October 23, 2014

Washington Budget Report: Aug. 9, 2011

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Responsible Fiscal Reform Could Build Public Confidence

In the week since President Obama signed the debt limit deal into law, stock prices have become highly volatile, Standard & Poor’s dropped its U.S. credit rating a notch below AAA, and political maneuvering began over the special congressional committee that will be charged with finding most of the deficit reduction promised in the new legislation.

The debt deal fell far short of what is needed to put the country on a sustainable path, making the familiar Washington mistake of focusing mostly on discretionary spending. In many ways, Concord Coalition Executive Director Robert L. Bixby writes in a new blog posting, the deal seems “specifically designed to avoid the two greatest fiscal challenges – entitlement and tax reform.”

On Monday pessimism swept through global financial markets, with the Dow Jones Industrial Average dropping 635 points. This followed substantial market losses last week amid worries about the European debt crisis, the faltering U.S. recovery and excessive partisanship in Washington.

Standard & Poor’s announced late Friday that it had dropped the U.S. government’s credit rating to AA+, saying the debt deal was insufficient. This week it also lowered credit ratings for government-backed entities, including mortgage giants Fannie Mae and Freddie Mac.

Two other ratings agencies, Moody’s and Fitch, have also expressed great concern about the nation’s fiscal path but have not downgraded the government’s credit rating.

On Monday President Obama sought to build public confidence, saying the country’s economic problems were “eminently solvable” and that he hoped the S&P downgrade would create “a new sense of urgency” about fiscal reform.

But if those who are named to the new Congressional Joint Committee on Deficit Reduction decide to take their mandate seriously, Bixby says, “they will likely have to make decisions in the public interest that will not sit well with the party leaders who appointed them.”

Fortunately, the committee -- with a target of at least $1.5 trillion in additional deficit reduction over 10 years -- need not start from scratch. Bixby points out that the president’s fiscal commission and other bipartisan groups have created templates for a “grand bargain” that would take a more comprehensive approach to fiscal reform. These proposals, he notes, “don’t pretend there is a magic solution that will preserve everyone’s favorite programs and simultaneously cut taxes.”

A Flawed Deficit Reduction Trigger

The new debt limit law includes a trigger that would impose severe spending cuts if legislation to reduce the deficit by more than $1.2 trillion has not been enacted by Jan. 15, 2012. It was designed to give an incentive for the new congressional committee to succeed where others have failed.

Beginning in Fiscal Year 2013, the trigger requires reductions in discretionary and mandatory spending to make up for any shortfall. The cuts would be evenly divided between defense and non-defense spending.

Social Security, payments to Medicare beneficiaries, Medicaid, unemployment insurance, and other low-income programs would not be subject to cuts under the trigger. Any cuts to Medicare would also be limited to 2 percent. Because these programs account for well over 90 percent of all mandatory spending over the next ten years, this is a significant loophole that could make the trigger an ineffective tool. The trigger also does not address revenues. 

Because of the exemptions, the cuts would fall disproportionately on annual appropriations for defense and non-defense programs. Little consideration would be given to the policy rationale behind the cuts to specific programs.

If the committee responds to the S&P downgrade by exceeding its target with a proposal approaching $4 trillion in deficit reduction, a trigger cutting only $1.2 trillion could provide policymakers with an incentive to block the larger proposal.

For a trigger to be most effective, it must apply to revenues and a substantial portion of the spending that is driving deficits in the first place. Exemptions and the temptation for Congress to block automatic spending cuts have weakened previous triggers. That poor track record suggests that both parties should focus on making the joint committee a success and not count on a trigger to address our nation’s fiscal challenges.

Tax Reform Could Have Bipartisan Appeal

Projections by the Congressional Budget Office make it clear that future choices about tax policy -- and particularly about expiring tax cuts -- will be a critical factor in the country’s fiscal outlook for many years to come.

Republicans counted it as an important victory that the first round of deficit reduction in last week’s debt limit deal contained no tax increases. But the deal leaves that as a possibility for the second round, with all options back on the negotiating table for the special congressional committee that will make recommendations later this year.

Diane Lim Rogers, chief economist for The Concord Coalition, argues that the tax reform strategy most likely to appeal to both Republicans and Democrats is to broaden the tax base by reducing tax expenditures -- such as exclusions, deductions and credits – while lowering marginal tax rates and raising additional revenue.

The committee, Rogers suggests, should consider strict pay-as-you-go rules on any extension of expiring tax cuts, including any of the Bush tax cuts that are set to expire at the end of next year. The panel should also work to identify tax breaks that could be eliminated.