On Monday February 6, President Bush will unveil his Fiscal
Year 2007 budget. A thorough evaluation of how it all adds up must await the
details, but based on proposals outlined by the President in his State of the
Union Address as well as statements by other administration officials, it is
possible to anticipate the broad outlines of the budget and the main arguments
that will be used to support it. In
addition, previous budgets submitted by President Bush contain proposals and
signal issues that may come up again.

On Monday February 6, President Bush will unveil his Fiscal
Year 2007 budget. A thorough evaluation of how it all adds up must await the
details, but based on proposals outlined by the President in his State of the
Union Address as well as statements by other administration officials, it is
possible to anticipate the broad outlines of the budget and the main arguments
that will be used to support it. In
addition, previous budgets submitted by President Bush contain proposals and
signal issues that may come up again.

This issue brief previews what to look for in the FY 2007
budget based on The Concord Coalition’s Seven Signs of Fiscal Sense. These
criteria, which were established to help sort through the strengths and
weaknesses of deficit reduction plans, are as follows:

1. Does the budget achieve actual deficit reduction?

2. Does the budget build on realistic assumptions?

3. Does the budget contain offsets for new
initiatives?

4. Does the budget achieve a path of sustainable
deficit reduction beyond the forecast window?

5. Does the budget share the burden of deficit
reduction across generations and income levels?

6. Does the budget establish credible enforcement
mechanisms?

7. Is the budget politically viable over the
long-term?

A confluence of factors makes the FY 2007 budget
significant. This is the first of the Bush administration budgets where
the five-year window must account for baby boomers turning 65 and qualifying for
both Social Security and Medicare benefits. It is also the first budget
that has to account for the cost of extending the 2001 tax cuts beyond their
current law expiration date at the end of 2010. Finally, it is an election
year—not exactly the best atmosphere for proposing hard choices. These
factors make it all the more important to scrutinize the budget for fiscal
sense.

1. Does the
budget achieve actual deficit reduction?

A true deficit reduction plan
should achieve a deficit path that trends downward smoothly over the budget
window with progressively smaller deficits year-by-year relative to current
law; produces a cumulative deficit within the budget window that is smaller
than what is projected under current law; and does not harbor a “cliff effect”
– an abrupt explosion in the deficit just beyond the budget window. A budget plan that backloads deficit
reduction is suspect since political and economic forces make out year deficit
targets less likely to materialize.

Scrutinizing the deficit path

The President’s
budget will begin with a deficit that is going up. Administration officials
have said that the FY 2007 budget will show a deficit in excess of $400 billion
for the current year (FY 2006). This would represent a 25 percent increase over
the $318 billion deficit in FY 2005 and rival the FY 2004 deficit of $412
billion for the highest ever in dollar terms. Measured as a percentage of the
economy, a $400 billion deficit would be 3.1 percent, up from 2.6 percent in
2005.

The Congressional Budget Office (CBO) has also projected an
increase in the deficit this year, ranging from $337 billion to $360 billion
depending on what is assumed regarding further supplemental spending.[1]
The CBO and administration numbers are not necessarily at odds because the
Administration’s deficit projection includes policy proposals that will be
contained in the President’s budget. Still, the administration’s higher number
may lead to claims in September that the deficit “is coming down” if it comes
in at something closer to the CBO number ¾ even though this would
constitute a substantial increase over the 2005 deficit.

Administration
officials have attributed the FY 2006 deficit increase primarily to relief
efforts in the Gulf Coast region following Hurricane Katrina. They have
indicated that Katrina-related relief (both spending and tax breaks) will be
temporary and that the budget will show the resumption of a downward trend in
the deficit. Assuming that Katrina relief is a one-time event with no lingering
effect suggests that after the new funding spends out, the deficit should be
similar to what the Administration projected in its July 2005 Mid-Session
Review, released just a few weeks before the hurricane hit. If so, this would
be a very precipitous drop ¾ all the way
down to $162 billion in 2008 and 2009.

Prior
Bush administration budgets have assumed substantial improvements between the
first and third years, but such optimistic projections are hard to turn into
reality. For example, the FY 2003 budget showed an $80 billion deficit in FY
2003 turning into a $61 billion surplus by FY 2005. The actual figure in
FY 2005 was a deficit of $318 billion. Similarly, the FY 2004 budget showed a
deficit of $307 billion that year declining to $201 billion by 2006. As it
turns out, the FY 2006 deficit is likely to be about twice that amount. The FY
2005 and FY 2006 budgets also showed dramatic improvements within a short time
frame. It remains to be seen how these projections will turn out, but
experience suggests that careful scrutiny should be given to projections of a
rapidly declining deficit three years into the future.

Thus,
the first thing to look for in the new budget is the assumed deficit
trajectory. A sure sign of a suspect budget plan is a sudden plunge in the
deficit. Such events can occur, as last year’s decline of $94 billion
demonstrates, but rarely do they occur as the direct result of policy
initiatives (i.e., spending cuts or tax increases). If the President’s budget
contains a steep decline in the deficit, it will be important to examine the
reasons:

• Is it
  because of explicit policy choices recommended in the budget?
• Is it
  because of baseline assumptions regarding the economy, revenue growth or
  discretionary spending?
• Is it
  because of scoring technicalities such as assuming a revenue windfall from
  the Alternative Minimum Tax (AMT) or that no new supplemental funding will
  be requested for military activities in Iraq and Afghanistan?

Cutting the deficit in half

The overall fiscal policy goal of the Bush administration is
to “cut the deficit in half” by 2009.[2]
Adherence to this goal is often cited by the administration as evidence of its
commitment to fiscal discipline and to ease fears of a rising deficit. It thus
deserves careful scrutiny when the budget is presented. Relevant questions
include:

• How
  much actual deficit reduction is needed to meet the goal?
• Is
  the goal realistic given the administration’s policy initiatives?
• How
  meaningful is the goal relative to the fiscal challenges we face?

How much actual deficit reduction is needed to meet the
goal?

The short answer is: not much. It may come as a surprise to
many who have heard the President speak of his progress in “cutting the deficit
in half,” but it would be possible for the administration to hit its mark with
a deficit as high as $343 billion in 2009 ¾ an amount higher
than last year’s $318 billion deficit.

 

The official goal begins with the 2004 deficit. However, the
calculation does not begin with the actual 2004 deficit, but with the 2004
deficit that was projected by the administration in February of that
year. The distinction is important because the February deficit projection
($521 billion, 4.5 percent of GDP) was considerably higher than the final
result ($412 billion, 3.6 percent of GDP). The table below shows the
difference.

Table 1. Deficit Reduction is Relative to the Starting Point

Establishing deficit reduction as an official goal is a
positive thing because it keeps at least some pressure on policymakers,
including the administration, to avoid actions that would jeopardize the goal
by expanding the deficit ¾ whether through increased spending or lower
revenues.

Within the administration’s framework, however, a deficit as
high as $343 billion in 2009 (2.25 percent of projected GDP) could be deemed
half of the 2004 deficit ¾ even though the actual reduction from 2004 to 2009
would be just 17 percent in dollar terms and 38 percent when measured as a
share of GDP.[3]

In short, while the goal of cutting the deficit in half may
sound impressive, not much heavy lifting is required to meet the standard the
administration has set for itself.

Is the goal realistic given the administration’s policy
initiatives?

The
goal is very realistic in the abstract. What may make it difficult is the
policy proposals contained in the budget, likely costs omitted from the budget
(such as war costs) and the absence of likely revenues assumed in the budget
(such as AMT receipts).

The
best way to assess the budgetary impact of the policy proposals in the
President’s FY 2007 budget is to measure them against the non-partisan CBO
baseline. As described by CBO, the baseline represents its “best judgment of
how the economy and other factors would affect federal revenues and spending if
current laws and policies remained the same.” It is not a prediction, but
rather “a neutral benchmark against which to measure the effects of proposed
changes in tax and spending policies.”[4]
The most recent CBO baseline was published on January 26, 2006 in The Budget
and Economic Outlook: Fiscal Years 2007-2016 (Table 2).

The CBO baseline shows a steadily downward trend in the
deficit with small surpluses emerging by the end of the 10-year forecast
period. The deficit falls to $241 billion in 2009, well within the
administration’s definition of cutting the deficit in half.

Over the five-year horizon used by the Bush administration,
the baseline deficit falls to $114 billion (0.7 percent of GDP) by 2011
assuming that Congress:

• Funds
  current programs, including war costs and hurricane relief, at this year’s
  level adjusted for inflation throughout the next five years;
• Funds
  all scheduled benefits;
• Adds
  no new spending, and
• Follows
  current law for tax provisions, including scheduled sunset provisions.

The cumulative deficit over the next five years under the
baseline is $1.1 trillion.

Table 2. CBO Baseline
Projections, January 2006

													Total	Total
													2007-	2007-
		2006	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2011	2016
In billions of dollars
On-Budget Deficit		-518	-466	-476	-474	-473	-380	-238	-243	-230	-218	-226	-2,269	-3,424
Off-Budget Surplusa		181	196	217	233	250	266	276	283	288	291	293	1,162	2,592
	Total Deficit	-337	-270	-259	-241	-222	-114	38	40	57	73	67	-1,107	-832
Memorandum:
Social Security Surplus		180	195	214	231	246	262	271	278	282	286	287	1,148	2,552
Postal Service Outlays		-2	-1	-3	-2	-4	-4	-5	-5	-5	-6	-6	-14	-40
As a percentage of GDP
Total Deficit		-2.6	-2.0	-1.8	-1.6	-1.4	-0.7	0.2	0.2	0.3	0.4	0.3	-1.4	-0.5
Debt Held by the Public		37.6	37.8	37.7	37.5	37.2	36.3	34.6	32.9	31.3	29.6	28.1	n.a.	n.a.
Source: Congressional Budget Office.
Note: n.a. = not applicable.
a.	Off-budget surpluses comprise surpluses in the Social Security trust funds as well as the net cash flow of the Postal Service.

When the budget is
released, it will be important to look at how the CBO baseline compares with
the administration’s baseline. In the recent past, the administration has used
a unique baseline calculation that assumes permanency of the tax cuts enacted
in 2001 and 2003. The sunsets on those tax cuts, which were written into law,
are simply assumed to not exist. The effect of this is to minimize the apparent
impact of the President’s policy proposals.

This issue will be
particularly relevant to the FY 2007 budget because it will be the first of the
administration’s budgets to show the bottom line effect of making the 2001 and
2003 tax cuts permanent. Up until now, the five-year budget window used by the
administration since enactment of the tax cuts has closed before the legislated
tax cut “sunsets” appear in 2011.

Estimates by the
Joint Committee on Taxation indicate that the one-year revenue loss of
extending the tax cuts in 2009 would be $20 billion. By 2011, however, it would
be $154 billion. Preventing the deficit from trending upward in 2011 and beyond
will require aggressive spending cuts or a level of economic growth that seems
improbable.

How meaningful is the goal relative to the fiscal
challenges we face?

The President’s very
modest goal of cutting
the deficit in half by 2009 is a significant retreat from the bipartisan
balanced budget consensus that developed in the late 1990s. It is easy to
forget now, but when President Bush took office in 2001 a bipartisan consensus
existed that the budget should not just be balanced but should be balanced
excluding the “off-budget” Social Security surplus. That goal was actually
achieved in 1999 and 2000. It was a responsible fiscal policy goal because it
had as its objective a much needed boost in national savings to help prepare
the budget and the economy for the challenges of an aging population.

In recent years, we have
drifted far from that goal. The deficit in 2005 was $494 billion excluding the
Social Security surplus, not the deficit of $318 billion that is the most
commonly used measure.

While
it is a plus that the President is promising deficit reduction ¾ thereby
acknowledging that the deficit is a problem ¾ his halfway goal trivializes the full
magnitude of the fiscal challenges ahead. Even if the policies in the
budget succeed in halving the deficit by 2009, regardless of how that is
defined, what policies will be proposed to prevent deficits from ballooning
again after 2009 due to rising entitlement costs and, if enacted, the permanent
extension of expiring tax cuts?

The
administration’s fiscal policy rhetoric is fixated on a goal that is too modest
and a timeframe that is too limited. Analysts of diverse ideological
perspectives and nonpartisan officials at CBO and the Government Accountability
Office (GAO) have all warned that current fiscal policy is unsustainable over
the long-term. Undue focus on whether the President can “cut the deficit in
half” by 2009 diverts attention from the more vital and daunting long-term
fiscal challenge.

2. Does the budget
plan build on realistic assumptions?

A fiscally responsible budget plan must be based on
realistic, attainable assumptions, and
reject the use of procedural tricks and gimmicks to hide costs or circumvent
budgetary limits. Inclusion of such procedural smoke screens is a
strong signal that a plan lacks credibility.

In past budgets, the Bush administration has not accounted
for some significant ongoing expenses and new initiatives. For example, the FY 2006 budget left out any
accounting for Social Security reform even though it was a major presidential
priority and policy initiative. The
administration has also consistently failed to include funding estimates in
their budgets for military operations in Iraq and Afghanistan. And, while the
budgets are supposed to be five-year blueprints, they have normally assumed
only one year—at the most—of Alternative Minimum Tax (AMT) relief even though
the administration supports further extensions. How the administration treats
these items in this year’s budget will offer the initial evidence as to whether
its plan meets the “realistic assumption” test.

Relevant questions about the assumptions underlying the
President’s budget include:

·
Does the budget include realistic estimates for
continued war costs and hurricane relief?

·
Does the budget assume that policies supported by the
President will expire to limit their costs on paper?

·
Are the estimates about savings in the health care
system realistic?

·
Are the levels of discretionary spending realistic
and attainable in the out years?

·
Does the budget rely on overly optimistic assumptions
about revenues?

Does
the budget include realistic estimates for continued war costs and hurricane
relief?

According to CBO, Congress has approved ten supplemental
appropriation requests for military operations in Iraq and Afghanistan totaling
about $323 billion, none of which were included in the President’s original
budget requests. CBO has indicated that
at the current rate of approximately $7.5 billion spending per month for
military operations in Iraq and Afghanistan, Congress would need to appropriate
an additional $40 billion beyond the $50 billion “bridge fund” enacted last
December for fiscal year 2006, which would increase outlays in FY 2006 by
$20-$25 billion. Indications are that
the President will ask for up to $70 billion in FY 2006 supplemental funds in
the FY 2007 budget, which would bring total funding for FY 2006 up to $120 billion.

Even if the President’s budget does contain additional
funding for this year, the larger issue is what assumptions are made for
military operations within the five-year budget window (FY 2007-2011).
According to some reports, the President may include a placeholder request of
roughly $50 billion for military operations in 2007. This would be better than
assuming no additional funding, but it seems clear that more will be needed
both in 2007 and beyond. Assuming only $50 billion over five years for military
operations in Iraq and Afghanistan would clearly not be an accurate reflection
of administration policies or likely expenses.

Another item to watch will be how the budget accounts for
Hurricane Katrina relief and rebuilding.
Although a substantial amount of rebuilding funds are in the pipeline
already, the administration, as well as members of Congress and local leaders,
all agree that more funding will be needed.
The question is whether there will be some estimate in the budget for
these funds, as there should be, or if it will be left for a supplemental
request later in the year. Press
reports indicate that the President’s budget will assume an additional $18
billion in funding for a hurricane relief supplemental.

Does
the budget assume that policies supported by the President will expire to limit
their costs on paper?

The
administration has consistently expressed support for AMT relief.[5] The AMT is intended to prevent high-income
taxpayers from escaping income taxes through extensive use of tax
preferences. However, it is capturing
more and more taxpayers who weren’t meant to be targeted. Because it is not indexed to inflation, the
number of taxpayers subject to the AMT will explode from 4 million in 2005 to
nearly 50 million by 2016, if the tax cuts are extended, and 33 million if they
are not. The 2003 tax bill contained a provision temporarily
increasing the AMT exemption amount to prevent more taxpayers from being
subject to the AMT for one year.
Congress extended this exemption for one year in 2004 and legislation
extending it for another year is likely to be enacted in the coming weeks.

The President’s FY 2005 budget proposed a one-year extension
of AMT relief. Last year’s budget did
not include any funding for AMT relief based on the stated assumption that AMT
relief would be enacted as part of revenue neutral tax reform. Given the broad bipartisan support for AMT
relief, it is not realistic to assume that AMT relief will be allowed to expire
after being extended for just one year.
It is also unrealistic to assume that a permanent AMT fix will be
enacted as part of revenue neutral tax reform since the administration and
leading members of Congress have already rejected the options recommended by
the President’s Tax Reform Commission to offset permanent repeal of the AMT.

A realistic projection of the likely deficit must include
the cost of permanently extending AMT relief.
According to CBO, extending the AMT relief enacted in 2003 would add
$233 billion to the deficit over the next five years — $60 billion in 2009
alone. A full fix of the AMT ¾ to
prevent the alternative tax from negating promised tax cuts and becoming the
de-facto tax calculation for the upper-middle class ¾ would cost substantially
more.

Are
the estimates about savings in the health care system realistic?

The principal domestic initiative in the
President’s State of the Union Address was a package of proposals intended to
improve the availability and affordability of health care. The centerpiece of his proposal is expanding
Health Savings Accounts (HSAs) and eliminating all taxes on
out-of-pocket spending through HSAs. The administration’s FY 2006
budget included a similar but more modest proposal that CBO estimated would
cost $33 billion over five years.

Previous
administration budgets relied instead on a “magic asterisk” – an unspecified
offset assumed in the numbers — to offset the costs of refundable health care
tax credits. Alternatively, the
administration could rely on optimistic feedback assumptions about the savings
in the health care system that will occur as a result of its policies.

Supporters of this approach argue that the
high deductible insurance policies in Health Savings Accounts will restrain
health care costs by reducing unnecessary utilization of care and using market
forces to squeeze out inefficiency in the system.
However, analysis by the Urban Institute and others have found that the
vast majority of health care expenses are related to catastrophic illness or
the end of life, which would not be affected by the market forces associated
with HSAs since those costs are well in excess of even the high deductibles in
HSAs.[6]

The President’s proposal is similar to,
although considerably less expansive than, a proposal put forward by economists
John Cogan and Glenn Hubbard and law professor Daniel Kessler in the book, Healthy Wealthy and
Wise ¾ Five Steps to a
Better Health Care System. They estimated that savings in health care
costs and other interactions under their proposal would offset more than two
thirds of the gross cost, which they estimate at $27 billion a year. The
administration may try to limit the projected cost of the President’s
initiatives by relying on similarly optimistic assumptions about the savings in
health care costs that will result from the HSAs proposal. While the proposals may result in some
savings in health care expenditures, there is little hard evidence to prove or
disapprove this assumption. It is
overly speculative to rely on assumptions that any proposal will substantially
pay for itself by reducing health care expenses to offset the costs of
expanding the tax advantages of health savings accounts.

Are the
levels of discretionary spending realistic and attainable in the out years?

It will also be important to pay attention to the
assumptions the budget makes about future discretionary spending.
Spending restraint is crucial to deficit reduction, but any
projection of a five-year freeze, or even a cut in domestic discretionary
spending over a multi-year period is unrealistic given the normal rate of
spending growth. Between 2001
and 2005, appropriations for domestic spending other than homeland
security increased by an average of 4.6 percent a year, from $338 billion
in 2001 to $404 billion in 2005 (excluding appropriations for hurricane
relief).

While most of the
attention will be focused on the specific proposals to reduce domestic
discretionary programs in FY 2007, the budget will likely include much larger
unspecified savings in discretionary programs in subsequent years. But that
assumption must be tempered by the reality that this category of spending has
steadily remained at about 3.5 percent of GDP since the late 1980’s. The President’s FY 2006 budget assumed that
non-defense discretionary spending would decline to less than 3 percent of GDP
by 2010, even with increased spending for homeland security programs. Non-defense discretionary spending has never
been below 3 percent of GDP since the statistic was first recorded in 1962. It
has grown from 3.4 to 3.8 percent of GDP since 2001.

It is obviously much easier to incorporate assumptions about
reductions in discretionary spending in future years than it is to put together
specific proposals to keep spending within those limits. Holding non-defense discretionary spending
(excluding emergencies) for FY 2007 to the level assumed in last year’s budget
will require the administration to reduce spending by $7 billion below the $411
billion appropriated last year. The
administration’s ability to follow through on projections of unspecified
savings for FY 2007 with specific policies in this years’ budget will provide
an indication of their commitment to adhering to the austere discretionary
spending assumptions in subsequent years.
It will be increasingly difficult to meet this challenge in each
subsequent year as the magnitude of the reductions increases.

Previous administration budgets have relied on user fees to
offset part of the costs of discretionary spending programs. Most of these proposals have been repeatedly
rejected by Congress and are unlikely to fare any better this year.[7] Without these offsetting user fees, the
magnitude of the reductions that will be necessary in discretionary
appropriations to stay within the overall discretionary spending levels in the
President’s budget will be much greater.

Similarly, in the past the administration has assumed
considerable savings from the elimination of spending on Congressional
earmarks. Not only is it unlikely that
Congress would agree to such a thing, but also the administration has had
numerous opportunities to veto earmark-laden spending bills or propose to
rescind specific earmarks, and has not done so. A sign that the President is
serious about his pledge to control earmarks would be to submit a list of
proposed earmark rescissions and other low-priority spending approved last year
and call on Congress to vote on those rescissions.

Does
the budget rely on overly optimistic assumptions about revenues?

The final area to watch is the administration’s projections
and discussion of the trends in revenue.
On the projection side, it will be important that the administration
does not rely on assumptions showing overly large increases in revenues based
on the unexpectedly high tax receipts from FY 2005. While these might be helpful in showing lower deficits, past
history has shown that longer-term projections based on optimistic estimates
are often dramatically wrong.

In 2001, the administration and CBO projected surpluses of
$5.6 trillion over the next ten years, based in large part on the assumption
that the strong revenue growth in the late 1990s would continue. (Although it
should be noted that CBO warned policymakers that the projections were highly
uncertain and there were no guarantees that the factors that caused revenues to
increase rapidly in the late 1990s would continue.)

The recent increase in revenues has occurred over a much
shorter period of time and provides much less evidence to determine whether the
trend will continue than the revenue increases of the late 1990s that led to
the projections of large surpluses in 2001. Consequently, any assumptions
regarding revenue growth in the next few years based on the recent growth in
revenues would be even more uncertain than the projections made in 2001. Treasury Secretary John Snow recently
acknowledged that the budget forecasts made in 2001 demonstrate the risk in
making projections based on the assumption that recent trends will continue.[8] Policymakers
should not repeat the mistakes of 2001 by allowing improvements in the budget
outlook from higher than expected revenues to serve as an excuse to relax
fiscal discipline.

On the administration’s discussion of the recent trends in
revenue, it will be important to put the revenue trends in context. FY 2005 saw a large increase in revenue from
FY 2004—up by 14.6 percent to $2,154 billion.
While this was a record in dollar terms, larger than the previous record
of $2,025 billion in 2000—it still represented a much lower percentage of GDP
than in 2000—17.5 percent of GDP as opposed to 20.9 percent. Revenues in 2005 were approximately $140
billion lower than 2000 revenues adjusted for inflation.

It is
true that total revenues set a record in nominal dollars in 2005 and almost
certainly will do so again in 2006.
Setting a record for revenues in nominal dollars is not remarkable;
revenues almost always set a record in nominal dollars every year as revenues
naturally increase with inflation, economic growth and other factors. What is remarkable is that revenues did not
set a record in the previous four years and the record set in 2000 was not
broken until 2005. Revenues
declined in nominal terms for three
years in a row between 2001 for the first time since the 1920s. It is
also important to note that the $2,473 billion in spending in 2005 was also a
record in dollar terms.

While total revenues finally climbed back above 2000 levels
in nominal dollars last year, revenues from individual income taxes were still
well below 2000 levels. Individual
income taxes totaled $927.2 billion last year, roughly 7.5% lower than the
$1,004 billion collected in 2000.
Adjusted for inflation, revenues from individual income taxes in 2005
were nearly 19% below 2000 levels.
Total revenues in 2005 exceeded 2000 levels primarily as a result of the
steady growth in social insurance revenues (which have increased from $653
billion in 2000 to $794 billion in 2005) and to a lesser extent the surge in
corporate tax collections ($278 billion in 2005 compared to $207 billion in
2000).

Furthermore, the increase in revenue was aided by a one-time
jump in corporate tax receipts due to the expiration of a tax break on business
equipment depreciation and the one-year amnesty for repatriation of overseas
profits. However, the strong economy
clearly aided in bringing up corporate receipts as well as substantial
increases in personal income taxes and social insurance taxes.

Whether
this increase in revenue reflects and depends on the tax policy of the
administration is questionable. While
short term economic growth can be assisted by lower tax rates under certain
conditions — there can be little debate that the tax cuts are net revenue
losers, i.e. that they have not paid for themselves.[9] An examination of the administration’s own
numbers in Chart 1 illustrates this case well.

In its FY 2004 budget, the administration included a package
of tax cuts that sped up some cuts in marginal tax rates they had included in
their 2001 tax package, along with cuts in the Capital Gains and Dividend tax
rates. They also included two
projections—one for what revenues would be if none of their policies were
enacted (their baseline)—and one for what revenues would be if their policies
were enacted. When these projections
are compared to actual revenues, one can see that even under the good economic
growth of the last few years, total revenue fell short of both
projections.

3. Does the budget
plan contain offsets for new initiatives?

The first step in bringing the deficit under control is to stop digging
the hole deeper. Rhetoric about deficit reduction will lack credibility
if Congress continues to treat rising debt as a viable alternative to spending
cuts or tax increases. Deficit reduction plans should only be taken seriously
if new or expanded spending initiatives and new or extended tax relief is fully
offset with spending reductions or tax increases.

Unlike
previous years in which the President proposed tax cuts without proposing
corresponding reductions in spending (and in many cases enacting substantial
increases in spending such as the Medicare prescription drug benefit), the
budget submitted by President Bush last year contained significant savings in
mandatory spending programs as well as domestic discretionary spending cuts to
accompany tax cuts. Unfortunately,
those savings
were more than offset by the costs of the President’s tax and spending
initiatives. Spending restraint
is crucial, but rhetoric about controlling the deficit won’t have much
credibility so long as the President goes forward with tax cuts financed by
borrowing.

Key
questions to ask about the President’s budget include:

• Are the costs of extending the tax cuts honestly
  acknowledged and offset?
• How does the budget handle the issue of tax reform?
• Does the budget rely on unspecified savings in
  non-defense discretionary spending to offset specific tax cut and spending
  increase proposals?

Are the costs of extending the
tax cuts honestly acknowledged and offset?

The
President reiterated his call to permanently extend all of the expiring tax
cuts in the State of the Union Address.
If deficit reduction and extending these tax cuts are both high
priorities for the President, his budget should identify offsets for the estimated
revenue loss. There are plenty of
revenue offsets available. The Joint Committee on Taxation has identified over
$350 billion worth of options to improve tax compliance and reform tax
expenditures.

Supporters
of the tax cuts under consideration argue that they are not new tax cuts, but simply
an extension of expiring tax cuts previously approved by Congress. In fact, in the budget submitted last year
the administration proposed to incorporate extension of the tax cuts into the
baseline, which would make the extension appear costless when measured against
that adjusted benchmark. This argument ignores the fact that extending these
provisions requires legislative action that would result in a greater tax
reduction (and higher deficits) than would be the case under current law.

The
tax cuts are expiring because Congress included a sunset provision when they
were passed to limit the official cost. This was done to fit them within
budgetary limits established to gain the support of moderate Republicans
concerned about the impact of the tax cuts on the deficit. Between 2001 and 2003, Congress enacted
three tax cut packages with an official cost of $1.3 trillion between fiscal
years 2004 and 2013. The cost of the tax
cuts would have more than doubled — to $3.1 trillion — over that period if
the tax bills had not included sunsets. Extending these tax cuts without
considering their budgetary impact over the long term and exempting the costs
from budget enforcement would undo the compromises made to limit the size of
the tax cuts when they were originally enacted

The
Concord Coalition criticized the use of sunsets to artificially limit the
official cost of the tax cuts, but did note that they could serve a useful
function as the ultimate trigger, requiring Congress and the President to
re-evaluate whether the tax cuts were affordable when they expired. “As events
unfold and we see whether future deficits are modest and manageable as the
Administration hopes, it may make sense to adjust fiscal policy accordingly –
perhaps removing some of the sunsets and allowing others to take effect. Although the sunsets were not designed to be
taken seriously, fiscal responsibility may ultimately require that result.”[10]

Circumstances
have changed dramatically since the tax cuts were enacted in 2001. Congress is no
longer “refunding a surplus” to the taxpayers.
The surplus era in which the tax cuts were enacted has been replaced by
deficits as far as the eye can see, and the budget faces new demands for the
war on terrorism and homeland security. A logical response to the dramatically
changed budgetary conditions would be to reassess whether all of the tax cuts
enacted during the surplus era should be extended now that we are facing
deficits.

In
light of the deteriorated fiscal outlook and the fact that we have not taken
action to prepare for the costs of the baby boomers’ retirement and health care
costs, it makes sense to offset the extension of some tax cuts by delaying,
scaling back or rescinding others.
Doing so would send a very positive signal that Congress is finally
prepared to acknowledge that we can’t have it all and that choices must be made
among competing priorities.

How does the budget handle the
issue of tax reform?

Last January, the President appointed an advisory panel on
tax reform to develop options to
fundamentally reform the tax code to make it simpler, fairer, and
pro-growth. The White House indicated
that tax reform would be the President’s next major domestic policy initiative. As mentioned earlier, the administration
relied on the tax reform panel to provide the solution to the problems created
by the Alternative Minimum Tax. More broadly, tax reform was expected to be the
administration’s avenue for advancing tax policy in the President’s second term
following the sweeping tax cuts enacted in the first term.

On November 1, 2005
the President’s Advisory Panel on Federal Tax Reform issued a
report making several recommendations for reforms of the tax code. It did achieve the administration’s goal of
addressing the AMT issue as part of a revenue neutral tax reform package. It also recommended several other proposals
supported by the administration, including tax-advantaged savings plans, lower
rates on capital gains and dividends and lowering the top marginal rates on
individuals and businesses.

However, the panel also proposed to repeal or scale back
several existing tax breaks, including limiting the deductibility of
employer-provided health care, converting the mortgage interest deduction into
a credit but limiting the amount of the mortgage on which the credit can be
claimed, and repealing the deductibility of state and local taxes. Not surprisingly, these provisions were
received with little enthusiasm from the President and Congress. The White House has distanced itself from
these recommendations and has explicitly rejected the proposal to limit the
deductibility of employer-provided health insurance.[11]

While the failure to include the proposals of the Advisory
Panel on Tax Reform or other tax reform proposals represents a lost opportunity
to improve the fairness and efficiency of the tax code, it would be much worse
for the President’s budget to include some or all of the more politically
popular, expensive elements of the panel’s report without embracing the
tradeoffs recommended by the panel or alternative savings to offset those
costs. It now appears that the
administration will continue to pursue its goals of encouraging savings through
tax advantages, reducing taxes on capital gains and dividends and maintaining
individual tax relief outside the context of revenue neutral tax reform.

Does the budget rely on
unspecified savings in non-defense discretionary spending to offset specific
tax cut and spending increase proposals?

It is all too easy to
offset tax cuts and spending increases in other areas by assuming unspecified
savings in non-defense discretionary spending.
As noted earlier, it is much easier to make assumptions about
substantial savings in future discretionary spending than it is to identify
specific reductions to achieve those savings. Last year, the President’s budget
assumed savings of $133 billion in unspecified non-defense discretionary
spending between 2007 and 2010.
Achieving those savings would require Congress to make progressively
larger cuts in non-defense discretionary programs: nearly 5 percent below the
CBO baseline in 2007 and 10 percent in 2010.
Under the President’s FY 2006 budget, non-defense discretionary spending
would be $40 billion below CBO’s baseline by 2010. The inability of Congress and the President to follow through
with the substantial savings in discretionary savings in the out years called
for in the 1997 budget agreement casts doubt on the likelihood that assumptions
of discretionary savings in the future will be realized. Meanwhile, the spending increases and tax
cuts enacted with the promise of future savings in discretionary spending will
remain in place.

4. Does the budget
plan achieve a path of sustainable deficit reduction beyond the forecast
window?

A
fiscally responsible budget plan is one that achieves a smooth, sustainable
path of deficit reduction during and beyond the budget window. Gaining control
of the short-term deficit is only the first step in a far greater fiscal
challenge. An explosion in entitlement spending associated with the retirement
of the baby boom generation lurks just over the horizon. A sound budget plan must lay the foundation
for dealing with the fiscal consequences of an aging America.

Although
the President has promised to submit a budget plan that cuts the federal
deficit in half by 2009, an explosion in entitlement spending just beyond the
President’s budget window threatens the economic well-being of future
generations.

According
to the Congressional Budget Office (CBO), the combination of falling birth
rates, increasing longevity and escalating health care costs will drive the
projected costs of Social Security, Medicare and Medicaid from 8.4% of GDP
today to 15.2% in 2030. The financial
demands of these three programs will exert pressures on the budget that
economic growth alone is unlikely to alleviate. Lawmakers must look beyond today and address the tough choices
that lay just over the horizon.

There
are several questions which will determine whether the President’s budget will
keep the budget on a sustainable path after the five-year budget window:

• Are
  the costs of policies beyond the five-year budget window acknowledged and
  displayed in the budget?
• Does
  the budget address the need for entitlement reform?
• Does
  the budget re-examine the Medicare prescription drug benefit?
• Does
  the budget contain reforms that will control the rising cost of health
  care?

Are the costs of policies beyond the five-year budget
window acknowledged and displayed in the budget?

In 2002, the Bush administration dropped the established
practice of ten-year budgeting in favor of a five-year budget window. The change was instrumental in hiding the
growing deficit in the latter half of the decade as the tax cuts were fully implemented. Unfortunately this myopic approach to
budgeting has encouraged lawmakers to ignore the looming financial crisis
associated with the retirement of the baby boom generation, and has left
federal finances ill-equipped to deal with national emergencies (hurricanes,
terrorist attacks, and energy price shocks). The fiscal impact of the baby boom
retirement will start to show up within the five-year budget window this year,
but using a ten-year budget outlook will provide a more complete view. Policymakers should be aware of and consider
the budgetary outlook after 2011 when making decisions about whether or not we
can afford certain tax or spending policies in the short term.

Does the budget address the need for entitlement reform?

In 2008, the leading edge of 70 million baby boomers will be
eligible for Social Security; and in 2011, Medicare. Already the retirement costs of baby boom generation are emerging
in the budget baseline. According to
CBO’s most recent Budget and Economic Outlook, spending on Medicare and
Social Security will increase from $941 billion to $1.85 trillion between 2006
and 2016. Already Medicare relies on general revenue transfers to keep the
program afloat and by 2017, so too will Social Security. Left unchecked, these two programs will
require significant tax increases, drastic cuts in discretionary spending, or
both. The longer lawmakers wait to
address the significant shortfalls in these programs, the harder it will be to
protect current and near retirees from any changes. In the State of the Union the President highlighted these
challenges and called for a bipartisan commission to address the impact that
the baby boomers’ retirement will have on entitlement programs. It is now incumbent on him to follow through
on this rhetoric.

Does the budget re-examine the
Medicare prescription drug benefit?

Proposals to establish a prescription drug benefit first
entered the political debate in the surplus era, but the proposals and price
tag were not adjusted to reflect the return to deficits. In the face of such daunting budget
deficits, it was irresponsible for Congress and the President to exacerbate the
entitlement crisis with yet another expensive benefit for seniors. According to CBO, the new prescription drug
benefit will add $30 billion to the FY 2006 deficit alone. Congress and the President should begin to
look for ways to make the benefit more efficient, better targeted and less
expensive.

Will the policies in the budget help control the rising
cost of health care?

Today,
Medicare and Medicaid comprise 21% of all federal spending ($515 billion).
Spending for these health programs is projected to grow briskly over the next
10 years and by 2016, CBO estimates that the two programs will cost $1.3
trillion, or more than 30% of all federal spending. As long as the cost of delivering health care routinely exceeds
economic growth (as it has since 1960), the federal government will have no
other recourse but to continually ration care through benefit reductions and
greater cost sharing while the ranks of the uninsured will soar. Clearly, resolving the financial crisis in
Medicare and Medicaid requires reigning in rising health care costs. As discussed earlier, the administration’s
health care plan relies primarily on Health Savings Accounts to control the
costs of health care through market forces.
The evidence is at best mixed as to whether this approach will have a
significant impact on health care costs.

5. Does the budget plan share the burden of
deficit reduction across generations and income levels?

All
Americans will enjoy the fruits of a balanced budget. Thus, no economic group except for the very needy should be
exempt from contributing to eliminating the federal budget deficit. Those who
can more readily shoulder the burden should be asked to do so. Moreover, no
generation should be exempt from shouldering some responsibility for this
national problem. Programs and benefits for senior citizens comprise more than
one-third of total outlays, and exempting them would place an even greater
burden on our children and grandchildren.

The “deficit
reduction” efforts last year disproportionately affected low-income populations
through cuts in Medicaid, Supplemental Security Income and other income support
programs. Meanwhile, middle class
entitlements and corporate subsidies were largely spared from the budget ax,
and middle and upper income individuals benefited from yet another tax cut.

A
disproportionately large share of current federal resources is devoted to the
elderly while investments in future generations are held to a
disproportionately small share. Yet, on the current policy path, future
generations face the prospect of far higher tax burdens and substantially lower
real benefits than enjoyed by today’s adults.

Questions
to ask about how the President’s budget addresses issues of fairness and
generational equity include:

• Does the budget spread the
  burden of deficit reduction between revenues and spending?
• Does the budget call for
  savings in middle class entitlements and corporate subsidies, or do the proposals
  for entitlement savings disproportionately affect programs that serve
  low-income populations?
• Does the budget address the
  burdens that will be placed on future generations by growing debt and the
  unfunded liabilities facing Social Security and Medicare?

Does
the budget spread the burden of deficit reduction between revenues and
spending?

Federal
revenues at 17.5 percent of GDP are well below the level they have averaged as
a percentage of GDP over the past 25 years (18.3 percent). Meanwhile, spending
is at 20.1 percent of GDP, which is below the average over the past 25 years
(21 percent). This suggests that it is
revenues, and not spending, that have deviated from recent norms. However, the administration’s budget
policies have relied exclusively on cuts in non-defense discretionary spending
and entitlement programs to reduce the deficit while continuing to pass tax
cuts. Relying on cuts in domestic
spending programs to achieve deficit reduction puts greater burden on
lower-income populations, while tax cuts inherently benefit higher income
populations.

Does the budget call for savings in middle class entitlements and corporate
subsidies, or do the proposals for entitlement savings disproportionately
affect programs that serve low-income populations?

The
entitlement savings proposed by the President in previous budgets have tended
to affect lower income programs more heavily, while the administration has
opposed mandatory savings proposals, which would affect insurance companies and
the pharmaceutical industry. Many of
the entitlement savings contained in the President’s budget last year that
Congress rejected in putting together the spending reconciliation bill affected
low-income programs.

Does
the budget address the burdens that will be placed on future generations by
growing debt and the unfunded liabilities facing Social Security and Medicare?

If the current generation fails to control the growth of our
national debt and address the looming challenges facing Social Security and
Medicare, future generations will face ever higher tax burdens simply to cover
increasing interest payments instead of addressing other needs such as keeping
our military the strongest in the world, protecting our domestic security,
providing health care and investing in our education system. Our current policy course assumes that we
can fight two wars, fund homeland security, rebuild the Gulf Coast, maintain
full promised benefit levels for entitlement programs and keep cutting taxes,
because we are going to send the bill to future generations. That is irresponsible and immoral. As the political process sorts out the
individual winners and losers in the budget debate, policymakers should not
lose sight of the gains or losses that will accrue to future generations.

6. Does the plan establish credible enforcement mechanisms?

Although process alone will never be able to
solve the nation’s fiscal problems, budget mechanisms can bring greater
accountability to the budget process and help provide Members of Congress with
the political cover to make the tough choices necessary to reduce the deficit.

When
Congress and the President were struggling with large and growing deficits in
the 1990’s, the budget process was primarily aimed at reining in the deficit.
The Budget Enforcement Act of 1990 established caps on discretionary spending
and Pay-As-You-Go (PAYGO) limitations requiring offsets for new entitlement
spending and tax cuts. The PAYGO rule helped to rein in deficits during the
1990’s by requiring anyone proposing entitlement expansions or tax cuts to
answer the question: “How do you pay for it?” These mechanisms were extended
with bipartisan support as part of the 1997 Balanced Budget Agreement, but
Congress and the President allowed them to expire in 2002, and have failed to
renew them or replace them with a new enforcement regime despite support from
bipartisan majorities in both chambers.

Key
questions to ask about any budget enforcement proposals in the President’s
budget include:

• Do budget enforcement rules
  apply equally to tax cuts and spending increases?
• Do budget enforcement rules apply to all legislation, or are
  policies proposed by the President exempt from budget discipline?
• Are discretionary spending
  limits set at reasonable levels?
• Does the budget contain enforcement
  mechanisms to address long-term fiscal challenges?

Do budget enforcement rules apply equally to tax cuts and spending
increases?

In previous budgets the President has proposed reinstating
budget enforcement mechanisms establishing discretionary spending limits and
PAYGO rules but exempt tax legislation from these rules. The only common sense way to restore fiscal
discipline is to apply budget rules to all legislation that would increase the
deficit. Since spending and tax decisions both have consequences for the
budget, there is no good reason to exempt either from enforcement rules.
Moreover, exempting tax cuts from PAYGO would encourage an expansion of
so-called ‘tax entitlements’ where benefits are funneled through the tax code
rather than by direct spending, a far less efficient approach. In addition, prohibiting tax increases from
being used to pay for entitlement spending increases under PAYGO rules would
create the notion that debt is a painless alternative to raising revenues
necessary to pay for entitlement benefits.

The concept of
applying PAYGO rules to all legislation which would increase the deficit, both
spending and revenues, has received support from both sides of the aisle since
it was originally enacted. “Two-sided”
PAYGO was originally enacted in the bipartisan budget agreement of 1990 and
extended in the bipartisan balanced budget agreement of 1997. Furthermore, it was included in the budget
passed by the Republican Congress in 1995.

Applying
PAYGO rules to tax cuts does not prevent Congress from passing more tax
cuts. All it would require is that
Congress must identify another source of revenue or reduce spending if it wants
to enact or extend a tax cut.

Do budget enforcement rules apply to all
legislation, or are policies proposed by the President exempt from budget
discipline?

The
other approach to watering down budget enforcement rules that has been included
in previous administration budgets is to establish a “post-policy” PAYGO rule
that only applies to legislation which would increase the deficit beyond the
levels assumed in the President’s budget.
This approach effectively exempts any initiatives proposed by the
President from budget enforcement. This rule has limited value in imposing
fiscal discipline because it essentially allows Congress to enact fiscally
irresponsible policies as long as they were included in the President’s budget.

Are
discretionary spending limits set at reasonable levels?

Previous experience has demonstrated that
discretionary spending limits can be an effective tool for fiscal discipline if
they are set at reasonable levels, but can actually work against fiscal
discipline if they are set at unrealistic levels. The discretionary spending
limits enacted in 1990 and extended in 1993 were quite successful in
restraining discretionary spending. By
contrast, the much more restrictive spending caps enacted as part of the 1997
budget agreement proved to be unrealistic and were effectively ignored, leaving
no credible restraint on discretionary spending in place. As noted earlier, the
President’s FY 2006 budget assumed substantial and growing reductions in
non-defense discretionary spending that would result in spending far below
historical norms.

Does
the budget contain enforcement mechanisms to address long-term fiscal
challenges?

The budget
submitted by the President last year proposed a budget enforcement tool which
would take a modest step toward acknowledging the long term fiscal problems by
restricting the ability of Congress to enact legislation which would increase
long term liabilities. This rule would only apply to legislation
increasing entitlement spending and would not apply to tax cuts that would
substantially increase the deficit in future years. The budget resolution adopted by Congress last year incorporated
this proposal as part of Senate rules, establishing a new 60 vote point of
order legislation that would increase mandatory spending by $5 billion or more
in any of the four 10-year periods from 2015 through 2055. The Medicare prescription drug plan
contained a provision requiring action by the President and Congress if general
revenue spending for Medicare exceeded a certain threshold. The President’s budget should strengthen and
build upon these proposals and extend the discipline to tax cuts with an impact
on the long-term fiscal outlook as well.

7. Is
the plan politically viable over the long-term?

A
plan to reduce the deficit is
unlikely to succeed over the long-term without sufficient political will to
enforce it. A successful plan must be capable of resisting pressure to undo the
tough choices it contains. The best way to ensure that a plan can stand up over
time is to infuse it with broad bipartisan support from the beginning. This, in
turn, requires that priorities be set and compromises be made. Everything must
be on the table.

In his State of the Union Address, President
Bush acknowledged the “unprecedented strains on the federal government” that
the growth of entitlement programs will place on the budget in the future,
forcing future Congresses to confront, “impossible choices: staggering tax increases, immense deficits
or deep cuts in every area of spending.”

His answer was to propose a bipartisan
commission to examine the impact of the baby boom retirement on Social Security,
Medicare and Medicaid and come up with bipartisan solutions, saying: “We need to put aside partisan politics and
work together and get this problem solved.”
The Concord Coalition agrees and has long maintained that only through
bipartisan effort can these enormous long-term challenges be met.

However, there is a disconnect between this
rhetoric and the President’s budget plans.
His budget further increases the deficit and makes those long-term
problems harder to solve. One reason it
does so is because it only puts very narrow areas of the budget on the table
for fiscal scrutiny, a problem in itself as mentioned above, but also a
surefire recipe towards inciting partisan strife.

It
is neither fiscally responsible nor politically viable to make cutbacks in
limited areas of the budget while exempting most areas from scrutiny. It will be extremely difficult to justify
maintaining tough choices on spending while continuing to go forward with every
tax cut. The recent experience in
Congress with the budget reconciliation package demonstrates exactly this
difficulty.

Not
only were the reconciliation spending cuts extremely difficult to pass, both
numerically and politically, but the end result was a “deficit reduction
package” that, when combined with the imminent passage of the reconciliation
tax cuts, will wind up increasing the deficit.
The particular cuts in mandatory
spending (where much cutting will be needed in the future) were very
unpopular—driving up opposition and creating leverage for individual members of
Congress to pass provisions favorable to their specific constituencies but
harmful to the overall deficit.

The better way to confront fiscal imbalance is to follow the
example of the past three presidential administrations. Following his initial tax cuts and defense
spending increases, President Reagan signed several tax increases and held the
line on new spending, even for the military, once it became clear that deficits
were on the rise. President George H. W. Bush negotiated a deficit reduction
plan with a Democratic Congress that achieved $482 billion in savings; roughly
63 percent from spending cuts and 37 percent from new revenues. And in 1997, President Clinton and the
Republican Congress negotiated an actual balanced budget plan that produced the
nation’s first surpluses in 29 years.

As The Concord Coalition board said in a recent New York Times Ad: “If
everyone insists on only cutting someone else’s priorities, talk about deficit
reduction will remain just that. The
best way to end this standoff is to agree on the common goal of deficit
reduction, put everything on the table—including entitlement cuts and tax
increases—and negotiate the necessary trade-offs…Unfortunately, actions have
been wanting. Leaders must put the national interests ahead of partisan or
parochial interests and develop a specific and realistic plan to put the
country on a sustainable long-term fiscal path.”