Issue Summary: Budget and Tax (Basics) updated 6/7/2004
Issue Summaries contain a quick reference to Centrists.Org policy ideas. They will be revised and updated periodically for clarity and usefulness, and as events and policy ideas change. Questions or comments? Please contact us at information@centrists.org .
Outline:
Taxes, Appropriations, Entitlements and Compassionate Conservatism
Two Big Lies on the Budget
Centrist Budget and Tax Strategy
Long-Term: Hold the Debt/GDP Ratio Under 50 Percent, Permanently
Short-Term: Raise Revenues to 19% of GDP and Lower Spending to 20% Percent of GDP By 2007
Action Steps:
A Tax and Budget Reform Commission
Re-Balance Medicare Benefits and Reforms
A Serious Discussion on Social Security Reform
Tax Reform Instead of Tax Cut Repeal
Back to Pay-As-You-Go; CBO and Process Reforms
Sunshine on the Appropriations Process
Detailed Issue Summary: Budget Process
Subcategories:
Brief History of Balanced Budget Politics
How Gimmicks Distort Budget and Tax Policy -- Good Budget Rules Gone Bad
New Rules for Offsets -- Pay-As-You-Go For Consumption, Save-As-You-Go
Detailed Issue Summary and Index: Centrists.Org No-BS Long-Term Budget Baseline
Taxes, Appropriations, Entitlements and Compassionate Conservatism: The economy seemed to recover well in the last three quarters of 2003. After several false starts since the 2001 recession, we hope this recovery will be enduring.
But the federal budget is in bad shape. Revenues are shrinking toward 16 percent of GDP, the lowest level since the 1950s. Meanwhile spending is soaring above 20 percent of GDP, driven by across-the-board increases, not just defense- and security-related spending.
In the past, legislators from both sides of the aisle occasionally put aside their differences to craft bipartisan compromises on the budget.
That doesn't happen now. Republican economic ideology is being driven by tax cut mania. Republican leaders actively penalize colleagues who hesitate to support the most irresponsible, regressive tax cuts.
Democratic ideology could be summarized as: "All entitlements all the time." Democratic leaders in Congress have succeeded in preventing all but a few moderate Democrats from even considering Social Security reform, or from supporting a smaller-sized prescription drug benefit in Medicare.
Tax-cut crazies on the right and entitlement zealots on the left are uniting in a new and dangerous circle of irresponsibility. With their reckless unconcern for the fate of the national treasury, the far right and far left have more in common with each other than with the remaining "fiscal discipline" centrists.
Meanwhile, the march of appropriations rolls on. Non-defense discretionary spending hit 3.9 percent of GDP in 2003, its highest level since 1985. Some of that is new spending for homeland security, but much of the increase is appropriations business as usual. Tax cuts and entitlement expansions make news while legislators quietly agree on higher and higher appropriations.
The boom in appropriations can't be blamed on any political faction. Left, right, and middle have been complicit.
Most moderate Republicans have been caught up in the rhetoric of "compassionate conservatism," which has come to mean: "tax cuts without offsetting spending cuts."
Many moderate Democrats have also been swept up in the surge of appropriated spending. It's hard to fight the gravy train.
Two Big Lies on the Budget: Politicians get in trouble when they offer small lies or fibs. The media jumps into "gotcha" mode without hesitation. Al Gore said he invented the Internet, President Bush said Iraq bought nuclear material in Africa -- that sort of thing.
However, on really big, important, purposeful misrepresentations of budgetary facts, the media is generally silent. That's partly understandable, because budgetary deception is hard to nail down -- definitions are murky enough that commentators are tempted to just report what each side says, without digging into who's really lying.
Since 1998, federal budget politics has been dominated by two big lies: President Clinton's lie that deferring popular tax cuts would "save" entitlement programs, and President Bush's big lie that tax cuts do not adversely affect the budget.
President Clinton promised that Social Security and Medicare could be "saved" if voters simply delayed tax cuts and built up budget surpluses. And by the way, we could add an expensive drug benefit to Medicare without doing much to reform the program. That logic was doubtful from the beginning, and it did not pass the test of time. Voters reckoned Congress wasn't going to restrain spending, and they decided they should take the tax cuts after all.
President Bush says that tax cuts are always good for the economy. He purposefully implies that tax cuts do not adversely affect the federal budget. In spite of the President's misleading rhetoric, tax cuts do not pay for themselves in terms of faster economic growth, at least not at current tax rates. And in all but the most extreme deflationary scenarios, the resulting deficits will slow long-term economic growth by raising the cost of private investment. Over time, the negative impact of uncontrolled deficits can overwhelm any positive effects of tax cuts on incentives to work or invest.
These two big lies have dominated budget politics over the last five years. The result has been a massive switch from budget surpluses to deficits. Only straight talk and tough choices will bring the budget back into balance.
Centrist Budget and Tax Strategy: Under realistic political assumptions, the national debt will rise from about 40 percent of GDP in 2004 to over 50 percent by 2012. That is before the baby boom generation retires and explodes entitlement costs, forcing the debt-to-GDP ratio toward 100 percent in the following decade.
This must not be allowed to happen. Centrists' budgetary goals can be stated several ways:
1. Long-Term: Hold the Debt/GDP Ratio Under 50 Percent, Permanently. In 2001, the national debt hit an 18-year low of 33 percent of GDP, the lowest level since 1983. Since then, however, the debt-to-GDP ratio has jumped to 36 percent in 2003, and is likely to be about 38 percent of GDP in 2004.
Under realistic political assumptions, including the assumption that tax cuts do not expire on their scheduled "sunset" dates -- Centrists.Org now projects that the public debt will reach 50 percent of GDP by 2012, and will climb rapidly thereafter as the baby boom generation retires and joins the entitlement rolls. By 2025, under current projections, the debt would approach 100 percent of GDP.
Congress and the President must not allow this to happen.
A maximum debt-to-GDP ratio of 50 percent leaves ample room for the federal government to deal with emergencies, most wars, recessions, demographic changes, or any other necessities or priorities.
Even the expensive transition costs of entitlement reforms can be financed while still keeping the debt below 50 percent of GDP over the next two decades. (And thereafter, entitlement reforms will help keep Social Security, Medicare, and Medicaid from causing deficits and debts to drift ever higher under pressure of an aging population.)
Importantly, centrists should not allow partisans on either side to claim to hold their budgets under the 50 percent debt ratio using dubious claims. For example, we often hear unfunded assertions about the economic impact of tax cuts or the amount of waste and fraud than can be cut from spending budgets. Likewise, dubious "sunset" provisions or "rosy scenarios" must be condemned.
Long-term budgets -- extending 30 to 75 years to capture demographic changes -- should include realistic spending and revenue projections.
2. Short-Term: Raise Revenues to 18 Percent of GDP and Lower Spending to 19 Percent of GDP By 2007. Revenues are projected to total less than 16 percent of GDP in 2004. Spending will be about 20 percent of GDP. The gap of over 4 percent of GDP -- the federal deficit -- is too large and must be narrowed over the next several years.
The economy has now recovered sufficiently that centrists should not be swayed by politicians' claims that restraining spending growth or raising tax revenues will cause a return to recession. At this point, the lack of confidence that stems from the federal government's lurch toward irresponsible budgeting is the greater danger.
Raising revenues by 2 percent of GDP beginning in 2005 (compared with a baseline that assumes the tax cuts do not "sunset" on their scheduled expiration dates) will not be easy.
However, some bounce-back in revenues will likely accompany the economic recovery in 2004 and 2005. If the stock market and corporate profits continue their recovery, taxable incomes may rise slightly faster than GDP, and revenues will probably drift up to around 17 percent of GDP within a year or two.
However, some of the Bush tax cuts will have to be rescinded -- totaling an additional 1 percent of GDP -- to reach the short-term revenue target of 18 percent of GDP by 2007.
Likewise, spending restraint will not be easy to impose. On its current trajectory, federal spending is likely to grow to about 21 percent of GDP by 2010. It must instead be held to 19 percent or below.
There are two reasons spending will be especially hard to restrain. First, Congress feels that as long as President Bush can use deficits to finance his tax cuts, legislators should be able to use deficits to fund their spending priorities as well. (This is the opposite of what many anti-tax conservatives believed would happen when taxes were cut. They reckoned the tax cuts would cause spending restraint by "starving the government." But that has turned to be a mistaken judgment, as legislators continue to spend and the deficits mount with no constraint.)
Second, defense and international spending, as well as spending for homeland security, will remain high in the coming years.
However, Congress must tighten its belt. There is no reason funding for many domestic programs couldn't be frozen for the next several years. For example, health research, a sacred cow on both sides of the political aisle, has increased dramatically in the last 5 years. It should at least be frozen.
Likewise agriculture subsidies. Subsidies should be restricted to small, owner-farmed operations, not huge agri-businesses. Farm subsidies were designed to help small farmers withstand huge swings in commodity prices. Large agri-businesses can use financial markets to hedge that risk without government assistance.
Action Steps
A. A Tax and Budget Reform Commission to Re-Build the Political Will for Budgetary Restraint and Responsibility. Expecting Congress and the President to submit austere and responsible budgets right now would be too much to wish for. Legislators have fully swallowed the "free lunch" philosophy on both tax cuts and spending. They are motivated by two big, contradictory rationalizations.
First, they believe that the economy needs deficit spending to speed the recovery from the 2001 recession. The contradiction is that they are voting not just for deficit spending now, but also for the future, when the economy would presumably not need extra stimulus (and when deficit stimulus would actually be harmful).
Second, they believe tax cuts and spending programs will somehow magically pay for themselves in the future. The contradiction is that they simultaneously believe this will occur in two opposite ways: either because economic growth is much faster than expected, causing a surge in incomes and tax revenues, or because high deficits will cause an economic crisis, which will force Congress to cut spending and reduce the deficits.
The immediate action step, therefore, is public education -- to point out the contradictions and force lawmakers back into reality on the budget. A high-profile tax and budget commission, led by Congressional leaders and the Administration's top economic and budget policymakers, might help refocus the media and the public on the benefits of responsible, no-BS budgeting.
B. Re-Balance Medicare Benefits and Reforms. The Medicare drug benefit enacted in late 2003 is unbalanced: The promised benefits will probably turn out to be very expensive and the cost-saving reforms will likely have a limited impact.
In retrospect, it would have been better had the Medicare bill either promised less on the benefit side or added more on the reform side. But what is done is done. Congressional Republicans -- who provided most of the votes for the bill -- got carried away promising drug benefits and mostly flinched on the subject of reform.
In the short run, Congress may even have to add funds for the drug benefit. Lawmakers let their promises to seniors far exceed the capacity of the stated $400 billion (10-year) budget. To make the promises fit, lawmakers fudged on several important aspects of the benefit, cutting corners that they knew would have to be squared back off with additional funding later. That means we may have to add an additional $100 billion in subsequent legislation in 2005 and 2006 just to make sure the promised benefit works, and to smooth over the rough edges in the law that would otherwise cause political problems.
However, in the long run, Congress will have to follow through on tougher reforms to keep Medicare spending under control. Or, it will have to face the public and explain that a more limited drug benefit would be advisable, at least at first.
C. Start a Serious Discussion on Social Security Reform. We expect the Social Security debate during the presidential election of 2004 to be just as shrill and meaningless as ever: Republicans pointing out the attractiveness of personal retirement accounts and Democrats decrying the horrors of "privatization."
The Bush Administration has sent a strong signal that Social Security is not a serious legislative issue by omitting the transition costs of reform from its annual budgets.
It's time to call both the Democrats' and the Administration's bluffs. Centrist policymakers should insist on a thorough and fair discussion of Social Security reform, including its inevitable transition costs. This means that moderate Democrats will have to engage on the real advantages of private accounts as a method of pre-funding Social Security's future budget shortfalls. And it means that moderate Republicans -- many of whom would rather just drop the subject entirely -- will have to come forward and discuss Social Security reform in full candor.
D. Tax Reform Instead of Tax Cut Repeal. The most straightforward way to re-balance the federal budget this decade would be to allow many of the tax cuts granted over the last 3 years to expire on their scheduled "sunset" dates.
It doesn't seem plausible to expect that the gap between spending and revenues -- now about 4 percent of GDP -- can be closed by spending cuts alone. Spending cuts will be important, of course, but with the transition costs of entitlement reform, and continuing defense needs, we can't expect too much from the spending side of the budget.
But canceling President Bush's signature tax cuts would be politically very difficult to do. Therefore, policymakers should concentrate on tax reform. The President could say "my tax cuts were intended to spark a weak economy. However, now it's time to go back through the tax code very carefully, and simplify its workings, improve its incentives, and remove distortions that hurt the economy in the long run."
Of course, tax reform could raise revenues in the long run, which would have the same practical effects as allowing the Bush tax cuts to sunset as planned.
E. Back to Pay-As-You-Go; CBO and Process Reforms. Even if spending cuts alone probably can't return the budget to an acceptable balance, we can make a strong push to prevent further spending increases (and tax cuts) from digging the budgetary hole even deeper.
Congress must return to a strict pay-as-you-go process for new legislation. This is more of a matter of political will than budget process, but several rule changes could help the public better understand the budgetary consequences of proposed laws.
First, Congress must elevate the cost estimates of the Congressional Budget Office (CBO) back to prominence. This could be done by requiring CBO to publish a formal report on legislation costing over a certain amount before conferees (who reconcile House and Senate versions of bills) could be appointed. Alternatively, Congress could place additional reporting requirements on conference agreements. For example, conferees would be required to allow 10-days notice of final legislative language, report language and complete, written CBO estimates of bills, before conference agreements would be allowed to come up for final House and Senate votes.
Second, Congress must require CBO to expand its estimates by including a narrative on the impact of major legislation outside the usual 10-year budget period. Moreover, CBO should be required to discuss the economic implications of any abrupt changes in tax or spending law that could have noticeable economic consequences, such as sudden "sunset" provisions, which, if implemented strictly, could cause significant economic disruption.
Finally, CBO should be required to discuss the impact of major legislation on national savings. For example, there are two kinds of tax cuts: (1) tax cuts where the funds are "new money" to the recipients, and (2) tax cuts where use of the funds is restricted. For example, corporate, personal, excise, or estate tax cuts are mostly new money, which would be funneled mostly into new consumption.
On the other hand, certain payroll tax cuts -- often associated with Social Security reform -- would be shunted into recipients' personal investment accounts. The proceeds could not be used except for retirement purposes. Of course, the funds in such "forced" savings accounts could induce some people to change their consumption or outside savings patterns. But depending on the circumstances, tax cuts associated with new savings or investment accounts could simply convert public savings into private savings with little or no change in overall national (combined public plus private) savings.
Tax cuts for consumption may be useful in a recession, but they are unlikely to improve the prospects for long-run economic growth unless their cost is offset elsewhere in the budget.
Tax cuts that are shunted into personal savings may have less of an impact on capital markets -- even if they are not offset elsewhere in the budget -- because national savings levels would be largely unchanged. Nevertheless, even these sorts of tax cuts would increase the federal deficit, increase the public debt, and raise the amount of interest payments within the federal budget on that debt.
Congress should instruct the CBO to comment on the likely impact of major legislation on national savings and investment, so that lawmakers could get a clearer view of which types of laws would more directly reduce national savings (by boosting consumption) and which laws would not have the same impact on national savings.
F. Sunshine on the Appropriations Process. The appropriations process is totally out of control. Appropriations committee leaders all but require members of Congress on both sides of the aisle to vote for bloated spending bills filled with special "ear-marked" projects in each legislative district. (To vote "No" on principle would hugely disadvantage a member's state or district since the amounts of pork-barrel spending have gotten so large.)
The biggest problem is secrecy. It's very hard for either the public or policymakers to get a good handle on what's actually in appropriation bills and what the various funding amounts mean.
CBO should be required to do more thorough and explanatory reports on appropriations bills at every stage of the process -- House and Senate committee action, House and Senate floor action, conference agreements, and final House and Senate votes -- with a clear lay-out of not just the amounts appropriated, but the special ear-marked projects for each district.
Rather than just producing accounting-style tables, CBO should produce an evaluation of each bill, with comparisons against past outlays, trends in appropriated programs, and so on. Let any member of Congress hold up an appropriation bill that is not accompanied by this sort of report. And let the sun shine on the appropriations process.
Ultimately, appropriations caps are necessary and appropriate. However, Congress has learned many ways to get around caps and otherwise obscure the true appropriations process. Sunshine will be the best disinfectant, and will probably do more than even high-profile caps to keep spending under control.
Links:
Congressional Budget Office Effective Federal Tax Rates, 1997-2000 (August 2003)
Congressional Budget Office Effective Federal Tax Rates, 1979-1997 (October 2001)
