On February 6th, President Bush unveiled his budget for the 2007 fiscal year. This issue brief evaluates the President’s 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:

On February 6th, President Bush unveiled his budget for the 2007 fiscal year. This issue brief evaluates the President’s 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?

Aspects of the President’s budget deserve praise, particularly the inclusion of proposals to restrain the growth of entitlement spending. Overall, however, the budget falls far short of meeting The Concord Coalition’s criteria of fiscal sense. Not only do the policy proposals in the budget fail to make the necessary trade-offs to achieve a more fiscally responsible path, the net effect would be to increase the deficit. And, in an ominous sign of building fiscal pressures, the deficit path turns upward in 2011 and beyond, shifting costs to future generations.

Moreover, President Bush’s budget fails to account for policies the Administration clearly and repeatedly has staked out as goals – policies that would significantly increase the short-term and long-term deficit. In addition, the budget resorts to a familiar combination of unrealistic assumptions and scorekeeping gimmicks that understate likely expenses, overstate likely revenues and hide the costs of certain initiatives. Lastly, the budget’s five-year window and limited goal of cutting the 2004 deficit in half by 2009 serve to divert attention from the fact that current policy is unsustainable over the long-term.

I. 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 outyear deficit targets less likely to materialize.
The President’s proposed deficit path is implausible
The President’s budget begins with a deficit that is rising. Assuming enactment of the President’s policies, the budget now projects a deficit of $423 billion for FY 2006, a 33 percent increase over the $318 billion deficit in FY 2005. A deficit of this size would be the highest ever in dollar terms, exceeding the record-setting FY 2004 deficit of $412 billion. Measured as a percentage of the economy, a $423 billion deficit would be 3.2 percent, up from 2.6 percent in 2005.1
While administration officials have largely portrayed the increase in the deficit as a result of emergency spending for Hurricane Katrina, the administration’s July Mid-Session Review projected a rising deficit in 2006 even before the hurricane hit ($341 billion). According to the President’s Office of Management and Budget (OMB), enacted or proposed emergency spending in response to Hurricane Katrina will total just over $50 billion in fiscal year 2006, roughly half of the increase in the deficit over FY 2005.
The remaining path of the federal budget deficit is improbable – the deficit rises sharply this year, declines modestly (reaching the President’s goal of halving the deficit by 2009), then reverses course once more and begins to climb – in perpetuity – after 2010 (see Figure 1).2
The deficit path described above is consistent with prior Bush Administration budgets, which have usually assumed substantial improvements between the first and third years. The fate of these past projections demonstrates the difficulty of turning optimistic assumptions into reality:
1 It should be noted that the $423 billion projected deficit for 2006 might well be too high. A comparable projection using Congressional Budget Office (CBO) numbers adjusted to reflect the policies in the President’s budget would come out to roughly $390 billion. The Administration’s higher estimate may lead to a misperception later in the year that the deficit “is coming down” if it comes in at something closer to the CBO number ? even though this would still constitute a substantial increase over the 2005 deficit.
2 Although the President’s budget doesn’t show deficit projections after 2011, the upward trend would likely continue. As in past years, charts displayed in the Analytical Perspectives show that the extended path of budget policy is one of escalating deficits (see Chart 13-3, Analytical Perspectives p. 186).
2
Figure 1. Deficit Trajectory under President Bush’s FY 2007 Budget Plan
• he FY 2003 budget projected an $80 billion deficit in FY 2003 and a $61 billion
The FY 2004 budget projected a deficit of $307 billion declining to $201 billion
• The FY 2005 budget projected the deficit would decline from $364 billion to
Rapid changes in the deficit can occur. Last year, a surge in tax revenues erased $94
lt of
ax
g for
learly, the administration’s numbers do not support its rhetoric. For the deficit
g a
ck
ies
and yet both are assumed in his budget numbers.
($318)($423)($354)($223)($208)($183)($205)($450)($400)($350)($300)($250)($200)($150)($100)($50)
$0
FY05 FY06 FY07 FY08 FY09 FY10 FY11
Billions of Dollars
The budget deficit
temporarily improves, but
reverses direction —
permanently — after 2010.
($318)($423)($354)($223)($208)($183)($205)($450)($400)($350)($300)($250)($200)($150)($100)($50)
$0
FY05 FY06 FY07 FY08 FY09 FY10 FY11
Source: Office of Management and Budget, February 2006
T
surplus by FY 2005. In reality, FY 2005 ended with a $318 billion deficit.
•
by FY 2006. In reality, the FY 2006 deficit is likely to be roughly twice that amount.
$241 billion in FY 2007. The FY 2007 deficit is now estimated to top $354 billion.
billion from the FY 2005 deficit. But rarely does such a decline occur as a direct resupolicy initiatives (i.e., spending cuts or tax increases). This year’s budget is no exception. The dramatic drop in the deficit projection between 2006 and 2008 ? from $423 billion to $223 billion ? is primarily due to the omission of items that would make the bottom line look worse, not because of explicit policy choices. Specifically, the deficit projection for 2008 assumes a revenue windfall from the Alternative Minimum T(AMT) when the current AMT “fix” expires, nor does the budget include any fundinmilitary activities in Iraq and Afghanistan. These two assumptions alone produce over $100 billion of phantom deficit reduction in 2008.
C
projections to be credible, one would have to assume that the President is planninrapid withdrawal of American forces from Iraq and Afghanistan and that he plans a badoor tax increase by allowing the AMT to recapture a large portion of his earlier tax reductions. From all indications, the President is firmly opposed to both of those polic
3
Under more realistic assumptions regarding AMT and military operations in Iraq and
fghanistan, the projected deficit would be nearly $500 billion higher over the next five
st
ent Bush’s Budget Paints an Unlikely Picture
A
years, with annual deficits remaining in the vicinity of $300 billion or higher for the reof the decade (see Figure 2). Figure 2. Presid Likely policy costs are not the only omissions of note. This year’s budget also omits a
standard table showing the impact of administration policy on the presumptive baseline.
e
seline vs. FY 2007 Budget
Billions of Dollars
2006 ‘07-‘11
Why? Because the table would illustrate that the President’ policies actually increase thdeficit (see Table 1). Under the administration’s baseline (assuming no new policy actions), the cumulative five-year deficit would be $949 billion, but the Bush policies actually drive up the deficit to $1.17 trillion. Table 1. Administration’s Ba
20920102011
007200820
Admin.’s baseline -367 -257 -201 -196 -149 -146 -949
Budget policy
-423
-354
-223
-208
-183
-205
-1,173
Deficit increase
56
97
22
12
34
59
224 Source of eme Bud bru 6
Even m
alculation assumes the extension of certain tax cuts as if the expiration dates (or
“sunsets”) on those tax cuts do not exist. The impact is an artificially high baseline
: Office
Manag
nt and
get, Fe
ary 200
ore deceptive is
the ad
ministration’s definition of “baseline.” Their baseline
c
4
deficit that when added to the stated policy changes in the budget, make the policy implications seem less expensive. The President’s baseline turns a policy proposalremoving legislated sunsets ? into an assumption and stands the baseline concept onhead. As explained by the Congressional Budget Office (CBO), the baseline provideneutral benchmark against which to measure the effects of proposed changes in tax andspending policies.”
?
its
s “a
the CBO’s baseline method in accordance with the Budget
nforcement Act of 1990 (BEA). This method assumes that Congress:
ar’s
• Funds all scheduled benefits,
• sunset provisions.
The CBO baseline shows a steadily downward trend in the deficit with small surpluses
emerging by the end of the 10-year forecast period. Over the five-year horizon used by
e Bush Administration, the baseline deficit falls to $114 billion (0.7 percent of GDP) by
ssentially the same as CBO’s and serves as a good starting point for assessing the impact
g
r
ts of emergencies. It shows
dministration policy increasing the cumulative five-year deficit by $413 billion.
claim
3 A better assessment of how the administration’s policies would affect the budget outlookcan be made by using
E
• Funds current programs, including war costs and hurricane relief, at this yelevel adjusted for inflation throughout the next five years,
• Adds no new spending, and Follows current law for tax provisions, including scheduled
th
2011. The cumulative deficit over the next five years under the baseline is $1.1 trillion. While not published along with other budget documents, OMB has prepared a baseline comparable to the CBO baseline using the conventional BEA method. This baseline is
e
of budget policy proposals. It is appropriate, however, to adjust this baseline by removinthe continuing effects of the unusually high level of FY 2006 supplemental spending fothe war and Hurricane Katrina. The result is a conventional baseline without the assumption that war costs and Katrina recovery spending will continue at the 2006 level, adjusted for inflation, indefinitely into the future. Table 2 summarizes the impact of the President’s policies on the deficit compared to the BEA baseline adjusted to remove the recurring cos
a
Plausible war costs and AMT relief could increase the deficit by an additional $490 billion. Under the circumstances, it is far from credible for the administration to that it has a plan to reduce the deficit.
3 CBO, The Budget and Economic Outlook Fiscal Years 2007-2016, January 2006 p.5.
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Table 2. Impact of the President’s Budget Policies on the Deficit1
Billions of Dollars
2006
2007
2008
2009
2010
2011
2006-2011
2007-2011
OMB baseline deficit
(BEA method excluding emergencies)
367
256
193
157
133
21
1,127
760
Permanent extension of 2001 and 2003 tax cuts
0
1
8
37
14
119
179
179
Additional tax Cuts2
16
29
8
16
24
31
123
107
Mandatory savings3
—
-3
-15
-14
-17
-18
-67
-67
Social Security personal accounts
—
—
—
—
24
57
82
82
Defense Discretionary (excluding Iraq)
—
7
10
19
26
26
88
88
Non-defense discretionary
(excluding emergencies)
—
-4
-15
-27
-37
-50
-133
-133
Additional funds for Iraq and Afghanistan
30
56
23
7
2
1
119
89
Further Katrina relief including flood insurance4
9
6
4
3
2
0
23
15
Avian flu supplemental
—
2
0
0
—
—
2
2
Debt service
1
5
8
10
12
18
53
52
Total deficit impact of President’s policies
57
98
30
51
50
184
470
413
Proposed deficit in budget
423
354
223
208
183
205
1,596
1,173
Adjustment for AMT fix5
—
22
46
58
73
86
285
285
Adjustment for continued funding for Iraq5
—
26
58
45
37
39
205
205
Adjusted deficit under President’s policies
423
402
327
311
293
330
2,078
1,663
Addenda: CBO baseline deficit
(excluding emerg.)
337
227
192
157
127
10
1,050
713
Source: The Concord Coalition
Notes:
1) Numbers may not add due to rounding
2) Includes costs of refundable tax credits
3) Excludes costs of refundable tax credits
4) Based on the assumptions in the budget submission; the actual supplemental request was slightly larger
5) Includes associated debt service
Not much “heavy lifting” is needed to meet the administration’s 2009 deficit target
The overall fiscal policy goal of the Bush Administration is to “cut the deficit in half” by 2009.4 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 much more scrutiny than it has received. Relevant questions include:
4 For example, at his January 26 press conference President Bush said that the budget would be “one that says we can cut our deficit in half by 2009 and make sure the American people still get their tax relief.”
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• 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?
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 $344 billion in 2009 ? a threshold that is 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.5 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 3. Deficit Reduction is Relative to the Starting Point
Projected FY 2004 Deficit
Actual FY 2004 Deficit
Billions of $
Percent of GDP
Billions of $
Percent of GDP
Starting point
521.0
4.50
412
3.6
Cut in half
260.5
2.25
206
1.8
Source: Concord Coalition analysis
Establishing deficit reduction as an official goal is a positive attribute because it keeps at least some pressure on policymakers, including the Administration, to avoid actions that would jeopardize the goal by expanding the deficit ? whether through increased spending or lower revenues.
Within the Administration’s framework, however, a deficit as high as $344 billion in 2009 (2.25 percent of projected GDP) could be deemed half of the 2004 deficit ? even though the actual reduction from 2004 to 2009 would be just 16.5 percent in dollar terms and 38 percent when measured as a share of GDP.6 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.
5 As stated in the budget, “By 2009, the deficit is projected to be cut in half by more than half from its originally anticipated peak of 4.5 percent of GDP in 2004 to just 1.4 percent.” Fiscal Year 2007 Budget, “The Nation’s Fiscal Outlook,” p.16 (emphasis added).
6 This formulation was used by Treasury Secretary John Snow when he told the National Chamber Foundation on January 5 that, “[D]eficits matter and one of our highest priorities is to achieve the President’s goal of reducing our deficit in half to below 2.3 percent of GDP by 2009. (emphasis added).
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The President’s deficit reduction target is realistic – in the abstract
As shown in Table 2 above, even assuming realistic war expenses and AMT relief, the 2009 deficit under President Bush’s budget would come to $311 billion and fit within the lax definition of being “cut in half.”
What may make the goal difficult to achieve is the assumption in the budget that non-security discretionary spending will remain flat through 2009. The likelihood that new emergencies, natural or manmade, will occur at some point over that time renders this assumption quite improbable (see Criteria 2 below).
Under The Concord Coalition’s plausible baseline scenario, which assumes extension of expiring tax cuts, continued AMT relief, diminishing war spending and other discretionary spending keeping pace with the economy, the deficit is nearly $400 in 2009. What’s telling about this is that even a $400 billion deficit in 2009 (2.58 percent of GDP) would come close to the administration’s goal of a deficit below 2.3 percent of GDP in that year.
All of which raises the most important question about this goal ? even if it is achieved, so what?
The President’s deficit goal is inadequate relative to the fiscal challenges we face
The President’s 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, policymakers have drifted far from that goal. The deficit in 2005 was $494 billion excluding the Social Security surplus, not the unified deficit of $318 billion that is the most commonly used measure. And, in a subtle but revealing change, the published tables in the President’s budget no longer show the deficit excluding the “off-budget” Social Security surplus under administration policy.7 The former fiscal policy goal has not only been abandoned, it has been deleted. If there were still a table in the budget reporting the non-Social Security (i.e., “on-budget”) deficit under the President’s policies, it would show the following:
7 The Social Security surplus under administration policy is lower than under current law because of the President’s proposal to begin allowing workers to direct a portion of their Social Security taxes into personal accounts beginning in 2010.
8
Table 4. Deficits Excluding Social Security Surplus Under the President’s Budget
Billions of Dollars
Fiscal Year
2005
2006
2007
2008
2009
2010
2011
2007-2011
Unified deficit
-318
-423
-354
-223
-208
-183
-205
-1,173
Off-budget surplus
175
179
189
213
230
225
210
1,067
On-budget deficit
-494
-602
-543
-436
-437
-408
-415
-2,239
Source: Office of Management and Budget, February 2006 (numbers may not add due to rounding)
Now is not the time to become fixated on a goal that is too modest and a time frame 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. Cutting the deficit in half by 2009 would do nothing to change that. Undue focus on this goal diverts attention from the more vital and daunting long-term challenge. While it is a plus that the President is promising deficit reduction ? thereby acknowledging that the deficit is a problem ? his minimal short-term goal trivializes the full magnitude of the fiscal challenges ahead and does little to prepare the nation for the kind of hard choices that will eventually be required to bring about a sustainable fiscal policy. It is a convenient goal, not a meaningful one.
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II. 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.
As has become standard, the President’s budget relies on unrealistic assumptions. The projections understate likely expenses for military operations in Iraq and Afghanistan and overstate likely revenues by assuming a revenue windfall from the Alternative Minimum Tax (AMT). The costs of other tax and spending policies that are likely to be extended — such as deductibility of state and local sales taxes and the hold-harmless provision for the Medicare physician payment formula — are not included in the budget. In addition, the budget assumes substantial outyear savings in domestic discretionary programs that will be difficult to achieve.
The budget assumes $70 billion for another war supplemental (for a total of $120 billion in 2006) and a $50 billion “bridge” for 2007, but no funds after 2007. In other words, the budget assumes that funding for the war will go from $120 billion in 2006 to $50 billion in 2007 to zero in 2008. While including a placeholder for war costs in 2007 is an improvement over previous budgets that did not include any additional funding for war costs, the larger issue is what assumptions are made for war costs within the five-year budget window (FY 2007-2011). Assuming only $50 billion over five years for military operations in Iraq and Afghanistan is clearly not an accurate reflection of administration policies or likely expenses.
Relying on emergency supplemental requests to fund military operations in Iraq and Afghanistan instead of including those costs in the regular budget process is becoming increasingly difficult to justify. The ongoing costs of operations have become relatively stable and can be reasonably predicted, since the Army has to plan its troop rotations a number of years in advance. The administration should be able to use this information to make reasonable projections of future costs which could be adjusted as circumstances warrant instead of assuming that there will be no costs at all after 2007. Furthermore, an increasing proportion of supplemental requests are for procurement to repair and replace equipment, which generally has a year lag from operations. These costs are relatively predictable and should be incorporated into the regular defense procurement budget. The administration has also increasingly relied on supplemental requests to replenish regular operations and maintenance accounts that have been reprogrammed to other accounts instead of funding these needs in the regular budget process.
It also remains to be seen whether the funding levels for additional hurricane relief and recovery expenses are realistic. The President’s budget assumes an additional $18 billion in funding for a hurricane relief supplemental, but whether that is the totality of need is unknown because of the lack of consensus among the administration, members of Congress and local leaders. In fact, the supplemental request submitted by the President on February 16, 2006 proposed $19.8 billion in additional funding, $1.8 billion more than assumed in the budget released less than two weeks earlier.
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The budget assumes that policies supported by the President will expire to limit their costs on paper
The administration has consistently expressed support for AMT relief8 and has signed bills to extend relief every year in office. 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 Bush tax cuts are extended, and 33 million if they are not.
The budget accounts for an extension of AMT relief for 2006 because Congress is likely to approve such an extension in the tax legislation currently pending in Congress. However, the budget does not propose AMT relief for 2007, or at any point in the budget’s five-year window. Allowing AMT relief to expire at the end of 2006, as the budget assumes, is not realistic given that there is broad bipartisan support for continued AMT relief in Congress. In fact, there have been suggestions by Congressional leaders that the pending tax bill could extend AMT relief for two years. If Congress does not provide AMT relief for 2007 in the current tax bill it almost certainly will do so in a subsequent tax bill.
The administration’s public position is that a permanent solution to the AMT issue should be enacted as part of revenue neutral tax reform. However, it is unrealistic to assume that a permanent AMT fix will be enacted as part of revenue neutral tax reform when: 1) the President’s budget did not contain reform proposals; 2) a push for reform does not appear forthcoming—and will certainly not be passed before 2007; and 3) the administration and leading members of Congress have already rejected some 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 $218 billion to the deficit over the next five years — $56 billion in 2009 alone. A full fix of the AMT ? to prevent the alternative tax from negating promised tax cuts and becoming the de-facto tax calculation for the upper-middle class ? would cost substantially more.
The levels of discretionary spending assumed in the budget are unrealistic, and probably unattainable, in the outyears
While most of the attention has focused on the specific proposals to reduce domestic discretionary programs in FY 2007, the budget includes much larger unspecified savings in discretionary programs in subsequent years. Non-defense discretionary spending will
8 For example, in his December 7, 2005 press briefing, White House Press Secretary Scott McClellan stated “The President wants to make sure that more middle-income Americans are not being hit by the alternative minimum tax, and that the tax relief we provided to those Americans, all Americans, is not taken away because of the alternative minimum tax.”
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essentially remain flat for five years under the assumptions in the budget. Homeland security outlays would increase from $34 billion in 2007 to just $40 billion in 2011 and outlays for other non-defense discretionary spending would fall from $492 billion in 2007 to $455 billion in 2011.
Although spending restraint is crucial to deficit reduction, proposing to hold non-defense appropriations flat for five years is unrealistic given the recent 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).
The President’s budget assumes that non-defense discretionary spending will decline to less than 2.8 percent of GDP by 2011, even with increased spending for homeland security programs. 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. 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. For example, the budget’s request for non-defense, non-homeland security discretionary budget authority for fiscal year 2007 is nearly $10 billion higher than last year’s budget assumed.9 Achieving the discretionary savings assumed in last year’s budget would require another two percent cut in appropriations for fiscal year 2007 below the already strict spending limits proposed in this year’s budget. Clearly, when it came time to specifying cuts, the administration was unable to follow through on their savings for FY 2007 assumed in last year’s budget. This underscores how difficult it will be to adhere to the austere discretionary spending assumptions made for subsequent years (2008-2011) in the new budget, especially as the magnitude of the reductions necessary increases over time.
The budget also relies on user fees to offset part of the costs of discretionary spending programs. The President’s budget assumes enactment of more than a dozen user fees totaling $3.2 billion in 2007 to offset discretionary spending. The user fee proposals in the budget include an increase in airline passenger security fees, charging some veterans enrollment fees for medical care, increased Tricare enrollment fees and deductibles for military retirees under 65, explosives regulatory fees and Food Safety Inspection Service user fees. Many of these user fees have strong policy rationales. Businesses who benefit from government regulatory or safety activities should be asked to cover the costs of these programs. Likewise, beneficiaries of government programs who are able to pay more for services should be asked to make a greater contribution to the costs of the
9 Table S-2 of the President’s Fiscal Year 2006 Budget showed $389 billion in new budget authority for operations of the government excluding Department of Defense and homeland security in Fiscal Year 2007. The Fiscal Year 2007 budget requested $398.3 billion in new budget authority for these programs in fiscal year 2007.
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program. Congress should give these proposals greater consideration that it has in the past.
However, given that most of these proposals have been repeatedly rejected by Congress and are unlikely to fare any better this year, the savings they generate to reduce overall discretionary spending totals may never materialize. Without these offsetting user fees, the magnitude of the reductions that would be necessary in discretionary appropriations to stay within the overall discretionary spending levels in the President’s budget would be much greater.
Revenue projections fall within the bounds of consensus forecasts, but outyear projections rely heavily current trends that may not continue
The economic and revenue assumptions in the Bush budget are in line with CBO and Blue Chip forecasts. While the similarity between OMB and CBO revenue projections provides reassurance, past history has shown that longer-term projections based on the assumption that recent trends will continue into the future are often dramatically wrong. 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.10 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 for relaxing fiscal discipline.
Optimistic assumptiosn about the growth of revenues based on the recent surge in revenues should be viewed with caution. In partiuclary, the recent increase in revenues should be viewed in the larger context of revenue collections over the last several years. The strong economy clearly aided in bringing up corporate receipts as well as substantial increases in personal income taxes and social insurance taxes in FY 2005. FY 2005 saw a large increase in revenue from FY 2004—up by 14.6 percent to $2.15 trillion. While this was a record in dollar terms, larger than the previous record of $2.02 trillion 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.
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. Between 2001 and 2003 revenues declined in nominal terms for three years in a row for the first time since the 1920s. It is also important to note that the $2.47 trillion of spending in 2005 was also a record in dollar terms.
10 On the January 6, 2006 edition of CNBC’s "Squawkbox", Snow responded to a question about revenues falling well below the projections in the administration’s FY2002 budget by stating “all of us who do economic forecasting need to…be humble. Because this was a cataclysmic mistake. This was a classic mistake of forecasters building a forecast precisely on the past.”
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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 percent lower than the $1.004 trillion collected in 2000. Adjusted for inflation, individual income taxes in 2005 were nearly 19 percent 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.
There is cause for concern, however, that a new proposal in the budget to establish a Dynamic Analysis Division in the Treasury Department may put the reliability of revenue projections at risk. While this new division may simply be an attempt to improve the forecasting and estimating capabilities of the executive branch relative to the CBO and Joint Committee on Taxation (JCT) (who each have their own dynamic analysis capabilities) and provide additional information for policymakers, statements by administration officials suggest that the new division might not be so benign.
In a recent speech, Vice President Cheney suggested that there is a need for such a division to do dynamic analysis of tax cut proposals because current forecasts have been wrong in not projecting that “the tax cuts have translated into higher federal revenues.”11 He continued, “It’s time for everyone to admit that sensible tax cuts increase economic growth, and add to the federal treasury.” In one of President Bush’s speeches on the new budget he also suggested that “tax relief not only has helped our economy, but it has helped the federal budget…you cut taxes, and the tax revenue increases.”12
If the new Dynamic Analysis Division is being set up to show that cutting taxes increases revenue, future revenue assumptions will be quite suspect. It is true that short-term economic growth can be assisted by lower tax rates under certain conditions. Nonetheless, there can be little debate that the tax cuts are net revenue losers — they have not paid for themselves.To date, no dynamic analysis completed by the JCT or CBO has shown that tax cuts similar to the ones proposed by the administration increase revenue to the Treasury over what revenue would have been otherwise. There is wide consensus among economists on this point. In fact, even the White House Council of Economic Advisors has said that lost revenue from tax cuts is not “completely recovered by the higher level of economic activity.”13 And, in his presentation of the 2007 budget to the House Budget Committee, OMB Director Josh Bolten repeatedly acknowledged that revenues are lower “than they otherwise would have been without those tax cuts.”14
11 Remarks at American Conservative Political Action Committee, February 9, 2006
12 Remarks at the Business and Industry Association of New Hampshire, February 8, 2006
13 White House Council of Economic Advisers, 2003, Economic Report of The President
14 Testimony before House Budget Committee, February 8, 2006
14
Any objective dynamic assessment of the macro-economic impact of policy changes must examine the impact of all changes taken together, not in isolation. It must also include the impact of increased debt, debt service costs and other spending on economic activity. For a number of years, the CBO has done such a dynamic analysis of the entire presidential budget and has found that when all aspects of the budget are taken into account, the macro-economic effect was likely to be very modest and in some cases negative. To the extent that the new office of dynamic analysis is used as a smokescreen to mask the effect of tax cuts on the budget, it could become a detriment to fiscal responsibility.
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III. 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 FY2007 budget contains savings in mandatory spending programs as well as domestic discretionary spending cuts. The proposals for savings in Medicare and other mandatory programs are particularly encouraging.
Unfortunately, those fiscally responsible savings are more than offset by the costs of the President’s tax cuts and spending initiatives. Moreover, the administration has placed much greater emphasis on the proposed tax cuts than on the proposals to reduce mandatory spending, and has given every indication that it will continue to press for tax cuts even if Congress rejects the proposals for mandatory savings. Rhetoric about controlling the growth of spending in order to reduce the deficit won’t have much credibility so long as the President continues to propose tax cuts financed by borrowing.
The revenue loss from the tax cuts is not honestly acknowledged nor offset
The budget reflects the administration’s position that the deficit impact of tax cuts does not need to be offset. Moreover, the budget fails to fully acknowledge the cost of the tax cuts by proposing changes in accounting rules that would make the President’s proposal to permanently extend tax cuts appear to have no cost at all.
The budget contains tax cuts totaling $305 billion between 2006 and 2011 and $1.75 trillion between 2006 and 2016 according to the Treasury estimates.15 The budget also includes provisions which would increase revenues by $3.5 billion over five years and $7.4 billion over ten years (not counting the increased revenues in the first five years from the Lifetime Savings Accounts, which reduce revenues after 2010), reducing the net cost of the tax cut proposals to $301 billion between 2006 and 2011 and $1.74 trillion from 2006 to 2016.
The largest revenue provision in the budget is the proposal to permanently extend the rate reductions, marriage penalty relief, child tax credit, estate tax repeal and other tax cuts enacted in 2001 as well as the capital gains and dividend tax cut enacted in 2003. Although the costs of extending the tax cuts will show up in the budget window for the first time this year, the overwhelming majority of the costs will occur outside the five
15 U.S. Department of the Treasury, General Explanation’s of the Administration’s Fiscal Year 2007 Revenue Proposals, February 2006, p.143.
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year budget window. Enacting a permanent extension of the tax cuts this year would make the costs of the extension appear relatively small within the budget window and allow Congress to avoid fully acknowledging the costs of doing so in the budget. Extending these tax cuts would cost $178 billion during the five-year budget window and $1.4 trillion over ten years.
Table 5. The Costs of Tax Cuts Increase Substantially Beyond the Budget Window
2007-2011
2012-2016
2007-2016
Permanent extension of ’01 and ’03 tax cuts
$178 billion
$1.234 trillion
$1.412 trillion
Additional tax cuts
$107 billion
$222 billion
$329 billion
Total cost of tax cuts
$285 billion
$1.456 trillion
$1.741 trillion
Proposed mandatory savings in budget
Percent of tax cuts offset by proposed mandatory savings
$67 billion
23.7%
$110 billion
7.6%
$177 billion
12.5%
Source: The Concord Coalition
In addition to extending the expiring tax cuts, the budget contains a variety of new tax breaks totaling $123 billion over five years. The costs of these provisions alone are nearly twice the mandatory savings in the budget over the same period. The costs of these new tax breaks would increase to $222 billion in the second five years. Several of these tax cuts such as the proposed Lifetime Savings Accounts (LSAs), Retirement Savings Accounts (RSAs) and Health Savings Accounts (HSAs) are structured in a way that results in much larger costs in the outyears than is acknowledged in the five-year budget window. For example, the LSA and RSA proposals would increase revenues by $26 billion in the first five years, but reduce revenues by virtually the same amount in the second five years. Consequently, even if the costs of these proposals were offset within the five-year window, the net effect would still be to raise the deficit after 2011.
If deficit reduction and extension of the 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 proposals making the expiring tax cuts permanent argue that these are not new tax cuts, but simply an extension of expiring tax cuts previously approved by Congress. 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.
Not only does the budget fail to offset the costs of making the 2001 and 2003 tax cuts permanent, the administration refuses to acknowledge these costs at all. The administration has also included a proposal to change budget rules to incorporate extension of certain tax cuts into the baseline. The budget justifies this proposal by claiming that “the 2001 and 2003 Act provisions were not intended to be temporary, and
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not extending them in the baseline raises inappropriate procedural roadblocks to extending them at current rates.” 16 The “procedural roadblocks” to which the budget refers are budgetary limitations on legislation increasing the deficit.
What the administration fails to note is that the tax cuts are expiring because Congress included a sunset provision when they were initially enacted to limit the official cost of the tax cuts. This was done to circumvent 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 been approximately $700 billion higher over that period if the tax bills had not included sunsets. Those additional costs were not subject to budget limits when the tax cuts were originally enacted. Extending these tax cuts without considering their budgetary impact over the long-term and exempting their costs from budget enforcement would undo the compromises made to limit the size of the tax cuts when they were originally enacted
Including the revenue loss from extending tax cuts in the baseline is not simply a matter of presentation. Indeed, the costs of extending the tax cuts can be found in the administration’s budget documents. The real significance of including extension of tax cuts in the baseline is the impact this would have on the consideration of tax cut extensions in the budget process. The baseline is used as the measuring stick in applying budget enforcement rules such as the limitations on the size of tax cuts allowed by the budget resolution. If permanent extension of tax cuts were assumed in the baseline, those costs would not be subject to the tradeoffs between competing priorities that are applied to all other tax and spending proposals. In addition, including tax cuts in the baseline would effectively exclude extensions from pay-as-you-go rules if Congress were to reinstate these rules.
The decision whether to extend the tax cuts is a policy decision and should be treated as such. New legislation is required to prevent the tax cuts from expiring at various times between now and 2011. The revenue loss from any such legislation should be weighed against other competing initiatives that Congress and the President may wish to undertake ? not simply assumed into the baseline.
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.”17
16 Fiscal Year 2007 Budget, Analytical Perspectives, p.211
17 May 28, 2003 Concord Coalition Issue Brief: Sunsets Hide More Than Half of the Revenue Loss From Recent Tax Cuts
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Circumstances have changed dramatically since the tax cuts were enacted in 2001 and 2003. Congress is no longer “refunding a surplus” to the taxpayers. The surplus era in which the tax cuts were originally enacted has been replaced by deficits as far as the eye can see, and the budget faces new demands for homeland security and the war on terrorism. Moreover, the economy has long since recovered from the mild recession of 2001 and is no longer in need of fiscal stimulus. 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 perpetual 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.
The President’s budget embraces elements of much-needed tax reform but fails to address or offset the costs
The Treasury Department’s Blue Book describing the tax provisions in the President’s budget asserts that they represent a step toward the goals of tax reform. The Blue Book specifically lists proposals to make health care more affordable, promote savings, encourage investment by entrepreneurs and reduce the cost of capital. These proposals, of course, all involve tax benefits that would reduce revenues. Missing from the budget is any acknowledgement of the tradeoffs involved in 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. 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 achieved 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. The President’s budget included several proposals similar to the commission recommendations, particularly with regard to the tax advantages for personal savings as well as investment income.
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.
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Not surprisingly, none of these provisions were included in the President’s budget. The White House has distanced itself from these recommendations and has explicitly rejected the proposal to limit the deducibility of employer-provided health insurance.18
While the failure to include the proposals of the Advisory Panel on Tax Reform or other fundamental tax reform proposals represents a lost opportunity to improve the fairness and efficiency of the tax code, the decision to include many 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 is much worse from a fiscal perspective.
The President’s budget relies on unspecified savings in non-defense discretionary spending to offset specific tax cut and spending increase proposals
It is all too easy to offset specific 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. The President’s budget assumed savings of $133 billion in unspecified non-defense discretionary spending between 2008 and 2011. Achieving those savings would require Congress to make progressively larger cuts in non-defense discretionary programs: 4.4 percent below the CBO baseline in 2008 and nearly 10 percent in 2011. Non-defense discretionary spending would be $40 billion below CBO’s baseline by 2011.
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.
The pay-as-you-go rule included in the 1990, 1993 and 1997 deficit reduction plans recognized this problem by requiring that tax cuts and mandatory spending increases had to be offset by tax increases or mandatory spending cuts. It did not allow changes in tax or entitlement spending law with ongoing costs to be offset with discretionary spending which can only be enforced on a year-by-year basis. The sound logic of this tradeoff shold not be abandoned even though the statutory pay-as-you-go rule has expired.
18 “Bush Rejects Proposal to Tax Health-Care Benefits, Hubbard Says,” Bloomberg News, January 12, 2006
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IV. 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.
According to projections by OMB, 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 percent of GDP today to 12.9 percent in 2030.19 Projections by the Congressional Budget Office and General Accounting Office are even higher, with spending on these three programs exceeding 15% by 2030. The financial demands of these three programs will exert pressures on the budget that economic growth alone will not be able to overcome (see Figure 3).
Figure 3. Entitlement Spending Will Outstrip Economic Growth
he President’s budget document, as well as administration statements regarding the
l
ate a
02468101214161820196219701978198619942002201020182026203420422050Fiscal YearPercent of GDPSource: The Long Term Budget Outlook, Congressional Budget Office, December 2005Social SecurityMedicareMedicaidActualProjected02468101214161820196219701978198619942002201020182026203420422050Fiscal YearPercent SecurityMedicareMedicaidActualProjected
T
budget, have appropriately stressed the importance of addressing these long-term fiscachallenges. The President’s budget message emphasizes the challenges posed by the unsustainable growth in entitlement spending and reiterates his commitment to entitlement reform. In addition, the President previously announced plans to cre
19 Table 13-2 Fiscal Year 2007 Budget, Analytical Perspectives, page 185. Projections by CBO and GAO show even higher cost growth in these programs depdning on what is assumed regarding the growth of health care spending
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bipartisan commission on entitlement reform to develop solutions to the challenges facing the budget with the retirement of the baby boom generation.
The Concord Coalition applauds the Administration’s recognition of the problem and its efforts to raise the profile of the long-term fiscal challenges facing our nation. Unfortunately, the specific proposals in the President’s FY 2007 budget do very little to address or even prepare our nation’s balance sheet for the liabilities will know will come due in the very near future.
In a December 2005 report on the long-term budget outlook, CBO concluded, “attaining fiscal stability in the coming decades will probably require substantial reductions in the projected growth of spending and perhaps also a sizeable increase in taxes as a share of the economy.”[3]
In contrast, the President’s budget proposes very modest overall spending restraint and additional tax reductions that, in combination, would add rising near-term debt to the already daunting long-term outlook. Low taxes may be a laudable policy goal, but taxes must be considered within the context of spending commitments. Even if Congress adopts all of the spending restraint assumed in the President’s budget, outlays would never get below 19 percent of GDP while revenues would remain below 18 percent of GDP if the tax policies were also adopted. The fundamental mismatch between spending and tax policies just gets worse over time. It is difficult, if not impossible, to square this with the administration’s professed desire to improve the fiscal outlook for future generations.
Debt is not a painless alternative to taxes, as the President’s budget implicitly suggests. The truth is that deficits merely shift the tax burden toward the future. The administration’s statements about entitlement reform and the proposal to establish an entitlement reform commission would have more resonance if Congress and the administration were willing to defer action on extending the tax cuts until reforms controlling the growth of entitlement spending were enacted. Doing the opposite puts the cart before the horse.
The administration acknowledges the costs of policies beyond the budget window but does not translate them into deficit projections
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 persists today. It has encouraged lawmakers to ignore the looming financial crisis associated with retirement of the baby boom generation and has left federal finances ill-equipped to deal with potential national emergencies (natural disasters, terrorist attacks, and economic shocks).
22
Although the administration’s FY 2007 budget does not restore ten-year budgeting, during recent testimony before the Senate Budget Committee, OMB Director Josh Bolten did acknowledge the problem of permanent deficits beyond the administration’s forecast window:
I’m glad you’re focusing on debt, on the long-term debt situation because that’s where the problem is. And the problem is not one of discretionary spending accounts, it is not one of being under-taxed, the problem and the reason why we have this exploding debt situation going out indefinitely into the future is a problem of the entitlement programs.20
Although the budget does not display annual costs of the proposed policies after the five-year window, it does provide total costs of mandatory spending and tax initiatives over the ten-year period of 2007 through 2016. For example, the budget tables show that the costs of the tax cuts in the President’s budget increase from $285 billion over the five year budget window to nearly $1.7 trillion between 2007 and 2016. By contrast, the mandatory spending proposals save only $67 billion over five years and $177 billion over ten years. This strongly suggests that the policies proposed in the budget would widen, rather than narrow, the deficit beyond the five year window.
The budget would make modest progress on entitlement reform
In 2008, the leading edge of 77 million baby boomers will be eligible for Social Security, and in 2011 for Medicare. The retirement costs of baby boom generation are beginning to emerge 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. Controlling the growth of mandatory spending is essential to address the budgetary pressures facing future generations.
It is therefore encouraging that the President’s FY 2007 budget submission follows up on the budget reconciliation bill enacted earlier this year with additional proposals to rein in entitlement spending. The budget includes $36 billion in Medicare savings from higher Part B premiums for wealthy beneficiaries and reduced fee schedules for some health care providers, $5 billion in Medicaid savings, $5 billion in savings from agriculture commodity programs and other mandatory savings. While the mandatory savings in the President’s budget are relatively modest in comparison to the rapid growth projected in mandatory spending, dealing with the growth in entitlement spending will require a concerted, ongoing effort. Making entitlement savings a regular part of the annual
20 Transcripts from the United States Senate Budget Committee hearing on the President’s Fiscal Year 2007 Budget Proposals, February 7, 2006.
23
budget process would represent an important development in the effort to address long-term fiscal challenges.
In addition, the President’s budget reiterates his support for Social Security reform. The budget totals include $81.6 billion for voluntary individual accounts. These costs were first included in the FY 2006 Mid-Session Review. Although individual accounts alone will not address Social Security’s long-term shortfall, accounting for their costs is a responsible first step in earmarking funds for reform. Indeed, had the administration left the cost out of its budget, critics including The Concord Coalition, would have said that this was simply hiding the cost of an expensive initiative. Because the President believes in this reform, it is appropriate that the costs be included in the budget.
The President has also embraced the idea of altering the indexation of initial retirement benefits on a sliding scale basis depending on average lifetime wages (a concept commonly referred to as “progressive indexing.”). Actuaries from the Social Security Administration estimate that progressive indexation would eliminate somewhere between 50 to 70 percent of the annual cash shortfall in Social Security over the next 75 years. Although progressive indexing would begin to achieve modest savings in 2012 as workers born in 1950 reach early eligibility age, the budget does not incorporate any savings because the administration has not put forward a specific proposal detailing the how the formula would be changed. The Concord Coalition encourages the Administration to work with Congress to expand and develop the proposal for progressive indexation or other proposals that would help reduce the budgetary pressures imposed by federal retirement programs.
The Medicare prescription drug benefit will add substantially to the deficit over the next five years
Proposals to establish a prescription drug benefit first entered the political debate in the brief 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 fiscally irresponsible for Congress and the President to exacerbate the entitlement crisis with yet another expensive benefit for seniors. According to OMB, the new prescription drug benefit will add $45 billion to the FY2006 deficit and $361 billion over the next five years. The President’s $36 billion proposal to trim Medicare spending appears trivial when viewed against this enormous expansion in retirement benefits. Indeed, estimates by the administration indicate that the unfunded obligations of the Medicare Part D drug benefit are roughly 50 percent more than those of the entire Social Security program. Congress and the President should begin to look for ways to make the benefit more efficient, better targeted and less expensive.
The budget is unlikely to control the rising cost of health care
There is no more important factor in the nation’s unsustainable long-term fiscal outlook than projected health care costs. Today, Medicare and Medicaid comprise 21 percent of
24
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 percent of all federal spending. If historic growth rates persist, by 2050 Medicare and Medicaid will absorb more of our nation’s economy than the entire federal government does today. 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 soar. Clearly, resolving the financial crisis in Medicare and Medicaid requires reining in rising health care costs.
The centerpiece of the President’s health care proposal is $51.7 billion to expand Health Savings Accounts (HSAs) and eliminate all taxes on out-of-pocket spending from HSAs, in addition to other smaller initiatives. Supporters of this approach argue that the high-deductible insurance policies in HSAs 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.21 Until lawmakers address actual health care pricing, Medicare and Medicaid will continue to consume larger portions of the federal budget.
21 See, Linda J. Blumberg, Lisa Clemans-Cope, and Fredric Blavin, “Lowering Financial Burdens and Increasing Health Insurance Coverage for Those with High Medical Costs,” Urban Institute, December 2005.
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V. 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 President’s budget makes a modest step toward distributing the burden of deficit reduction more fairly by proposing some savings in middle class entitlements, most notably in Medicare. The President’s budget is an improvement over the entitlement reduction efforts last year, which disproportionately affected low-income populations through cuts in Medicaid, Supplemental Security Income and other income support programs while sparing middle class entitlements and corporate subsides from the budget ax. Nonetheless the overall impact of the budget again places a disproportionate burden on lower income individuals and leaves in place a crushing burden of debt and unfunded liabilities for future generations to bear.
The budget does not put everything on the table for deficit reduction
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 (see Figure 4). Meanwhile, spending is at 20.1 percent of GDP, which is below the average over the past 25 years (21 percent). Revenues would remain below 18 percent of GDP through 2011 under the President’s budget, averaging 17.8 percent of GDP. Spending would decline to 19 percent of GDP in 2010 under the President’s policies (increasing slightly to 19.1 percent in 2011). This suggests that it is revenues, and not spending, that have deviated from recent norms.
However, the administration’s budget policies rely heavily on cuts in non-defense discretionary spending and entitlement programs to reduce the deficit while continuing to propose additional tax cuts that outweight all of the tax cuts. Relying on cuts in domestic spending programs to achieve deficit reduction puts a greater burden on lower-income populations who derive greater benefits from these programs, while tax cuts inherently benefit higher income populations who pay a greater share of taxes.
26
Figure 4. Revenues and Spending as a Percent of Gross Domestic Product (GDP)
he budget calls for savings in middle class entitlements and corporate subsidies,
10%12%14%16%18%20%22%24%26%1966197119761981198619911996200120062011Percent of GDPSpending (historical average: 20.3%)Revenues (historical average: 18.1%)ActualProposedSource: Congressional Budget Office and Office of Management andBudget, February 200610%12%14%16%18%20%22%24%26%1966197119761981198619911996200120062011Percent 2006
T
but the proposals for substantial savings in programs that serve low-income
populations The budget proposes $36 billion in Medicare savings, including a slight expansion of
means-testing for the Medicare Part B premium and reductions in payments to health care
e
ates
nding is in Medicare, the
budget also proposes an additional $5 billion in Medicaid savings over the next five years
ill
alls for $5 billion in savings from agricultural subsidies. The budget
proposes to reduce in the payment limit for individuals to $250,000 and make other
savings in the budget include some savings from
corporate subsidies such as termination of the Advanced Technology Program and deep
providers. The budget adopts many of the recommendations proposed by the MedicarePayment Advisory Committee (MedPAC) for changes in payments to health care providers, but does not include any of the recommendations reducing payments to privatMedicare managed care plans under the Medicare Advantage program. CBO estimthat the MedPAC recommendations regarding the Medicare Advantage program would achieve more than $20 billion in savings over five years. While the bulk of the savings in mandatory health care spe
in addition to the $4.9 billion in savings enacted as part of the budget reconciliation bearlier this year. The budget also c
changes tightening payment limits. The proposed domestic discretionary
reductions in the Manufacturing Extension Partnership, but contains much greater
27
savings from health, education and income support programs benefiting lower incopopulations.
me
The budget increases the debt burden that will be placed on future generations and
fails to address the unfunded liabilities facing Social Security and Medicare Although the budget emphasizes the burdens that will be placed on future generations by
.
in
d
The budget continues the policy assumption that we can fight two wars, fund homeland
an
the unsustainable growth in entitlement spending, it fails to control the growth of our national debt and address the looming challenges facing Social Security and MedicareThe Medicare savings in the budget will not have a noticeable impact on the unfunded liabilities of Medicare. Although the budget reiterates the President’s commitment to Social Security reform and his proposal to reduce the growth of benefits by adopting progressive price indexing, the only specific Social Security reform proposal includedthe budget is the personal account proposal which will at best represent a net wash in terms of liabilities, replacing future liabilities with up front expenditures (and increasedebt with resulting interest costs into the future).
security, rebuild the Gulf Coast, maintain full promised benefit levels for entitlement programs and keep cutting taxes by sending the bill to future generations. The result isescalating national debt. By 2010, the total national debt will be nearly $11 trillion and debt held by the public will exceed $6 trillion. 02,0004,0006,0008,00010,00012,000200520062007200820092010Fiscal YearBillions of DollarsIntragovernmental DebtDebt Held by the PublicTotal DebtComponents of Debt Under the President’s PoliciesComponents of Debt Under the President’s PoliciesFY 2005-2011Source: Office of Management and Budget2011
28
These increases in the debt will result in rapidly rising costs to service the debt. Spending for interest on the national debt will increase by 75 percent between 2006 and 2011 under the administration’s budget policies, making it the fastest growing category of spending in the federal budget. The rapid growth in spending for interest payments will leave future generations with fewer resources to address other national priorities.
Table 6. Net interest will be the fastest increasing item in the budget
Billion of Dollars
2006
2007
2008
2009
2010
2011
Avg. Annual
Increase
Net interest
$220
$247
$272
$291
$307
$322
Percent Change
20%
12%
10%
7%
5%
5%
10%
All other spending
$2,489
$2,523
$2,542
$2,631
$2,754
$2,918
Percent Change
10%
2%
2%
4%
5%
6%
5%
Source: Office of Management and Budget, February 2006
It is important to remember that the increase in the debt and spending for interest in these charts are based on the unrealistic deficit path in the President’s budget. If the likely costs for AMT relief and additional costs for Iraq are added to the President’s budget, the national debt would be nearly $500 billion higher by 2011 and interest costs would be nearly $20 billion a year higher by 2011.
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VI. 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.
In the introduction to the budget process chapter of the Analytical Perspectives volume the administration notes, “No one change can fix the budget process, and process alone cannot address important fiscal issues. Nevertheless, process changes can be a key factor in the effort to control spending.”22 The Concord Coalition agrees with this statement. The budget outlines several process reform proposals intended to help achieve the goals of making the budget process “transparent, accountable and orderly.” Many of these proposals have been included in previous administration budgets.
The primary enforcement proposals in the budget are pay-as-you-go (PAYGO) rules for mandatory spending, a provision strengthening the Medicare trigger established in the Medicare Modernization Act, a mechanism to make it harder to enact legislation increasing long-term unfunded liabilities of entitlement programs, reinstating statutory discretionary spending limits and establishing a stricter definition for emergency spending. The budget also contains a variety of other budget process reforms including a joint budget resolution signed by the President, automatic continuing resolutions when appropriations bills have not been passed, a results and sunset commission and line item veto.
The budget also proposes a change that would weaken budget enforcement rules by making changes in baseline rules to include the costs of extending certain tax cuts in the baseline. This change would effectively exempt extensions of expiring tax cuts from budget rules by making them appear to be “free” for purposes of budget enforcement. This would primarily affect the tax cuts enacted in 2001, which would expire in 2010. As noted earlier, the tax cut sunsets were added so that the cost of the tax cuts after 2010 would not count for enforcing budget limits when they were enacted. Assuming extension of these tax cuts in the baseline would effectively prevent those costs from ever being subject to budget enforcement.
The administration has given particular emphasis this year to the proposal calling on Congress to pass a line item veto “that would withstand constitutional challenge.” The proposal would give the President the authority to defer new spending whenever he “determines the spending is not an essential Government priority.”23
Although the Line Item Veto proposal and proposals for earmark reform in Congress have received a great deal of attention, they are not likely to have a significant impact on budgetary outcomes. According to the House Appropriations Committee, appropriations earmarks totaled $17 billion last year. Unnecessary or low priority spending should be
22 Fiscal Year 2007 Budget, Analytical Perspectives, p.211
23 Analytical Perspectives, p.216.
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eliminated, but focusing on the small sliver of spending that would be affected by these proposals is a distraction from the much larger issues contributing to fiscal imbalances. Moreover, President Bush has never used his authority under current law to submit rescissions of earmarks or other spending he considers low priority, so it is questionable whether granting him this additional authority would have much of an impact at all.
The administration proposes to apply budget enforcement rules to spending increases while exempting tax cuts from discipline
The administration proposes reinstating budget enforcement mechanisms by establishing PAYGO rules for mandatory spending (referred to in budget documents as Mandatory Spending Control). These rules would not apply to tax legislation and would not allow increases in mandatory spending to be offset by increased revenues. The budget also exempts tax cuts from the proposed mechanism to analyze the impact of legislation on long-term liabilities.
Moreover, the proposal to change budget baseline rules to assume extension of expiring tax cuts in the baseline would exempt legislation extending these tax cuts from PAYGO rules even if Congress were to approve legislation applying PAYGO rules to tax cuts in general. PAYGO rules examine whether legislation increases or decreases the deficit relative to the baseline and require legislation that would increase the deficit above the baseline to be offset. If extension of the tax cuts were assumed in the baseline, legislation extending the tax cuts would not be scored as reducing revenues (and therefore increasing the deficit) compared to the baseline for purposes of applying PAYGO 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. In addition, prohibiting tax increases from being used to pay for entitlement spending increases under PAYGO rules fosters the notion that debt is a painless alternative to raising revenues necessary to pay for entitlement benefits.
Exempting tax cuts from budget enforcement, as the administration has proposed, would also 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. The arbitrary nature of the distinction between taxes and mandatory spending for purposes of budgetary enforcement is highlighted by the treatment of the tax credit proposals in the President’s budget. The outlays resulting from the refundable tax credits would be subject to the PAYGO rules proposed in the budget, but the revenue reductions from the same provision would be exempt from the rules.
The concept of applying PAYGO rules to all legislation — 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 pay-as-you-go rules to tax cuts does not prevent Congress from passing more tax cuts. All it
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would require is that Congress must identify another source of revenue or spending reduction if it wants to enact or extend a tax cut.
The budget proposes to set discretionary spending limits at improbable levels
The budget proposes to reinstate statutory discretionary spending limits for new budget authority and outlays enforced by sequestration. The caps would be set at the discretionary spending levels in the President’s budget enforced by sequestration of discretionary programs. There would be separate caps for defense and non-defense spending through 2008 and a single discretionary cap for 2009- 2011. In addition, there would be a separate category for transportation outlays for 2006 through 2009 at levels consistent with the highway bill enacted last year.
Table 7. Proposed Discretionary Spending Limits
Billions of Dollars
2006
2007
2008
2009
2010
2011
BA
843.3
870.7
895.4
916.6
928.4
940.5
Overall discretionary
OL
998.3
965.6
952.3
965.3
979.1
992.5
BA
432.4
459.7
482.1
NA
NA
NA
Defense
OL
502.2
468.4
467.9
NA
NA
NA
BA
411.0
410.9
413.3
NA
NA
NA
Non-defense
OL
456.9
452.7
437.3
NA
NA
NA
Highway
OL
33.5
37.1
38.7
39.9
NA
NA
Mass Transit
OL
5.8
7.3
8.5
9.3
NA
NA
Source: Fiscal Year 2007 Budget, Analytical Perspectives
As noted earlier, the budget assumes substantial and growing reductions in non-defense discretionary spending that would result in spending far below historical norms. Although the outyear assumptions regarding discretionary spending are regularly ignored and revised with subsequent budget submissions (as was the case with the fiscal year 2007 discretionary spending levels in this year’s budget), codifying these levels in discretionary spending limits would give these assumptions the force of law enforced by sequestration.
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
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part of the 1997 budget agreement proved to be unrealistic and were effectively ignored, leaving no credible restraint on discretionary spending in place.
Enforcement mechanisms addressing long-term fiscal challenges
The budget contains two proposals designed to address long-term fiscal problems. The first provision would strengthen the mechanism established in the Medicare prescription drug bill requiring action by the President and Congress if general revenue financing for Medicare exceeded 45 percent of total Medicare spending. Specifically, the proposal would require an automatic reduction in Medicare provider payments of four-tenths of a percent for every year the threshold was exceeded in order to put pressure on the President and Congress to enact Medicare reforms to bring spending back in line with the threshold. While it is not clear whether the automatic reductions would directly correspond to the triggering event, the basic approach of implementing automatic stabilizing mechanisms to control the growth of entitlement programs has proven to be successful in other countries.24 Moreover, this mechanism would put teeth into the Medicare spending review process by creating real consequences if Congress and the President fail to act.
The second proposal would restrict the ability of Congress to enact legislation that would increase long-term liabilities and establish a reporting requirement highlighting legislation that increased 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 against legislation that would increase mandatory spending by $5 billion or more in any of the four 10-year periods from 2015 through 2055. Bringing more attention to the long-term fiscal impact of legislation and establishing procedural roadblocks for legislation increasing unfunded liabilities could have a salutary effect on the legislative process.
24 See The “State of the Art” in Entitlement Reform: Lessons from Abroad”, Concord Coalition Facing Facts Quarterly Volume II, Number 1
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VII. 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. This budget asks for difficult cuts in Medicare and discretionary spending. The Medicare cuts will be exceedingly difficult to pass even with just Republican votes in an election year. The discretionary cuts will also be tough. However, as long as every tax cut is untouchable and substantially more expensive than proposed spending cuts, bipartisan cooperation, and ultimately action on any of the tough cuts, will be impossible.
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 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
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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.”
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