The Bottom Line
Yesterday CRFB President Maya MacGuineas appeared on Bloomberg Television to talk about how imperative it is to address our dire fiscal outlook while at the same time raising the debt ceiling on time. MacGuineas argued that the current debt ceiling debate has been different than previous ones:
There are serious commitments not to actually increase the debt ceiling by enough people that it is going to be a much harder vote than it has been in the past--and let me be clear we do have to lift the debt ceiling as someone who believes strongly and firmly that we need to change our budgetary ways. Failing to lift the debt ceiling would be potentially catastrophic and make all of these things much worse. But at the same time we also do want to make changes to the budget. We are on the precipice of deciding whether we want to make fundamental changes to our budget or kick it till after the election so we have a lot of big choices facing us right now.
According to MacGuineas, there is enough blame to go around for everyone in regards to how we got into this fiscal mess and the oncoming explosion in debt. In order to avoid a looming fiscal crisis, lawmakers from both sides need to come to the table and compromise.
Last week the Economist published an article entitled America's debt ceiling: The mother of all tail risks. This article explains what could happen if the United States defaults, in light of the August 2nd deadline being a mere five weeks away. Of paticular note, the Economist highlights the recent upward trajectory of credit-default swaps and provides further insight as to why even a technical default could cause turmoil in markets and how this would likely cost the government significantly.
Trading in credit-default swaps (CDS) on Treasury securities has multiplied as investors seek protection against default, with the price of one year of protection now close to that of five year protection. While there is a great deal of debate over how a deafult could play out, the article makes a good case for why even a minor default should be avoided.
As the Economist points out, history indicates that technical defaults can be costly. For example,
America’s only known instance of outright default (other than refusing to repay debts in gold in 1933) occurred in 1979 when the Treasury failed to redeem $122m of Treasury bills on time. It blamed unprecedentedly high interest from small investors, a delay in raising the debt ceiling and a word-processing-equipment failure. Although it repaid the money and a penalty to boot, a later study by Terry Zivney, now of Ball State University, and Richard Marcus of the University of Wisconsin-Milwaukee found it caused a 60-basis-point interest-rate premium on some federal debt. Today that would cost $86 billion a year or 0.6% of GDP, a hefty penalty for something so avoidable.
Steven Hess of Moody's credit rating agency warns in the event of even a "quick" default where Congress swiftly raises the debt ceiling, the US's prized Aaa status would still be tarnished. According to Hess, "In the past our assumption was interest would always be paid on time. If an actual payment were missed once, might that happen again? If you thought it could, that is clearly not compatible with Aaa." Even a quickly-resolved default could sow doubts in markets regarding our debt, causing interest rates to rise and prompting investors to look elsewhere to put their money.
A great deal is at stake in the current debt limit negotiations. As CRFB recommends in a recent paper on "What Needs to Come Out of the Debt Ceiling Negotiations," a debt limit increase must be approved as soon as possible and a breach of the limit that would cause default avoided. However, we should also take concrete steps to reduce the debt so to avoid such a predicament in the future. As we point out in another recent article, averting a fiscal crisis caused by mounting debt will require a comprehensive fiscal plan.
In their recent Long Term Outlook, CBO shows the nation to be on an unsustainable fiscal path if we continue our current policies. Under its Alternative Fiscal Scenario, debt reaches 100 percent of GDP by the end of the decade and 200 percent by 2037.
However, some have rightfully pointed out that the situation looks much better under their current law scenario -- that is, if politicians allowed everything scheduled into law actually occur. As Ezra Klein wrote on the matter, last week:
We have a congress problem, not a deficit problem. The deficit only explodes if the next few congresses vote to detonate it. Congress doesn't have to extend the Bush tax cuts without offering offsets, or put off the Medicare cuts without paying for them in other ways, or do the easy parts of the health-care law without doing the hard parts.
And indeed he is correct. We ran the numbers on a scenario in which policymakers kept to current law on mandatory spending and revenue, held regular discretionary spending growth to inflation, and allowed for a gradual drawdown of troops in Iraq and Afghanistan, and in this scenario found that debt would fall to 67 percent of GDP by 2020 and continue to fall toward 55 percent by 2050.
A major reason for this improved debt situation has to do with the expirations of the 2001/2003 tax cuts at the end of 2013 (the Alternative Fiscal Scenario assumes the cuts are continued through 2021 and then revenue is frozen as a percent of GDP). However, other factors also weigh heavily. For example, if policymakers allowed the tax cuts to expire but continued to enact AMT patches and Doc Fixes as they always have, debt would fall to only 71 percent of GDP in 2020, and would grow after that reaching 100 percent by 2050. If the recently-passed health reform legislation were unsuccessful in controlling costs after 2021 -- as many experts suspect they may be -- debt would rise to 120 percent by 2050.
Compared to current policy (as reflected in the Alternative Fiscal Scenario), of course, all these scenarios are a major improvement. That doesn't mean that sticking to current law would be desirable, though. If politicians continued to abide by current law, it would mean the following:
- Marginal income tax rates would go up across-the-board, ranging from 15% to 39.6% instead of 10% to 35%. The average effective marginal rate would increase from 25% today to 35% by 2035.
- Revenue as a whole would rise from the historical average of about 18 percent of GDP to about 23 percent in 2035 and 26 percent by 2050.
- Physicians payments under Medicare would drop immediately by 30% and continue to fall thereafter.
- The Alternative Minimum Tax would no longer be patched, and so instead of impacting less than 3 percent of families as it does today, it would impact 11 percent of families in 2013, 22 percent by 2020, and nearly 50 percent by 2035.
An observer could make the case that these policy changes are undesirably sudden, will weaken the economy, and represent a departure from where we have been historically. More to the point, they are unrealistic -- and most will never happen.
But there is a solution. If current law (with a war drawdown) leads to sufficient debt levels, but not necessarily the right policies, then budget process can be used to keep the country on a sustainable path. Strict Pay-As-You-Go (PAYGO) rules, which call for every tax cut and spending increase to be fully offset, could help to put the country back on track.
Want to renew the tax cuts? Fine, identify tax expenditure and/or spending cuts to offset the cost. Want to avoid cutting physician payments? OK, make other policy adjustments to make the make up the difference. Can't find offsets you are willing to make? Then the policy was probably not important enough to continue in the first place.
Simply offsetting policies on a one-off basis might not necessarily be the best strategy to achieve the goal of getting the debt under control, since it might make it more difficult to focus on long-term entitlement growth (or on discretionary caps and Social Security, which are not technically covered under PAYGO). But the principle of paying for everything we do, including expiring provisions, should be there.
And while we are at it, PAYGO has been biased in how it treats taxes and spending for too long. Extensions of entitlement programs such as the Farm Bill must also be subject to the same budgetary hurdle.
If we can make rational tax and spending choices with the current law debt path as a starting point, it would go a long way to bringing our debt under control. If we can't even stop ourselves from making things worse, the prospects for making things better seem grim.
In a recently published op-ed in The Hill, CRFB board members Erskine Bowles and Alan Simpson write that a serious fiscal reform plan must be agreed to and enacted in order to get our exploding debt under control.
The op-ed, which was also the topic of a post on The Hill's On the Money blog today, states that Washington must agree to and enact "a $4 trillion-plus, gimmick-free fiscal consolidation package that stabilizes and then reduces our debt as a share of the economy."
As the authors explain:
"Such a plan need not look exactly like the Fiscal Commission plan we produced, but it must cut wasteful or low-priority spending everywhere — in both the domestic and defense budgets, as well as the tax code where actual spending is dressed up as deductions, credits and other preferences. More importantly, this package must tackle the biggest source of our burgeoning debt — growing entitlement spending. That means it must slow the growth of healthcare and make Social Security sustainably solvent."
Bowles and Simpson write that the difficultly of enacting such a plan--not to mention writing it into legislation--makes the case for a two-part approach: a significant down payment now followed by larger structural and structural reforms in the near future. The authors stress the importance of taking action soon, saying:
"And policy makers must agree--including with an honest process and strict enforcement mechanisms--to address the remainder of the problem before the next election. Elections take all options off the table, instead of setting the table for reform. There can be no more kicking the can down the road or handing the baton to the next guy--the markets won’t allow it and the American people should not tolerate it.
…Recent turmoil in the so-called Biden discussions and Gang of Six seem to call into question whether our politicians can agree to any such a package. The truth is, we have no choice but to do it."
Click here to read the full op-ed.
"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the Committee.
Where Is Our Columbo? – Peter Falk, the award-winning actor best known for playing the rumpled, yet wily, Lt. Columbo, died on Thursday. Falk, who was an analyst with the Connecticut State Budget Bureau before embarking on a professional acting career, created an endearing and enduring character who used unique techniques to get the job done. Detective Columbo always got the bad guy using a brilliant mind and obsessive desire to tie up loose ends, all hidden behind a disheveled facade to lull the guilty party into a false sense of complacency. We’ve lost Columbo just as we need him in Washington. We have a crime in the mounting national debt and the perpetrators seem pretty complacent about it. In the show, the mystery was never in who committed the crime, but in how it would get solved. We face a similar problem now and could use Columbo’s eye for detail and ability to piece it all together to get a resolution. Who’s going to make the bust before we go bust?
Biden Talks Transfer to Obama and Congressional Leadership – The Biden group budget negotiations met a sudden and untimely end last week. Although the group agreed on about $2 trillion in deficit reduction, the talks fell victim to an impasse over issues such as revenue and Medicare. Democrats want a revenue component by eliminating some corporate tax breaks (see ideas for reforming tax expenditures here) while Republicans want changes to health care entitlements (see some ideas here). In a hopeful sign, according to the Washington Post, there appears to be growing consensus on cutting defense spending, just as former OMB Director Leon Panetta was confirmed last week to take his vast budget background to the Pentagon. President Obama is now stepping into the debt limit talks by holding separate meetings today with Senate Majority Leader Harry Reid (D-NV) and Minority Leader Mitch McConnell (R-KY) after a meeting last week with House Speaker John Boehner (R-OH). CRFB last week offered its thoughts on what the debt limit negotiations should, and should not, accomplish.
Investigating the CPI – As lawmakers look for deficit savings that can gain bipartisan support, more eyes are turning to an alternative measure of inflation. The Consumer Price Index (CPI) is used throughout the budget to adjust federal benefits like Social Security payments for cost of living. It also affects certain tax provisions. Earlier this year CRFB’s Moment of Truth project recommended in a paper that using an alternative inflation measure, known as chained CPI, could save about $300 billion over the next decade. Since then the idea has gained support on both sides (for example, see here and here) and is now being considered as a part of the debt limit negotiations.
CBO Puts Out an APB for Debt Solutions – The Congressional Budget Office (CBO) last week released its annual Long-Term Budget Outlook, reinforcing that the current fiscal trajectory of the country is unsustainable. The report states that “the sooner that medium and long-term changes to tax and spending policies are agreed on, and the sooner they are carried out once the economy recovers, the smaller will be the damage to the economy from growing federal debt.” CRFB offered an analysis of the forecast, saying that “these chilling projections should be a cold shower on any plans to delay enacting a comprehensive plan to address the debt.”
Restoring Order Through Fiscal Rules – Congress is considering stricter budget rules to clamp down on the deficit. Senate Republican leader McConnell wants a vote on a balanced budget amendment next month. His caucus has coalesced around a bill that would require an annual balanced budget along with capping spending at 18 percent of GDP and a 2/3 majority to raise taxes. The House is planning to vote on a similar proposal the week of July 5. In addition, Rep. Kevin Brady (R-TX) last week introduced legislation imposing “mandatory smart caps” on federal spending that would limit non-interest spending as a percentage of ‘potential’ GDP. The bill also would create a sequestration process to enforce the caps that involves all federal spending; require prioritizing spending programs in the budget; a form of line-item veto for the president to strike out particular spending; a Sunset Commission to review federal programs; and a permanent continuing resolution that would automatically reduce spending from the previous year if a budget is not agreed to. The Peterson-Pew Commission on Budget Reform, a project of CRFB, has studied fiscal rules for over two years and unveiled a comprehensive blueprint for improving the budget process in the report, Getting Back in the Black. The Commission also recently provided a Fiscal Toolbox summarizing and comparing various fiscal rules and has just created a one-stop resource on the web with easy-to-access information on budget tools to help reduce the debt.
Just One More Thing – The famous detective liked wrapping everything up at the very end. In that spirit, CRFB has produced a wrap-up of our recent annual conference and dinner, which featured an all-star cast of economists, policymakers, and budget experts such as Federal Reserve Chairman Ben Bernanke, House Budget Committee Chair Paul Ryan (R-WI), and White House National Economic Council Director Gene Sperling. Check it out here to read the recap and watch videos of the conference as well as the subsequent cocktail reception with remarks from Office of Management and Budget Director Jack Lew and dinner event with a discussion between PBS NewsHour's Judy Woodruff and Fiscal Commission co-chairs Erskine Bowles and Alan Simpson.
Key Upcoming Dates
- Conference Board releases consumer confidence index for June.
- Senate Finance Committee hearing on “Perspectives on Deficit Reduction: A Review of Key Issues” at 10 am.
- Treasury Secretary Geithner says that the U.S. will default on its obligations by around August 2 if the statutory debt ceiling is not increased before then.
Continuing our analysis of CBO's Long-Term Outlook, we looked yesterday at the policy assumptions under CBO's two budget paths and at spending and revenue projections in their analysis. Today, we will look at what CBO believes will happen to the economy as a result of our growing debt burden.
Under CBO's Alternative Fiscal Scenario, debt would exceed 100 percent of GDP in 2021, 200 percent in 2037, and theoretically hit 800 around 2080. Long before levels got this high -- and perhaps even in the next few years -- this could lead to a fiscal crisis. In such a crisis, CBO explains:
Investors become unwilling to finance all of a government’s borrowing needs unless they are compensated with very high interest rates; as a result, the interest rates on government debt rise suddenly and sharply relative to rates of return on other assets... [This could force] policymakers either to immediately and substantially cut spending and increase taxes to reassure investors—or to renege on the terms of the country’s existing debt or increase the supply of money and boost inflation... Thus, such a crisis would confront policymakers with extremely difficult choices and probably have a very significant negative impact on the country.
Even if projected levels of debt could somehow be sustained without a crisis, the impact on the economy is not pretty. In making its long-term projections, CBO assumes the economy will essentially return to trend levels after 2021 -- which means about 2.2 percent annual growth in real GDP every year, after accounting for the smaller labor force they expect to see in the future. Unfortunately, CBO projects that continued accumulation of debt will tend to slow economic growth.
Under the Alternative Fiscal Scenario -- which is the closer representation of current policy -- CBO projects that the economy could be as much 3% smaller in 2025 and as much as 10% smaller in 2035. Looking out beyond 2035, as debt grows higher, these effects would surely grow substantially.
|Effects of Fiscal Policy on GDP (percent)|
|Extended Baseline||Fiscal Scenario|
|Low Estimate||High Estimate||Low Estimate||High Estimate
Under CBO's Extended Baseline Scenario -- which represents the continuation of current law without regard to political reality -- the economic effects are substantially smaller -- GDP would be up to 0.2% lower in 2025 and 1.3% in 2035. And this change results largely from changes to marginal rates rather than debt, since the Extended Baseline Scenario allows all the 2001/2003/2010 tax cuts to expire, ceases patching the Alternative Minimum Tax, and allows continued bracket creep into the indefinite future.
Importantly, slower economic growth doesn't just mean a weaker economy -- it means a worsened debt. CBO finds that continuing current policy would result in both higher interest rates and slower growth, with the former mainly increasing spending and the latter mainly reducing revenue (and the denominator in the debt-to-GDP equation). This causes a vicious cycle that leads to a worsening debt and in turn a weaker economy.
Whereas CBO projects debt to be about 190 percent of GDP in 2035, it could be as high as 250 percent after accounting for the dynamic effects of higher debt (assuming no fiscal crisis).
Clearly, the never-ending cycle between higher debt and lower growth can make our fiscal problems harder to solve. Making the necessary adjustments now, instead of waiting for years, will allow them to be less severe and prevent a high debt burden from weighing down our economy further.
Despite House Majority Leader Eric Cantor’s (R-VA) decision yesterday to withdraw from the Biden-led negotiations to avoid default, there is still hope in Washington that lawmakers can reach an agreement by August 2nd. In response to Cantor’s withdrawal from the talks, Derek Thompson -- a visiting fellow at CRFB -- wrote an interesting article titled The Only Solution to the Budget Mess: Raising Revenues, Not Taxes. Derek asserts that halfway reasonable members of the Republican Party are willing to raise revenue as long as taxes are also not raised.
Derek highlights how tax expenditures have led to a gaping hole in federal revenue collection:
You can think of the tax code in two parts: (1) Tax rates take income out of the economy, and (2) tax spending "gives" money back. When you filed taxes this year, the IRS asked you to fork over a certain percentage of your income, but it also helped you reduce your tax bill. Got kids? Tax credit. Got business expenses? Deduct them. Got neither? That's okay, you can still claim personal exemptions and a host of other items that save you money.
These measures, formally called tax expenditures because they "spend" through the tax code, are used to encourage behavior we like. We like houses, so the government spends hundreds of billions of dollars subsidizing mortgage interest. We like health care, so Washington lets employers offer insurance to their workers tax-free. We offer subsidies to companies, to industries, and to consumers, because we think there is lots of behavior worth promoting by making it tax preferable. There are good things about using the tax code to encourage good behavior. But too much of a good thing makes a $1 trillion hole in the middle of our tax code.
CRFB continues to encourage lawmakers to end and reduce many of the current tax breaks because it will help set the budget towards a fiscally sustainable future, while also having the benefit of making the tax code simpler and fairer. Click here to read a recent blog on how tax expenditures help the budget.
According to Derek, in order to avoid default and to reach a budget deal it is absolutely necessary to raise revenue without raising taxes:
To get a budget deal, we need Democrats. To keep Democrats, you need more revenue. To keep Republicans, you can't raise tax rates. There's really only one solution. Tax revenue will go up. Tax rates won't.
Many of the fiscal plans proposed by lawmakers, experts, and other groups over the last few months have relied on cutting back on tax expenditures to raise revenues and reduce deficits and debt. Check out our new comparison tool to learn more about all the plans.
Spending and revenues in the long-term outlook is always an interesting topic to discuss. Just like with debt, you find words and phrases like "unprecedented" or "extraordinarily high" used frequently. In this blog, we'll use those words a number of times while showing spending and revenue levels under the Extended-Baseline Scenario and Alternative Fiscal Scenario (AFS).
We noted in our release yesterday that both baselines project extraordinarily high levels of spending. The Extended-Baseline has spending at 27 percent of GDP in 2035, 29 percent in 2050, and 33 percent in 2080. The Alternative Fiscal Scenario has spending rising even higher. It hits 34 percent of GDP in 2035, 43 percent in 2050, and a shocking 70 percent in 2080.
As you can see from the graph and numbers above, there is a massive difference between the AFS and the Extended-Baseline, especially with regards to spending. Our blog yesterday explained that a number of assumptions in the AFS result in higher spending (especially health spending) than the baseline. However, differences in health care spending between the scenarios do not account for most of the difference; primary spending is only about two percentage points of GDP higher under the AFS. The bigger difference is in interest costs: the Extended-Baseline has net interest payments of 3.6 percent of GDP in 2080, while the AFS has interest at a cartoonish 38 percent of GDP in 2080. Higher primary spending does contribute to higher interest costs a little bit in the AFS, but it is mostly explained by drastically lower revenues.
The Extended-Baseline manages to keep debt manageable by having revenues continue to grow, eventually reaching 30 percent of the economy by 2080. We noted last year that revenue levels increased significantly over the long-term due to the tax increases in the health care law, and revenue has remained at about the same level this year. It rises from 15 percent of GDP this year to 23 percent in 2035, 26 percent in 2050, and 30 percent in 2080. These levels are unprecedented; revenue has never been above 21 percent of GDP and it has averaged about 18 percent over the past 40 years. In contrast, the AFS holds revenue constant as a percent of GDP after 2021 at 18.4 percent. This is near the historical average but well below the current law baseline.
These statistics show what we always knew: neither baseline represents a good path for fiscal policy. The Extended-Baseline does hold debt to reasonable, albeit high, levels, but does so with unrealistic policy assumptions and an unprecedented size of government. The Alternative Fiscal Scenario has absurd debt and spending levels, with revenues remaining fixed as a share of the economy over the long-term. No matter how you slice it, we need a fiscal plan soon.
As we explained in our recent analysis of CBO's Long-Term Budget Outlook, the debt is on an unsustainable path. Only a decade from now, under their Alternative Fiscal Scenario, debt will surpass 100 percent of GDP. And by 2037, it will exceed 200 percent.
Driving this is the increasing cost of entitlement spending -- Social Security, Medicare, Medicaid and (to a lesser extent) other health spending. But what drives the growth of these programs?
There are two main factors that are increasing entitlement spending: the aging of the population -- caused by the retirement of the babyboomers and growing life expectancy, and excess health care cost growth -- the fact the health care grows faster than the economy. Aging leads an increased number of beneficiaries that collect Social Security and Medicare (and Medicaid for long-term care) while health care cost growth drives up per-person costs in Medicare and Medicaid (and, to a lesser extent, other heath programs).
Through 2035, aging will be the dominant force in entitlement spending cost increases. CBO projects that it will account for 64 percent of the growth in entitlement spending, when interactions are distributed proportionally. Even excluding Social Security, aging will account for about half of the growth in the health care programs.
Over the longer term, that trend reverses. By 2085, aging will account for 44 percent of cost growth, with excess health care cost growth accounting for the remaining 56 percent.
The fact that aging and health care play such a big role in entitlement cost growth -- which would actually decline in their absence -- suggests that these factors need to be taken seriously. This is especially true given that both factors will also hurt revenue (by reducing the size of the labor force and increasing the amount of un-taxed compensation, respectively) and could slow economic growth.
As policymakers enact deficit reduction measures in the coming months, they should pay special attention to those measures which can slow health care cost growth or mitigate the effects of population aging.
At 10am today, CBO director Doug Elmendorf will testify before the House Budget Committee on CBO's latest Long-Term Budget Outlook, released yesterday. Click here to see the live webcast of the Committee hearing (webcast should be live soon), and look here to see Elmendorf's prepared testimony and charts. Yesterday, CRFB released its preliminary analysis of the report. Keep an eye on our blog as we continue to post further analysis.
With the release of CBO's Long-Term Outlook, we thought it would be useful to break down the assumptions that the Extended-Baseline and the Alternative Fiscal Scenario make. Considering the huge divergence in the debt paths of these two scenarios, it is important to understand what they do.
First, we'll go through the paths of both of them. The Extended Baseline has debt as a percent of GDP rising to 87 percent by the 2040s, but it declines after that to 75 percent of GDP by 2085. CBO only provided debt data for the Alternative Fiscal Scenario through 2036, when debt exceeded 200 percent of GDP, but our extrapolation of the data has debt rising exponentially to 880 percent by 2085.
The difference in assumptions between the two baselines are detailed in the table below.
|Description of Differences in the Baselines|
|Area||Description||Extended Baseline||Alternative Fiscal Scenario|
|Doc Fix||Current law calls for a 30 percent cut to physician payments in 2012, but Congress has always overriden scheduled cuts in the past.||Assumes the 30 percent cut takes place and the SGR continues to take effect||Continues doc fixes through 2021 at nominal 2011 levels; CBO estimated this would cost $300 billion over ten years|
|Health Care Reform||The health care reform law has a number of provisions that could affect health care spending, but there are questions about their sustainability.||Assumes that provider payments are reduced by economy-wide producitivity, IPAB cuts take effect, and exchange subsidy growth slows as scheduled. Also assumes slow down in cost growth of health programs||Assumes that none of these provisions are in effect after 2021 and assumes prior (higher) cost growth|
|Tax Cuts||There is great uncertainty about what will happen with the 2001/2003/2010 tax cuts when they expire.||Assumes the expiration of the tax cuts in 2012 and no patching of the AMT||Assumes extension of all tax cuts, estate tax at 2011/2012 parameters, and patching of the AMT|
|Long Term Revenue||CBO uses different assumptions for how revenue grows past this decade.||Uses current law to project revenue; bracket creep and health insurance excise tax push revenue up to 30% of GDP||Holds revenue constant as a percent of GDP at 2021 levels (18.4%)|
|Other Spending||Other mandatory spending and discretionary spending are projected differently under each baseline||Grows as scheduled under current law baseline until 2021, remains constant as a percent of GDP after that||Grows mandatory spending as scheduled, grows discretionary spending with GDP through 2021; total category remains constant as a percent of GDP after that|
So which baseline is more realistic? Well, they both have their flaws. The Extended Baseline is very unrealistic in terms of policies and long-term revenue levels. However, the Alternative Fiscal Scenario may be too pessimistic on the tax cuts and ACA's ability (and Congress's willingness) to control health care spending, and their assumption on long-term revenue being 18.4 percent of GDP might not pan out. Nonetheless, it's easy to say that the Alternative Fiscal Scenario is probably a lot closer to where we are going, even if it has some flaws.
But, CRFB will be updating its Realistic Baseline, which we feel is the best representation of a long term baseline. Last year, our baseline basically split the difference between the two CBO baselines over the long term. We'll see how it turns out this year.
Update: Our paper on CBO's Long Term Outlook has been released.
CBO has just released its 2011 Long Term Outlook, detailing spending, revenue, and debt levels over the next 75 years. The report shows a similar trend in both the Extended Baseline and Alternative Fiscal Scenarios: worsening in the short term, improvement in the long term compared to last year.
Below is a graph of debt under both baseline scenarios. However, since CBO only provides data for the Alternative Fiscal Scenario through 2036, the graph only goes up until that year.
CRFB will release a more detailed analysis very shortly, and will dive further into the findings in the report here on The Bottom Line through the rest of this week. So continue to check back.
The Sustainable Growth Rate (SGR), the formula which sets provider payments for physcians under Medicare and which was originally enacted in 1997, calls for an unrealistic 30 percent cut in provider payments in 2012 if Congress does not act. Of course, it has acted frequently in the past decade to override the payment cuts that SGR has mandated. POLITICO has an article today talking about the difficult but necessary task of "weaning" Congress off of the SGR formula for Medicare. The article discusses the numerous problems with SGR and why it is hard to reform.
As the article explains, the SGR sets expenditure targets for Medicare. If Medicare spending exceeds the target, physician payments are updated by the change in the Medicare Economic Index (MEI) minus seven percent. If Medicare spending is below the target, payments are updated by the MEI plus three percent. In the first few years, spending did actually come in under the targets, so physicians were able to get payment increases in those years. However, beginning about a decade ago, Medicare spending has exceeded its targets, leading to scheduled cuts in provider payments and Congressional action ("doc fixes") to prevent that from happening. However, doc fixes from 2003-2006 were designed to recoup the costs of the temporary fixes in later years, which only added to the size of the cuts mandated in later years. Starting in 2007, temporary fixes have simply had "cliffs" with huge cuts scheduled after the expiration of the doc fix.
The article points to the most recent MedPAC report to highlight the many flaws of SGR. First of all, the budgetary issues are enormous. Congressional doc fixes have been temporary, which hides the true cost of a permanent solution. The temporary nature of these fixes has led to considerable uncertainty among physicians; for example, there were five doc fixes enacted in 2010 alone. In addition, as the MedPAC report notes, the SGR does nothing to incentivize more efficient use of health care and, in fact, promotes greater use of services (arguably, some overuse).
However, the article points out a budgetary issue with these payment system reforms: while an SGR fix would cost significant money, the savings from a payment system reform will not score and would take a long time to come about even if it restrains health care cost growth. CBO has produced a very helpful report on the SGR that has a number of options for fixing it that all cost a significant amount of money. A few of these options are presented in the table below. They also include an SGR reset at 2010 levels (wiping out all the past accumulated cuts) and the Fiscal Commission plan, which would have a freeze through 2013, a one percent cut in 2014, and a reinstatement of the SGR in 2015 with a reset at 2014 levels.
|Cost of Various SGR Replacements (billions)|
|0% Annual Update (Pay Freeze)||$298|
|1% Annual Update||$342|
|Update with Medicare Economic Index||$358|
|2% Annual Update||$389|
|Fiscal Commission Plan Update||$262|
|SGR Reset at 2010 Spending Levels||$195|
To us, the solution to this budgetary conundrum is still to pay for any future changes to the SGR. We have said that doc fixes should be paid for, and the same should go for payment system reforms that include an elimination of the SGR. If the reform helps to hold down cost growth, then that would be bonus deficit reduction on top of the offset SGR. We have a number of ideas to pay for the doc fix/SGR reform, and the Fiscal Commission also had some proposals, like increasing Part D drug rebates and reforming Medicare cost-sharing rules. Reforms to the SGR are important for the overall physician payment system and health care system, but they should be deficit-neutral.
Today, the Senate confirmed former CIA Director (and former CRFB Co-Chair!) Leon Panetta by a unanimous vote to become our new Secretary of Defense.
As Mr. Panetta steps up to face some tough decisions about policy in the Middle East, Afghanistan, Iraq, and Libya, he will also be faced with some tough fiscal policy decisions as the nation looks for ways to trim the federal budget, including defense spending. Mr. Panetta will strike the right balance to handle both our security and fiscal threats. And as the current Chairman of the Joint Chiefs of Staff Admiral Mike Mullen has said, “[t]he most significant threat to our national security is our debt.”
With forecasts of our nation’s fiscal trajectory worsening with each passing year, it has become increasingly important for a comprehensive fiscal plan that addresses all elements of the budget. Mr. Panetta’s experience as former chairman of the House Budget Committee and both former director of the Office and Management and Budget and former White House Chief of Staff under President Clinton -- where he played a significant role in the balanced budget negotiations of the 1990s -- proves that Mr. Panetta will be more than capable of tackling the tough decisions that will have to be made in the coming years.
At his Senate confirmation hearing today, Mr. Panetta already endorsed a review of the military pay and benefits structure as well as a plan to reduce the costs of some weapons programs. He has also expressed support for Secretary Gates’ plan to begin identifying $400 billion in defense savings, as called for in the President’s Budget Framework.
In a town where consensus is a rarity, the unanimous vote for Mr. Panetta's confirmation shows that policymakers agree with CRFB's sentiment -- that Mr. Panetta will be invaluable in the Obama administration with regard to the defense budget. As one example, Sen. Jeanne Shaheen (D-NH) said in a statement, “[w]hether it is balancing budgets or fighting foreign insurgency abroad, Mr. Panetta has consistently proved himself as a strong and pragmatic leader.”
CRFB applauds Mr. Panetta’s confirmation as a step in the right direction toward getting the enactment of a comprehensive fiscal plan, and we wish Mr. Panetta the best of luck at his new position!
This afternoon, CRFB released a paper that lays out the dos and don'ts for the Biden group negotiations. We provide a list of goals to accomplish and a number of steps to avoid.
The things we need to see are:
- An increase in the debt ceiling as soon as possible
- A debt deal that calls for $4 to $5 trillion of deficit reduction
- A deal that has a down payment that includes steps to reforming entitlement programs
- A deal that includes a process for making the necessary further changes to entitlements and taxes
The things we need to avoid:
- Breaching the debt limit
- Failing to address the debt before raising the debt limit
- Using budget gimmicks to inflate the amount of savings
- Deferring decisions until after the 2012 elections
In addition, we included a few helpful appendices that outline some of the common-ground policies, options to reduce health care costs, and options to make Social Security solvent.
The major point to take from this paper is that while not raising the debt ceiling would be catastrophic, not using this opportunity to address our debt would also be a poor outcome. We need to get a large fiscal plan that addresses the drivers of our long-term debt and doesn't use any phony accounting.
Click here to read the full paper.
Recently, CBO Director Doug Elmendorf spoke to the Federal Reserve Bank of New York about current policies and how they affect the nation's fiscal future. Elmendorf’s presentation, titled Federal Budget Math: We Can’t Repeat the Past, highlighted key aspects of federal budget policy in the last forty years and of CBO’s projections for 2021.
Elmendorf's key argument is that we cannot continue to do everything we'd like to -- the math just doesn't add up. In particularly, we cannot do all three of the following:
- Keep federal revenues at the average share of GDP seen during the past 40 years.
- Provide the same sorts of benefits for older Americans that we have provided in the past 40 years.
- Operate the rest of the federal government in line with its role in the economy and society during the past 40 years.
As Elmendorf explains, "The question is not whether to change current policies, but when and in what ways." He continues, "Fiscal policy cannot be put on a sustainable path just by eliminating waste and inefficiency; instead, changes will need to significantly affect popular programs, people’s tax payments, or both."
Time ‘Fore’ Action – Golf, that favorite pastime of power players, was even more popular than usual in Washington last week. Not only did the U.S. Open bring the best professional golfers in the world to the D.C. area, but a powerful foursome also hit the links, perhaps linking fiscal policy matters to their conversation as they played their round. Yet, while the Congressional Country Club in Bethesda, Maryland saw a dominating U.S. Open performance by Rory McIlroy and a record score, the congressional club on Capitol Hill is well over par when it comes to addressing the nation’s fiscal challenges. Unlike golf, where the goal is to get the ball in the hole, legislators must get out of the fiscal hole we are in. Its time that lawmakers picked up their legislative game and lowered the federal budget deficit score.
Of Golf and Gulfs – The much anticipated ‘Golf Summit’ between President Obama and House Speaker Boehner occurred Saturday. They paired up to beat Vice President Biden and Ohio Governor John Kasich, a former House Budget Committee chairman. While it was no Ryder Cup, a lot is riding on the ability of Obama and Boehner to work together in brokering a deal that increases the statutory debt limit and achieves significant deficit reduction. Time is running out to bridge the wide gulf between the two parties on how to reduce the national debt. While it is not clear how much time was spent on the golf course discussing how to get our fiscal situation back on course, perhaps the victory by Obama and Boehner that netted each two bucks is a good sign that the two will team up for a victory in a contest with a lot more money on the line.
Bernanke Tees Off on Debt – Federal Reserve Chairman Ben Bernanke offered his strongest remarks yet on U.S. fiscal policy at the CRFB Annual Conference on Tuesday (read highlights of his speech here). He warned that mounting national debt threatens the economy and that the current trajectory cannot be maintained. While he cautioned that the debt limit should be raised quickly and not used to force deficit reduction, he also made clear that a long-term, comprehensive fiscal plan should be devised now, and that putting a credible plan in place would benefit the economy in the shorter term as well as the long run. He also gave some guidance on what an effective plan would look like – possibly including triggers (see the recommendations from the Peterson-Pew Commission for making a debt trigger work here); stabilizing the debt at a certain ratio of GDP in the shorter term and reducing it further in the longer term (Peterson-Pew recommended a goal of a 60 percent debt/GDP ratio by the end of the decade); and simultaneously finding specific savings over 10 years while addressing the long-term sustainability of entitlement programs (see CRFB’s ideas for reforming Social Security and health care programs).
CRFB Unveils Tool to Compare Plans – Just like choosing the right club is a crucial part of golf, choosing the right plan will be imperative to making sure U.S. budget policy makes the cut in meeting our fiscal challenges. On the heels of Chairman Bernanke’s remarks on the need for a comprehensive fiscal plan and what an effective one could look like, CRFB unveiled a new interactive online tool that makes it easier to compare the plans that are out there and see how they stack up. The Deficit Reduction Plan Comparison Tool allows the user to easily compare the 30 plans that have been offered so far and will be updated as more plans emerge. Many plans share common elements but also diverge in important aspects. The new tool lets the user compare specific plans side-by-side to easily flesh out similarities and differences. It joins our “Stabilize the Debt” budget simulator as a useful educational resource.
Biden Group Drives Hard – The bipartisan, bicameral group of lawmakers negotiating a deal to raise the debt limit and reduce the deficit is playing through as it seeks a speedy resolution. The group met three times last week. The Tuesday meeting focused on discretionary spending. The group then discussed budget process mechanisms on Wednesday; Democrats wants a debt trigger while Republicans prefer a spending cap. The new Fiscal Toolbox from CRFB summarizes and compares the various budget tools available to help reduce the debt and the Peterson-Pew Commission recently provided recommendations for making a debt trigger work. At the meeting, Rep. Chris Van Hollen (D-MD) also provided a list of corporate tax subsidies to reduce or eliminate in order to achieve budget savings. CRFB has also provided tax expenditure reform ideas to reduce the deficit. The Thursday meeting looked at areas such as military compensation and farm subsidies. The group will meet at least three times this week, possibly more, and have longer meetings in an attempt to have a deal by July 1. CRFB has identified over $1 trillion in common-ground savings that the group could agree on as a down payment towards achieving the goal of $4 trillion in deficit reduction over the next decade.
Working on the Long Game – Some fear that the Biden group will not reach the $4 trillion target and instead settle for a shorter-term measure with less savings. In that case, there will be alternatives that go the distance. The Gang of Six, now five, says it is close to agreement on a plan that would reduce the deficit by around $4.5 trillion with a ration of spending cuts (including lower interest payments on the debt) to revenue increases of 3:1. Meanwhile, Senator Kent Conrad (D-ND), chairman of the Senate Budget Committee and a member of the Gang of Six, says he is close to a budget resolution that could pass his committee with Democratic votes that generates about $4 trillion in deficit savings through an even mix of spending reductions (including lower interest payments on the debt) and increased revenue. Both plans would rely on reducing or eliminating tax expenditures to raise revenue.
Taking Aim at Defense Spending – While Defense spending has usually received a mulligan in past budget cutting episodes, many are taking whacks at it now. Although the FY 2012 Defense appropriations bill passed by the House Appropriations Committee last week and due for House floor consideration this week includes a spending increase over last year, even the Pentagon is preparing for significant cuts. Outgoing Defense Secretary Robert Gates and Joint Chiefs of Staff Chairman Adm. Mike Mullen testified before the Senate Appropriations Committee on Wednesday on DoD’s 2012 budget and both discussed the new fiscal reality. Mullen reiterated his view that public debt is the greatest threat to national security. "If we as a country do not address our fiscal imbalances in the near-term, our national power will erode. Our ability to respond to crises and to maintain and sustain our influence around the world will diminish." He admitted that the military in the past was not "disciplined" in its fiscal choices, but now "cost will be a critical element of nearly every decision we face." Secretary Gates discussed his efforts "to replace a culture of endless money with one of savings and restraint" and listed some of the cost-cutting and efficiency measures he has instituted. Gates will be stepping down at the end of the month. His designated successor, CIA Director Leon Panetta, was approved last week by the Senate Armed Services Committee and is on track for confirmation by the full Senate this week. Panetta, who is a former OMB director, House Budget Committee chairman, and CRFB co-chair, will be tasked with meeting President Obama’s goal of finding $400 billion in savings in the Pentagon budget.
Entitlements in the Spotlight – Policymakers usually avoid entitlements like sand traps on the golf course. Yet, there has been recent movement on the entitlement reform front. Sen. Joseph Lieberman (ID-CT) recently wrote an op-ed calling for a balanced approach to making Medicare more fiscally sustainable that involves both revenue increases and changes to benefits, including gradually raising the eligibility age to 67. He says he is drafting legislation to that effect. A new report from the Medicare Payment Advisory Commission (MedPAC), an independent agency tasked with advising Congress on Medicare issues, echoes some of the ideas Lieberman mentioned, such as capping out-of-pocket expenses, requiring fixed-dollar copayments for services, and changes to supplemental coverage to reduce costs. The report also warns about the sustainability of the program. In addition, most Senate Republicans wrote to President Obama asking him to put forward a plan to reform Medicare in light of the recent Medicare trustees report detailing its long-term financial issues (see here for some ideas on health care reform, including Medicare). Meanwhile, Sen. Kay Bailey Hutchison (R-TX) introduced legislation to reform Social Security that includes raising the Normal Retirement Age over time to 69 and the Early Eligibility Age to 64 and reducing the annual cost-of-living adjustment (COLA) by one percent. A recent news report says that the powerful seniors lobby, AARP, is softening its opposition to Social Security benefits changes (which CRFB praised). The group's former CEO, Bill Novelli, urged action now to strengthen the program’s finances for future generations through a mix of revenue increases and benefit changes, and stated that increasing the retirement age should be on the table. CRFB offered ideas for reforming Social Security here, and explained why raising the retirement age is a good idea in blog posts here and here.
Clearing the Way for More Transparency – Initiatives to enhance transparency in the budget process and cut waste are becoming more prevalent than birdies at this year’s U.S. Open. Last week the White House announced a new ‘Campaign to Cut Waste’ that will target inefficiency in the government. Vice President Biden will chair a new oversight and accountability board to improve transparency by publicly tracking where federal dollars go. A first priority will be consolidating the nearly 2,000 government websites to make it easier to follow spending. Rep. Darrell Issa (R-CA), chairman of the House Oversight and Government Reform Committee, has gone even further, introducing legislation creating a statutory commission similar to the group that Biden will chair and creating a single online platform to track all government spending. The idea has bipartisan support; Sen. Mark Warner (D-VA) sponsored the Senate version of the bill, the Digital Transparency and Accountability Act (DATA). Rep. Issa held a hearing on the topic in his committee on Tuesday. The Peterson-Pew Commission on Budget Reform provided recommendations to improve the budget process to promote transparency and accountability in the report Getting Back in the Black. On a related note, the Advisory Committee on Transparency convened a forum examining tax expenditures, which account for about a quarter of the federal budget (just over $1 trillion) but are subject to little scrutiny and are difficult to trace. The event explored ways to make them more a more visible part of the budget process. Getting Back in the Black also offered proposals for integrating tax expenditures into the budget process. Finally, our New America Foundation colleagues at the Federal Education Budget Project launched an improved website last week that tracks K-12 and higher education funding as well as data on educational outcomes.
CRFB Holds Annual Conference and Dinner – On Tuesday CRFB convened its annual conference and dinner, which drew more heavy hitters than the Congressional clubhouse. In addition to Chairman Bernanke’s remarks described above, the conference also featured House Budget Committee Chairman Paul Ryan (R-WI), White House National Economic Council Director Gene Sperling, and many others. It was moderated by CNBC Correspondent Steve Liesman. The reception afterwards included remarks from OMB Director Jacob Lew and the dinner was highlighted by Fiscal Commission Co-Chairs Alan Simpson and Erskine Bowles talking to PBS NewsHour Senior Correspondent Judy Woodruff. Highlights of the event can be found here and more information is available here. Video of the conference can be viewed here and video of the dinner discussion can be viewed here.
Key Upcoming Dates
- Joint Economic Committee of Congress hearing on "Spend Less, Owe Less, and Grow the Economy" at 2 pm.
- CBO releases its Long-term Budget Outlook on its website at 10 am.
- House Ways and Means Committee Health Subcommittee hearing on the Medicare Trustee’s 2011 report on Medicare’s finances at 9:30 am.
- The House Budget Committee holds a hearing on CBO's Long Term Budget Outlook with CBO Director Douglas Elmendorf at 10 am.
- Senate Finance Committee hearing on "Health Care Entitlements: The Road Forward" at 10 am.
- House Ways and Means Committee Social Security Subcommittee hearing on Social Security's finances at 1:30 pm.
- First quarter GDP revision from the Department of Commerce.
- Deadline set by Biden group to come up with debt limit deal.
- Treasury Secretary Geithner says that the U.S. will default on its obligations by around August 2 if the statutory debt ceiling is not increased before then.
Highlighting the growing concern within international circles and among the various ratings agencies, the International Monetary Fund released its newest World Economic Outlook today, and the verdict is unpleasant. Aside from lowering our economic growth projections since its last iteration (2.5 percent in 2011 as opposed to April's 2.8 percent), the IMF says that the United States so far failing to address its fiscal situation and policymakers 'playing with fire' on the debt limit are posing risks to global economic recovery.
The IMF states clearly that the U.S., in order to prevent unbalanced global economic growth, should:
"[I]mplement credible and well-paced consolidation programs focused on bolstering medium-term debt sustainability. Given the tepid recoveries in these economies thus far, consolidation should ideally be gradual and sustained, so as not to undermine growth prospects. For the United States, it is critical to immediately address the debt ceiling and launch a deficit reduction plan that includes entitlement reform and revenue-raising tax reform."
Furthermore, the IMF says that if the U.S. delays in implementing fiscal adjustments, global economic growth -- including growth in the U.S. -- would be negatively effected. In a rather grim comparison, Jose Vinals, director of the IMF's monetary and capital markets department said, "If you make a list of the countries in the world that have the biggest homework in restoring their public finances to a reasonable situation in terms of debt levels, you find four countries: Greece, Ireland, Japan and the United States."
Following recent gloomy outlooks on the U.S. credit rating from ratings agencies Moody's, S&P, and Fitch, this warning from the IMF is just one more shot across the bow. Policymakers in the U.S. must increase the statutory debt limit in order to avoid a default on our nation's obligations, and must put in place a significant long-term debt reduction plan that phases in savings as to protect a fragile economic recovery while setting the nation on a sound fiscal path in order to ease market fears and show we can and will get our finances in order.
For anyone who is interested in seeing tax subsidies cleaned up, there's a bit of good news for you. The Senate voted yesterday to eliminate a $5.4 billion per year ethanol tax credit by a tally of 73-27. The vote came on an amendment to the economic development bill that is making its way through the Congress.
This vote is the culmination of a four-month back-and-forth between Sen. Tom Coburn (R-OK) and Americans for Tax Reform president Grover Norquist. In February, the (at the time) three Republican members of the Gang of Six--Coburn, Sen. Mike Crapo (R-ID), and Sen. Saxby Chambliss (R-GA)--sent a letter to Grover Norquist saying that cutting spending in the tax code should not be a violation of ATR's anti-tax pledge. This was in response to a Norquist letter arguing the opposite.
Ethanol came into the picture in late March when Sen. Coburn attempted to end the tax credit for ethanol that was voted on yesterday. Once again, Grover Norquist stated that voting for this amendment would violate his tax pledge unless it was offset with other tax cuts. And once again, Sen. Coburn shot back with a letter criticizing Norquist's position, saying that "you are defending wasteful spending and a de-facto tax increase on every American."
The tension among conservatives over whether to defend tax expenditures has been great in the past few months, with observers wondering whether Republicans in Congress would support cutting them or side with Norquist and the no-new-taxes pledge. In this case, Senate Republicans have overwhelmingly sided with the former group, recognizing that tax expenditures are merely spending through the tax code. This opens the door to meaningful tax reform that could be part of a budget deal, and that is all around great news.
It seems that interactive tools are definitely in vogue. We'd like to say we started the trend with the Stabilize the Debt simulator, and we have continued it with the fiscal plan Comparison Tool we released yesterday. Today, The Wall Street Journal highlighted an interactive tool of its own on its website allowing users to construct their own Social Security reform plan from a menu of given options. The tool acts as an easily digestible version of the solvency provisions section of the Office of the Chief Actuary's website.
The graphic contains fifteen different options for making changes to Social Security. Among them are various changes to benefits--like increases in the retirement age, reductions to initial benefits, and switching to the chained CPI--and tax increases generally involving the payroll tax cap; in addition, there are a few of the more common benefit increase options included such as a robust minimum benefit and an age-85 benefit bump up. When you click an option, a slider at the top of the page shows how that option affects the 75-year actuarial balance of Social Security.
Try to make your own plan! Although WSJ has only included a small sampling of the options available for reform, it is good interactive tool that helps show the magnitude of the changes needed to restore 75-year solvency to the program. For more options, check out the Office of the Chief Actuary's solvency provisions here and CBO's most recent Social Security Options here.