The Bottom Line
At a press briefing yesterday, President Obama invited Congressional leaders of both parties to the White House tomorrow to continue ongoing debt ceiling negotiations. As the August 2nd deadline for raising the limit draws nearer, the President also stressed the need for lawmakers to be open to compromise, saying he hoped "that everybody is going to leave their ultimatums at the door."
As pressure intensifies and opposing parties continue to cast blame, using budget gimmickry as a quick fix to the problem probably seems like an increasingly appealing solution. However, as we stated in our recent paper What Needs to Come Out of the Debt Ceiling Negotiations, using budget gimmicks to avoid making the necessary tough choices is a huge DON'T.
While failing to raise the debt ceiling in time would be a serious mistake, so too would be failing to enact a credible plan to reduce and stabilize the debt. If the plan resulting from ongoing negotiations is seen as weak or ineffective in addressing long-term drivers of the debt, it could be perceived as a sign that Washington is unable to correct its fiscal imbalances, which could also damage the economy. Using budget gimmicks would undermine the credibility and effectiveness of any fiscal plan, and should be avoided.
Here are some potential budget gimmicks to look out for:
- Manipulating the baseline: There are many reasonable baselines for policymakers to choose from. However, different baselines can make the total amount of savings bigger or smaller than the $4 trillion target we have called for -- so each baseline requires a different deficit target. Policymakers should focus on what levels they can get deficits and debt down to.
- Counting war savings: Under current law, spending in Iraq and Afghanistan is technically projected to grow with inflation, despite plans for withdrawal being in place. While it may be sensible to apply budget controls to war spending, such savings (which could total more than $1 trillion) should not be counted towards the $4 trillion in total deficit reduction since policies to achieve them are already in place.
- Expanding the timing window: Stabilizing and reducing the national debt will require at least $4 trillion in savings over ten years compared to our plausible baseline. Extending that time frame to more than ten years would result in insufficient deficit reduction and should be avoided.
- Excessively back-loading savings: A sensible plan to stabilize the debt will implement policies gradually both to avoid disrupting a very fragile economic recovery and to give people time to adjust. However, excessive and arbitrary back-loading might be a sign that politicians are not serious about deficit reduction and are instead counting on future Congresses to override what they have put in place.
- Assuming expiring provisions are paid for (or expired): When identifying a plan's effect on the debt and deficit, lawmakers must make realistic assumptions about the future. In assuming current law (under which the Bush tax cuts, the AMT, and the SGR either expire or revert to levels never allowed by Congress), lawmakers could greatly exaggerate the effectiveness of their plan.
The debt ceiling offers lawmakers an opportunity to begin dealing with deficits and debt. Let's hope they avoid resorting to budget gimmicks.
More Fireworks in Store – Washington, DC celebrated Independence Day on Monday night with its annual fireworks display on the National Mall. Though the traditional pyrotechnics may be out of the way, lawmakers returning to work today could produce more fireworks in the nation’s capital. The Senate cancelled its planned recess this week to tackle debt limit negotiations, but leaders still appear to be no closer on the matter of whether taxes will be included in a package pairing a debt ceiling increase with deficit reduction. President Obama asked Congress to stay in Washington until a debt limit agreement is reached in a White House press conference on Tuesday. He also called for a balanced approach that includes reductions in defense spending, entitlements, and “spending in the tax code,” also known as tax expenditures. To put it all in perspective, CRFB last week updated its Long-Term Realistic Baseline, which now shows the national debt reaching 88 percent of GDP in 2020 and 140 percent by 2035.
Heading Towards a Short Term Debt Limit Deal? – The Declaration of Independence remains an enduring document 235 years after its adoption. Those negotiating a debt limit increase have a much shorter timeframe in mind, perhaps very short. With no signs of the impasse over taxes being lifted, an increase of a few months is looking more likely. Former President Bill Clinton urged Obama to take such an approach if Republicans don’t budge on taxes, and Sen. John Cornyn (R-TX) hinted on Sunday that things may go in that direction. CRFB offered its thoughts on what the debt limit negotiations should accomplish in a recent paper.
Declaring Independence from Tax Breaks – Tax expenditures have become a popular topic on Capitol Hill as policymakers look for revenues to include in a debt limit deal. President Obama specifically singled out tax breaks for oil and gas companies and corporate jet owners in his Tuesday press conference. Senate Majority Leader Harry Reid (D-NV) said he may schedule a vote on ending a particular tax expenditure or package several together for a vote. Meanwhile, Sens. Amy Klobuchar (D-MN), John Thune (R-SD), and Dianne Feinstein (D-CA) are working on legislation to pare back tax subsidies for ethanol. Also, Sen. Kent Conrad (D-ND) suggested that coupling tax increases with permanent relief from the Alternative Minimum Tax (AMT) could achieve Republican support. See here and here for ideas for eliminating and reducing tax expenditures.
Democratic Budget on Deck – Like throwing burgers on the grill, we can soon add another budget plan to the heat of scrutiny. Sen. Conrad, who is chairman of the Senate Budget Committee, will share his long-awaited budget proposal with his fellow Senate Democrats this week. Conrad says it will contain over $4 trillion in deficit savings over the next decade. But there are still no plans for a committee mark-up because Conrad wants to reserve the budget resolution as a vehicle for a possible debt limit deal. Compare the fiscal plans that have already been released using CRFB’s comparison tool.
Appropriations Bills March Forward – With the House back from its recess, the parade of FY 2012 spending bills will continue. Floor action on the Defense appropriation measure will resume with votes on amendments and final passage expected this week. The Energy-Water spending bill is next in line for floor consideration. On the other side of the Capitol, the Senate Appropriations Committee adopted its first spending bill (Military Construction-Veterans Affairs) last week, with a price tag of $142 billion. But work on other bills is not expected as the chamber has yet to agree on a top-line spending figure to guide the process. With the budget process becoming more drawn out, the ideas offered by the Peterson-Pew Commission on Budget Reform for making the process more functional in Getting Back in the Black are becoming more essential.
More Warnings on Debt Limit – Like Paul Revere making his famous ride, there are plenty of voices warning of the perils of the forthcoming debt limit deadline, which the Treasury Department reaffirmed is August 2. Bond rating firm Standard & Poor’s warned that failure to increase the debt ceiling would result in a swift lowering of the U.S. credit rating. And a detailed analysis by the Bipartisan Policy Center illustrates the effects on government operations that will ensue if the limit is not raised by early August. Check out CRFB’s ongoing Debt Ceiling Watch to stay abreast of the “extraordinary measures” being taken by the Treasury Department to avoid breaching the limit.
Medicare Changes Considered – The New York Times reports that the White House is offering Medicare and Medicaid cuts as part of a debt limit deal, contingent on if Republicans agree to revenue increases. In addition, last week Sens. Joe Lieberman (ID-CT) and Tom Coburn (R-OK), introduced Medicare reform legislation designed to strengthen the program’s long-term finances and save over $600 billion over ten years. See some ideas from CRFB for health care savings.
Spending Cap Bill Introduced – While many removed their caps at some point this weekend for the national anthem, Sen. Pat Toomey wants to put on a cap, namely a cap on federal spending. He unveiled legislation last week that divides federal spending into six categories with different caps. For example, non-discretionary defense spending would be reduced to $435 billion in 2012, frozen at that level for seven years and then indexed to inflation thereafter. CRFB has provided a handy Fiscal Toolbox that summarizes and compares various budget tools being discussed to reduce the national debt, such as spending caps and debt triggers. See more budget resources here.
Promoting Bipartisanship – Just as the signers of the Declaration of Independence cast aside ideological differences in agreeing on the document, Sen. Mark Udall (D-CO) is seeking that same spirit in addressing the debt. He is circulating a letter for signatures supporting a bipartisan approach to addressing the national debt using the recommendations from the White House Fiscal Commission as a template. Meanwhile, the Moment of Truth Project, which is led by Fiscal Commission Co-chairs Sen. Alan Simpson and Erskine Bowles and “aims to use the Fiscal Commission’s findings to spark a national discussion on the need to implement a comprehensive budget fix, and to help further develop the policy reforms to improve the nation’s fiscal outlook,” launched its new website last week, along with an updated estimate of the Commission’s proposal.
Rockefeller Rolls Out Ideas – Sen. Jay Rockefeller (D-WV) has put forth his ideas for reducing the deficit. His 18 proposals, all on the revenue side, would reduce the deficit by $1.29 trillion over ten years, according to his office. Recommendations include eliminating tax breaks for oil and ethanol, ending the 2001/2003/2010 tax cuts for the wealthy, and capping itemized tax deductions.
Key Upcoming Dates
- White House Twitter Townhall on the economy and jobs at 2:00 pm.
- House Budget Committee hearing on “Budgeting for America’s National Security” at 10:00 am.
- House Ways and Means Committee hearing on Social Security’s finances at 9:00 am.
- Treasury Secretary Geithner says that the U.S. will default on its obligations by around August 2 if the statutory debt ceiling is not increased before then.
After a sold-out presentation in Jackson Hole, Wyoming last week in which Fiscal Commission co-chair Senator Alan Simpson detailed the Commission's $4+ trillion long-term deficit reduction plan, over 200 Wyoming residents signed a letter urging their elected officials -- President Obama, Senators Enzi and Barrasso, and Congresswoman Lummis -- to endorse a compromise along the lines of the Commission plan, if not the plan itself. As a sign of bipartisan agreement on the letter, leading the signees are the chairs of the Democratic and Republican parties for Teton County (the county that Jackson Hole is in).
This letter is just one example of the support many citizens have for bipartisan action on a comprehensive plan that can set our nation on a sound fiscal path. The signers write:
"The political games must end. Everything needs to be on the table and compromise will be essential to success."
Sen. Simpson, a member of the CRFB board, spends much of his time on the road giving talks just like the one in Jackson Hole. With a little luck, he and other voices can help lead the discussion across the country toward promoting a long-term, comprehensive fiscal consolidation plan.
Check out the letter at the Concord Coalition's website here.
In a recent report, CBO estimated the base defense budget from 2012 out through 2030 using the Defense Department's Future Years Defense Program (FYDP) -- DoD's five-year plan for defense spending submitted to Congress in April 2011 -- to project future spending.
While the FYDP only provides for spending through 2016, CBO has extrapolated what defense spending would be if the budget were to be maintained through 2030, projecting the budgetary effects of decisions included in the near-term five-year window. For the 2012-2016 period, CBO estimates that the FYDP would grow defense spending by 1.8 percent annually after adjusting for inflation. Beyond 2016, the budget would have 0.5 percent real growth.
CBO expects that increases in operation and support costs will be the big driver of the increases in defense spending over the next few decades under this budget plan. This category basically breaks down into spending on military personnel -- compensation and health care -- and operation and maintenance. Both categories are expected to be on the rise through the next decade in the FYDP, taking up a larger share of the overall defense budget. We've broken down spending by category (in 2012 dollars) in the table below.
|Defense Spending by Category (Billions of 2012 Dollars)|
|Operation and Maintenance||$207||$226||$248||$284|
|Research and Development||$76||$69||$69||$58|
|Total, Base Budget||$554||$594||$625||$642|
Compared to last year, the path is similar for the first decade, but growth rates diverge in the second decade. Based on the average growth rates, defense spending by 2030 in this year's FYDP is about $50 billion lower than last year's FYDP. In particular, the acquisitions portion of the budget is more restrained compared to last year's plan.
Of course, making projections for discretionary spending can be very difficult, given that lawmakers must appropriate funding each year and the unpredictability of future security needs. However, it is still useful to see what the Pentagon is looking to spend on defense over the long-term as we comb through the defense budget for savings. With this in mind, defense spending -- like all areas of the budget -- should be part of any fiscal plan to put our fiscal house in order.
In today's Washington Post, CRFB board member Dan Crippen makes the case for closing the tax loophole for online retailers.
Mr. Crippen argues that the tax break harms local retailers that pay state and local taxes, create jobs, and contribute to the local economy and community. He also points out that because online retailers can escape sales taxes, "state and local governments will be forced to rely more heavily on personal and corporate income taxes, undermining consumption taxes that economists mostly favor." He concludes:
"States are under enormous fiscal pressure. All states must balance their budgets, and the erosion of the sale tax base means less money for education, transportation, infrastructure and the myriad services that states uniquely provide.
There are thousands of organizations focused on Washington, trying to preserve federal funding for their specific programs while Congress tries to cut spending. Constituents might be well served if lawmakers closed this glaring loophole so states can collect what they are owed, and helped prevent the creation of other special-interest exemptions."
Click here to read the full op-ed.
"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the Committee.
It’s hard to deny that Twitter has become an important medium, having recently surpassed 300 million registered users. The White House has recognized its emergence by scheduling its first Twitter Townhall for Wednesday, July 6. The topic will be the economy and there likely will be, and should be, questions on the debt limit and national debt in general. You can submit your own question via Twitter using the #AskObama hashtag.
CRFB has been active on Twitter as well with our @BudgetHawks account recently surpassing 1,000 followers. Among our recent followers is @DavidHasselhoff, “The Hofficial Tweet!” If you are not following us already, we encourage you to do so for the latest fiscal news, timely information and discussion on the federal budget and national debt.
Our projections use slightly different assumptions than both the Extended Baseline and the Alternative Fiscal Scenario (AFS). The resulting fiscal path just about splits the difference between the two baselines, which amounts to a wholly unsustainable fiscal outlook (if slightly less dire than the AFS). Under the CRFB Realistic Baseline, debt reaches 88 percent of GDP by 2020, 140 percent by 2035, and 437 percent by 2080. You can read more on the assumptions we made and the numbers that come out of it here.
But understanding why our baseline differs from CBO's other two scenarios requires understanding the difference between their current law scenario ("Extended Baseline") and their current policy scenario ("Alternative Fiscal Scenario"). Under the former, debt never exceeds 90 percent of GDP (and would fall to about 60 percent by 2050 if the wars were drawn down) while in the latter it exceeds 200 percent by 2037. The differences that lead to these disparate outcomes include:
- Doc Fixes: Under current law, Medicare physician payments are scheduled to be cut by 30% as part of something called the Sustainable Growth Rate. The AFS (and CRFB's Realistic Baseline) assumes politicians freeze physician payments instead.
- AMT Patches: The Alternative Minimum Tax is a secondary tax meant to capture high earners with low tax burdens. However, for a number of reasons, it now technically impacts middle-income families and so politicians pass annual "patches" to avoid this from occurring. Under current law, patches will stop while under the AFS (and CRFB's Realistic Baseline) they continue.
- Tax Cuts: Under current law, the 2001/2003/2010 tax cuts expire at the end of 2012, as do a number of temporary "extenders". The AFS assumes that policymakers make both permanent (while CRFB's Realistic Baseline only assumes the 2001/2003/2010 tax cuts continue).
- PPACA Cost Controls: The health reform law included a number of cost controls for Medicare and the exchange subsidies which are now part of current law but may prove unsustainable over the long-run. The AFS assumes that they are effective through 2021 but are overridden thereafter (CRFB's Realistic Baseline assumes they are partially overridden).
- Discretionary Spending Growth: By budget convention, the current law baseline assumes discretionary spending grows with inflation through 2021 (as does CRFB's Realistic Baseline). The Alternative Fiscal Scenario instead assumes it grows with GDP.
- Revenue Freeze: Were all the tax cuts (and AMT patches) to be renewed, revenue would still grow as a share of GDP due mainly to something called "real bracket creep" -- as well as due to the effect of the health care excise tax. However, the Alternative Fiscal Scenario holds revenue constant at 18.4 percent of GDP after 2021, essentially assuming that policy makers will enact future additional tax cuts.
- War Drawdown: By convention, CBO's current law baseline assumes all discretionary spending -- including for the wars -- will grow with inflation. However, the Alternative Fiscal Scenario (as well as CRFB's Realistic Baseline) assumes that troops will gradually be drawn down.
Here is a graphical bridge between the two scenarios (with the war drawdown added to current law).
Note: Interaction between the tax cuts and the AMT has been distributed among the two categories proportionally.
Not surprisingly, the tax cut extension contributes a significant chunk of debt to the AFS, although over the 75-year window, the assumption that revenue is frozen as a share of GDP plays a bigger role. AMT patches, discretionary spending growth, and the success of health reform's cost controls all play a big role as well.
The AFS and our Realistic Baseline paint a very bleak fiscal picture. However, as we pointed out earlier in the week, if lawmakers simply pay for any policy that diverges from current law, we will find ourselves in a much better situation.
June has come to a close. With that also comes an end of the second round of quantitative easing, known as QE2.
QE2 started off small in August 2010 after the promising early-year economic numbers had turned south. At the August 10th FOMC meeting, the Committee agreed to re-invest proceeds from maturing mortgage-backed securities and agency debt into long-term Treasury securities. The move would hold the size of the Fed balance sheet constant, instead of having it shrink as it otherwise would. The idea was that increased Fed holdings of long-term Treasuries would push down long-term interest rates, hopefully to help promote economic activity and investment now.
The "re-investment" stage of QE2 was only a small step. In the three months between its start in August and the second phase of QE2 in November, Fed holdings of long-term Treasury bonds rose by about $70 billion. Because the economic outlook continued to deteriorate into the fall and the specter of deflation seemed looming, the Fed found itself willing to act with more force three months later.
On November 3, the FOMC announced a plan to buy $600 billion of long-term bonds through June 2011 in addition to the re-investments it had already started making. Considering the subdued inflation numbers in recent months, the Fed wanted to move inflation back towards its implicit target of two percent, so they felt an expansion of the balance sheet was necessary.
Overall, it was expected that the Fed would end up buying an additional $800-$900 billion over that time period. The Fed has just about met that target, increasing its holdings of long-term Treasuries by about $750 billion since November 3rd and $800 billion since early August. Since November, the size of the overall balance sheet has increased by roughly $600 billion as expected.
What is the legacy of QE2? Certainly, the prospect of deflation has gone away, and inflation is running closer to the Fed's implicit target, so in attempting to achieve one part of its dual mandate, it has seemed to succeed. However, its impact on other economic indicators seems to have been limited, a point made in a well-publicized article back in April. Although hiring numbers this year have been improved compared to last fall, the improvement is not great and it is unclear whether the small progress is a result of QE2, the stimulus in the tax cut deal, or other factors. Others have defended QE2 (see here and, more recently, here) as having done what it was supposed to do--ward off deflation and boost financial markets--and that it shouldn't have been expected to bear the full burden of having to improve employment and growth numbers significantly.
As of right now, it does not seem as if QE3 is in the works. The FOMC did announce last week that it would continue re-investing its securities holdings as they mature to ensure the balance sheet does not shrink, but further expansion is not on the horizon yet.
So, it seems we must bid farewell to quantitative easing. To continue to track changes in the Fed balance sheet, among other government efforts to stabilize the economy and financial markets, check out Stimulus.org.
As our nation’s debt continues along its unsustainable path, it has become increasingly essential for a comprehensive fiscal plan that targets all areas of the federal budget—including defense.
The Senate’s Armed Services Committee issued a report along with its version of the fiscal 2012 defense authorization bill (S. 1253) that urges the Marine Corps to reconsider its plans for development of new amphibious-armor vehicles, calling the current thinking “misguided and too expensive.” The report orders a halt on further development of the Marine Personnel Carrier until completion of an analysis on alternatives to the Expeditionary Fighting Vehicle (EFV), which was terminated earlier this year by Secretary Robert Gates because of cost issues. In addition to this analysis, the Marine Corps is expected to conduct a cost assessment for its entire portfolio of ground vehicles.
The report asserts that the Marines’ amphibious vehicle plans are not affordable even without the EFV because these new vehicles are “far more complex and significantly more expensive than their predecessors,” according to CQ Budget Tracker. The Senate committee report states, “in view of the coming austerity, the Marine Corps will have to make difficult trade-offs in multiple areas.”
The trade-offs facing the Marine Corps are just one part of the larger cutbacks facing the Department of Defense. Incoming Defense Secretary Leon Panetta will continue the comprehensive review of Defense spending already begun by Secretary Gates identifying ways to achieve the $400 billion in savings over 12 years called for in the President’s Budget Framework. Panetta plans to continue reviewing military pay and benefits structure and reduce the cost of expensive weapons programs—suggestions straight from Sec. Gates’s playbook.
Tough decisions will have to be made as leaders in Congress as well as the Pentagon work to reduce defense spending while ensuring that our troops have the resources needed to protect our nation’s security.
Yesterday the Government Accountability Office (GAO) released a study on the complexity of the federal tax code at a Senate Finance Committee hearing on tax reform. The GAO study shows that switching to a simpler, fairer, and more efficient tax code would be a relatively easy way to control the deficit while bolstering the economy.
The study notes that the complex rules in the tax system lead to taxpayer errors which result in uncollected taxes. In 2001, the most recent year the IRS estimated the tax gap (the difference between what taxpayers owe and what they pay), the tax gap was calculated to be $345 billion. The figure has unquestionably risen since then, and the complex rules of our tax system are a major contributor.
"A simpler tax code will ease the burden of compliance on honest Americans and help them meet their responsibilities,” said Senate Finance Committee Chairman Max Baucus (D-MT) at the hearing. Ranking Member Sen. Orrin Hatch (R-UT) agreed, saying “complying with the tax code should not be a "Choose Your Own Adventure" story, where the complexity of the code leaves citizens guessing their tax liability."
In addition to reducing the tax gap, simplifying the tax code has the potential to boost the economy’s efficiency. GAO noted that complying with complex rules that demand recordkeeping, computations, and planning costs businesses and individual taxpayers valuable time and money. According to the IRS, taxpayers spend more than six billion hours each year complying with tax responsibilities, and GAO reported in 2005 that low-end estimates for annual compliance costs totaled $107 billion (close to 1 percent of GDP).
After yesterday’s hearing, Sen. Thomas Carper (D-DE) introduced legislation that would attempt to ease compliance burdens on law-abiding taxpayers. The legislation, titled the “Taxpayer Advocacy and Government Accountability Promotion (TAX GAP) Act”, also attempts to crack down on delinquent taxpayers, thereby reducing the tax gap. "Reducing the tax gap is a common-sense approach to combating our nation's ballooning debt," said Sen. Carper.
CRFB applauds Sen. Carper’s efforts to simplify our tax code. As we’ve stated countless times, fundamental reform that broadens the base, lowers rates, and closes loopholes in our tax code can help reduce the deficit as well as improve the efficiency of our tax system and strengthen the economy. (A tax reform proposal along these lines is outlined in the paper Less is More: The Modified Zero Plan for Tax Reform, co-authored by CRFB policy director Marc Goldwein) We hope that Sen. Carper’s proposed legislation succeeds in moving the debate over this issue forward and calls further attention to the urgent need for comprehensive tax reform.
Earlier today, Sens. Joe Lieberman (I-CT) and Tom Coburn (R-OK) released a Medicare reform proposal similar to one that Sen. Lieberman proposed a few weeks ago. This proposal, however, has more cost savings than Sen. Lieberman's first Medicare reform plan and would use some of the savings to offset a three-year fix for the SGR.
Many of the policy changes contained in the bill come from recommendations in the Fiscal Commission's plan. Below is a list of the bill's recommendations:
- Raise the Medicare retirement age to 67 by 2025
- Restrict Medigap coverage of first-dollar cost-sharing
- Reform Medicare cost sharing rules by establishing a combined deductible, uniform co-insurance, and catastrophic limit -- with a higher catastrophic limit for higher earners
- Accelerate home health provider payment reductions
- Phase out payments to hospitals for bad debts
- Increase the base Part B premiums to cover 35% of program costs
- Require couples making more than $300,000 per year to pay the full cost of their Part B and Part D coverage
- Enact three-year doc fix to prevent 30% physician payment cut next year
- Enact numerous provisions to reduce fraud and abuse
According to their release, the bill would save more than $500 billion over ten years, with a possible additional $100 billion from the program integrity provisions. The deficit reduction from each provision of the bill is outlined below.
|Savings from Medicare Reform Proposal (billions)|
|Raise retirement age||$124|
|Reform cost-sharing rules (including Medigap)||$130|
|Further increase cost sharing for high earners||unknown|
|Accelerate home health savings||$9|
|Phase out payments for bad debts||$23|
|Means test Part B and Part D premiums||$15*|
|Increase Part B premiums||$241|
|Enact three-year doc fix||-$38|
|Enact anti-fraud and anti-abuse measures||unknown+|
*Estimated at $10 to $20 billion; +Estimated by staff at up to $100 billion
This is a strong proposal from the two Senators, and deserves attention from all other lawmakers. While it would not solve the entire Medicare problem, it would make a very significant dent in Medicare cost growth. Additionally, it includes a few reforms to cost-sharing in Medicare that may serve to prevent overutilization of services and may help to reduce excess health cost growth, potentially leading to even greater savings in subsequent decades. The increase in the Medicare Age, meanwhile, could help to spur growth by encouraging work while targeting scarce resources toward those who need them most through the coverage expansion under PPACA.
Entitlement reform must be an important piece of the current budget negotiations, and will be central to ultimately getting our fiscal situation under control.
Instead of demagoguing this plan, those who don't embrace it should suggest alternatives to do at least as much to reign in federal health spending (see Appendix II for some suggestions).
Senators Coburn and Lieberman certainly don't have all the answers, but their plan would sure put us on the right path.
Yesterday CRFB President Maya MacGuineas appeared on Bloomberg Television to talk about how imperative it is to address our dire fiscal outlook while at the same time raising the debt ceiling on time. MacGuineas argued that the current debt ceiling debate has been different than previous ones:
There are serious commitments not to actually increase the debt ceiling by enough people that it is going to be a much harder vote than it has been in the past--and let me be clear we do have to lift the debt ceiling as someone who believes strongly and firmly that we need to change our budgetary ways. Failing to lift the debt ceiling would be potentially catastrophic and make all of these things much worse. But at the same time we also do want to make changes to the budget. We are on the precipice of deciding whether we want to make fundamental changes to our budget or kick it till after the election so we have a lot of big choices facing us right now.
According to MacGuineas, there is enough blame to go around for everyone in regards to how we got into this fiscal mess and the oncoming explosion in debt. In order to avoid a looming fiscal crisis, lawmakers from both sides need to come to the table and compromise.
Last week the Economist published an article entitled America's debt ceiling: The mother of all tail risks. This article explains what could happen if the United States defaults, in light of the August 2nd deadline being a mere five weeks away. Of paticular note, the Economist highlights the recent upward trajectory of credit-default swaps and provides further insight as to why even a technical default could cause turmoil in markets and how this would likely cost the government significantly.
Trading in credit-default swaps (CDS) on Treasury securities has multiplied as investors seek protection against default, with the price of one year of protection now close to that of five year protection. While there is a great deal of debate over how a deafult could play out, the article makes a good case for why even a minor default should be avoided.
As the Economist points out, history indicates that technical defaults can be costly. For example,
America’s only known instance of outright default (other than refusing to repay debts in gold in 1933) occurred in 1979 when the Treasury failed to redeem $122m of Treasury bills on time. It blamed unprecedentedly high interest from small investors, a delay in raising the debt ceiling and a word-processing-equipment failure. Although it repaid the money and a penalty to boot, a later study by Terry Zivney, now of Ball State University, and Richard Marcus of the University of Wisconsin-Milwaukee found it caused a 60-basis-point interest-rate premium on some federal debt. Today that would cost $86 billion a year or 0.6% of GDP, a hefty penalty for something so avoidable.
Steven Hess of Moody's credit rating agency warns in the event of even a "quick" default where Congress swiftly raises the debt ceiling, the US's prized Aaa status would still be tarnished. According to Hess, "In the past our assumption was interest would always be paid on time. If an actual payment were missed once, might that happen again? If you thought it could, that is clearly not compatible with Aaa." Even a quickly-resolved default could sow doubts in markets regarding our debt, causing interest rates to rise and prompting investors to look elsewhere to put their money.
A great deal is at stake in the current debt limit negotiations. As CRFB recommends in a recent paper on "What Needs to Come Out of the Debt Ceiling Negotiations," a debt limit increase must be approved as soon as possible and a breach of the limit that would cause default avoided. However, we should also take concrete steps to reduce the debt so to avoid such a predicament in the future. As we point out in another recent article, averting a fiscal crisis caused by mounting debt will require a comprehensive fiscal plan.
In their recent Long Term Outlook, CBO shows the nation to be on an unsustainable fiscal path if we continue our current policies. Under its Alternative Fiscal Scenario, debt reaches 100 percent of GDP by the end of the decade and 200 percent by 2037.
However, some have rightfully pointed out that the situation looks much better under their current law scenario -- that is, if politicians allowed everything scheduled into law actually occur. As Ezra Klein wrote on the matter, last week:
We have a congress problem, not a deficit problem. The deficit only explodes if the next few congresses vote to detonate it. Congress doesn't have to extend the Bush tax cuts without offering offsets, or put off the Medicare cuts without paying for them in other ways, or do the easy parts of the health-care law without doing the hard parts.
And indeed he is correct. We ran the numbers on a scenario in which policymakers kept to current law on mandatory spending and revenue, held regular discretionary spending growth to inflation, and allowed for a gradual drawdown of troops in Iraq and Afghanistan, and in this scenario found that debt would fall to 67 percent of GDP by 2020 and continue to fall toward 55 percent by 2050.
A major reason for this improved debt situation has to do with the expirations of the 2001/2003 tax cuts at the end of 2013 (the Alternative Fiscal Scenario assumes the cuts are continued through 2021 and then revenue is frozen as a percent of GDP). However, other factors also weigh heavily. For example, if policymakers allowed the tax cuts to expire but continued to enact AMT patches and Doc Fixes as they always have, debt would fall to only 71 percent of GDP in 2020, and would grow after that reaching 100 percent by 2050. If the recently-passed health reform legislation were unsuccessful in controlling costs after 2021 -- as many experts suspect they may be -- debt would rise to 120 percent by 2050.
Compared to current policy (as reflected in the Alternative Fiscal Scenario), of course, all these scenarios are a major improvement. That doesn't mean that sticking to current law would be desirable, though. If politicians continued to abide by current law, it would mean the following:
- Marginal income tax rates would go up across-the-board, ranging from 15% to 39.6% instead of 10% to 35%. The average effective marginal rate would increase from 25% today to 35% by 2035.
- Revenue as a whole would rise from the historical average of about 18 percent of GDP to about 23 percent in 2035 and 26 percent by 2050.
- Physicians payments under Medicare would drop immediately by 30% and continue to fall thereafter.
- The Alternative Minimum Tax would no longer be patched, and so instead of impacting less than 3 percent of families as it does today, it would impact 11 percent of families in 2013, 22 percent by 2020, and nearly 50 percent by 2035.
An observer could make the case that these policy changes are undesirably sudden, will weaken the economy, and represent a departure from where we have been historically. More to the point, they are unrealistic -- and most will never happen.
But there is a solution. If current law (with a war drawdown) leads to sufficient debt levels, but not necessarily the right policies, then budget process can be used to keep the country on a sustainable path. Strict Pay-As-You-Go (PAYGO) rules, which call for every tax cut and spending increase to be fully offset, could help to put the country back on track.
Want to renew the tax cuts? Fine, identify tax expenditure and/or spending cuts to offset the cost. Want to avoid cutting physician payments? OK, make other policy adjustments to make the make up the difference. Can't find offsets you are willing to make? Then the policy was probably not important enough to continue in the first place.
Simply offsetting policies on a one-off basis might not necessarily be the best strategy to achieve the goal of getting the debt under control, since it might make it more difficult to focus on long-term entitlement growth (or on discretionary caps and Social Security, which are not technically covered under PAYGO). But the principle of paying for everything we do, including expiring provisions, should be there.
And while we are at it, PAYGO has been biased in how it treats taxes and spending for too long. Extensions of entitlement programs such as the Farm Bill must also be subject to the same budgetary hurdle.
If we can make rational tax and spending choices with the current law debt path as a starting point, it would go a long way to bringing our debt under control. If we can't even stop ourselves from making things worse, the prospects for making things better seem grim.
In a recently published op-ed in The Hill, CRFB board members Erskine Bowles and Alan Simpson write that a serious fiscal reform plan must be agreed to and enacted in order to get our exploding debt under control.
The op-ed, which was also the topic of a post on The Hill's On the Money blog today, states that Washington must agree to and enact "a $4 trillion-plus, gimmick-free fiscal consolidation package that stabilizes and then reduces our debt as a share of the economy."
As the authors explain:
"Such a plan need not look exactly like the Fiscal Commission plan we produced, but it must cut wasteful or low-priority spending everywhere — in both the domestic and defense budgets, as well as the tax code where actual spending is dressed up as deductions, credits and other preferences. More importantly, this package must tackle the biggest source of our burgeoning debt — growing entitlement spending. That means it must slow the growth of healthcare and make Social Security sustainably solvent."
Bowles and Simpson write that the difficultly of enacting such a plan--not to mention writing it into legislation--makes the case for a two-part approach: a significant down payment now followed by larger structural and structural reforms in the near future. The authors stress the importance of taking action soon, saying:
"And policy makers must agree--including with an honest process and strict enforcement mechanisms--to address the remainder of the problem before the next election. Elections take all options off the table, instead of setting the table for reform. There can be no more kicking the can down the road or handing the baton to the next guy--the markets won’t allow it and the American people should not tolerate it.
…Recent turmoil in the so-called Biden discussions and Gang of Six seem to call into question whether our politicians can agree to any such a package. The truth is, we have no choice but to do it."
Click here to read the full op-ed.
"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the Committee.
Where Is Our Columbo? – Peter Falk, the award-winning actor best known for playing the rumpled, yet wily, Lt. Columbo, died on Thursday. Falk, who was an analyst with the Connecticut State Budget Bureau before embarking on a professional acting career, created an endearing and enduring character who used unique techniques to get the job done. Detective Columbo always got the bad guy using a brilliant mind and obsessive desire to tie up loose ends, all hidden behind a disheveled facade to lull the guilty party into a false sense of complacency. We’ve lost Columbo just as we need him in Washington. We have a crime in the mounting national debt and the perpetrators seem pretty complacent about it. In the show, the mystery was never in who committed the crime, but in how it would get solved. We face a similar problem now and could use Columbo’s eye for detail and ability to piece it all together to get a resolution. Who’s going to make the bust before we go bust?
Biden Talks Transfer to Obama and Congressional Leadership – The Biden group budget negotiations met a sudden and untimely end last week. Although the group agreed on about $2 trillion in deficit reduction, the talks fell victim to an impasse over issues such as revenue and Medicare. Democrats want a revenue component by eliminating some corporate tax breaks (see ideas for reforming tax expenditures here) while Republicans want changes to health care entitlements (see some ideas here). In a hopeful sign, according to the Washington Post, there appears to be growing consensus on cutting defense spending, just as former OMB Director Leon Panetta was confirmed last week to take his vast budget background to the Pentagon. President Obama is now stepping into the debt limit talks by holding separate meetings today with Senate Majority Leader Harry Reid (D-NV) and Minority Leader Mitch McConnell (R-KY) after a meeting last week with House Speaker John Boehner (R-OH). CRFB last week offered its thoughts on what the debt limit negotiations should, and should not, accomplish.
Investigating the CPI – As lawmakers look for deficit savings that can gain bipartisan support, more eyes are turning to an alternative measure of inflation. The Consumer Price Index (CPI) is used throughout the budget to adjust federal benefits like Social Security payments for cost of living. It also affects certain tax provisions. Earlier this year CRFB’s Moment of Truth project recommended in a paper that using an alternative inflation measure, known as chained CPI, could save about $300 billion over the next decade. Since then the idea has gained support on both sides (for example, see here and here) and is now being considered as a part of the debt limit negotiations.
CBO Puts Out an APB for Debt Solutions – The Congressional Budget Office (CBO) last week released its annual Long-Term Budget Outlook, reinforcing that the current fiscal trajectory of the country is unsustainable. The report states that “the sooner that medium and long-term changes to tax and spending policies are agreed on, and the sooner they are carried out once the economy recovers, the smaller will be the damage to the economy from growing federal debt.” CRFB offered an analysis of the forecast, saying that “these chilling projections should be a cold shower on any plans to delay enacting a comprehensive plan to address the debt.”
Restoring Order Through Fiscal Rules – Congress is considering stricter budget rules to clamp down on the deficit. Senate Republican leader McConnell wants a vote on a balanced budget amendment next month. His caucus has coalesced around a bill that would require an annual balanced budget along with capping spending at 18 percent of GDP and a 2/3 majority to raise taxes. The House is planning to vote on a similar proposal the week of July 5. In addition, Rep. Kevin Brady (R-TX) last week introduced legislation imposing “mandatory smart caps” on federal spending that would limit non-interest spending as a percentage of ‘potential’ GDP. The bill also would create a sequestration process to enforce the caps that involves all federal spending; require prioritizing spending programs in the budget; a form of line-item veto for the president to strike out particular spending; a Sunset Commission to review federal programs; and a permanent continuing resolution that would automatically reduce spending from the previous year if a budget is not agreed to. The Peterson-Pew Commission on Budget Reform, a project of CRFB, has studied fiscal rules for over two years and unveiled a comprehensive blueprint for improving the budget process in the report, Getting Back in the Black. The Commission also recently provided a Fiscal Toolbox summarizing and comparing various fiscal rules and has just created a one-stop resource on the web with easy-to-access information on budget tools to help reduce the debt.
Just One More Thing – The famous detective liked wrapping everything up at the very end. In that spirit, CRFB has produced a wrap-up of our recent annual conference and dinner, which featured an all-star cast of economists, policymakers, and budget experts such as Federal Reserve Chairman Ben Bernanke, House Budget Committee Chair Paul Ryan (R-WI), and White House National Economic Council Director Gene Sperling. Check it out here to read the recap and watch videos of the conference as well as the subsequent cocktail reception with remarks from Office of Management and Budget Director Jack Lew and dinner event with a discussion between PBS NewsHour's Judy Woodruff and Fiscal Commission co-chairs Erskine Bowles and Alan Simpson.
Key Upcoming Dates
- Conference Board releases consumer confidence index for June.
- Senate Finance Committee hearing on “Perspectives on Deficit Reduction: A Review of Key Issues” at 10 am.
- Treasury Secretary Geithner says that the U.S. will default on its obligations by around August 2 if the statutory debt ceiling is not increased before then.
Continuing our analysis of CBO's Long-Term Outlook, we looked yesterday at the policy assumptions under CBO's two budget paths and at spending and revenue projections in their analysis. Today, we will look at what CBO believes will happen to the economy as a result of our growing debt burden.
Under CBO's Alternative Fiscal Scenario, debt would exceed 100 percent of GDP in 2021, 200 percent in 2037, and theoretically hit 800 around 2080. Long before levels got this high -- and perhaps even in the next few years -- this could lead to a fiscal crisis. In such a crisis, CBO explains:
Investors become unwilling to finance all of a government’s borrowing needs unless they are compensated with very high interest rates; as a result, the interest rates on government debt rise suddenly and sharply relative to rates of return on other assets... [This could force] policymakers either to immediately and substantially cut spending and increase taxes to reassure investors—or to renege on the terms of the country’s existing debt or increase the supply of money and boost inflation... Thus, such a crisis would confront policymakers with extremely difficult choices and probably have a very significant negative impact on the country.
Even if projected levels of debt could somehow be sustained without a crisis, the impact on the economy is not pretty. In making its long-term projections, CBO assumes the economy will essentially return to trend levels after 2021 -- which means about 2.2 percent annual growth in real GDP every year, after accounting for the smaller labor force they expect to see in the future. Unfortunately, CBO projects that continued accumulation of debt will tend to slow economic growth.
Under the Alternative Fiscal Scenario -- which is the closer representation of current policy -- CBO projects that the economy could be as much 3% smaller in 2025 and as much as 10% smaller in 2035. Looking out beyond 2035, as debt grows higher, these effects would surely grow substantially.
|Effects of Fiscal Policy on GDP (percent)|
|Extended Baseline||Fiscal Scenario|
|Low Estimate||High Estimate||Low Estimate||High Estimate
Under CBO's Extended Baseline Scenario -- which represents the continuation of current law without regard to political reality -- the economic effects are substantially smaller -- GDP would be up to 0.2% lower in 2025 and 1.3% in 2035. And this change results largely from changes to marginal rates rather than debt, since the Extended Baseline Scenario allows all the 2001/2003/2010 tax cuts to expire, ceases patching the Alternative Minimum Tax, and allows continued bracket creep into the indefinite future.
Importantly, slower economic growth doesn't just mean a weaker economy -- it means a worsened debt. CBO finds that continuing current policy would result in both higher interest rates and slower growth, with the former mainly increasing spending and the latter mainly reducing revenue (and the denominator in the debt-to-GDP equation). This causes a vicious cycle that leads to a worsening debt and in turn a weaker economy.
Whereas CBO projects debt to be about 190 percent of GDP in 2035, it could be as high as 250 percent after accounting for the dynamic effects of higher debt (assuming no fiscal crisis).
Clearly, the never-ending cycle between higher debt and lower growth can make our fiscal problems harder to solve. Making the necessary adjustments now, instead of waiting for years, will allow them to be less severe and prevent a high debt burden from weighing down our economy further.
Despite House Majority Leader Eric Cantor’s (R-VA) decision yesterday to withdraw from the Biden-led negotiations to avoid default, there is still hope in Washington that lawmakers can reach an agreement by August 2nd. In response to Cantor’s withdrawal from the talks, Derek Thompson -- a visiting fellow at CRFB -- wrote an interesting article titled The Only Solution to the Budget Mess: Raising Revenues, Not Taxes. Derek asserts that halfway reasonable members of the Republican Party are willing to raise revenue as long as taxes are also not raised.
Derek highlights how tax expenditures have led to a gaping hole in federal revenue collection:
You can think of the tax code in two parts: (1) Tax rates take income out of the economy, and (2) tax spending "gives" money back. When you filed taxes this year, the IRS asked you to fork over a certain percentage of your income, but it also helped you reduce your tax bill. Got kids? Tax credit. Got business expenses? Deduct them. Got neither? That's okay, you can still claim personal exemptions and a host of other items that save you money.
These measures, formally called tax expenditures because they "spend" through the tax code, are used to encourage behavior we like. We like houses, so the government spends hundreds of billions of dollars subsidizing mortgage interest. We like health care, so Washington lets employers offer insurance to their workers tax-free. We offer subsidies to companies, to industries, and to consumers, because we think there is lots of behavior worth promoting by making it tax preferable. There are good things about using the tax code to encourage good behavior. But too much of a good thing makes a $1 trillion hole in the middle of our tax code.
CRFB continues to encourage lawmakers to end and reduce many of the current tax breaks because it will help set the budget towards a fiscally sustainable future, while also having the benefit of making the tax code simpler and fairer. Click here to read a recent blog on how tax expenditures help the budget.
According to Derek, in order to avoid default and to reach a budget deal it is absolutely necessary to raise revenue without raising taxes:
To get a budget deal, we need Democrats. To keep Democrats, you need more revenue. To keep Republicans, you can't raise tax rates. There's really only one solution. Tax revenue will go up. Tax rates won't.
Many of the fiscal plans proposed by lawmakers, experts, and other groups over the last few months have relied on cutting back on tax expenditures to raise revenues and reduce deficits and debt. Check out our new comparison tool to learn more about all the plans.
Spending and revenues in the long-term outlook is always an interesting topic to discuss. Just like with debt, you find words and phrases like "unprecedented" or "extraordinarily high" used frequently. In this blog, we'll use those words a number of times while showing spending and revenue levels under the Extended-Baseline Scenario and Alternative Fiscal Scenario (AFS).
We noted in our release yesterday that both baselines project extraordinarily high levels of spending. The Extended-Baseline has spending at 27 percent of GDP in 2035, 29 percent in 2050, and 33 percent in 2080. The Alternative Fiscal Scenario has spending rising even higher. It hits 34 percent of GDP in 2035, 43 percent in 2050, and a shocking 70 percent in 2080.
As you can see from the graph and numbers above, there is a massive difference between the AFS and the Extended-Baseline, especially with regards to spending. Our blog yesterday explained that a number of assumptions in the AFS result in higher spending (especially health spending) than the baseline. However, differences in health care spending between the scenarios do not account for most of the difference; primary spending is only about two percentage points of GDP higher under the AFS. The bigger difference is in interest costs: the Extended-Baseline has net interest payments of 3.6 percent of GDP in 2080, while the AFS has interest at a cartoonish 38 percent of GDP in 2080. Higher primary spending does contribute to higher interest costs a little bit in the AFS, but it is mostly explained by drastically lower revenues.
The Extended-Baseline manages to keep debt manageable by having revenues continue to grow, eventually reaching 30 percent of the economy by 2080. We noted last year that revenue levels increased significantly over the long-term due to the tax increases in the health care law, and revenue has remained at about the same level this year. It rises from 15 percent of GDP this year to 23 percent in 2035, 26 percent in 2050, and 30 percent in 2080. These levels are unprecedented; revenue has never been above 21 percent of GDP and it has averaged about 18 percent over the past 40 years. In contrast, the AFS holds revenue constant as a percent of GDP after 2021 at 18.4 percent. This is near the historical average but well below the current law baseline.
These statistics show what we always knew: neither baseline represents a good path for fiscal policy. The Extended-Baseline does hold debt to reasonable, albeit high, levels, but does so with unrealistic policy assumptions and an unprecedented size of government. The Alternative Fiscal Scenario has absurd debt and spending levels, with revenues remaining fixed as a share of the economy over the long-term. No matter how you slice it, we need a fiscal plan soon.