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Public debt and budget issues take center state: Last week the growing public debt and budget strategies to rein in the debt took center state, with President Obama and Republican presumptive-nominee Mitt Romney attacking each other's positions.

President Obama's April 3, 2012 Budget Speech

House of Representatives approves FY 2013 Budget Plan: The House of Representatives on March 29, 2012 approved 228-191 House Budget Chairman Paul Ryan's (R-WI) budget resolution for FY 2013 (H.Con.Res. 112) which calls for: (1) reductions in total discretionary spending of $19 billion below the level agreed to in last year's budget deal with all of the cuts to come from non-defense programs: (2) a further reduction in discretionary spending by requiring that all disaster spending be offset; (3) avoiding the 2013 automatic cuts in defense spending by substituting unspecified cuts in entitlement spending; (4) transforming the Medicare program into a hybrid combination of traditional fee-for-service and private insurance options; (5) repealing the Affordable Care Act (the President's health care reform);
(6) eliminating federal entitlement guarantees for Medicaid (health and long-term care coverage for low-income Americans) and Food Stamps to be replaced by block grants to states; (7) permanently extending all of the Bush tax cuts; (8) individual income tax reforms that would reduce the top rate to 25 percent -- paid for with unspecified elimination of tax deductions and/or credits; (9) corporate tax reforms that would reduce the corporate rate from 35 to 25 percent and adopt a "territorial" model; and (10) reducing farm price supports and crop insurance subsidies.

During two days of Floor consideration, the House rejected several alternative budget plans:

Ryan House Republican Budget Plan -- approved 228-191

Analysis of the Ryan Plan by the Center on Budget and Policy Priorities

Democratic Budget Alternative-- rejected 163-262

Republican Study Committee Alternative -- rejected 136-285

Congressional Black Caucus Alternative -- rejected 107 - 314

Congressional Progressive Caucus Alternative -- rejected 78-346

Cooper-LaTourette Alternative based on Simpson-Bowles plan -- rejected 38-382

Cuts in non-defense discretionary spending: Last year's bipartisan budget deal (Budget Control Act of 2011) called for total FY 2013 discretionary (that is, non-entitlement) spending to be $1,047 billion -- comprised of $546 billion in defense and $501 billion in non-defense spending. The Ryan budget would reduce the total by $19 billion and increase defense spending by $8 billion -- leading to reductions in nondefense spending of $27 billion.

In addition, the Ryan budget requires that all disaster spending be offset by other spending cuts -- as opposed to previous budget rules that effectively exempted disaster spending from spending caps.

Ryan's proposed discretionary spending total is $1, 028 billion. By way of comparison, total FY 2012 discretionary spending is $1,043 billion, while in FY 2011 it was $1,353 billion (which included stimulus spending). This raises a key fiscal policy issue: how to balance austerity measures to reduce long-term debt, with near-term public investments to stimulate economic recovery. Critics argue that Ryan's near-term cuts in public investment could slow or stall the economic recovery.

Avoiding Automatic Cuts: Last year's Budget Control Act (BCA) set up a congressional "super-committee" to come up with a plan to reduce deficits by $1.2 trillion over 5 years. However, because the super-committee failed to produce a bipartisan plan, automatic cuts are scheduled to take effect in January 2013 that will cut defense by an additional $55 billion each year through 2021; and will cut non-defense spending by an additional $55 billion each year (from discretionary spending and entitlement programs). These cuts are in addition to the spending caps already imposed last year by the BCA. The Ryan budget would avoid the automatic defense cuts by directing House authorizing committees to come up with more than $200 billion in entitlement savings over 10 years.

Medicare Reforms: Ryan says his Medicare proposal is similar to a model he has been developing in collaboration with Democratic Senator Ron Wyden of Oregon. (It is also similar to the Medicare reform proposals in the Domenici-Rivlin bipartisan debt reduction plan.) The approach would phase in a "premium support" model, under which seniors would receive federal payments they could use either to remain in traditional Medicare or purchase private insurance from an "exchange." Costs would be held down by limiting Medicare premium support payments to the second-least-expensive plan in an insurance exchange; seniors wanting more expensive plans (presumably including traditional Medicare) would pay higher premiums. Ryan's new Medicare reform plan differs from last year's proposal by including the option to remain in traditional Medicare, although critics question whether seniors would receive sufficient premium support to purchase adequate coverage.

Ironically, Ryan's Medicare plan utilizes private insurance "exchanges" similar to those created under the Affordable Care Act (President Obama's health care reform), which he proposes to repeal.

Block Granting Medicaid: Ryan's Medicaid proposal would change the program from an open-ended federal entitlement that matches state expenditures for basic healthcare and long-term care to a block grant that caps spending each year and allocates available funds among the states by a specified formula. Estimated federal budget savings are $810 billion over 10 years. Critics argue the proposal would cause states to cut benefits and limit Medicaid enrollment.

Cutting and block-granting Food Stamps (SNAP): The Ryan plan would convert food stamps (now called the supplemental nutrition assistance program or SNAP) from an entitlement that provides a guaranteed level of food assistance to all low-income Americans, into a block grant program that would cut food assistance by $122 billion over 10 years.

Individual Income Tax Reform: The Ryan plan calls for permanent extension of all Bush tax cuts at a cost of $5.4 trillion over 10 years. In addition, he calls for "revenue neutral" reforms of the individual income tax, replacing the current six brackets with two brackets: 10 percent and 25 percent at a cost of $2.5 trillion over 10 years. This would dramatically reduce taxes for upper income earners, although the extent of the reduction would depend on which credits or deductions would be eliminated to pay for the cuts -- details left out of the tax plan. The Domenici-Rivlin and Bowles-Simpson plans have both called for reducing and simplifying tax rates and broadening the tax base, although the Domenici-Rivlin plan included significant credits for lower-income earners to maintain the progressivity of the tax code.

Link to nonpartisan Tax Policy Center revenue estimates of the Ryan tax plan

Corporate Tax Reform: Ryan's tax plan, in addition to broadening the base and reducing individual rates, would reduce the corporate tax rate from 35 to 25 percent and replace the current corporate tax with a "territorial" system in which companies would pay tax only on income earned in the U.S. -- not on income earned abroad and brought back into the country. The 10-year cost, according to the Tax Policy Center, is $1.1 trillion.

Farm Program Cuts: Ryan's plan would reduce farm price supports and federal subsidies of crop insurance by $30 billion over 10 years.

House Floor Action, but No Action in the Senate: The full House will consider the Ryan budget plan the last week of March, but no Senate action is expected on an FY 2013 Budget Resolution. Senate Majority Leader Harry Reid (D-NV) said the Senate will not consider an FY 2013 budget resolution and will instead proceed with FY 2013 appropriations bills based on FY 2013 spending levels set in last year's Budget Control Act. Since budget resolutions require the agreement of both chambers, there will be no Concurrent Resolution on the Budget for FY 2013.

The absence of an FY 2013 budget resolution will have three implications. First, there will be no debate on spending and tax policy in the Senate this year.

Second, the House Appropriations Committee will base its appropriations bills on the lower discretionary spending levels in the Ryan plan, setting up a clash on spending levels in September -- likely leading to adoption of a stop-gap spending measure ("continuing resolution") until after the November 6 elections.

Third, there will be no budget reconciliation bill this year (a filibuster-proof, expedited process for considering entitlement and tax reforms) since the reconciliation process can only be initiated by passage of a House-Senate budget resolution. The budget reconciliation process is essential to agreement on a long-term package of entitlement and tax reforms to stabilize the rapidly growing U.S. debt.

A "Perfect Storm" Approaching at Year's End: For the nation's fiscal policy, a perfect storm is approaching after the November 6th elections. Unfortunately, due to political posturing in anticipation of the elections -- where either political party could win the White House and Senate -- little bipartisan progress is expected between now and election day. However, after election day, the following time-sensitive issues will require immediate consideration:

1. Completion of FY 2013 spending bills. As discussed above, with the House and Senate $19 billion apart on total appropriations levels for 2013, a stop-gap measure (continuing resolution) expiring after the November elections is likely.
   
   
2. Automatic cuts in defense and nondefense spending scheduled to take effect in January of 2013. Both political parties want to avoid the automatic cuts but have yet to begin discussing any bipartisan approaches to replacing the across-the-board cuts.
   
   
3. Expiration of the Bush tax cuts at the end of 2012. Republicans want permanent extension of all the cuts; Democrats want to let the cuts for upper income earners expire as scheduled.
   
   
4. Raising the Debt Ceiling. The Treasury is likely to bump up against the statutory debt ceiling shortly after the elections (and possibly before, due to revenue losses from the payroll tax cut).
   
   
5. Extending (and finding offsets for) the R&D and several dozen other popular "tax extenders."
   
   
6. Expiration of the AMT (Alternative Minimum Tax) fix at the end of 2012. Without extension of the AMT fix, the provision will impact middle income taxpayers because it is not adjusted for inflation.
   
   
7. Expiration of the Medicare physician payment "doc fix" at the end of 2012. Without extension of the doc fix, deep cuts in Medicare physician payments will automatically go into effect.
   

Congressional Budget Office releases analysis of President Obama's FY 2013 Budget Plan: The CBO analysis, released March 16th, analyzes the President's budget plan using the nonpartisan agency's own economic projections and incorporates revenue estimates prepared by the nonpartisan Joint Committee on Taxation. On net, CBO's estimate of the cumulative deficit for the 2013-2022 period that would result under the President's budget is about 5 percent less than the Administration's estimate. Highlights of the analysis:

1. "CBO's estimates of deficits under the President's budget are generally smaller than those of the Administration...by a total of $294 billion (or 4 percent) for the following 10 years. CBO projects $1.5 trillion (or 3 percent) less in outlays under the President's budget than the Administration does, because of differences both in economic assumptions...and other technical assumptions. CBO's estimates of revenues under the President's budget are also lower than the Administration's--by $1.2 trillion (or 3 percent)--primarily because of differing economic assumptions (particularly about wages and salaries)."
   
   
2. CBO's analysis shows that under the President's proposals the deficit would decline in 2013 to $977 billion, or 6.1 percent of GDP; and would decline further relative to GDP in subsequent years, reaching 2.5 percent by 2017, but then would increase again, reaching 3.0 percent in 2022.
   
   
3. At the end of 2022, debt held by the public (the best measure of the nation's debt burden) would stand at $18.8 trillion or 76 percent of GDP -- compared to CBO's "alternative" (realistic) baseline projection of debt rising to 94 percent of GDP in 2022 (if no policies are changed). "Deficits and debt under the President's budget," according to CBO, "would be significantly smaller than the amounts projected in the alternative fiscal scenario." However, many economists believe that fiscal stability lies at about 60 percent of GDP.
   
   
4. The CBO analysis notes that the President proposes to eliminate the automatic budget cuts scheduled to go into effect in January, boosting outlays by about $1 trillion over the next 10 years. The President proposes to replace the costs savings by allowing tax cuts for upper income earners to expire, along with various healthcare and other entitlement reforms.
   

CBO Analysis

See US Budget Alert archives (click at top of this page) for a summary of the President's Budget

House passes bill to eliminate Medicare cost-cutting board: On March 22d, the House passed legislation to repeal provisions in the Affordable Care Act (health care reform) that established a Medicare cost-cutting board. The 15-member Independent Payment Advisory Board is empowered, beginning next year, to determine whether projected Medicare expenditures will exceed target levels and submit proposals to Congress to eliminate the overage. The Board's proposals would take effect unless Congress enacts alternative cost savings.

GAO releases 2012 "Opportunities to Reduce Duplication, Overlap and Fragmentation, Achieve Savings, and Enhance Revenue"....The report identifies 32 areas of "duplication, overlap, and fragmentation" across the budget, and 18 areas of "other cost savings or revenue enhancement opportunities." Link to report

Panetta says defense cuts should be averted...Last summer's Budget Control Act requires that the Office of Management and Budget implement nearly $500 billion in automatic defense cuts (and an equal amount in nondefense cuts) beginning in January 2013 and continuing through 2021. As reported by Congressional Quarterly, Defense Secretary Leon Panetta said on February 28th that he will work with Congress "to develop some approach that can de-trigger sequestration before it happens."

There is broad agreement in both political parties that the automatic cuts are bad defense policy, although the path forward to avoid the cuts remains unclear. President Obama has vowed to veto any efforts to simply repeal the cuts, insisting on alternative budget savings -- a view shared by deficit hawks in Congress.

The difficulty is finding alternative cuts which Democrats and Republicans can agree on. The Administration has proposed allowing the Bush tax cuts to expire for taxpayers earning over $250,000, but Republicans strongly oppose allowing the top tax rate to return to 1990s levels. House Armed Services Chairman Buck McKeon (R-CA) has proposed a one-year delay in the cuts, paid for through reducing the size of the federal workforce over the next decade. Panetta said Congress should not seek to "de-trigger sequestration on the backs of the civilian workforce" and said the Pentagon's civilian ranks are already declining.

President transmits FY 2013 Budget to Congress....The President's FY 2013 budget proposal lives within the tight discretionary spending caps adopted last summer in the Budget Control Act. The deficit would fall from $1.3 trillion this year to $901 billion in FY 2013 -- a reduction from 8.5 percent of GDP this year to 5.5 percent next year.

The budget plan proposes to cancel the $1.2 trillion in automatic spending cuts scheduled to go into effect in January of 2013, and instead proposes alternative spending cuts and new revenues including $1 trillion from not extending the Bush tax cuts for upper income earners and $600 billion from health care and other entitlement reforms.

Debt held by the public (the best measure of the nation's debt burden) would level out over the next 10 years at about 77 percent of GDP, as compared to CBO's "alternative" (realistic) baseline projection of debt rising to 94 percent of GDP in 2022 (if no policies are changed). Many economists believe that fiscal stability lies at about 60 percent of GDP. (Debt was over 100 percent at the end of World War II, but declined very rapidly because all of the debt was domestically held and the U.S. economy was booming in a world dependent on the U.S. for postwar rebuilding.)

There's been a great deal of political banter since release of the President's budget about how much his proposals would actually reduce annual deficits, but annual deficit reduction numbers are often quite misleading since they depend on what baseline one adopts as a starting point. The best measure of budget proposals is how they would impact over time debt held by the public as a percentage of GDP, and on that score, the President's plan makes significant, but not sufficient, progress.

Highlights of the President's Budget:

1. As required by last summer's Budget Control Act, total discretionary spending under the President's plan (defense and nondefense) would decline as a percent of GDP from 8.7 percent in 2011 to 5.0 percent in 2022. If the automatic cuts scheduled to begin next January take effect -- and they will unless the President and Congress agree to change the law -- discretionary spending would fall much further. Many analysts are concerned about the potential negative impact the automatic cuts will have on the U.S. economy.
   
   
2. Discretionary spending freeze: The Budget Control Act's spending caps nearly freeze discretionary spending for 2013 at this year's dollar level, without any upward adjustments for inflation, population growth, the aging of the population, or rising health care costs. All of those costs have to be absorbed within the freeze. Also absorbed within the freeze are the cost of short-term job creation measures outlined below.
   
   
3. Short-term job creation measures: extension of the payroll tax cut and unemployment benefits for the rest of 2012 (see the article above); accelerated investment of $50 billion in roads, rails, and runways; $30 billion to modernize schools; $30 billion to help states and localities retain and hire teachers and first responders; $1 billion for a veterans job corps; creation of a $10 billion National Infrastructure Bank to support transportation, water, and energy projects through loans and loan guarantees; $8 billion for community colleges to improve access to job training; and a new $6 billion HomeStar program for energy and home improvement investments. Tax incentives for job creation include: extension of 100 percent expensing allowing businesses to write-off the full amount of new investments; extension of the New Markets Tax Credit; a temporary new tax credit for businesses that add jobs; and elimination of capital gains taxes on small businesses.
   
   
4. Education: $850 million for a fifth round of "Race to the Top" competitive grants; a new $5 billion challenge grant for states to attract quality teachers; doubling work-study jobs over the next 5 years; prevent subsidized "Stafford" student loan interest rates from doubling this summer (as scheduled under current law); make permanent the "American Opportunity Tax Credit" to help students and families afford college; and create a new $1 billion "Race to the Top" grant competition for states that contain college costs.
   
   
5. Boost R&D by making permanent the research & experimentation tax credit; as well as increasing funding for the National Science Foundation, the Dept. of Energy's Office of Science, and the National Institute of Standards and Technology Labs.
   
   
6. Revenue Increases: allow the Bush tax cuts to expire in 2012 for upper income taxpayers generating $968 billion in new revenues over 10 years (used to offset the cost of eliminating the automatic cuts); reduce the estate tax exemption to $3.5 million and increase the rate to 45 percent; reinstate the limitations on personal exemption and itemized deductions for high income earners; repeal fossil fuel tax subsidies; and end the tax break on carried interest that allows fund managers to pay capital gains rather than ordinary income tax rates.
   
   
7. Revenue Decreases: permanently extend the cuts for those with incomes under $200,000 ($250,000 for couples) costing $3.5 trillion over 10 years; permanently index the Alternative Minimum Tax to inflation so it doesn't impact middle income taxpayers; reduce the employee payroll tax from 6.2 percent to 4.2 percent through the end of 2012; continue expanded Earned Income Tax Credit benefits; make permanent the R&D tax credit; reform and expand the Low-Income Housing Tax Credit;
   
   
8. Proposed entitlement reforms: Reduce Medicare spending $300 billion over 10 years by increasing rebates from drug manufacturers, reducing post-acute care payments, increasing premiums for upper income beneficiaries, increasing the Part B deductible, reducing bad debt, reducing support of teaching hospitals, reducing rural hospital payments, requiring copayments for home health services, and imposing a premium surcharge for beneficiaries with generous medigap coverage. Reduce Medicaid spending by $56 billion over 10 years by restricting the use of "provider taxes" for financing the state share of Medicaid expenses, adjusting the Medicaid matching rate, reducing payments for uncompensated care, and limiting reimbursements for durable medical equipment. Increase TRICARE (military healthcare) pharmacy benefit copayments.
   
   The President's budget also proposes to eliminate the flawed current law formula that calls for increasingly drastic cuts in Medicare physician payments. Technically, the "cost" of this so-called "doc fix" is $438 billion over 10 years, although there is a bipartisan consensus that this payment formula is grossly unrealistic and will never be allowed to take effect. Consequently, the Congressional Budget Office assumes a "doc fix" in its "alternative" (realistic) baseline.
   
   
9. Defense: Compared to the President's 2012 budget request, the president is proposing to spend $487 billion less over 2012-21 in order to remain within the Budget Control Act spending caps. Not included in the caps is the cost of war funding, and the budget assumes $97 billion of war funding for FY 2013 which is nearly $30 billion below FY 2012. Non-war funding would be about $5 billion below last year. The President's defense budget does not include the nearly $500 billion in additional cuts through 2021 that will occur if automatic budget cuts go into effect in January of 2013 (due to the failure of last fall's congressional Super Committee).

Link to President's FY 2013 Budget

House Budget Committee Democratic Analysis of President's Budget

Senate Budget Committee Republican Analysis of President's Budget

 

The Fiscal Calendar:

- March 28-29: House Floor consideration of FY 2013 Budget Resolution

Below:
The Top 5 Stories We’ll be Watching in 2012
The 3 Big Stories of 2011:
Budget Control Act; Super Committee & Automatic Budget Cuts; Payroll Tax Cut
Key Numbers. . . From RealTimeNumbers.com


The Top 5 Stories We’re Watching in 2012

1.      The Debt Ceiling

The House voted largely along party lines (239-176) on January 18 to disapprove a $1.2 trillion debt ceiling increase requested by the President. However, the Senate rejected the House measure 44-52 on January 26, clearing the way for the statutory debt ceiling to increase on January 27, 2012.

The debt ceiling increase was never in doubt since the President was poised to veto any measure blocking the increase. Failure to raise the ceiling would have led to a catastrophic U.S. default. It is unlikely the debt ceiling will need to be raised again until after the November elections.

Background: Last summer's Budget Control Act triggered an initial $400 billion increase in the debt ceiling in August; and an additional increase of $500 billion in September (when a disapproval resolution only passed the House). A third increase of $1.2 trillion occurred on January 27, 2012, after the Senate rejected a House resolution to block the increase. Congress has voted to raise the debt ceiling 11 times since 2001 due to annual deficits and the requirement that Social Security and other federal trust funds invest their receipts in U.S. securities.

As discussed below, under major stories of 2011, last summer’s debt ceiling fight was an example of Members of Congress using the imminent debt crisis and the threat of a U.S. default to force changes in spending policies – in that case, the adoption of tight spending caps on domestic spending and the creation of the now-defunct Super Committee.

A similar debt ceiling stand-off is likely to occur again towards the end of 2012, when the Treasury's borrowing authority is again expected to bump up against the statutory debt limit.

2.      Payroll Tax Cut, Unemployment Benefits Extension, and "Doc Fix" 

On February 22, 2012, President Obama signed the Middle Class Tax Relief and Job Creation Act of 2012, which: (1) extends the payroll tax cut through the end of this year, reducing the employee payroll tax rate from 6.2 to 4.2 percent; (2) extends long-term unemployment benefits through the end of this year (although reducing maximum benefit weeks from 99 to 73 weeks); (3) nullifies the scheduled 27 percent cut in Medicare physician payments, extending current payment rates through the end of this year (aka the "doc fix"); and (4) extends Temporary Assistance for Needy Families (TANF) through September 30.

The costs of the payroll tax cut are not "offset," but the unemployment extension and doc fix are paid for by selling electromagnetic spectrum, raising the retirement contribution level of new federal employees, and cutting $5 billion from the Prevention and Public Health Trust Fund established by health care reform. While some in Congress strongly opposed the decision not to offset the nearly $100 billion cost of the payroll tax cut, others point out that for a stimulus measure to impact the economy it should not be offset.

3.      FY 2013: A tough year ahead for appropriations - spending caps and automatic cuts

Release of the President’s FY 2013 Budget on February 6^th will kick off the FY 2013 budget process.  FY 2013 will be a tough year for appropriations. The spending cap enacted last summer for FY 2013 is $1,047 billion, as compared to last year's cap of $1,043 billion -- a virtual freeze that provides no adjustments for inflation, population growth, rapidly escalating veterans healthcare expenditures, or growing infrastructure needs. (Adjustments are limited to war spending, disaster relief, and other emergencies.)

In addition, in January of 2013 automatic spending reductions will kick in amounting to nearly $100 billion in defense and nondefense appropriations -- due to the failure of last fall's congressional Super Committee to reach a deficit reduction agreement. (See major stories of 2011, below, for an explanation of the automatic cuts.)

Moreover, with this year being a highly contentious election year, expect the appropriations process to be brimming with posturing by both political parties over defense and homeland security spending levels, insufficient funding for infrastructure, and a host of policy riders to appropriations bills. As October 1^st approaches, it is unlikely that Republicans and Democrats will be able to come together to pass full year appropriations for FY 2013, and will likely resort to a continuing resolution to keep the government running until after the November 6 elections. 

4.      December 31: Will the Bush tax cuts expire?

Background:  The Bush tax cuts – enacted in 2001 and expanded in 2003 – were originally set to expire at the end of 2010, due to a Senate rule designed to prevent increases of federal debt over the long-term (the so-called Byrd Rule). 2010 saw an intense political debate about whether to make permanent the lower rates and expanded credits and deductions.  Deficit hawks raised concerns about extending the cuts. Republicans sought a permanent extension of all tax cuts arguing that increasing taxes on upper income Americans would slow economic growth. The White House and congressional Democrats sought to extend the cuts for the middle class but allow tax rates on upper income taxpayers to return to pre-Bush levels to reduce projected deficits.    In the end, after Democrats took a beating in the 2010 mid-term elections, the White House agreed to a two-year extension of all the cuts.

The debate over extension of the Bush tax cuts returns to center stage this year, with the cuts expiring at the end of 2012.  Much of the FY 2013 budget process will focus on efforts in the House to permanently extend all of the tax cuts and Senate efforts to allow the cuts to expire for upper-income taxpayers.  Also tied in with this issue is the fate of dozens of expired tax incentives (the so-called “tax extenders”) such as the R&D tax credit, the New Markets Tax Credit and other popular measures, as well as dealing with the Alternative Minimum Tax which continues to threaten middle class taxpayers.

Despite all of the partisan posturing over the fate of the Bush tax cuts, there is growing agreement among Members in both parties, that the tax code needs a major overhaul in 2013 to reduce the vast number of credits and deductions (now costing over a trillion dollars per year).  Where the agreement dissolves is how to use the budget savings – for deficit reduction, to reduce individual and corporate rates, or some combination of the two approaches. This movement for sweeping away many of the credits and deductions and simplifying the code gained a big head of steam when endorsed by both the Domenici-Rivlin and Simpson-Bowles Debt Reduction Commissions.

5.      Will Congress repeal / modify the automatic defense and domestic spending cuts before they take effect in January 2013?  

Last year’s debt ceiling deal required that if the congressional Super-Committee failed to report $1.2 trillion in deficit reduction over 10 years, automatic cuts kick in for both defense and domestic spending.  As explained below, under “Big Stories of 2011,” the automatic cuts will require between 8 and 10 percent cuts in total defense spending in each year between 2013 and 2021, and between 5 and 8 percent cuts in total nondefense spending in each year through 2021 (with “cuts” being measured against a baseline that grows with inflation).

Republicans have already introduced legislation to roll back the defense cuts and Democrats are deeply concerned about the domestic cuts. However, repeal is unlikely.

President Obama has promised to veto any legislation to repeal the automatic cuts unless accompanied by an alternative deficit reduction plan that is “balanced” – with new revenues as well as entitlement reforms. 

Given the current political stalemate, the prospects for a comprehensive alternative plan emerging prior to November 6^th are slim at best.  However, depending on the outcome of the election, modification of the automatic cuts following Thanksgiving or immediately after the New Year are possible – particularly in conjunction with legislation addressing the expiration of the Bush tax cuts and various other expiring tax provisions, as well as a necessary debt ceiling increase.

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The 3 Big Stories of 2011


1. August 2011 Debt Ceiling Agreement:  The August 2011 Debt Ceiling Agreement included more than $750 billion in spending cuts (compared with what spending would have been if appropriations were allowed to grow with inflation) by placing statutory caps on discretionary spending for 10 years. Including interest savings, this totals up to deficit reduction of more than $900 billion.  In addition, the Debt Ceiling Agreement established a “Super Committee” to achieve another $1.2 trillion in deficit reduction.  

The total deficit reduction of about $2.1 trillion over 10 years —even though an enormous reduction in discretionary spending—is not sufficient to stabilize the projected explosion of U.S. debt. The Domenici-Rivlin Bipartisan Debt Reduction Task Force estimated that fully stabilizing the debt for the long-term would require nearly $6 trillion in deficit reduction over 10 years.

Background:  In August, the Treasury was close to hitting the statutory ceiling on the (gross) U.S. debt (about $15 trillion), threatening a possible default.  Deficit hawks used the threat of default to force enactment of the Budget Control Act of 2011 which had two key provisions:

1. The BCA imposed tight caps for the next 10 years on total discretionary spending. The programmatic impact of these reductions will be determined each year in the appropriations process.  (“Discretionary spending” refers to programs that are annually appropriated, as opposed to “entitlements” like Social Security and Medicare – the costs of which are driven by benefit formulas written into the law.) 

The BCA’s 10-year spending caps are very tight and will significantly impact many programs – both defense and non-defense.  Under the spending caps, total discretionary spending remains well below FY 2011 levels for the next decade (see the table below).

Although, recent political rhetoric might suggest that the caps are not significant, the challenges for policymakers are daunting because: (1) the costs of a growing and aging population must be absorbed within declining spending caps; (2) vital transportation infrastructure repairs and expansions must be absorbed within the caps; (3) the rapidly growing costs of veterans health care must be accommodated; and (4) the costs of inflation must be fully absorbed. (Adjustments are permitted for emergencies and military operations.)

To put this in perspective, under the spending caps total discretionary spending declines as a percent of Gross Domestic Product (GDP) from 9% in FY 2011 to 6.1% in FY 2021.  Since FY 1962—the first year for which data is available—discretionary spending has only been that low as a percent of the economy in one other year.

The spending caps are enforced through automatic across-the-board cuts that are implemented by the Office of Management and Budget if the cap for any year is exceeded. 

 

2. The Debt Ceiling Agreement also established a Joint Select Committee on Deficit Reduction – the so-called “Super Committee” of 6 Democrats and 6 Republicans – which was required to report to the full Congress by Thanksgiving a plan to further reduce projected deficits by $1.2 trillion over 10 years.  Republicans hoped the Super Committee would tackle entitlement reform and Democrats hoped the Super Committee would tackle tax reform (but as explained below, the Super Committee failed).

2. Failure of Super Committee triggers automatic cuts:  On November 21^st, the Super Committee announced failure to reach agreement, setting up automatic spending cuts in January 2013.

Under the terms of the Budget Control Act, failure of the Super Committee to come up with $1.2 trillion in budget savings will trigger in January of 2013 automatic across-the-board cuts that will drive discretionary spending even lower than the already established caps. Automatic cuts will also be made in some mandatory (entitlement) programs, primarily Medicare.

Here’s how the automatic cuts will work (in plain English):

- The automatic cuts are designed to save $1.2 trillion by FY 2021, since the Joint Committee failed to do so.  Excluding interest savings, this requires about $1 trillion in program cuts.

- The cuts are to be divided evenly between defense and non-defense programs – about a half trillion from defense and a half trillion from non-defense over the 9 years.

- The cuts are to be spread evenly over the 9 years (2013-2021), requiring about $55 billion in cuts from defense and $55 billion in cuts from non-defense in each of the nine years.

- In FY 2013, the required budget cuts of $55 billion in defense and $55 billion in nondefense, are to be carried out through across-the-board cuts.  The Congressional Budget Office (CBO) has calculated that this will require 10 percent cuts in all defense accounts, and 7.8% in all non-defense accounts (except for those programs that are exempted by law).  These are cuts in addition to those already required to comply with the spending caps enacted by the Budget Control Act.

- Most of the cuts will come from discretionary spending programs (i.e., programs that are annually appropriated) because most of the entitlement programs – such as Social Security, Medicaid, Veterans Compensation and Food Stamps -- are exempted by law.  In addition, the President has discretion to exempt military pay from the automatic cuts.

- Medicare, however, is only partially exempted and is subject to a 2 percent cut in most areas of the program in each of the years, amounting to $117 billion in benefit cuts over 9 years.

- In each of the years after FY 2013, the cuts are not required to be across-the-board as long as they produce the required $55 billion in defense and $55 billion in non-defense savings.  If Congress fails to produce the required amount of savings, the Office of Management and Budget is required to make up the difference through across-the-board cuts.

- The automatic spending reductions required in each of the 9 years are estimated by CBO as shown in the table below. The cuts are measured against the spending caps imposed by the Budget Control Act of 2011 in the case of discretionary spending, and against projected spending in the case of mandatory programs.

Amt. of Reductions (billions)
	2013	2014	2015	2016	2017	2018	2019	2020	2021
Defense	$55	$55	$55	$55	$55	$55	$55	$55	$55
Non-Defense:
-Discretionary	$43	$38	$37	$36	$36	$36	$34	$34	$33
-Medicare	$6	$11	$12	$13	$13	$14	$15	$16	$17
-Other*	$6	$5	$6	$5	$5	$5	$5	$6	$5
Percentage Reductions to Implement the Automatic Cuts
Defense	10%	9.8%	9.7%	9.5%	9.3%	9.1%	8.9%	8.7%	8.5%
Non-Defense:
-Discretionary	7.8%	7.4%	7.1%	6.8%	6.6%	6.4%	6.1%	5.8%	5.5%
-Medicare	Reductions capped at 2% in each year
*Refers to non-exempt mandatory (mostly entitlement) programs      Source: CBO, Updated January 2012

The following table shows the resulting dollar levels for discretionary spending following implementation of the automatic cuts:

Limits on Discretionary Budget Authority for Fiscal Years 2013 to 2021 (billions of dollars)
	2013	2014	2015	2016	2017	2018	2019	2020	2021
Caps Set in the Budget Control Act
Defense	546	556	566	577	590	603	616	630	644
Non-Defense	501	510	520	530	541	553	566	578	590
TOTAL	1,047	1,066	1,086	1,107	1,131	1,156	1,182	1,208	1,234
Effect of Automatic Cuts
Defense	-55	-55	-55	-55	-55	-55	-55	-55	-55
Non-Defense*	-43	-38	-37	-36	-36	-36	-34	-33	-33
Revised Caps
Defense	**	501	511	522	535	548	561	575	589
Non-Defense	**	472	$483	493	505	517	531	545	557
TOTAL	**	973	$994	1,016	1,040	1,066	1,093	1,120	1,146
*Medicare and other mandatory cuts increase the non-defense cuts to $55 billion per year **The 2013 reductions are implemented through across-the-board cuts, but the caps are not technically reduced. Source: CBO, Updated January 2012

 

The idea behind the automatic cuts is that they would serve as a “Sword of Damocles” to force agreement by the Super Committee and, in the event of failure, would guarantee an additional $1.2 trillion of deficit reduction – and possibly cause Congress to act in 2012 on legislation to replace the across-the-board cuts with a more sensible approach.

However, the automatic cuts won’t solve the debt crisis and have some serious flaws...The cuts fail to address the largest drivers of projected debt – entitlement growth driven by the aging of the population and health care costs growing faster than the economy – and a deficient tax system that loses too much in special deductions and credits and places the U.S. at a competitive disadvantage.  In addition, some argue that the automatic cuts are economically risky, because they’ll reduce government investment in highways & bridges, schools, public transit, airport modernization, and health research when the economy is weak and needs public investment. 

3. Two-month extension of payroll tax cut:  After a protracted political showdown, Congress in late December again kicked the can down the road approving an extension of the payroll tax cut and unemployment insurance for a mere two months.  This continuing logjam comes at a time when the expiration of tax relief for the middle class and unemployment benefits could further slow the economic recovery. 

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Key Numbers.... from RealTimeNumbers.com

Fiscal Year 2011 ended with a budget deficit of $1.3 trillion, about the same as the previous year – but a bit lower as a percentage of GDP: 8.7% as opposed to the previous year’s 9%.  This marked the third year in a row in which deficits exceeded $1 trillion – having exploded upward in 2009 due to the budgetary effects of the Great Recession and policies implemented in response to it. From FY 1946 to FY 2008, budget deficits averaged 1.7% of GDP and exceeded 5% only 3 times (’46, ’83, and ’85). From FY 2009 – 2011, deficits will average roughly 9.4% of GDP.  The Federal Debt Held by the Public (now about $10.5 trillion) has grown from 40% of GDP in 2008 to 69% in 2011. How much are we really spending?  With all the political spinning, it’s difficult to get a clear idea of what’s really going on with federal spending.  The nonpartisan Congressional Research Service recently reported that last year’s Debt Ceiling Agreement “was enacted after a period of rapid growth in discretionary spending....Between FY2000 and FY2009, discretionary spending rose by 8% per year, on average. Discretionary spending rose by 8.9% in FY2010. Increases in discretionary spending since FY2000 can be attributed primarily to a rise in defense spending throughout the decade, and an increase in spending as a result of economic stimulus programs since 2009,” most of which will occur by FY2012.  However, if one looks at the big picture of total government spending, the main drivers will increasingly be Medicare, Medicaid, and Social Security due the aging of the population and health care costs growing faster than the economy. Shrinking Middle Class...Nearly one of two Americans (more than 146 million people) are now classified as either in poverty or “low income,” according to new U.S. census data.  “Low income” is defined as those earning between 100 and 199 percent of the poverty level. Budget Costs of TARP...The Troubled Asset Relief Program (TARP) was created in October 2008 by the Economic Stabilization Act following the financial meltdown.  Initially capitalized at $700 billion, it was later reduced to $475 billion (by the Dodd-Frank legislation).  Due to repayments by banks and the auto industry, the nonpartisan Congressional Budget Office (CBO) now estimates the overall budget cost to have dropped to $19 billion.

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