caps. What’s lacking is the common sense and courage in Washington to make those choices – and passage of fiscally-responsible spending bills – possible.
Some of the spending examples highlighted in his report are:
- Paid to Do Nothing – At least $400 million: During the government shutdown, many employees whose jobs do not directly preserve life or property were furloughed. However, Congress granted them back pay for hours not worked when the shutdown was lifted. Senator Coburn calculates that there were at least 100,000 employees in this category with an annual salary over $100,000.
- Uncle Sam Looking for Romance on the Web – $914,000: The Popular Romance Project has received nearly $1 million from the National Endowment of the Humanities (NEH) since 2010 to “explore the fascinating, often contradictory origins and influences of popular romance as told in novels, films, comics, advice books, songs, and internet fan fiction, taking a global perspective—while looking back across time as far as the ancient Greeks.”
- Mass Destruction of Weapons – $7 billion As the U.S. war effort in the Middle East winds to a close, the military has destroyed more than 170 million pounds worth of useable vehicles and other military equipment. The military has decided that it will simply destroy more than $7 billion worth of equipment rather than sell it or ship it back home.
- Let Me Google That for You: National Technical Information Service – $50 million: Established before the Internet, the Department of Commerce’s National Technical Information Service (NTIS) collects government-funded reports and sells them to other federal agencies. However, about three-quarters of the reports are available for free from other public sources.
- Hurricane Sandy “Emergency” Funds Spent on TV Ads – $65 million: In January 2013, Congress passed a bill to provide $60.4 billion for the areas devastated by Hurricane Sandy. However, instead of rushing aid to the people who need it most, state-level officials in New York and New Jersey spent the money on tourism-related TV advertisements.
- Need Brains! Fighting Zombies with Pluses and Minuses – $150,000: A grant from NSF went to a company in North Carolina to develop a math learning game based on the zombie apocalypse.
It has been one week since Sen. Patty Murray (D-WA) and Rep. Paul Ryan (R-WI) announced they had reached a bipartisan budget agreement, which is now being considered in the Senate. CRFB board member Bill Hoagland, a longtime expert on the federal budget process and former staff director of the Senate Budget Committee, weighed in on the deal in an op-ed today. Even though the agreement is small and leaves many challenges unaddressed, the fact that they were able to reach an agreement is a positive step in the right direction, demonstrating "that two very different political philosophies can still find common cause in a polarized country and a divided Congress."
How remarkable is this achievement? Understand that not since 1986 has a divided Congress – then a Senate controlled by Republicans and a House run by Democrats – reached a budget conference agreement under the orderly procedures of the Budget Act. But even more astonishing is the simple fact that in the nearly 40 year history of the Budget Act there has never been a conference agreement on a budget outline when the House was controlled by Republicans and the Senate controlled by Democrats. We have had budget agreements over the years but primarily when one party controlled both chambers or, as has been the case for the last four years, no agreement with divided chambers, and ad-hoc procedures held together with little structure. Ryan and Murray have clearly shown that even with a conservative House and a left of center Senate, the federal government can still do its job of budgeting.
There is still much more to accomplish in the coming months, including raising the debt ceiling and addressing many expiring provisions. But whatever the flaws of the budget agreement, it should be valued as a sign that compromise and cooperation is still possible in Washington.
And while the policies and the numbers of the Ryan-Murray agreement will be arrayed and flayed by those on the polar opposites of the right and left, such critiques will miss the real value of their accomplishment. It is a step, yes a baby step, in restoring some order and structure to our fiscal decision making process. After the recent government shutdown, the mindless sequester, threats of default to our national debt and a federal government stumbling from one crisis to another managing its operations, it breathes life back into a system that has always operated best with compromise and bipartisanship.
Can a democracy survive without compromise? The answer from the last few difficult years of failed budget negotiations, is probably yes, but at what cost? The biggest cost has been not to the federal accounting sheet, but the trust and support of the American public for our institutions of governance. The Founding Fathers of our democratic system, who themselves possessed strongly held and often opposing positions on the respective roles of the federal government, a federal executive and the states in managing the affairs of a young and expanding country, found the need to compromise and move forward. Indeed the Great Compromise of 1778 – the Constitution – was and is the touchstone upon which our democratic system has survived (and thrived) over 220 years. The Ryan-Murray agreement can never be compared to that agreement, but it can be a start to restore much needed faith in a functioning democratic government once again.
Click here to read the full article.
"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.
As CRFB has explained in a recent analysis, the Bipartisan Budget Act under consideration in the Senate would replace a portion of the mindless sequester cuts with more targeted reforms. One controversial proposal in the bill would reduce cost-of-living adjustments for working-age military retirees. This blog explains that provision.
In broad terms, the Bipartisan Budget Act would use $85 billion of targeted deficit reduction to pay for almost $63 billion of defense- and non-defense sequester relief. As a result, the $20 billion defense cut which would occur in mid-January is replaced with a small increase.
The military retirement provision in particular would reduce COLAs by 1 percent (but not to below 0) for working-age pensioners below 62 (many of whom work in second careers), with a one-time catch-up at 62 so that retirees above age 62 are held completely harmless. This provision would save $6 billion in mandatory spending, but by reducing the amount the Department of Defense has to fund their pension accounts, actually allows $8 billion more in defense spending.
In other words, the savings from the military retirement provisions are not actually going toward deficit reduction, but instead toward funding other defense needs. The Pentagon can make much-needed reductions to its compensation costs and free up resources to build an adaptive 21st Century military.
Understanding Military Retirement Benefits
Currently, members of the military become eligible for retirement benefits after 20 years of service. As a result, many start receiving retirement benefits as early as their late 30s, and on average begin collecting by age 42. For 20 years of service, benefit levels generally equal half of a beneficiaries' highest 3 years of work, and 2.5 percent more for each additional year worked beyond 20. Benefits then grow every year with the Consumer Price Index.
The fact that members of the military can retire so young has important implications. For one, most retirees have second careers while collecting their pensions – sometimes as civilian employees at DoD, sometimes as military contractors for high profile companies, and sometimes in fields completely unrelated to their military service.
It also means that a military retiree is likely to spend more time collecting retirement than serving in the military; an officer who serves for 20 years beginning at age 22 and then lives to the average male life expectancy of 82 will have collected 40 years of retirement benefits for 20 years of service. In the private sector and civilian workforce, the opposite tends to be true – most Americans spend closer to 40 years working to collect 20 years of retirement benefits.
Why Is Military Retirement In Need Of Reform?
According to the Defense Business Board, military retirees eligible for pensions receive a benefit more than 10 times greater than private sector equivalents. Although there is good reason to provide generous benefits for those who serve in the military, many defense experts and officials worry this level of benefits is ultimately unsustainable.
According to Defense Secretary Gates in 2010, "Health-care costs are eating the Defense Department alive, rising from $19 billion a decade ago to roughly $50 billion." Current Secretary Hagel said “Without serious attempts to achieve significant savings in this area, which consumes roughly now half the DOD budget and increases every year, we risk becoming an unbalanced force, one that is well-compensated but poorly trained and equipped, with limited readiness and capability.”
Although health benefits are a big part of this, funding retirement benefits cost about $16 billion per year – which is about 34 cents for each dollar of basic pay for active duty personnel. The cost of military benefits is growing over time, while sequestration means that the total money available is shrinking. The chart below shows the amount of each service member's total compensation package (including health and retirement costs), which has grown faster than inflation.
In addition to funding concerns, the current military retirement system is in many ways broken. As a Moment of Truth Project paper explained in 2011, those with 19 years of service get nothing while those with 20 years walk away with one of the most generous pensions in the country. This creates bad incentives, including by encouraging skilled members of the military to exit shortly after their 20th year, but also creates questions of fairness.
How Does the Bipartisan Budget Act Change Military Benefits?
Although fundamental reform is ultimately needed, the Bipartisan Budget Act makes only a modest change to military retirement benefits – temporarily reducing COLAs for those below the age of 62. This means that instead of receiving 2.3 percent benefit increases in a typical year, working-age military retirees would receive 1.3 percent. In years inflation is higher they would receive more, but in no case could their increase fall below 0. This policy is far more modest than the recommendation of the Bowles-Simpson Fiscal Commission, which recommended completely eliminating COLAs for retirees under age 62.
Yet like the Fiscal Commission recommendations, this policy would provide a one-time "catch-up" in pension levels at age 62 (to what they otherwise would have been), and then grow benefits with CPI after that. This means that there is no change to pensions for beneficiaries older than age 62 either now or in the future.
Some critics have argued that this modest change would reduce the lifetime value of pensions by more than $80,000. Although their figures are accurate, critics fail to put the number in context of an average lifetime benefits for enlisted personnel of $2.4 million. In other words, the total reduction, relative to current law, would be about 4 percent of cash pensions (forgetting health and other benefits) – and this would come when most retirees are working elsewhere and earning supplemental income.
In addition to saving money and enabling more targeted spending on defense programs, reducing COLAs until age 62 could also help encourage longer careers in the military and help retain experienced military officers. The reduced COLA would still leave military pensions better protected from inflation than most of those in the private-sector.
Finally, it is important to understand where this money would go. As we've explained before, the Bipartisan Budget Act provides over $22 billion of sequester relief on the defense side – meaning defense spending will be $22 billion higher than under current law. But the $6 billion of savings from this provision would allow DoD to contribute $8 billion less to the Military Retirement Fund to cover future pensions, thus providing an additional $8 billion, beyond the $22 billion, to put toward military readiness and other defense priorities.
How Does This Proposal Affect the REDUX Retirement System?
Currently, service members can choose from two retirement systems – the High-36 system we described above, or an alternative system called REDUX. Although most choose the traditional system, those choosing REDUX receive a one-time $30,000 payment in exchange for accepting initial benefits that are 10 percent lower and a COLA of CPI minus 1 percent. This proposal would not change REDUX at all, and thus might make it somewhat more attractive to servicemembers.
Pension Payments of a Typical Military Retiree Under Three Systems
Source: CRFB staff calculations based on a service member who retired in 2013 at age 38 with an E-8 rank (Sergeant First Class). Salary information from the Office of the Secretary of Defense.
There is broad recognition, from Chairman Ryan to Defense Secretary Hagel to Army Chief of Staff Ray Odierno, on the need to reform military compensation. The changes to military pensions in the Bipartisan Budget Act of 2013 is a modest step in that direction, slowing the growth of one of the nation's most generous retirement systems for those not yet of retirement age.
These changes come with a cost – lifetime benefits will be 4 percent lower, on average, than they otherwise would have been. But these reforms are part of a package with substantial benefits. This package avoids immediate cuts in defense spending, provides relief to the mindless non-defense discretionary cuts, frees up further resources for military readiness, and reduces the deficit by more than $100 billion over the next two decades.
This is the fifteenth post in our blog series, The Tax Break-Down, which will analyze and review tax breaks under discussion as part of tax reform. Previously, we wrote about the Low-Income Housing Tax Credit, which provides credits to state-run housing agencies, which are then distributed to developers and investors to build low-income rental housing.
The charitable deduction allows taxpayers to deduct donations they make to non-profit organizations. A donation can be made from pre-tax income, effectively reducing the "cost" to the donor.
It was first enacted in 1917, four years after the modern income tax. At the same time, the top income tax rate was increased dramatically from 15 percent to 67 percent in order to generate revenue for World War I. Policymakers were concerned that raising the top income tax rate significantly would deprive well-off people of the surplus income from which they had been making charitable contributions.
Taxpayers who make a charitable donation can deduct the donation from their income but cannot reduce their income by more than half. So a taxpayer in the 25 percent bracket giving a $100 donation would receive a tax benefit of $25, and the donation would only “cost” the donor $75. Since it is an itemized deduction, taxpayers who take the standard deduction get no benefit from making charitable donations.
Not all donations to tax-exempt organizations qualify for the deduction. Traditional 501(c)(3) non-profits and churches (even if they are not registered as a non-profit) qualify, but donations to many other types of tax-exempt organizations, such as political committees, labor unions, and chambers of commerce are not deductible.
In 2011, there was nearly $300 billion given to 1.1 million charities, but only $175 billion was deducted as a charitable contribution. The rest was either donated by non-itemizers (who cannot claim the deduction) or simply not reported.
The deduction - along with all other itemized deductions - is reduced for high-income taxpayers due to a provision enacted in the fiscal cliff deal called the Pease provision. The total amount of itemized deductions that a person can claim is reduced if a taxpayer's income is above $250,000 for single couples or $300,000 for married couples. However, studies show that this limitation has little effect on charitable giving, since the reduction is determined by the total amount of income, not on the amount of charitable donations.
How Much Does It Cost?
According to the Joint Committee on Taxation (JCT), the charitable deduction will cost $42 billion in 2013 and approximately $570 billion over the next ten years. JCT's tax expenditure list details three separate categories of the deduction: for health, for education, and for everything else. Deductions for donations to health organizations comprise approximately 10 percent of the deduction's cost, while deductions to educational institutions make up 12 percent. OMB estimates a larger figure for the whole deduction, $49 billion in 2013.
If the deduction were eliminated, the Tax Foundation estimates that the revenue could finance a tax cut of 3.7 percent (the 39.6 percent rate would become 38.3 percent).
Who Does It Affect?
Only taxpayers who itemize their deductions can claim the charitable deduction. In 2011, 32 percent of taxpayers itemized their deductions, and 81 percent of those claimed the charitable deduction.
Data from CBO suggests that each income group gives a similar percentage of their income to charity: every group making below $500,000 gives between 2 and 2.5 percent of their income to charity, while those over that threshold give over 3 percent on average. However, the value of the deduction accrues primarily to wealthy individuals, because they give more in dollar terms, are more likely to itemize, and face higher marginal tax rates so the value of their deduction is worth more. Households under $50,000 give one-fifth of all the donations in the United States, but only receive 5 percent of the tax subsidy.
Different Income Groups’ Shares of Total Contributions and the Total Tax Subsidy, 2006
The fact that the charitable deduction mostly benefits the wealthy has important implications for charities: not every charity benefits equally. Donors with an income over $1 million are much more likely to give to health organizations, museums, and schools and give less than one-fifth of their income to churches. By contrast, donors with income less than $100,000 give two-thirds of their donations to churches. However, only 18 percent of these taxpayers claimed the deduction in 2011.
How Donors Allocate Their Charitable Contributions, by Income Group and Type of Recipient, 2005
What Are the Arguments For and Against the Charitable Deduction?
Supporters argue that the deduction is a critical form of support for non-profits. Many donors, particularly wealthy donors with multimillion dollar donations, are sensitive to losing the tax benefit. If the deduction were limited at 28 percent, estimates show that between $3 and $5.6 billion less would be given every year. Supporters also argue that charities provide public goods, and often meet needs that the government would otherwise need to provide. They argue that the deduction increases fairness between taxpayers: a taxpayer who donates would have less money available to pay taxes and should not be penalized for charity.
Further, supporters argue that the behavior encouraged by the charitable deduction benefits society as a whole, not the taxpayer, so it should not be treated like other deductions. Any reduction in giving hurts charities, not the taxpayer. Finally, they point out that charitable giving is optional, unlike other sources of deductions like mortgages or medical expenses, and any proposal to limit tax deductions across-the-board to a specific dollar amount will hit charitable contributions the hardest (in economic terms, charitable giving is more elastic).
Opponents point out that the charitable deduction funnels money to projects that may not be a government priority or traditionally thought of as charity – only one-third of contributions were targeted at helping the poor in 2011. Further, they argue donations are not completely selfless – donors also benefit, either from the "warm glow" of giving to others, or through the recognition of having buildings constructed with their names. If donors receive private benefits from a donation, opponents argue, the donation should be treated like consumption and taxed. Further, an organization does not have to serve the needy to claim tax-exempt status, and some tax-exempt organizations appear to serve private interests in the same way as for-profit corporations.
Opponents also criticize the structure of the charitable deduction, even if they agree with its purpose. The current deduction does not accrue to everyone who gives, nor does it accrue to its beneficiaries equally. It only benefits those who itemize and especially those in the higher income tax brackets. Critics say the deduction is not well-targeted: most of the deduction is a tax windfall for donations that would have occurred anyway. They propose reform options, discussed below, which could encourage more giving at a lower cost or at least minimize the negative effect on giving.
What Are the Options for Reform?
The deduction could be repealed entirely, which would raise somewhat less than the deduction’s 10-year cost of $570 billion, since some taxpayers would change their giving patterns. The deduction could be repealed only for donations to nonprofit hospitals, who in some ways act similarly to for-profit hospitals, or for donations to universities.
The provision could be made more cost-effective by adding a floor which would maintain the marginal incentive to give, but limit the windfall subsidy for donations that would have been made anyway. The tax benefit would not be available on the entire donation, but only on giving above the floor. The table below lists two potential floors: the first limits the tax benefits to donations above $500 ($1,000 for couples), and the second only gives credit for donations above 2 percent of income (which is approximately the “normal” amount of giving).
Short of repeal, the charitable deduction could be dramatically restructured. Converting it to a credit would give the same amount of tax benefit to taxpayers at all income levels. The deduction could also be moved “above-the-line” on tax forms, so all taxpayers could benefit regardless of whether they itemized their other donations.
Using floors, it is possible to design a reform that would both reduce the cost of the deduction and increase total charitable giving. For instance, adding a $500 floor along with making the deduction available to all taxpayers or converting it to a 25 percent credit would simultaneously raise revenue and increase the number of donations. Both proposals would raise about $3 billion per year and increase charitable giving by about $1 billion per year. Other policy changes might represent a cost-effective trade-off: adding a $500 floor to the existing deduction would decrease donations by about $0.5 billion, but it would raise $6-7 billion in federal revenue per year.
Policies that raise a similar amount of money can have a very different impact on charitable giving. For example, converting the deduction to a 15 percent credit and making it above-the-line with a 2 percent floor would both raise about $175 billion, but the first option would cause donations to drop by almost 4 percent, while the latter would only decrease donations by 1 percent.
|Revenue Impact from Reforming the Charitable Deduction (Billions, 2014-2023)
|Policy||No Limit||Add a $500/$1,000 floor||Add a 2% of AGI floor|
|Repeal the charitable deduction||$550||n/a||n/a|
|Repeal the charitable deduction for nonprofit hospitals and health organizations||$50||n/a||n/a|
|Repeal the charitable deduction for universities||$70||n/a||n/a|
|Repeal the charitable deduction for corporate donations||$30||n/a||n/a|
|Put a floor on the existing deduction||n/a||$75||$210|
|Impose a 28% limit on the value of the deduction||$75||$135||$250|
|Impose a 22% cap on the value of the deduction||$150||$210||$330|
|Make charitable deduction above-the-line, so it can be claimed by all taxpayers||- $70||$30||$175|
|Convert the deduction into a 25% credit||
|Convert the deduction into a 15% credit or matching grant to the charity||$180||$260||$330|
*All scores are rough estimates and may not match official CBO scores. Scores were chiefly estimated from a 2011 CBO analysis based on 2006 data, but are consistent with more recent estimates.
In addition, policymakers could consider a host of smaller options to prevent abuse of non-cash contributions, make it easier to track donations, or simplify the way the law works. Some of the smaller changes, which either have savings below $1 billion a year or do not have available public estimates, are:
- Allow lottery winners to donate their winnings to charity without paying tax
- Impose various limits on conservation easements, which are difficult to value and sometimes abused: by converting the deduction to a capped credit, eliminating it for golf courses, or limiting it for personal residences and historic property.
- Limit deductions to $500 of clothing or household items, which are often overvalued
- Prevent deductions for donating property that is not useful to the receiving non-profit
- Prevent taxpayers from claiming the charitable deduction for donations required to buy collegiate athletic tickets, or prevent deductions for donations to college sports teams altogether
- Allow donations to count in the previous year until April 15th. If the policy’s goal is to encourage giving, the best time for donations would be when people are preparing (and trying to save on) their taxes.
- Exempt the charitable deduction from the Pease limitation, so the deduction is not reduced for high-income taxpayers
- Simplify the complicated language around the measurement of deductions
- Limit the deduction to "traditional" charities forming part of the social safety net
- Reform and simplify the rules regarding partial gifts (for example, when co-owners give a piece of art)
- Prevent abuse of charitable trusts
- Prevent taxpayers from claiming the deduction based on capital gain
- Require charities to report large gifts to the IRS (over $250 or $600, for example)
- Require fewer appraisals, raising the limit for the gifts that must be appraised from $5,000 to $10,000
- Eliminate a Cold War-era prohibition on claiming the deduction for donations to communist-controlled organizations.
What Have Other Plans Done?
Even tax reform plans that eliminate most other tax expenditures keep an incentive for charitable giving. The Fiscal Commission converted the deduction into a flat nonrefundable credit set at that plan's bottom tax rate: 12 percent. Domenici-Rivlin would also change the deduction to a credit based on that plan's bottom rate of 15 percent, although the credit would be given as a matching grant to the charity rather than to the taxpayer.
The 2005 Bush Panel on Tax Reform would add a floor of 1 percent of income to the deduction. Recognizing that most taxpayers give at least 1 percent to charity, this option restricts the tax benefit to "extra" donations. The Bush Panel would also require charities to report donations above $600 to the IRS, which would prevent fraud and help verify large donations.
Three other organizations would replace the deduction with a credit available to all taxpayers: the Economic Policy Institute proposes a 25 percent refundable credit, the Center for American Progress proposes a 15 percent credit, and the American Enterprise Institute has a 15 percent refundable credit with a $500 floor on donations.
The Heritage Foundation would retain the charitable deduction in its current form.
Where Can I Read More?
- Congressional Budget Office - Options for Changing the Tax Treatment of Charitable Giving
- Committee for a Responsible Federal Budget - Taking a Closer Look at the Charitable Deduction
- Committee for a Responsible Federal Budget - Softening the Blow on the Charitable Deduction
- Bruce Bartlett - The Future of the Charitable Deduction
- Urban Institute - Evaluating the Charitable Deduction and Proposed Reforms
- Joseph J. Cordes - Re-thinking the Deduction For Charitable Contributions: Evaluating the Effects of Deficit Reduction Proposals
- Joint Committee on Taxation - Present Law and Background Relating to The Federal Tax Treatment of Charitable Contributions
- Senate Finance Committee - Options to Change Tax-Exempt Organizations and Charitable Giving
- C. Eugene Steuerle - Testimony Before the Ways & Means Committee
- The Center for Philanthropy at Indiana University – Patterns of Household Charitable Giving By Income Group, 2005
- Elaine S. Povich - Charitable Giving Tied to State Tax Deduction Decisions
- American Enterprise Institute - The Great Recession, Tax Policy, and the Future of Charity in America
* * * * *
The charitable deduction is a long-standing and popular income tax break. However, it deserves the same scrutiny as other tax breaks to ensure that the policy is as cost-effective as it can be. There are a number of ways to make the deduction cheaper, more progressive, and more efficient -- including some that could actually increase charitable giving. If policymakers choose to keep the charitable deduction, they would be wise to consider options for improving it.
Read more posts in the Tax Break-Down here.
The budget agreement reached by the Senate and the House last week both has some good elements and bad elements. In particular, it replaces some of the sequester in 2014 and 2015 with targeted and permanent savings policies like reforming military and civilian retirement and improving the Pension Benefit Guaranty Corporation but does not do enough to make the long-term debt sustainable.
But Fiscal Commission co-chairs and CRFB board members Al Simpson and Erskine Bowles wrote in the Los Angeles Times on Friday that the greatest accomplishment of the agreement might be a demonstration of bipartisanship. Write Bowles and Simpson:
Perhaps most important, this agreement demonstrates that leaders in Washington can actually work together to reach some agreement on fiscal policy. The sad lack of trust between the two parties has been perhaps a greater obstacle to a "grand bargain" than the policy details themselves. We hope that this agreement can serve as a confidence-building measure that will lead to compromise on significant deficit reduction, as other lawmakers follow the good example set by House Budget Committee Chairman Rep. Paul D. Ryan (R-Wis.) and Senate Budget Committee Chairwoman Patty Murray (D-Wash.).
This symbolic victory is important, as going forward, most of the easy decisions have been made and lawmakers are left with only tough choices. Tax and entitlement reform cannot wait, say Bowles and Simpson.
Policymakers should take advantage of the need for legislation to fix the flawed Medicare payment formula — which is scheduled to cut physician payments by almost one-quarter — by enacting changes that make Medicare more cost-effective. In avoiding this cut, we must start paying doctors based on quality rather than quantity of care, and we must fully offset the costs of this "doc fix" with structural reforms that slow the rate of growth in federal healthcare spending.
At the same time, Congress should follow the lead of Senate Finance Committee Chairman Max Baucus (D-Mont.) and House Ways and Means Chairman Dave Camp (R-Mich.) to enact comprehensive tax reform that promotes growth and makes the U.S. more globally competitive globally. With $1.3 trillion of annual "tax preferences" in the tax code, there is plenty of money that can be raised from eliminating or scaling them back to reduce rates and deficits.
Policymakers should also go further in paring back the sequestration cuts. They should pay for that additional relief by eliminating unwarranted subsidies and low-priority spending, further reducing Medicare costs and improving the way we measure inflation in the federal budget and tax code.
Finally, we must reform Social Security to make the program financially sound for future generations.
Lawmakers clearly have a great deal left to do. Hopefully they can take advantage of this new momentum.
Click here to read the full article.
"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.
As we've said before, paying for temporary costs with savings that grow over the long term is very helpful for the long-term budget outlook, as it provides deficit reduction when it is most needed and after the costs have been incurred. In addition, doing so can provide up-front help for the economy. There are several policies in the Bipartisan Budget Act (BBA) that achieve this objective, saving relatively little in the first ten years but whose savings grow over time. These policies include the reduction in military pension cost-of-living adjustments (COLAs) for working-age retirees, the increase in new federal employee contributions, and the increase in Pension Benefit Guaranty Corporation (PBGC) premiums. In this blog, we'll take a look at these three provisions and do our best to estimate how much each would save in the second decade, which is one of the long-term methods of analysis we detailed in a recent paper. On net, we estimate the bill will save around $100 billion in the second decade.
- Military Pension COLAs: The military retirement system faces a significant unfunded liability. The BBA would help close that gap by reducing by one percentage point the COLA that military retirees under the age of 62 receive on their pensions. It would then provide a one-time catch-up at age 62, in order to bring pensions in line with levels they would have received without the one percentage point decrease before then. CBO estimates this provision will save $6.2 billion over ten years, although the savings grow from $150 million in 2016 to $1.3 billion in 2023. This is the type of provision that would benefit from lawmakers getting a longer-term score, since it's a policy that changes an annual index. Our estimate is that the policy would save about $25 billion in the second decade, or more than four times as much as it does in the first decade. Note that GDP is only about 50 percent higher in the second decade than it is in the first.
- Federal Employee Contributions: The Federal Employee Retirement System (FERS) also has an unfunded liability totaling $20 billion in FY 2011. For federal workers hired after 2013, they will have to contribute 4.4 percent of their income to FERS, up from 3.1 percent for workers hired in 2013 and 0.8 percent for workers hired before 2013. The FERS benefit is estimated to be worth 12.7 percent. Due to the grandfathering of existing federal workers (and those hired in the next three weeks), the ten-year score provides an incomplete picture of this provision's savings, which will grow over time as more workers are subject to the new contribution percentage. CBO estimates that the policy will save $6 billion over ten years, and we estimate it will save around $20 billion in the second decade.
- PBGC Premiums: The Pension Benefit Guaranty Corporation (PBGC) insures defined benefit pensions, funded by premiums imposed on pension plans (described here). The program currently has a $34 billion unfunded liability that, if unaddressed, would require the federal government to step in to cover underfunded pensions down the road. The BBA would increase flat-rate premiums from $49 per participant in 2014 to $64 by 2016 and increase variable-rate premiums from $9 to $19 per $1,000 of underfunding by 2016. CBO estimates that this will save $8 billion over ten years. Since the premiums are indexed to wage growth, the savings should grow over time as well, since indexing based off a higher premium will result in increasingly higher premiums in subsequent years. We estimate that in the second decade, this increase will save about $10 billion. In addition, the increased premiums will reduce the likelihood that the federal government will need to bail out the PBGC sometime in the future, which is an important benefit that isn't accounted for in these estimates.
|First- and Second-Decade Savings (billions)|
|Reduce military pension COLAs||$6||$25|
|Increase federal retirement contributions||$6||$20|
|Increase PBGC premiums||$8||$10|
Source: CBO, CRFB extrapolations
Conversely, using temporary savings is not ideal, since either, by definition, the savings won't last, or that they will become a "piggy bank" for lawmakers to offset other costs with extensions of these existing policies. Ideally, lawmakers would make savings permanent to address long-term debt. Examples of temporary savings (which last only through 2023) include the extension of the mandatory portion of the sequester for two years, the increase in airline fees that expires after 2023, and the extension of customs fees. If Congress believes that these policies are worth extending through 2023, they should have extended them permanently. Nonetheless, we are encouraged that the deal does contain a few policies which take a step toward addressing long-term fiscal challenges.
On Wednesday, we published an analysis of the Bipartisan Budget Act, which would replace a portion of the FY2014 and FY2015 sequester with mandatory cuts and user fees. Based on our analysis, the legislation would increase the deficit in the short run, modestly reduce it over ten years, and save about $100 billion in the second decade.
The legislation includes some admirable elements but also some troubling ones. Below, we walk through the good, the bad, and the ugly takeways from the bill.
- The budget agreement adheres to PAYGO principles by fully offsetting its costs and going further to actually reduce deficits over the next decade.
- The budget agreement replaces some temporary spending cuts with permanent deficit reduction and, as a result, reduces deficits by about $100 billion in the second decade.
- The budget agreement would reduce the upfront sequestration cuts, which will improve short-term economic growth and allow appropriators to better prioritize spending.
- The agreement reduces unfunded pension liabilities through reforms to federal worker retirement programs and the Pension Benefit Guaranty Corporation, which insures private pensions.
- The agreement replaces mindless cuts with better targeted savings.
- The agreement shows that the parties are capable of working together to craft better budget policy rather than governing by showdowns and crises.
- The deal does not have a noticeable impact on the debt. We project that the debt under this plan would reach 78.7 percent of GDP in 2030, as opposed to 78.9 percent had the sequester been left in place entirely.
- The agreement does not include or set up a process for entitlement or tax reforms
- The deal relies heavily on temporary savings. About 65 percent of the gross savings come from temporary policies, including more than 55 percent from policies that explicitly expire after 2023. Ideally, savings would be permanent to help address the long-term debt problem.
- The deal could make further sequester replacement less likely by depleting most low-hanging fruit and creating a glide path to future sequester spending levels.
- The deal includes a $6 billion budget gimmick that counts military retirement savings both toward deficit reduction and for discretionary spending relief (see our blog on this issue here) and the accompanying three-month "doc fix" package includes a $2 billion budget gimmick which makes 2024 cuts in 2023 instead. Absent these gimmicks, the two pieces of legislation would save about $10 billion less.
- The deal represents an incredible missed opportunity to reach a comprehensive budget agreement that could have ultimately led to a permanent replacement of the sequester, further spending cuts, a slowing of health care costs and retirement programs, and a comprehensive re-write of the tax code.
* * * * *
CRFB hopes that lawmakers will build on some of the bipartisan measures agreed upon in the conference committee to work out solutions to our underlying fiscal challenges, which for the large part remain untouched. Health care costs, retirement costs, and an outdated tax code will take true leadership to address. This package of reforms is a step in the right direction, but much more needs to be done.
Today, Kiplinger's Personal Finance published a new interview with Fiscal Commission co-chair and CRFB board member Erskine Bowles. In a discussion with editor Janet Bodnar, Bowles argues that despite modest improvements in our country's fiscal outlook, we still face a crisis unless lawmakers deal with the long-term drivers of the national debt.
If the country sticks its head in the sand and chooses to ignore the big problems, sooner or later the markets will wake up and demand that we take action...at some point the markets will look at our country and say, Whoa, you guys have a dysfunctional government, you're addicted to debt, clearly the fiscal path you're on is not sustainable over the long term, and you have no plan-nothing-to deal with it.
This commentary is especially timely given the Murray-Ryan bipartisan budget agreement, which the House passed yesterday. While that agreement is a step in the right direction, it barely improves deficits over the long term. Lawmakers should build on Ryan and Murray's example and find common ground on real reforms to put us on the right fiscal path.
Both sides are going to have to do this together because Democrats are not going to agree to any changes in entitlement programs unless there's additional revenue, and Republicans aren't going to agree to any new revenue unless there are substantive changes in entitlements.
As a co-chair of the Fiscal Commission, Bowles understands how difficult the politics of this issue can be, but also believes that a principled deficit reduction proposal can get support from both parties. Specifically, he recommends that any compromise follow several major principles that he and Senator Alan Simpson followed in their proposal.
In our plan, we laid out a number of principles that we wouldn't violate. First, we didn't want to do anything that would disrupt a very fragile economic recovery...our second principle was that we didn't want to do anything that would hurt the truly disadvantaged...Third, we wanted to make sure we reformed the tax code so that the U.S. would be more globally competitive. Fourth, we wanted to make Social Security sustainably solvent so it will actually be there for the people who need it. And we wanted to bend the health care cost curve because if we don't, it will bankrupt us. Finally, we wanted to get rid of some of the inane, really stupid cuts that are in the sequester and replace them with smart reforms in other mandatory programs.
If lawmakers are willing to pursue a balanced deficit reduction strategy that follows these core principles and includes real entitlement and tax reforms, Bowles believes that our government's fiscal credibility will be well on its way to being restored.
Click here to read the full interview.
On Tuesday, Sen. Patty Murray and Rep. Paul Ryan announced a budget deal that set discretionary spending levels for the next two years, removed some of sequestration's cuts, imposed targeted spending cuts and fee increases, and modestly reduced deficits over the next decade (see our full analysis of the deal).
According to Chairman Ryan, this deal is the first bipartisan budget agreement to come out of a divided Congress since 1986. So where did the final agreement end up?
For the current fiscal year (FY2014), the deal set total discretionary spending at $1,012 billion, exactly halfway between the $967 billion proposed by Ryan and the $1,058 billion in Murray's budget.
One widely circulated graph by the Center for American Progress points out that while the deal represents a compromise relative to the most recent budgets, it actually sets spending levels far lower than envisioned by past budgets – even by those proposed by Chairman Ryan. This is certainly true when looking at discretionary spending as a whole: the original Ryan budget, which was for FY2012, proposed 2014 spending levels at $1,039 billion, well above the $1,012 billion in the current agreement. Budget proposals from the left had set spending even higher.
However, looking at total discretionary spending obscures the fact that the cuts over the past two years have not fallen equally on defense and non-defense spending. Taking our cue from CAP, we've developed a similar chart that shows defense and non-defense spending separately.
As it turns out, the non-defense levels in the Murray-Ryan deal are about halfway between the 2014 spending levels that had been laid out in Ryan's FY2012 budget (his first budget) and the President's. Defense spending, meanwhile, is far lower than either party had envisioned. In other words, relative to FY2012 proposals, the lower spending is driven not by either side being more successful in setting non-defense spending levels, but by a 15 percent reduction in defense spending relative to what either side wanted.
The above chart also offers other insights. Defense spending is a couple billion dollars higher than current spending and more than $22 billion higher than sequester levels, but 6 percent below what Ryan and Murray proposed in their budgets this year. Non-defense spending is also $22 billion higher than the sequester called for, and falls between the proposals of either side.
These numbers only reflect a snapshot of spending in 2014, and show the problem with the current debate. Although both defense and non-defense spending cuts can help to improve the fiscal picture, discretionary spending is already at historically low levels. To truly put the debt on a sustainable path, the real focus must be on tax and entitlement reform. As we noted yesterday, the budget deal did almost nothing to change the trajectory of our debt.
Any fiscally responsible bipartisan agreement is a positive step forward, but policymakers have many more steps to take on the road to a sustainable budget.
*This appendix added after the original posting. For design reasons, we had to choose which budgets to display in the chart and displayed budgets from FY2012 and FY2014. However, we could have reasonably displayed different spending levels and made the same point. Below are some of the defense and non-defense levels in previous budgets.
|2014 Discretionary Spending Proposed By Various Budgets (billions)|
|Bipartisan Budget Act of 2013||$520||$492||$1,012|
|October 2013 continuing resolution||$518||$468||$986|
|Post-sequester (without an agreement)||$498||$468||$967|
|FY2014 Murray budget||$552||$506||$1,058|
|FY2014 Ryan budget||$552||$414||$966|
|FY2012 Obama budget||$610||$548||$1,158|
|FY2012 Ryan budget||$610||$429||$1,039|
|2011 debt limit compromise||$556||$510||$1,066|
|2010 enacted spending, increased for inflation||$602||$583||$1,185|
|Original Obama Budget||$600||$603||$1,203|
*Defense and Non-Defense may not add to total because of rounding.
Sources: Office of Management and Budget, House Budget Committee, Budget Control Act of 2011, and Congressional Budget Office.
So far, reactions to the budget agreement have been mixed. As we said in our report yesterday, Understanding the Bipartisan Budget Act, the deal replaces short-term savings in sequestration with smarter, permanent savings from mandatory savings and user fees, a positive development. But it largely pushes the big decisions down the road.
Today, the Washington Post weighed in on the deal, remarking that "a flawed deal is better than no deal." Perhaps the greatest achievement of the budget committee was showing that bipartisan compromise is possible.
Yet the deal has one overriding virtue: It exists. Republican and Democratic leaders have produced a bipartisan spending plan — and one that doesn’t increase the deficit through fiscal year 2015 at that. Now House and Senate appropriations committees can proceed to allocate funds within the overall caps set by the Murray-Ryan agreement: roughly $520 billion for defense and $490 billion for non-defense discretionary spending over the next two years. This eases the “sequester,” restores needed funds to defense and all but banishes the threat of a government shutdown like the GOP-engineered fiasco that so badly damaged this country’s reputation in October.
In short, the agreement’s importance is not fiscal but political: It amounts to a truce in the destructive budgetary wars that have plagued Washington since the advent of a Republican-majority House in 2011. During the interlude, U.S. businesses can invest in job-creating (and deficit-reducing) growth without worrying too much about disruptions from Washington. And lawmakers can address long-term questions such as tax and entitlement reform — assuming they want to.
The bill resolves some short-term concerns on sequestration, but does not make the kind of progress we were hoping for on the long-term problem. The Post notes that on this front, they still have a long way to go.
They should. Yes, President Obama and Congress have already achieved some long-term fiscal adjustment, to the tune of $2.7 trillion over 10 years, according to the Committee for a Responsible Federal Budget. Yet deficits are hardly the stuff of “a stale debate from two years ago or three years ago,” as President Obama suggested in a speech last week. What little deficit reduction the Murray-Ryan agreement claims to produce comes from a classic budgetary “magic asterisk”: $28 billion in promised restraint in mandatory spending (mostly Medicare) in 2022 and 2023.
The Washington Post notes that in order to reverse our upward fiscal course, we will have to turn to serious entitlement reform and closing tax loopholes. This deal did not do that in a meaningful way. But lawmakers can build off it and achieve a larger deal that would resolve sequestration in the remaining years if they choose and put debt on a sustainable downward path. There are few low hanging fruit in the budget left, now we only have the tough choices.
With the details on the agreement reached by Budget Committee chairs Paul Ryan (R-WI) and Patty Murray (D-WA) made fully available yesterday, CRFB has gone deeper into the Balanced Budget Act in a new paper and breaks down the sequester relief, the offsets, and finally the overall effect on the budget this decade and over the long term.
On the discretionary spending and sequester front, we show that the deal will ease the path of spending in the short term to ultimately reach sequester levels in 2016. Rather than spending being reduced by $20 billion come January, discretionary funding will rise by $25 billion. It will then raise very slightly to 2016 levels where it will continue on the current law path. In total, the sequester relief is $63 billion of budget authority, with the deficit impact totaling $62 billion.
The offsets come from a variety of sources, with many smaller policies and a few relatively big one. Some of the more notable offsets include increasing federal employee retirement contributions by 1.3 percentage points to a total of 4.4 percent of wages for employees hired after 2013, reducing the military pension cost-of-living adjustment for working-age retirees, and increasing aviation security fees. These offsets and other changes save $85 billion over ten years, more than the cost of the sequester relief. See the analysis for a full listing and discussion of the offsets.
In terms of debt, the agreement does very little since it includes only small net savings in the first decade, even though those savings grow over time. As you can see below, there is very little change in the CRFB Realistic Baseline assuming that the sequester stays in place. If, however, this deal allows the sequester to be kept in place permanently, it would produce some savings relative to the default Realistic baseline, which assumes the sequester is repealed.
Click here to read the full paper.
We Have a Deal – Rep. Paul Ryan (R-WI) and Sen. Patty Murray (D-WA) announced a budget deal late Tuesday after weeks of negotiation and a few days ahead of the December 13 deadline for their conference committee to report an agreement. The deal sets topline spending numbers for the next two years, $1.012 trillion for fiscal year 2014 and $1.014 trillion for fiscal year 2015. These levels are $45 billion above the sequester level for FY 2014 and $18 billion higher for FY 2015. The extra spending will be offset by spending cuts elsewhere and new non-tax revenue over ten years. Because the offsets exceed the spending increases, the deal will reduce the deficit slightly over the next decade and beyond. Ahead of the deal, we looked at what possibly could be included, some of which was in the deal. Shortly before the deal was announced, a bipartisan group of House members sent a letter to Ryan and Murray urging them “to find commonsense, bipartisan solutions to the serious fiscal challenges we face as a nation.” Ryan and Murray made it clear that this wasn’t the deal they each wanted and it does not address the long-term budget issues that must be contended with, but it represents a compromise that moves in the right direction.
Doesn’t Deal with the Long Term – The agreement does little to address the long-term fiscal challenges facing the country, but it does provide some much-needed stability for the federal budget process and hopefully can set the stage for more substantive bipartisan deals. As Fiscal Commission co-chairs Erskine Bowles and Alan Simpson put it, “The agreement is but a small step forward in restoring some sanity and order to the budget process, and puts in place a slightly more rational fiscal policy by replacing a portion of the inane across the board cuts in discretionary spending from sequestration with smarter, permanent cuts in mandatory programs.” The Campaign to Fix the Debt echoed that sentiment saying, “it is preferable to another round of punts, gimmicks, and showdowns. Lawmakers should pass this legislation with the understanding that it is a step forward not a victory.” Read our summary of the deal and a brief explaining it here.
Still a Good Deal of Work to Be Done – The budget deal still has to be approved by Congress. The House plans to vote on it on Thursday just before it adjourns for the rest of the year on Friday. The Senate is expected to take it up next week before it adjourns. Leaders in both chambers feel confident that the agreement will be approved by bipartisan majorities. Appropriators will then craft spending bills for the rest of this fiscal year based on the topline budget number. Appropriations legislation is expected to be considered the week of January 6 when lawmakers return from the holiday recess and just ahead of the January 15 expiration of the continuing resolution currently funding the government. Passing spending bills, as opposed to relying on the stopgap measures that have been used in recent years, will provide more guidance to federal agencies on how to proceed.
Will Unemployment Benefits Be Dealt In? – Legislation extending the period the unemployed can collect jobless benefits from 26 to 73 weeks expires on December 28. Some legislators are working to extend the expanded benefits for another year. An extension, which would cost $25 billion, was left out of the budget deal. We argue that any extension of unemployment benefits, just like any other extensions, should be paid for.
Permanent Doc Fix Even More of a Deal – Earlier this year, the Congressional Budget Office (CBO) significantly reduced its estimate of permanently replacing the Sustainable Growth Rate (SGR) -- known as the “doc fix” -- because of slowing growth in health care costs. That news spurred efforts to enact a permanent fix this year, as opposed to the annual patches preventing a steep reduction in payments to Medicare physicians. Now the estimate has been lowered even further, to $116.5 billion over ten years. While lawmakers are close to a deal on a permanent fix, agreement has still not been reached on offsetting the cost. With time running out to complete an agreement by the January 1 deadline for avoiding a 24 percent cut in physician payments, a three-month fix will be considered in the House to buy negotiators a little more time.
Hopes for Farm Bill in 2013 Dealt a Blow – Another major bill that is close but won’t be finished this year is the farm bill. Again, the House may vote for a short extension to buy some time, in this case through the end of January. A farm bill agreement could include significant deficit savings.
Key Upcoming Dates (all times are ET)
December 12, 2013
- Senate Finance Committee executive session to consider legislation to repeal the Sustainable Growth Rate (SGR) - "doc fix" - at 10 am.
December 13, 2013
- Target adjournment date for the House.
December 20, 2013
- Target adjournment date for the Senate.
January 1, 2014
- The "doc fix," temporary tax extenders, extended unemployment insurance benefits, and the farm bill expire.
January 15, 2014
- The continuing resolution funding the federal government expires.
- 2014 sequester cuts take effect.
- First set of IPAB recommendations expected.
February 7, 2014
- The extension of the statutory debt ceiling expires.
Update: See our full analysis of the deal here
On December 10th, Budget Committee chairmen Patty Murray and Paul Ryan announced an agreement to set discretionary funding levels for 2014 and 2015 and provide a package of reforms to offset the costs of appropriating funds above the levels set by sequestration.
The package would provide $45 billion of sequester relief in FY2014 and $18 billion in FY2015, split evenly between defense and non-defense. This $63 billion in sequester relief -- which is projected to increase outlays by $62 billion -- would be offset with $85 billion of cuts and user fees over ten years, including from:
- Increasing airline security fees (Read our discussion of this policy here)
- Increasing PBGC premiums (Read our discussion of this policy here)
- Increasing federal civilian retirement contributions and reducing COLAs for military retirees (Read our discussion of this policy here)
- Extend Medicare and other mandatory spending sequester cuts into 2022 and 2023
- Reduce overpayments and other fraud
- Add a "self plus one" option to the Federal Employees Health Benefits program
- Reduce compensation to guarantee agencies for rehabilitated loans
- Other spending cuts and user fees, including extending customs fees until 2023, ending the ability of the Strategic Petroleum Reserve to accept oil, reforming some mineral leases, among many others
As more details become available, we will continue to study and analyze the proposal. At face, the package appears to replace some of the abrupt mindless sequester cuts with more gradual and targeted reform while reducing deficits by $15 billion over the next decade and more in the following decade.
Savings and Costs in the Budget Conference Committee Agreement
*Mandatory sequester and customs fees only are extended through 2023. They would save a comparable amount annually in the second decade if they were extended further.
**While airline fees continue after 2023, they are used as "offsetting collections" which are not considered deficit reduction. If these collections were used to lower the spending caps in those years, the savings would be about $20 billion.
^Could add $2 billion to the deficit over ten years if the reduced accrual payments are used to increase spending in other areas.
The budget agreement would have only a very minor impact on debt levels relative to keeping the sequester in its entirety. Under the CRFB Realistic baseline with the sequester, debt would have reached 68.7 percent of GDP in 2023 and 78.9 percent in 2030. Under this plan, it would be around the same place in 2023 at 68.6 percent and at 78.7 percent in 2030. Importantly, assuming the sequester remains in place permanently, debt levels would be several points lower than a baseline which repealed the sequester.
Debt as a Percent of GDP, 2010-2030
In a statement reacting to the announcement of the deal, the Fix the Debt Campaign congratulated Congressman Ryan and Senator Murray for working on a bipartisan basis to address the sequester and put in place at least some permanent savings. However, much more work is still needed to address the long-term debt.
This deal demonstrates that Republicans and Democrats in Congress can work together on a proactive basis, rather than relying on 11th hour deals and governing by crisis. All indications are that we will need to fix the system before we can fix the debt, and it is a small start that this agreement takes a responsible and bipartisan approach to dealing with policy trade-offs and paying for necessary changes instead of adding to the deficit.
To be clear, this deal falls well short of what is needed to deal with the nation’s fiscal challenges. It will have only a marginal impact on the debt and it does not tackle the difficult choices we will have to make. It does not address the growth of entitlement spending, provide for tax reform, or help target government spending away from consumption towards more productive investments. It does not even put in place any further steps to help deal with these challenges in a timely manner...
...Still, it is preferable to another round of punts, gimmicks, and showdowns. Lawmakers should pass this legislation with the understanding that it is a step forward not avictory. There is more work to be done.
Be sure to check back at crfb.org over the next couple of days for further analysis.
With the end of the year fast-approaching and the looming prospect of a 24 percent cut to Medicare physician payments on January 1, the House of Representatives has introduced a bill to delay the Sustainable Growth Rate (SGR) mechanism through the end of March.
A 3-month delay will buy some time for the relevant committees to continue working on a much-needed permanent fix, while still maintaining a deadline for them to do so. The Senate Finance and House Ways & Means Committees appear to be near agreement on how to reform provider payments, but have yet to figure out how the added costs will be offset. The newest estimates from Friday put the cost of a 10-year payment freeze at $116.5 billion, and presumably the Finance/Ways & Means reform would cost a little bit more than that.
The 3-month delay bill would include the regular health extenders and temporarily patches the SGR by providing physicians a 0.5 percent payment update from 2013 through March 31, 2014. It would also delay the Affordable Care Act's reductions to Medicaid Disproportionate-Share Hospital allotments for two years to 2016, and extend them one year further through 2023 (currently they end in 2022). Altogether, CBO projects that the temporary delays will cost around $8.7 billion, and thus require that much in offsets.
The fact that the bill provides a 0.5 percent payment update instead of the usual flat freeze is likely due to a quirk in the SGR formula, which makes a short-term 0.5 percent payment increase slightly cheaper than a freeze over 10 years because the increase would then require larger cuts going forward once the patch expires. Unless lawmakers are planning to actually let the SGR hit soon – and they're not – the fact that a payment increase is cheaper is just an apparition and will actually make a permanent fix slightly more expensive (and if the short-term increase sets expectations going forward, future payment costs could increase significantly). According to CBO, while a one-year SGR fix with a 0.5 percent update costs $900 million less than a freeze ($18.7 billion over ten years compared to $19.6 billion), a permanent increase with 0.5 percent updates would cost nearly $20 billion more than a freeze ($136.1 billion for 0.5 percent updates versus $116.5 billion for a freeze).
The bill would offset the added costs over 10 years by:
- Extending the Medicaid DSH payment reductions through 2023 ($4.3 billion);
- Introducing site-neutral payments for certain services performed in Long-term Care Hospitals ($2.6 billion); and
- Shifting some of the savings from the sequester's Medicare cuts from Fiscal Year (FY) 2024 into FY 2023 ($2.1 billion).
Equalizing payments for the same service between different sites of service is positive step forward, and has great potential to be extended more broadly in line with multiple MedPAC recommendations. The extension of DSH payment reductions produces real savings compared to current law, but lawmakers should eventually make it permanent.
The third policy, "realigning the Medicare sequester for fiscal year 2023," however, is a pure timing shift and gimmick. The sequester relief deal extended the Medicare sequester through 2023, but part of its savings actually occur in FY 2024 (due to the technicalities of the sequester, the 2 percent Medicare cut that counts toward 2023 actually occurs from February 1, 2023 through January 31, 2024). This SGR bill would simply shift $2.1 billion of this cut that was set to occur in FY 2024, and thus outside the 10-year CBO scoring window, into FY 2023. Instead of applying a 2 percent sequester for the full year, the bill would impose a cut in provider payments of 2.9 percent for the first six months of the year and a cut of 1.11 percent for the second six months of the year. This produces zero actual savings. Consequently, the legislation would increase the deficit by $1.8 billion ($2.1 billion minus the $0.3 net savings in the 10-year budget window).
This gimmick also potentially reduces the amount of savings from further extensions of the Medicare sequester, as Congress may find it difficult to reinstate a sequester of 2 percent after having allowed it to decrease to 1.11 percent.
A short-term "doc fix" to buy time for a permanent replacement is positive step forward, but lawmakers should work to ensure temporary fixes do not make a permanent fix more difficult and avoid gimmicks in such a deal.