The Bottom Line
The debate that won’t end drags on in the Senate as legislation to extend tax breaks, expanded unemployment insurance and the Medicare “doc fix” didn’t come close to getting 60 votes in a key procedural vote. The 45-52 vote failing to waive a budget point of order means the bill will undergo more changes to trim its cost.
A likely change will be to shorten the length of the so- called “doc fix.” The Senate version originally postponed cuts to physician Medicare payments through 2011. The issue has been kicked around more than any soccer ball in South Africa. Postponing the cuts for a shorter period of time is like putting off that yearly physical exam – it may delay hearing the usual exhortations from the doctor to change your diet and exercise habits, but does nothing to better one’s health. A shortened “fix” only means that it will be extended again sooner and does nothing to improve the nation’s fiscal condition.
The constant extensions only prove that the “doc fix” is no fix at all. It merely puts off dealing with an unsustainable situation. Maybe we should just extend it by the hour; that would provide a smaller price tag per extension while underscoring the absurdity of the exercise.
The Wall Street Journal points out that deficit aversion is coming to Washington at a bad time. Just as lawmakers are looking to provide an extra kick to the economic recovery, a growing number of them have become concerned about adding to the deficit. As the article states, President Obama has been forced into "arguing...that spending be increased and cut at the same time," and Congress has been reluctant to move on the extenders bill.
Stimulus or a jobs package should not add to the long-term debt, but that doesn't mean that we should shy away from any sort of package at all. The unfortunate fact is that lawmakers seem more willing to do nothing than to simply pay for the measures they are proposing. We have argued that a short-term stimulus combined with longer-term offsets would be the most effective one-two punch for the economy, since the fiscal credibility of the plan would keep interest rates down as the stimulative effects went to work.
If lawmakers are going to pass a stimulus package, then they should pay for it over the medium term. More importantly, they should develop a fiscal consolidation plan to take effect when the economy recovers. They should not start slashing the budget deficit immediately, and they also should not keep deficit spending under the catch-all banner of "stimulus."
Bottom Line: Fiscal concerns are not a reason to ignore the economic recovery, but stimulus concerns are certainly not a reason to delay in committing to a fiscal plan.
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.
Larry Summers, top economic advisor to President Obama, joined the Announcement Effect Club after remarks on a few occasions. First, in a speech at the John Hopkins School of Advanced International Studies:
On the other hand, those who recognize the fiscal and growth benefits of strong expansionary policies must also recognize that it is simultaneously desirable to provide confidence that deficits will come down to sustainable levels as recovery is achieved. Such confidence both spurs recovery by reducing capital costs and reduces the risk of financial accidents.
Perfect. Then, yesterday in a Washington Post column by E.J. Dionne Jr.:
But for a policy centered around economic growth to be credible in the short term we must show a commitment on returning to a fiscal sustainable path over the medium- and long-term. That's why the president has taken important steps to bring responsibility back to the federal budget through health care reform and in creating a bipartisan fiscal commission.
Lately, the Announcement Effect Club's argument is becoming more important as the prospects of further stimulus is being discussed. There is a perception that either we have to put out unpaid-for stimulus or we have to stop all stimulus and start consolidating now. The Club is a middle ground that some people seem to be overlooking. Short-term stimulus accompanied by medium-term plans for fiscal consolidation can be more effective than stimulus alone. The demonstrated commitment to fiscal responsibility would assure markets and, consequently, would help keep interest rates down. Stimulus and fiscal responsibility are not mutually exclusive; Economist Mom Diane Rogers refers to this as "walking and chewing gum at the same time." If we do both, we can strengthen the economy in the short-term and provide more sustainable growth over the long haul.
“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.
Over the weekend, the President sent a letter to the Hill urging Congress to pass new stimulus measures. As we have written, we think the costs of stimulus should be offset over time to avoid adding to the debt.
But beyond that, it is critical that any stimulus — jobs, loophole-closing, whatever you want to call it — package (and there is a strong case to be made that more should be done to help the economy) be credible. That involves two things: a well-designed, economically-motivated package, and pairing it with a medium term fiscal consolidation plan.
First, there is the obvious risk with any stimulus package that all sorts of non-stimulative policies are given the stimulus label as a “Get Out of PAYGO Free” card.
But to be credible, a stimulus package has to be designed with one purpose in mind — to generate the most “bang for the buck”. If it is used as a vehicle for a host of unrelated items, credibility is shot, and the ability to pass future measures is diminished. When a bill becomes overly political by including policies that are really meant to be permanent but are stuck in a package temporarily to get a foot in the door (see this warning), or policies that have little hope of doing much to aid the economy (uh, the doc fix), credibility is compromised. The result, as we are seeing, is that there is less appetite for future packages even if they are warranted.
Second, the emphasis now has to be on balancing 1) the need to continue to help the economy strengthen and 2) the need to take measures to control the burgeoning debt.
In order for a coordinated suite of policies to be credible, both sides of the equation need attention and action. So far, hundreds of billions of dollars have been thrown at the economic recovery side of the equation, and little more than lip service has been devoted to the fiscal piece. Credibility is at stake, and if it is not regained, it will make taking future actions to help the economy in the short-run all the more difficult.
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.
As part of a celebration of Albert Gallatin's upcoming 250th birthday the Swiss Embassy held a panel discussing the Swiss federal government's "debt brake" and what could be learned from its use. The panel included Swiss Federal Finance Administration Director-General Fritz Zurbruegg, IMF Fiscal Affairs Director (and Announcement Effect Club member) Carlo Cottarelli, House Budget Committee Chairman John Spratt, and former OMB director, former House Budget Committee Chairman, and current CRFB board member Jim Nussle.
Zurbruegg explained how the Swiss debt brake works. After years of rising deficits and debt in the 1990s, Switzerland's citizens adopted the debt brake as a constitutional amendment in 2001 (with 85% approval!) The rule was to be implemented starting in 2003. It stated that each year, the budget must be in balance, adjusted for economic conditions. They do this adjustment by multiplying expenditures by a cyclical factor (the ratio of trend real GDP to expected real GDP), thus either allowing for deficits during recessions or forcing lawmakers to have surpluses during booms. Essentially, the rule calls for structural balance in each year and absolute balance over the course of a business cycle. So if lawmakers want to have expansionary fiscal policy during recessions, they need to pay for it by saving up during good economic times. The rule did initially allow for "extraordinary spending" if a qualified parliamentary majority approved, but recent changes have made this spending count as normal expenditures.
In practice, there is obviously limited experience to pull from, but it has worked out well so far, according to Zurbruegg. Upon finding out that the Swiss budget had structural imbalances in 2003, lawmakers undertook a three year plan to put the budget back in balance (and in surplus). Using the surplus from the good years, they were able to weather the economic downturn without resorting to using any emergency spending. Zurbruegg though did express some concern that lawmakers were so focused on abiding by the debt brake that they risked ignoring their longer term fiscal challenges.
Carlo Cottarelli then gave the criteria for a good design for a fiscal goal/rule. He said that it should have the following: broad coverage (not excluding any category of the budget); transparency, like in the form of an independent fiscal agency; constitutional power if possible, so lawmakers can't just change it whenever convenient; flexibility for economic conditions; and finally, a mechanism for enforcement. Certainly, the debt brake measures up well to these criteria.
Overall, our own lawmakers could learn a lot from the Swiss example. They designed a budget rule that neatly walks the tightrope between too rigid and too soft. In doing so, they made a rule that wasn't so hard to follow that lawmakers tried to ignore it, and one that wasn't too easy to find a way around. It will be interesting to see how the debt brake works out for Switzerland in the future.
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.
In testimony before the House Budget Committee this week, Ben Bernanke called for a plan to be put in place now to reduce deficits once the economy recovers. Already being a (frequently re-affirmed) member of the Announcement Effect Club, Bernanke's testimony was no surprise to readers of our blog or anyone who is familiar with Bernanke's public statements. However, we came close to getting another Announcement Effect Club member during the individual questioning by Budget Committee members. Check out this exchange between Bernanke and Rep. Jeb Hensarling (R-TX):
HENSARLING: Chairman Bernanke, my seconds are ticking away. So real quickly, hopefully it's a yes-or-no question. I thought I've heard you testify before that not only is it important to the long- term sustainability that we have a program to deal with our debt, but it's actually important to economic growth today to send the signal that we have a plan in place. Did I understand you correctly...
BERNANKE: You did.
HENSARLING: ... it's important to have a plan today?
BERNANKE: A plan in place will help keep interest rates down and help growth be stronger in the near term.
It's not exactly clear whether Hensarling was simply clarifying Bernanke's position on the importance of a fiscal plan, or whether he was trying to make his point through the Fed Chairman. Either way, we definitely agree with the thrust of Bernanke's argument, and it is especially relevant with all of the attention being placed on the new stimulus. Coupling an effective stimulus plan with a longer-term deficit reduction plan would show that the government is both supporting the economic recovery in the short term and committing to greater fiscal balance in the medium term.
As for Rep. Hensarling, we're going to need a more affirmative statement of support before we consider making him a full-fledged member of the Club. We're waiting, Jeb.
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 Obama Administration has been putting out a flurry (see here and here) of modest savings proposals over the past few weeks. The latest comes in a memorandum from President Obama that would order more efficient use of federal real estate. In a blog post on OMB's website, OMB director Peter Orszag explained that of the 1.2 million "buildings, structures, and land parcels" that the government owns, about 14,000 of them are designated as "excess" and 55,000 are either under-utilized or not utilized.
In order to better make use of this space, the agencies would either sell buildings they didn't need or make better use of the existing space. The process for determining what excess buildings or assets the government has would be streamlined to accelerate the savings. Orszag estimates that the efforts will save $8 billion, with $5 billion of that coming from the BRAC commission, and $3 billion coming from the agencies (the memorandum states that the agencies should save "no less than $3 billion.")
It's great that the White House is making a continued effort to attack wasteful and inefficient spending. The savings from all these proposals might be small, but they still help in making sure we get as much as we can from each tax dollar. However, we seriously hope that the White House will attack the drivers of our future debt with as much vigor as they are doing with wasteful spending.
Chairman Bernanke's testimony today underscored the fundamental lack of sustainability of the growing federal budget deficit, while simultaneously defending the large increases in deficit spending that were necessary to support economic recovery. Bernanke predicts real GDP to grow at 3.5% over the course of 2010, yet he acknowledged that this must be tempered by latent problems in the housing market.
Bernanke noted that it is crucial for the United States to reduce our federal budget deficit and commit to long-term fiscal sustainability in order to ensure that we don’t face the possibility of a sovereign debt crisis in the future. Even though the Greek debt crisis has temporarily bolstered confidence in the US as a "safe haven" market, measures must be taken to reduce our federal budget deficit soon or else investors could lose confidence in our ability to pay back our debt 10 or 15 years down the line. Yet while the budget must be reduced in the medium run, without continued stimulus in the short run, the US faces a second problem - the threat of a double dip recession.
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.
Lawmakers have railed against the inability to stop the leaking of oil into the Gulf of Mexico, yet they are having no better success in staunching the flow of red ink. Congress needs its own containment cap to suppress spending and tax cuts that are deficit-financed.
At the end of last month the House narrowly passed tax extenders legislation after scaling back its cost because members balked at the sizable portion that was not paid for. You may think that the Senate would see this as a sign that it is time to budget responsibly and pay for legislative priorities, but that seems as likely as the “top kill” working in the Gulf. The Senate now seeks to add spending and decrease offsets. The Senate bill has a $140 billion price tag with about $77.5 billion of that adding to the deficit.
Leaders in the Senate hope to pass by early next week their version of the bill including $24 billion in Medicaid aid to the states that was dropped in the House. The Senate will also look to reduce the taxation of carried interest provided for in the House version, diminishing one of the few offsets in the measure. The Senate version seeks to recoup the loss of carried interest revenue largely by raising the excise tax on oil from 34 cents per barrel in the House version to 41 cents. However, that money is obligated for the Oil Spill Liability Trust Fund to finance oil spill clean-ups. Maybe it should be renamed the Black Oil and Red Ink Mitigation Fund.
We are not saying that expanded unemployment benefits should not be extended, as called for in the bill. But we believe that such spending should be paid for, at least in the longer run so that it does not add to the long-term debt. Stabilizing the debt could aid the economic recovery by convincing creditors that the U.S. will not become Greece, thereby keeping interest rates lower.
The difficulty in using increased revenue as an offset illustrates that spending cuts must also be part of the offset mix. If lawmakers truly believe that the spending and tax cuts included in the legislation are important, they should work together to find other areas of the budget that can be sacrificed. One of the amendments offered to the bill is a proposal from senators Jeff Sessions (R-AL) and Claire McCaskill (D-MO) to institute a three year discretionary spending cap. That would be a good start. CRFB criticized the lack of pay-fors in the legislation and offered recommendations for longer-term offsets in a recent statement.
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:
|(Billions of Dollars)||FY2012||FY2013||FY2014||FY2015||FY2016||Total|
|Defense Agency/Field Activity Goal||$1||$2||$3||$4||$7||$17|
|Memorandum: Department of Defense Budget||$566||$582||$598||$616||$635||$2,997|
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 Obama Administration is looking at spending once again. A day after the White House announced a plan to encourage savings by executive agencies, it has announced a required review of all agency budgets. According to an OMB memo sent today, all agencies must submit cuts for FY 2012 that total at least 5% of their FY 2010 discretionary budget. They are directed to find low-impact, low-priority, and duplicative programs to cut, so they can't simply accomplish this task by doing an across-the-board budget cut.
One important aspect of the plan is the scope of the review. The memo specifies that these cuts are designed to help accomplish the three year discretionary spending freeze proposed by Obama a few months ago. However, the freeze would exclude a big chunk of discretionary spending (security spending). If the cuts are done in a similar way, it will save significantly less money than applying 5% cuts to every agency. The memo does say "All agencies are required to undertake this review, including both security and non-security agencies," but when it comes down to it, it's uncertain whether the Administration will actually propose cuts from, say, the VA or defense.
You can see the differences in spending below. Although it is not specified, we assume that the Administration's plan to return half of agency savings back to the agencies would apply to these cuts, so the 5% cut would in effect only be a 2.5% cut. The 2.5% overall cut would save about $650 billion ($800 billion including interest) relative to the President's FY 2011 Budget, while the 2.5% non-security cut would save about $150 billion ($185 billion including interest), so there is a significant difference in savings between the two cuts.
We applaud the White House effort to bring the hammer down on discretionary spending. As we have shown in the past, discretionary spending grew faster than mandatory spending in the past decade, so its importance in the short- to medium-term should not be overlooked. And with deficits as far as the eye can see, we should look at cutting those programs that are lower priorities or flat-out unnecessary. The agency budget reviews are certainly a start down the right path. We hope that OMB and the White House will follow through with actual cuts in FY 2012 that spare no category of discretionary spending--or mandatory spending for that matter.
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.