A Mini-Bargain to Improve the Budget: An Update

Note: This paper is an update from our August 2017 piece “A Mini-Bargain to Improve the Budget.” It adds a new section on how to pay for disaster relief.

The national debt is currently at its highest share of the economy since just after World War II and set to rise rapidly. Fixing our unsustainable fiscal situation will require a multi-year plan with a mix of spending cuts, structural reforms to slow the rising costs of health care and retirement programs, and an increase in revenue.

Unfortunately, policymakers are far from negotiating a “grand bargain” to fix the debt. Instead, many are pursuing policies that would further increase debt by cutting taxes under the guise of tax reform and increasing defense and non-defense discretionary spending above current law caps. Policymakers are also pursuing significant disaster relief funding to assist communities afflicted by hurricanes this season. While this funding is surely needed, it would add to an already unsustainable debt unless offsets are included.

To refocus efforts in the right direction, America needs a “mini-bargain” on the budget. That bargain should put in place measures to prevent unpaid-for tax cuts and spending increases, finance sequester relief, pay for new disaster funding, make a down payment on debt reduction, and establish a process for further reforms down the road. We propose a seven-part framework:

1. Replace the sequester with realistic and responsible discretionary caps, fully offset with $400 billion of savings from measuring inflation properly.
2. Enact fiscally responsible disaster relief, offset with both spending cuts and revenue increases.
3. Strengthen Pay-As-You-Go (PAYGO) to facilitate responsible tax reform that is at least revenue neutral on a conventional basis. Rather than cutting taxes, policymakers should enact tax reform, which could help grow the economy and therefore realistically generate $400 billion of deficit reduction.
4. Enact bipartisan mandatory savings to save $400 billion over ten years with reforms to some of the largest drivers of the debt, including health care and retirement programs.
5. Establish a Social Security commission tasked with averting the 23 percent across-the-board cuts looming in 2034 and ensuring sustainable solvency.
6. Increase the debt ceiling to avoid a default on the national debt.
7. Reform the budget process to increase efficiency, improve accountability, and include a long-term focus.

This plan will not fix the debt, but it could produce $1.3 trillion of gross savings. About two-fifths  of these savings would be used for disaster relief and to make important investments in education, infrastructure, research, national security, and other core government functions. The rest would help slow the growth of the national debt, improve Social Security solvency, and buy time for further reforms. Over two decades, this package could save nearly $4 trillion in total. Policymakers should seriously consider this mini-bargain as an important first step toward long-term sustainability and prosperity. We cannot afford to continue on our current path.

Replace Sequester with Realistic and Responsible Discretionary Caps

Sequester-level caps on defense and non-defense discretionary spending are set to return in full force in Fiscal Year (FY) 2018, lowering discretionary spending levels about $90 billion below the originally agreed-upon Budget Control Act caps (this year, spending is about $61 billion below those levels, though this reduction is partly offset by excessive spending on overseas contingency operations). Under current law, these sequester-level caps will continue through 2021, after which discretionary spending will no longer be capped at all. A “mandatory sequester” also cuts certain mandatory spending programs by $10 billion to $15 billion per year through 2025.

Congress has never actually adhered to the sequester-level caps, and there is broad desire to lift the defense caps, the non-defense caps, or both. This is not surprising: the sequester was intended to be an enforcement measure to prompt policymakers to agree to smarter deficit reduction, not an actual policy to be followed. Rather than adjusting the caps a year or two at a time as lawmakers have done since 2013, a responsible budget deal could permanently replace the sequester with new sustainable caps that continue through the next decade.

As part of the mini-bargain, we propose eliminating two-thirds of the sequester for FY 2018, setting total caps at $1.13 trillion instead of $1.06 trillion. We then propose indexing those caps with inflation – as measured by the chained CPI – through 2027. This would permanently replace the discretionary sequester and extend the caps well beyond their current 2021 expiration.

We also propose replacing the mandatory sequester with a permanent “rebasing” of Medicare and other payments that allows them to grow off today’s levels. This would effectively continue reductions from the mandatory sequester but do so in a more transparent and predictable way. Spending levels would be set by legislation instead of annual calculations from the Office of Management and Budget.

Finally, we propose rescinding money from the Crime Victims Fund (CVF). On paper, this will generate $10 billion of savings, but much more importantly, it will prevent policymakers from repeatedly delaying spending of CVF funding in order to claim $10 billion per year of changes in mandatory programs (CHIMPs) to offset discretionary costs. In other words, this would remove a major budget gimmick.

Taken together, this sequester relief package would cost about $400 billion over a decade. That cost could be fully offset by adopting a more accurate measure of inflation throughout the budget and tax code.

A number of programs and tax provisions are currently indexed using the Consumer Price Index (CPI), even though economists across the spectrum agree this index overstates inflation. Correcting this overstatement by adopting the chained CPI instead would reduce projected spending by roughly $230 billion over a decade (including $150 billion from Social Security) and increase revenue by about $170 billion.

Though this sequester replacement would be budget neutral in the first decade, we estimate it would reduce the debt by roughly $1 trillion (2.4 percent of Gross Domestic Product) after two decades.

Enact Fiscally Responsible Disaster Relief

The devastation caused by Hurricanes Harvey, Irma, and Maria has created a need for rebuilding efforts across the United States. Lawmakers have discussed significant additional disaster relief on top of the roughly $20 billion enacted to date.

Though offsets at the time are not always possible in the case of a truly urgent and unexpected emergency, future packages – focused largely on rebuilding and written with much more lead time – should be fully offset.

We have no specific proposal as to what disaster relief should look like, but for purposes of this “mini-bargain,” we assume the package will cost roughly $100 billion and include resources for Federal Emergency Management Agency (FEMA) funding, flood insurance borrowing authority, infrastructure rebuilding, and other priorities.

Given the possible composition of the package, we developed a number of offsets based on finding existing programs and diverting some of their long-term funding toward more immediate hurricane-related needs. Since scientists believe climate change is a contributor to the increasing frequency and intensity of natural disasters, we also identified additional offsets that we believe would marginally help reduce greenhouse gas emissions.

Specifically, we propose $50 billion of spending offsets and $50 billion of tax offsets. For the spending offsets, we propose (savings estimates over ten years):

Flood Insurance Reforms ($10 billion). As one form of disaster relief, policymakers are likely to increase the borrowing authority of the National Flood Insurance Program (NFIP), allowing it to pay out more claims despite being significantly underfunded. Instead of permanently increasing this borrowing authority, policymakers could do so temporarily by giving the NFIP the tools to pay back these funds overtime. Specifically, policymakers could increase premiums (particularly on grandfathered properties), adjust deductibles, or means-test subsidies.

Reprioritization of Highway and Community Development Funds ($15 billion). Significant disaster relief is likely to go toward rebuilding infrastructure, improving community development, and offering needed social services. Some of this spending could come from existing funding streams. We recommend a small share of Highway Trust Fund spending over the next decade be diverted toward near-term rebuilding in disaster-afflicted area. We also suggest the consolidation of Community Development Block Grant and Social Services Block Grant funding and an increased grant amount for 2018 but a slower growth rate for future grants.

Farm Subsidy Cuts ($25 billion). The United States spends $15 billion per year on farm subsidies, some of which encourage more production and consequently exacerbate climate change. Therefore, we propose a modest reduction in these subsidies to help finance disaster relief. Both President Trump and President Obama supported reducing crop insurance subsidies, streamlining conservation programs, and reducing commodity payments. In particular, President Trump produced his largest agricultural savings by limiting the amount of and income eligibility for crop insurance subsidies.

These spending reductions and reprioritizations would cover half the cost of a $100 billion disaster relief package, we recommend new revenues be raised to cover the other half. Specifically, we suggest a disaster relief oil surtax ($50 billion), reflecting the fact that petroleum is a key source of carbon emissions. The surtax could be imposed temporarily until funds are recouped and then be allowed to expire. We recommend a five-year surtax that starts at $1 per barrel and phases up to $3 or $4. Alternatively, lawmakers could raise $50 billion by ending various tax breaks. We suggest eliminating all major fossil fuel tax preferences ($30 billion), closing the “SUV loophole” that allows businesses to get around limits on vehicle deductions ($10 billion), and reforming the low-income housing and new markets tax credits ($10 billion) to reprioritize their use for disaster relief.

Strengthen PAYGO to Facilitate Responsible Tax Reform

The federal tax code is in many ways broken and has not been seriously reformed in over 30 years. Currently, policymakers are in the process of negotiating reforms to the tax code. Designed properly, such a package could improve simplicity, fairness, efficiency, and overall economic growth. However, those goals would be undermined if the reform turned into a debt-financed tax cut.

As part of the mini-bargain, policymakers should therefore strengthen Pay-As-You-Go (PAYGO) rules to ensure that tax reform is not allowed to add to the debt.

Perhaps most importantly, the existing Senate PAYGO rule – which aims to prevent most legislation from adding to the debt – should be codified into law so that the Senate cannot reverse it in its budget resolution. Emergency exemptions should still be allowed, but they should require a 60- or 67-vote threshold in the Senate and a separate vote in the House. In addition, Congress should be prohibited – absent a super majority – from exempting costs from PAYGO in a budget resolution or tax and spending legislation and prohibited from wiping deficit increases from the PAYGO scorecard.

Second, policymakers should clarify that PAYGO will be measured using conventional scoring relative to the Congressional Budget Office’s (CBO) current law baseline. This would prevent policymakers from slipping a $450 billion “current policy” tax cut into a tax reform bill and would ensure dynamic revenue gains from pro-growth tax reform would go towards debt reduction.

These changes would have no direct effect on the budget, but they could forestall hundreds of billions, or perhaps trillions, of dollars from being added to the deficit. At the same time, they could lead to pro-growth and fiscally responsible tax reform that ultimately would generate significant deficit reduction – perhaps in the range of $400 billion – as a result of faster economic growth. While actual revenue gains would vary, aiming for $400 billion is a reasonable goal. For example, the Joint Committee on Taxation estimated that the Tax Reform Act of 2014, which lowered rates and broadened the base in a revenue neutral matter, would generate between $50 and $700 billion in additional dynamic revenue.

Enact Bipartisan Mandatory Savings

Just keeping the debt at today’s post-war record-high share of the economy over the next decade would require $4 trillion of spending cuts or tax increases. Putting debt on a downward path would require even greater savings.

While a mini-bargain will not include enough savings to fix the debt, it should at least make progress where areas of agreement already exist. Many proposals from President Trump’s budget, former President Obama’s budgets, or elsewhere have the potential for bipartisan support.

We therefore propose that, as part of this mini-bargain, policymakers pass at least $400 billion of savings over ten years. Congress and the President will need to negotiate the precise details of such a package, but it could be based on the following framework (savings estimates over ten years):

Medicare Reforms ($200 billion). Medicare is the second-largest and second-fastest growing government program. Experts and policymakers from all ideological stripes agree there are ways to slow its cost growth without hurting access to or quality of care. A $200 billion package of savings could include the expansion of various payment reforms, reductions in overpayments to providers (particularly for post-acute care), the elimination of reimbursements for bad debts, reforms to discourage the unnecessary use of brand-name and high-cost prescription drugs, and a modest expansion of existing means-tested premiums. Nearly all of these proposals, in some form, were included in President Obama’s final budget and should be acceptable to Republicans as well.

Medicaid Savings ($50 billion). Medicaid, a joint federal-state program, is one of the fastest growing parts of the federal budget. While the program does serve a vulnerable population, cost reductions are possible. We recommend policymakers pursue $50 billion of savings, totaling about 1 percent of program costs. To achieve this, the federal government should crack down on state efforts to manipulate their federal match through provider taxes and other gimmicks. Smaller additional savings could be generated by better accounting for lottery winnings in determining eligibility, modifying payments for administrative costs, and encouraging states to experiment with cost-saving initiatives.

Student Loan Reforms ($50 billion). The Federal Direct Student Loan Program, which issues loans for undergraduate and graduate studies, is another possible area for savings. Both President Trump and President Obama proposed moving toward a single, progressive, and streamlined income-based repayment program. Policymakers could either adopt an ambitious reform to repeal the ineffective and poorly targeted “in-school interest subsidy” and overhaul income-based repayment or a more modest reform to simply streamline income-based repayment and limit the in-school interest subsidy to one’s time as an undergraduates. Either option would save federal dollars while increasing simplicity and progressivity.

Federal Retirement Changes ($50 billion). Federal employee retirement benefits remain far more generous than most private sector benefits. Lawmakers could modify these benefits in a number of ways, including by equalizing pension contributions for all employees (employees hired after 2013 currently contribute 4.4 percent of their income while longer-tenured employees contribute only 0.8 percent). They could also eliminate the special retirement supplement available to some retiring as young as age 56, calculate benefits based on more than the current highest three years of salary, or index retirement ages to growing life expectancy. Lawmakers could also reduce excessive returns paid to the “G-Fund” within the Thrift Savings Plan.

User Fees, Premiums, and Contributions ($25 billion). Both President Trump and President Obama proposed increasing non-tax government receipts through a variety of policy changes. A mini-bargain could incorporate many of these ideas, including higher Pension Benefit Guaranty Corporation (PBGC) premiums and higher user fees for spectrum, inland waterways, food safety inspection, nuclear waste, customs, and border protection. The plan could also include revenue-generating energy reforms, such as selling part of the Strategic Petroleum Reserve or negotiating new leasing agreements.

Reforms to Strengthen and Improve the SSDI Program ($25 billion). The Social Security Disability Insurance (SSDI) trust fund is projected to exhaust its reserves by 2023, at which point a roughly one-sixth across-the-board cut would occur. Meanwhile, as we explained through our SSDI Solutions Initiative, significant improvements could be made to the SSDI program to better serve those with disabilities and taxpayers as a whole. Policymakers should include a package of SSDI reforms that improve the program, support work, and ensure or improve solvency. The President’s budget includes a useful starting point for negotiating such a package. It proposes a number of modest cost-saving reforms to improve program integrity, eliminate certain double payments, limit windfall retroactive benefits, and make other changes; it also proposes investments in pilot projects to encourage attachment to the labor force over receipt of benefits. This could be supplemented with other reforms and other savings and revenue options to help achieve long-term solvency.

Establish a Social Security Commission

Social Security is the largest federal government program and is responsible for over half of non-interest spending growth as a share of GDP over the next two decades. Because of the aging population, the program’s costs already exceed its dedicated revenue, and insolvency is projected by 2034 or sooner. At that point, all beneficiaries regardless of age or income would see their benefits immediately slashed by 20 to 25 percent.

Elements of our mini-bargain, including better measuring inflation and making SSDI solvent, would extend the life of the (theoretically) combined Social Security trust funds until roughly 2037 and close one-quarter to one-third of the combined solvency gap. However, a large shortfall would remain.

Time is running out to enact sensible solutions to avoid Social Security insolvency without dramatic changes, and so a mini-bargain should include a process to begin negotiations over Social Security reform. We recommend the appointment of a bipartisan Social Security commission tasked with ensuring 75-year sustainable solvency for the Social Security trust funds while also promoting economic growth and improving retirement security for vulnerable populations.

The commission could be modeled after bipartisan legislation introduced by Representatives Tom Cole (R-OK) and John Delaney (D-MD) in the last Congress. If successful, Social Security solvency would reduce roughly two-fifths of the fiscal gap over the next 75 years and would also ensure predictability and financial security for tens of millions of Americans.

Increase the Debt Ceiling

The United States cannot borrow beyond its statutory debt ceiling, even to pay for past obligations and expenses. In September, lawmakers suspended the debt ceiling until December 8, at which point the Treasury Department will be able to use extraordinary measures to extend the true deadline into early next year. Failing to raise or suspend the debt limit would be unacceptable and potentially disastrous, leading to a default on U.S. debt and/or other obligations.

Even threatening default by coming close to the deadline could have negative consequences.

Congress should raise or suspend the debt ceiling as soon as possible and might consider coupling an increase with other debt ceiling reforms – for example, indexing the debt ceiling to GDP growth. This increase could be part of a mini-bargain on the debt.

Budget Process Reform

There is a growing consensus that the budget process is broken. Deadlines are missed, controls are circumvented, gimmicks are employed, and the long-term outlook is ignored. Both incremental and structural improvements are necessary to improve transparency, accountability, and focus on the long term.

A mini-bargain on the budget should take some important first steps to improve the budget process. Policymakers should look to our Better Budget Process Initiative for a wide variety of options.

Conclusion

The current fiscal situation is unsustainable, and policymakers should deal it with sooner rather than later. Ultimately, the country needs a major budget deal to reduce spending, secure entitlement programs, raise new revenue, and promote economic growth.

Yet the perfect should not be the enemy of the good. A mini-bargain could help to avoid fiscally irresponsible tax cuts and spending increases without offsets and could offer an important down payment on debt reduction.

Assuming revenue-neutral but pro-growth tax reform, a package based on the mini-bargain framework outlined above would reduce deficits by $800 billion over the next decade and reduce the debt by $4 trillion, or 10 percent of GDP, after twenty years. It would also set in motion an important and necessary effort to make Social Security permanently solvent. And it would responsibly offset needed disaster relief.

We propose a mini-bargain that would not go as far as is needed but that would take an important step forward and avoid several steps backward. Policymakers should at least go this far to start making the country’s fiscal future much brighter.