The Bottom Line
Our new series, "The Tax-Break Down," continues to look into the costs associated with specific tax breaks, the arguments for and against them, and several options for reform, and it is gaining a lot of attention from policymakers and the media. Over the last two weeks, we published three more entries in the series, profiling a popular manufacturing deduction, municipal bonds that finance infrastructure, and fringe benefits offered by employers. Our posts have been covered in Forbes magazine, the Bond Buyer, and Global Tax News. We were also mentioned by Reuters and prompted other think tanks to write op-eds based on our posts.
The article in Forbes did a particularly nice job summarizing why the series is important:
It’s part of a series of reports, The Tax Break-Down, analyzing lesser known tax expenditures, to coincide with Congress’ return from summer break and return to tax reform talks. The idea is that paring back tax preferences will allow for lower tax rates and help reduce the deficit.
The problem is that everyone has a favorite tax break. Maybe yours is the mortgage interest deduction or the charitable deduction or the exclusion of interest income on municipal and private activity bonds.
Everybody has favored tax expenditures, but the series shows that even the most popular expenditures could often be reformed, simplified, or better targeted. For instance, converting the tax exemptions on municipal bonds to a credit could deliver the same subsidy to local borrowing at at less cost to the taxpayer. And earlier, we wrote about reforms to the charitable deduction that would make the tax break available to more people and increase charitable giving, while reducing the deficit.
Below you can read all the Tax Break-Downs, listed individually:
- The State and Local Tax Deduction
- LIFO Accounting
- Preferential Rates on Capital Gains
- Child Tax Credit
- Section 199, the Domestic Production Activities Deduction
- Municipal Bonds
- Cafeteria Plans and Flexible Spending Accounts
- Accelerated Depreciation
- Individual Retirement Accounts
- American Opportunity Tax Credit
- Intangible Drilling Costs
- Foreign Earned Income Exclusion
- FICA Tip Credit
- Low-Income Housing Tax Credit
Reading the news these days, you might think our debt problem has been solved: the federal deficit has been revised downward and is falling to its lowest level in five years. Yesterday, however, Congressional Budget Office (CBO) Director Doug Elmendorf made clear that he, for one, does not subscribe to that view.
In a presentation entitled, The Deficit is Down, But the Fundamental Challenge Remains, Elmendorf made clear that "debt remains historically high and is on an upward trajectory in the second half of the coming decade" and that "the fundamental federal budgetary challenge has hardly been addressed."
Elmendorf also shows how projections for the deficit in 2013 are nearly identical to current law projections in January 2011 — when the Fiscal Commission had just called for a large, comprehensive deficit reduction package and before Congress started addressing the fiscal situation with the 2011 debt limit showdown, the sequester, and the fiscal cliff deal. Although Congress has agreed to nearly $2.7 trillion in deficit reduction since December 2010 (relative to current policy), much of the savings were offset by extending almost all of the 2001/2003/2009 tax cuts, previously assumed to expire under current law. The deficit situation today is roughly the same as if Congress had done nothing since 2011.
The fact that the deficit is still rising in the second-half of the decade points to our longer-term fiscal problems. One slide illustrates how Social Security, health programs, and interest payments are projected to consume an increasing share of the budget, and that federal deficits will grow unless our fiscal path is altered.
Yet Elmendorf makes clear that the longer-run nature of our biggest fiscal problems should not dissuade us from acting now:
Even if policy changes were not implemented for a few years, however, making decisions about those changes quickly would give people more time to plan and would tend to increase output and employment in the next few years by holding down longer-term interest rates, reducing uncertainty, and enhancing businesses’ and consumers’ confidence.
This presentation echoes many of the points we made in a recent report, "Our Debt Problems are Far From Solved," in which we also highlight the debt's fast-rising trajectory beginning at the end of this decade and continuing in perpetuity. Both make clear that the core drivers of our future deficits -- health care cost inflation, the aging of the population, and an outdated tax code that raises too little revenue -- remain unaddressed.
See Dr. Elmendorf's full presentation here.
The current volume-based reimbursement that pervades America’s health care system encourages more, not better, care and is driving up spending at an unsustainable rate. National health expenditures continue to outpace the growth of the overall economy and are projected to grow from $2.9 trillion in 2013 to $4.72 trillion by 2021. Federal health spending will grow from 4.9 percent of Gross Domestic Product (GDP) in 2013 to 6.3 percent by 2023. Unaddressed, these rising costs will put increasing pressure on other priorities of households, businesses and governments. Yet, despite high and rising spending, quality of care in the U.S. is uneven and often uncoordinated and inefficient. To address these mounting challenges, there is a strong need for delivery system and payment reforms in Medicare and across the health system overall. These reforms must look beyond one-time reductions in spending and cost-shifts to a fundamental realignment of incentives aimed at better care and lower cost growth.
Today, CRFB's Moment of Truth Project and the National Coalition on Health Care released a paper taking a closer look at some of these proposed reforms, many of which have bipartisan support.
What Sort of Reforms Have Been Proposed?
Health care stakeholders, thought leaders and policymakers on both sides of the aisle have united around the notion that more can be done to place health care spending on a sustainable path. This new, emerging consensus embraces three key principal strategies: 1) reward value of health care services over volume; 2) promote care coordination; and 3) inject more competition into our health care system.
Rewarding Value, Not Volume
- Physician Payment Reform: Replacing Medicare’s Sustainable Growth Rate (SGR) formula with payment reforms that move providers away from volume-based fee-for-service reimbursement to payment models that encourage care coordination and enhanced quality
- Value-Based Purchasing (VBP): Basing a portion of a provider’s payment on measures of care quality or value
- Value-Based Insurance Design: Implementing value-based insurance design (VBID), an approach which adjusts cost-sharing to incentivize beneficiaries to seek higher value, more coordinated providers and treatments
- Shared Savings: Allowing providers to share in savings if certain budget and quality targets are achieved, through expansion of existing programs like the Medicare Shared Savings Programs or new value-based payment withhold proposals, and enabling state governments to share in the savings if they lower health care spending rates without compromising quality or access
- Reducing Rates of Readmissions: Expanding and increasing current penalties for avoidable hospital readmissions
- Cracking Down on Healthcare-Acquired Conditions: Increasing penalties for high-rates of avoidable complications and expanding the penalties to a broader set of providers
- Reforming the Medical Malpractice System: Reforming the medical malpractice system to reduce the cost of defensive medicine and promote safe, evidence based medicine
Improving Care Coordination
- Episodic Bundled Payments: Expanding bundled payment arrangements whereby providers are paid with a fixed amount for a bundle of services, including some combination of acute, post-acute and physician care
- Improve Care Coordination for Dually Eligible Beneficiaries: Improving care coordination for beneficiaries enrolled in Medicare and Medicaid, especially those with high costs and complex care needs
- Implementing Alternative Benefit Packages: Creating an alternative benefit package that moves away from fee-for-service Medicare and encourages care coordination
- Competitive Bidding: Expanding competitive bidding for durable medical equipment and other services
- Prescription Drug Policy: Remove barriers to generic competition in Medicare Part D's Low-Income Subsidy program
Achieving Budgetary Savings from Delivery System Reform
Improved quality and better value for Americans’ health care dollars are worthy goals in and of themselves, but finding budgetary savings remains a vitally important consideration.
The Congressional Budget Office has found that reforms such as policies to prevent readmissions, expand competitive bidding and encourage generic drug utilization can produce “scoreable” budgetary savings. Other reforms such as care coordination, improved integration of care for dually eligible beneficiaries and value-based purchasing may not produce “scoreable savings” today, but are worth pursuing and testing because of the potential for savings in the future.
Policymakers could consider coupling delivery system reforms with well-designed enforcement mechanisms that can both spur the transformation of health care delivery and provide some assurance of budgetary savings. One such mechanism is to build targeted, scoreable payment reductions into a delivery or payment reform proposal, thereby sharpening the incentives for providers to deliver higher-value, more coordinated care. A “value-based withhold” could also serve to guarantee savings from delivery system reforms.
While other proposed reforms to federal health care programs have proven politically challenging, a broad, bipartisan consensus is building around delivery and payment reforms, and that consensus could make them viable, realistic solutions in coming months. For policymakers who want to place our health system on a sustainable path while promoting the best care for patients, these policies are a great place to start.
Click here to read the full report.
Today, the Congressional Budget Office (CBO) released its score of H. J. Res. 59, the continuing resolution (CR) recently proposed by several House Republicans that would provide funding for the government through December 15th, although the bill was pulled from consideration yesterday. CBO estimates that the bill would provide an annualized $518 billion in base defense funding and $468 billion in base nondefense funding, for a total of $986 billion. The bill would prevent a government shutdown at the end of the month, but the sequester would still have to be addressed in December, as the CR would exceed the sequester cap on defense by $20 billion. If the sequester were not subsequently addressed, 15 days after Congress adjourns (likely in mid-January), defense funding would face $20 billion in across-the-board reductions to bring it in line with the cap.
Also today, House Budget Committee Ranking Member Chris Van Hollen (D-MD) said in a press release that he would be proposing an alternative bill that would fund the government through November 15 and cancel sequestration for Fiscal Year (FY) 2014, setting defense and nondefense levels according to the original caps in the Budget Control Act -- $552 billion for defense and $506 billion for nondefense. While CBO has not yet scored the current legislation, according to Van Hollen's office, the bill would include approximately $180 billion in offsets, $75 billion more over ten years than the 2014 sequester. Savings are split roughly 50-50 between spending cuts and revenue increases, including disallowing Last-In-First-Out accounting for oil companies, repealing the Section 199 deduction for oil and gas companies, implementing the so-called "Buffet Rule," reducing farm subsides, and decreasing base defense caps later in the decade. Van Hollen previously proposed a similar sequester replacement bill without a continuing resolution back in May.
|Comparing the Recent House Republican and Van Hollen CR Proposals (Billions)|
|Subtotal: Base Discretionary||$986.3||$1,058.0|
|Overseas Contingency Operations||$94.9||Unk.|
|Total Base Spending in Excess of Sequester Caps||~$19||~$90|
|Length of Continuing Resolution||2.5 Months||1.5 Months|
|Size of Offsets||N/A||~$180|
Sources: CBO, Van Hollen
Note: Van Hollen's legislation has not yet been scored by CBO, savings are approximate
Earlier this week, we released a paper, "What We Hope to See from the Government Funding Negotiations," which set clear expectations for dealing with the sequester. Ideally, lawmakers would enact a comprehensive plan that would fully address our debt problem, but at a minimum, lawmakers should offset any appropriations above the sequester caps with savings in other areas.
Though enacting a temporary CR is a wasted opportunity, we can take some comfort that the proposals would not dramatically increase the debt. The House Republican's CR does spend 20 billion above the caps on the defense side -- which must be fixed -- but at least leaves in place the enforcement. Van Hollen's decision to more than fully offset his sequester is encouraging -- though we have some concerns about using out-year cap reductions, which may not be credible.
It is important that we do not worsen our budget outlook as we continue to work toward a larger budget deal.
Note: Blog was updated shortly after original post.
This is the seventh post in a new CRFB blog series, The Tax Break-Down, which will analyze and review tax breaks under discussion as part of tax reform. Earlier this week, we profiled the tax-exemption for municipal bonds.
Since 1978, cafeteria plans have allowed workers to divert some of their pre-tax pay toward fringe benefits, thus reducing their tax burden. Some of the most common uses of cafeteria plans are to pay for the employee’s share of health care premiums, supplemental coverage like dental and vision, medical expenses through Flexible Spending Accounts and Health Savings Accounts (FSAs/HSAs), and dependent care costs like child care or day care.
In order to qualify for a cafeteria plan, the employer must offer employees a choice between different compensation packages, hence the “cafeteria” name. As long as employees have the option to take taxable cash instead of benefits, the options under the cafeteria plan can be paid with pre-tax dollars.
Cafeteria plans reduce an employee’s taxable income under both the income tax and payroll tax, in contrast to 401(k) plans which are only deductible for income tax purposes. As a result of the payroll tax deduction, those who contribute more to cafeteria plans both pay less taxes and ultimately receive lower Social Security benefits.
How Much Does It Cost?
According to the Joint Committee on Taxation (JCT), cafeteria plans will cost $32 billion in lost income tax revenue in 2013, or more than $450 billion over 10 years. Repealing the exclusion for cafeteria plans entirely would allow for nearly a 4 percent cut in rates (the top rate would fall from 39.6 percent to 38 percent), based on a similar estimate from the Tax Foundation.
The JCT only measures income tax expenditures; cafeteria plans cost an additional $150 to $200 billion over ten years in lost payroll tax revenues. Most of this would come from the Social Security payroll tax. Repealing cafeteria plans would close 9 percent of the program’s 75-year shortfall, according to our Social Security Reformer.
Who Does It Affect?
Cafeteria plans are much more likely to benefit high-income employees and those at large firms. Less than one-tenth of workers in the bottom 10 percent of the wage distribution have access to flexible benefits provided under cafeteria plans. By contrast, three-fifths of workers in the top quarter of the wage distribution have access to dependent or health care reimbursement accounts.
Source: Bureau of Labor Statistics, 2012
Large employers are much more likely to offer cafeteria plans, since they are better able to manage the complexity of offering plans and the administrative costs, which average $100 per year per employee. According to the Bureau of Labor Statistics, only 20 percent of employees working at firms with less than 100 employees offer health care or dependent care reimbursement accounts, compared with 70 percent of employees at firms with more than 500 employees.
In many discussions of the tax benefits for health, cafeteria plans are lumped with the exclusion for employer-provided health insurance; most statistics talk about the two together. The linkage is not unfounded: recent studies have shown that four-fifths of workers with an employer sponsored health plan also have access to a cafeteria plan. Because low-income jobs generally do not offer health insurance, and because income exclusions are more valuable to those with a higher tax rate, the benefits of cafeteria plans accrue mostly to the upper end of the income spectrum, though not disproportionately to the ultra-rich. Income distribution is likely similar to the health exclusion, where the top half of the income spectrum receives five-sixths of the benefit, and the top fifth receives nearly half. Because the exclusion comprises a larger percentage of income at the bottom, however, it provides a bigger boost in after-tax incomes to the bottom: 13 percent higher than for those in the middle of the income spectrum.
What are the Arguments For and Against Excluding Cafeteria Plans?
Opponents of cafeteria plans argue they provide an unnecessary vehicle for tax avoidance and offer a regressive benefit since those at higher income tax brackets get a larger effective subsidy. With regards to flexible spending accounts specifically, the “use it or lose it” nature has discouraged many people from signing up, and cost the average employee more than $100 per year in forfeited benefits in 2005. In addition, many argue that excluding cafeteria plans from the payroll tax hurts Social Security’s solvency by ignoring part of an employee’s compensation. Finally, there is a broader concern that offering health benefits with pre-tax dollars encourages individuals to purchase excessively generous health plans, thus driving up health costs.
Proponents of cafeteria plans and flexible spending accounts respond that treating cafeteria plans separately from equivalent preferences offered on the employer side – for example, the employer-provided health exclusion – would result in unequal and unfair tax treatment. Proponents also argue that cafeteria plans encourage employers to offer generous benefit packages and give employees control over their own health care dollars, while helping to strengthen the health care market in the United States. Changing the tax treatment of health care might create special challenges if done simultaneously with the implementation of the Affordable Care Act.
What Have Other Plans Done with Cafeteria Plans and What Are the Options for Reform?
The Wyden-Gregg tax reform bill, Domenici-Rivlin, and the American Enterprise Institute repealed the preference for cafeteria plans entirely. Unlike those three, the Fiscal Commission would have separated different elements of cafeteria plans. It eliminated non-health cafeteria plans immediately, along with most other tax expenditures. The income tax portion of cafeteria plans spent on health premiums was phased out over 25 years along with the employer-provided health exclusion.
The Center for American Progress didn’t touch cafeteria plans as part of their tax reform proposal, but did propose changes as part of their plan to improve Social Security solvency. Specifically, they would treat cafeteria plans like 401(k)s—exempt from income tax, but subject to the payroll tax and counted as wage income for the purpose of calculating Social Security benefits.
Although many tax reform plans completely repeal cafeteria plans, options exist to trim the exclusion short of repeal. For example, cafeteria plans could be repealed only for the payroll tax or just for the income tax. Cafeteria plans could also be trimmed by disallowing certain types of benefits: restricting the ability to pay for health premiums, health FSAs, or child care, for example; or by changes to the rules within any of those contribution categories.
This year and last year, Congress has also considered numerous options to expand the cafeteria plan exclusion, by repealing the annual $2,500 cap on flexible spending accounts or expanding health savings accounts, for instance.
The below table includes rough estimates for the amount of revenue raised by changing the tax treatment of cafeteria plans, based on other official revenue estimates.
|Revenue from Reform Options on Cafeteria Plans
|Repeal entire tax exclusion for cafeteria plans||$600-650 billion|
|Make cafeteria plans subject to the income tax, but still exempt from the payroll tax||$400-450 billion|
|Make cafeteria plans subject to the payroll tax, but still exempt from the income tax||$150-200 billion|
|Repeal Health FSAs only||$60 billion|
|Eliminate tax-free benefits for employer-provided child care||$15 billion|
|Allow unused portions of FSAs to be returned to the employee at the end of the year||- $10 billion|
Where Can I Read More?
- Congressional Research Service – Health Care Flexible Spending Accounts
- Internal Revenue Service – Publication 15-B Employer’s Tax Guide to Fringe Benefits
- Employers Council on Flexible Compensation – Consumer Directed Benefit Accounts
- Joint Committee on Taxation - Present Law And Background On Federal Tax Provisions Relating To Retirement Savings Incentives, Health And Long-Term Care, And Estate And Gift Taxes
- Cato Institute – Overcoming Obstacles Facing the Uninsured: How the Use of Medical Savings Accounts, Flexible Spending Accounts, and Tax Credits Can Help
- Urban Institute – Timely Analysis of Immediate Health Policy Issues
- Jonathan Gruber – The Tax Exclusion for Employer-Sponsored Health Insurance
- National Conference of State Legislatures – State Use of “Cafeteria Plans” to Provide Health Insurance
- Joint Committee on Taxation – Present Law and Background Relating to the Tax Treatment Of The Cost Of Over-The-Counter Medicine As a Medical Expense
* * * * *
The tax break for cafeteria plans encourages employers to offer and employees to choose more generous benefit packages, by allowing their employees exclude those benefits from taxation. Most, but not all, of cafeteria plan dollars go towards health and in many cases drive up health care spending. Repealing cafeteria plans could help, along with other reforms, to reduce health care spending. On the other hand, repealing or reducing the provision in isolation may create new inequities with nearly identical exclusions offered directly to employers. Still, repealing or reducing this tax break as part of a broader package offers an opportunity to reduce economic distortions and raise revenue that can reduce rates or reduce the deficit.
Read other pieces in the Tax Break-Down here.
Last month after the Bureau of Economic Analysis revised their GDP numbers going back to 1929, we decided to take the intiative and project what the changes would do to CBO's current ten-year budget projections. Now, CBO has graciously confirmed our numbers with a re-release of their May baseline numbers incorporating the new GDP estimates. That they came to the same conclusion is no surprise, since they did not change their previous economic growth projections; instead, they simply adjusted the GDP levels.
Since it was only the GDP levels that have been adjusted upward, the adjustment to the debt-to-GDP ratio is also only a level change, rather than a trajectory change. Debt is projected to fall from a high of 73.6 percent of GDP in 2014 to a low of 68.4 percent in 2018 before rising to 71.1 percent in 2023. There is a similar story for the CRFB Realistic baseline, which incorporates current policies into the numbers. In that baseline, debt will fall from 74 percent in 2014 to 69.5 percent in 2018 before rising to 73 percent by 2023.
Source: CBO, CRFB
Under current law, spending will total 21.1 percent of GDP over the next ten years while revenue will total 18.3 percent, for a ten-year deficit of 2.9 percent of GDP. In 2023, those totals will be 21.8 percent, 18.5 percent, and 3.3 percent, respectively. In the CRFB Realistic baseline, spending will total 21.3 percent of GDP, revenue will total 18.3 percent, and the deficit will total 3.1 percent over the next ten years. In 2023, those totals will be 22 percent, 18.5 percent, and 3.5 percent, respectively.
|CRFB Realistic Budget Metrics (Percent of GDP)|
|Memo: GDP in Trillions||$16.6||$17.2||$18.3||$19.5||$20.7||$21.7||$22.7||$23.7||$24.7||$25.7||$26.8|
Source: CBO, CRFB
As you can see, the new GDP numbers only change debt-to-GDP levels going forward rather than the trajectory. We will have a much better idea next Tuesday what the long-term fiscal outlook will look like, but in all likelihood it will show the federal debt is on an unsustainable path over the long run.
In an effort to help address the unsustainable growth of our health care programs, a few legislators are reaching across the aisle in an effort to both curb costs and protect citizens. In an article in The Hill, Senators Tom Carper (D-DE) and Tom Coburn (R-OK), and Representatives Peter Roskam (R-IL) and John Carney (D-DE) described their recent legislation that addresses fraud prevention in Medicare and Medicaid. The Preventing and Reducing Improper Medicare and Medicaid Expenditures Act (PRIME Act) will address fraudulent prescriptions, impersonations, and overpayments, among other things, which they estimate to cost taxpayers $60 billion per year.
The group touts the bill as a way to easily reduce Medicare and Medicaid spending without hurting beneficiaries. They call on legislators to act upon easily-agreed reform that utilizes up-to-date technology and best practices to ensure that funds in the two programs are spent wisely. They write:
Our bill also makes it more difficult for bad actors to misuse doctors’ identities to inappropriately prescribe drugs, including controlled substances, by requiring the Medicare prescription drug program to verify the prescriber’s legitimacy before paying for the medication. In 2007 alone, $1.2 billion in Medicare prescription drug claims contained prescriber identifier numbers that were not valid.
The PRIME Act also makes it a crime to fraudulently buy, sell or distribute Medicare and Medicaid patient information, specifically beneficiary identification numbers. Furthermore, our legislation encourages information sharing between federally administered Medicare and state-administered Medicaid to prevent fraudulent activity in both programs.
Medicare fraud affects millions of seniors each year, and PRIME calls for actively engaging the very patients that rely on Medicare to help fight it. Today, a team of volunteers and staff, the Senior Medicare Patrol, help Medicare patients report instances of suspicious or wasteful practices in the program. The PRIME Act would build on this program by better engaging and incentivizing those enrolled in both Medicare and Medicaid to find and report suspicious charges or practices, creating a stronger front-line defense against fraud and abuse.
On the business side, the PRIME Act takes steps toward holding contractors more accountable and harnessing basic business incentives to reduce errors. Unfortunately, even though today we have systems to catch mistakes after the first offense, officials aren’t doing a good job of making sure the same mistake isn’t made again. Last year, the Medicare “fee-for-service” program made almost $30 billion in improper payments, a startling 8.5 percent error rate. Currently, the government contractors who handle the billions of annual Medicare claims get paid the same amount regardless of their level of accuracy. PRIME makes sure these companies have skin in the game when it comes to reducing errors and fraud by ensuring that the government’s contracts are based in part on contractors’ level of accuracy.
Senator Coburn previously has teamed up with former Senator Lieberman (I-CT) to propose Medicare reforms, which was recently scored by Center for Medicare and Medicaid Services's Office of the Actuary (OACT) as saving $536 billion over the next ten years. While not scored by the OACT, the fraud-reducing measures in Coburn and Lieberman's Medicare proposal could provide additional savings. There is also the FAST Act, introduced last Congress, which is similar to the PRIME Act and had bipartisan backing. The Bipartisan Path Forward also included reducing Medicare fraud, with roughly $25 billion in savings.
We recognize that reaching any agreement on entitlement reform will be difficult, but it is necessary to ensure our long-term fiscal solvency. Reducing fraud will not be sufficient to slow the growth in health care spending to a sustainable rate, but it is a good first step, and the four lawmakers should be commended for the effort.
Although the possibility of a US military strike on Syria is now in question, the possibility has also led to public statements regarding the relationship between defense priorities and the budget. Specifically, both House Armed Services Committee chair Buck McKeon (R-CA) and Senate Armed Services Committee ranking member Jim Inhofe (R-OK) have both said in recent weeks that they would oppose a strike on Syria unless the sequester was addressed.
A few weeks ago, Inhofe said that the military "has no money left" to conduct an operation in Syria, and suggested that the sequester would hollow out the military. McKeon had the following to say in an op-ed in The Wall Street Journal:
I plan to ask the president, in light of the weight of his decision to intervene in Syria, for his commitment to address sequestration as part of any deal on the debt ceiling. If he makes that commitment, then he has my support. If not, I won't be able to vote to send our over-stretched and under-funded military into action. The opportunity to undo the harm of the budget sequester is unlikely to come around again.
Neither lawmaker specifically talked about offsetting sequester repeal, and McKeon did seem to imply that he would prefer the sequester be handled in a broader budget context.
There can be legitimate concern about the extent to which the sequester has affected military readiness, particularly with the across-the-board nature of the cuts in FY 2013. In 2014 and beyond, however, appropriators can allocate cuts where they choose, provided that Congress enacts appropriation bills or changes in current funding levels. A temporary continuing resolution, on the other hand, would likely continue the across-the-board nature of the FY 2013 cuts, and it increasingly appearing to be the likely outcome before October 1.
Certainly, appropriators will have to pay close attention to priorities in the defense budget as they change over time. However, trading an non-offset sequester repeal for votes on the Syria strike would be a fiscally irresponsible way to go about replacing it. Absent any new offset, not abiding by sequestration cuts -- cuts that were meant to prompt smarter deficit reduction -- would damage our fiscal credibility.
Furthermore, based on cost estimates of the type of strike that has been discussed -- maybe in the couple hundred million dollar range -- and the fact that many of the inputs involved will have already been purchased, it is very likely that the military could carry it out within their existing budget. Even if policymakers determined that supplemental spending would be necessary, it would not warrant the extra $54 billion that would come from exempting defense from the sequester in 2014. Thus, it would not be necessary to repeal the sequester simply to carry out the strike. Based on the grading scale in our most recent paper, repealing the sequester without offsets would be a flat-out F.
Lawmakers should resist any temptation to use Syria as an excuse to replace the sequester without any offsets. Rather, policymakers should use the upcoming negotiations over the budget to replace the sequester, while fully offestting its cost, and at the same time achieve meaningful long term deficit reduction.
Syria-ous Business – The kids are back in school. People across the country are back from vacation and returning to the daily grind, including Congress, which is back this week after the long August recess. The main topic of conversation in Washington this week is Syria, as policymakers deliberate on how to deal with its use of chemical weapons. But attention should also be given to key fiscal disputes, namely funding the federal government and raising the statutory debt ceiling. House and Senate leaders will meet on Thursday to discuss how to move forward on the fiscal issues, which represent two critical fiscal speed bumps ahead.
Approps of Nothing – Given the recent track record of Congress, it’s no surprise that the annual appropriations process has stalled yet again. Congress is not expected to produce any of the twelve spending bills to fund the federal government before the new fiscal year begins on October 1, meaning that a stopgap continuing resolution (CR) will be required to prevent a government shutdown. The House is planning to vote on a CR this week that would continue funding the government at current spending levels through mid-December. However, some House members are contemplating tying the vote on the CR to a vote on defunding the president’s health care reform law.
Will Policymakers Make the Grade? – We put out a new paper on Tuesday that lays out what we would like to see from the government funding negotiations that includes a grading scale. Policymakers get an “A’ if they replace sequestration with a comprehensive fiscal plan and a "F" if they appropriate about sequester levels without finding offsets or using gimmicks. See the full paper and grading scale here.
How Will this Debt Ceiling Debate Work Out? – On the heels of the fiscal year deadline to avoid a government shutdown, policymakers must also navigate an impending breach of the statutory debt limit, which will cause a national default if the limit is not raised. Treasury Secretary Jacob Lew says the “extraordinary measures” now being undertaken to prevent a debt limit breach will be exhausted in mid-October. The Bipartisan Policy Center puts the “X Date” in a range between October 18 and November 5. Track debt ceiling developments here and learn more about the debt limit here. Meanwhile, the Organization for Economic Co-Operation and Development (OECD) warned the U.S. that another debt ceiling stand-off like two years ago would imperil the economy not only in this country, but globally. They also urged adoption of a "credible medium-term" fiscal plan.
Still Laboring on Tax Reform – Senate Finance Committee chair Max Baucus (D-MT) and House Ways and Means Committee chair Dave Camp (R-MI) took their tax reform tour to Tennessee on Monday, meeting with farmers and local business leaders in Memphis. The bipartisan duo was greeted by an op-ed from another bipartisan pair, former Governors Phil Bredesen and Winfield Dunn, encouraging their efforts. Baucus and Camp say that consensus is forming in Washington on corporate tax reform. President Obama broached the subject over the summer by proposing reform that gets rid of corporate tax breaks while lowering tax rates and putting the proceeds towards projects designed to increase jobs. Try your hand at reforming the corporate tax code with our simulator. As a sign of his commitment to fundamental tax reform Camp has told his committee that they will dedicate the month of September to the topic, working towards Camp’s goal of an October mark-up of tax reform legislation. With the increased scrutiny of the various loopholes and preferences in the tax code that are ripe for reform, CRFB launched a “Tax Break-Down” blog series that will examine these tax expenditures one at a time.
Key Upcoming Dates (all times are ET)
- Treasury Department monthly federal budget statement.
- Weekly jobless claims report from the Department of Labor.
- Consumer Sentiment Index from the University of Michigan.
- Congressional Budget Office (CBO) releases Long-Term Budget Outlook.
- Federal Open Market Committee (FOMC) of the Federal Reserve meets.
- Fiscal Year 2014 begins. A continuing resolution must be approved by this date in order to prevent a government shutdown.
- 100th Anniversary of the Revenue Act of 1913, which instituted the federal income tax.
October 18 - November 5
- Time range in which the Bipartisan Policy Center estimates the statutory debt ceiling will be breached. A national default will occur unless the debt limit is raised before that point.
Tomorrow, September 12, CRFB's Moment of Truth Project and the National Coalition on Health Care will host a briefing on Medicare delivery system and payment reforms. The briefing will begin at 10:30 AM in the Capitol Visitor Center with presentations by John Rother of NCHC, and Ed Lorenzen of the Moment of Truth Project. Sarah Kliff of the Washington Post will moderate a panel discussion with Bipartisan Policy Center's Bill Hoagland and the Brookings Institution's Keith Fontenot.
Thursday, September 12, 2013
10:30 AM - 12:00 PM
Capitol Visitor's Center
Congress already has its hands full with finding a fiscally-responsible solution for the expiration of the government funding bill at the end of the month, but another budget deadline is just around the corner.
Today, the Bipartisan Policy Center (BPC) released their detailed analysis of the debt ceiling, projecting Treasury to run out of cash to pay bills between October 18 and November 5. This news comes on the heels of Treasury Secretary Jack Lew’s letter to Congress, which predicts the exhaustion of borrowing authority by mid-October (at which point Treasury would have $50 billion cash on hand).
The U.S. already reached its statutory debt limit of $16.699 trillion on May 19, and the BPC report, authored by Steve Bell, Shai Akabas, and Brian Collins, highlights the “extraordinary measures” that Treasury is currently using to delay defaulting on obligations, including the estimated $108 billion of remaining measures that were available as of the end of August. As we’ve discussed in great detail before, these measures include borrowing from the Federal Employees’ Retirement System G-Fund, the Exchange Stabilization Fund, interest payments and cash receipts to the Civil Service Fund and Postal Fund, and maturing securities in the Civil Services Fund and Postal Fund. Unfortunately, October is a bad month for the government’s finances, and therefore Treasury is likely to run out of cash to pay bills in the latter half of the month or very early November.
In addition to predicting the timing of the so-called “X date,” the BPC report provides a host of information on major payments due after the X date, necessary debt rollovers in that time, and what might happen after the X date. Most critically, they estimate that Treasury would be about $106 billion short of making all payments owed due between October 18 and November 15, thus leaving 32 percent of bills unpaid. On top of that, during what is sure to be a chaotic time, Treasury must roll over $370 billion of maturing debt. While this is a straightforward process during normal times, the operation is far more unpredictable in a post-X date environment. Treasury may have to pay higher interest rates to attract enough buyers, and although unlikely, there is a small risk that the auction would not attract enough bidders, forcing them to use cash on hand to redeem securities or even potentially default on the debt.
There are many theories about how Treasury would operate in a post-X date world, but according to a report from Treasury’s Office of the Inspector General (OIG), the most likely course of action would be to wait until there is enough cash available to make an entire day’s payments at once. Payment delays would therefore continue to lengthen and cascade the further past the X date we went. If the X date were October 18, payments on that day might “only” be delayed by three days, but Social Security and Veterans benefit payments due on November 1 might be delayed by nearly two weeks.
To get us through the end of 2014, BPC estimates that lawmakers would need to increase the debt limit by around $1.1 trillion. With the expiration of annual appropriations on October 1 also fast-approaching, BPC’s analysis provides important insight into the timing the other big fiscal hurdle. As we said back in May, lawmakers should raise the debt limit as quickly as possible to prevent this analysis from becoming reality, while also using the opportunity to enact enough deficit reduction to put debt on a downward path as a share of GDP.
It is now three weeks and counting until the start of FY 2014, when lawmakers will have to pass a bill funding the government or incur a shutdown. With the two chambers $91 billion apart on funding levels, they have some work to do in the next few weeks -- and perhaps in the coming months -- to find a level they are both comfortable with for the year. And with Congress only in session for nine legislative days before the end of the month, they will have to work quickly. A new infographic from the Peterson Foundation shows the to-do list that Congress faces in its limited time in session, including the appropriations process.
A comprehensive agreement would be ideal, but at minimum lawmakers should either find accompanying offsets for a repeal or abide by sequestration levels. To help make sense of the challenges faced by Congress, CRFB has released a new paper, "What We Hope to See from the Government Funding Negotiations," which outlines the state of play and our expectations of how policymakers should handle the situation. In short, the appropriations process is much entwined with the sequester, which accounts for the difference in funding levels between the House and Senate. The sequester does not seem to be politically sustainable since both chambers have put forward plans to violate the caps -- the House on the defense side and the Senate on both sides of the discretionary budget -- so a replacement is greatly needed.
With that said, we've created a grading scale for different scenarios based on their benefits for the debt and the economy. Here is how we would view each approach:
In short, lawmakers can get an A if they pass a plan which solves the long-term fiscal imbalance, and they can still get a passing grade if they at least do no fiscal harm. They will get an F if they add to the debt with a long-term sequester replacement, and they will get an incomplete for any short-term funding solution. Of course, we hope lawmakers have been studying over the August recess so they can pass with flying colors.
Click here to read the full report.
This is the sixth post in a new CRFB blog series, The Tax Break-Down, which will analyze and review tax breaks under discussion as part of tax reform. Last week, we profiled the Section 199 manufacturing incentive, one of the largest corporate tax breaks.
Interest earned from state and local government bonds has been tax-free since the income tax started in 1913. The interest that people earn from holding these bonds, unlike other interest, does not count as income. In this case, the federal government forgoes income tax revenue to indirectly subsidize the cost of borrowing for local governments.
Because these municipal bonds offer tax-free return, investors are willing to accept a lower level of interest, depending on their individual tax rates. For instance, an investor in the 25 percent tax bracket who earns 6 percent interest on a taxable bond will pay a quarter of that interest in taxes (1.5 percentage points). The investor would receive the same after-tax return from a municipal bond providing 4.5 percent in tax-free interest. An investor in a higher tax bracket would see a larger benefit and so would prefer a 4.5 percent municipal bond to a 6 percent taxable bond. Investors in lower tax brackets would prefer the taxable bond.
Source: Congressional Budget Office
Since investors accept a lower rate of return than would otherwise be the case, the tax exemption lowers the cost of borrowing for state and local governments, who issue bonds to support transportation, education, health, utilities, and many other capital projects. This category of tax-exempt bonds comprises a substantial municipal bond market, with over $3.7 trillion in outstanding bonds and $11.3 billion traded daily in 2012.
Prior to 1960, state and local governments could essentially engage in unlimited tax-preference borrowing on behalf of themselves or private businesses. Restrictions enacted over the last 30 years have restricted but not eliminated the issuance of tax-exempt "private activity bonds." For taxpayers paying the Alternative Minimum Tax (AMT), no private activity bond interest is exempt from taxes.
How Much Does It Cost?
The exclusion of interest income on municipal and private activity bonds will cost the federal government $58 billion in 2013 and approximately $540 billion over the next ten years, according to the Joint Committee on Taxation (JCT). Of that total, traditional governmental bonds cost $420 billion and private activity bonds cost another $120 billion. Approximately $130 billion goes to corporate bondholders, and the other $410 billion goes to taxpayers paying the individual income tax.
The tax treatment of municipal bonds is a small but significant portion of federal aid to states. The largest segment of federal aid is grants given directly to the states, which totaled $560 billion in FY 2013. Next is the state and local tax deduction, costing $77 billion. Third is the tax break for municipal bonds, costing $34 billion this year.
Assuming full repeal of the tax exemption would raise approximately $500 billion over ten years, doing so would finance a 4.5 percent across-the-board cut in tax rates (the 39.6 percent rate would drop to 37.8 percent, for example), based on Tax Foundation estimates from repealing other provisions with similar costs.
Who Does It Affect?
Tax-free income on municipal bonds has both direct and indirect beneficiaries. The direct beneficiaries are the investors – bond holders who receive tax-free interest. Three-quarters of municipal bonds are held by individuals, either directly or indirectly through mutual funds. Measured by the direct effects, the benefits are skewed to those at the top of the income spectrum. One analysis from the Tax Policy Center found that, under a hypothetical tax plan with a top marginal rate of 28 percent, 85 percent of the benefit of this provision would go to taxpayers making over $200,000. Current law has a top tax rate more than 10 points higher, so taxpayers at the top likely benefit even more.
Importantly, though, looking only at the direct benefit of the preference misses a key benefit of the tax break – to provide the states and localities with cheaper borrowing costs.
The largest share of municipal bonds goes to fund public and nonprofit education projects, which totaled almost $700 billion from 1997 to 2007. Transportation projects are the next largest segment, making up one-fifth of the total. Health care bonds make up 15 percent, mostly in the form of private activity bonds.
Source: Congressional Budget Office
Those states and localities that rely more heavily on bond financing receive more of the benefit. Heavily-populated states like California, Texas, New York, and Florida disproportionately benefit.
Source: National Association of Counties
What are the Arguments For and Against Excluding the Interest on Municipal Bonds?
Proponents of the municipal bond tax exemption argue that the exclusion provides important support for state and local governments to invest in infrastructure, education, health care, and other productive public investments. They also point out that infrastructure investment in the United States is centered around the tax-exemption, with a $3.7 trillion bond market. Changes to the exclusion – especially for existing bonds – could cause severe disruptions in this large market and thus the broader economy. Reduction could also hurt the ability of state and local government to borrow, as evidenced by S&P’s warning that reducing the tax benefits around municipal bond interest would have "negative credit implications for state and local governments and other tax-exempt issuers."
Opponents of the exclusion argue that the tax code should not be the vehicle for supporting local governments and local projects, especially those that are private purpose and benefit a small group of people, like a sports stadium. To the extent these projects are worthy, opponents argue that a tax exemption is an expensive and poorly targeted way to encourage investment, often citing a report by CBO that one-fifth of the subsidy has no impact on interest rates and is simply a windfall to investors in higher tax-brackets. Finally, the tax-exemption for municipal bond interest provides a huge benefit for some who want to minimize or possibly eliminate their tax burden. Along with charitable giving, municipal bonds are a major reason that some rich people have a very low or sometimes zero tax bill. Over 16,000 taxpayers with an income over $200,000 do not pay any taxes; tax-free bonds are the reason for three-fifths of them, according to the IRS.1
What are the Options for Reform?
On a static basis, repealing the interest exclusion for tax-exempt bonds would raise about $500 billion over a decade, or $200 billion if applied only to newly-issued bonds. As with most large tax expenditures, however, a number of options exist to trim or reform the tax break without completely repealing it. Any reform option could be applied to all municipal bonds, changing the tax treatment of investments that have already taken place, or phase-in the change with only newly issued bonds.
As one example, Congress could repeal certain elements of the tax-exemption – such as disallowing private activity bonds or repealing the exclusion for corporations (who can also borrow tax free). Policymakers could also pursue a haircut approach like limiting the value of the exclusion to that provided by the 28 percent tax bracket.
Another often-discussed option would be to eliminate the exclusion and in place offer a credit. That credit could be set at a specific level or adjustable to achieve a certain interest rate, it could itself be taxable or not, and it could go to the owner of the bond or directly to the issuer. This credit would not only be more progressive than the current system, but it would be more efficient since much of the “windfall” associated with the current system comes from the fact the current system provides a higher effective subsidy to those in the top tax brackets. According to the CBO, this change can offer the equivalent investment subsidy at a lower cost to the government (or a higher subsidy at the same cost).
|Revenue from Reform Options for Municipal Bonds (2014-2023)
|Policy||Apply to New Bonds
||Apply to All Bonds
|Eliminate exclusion for all municipal bonds||$200 billion*F||$500 billionS|
|Eliminate exclusion for private activity bonds, only||$30 billion||$100 billionS|
|Eliminate corporate exclusion for all bonds||$50 billionF||$120 billionS|
|Eliminate corporate exclusion for private activity bonds, only||$10 billion||$25 billionS|
|Cap income exclusion at 28%||$20 billionF||$50 billion|
|Replace Exclusion with a 25% Credit||$25 billion||$60 billionF|
|Replace with 15% Credit||$150 billion||$375 billionF|
|Eliminate private activity bonds for non-profit hospitals||$10 billionF||$25 billionS|
|Eliminate advanced refunding of bonds to eliminate “double subsidy”||$10 billion||unknown|
|Limit issues to $100 million of tax-exempt debt annually||$50 - $85 billion†||
* - JCT recently estimated that repealing the tax-exemption for newly-issued bonds would raise $124 billion; However, it is not clear if this score includes private activity bonds or interest received by corporations.
S - Static estimate based on tax expenditure value
F - Based on assumption that grandfathering existing bonds will result in savings 40 percent as large as applying to all bonds.
† - Estimate provided by Breckinridge Capital Advisors, Inc., at the author's request.
What Have Tax Reform Plans Done With Municipal Bonds?
Most major tax-reform plans would retain some form of tax preference for municipal bonds, though at a lower cost than the current preference. The Wyden-Gregg/Coats legislation would replace the exclusion with a 25 percent credit for new issuers, for example. The Center for American Progress would limit municipal bonds with a per-state cap similar to private activity bonds and fully reinstate Build America Bonds, a type of tax credit bond that was enacted in the 2009 stimulus on a temporary basis. The 2005 tax reform panel kept the exclusion for individuals, but eliminated the exemption for businesses “because of the flexibility businesses have to deduct interest.” The Domenici-Rivlin plan, meanwhile, retained the exclusion for public purpose bonds but eliminated it for private activity bonds.
Only the Fiscal Commission would repeal the tax-exemption entirely, and even they would do so only for newly issued bonds and would phase out the exemption for those new bonds gradually rather than immediately.
Where Can I Read More?
- Congressional Budget Office/Joint Committee on Taxation – Subsidizing Infrastructure Investment with Tax-Preferred Bonds
- Congressional Budget Office – Testimony on Federal Support for State and Local Governments Through the Tax Code
- National Association of Counties – Municipal Bonds Build America: A County Perspective on Changing the Tax-Exempt Status of Municipal Bond Interest
- Calvin Johnson – Repeal Tax Exemption for Municipal Bonds
- Center for American Progress – Bring Back BABs: A Proposal to Strengthen the American Bond Market with Build America Bonds
- Congressional Budget Office – Tax-exempt bonds
- Joint Committee on Taxation – Present Law and Background Information Related to Federal Taxation and State and Local Government Finance
The exclusion for interest on state and local bonds is an expensive tax preference that steers investors toward a category of investments that may not otherwise be preferable to unsubsidized investments. On the other hand, states and investors have come to rely on tax-free municipal bonds as the main way to finance infrastructure. Importantly, whatever the merits of having the exclusion in the first place, there is a $3.7 trillion market built around the exclusion. Reforms must be careful and deliberative, particularly in how they treat previously-issued debt. Still, tax reform offers an opportunity to make the way we subsidize public investments far more efficient, or carefully unwind subsidies if they are determined to be undesirable. In the process, these reforms could generate new revenue for rate reduction, deficit reduction, or both.
Read other pieces in the Tax Break-Down here.
1As described by former Representative (and CRFB board member) Bill Frenzel, the main impetus for enacting the AMT was to ensure that high earners whose income relied mainly on municipal bonds paid at least some tax. However, Congress ultimately decided to enact the AMT without taxing bonds.
Note: This post has been updated on September 13, 2013 to include an additional revenue estimate from Breckinridge Capital Partners that was not available at the time of publication.
Congress returned to Washington today and lawmakers will find their to-do list packed. But in today's The Hill, former Governor and Senator Judd Gregg (R-NH), co-chair of the Fix the Debt Campaign, writes that only one domestic issue must be resolved by the end of this month: the budget and the debt.
With the expiration of the continuing resolution at the end of September and a deadline on the debt ceiling as soon as mid-October, the budget will demand attention in the next month. With this prime opportunity to resolve our fiscal troubles, lawmakers should resist any suggestion that the budget can be put on the back burner. Gregg writes:
It is true the deficit has dropped a great deal in the last six months. It is also true that the sequester, if allowed to continue to operate, will cut that deficit even further. But no great solace should be taken from either fact, even though certainly on their faces they represent positive movement.
The fact that the deficit is down by over half from its high point is like saying that a person who has fallen off a tall building is doing "OK" when they are only halfway down.
When CBO's long-term projections are released later this month, we will likely see confirmation that the steps taken so far, while admirable, have still left us with a long way to go to solve our debt problem. According to our CRFB Realistic Baseline, debt will exceed the size of the economy by 2037 and explode in the decades that follow. Lawmakers have resisted repealing sequestration without a replacement so far, showing they are committed to at least maintaining it until they find agreeable replacements, but the sequester does not contain long-term savings. Gregg notes:
The sequester does save money and it does cut spending, but it does it in the wrong places, in the wrong way and at the wrong time.
The issue has never been discretionary spending. This is especially true after the almost trillion dollars in cuts put in place with the agreement reached in the summer of 2011.
The issue has always been entitlement spending and how to change the major entitlement programs so that they can be put on a glide path to sustainability, even as they still serve as a necessary safety net for seniors.
The problem and solutions are well-known in Washington, but that does not mean action will be taken. For Gregg, there are no excuses: it is time to find agreement.
The folks are back in Washington. One presumes they came back to do something. Or is that too optimistic?
Click here to read the full op-ed.
"My Views" are works published by people affiliated with the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.
As Congress returns to Washington today, the clock is ticking to September 30, the end of the government's fiscal year and the date after which the government will shut down unless a funding measure is passed for FY 2014. Only 9 legislative days remain before the end of the month.
CRFB board member Bill Hoagland served as staff director to the Senate Budget Committee in 1995, the last time there was a substantial government shutdown. He wrote an op-ed last Friday in The Hill, cautioning against repeating the "sad experience" of 1995. Only one-fifth of the current Congress was in office in 1995, and new members may not remember that the shutdown brought no benefits with some great disruptions in government operations:
Fortunately, the four current leaders, Speaker Boehner (R-Ohio) and Minority Leader Pelosi (D-Calif.), as well as Senate Majority and Minority Leaders Reid (D-Nev.) and McConnell (R-Ky.) were on the scene in 1995. They should know no one benefited, neither political party, from the experience. In the presidential and congressional elections that followed, Republicans lost 4 House seats, President Clinton won reelection over Senator Dole, and the Senate remained unchanged. The public’s respect for Congress was the real loss to our system of governance. The unfavorable rating of Congress increased over 5 points to 60 percent shortly after the 1995 shutdowns -- an unfavorable rating the current Congress would enjoy since today that metric tops 80 percent.
Besides the politics, the implementation of the shutdown was a major negative. One current Republican member, then chairman of the Subcommittee on Civil Service of the House Oversight and Government Reform Rep. John Mica (R-Fl.), reviewed the 1995 shutdown in detail. Mica concluded that the execution of the shutdown by the agencies and the President’s Office of Management and Budget, was “disorganized and illogical, at best, and oftentimes chaotic."
Hoagland criticizes any talk of shutting down the government or defaulting on the national debt, but is especially critical of the demands of some Republican lawmakers to defund the Affordable Care Act. Although he has concerns with some elements of the bill, Hoagland argues that defunding the bill through the appropriations process would be ineffectual since most of the bill's spending is in the form of mandatory programs that would not be impacted by a government shutdown.
Second, even if “defunding” on a House-passed CR could make it out of the Senate, which is extremely unlikely, it would be vetoed by the president and the veto would not be overridden. Then the government would shutdown. But even more disconcerting for “defunding” proponents, if magically the president were to sign such legislation, because most of the funding for the law is not subject to annual appropriations, a government shutdown would be avoided but the key provisions of the ACA would continue. It would be a futile exercise; accomplishing nothing that advocates for defunding the law have sought.
The country should avoid a government shutdown, which introduces complexity into an already choppy year, needlessly hurts public respect for Congress, and creates chaos for people trying to use or administer government services. Ultimately, they will need to come to an agreement, at a minimum in the short term, on funding levels for discretionary spending for the fast-approaching fiscal year.
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.
The President's decision to ask for a congressional resolution authorizing military force in Syria has added to an already busy congressional schedule in September. In a Forbes op-ed, CRFB board member and former Representative Bill Frenzel (R-Minn.) describes the current legislative climate surrounding Syria as "one of the worst of the bad old days." Frenzel points out that in earlier Congresses, members had to make tough decisions on problems with no apparent good choices or outcomes. The question of whether to intervene in Syria is contentious, as Democrats and Republicans both face competing political pressures.
Frenzel describes how President Obama put Congress in this tough place by asking for their approval; he did not seek similar approval before intervening in Libya. Now, both parties are faced with a tough decision that provides no political payoff.
Republicans, like the House leadership, may not trust the President, but they dare not leave the Republic swinging in the wind (the McCain argument). Democrats, whose normal nature is peaceful, may, with deep regret, feel obliged to support their President. Both sides would rather let him take responsibility, and some members may resent having this unhappy decision thrust upon them.
Much more important than the actual vote, Frenzel argues, is the political capital that Obama is using up in this fight - capital that should be used to address pressing long-term concerns. We discussed last week the potential budgetary implications of intervention in Syria, including the tightening of fiscal space that could occur with wider involvement. While Congress is discussing Syria, underlying issues with the budget, deficits, and the national debt are going unaddressed. Frenzel worries that domestic concerns will be pushed by the wayside as the government's focus continues to be on the question of intervention.
Worse, the decision comes at a time when Congressional energies ought to be focused on the FY14 CR, the sequester repair, and the Debt Ceiling extension. Congress is already a polarized battleground. Syria, because it is different, may relieve tensions. More likely, it will crank up animosities and resentments between parties, branches and houses. Surely, it will burn valuable negotiating time.
Syria is an important foreign policy/national security issue. But it’s a mouse compared to the elephantine domestic fiscal problem. It now seems probable that the Syria vote may delay and confuse settlement of the budget question, and exacerbate existing budget tensions.
Read the full post 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.
Today, the Congressional Budget Office released a new report on Pell Grants which details the program and recent changes made to it, shows options to reform it, and possible alternatives to the existing program. Pell Grants are the largest of the federal governments' grant programs for higher education and are the primary channel for federal financial aid besides federal student loans. Eligibility is determined by a formula called the expected family contribution (EFC), and also determines the size of the grant, based on course load.
In the 2011-2012 school year, the most recent in which CBO has data available, the federal government spent $33.6 billion on grants for 9.4 million students. That is a 158 percent increase in spending since 2006-2007, after adjusting for inflation. The expansion is a result of a number of factors. The recession increased the number of beneficiaries as workers attempted to acquire new skills and caused many more to be eligible as households faced losses in income and assets. Policymakers have also played a role, as changes in eligibility requirements allowed for more potential recipients. Lawmakers also increased the size of the maximum grant to $5,645 today, from $4,050 in 2006, accounting for about one-third of the increase in spending.
Pell Grants are funded by both mandatory funding and discretionary appropriations. The stimulus bill of 2009 appropriated funding for the expansion of the Pell Grant program, which was replaced by a mandatory appropriation after the stimulus funds were exhausted. However, projected grant spending exceeds the projected appropriations for Pell Grant program, creating a nearly $50 billion shortfall through 2023.
With that in mind, the table below shows a few possible options to reform the program.
|Options for the Pell Grant Program|
|Reduce Expected Family Contribution Ceiling to $3,850||$7|
|Reduce EFC Ceiling to $0||$100|
|Tighten Academic Requirements for Initial Eligibility Starting in 2018-2019||$15|
|Tighten Academic Requirements for Continuing Eligibility||$15|
|Eliminate Grants for Students Enrolled in <6 Credit Hours||$3|
|Reduce Maximum Grant to $4,860 in 2014||$68|
|Eliminate Inflation Indexing of the Maximum Grant||$29|
|Increase Credit Hour Requirement for Maximum Grant||$23|
|Raise the Maximum Grant to $6,400 in 2014||-$53|
|Increase and Extend the Inflation Adjustment for the Maximum Grant||-$52|
|Provide Supplemental Grants to Certain Student||-$11|
|Change the EFC Formula to Require Less Financial Information||-$10|
|Use Federal Poverty Guideline to Determine Pell Grant Awards||$14|
Source: CRFB calcualtions based on annual CBO numbers multiplied by ten.
Particularly useful in the CBO report is a summary table presenting the arguments for and against each of the above options; showing the tradeoffs policymakers should consider. For instance, CBO argues that tightening academic requirements for continuing eligibility could encourage students to study harder, but could also affect some students that have a temporary setback. It should be noted that the options have considerable overlap and interative affects. For example CBO estimates that reducing the Expected Family Contribution (EFC, a measure of a family's financial resources) ceiling to zero, tightening the academic requirement for both initial and continuing eligibility, and implementing all of the Grant reductions together would save $20 billion over ten years. In addition, CBO presents four alternatives to the Pell Grant program - forgivable loans, grant commitments to middle and high school students, supplements to the state's grant programs, and occupational training grants - and provides a overview of the positives and negatives for each.
We've shown before that compared to higher education tax expenditures, Pell Grants are better targeted in that they direct most of their benefits to lower income households. However, it is less clear what effect Pell Grants have on encouraging lower income students to attend college, or if they just reduce the financial burden for students that would have done so regardless. Even in the latter case, CBO suggests that by easing the burden, Pell Grants might allow for better student performance.
While policymakers could address the Pell Grant shortfall through changes to the program, a number of plans have found savings in other areas. The Bipartisan Path Forward was able to address the shortfall by finding higher education savings from reforms to student loan programs, including eliminating the in-school interest subsidy for subsidized Stafford loans. Alternatively, the New America Foundation's Education Policy Program chose to eliminate many higher education tax expenditures, and enact some student loan reforms in order to finance an expansion of the Pell Grant program.
With the current shortfall needed to be addressed soon, lawmakers might consider many of the options CBO puts forward. The most recent President's Budget addressed the shortfall, but real action will be needed soon if current grants are to be continued. In the ongoing discussions on higher education reforms, the Pell Grant program cannot be ignored.
Click here to read the full report from CBO.
Although talks between the White House and Senate Republicans now appear to be in hiatus, a few interesting articles have offered new insights into what they were trying to accomplish. Among these tidbits, a mysterious savings target -- $518 billion -- has emerged with many folks unclear where that number came from. In this blog, we will attempt to dissect how the negotiators got to $518 billion, whether that total would actually offset the sequester, and whether it would be sufficient for long-term fiscal sustainability.
Where Does $518 Billion Come From?
Although we cannot know precisely how negotiators arrived at $518 billion, below we explain how one could get there given what we do know. In short, it appears that negotiators set a target which would pay for the repeal of sequestration, but leave in place about $200 billion in discretionary cuts as well as all of the mandatory cuts called for in the sequester.
In total, CBO scores sequestration repeal as costing $940 billion through 2023. Importantly, though, about $120 billion of those savings are from assuming appropriators will continue to spending at post-sequester levels (adjusted for inflation) in 2022 and 2023, after the caps and sequester have ended. Negotiators apparently decided to ignore this $120 billion and focus only on the direct effects of the sequester, bringing our total from $940 billion down to $820 billion.
|Repeal Sequester (CBO Method)||$1,055||$940|
|Remove 2022-2023 Extrapolated Savings (Switch to OMB Method)||-$180||-$120|
|Keep Mandatory Sequester||-$155||-$120|
|Add Back Discretionary Savings||-$200||-$180|
Source: CRFB calculations
From there, negotiators apparently agreed to retain the portion of sequestration which cuts mandatory rather than discretionary programs, about $120 billion in total including about $70 billion from Medicare providers. That brings our total down to about $700 billion.
How we get from $700 billion to $520 billion is a bit less clear to us. If negotiators agreed to the $200 billion of discretionary cuts in the President’s budget, that would bring the total down to $500 billion. It’s possible that instead they agreed to $200 billion in cuts to budget authority, which might equal more like $180 billion in actual outlay cuts. It is also possible that negotiations were over budget authority as opposed to outlays in the first place. Or that negotiators identified an additional $20 billion worth of cuts they needed to pay for (for example, for a doc fix or to fund Pell Grants). Any of these answers could bring us down to the $518 billion target. Notably, in this scenario, BA and outlays are very similar for the remaining savings to offset the sequester. If they had used the President's budget's discretionary savings exactly, BA and outlays would be higher than $518 billion by $40 billion and $20 billion respectively.
Is $518 Billion The Right Offset Number?
Though we believe sequestration is poor policy, we are strong believers that any change policymakers make to reduce its impact must be fully offset with other tax or spending changes. The $518 billion number clearly represents an attempt to accomplish this, but there are some real questions over whether it achieves that end.
The first question is whether policymakers should be allowed to dismiss the indirect discretionary savings in 2022 and 2023. Because there are no legal limits on discretionary spending for those years, and CBO must instead project those levels based on assumptions, the answer on this question is not clear. On the one hand, the sequester has no technical impact on discretionary spending in 2022 and 2023. On the other hand, a higher cap in the years leading up to 2021 will mean less pressure to cut various programs and therefore higher likely spending levels. CBO and OMB disagree on which of these factors is more important, which is why CBO scores incorporate 2022 and 2023 discretionary changes while OMB scores do not.
Although there can be disagreement over the right way to account for sequester costs, we would find it quite troubling if negotiators are using discretionary savings (relative to a pre-sequester baseline) in 2022 and 2023 – which make up about half the discretionary cuts in the President’s budget – to pay for higher discretionary numbers (relative to a sequester baseline) in the other years. In other words, if the discretionary sequester only count through 2021 the portions that are retained should only count as offsets through 2021.
In addition to this concern, it also seems to us a mistake to retain the mandatory portion of the sequester as is. In general, we view across-the-board sequestrations as bad policy. But if any of these cuts (for example, the 2 percent reduction in Medicare provider payments) are deemed policies worth keeping, they should be policies worth keeping permanently. Forcing OMB to recalculate new cuts every year through 2021 makes no sense when policymakers could instead simply reduce the base by an equivalent amount, locking in savings beyond 2021 when they are most needed.
Is $518 Billion Enough?
If negotiators were truly working to replace only $518 billion of the sequester and provide no additional deficit reduction, the plan simply wouldn’t be big enough to put debt on a downward path. We constructed a reasonable package $518 billion in size (on top of keeping the mandatory portions of sequester and $180 billion in discretionary cuts) and found that under such a package, debt would continue to grow as a share of GDP in the long term to 77 percent by 2030.
Source: CBO, CRFB
This scenario would certainly represent an improvement from our Realistic baseline over the next decade, and would be better than simply keeping sequester over the long-run. But it would only temporarily flatten rather than bend the "debt curve" and debt would be on a continuous upward path starting in 2019.
While the budget talks are on hiatus, lawmakers are likely to be dragged back to the table by the circumstances, so it is interesting to see where their initial talks took them. Of course, we would hope that lawmakers go for a bigger deal which more than offsets the sequester with $2.2 trillion of total savings.
Today, Senator Tom Coburn (R-OK) and former Senator Joe Lieberman (I-CT) sent a letter to House Ways and Means Chairman David Camp (R-MI) that submitted their 2011 proposal for the ongoing discussions of reforming Medicare. We praised their plan when it was first released and two years later, the Bipartisan Proposal to Save Medicare & Reduce Debt remains a strong proposal. With a new score from the Medicare Actuaries, we can clearly see the improvement.
An analysis done in April by Office of the Actuary (OACT) at the Centers for Medicare and Medicaid Services showed that the plan could save the federal government $536 billion over the next ten years. The plan would also extend the life of the Medicare Part A trust fund, which is due to become insolvent by 2026, to 2037.
The Actuaries' Report contains a wealth of information on how the plan would affect Medicare benefits and premiums, Medicaid, the health exchanges, and other related factors. Just one of the findings, the plan would actually decrease Medicare premiums compared to current law.
|Savings From Coburn-Lieberman Proposal (in billions)|
|Raise Medicare eligibility age||$76.3|
|Reform cost-sharing rules (including Medigap)||$262.2|
|Accelerate home health care payment adjustments||$7.0|
|Reduce Medicare payments for bad hospital debts||$23.4|
|Means test Part B and Part D premiums||$46.6|
|Increase Part B premiums||$217.8|
|Enact a three-year doc fix||-$88.7|
|Additional Medicaid payments for dual-eligibles||-$23.9|
|Net federal savings||$535.9|
The plan is especially useful as it contains many policies that could be part of a "grand bargain." Cost-sharing reforms in particular have recieved bipartisan support and could help control the growth of health care spending. Likewise, raising the Medicare eligibility age has received support from both sides of the aisle, especially when included with a buy-in like in the Bipartisan Path Forward. Enacting a three-year patch for the Sustainable Growth Rate formula would also prevent one-year "doc fixes" while lawmakers work toward finding a permanent solution for the SGR.
Solving our debt problem will require lawmakers to go even further in entitlement reform, but the plan from Coburn and Lieberman is a great place to start. Medicare is a popular program, but as Coburn and Lieberman note in their letter, changes will need to be made to make it sustainable.
Click here to read the OACT's analysis.
Over the weekend, President Obama made his widely anticipated remarks on the conflict of Syria, making his case for taking military action against the Syrian regime in response to a chemical weapon attack a few weeks ago. He also stated that while he believed that he had the authority to take action himself, he would leave it up to Congress to vote on. So far, the Senate Foreign Relations Committee has passed a resolution by a 10 to 7 count, with a vote expected by the full Senate next week. Naturally, there has been widespread debate about the merits of engaging in military strikes or not, but questions have also arisen about the potential fiscal implications.
After a decade of significant defense spending increases (85 percent in real terms), the overall defense budget has fallen over the past few years as the Budget Control Act spending caps and the sequester have hit base defense spending while drawdowns in Iraq and Afghanistan have dropped war spending ("overseas contingency operations") by about half from its peak. Overall, the defense budget has declined from its peak of $720 billion in 2010 to about $600 billion in 2013 after the sequester, although it still well above pre-war levels in 2013 dollars. Beyond 2013 under current law, defense spending will roughly remain flat in real terms, assuming that war spending is drawn down as in CBO's alternative scenario.
Source: OMB, CBO
Note: Assumes CBO war drawdown scenario for war spending after 2013.
The Cost of the Operation
It is uncertain exactly what form the strikes will take, but we can use the military action in Libya in 2011 and in Iraq in December 1998 (Operation Desert Fox) as guides for the Syria operation. A recent article in DefenseNews cites a Congressional Research Service report extrapolating from the first few weeks of military action in Libya a cost of $600 million, with $340 million spent on replacing munitions that were used. The article notes, though, that there doesn't seem to be a plan for a no-fly zone in Syria as there was in Libya. In July, Chairman of the Joint Chiefs of Staff Martin Dempsey estimated that enforcing a no-fly zone in Syria would cost $1 billion per month.
As for the 1998 Iraqi bombings, a CRS report puts the cost of the operation itself and the associated build up at $135 million, which would be $190 million in 2013 dollars. This type of strike would arguably be most comparable to the current operation envisioned in Syria (assuming that it does stay as "limited").
Judging by these two estimates, a targeted military strike in Syria could cost in the low- to mid-hundred million dollar range. That does not account for potential humanitarian costs the U.S. may be obligated to incur in association with the bombings (as they did in Libya to the tune of about $100 million), and it does not account for the possibility of a wider and more prolonged intervention in the country.
Cost vs. Budgetary Effect
There are a few things to consider with these cost estimates as it relates to the budget. For one, the cost of an operation is not necessarily equal to the budgetary impact because of the way discretionary spending works. The operation would only affect the budget overall if Congress appropriates supplemental funds; otherwise, the cost will simply be absorbed within the pre-existing defense spending levels. A Reuters article quotes retired Navy Admiral Gary Roughead as saying that this was the case with Libya and would likely be the case with Syria. Granted, the FY 2014 appropriations process is creating uncertainty about what funding levels will be for defense, so that may change.
Another thing to note is the timing this cost would be incurred within the budget. Some costs, particularly related to munitions, are only incurred when they are replaced, meaning that the actual incurment of expenditures happens in the future. The budget authority for replacement may only come in future years, and the actual outlays spent when the government receives the munitions would happen even further out. Thus, if there were supplemental funds granted for Syria some of the budgetary effect would only come later. Theoretically, this would mean that the cost of a Syria operation would not factor in to when the government breaches the debt limit.
Potential Supplemental Funding
As policymakers debate how to fund efforts in Syria, we would urge them to first look within the base defense budget, since it would seem that the size of the operation being discussed at the moment would not warrant a supplemental bill. If a supplemental does prove necessary, it should be offset with other spending cuts or revenue, and its funds should be used solely for direct spending on the Syria effort, not for unrelated "Christmas tree" items or to backfill the cuts from the sequestration.
There has currently been no discussion of a full-fledged intervention in Syria, and of course it could take many forms, but the Brookings Institution did estimate in March 2012 that "done properly" it could involve to 200,000 to 300,000 troops and cost $200 to $300 billion. For context, the peak of the combined troop strength and cost of the wars in Afghanistan and Iraq was at the lower end of those ranges, and in total they have cost almost $1.5 trillion since 2001.
Although the cost of targeted strikes on Syria might be small, it is still a reminder of the value of having fiscal space to be able to respond to new priorities, whether they are related to national security or domestic in nature. This is especially true if there ends up being wider involvement in the country in the future. It also is a reminder about the harmful nature of the sequester and continuing resolutions, since they restrict Congress's ability to be flexible with the defense budget as different aspects may be higher priorities than they were previously.