Year-End Borrowing Could Worsen Deficits and Inflation

With inflation surging and debt approaching record levels, policymakers should avoid worsening the deficit and should at least pledge to add no new debt for the rest of 2022. Yet, policymakers are currently considering an end-of-the-year fiscal package that would make things much worse.

We estimate that an end-of-year package that delays, extends, or enacts various tax and health care provisions while boosting appropriations and providing new emergency funding could cost $240 billion in the first year and more than $1.9 trillion over a decade if made permanent. Adding in the cost of other policies being considered and the fiscal impact of waiving the PAYGO sequester (relative to allowing it to hit), we estimate lawmakers could add as much as $585 billion to debt in the first year and up to $5 trillion over a decade, assuming future extensions. We estimate, roughly, that the full set of policies could boost inflation by up to 150 basis points relative to the counterfactual, including 50 basis points from the various extensions and appropriations.

Sources: Congressional Budget Office and Committee for a Responsible Federal Budget.

*Expensing of equipment and R&E will have very little ten-year cost if enacted for only one year, since timing of tax payments would just be shifted. However, this low cost of largely a mirage, given the likelihood of further extensions. 

Figures may not add due to rounding.

The below analysis is partially an update of a piece we previously published in September, reflecting press reports and new information regarding Congressional priorities. As we’ve argued before, policymakers should be able to at least go through the end of the year (only 40 more days as of this writing) without adding more new debt.

Many of the policies under consideration would extend or avoid changes to the tax code. We estimate these would cost $95 billion in the first calendar year and $625 billion if extended over a decade. A true one-year extension that is allowed to expire would cost about $25 billion due to timing issues.

Three provisions from the 2017 Tax Cuts and Jobs Act (TCJA) could be particularly expensive. Under the TCJA, a limit on net interest deductions tightened at the beginning of 2022; businesses were required to write off research & experimentation (R&E) expenses over several years instead of deducting them immediately starting in 2022; and 100 percent bonus depreciation, which allows business equipment purchases to be deducted immediately, will start phasing out in 2023. Restoring the pre-2022 policy for these three changes would cost roughly $95 billion in the first calendar year they are in effect – including the retroactive effects from R&E expensing – and $605 billion over a decade if continued on a permanent basis. Other tax extenders would cost an additional $2 billion in the first year and $20 billion if made permanent.

Sources: Congressional Budget Office and Committee for a Responsible Federal Budget. Figures may not add due to rounding.

+Represents outlay or revenue loss in calendar year 2023.

`CBO’s baseline does not assume the PAYGO sequester will go into effect. Because the policies that lead to the PAYGO violation add to the debt, PAYGO sequester repeal is not scored as an additional cost.

^#This assumes only a one-time appropriation. However, not all of the new spending will be spent in the first year.

*Expensing of equipment and R&E will have very little ten-year cost if enacted for only one year, since timing of tax payments would just be shifted. However, this low cost is largely a mirage, given the likelihood of further extensions.

^This policy has not been recently estimated by CBO or JCT, and actual costs could differ substantially.

^"Senate retirement bill contains timing gimmicks that make its ten-year cost negligible; this represents the steady-state cost of the policies (see here for details).

There are also several health-related provisions that Congress could decide to take action on that could cost as much as $35 billion in the first year and $460 billion over ten years if made permanent. The most costly would be a revival of the emergency suspension of the 2 percent Medicare sequester, which was put on pause during the pandemic but has been in full effect since July. There is also talk about extending the 10 percent increase in the federal matching rate for Medicaid home- and community-based health services from the American Rescue Plan, continuing bonus payments for physicians, cancelling scheduled payment adjustments for physicians and home health providers, enacting new policies to cap the cost of insulin and reform Medicare Advantage prior authorization rules, and other changes.

At the same time, an end-of-year deal is likely to substantially increase discretionary spending – both through normal defense and nondefense appropriations and through supplemental appropriations. Assuming the total top-line appropriations number matches the House-proposed levels (even with a different defense/nondefense split), outlays would be about $65 billion higher in the first year and $740 billion higher over a decade. It’s possible negotiators are considering an even larger increase. There might also be as much as $80 billion in temporary additional funding for Ukraine, COVID, Hurricane Ian, and other emergencies.

On top of all of this, there has been some discussion of enacting new deficit-boosting measures at year's end. For example, there is talk of expanding the child tax credit (CTC) and earned income tax credit (EITC) in combination with extensions of business provisions. A full revival of the expansions from the American Rescue Plan would cost $145 billion in the first year ($1.45 trillion over ten years) – though policymakers would likely do something smaller (see our Build Your Own CTC calculator). There is also discussion of increasing the $10,000 cap on the state and local tax (SALT) deduction, enacting a retirement bill that advanced in the Senate earlier this year, and repealing Social Security's Government Pension Offset (GPO) and Windfall Elimination Provision (WEP).

Finally, policymakers will likely enact a bill to avoid the PAYGO sequester, an automatic spending cut which would reduce Medicare spending by 4 percent and spending on other non-exempt programs by 100 percent in order to enforce violations of the Statutory Pay-As-You-Go Act in 2021 and 2022 (mainly from the $1.9 trillion American Rescue Plan). That sequester was originally scheduled to go into effect earlier this year, but lawmakers shifted the cuts into 2023, increasing the intended cut from $370 billion to $740 billion. Because both these numbers are larger than allowable cuts, the actual scheduled cut would be about $120 billion in size. CBO’s baseline does not assume the cut goes into effect (which is appropriate, since CBO scores the full cost of deficit-boosting legislation). Relative to the sequester going into effect, repeal would cost roughly $120 billion – or $1.2 trillion over a decade.

If lawmakers enacted all of these changes, including the extensions and PAYGO sequester repeal, it would cost $585 billion in the first year and $5 trillion over ten years. Enacting these policies on a temporary one-year basis would cost $545 billion.

Not only would these policies increase deficits, but they would also worsen inflation. The effect will depend on each policy's demand multiplier and how much of new consumption flows into prices. We roughly estimate that the tax extensions, health extensions/expansions, and appropriations would boost inflation by as much as 50 basis points. All of the policies together, relative to the PAYGO sequester going into effect, could boost the inflation rate by as much as 150 basis points. These figures are rough for illustrative purposes.

* * *

With inflation surging and debt approaching record levels, policymakers should avoid passing costly end-of-year policy changes. Any policies that are enacted should be fully offset over the near- and long-term to avoid adding to the debt or worsening inflation. Fiscal policy should be helping make the Federal Reserve's inflation-fighting job easier in order to reduce the risk of persistent inflation or a painful recession. At a minimum, policymakers should be able to agree to no new debt through the end of 2022.