The Bottom Line
Last week CRFB provided Ten Questions to Ask the Candidates on fiscal policy as a way to help voters gauge how serious a candidate truly is regarding fiscal responsibility. While the federal budget deficit has been prominently featured during this election season, it has been little more than a talking point for most candidates as they have avoided discussing specifics. In the run up to Election Day The Bottom Line will highlight these questions in a blog series to move beyond the campaign rhetoric towards discussing potential solutions. This blog post covers the first two questions.
1. Picking a Fiscal Goal. Do you believe the country has a serious fiscal problem? If so, do you think the country needs a “fiscal goal?” What particular fiscal goal would you support? The current fiscal path is unsustainable. Public debt is on course to pass 100% of GDP in the 2020s and 500% in the 2080s. The Peterson-Pew Commission on Budget Reform has argued for a fiscal goal of 60% debt-GDP by 2018 to reassure credit markets that the United States is on course to gradually bring its debt back to sustainable levels.
It’s difficult to measure our progress towards fiscal sustainability if we don’t have benchmarks guiding us. We discussed the merits of setting a fiscal target here. It’s not enough for a candidate to simply say they will reduce the deficit and cut federal spending; having a goal indicates that a candidate is serious about addressing our fiscal challenges. We don’t suggest that the 60 percent debt-GDP target is the only viable goal, but we need to establish a credible, yet ambitious, goal now.
2. Going Beyond the Budget Myths. Eliminating waste, fraud, abuse, earmarks, and tax evasion will not solve our fiscal problem. What other specific cuts are you willing to accept? Yes, wasteful government spending should be eliminated, earmarks are bad process, and we should collect all the taxes that are owed—thereby closing the “tax gap.” But that is not enough. The largest drivers of the debt are aging, growing health care costs, and the imbalances between how much we spend and what we pay in taxes. It is hard to imagine a credible budget plan that does not include changes to these areas of the budget as well as defense, domestic discretionary spending…and…well, pretty much all areas of the budget.
Candidates often fall back on these items when asked to name the budget issues they will address. While these low-hanging fruit should be picked, much more will need to be done to address our fiscal imbalances. Defense and security, entitlements, and interest on our debt account for roughly two-thirds of our budget as opposed to the old stand-bys such as waste, fraud and abuse, which represent only a tiny fraction.
Candidates must get specific! We offer some ideas in our new Lets’ Get Specific series of papers. We've already looked at Social Security, Health Care, and Tax Expenditures. Doing our “Stabilize the Debt” online budget simulator can also help in determining the magnitude of the changes we must make to reach the goal and put us on a sustainable fiscal course.
“Virtually all advanced economies are likely to conduct fiscal consolidation at some point in the future to put their fiscal positions back on a sustainable footing.” - International Monetary Fund, World Economic Outlook, October 2010, p.21
The United States, like a number of other countries, needs to figure out how to best design a fiscal recovery package that will not derail a lackluster recovery, while at the same time, phases in debt reduction policies soon enough and aggressively enough to reassure credit markets.
Helpfully, the International Monetary Fund’s chapter “Will it Hurt? Macroeconomic Effects of Fiscal Consolidation” in the most recent World Economic Outlook provides some answers.
The benefits of fiscal consolidation. For a start, the Fund confirms the bulk of research that shows that fiscal consolidation in high-debt countries will be beneficial and likely increase output over the long-run. A reduction in government debt will reduce the crowding out of private investment as the economy approaches full employment. In fact, the reduction in government debt will “crowd in” private investment - which ultimately raises underlying growth - by lowering inflation-adjusted interest rates and reducing debt service payments. This lesson is clearly relevant for the United States.
But what about the short-run? Fund economists also take a close look at the mixed evidence on short-run costs to the economy from fiscal consolidation. The IMF identifies two things that are likely to help mitigate contractionary effects in the short run and over time: focusing on policy changes that are conducive to growth, including what many refer to as structural policy changes (we have suggested, for example, fundamental tax reform including broadening the tax base significantly, in our paper on reforming tax expenditures, and shifting from a consumption-focused to an investment-focused budget), and increased coordination with other nations.
For advanced economies as a group, policies that have relied on spending cuts, particularly cuts in transfers, have tended to be less contractionary than tax-based adjustments—in part because central banks often have responded to spending cuts by lowering interest rates. Given how low rates are in the U.S., though, this may be less relevant now than it would be normally. Moreover, it is not clear how relevant these findings are to the US now – most of the other advanced economies have started with far higher spending and taxes as a share of the economy, which can reduce the scope for adjustment on the tax side and increase incentives to have spending-heavy programs. It is also not at all clear what motivated the central banks to act in response to spending shifts. These points are critical for the US – and it is important to get them right.
The IMF also found that the contractionary effects are worse when many nations engage in debt reduction all at once. This is why, while we watch what is going on in Britain with admiration and awe and keep our fingers crossed it will work, we realize it may well make our own job even more difficult. If the shaky global economy is a table with each country serving as a stabilizing leg, the risk is that the U.S. will be left as one of the only support systems for demand as other countries engage in debt reduction more aggressively. This is, in part, because they have to, since they do not have our dollar and safe-haven advantages, which our creditors perceive as lowering our sovereign risk (at least for the time being – history shows that confidence can shift suddenly). Under these circumstances, competitive currency devaluation can get nasty, as countries try to boost their exports as much as possible to help their economies when fiscal adjustment is underway. More global coordination would be wise, and it can take many forms.
The IMF finds that even in the bulk of the cases in which fiscal consolidation had a contractionary effect on the economy in the short-run, the negative effects on aggregate demand were often offset through stronger growth in net exports and the easing of monetary policy by the central bank. In the current environment however, there may be limits to these offsets: many major trade partners have fiscal adjustment under way simultaneously and not everyone can boost exports through a depreciating currency at the same time; and because interest rates are near zero, central banks may not be able to provide monetary stimulus as they did in the past.
Luckily, the Fund suggests policy actions to increase fiscal adjustment credibility, which could help limit negative short-run effects: strengthening fiscal institutions, reforming pension entitlements and reforming public health systems. “To the extent such measures improve household and business confidence and raise expectations about future income, they could help support activity during the process of fiscal adjustment”. No question, this won’t be easy and it will not be painless, but there are steps we can take to make the transition easier.
Nine months since the creation of the Fiscal Commission, we are now just one month away from the scheduled release of its report/recommendations. For the past nine months the Commission has been pelted with letters and requests to keep off of Social Security. So when the American Academy of Actuaries sent a letter to the Commission arguing for raising the retirement age, it was something worth noting.
The letter addresses many points that have been raised by opponents of making changes to Social Security. The Academy basically lumps such arguments into two categories: one challenging the view that raising the retirement age is a de facto benefit cut, and one addressing many "specific concerns" over an increased retirement age (such as people in physically demanding jobs and unequal distributional effects of gains in life expectancy).
First, they combat the "benefit cut" view specifically. They point out that for all the years that the retirement age remained fixed (and even after adjustments included in 1983 legislation), retirees have been getting a de facto benefit increase, since they will spend more years collecting benefits in the system than previous generations. This increase comes on top of the fact that initial benefits grow with wage inflation and retirees have (for the most part) recevied annual COLAs.
In addition, the Academy says that raising the retirement age creates a "signaling effect" that people should work longer and delay retirement. They explain it below:
For example, if the retirement age is raised by one year, and a worker retires a year later, the worker’s annual benefit is approximately the same as if he or she retired a year earlier and the retirement age had not been raised. The combination of the change in retirement age and the change in behavior leaves the retiree with approximately the same degree of retirement security as without those changes. That is the intended effect, which is very different from a direct cut in the benefit formula.
Basically, raising the retirement age--and specifically indexing it to life expectancy--reduces the "benefit increase" associated with longer life expectancy, rather than actually cutting benefits. And even with an increase in the retirement age, benefits would still be growing as they always do.
After addressing the benefit cut view, the Academy discusses the myriad concerns involving the view that raising the retirement age would allow more Americans to slip through the cracks. These concerns include the unequal distribution of gains in life expectancy (the rich have generally seen larger gains in life expectancy than the poor) and the hardship an increased retirement age could create for people who simply cannot work, like those in physically demanding jobs.
The Academy states that the concerns are legitimate, but that is no reason to leave the retirement age unchanged for the whole population. These targeted concerns could be addressed in other ways, for example, by reforming disability programs or making the PIA formula more progressive.
Remember that an increase in the retirement age should come in the context of an overall reform plan. It is not a stand-alone policy. While we often present Social Security reform as a choice of different levers, the choices made should be part of a coherent plan. So, categorically rejecting a raise in the retirement age without the context of a reform plan is not constructive.
We appreciate the Academy's constructive addition to the Social Security debate.
Today, Standard and Poor’s reaffirmed their rating of the U.K.'s AAA debt instruments in response to the UK’s recently devised fiscal consolidation plan that is projected to reduce their deficit from around 11 to 3 percent of GDP in 2014. Within the AAA credit rating, S&P raised their outlook of U.K. debt from "negative" to "stable". Their ratings improvement comes as a result of the increased economic growth (by 0.8 percent) that has followed the coalition-implemented new budget and the expectations of future growth to come.
The positive results of the British fiscal consolidation prove the importance of fiscal sustainability for the U.S. as well—we must focus on similar deficit reduction planning if we want to ensure long-term economic growth. Furthermore, this shows that devising plans now for future fiscal consolidation can have positive economic effects in the short-run too, increasing consumer and investor confidence in the overall health of the economy.
CRFB President Maya MacGuineas has another commentary on CNN Money, discussing Britain's fiscal austerity plan, setting the right place and the importance of political courage in confronting our fiscal challenges. You can check it out here.
"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
With the November elections just two weeks, demagoguing has reached a fever pitch. So, predictably, when the SSA sent a letter to Rep. Earl Pomeroy about how different reform provisions would affect benefit levels, reform opponents (or at least spending side reform opponents) took aim at the most notorious reform plan in Washington right now: Paul Ryan's Roadmap.
The letter estimated the effect of instituting progressive price indexing, raising the retirement age, and switching to the chained CPI-U for COLAs (which by the way, are the proposals we include in our Let’s Get Specific on Social Security paper). All the proposals showed cuts in average benefits, leading CBPP and Pomeroy (who you might recognize from the ad-hoc COLA debacle) to go on the offensive against Ryan's plan, which includes progressive indexing and an increase in the retirement age.
There are a few problems with the attacks. Let's go through them.
- Comparisons to promised benefits: SSA compared benefit levels under different reform options to scheduled benefits. Scheduled benefits assume that all the current benefit calculations remain the same. The problem with this is that the system doesn't have the money to pay these benefits. If no changes are made to Social Security, scheduled benefits won't happen: once the Trust Fund runs out, the SSA will only be able to pay less than 80% of scheduled benefits (and that assumes immediate cuts for all those already retired, which no reform plan would do).
- Using wage-indexed dollars: SSA also used wage-indexed 2010 dollars to measure benefit levels. If you don't look closely enough to realize this, the letter makes it look like these provisions drastically cut the nominal benefit level over time when, in fact, that's not the case. Even if progressive price indexing and an increased retirement age were implemented, nominal benefits and real benefits would still increase over time, since real benefits by definition account for price inflation. The only people who might see their real benefits decrease would be the highest earners. Reform plans merely slow the growth of benefits relative to the scheduled benefits baseline.
- Attacking (and misrepresenting) Ryan's plan specifically: Even though CBPP claims the Goss letter "allows one to calculate the size of the benefit reductions that Rep. Paul Ryan’s budget plan would generate" that is not true. This only measures some of the benefit reduction provisions of the Roadmap plan, but doesn't include many of the benefit increases, such as the low earner enhancement or the benefits from private accounts. It’s like attacking your company for cutting health insurance benefits while ignoring a big wage increase they also gave you. Listen, Social Security is unsustainable. Just about any credible plan is going to show a reduction in benefits. Critics need not stack the deck against reform—the reality is that benefits will have to be lower than what we have promised.
|Roadmap Benefits Compared to Payable Benefits|
|10 Year Birth Cohort Starting in Year||Total Benefits as Percentage of Payable Benefits|
|10th Percentile of Earnings||1970||130%|
|50th Percentile of Earnings||1970||100%|
|90th Percentile of Earnings||1970||80%|
Source: Congressional Budget Office
- How about producing a plan instead of throwing stones: It's perfectly fine to disagree with a reform plan, but then provide an alternative.. For those who have not, we have to assume the plan is to drain the budget of resources over the next few decades to repay the Trust Funds and then abruptly cut benefits across the board by more than 20% in 2038, when the Trust Funds run out. That must be little comfort to those who will be depending on Social Security for the bulk of their retirement income. Pomeroy to his credit points out that "a cut in benefits after 2037 can be avoided if steps are taken by Congress before that time to improve the financial status of the program over the long-term" but the longer he and others delay action of any kind, the more drastic the "steps" need to be.
On a more positive note, though, an alternative plan was just recently scored by the SSA from Rep. Ted Deutch. Basically, it's a no-benefit-cut scenario. Deutch would eliminate the payroll tax cap (currently at $106,800) and he would provide a small benefit credit--an "AIME+" for the earnings above the cap. Also, it would use the CPI-E for COLAs--which is about 0.2 percentage points higher than the CPI-W--and provide a $250 payment whenever there is no COLA (you know our thoughts on this).
We applaud Deutch for getting specific on how he thinks we should fix the program. That said, his plan does not do nearly enough to put the system on a sustainable track. Though it technically makes the system solvent through the 75-year period, it does not achieve sustainable solvency since it doesn't get to permanent (near) cash balance. Beginning in 2024, under the Congressman's plan, costs exceed revenue and the system draws on the trust fund (meaning the rest of the budget has to pay for it) until the point when it empties in the 2080s. Keeping the system solvent and achieving cash-flow balance would require eventually raising payroll taxes by another 2 percentage points or so. Effectively, looking to the 75th year, Congressman Deutch's plan would only solve about half the problem.
Nonetheless, we very much appreciate Deutch's willingness to get specific on Social Security. It is certainly more constructive than election year demagoguery and is exactly the type of specific plan we need to start the comparison between different approaches to reform. Thank you, Congressman Ryan and Deutch. Anyone else ready to step up?
In an op-ed in today’s Wall Street Journal, Alan Blinder discusses his frustrations with what he dubs the “fiscal policy paradox”: that the economy-boosting “policies that might work won’t be tried,” due to partisan infighting, and the “policies that will be tried might not work.” He laments that fiscal policy has largely been on the sidelines while monetary policy undertaken by the Federal Reserve has done most of the heavy lifting to spur the economy. He argues for the reverse and contends that while monetary policy is close to being out of bullets, there is plenty of fiscal artillery left. Blinder goes on to detail just a few of the ways in which fiscal policy could help speed up economic growth.
- A sustained, large-scale new jobs tax credit would offer tax incentives for firms to increase employment above a certain level;
- Increased government hiring, like that done by FDR during the New Deal, would also put more people back to work and increase growth;
- Third, a sales tax cut to encourage consumer spending.
These three options are only a few of the myriad possibilities out there, says Blinder, but partisan paralysis and demagoguery are preventing any comprehensive response. Blinder is correct in pointing out that political factors are hindering the formulation of rational fiscal policy at a critical time. He is also right in arguing that stimulative measures, coupled with credible future deficit reduction, could pack a potent punch. We wish he would have provided his best deficit reduction proposals along with his stimulus ideas.
This argues for a credible fiscal plan to be implemented as the economy gains strength. The deficit should not be an excuse for blocking all stimulative measures, but medium- and long-term debt concerns dictate that any stimulus be well-crafted to have the most bang for the buck and be devised in a way that it does not add to the debt in the longer run.
David Chavern of the Chamber of Commerce and Christina Romer, former chair of the Council of Economic Advisors (CEA), both joined the Announcement Effect Club this month. Interesting that two people on very different sides of the economic debate have something in common.
First, Romer in a New York Times article on Sunday:
Such backloaded deficit reduction would not hurt growth in the short run — and could raise it. If uncertainty about future budget policy is harming confidence, as some business leaders suggest, spelling out future spending and tax changes could be helpful. More important, showing that policy makers can come together and make essential decisions about our fiscal challenges would reassure all Americans that our economic future is better than the current grim reality.
She notes that backloaded plans have been done before with regards to Social Security and taxes, with some changes not taking effect until years or even decades (think 1983 Social Security changes) after the plans were passed.
It's also important to note that Romer makes this point in an article in which she calls for more stimulus (the title of the article is "Now Isn't the Right Time to Cut the Budget Deficit"). It cannot be stressed enough that short-term stimulus and deficit reduction are not mutually exclusive; in fact, pairing them can make each separate component more effective.
Now on to Chavern, who takes a little different approach to the AEC:
Now, imagine if you will, that we took our biggest and most politically intractable domestic problem - long term deficits and entitlement reform - and solved it! Not solved it completely or immediately, but adopted a reasoned compromise plan that gave high assurance that long-term deficits would be dramatically reduced over next several decades. All of the sudden, the future of the U.S. doesn't look so bleak. We would have a reasonable fiscal outlook (unlike Europe), a favorable demographic outlook (unlike Europe or China), some of the best creative talent and entrepreneurs in the world and continued access to tremendous natural resources. Where would you want to put your money then? Maybe, in fact, the pain of long-term deficit reduction could lead to a large short-term economic gain.
While many Club members have advocated for medium-term deficit reduction, few have put solving our long-term problem as a way to stimulate growth. Certainly it would need to be backloaded, since the twin problems of aging and health care cost growth can't be solved overnight. And as reducing medium-term deficits would reduce pessimism about the outlook of the next decade, so would alleviating our long-term imbalances reduce pessimism about the next half-century or so. Imagine: no more of those ubiquitous exponentially growing debt projection charts! Obviously, it's easier said than done.
For a full list of members in the Announcement Effect Club, see here.
Surprises We Want to See – With pivotal mid-term elections next week that will decide control of Congress, observers are awaiting this year’s “October surprise” – the breaking news that could change the course of the election. We at The Bottom Line have our own ideas for surprises we would like to see.
Candidates Move Beyond Rhetoric – Those running for office have been quick to decry the large federal budget deficit, but few have offered detailed plans on how they will address the mounting debt and put the country on a sustainable fiscal course. CRFB has endeavored to move the campaign rhetoric from sound bites to solutions by providing ten questions voters should ask their candidates on fiscal responsibility last week. We also are leading the way with a Let’s Get Specific series of papers and recent event. Our Stabilize the Debt budget simulator provides everyone the opportunity to see how numerous specific ideas can contribute to closing the fiscal gap.
U.S. Devises a Fiscal Plan – CRFB has been calling for the creation of a credible plan now to be implemented as the economy recovers. Some recent events provide hopeful signs this may occur. U.S. Treasury Secretary Tim Geithner sent a letter to G-20 ministers supporting the setting of medium-term fiscal targets consistent with sustainable debt levels. The Peterson-Pew Commission on Budget Reform recommended a goal of a 60 percent debt-GDP ratio by 2018 in the report, Red Ink Rising. The United Kingdom also announced a comprehensive plan to reduce its debt.
A Rational Budget Process is Created – Congress will return for a lame duck session beginning November 15. One of the reasons it must reconvene is to complete its work funding government operations. The new fiscal year began on October 1 without any of the annual appropriations bills enacted, requiring a stopgap funding measure to prevent a government shutdown. Congress was also unable to adopt a budget blueprint this year, for the first time since the 1974 Budget Act the House was unable to approve of a budget resolution. The U.S. cannot properly address its fiscal challenges with a dysfunctional budget process. The Peterson-Pew Commission on Budget Reform will soon unveil its recommendations for creating a more effective, transparent, and accountable budget process.
Fundamental Tax Reform is Tackled – Congress will also address the matter of the expiring 2001/2003 tax cuts as well as other expiring tax provisions in the lame duck. The debate over extending all or a portion of the tax cuts has overshadowed the need for comprehensive reform of the tax code. Creating a simpler tax system with a broader base will be essential to tackling our fiscal challenges. CRFB made some recommendations for reforming tax expenditures in a recent paper.
We at CRFB applaud Treasury Secretary Tim Geithner’s support of medium-term fiscal targets, in the run-up to this weekend’s meeting of G-20 finance ministers. In the context of correcting external imbalances, Treasury Secretary Geithner sent a letter (excerpts from the Financial Times) indicating three steps that he believes G20 countries should commit to:
- Reduce external imbalances. Countries "should boost national savings by adopting credible medium-term fiscal targets consistent with sustainable debt levels and by strengthening export performance."
- Don't undervalue currencies. Countries should commit to refraining from weakening their currencies, or preventing undervalued currencies from appreciating.
- IMF Involvement. The IMF should monitor progress on these commitments.
As budget wonks, we find the first goal especially important – although history shows that the importance of avoiding competitive currency devaluations should not be underestimated.
Credible medium-term fiscal targets are a way to begin signaling to markets that we are serious about deficit reduction. With a reasonable target path agreed to (a sort of budget constraint), the challenge will be for policymakers to work together with taxpayers to figure out how the U.S. can sensibly meet our fiscal goals so that we can bring our debt back down to sustainable levels. The Peterson-Pew Commission has argued for a fiscal target of a 60 percent debt-GDP ratio by 2018, and other groups have argued for similar goals.
For why fiscal goals are important and how they can help bring down future debt, see CRFB president Maya MacGuineas's testimony from July before the Fiscal Commission. We hope other policymakers join the Treasury Secretary in supporting fiscal goals.
Photo Credit: Chip Somodevilla / Getty.
Update: This blog has been updated to reflect additional information.
A new report by the Federal Housing Finance Agency shows the agency's first look at how much the government’s financial backing of Fannie Mae and Freddie Mac may cost. The report, released Thursday, provides three scenarios demonstrating the Government Sponsored Enterprises' (GSEs) financial condition and how much they will cost the taxpayers through 2013.
As a reminder, Fannie Mae and Freddie Mac are two GSEs that back mortgage loan guarantees. They allow banks to sell the mortgages that they make, providing the banks with more capital for loans. This creates a market distortion in which money lent by banks for mortgages is less expensive and less risky for the banks but more risky for Fannie and Freddie. With the 2008 economic collapse and the housing sector calamity that followed, the GSEs required a insignificant infusion of cash through purchases from the U.S. Treasury. This program remains in place today. The Treasury, through authority granted to it in the Housing and Economic Recovery Act of 2008, has provided $148 billion (in gross terms) in assistance to Fannie and Freddie.
Going forward, uncertainty remains with how much more support both GSEs will require. In the August update CBO projects that over the 2011-2020 period, outlays to Fannie and Freddie will run about $53 billion, on top of the $137 billion (in net terms) that has gone out the door already.
FHFA detailed three scenarios in its report: a low-cost, medium-cost, and high-cost scenario. All three scenarios rely on the same assumptions on interest rates, securities pricing, Agency MBS swap spreads, credit growth guarantees, and non-performing loan portfolio growth. The scenarios differ in their treatment of the three different Moody’s housing pricing scenarios:
- The low-cost scenario assumes Moody’s "Stronger Near-term Recovery" house price path, which leads to higher housing prices in a housing market economy;
- The medium-cost scenario assumes Moody’s “Current Baseline” house price paths, which leads to slightly lower future housing prices and then improvement;
- The high-cost scenario assumes Moody’s “Deeper Second Recession” house price paths, which assumes a second economic recession resulting in deep housing price reductions.
See Page 5-6 of the FHFA report for a discussion of Moody's projected housing pricing.
With the uncertainty of the housing market, it is hard to know for sure which of these three scenarios is the most likely, nor is it recommended that the middle scenario be used as a realistic measure since it is no more likely than the other two (see here for a new report from the Fed on the housing market). With the uncertainty of the economy, continued uncertainty over tax policy, problems with the mortgage market (such as the foreclosure legal problems arising now), it is very difficult to project what the housing market will look like over the next three years.
With the current outlays by the government already at $148 billion, the three estimates predict the federal government ultimately will spend billions more. The low-cost estimate adds $73 billion, the medium-cost adds $90 billion, and the high-cost adds $215 billion by 2013. Putting these estimates on par with CBO, which looks at net outlays, FHFA projects $22 billion less than CBO in the low-cost scenario, $9 billion less than the middle-cost scenario, and $96 billion more for the high cost scenario for the next three years. Also, see Stimulus.org for up-to-date tracking of Fannie and Freddie costs, and all other Fed and economic stimulus actions.
These two GSE are vital to the housing market and we remain quite hopeful about President Obama’s plan for reforming these two entities, which will be released in January. We welcome all other reform plans that policymakers propose. GSE reform is vital and it should be done sooner rather than later to better insulate taxpayers from exposure and additional cost. Until then, it's just another reason to hope that our economy does not sink into a new recession.
Budgeteers have been closely watching the United Kingdom during the past six months, as Chancellor of the Exchequer George Osborne and Prime Minister David Cameron have been attempting to overhaul the U.K. budget (see here, here, here, and here). Their plans have come out in small pieces, but now, the entire plan is available.
In June, the British government issued its Budget, setting a target of serious debt reduction (about £113 billion, or about $180 billion) to be reached by 2014-2105. The June Budget set broad tax rates, making several changes to raise an additional £29 billion in revenue, leaving £83 billion in savings to be found among Departmental Expenditure Limits (i.e. discretionary spending) in the 2010 Spending Review.
The British government released the 2010 Spending Review this week, with Osborne identifying £83 billion (about $130 billion) in cuts and savings over the next four years. They amount to an average of a 19 percent cut across all departments--less than the 25 percent that was expected. While the National Health Service is protected from budget cuts and International Development funding is increased, the same cannot be said for the other departments; all of them face cuts of varying degrees.
Welfare programs are cut an additional £7 billion through changes in housing benefits and some tax credits. In addition, employee contributions to public sector pensions will increase by £3.5 billion. Higher education spending will take a significant hit, as will the Foreign Office, the Home Office, law enforcement and Justice, and money to local governments. Defense will face a cut of about 8 percent in real terms, and overall Education a relatively small one (one percent in real terms).
In addition to these changes, the government will increase the retirement age for old-age pensions to 66 by 2020, six years earlier than had been scheduled. These spending cuts come with tax changes that already have been made, such as making their bank levy permanent, raising the VAT rate by 2.5 percentage points, and raising capital gains rates. The sum of all these changes is projected to eliminate the structural deficit by 2015.
The Office of Budgetary Responsibility (basically, the UK's CBO) estimates that the spending cuts could result in the cutting of 500,000 public sector jobs by 2015.
Members of the Labour Party have already been calling for more debate and even votes on the Spending Review. But it looks like, historically, not very many changes have been made to Spending Reviews.
Cameron's and Osborne's fiscal consolidation plan is ambitious and it cuts across a wide spectrum of government, which is laudable. In the U.S., candidates are more willing to fence off parts of the budget (Social Security, Medicare, security spending) or oppose all tax increases than say which parts of the budget they would actually change (click here to read our new release on questions to ask candidates to help determine whether they are serious about fiscal responsibility). Perhaps, David Cameron and company have provided a useful blueprint for the beginning of a deficit reduction plan for the U.S.
In the same light as CRFB's Stabilize the Debt budget simulator, The Guardian has launched a simulator for the U.K budget! In response to the 2010 Spending Review, the simulator lets users make the cuts that they would choose, with a goal of finding £49 billion ($78 billion) in savings by 2014-2015. We recommend having a look.
Getting to real solutions to the fiscal challenges facing the country requires asking the right questions. Today CRFB offered “Ten Questions to Ask the Candidates” in order to move the election rhetoric away from the grandstanding and finger-pointing that are dominating the campaign.
Candidates of all stripes are talking about the deficit, yet few are offering specific ideas that will address the issue in a significant way. This new reference from CRFB was designed to help voters identify truly fiscally responsible candidates. The questions involve critical topics such as extending the tax cuts, Social Security, health care, and defense spending.
The deficit has become a top campaign issue, which is promising, but such prominence for the topic will only be helpful if it gets policymakers and candidates for office to seriously talk about the issue and what will be required to address it.
Why is this so important? Our national debt is headed toward previously unseen levels. It is rapidly rising as a share of our economy. The primary drivers are rising health care costs, our aging population, and an imbalance of government revenue and spending.
Soaring debt will cause multiple problems:
Economic: Crowds out private investment, driving up the cost of capital and credit, slowing economic growth, lowering standards of living.
Budgetary: Growing interest payments squeeze out other spending and room for future tax cuts.
Fiscal: Loss of fiscal flexibility for when we need to respond to the next emergency.
Psychological: Uncertainty for individuals and businesses.
Risk: Increases the likelihood of a fiscal crisis.
So ask your candidates the tough questions and demand answers. While you are at it, challenge them to do CRFB’s Stabilize the Debt budget simulator and make their results public.
Following Friday's announcement by the Social Security Trustees that there would be no automatic increase for Social Security benefits in 2011 and the slew of compelling arguments about why that is appropriate, there has been significant discussion about how prices have changed over the past few years and how Americans aged 62 and older have faired. (To read why politicians should not go the pander-to-seniors-route, see our commentary on the announcement and the political pandering of lawmakers here, the Washington Post editorial here, the Los Angeles Times piece here, and CNN piece here.)
But aren’t costs for the elderly going up faster? Some have asked us. Take for instance, a comment we recently received on our website:
“…the price index used for S.S. [calculation] is based on the "market basket" of wage earners and clerical workers--in other words, the actual spending of retired persons is deliberately excluded from the weights in the index base! Spending by the elderly includes proportionately more out-of-pocket medical expenses than spending by households of working age, and medical costs consistently rise faster than the costs of other components of household budgets…. In view of the typical under-estimation of the inflation actually experienced by seniors and others with high medical expenses in calculating their COLAs, I think a modest one-time extra payment at a time of general economic hardship is not outrageous."
Well, that is a great question and a legitimate concern. Let’s address it…
Since annual cost-of-living adjustments (COLAs) are calculated from third quarter to third quarter changes in inflation (as measured by the CPI-W), here’s a look at price changes over the past few years according to a few distinct measures.
|CPI^||% Change||Change in S.S Benefit Levels for Following Year*||CPI-E||% Change
||Chained CPI||% Change
Note: CPI estimates shown reflect non-seasonally adjusted data for the third quarter (July, August, September) of the given year, as used by the Social Security Trustees in calculating annual COLAs.
^Reflects third quarter average for the Consumer Price Index for all urban wage earners and clerical workers (CPI-W).
*Based on percentage change in CPI from previous year to current year.
First off, we all agree that while prices (as measured by the CPI) have increased over the past year, they have not yet returned to the levels reached in the third quarter of 2008 - the period when the last COLA of 5.8 percent was set. And remember, COLAs cannot be negative--they face a zero bound.
But what’s also important is how inflation has fallen according to other measures as well, specifically the CPI-E which seeks to measure price changes affecting those aged 62 or older.
The experimental Consumer Price Index (CPI-E), shown in the table above, attempts to measure price changes affecting those aged 62 or older. The CPI-E differs from other CPI measures only in the relative weights of the 211 categories in the measure's basket of goods to reflect purchasing patterns among more elderly Americans. Granted, the CPI-E has not fallen as much as the CPI over the past few years, but even according to this alternate measure, prices have not reached their peak 2008 levels.
But don't energy prices affect older Americans less, meaning that prices for them didn't fall as much after 2008? Some critics contend that since the CPI-E puts less weight on the changes in costs of energy (because older Americans presumably have fewer energy and fuel needs), then prices haven't really dropped for older Americans as much as is being claimed. But extending this logic back to the last COLA calculated in 2008 would mean that older Americans didn't need the large 5.8 percent increase in benefits levels for 2009--since most of the uncharacteristically high COLA for 2009 was based on inflated energy prices during the summer of 2008.
Of course, CPI-E is not without its downsides though (including substitution bias problems, sampling issues arising from seeking to only focus on people aged 62 and older, and not factoring in senior citizens discounts). See CBO's report on inflation measures for more info.
But haven’t Medicare Part B premiums gone up, meaning that seniors should still receive a COLA? Well, not for the large majority of Medicare beneficiaries. With Social Security benefits frozen in nominal terms, Medicare Part B premiums will also remain frozen for about 75 percent of all Medicare beneficiaries due to the "hold-harmless" provision, which prevents Medicare beneficiaries from paying higher Medicare premiums (despite increases in Medicare expenditures) when they don’t receive an annual COLA. So, arguing that Medicare premiums have been increasing as a rationale for a COLA doesn’t apply for most beneficiaries.
Another significant argument for why actual prices have likely not returned to their peak 2008 levels is that many experts and economists believe that CPI measures (including CPI-W and CPI-U) actually overstate inflation as a result of this economic substitution problem (i.e. people changing their spending patterns between categories and not just within them in response to changing prices). To correct for this problem, economists developed another measure of inflation, the chained CPI. CBO concludes that the chained CPI has been on average 0.3 percent points lower each year than normal CPI inflation estimates. So we’re not talking about a “typical underestimation of inflation experienced by seniors”, but more likely an overestimation.
Thus, even according to the chained CPI, prices haven't returned to previous levels, meaning that the actual purchasing power of benefits today are higher than they were last year. And if Social Security relied on the chained CPI, the last COLA would have been 5.2 percent instead of 5.8 percent.
The public and our readers continue to bring up great questions about inflation and Social Security COLAs. But no matter how you look at it, the slight price increases this past year just haven’t been large enough to warrant a new COLA. Yet this hasn’t stopped lawmakers from proposing a CORA—a “Cost of Reelection Adjustment" (or as Andrew Samwick puts it at Capital Gains and Games, a “Cost of Lobbying Adjustment”).
On Friday, Fed Chairman Bernanke provided a lesson that fiscal policymakers should take to heart: Expectations matter.
In a much anticipated speech at the Federal Reserve Bank of Boston, Bernanke confirmed that the Federal Open Market Committee (FOMC), the Fed's decision making board, is likely to move toward generating more liquidity and adding more downward pressure on interest rates. Fed-watchers were anxious to learn whether Chairman Bernanke would support additional easing (now commonly referred to quantitative easing, round two--or just QE2 for short). That question seems to have been answered with a resounding "yes." With inflation trending too low and unemployment too high, Bernanke said taking further monetary policy steps are warranted.
But then he went on to note:
"To address such concerns and to ensure that it can withdraw monetary accommodation smoothly at the appropriate time, the Federal Reserve has developed an array of new tools. With these tools in hand, I am confident that the FOMC will be able to tighten monetary conditions when warranted, even if the balance sheet remains considerably larger than normal at that time."
Call this the Announcement Effect Club: Monetary Policy version.
Just as a lack of an "exit" from expansionary fiscal policy can lead to big trouble when the economy recovers, the perception that the Fed is a helicopter that perpetually drops money also can cause trouble. Perceptions of both fiscal and monetary policy can be affected by actions that, on their own would seem to be small, but, in fact, “anchor” basic views of where we’re headed in the future. So the Fed has talked about keeping rates low "for an extended period," meaning "we will not raise interest rates for awhile." At the same time, Bernanke has talked about ways to tighten monetary policy effectively when we reach that point, in an effort to show that the Fed's expanded balance sheet will not be permanent.
This strategy in monetary policy is easily adaptable in fiscal policy. Budget blueprints such as the President's Budget and the Congressional budget resolution (or the lack thereof this year!) show when, how, and to what extent fiscal policy may be expanded or tightened in the future. Legislative actions, such as how Congress deals with the President's Fiscal Commission's recommendations or how the House and Senate handle a possible ad-hoc Social Security payment, can idicate how serious policymakers are about getting the nation's fiscal policy back on a sustainable track.
Expectations matter – and expectations of policy can be extended into the future, as far as the eye can see, whether we’re talking monetary policy – or fiscal policy.
The fiscal world can learn plenty from the Fed here. Fiscal policymakers have been unable to constructively shape expectations that policy will be well- managed. Of course, the number one indication of seriousness would be to enact a medium-term deficit reduction plan that kicks in slowly once the recovery is on firm footing.
To take some lessons from the Fed, just try substituting “fiscal” for “monetary” – and the appropriate fiscal concepts and institutions where applicable – in Bernanke’s remarks:
“To evaluate policy alternatives and explain policy choices to the public, it is essential not only to forecast the economy, but to compare that forecast to the objectives of policy. Clear communication about the longer-run objectives of monetary policy is beneficial at all times but is particularly important in a time of low inflation and uncertain economic prospects such as the present. Improving the public's understanding of the central bank's policy strategy reduces economic and financial uncertainty and helps households and firms make more-informed decisions. Moreover, clarity about goals and strategies can help anchor the public's longer-term inflation expectations more firmly and thereby bolsters the central bank's ability to respond forcefully to adverse shocks.”
On Stimulus.org, we have been tracking the number of bank failures by FDIC-insured institutions since the beginning of 2008. As we have mentioned before, due to the financial crisis, the number of bank failures and their cost in each of the past three years has completely dwarfed the numbers from the prior eight years. This fact shows the depth of the recession we were in and the problems we still face. Even though the recession was dated to have ended in June 2009, and the collapse of Lehman Brothers (which helped set off widespread bank failures) is two years in our rear view mirror, bank failures still continue to roll as frequently as ever. In fact, this year's total will, in all likelihood, surpass the total from 2009 (although the cost to the FDIC will probably be lower).
With three more bank failures last week, we've reached a "milestone": 300 bank failures since the start of 2008. We've broken down the number of failures and the cost by year in the table below.
|FDIC Bank Failures and Costs Since 2008|
|Year||Number of Bank Failures||Cost (billions)|
It's interesting to note that 2008 has been more costly than 2010, despite this year having many more failures. This, of course, is due to the fact that two of the largest bank failures in FDIC history occurred in 2008: Washington Mutual and IndyMac. These two alone cost the FDIC about $20 billion!
These failures show just one aspect of the cost of the financial crisis. For other aspects of the cost and the response to the recent recession, check out Stimulus.org. We'll keep tracking the bank failures, since they show no sign of slowing down.
Loads of BCS – The first edition of this season’s rankings from the much-maligned BCS is now out. The system uses computer algorithms and polls to determine which two teams will ultimately face off for the college football championship. So, we at The Bottom Line fired up our supercomputers to rank some of the recent developments regarding the political football of fiscal policy.
- FY 2010 Deficit Near $1.3 Trillion – On Friday, a joint statement from the Treasury Department and OMB put the official federal budget deficit for fiscal year 2010 at $1.294 trillion (See our short blog on this here). At 8.9 percent of GDP, this is the second largest deficit as a share of the economy (just behind last year’s 10 percent) since World War II. The statement attributed the $122 billion improvement over last year to a combination of higher receipts and lower outlays. While individual and payroll tax receipts actually declined, higher corporate income tax receipts and higher earnings from the Federal Reserve’s investment portfolio boosted receipts. The decline in outlays was mostly attributable to significant decreases in spending related to TARP, aid to Fannie Mae and Freddie Mac, and the deposit insurance activities of FDIC and NCUA. Excluding those three programs, outlays for other government agencies and programs increased 5.5 percent. In the statement, the heads of OMB and Treasury “underscored the Administration's commitment to getting Federal finances back on a sustainable path and ending emergency programs that proved instrumental to reviving growth while beginning the process of bringing down our deficit.”
- This COLA War Won’t be So Refreshing – Also on Friday, the Social Security Trustees announced there would be no cost-of-living adjustment (COLA) for Social Security benefits for the second straight year. The automatic COLA was instituted in 1975 to ensure that inflation does not erode the value of benefits. Since a 5.8 percent adjustment was announced in 2008 for benefit levels in 2009, the economic recession brought consumer prices down significantly and they have yet to return to the previous level. Social Security benefits were not lowered when prices fell. House Speaker Nancy Pelosi and others are calling for a vote on a one-time payment of $250 during the upcoming lame duck session. CRFB is strongly against a one-time payment or an ad-hoc COLA (see here and here), seeing it as a fiscally irresponsible political ploy.
- Concern for Deficit High in Poll; Support for Solutions, Not So Much – According to a Bloomberg poll released last week 55 percent of respondents believe that the federal budget deficit “is dangerously out of control and threatens our economic future.” Yet the poll also found that the public is fairly split over whether several possible solutions should be considered or taken off the table. A separate poll from The Hill newspaper found that 52 percent of independent voters see debt reduction as a priority, compared to 39 percent who prioritize increased federal spending to spur the economy.
- Defensive About Defense Spending – Last week 57 members of Congress sent a letter to the White House fiscal commission asking that the defense budget not be immune from the “rigorous scrutiny” that the rest of the budget will be subject to. At the same time, others are warning that looking to defense for savings would be unwise.
- Feldstein Gets Specific – Martin Feldstein has a new paper out with a three-part plan (subscription required) to reduce the national debt to less than 50 percent of GDP. The strategy includes reducing proposed spending increases and tax reductions over the next decade; augmenting “the tax-financed benefits for Social Security, Medicare and Medicaid with investment based accounts;” and reducing tax expenditures. Feldstein participated in CRFB’s recent “Getting Specific” forum and CRFB has encouraged specific ideas to address fiscal imbalances through its new Lets’ Get Specific series.
- Cranford Gives the ‘Hook’ to Announcement Effect – CQ Weekly columnist John Cranford pans the “announcement effect” in his recent column (subscription required). He contends that trusting lawmakers to come together to enact medium and long-term fiscal rules, and especially to follow through on those rules down the road, is the stuff of fantasy. He concludes that “it might be easier to keep Tinkerbell alive.” CRFB, as Cranford notes, is a big proponent of the announcement effect, believing that announcing a credible plan now to reduce the long-term debt to be implemented as the economy recovers will be economically beneficial. Our “Announcement Effect Club” highlights those who agree with this view. Cranford’s skepticism that policymakers will have the political will to carry out such a plan is well taken. We understand that political will is the biggest obstacle and have no fantasies regarding how difficult that will be to overcome. Yet, after being accused by so many of being gloom and doom, it is nice that someone considers us to be wide-eyed optimists.
- States Debate Taxes – USA Today points out that taxes will be on hundreds of state and local ballots in next month’s election. States like California, Massachusetts, and Washington will vote on revenue measures.
"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.
Treasury and OMB released the final deficit number for FY 2010 on Friday: $1.294 trillion. While $120 billion lower than last year's deficit, it still represents the second biggest deficit in the country's history in nominal terms. It also represents 8.9 percent of GDP, a percentage point lower than last year's deficit.
The final number is just about the same as the one that CBO produced in its final Monthly Review for FY 2010. However, the deficit is a few hundred billion dollars lower than the Administration projected either in the President's Budget or in the Mid-Session Review. All of that difference is accounted for with lower outlays. In fact, instead of increasing by a couple hundred billion dollars--as both projections expected--outlays actually declined from 2009 to 2010. Also, the deficit is $50 billion lower than CBO projected in August. Regardless of these differences, the deficit number is unusually high.
|Receipts, Outlays, and Deficits in FY 2009 and 2010 (billions)|
|FY 2009 Actual||$2,104||$3,520||$1,416|
|(Percent of GDP)||14.9%||25.0%||10.0%|
|FY 2010 Estimates|
|CBO August Budget Update||$2,143||$3,485||$1,342|
|FY 2010 Actual||$2,162||$3,456||$1,294|
|(Percent of GDP)||14.9%||23.8%||8.9%|
Much of the decrease in the 2010 deficit compared to 2009 is due to lower spending on emergency programs, mainly TARP, Fannie Mae and Freddie Mac, and deposit insurance. In fact, excluding these three programs, outlays actually increased by slightly less than $200 billion. The net effect was a $65 billion decline in outlays, which, coupled with economic growth over the past year, decreased outlays as a percentage of GDP by 1.2 percentage points between 2009 and 2010. The rest of the deficit decrease is accounted for by increased revenue as a result of moderate economic improvement since 2009.
The decline in the deficit, though, does not mean we'll be out of the woods in a few years. Even when our deficit declines as the economy (presumably) recovers, it never reaches a sustainable point. It will only decline to about 4 percent of GDP (in the President's Budget) before rising again by the end of the decade; this means that the national debt will continue to grow as a share of the economy throughout the decade.
The $1.3 trillion deficit this year may be tolerated as a necessary move to get the economy going, but it serves as a reminder that we have some serious fiscal problems to deal with very soon.