The Bottom Line
This week, The Bottom Line will be celebrating Social Security’s upcoming 75th birthday on August 14th, and our main present is a comprehensive look at its future. Today, we will be examining the two ways that Social Security can be thought of in respect to America’s budgetary future, and how each of those viewpoints affect the possibility for, and probable methods of, reform.
In one view, Social Security can be thought of as a publicly-run but self-contained pension system. It has its own revenue source, its own trust fund, and is even technically "off-budget". On the other hand, Social Security can be thought of as a government transfer program, no different from other spending programs in the budget.
Neither view is wrong, and under both views reform is necessary -- but the overall implications of these views are somewhat different. Under the first view, the Social Security program is on solid ground through 2037, since it can continue to draw from its trust fund over the next three decades.
While not wrong, this view largely ignores the effect of Social Security on the overall fiscal picture. Over the next two decades, unfortunately, Social Security's costs will grow by about one percent of GDP -- and its revenues will not follow in suit. As such, it will add significantly to overall debt held by the public -- even as its trust fund continues to maintain a positive balance.
CRFB President Maya MacGuineas addressed this issue in a recent CNN article, explaining that:
When Social Security runs a surplus, the extra money is used to purchase U.S. Treasurys, and the dollars are used to help finance the rest of the government, which is almost always running a deficit. So when those assets to Social Security -- and liabilities to taxpayers -- come due, we have to find a way to raise the money, which has already been spent. You know what that means: Raising taxes, cutting spending or borrowing. And because the downturn has drained Social Security surpluses more quickly than expected, that strain on the rest of the budget will begin even sooner.
Stay tuned to The Bottom Line the rest of this week for our series on Social Security. Tomorrow we will discuss reform proposals, while Wednesday we will discuss how other countries enact Social Security-like systems. Thursday will see a blog on the economic consequences of demographic shifts, and Friday will wrap it all up.
Gone and Back – The Senate has left for its August recess, the House will return this week (for a day). Congress will be back in session after Labor Day for a frenetic month before adjourning again in October for final pre-election campaigning.
State Aid Frees Senate, Brings Back the House – The Senate approved a package of aid to states and localities on Thursday and adjourned later in the day. The bill, HR 1586, provides $16 billion to states for Medicaid payments and $10 billion to help keep teachers, police, and other civil servants from being laid off. The House will return to Washington for one day this week to approve of the measure so that the aid can get to states before the school year begins. The $26 billion cost is fully paid for.
Small Biz Bill Forgotten But Not Gone – The Senate was not able to complete work on a bill to aid small businesses, HR 5297, last week, largely due to the state aid bill and the vote on Elena Kagan’s nomination to the Supreme Court, but Senators vowed to resume work as soon as they return. The bill will provide $12 billion in tax breaks and create a $30 billion lending pool for small businesses.
Tax Debate Coming Next Month – The Senate will take up the issue of the 2001 and 2003 tax cuts that are set to expire at the end of the year in September, setting up a heated debate just before the election between those who want to permanently extend all the cuts and those who want to follow the president and extend them only for families making less than $250,000. Those supporting the complete extension argue that it will help stimulate the economy while those favoring only the extension for the middle class contended that giving tax breaks to the wealthy in a time of massive budget deficits is unwise. While it is necessary to deal with the tax cut issue, it should be framed within the larger debate over how we reform our antiquated and inadequate tax system so that it can efficiently meet our needs going forward. A possible solution is a temporary extension that will create space for a deal on fundamental tax reform and a credible fiscal plan to deal with the debt.
Social Security and Medicare: Here Today, Gone Tomorrow, Without Action -- The Trustees overseeing Social Security and Medicare released their annual reports Thursday on the finances of the two programs. They warned that both vital programs are on an unsustainable path in the long run because of demographic trends and that changes will be required to bolster their long-term finances. See here for CRFB’s analysis of the Social Security report.
Our policymakers need to focus more how shaping and managing fiscal expectations can help us get our fiscal house in order while supporting growth at the same time. (Hint: No, it’s not magic. It’s thoughtful policy design – which basically means taking great care with timing and composition.)
When we think about Social Security reform, we tend to look at options in terms of their impact solvency -- measured over a 75 years period. In their latest report, the Trustees estimate this shortfall to be 1.92 percent of taxable payroll. While solvency is a necessary condition for Social Security reform -- it is not a sufficient one. At minimum, policy makers must ensure we achieve something called sustainable solvency, which insures the program can be sustained over the long-run.
There are a number of problems with looking only at solvency, but one of the key issue is that this measure essentially works on closing the average 75-year gap (after accounting for trust fund assets and interest), even though the program's costs are growing over time. While the program's 75-year shortfall is 1.92 percent of taxable payroll, that shortfall is more than twice as big -- about 4 percent of payroll -- by 2080. That means that an immediate 2 percent payroll tax increase (or equivalent spending cut) would more than make Social Security solvent -- but would only close half of the program's gap in the final years of the budget window. Such a cliff effect will cause the program to fall out of 75-year solvency in the not-to-distant future.
This is one of the reasons that CRFB encourages a focus on cash flow. Though it may be too late to make the changes sufficient to balance Social Security's revenues and expenses every year, any reform plan must eventually bring the two in line -- and the sooner the better. When evaluating based on this measure, policy makers may choose different options.
The following options would each achieve or nearly achieve solvency based on CBO's current law estimate of the short-fall -- but would have drastically different cash-flow effects.
|Percent of Shortfall Closed|
|Increase Payroll Tax by 2% by 2030||100%||50%||60%|
|Eliminate Taxable Maximum||100%||50%||30%|
|Implement Progressive Price Indexing, Protecting the Bottom 30%||90%||30%||110%|
|Index AIME and Bend Points in PIA Formula to Prices||110%||40%||130%|
Numbers based on percent of GDP and rounded to the nearest 10%
Notice that although these options would also achieve solvency, or at least come close, they would have very different cash flow implications. The second two options put the system on a sustainable path -- since they offer a growing amount of savings over time -- enough to close the cash-flow gap in 2080. The first two options have their own advantage though -- they tend to do more in the earlier years. When designing an entire reform package, policy makers should look to both minimize cash-flow deficits over the next few decades and ensure savings grow over time in order to lead to eventual cash-flow balance.
Achieving sustainable solvency is important for anyone serious about reform.
Check out our analysis of the Social Security Trustees report.
Today’s disappointing employment report (unexpectedly, June was revised downward and July was weak) prompted a Treasury rally, attributed by the financial press to safe haven flight once again. Deflation concerns however may have also driven investors. With prices rising for the benchmark 10-year note (and for most maturities), yields headed even lower on Friday after drifting downward most of the week. The unemployment news also resulted in stock market losses and a weakening of the dollar (as the prospect of lower interest rates in the US drove investors to seek higher returns elsewhere.)
The weak employment data appears to have increased downside risk concerns of market players. But, it is still early and there is a lot more July data to come. Another important signal about the outlook and policy stance may come next week when the Fed’s monetary policy setting body (the FOMC, or Federal Open Market Committee) meets (August 10).
Market players are focused on many of the same burning questions as the American taxpayer and our policymakers. In a nutshell, what is the outlook for the economy? Are we firmly entering recovery territory, will we go back into recession, or will we see positive but subpar growth (in earlier years, the term “growth recession” was used)? Are the risks on the side of deflation, inflation or neither? And what about persistent high unemployment and the still troubled housing market? When will our financial system get back to “normal”?
And what should policymakers do: should there be more fiscal stimulus (Zandi, Blinder, and Stiglitz have been making the case) or less (consider the debt, near peacetime highs as a share of the economy); can the two fiscal positions be reconciled; should there be additional monetary stimulus, possibly through more quantitative easing – or an unwinding of the Fed’s positions (newspaper leaks in the run-up to next week’s FOMC meeting suggest there may be a debate on precisely this question within the Fed)?
Treasury auctions may also be affected by diminishing supply over time. The Treasury Department has announced that it is gradually downsizing the amount of notes and bonds offered in its quarterly refunding auctions based on its economic projections. According to Treasury officials, future borrowing forecasts will also be based on the assumption that the 2001 upper tax bracket cuts will be allowed to expire as scheduled (President Obama’s budget proposals). Based on borrowing projections, Treasury does not expect to hit the debt ceiling limit (always controversial) until the first or second quarter 2011.
Today, the Social Security and Medicare Trustees released their annual reports on the financial status of the two programs. The Trustees now project that Social Security will face a deficit of $41 billion this year before returning to surplus in 2012. In 2015, deficits will return and will continue to rise thereafter, reaching 1.1 percent of taxable payroll in 2020 and 3.2 percent by 2030, before depleting the trust fund entirely by 2037. The graph below shows outlays and revenues of the Social Security program projected for future years, with revenues staying flat and outlays increasing significantly.
The Trustees’ Report shows the projected cost outlook for both Social Security and Medicare as worse than prior estimates, with combined costs amounting to 8.5 percent of GDP in 2010 and increasing to more than 17 percent by 2083. To put this number in perspective, total federal receipts in 2008 amounted to almost exactly the same 17 percent figure (and revenues over the past few years have been lower). Over the next several decades, the report asserts, “both Medicare and Social Security costs are projected to grow substantially faster than the economy, but tax income to the HI and OASDI trust funds will not.”
As soon as possible, and before the system dips into continual deficit operation, reforms are needed to ensure the program’s solvency for future generations.
CRFB has been calling for policymakers to set fiscal targets for some time. Apparently we haven’t been clear enough on what that means.
Unfortunately, some in Congress have put a bullseye on the few legislators courageous enough to offer ideas to reduce our mounting debt. The Hill today reports on leaders within the House Democratic caucus tearing into four junior members who were naïve enough to offer a measure to moderately reduce spending.
Congressmen John Adler, Gary Peters, Jim Himes, and Peter Welch were castigated for introducing an amendment to the Transportation, Housing and Urban Development spending bill that would have cut a few programs totaling $1.4 billion, out of a $126.1 billion spending bill. The four Democrats came under intense pressure from their own party and ultimately withdrew the amendment.
This episode not only proves how we got on an unsustainable budget path, but also underscores the utter dysfunction of Congress and why it is so difficult to change course. The overbearing reaction to a modest proposal to trim spending is completely irresponsible.
The U.S. faces a difficult situation. We must support a fragile recovery in the short term while keeping an eye on the long-term debt trajectory that threatens to precipitate an economic crisis somewhere down the road if left unchecked. True leadership and cooperation on sensible solutions will be required to overcome these challenges. Slapping the “stimulus” label on favored spending and tax cuts and brow-beating those brave enough to put reasonable ideas on the table is not leadership; it is the business-as-usual that got is into this predicament.
“The whole point of putting specific cuts on the table was to start a discussion. And boy, did we ever start a discussion. Discussion is maybe a euphemism for some of the pressure we came under,” The Hill quotes Himes. He is later quoted in the piece, “[i]n a sense, [the] experience has only reinforced what we believe, which is that we have a long way to go toward a sane discussion about fiscal responsibility.” Sadly, that is true.
The article also quotes Adler, “[w]hat I advocate, and what I think some other members of both parties advocate, is a more rigorous review of our current spending to eliminate unnecessary programs, or even programs that may be useful, but that aren’t vital right now, and aren’t stimulative to our economy but might end up just increasing our deficit in ways we can’t sustain.” Is this really such a revolutionary concept?
The four Congressman are also sponsors of the REDUCE Acts, which propose to cut the deficit by $70 billion over the next decade. Maybe they should bring bodyguards to the next caucus meeting.
When we call for fiscal targets, we mean that policymakers must set goals for reducing the debt and act within those goals; not set their sights on those willing to be fiscally responsible. Kudos to the four lawmakers who proposed modest measures to get the ball rolling on reducing the debt; let’s hope the terribly disappointing response from their colleagues is not a sign of what we can expect when we start talking about the much larger types of changes that will be necessary to fully deal with our debt problems.
The Wall Street Journal reports that a package of tax extenders might have a harder time getting by the PAYGO regime. Since the planned offsets were used up in the recent state aid package, Congress will need to find another way to pay for them.
The offsets, mostly involving changes to the foreign tax credit, would have been used to pay for these tax extenders, tax expenditures that are temporary but are routinely extended. The R&D credit, for example, is a "temporary" credit that was put in place during the first Reagan tax cut in 1981.
While it has been argued that giving tax expenditures sunset dates would force lawmakers to look more carefully at them when they came up for extension, that has not been the case in practice. But now with statutory PAYGO in place, legislators have to determine whether it's worthwhile to use up offsets on these tax breaks. Some of the extremely low hanging fruit has already been used on the the aforementioned state aid package, the HIRE Act, and an unemployment benefit extension enacted last November. It's possible the Senate will determine that the offsets will cut too deep and that they are not worth sacrificing for the extenders.
This is exactly how budgeting is supposed to work. It's all about trade-offs and priorities. If a program or a bill is important, then it should be paid for with less prioritized spending programs or with tax increases. We had none of this in the past decade and the result was clear: numerous deficit-exploding bills and an out-of-control budget.
This minor tax extender episode demonstrates the importance of a strong PAYGO system. It forces us to take a look at different programs and tax breaks and see what's worth keeping around and what can be "sacrificed" to pay for something else. Granted, this PAYGO system did allow for unpaid stimulus spending, but that means we should strengthen it, not write it off. It is an important tool for making government actually budget, instead of deficit-finance everything.
Yesterday morning, Richard Berner of Morgan Stanley, Simon Johnson of MIT, and Joel Naroff of Naroff Economic Advisors testified before the Senate Budget Committee on the state of the economy in the short-term and prospects down the road. All three displayed some concern about the vitality of the economy in the next few years, but they each focused on different aspects: the housing market, financial markets, and consumer spending, respectively.
Berner said that in the short run, the government should take steps improve both the housing situation and the employment situation. He noted that the Home Affordable Modification Program (HAMP) did not have sufficient scope (and has in fact shrunk in recent weeks) to address the foreclosure issue. He suggested both strengthening this program and other housing refinance programs, in addition to attempting to get borrowers to refinance government guaranteed loans. As for employment, he suggested a payroll tax credit (although there is already one in place through the end of this year) and job retraining efforts to mitigate the effects long unemployment has on workers' skills. Also, he said that extending the tax cuts "should reduce uncertainty as well as sustain fiscal stimulus."
Berner also re-affirmed his membership in the Announcement Effect Club when he discussed the positive effects that removing uncertainty would have on the economy.
Mr. Chairman, Ranking Member Gregg, your work as Commissioners on the National Commission on Fiscal Responsibility and Reform is critical. I know you agree that crafting a long-term credible plan to restore fiscal sustainability will ease concerns and uncertainty about future tax hikes and the potential loss of our safety nets.
Johnson focused on the importance of financial crises in the context of fiscal policy. As he notes, the serious deterioration in the medium-term fiscal outlook is mainly due to lower tax revenues from the financial crisis, and the crisis necessitated many actions which added significantly to the debt. He said that the Dodd-Frank bill would not do enough to prevent excessive risk-taking and future financial crises, so we might be in danger for another large jump in debt as a result. As for direct fiscal policy, he brought up the "big three" of new revenue sources: a VAT, carbon tax, and a financial activities tax levied on big banks. On the long-term situation, he said that to get Medicare spending under control, lawmakers should focus more on cutting the cost of health care rather than reducing the amount of health care Medicare pays for, since the latter would simply shift costs around and would be unproductive. Also, during questioning, he said that it was quite possible that there could be a shift away from US bonds (as Treasuries lose their safe haven status) as soon as next year, which underscores the importance of acting--though not actually cutting--now.
Naroff focused somewhat on consumer confidence in the short-run and how it relates to economic performance. He pointed out that there is a cycle between consumer confidence and business confidence, where depressed spending lowers business confidence, which limits their hiring, which hurts consumer confidence further. He added that uncertainty further aggravates this cycle. As for fiscal policy, he offered few specific recommendations, but seemed to be less bullish on demand-side stimulus measures than the other two, saying that "alternatives that produce less initial bang but more long term bucks should be considered....Public capital must be used judiciously and should maximize long term growth potential." Also, he repeated a line that we have said many times: we shouldn't wait until a crisis to deal with our long term debt problem, because then the fiscal adjustment will need to be drastic.
These testimonies came in the first of a series of hearings on the economy by the Budget Committee. This is truly important, because how we deal with both economic weakness and our deficit problems will be critical to the economic future of the U.S.
Since Social Security was signed into law by Franklin D. Roosevelt on August 14, 1935, it has become the largest government social insurance program in the world and the U.S. government’s single greatest expenditure, constituting $678 billion in outlays last year (about 5 percent of total U.S. GDP and 20 percent of the budget). Also known as OASDI (or Old Age, Survivors, and Disability Insurance), the Social Security system in the U.S. has developed into an important financial safety net for older Americans, as well as survivors and those with disabilities, providing them with a defined benefit during retirement in exchange for contributions through the payroll tax while they are in the workforce. In recent years, the Social Security program has paid out more than half a trillion dollars per year in benefits to more than 51 million American retirees, and with some estimates claiming that the program has been responsible for keeping up to 40 percent of Americans age 65 or older above the poverty line, its importance and positive impact are undeniable.
But with the Baby Boom generation beginning to retire in droves, the underlying financial structure of the program—with benefits for each generation of retiring workers being paid for by those currently in the workforce—will be strained because it must rely on an increasingly smaller workforce to support a growing proportion of retired Americans. With this ratio set to shrink significantly, calls for the reform of the Social Security system are becoming more and more urgent.
Without change, the Congressional Budget Office predicts that the program’s outlays will surpass revenues on an ongoing basis by 2016 and that the Social Security trust fund will be exhausted by 2043. The Trustees overseeing Social Security have issued even grimmer forecasts in the past; they are expected to issue their newest report on the state of the program tomorrow. The release of the report will no doubt highlight that Social Security is on an unsustainable path and likely stir new debate over what should be done to bolster its long-term finances.
Because the financial problems with Social Security won't come to a head for many years, policymakers have been loath to deal with the issue. But reforming the system now would be the more responsible course of action. The sooner we act, the more gradually changes can be implemented, allowing more options to be considered and giving those affected more time to adjust to any changes.
Everything must be on the table, including adjustments to both the benefits and the revenues side. Lawmakers must work in a bipartisan manner to devise a balanced set of reforms that will strengthen the program so that it will be around for future generations. If reform is done well, it can also help improve the long-term budget outlook for the nation.
Social Security will celebrate 75 years on August 14. Leading up to that momentous milestone, CRFB will post a series of blogs through next week looking at the program and how it can be reformed. We celebrate Social Security's 75th birthday and look forward to celebrating the next 75 years and beyond.
Finally, the Senate got it right: we have a deficit-neutral stimulus. In fact, the bill would even slightly reduce deficits by $1.4 billion over the coming decade, according to CBO. After months of failed attempts to pass deficit-increasing stimulus packages, Senate Democrats just cleared a hurdle this morning by successfully invoking cloture on the $26.1 billion package, and final passage in the Senate is expected shortly. The package includes an education jobs fund, which was previously attached to (and subsequently removed from) a supplemental bill and an extension of the increased Medicaid payments to states -- previously dropped from HR 4213. The two provisions would cost $10 billion and $16 billion, respectively. According to CBO, transfer payments to state governments have among the highest bang-for-buck (its multiplier ranging from 0.7 to 1.8), so it's good that in doing a stimulus, the Senate chose both effective policies and a fiscally responsible way of doing them.
|Education Jobs Fund||$10|
|Medicaid AMP Provision||-$2|
|Food Stamp Reduction in 2014||-$11.9|
|Eliminate Advanced Refundability of EITC||-$1|
|Other Revenue Offsets
Since the cost is not that big, it isn't hard for Senators to find offsets. The most notable offset is an early termination of the ARRA increase in food stamp benefits. The one-time increase was supposed to last until 2014, when the normal inflation-adjusted benefit caught up and overtook the ARRA benefit; however, CBO estimated earlier this year that the benefit would not catch up until 2018. This offset would simply terminate the ARRA benefit in March 2014. Another spending offset is a minor change to the Medicaid AMP, the drug reimbursement formula. Other deficit-reducing changes are mostly minor tax provisions, including the elimination of the advanced EITC -- a move the Administration has called for since last year--and many changes relating to the taxation of foreign income and subsidiaries.
CBO estimated that the bill would reduce deficits by about $1.4 billion from 2010-2020. It was tabled earlier in the week after it was discovered that it would increase deficits by $5 billion. Subsequent changes were made.
We're glad that legislators are getting the message. Lawmakers have decided that additional state support was necessary and then offset those costs over the coming decade, providing short-term spending boosts without further jeopardizing our fiscal health -- exactly what CRFB has been recommending should lawmakers and economists agree that additional spending is needed. After the debacle with HR 4213, when provision after provision was stripped away until a deficit-financed unemployment extension was passed, this bill provides stimulus in a fiscally responsible way. But this is just the beginning of fiscal responsibility -- when you're in a hole, the first thing you need to do is stop digging. There will be plenty more for both Democrats and Republicans to do over the coming months to actually begin reducing deficits in significant ways.
We will have this package up on Stimulus.org as soon as it becomes law.
The Senate appears headed toward cutting discretionary spending even below the level called for by Senate appropriators. Senate Majority Leader Harry Reid (D-Nev.) said on the Senate floor this week that he has an informal agreement with Republican leaders that spending be capped at $1.08 trillion, less than the $1.114 trillion established by Senate appropriators in their subcommittee allocations. That is the amount called for in the spending plan offered by Sens. Claire McCaskill (D-Mo.) and Jeff Sessions (R-Ala.)
Since there was no agreement on a Fiscal 2011 budget resolution, each committee is working from its own bottom-line discretionary spending total. The House Appropriations Committee's allocations total $1.121 trillion. In many past years, the Senate has proposed spending more on discretionary programs than the House proposed, but that's clearly not the case here. This year, many allocations also are set below last year's funding level and below President Obama's budget request. The President requested a discretionary spending level of $1.128 trillion. Last year, Congress and the President agreed to spend almost $1.090 trillion
The McCaskill-Sessions plan, which the senators have offered as amendments to other legislation, would cap discretionary spending for five years; but since appropriations action in Congress only covers one year, it is unlikely that the Senate will agree to multi-year caps this year. Adopting the McCaskill-Sessions plan for one year is a start. But we believe that a comprehensive plan that would include multi-year spending caps should be the next step.
While discretionary spending makes up only 40 percent of the budget, it has grown faster than inflation in recent years. And along with strong PAYGO rules, spending caps can help keep the debt crisis from getting worse.
With Peter Orszag leaving OMB last Friday and Jacob Lew yet to be sworn in, Jeff Zients has been called in to fill the gap as acting director of OMB. Zients currently serves as Chief Performance Officer of the Federal Government, the first person ever to hold that position.
Naturally, his first blog post on OMB's website focused on program performance evaluations. His post linked to a memo written to agencies by OMB on Thursday (when Orszag was still director), directing them on how to conduct voluntary program evaluations that OMB has set aside some money for. As Zients said, "Running rigorous evaluations takes money, but investments in rigorous evaluations are a drop in the bucket relative to the dollars at risk of being poorly spent when we fail to learn what works and what doesn’t."
While his tenure may be very short, we hope that his emphasis on program evaluation is taken to heart by the next OMB director. This emphasis on program efficacy, combined with an eye towards what our priorities are, can be very useful as the government shifts from stimulus to cutting back over the next few years.
Welcome to OMB, Jeff, even if it's only for a short time.
House Gone, Senate Eyeing the Exit – The House started its six-week recess Friday and the Senate will adjourn at the end of this week. Debate and a vote on the nomination of Elena Kagan to the Supreme Court is expected to take up a lot of the schedule, and oxygen, this week for senators.
War Supplemental Adopted – The president signed a supplemental spending bill to finance operations in Iraq and Afghanistan last week after a protracted battle in Congress over additional domestic spending that the House tried to tack on. In the end that extra spending was dropped. The bill also includes $2.8 billion to support relief efforts in Haiti; $5.1 billion to FEMA’s Disaster Relief Fund; 13.4 billion for Vietnam veterans exposed to Agent Orange and about $112 million for activities relating to the Gulf Coast oil spill. The bill’s total cost of $59 billion was deemed emergency spending, and thus not offset.
Small Business Bill Languishes in Senate – The Senate failed to break a filibuster last week to vote on legislation providing $12 billion in tax breaks and a $30 billion lending fund for small businesses. Without an agreement between Democrats and Republicans on the number of amendments that will be considered, no action will occur this week.
Approps Pause – Despite some activity last week, the FY 2011 appropriations process remains behind schedule, and not much action is expected in the Senate this week, increasing the likelihood of an omnibus spending bill after the elections.
Senate to Vote Today on State Funding – Later today the Senate will hold a cloture vote on a measure to provide $10 billion to states and localities to avoid teacher layoffs and $16 billion for a six-month extension of Medicaid aid to states. The total cost is offset through closing foreign tax credit loopholes, cuts in Medicare drug pricing, spending rescissions, and ending an increase in food stamp funding that was included in the stimulus.
CBO Speaks on Possible Fiscal Crisis – Last week the Congressional Budget Office released a report on “Federal Debt and the Risk of a Fiscal Crisis.” CBO echoed CRFB’s contention that our mounting debt could precipitate a fiscal crisis, either gradually or abruptly.
Fiscal Commission Hears from CRFB – CRFB President Maya MacGuineas and board member Barry Anderson testified before the White House National Commission on Fiscal Responsibility and Reform last week. MacGuineas discussed the work of groups like the Peterson-Pew Commission on Budget Reform and the need for a credible fiscal plan. Anderson testified on lessons to be learned from other countries.
Deficit Will be Big Issue at the Ballot Box – According to a recent Congressional Connections poll, more Americans support reducing the federal budget deficit to cutting taxes or increasing spending to stimulate the economy. And candidates are making the deficit a campaign issue as the mid-term elections draw near.
Budget Committee Will Look at Economy – The Senate Budget Committee will hold a hearing tomorrow on “A Status Report on the U.S. Economy.” Witnesses will be Richard Berner of Morgan Stanley; Simon Johnson of MIT, and Joel Naroff of Naroff Economic Advisers.
A few weeks ago, Fiscal Commission co-chair Erskine Bowles suggested that in designing a plan, "revenue as a percentage of GDP [should not] be much higher than 21%... [and] we have to work to make the tough choices to bring spending down to the same level"
Earlier this week, both Matt Miller and the Center on Budget and Policy Priorities criticized this spending target as far too low. Though we agree that spending cannot be brought down to its historical average overnight, we think that Bowles' goal of letting revenues rise to 21 percent of GDP and eventually bringing spending down to that level is perfectly reasonable. If we don't get spending under control, we can't hope to control our rising debt over the long-run.
In criticizing this 21 percent goal, Miller argued that "federal spending under Ronald Reagan averaged 22 percent of GDP. Under Bowles's view, therefore, the outer limits of the Democratic Party's 21st-century aspirations would be to run government at a size smaller than did a 20th-century conservative icon... [and] Reagan ran government at this size at a time when 76 million baby boomers weren't about to hit their rocking chairs."
CBPP relies on three basic arguments:
- Population aging and health care cost growth means that our biggest programs will cost more than they used to.
- The government has taken on new responsibilities by enacting new programs.
- Interest on the debt will cost more in the future than it has historically, due to higher levels of debt
Let's address these arguments one at a time.
Miller suggests that bringing spending down to 21 percent of GDP would mean having a smaller state than we did under "conservative icon" Ronald Reagan. Well Reagan may have been a conservative icon, but he did not oversee a small government by any means. In fact, spending as a percent of GDP was larger under Reagan than any other time since World War II, save the current situation. In other words, getting spending down to 21 percent of GDP means spending less than during an era where spending was at its highest, not at its lowest as Miller implies.
During the Clinton Administration spending averaged less than 20 percent of GDP. And by the end of his presidency, it was down to just over 18 percent of GDP. So spending at 21 percent of GDP means spending 1 to 3 percentage points more than our last Democratic president.
That brings us to Miller's second argument (which is also CBPP's first argument): that health care cost growth and population aging threaten to make the same government programs cost far more -- and are already doing so. This is a fair point; as the baby boomers retire and health care grows faster than the economy, the cost of Social Security, Medicare, and Medicaid will skyrocket. But here, we as a society need to make a choice: do we want to maintain historical levels of services, historical levels of spending (and therefore taxes) for these services, or do something in between?
The answer is almost definitely the third, since the first choice is unsustainable and the second choice is unrealistic. In other words, as certain programs tend to become more expensive, we need to do a better job of targeting spending toward where it is needed most -- making hard choices about what we are and aren't willing to spend our scarce resources on. At the same time, of course, we should be trying to attack these drivers directly by encouraging longer working lives and more savings, and by bending the health care cost curve.
We also can't help but point out that while costs of Social Security and Medicare tend to rise faster than GDP, there is no reason that the costs of other programs need to. Defense has already come down significantly since President Reagan was in office, and can come down far more as the wars in Iraq and Afghanistan wind down and as we actually begin to carefully scrutinize normal defense spending. There are many other areas of spending that can and should grow slower than the economy, and others which should shrink or be eliminated altogether.
But what about CBPP's second point, that the government has many new responsibilities now? Maybe so, but governing is about prioritizing. Would Americans be willing to pay higher taxes for a generous Medicare prescription drug plan? For more federal education spending? For larger farm subsidies? Maybe, but since most of these costs have been deficit-financed, we can't know for sure. And if there are newer needs which the government has had to meet, certainly there are older needs toward which the government should no longer be dedicating resources. Let's have that debate, and decide what the government should and shouldn't be spending its money on.
And then there is CBPP's interest argument: the debt is higher, and therefore interest payments are -- so spending will inevitably be a greater share of GDP. Yet if we actually move toward a balanced budget, this simply won't be true. As we bring down the debt, as a share of the economy, it will create a virtuous cycle of deficit reduction. Lower debt means less interest payments means lower spending means lower debt. Not to mention the potential for stronger economic growth (and therefore greater revenues and a higher GDP denominator) which many economists believe will accompany debt reduction.
All these arguments aside, let's keep in mind two things. First, bringing revenues up to 21 percent of GDP would suggest a 3 percentage point increase from the historical average for revenues, and it would mean higher levels of revenue than ever before. Given the fiscal situation, this new normal may indeed be warranted. But taxes cannot do all the lifting -- we need to first and foremost control spending growth. In addition, its important to think about 21 percent of GDP as an aspirational goal for spending; it is what is necessary to balance the budget. Even if we can't get all the way there, as long as our economy is growing faster than our borrowing, we can bring down our debt-to-GDP ratio.
While there is certainly no magic number, 21 percent sounds like a pretty reasonable goal to us.
Sen. John Thune (R-SD) introduced a deficit reduction and budget reform bill yesterday, aptly titled the Deficit Reduction and Budget Reform Act of 2010. The bill sets (non-security) discretionary spending limits and makes numerous changes to the budget process.
Thune doesn't stipulate specific discretionary spending amounts, but his bill does specify that for every year there is a budget deficit, non-security discretionary spending is limited to the FY 2008 level adjusted for inflation. The unclear part is whether the starting point, FY 2011, is the FY 2008 number unadjusted or if the starting point is the FY 2008 number adjusted for inflation. While it may seem like minor semantics, the difference actually is pretty significant: about $20 billion per year. In addition to the discretionary caps, Thune also included an oft-used, more-oft-ignored provision to end all unobligated ARRA spending.
Add another solid idea to the growing list of proposals to help improve federal budgeting and put the country on a sustainable fiscal course. Representatives Gabrielle Giffords (D-AZ) and Charles Djou (R-HI) yesterday introduced the Truth in Spending Act (H.R. 5954).
The new bill is a modest, yet important, step towards more fiscal accountability in Washington. It recognizes that while cost estimates of legislation from the Congressional Budget Office are objective and represent the best effort to project future costs, predicting the budgetary impact of a bill many years from now is tricky business.
The bill requires the Office of Management and Budget to review cost estimates of legislation five and ten years after it has been enacted. If the costs are higher or savings lower than initially projected, Congress must rectify the discrepancy through a fast-track legislative process. The measure also covers legislation adopted since 2005.
Giffords and Djou explained in The Hill, “We can get a handle on the federal deficit by putting teeth into the cost estimates that legislation is built upon.” It will take a lot more to overcome the mounting debt, but this a good step in the right direction. CRFB applauds the two Members and their over 30 co-sponsors for this thoughtful idea and we hope more lawmakers will follow suit in advancing specific solutions to improve our budget process and fiscal outlook.
The week saw ups and downs of interest in Treasury debt instruments on the margin. Foreign interest backed off a little as perceptions of risk: return trade-offs shifted, like a yo-yo. The week ended with Treasury yields near record or recent lows, a positive sign of strong demand. Debt remains cheap – for now.
As traders wrapped up for the month and the weekend, they turned their focus back to Treasury debt instruments. As a result, demand for the benchmark 10-year note rose as of Friday morning. Safe haven effects appeared to have kicked in again, as higher demand reflected weaker than expected US second quarter GDP news (+2.4%, a slowdown from the first quarter). Investor concerns over a weakening economy were also raised by recent statements about economic weakness by several regional Fed Bank Presidents. (Demand was also bolstered by the need for fund managers to buy Treasuries to match adjustments in their indexes for end of the month internal housekeeping.) As a result, the yield on the 10-year note was below 3% once again, close to one of the lowest point since the recession began. Similar trends can be seen for debt at other maturities.
But markets can shift quickly – at least at the margin. In contrast to today’s interest, yesterday’s Treasury auctions (the end of this week’s $104 billion government note auction) were considered disappointing. Reports blamed tepid interest from foreign central banks and investors, possibly due to low interest rates, which did not provide sufficient return. Foreign interest is not considered to have shifted in a fundamental way.
Signaling their desire to be more austere, House and Senate appropriators continued pushing their Fiscal 2011 spending bills through the system this week, as the first measures went to the House Floor. The House passed its Transportation-HUD spending bill. It contains $67 billion in discretionary funding, which is $800 million below this year and $1.6 billion below President Obama's budget. House Republicans opposed the bill, saying the funding levels still were too high. The House also passed its version of the Military Construction-Veterans Affairs bill; its $76 billion in discretionary spending amounts to a 1 percent cut below the current fiscal year and is equal to President Obama's request.
Even the popular Labor-Health and Human Services and Education spending bill is more austere than in many years. The Senate Appropriations Committee approved its bill containing $169 billion in discretionary spending; a $5.9 billion boost from last year, but $986 million below the President's request.
Since there was no agreement on a Fiscal 2011 budget resolution, each committee is working from its own bottom-line discretionary spending total. The House Appropriations Committee's allocations total $1.121 trillion; the Senate's allocations total $1.114 trillion. In many past years, the Senate has proposed spending more on discretionary programs than the House proposed. This year, many allocations also are set below last year's funding level and below President Obama's budget request. The President requested a discretionary spending level of $1.128 trillion. Last year, Congress and the President agreed to spend almost $1.090 trillion.
While the House and Senate committees appear to be slogging through the bills, the process is likely to grind to a halt sometime this fall. At that point, Congress may well pass a Continuing Resolution funding most programs at current levels until sometime after the election. The House and Senate are likely to make most critical funding decisions during a lame duck session.
Ever since health care reform passed in March, it's had a huge target on its back by those who want to repeal it. Unfortunately, the bullseye for some is on one of the Medicare cost-control provisions in the legislation that is essential to bending the health care cost curve down.
The Independent Payment Advisory Board (IPAB) is charged with finding ways to reduce Medicare spending when it exceeds certain limits. Its recommendations are subject to an up-or-down vote by Congress. If they are not approved, then Congress must find equivalent savings elsewhere. After six months, if Congress fails to act either with IPAB's recommendations or their own, the Department of Health and Human Services can implement the original IPAB policies.
Five senators--John Cornyn, Jon Kyl, Orrin Hatch, Pat Roberts, and Tom Coburn--are leading the charge to repeal IPAB. They object to essentially taking away the decision-making power from Congress (although that isn't really the case) and putting it into the hands of unelected officials.
Elected officials have had plenty of opportunities to take significant steps to control the growth of Medicare. Currently, a Medicare commission already exists--the Medicare Payment Advisory Commission--but its recommendations are non-binding and have been consistently ignored by Congress. And as Ezra Klein has said, when Congress is unwilling to take action on something, "the result isn't inaction, but non-congressional forms of action." That is what we are seeing here.
We have argued that cost-control provisions like IPAB need to be strengthened, not repealed, especially considering how important controlling cost growth is to our long-term fiscal health. IPAB is a good step towards forcing Congress to act, when inaction has been the default option.
We've suggested ways to strengthen IPAB to better control Medicare growth, mainly by "spreading the pain." The current scope of the Board mainly only allows it to deal with provider payments, but this approach has raised concerns about reduced access. If the scope of IPAB is widened to include changes to beneficiary costs and eligibility rules, it would be a more effective cost control method than one that simply relies on reducing provider payments.
Improving IPAB should certainly be looked at, but repeal should be out of the question unless opponents propose an alternative way to control costs.