The Bottom Line
Appearing at his old alma mater, the Brookings Institution, Wednesday, Peter Orszag bid adieu to public sector employment in his final public appearance as director of OMB. He will officially leave the Obama administration Friday, but the Brookings event amounted to his “Greatest Hits” as budget director. Orszag focused on three main areas in his speech: reviewing the effects of the stimulus, discussing the budgetary implications of the new health care bill, and outlining some interesting ways that OMB has worked to modernize the federal government.
Beginning with the stimulus, he cited reports by economists Alan Blinder and Mark Zandi and analysis by CBO as evidence of its success. Questioned about whether it should have been bigger, Orszag responded with a politically realistic response, politely, answering that, (paraphrasing) “I was in the room, and there was 0.0000% chance politically of a bigger package.”
Moving on to healthcare, he stressed the importance of fully implementing its reforms to ensure that the deficit-cutting measures, which he said could reach $1 trillion in the second decade, actually occur. When discussing health alternatives Orszag respectfully dismissed Rep. Paul Ryan’s recent proposal, taking issue with its inability to address the highest-cost quarter of Medicare patients, who absorb an astonishing 85% of Medicare costs.
Finally, on the less sexy part of the job, Orszag described some efforts that OMB has taken to modernize the government while simultaneously curtailing waste. They included some obvious decisions, such as updating computer systems to ensure sure that entitlement payments were not being made to dead people or felons.
The Brookings setting was friendly and familiar – save one sonorous interloper. The man introduced himself as a representative of a Lyndon LaRouche PAC and launched into a song deriding the policies that Orszag, Larry Summers and President Obama have implemented. It was colorful to say the least, and not the type of serenade the sexy budget nerd expected. But Orszag handled it well, quipping to Ruth Marcus that her question must be in verse form.
Orszag concluded his presentation by thanking the Obama administration for giving him the chance to head OMB. CRFB, also, would like to sincerely thank Orszag for his dedication to our nation’s fiscal future, and wish him luck as he moves on to the Council on Foreign Relations.
This morning, CRFB president Maya MacGuineas will testify before the National Commission on Fiscal Responsibility and Reform, an executive committee formed by President Obama to tackle our nation's mounting fiscal crisis. The topics covered will be broad, but the focus must be on fixing America's unsustainable fiscal situation.
You can watch video of the testimony and the Commission meeting here.
"The current fiscal path of the federal government is unsustainable." This sentence begins any discussion about the future of US fiscal policy and CBO uses it a lot. But when they go into detail about the increased possibility of a fiscal crisis related to our rising fiscal debt picture, it's bound to raise some eyebrows on Capitol Hill - not to mention sending shivers down some spines on both sides of the aisle.
We'd like to think that we were the inspiration for this more detailed brief. After all, we did write a paper talking about the increased risk of a debt crisis if US fiscal conditions were left on auto pilot. We looked at different possibilities of how a fiscal crisis could play out in the US, based on real-life points of vulnerability in the US economy. The paper (and others - by Len Burman and Fred Bergsten) was discussed by an impressive group of experts (including CBO Director Elmendorf) at a CRFB event.
CBO doesn't go into specific scenarios as we did. But it puts us all on notice that there's a new kid on the block: as we think about negative consequences from our rising fiscal debt, add the increased chance of a fiscal crisis to our tried and true standard list of worries (eg, the crowding out of investment, the crowding out of fiscal priorities, the need to raise taxes and/or cut spending simply to keep up with debt service on existing debt; and the lack of flexibility when faced with a new or unexpected problem domestically or internationally.)
What makes normal tough fiscal situations turn into crises? Sometimes, tough debt situations can be managed, but, under certain conditions, CBO writes, an already daunting fiscal management challenge can suddenly turn to a crisis. A country with low domestic savings like the United States is particularly vulnerable - even if its "safe haven" status has allowed it to more freely issue debt under altogether different circumstances. Another cautionary note for the United States, countries already in recession are also quite vulnerable, particularly if new borrowing requirements pop up unexpectedly and investors lose confidence.
While the lessons of fiscal crises elsewhere do not "necessarily" apply to the United States, CBO notes that their main elements can be instructive. First, the situation can deteriorate very rapidly. In Ireland and Greece, changes in interest rates happened quickly. Two years ago, interest rates on their ten year bonds were less than a percentage point higher than Germany's. Right now, the spread is at about three percentage points for Ireland and eight percentage points for Greece. In both countries, they had to undertake austerity measures, despite adverse economic conditions. In Argentina's case, the early 2000s recession exacerbated their fiscal situation, and due to their past history of defaulting on debt, interest rates quickly spiraled out of control until Argentina simply ceased to pay its creditors. It has had trouble borrowing since then.
In all three of these cases, fiscal crisis resulted in part from recessions that significantly raised each country's debt burden. Plus, there were other factors making each country highly vulnerable to a collapse in confidence under certain circumstances. In Ireland's case, the country's rapid growth path had been based on high leverage. In Greece, growth was also deficit financed, plus extremely high unfunded liabilities were hidden and announced in a fiscal information shock. Greece's fiscal credibility (and also, by the way, the eurozone's) was undermined. In these cases, to sustain financing at a reasonable interest rate cost, governments were forced to tighten fiscal policy during a recession, setting off the growth-deficit spiral.
The timing of fiscal crises underscores the importance of prudent fiscal policy during good times. The possible aftermath in the US of a sudden fiscal crisis is not pretty: restructuring of debt, inflationary monetary policy (to remedy the crisis), and drastic fiscal austerity. All of these options would be extremely painful and the first two would severely hamper the ability of the federal government to borrow in the future.
The bottom line is: why take the chance that we can muddle through? CBO has given us a warning: it is better to put our fiscal house back in order on our own terms rather than to be forced by our creditors to take a hachet to our standard of living. We still have a window of opportunity to get it right.
The OMB's Mid-Session Review (MSR) came out late on Friday afternoon with no fanfare from the Administration (though we did put out a paper yesterday). While the MSR showed improvement in the 2010 deficit number (the fiscal year that ends in September), there was little change in the ten year deficit and debt projections. However, the one number that jumped out for those who took a closer look was the much higher deficit projection for FY 2011, almost a full percentage point of GDP higher. Similarly, for 2012, the deficit is now foreseen at 5.6% of GDP - above February's view of 5.1%.
The $150 billion jump in deficits for 2011 is almost entirely accounted for by a drop in revenue. OMB projects the government to collect a full percentage point of GDP less in revenue in 2011 than it predicted back in February. In fact, over just the next three years (not including 2010), OMB has revised its estimate of revenue downward by $339 billion.
But revisions for this and the next two years do not lend themselves to a simple story, unfortunately. The difference is not because the economy was weaker than expected - at least as still forecast by the Administration for this year. The revisions essentially reflect what the Administration calls "technical" re-estimates related to how much revenue is raised from a given amount of income, based on new tax collection data. Although there can be a fine line between economic versus technical revisions, in this case the culprit appears to be “technical”. (The revisions also reflect some shifting of tax relief measures – revenue losers - expected to be in place earlier into 2011 – the Administration gives the example of accelerated depreciation of new business investment.) However, we'll see later this week whether this "technical" revision portends a downward revision of GDP as well, when the Bureau of Economic Analysis does its annual benchmark revisions. This might not be a good thing for the fiscal picture.
This is not to elevate technical matters above economic projections. The projections are very important, in fact, when discussing the President's Budget and the MSR. The Administration's projections, while still in the reasonable range, are actually on the high side (or the low side, in the case of inflation and interest rates) compared to most estimates. This perspective makes a huge difference, since economic projections change both the numerator (both revenue and spending effects) and the denominator of the debt-to-GDP ratio. Thus, small differences in predictions can make large differences in debt projections - especially over time.
These differences are borne out when comparing the MSR and the latest Blue Chip forecast. The Blue Chip, an average of some 50 top forecasters, is the widely used proxy for the reasonable market view. It has a much less bullish forecast for 2011, which, if it is more realistic, could mean deficit numbers reaching 2010 levels for that year. The MSR is usually also compared to the CBO's estimate of the President's Budget, but their economic estimate is from March and it is difficult to say whether they would revise their numbers up or down; they are currently in the process of doing that.
We believe in being prudent or conservative in economic estimates, to prepare more for downside risks. A prudential forecast will provide more fiscal room for maneuver in the case of problems - and it will yield dividends in the form of unanticipated additional revenue, if things are better than expected. Other countries take this approach, which is considered quite useful fiscal management.
How realistic is the Administration's near-term economic outlook? It’s hard to say, with cross currents in the economy making any read quite difficult. But, if additional stimulus is nonetheless pursued, it should be done by pairing short-term stimulus with a medium-term deficit reduction plan. As we have said many times, this would provide a boost to the economy not just from the stimulus of demand, but, through the expectations channel, contribute to downward pressure on interest rates. That way, the Administration could hopefully fulfill its growth projections and make the necessary fiscal adjustment more manageable.
But, parse as we might the near-term outlook, the bottom line remains the same: while our debt path will show some improvement as the economy recovers and stimulus spending ends, it will set out on a new path that is not sustainable, particularly once the fiscal costs of an aging population kick in.
If You Can’t Stand the Heat… – Washington has been experiencing a heat wave, but it can’t all be blamed on the friction between the two parties. Before members of the House can escape at the end of the week for a long break, they must complete work on the war supplemental that has bounced around more than a beach ball. The Senate will stay an extra week before its month-long recess and will try to complete a small business measure amid votes on the Elena Kagan nomination to the Supreme Court, campaign finance reform, and energy legislation.
War Supplemental a Hot Potato – A measure to fund operations in Iraq and Afghanistan has gone back and forth between the two chambers as $23 billion in domestic spending added by the House has made it too hot to handle for the Senate. On Thursday the Senate sent back the version it originally passed without spending for domestic items like aid for teachers and summer jobs after a test vote on the House version came well short of the votes needed. The House wants to send a bill to the president this week so that funding for the troops is not affected. The likeliest outcome is for the House to adopt the Senate version and try later to attach the domestic funding to other legislation.
Trying to Keep the Small Business Fires Burning – The Senate is moving slowly on legislation to aid small businesses. Leaders agreed to drop a $30 billion lending program that some criticized as TARP junior only to have an amendment reinstating the fund get 60 votes to end a filibuster. Some senators are also pushing a divisive amendment reinstating the estate tax at lower levels. Leaders still need to reach agreement to bring the bill to a final vote.
Heat Turning Up for Tax Cuts – The issue of what to do about tax cuts set to expire at the end of the year is getting more attention as the expiration date draws near. The Senate Finance Committee recently convened a hearing on the topic and members held a private meeting last week, with the possibility of a committee mark-up before the recess. President Obama has recommended permanently extending the tax cuts for families making under $250,000 a year, but not all lawmakers are on board. The idea of extending the tax cuts for two years is gaining traction. It could have the affect of aiding the recovery in the short run and providing a space for much-needed fundamental tax reform to be considered. The House has said it will let the Senate go first on this difficult issue. Some have suggested that the costs of extending the tax cuts should not have to be offset. CRFB countered this argument in a blog post last week.
Social Security a Hot Topic – In advance of its 75th anniversary next month and a report expected soon from those overseeing the program that will highlight the need to shore up the finances of Social Security, possible reform is being discussed. Leaders from both parties in the House separately broached the idea recently of making adjustments to improve its long-term solvency. The idea of raising the retirement age is being discussed as a part of reform. This comes as more Americans doubt that Social Security will be there for them. A recent USA Today/Gallup poll indicates that a majority of non-retirees don’t think they will get benefits when they retire. The proportion is much higher among younger workers.
Four Congressmen Seek to REDUCE the Budget Heat – Last week four legislators introduced a package of legislation to reduce the national deficit by more than $70 billion over the next decade. The four bills, collectively known as the REDUCE Acts, cover defense, agriculture, the treasury, and energy.
Voters Cold to Congress – According to the latest Gallup poll, only 17 percent of voters have confidence in Congress, an all-time low. This comes as lawmakers have been unable to adopt a basic budget blueprint or to address long-term debt.
Mid-Session Review Released – The White House released its Mid-Session Review on Friday. It showed slight improvement for the deficit outlook this year, but a dreary picture in the longer term. See here and here for initial analysis from CRFB and check back soon for a more in-depth examination.
The OMB released its Mid-Session Review today (see our press release here), showing slightly improved deficit numbers for this year, but still an alarming outlook over the next decade. They estimate that deficits will total about $8.47 trillion over the next ten years, about a $100 billion improvement over their projections in the President's budget in February. Debt held by the public is projected to reach $18.5 trillion or 77.4 percent of GDP.
In the short term, the deficit picture has both improvement and deterioration from February. The 2010 deficit number, $1.47 trillion, has improved by about $60 billion due to lower than expected unemployment, desposit insurance, and discretionary outlays, along with high than anticipated TARP repurchases (follow TARP repurchases on Stimulus.org). On the flip side, 2011 looks worse, with a deficit eerily similar to 2010 at $1.42 trillion. This is mostly due to lower projected revenues, but also due to the health care law and other legislative changes made since February.
|Billions of Dollars
|Percent of GDP|
Over the longer-term, the deficit and debt trajectory looks relatively similar to how it did in the President's budget. The deficit will come down from its high this year, declining to a low of $698 billion (3.8 percent of GDP) by 2014. Then, as the recovery is fully in place (hopefully) and the effects of the baby boomers start to kick in full force, the deficit increases, especially towards the end of the decade, up to $900 billion (still 3.8 percent of GDP) by 2020. Unfortunately, our goal isn't to stabilize the deficit as a percentage of GDP.
Overall, though, the outlook remains the same: gloomy. We have to get going on a plan to make these numbers significantly better.
Check out our press release on the Mid-Session Review and be sure to check back with CRFB next week for more on this subject.
In an op-ed for the Wall Street Journal this Wednesday, Martin Feldstein discusses the pivotal role of tax expenditures in increasing the federal deficit and how they should be considered, perhaps even more than direct spending cuts, in reducing the deficit as well. Tax expenditures are the special tax breaks that indirectly subsidize spending on education, healthcare, and other programs and, accordingly, cause the government to lose substantial amounts of revenue—this year, about $1 trillion.
Feldstein notes that despite Obama’s call to freeze nondefense discretionary spending, he has also advocated substantial increases in some of the most politically popular tax expenditures on the books today, which could dramatically undermine if not negate entirely any plans for deficit reduction. To date, Feldstein notes, neither Democrats nor Republicans have given significant attention to the large revenue drain caused by tax expenditures—but, he argues, eliminating some of the biggest tax expenditures would increase revenues and economic efficiency, while not increasing marginal tax rates at all. Total tax expenditures today form 6.4 percent of GDP, and while they shouldn’t be completely cut, they could be significantly (as was done under Reagan in 1986 with a combined tax break). Feldstein states that cutting them 2 percent would reduce the national debt by 18 percent in 2020, or some $4 trillion.
Tax expenditures are indeed an oft-overlooked yet very promising method of effectively cutting spending that we all must consider, especially at a time when deficit reduction is a more pressing issue than ever before.
As of mid-morning Friday, U.S. and overseas markets await the results of the stress tests conducted on European banks, to be released at noon. Based on the Fed’s stress tests of U.S. banks, the idea is to give markets credible information (and presumably assurances) about the financial condition of individual European banks, which have been under great pressure from the fiscal crisis in the eurozone.
The stress test results are also important for U.S. financial markets, which have critical linkages to European financial markets in our era of global capital. Important global capital relationships underpin our financial sector funding, trade, and investment flows.
But we fiscal wonks have seen a downside of these linkages. Important spillover effects from the eurozone fiscal and financial crisis have lowered US interest rates more than U.S. economic fundamentals would warrant. Investors seeking a safe haven in the face of increased – but unknown – risk from the eurozone, have turned increasingly to Treasury debt instruments in what is often called “a flight to quality”. As a consequence, we have been able to finance our massive debt far more easily than otherwise. While in some ways this is a good thing (U.S. debt service is cheaper and so needed stimulus measures have cost less than in normal times), the bottom line is that it makes us all think that debt has no cost. Fred Bergsten of the Peterson Institute for International Economics has led the chorus in saying that maybe we shouldn’t be so fortunate that our massive debt is financed so easily. Yields on government debt this week remain unusually low (at the long end, below 3 percent for the 10-year note and below 4 percent for the 30-year note) as a result.
Among factors driving the markets this week have been concerns that the US economy is slowing more than expected (and may be slowing relative to Europe, which had a series of better than expected economic news). Chairman Bernanke’s semi-annual monetary policy report to Congress this week drove sentiment here – which was confirmed by persistent weak housing and unemployment reports. Some reports suggest that markets are concerned about deflation, but trading positions do not yet confirm the worry.
At a time when Social Security is increasingly getting lawmakers' attention for the possibility of reform, raising the retirement age is starting to emerge as one of the more palatable options. Coincidentally, the Urban Institute held an event on it recently at the exact same time the Senate held a hearing about older Americans' participation in the labor force. The two issues are very much intertwined and many other issues also combine to raise questions about how we balance retirement security, health security, labor force participation, and fiscal sustainability in an effective way.
The normal retirement age (NRA) currently sits at 66, having been bumped up from 65 gradually. It is scheduled to increase again starting in 2017, increasing two months each year until it reaches 67 in 2022. There has been talk of further increasing the retirement age to 68 or even 70, justified by the fact that life expectancy has increased significantly since Social Security was enacted 75 years ago.
The benefits of raising the retirement age obviously come through the most in the fiscal equation. While retirement age increases are generally thought of as benefit reductions on the individual level, they improve both sides on a macro level. By encouraging people to work longer, the worker-to-beneficiary ratio increases, having the effect of both increasing payroll tax revenues and reducing the benefits paid out. It is one of the few options talked about that works on both sides of the fiscal equation.
Additionally, there are some economic benefits. Encouraging longer labor force participation obviously increases the labor supply over the long-run. It can also increase the wealth of older workers and consequently increase their savings. In the long-run, both of these effects--bigger labor force and higher savings--will lead to higher economic growth. Also, working longer will mean that retirees will have fewer years to rely on their own wealth, a particular concern for those at the lower end of the income distribution.
However, much concern about increasing the NRA comes from a distributional perspective. A common argument against retirement age increases is that it is a regressive policy since longevity increases have accrued to top earners more than to low earners. One measure used by EPI's Monique Morrissey at the Urban Institute event shows that since 1982, male life expectancy at age 65 has increased by five years for the top half of earners, while it has only increased by one year for the bottom half.
Other concerns stem from the ability of workers to be able to keep working into their mid- to late-sixties. The Urban Institute event focused heavily on the vulnerability of older workers to "health shocks" and how the Social Security disability insurance program (SSDI) might not be well equipped to handle a larger number of these cases. Many workers who are unable to work at their jobs in their later years don't qualify for SSDI because they are not strictly disabled, but rather have physically strenuous jobs. Many of the event participants also argued that those who do qualify for SSDI do not get benefits that adequately replace the income and wealth lost due to disability. Those who oppose increasing the retirement age say that these problems are made worse if people have to work into their late sixties to receive full Social Security benefits. Also, these issues are distributional in nature, since low earners are more likely to have strenuous jobs, more likely to have "health shocks", and less likely to have the wealth to weather a disability.
These concerns certainly are not unfounded and could be addressed in the context of a Social Security reform plan that raises the NRA. The Brookings Institution's Gary Burtless, who supports raising the retirement age, suggested liberalizing eligibility for SSDI to allow people with physically strenuous jobs to qualify. An expansion of SSDI is one way to deal with the health concerns of an increased NRA. An option to address the distributional concerns would be to modify benefits for low-income earners to offset the effects of a higher retirement age. This could be done, for example, by instituting a minimum Social Security benefit (one of the illustrative options in our budget simulator) or by modifying the PIA formula favorably for low earners (either by increasing the first PIA factor modestly or increasing the first bend point). These "sweeteners" could help bring together lawmakers to enact a plan that balances the concerns of income security and fiscal sustainability.
Today, President Obama signed the Improper Payment Elimination and Recovery Act, hoping to make a dent in wasteful spending. Improper payments are exactly like they sound: payments made to the wrong people, at the wrong time, or for the wrong reason. After they totaled a high of $110 billion in 2009, the Obama Administration decided to crack down hard on these payments.
The Administration's goal is to cut improper payments by $50 billion by 2012. They have made a number of steps to get there already, such as expanding the use of payment recapture audits, establishing a single Federal Do Not Pay List, and focusing on improving Medicare's improper payment rate (which is disproportionately high). This bill would further the cause by mandating agencies to assess their risk for improper payments and making "high-risk" agencies measure their improper payments, expanding further the use of payment recapture audits, and instituting punishments for agency non-compliance.
We support President Obama's effort to cut down on improper payments, since it is long overdue. The savings could be significant if they are able to accomplish their goal. Of course, this is no replacement for having a plan to get our medium- and long-term deficit problems fixed.
There have been a lot of numbers thrown around with regards budget resolutions, deeming resolutions, and discretionary spending limits. To keep it simple, we've put the numbers for a bunch of different proposals below (hat tip to our colleague Jason Delisle with the Federal Education Budget Project at the New America Foundation for putting together these numbers).
|Proposal||FY 2011 (trillions)|
|FY 2011 from 2010 Budget Resolution||$1.108|
|FY 2011 President's Budget||$1.134*|
|House Deeming Resolution||$1.121|
|Senate Budget Committee||$1.124|
|Senate Appropriations Committee||$1.114|
*To compare on an apples-to-apples basis, war spending was removed and Pell grants were added to the discretionary category in the President's budget. The actual budget removes Pell grants from discretionary and puts them in mandatory.
Note: House Blue Dog numbers aren't here because they haven't provided complete numbers for discretionary spending.
Notice how with the exception of Sessions-McCaskill, all these resolutions represent increases from the FY 2011 levels in the 2010 budget resolution. And at a time when lawmakers are trying to claim the mantle of "fiscal responsibility."
The OECD recently published a great report on possible fiscal scenarios, and the results are exactly as expected: if the advanced countries of the world want to return to a sustainable growth path, they must combine medium-term fiscal consolidation with long-term structural reform. These results are based off econometric modeling the OECD has carried out in the past, extended to simulate fiscal and structural reform.
The OECD divides the world’s possible actions into three categories: inaction, a largely baseline scenario; a fiscal consolidation as soon as economically possible; and fiscal consolidation paired with long-term structural reform. According to the OECD, a fiscal consolidation would see reduced government spending and possible tax increases with the ultimate goal of lowering the deficit to pre-crisis levels. In the U.S, this level of sustainable debt is believed to hover somewhere around 3 percent of GDP. On the other hand, long-term structural reform would address not just the current levels of spending and taxation, but also the long-term drivers of increasing government debt, such as population-wide demographic shifts and distortionary tax policies. The resulting numbers undeniably favor eventual consolidation followed by long-term reform.
While lone fiscal consolidation as the economy recovers over the medium-term (without longer-term strucutural reforms) does bring benefits, it is probable that many advanced nations will begin cutbacks nearly simultaneously as the economy recovers. While this is forecasted to lead to a 2 percentage point growth in medium-term global GDP, a welcome change from the currently sluggish rate, the lack of attention toward longer-term global debt imbalances would scuttle the hope for strong long-term growth. Failure to encourage consumption in surplus nations and savings in debtor nations would lead to an eventual reduction in global demand, negating the medium-term growth brought by fiscal consolidation.
However, when fiscal consolidation is paired with long-term structural reform in advanced countries, global growth and imbalances would largely be alleviated relative to both the baseline and eventual fiscal consolidation scenarios. Lower long-term interest rates paired with actions to reduce distortions in global demand would lead to a reduction of global imbalances and an increase in growth. This is truly the optimal scenario.
|Growth Rate and Gross Indebtedness (Percent of GDP, 2021-2025)|
|Baseline||Fiscal Consolidation||Fiscal and Structural Consolidation|
|U.S. Gross Indebtedness||129%||74%||75%|
|OECD Gross Indebtedness||117%||86%||83%|
Don't let the numbers from 2021-2025 confuse you; over the longer term, fiscal consolidation combined with structural reform actually yields the greatest benefits. Due to the amount of time it takes to enact true structural reform, the 2021-2025 period doesn't capture the full effects. In the words of the OECD, fiscal consolidation alone would "only have a limited impact on external imbalances," while "concerted efforts in a number of policy domains, including fiscal consolidation... and structural reforms" will "get economies back onto the path of strong, sustainable, and balanced growth."
So how does the U.S. get there? Fiscally, the OECD recommends that governments reduce their debt-to-GDP ratios to pre-crisis levels by 2025. Structurally, the OECD sees the need for stronger market regulation (check!), the “elimination of distortionary tax incentives,” and a system by which emissions and pollution can be taxed. They estimate that undertaking these actions would boost U.S. long-term growth by 0.2 percentage points per year. reduce our deficit by 5.8 percentage points per year, lower our indebtedness by 54 percentage points, and improve our current balance by 0.7 percentage points (all relative to the do-nothing baseline). Seems like a winning plan.
The Senate essentially voted to pass an extension of unemployment benefits yesterday, invoking cloture on the measure with the requisite sixty votes. The bill would extend unemployment benefits through the end of November, ensuring that we won't need to witness constant bickering over the extension as we did this past spring. The $34 billion price tag had previously held up its passage, as lawmakers refused to offset the cost (we have been calling for them to do so). The bill itself is the final version of what was originally a nearly $200 billion dollar bill, but as passage grew tougher, the bill was whittled down. COBRA subsidies, tax extenders, and aid to states for Medicaid were all dropped from the bill and the doc fix was passed separately. It's telling that the Senate chose to jettison other priorities rather than simply pay for them.
Once the bill passes the Senate, it will go back to the House, where it will likely be approved quickly and then sent up to the White House for signing. We will post this new bill on Stimulus.org as soon as it is officially passed. The current average weekly unemployment benefit is about $307 and the maximum number of weeks for collecting unemployment benefits is 99.
In other stimulus news, the small business bill--one that combines a $30 billion small business lending fund to community banks and targeted small business tax breaks--is being held up over Republican concerns that the lending fund would be another TARP. Sen. Kent Conrad (D-ND) said that dropping the fund altogether was a possibility. This bill--having already passed in the House--is actually deficit neutral over ten years, offsetting its costs by closing some tax loopholes.
|Unemployment Insurance Extensions
||Gross Cost||Deficit Impact|
|2009 Stimulus||$60 billion||$60 billion|
|November 2009 Extension||$2 billion||$0 billion|
|December 2009 Extension||$11 billion||$11 billion|
|March 2010 Extension||$8 billion||$8 billion|
|April 2010 Extension||$14 billion||$14 billion|
|Total||$95 billion||$93 billion|
Remember you can follow all of the unemployment benefit extensions since the 2009 stimulus on Stimulus.org. So far there have been four unemployment benefit extensions (this one will make five) since ARRA, at a gross cost of $35.6 billion and a net cost of $33 billion, since one of the extensions was offset. You can also track all other government actions undertaken in the last three years to support the economy at Stimulus.org.
The blogosphere exploded last week (see here and here) when a number of Republicans suggested that Congress need not offset the costs of tax cuts. According to Senator Jon Kyl (R-AZ), "you do need to offset the cost of increased spending, and that's what Republicans object to. But you should never have to offset cost of a deliberate decision to reduce tax rates on Americans."
Senate Majority Leader Mitch McConnell actually went further than this, arguing that tax cuts don't need to be offset because they pay for themselves. According to McConnell "there's no evidence whatsoever that the Bush tax cuts actually diminished revenue. They increased revenue, because of the vibrancy of these tax cuts in the economy."
On Senator Kyl's point, we just don't buy it. Why should Congress have to fully offset the costs of extending unemployment benefits or expanding health coverage (and we think they should) but not have to offset tax reductions? If Congress makes a deliberate decision to reduce the size of government, that's great; but they should proceed by cutting spending and then taxes commensurately. Or turned the other way, feel free to cut taxes and offset the revenue losses with spending cuts rather than other tax increases, but just kicking the can down the road by adding to the debt is not an economic strategy that markets are going to tolerate much longer.
We also can't help but point out that if only spending increases needed to be offset, policy makers would just replace spending policies with equivalent tax policies. Hello, unemployment tax credit anyone?
There is a reason PAYGO applies to both sides of the budget -- both tax cuts and spending increases cause our deficits and debt to rise.
Which brings us to our next point. At current levels, it is exceedingly unlikely that tax cuts would come anywhere near to paying for themselves. Yes, tax cuts generally have a positive effect on growth, but our income tax is no where near the "wrong side of the Laffer curve" -- the place where the tax is so damaging that cutting it would raise more revenue than keeping it.
For a little background, the Laffer curve starts from the basic premise: if the income tax rate is 100% it will generate little or no revenue, since few would be willing to work for no pay. From there, a reduction in taxes is likely to strengthen revenue collection. But at the other end, the Laffer curve also shows that a tax rate of 0% would raise no revenue. The question from there becomes -- what is the revenue maximizing rate of taxation?
And of course, nobody knows for sure. But you would be hard pressed to find an economist who suggested we were at or past this point. Instead, most economists believe that a tax cut would have a moderate amount of positive feedback.
This is certainly the view of a number of conservative economists, who have affirmed this point. Andrew Samwick, former chief economist of Bush's Council on Economic Advisors, has said that while "the ultimate reduction in tax revenues can be less than this first order effect.. [but] No thoughtful person believes that this possible offset more than compensated for the first effect for these tax cuts." Henry Paulson, President Bush's Secretary of Treasury, has said that "as a general rule, I do not believe that tax cuts pay for themselves." And even the 2003 Economic Report of the President stated that "although the economy grows in response to tax reductions (because of higher consumption in the short run and improved incentives in the long run), it is unlikely to grow so much that lost tax revenue is completely recovered by the higher level of economic activity.”
According to the CBO, the feedback could range from 28 percent in one extreme, to slightly negative on the other.
The point here is that tax cuts can be good for the economy, and can result in less revenue loss than static estimates suggest, but they can't pay for themselves. We don't know how much feedback they will generate -- and whatever feedback we do get should be considered a bonus to help us pay down our debt -- but even in the best case tax cuts won't come close to paying for themselves. And if tax cuts add to the debt and lead to a crisis, they'll end up costing us far more than what CBO suggests.
Tax cuts, like spending, must be paid for.
Ben Bernanke, the Chairman of the Federal Reserve, will present his twice-yearly testimony to Congress tomorrow (the Senate) and then again on Thursday (the House), accompanied by the always must-read semi-annul monetary policy report by the Fed Board. The big questions this time (and somehow there are always big questions when the Chairman speaks to Congress) are:
- Whether we should be concerned about an economic slowdown and inflation coming in below the Fed’s lower target;
- Whether in present circumstances, the Fed’s present monetary policy stance and plans for an exit strategy from its extraordinary stimulus measures are still appropriate.
We’ll also watch for any statements by the Chairman on our fiscal challenges. Chairman Bernanke and other Fed officials have placed considerable emphasis on getting our fiscal house in order sooner rather than later, to take heat off the Fed. It is still early days, but concern has already started to surface that politicians, who might ultimately be unable to take the tough decisions needed to get our fiscal house in order, might then turn to the Fed to get them off the hook by monetizing our huge debt. We could pay a dear price through inflation.
Stay tuned to this space tomorrow.
Today, four Democratic congressmen—Reps. Gary Peters, John Adler, Jim Himes, and Peter Welch—introduced four-pronged legislation, called the REDUCE Acts, meant to reduce the national deficit by more than $70 billion over the next decade. This series of bills proposes to achieve this goal through a combination of reduced spending and the elimination of “inefficient programs and costly industry subsidies.”
Each of the four congressmen has spearheaded one of the proposals within this legislation. Rep. Peters is sponsoring the energy portion, which will most notably eliminate tax loopholes for oil giants, stop the expansion of the strategic petroleum reserve, and sell federally-owned energy facilities to private utility companies—which Peters claims will save the government almost $4 billion in 2011 and almost $60 billion over 10 years.
Rep. Adler is sponsoring the Treasury and housing component. Including the implementation of electronic payroll for Treasury employees, and the elimination of the rarely-used Advanced EIC, and the Overseas Private Investment Corporation (which subsidizes U.S. companies’ investment abroad), this is estimated to save $169 million in 2011 and $3.7 billion over 10 years. Rep. Himes focuses on agriculture, proposing cuts to private agriculture subsidies and the reduction of commodity payments to wealthy farmers. He also proposes reductions in the federal reimbursement rate for private crop insurers, saving in total about half a billion dollars in 2011 and just over $6 billion in 10 years.
Finally, Rep. Welch’s defense cuts include the termination of three systems which the Defense Department supports eliminating, saving $2.6 billion in 2011 and at least $4.1 billion over the next decade.
The hard work of these four congressmen in drafting this plan only highlights the increasing importance we must place on finding specific ways to bring down deficits as the economy recovers. Those who disagree with the specifics of these bills should step forward with their own proposals for how to reduce deficits over the medium-term.
We eagerly await the future of the REDUCE bills.
Larry Summers, the Administration's top economist (and former CRFB board member), has an op-ed in the Financial Times today, looking at why the current debate in Congress muddies the fiscal waters.
In his op-ed, he suggests a more comprehensive way of thinking about our real fiscal choices: our challenges are not a matter of a simple choice between "jobs" and "deficits"; and supporting recovery in the short-term yet calling for deficit reduction in the medium- and long-run is an appropriate rather than a "mixed" message about fiscal responsibility.
In his view, while budget deficits are unproductive, if not harmful, during economic expansions, right now with interest rates close to zero and the unemployment rate at 9.5%, expansionary fiscal policy can have a powerful, positive effect on the economy. Also, since it boosts economic growth, it will help with reducing deficits in the medium-term.
However, in his view (and ours), there is most certainly a cost. Running budget deficits (especially high budget deficits) will have a cost to the economy--and the taxpayer--through the debt channel. Budget deficits if not offset translate into debt accumulation. And our debt has to be paid for somehow, somewhere, sometime, managed normally through interest payments on debt held. And there are many ways in which our budget deficits are financed: foreigners might buy more debt (or not), our domestic bond vigilantes might buy more debt (or not). To keep buyers coming to the Treasury auction table, higher interest rates might be needed, especially if the private economy looks more appealing as the economy runs closer to the full employment of people, buildings, and machines. Our government might be tempted to inflate some of the debt away--which doesn't work for long, by the way. In this process, other government priorities might be crowded out. None of these situations can be sustained for long and we don't want to go there.
So how do we avoid the costs of higher debt? In other words, what do we do to balance our short-term needs with our need to get the budget on a sustainable track? Dr. Summers points out that deficit reduction is important when the economy is on stronger footing, and it can have positive effects on the economy:
There is a very strong presumption that there are likely to be beneficial effects from the expectation that budget deficits will be reduced after an economy has recovered and is no longer demand-constrained. Not least of these are increased confidence and reduced capital costs that encourage investment, even before the deficit is reduced. Such impacts are likely to be particularly important when prospective deficits are large and raise substantial questions about sustainability or even creditworthiness.
This statement re-affirms his membership in the Announcement Effect Club and brings us to an important point. We can't have significant medium-term deficit reduction without relatively strong economic growth, and considering our future fiscal situation, we can't have robust economic growth in the long-term without deficit reduction. By announcing a deficit reduction plan now that will take effect when the economy recovers, we can increase short term economic growth, and this increased growth will further cut into our deficit. We have expanded on this point in the past.
Alan Blinder, in an op-ed in The Wall Street Journal, suggests stimulating the economy in a deficit-neutral way by letting the upper-income tax cuts expire and using the money saved over the next two years to finance further stimulus efforts. Citing multiplier calculations by Mark Zandi, Blinder estimates that "trading" upper-income tax cuts for unemployment benefits would add $100 billion to aggregate demand and one million jobs to the economy over the next two years. Even if the numbers are high, he says, the stimulative effects of unemployment benefits would certainly be higher than those of the tax cuts, since high earners save much more of their income than unemployed workers.
Summers gives the Administration credit for making recommendations to put the U.S. on a more sustainable fiscal path in the medium-term. The policies he cites are the three year freeze on non-security discretionary spending, the expiration of upper income tax cuts, the health care law, and the formation of the fiscal commission. While these are positive steps, there is still much more to be done, especially since the President's 2011 budget would put public debt at 90 percent by 2020. The freeze is good, but it should be expanded to all discretionary spending and actual cuts should be considered. The expiration of the upper income tax cuts translates as "extending the tax cuts for everyone making under $250,000 at a staggering cost"; instead the costs should be offset. Limiting the roughly $1 trillion in individual and corporate tax expenditures would be one good approach. The jury is still out on the health care law over the longer-term (see our analysis here), though it seems that if Congress sticks to their guns, it will have quite a positive effect over the long term (though much more will still need to be done). Finally, while its work could prove to be extraordinary useful for America's fiscal future, it is far from clear whether the fiscal commission will even be able to agree on recommendations to reduce medium-term and long-term deficits -- although we certainly do hope they will succeed. It would help if the President was doing more to elevate the importance of the Commission's work.
We think that Summers has it right in terms of the timing of fiscal policy. There are certainly differences in opinion over the right mix of stimulus and deficit reduction, but it is clear that we can't get our deficits under control by mid-decade with weak growth and we won't be able to have strong growth later on if our debt is rising rapidly. The announcement effect of a deficit reduction plan takes advantage of this feedback starting this year. The Administration, and the Congress for that matter, should get working on a plan that would truly put the country on a fiscally sustainable path. Everything should be on the table and everyone should be at the table.
Opens and Tours – Americans did not fare well in sporting events across the pond this weekend; leaving us Yanks to rely on past memories of success at the British Open and Tour de France as well as the understanding that our economy is not quite as bad off as those of the countries that are beating us. Meanwhile, lawmakers in Washington continue to negotiate treacherous links and steep climbs in the quest to complete legislation.
Wall Street Reform Finally in the Clubhouse – After months of debate and deliberation, legislation reforming the regulation of the financial sector was cleared for the president’s pen with Senate approval on Thursday. The last sticking point involved offsets for the measure.
Unemployment Insurance Sees Finish Line – The Senate will vote tomorrow on a measure to extend expanded unemployment benefits, right after the replacement to the late Robert Byrd is sworn in, which will provide the 60 votes needed to move forward. The bill will restore assistance beyond the traditional 26 weeks through November that was provided initially by the Recovery Act. The extension has been languishing for months as a part of the extenders bill that senators can not reach agreement on, largely due to disagreement over offsets. Congressional leaders reluctantly decided to break off the enhanced unemployment assistance in order to get it approved. The $34 billion cost of extending the increased benefits is not offset.
Small Business Bill Teeing Up for Vote – The Senate is also looking to finish up work on legislation aiding small businesses this week. While the cost of the Small Business Jobs and Credit Act is technically offset, CRFB has taken issue with one of the offsets. Allowing workers to roll over their individual retirement accounts into Roth IRAs would raise about $5 billion in the short run because the new contributions would be taxable, but since withdrawals from Roth IRAs are not taxable, in the long run the provision is expected to cost $15 billion in lost revenue. CRFB thinks that short-term stimulus should be paid for in the longer run; this gimmick has the opposite effect, adding to the cost in the longer term. Bringing the debt under control will also aid small business, as evidenced by the results of a recent poll of small business owners illustrating that 90 percent are concerned about the effect of national debt on job creation.
Senate Appropriators Sprint to the Front of the Pack – The Senate Appropriations Committee marked-up three spending bills last week and plans to tackle up to four more this week. Meanwhile its House counterpart will begin full committee mark-ups this week. Senate appropriators also set their 302(b) allocations last week, which are the limits that can be appropriated for each discretionary spending category. The total approved by the committee is $1.114 trillion for FY 2011. That amount is $7 billion less than the cap deemed by the House of Representatives in its “budget enforcement resolution” and $14 billion below that requested by the President in his budget proposal. Adding to the confusion, Senate Budget Committee chairman Kent Conrad (D-ND) last week said he may pursue a resolution similar to that passed by the House. It is not clear what spending level he would seek and how that would play out seeing as appropriators have already moved forward. Lawmakers doubt that they will complete all action on the spending bills this year, likely depending on a continuing resolution to fund at least some parts of the government when the fiscal year begins in October and requiring an omnibus spending bill during a lame duck session after the elections. CRFB predicted fiscal chaos this year in the absence of a budget resolution and noted the need for budget process reform. A solid bill was introduced last week in the House to add more transparency and discipline to the budget process.
War Supplemental in the Rough – The Senate may attempt a cloture vote on the version of the supplemental bill to fund operations in Iraq and Afghanistan passed by the House earlier this month, but it is likely to fail. The main source of contention is nearly $23 billion in domestic spending tacked on by the House.
Lew Tapped for Yellow Budget Jersey – Jacob Lew has been nominated by the White House to replace Peter Orszag as Director of the Office of Management and Budget. Meanwhile, OMB will release its Mid-Session Review of the budget and economy this Friday. Fridays are often when administrations release bad news. This update could contain forecasts that are revised downward from what was projected in the President’s budget request earlier this year. Watch out for CRFB’s analysis of the numbers shortly after they are released.
Some Democrats Break Away from the Peloton– A group of nearly 60 House Democrats sent a letter last week to House leaders expressing their desire for more spending discipline. They specifically called for ending the abuse of the “emergency” spending designation to circumvent pay-as-you-go requirements for legislation and long-run offsets for new stimulus spending. House Speaker Nancy Pelosi said that new stimulus spending, such as aid to the states, will be paid for.
Panetta Warns of Uphill Climb for Future Intelligence Funds – The Washington Post’s blockbuster special report on the intelligence community has an interesting nugget from CIA Director Leon Panetta. Panetta, a former OMB Director and CRFB Board Member, says that he is charting a five-year plan for his agency because its post-9/11 budget is unsustainable. He is quoted, “Particularly with these deficits, we're going to hit the wall. I want to be prepared for that.”
CRFB board member Eugene Steuerle joined the Announcement Effect Club in a post on the Urban Institute's website. In the post, he talked about the need to separate the difference between our short-term deficits and our medium-term structural deficits. First, the main quote:
Finally, there's a bonus in handling the first, short-term problem by starting to solve the second, long-term problem immediately: it gives greater assurance to the markets that countries are going to get their fiscal houses in order. Many solutions to long-term fiscal problems—such as reducing powerful incentives to retire—could also be designed to boost recovery.
As he points out, there's no need to wait to develop a plan, since there obviously can be a lag between when a policy is enacted and a policy is implemented. Because of this lag, he says, "The economics always [say] we should adopt and maintain good long-term budget policy as soon as possible, even when we disagree on the timing of short-term stimulus." Since a medium-term deficit reduction plan would have little, if any, contractionary effect in the short term, enacting one now makes economic sense, especially since a credible plan would reduce upward pressure that fears of excessive debt could have on long-term interest rates.
The (brief) stock market rally had dominated trading in the earlier part of the week. However, investor interest in U.S. government bonds picked up again toward the end of the trading week with a refocus on safe haven effects and increased signs of U.S. economic weakness. As a result, yields on the benchmark 10-year Treasury bond dipped below 3 percent again and came close to lows for the past year. (Yield haves been below 3 percent a lot of the time since late June and now.) The 30-year government bond has performed similarly.
Increasing concern about the strength of the economy and signs that inflationary pressures remain extremely subdued (always the biggest plus for bonds) led investors to shift relative portfolio preferences from stocks to bonds by the end of the week. Economic news of note included disappointing second quarter profit announcements over the course of the week, a disappointing consumer sentiment report, and a low consumer inflation report.
The series of weak economic news confirmed the message put out by the Fed during the week through the release of the minutes from its late June meeting: many (although not all) Fed officials think that while forward momentum continues, the economy is slowing down and the risks may be on the downside. (See its recently released FOMC minutes--along these lines, Chairman Bernanke is expected to give his Semi-Annual Monetary Policy testimony to Congress next week.)
Concerns about the economic and fiscal outlook for the eurozone also continued to underpin trading, although the earlier near-panic has subsided. During the week, the so-called “bond vigilantes” (PIMCO, the largest private holder of bonds) announced that they had reduced their exposure to eurozone debt instruments and had increased their holdings of U.S. instruments (“the U.S. remains the flight-to-quality country in the world”).