The Bottom Line
September 22, 2010
The remarkable level of austerity proposed in Britain’s new emergency budget made news around the world (see our earlier blog for details) as, in the wake of the Grecian debt crisis, the British coalition government declared deficit reduction their number one priority. If enacted, the emergency budget would reduce the nation’s budget deficit from 11 percent of GDP last fiscal year to 1.1 percent by 2015—a very dramatic reduction.
What would it look like if the U.S. adopted a similar budget policy in the coming years? In a recent paper, taxanalysts showed that over 10 years, the UK budget austerity package would translate to a $10.4 trillion U.S. deficit reduction package, with just over $2.5 trillion of that coming from tax increases and almost $8 trillion in non-health spending. Such a package would bring the U.S. debt-to-GDP ratio down to roughly 45 percent by 2020 (using CRFB's Realistic Baseline), which is only slightly above historical averages.
While the Administration is aiming to reduce the deficit by 2015 in a manner that would stabilize the debt-to-GDP ratio, Britain’s austerity budget would have their debt-to-GDP ratio steadily declining by that year. (Note: The Peterson-Pew Commission has called for stabilizing the debt-to-GDP ratio at 60 percent by 2018, and to decline thereafter.) Major spending cuts would include adjustments to the indexing of government payments for inflation and the freezing of all government salaries.
Considering that we are currently debating the extension of the Bush tax cuts—which would cost about $3.3 trillion under the President's proposal and about $4 trillion if all the tax cuts are extended (see our blog from Monday for more discussion)—it is clear that a package like Britain’s is about 10 steps ahead of the discussion here in the U.S. (and it’s highly controversial there as well). However, the time has come for us to enact our own fiscal plan that will slowly phase in changes as the economy recovers. Such a plan could actually strengthen the recovery now while eliminating the threat of a fiscal crisis down the road.
September 21, 2010
Today, the Fed widened the door further toward easing monetary policy (presumably in the form of additional quantitative easing). The Fed's shift rests on a weaker outlook for growth (investment appears to have started to slow again, too), limited prospects for a pick-up in employment, combined with inflationary pressures below its target. It does not however make it at all clear what would prompt it to "take the plunge" and actively ease. The key passage in today's Federal Open Market Committee (FOMC) statement is as follows: "The Committee ... is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate." The lone dissenter continued to be Kansas City Fed President Thomas M. Hoenig, who did not support additional easing because he judges that the economy is recovering at a moderate pace anyway.
September 21, 2010
Attemping to show how deep policymakers would have to cut spending to reduce the deficit to primary balance in 2015, the Center for American Progress today released a paper titled “A Thousand Cuts”.
The paper begins by looking at the projected 2015 deficit in the President's FY 2011 Budget, and then presents five different budget scenarios looking at how a set proportion of spending cuts could be used to reduce the deficit to primary balance in 2015 (a balanced budget except for interest payments). The five scenarios offer an illustrative picture for the types of spending changes that would be necessary to meet this goal. The Center did not include large revenue increases in its research in an effort to show the huge impact of using only spending cuts to reach balance.
Stay tuned, as we will have more analysis of these five scenarios shortly.
September 21, 2010
Can Budget Offices Help Us Address Demographic Pressures?
As pressures mount on the nation's long-term budget, the Congressional Budget Office now views the aging of the population as the main stressor and health care costs as a close second. Yet, CBO and the Office of Management and Budget (OMB) have traditionally offered only limited analysis and estimates on addressing these demographic concerns, often leaving them to the Social Security Administration, which focuses only on the Social Security piece of the budget puzzle.
Accordingly, when groups like the president's budget commission meet, they get too few options on how government might adjust to the two distinct forces mistakenly put under a single "aging" banner: (1) longer lives and (2) fewer children (new workers) than previous generations. For better and often worse, reform groups frequently stack up reforms by their budget impact. But where there's no estimate, there's no political traction and, alas, no action.
If we want real budget reform, we need to get over this hurdle.
To start, we have to understand what puts it there in the first place. Put simply, we may soon see a fairly dramatic drop in the proportion of workers in the population and the taxes they pay, along with a commensurate increase in the number of people who depend on government for support. As baby boomers retire, this triple whammy on output, revenues, and spending intensifies.
The hit on government is most often discussed as a Social Security problem. That's misleading. The real, far bigger problem is fewer people producing less output and generating far less income for themselves. In turn, these individuals start saving less, spending down their savings sooner. When it comes to government, they start paying less income tax and start relying more on programs like Supplemental Security Income (SSI) and Medicaid—close to half of the latter's budget pays for long-term care. All these repercussions are in addition to any effect on Social Security taxes and benefits.
If policymakers could relieve some of this demographic pressure—particularly by avoiding some of the projected drop in employment rates among those in late middle age and older—then revenues rise without tax rate hikes, and those higher revenues support additional benefits at any tax rate. Such a win/win scenario should be easy for both Republicans and Democrats to embrace.
So what's stopping them? For one, the ingrained habit of raising this issue strictly as a Social Security problem even though the Social Security Trust Fund balance doesn't tell the whole story.
But there's another, more complicated reason. Budget offices seldom project changes in national output and income from reforms. Politicians assert that their every proposal promotes growth by helping people, improving incentives, or reducing deficits. As Congress drafts and redrafts bills, estimators don't have the ability—or the time—to rank every proposal by its impact on growth. Also, evaluating all legislation affecting the budget by very uncertain impacts on national income gives estimators too much power over issues that require a broader legislative debate.
In practice, there are exceptions. The Social Security actuaries do project some changes in long-term behavior when it affects Social Security. And unified budget projections (as opposed to cost projections of congressional bills) do incorporate some estimate of where the economy is headed.
Still, more generally, the budget impacts of a populace that works more and longer aren't going to emerge from traditional budget and Social Security analyses. A recent CBO report on Social Security reform options that affect Trust Fund balances, for instance, didn't touch on proposals to bump up the early retirement age or to backload benefits more to older ages. These proposals trade off fewer benefits in early retirement for more benefits in later retirement, but they generally don't help the Social Security Trust Fund balances unless they increase work effort. Thus, once CBO excluded estimating behavioral shifts, as well as impacts on income tax revenues, it effectively excluded the proposals from the report. Such proposals, by the way, have another non-Trust Fund objective: improving protections for the frail by reorienting payments to when people are truly old.
As another example, a few years ago the CBO staff wisely decided to check out statements that budget problems were driven almost solely by health care cost growth. But even when the analysts provided credible measures of the relative budgetary effects of health cost growth, demographic shifts, and their interaction, they didn't venture to estimate the impact on general revenues of any projected drop in share of the population employed.
Of course, estimating these impacts is no piece of cake. Budget offices lean toward conservative estimation on grounds that large behavioral shifts, however frequent or powerful, are hard to predict. That's one reason budget offices have underestimated the cost of, say, Medicare as implemented or guarantees for Fannie Mae and Freddie Mac. But budget analysts often underestimate upside potentials of legislative actions as well.
My work with Brendan Cushing-Daniels, for instance, suggests that the signal government sets by fixing Social Security retirement ages significantly affects the decision of when to retire—independently of whether there are any real economic gains from retiring at those ages or later (see http://www.urban.org/publications/412201.html). But think about trying to estimate the ultimate effect of changing those signals amid demographic shifts unlike any the developed world has ever seen. (I'm emboldened a bit here because one of my past predictions is proving correct: Social Security underestimated the work efforts of older workers once earlier retirement was not so easily supported by baby boomers and women entering the workforce in droves.)
Since budgeteers have to live with some uncertainty, one key to successful reform is not to depend so much on estimates being right, but to set in place triggers that keep a system in balance as behavioral patterns shift. If reform increases work, for instance, then fewer other benefit cuts or tax increases would go into effect.
Such reform options won't even be considered as long as the budget offices can't improve ways to analyze and estimate proposals addressing these demographic shifts. But with looming deficits threatening to hamstring growth, opportunity, and the safety net itself, there's no longer much time to wait.
Gene Steuerle is a member of the board of directors of the Committee for a Responsible Federal Budget. He also is a senior fellow at The Urban Institute, co-director of the Urban- Brookings Tax Policy Center, and a columnist for Tax Notes Magazine.
"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.
Note: This article was originally published as a Government We Deserve column at the Urban Institute.
September 20, 2010
With Congress back in session, the mid-term election right around the corner, and a looming expiration, the debate of the 2001-2003 tax cuts is getting hotter and hotter. Up until now, the debate over the tax cuts, which are set to expire at the end of the year, has mainly centered on whether or not to extend all of them or let them expire for the highest income earners. We believe that this type of debate is missing a key component: each plan’s specific and relative deficit impact.
Some observers have decried the costs of extending the tax cuts for all earners based on the additional $700 billion in costs. Such a relative deficit view ignores the immense costs of extending the tax cuts for middle- and lower-income earners. Let’s take a deeper look at their specific and relative costs.
As can be seen by the graph below, each of the two tax cut extensions have vastly higher 10-year deficit impact than the other selected spending options enacted since the recession began. Extending all of the tax cuts will have a 10-year impact of nearly $4 trillion (when combined with annual AMT “patches”). The still incredibly expensive--yet less expensive-- partial extension would still cost over $3 trillion. In comparison, the 2008 stimulus will have a more "modest" cost of $114 billion. Even more enlightening is the fact that the partial extension is over 4 times more than the 2009 Stimulus (ARRA is now projected to cost $814 billion over 10-years) and about 50 times larger than TARP ($66 billion 10-year cost). A full extension is nearly 5 times larger than the costs of ARRA and nearly 60 times larger than TARP.
Note: All Others include FDIC Bank Takeovers, Housing, Unemployment, Pension and other Relief, Extended Provisions from ARRA and New Stimulus, and Credit Union Rescues--taken from Stimulus.org.
You could also compare the cost of the tax cuts with other baseline projections of government spending. The graph below compares these plans to Social Security, Medicare, Medicaid, the defense discretionary budget, and the non-defense discretionary budget. This spending is, for the most part, more expensive than these tax cuts--except for Medicaid, which is roughly the same cost as the full extension--but it shows just how much money policymakers are talking about. Using these programs, which account for about 77 percent of all projected government spending over the next 10 years (about $10 trillion is not included in the figure), to fully offset these tax cuts, we could do the following highly unrealistic and fairly ridiculous program changes: cut about 2/3 of Medicare or the non-defense discretionary budget, about ½ of the defense budget, 40 percent of the Social Security budget, or eliminate Medicaid entirely. We don’t support doing anything this drastic to any one program, as every area of the budget must contribute to deficit reduction. We simply wish to demonstrate the size of these tax cuts to policymakers and the public.
But what about the argument that the tax cuts would increase economic growth? Well, yes, lower rates can encourage faster growth -- if they are accompanied by lower spending and/or a broader tax base. If deficit finainced, though, the negative effects of borrwing would likely overhwhelm any positive affects from reduced taxation on capital and labor. Note that when CBO looked at its Alternative Fiscal Scenario which assumes the continuation of the tax cuts (combined with a few additional practices that will further increase deficits over the coming decade), it found that:
"Over time, [as] the negative consequences of very high federal borrowing build up [under CBO's Alternative Fiscal Scenario]....real GDP would fall below the level in CBO’s baseline projections later in the coming decade because the larger budget deficits would reduce or 'crowd out' investment in productive capital and result in a smaller capital stock."
(Note that the opposite is true in the short-run, when higher deficits are expected to have a stimulative effect on the economy).
It must be noted that CBO's Alternative Fiscal Scenario includes more than a mere extension of the 2001/2003 tax cuts. It also includes faster discretionary spending growth and fixes to the Medicare remibursement formulas. As CRFB has argued for here and here, policymakers could use the upcoming expiration of the tax cuts as a “hammer” to work out broader tax reform and/or a medium-term deficit reduction plan.
September 20, 2010
Today, the National Bureau of Economic Research announced in a statement that the recession that began in December of 2007 had ended in June of 2009. After waiting for the release of the updated Gross National Income and Product Accounts (released in August of this year), it became clear that the recession had bottomed out in June of 2009.
Although this seems to be good news for the American economy, it was accompanied by a few important cautionary notes. The official end of the recession does not mean that the economy has since “returned to operating at normal capacity,” the NBER said. Furthermore, this official decision that the recession has ended means that any future recessionary economic activity must be considered a new, or double-dip, recession—which would indicate that the economy has indeed not returned to “business as usual."
September 20, 2010
Falling Into Pieces – Fall officially begins this week. A short congressional calendar and the quickly-approaching elections mean that the legislative agenda will largely fall by the wayside. Only a few bills will get passed this month, with a post-election lame duck session set to rake up with the rest.
Leaving Tough Tax Cut Decisions Until Later – The tax cut debate is turning about as much as the leaves soon will. Last week Senate Minority Leader Mitch McConnell (R-KY) introduce a proposal, the Tax Hike Prevention Act of 2010, to permanently extend all the 2001/2003 tax cuts for all tax brackets. It will also permanently extend Alternative Minimum Tax relief to middle class families and permanently set the estate tax at a 35% rate with a $5 million exemption for individuals. Meanwhile, Senate Finance Committee Chairman Max Baucus (D-MT) is drafting a proposal that will permanently extend the tax cuts for families making less than $250,000 (as the White House proposed) and also permanently extend the estate tax, possibly at the 2009 rate of 45% with a $3.5 million exclusion. Neither of the tax plans are paid for; CRFB has been adamant that any tax extension be paid for over the longer term. House Democrats were briefed last week by a pollster who told them that deficit reduction should be a key part of their tax message. Although Senate Majority Leader Harry Reid (D-NV) has promised a debate on renewing the tax cuts this month, it is doubtful there will be votes ahead of the election on the politically-charged issue. Some Senators, like, George Voinovich (R-OH) and Ron Wyden (D-OR), who has co-sponsored a tax reform plan of his own, are calling for a larger debate on fundamental tax reform. Such a debate certainly is needed.
Small Biz Aid Falls to the House – The Senate passed H.R. 5297, the Small Business Jobs Act, last week. The House is expected to accept the Senate version this week in order to speed its way to the White House for enactment ahead of the election.
Tax Extenders Fallout – The never-ending “tax extenders” debate may once again sprout up as Senator Baucus last week introduced legislation that extends many of the tax breaks, such as the research and development tax credit, that have so far been unable to clear Congress.
Will CR Bring a Harvest of Add-ons? – Action on FY 2011 appropriations bills has come to a stop, meaning that a continuing resolution (CR) will be required by October 1, the beginning of the fiscal year, in order to keep government functioning. Must-pass legislation such as this often attracts other bills along for the ride. This could set up a showdown over the unrelated add-ons with threats of a government shutdown.
September 17, 2010
How Weak is the Economy? Do We Believe the Stock Market or Most Economists?
Action this week has been in the stock and currency markets. “Stocks are on a September roll” (Wall Street Journal), as the US growth play continues despite the outlook pessimism of most economists and policymakers, some of whom support extending upper end tax cuts on the grounds of the weak economy. With conflicting data at a time of transition in the economy (economic and financial sectors are still adjusting like crazy to the shocks of the past few years), the momentum and outlook are still unclear. In the currency markets, the big move of the Bank of Japan earlier in the week to dampen the yen’s rise has boosted the dollar. But, a strong dollar will hurt our much-needed export growth.
The bond markets have been relatively quiet, although the growth play, reduced risk worries among market players for the time being, and relatively low returns have induced large bond holders like Pimco (the Pacific Investment Management Co, the most visible “bond vigilante”) to rebalance holdings from US government-related debt to investments with higher return for the second straight month. Lurking in the background however are potential safe haven drivers coming from the other side of the Atlantic, as Europe continues to adjust to its own financial and fiscal shocks.
September 17, 2010
Yesterday, the Senate Budget Committee held a hearing on Jacob Lew’s nomination as the new head of the Office of Management and Budget, where he received bipartisan support. Mr. Lew is currently the Deputy Secretary of State for Management and Resources and previously served as the head of OMB under former President Clinton.
Lew left OMB in 2001 amid a budget surplus and projected surpluses for many years to come. That track record and Lew’s experience crafting bipartisan agreement on fiscal matters were major selling points during his testimony. Lew did, however, acknowledge that the fiscal situation he is being thrust into today is far different than the one he confronted during his years in the Clinton Administration.
During the hearing, Lew argued that “there is no doubt that we are in an unsustainable fiscal situation right now.” Continuing in his opening statement, Lew stated that:
“In the late 1990’s, our challenge was how to maintain a prudent fiscal policy while transitioning into a world of budget surpluses and robust economic growth...Today, a series of policy choices and the worst economic downturn since the Great Depression present us with a very different set of challenges...I don’t think we’ve faced a more significant fiscal challenge in my lifetime, and we will be judged based on our ability to respond.”
When referring to the need for balancing economic recovery with the need for fiscal discipline to address the looming crisis, Mr. Lew argued:
“At the same time, we must put our nation back on a sustainable fiscal course in the medium-term while making investments critical to long-term economic growth; and how to shore up our fiscal position for decades to come. Indeed, the coming months may be the most critical time in fiscal policy in recent memory.”
Of particular note, Lew, when referring to our unsustainable budget path, said:
“We can’t put off for years worrying about the deficit...[the country must] take actions that will send a signal of real confidence that right over the horizon we’re putting in place the policies that will put us back on a path towards fiscal discipline.”
That statement got Lew close to joining CRFB's Announcement Effect Club, but not quite. A statement on how enacting a medium-term consolidation plan can actually improve the economy both now and in the long-term--by putting further downward pressure on interest rates and restoring confidence--would have been welcomed, but we'll keep listening for it.
As for the President's fiscal commission, Lew was hopeful, stating that:
“We’re looking very, very hopefully towards the results [of the commission] being in a place where the beginning of a bipartisan consensus can begin to develop.”
We're certainly hopeful too. But as we've argued here, the administration must have a Plan B in case the commission does not succeed, and there's no reason why the White House has to wait until December to begin seriously focusing on medium-term deficit reduction.
Lew also recognized that all options must be on the table for closing the fiscal gap and that there is no magic bullet:
“The challenge we have is to leave things on the table because the answer will not be one [policy] or the other.”
We at CRFB wish Jack Lew the best of luck and look forward to working with him to achieve fiscal sustainability. Click here to view the entire hearing and here to see how you would bring our fiscal house in order.
September 16, 2010
Today, the White House announced its intent to appoint CFRB Board Member Jim Kolbe and CFRB Co-Chair Bill Frenzel to the Advisory Committee for Trade Policy and Negotiations. The Advisory Committee for Trade Policy and Negotiations is part of the Office of the United States Trade Representative. Members on the Advisory Committee “broadly represent key economic sectors affected by trade” and the Committee “provides policy advice on trade matters”.
Bill Frenzel served 20 years as a member of the U.S. House of Representatives from Minnesota and also served as the Ranking member of the House Budget Committee and was a member of the House Ways and Means Committee. He has served as a special advisor to President Clinton and was on the President’s Social Security Commission in 2001. Mr. Frenzel is a Co-Chair of the Committee for a Responsible Federal Budget.
Jim Kolbe served 22 years as a U.S. Representative from Arizona and was a member of the House Appropriations Committee serving as chair of the Subcommittee on Foreign Operations. He now serves as a senior transatlantic fellow at the German Marshall Fund and is an adjunct professor in the College of Business at the University of Arizona. Mr. Kolbe is on the Board of the Committee for a Responsible Federal Budget.
CRFB would like to congratulate Jim and Bill for being nominated.
September 15, 2010
Nobody's breaking out the champagne for this anniversary.
On this day two years ago, the collapse of Lehman Brothers turned an already bad-looking recession into an all-out financial panic. The collapse sent the stock market on a wild ride for the next month and rapidly accelerated the pace of job losses, turning 6 percent unemployment into 9.5 percent unemployment in just six months.
The Bush Administration allowed Lehman Brothers to fail then, but the shockwaves it sent through the economy forced them to make an about-face pretty quickly. Less than a month later, Congress passed the $700 billion Troubled Asset Relief Program (TARP) , which was originally created just to buy toxic assets in financial institutions (known as the Capital Purchase Program). Under the Obama Administration, it has been expanded to include a variety of initiatives. The latest CBO estimate of the program puts the net cost of the program at about $70 billion.
At the same time, the Federal Reserve sprang into action and in the fall of 2008, cut interest rates from 2 percent down to near zero. It also took several unconventional actions, drastically expanding its balance sheet by lending directly to institutions, opening a variety of new lending facilities, and purchasing mortgage-backed securities.
Also, with the financial crisis came a wave of failed banks, which racked up costs for the FDIC. In fact, in the two weeks around the collapse, September 12th to September 26th 2008, the FDIC incurred $9 billion in costs, more than they had incurred in the previous 8 1/2 months of the year. Since September 2008, roughly 280 banks have failed at a total cost to the FDIC of about $70 billion, many times more than they cost the FDIC from 2000-2007.
Obviously, the failure of Lehman Brothers and its effects have cost the Federal government greatly, even when all of the fiscal policy moves are excluded.
You can track all of the moves--financial, fiscal, or otherwise--the government has made since the start of the recession at Stimulus.org. And with the small business aid bill coming closer to final passage, it looks like we'll have more to add to Stimulus.org in the near future...
September 15, 2010
The Washington Post reported Tuesday that the number of workers seeking disability benefits from Social Security’s Disability Insurance Program has risen. From 2008 to 2009, according to the Social Security Administration, the number of applicants increased 21.4 percent.
As of the end of the second quarter of this year, there were more than 8 million people on the Social Security Disability program’s rolls. Since the end of 2007, there has been an increase of 12.6 percent in the Disability Insurance Trust Fund Program applications (end of 2007 to the end of the second quarter, 2010).
The Post cites economic conditions as the major factor in the increase in program applications. That may be the case, but if this trend continues, the already precarious state of the Disability Trust Fund will become even questionable. The Disability Trust Fund began running deficits in 2005 (excluding interest) and will run out of money in 2018 according to the Social Security Administration’s most recent report. Given the overall state of Social Security (shown in the graph below) if the increase in applications to the Disability Program continues, the Disability Trust fund may run out sooner than expected (as would the combined OASDI Trust Fund).
As can be seen by the graph above, the Trust Fund will run out in 2018 after a steady drop in value (a ratio of 100 means that assets at least equal projected costs). The rise beginning in the late 1990's as a result of lawmakers in 1994 responding to an earlier SSA report saying that the DI trust fund would run out in 1995. The Social Security Domestic Employment Reform Act of 1994 changed the rate from the total OASDI trust fun going to the DI Trust fund. The law made the following changes; in 1994 to 1996, the rate increased from 0.60 percent to 0.94 percent, in 1997 to 1999 the rate increased from 0.60 percent to 0.85 percent and in 2000 the rate increased from 0.71 percent increased to 0.90 percent. Beginning with the year 2000, the DI Trust Fund allocation was increased from 0.71 percent to 0.90 percent . As CBO states in its recent review of the Disability Program, doing so again would solve the sustainability problem, but would only speed up the eventual depletion of the combined OASDI trust funds.
The recent rise in applications for disability insurance highlights the need for broader Social Security reform now. As we've argued, implementing changes sooner rather than later will give policymakers more options for reform while also giving workers more time to adjust to any changes. The increase in DI applications will speed up the depletion of the program's trust fund after which it will put an additional burden on the OASI Trust Fund.
Click here for our analysis on the Trustees report, and here for a recent analysis about the cost and size of the Trust Fund gap.
September 14, 2010
UPDATE: The Senate passed the small business package on Thursday 9/16, and the House is expected to pass the legislation early next week.
The Senate today successfully invoked cloture by a 61-37 vote on HR 5297, a bill to provide relief to small businesses. The legislation provides $12 billion in tax breaks, a $30 billion lending fund and other aid. A vote on final passage is expected by Thursday and the House will likely accept the Senate version in order to move it to the president for his signature. It may be the last stimulus spending bill that the deeply-divided Congress adopts this year.
Before invoking cloture on the Senate substitute amendment, two amendments involving an offset to the health care reform bill passed earlier this year were rejected. An amendment from Senator Mike Johanns (R-NE) to repeal the 1099 reporting requirement for business purchases from corporate vendors of $600 or more failed. The $17 billion cost would have been offset by limiting a preventive care fund and the individual mandate to purchase health insurance. Another amendment that would have exempted more businesses from the requirement also failed. Its $10 billion cost would have been paid for by repealing the manufacturing tax deduction for the five biggest oil and gas firms.
The Senate had to modify the bill because one of the original offsets was used by legislation to provide extra funding to states. The loss of eliminating the Advanced EITC was offset by jettisoning nearly $1.5 billion in agriculture disaster relief.
While the cost of the package is supposedly offset, CRFB takes issue with one of the pay-fors. Allowing people to rollover their individual retirement accounts to Roth IRAs will technically raise just over $5 billion over the ten year period since the rollovers will be taxed. But it will cost an estimated $15 billion over the longer run because withdrawals from Roth IRAs are not taxable.
CRFB supports finding long-term offsets for short-term stimulus. But using short-term offsets that actually increase the debt over the longer term not only goes against the principle of offsets, but is fiscally irresponsible.
September 13, 2010
Kick-off Time – Football season got underway this weekend, and the final legislative drive before the mid-term elections also commences this week. The elections will loom over the work of lawmakers as they return to work for a short period before adjourning in October, making major breakthroughs unlikely. But stranger things have happened (like the Redskins winning).
Small Biz Bill in the Red Zone – The Senate is expected tomorrow to resume work on a bill (HR 5297) to aid small businesses that includes a lending fund and tax breaks. With Senator George Voinovich (R-OH) saying he no longer will support a filibuster, it looks like the legislation will have the 60 votes needed to move forward. While the package is technically paid for, CRFB previously took issue with one of the offsets. We hope Congress will include gimmick-free offsets that do not add to the long-term debt.
Waiting for the Play on Tax Cuts – Senate Majority Leader Harry Reid (D-NV) has promised a Senate debate on extending the 2001/2003 tax cuts this month, yet is unlikely that Congress will complete work until after the election. In the meantime, players are lining up on both sides of this political football. Some Democrats are reportedly sending a letter to House leaders asking them to call a new play on the tax cuts, rejecting the White House proposal to extend the cuts only for families making less than $250,000 and instead extending them for all taxpayers. Calls for a temporary extension have grown louder since former OMB Director Peter Orszag recommended such an idea last week. But CRFB warned in a blog Friday that the second part of Orszag’s suggestion was to let all the cuts lapse after the two-year extension expires.
Lew Hearings Set for This Week – The man tapped to be the administration’s new budget quarterback will have his confirmation hearings this week. The Senate Budget and Homeland Security and Government Affairs committees will hold hearings on Thursday on the nomination of Jacob Lew to be the new director of the Office of Management and Budget. The hearings will no doubt provide a lot of posturing and finger-pointing over the budget outlook.
No Rush on Appropriations – Neither chamber is expected to make much movement on the FY 2011 spending bills. Instead, a continuing resolution is expected before the new fiscal year begins on October 1.
September 13, 2010
We reported a lot in June about small efforts the White House and OMB were taking to cut costs in the government. Now, the Obama Administration is taking a whack at travel allowances for federal employees. Citing lower costs due to the recession, they have reduced the daily allowance for hotel rooms in most major cities. The cuts average to about a 4 percent reduction.
Naturally, the hotel industry is opposed to this change, but it seems like a common sense measure, considering the lower cost of hotel rooms compared to last year. We encourage the White House to continue to find ways to make government operate more efficiently and save taxpayer money.
September 10, 2010
The “Orszag Plan” laid out by former OMB director Peter Orszag in his inaugural New York Times column argues that we should extend the tax cuts for two years--all of them--but let them expire after that (click here for our response to it).
While the focus has been on his departure from his former employer's position that we should only extend the middle class tax cuts (though really – since when is $250,000, or about the top 3 percent of earners considered the threshold for middle class?) the more important break from the Administration is his suggestion that we should let the tax cuts expire after that.
Though extending the tax cuts for only two years, given the nature of politics, the risk is that people will jump onto the first half of the idea while ignoring the second half. Indeed, many in the permanent-tax-cut camp have jumped on the Orszag bandwagon, hoping that politics will turn a two-year extension into a permanent extension.
As you can see below, even though the Orszag Plan would add to the deficit relative to current law if not offset, it is still significantly better from a fiscal perspective than the Obama Plan and the permanent extension of all tax cuts.
| The Cost of Tax Cost Extensions Including AMT Patches (billions) | ||
| Option | Two-Year Cost | Ten-Year Cost |
| Below $250,000 | $400 | $3,000 |
| All | $500 | $4,000 |
There is also some concern about how the Orszag Plan might play out in terms of process. The cost of extending the tax cuts for the highest earners is not covered by the PAYGO legislation while the cost of the middle class ones is covered. However, on that PAYGO scorecard sits roughly $40 billion in savings from health reform. There may be a temptation to "grab" that savings to offset the high-earners extension (which would cost $37 billion in the first year) for at least one year.
Don’t do it. Just don’t.
The savings from health should have been designed so they couldn’t be used to offset other deficit spending, and that was clearly the intention. The savings are frankly pretty puny and spending them rather than walling them off for deficit reduction would add insult to the injury of the health care reform bill that didn't go far enough in controlling costs. Letting the tax cuts expire after two years would go a long way towards bringing the deficit back to manageable levels. Or, Congress could, as we have suggested use their expiration as a hammer for real tax and budget reform, agreeing not to extend them again unless they were fully paid for and part of a more comprehensive budget deal to get the debt under control.
September 10, 2010
US markets this week continue to reflect a modest growth play despite uninspiring data. Safe haven concerns from abroad and deflation worries have diminished, although unexpected news could quickly reverse trends – as we have so vividly seen over the past few years. The yield on the benchmark 10 year bond headed up again from its nearly two year low at the end of August and start of September (although it remains very low), as capital shifted into stocks at the margin.
Data has been thin and sentiment modestly positive in this shorter post-Labor Day week. Still reeling from last week’s weak unemployment data for August, US financial markets have been chewing on possibly more positive news on the labor market front (unemployment claims may be showing some trend improvement). Still, weak data and surrounding discussion from the past few weeks led forecasters to revise downward their 2010 and 2011 outlooks (eg, the new Blue Chip.) While a double dip recession is not expected, growth and labor market improvements are expected to be weak. Deflationary worries have receded slightly, but the deflation ghost hovers in the background of market activities and policymaker risk concerns. (The US slowdown and a few other factors have just led the OECD, the advanced industrial economies’ policy think tank, to call for additional stimulus in countries that have fiscal room for maneuver, aka “fiscal space”.)
Awaiting any economic policy surprises today from the President in his scheduled news conference, markets have not reacted much to the President’s announcement earlier this week of additional proposals to modernize the economy’s infrastructure through basic capital spending projects – perhaps because they think it won’t get through Congress. (His proposals are not stimulus of the same variety we have seen over the past few years to jump-start the economy. Rather, they are growth friendly investment proposals to fix some of the aging infrastructure – highways, bridges – for the longer term. The ARRA – last year’s stimulus package – included infrastructure spending, but it was for the most part shovel-ready so that resources could be moved into the economy relatively quickly.)
Safe haven pressures on the US market have so far been relatively limited this week, with financial pressures coming from Ireland (a tighter fiscal policy has increased pressures on its financial sector, still overextended from its construction boom) and some so far quiet concerns about European bank capital. It remains to be seen how the new Japanese stimulus measures will affect US markets.
China has also been on top of the agenda. The financial press has covered the visit to China of two of the President’s top economic advisers (including Larry Summers), presumably to discuss market valuation of the Yuan among other concerns with the leadership. At the end of the visit, Treasury Secretary Geithner criticized the lack of market orientation of the currency. Next week, Congress is expected to put the spotlight on the Chinese currency and its undervaluation (creating problems for the US manufacturing sector), which could be particularly sensitive as the mid-term elections approach. China is the largest foreign holder of our sovereign debt.
September 9, 2010
Comparing the Upper-Income Tax Cuts to the Social Security Shortfall
A small controversy has been brewing in the blogosphere over the relative value of the higher-income 2001/2003 tax cuts and the Social Security shortfall. A couple of weeks ago, the Center on Budget and Policy Priorities displayed this graph, showing the present value of the two being roughly equal:
Some bloggers (but not CBPP) have held this up to essentially argue that we can let the top cuts expire to pay for Social Security. Others, meanwhile, have disputed CBPP’s findings or its relevance. Megan McArdle over at The Atlantic, for example, has argued that Social Security’s shortfalls would exceed the value of the trust funds in the out-years – a point which is obscured by using “present value” calculations. CBPP responded that while the Social Security shortfalls grows over time, so too do the value of the tax cuts (they further responded to McArdle’s concerns here). Over at his blog, Ezra Klein said he was “calling this one for CBPP, at least for the moment.” We aren’t so sure it’s that simple.
Present value calculations are an important way to measure our fiscal obligations. But cash flow matters too. Here is a graph comparing CBPP’s projections of the upper-income tax cuts to Social Security’s shortfalls as measured by the Trustees:
As you can see, the Social Security shortfall begins to exceed the value of the upper-income tax cuts at the very beginning of next decade, and is projected to be significantly larger over the course of the following quarter century.
So why do the cash-flow numbers make Social Security’s shortfall look so much larger? Well, there are two major reasons. First, by their very natures, present value estimates favor the near-term over the far term. This is logical, since a dollar today is worth more to us than a dollar tomorrow. But it also means that the first decade of relatively modest deficits (and brief surpluses) in Social Security weigh heavily on the calculation.
Secondly, these calculations include the value of the $2.6 trillion Social Security trust fund – and weight those heavily since we are holding that money today. If we were looking at the present value of Social Security’s future shortfalls, as opposed to accounting for its past surpluses (which have accumulated in the trust fund), the program’s unfunded costs would be closer to 0.9 or 1 percent of a GDP, rather than 0.7 percent. (That 0.7 percent isn’t irrelevant, since most reform plans would rely on the trust fund, at least for a while. But looking out to the end of the 75-year window, the gap will reach 1.4 percent of GDP.)
Aside from these cash-flow issues, we also have some concerns about CBPP’s methodology for projecting forward the value of the tax cuts – which appears to be highly sensitive to a few uncertain assumptions.
Essentially, CBPP assumes that the growth rates in revenue loss from 2017 through 2020 will continue forever. Over time, the compounding effects of these growth rates are significant -- increasing the value of the cuts to about 1.1 percent of GDP by 2080. Yet tiny changes in some of the numbers they use can drastically alter this number.
For example, they estimate that the tax cuts will cost $99 billion in 2017 and $120 billion in 2020 based off of a combination of Treasury and TPC estimates. We used some TPC tables to estimates these numbers at $102 billion in 2017 and the same $120 billion in 2020. When we tried to roughly apply their methodology using our $102 billion instead of their $99 billion (in other words, a nominal growth rate of about 5.6% instead of 6%) we found that the shortfall only reaches about 0.65 percent of GDP rather than 1.1 percent.
This is not to say that our $102 billion is right and their $99 billion is wrong – both are plausible and surely both will be wrong. The point is that tiny changes in these numbers cause wild swings in the ultimate cash flow results. (Though the magnitude of the present value cost wouldn’t swing nearly as much – under the scenario we presented, the present value of the upper-income cuts would be between 0.5 and 0.6 percent of GDP rather than 0.7 percent).
We also tried projecting forward two other ways: assuming that the upper income tax cuts remained a fixed proportion of total revenue under CBO’s extended baseline scenario and assuming bracket creep for the upper-income cuts in line with the total bracket creep we estimate in our CRFB baseline.
Here are the results:
Note: CBPP estimate (blue line) is the same line from the above graph.
We have one more point – a point which CBPP has rightly made many times: reforming Social Security and letting the upper-income tax cuts expire is not an either or question. Based on CBPP’s estimates, doing both would generate present value savings of 1.4 percent of GDP or so. Based on CBO’s 2009 alternative baseline, the fiscal gap is more like 8 percent over the next 75 years.* That means we will need to do the fiscal equivalent of letting the top income tax cuts expire AND reform Social Security AND a whole lot more. This is what CBPP's graph from above would look like if we compared the costs of upper-income tax cuts and Social Security shortfalls to the fiscal gap:
Those who think that reforming Social Security is a fiscal imperative but there is no need to pay for the expiring tax cuts simply aren’t being honest with themselves. As CBPP argues, it’s “time for hard choices – not hypocrisy”.
*Note that we used the 2009 Alternative Fiscal Scenario because it assumes that the upper-income tax cuts are renewed. The 2010 Alternative Fiscal Scenario assumes that only the tax cuts for those below $250,000 a year are renewed, and that after 2020 revenue is fixed as a percent of GDP. Also note that numbers are not strictly comparable.
September 9, 2010
The Tax Policy Center recently unveiled their new “Tax Calculator,” which examines how the decisions regarding the 2001/2003 tax cuts will affect people’s tax payments. The Tax Calculator allows you to calculate the impact of three distinct scenarios on your bottom line: current policy where all of the 2001/2003 tax cuts are in place; current law where they all expire; and having the tax cuts continued except for individuals making over $200,000 or couples making over $250,000 (the plan outlined in President Obama’s 2011 budget).
Their calculator has six sample taxpayer options: married and under age 65 with no children, married with one child in college, married with two children under 13, single, head of household with two children under age 13 and married and over 65. The calculator spits out a host of tax metrics on your different assumptions about income and other houshold variables. It's really cool. Year, we said it - a tax calculator is really cool.
Using the Tax Calculator and their pre-determined “Middle Income” bracket, the following results were produced:
| Married, Under 65, No Children | Married, 1 Child in College | Married, 2 Children Under Age 13 | Single | Head of Household, 2 Children Under Age 13 | Married, 65 and Over | |
| Current Tax Law (with all 2001/2003 Tax Cuts) | No Change | No Change | No Change | No Change | No Change | No Change |
| All 2001/2003 Tax Cuts Expire | $1,944 Higher | $2,138 Higher | $2,638 Higher | $819 Higher | $2,400 Higher | $852 Higher |
| President Obama's Plan | $160 Lower | No Change | $645 Lower | No Change | No Change | No Change |
However, it should be noted that this calculator does not take into account the resulting fiscal costs that President Obama’s plan or a full extension would entail. The following table details the budgetary impact of these options (as we detailed in a previous blog):
| Action |
2011-2020 Budgetary Impact |
| Fully Extend Tax Cuts (without AMT) | $2.7 Trillion |
| Fully Extend Tax Cuts (with AMT) | $3.9 Trillion |
| Extend the Tax Cuts for All but Top Earners (without AMT) | $1.7 Trillion |
| Extend the Tax Cuts for All but Top Earners (with AMT) | $3.0 Trillion |
Click here for our Budget Simulator to see how these tax cuts, and a wide variety of other budget alternatives, can be used to help bring our long-term fiscal house in order.
September 9, 2010
Secretary of State Hillary Clinton spoke yesterday about the importance of taking action soon to ensure future fiscal sustainability, calling the mounting federal deficit a threat to our national security in two ways:
“It undermines our capacity to act in our own interest, and it does constrain us where constraint may be undesirable. And it also sends a message of weakness internationally. It is very troubling to me that we are losing the ability not only to chart our own destiny, but to have the leverage that comes from having this enormously effective economic engine that has powered American values and interests over so many years. So I don’t think we have a choice – it is a question of how we decide to deal with this debt and deficit…. There is no free lunch, and we cannot pretend that there is without doing grave harm to our country and our future generations.”
Secretary Clinton's statement reflects the growing number of our nation's leaders (listed here are the members of the Announcement Effect Club) who recognize that our current unsustainable fiscal path will have ripple effects beyond just our federal budget. Our skyrocketing national debt will impact not only America at home but also our global economic and political relationships -- making it more important than ever to enact a plan now that will outline how we will bring down future deficits, before it's too late.
