Update: This post has been updated as of February 27, 2013 to reflect new proposals from the Senate Republicans

With time running out before the sequester is scheduled to hit, Senate Democrats have released a proposal that would replace the across-the-board cuts until January 2, 2014 with a 50-50 mix of revenue and spending changes. On February 27, CBO scored The American Family Economic Protection Act as adding $7.2 billion to the deficit. Provisions include:

• The “Buffett Rule,” requiring taxpayers earning over $1 million annually to pay a 30 percent effective rate; phased in from $1 to $2 million ($53 billion).
• Eliminating tax deductions for outsourcing costs — i.e. the costs of relocating a U.S. business unit to a foreign country (less than $1 billion).
• Changes to the tax treatment of oil extraction from oil sands. Establishes an 8-cent per barrel fee on domestic and imported supplies, with revenues going to the Oil Spill Liability Trust Fund ($2 billion).
• Ends direct agriculture subsidies, saving $31 billion, and uses $3 billion of those savings to pay for the extension of Farm Bill programs that were left without funding after the fiscal cliff deal and $6 billion to exempt mandatory accounts in the Department of Agriculture from the sequester (net $21.7 billion).
• Cuts defense spending by $27 billion beginning in FY2015 spread out over 7 years. The reduction would be about $3 billion in FY2015 and FY2016, and then would rise slowly to reach about $5 billion in FY2021.

This is the latest in many plans put forward to either prevent one year of sequestration cuts or replace the sequester altogether. Below are summaries of some of the other proposed plans:

The White House Proposal: While details are still unclear, White House spokespersons have said that everything the President proposed in the fiscal cliff negotiations is still on the table, including an additional $600 billion in revenue that could be achieved through limiting tax expenditures. Specifically, these policies include:

• Taxing carried interest as ordinary income as opposed to at capital gains rates
• Eliminating special depreciation schedule rules for corporate jets
• Repealing various tax preferences for fossil fuels
• Limiting the value of itemized deductions and certain exclusions to 28 percent
• Switching to the Chained CPI

The Down Payment to Protect National Security Act of 2013: This sequester replacement bill has been introduced in the House by Rep. Buck McKeon (R-CA) and in the Senate by Sen. Kelly Ayotte (R-NH). It would pay for the first year of sequestration by achieving approximately $85 billion in savings, sufficient to pay for both defense and non-defense accounts. The offsets for this bill include:

• Requiring a government-wide reduction in the number of federal employees by 10 percent through attrition. This would allow federal agencies to hire 1 person for every 3 who leave their employment. It would occur on an agency level as opposed to an across-the-board reduction and could be waived due to a national security concern or another emergency.
• Freezing pay for Members of Congress in years that they are not able to achieve a federal budget surplus.

The Balancing Act of 2013: This bill, introduced by Keith Ellison (D-MN) and members of the House Progressive Caucus, would replace the sequester with $960 billion in new revenue through reforms to the individual and corporate tax code. It would also reduce defense spending by $278 billion to pay for a one-year re-instatement of the Making Work Pay tax credit ($61 billion), funds for teacher and school modernization ($55 billion) and transportation infrastructure investments ($160 billion). Some of the largest options in their bill include:

• Limiting the value of deductions and certain exclusions to 28 percent ($482 billion).
• Closing the carried interest loophole ($17 billion).
• Eliminating special depreciation schedule for jets and eliminating mortgage interest deduction for boats used as second homes ($4 billion).
• Enacting international tax reforms ($161 billion).
• Eliminating fossil fuel subsidies ($94B).

Senate Republican Proposal: Senate Republicans are developing a sequestration replacement proposal that would cancel the across-the-board cuts for FY2013, but:

• Require the President to offer a sequester alternative by March 8. Congress would then have until March 22 to pass a resolution of disapproval by a simple majority vote. If that resolution is signed by the President, the original sequestration order would be restored. The process is subject to a veto, requiring two-thirds to overrule.
• Require that no more than $42.6 billion of the cuts come from defense (like sequester).

Senate Republican Alternative Plan: Sens. Lindsey Graham (R-SC), John McCain (R-AZ), and Kelly Ayotte (R-NH) are developing their own alternative to the Senate Republican proposal. Details have not yet been released, but reports indicate that it would be similar to the House Republican replacement plan from last year. Specifically, the plan would include:

• A $10 billion cut from defense appropriations
• Other unspecified savings, targets may include food stamps, the refundable child tax credit, and federal employee retirement benefits

Sequester Replacement Reconciliation Act of 2012 (H.R. 5652): Last year, Rep. Paul Ryan (R-WI) put forward a bill, which was passed by the House, that would have canceled the sequester and offset the cost through budget reconciliation savings from six House committees -- Agriculture, Energy & Commerce, Financial Services, Judiciary, Oversight & Government Reform, and Ways and Means. The sequestration of FY2013 non-defense mandatory funding of approximately $12 billion would remain in place and include additional mandatory spending cuts, equaling $316 billion in ten year savings. The changes to mandatory programs include (longer description here):

• Altering food stamp (SNAP) benefits and eligibility criteria
• Modifying certain housing and financial authorities
• Reducing spending related to health insurance exchange subsidies established by the ACA
• Increasing the required retirement contribution rates paid by federal employees and Members of Congress
• Making a number of changes to Medicaid and CHIP

Sen. Whitehouse's One-Year Plan: Sen. Sheldon Whitehouse (D-RI) has proposed two plans for replacing the sequester, a one-year waiver and a full replacement, paying for both by making changes to the corporate and individual tax code. The one-year repeal of the sequester for the rest of FY2013 would pay for the $85 billion in lost savings using a combination of the following options, together totaling $102.7 billion:

• Enacting the “Buffett Rule,” requiring taxpayers earning over $2 million annually to pay a 30 percent effective rate. The minimum tax begins to phase in at $1 million ($46.7 billion).
• Requiring S corporation owners to pay payroll taxes on all their business income, not just their compensation ($9 billion)
• Repealing special depreciation schedule for private jets ($3 billion).
• Ending various tax expenditures for oil and gas companies ($24 billion).
• Prohibiting deferral of taxation for manufacturers that produce goods overseas for sale in the U.S. ($20 billion).

Sen. Whitehouse's Nine-Year Plan: Whitehouse has also proposed a full replacement for the sequester. The plan would include all of the offsets in the one-year plan above ($102.7 billion), as well as the following proposals:

• International tax reforms such as ending tax incentives to outsource jobs and profits to foreign countries ($148.5 billion).
• 28 percent limit on itemized deductions for families earning over $250,000 and individuals over $200,000 ($293.3 billion).
• Impose a 0.15% fee on the largest financial firms ($70.9 billion).
• Tax transfers of securities at a rate of 0.03 percent and provide a tax credit for transfers within tax preferred savings accounts ($352 billion).
• Ends the "last in, first out" (LIFO) and the "lower cost or market" (LCM) methods of taxing inventories ($97.5 billion).
• Repeals the corporate deduction for stock options cashed in by an employee at the inflated current market value, rather than the original cost to the corporation ($24.6 billion).

Rep. Chris Van Hollen's Amendment: Rep. Chris Van Hollen (D-MD) submitted an amendment to the Require a PLAN Act which would offset the costs of eliminating the sequester for 2013 with a combination of spending cuts and revenues, but it did not receive consideration on the floor. Offsets in the amendment include:

• Eliminating direct payments to farmers (roughly $30 billion).
• Eliminating several oil and gas tax breaks (roughly $30-$35 billion).
• Enacting the Buffett Rule (unknown savings post-ATRA).

* * * * *

The sequester was never intended to be policy; rather, it was enacted as an enforcement mechanism to help pressure the Super Committee to come to an agreement on deficit reduction. While these proposals that offset the cost of a one-year repeal or a full replacement of the sequester will at least ensure that deficit reduction does take place, lawmakers should ideally use this opportunity to come together and enact a comprehensive plan that would do more than just tread water.

We can do much more if we are willing to take up entitlement and tax reform but above all, lawmakers should avoid the worst option of simply waiving the sequester without offsets and without addressing our unsustainable debt path.

The Hill is reporting that the House Ways and Means Committee will take the next step in creating a broad tax reform plan by announcing 11 separate working groups on different components of reform. The working groups would be composed of members of both parties and will be used to lay the groundwork in these different areas, not necessarily making recommendations.

The 11 working groups would cover the following topics:

• Manufacturing
• Pass-through entities and small business issues
• Charitable and other tax-exempt organizations
• Education and family benefits
• Energy
• Financial services
• Real estate
• Debt, equity, and capital
• Income and tax distribution
• International taxation
• Pensions and retirement

Committee Chair Dave Camp (R-MI) has already released discussion drafts on two of these topics, financial products and international taxes. The Hill reports that the Senate Finance Committee hopes to release a discussion draft or reform options paper in the spring. Ways and Means will also be holding a hearing on the charitable deduction tomorrow morning at 9:30 am.

Overall, it's promising to see tax reform efforts moving forward. It will take a lot of time and information-gathering to get a broad tax overhaul done right, considering all the moving parts. Ways and Means has gotten the ball rolling, and we hope to see it continue until a reform bill that raises revenue crosses the finish line.

Happy New Year – The Chinese New Year was ushered in over the weekend and 2013 is the year of the Snake. According to at least one horoscope, “This 2013 year of Snake is meant for steady progress and attention to detail. Focus and discipline will be necessary for you to achieve what you set out to create." Those born in the year of the Snake are said to approach problems rationally and logically and to be financially secure. Those are definitely attributes we would like to see more of this year as they have been largely absent from Washington so far.

CBO Finds that Debt is a Slippery Issue – The nonpartisan Congressional Budget Office (CBO) last week released its 2013 Budget and Economic Outlook. The report illustrates the need for a smart, long-term approach for addressing the deficit, as well as how the national debt and economy are intertwined. CBO predicts that abrupt deficit reduction like the sequester would impair economic growth in the short term while failing to address the long-term growth of the debt will impair the economy significantly down the road. A companion report also shows that $2.3 trillion of additional deficit reduction over the next decade would result in higher economic growth than currently projected in the longer term. CRFB has a summary and analysis of the report. Under current law, CBO predicts that debt will reach 77 percent of the economy by 2013. Under its Alternative Fiscal Scenario, assuming that the sequester is waived, various tax breaks are extended and the "doc fix" continues, the debt will reach 87 percent of GDP by 2023. CRFB estimates using its own realistic baseline that debt will reach 79 percent of the economy by 2023.

No Venom in State of the Union? – President Obama will give the annual State of the Union address tonight at 9 pm EST. The New York Times reports that the President will offer an optimistic vision and focus on improving the economic prospects for the middle class in his remarks. According to sources cited in the article, any new initiatives mentioned in the speech will be fully offset by new savings or revenues elsewhere in the budget and that Obama will revive his call for a comprehensive "big deal" to reduce the deficit. Our updated brief illustrates that much more work is still required when it comes to the national debt. We calculate that a minimum of $2.4 trillion in additional savings will be required to put the debt on a downward path over the next decade and beyond.

Will Congress Turn Cold-Blooded on the Sequester? – Word is that President Obama will also continue to urge lawmakers to avoid the across-the-board spending cuts of sequestration ahead of the March 1 deadline in his State of the Union Address. He began last week by urging a short-term plan with revenue and spending cuts to delay the sequester and followed it up by releasing a fact sheet detailing how the cuts of the sequesters would impact Americans. The pressure will continue this week with hearings highlighting the effects of sequestration and legislation from Senate Democrats by Thursday to replace this year’s sequester cuts with other spending cuts and tax increases. Congressional Republicans are loathe to include any new revenue in any sequester deal, which has many fearing that the sequester will go into effect.

Rolling Snake Eyes on 2013 Appropriations? – Sequestration is not the only March deadline facing policymakers. The continuing resolution currently funding the federal government expires on March 27. Without a spending plan for the rest of the fiscal year or another short-term stopgap measure, the government will shut down. Appropriators are said to be preparing another stopgap measure, meaning that a more comprehensive spending bill is not likely. Their work will also be affected by the sequester debate, since the sequester is scheduled to cut discretionary spending by $70 billion.

Slithering Around Fiscal Speed Bumps – The sequester and continuing resolution are just a couple of deadlines among a handful of "fiscal speed bumps" ahead; check out our infographic that lays them all out. Washington hasn’t had such a good track record of dealing with fiscal deadlines so far, only partially dealing with the fiscal cliff and kicking the can on the debt ceiling. The only way to avoid more fiscal drama is to develop a long-term, comprehensive fiscal plan.

Solution Coming for Doc Fix Snake Oil? – One of the few pieces of good news in last week’s CBO report was that the cost of a permanent "doc fix" is now significantly lower than previous estimates. The doc fix prevents a scheduled cut in Medicare payments to physicians known as the Sustainable Growth Rate (SGR) formula. SGR was never a real solution to rising health care costs, since Congress has always shelved the steep cut when it was set to occur. Bipartisan legislation was introduced in the House last week to permanently repeal the cuts, and the House Ways and Means Committee outlined a similar solution. No matter what is done regarding the doc fix, Congress must get serious about bending down the health care cost curve.

Deficit a Top Snake in the Grass for Voters – A Quinnipiac University poll finds that the economy and federal budget deficit are the two issues Americans most want addressed in the State of the Union. The poll echoes the results of other recent polls findings these are the top issues. It is fitting as the two issues are so closely connected. A smart approach to reducing the deficit that phases in cuts gradually and contains pro-growth policies can benefit the economy.

Congress Revisits Balancing the Budget Scales – The National Review reports that Senate Republicans plan to offer a balanced budget amendment. The last Congress saw several balanced budget proposals. As we noted at the time, the balanced budget debate rightly shines a light on the need to reform the dysfunctional budget process. However, there are plenty of other options that do not require changing the Constitution and could more easily gain broad support.

Key Upcoming Dates (all times are ET)

February 12

• Senate Budget Committee hearing on the Congressional Budget Office (CBO) 2013 Budget & Economic Outlook with CBO Director Douglas Elmendorf at 10:30 am.
• President Obama delivers the State of the Union address to a joint session of Congress at 9 pm.

February 13

• House Budget Committee hearing on the Congressional Budget Office (CBO) 2013 Budget & Economic Outlook with CBO Director Douglas Elmendorf at 10 am.
• Senate Finance Committee confirmation hearing on the nomination of Jacob Lew to be Secretary of the Tresaury at 10 am.
• House Armed Services Committee hearing on the impact of the continuing resolution and sequester on defense at 10 am.
• Senate Budget Committee hearing on the "Impact of Budget Decisions on Families and Communities" at 10:30 am.

February 14

• House Ways and Means Committee hearing on tax reform and charitable contributions at 9:30 am.
• Senate Appropriations Committee hearing on the effects of sequestration at 10 am.
• House Committee on Education and the Workforce subcommittee hearing on sequestration at 10 am.
• House Energy & Commerce, Health Care Subcommittee hearing on building a future Medicare physician payment system at 10:15 am.

February 21

• Dept. of Labor's Bureau of Labor Statistics releases January 2013 Consumer Price Index data.

February 28

• Bureau of Economic Analysis releases second estimate of 2012 4th quarter and annual GDP.

March 1

• Across-the-board cuts to defense and non-defense discretionary spending prescribed in the Budget Control Act, known as "sequestration," will take effect.

March 8

• Dept. of Labor's Bureau of Labor Statistics releases February 2013 employment data.

March 15

• Dept. of Labor's Bureau of Labor Statistics releases February 2013 Consumer Price Index data.

March 27

• Current continuing resolution (CR) funding the federal government expires.

March 28

• Bureau of Economic Analysis releases third estimate of 2012 4th quarter and annual GDP.

April 5

• Dept. of Labor's Bureau of Labor Statistics releases March 2013 employment data.

April 15

• Congress must pass a budget resolution as specified in the Congressional Budget Act. Also, due to the debt ceiling suspension bill, lawmakers will have their pay withheld after this date until their respective chamber passes a resolution.

April 16

• Dept. of Labor's Bureau of Labor Statistics releases March 2013 Consumer Price Index data.

April 26

• Bureau of Economic Analysis releases advance estimate of 2013 1st quarter GDP.

A popular secondary story from the newest CBO baseline centers on the "doc fix," the patch that prevents a large cut to physician payments due to the Sustainable Growth Rate (SGR) formula. The American Taxpayer Relief Act (ATRA) put off a 27 percent cut to physician payments for 2013, but left in place cuts for future years (now scheduled to be 25 percent in 2014). However, CBO's baseline estimated the cost of extending the doc fix permanently -- freezing physician payments at current rates rather than allowing them to be cut -- declined significantly. Whereas the August baseline scored the cost of a permanent doc fix at about $250 billion, the latest estimate now puts it at less than $140 billion, over a $100 billion change.

For background, the SGR was enacted in the Balanced Budget Act of 1997 as a backstop to control Medicare spending. It set out specific spending targets and increased or decreased physician payments if actual Medicare spending met or exceeded the target, respectively. For the first few years, spending did meet the targets, so physicians saw payment increases. However, starting in the early 2000s, spending exceeded the targets, and rather than allow scheduled cuts to take place, lawmakers continually put them off a year or two at a time, sometimes replacing it with other health care cuts. Because these fixes were only temporary and Medicare spending continued to exceed its targets, the scheduled cut grew larger year after year.

But in recent years, Medicare spending growth -- as well as total health care spending growth -- has slowed, and the trend has reversed. In fact, CBO is now estimating physician payment rates would increase in 2015 (assuming a 25% cut in 2014). As CBO explained in its latest baseline:

Actual spending has been lower than projected—and lower than the spending targets inherent in the sustainable growth rate—for the past three years. Because actual spending has been lower than spending targets, CBO now estimates that payment rates will increase beginning in 2015. Those higher payment rates narrow the difference between growth under current law and a freeze at current levels, thereby reducing the estimated cost of restricting the payment rates.

As a result, the recent decline in Medicare cost growth has had a big impact on the costs of doc fixes. The table below shows the projected cost of a permanent SGR repeal in 2018 fell from a high of $34 billion in August 2011 to $12 billion today.

^{Source: CBO}

Even though health spending growth has slowed, that is no reason to be complacent on health care spending. For one, future Medicare spending growth is uncertain and could end up being higher than CBO projects, making SGR repeal more expensive than it is currently (offsets may also increase, depending on how they are designed). More importantly, even if CBO's projections hold, simply offsetting the doc fix will still leave health care spending rising faster than the economy. Even after the Affordable Care Act's cost controls fully phase in, federal health spending will still rise from 5.7 percent of GDP in 2017 to 6.4 percent in 2023. The chart below shows the small difference between a deficit-financed doc fix and one that is offset.

^{Source: CBO}

Perhaps the most prominent SGR repeal bill right now is the Medicare Physician Payment Innovation Act, co-sponsored by Reps. Allyson Schwartz (D-PA) and Joe Heck (R-NV). The bill repeals the SGR, provides small payment increases for physicians instead of a freeze, and directs the Centers for Medicare and Medicaid Services (CMS) to develop options for a new physician payment system to be implemented in 2019. This bill was introduced in the last Congress, offsetting the cost of SGR repeal with the drawdown of war spending, a budget gimmick we opposed. While the reintroduced bill is silent on offsets, the much lower cost of repeal will make it easier for lawmakers to find them.

In addition, last week the House Ways and Means Committee released an SGR replacement outline containing principles for repeal that are very similar to the Schwartz-Heck bill. This outline calls for the SGR to be replaced with stable payment rates and a new physician payment system that better rewards quality and efficiency of care.

Overall, the lower cost of repealing the SGR should be welcome news for those eager to replace a flawed formula. However, lawmakers should remain aggressive on tackling federal health spending as the aging population and health care costs growing faster than the economy will continue to drive future deficits. As we detailed in a report last December, there is a wide variety of options that can offset the doc fix and go well beyond that to address increasing health spending. Lawmakers should explore all options, as controlling the growth of health care spending is a key element to getting our fiscal house in order.

In CBO’s latest Budget and Economic Outlook, much has changed since their August baseline. As we explain in our report on the February baseline, the majority of change results from the American Taxpayer Relief Act (ATRA). However, there are several other legislative, technical, and economic revisions that for the most part cancel each other out but are still worth highlighting.

Legislative Changes

Legislative changes, predominately the ATRA, increased the cumulative deficit by an estimated $4.7 trillion. We’ve explained ATRA’s impact on the deficit in detail before, but the impact on revenues was by far the largest, reducing them by nearly $4 trillion through 2022. Also included in the $4.7 trillion is an additional $41 billion in emergency spending in 2013 recently appropriated in the aftermath of Hurricane Sandy as well as a reduction in funding allocated for overseas contingency operations (the budgetary term for spending in Iraq and Afghanistan.)

Economic Changes

Updated economic projections increased deficits by $141 billion. Even with improved economic growth in the short-term due to avoiding part of the fiscal cliff, higher debt levels over the next ten years will produce higher interest rates and therefore increase net interest payments by $192 billion more than projected in August. Another reason for increase in projected deficits is that CBO has revised spending on student loans (which had been revised down in August) upwards by $35 billion. Additionally, because of the recent 1.7 percent increase in cost of living adjustments, which was greater than anticipated, Social Security payments are projected to increase by $19 billion through 2022.

Technical Changes

On the other hand, technical changes resulted in a net decrease of $270 billion through 2022. An important factor here is health care spending. Medicaid spending is $236 billion less due to lower anticipated enrollment and per capital costs. Since August, CBO has improved its measurements of enrollment and now projects fewer people to enroll in Medicaid. A greater share of children and healthier adults are also expected to qualify, leading to 6 percent lower per capita costs.

Medicare projections are now $137 billion less than they were in August due to updated spending data that reflects lower than expected health care cost growth. CBO notes that since 2010, revisions to their earlier estimates have lowered Medicare spending by $200 billion in 2020. However, as we’ve argued before, it is unclear how long this lower growth trend will continue to last.

Another technical update is an increase of $44 billion in estimated revenue related to the Treasury’s transactions with Fannie Mae and Freddie Mac. Revenue over ten years was also revised up by $90 billion.  This reflects an increase of $138 billion over the first five years, but a decrease of $42 billion thereafter through 2022. In the first five years, CBO projects increased wages, salaries, and corporate profits due to strong near-term growth, but lower wages and salaries will decrease revenue slightly in the second half of the decade.

^{Source: CBO}

Overall, the total effect of these changes, particularly from ATRA, has brought current law estimates much closer to current policy estimates. Compared to August’s baseline, CBO’s February report shows current law no longer puts our debt on a downward path and brings these projections closer in line to a more realistic, current policy scenario. That means policymakers will have more work to do on the debt.

Former U.S. comptroller general and CRFB board member David Walker writes in a Poltico op-ed about the need for lawmakers to focus on reaching a compromise on a bipartisian deficit reduction plan. He draws inspiration from the "No Budget, No Pay" provision in the debt ceiling bill, which withholds Members' salaries until their respective chamber passes a budget resolution.

Walker wants to further put pressure on Congress to reach an agreement by requiring the members to stay in Washington and not recess until a comprehensive agreement is reached. Noting the many fiscal issues Congress must address in the coming months, he writes:

We need a fiscal grand bargain in 2013, and we have several critical deadlines facing us over the next several months that must be addressed: automatic spending cuts (sequestration) that kick in March 1; an expiration of the funding for fiscal 2013 and possible government shutdown on March 27 (if continuing resolutions aren’t passed); budgets that must be approved by April 15; and the deferred debt ceiling confronting us again on May 19. Elected officials should use these upcoming deadlines as an incentive to move toward that ultimate grand bargain, and this deal must effectively address the huge structural deficits that pose a serious threat to our collective future.

Clearly our elected officials have very little time to achieve a lot of things. They have even less time than you’d think for a reason you may find hard to believe: Congress plans to be adjourned and outside of Washington for a full month during this critical period!

Yes, you heard right. Starting with last week, the week of Jan. 28, the House of Representatives has breaks scheduled that include Feb. 18-22, March 25-April 5 and April 29-May 3, and the Senate plans to take several weeks off as well. And this is not unusual. For example, according to the House calendar, it only plans to be in session during 2013 for 49.5 percent of weekdays. Compare that with a person who typically gets 20 days off a year (10 vacation days and 10 holidays) — they work 92.3 percent of weekdays.

It’s outrageous that at a time when our nation’s finances are in such disarray, and the clock is ticking on our potential debt bomb, our elected officials are taking “spring breaks” and a week off for every federal holiday instead of focusing full time on the task at hand. For this reason, my organization along with other groups is launching a new campaign we are calling No Deal, No Break. The premise is simple: Stay in Washington, do your job and strike a meaningful fiscal deal that can restore fiscal sanity. And until that happens, don’t recess.

It's important that members of Congress interact with their continuents so that they can best represent the voters in Washington, but it is also important that the members have enough time to sit down and work out an agreement on the pressing issue of debt and deficits. We cannot wait any longer.

Click here to read the full op-ed.

"My Views" are works published by members of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members of the committee.

On the same day they released their February Baseline projection, the Congressional Budget Office (CBO) released a companion report on Macroeconomic Effects of Alternative Budgetary Paths. The report estimates the effects on the economy of different fiscal paths. Importantly, it speaks to the potential economic benefit of deficit reduction, in contrary to those who claim that doing deficit reduction now, regardless of its composition and timing, is damaging. It also provides an important illustration of the reverse economic effects of fiscal policies that increase deficits beyond current law.

The report analyzes three alternative paths: (1) a $2 trillion deficit increase, (2) $2 trillion of deficit reduction, and (3) $4 trillion of deficit reduction. Its analysis does not make assumptions about the types of spending and revenue policy changes that lead to the level of primary deficit spending growth or reduction. Therefore, the only effects they are examining are the effects of deficit reduction itself.

The conclusions are not surprising, but highly informative about the benefits of deficit reduction and the importance of its timing:

• Paths 2 and 3 lead to slightly lower output between 2014 and 2016 than Path 1,
• Following paths 2 and 3 would lower deficits and lead to higher output by 2018 than Path
• With a $2 trillion deficit reduction/increase, output would be 0.9 percent higher/lower (respectively) by 2023. 
• On the other hand, the $4 trillion deficit reduction plan would increase output by 1.7 percent. The effects are much greater in 2023 than they are in 2014, and the 2014 effects could be muted more with greater back-loading.

Higher growth from deficit reduction is a result of less crowding out of private investment. That factor becomes more significant after the economy reaches its potential, which is projected to happen in 2017. The effects on growth would most likely get much larger beyond 2023.

^{Source: CBO}

These macroeconomic effects also feed back into budget deficits, taking into consideration that lowering the deficit would push interest rates lower, while raising output would bring more revenue into the government and reduce spending on means-tested programs. The economic effects increase deficits by an additional $150 billion over ten years for Path 1, reduce deficits by an additional $100 billion in Path 2, and reduce deficits by an additional $185 billion in Path 3.

^Source: CBO

The CBO's report illustrates the importance of not waiting to enact a package of comprehensive deficit reduction in order to secure our fiscal future. The economic benefit of deficit reduction when the economy has recovered is large, and conversely, the cost of waiting too long may be large as well. The report also shows, to a lesser extent, the importance of making those changes gradually so as to minimize the short-term harm. The CBO sums up the lessons from the paper quite well, saying:

The longer that significant deficit reduction is deferred, the larger the government’s accumulated debt will be (with its associated costs and risks), and the greater the policy changes will need to be when deficit reduction begins. Conversely, the sooner that the deficit is cut, the more the economic effects will be felt when the economy is still relatively weak, and the less time that households, businesses, and state and local governments will have to plan and adjust their behavior.

For 49ers and Ravens fans, the Super Bowl was the big game of the 2012 NFL season. For budget wonks, today is that day, as CBO has released its budget and economic projections. These projections show what we previously thought, that debt is on an upward path as a percent of GDP under CBO's current law and Alternative Fiscal Scenario projections. Current law debt is projected to reach 77 percent of GDP by 2023, while CBO’s AFS projections show debt reaching 87 percent.

Largely as a result of the fiscal cliff deal (the American Taxpayer Relief Act), current law deficits and debt are much higher than previously projected, given that the expiring tax cuts and AMT patches were extended for most households. Ten-year deficits will total nearly $7 trillion (3.3 percent of GDP on average) over the next ten years, whereas CBO’s August projections were $2.3 trillion in total deficits (1.1 percent of GDP).

Obviously, revenue projections have fallen significantly as a result of the fiscal cliff deal. They are now projected to average 18.9 percent of GDP over ten years, compared to 20.6 percent in their previous baseline. Spending is slightly higher, averaging 22.1 percent over ten years compared to 21.7 percent in their previous estimate.

^{Source: CBO}

CBO also estimates an Alternative Fiscal Scenario, which assumes the sequestration is canceled, policymakers continue to enact “doc fixes” to avoid deep cuts to physician payments, and a number of temporary expiring tax provisions continue. Under this scenario, debt will rise to 85 percent of GDP by 2022 and 87 percent by 2023. By comparison, CBO’s previous AFS had debt rising to 90 percent of GDP in 2022. About 3 percent of GDP in the difference is attributable to the expiration of tax cuts for people making over $450,000 as a result of the fiscal cliff deal.

^{Source: CBO}

Later today, CRFB will be releasing a fuller analysis which goes into detail on CBO’s budgetary and economic projections. For those not on our email list, you will be able to find that document at http://www.crfb.org.

A recent blog post by International Monetary Fund (IMF) economists Carlo Cottarelli and Philip Gerson on the IMF Direct blog highlights the importance of how deficit reduction plans are designed. Like many of the economists in our post last week, they make the case for a well-designed deficit reduction plan for the federal government to solve its fiscal problems.

Cottarelli and Gerson note the strong performance of many advanced economies in reducing government deficits in 2012. However, there is still a great deal of work to be done: several major economies have not posted strong enough deficit reduction numbers, including the United States:

But there is another group of countries—which unfortunately contains some of the very largest economies—where debt ratios are continuing to rise rapidly or have stabilized but at very elevated levels. Many of these countries will need to undertake significant deficit reduction in the coming years to return debt ratios to more sustainable levels, and even those countries where debt ratios have stabilized or started falling will need to commit to keeping their fiscal positions strong for many years to return public debt to safer levels.

In some countries, a few other resolutions would also be in order. The United States and Japan need to resolve to adopt and begin enacting credible medium-term plans to get their public finances back in shape. The short-term fiscal stimulus recently introduced by the Japanese authorities makes it even more imperative to tie down the longer term path for debt and deficits.

And while the United States has thankfully avoided the so-called fiscal cliff, it also needs to resolve to increase the debt ceiling expeditiously (and not just for a few months).

Cottarelli and Gerson emphasize that it is important how and when lawmakers reduce deficits. In the near term, lawmakers should protect the recovering economy and hold off changes but not indefinitely. An ideal plan would time most of the deficit reduction until after the economy has had more time to recover, but with the tremendous uncertainty surrounding the nation's current fiscal situation, a plan should be enacted now even if measures are phased-in slowly.

The concerns about the impact of deficit reductions on growth are valid, but the effect will depend on the specific design of fiscal adjustment policies, as well as on their timing.

Under normal circumstances, when the government cuts spending by $1, output normally falls by less than that because some of the resources that used to be employed to produce goods and services for the public sector will be freed up to produce for the private sector, instead.

But with a weak private sector, cuts in government spending are not partially offset by higher spending by households and firms. And with interest rates in many advanced economies close to zero, there is little scope for central banks to limit the impact of fiscal tightening by loosening monetary policy. That’s why governments that can afford to move gradually need to be careful not to tighten policy too much now.

But the current weak conditions will not last forever. As private sector balance sheets are mended and banks recover their lending capacity, private demand should pick up. When this happens, lower government demand for goods and services will be replaced in part by stronger private demand. Of course, this will require that monetary conditions remain relaxed for a long time. This is what the Fed has recently reiterated and what other central banks should do.

This means that, when financing conditions allow, countries that need to tighten policy should resolve to reduce their fiscal deficits in a gradual and steady manner that avoids excessive front-loading, a position we have advocated for some time.

The emphasis should be on both “gradual” and “adjustment”: just postponing all adjustment to the future would hardly be credible. The need to avoid excessive front loading has been recognized in many countries that are currently implementing Fund-supported adjustment programs. For example, in response to slow growth fiscal targets have been revised in both Ireland and Portugal, allowing for a more gradual pace of consolidation than would have been possible if the original deficit targets had been maintained.

Lawmakers will need to agree upon a plan that puts debt on a downward path of GDP. But just as important as the overall sizeof the package is the pace and structure of the plan. To minimize harm, lawmakers should look for phased-in policies that will promote greater efficiency both economically and fiscally, making the case for a serious look at our tax code and entitlement programs.