Policy Paper

Nine Social Security Myths You Shouldn’t Believe


Summary of 4 myths related to 2016 campaign

Social Security is a vital program for tens of millions of seniors, dependents, and workers with disabilities, and it has been a hot topic of conversation in the 2016 election campaign as well as discussions in and outside of Washington. Unfortunately, the program is currently on a financially unsustainable path toward insolvency. Already, Social Security pays more in benefits than it is raises from payroll taxes, a trend that is projected to worsen as the baby boom generation continues to retire and life expectancy grows.

The Social Security Trustees project that the trust funds will run out of reserves in just 18 years, and the Congressional Budget Office (CBO) projects they will run out in 13 years. Little time remains to enact sensible changes that would avoid deep cuts for nearly all seniors and workers with disabilities.

Yet too little of the discussion in Washington and on the campaign trail is about the types of solutions necessary to fix Social Security, and too much is focused on perpetuating myths that cloud the discussion. In this paper, we identify and debunk nine such myths:

Myth #1: We don’t need to worry about Social Security for many years.
Myth #2: Social Security faces only a small funding shortfall.
Myth #3: Social Security solvency can be achieved solely by making the rich pay the same as everyone else.
Myth #4: Today’s workers will not receive Social Security benefits.
Myth #5: Social Security would be fine if we hadn’t “raided the trust fund.”
Myth #6: Social Security cannot run a deficit.
Myth #7: Social Security has nothing to do with the rest of the budget.
Myth #8: Social Security can be saved by ending waste, fraud, and abuse.
Myth #9: Raising the retirement age hits low-income seniors the hardest.

Below, we debunk these myths in the hopes that an honest discussion of the facts will lead the next President and Congress to come together and put Social Security on sound financial footing.

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Myth #1: We don’t need to worry about Social Security for many years

Fact: There is a high cost of waiting to reform Social Security.

According to estimates from CBO and the Social Security Trustees, the Social Security trust funds have sufficient reserves to pay full benefits through 2029 or 2034. This has led some to claim Social Security reform can be put off well into the future; they are wrong.

Although 2034 seems to be far away, many of today’s newest retirees would likely still be on the program – turning 80 – and today’s 49-year-olds would be reaching the normal retirement age. At that point, all beneficiaries would face an immediate across-the-board benefit cut of about one-fifth.

The cost of waiting to avoid this cut is high. The longer lawmakers wait to enact Social Security reform, the more abrupt and less targeted changes will have to be, the less time workers will have to plan and adjust, and the fewer the options policymakers will have. Perhaps more importantly, the size of the problem literally grows over time.

For example, based on projections from the Trustees, the payroll tax would need to rise 21 percent (2.6 points) today to make Social Security solvent but by 32 percent (4.0 points) if lawmakers wait until 2034 to act.

The size of the necessary across-the-board benefit cut would similarly grow from 16 percent today to 20 percent in a decade and 23 percent by 2034. If lawmakers exempted existing beneficiaries, that cut would be 20 percent today, 33 percent in a decade, and literally could not solve the problem by 2034.

 

Prompt action is the best way to keep the program solvent. For this reason, “the Trustees recommend that lawmakers address the projected trust fund shortfalls in a timely way in order to phase in necessary changes gradually and give workers and beneficiaries time to adjust to them… [and] allow more generations to share in the needed revenue increases or reductions in scheduled benefits.”

Read more about the cost of waiting here.

Myth #2: Social Security faces only a small funding shortfall.

Fact: Social Security faces a large but manageable financing gap.

Although many have claimed Social Security’s shortfall is small, the reality is that significant adjustments will be needed to bring spending and revenue in line. In 2016, Social Security will spend about $70 billion more on benefits than it will generate in tax revenue. As the population ages, that gap will only widen.

Social Security spending has already risen from 10.4 percent of payroll in 2000 to 13.9 percent of payroll this year. The Trustees project the cost of scheduled benefits to further grow to 16.7 percent of payroll by 2040 and 18 percent by 2090. Meanwhile, revenue will remain relatively constant at about 13 percent of payroll.

Addressing this large and growing gap will require significant adjustments. Even acting immediately to make Social Security solvent for the next 75 years would require the equivalent of an immediate 21 percent (2.6 point) payroll tax increase or 16 percent across-the-board benefit cut, according to the Trustees. CBO estimates that a much larger 35 percent (4.4 point) tax increase or 26 percent benefit cut would be necessary. Closing the program’s structural gap permanently will require a much larger tax increase of 38 to 52 percent, or a spending cut of 27 to 32 percent.

These shortfalls are much larger than the shortfall closed in the 1983 Social Security reforms. 

Myth #3: Social Security solvency can be achieved solely by making the rich pay the same as everyone else.

Fact: Eliminating the payroll tax cap would still leave a shortfall.

Currently, Social Security’s 12.4 percent payroll tax applies to a worker’s first $118,500 of wage income, and benefits are calculated based on that income. Though this “taxable maximum” is indexed to wage growth, it currently only covers about 83 percent of all wages – meaning 17 percent remain tax free.

One common suggestion for solving the Social Security shortfall is to lift or eliminate the taxable maximum so more income is subject to the 12.4 percent payroll tax. This change would significantly improve Social Security’s finances, but it would not by itself make the program sustainably solvent – and thus other actions would be necessary.

According to the Chief Actuary of the Social Security Administration, eliminating the taxable maximum would extend the life of the trust fund by 32 years, close 71 percent of the program’s 75-year gap, and close 34 percent of the structural gap by the end of the projection window. CBO estimates the same policy would extend the life of the trust fund by 10 years, close about 40 percent of the program’s 75-year gap, and close 19 percent of the structural gap.

One reason this policy does so little in the longer term is that the current Social Security structure pays benefits based on the amount of income being taxed, so eliminating the taxable maximum would significantly increase future benefits for higher earners. Breaking this link between taxes and contributions so that higher earners pay more taxes but do not receive more benefits would allow policymakers to close 71 to 88 percent of the 75-year gap and slightly more than half of the structural gap.

Even in this case, more would need to be done to fully ensure solvency. Working within the confines of the current system, such a policy would likely need to be accompanied by changes that slow the growth of benefits and/or increase taxes on income below the taxable maximum.

Myth #4: Today’s workers will not receive Social Security benefits.

Fact: Even if policymakers do nothing (which they shouldn’t), the program will still be able to pay about three-quarters of benefits.

Social Security has been around since 1935, and there is no indication that anyone intends to eliminate the program. Although Social Security faces serious financial challenges, benefits would not disappear unless lawmakers acted to eliminate them.

While the Trustees expect the combined trust fund reserves to be depleted in 2034, payroll tax revenue will continue to flow into the trust funds. This revenue would initially be sufficient to pay 79 percent of scheduled benefits and would ultimately decline to 73 percent by 2090.

Rather than causing benefits to “disappear,” the absence of legislation would probably either lead monthly checks to be reduced by about one-fifth (more in later years) or to be issued on a delayed basis, resulting in equivalent annual benefit cuts.  This cut would apply to all current beneficiaries regardless of age or income as well as to future beneficiaries.

An immediate cut of that magnitude – particularly for older and lower income retirees – could be devastating. For that reason, most observers agree that Congress should take action to avoid such an abrupt cut.

Myth #5: Social Security would be fine if we hadn’t “raided the trust fund.”

Fact: The program’s financial shortfall stems primarily from a growing mismatch between benefits paid and incoming revenue.

In the 1990s and 2000s, Social Security ran $1.1 trillion in primary surpluses, and including interest, it has accumulated $2.8 trillion of trust fund assets.  Those assets are invested in special U.S. Treasury bonds and effectively loaned to the rest of the government. Many argue that these Social Security surpluses masked other deficits in the rest of the government and thus allowed policymakers to enact more deficit-financed tax cuts or spending increases than they otherwise would have.  In that sense, it could be argued that Congress and the President “raided the trust fund.”

However, regardless of how that money was used, the full $2.8 trillion is still owed to the Social Security trust fund under current law, and nearly all measures of Social Security’s long-term projections assume the $2.8 trillion will be repaid. Redeeming these bonds will require the non-Social Security parts of government to tax more, spend less, and/or borrow more than would have otherwise been necessary. In nominal dollars, the Trustees project paying trust fund principle and interest will cost the rest of the government about $4.4 trillion through 2034.

The reality is that Social Security doesn’t face financial problems because those funds will not be repaid (they will) but rather because the trust fund is dwarfed by the system’s projected shortfall over time. On a present-value basis, the program is projected to spend $13.5 trillion more than it raises in revenue over the next 75 years – far more than the $2.8 trillion held in the trust fund. In other words, policymakers must identify $10.7 trillion, or about 2.7 percent of payroll, to make Social Security solvent even after the trust fund’s holdings are paid back.

Myth #6: Social Security cannot run a deficit.

Fact: Social Security is running a cash deficit today, and it will keep running deficits until its trust funds run out.

Social Security is legally barred from going into debt; in other words, it cannot spend more than it takes in (or has transferred in) over the life of the program. However, the program can (and does) run annual deficits. In 2016, for example, Social Security will run a cash-flow deficit of about $70 billion. Over the next decade, the Trustees project cash-flow deficits of $1.5 trillion, and CBO projects deficits of $2.2 trillion.  Even including interest income, the program is projected to begin running deficits by 2018 or 2020.

Because the Social Security trust funds currently hold $2.8 trillion in reserves, the program is projected by the Trustees to continue to run “annual deficits for every year of the projection period” until the trust funds are depleted in 2034.  At that point, current law bars Social Security from paying benefits beyond what is collected in revenue.

Myth #7: Social Security has nothing to do with the rest of the budget.

Fact: Regardless of how Social Security is viewed, it interacts in many ways with the broader federal budget.

There are two different ways to look at Social Security: as its own isolated “off-budget” program or as part of the broader “unified” budget. We discuss these two frameworks in detail in our 2011 paper, “Social Security and the Budget.” Both of these frameworks are valid, and both show the program to have a financial problem. If treated in isolation, Social Security is on the road towards insolvency. If treated as part of the unified budget, Social Security is adding to the deficit, and this effect will increase over time.

If viewed as an off-budget program, Social Security does not directly add to the “on-budget deficit.” However, it indirectly contributes to the on-budget deficit because the interest payments it receives from the general fund are on-budget. It also receives funding from income tax revenue on Social Security benefits, which is technically on-budget, and has at times received general revenue transfers to compensate for policies that would reduce Social Security revenue (such as when lawmakers cut payroll taxes in 2011 and 2012).

Viewing Social Security as a self-financed program is not a reason to exclude it from fiscal constraints. In fact, this view highlights the need to make the program solvent for its own sake without relying on general revenue transfers or borrowing. To be self-sufficient, the program would need changes to bring spending in line with revenues.

Although Social Security is excluded from on-budget calculations, most economists consider the unified budget deficit to be a more meaningful measure of the government’s fiscal health because it better measures the budget’s impact on the economy. The Social Security system has been contributing to unified budget deficits on a cash-flow basis since 2010 and will continue to do so indefinitely. The federal government will have to borrow more, cut other spending, or raise taxes to make up for the Social Security system’s cash-flow deficit.

The Trustees noted the impact of the Social Security program on the federal budget in their recent report:

The trust fund perspective does not encompass the interrelationship between the Medicare and Social Security trust funds and the overall federal budget ... From a budget perspective, however, general fund transfers, interest payments to the trust funds, and asset redemptions represent a draw on other federal resources for which there is no earmarked source of revenue from the public. In the past, general fund and interest payments for Medicare and Social Security were relatively small. These amounts have increased substantially over the last two decades, however, and the expected rapid growth of Medicare and Social Security will make their interaction with the Federal budget increasingly important.

Myth #8: Social Security can be saved by ending waste, fraud, and abuse.

Fact: Even eliminating Social Security fraud would close only a tiny portion of the shortfall.

One popular idea to reduce Social Security spending is to eliminate improper and fraudulent payments made by the program. Certainly, some beneficiaries are fraudulently collecting Social Security retirement and (perhaps more frequently) disability benefits, and policymakers should do whatever they can to prevent this. However, even eliminating all fraud would not significantly improve the solvency of the program.

Simply put, there is not nearly enough waste, fraud, and abuse in the system to significantly impact its costs. The Social Security Administration estimates that improper payments – or payments made to the wrong person, for the wrong amount, or with insufficient documentation – total about $3 billion per year. By comparison, benefits would need to be cut by about $150 billion per year to make the program solvent.

This means that even assuming that the government could fully eliminate improper payments and do so with no additional spending on anti-fraud efforts – an impossible task – it would only close 2 percent of the program’s solvency gap. More realistic anti-fraud efforts would save only a fraction of that.

Myth #9: Raising the retirement age hits low-income seniors the hardest.

Fact: Raising the normal retirement age has roughly a proportional effect on benefits that actually affects the benefits higher earners slightly more.

One common proposal to improve Social Security’s finances – raising the normal retirement age – has been criticized as disproportionally affecting lower-income seniors. This claim makes intuitive sense, since workers with higher incomes tend to live significantly longer than those with lower incomes. However, the claim is based on a misunderstanding of how the retirement age works.

Social Security actually has several retirement ages, including an earliest eligibility age (62), a normal retirement age (headed to 67), and a delayed retirement age (70). Raising the normal retirement age – the only policy of the three that would significantly improve solvency – does not change eligibility but rather reduces the benefits one can receive at any age. In other words, raising the normal retirement age does not affect when people can claim benefits; it only affects when people can claim full benefits or how much they are penalized for claiming early.

Thus, an increase in the normal retirement age would result in a roughly proportional cut in scheduled benefits (both annual and lifetime) for all beneficiaries regardless of how old they are when they retire and when they pass on. The fact that higher earners are living relatively longer over time reduces the overall progressivity of the Social Security program but has virtually no impact on the progressivity of changing the normal retirement age.

Social Security experts from the left and the right agree on this fact. Former Social Security Administration Deputy Commissioners Andrew Biggs of the American Enterprise Institute has explained multiple times that raising the normal retirement age does not impact lower-income beneficiaries any more than higher income seniors. Social Security Advisory Board Chairman Henry Aaron of the Brookings Institution recently made a similar point, noting that “’raising the full benefit age from 67 to 70’ is simply a 24 percent across-the-board cut in benefits for all new claimants, whatever their incomes and whatever their life-expectancies.”

Indeed, actual analysis of raising the normal retirement age shows it is actually likely to be somewhat progressive relative to benefit levels. For example, CBO finds raising the retirement age by one year would reduce lifetime benefits for the highest earners by 5 percent but only reduce benefits by 3 percent for the lowest earners. Similarly, the Urban Institute finds annual benefits would fall 5.9 percent for the top quintile of earners compared to 2.9 percent for the bottom quintile. The main reason for this progressivity is that workers on the Social Security Disability Insurance (SSDI) program – who are disproportionally lower income – are unaffected by changes in the retirement age even after they enter the old-age program. Studies that find the policy to be literally across-the-board generally exclude these workers.

 

One caveat is that some proposals to raise the normal retirement age would also increase the earliest eligibility age. Enacting these policies together leads to complicated distributional outcomes that could be viewed as progressive or regressive depending in part on which measure of distribution one views as most important (annual, initial, or lifetime benefits), how one accounts for behavior, and whether one takes into account non-Social Security benefits.

In any case, it would be a mistake to look at the distributional impact of only one aspect of a comprehensive Social Security plan in insolation. Many plans that raise the retirement age would make the system much more progressive overall.

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Adding Up Senator Sanders's Campaign Proposals So Far

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Senator Bernie Sanders deserves credit for trying to pay for his spending proposals' costs but, the offsets fall short according to our new analysis as part of our Fisacl FactCheck project. Senator Sanders's proposals would add $2 trillion to $15 trillion to the debt, depending on whether his health plan's costs run higher than he estimates. As a share of the economy, debt under these policies would grow from roughly 75 percent of Gross Domestic Product (GDP) today to between 93 percent and 139 percent of GDP in 2026 (compared to 86 percent of GDP under current law).

Read the full analysis on our Fiscal FactCheck website. 

Senator Sanders would also increase spending and revenue levels as a share of the economy to well-above historical averages. Spending as a percentage of GDP would average about 30 percent over the next decade, compared to the historical average of about 20 percent. On the revenue side, it would increase to 25 percent over the next decade, while revenue as a share of GDP has averaged about 17.4 percent over the last half-century.

Ultimately, using Senator Sanders's tax increases in order to pay for new spending would leave less options available to address the current fiscally unsustainable path of our nation's debt.

Read the full analysis on our Fiscal FactCheck website.

Adding Up the Cruz Campaign’s Proposals

Senator Ted Cruz's campaign promises to date would cost more than $12 trillion over a decade, according to the central estimate calculated as a part of our Fiscal FactCheck project . As a share of the economy, debt under these policies would grow from roughly 75 percent of Gross Domestic Product (GDP) today to 131 percent of GDP in 2026 (compared to 86 percent of GDP under current law).

Read the full explainer on our Fiscal FactCheck website. 

Because of widely varying estimates of his consumption tax from outside organizations, there's a wide range of potential costs from $3 trillion to $21 trillion. Under the high-cost estimate, debt could reach as high as 163 percent of GDP and under our low-cost estimate – assuming significant economic growth – debt would remain on roughly its current course relative to the economy and reach 84 percent of GDP. However, even at the lowest estimate, debt would be be at record-high levels and increasing unsustainably.

 

Read the full explainer on our Fiscal FactCheck website.

How Do Donald Trump's Campaign Proposals So Far Add Up?

Republican presidential candidate Donald Trump has put forward five major sets of initiatives on his campaign's website in the areas of U.S.-China trade relations reform, protecting second amendment rights, immigration reform, Veterans Administration reform, and tax reform. By our very rough and initial estimates, these five initiatives together would add between $11.7 and $15.1 trillion to the debt over the next 10 years, including interest. This would increase debt held by the public from nearly $14 trillion today to between $35 and $39 trillion by 2026 (compared to $23.8 trillion in 2026 without these proposals). This means debt would grow from 75 percent of Gross Domestic Product (GDP) today (and headed to 86 percent by 2026) to as high as 140 percent by 2026, or to as low as 115 percent assuming his plans also lead to significant economic growth. 

Read the full explainer on our Fiscal FactCheck website. 

Trump Debt 3

Read the full explainer on our Fiscal FactCheck website. 

 

 

Interest Rates and the Debt

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This paper was updated on 12/16/15 to correct a typo

The PREP Plan: Paying for the Tax Extenders to Set Up Tax Reform

Before the end of the year, Congress will again consider renewal of the “tax extenders,” a collection of more than 50 expired tax breaks for individuals and businesses. These tax breaks, which are often extended a year or two at a time, range from the research and experimentation (R&E) tax credit and a deduction for teachers that buy school supplies to special depreciation for NASCAR tracks and racehorses.

Reinstating the normal tax extenders retroactively for 2015 and extending them through the end of 2016 without offsets would cost nearly $95 billion over ten years. A permanent extension would cost nearly $500 billion. If temporary stimulus-era provisions and refundable tax credits were also continued, the cost would rise to almost $1 trillion. CRFB’s Paying for Reform and Extension Policies (PREP) Plan, originally released in the fall of 2014, offers a better approach.

The PREP Plan includes principles that should be used for tax extenders legislation. It is paid for using $95 billion of offsets that increase tax compliance and decrease avoidance and includes a process for tax reform to happen in 2016.

Principles for Addressing Tax Extenders

  1. Address tax extenders permanently in the context of tax reform
  2. Fully offset the cost of any continuations without undermining tax reform
  3. Include a fast-track process to achieve comprehensive tax reform

 

Policy Ten-Year Savings
Extend Normal Tax Extenders Through 2016 -$95 billion
Improve Tax Reporting and Enforcement
$35 billion
Increase program integrity spending $35 billion
Improve various reporting and enforcement rules $5 billion
Increase oversight and accountability of the IRS *
Close Loopholes that Promote Tax Avoidance $50 billion
Close the "John Edwards/Newt Gingrich” S-Corp loophole $15 billion
Close the carried interest loophole $15 billion
Tighten deduction limits for executive pay $10 billion
Close other loopholes which encourage evasion $10 billion
Restrict Inversions $5 billion
Enact a one-year inversion ban *
Reduce the profitability of inversions $5 billion
Total Offsets $95 billion
Establish Fast-Track Process for Tax Reform TBD

*less than $500 million in costs or savings

 

Details of the PREP Plan

The PREP Plan assumes policymakers will enact a clean two-year extension of all the expired regular extenders. We assume bonus depreciation, which was originally put in place to help strengthen the economy during the recession, remains expired. In total, this would cost about $95 billion over the next decade, before interest. Note: we are not endorsing the choice to extend all expired regular extenders, just showing how it could be paid for.

The PREP Plan offsets this $95 billion cost by generating an equivalent amount of revenue with enforcement and savings from refundable credits. To ensure this package does not interfere with decisions that should be made in tax reform, its policies increase compliance within the current confines of the tax code (or spirit thereof). In other words, the package does not adjust tax rates, change the design or size of any tax expenditure, or otherwise alter the structure of the code. Instead, it increases enforcement, improves rules, and closes loopholes so that individuals and businesses pay the taxes they should be paying under the current code.

Many components of the plan have bipartisan support and draw from either the President’s budget or former Ways & Means Chairman Dave Camp’s (R-MI) Tax Reform Act of 2014. The PREP Plan also includes a fast-track process for broader tax reform, and it restricts “inversions” to allow time for that reform to be put into place.

 

Principles for Addressing Tax Extenders

  1. Address tax extenders permanently in the context of tax reform. With a few exceptions, there is little logic to writing tax policy for one or two years at a time. Comprehensive tax reform should decide whether to repeal, reform, or make permanent most tax extenders, and it should do so in the context of other decisions about tax rates, breaks, and the structure of the code.
  2. Fully offset the cost of any continuations without undermining tax reform. Tax reform will not be possible before the expired provisions must be addressed. In the meantime, any extension should be not undermine future tax reform efforts and should be fully paid for so as not to add to the debt.
  3. Include a fast-track process to achieve comprehensive tax reform. The need to act quickly is not an excuse to abandon efforts to reform a tax code that is complicated, anti-growth, and in many ways broken. Temporary action on extenders should advance a plan that would broaden the tax base, lower rates, promote economic growth, and reduce the deficit.

 

Improve Tax Reporting and Enforcement ($40 billion)

  • Increase program integrity spending ($35 billion): The PREP Plan reduces the amount of unpaid taxes by providing dedicated mandatory funding for the Internal Revenue Service (IRS) to audit and enforce tax compliance. The IRS estimates that every $1 spent on program integrity can generate $6 of revenue.
  • Improve various reporting and enforcement rules ($5 billion): The PREP Plan makes statutory changes to close the tax gap such as improving reporting on tuition and increasing various tax penalties.
  • Increase oversight and accountability of the IRS: The PREP Plan includes increased internal and external oversight over the IRS along with the new funding.

 

Close Loopholes that Promote Tax Avoidance ($50 billion)

  • Close the “John Edwards/Newt Gingrich” S-Corp loophole ($15 billion): The PREP Plan prevents self-employed individuals from avoiding payroll taxes by disguising wages as “business income.”
  • Close the carried interest loophole ($15 billion): The PREP Plan prevents hedge fund and private equity partners from paying lower rates by structuring their earned income as capital gains.
  • Tighten deduction limits for executive pay ($10 billion): The PREP Plan removes exceptions to limits on the amount of wages a company can deduct as a business expense for its highest-paid employees.
  • Close other loopholes which encourage evasion ($10 billion): The PREP Plan closes a variety of other loopholes by preventing investors from using shell companies to evade taxes, stopping cruise ship companies from using rules intended for cargo ships to avoid taxes, banning companies from borrowing simply to buy tax-exempt bonds, and preventing other tax evasion strategies.

 

Restrict Inversions ($5 billion)

  • Enact a one-year inversion ban (<$1 billion): Companies are again showing increased interest in corporate inversions: the practice of an American company moving its headquarters overseas, often to lower its U.S. tax bill. The PREP Plan calls for a one-year ban on inversions to give time for tax reform that will increase the competitiveness of our tax system and reduce the pressure for companies to invert.
  • Reduce profitability of inversions ($5 billion): The PREP Plan permanently limits “earnings stripping” among inverted companies, preventing them from deducting interest on intercompany loans designed to move income overseas.

 

Promote Comprehensive Tax Reform (to be determined by Congress)

  • Enact a “fast track” process for tax reform: The current tax code is complex, anti-growth, and in need of an overhaul. Yet tax reform has proved elusive so far. The President and Congress should agree to put tax reform near the top of their agenda and establish a fast-track process for business tax reform, individual tax reform, or both. Any tax reform should broaden the tax base, lower rates, promote economic growth, improve fairness and simplicity, and reduce the deficit.

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FY 2015 Deficit Falls to $439 Billion, but Debt Continues to Rise

This paper was updated on October 15, 2015 to reflect the final end of year deficit as announced by the Treasury Department.


 

The Fiscal Year (FY) 2015 budget deficit totaled $439 billion, according to today’s statement from the Treasury Department. Although this is roughly 10 percent below the FY 2014 deficit and nearly 70 percent below its 2009 peak, the country remains on an unsustainable fiscal path.

In this paper, we show:

  • Annual deficits have fallen substantially over the past six years, largely due to rapid increases in revenue (largely from the economic recovery), the reversal of one-time spending during the financial crisis, small decreases in defense spending, and slow growth in other areas.
  • Simply citing the 70 percent fall in deficits over the past six years without context is misleading, since it follows an almost 800 percent increase that brought deficits to record-high levels.
  • Even as deficits have fallen, debt held by the public has continued to rise, growing from $5.0 trillion in 2007 and $7.5 trillion in 2009 to $13.1 trillion today. As a share of GDP, debt rose from 35 percent in 2007 to about 74 percent in 2014 and 2015.
  • Both deficits and debt are projected to rise over the next decade and beyond, with trillion-dollar deficits returning by 2025 or sooner and debt exceeding the size of the economy before 2040, and as soon as 2031.

Unfortunately, the recent fall in deficits is not a sign of fiscal sustainability.

 

The Deficit in FY 2015

According to the Treasury Department, the federal deficit totaled $439 billion in FY 2015 (an initial report from the Congressional Budget Office on October 7th estimated the deficit at $435 billion), with $3.25 trillion of revenue, $3.69 trillion of spending.

 

Since 2009, the budget picture has changed significantly, with deficits falling by 70 percent, from $1.4 trillion to $439 billion. This reduction was driven mainly by the 54 percent ($1.1 trillion) increase in tax collections that has come largely as a result of the economic recovery but also due to real tax bracket creep, new taxes from the American Taxpayer Relief Act, the Affordable Care Act, and increased remittances from the Federal Reserve.

At the same time, nominal spending is only slightly higher than in 2009, even as the economy has grown, and inflation has eroded the value of this spending. Indeed, nominal spending has decreased in a number of areas, particularly due to the absence and reversal of financial rescue and economic recovery programs through the Troubled Asset Relief Program (TARP), the rescue of Fannie Mae and Freddie Mac, and the expiration of stimulus spending. Defense spending has also fallen as a result of the drawdown in war spending along with spending caps (further reduced under “sequestration”) on base defense spending. Meanwhile, non-defense discretionary spending has remained relatively flat in nominal terms since 2009, while Medicare, non-ACA Medicaid, and interest costs have all grown slowly relative to their historical trends.

With spending growing at a relatively slow pace, revenue has largely caught up – leading to a substantial reduction in deficits between 2009 and 2015. However, at $439 billion (2.5 percent of GDP), the deficit in 2015 was still significantly higher than the pre-recession deficit of $161 billion (1.1 percent of GDP) in 2007.

Deficits Fell From Record Levels, And They Will Rise Again

A 70 percent drop in annual deficits since 2009 is certainly significant, but it is less impressive than some would suggest when put in context. The rapid fall was from record-high levels and followed an even more rapid increase. At $1.4 trillion, the 2009 deficit was the highest ever in both real and nominal dollars, and the largest as a share of the economy except during World War II. The 2009 deficits represented a 779 percent increase from 2007 – only two years earlier.

While legislated spending reductions, tax increases, and other factors have played a role in reducing deficits from since 2009, the end of trillion-dollar deficits was largely the expected result of the recovering economy and the fading of measures intended to boost the recovery. As unemployment rates have fallen and GDP risen, revenue collection has returned to more normal levels and countercyclical spending has subsided in areas such as unemployment insurance and food stamps. Meanwhile, stimulus and financial rescue measures enacted to speed the recovery have mostly ended and are in some cases now generating income for the government.

 

Unfortunately, even with these gains, the deficit remains about 270 percent as high as in 2007 (1.4 percentage points higher as a percent of GDP) and is projected to grow over time. Under CBO’s current law baseline, annual deficits will return to trillion-dollar levels by 2025. In 2016 deficits are projected to fall slightly however the likely continuation of tax extenders – even if only retroactively – means deficits will almost certainly rise that year. Under the more pessimistic Alternative Fiscal Scenario in which policymakers fail to pay for new spending and tax cuts, the deficit will reach $1.3 trillion in 2025, rapidly approaching the nominal-dollar record set in 2009.

As Deficits Fall, the Debt Keeps Rising

Arguably the most important metric of a country’s fiscal health is its debt-to-GDP ratio. And unfortunately, even as deficits have fallen the last six years, debt has grown. Indeed, over the same period that deficits fell by 70 percent, nominal debt held by the public grew by about 75 percent – from $7.5 trillion to $13.1 trillion. As a percent of GDP, debt has also grown rapidly, from 35 percent of GDP in 2007 to 52 percent of in 2009 and nearly 74 percent in 2015. This puts debt at just under twice the 50-year historical average of 38 percent of GDP, and leaves it near record-high levels never seen other than around World War II.

Falling deficits have not prevented the debt from growing; rather, they have only slowed down the growth trend. While the debt-to-GDP ratio was essentially stable between 2014 and 2015 and may remain so for the next few years, debt is projected to continue growing faster than the economy over the long run. As the population ages, health care costs grow, and interest rates rise to more normal levels, CBO projects debt will rise from 73 percent of GDP in 2018 to 77 percent of GDP by 2025, and will exceed the size of the economy before 2040. Under CBO’s Alternative Fiscal Scenario (AFS), debt will exceed the size of the economy by 2031.

Conclusion

The fact that deficits have fallen from their trillion-plus dollar levels is encouraging, but more a sign of the economic recovery than enacted deficit reduction. And unfortunately, Washington’s myopic focus on near-term deficits has led to savings which will do little to alter the trajectory of our growing debt.

The significant decline in the deficit followed a massive increase in response to the economic crisis.  Moreover, this decline does not suggest the country is on a sustainable fiscal path as debt levels are near historic highs and are projected to grow unsustainably over the long run. In only a decade, deficits are projected to again exceed $1 trillion, and within 15 to 25 years debt is projected to exceed the entire size of the economy.

Policymakers must work together on serious tax and entitlement reforms to put debt on a clear downward path relative to the economy, and should not declare false victories while sweeping the debt issue under the rug.

 

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This paper was updated on October 15, 2015 to reflect the final end of year deficit as announced by the Treasury Department.  In addition, the paper is an update of “Deficit Falls to $483 Billion, but Debt Continues to Rise” from October 2014

Sequester Offset Solutions (SOS) Plan

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Update 9/16/2015: The appendix was corrected to accurately describe the proposed change to federal employee retirement contributions.

The Gathering Storm: Fiscal Clouds Amass This Fall

In early 2015, the Committee for a Responsible Federal Budget (CRFB) warned of the upcoming Fiscal Speed Bumps, explaining “lawmakers will face a number of important budget related deadlines…that will require legislative action.”

Inaction and postponed deadlines have created a gathering storm where Congress and the President must address four remaining Fiscal Speed Bumps before the end of the year:

  • The end of 2015 appropriations and return of sequester caps (October 1)
  • The expiration of the highway bill and insolvency of the Highway Trust Fund (October 30 & Summer 2016)
  • The exhaustion of extraordinary measures to avoid raising the Debt Ceiling (mid-Fall)
  • The deadline to renew tax extenders retroactively (December 31)

Although deadlines vary, political considerations may cause lawmakers to combine these issues – leading to a double, triple, or even quadruple cliff.

An irresponsible approach could add up to $2.5 trillion to the debt by 2025 above what current law allows, after interest. Instead, lawmakers should take advantage of this gathering storm to make sensible reforms to improve policy, accelerate economic growth, and address the overall fiscal situation.

Appropriations End. Sequester-Level Caps Return (October 1)

When the government’s fiscal year ends on September 30, so too will the laws that provide discretionary dollars. In theory, Congress is supposed to pass 12 appropriations bills before October in order to fund the government for Fiscal Year 2016 (FY 2016). However, the House has passed only six so far, while the Senate has not passed any. Failure to pass appropriations bills or a Continuing Resolution (CR) would result in a government shutdown.

Assuming policymakers avoid a shutdown, they will still need to decide at what level to fund the government. The Ryan-Murray Bipartisan Budget Act set spending levels for only FY 2014 and FY 2015. For FY 2016, current law spending caps will be dictated by automatic spending reductions commonly referred to as the “sequester.”

Under sequestration spending levels, nominal discretionary caps will rise only $3 billion (0.3 percent) next year – and remain about $90 billion below the pre-sequester caps set in the Budget Control Act. A number of policymakers and outside analysts have called for repealing or reducing the impact of this sequester.

Permanent sequester repeal would cost $1 trillion before interest over the next decade – although policymakers could enact a partial and/or temporary reduction of the sequester cuts. In any case, lawmakers should fully offset the costs with more thoughtful permanent savings that grow over time, without relying on gimmicks.

Legislation increasing the discretionary caps could also be accompanied by budget process reforms to strengthen their enforcement and restrict the use of gimmicks – such as the use of the Overseas Contingency Operations in the Congressional budget to effectively circumvent the defense caps. We describe such reforms in Strengthening Statutory Budget Enforcement.

In September, CRFB will release a plan to replace a portion of the sequester cuts over the next two years and on a permanent basis with savings elsewhere in the budget.

To learn more, read Everything You Should Know About Government Shutdowns, Appropriations 101, and Understanding the Sequester.

Highway Bill Expires and Trust Fund Runs Low (October 30 & Summer 2016)

At the end of October when the current highway bill expires, no new funds may be obligated to transportation projects without additional legislation. If highway spending is continued at current levels without additional revenue, the Highway Trust Fund will run out of money in the fourth quarter of FY 2016, or next summer.

Ultimately, policymakers should close the structural gap between dedicated tax revenue (e.g., the gas tax) and highway spending, which is projected to total about $13 billion this year and $175 billion through 2025. Preferably, this gap would be closed permanently with structural changes to revenue and/or spending, although a fully-offset general revenue transfer could be used to buy time, as it was this July.

CRFB released an illustrative plan in May: The Road to Sustainable Highway Spending, which included a fully-offset, short-term cash infusion into the trust fund, a process for tax and transportation reform, a scheduled 9-cent per gallon gas tax increase if alternatives were not identified, and a spending limit to keep future highway costs in line with revenue.

For more background, see our paper Trust or Bust: Fixing the Highway Trust Fund.

Federal Debt Ceiling is Reinstated (Mid-Fall)

The federal debt ceiling – which was suspended in February 2014 – was reinstated this March, limiting gross federal debt to its current level of $18.15 trillion. Through “extraordinary measures,” the Department of Treasury has been able to delay the need to address the debt ceiling even as the federal government continues to borrow. However, those measures are estimated to run out sometime after the end of October.

Policymakers must increase or suspend the debt ceiling to avoid a potentially disastrous government default, and should do so in a timely manner because waiting until the 11th hour could have negative economic consequences. At the same time, the debt ceiling can be – and in the past has been – an opportunity to take stock of the nation’s unsustainable fiscal situation and make fiscal reforms. An increase would ideally be accompanied with improvements to reduce the long-term debt.

Reforms to the debt ceiling itself should also be considered. Through our Better Budget Process Initiative, CRFB has presented a number of ideas for Improving the Debt Limit to better promote fiscal responsibility without generating as much economic risk.

To learn more about the debt ceiling, read Q&A: Everything You Should Know About the Debt Ceiling and Understanding the Debt Limit.

“Tax Extenders” Reach Reinstatement Deadline (December 31, 2015)

At the end of last year, over 50 temporary “tax extenders” expired. These include individual and business tax breaks for research and experimentation, wind energy, state and local sales tax, and many others.

Most are renewed regularly and can be reinstated retroactively through the end of 2015, and possibly later. Doing so for 2015 would cost over $40 billion before interest, and extending them into 2016 would cost about $95 billion. Many of these provisions have been enacted temporarily to hide their costs, but the price mounts if they are continued year after year. A permanent extension would cost roughly $500 billion through 2025 for traditional extenders, $245 billion for bonus depreciation, and $200 billion for expiring refundable credits – about $940 billion total, without factoring in interest costs.

Rather than add to the debt, lawmakers should use this deadline as an opportunity for comprehensive, pro-growth tax reform that simplifies the tax code, reduces tax rates and deficits, broadens the tax base, promotes growth, and makes thoughtful choices about how to address each tax extender. Last year, CRFB proposed the PREP Plan, which combined a temporary extension with a fast-track process for tax reform and offset the cost with tax compliance measures.

To read more about the tax extenders, see The Tax Break-Down: Tax Extenders.

* * * * *

The gathering fiscal storm facing our country this fall will require legislation to address the important budgetary issues mentioned above. We hope Congress and the President use this as an opportunity to improve, rather than worsen, the nation’s unsustainable fiscal situation.

Update 9/10/2015: This paper was updated for the Department of Transportation's announcement that the Highway Trust Fund would last through the third quarter of FY 2016, and updated to clarify when listed costs included interest.

 

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