December 19, 2014

The President’s FY 2012 Budget: Pressing the Pause Button

President Obama’s Fiscal Year 2012 budget is not a bold policy proposal. It is an oddly complacent budget for a situation that requires anything but complacency.

Faced with a growing chorus of warnings from official and unofficial sources that we are on a perilous fiscal path, the President’s budget would, at best, temporarily stabilize deficits at about three percent of the gross domestic product (GDP) by 2017 and debt held by the public at more than 70 percent of GDP -- roughly twice the average over the past 50 years.

Stabilizing the debt may be a necessary first step, but it leaves in place an underlying structural deficit that will push debt to new and unsustainable heights in the years beyond the budget’s 10-year outlook (2012-2021). As acknowledged in the budget’s Analytical Perspectives, “beyond 2021, the fiscal position deteriorates again mainly because of the aging of the population and the high continuing costs of the Government’s health programs. The publicly-held debt rises unsustainably relative to GDP.”[1]

This projected fiscal deterioration does not come as a surprise. In last year’s budget, the President proposed a National Commission on Fiscal Responsibility and Reform, which he charged with identifying “policies to meaningfully improve the long-run fiscal outlook, including changes to address the growth of entitlement spending and the gap between the projected revenues and expenditures of the Federal Government.”

Last December, the commission came back with its report, supported by a bipartisan majority of the members. In addition to tough constraints on discretionary programs, including defense, it recommended limits on the growth of federal health care spending and reform of Social Security. On the tax side, it proposed ways to bring in higher revenues by flattening rates and eliminating, or greatly restricting, a wealth of exclusions, deductions and credits. Many of these recommendations would prove controversial if presented in the budget and not all of them were fully developed.

Yet instead of embracing and building upon the fundamental changes recommended by the commission, the President chose to press the pause button. While he did not reject the panel’s recommendations, thus keeping them alive for future consideration, he declined to give them the powerful public boost they will need to be translated into action.

To the extent that the budget arouses any sense of urgency at all, it is overly focused on non-security discretionary programs which comprise roughly 12 percent of federal spending and pose much less risk to the fiscal outlook than defense spending, entitlement programs and interest on the growing debt.

For the most part, the budget is a spruced-up rerun of previous proposals:

  • Last year’s three-year freeze on non-security discretionary spending is now a five-year freeze.
  • Relief from the Alternative Minimum Tax (AMT) is now paid for over three years, but with 10 years’ worth of savings from an offset Congress has repeatedly rejected (a reduction in itemized deductions for high-income households). The remaining seven years of AMT relief are not paid for.
  • A two-year “doc fix” preventing large cuts in Medicare physician reimbursements is paid for, but again with 10 years’ worth of savings. The remaining eight years are assumed to be paid for but no specific offsets are identified.
  • Certain business tax breaks are closed but others for individuals and families are created or extended. As with past budgets from presidents of both parties, many “temporary” tax breaks are extended for a limited period, which obscures their likely ultimate revenue loss.
  • A $50 billion annual plug is again inserted for the cost of future operations in Afghanistan and Iraq beyond the $126.5 billion requested for 2012. This is recorded as a $1.1 trillion savings over 10 years but is subject to uncertainty regarding the pace and extent that these operations can be scaled back.
  • The budget once again assumes a 10-year revenue loss for the extension of “middle income” tax cuts scheduled to expire in 2012 ($1.25 trillion), while assuming revenue gains from letting the tax cuts expire for families earning above $250,000 a year ($709 billion).

In total, policy proposals in the budget -- things the President is actually proposing to do -- only have a marginal effect on the bottom line. They would cut projected spending by $677 billion, raise projected revenues by $273 billion and lower interest costs by $161 billion for a combined deficit reduction of $1.1 trillion over 10 years. This stacks up against a projected $9.4 trillion 10-year deficit in the administration’s adjusted baseline, leaving a cumulative post-policy 10-year deficit of $7.2 trillion.[2]

 The most significant thing about the budget, however, is what’s missing. There are no significant cost-saving proposals for the three largest entitlement programs: Social Security, Medicare and Medicaid. Nor is there a proposal for comprehensive tax reform.

Overview of the Numbers

The President’s budget projects a 2011 deficit of $1.6 trillion, up from the $1.3 trillion deficit in 2010. It will be the third straight year of trillion-dollar-plus deficits and the largest as a share of GDP (10.9 percent) since the end of World War II.


While the economy has shown signs of improvement, which is a key factor in reducing federal borrowing, last December’s $858 billion tax-and-spending deal will add to the deficit by an estimated $390 billion this year and by $407 billion in 2012.

The deficit would come down to $1.1 trillion in 2012 under the President’s budget (7 percent of GDP). This would actually represent a slight increase ($11 billion) in the administration’s baseline deficit.

Spending would fall slightly from 23.6 percent of GDP in 2012 to 23.1 percent in 2021. Revenues would rise from 16.6 percent of GDP in 2012 to 20 percent of GDP in 2021. The resulting deficits would fall from seven percent of GDP in 2012 to 3.1 percent in 2021. Meanwhile, debt held by the public, which best measures the federal government’s effect on the economy and credit markets, would slowly climb from 75.1 percent of GDP to 77 percent. Interest on the debt would soar from $242 billion in 2012 to $844 billion in 2021.

The Spending Path

Over the years covered by the budget (FY2012-21), total outlays would grow from $3.729 trillion in 2012 to $5.697 trillion by 2021, reaching a total of $45.952 trillion. As a percentage of GDP, outlays remain relatively stable -- declining slightly from 23.6 percent in 2012 to 23.1 percent by 2021, and averaging 22.7 percent over 10 years. As a share of the economy, spending in the President’s budget continues to be well above the 20.8 percent average for the past 40 years and consistently higher than the path outlined by the fiscal commission. The reasons are clear. While discretionary spending drops substantially over the next 10 years as a share of the economy, overall spending remains about the same due to the growing costs of mandatory programs and, particularly, net interest. Total spending in the President’s budget is slightly above the CBO baseline for 2012 and slightly below the baseline over ten years.


 
It is somewhat encouraging that the President’s budget does not propose spending increases significantly above CBO’s baseline over ten years, though this is not enough. The fact that spending is close to baseline levels indicates that the budget does virtually nothing to reverse an upward trend in spending that is fiscally unsustainable over the long term without revenue increases higher than projected in the budget.

Mandatory Spending

The most significant weakness in the President’s budget is the lack of any substantial reforms to restrain the growth of mandatory spending. Mandatory spending includes entitlement programs -- such as Medicare, Medicaid and Social Security -- that automatically expand each year due to benefit formulas already written into law.

As the population ages and health care costs grow faster than the economy, these programs will increasingly crowd out discretionary spending or put upward pressure on taxes. For example, CBO projected last year that if no changes were made, outlays for major health care entitlement programs alone would double as a share of GDP over the next 25 years.[3]

The President’s budget proposes $2.140 trillion for mandatory spending in 2012 and $27.302 trillion over ten years. As a share of GDP, mandatory spending in the President’s budget goes from 13.5 percent in 2012 to 14.1 percent by 2021. Total mandatory spending averages 13.5 percent of GDP over ten years. This is slightly above CBO’s baseline, which assumes mandatory spending will be 13.3 percent of GDP over 2012-21. Over the decade, more than 75 percent of the mandatory spending in the President’s budget is attributable to only three programs: Social Security, Medicare and Medicaid. As a share of GDP, Social Security spending goes from 4.8 percent in 2012 to 5.2 percent in 2021; Medicare goes from 3.1 percent in 2012 to 3.4 percent in 2021; and Medicaid goes from 1.7 percent in 2012 to 2.4 percent by 2021.

While the President’s budget generally maintains the status quo for mandatory spending, it does include some policies intended to produce savings on the mandatory side of the budget. However, in several cases the budget’s proposals to pay for costly policies are missing specific offsets.

To the President’s credit, the budget proposes paying for relief from scheduled cuts to Medicare physician reimbursements. The budget assumes that the proposal will be fully paid for over ten years, though specific offsets are only included for two years. Proposing to pay for the “doc fix” and including at least some specific offsets are positive developments.

However, a more responsible budget would have included specific offsets that fully paid for the proposal, rather than including offsets through 2013 and then assuming the savings from unspecified offsets beginning in 2014.

Similarly, the budget makes a fiscally responsible commitment to pay for a six-year surface transportation re-authorization proposal, but does not support the commitment with examples of specific offsets to pay for it.

The budget also includes savings from a proposal to reform the Pension Benefit Guaranty Corporation (PBGC), and a variety of proposals that would affect programs at several government agencies. Many of these proposals have merit and should be seriously considered as Congress reviews options for deficit reduction. However, even if every one of them were enacted exactly as the President proposed, the savings would fall well short of what is needed to place our nation on a fiscally sustainable path.

Addressing a $14 trillion debt and high projected deficits requires mandatory spending proposals that go far beyond simply trimming at the margins of various government agencies. Restraining the growth of mandatory spending will not occur unless significant changes are made to the three programs driving that spending: Social Security, Medicare and Medicaid.

Net Interest

Perhaps the fiscal challenges posed by our growing debt are most apparent from the net interest estimates in the President’s budget. From FY 2011 to FY 2021, it projects that actual dollars devoted to interest payments will more than quadruple.

As CBO and other experts have frequently noted, while our debt has rapidly escalated over the last several years, net interest payments have still remained relatively low due to extremely low interest rates. The estimates in the President’s budget illustrate the dramatic increase in interest payments that could occur as interest rates return to more traditional levels and as deficits continue to pile up.

Of the $7.2 trillion in deficits that the President’s budget assumes over 2012-21, interest payments on the debt account for $5.7 trillion or nearly 80 percent. Under the President’s budget, net interest will increase from $242 billion in 2012 to $844 billion by 2021. As a percentage of GDP, net interest will increase from 1.5 percent in 2012 to 3.4 percent by 2021. As a share of revenues, interest payments almost double from 9 percent to 17 percent.

By 2021, spending on interest would be almost double non-security discretionary spending ($844 billion vs. $453 billion). As soon as 2018, interest costs would begin to exceed even Medicare spending.

Discretionary Spending

For discretionary appropriations, the President requests $1.243 trillion in total budget authority for 2012, including $719 billion for security-related programs, $397 billion for non-security-related programs, and $127 billion for overseas contingency operations.

As a share of the economy, the budget assumes discretionary outlays will decrease from 8.5 percent in 2012 to 5.6 percent by 2021. This is accomplished primarily by assuming $406 billion in savings from a five-year freeze on non-security discretionary spending. The budget also includes $78 billion in savings from a series of efficiency and acquisition reforms at the Department of Defense.

The budget’s discretionary spending totals assume $1.1 trillion in reductions to security-related spending primarily due to reduced costs of military operations in Afghanistan and Iraq.

The budget proposes a list of specific cuts to a number of popular programs such as the Low Income Home Energy Assistance Program (LIHEAP), the Community Development Block Grant program, and the Environmental Protection Agency’s water infrastructure state revolving funds.

It is encouraging that the budget makes some difficult choices to limit non-security discretionary spending. However, as The Concord Coalition has long argued, simply focusing on non-security discretionary spending is insufficient for the task at hand. This category of spending only accounts for about an eighth of the federal budget. The $406 billion in savings from a five-year freeze on non-security discretionary spending would not even offset the $1.1 trillion deficit projected during the first year of the budget and is only a fraction of projected ten-year deficits that total $7.2 trillion and 3.7 percent of GDP.

It is also worth noting that meeting the budget’s assumption that discretionary spending outlays will be limited to 5.6 percent of GDP by 2021 will require a historic commitment to fiscal responsibility that has rarely occurred during the annual appropriations process. If this target were successfully reached, it would be the only time this has occurred during the last 50 years.

Historically, multi-year targets for discretionary spending have been difficult to enforce because they can be revised annually in the budget resolution and Congress rarely considers them binding in subsequent years. The targets included in the President’s budget may also be particularly difficult to enforce if war costs end up exceeding the budget’s assumptions for reduced spending in Iraq and Afghanistan.

Enacting statutory caps with an enforcement mechanism such as automatic sequestration would improve the chances of success. Separate caps could be applied to non-defense and regular defense appropriations.

Revenues

The budget projects 2011 revenues will only total 14.4 percent of GDP. This would be the lowest level of revenue since 1950, when it also dropped to 14.4 percent. Such low levels are due both to the continuing softness of the economy and to the tax cuts enacted in December, which not only extended the 2001 and 2003 cuts but reduced the payroll tax rate by two percentage points for 2011.

In 2012, revenues are projected to jump to 16.6 percent of GDP, and then grow to 20 percent of GDP by 2021 (on spending of 23.1 percent).


As with mandatory spending, the budget’s revenue proposals fall far short of the broad reform recommendations made by the bipartisan fiscal commission. Not only does the budget propose lower revenues than the commission in every year of the budget window, (the commission plan reaches 20.6 percent of GDP in 2020, while the President’s budget only gets to 19.1 percent,) the budget does so even while assuming faster economic growth than the commission did.

Additionally, the budget does not move substantially towards tax simplification by limiting “tax expenditures” -- one of the primary suggestions of the commission. To the contrary, the budget proposes nearly $400 billion over ten years for the extension, expansion and creation of tax expenditures (deductions and tax credits).

This reluctance to propose major tax simplification runs counter to the commission’s experience that such simplification is an area where bipartisan agreement is reachable and offers substantial fiscal and economic gains.

There are some counter-examples to these points. The budget proposes a number of loophole closings and acknowledges that there is little difference between narrowly targeted tax deductions and spending programs. The single largest nod to tax expenditure reform is the proposal to pay for a three-year “fix” to the Alternative Minimum Tax (AMT) to prevent it from hitting dramatically more middle-class taxpayers. For this, the administration resurrected its proposal from the last two budgets to limit the tax rate on itemized deductions for those in the top income brackets.

While it is a reasonable attempt to begin broadening the income tax base, this permanent tax code change still leaves seven years of expensive AMT fixes because it does not bring in enough revenue. A better proposal would have phased in a more dramatic roll-back of tax expenditures to keep pace with a permanent AMT fix. But without the sort of comprehensive approach recommended by the commission, the administration has limited itself to partial and second-best solutions that will ultimately be less effective.

The same general flaw is also apparent in the administration’s approach to extending the 2001 and 2003 tax cuts. The commission was able to break out of the trench warfare over whether to extend these tax cuts by bringing in more revenues from scaled-back tax expenditures and by actually lowering rates. Without such a game-changing initiative, the administration and the legislative process in Washington are stuck in the partisan trenches.

Worse yet, the administration has buried the trade-offs in the baseline. Reading the budget, one could be forgiven for assuming the future of the 2001 and 2003 tax cuts is no longer an open question. Although under current law they are all scheduled to expire in 2012, their fate is not dealt with as a policy proposal in the budget. While that would be fine if the administration were intent on letting them all expire, that isn’t the case. Instead, the administration’s policy preference – to extend a portion of the tax cuts and let the rest expire -- is assumed into the baseline as if the cost were a foregone conclusion and as if no legislation would ever be needed to enact this policy.

The administration assumes in the “adjusted” baseline that the middle-income tax cuts will be permanently extended while the upper-income tax cuts will be allowed to expire. So although legislation will still have to be enacted to extend the middle class tax cuts, administration officials seem to be ignoring the lesson from the difficult negotiations in December -- that their preferred result is not a foregone conclusion and thus will require a major legislative push. Furthermore, after all of this disguising, the administration still tries to claim credit for allowing the upper-income tax cuts to expire in summary table S-2 memorandum referring to “costs avoided.”

The primary takeaway, however, should be that the unspecified piece of legislation to extend some of the tax cuts will cost over $3 trillion -- three times as much as all of the President's proposed budgetary savings from revenue increases, mandatory spending changes and discretionary spending cuts.

Conclusion

As the President has suggested, this budget may simply represent a political calculation that behind-the-scenes discussions on entitlement and tax reform will be more productive right now than a high-profile campaign for specific solutions. There is, however, significant downside risk to the President’s go-slow approach. It fails to set an action agenda, to designate a process to accomplish such an agenda, or to engage the public in what will surely be fundamental policy trade-offs.

Two things are certain. First, the problem will not solve itself, and second, the longer action is delayed the more dire the situation will become. So even if the President’s budget seems lacking as an opening bid,  it will not be the last word.


[1] Analytical Perspectives, FY 2012 Budget of the U.S. Government, p.50.

[2] See Table S-2, Summary Tables, Fiscal Year 2012 Budget of the U. S. Government.  The policy reduction figure does not include the assumed $1.1 trillion of savings from reducing operations in Iraq and Afghanistan from current levels, which the administration did not claim as a policy savings in presenting its budget. Together, the war cost and policy savings reduce the adjusted baseline deficit by $2.2 trillion.

[3] The Long-Term Budget Outlook, Congressional Budget Office, June 2010.
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