The Bottom Line
What to do about the 2001 and 2003 tax cuts that are set to expire at the end of the year has been a critical question that Congress has largely ducked so far. But a Senate hearing yesterday marked the beginning of what will likely be a contentious debate. The hearing previewed some of the messages that will be used during the upcoming debate and underscored the need for serious reform of the tax system and an eye on debt reduction.
Shaping the tax debate are rising concerns over the long-term budget picture and election-year politics. President Obama has promised to permanently extend the tax cuts for the “middle class” – classified as those individuals who make less than $200,000 a year and families that bring in less than $250,000. But leaders in Congress, looking for ways to close the fiscal gap, have signaled that they won’t necessarily follow that path.
Senate Finance Committee Chairman Max Baucus (D-MT) kicked-off the hearing by stating that the budget deficit was the “elephant in the room” in considering extending the tax cuts and questioned whether tax breaks for the wealthy could be maintained in such a fiscal environment. He urged his colleagues to proceed with “an eye on the budget picture.”
Witnesses at the hearing were CRFB board member Douglas Holtz-Eakin of the American Action Forum, Donald Marron of the Tax Policy Center, Leonard Burman of Syracuse University, CPA Carol Markman, and David Marzahl of the Center for Economic Progress. While they disagreed on what to do exactly about the tax cuts, there was broad agreement on the need for comprehensive tax reform.
Burman argued against permanent extension of the tax cuts because it would make tax reform more difficult; stating in his written testimony that “A system-wide reform along the lines of the Tax Reform Act of 1986, but with the goal of eventually raising enough revenue get the national debt out of the red zone should be a top priority for the Congress.” At the same time he asserted that allowing the middle-class tax cuts to expire now would hamper the economic recovery. He proposed a two-year extension, with Congress committing to a tax reform plan before the temporary extension expires.
Burman also advised a focus on reigning in America’s long-term debt and suggested the solution will be a combination of taxes and reduced spending. His recommended three goals for budget and tax policy:
• Do not stifle the nascent economic recovery.
• Implement a credible plan to get the debt down to a sustainable level within the next decade.
• Reform the tax system to make it simpler, fairer, and more conducive to economic growth.
Holtz-Eakin agreed with Burman on the need for deep tax reform, but contended that extending the tax cuts would ease the path to reform, not make it more difficult. He also agreed that the growth in debt must be addressed, but contended that the focus should be on reducing federal spending.
He argued for a “ruthless” focus on economic growth and claimed that extending the tax cuts would promote growth through providing tax law certainty and lower rates for small businesses, while a temporary and partial extension would not encourage sufficient growth. Burman, on the other hand, testified that a continuation of current policy would not promote growth, instead putting us on the path to being Greece. Whereas Burman argued that temporarily keeping the tax cuts affecting middle- and lower-class taxpayers would aide the economy by propping up consumer spending while higher marginal income tax rates for high-income earners would have little impact on spending or entrepreneurship, Holtz-Eakin countered that maintaining lower rates would help small businesses while some provisions like refundable tax credits and marriage tax relief have no impact on growth.
Marron concurred that fundamental tax reform and debt reduction must be pursued. He also noted that many analysts believe that the economic benefits of extending some or all of the tax cuts will be maximized if they are offset.
The House leadership is reportedly considering a one-year extension of the middle-class tax cuts and a two-year extension of the “patch” preventing the Alternative Minimum Tax (AMT) from hitting middle-class taxpayers. CRFB supports fundamental tax reform that broadens the tax base and is more efficient. We have also suggested a temporary extension of the tax cuts in conjunction with a commitment to adopt a credible plan to stabilize the debt at a reasonable level.
Today, CRFB released its report on the long-term effects of the recent health care reform package (be sure to check it out!), based on information provided in CBO's Long Term Outlook. CBO's analysis reflects the relatively inconclusive results of health reform's true budget impact. While those on the right and the left have argued that the reform package will either substantially increase or decrease the U.S. deficit, in reality, it is very difficult to predict what effect it will have in the long-run.
In the short run, the reform is projected to reduce the deficit by $143 billion as a result of tax increases and Medicare cuts which more than offset new spending on Medicaid and exchange subsidies. Beyond that, several measures -- including cuts in annual updates for provider payments, a slowing in the growth of premium subsidies, an Independent Payment Advisory Board, and a growing excise tax on high-cost plans -- are supposed to put downward pressure on the growth of the deficit.
Unfortunately, the exact impact of these changes is very difficult to measure considering the inherent uncertainty of health care projections, the untried nature of many of these changes, the fact that CBO's long-term projections alreadyassume health care cost growth will slow, and the fact that many measures in the legislation may prove politically and economically unsustainable in the long-run.
With the information they do have, CBO presents two long-term budget scenarios -- one which shows health reform significantly reducing the long-term deficit (mainly as a result of higher revenues), and one which shows it having little effect at all.
We cannot be sure which is these scenarios is a closer projection of reality, though we do know that the growth of Medicare and Medicaid remains unsustainable under either.
In our report, we not only attempt to explain CBO's analysis on the impact of health reform, but also discuss ways to maximize the chances that reform succeeds in controlling costs.
Regardless of what scenario we look at, a lot more work has to be done.
Below is a table from the report, showing the effects and CBO's assumptions of health reform on the long-term.
|Baseline-Extended Scenario||Alternative Fiscal Scenario|
|First Decade||Spending and revenue provisions play out as written in law||Spending and revenue provisions play out as written in law|
|Deficit Impact in 2020
||0.1 percent of GDP reduction|| 0.1 percent of GDP reduction
|Second Decade||Federal health spending grows at slowed rate based on estimated "broad growth rates" of provision in health legislation; tax provisions play out as written into law||Federal health spending grows at rates estimated absent reform, under the assumption that policymakers will not allow certain cost-controlling measures to continue; overall revenue levels will remain fixed percent of GDP|
|Deficit Impact in 2030
|| 1 - 1.3 percent of GDP reduction
|| 0 - 0.1 percent of GDP reduction
|Beyond Second Decade||Federal health spending grows at rates estimated absent reform (though from a lower level); tax provisions play out as written into law||Federal health spending grows at rates estimated absent reform; overall revenue levels will remain fixed percent of GDP|
|Deficit Impact in 2080
|| 4 - 5 percent of GDP reduction
|| 0.3 percent of GDP increase
Republicans on the Senate Appropriations Committee backed the discretionary spending caps proposed by Jeff Sessions and Claire McCaskill yesterday, saying they would re-propose them at some point. While the caps do not freeze discretionary spending, they do represent significant reductions from where the President's budget and both the proposed House and Senate resolutions would be.
The Sessions-McCaskill caps have been voted down by just a few votes in the past, but it is unclear if this additional enthusiastic support will put them over the top since it is a few more Democrats who will need to come on board to get them passed.
The importance of these discretionary spending caps should not be understated, even if the driver of growing deficits in the future is mandatory spending. As we noted in this policy paper, discretionary spending actually grew faster than mandatory spending over the last decade.
The graph below shows discretionary budget authority under each of the proposals. The House resolution is not shown because it only covers 2011; its level is just about the same as the Senate resolution. Note that this is budget authority, not outlays. Budget authority represents how much can be committed to be spent in the future, while outlays represent how much cash is actually spent within a given year (outlays can include budget authority from previous years). Discretionary budget authority is usually lower than the actual outlays; however, it is the only measure that the Sessions-McCaskill cap applies, so it is used here for an apples-to-apples comparison.
Note: The Senate resolution and Sessions-McCaskill estimates come directly from the bills, and the President's budget numbers come from OMB (minus war spending and adding in Pell grants).
The Sessions-McCaskill caps are significantly lower than all other major proposals out there, especially the President's budget.
It's great that the Republicans of the Appropriations Committee are getting their full weight behind the caps. In conjunction with (a more strengthened) PAYGO, discretionary caps are a proven way to get spending under control when Congress is unwilling to do so by itself. We hope that Sessions-McCaskill can finally make it over the top and get the 60 votes it needs to pass.
It’s official, budget commissions are now sexy. Esquire magazine confirmed it with the creation of its own Blue Ribbon Commission to Balance the Federal Budget.
The Esquire commission is made up of a bipartisan group of former senators – Bill Bradley, Bob Packwood, Gary Hart, and John Danforth – and will be chaired by Lawrence O’Donnell, pundit, former senate aide and “The West Wing” producer. The group will be tasked with creating “a specific, actionable plan that outlines how the government can eliminate the federal deficit by 2020.”
According to the magazine, everything will be on the table for the panel and the members will “negotiate, compromise, and forge a nonpartisan, commonsense alternative to the hyperpartisan status quo.”
If Esquire can make bipartisanship and making tough fiscal decisions hip, then it will have performed a great service. Just remember, we at CRFB were trend setters with our Peterson-Pew Commission on Budget Reform.
Under the radar due to other priorities, the Senate has taken up its version of a small business stimulus bill. The bill combines two different small business bills that passed the House last month (one that created a lending fund and one that would provide tax breaks).
As with the House bills, the Senate version would create a $30 billion small business lending fund to provide equity to community banks. The banks in turn pay varying dividends on that equity based on how much they increase their lending to small businesses. CBO estimated (for the House bill) that the lending fund itself would cost $1.4 billion, although a press release by the Senate Finance Committee expects that the Lending Fund would raise $1.1 billion over ten years. That bill also included $2 billion for a State Small Business Credit Initiative, which is cut in half in the Senate version.
The bill also provides numerous tax incentives for small business investment, which make up the bulk of the gross cost. The bill extends "bonus depreciation", which allows businesses to deduct more capital purchases faster than under normal depreciation schedules. This is the single costliest measure, reducing revenue by $5.5 billion over ten years. A few other provisions include a 100 percent tax exclusion of capital gains that are from the sale of small business stock and an increased deduction for start-up expenditures. These two would cost about $750 million over ten years.
The bill is ostensibly deficit neutral over ten years. Like with the House bill, it includes a tightening of the cellulosic biofuels credit, which will raise $2 billion. Otherwise it relies on reducing the tax gap and a timing gimmick -- not exactly a great way to offset the costs of a bill.
The timing gimmick comes from allowing people to roll over their individual retirement accounts into Roth IRAs. This provision would actually raise about $5 billion over the next ten years since the rollovers would be taxed. However, since withdrawals from Roth IRAs are tax-free and traditional retirement accounts are not, Tax Policy Center estimates this provision would reduce revenues by $15 billion (in present value) through mid-century.
The House was able to pay its small business bills in a fiscally responsible and non-gimmicky manner. We should expect no less from the Senate.
See stimulus.org for all the other measures the government has taken to stimulate the economy.
Recent fiscal performances have been a mixed bag. The troubled Greek government finally pushed through significant pension reform, but doubt still lingers over their long-term viability. At the same time, trouble on the Iberian Peninsula seems to be brewing. To top it all off, the head of a global banking giant has warned that we aren’t out of the woods just yet.
Starting with the positives, the New York Times reports that Greece has finished major legislation to improve their fiscal outlook. Changes include upping the retirement age from late 40s to a flat 65, modifying the formula used to calculate pensions, and making it easier for private companies to fire employees. The legislation was met with obvious displeasure from Greek citizens, though the protests resulted in only one injury and no arrests, a serious improvement from the previous riots. In fact, the New York Times speculates that this calmer opposition may reflect a wider acceptance amongst the Greek populace that spending cuts have become necessary.
While this is obviously a positive step for the Greek government, they are still getting hammered in the bond market, where traders cannot shake the fear of an imminent debt restructuring. As a result of these jitters, the yield on Greek long-term bonds is still an incredibly high 10 percent.
Travelling westward, Portugal got hit today with another sovereign debt downgrade. This two-notch drop by Moody’s follows S&P’s two-notch drop in early May. Citing a growing debt-to-GDP ratio and very modest projected growth, Moody’s does not seem to be forecasting a pretty future for Portugal. Moody’s view on Portugal is now much closer to that of the other two major ratings agencies, S&P and Fitch, both of which have a similarly negative outlook on Portuguese creditworthiness.
Finally, Stephen Green, the Chairman of British banking giant HSBC Holdings, has warned that, though we are “on our way out,” the fiscal crisis is not over yet. He claims that the possibility of further macroeconomic shocks from indebted nations and protectionist policies enacted by countries struggling to boost growth underscore the need for global fiscal cooperation and coordination.
Though it may be unpleasant to watch, it is quite obvious that the global fiscal dance is far from over. Intermission just ended, and the critics are still debating over whether the second act will see the dreaded double-dip or simply a slow recovery. One thing, however, is for certain: if the United States doesn’t get its fiscal policies in order, we may soon be entering stage left.
Today, President Obama has announced his intention to nominate Jacob Lew, the current Deputy Secretary of State for Management and Resources, to replace Peter Orszag as Director of OMB. Lew was previously OMB director during the Clinton administration. In a statement today Obama praised Lew’s “experience and good judgment,” saying that if confirmed, he will prove to be an “extraordinary asset” in efforts to cut the deficit and develop a sustainable fiscal path for the nation. We wish him the best of luck in this endeavor.
Running for the Exits – The “Running of the Bulls” has begun in Pamplona, Spain. Combine that with the celebrations over the country’s World Cup victory yesterday and you have quite a volatile mix. Washington has its own precarious situation, though not nearly as colorful or fun. A full agenda and little time on the Congressional calendar will make for a hectic rush, especially in the Senate. Congress returns this week from its July Fourth recess with a small window before it leaves again for a month-long August recess. Lawmakers may be running like mad, but they won’t be very bullish.
Small Business Looks to Avoid Being Gored by Tax Politics – The Senate this week will consider legislation to improve lending to small businesses (HR 5297), but other issues could get in the way of fast adoption. The bill will create a $30 billion lending poll and add $12 billion in tax incentives for small businesses. Some legislators also want to include in the measure a controversial provision to extend the estate tax at lower levels.
Seeing Red in the War Supplemental – The Senate must also consider the supplemental spending bill passed by the House just before the recess to fund operations in Iraq and Afghanistan that also includes about $23 billion in domestic funding. But many doubt that version can pass the Senate.
Mid-Session Review Lost in the Stampede? – July 15 is the deadline for the administration to produce its mid-year adjustment of budget and economic projections, but that deadline is often missed. Amid fears that the new numbers will not be as good as had been hoped, it is not clear when the update will be released. However, Congress will get a report on the economic picture Wednesday as White House Council of Economic Advisers Chair Dr. Christina Romer will testify before the Joint Economic Committee on “The Economic Outlook.”
Will Energy Reform Get a Chance to Run? – Senate Majority Leaders Harry Reid (D-NV) wants to bring energy legislation to the Senate floor this month in spite of the cramped agenda the body already faces. It is not clear if putting a price on carbon will be a part of any energy bill that comes to the floor, as agreement continues to be elusive.
Tax Cuts Are the Bull Waiting to Get in the China Shop – What to do about the 2001 and 2003 tax cuts that will expire at the end of the year remains to be a simmering debate just waiting to boil over in Washington. The Senate Finance Committee will wade into the topic Wednesday with a hearing.
The IMF just released its experts' assessment of the US economic and fiscal outlook to the public (although it was dated June 21). The report recommends ways in which the US can get itself back on track fiscally, when to do it, and what goals it should set for the medium term.
The US economy's recovery is considered increasingly well-established, due to the massive policy measures undertaken. However, going forward, risks to the economy are seen increasingly on the downside. [Comment: contrast this to increasing Wall Street optimism in the past week.] The biggest trouble spots seen by the Fund are persistent housing sector and financial sector weakness plus possible negative spillover effects from the Eurozone fiscal crisis.
The economic forecast is less optimistic than the Obama Administration's. The Fund staff expects growth of 2.9% next year and 2.8% in 2012. In contrast, the Administration (early this year) projected 3.8% next year and 4.3% in 2012. The Fund expects unemployment to be about a point higher than the Administration's forecast.
Because of the more pessimistic economic assumptions, the IMF projects debt held by the public to reach 96% of GDP by 2020, about 20 percentage points higher than a comparable forecast by the Administration. The challenge for the US is to put its public debt on a sustainable path without jeopardizing the economic recovery, says the Fund.
Against this backdrop, the Fund supports the Administration's commitment to halve the annual budget deficit by 2013 and to stabilize the debt at 70% of GDP starting in 2015. However, based on its less optimistic economic assumptions and resulting higher debt projections, the IMF sees the necessity of stiffer medium term annual budget goals than those given to the Fiscal Commission. The Fund calls for a primary surplus of 3/4% of GDP by 2015, rather than the primary balance that is the goal of the Commission. In order to accomplish this goal, it estimates that the US should undertake adjustment of 8% of GDP to its underlying fiscal position (ie, excluding business cycle effects), almost 3 percentage points more than the Obama Administration is planning. Suggestions to fill this gap include changes on both the spending and revenue sides, such as cutting into tax deductions, especially the mortagage interest deduction, and tapping the "big three" of new revenue sources: a VAT, a carbon tax, or a financial activities tax (or some combination of the three.)
To offer guidance on how the US can balance its need to come up with credible sustainable fiscal policy (including fiscal policy which is seen as credible) with the need to support demand until the economy is on stronger footing, the IMF discussed the timing and composition of fiscal consolidation. For the near future, it supported upfront fiscal consolidation and noted that the structural adjustment already proposed for 2011 (a budget deficit reduced by 2% of GDP, as compared to 2010) would be appropriate. If measures supporting labor markets are seen to be needed by Congress, they should be limited and undertaken within the proposed budget framework for next year. Or, they can and should be offset over the longer term. The Fund suggests shifting away from unemployment support and more towards hiring credits once unemployment starts to decline more (perhaps by expanding the generosity of the HIRE Act, which already has a hiring credit in place).
The Fund recommends that any fiscal consolidation steps for the next few years should be accompanied by measures affecting the longer run, including putting fiscal goals and/or other measures in legislation, and making changes in US entitlement programs, none of which would weaken demand in the nearer future.
The Fund points out that if a consensus over critical entitlement changes could be reached, then more fiscal of the fiscal adjustment could be back-loaded. If the economy were weaker than expected, for example, it commented that backloading fiscal adjustment would help limit negative effects of nearer term demand. It specifically thinks that Social Security could be addressed, since "the needed policies are well known." As for measures to control health care costs, Fund expert David Robinson believed that the Independent Payment Advisory Board would be very important going forward and the report suggests going after the exclusion for employer-sponsored insurance if the recent health care reform proves to not be enough.
Beyond 2015, the Fund states: "[T]he aim should be to put public debt firmly on a downward path to rebuild the room for fiscal maneuver (especially given the risks from large funding shortfalls in state and local government pension and health schemes)."
So, a tougher medium term goal plus a credible and sustainable plan for the long term is what the IMF is looking for, keeping in mind the near-term weakness of the economy yet the need for fiscal consolidation. Let's see 'em!
CRFB’s earlier post on CBO’s Social Security Options publication covered some of the broad reform options, especially those effecting Social Security Revenues. Today, we’d like to focus a little more on a few options on the benefits side.
Raising the retirement age is one often cited possibility (see our previous post on this here). Since the average American retiree’s expected life expectancy has increased by more than five years since the inception of the Social Security program in the 1940s, it is fundamentally more costly for the government to provide benefits to them for the duration of their retirement years. This problem could be offset by an increase in the retirement age. One option CBO presents is a raise to age 68 (Option 26), which would occur gradually by 2028. According to CBO, this would decrease Social Security’s total outlays by 3 percent of current GDP and also decrease lifetime benefits to retirees by about 6 percent. The federal retirement age (FRA) could also be raised to 70 (Option 27) in the same 30 year time window, an increase that would more fully offset the increase in life expectancy that has put stress on the program, reducing Social Security outlays by 6 percent by 2040 and benefits to retirees by 15 percent.
Another option is the lowering of initial benefits, often called “progressive price indexing.” CBO includes two options (Options 18 and 19) for this: implementing the indexation for either the top 70 or top 50 percent of earners, with no effect on the scheduled benefits for the bottom percent of average earners. This option would require initial benefits for such earners to gradually decline over time (relative to current law, not in nominal terms) by approximately 30 percent, decreasing total Social Security outlays by about 7 percent from the current level. If initial benefits were lowered for the top 50 percent of earners instead, the reduction in outlays would be 6 percent.
Markets are justifiably confused about the strength of the economy: is growth slowing? Is it slowing a lot or just a little? Will it keep chugging along and sustain forward momentum as fiscal stimulus lessens? A reasonable case can be made for any of these views based on a reading of key indicators in the U.S., Europe and China.
With this uncertainty, how can fiscal policymakers respond? While at times of great uncertainty like the present it may be more useful to think about the outlook in terms of risk rather than point to estimate paths, the answer here is also not very clear at this time of transition from recession to recovery.
With high uncertainty about the U.S. and global outlook continuing, demand for U.S. government debt remained strong in this short post 4th of July trading week, as investors still sought a safe haven. However, as the week progressed, trader interest in U.S. stocks increased in response to good news on the U.S. economy from the corporate sector.
The shift from Treasuries to U.S. stocks reflected the repositioning of investors for the coming second quarter earnings reports. The repositioning was based on unexpected strong profit guidance from a major U.S. financial firm and solid reports that U.S. companies are sitting on a lot of cash. (The company cash balances could also be a seen as a source of weakness, however, as firms remain reluctant to hire and invest because of uncertainties over the outlook.)
Market anxiety about the Eurozone’s fiscal problems and financial sector health was also at a lower pitch. Safe haven effects for the U.S. markets were slightly reduced as interest in euro-denominated instruments was slightly higher as a result.
OMB and the President have just kicked off the 2nd annual SAVE Awards, a contest that allows federal employees to submit their ideas to save money for the taxpayers by making the federal government more efficient. Last year's winner was Nancy Fichtner, who suggested that the VA allow patients to take their medication with them upon discharge. OMB has also proposed the implementation of a few other ideas that didn't win, such as using electronic payroll statements.
As with last year, the winning idea will be guaranteed a spot in the 2012 President's Budget, most likely along with a few other prime ideas. We commented last year that this was "a gimmick we like" since it is important to make the government as efficient as possible. Also, many commentators have suggested that making these small cost-saving changes are a good trust exercise for the American people. If they believe that the government is using their money relatively efficiently, then they will likely be more willing to share in the sacrifice, whether it be on the tax or spending side.
The race for the SAVE Awards winner is on once again!
As Washington struggles with confronting the mounting federal debt, the public has been given the opportunity to register their thoughts through CRFB’s online budget simulator. The early results indicate that Americans are willing to make some of the difficult fiscal choices that the politicians are avoiding.
Since CRFB unveiled its “Stabilize the Debt” budget simulator in May, thousands of people have taken up the challenge to stabilize U.S. debt at 60 percent of GDP by 2018. The site has had over 60,000 visits.
The simulator was designed to help educate Americans about the fiscal outlook and what can be done to place the country on a sustainable fiscal course. The results can help educate policymakers regarding what budget choices Americans are willing to support. And given the encouraging responses, it appears voters are well ahead of politicians on this one.
Last week, Murilo Portugal, the Deputy Managing Director of the IMF, gave the opening speech at the IMF Forum in Stockholm. In his remarks, he succinctly distilled the global debt problem into a simple message:
“Concerns about fiscal and debt sustainability in advanced economies, if left untreated, can undermine the economic recovery and jeopardize global financial stability.”
He stressed the importance of presenting a fiscal turnaround plan to reassure a cautious market, coming a hair’s width away from joining our Announcement Effect Club, but failing to mention the mere "announcement" specifically. An honorary membership might be considered, however:
“Reassuring markets about fiscal sustainability is critical to preserve the recovery and contain volatility in sovereign debt markets. Deteriorating fiscal fundamentals need to be credibly addressed; governments urgently need to communicate fiscal consolidation strategies specifying the measures and the timetable for implementing them. The strategic goal should be to reverse the rise in debt, not just to stabilize it at post-crisis level.”
After laying out his case for fiscal consolidation, Mr. Portugal presents a common-sense set of solutions for the world’s heavy-debtor economies. Eschewing immediate fiscal consolidation in advanced economies lest the fledging recovery falter, he claims that most countries don’t have to immediately tighten their belt, except for those already in crisis mode (see: Greece, Spain). However, Mr. Portugal feels that a plan for medium- and long-term consolidation is essential, and stresses its formulation as soon as possible.
For nations with little to no debt, Mr. Portugal recommends monetary tightening and exchange rate adjustment instead of fiscal measures. All these measures seem to take the middle road between immediate, harsh fiscal austerity and unsustainable budget growth. Let’s just hope people listen.
CBO issued its monthly review for June, finding that so far this year, the federal government has run a deficit of just over $1 trillion, $81 billion lower than over the same period last year. The drop in deficits is due to a decrease in outlays and a slight increase in revenues over last year.
Revenues have inched up by $8 billion this year, despite a drop in individual income and social insurance revenues. The increase is based on corporate income tax increases and higher receipts for the Federal Reserve due to their vast expansion of their balance sheet (see stimulus.org for details.)
The decrease in outlays comes despite increases in many programs in the budget, including defense, Social Security, Medicare, Medicaid, and unemployment insurance. However, TARP program costs have dropped by about $250 billion from last year, actually gaining $110 billion for the federal government so far this year.
The June deficit comes in at $69 billion, $25 billion lower than last year, with all of that increase coming on the strength of revenue.
Social Security has been described as the "third rail" of American politics: if you touch it, you get burned. Now, it seems that touching Social Security might be becoming as easy for lawmakers as picking strawberries.
More and more, there is talk that Social Security reform is the new "low hanging fruit" in plans to deal with our structural deficits. As our long-term budget difficulties have become more publicized, lawmakers have started to realize that compared to fixing Medicare or making significant changes to our tax system, reforming Social Security is a walk in the park. The funding gap is much smaller than it is for Medicare and the options to solve Social Security's problems are clear and easy to quantify.
With the political climate turning towards attention to structural deficits--and even our current ones--it seems political leaders are finally getting the message. Granted, there have been no new major bipartisan proposals on the table yet, but just getting Congressional lawmakers to propose solutions in public has been difficult to come by. Not anymore though.
We mentioned House Majority Leader Steny Hoyer's speech at the think tank Third Way on the blog a few weeks ago. In it, he said "unfortunately, we can blame our long-term deficit on policies that are almost universally popular," and suggested raising the retirement age for Social Security (and possibly Medicare too, though he didn't specify) and indexing it to life expectancy. But he's not the only one talking about solutions.
Last week, in an interview with the Pittsburgh Tribune-Review, House Minority Leader John Boehner suggested raising the retirement age to 70 and indexing COLAs by prices instead of wages. Additionally he said "We need to look at the American people and explain to them that we're broke...If you have substantial non-Social Security income while you're retired, why are we paying you at a time when we're broke?"-- suggesting that he would favor more progressive solutions on the benefits side of the program.
It's very encouraging to see both the Majority and Minority Leader proposing specific solutions to Social Security's long-run finances. There already seems to be some common ground, and there are solutions that both sides of the aisle would find palatable. Specifically, there seems to be consensus on indexing the retirement age at least to longevity and reducing benefits for high earners (a few of the options in CBO's report). Let's hope that Congress uses some of these "compromise" options in a plan that puts Social Security back on balance.
In her testimony before the President’s Fiscal Commission last week, CRFB President Maya MacGuineas presented the following plan as an option to stabilize the federal debt at the popularly considered maximum, 60 percent of GDP, in response to the request for specific policies to deal with the debt. Her plan (shown in the below table) is meant to achieve the 60 percent goal in a balanced manner, while protecting the most vulnerable and promoting economic growth. What follows is only one option for stabilizing the debt—but regardless of the plan we ultimately choose, it’s time to get specific in determining exactly how we are going to fix this grave problem.
A PLAN TO STABILIZE DEBT AT 60% OF GDP
Savings in 2018 (Billions)
Here are the highlights from this weekend’s editorials on fiscal and budget policy:
The Denver Post said that although they opposed a large stimulus package, they did not believe that Congress should penny pinch on the unemployed in the current economic situation. Noting the recent upward trends in unemployment claims, they believed that it was important to extend benefits in an economic climate where "even the most talented and ambitious job-seekers" cannot find a job. The Post believed that the benefits of extending unemployment benefits outweighed the costs of not paying for them.
The Kansas City Star also called for unemployment benefits to be extended, criticizing Congress for playing political games at the expense of the unemployed. They pointed out that unemployment benefits have a high multiplier effect, since recipients have to spend almost all of the money on living expenses. As with the Denver Post, they used the current state of the job market as justification for the extension of benefits.
On the news that TARP could end sooner than expected in order to pay for the financial reform legislation, The Washington Post wrote a eulogy of sorts for the program, noting that its relative economic success may be obscured by its political unpopularity. They pointed to the modest cost of $105 billion of TARP and said that "it arguably saved the U.S. economy." However, they also said that there were many "TARP martyrs": Congressional incumbents who lost their seats partially because they voted for TARP.
The New York Times praised a bill in the House that would provide states with $10 billion to prevent teacher layoffs but said that the cost should not be offset by cutting $500 million from the Race to the Top program, which provides grants to states to implement school reforms. Although they said that preventing teacher layoffs was important, they thought that cutting a program that had spurred school reform plans in almost every state would be very counterproductive. They wanted Congress to find offsets elsewhere.
Last Friday, CBO released a report on 30 options for changing the Social Security system, analyzing both the savings and distributional effects of the options. After CBO released such dismal long-term budget projections last Wednesday (see our analysis here) showing that population aging is set to become the largest driver of entitlement spending through 2035, surely any real reform to our country's finances over the medium- and long-term must make changes to the largest single government program.
The report first focuses in the imbalance between projected revenues and outlays (actually, CBO even expects Social Security deficits to begin this year). While outlays are expected to increase from about 4.8% of GDP currently to 6.2% in 2040 and 6.3% in 2080, revenues are projected to mostly stay flat at around 5%. This leaves a program imbalance that grows from 0.3% of GDP in 2020 to 1.3% in 2040, staying in the 1%-1.5% range throughout the rest of the projection. The total imbalance over the next 75 years is 0.6% of GDP or 1.6% of taxable payroll.
In discussing the reform options, CBO groups the 30 Social Security options into five broad categories:
- Increases in the Social Security payroll tax
- Reductions in people's initial benefits
- Increases in benefit for low earners
- Increases in the full retirement age
- Reductions in COLA's that are applied to continuing benefit
CBO measures each option by how much of a change in the 75-year outlook an option would make, both as a percentage of GDP and payroll. They also find out when the trust fund would be exhausted under each option, but we generally find it more helpful to look at the cash flows of the program. This way, we can see the effects on the budget, as well as if gradually phased-in changes (such as changes in indexing) would put the program on balance when their effects start to accumulate.
It is also worth noting, as CBO does, that different changes to Social Security can affect the future economy in different ways and should be taken into consideration. As they note, raising taxes either through the existing FICA tax or by raising the tax cap would give workers incentives to shift more of their wages into tax-free fringe benefits, especially high income workers who have more flexibility in choosing their compensation. Considering that the excise tax enacted in the health care legislation was designed to do the opposite (or at least reduce the amount of fringe benefits taken in the form of health insurance), this incentive would probably be considered counterproductive. Additionally, CBO notes that benefit reductions might incentivize workers to save more for their retirement, and the increased savings rate would help economic growth. This case is especially true of middle- and high-income workers, which have more after-tax income to save in the first place.
The tax increases come in two forms: changes in the current payroll tax rate or changes in some way involving the FICA tax cap (set at $106,800 currently). CBO offers rate increases of one, two, and three percent, phased in at different rates. None of these options would eliminate the cash flow deficit, although the three percent increase would cut the 2080 cash flow deficit significanly, down to 0.2% of GDP. Eliminating the payroll tax cap without providing new benefits would eliminate the program deficits in the near-term but it would fail to completely close the gap in the years beyond 2040, raising a flat 0.9% of GDP through all those years. Raising the cap to $250,000 without providing new benefits would improve cash flow in 2080 by 0.6% of GDP, cutting the program deficit in half. A more politically realistic option (similar to one proposed by Rep. Robert Wexler) that would tax income above the cap at 4% would improve cash flow by 0.1% of GDP in 2080.
To understand the myriad of benefit reduction options, one must first understand exactly how Social Security benefits are calculated (the CBO report also explains it). Basically, the Social Security Administration (SSA) takes a worker's average monthly earnings over his top 35 earning years and indexes that for wage growth. This number is the AIME (average indexed monthly earnings). The number that SSA comes up with is used to determine the benefit, referred to as the Primary Insurance Amount (PIA). The PIA is determined in 2010 by multiplying the first $761 of the AIME by 0.9, then multiplying the next $3,825 by 0.32, then any amount after that minus the first $4,586 by 0.15 (see here for an example). The points where the multipliers change, $761 and $4,586, are referred to as "bend points" and the multipliers are referred to as "PIA factors." After the initial benefit is determined, SSA then indexes the benefits semi-annually based on price growth; these are "COLAs."
Because there are a lot of moving parts to the calculation of benefits, there are also many ways to reduce benefits, both initially and in the indexing of benefits thereafter. For reductions in initial benefits, CBO offered many options, whether it was increasing the number of earning years included in the calculation, reducing the PIA factors, changing the indexing of lifetime wages in the calculation of benefits, or indexing the PIA factors differently.
The biggest change from the initial benefits options came from the option to reduce the PIA factors by the amount of real wage growth. This would immediately start reducing benefits from current law (by 1.3 percent each year in CBO estimates). The change would improve the cash flow in 2080 by a whopping 2.6% of GDP and the savings would continue to grow over time. Such a drastic option is probably overkill though, and it would be politically unfeasible to cut benefits by 40 percent, which is what this option would do by 2080 relative to current law.
In fact, many of the big options that would eliminate cash flow deficits in one fell swoop are politically difficult. It is more likely that Congress will enact a combination of smaller options on both the revenue and benefit sides that together would put Social Security in balance. Here are some smaller options on the benefit side:
|Option||Improvement in 2080 Cash Flow (% GDP)||75 Year Improvement (% GDP)||75 Year Improvement (% Taxable Payroll)|
|Index AIME to Prices||0.5||0.2||0.5|
|Reduce Top PIA Factor By One-Third||0.1||0.1||0.2|
|Index Initial Benefits to Changes in Life Expectancy||0.6||0.2||0.6|
|Raise Normal Retirement Age to 68||0.2||0.1||0.4|
|Index Retirement Age to Life Expectancy||0.5||0.2||0.5|
|Base COLAs on Chained CPI-U||0.2||0.2||0.5|
|Increase AIME Computational Period to 38 Years||0.1||0.1||0.2|
CBO has done a good job of laying down the options here. Unlike Medicare, which is a more difficult and complex problem to solve, Social Security's options are clear and stir up less disagreement on the technical estimates of reform options. Most importantly, if we enact a plan now, the options can be less painful and they can be phased in more gradually.