The Senate will seek an end to the extended debate over tax extenders legislation tomorrow with a cloture vote on HR 4213 even though it is not clear that the bill has the 60 votes necessary to cut off debate and move to a vote on final passage. Concerns about the cost of the package, much of which is not paid for, is the main point of contention.

The House version of the bill, which extends some popular tax breaks, expanded unemployment insurance and the Medicare doc fix, passed narrowly just before Memorial Day after leaders there significantly scaled down the measure in response to cost concerns from members. Senate leaders had sought to restore some of the funding, including $24 billion in Medicaid matching funds for states. However, senators are expressing the same anxiety over the debt impact as their House colleagues, causing Senate leaders to consider paring down the bill so that it is closer in cost the House version.

Senator John Tester (D-MT) introduced an amendment to eliminate the extra unemployment compensation ($25 per week) originally provided by the Recovery Act, which would shave $6 billion off the cost of the bill. CongressDaily reports that Senator Max Baucus (D-MT) is preparing a scaled-down version that will shorten the extension of the doc fix to perhaps seven months and decrease the state Medicaid aid. At the same time, Senator Bob Casey (D-PA) wants to restore the $7 billion COBRA subsidy for unemployed workers that the House jettisoned. Votes on amendments may occur today.

Republicans have offered their own version in the form of an amendment from Senator John Thune (R-SD) that would completely offset the costs of the extensions through spending cuts elsewhere. The Congressional Budget Office estimates the proposal will reduce the deficit by about $68 billion. Its provisions include rescinding $38 billion in unobligated stimulus funds; cutting wasteful federal spending; freezing the salaries of federal employees; instituting a five percent across-the-board-cut in federal spending (exempting the Departments of Defense and Veteran’s Affairs); and pairing the doc fix with medical malpractice reform.

It is about time that lawmakers start thinking about paying for legislation. As we argued yesterday, CRFB is not opposed to well-designed stimulus, but we believe that such measures be offset over the longer run so that they do not add to the debt. What we object to is deeming every initiative as “emergency” spending and as a “jobs” bill with no intention of mitigating its impact on the long-term debt. Lawmakers should work together to develop credible measures. Extending the long-term debt will not help the economy.

“Beautiful Game”and Not-So-Pretty Agenda – Add soccer to all the other distractions in Washington as lawmakers face a packed agenda. With the World Cup under way and workers gathered around monitors in offices across the globe (when they’re not at the local bar), legislators in DC face action on key bills that will affect the nation’s bottom line. Meanwhile, the growing chorus for fiscal responsibility and offsets to spending are becoming as loud and ubiquitous as the sound of the vuvuzela at matches. It may be considered annoying by some, but is music to the ears of debt hooligans like us.

Extenders Bill Can’t Find the Net – The Senate will resume consideration this week of legislation (HR 4213) that will extend tax cuts and expanded unemployment benefits, but getting 60 votes is proving to be even more difficult than scoring goals in South Africa. Senate Majority Leader Harry Reid (D-NV) wants to restore Medicaid aid to states and COBRA subsidies that were dropped from the House version because of widespread concerns about the costs that were largely not paid for. Some senators also want to trim the few revenue-raisers that are in the package. But the same deficit concerns that forced House leaders to pare down their bill are slowing progress in the other chamber. The Bottom Line has been charting the changes in the legislation and impact on the budget. CRFB wants to see more long-term offsets and has offered some suggestions in a paper.

Republican Side Offers Competing Measure – Senate Republicans are offering an alternative to the extenders legislation. Their proposal seeks to fully offset the tax cuts, unemployment insurance and Medicare “doc fix” through spending cuts, as opposed to the revenue provisions in the Democratic version. They don’t have the votes for their measure, but will it force more offsets in the bill?

Supplemental May Take to the Pitch in House – The House may begin consideration of a supplemental to fund operations in Iraq and Afghanistan this week, though it is unclear what other spending the bill may include. House Appropriations Committee Chairman David Obey (D-WI) wants to include additional money to states to prevent layoffs of teachers and other public employees. Democratic leaders wanted the additional spending marked as “emergency” so that it would not have to be offset under pay-as-you-go rules, but now are considering applying unused stimulus funds to pay for the cost after many lawmakers objected. President Obama sent a letter to congressional leaders over the weekend in support of the state aid and provisions in the extenders bill as a means of stimulating the economic recovery. He also called for “additional steps to establish a fiscally sustainable budget path over the medium- and long-term.” He did not offer specifics for reaching this path beyond noting that he wants a three-year discretionary spending freeze and a fee on Wall Street firms to recoup TARP costs. Yet it is time to get specific about how we will address mounting debt in the medium- and long-term. As we argue here, economic stimulus will only be credible if paired with a medium-term fiscal consolidation plan. Like many teams in South Africa, lawmakers are struggling to find a balanced attack; in this case aiding the recovery while not adding to the long-term debt.

Will Estate Tax Be Called Offsides? – CQ reports that a proposal to reinstate the estate tax at a lower level than it is currently scheduled to reappear at next year may be taken up by the Senate as a part of a small business tax incentive bill after work on the tax extenders legislation is finally complete. But estate tax changes face a significant barrier in PAYGO requirements dictating that any changes after 2011 must be offset. Getting 60 votes to circumvent the rule will be tricky in an election year. Voters concerned about federal debt likely will frown upon a big tax break for the wealthiest Americans.

White House Looks to Score on Fiscal Responsibility – Budget reform proposals from the White House have been as prevalent as goalie errors on the field as of late. First it asked for new authority to allow federal agencies that save money to keep half of it to spend in other areas, providing an incentive to agencies to spend wisely. Agencies currently have no such inducement as they are required to give back any unused funds. Then the White House announced that agencies must review their budgets and find five percent spending cuts. That was followed by a presidential memo calling for more efficient use of federal real estate. These are modest proposals, but they get the fiscal responsibility ball rolling in the right direction.

Will Defense Budget Produce Goals? – Unlocking Pentagon spending can be trickier than the Jabulani ball, but recent developments may foretell changes in defense budgeting. Defense Secretary Bill Gates recently announced that the Pentagon will aim to find over $100 billion in savings over the next five years, to be redirected to other areas of the defense budget. We applauded the effort in the Bottom Line, but also noted that the effort does not go far enough; defense savings should also contribute to deficit reduction. In that vein, a bipartisan group of lawmakers sent a letter to the president’s deficit commission last week recommending cuts of over $1 trillion over ten years based on a report from a panel of experts.

House May Consider Enhanced Presidential Rescission Authority – Getting Congress to loosen its control of the purse strings is harder to pull off than a bicycle kick, but the president has some support for his version of a watered-down line item veto. Speaker of the House Nancy Pelosi (D-CA) says she supports the proposal for enhanced rescission authority and the House Budget Committee will hold a hearing this Thursday.

Bruce Bartlett posits an interesting scenario for when debt default could occur in the US: next year. Before the panic sets in, we should clarify.  He means that there is an increased possibility that, for political reasons, Congress might not pass a debt ceiling increase next year. This move would technically force the US to default. He explains the politics below:

The party opposite the White House always demagogues increases in the debt limit to score cheap political points. Economist Donald Marron calls the vote on raising the debt limit a tax on the party in power. Barack Obama knows this very well. As a U.S. senator he voted against a debt limit increase in 2006, saying that the necessity of raising the limit was “a sign of leadership failure.” 

To be sure, the debt limit has always been raised in time to prevent a default, although Treasury sometimes had to push the limits of the law to move money around to pay the government’s bills. However, I believe the game has changed because Republicans have become extremely bold in using the filibuster to make it extraordinarily difficult to pass any major legislation without at least 60 votes in the Senate.

Especially considering the possibility of political shake-ups after the 2010 elections, a Republican-controlled Congress could hold a debt limit vote hostage in order to blame the Democratic White House for the debt. While debate on the debt is certainly welcome, playing a game of political chicken with the nation's fiscal and economic health is not. The public recognizes this as well, which is why when Newt Gingrich threatened default during the 1995 Clinton budget showdown, he had to back down.

But Bartlett says that a new element makes default this time around more likely: a number of conservatives who actually favor it. Their argument is essentially that since government spending cannot be kept under control through the political system, only a default that would make investors unwilling to fund any US debt would force lawmakers to balance the budget (presumably by cutting spending.) Granted, none of the members of Congress have taken this position and they likely never would, since they would be calling themselves too weak to balance the budget (not exactly a great political move.)

This "political" default is a variant on one of CRFB's possible fiscal crisis scenarios (if we don't change our fiscal course), detailed in a paper exploring several potential fiscal crisis variations and their related risks. A mix between the "Political Risk Crisis" and the "Default Crisis" scenarios in our paper, lawmakers delay acting on deficits until years down the line. When they do, the adjustments necessary are so great that political pressures force them to repeal their fiscal consolidation plan. Eventually, the government defaults on the debt, sending shocks throughout the domestic economy.

Our main point in that paper was that acting, or planning to act, on our debt and deficits now is always a better option than waiting. Each scenario was exacerbated by inaction and succumbing to political convenience. Next year, instead of succumbing to the convenience of politicizing the debt limit or playing chicken with it, lawmakers could tie in a medium-term deficit reduction plan (that phases in slowly as the economy recovers) to a debt limit increase. Better yet, lawmakers should act now to approve such a plan.

Correcting our nation's fiscal outlook would be a much better use of lawmakers' time than threatening default in 2011.

U.S. financial markets this week have continued to be dominated by global capital seeking a safe haven in U.S. Treasury instruments, as the eurozone continues to struggle getting its fiscal problems under control. When safe haven effects kick in due to fears about problems with the U.S. recovery or elsewhere, investors turn to U.S. Treasury instruments and U.S. interest rates go down. When investors become more bullish over U.S. economic prospects (including relative to other countries), the U.S. stock markets looks better and assets are shifted from the bond markets.

The safe haven factor has roiled U.S. financial markets since April, as described by Fed Chairman Bernanke in his testimony to the House Budget Committee yesterday:

U.S. financial markets have been roiled in recent weeks by [developments in the Eurozone related to the ability of Greece and the other euro countries to manage their debt problems. These developments] have triggered a reduction in demand for risky assets: Broad equity market indexes have declined, and implied volatility has risen considerably. Treasury yields have fallen as much as 50 basis points since late April, primarily as a result of safe-haven flows that boosted the demand for Treasury securities. Corporate spreads have widened over the same period, and some issuance of corporate bonds has been postponed, especially by speculative-grade issuers.

This week, several other factors have been in play. Disappointing U.S. retail sales data for May (following upon weaker than expected May employment data, released last week) has raised questions about the strength of the recovery. (Although retail sales were below expectations, they still might show an upward trend over the quarter – just not as strong as forecasters would have liked.) Some unusually strong consumer confidence data for June has partly offset consumer spending concerns based on the May number. In addition, news that China’s exports have continued to surge has been digested in several directions: positive news that China is continuing to be the global engine of growth (although there have been signs of a pick up in China’s inflation); concerns that the Chinese currency remains overvalued; and worries that such export growth is in fact unsustainable in the medium run.

Start with a basic question: Do you think politicians are better at cutting taxes and increasing spending, or the reverse? The answer should help you to determine whether to worry more about politicians doing too little to stimulate the economy or too little to control the debt.

“Deficits will have to be reduced once the recovery gains more traction and unemployment recedes. Right now, for the most robust economies — the United States, Germany, Britain, Japan — slashing budgets is the wrong thing to do.”

The establishment of a fiscal commission either in Congress or by the President was attacked from both sides of the political spectrum.  Liberals thought that the group would be cover for cutting entitlement programs, while conservatives thought the commission would be a cover to raise taxes. When President Obama's National Commission on Fiscal Responsibility and Reform came to be, both sides wanted to fence off different options for consideration. And it continues to happen.

A Washington Post article details different liberal groups who want Social Security cuts to be off the table. In fact, MoveOn is planning to ask candidates to sign pledges opposing Social Security benefit reductions. They would like to see the entire fiscal imbalance of Social Security solved on the tax side; Nancy Altman of Social Security Works suggests raising the payroll tax cap or enacting a financial transactions tax to cover the deficit.

We at CRFB of course like to say that everything should be on the table when it comes to fixing our fiscal problems. We should not try to solve them just on one side of the budget while completely ignoring the other. We particularly like what House Majority Leader Steny Hoyer had to say:

"My advice to members is: Do not sign yourself into a corner.... That's not because anybody intends to cut the benefits of any Social Security recipient today or tomorrow. But given the magnitude of the problems that confront us, do not limit your options."

These pledges are coming from both sides, with conservative counterparts offering up "no new taxes" pledges, the likes of which have been seen at the state level, and have proven to be detrimental to state budget negotiations. We at CRFB agree with Rep. Hoyer: given the severity of our fiscal problems, we should not be limiting ourselves. Fencing off options not only is bad budgeting, but also bad politics. Limiting options reduces the chances for a bipartisan deficit reduction plan, which obviously reduces the likelihood that anything will get done. We'd prefer a different kind of pledge: keep everything on the table.

The Department of Defense recently announced that it will aim to cut over $100 billion from existing programs over the 2012-2016 period in order to redirect savings to maintaining and building the force's warfighting capabilities, according to a department news article. We're glad to see Defense officials cracking down on unnecessary and less effective spending in the Defense budget, but we were also hoping that some of the savings would also be used to actually bring down total defense spending.

Deputy Secretary of Defense William Lynn made it clear that these proposed savings are "not an attempt to reduce the defense budget, or top-line." Shucks.

According to Lynn, the Defense Department needs 2 to 3 percent in real growth each year to update technology, recapitalize and modernize, and give troops what they need. Beginning in 2012, the department expects just 1 percent growth for five years. To ensure that top-line defense spending doesn't increase to cover the gap, Defense officials are searching for savings.

In a release Friday, Secretary Gates argued that:

"To sustain necessary investment levels for Department of Defense mission essential activities, we must significantly improve the effectiveness and efficiency of our business operations. Doing so will increase funding available for our mission functions from efficiency savings in overhead, support and non-mission areas."

Adding more specifics to where the dictated savings will be redirected, the release also stated that:

"The services will be able to keep savings within their budgets and at least two-thirds of the reductions should be transferred to produce increases in funding for personnel in units, other force structure costs, readiness, procurement and research development test and evaluation (RDT&E) accounts."

Here's where the proposed savings will come from:

The savings required each year will grow from just $7 billion in 2012 to $37 billion in 2016, calling for equal savings in overhead and unnecessary costs from the Army, Navy, and Air Force.

CRFB believes that Secretary Gates's proposal to identify savings is good for three reasons--well, maybe two and a half. First, it's great that the Defense Department and all of its agencies will be working to cut back on low-priority and unnecessary spending to be able to fully fund higher priorities. (In doing so, the Defense Department will also be showing us, and the President's Fiscal Commission, which programs aren't high on the priority list and are prime-for-the-cutting.)

The proposal is also fiscally beneficial because saving $100 billion will almost certainly prevent any top-line increases, or requests for increases, for the Defense budget. Although this won't make our deficits any better, it shouldn't make them any worse.

But, unfortunately, not making our fiscal hole any deeper just simply won't be enough. We have to eventually climb out. Identifying defense savings and reduction for the purpose of deficit reduction should also be part of this proposal, and any future proposals. 

See our previous post on Secretary Gates's statements on the need to reduce defense spending.

The Administration is taking important steps in improving the budget situation:

• The proposed 3-year spending freeze of non-security discretionary spending is helping to propel a raft of new spending freeze proposals. Good idea.
• Efforts to uncover significant Defense Department savings are underway. Good idea.
• There is the enhanced rescission proposal. Good idea.
• New incentives for agencies to find savings from least effective programs. Good idea.
• And now, agency requirements to suggest lowest priority programs to hopefully be eliminated. Good idea.

All of these focus on the discretionary portion of the budget. No one should think that reducing waste, fraud, and abuse is going to balance the budget, or that discretionary spending is the cause of the long-term problem. That said, the overall sequencing of how budgetary changes are introduced is extremely important and discretionary savings strike us as the right place to start in terms of building public support.

Many voters don't trust the government to spend their money well. Going after the least effective or most wasteful spending will be a critical first step in building trust with the American public before the most difficult choices have to be made. The potential savings are by no means inconsequential. Discretionary spending makes up nearly 40 percent of the budget, and over the past decade, has actually grown faster than mandatory spending. We reported that between 1999 and 2008, discretionary spending grew by an annual average of 7.5% while mandatory grew by 6.4%. (Note: both seem awfully high.)

A promising approach to disciplining discretionary spending is statutory caps, such as the Sessions-McCaskill proposal in the Senate, or the Kratovil-Childers proposal in the House.

Once we have scoured the budget for discretionary savings, it will be clear that entitlement programs such as Social Security, Medicare and Medicaid have to be the largest part of the solution. And then, after structural entitlement reforms have been identified, it will also be clear that additional revenues will almost certainly be needed in order to achieve reasonable medium and long-term fiscal goals.

So, ferreting out waste from the discretionary budget, then moving to entitlement reform, and then filling in any remaining gap with revenues, makes sense to us. So, kudos to the White House. Still, the real work has not yet begun.