This paper was updated on 12/16/15 to correct a typo
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
- Address tax extenders permanently in the context of tax reform
- Fully offset the cost of any continuations without undermining tax reform
- Include a fast-track process to achieve comprehensive tax reform
|Extend Normal Tax Extenders Through 2016||-$95 billion|
|Improve Tax Reporting and Enforcement
|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
- 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.
- 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.
- 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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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.
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
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.
August 14 marks the 80th birthday of the Social Security program, which was established in the Social Security Act of 1935. Over the past 80 years, Social Security has provided important cash benefits and income security to seniors, survivors, individuals with disabilities, and their families – including to nearly 60 million people today.
Yet Social Security is on a financially unsustainable course – and is not on track to be able to pay full benefits through its 100th birthday. Last year, the program paid $73 billion more in benefits than it raised from taxes. As the more of the baby boom population retires and Americans continue living longer, that gap is projected to grow – depleting the trust fund reserves of the disability program late next year and the old age program in the early- to mid-2030s. Failure to address the gap between spending and revenue could result in an immediate 19 percent cut to all workers with disabilities, and a 20 to 30 percent across-the-board cut to retirees.
Sadly, instead of identifying solutions to prevent depletion of the trust funds, many commenters have relied on myths and half-truths to avoid having a conversation about the necessary choices. In this paper, we identify eight such myths – though there are many more:
- Myth #1: Social Security does not face a large funding shortfall
- Myth #2: Today’s workers will not receive Social Security benefits
- Myth #3: Social Security would be fine if we hadn’t “raided the trust fund”
- Myth #4: Social Security cannot run a deficit
- Myth #5: Social Security has nothing to do with the rest of the budget
- Myth #6: We don’t need to worry about Social Security for 20 years
- Myth #7: Social Security reform is code for slashing benefits, especially for the poor
- Myth #8: Social Security is too hard to fix
Below, we debunk these myths in the hopes that an honest discussion of the facts will lead policymakers to come together and put Social Security on a sustainable path for the next 80 years.
See the full document below or download it here.
Update 8/17/2015: The original version of this paper described the changes needed to fix Social Security as “modest” while describing the changes that could gradually take place over time. We've updated the language to “incremental” for clarity.
Update: The original version of this paper had a mathematical typo, saying that Medicare beneficiaries get, on average, 350% more out of the program than they paid in. The average beneficiary actually receives 250% more than they paid in, which is 350% of the taxes paid.
The current legislation authorizing highway and mass transit spending is scheduled to expire at the end of May, and only a few months later the Highway Trust Fund will run out of reserves. Extending the life of the trust fund through the end of the year will require $11 billion, and extending it for a decade will require nearly $175 billion.
For over 50 years, federal highway spending had been financed with dedicated revenue, mainly from the gas tax. Since 2008, however, dedicated revenues have fallen short of spending, and policymakers have covered the difference with about $65 billion of general revenue transfers – often without truly paying for the cost. Those transfers are projected to run out before the end of the year, disrupting infrastructure spending across the county.
To maintain important infrastructure investments and avoid adding an additional $175 billion to the debt, Congress must identify responsible solutions to close the shortfall in the Highway Trust Fund. Fortunately, Congress has many options at its disposal to do so (see Appendix for more).
One solution that has recently gained popularity would rely on revenue generated from business tax reform to close some of the $175 billion gap. While this would be a sensible solution, tax reform will not pass before the current highway bill expires, and there is a risk it will not pass at all this year.
CRFB’s plan, The Road to Sustainable Highway Spending, would encourage the passage of tax reform while also ensuring the Highway Trust Fund remains adequately funded regardless of tax reform’s fate. The plan would:
- Get the Trust Fund Up to Speed ($25 billion) by paying the “legacy costs” of pre-2015 obligations with savings elsewhere in the budget.
- Bridge the Financing Gap ($150 billion) with a default policy to raise the gas tax by 9 cents after a year and limit annual spending to income.
- Create a Fast Lane to Tax Reform to help Congress identify alternative financing before the gas tax increase and spending limits take effect.
The Road to Sustainable Highway Spending would ensure the Highway Trust Fund remains solvent while giving policymakers flexibility to decide the level of highway spending and how it would be paid for. Our plan represents just one of many possible solutions. Importantly, any solution must responsibly address the gap between spending and revenue without resorting to gimmicks or deficit-financed transfers.