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Posts Tagged ‘Deficit’

Senate Republicans made a striking error in the balanced budget amendment they introduced last week. As written, the amendment would limit federal spending far more than those senators realize or, I suspect, desire.

The Republicans want the budget to be balanced by keeping spending down rather than by raising tax revenues. They thus propose limiting spending to no more than 18% of gross domestic product (GDP). That’s in line with average tax revenues over the past four decades, but well below average spending, which has been just short of 21% of GDP.

So what’s the problem? The way the amendment would implement the spending limit:

Total outlays for any fiscal year shall not exceed 18 percent of the gross domestic product of the United States for the calendar year ending before the beginning of such fiscal year, unless two-thirds of the duly chosen and sworn Members of each House of Congress shall provide by law for a specific amount in excess of such 18 percent by a roll call vote.

The amendment compares spending in one period (the upcoming fiscal year) to the size of the economy in an earlier period (the last complete calendar year). If the amendment were in force today, for example, spending in fiscal 2012, which starts in October, would be limited to 18 percent of GDP in calendar 2010. That’s a gap of 21 months.

As Bruce Bartlett pointed out in analyzing an earlier version of this amendment, that time lag can add up to big money. Why? Because both real economic growth and inflation will expand the economy during those 21 months.

The Congressional Budget Office projects, for example, that nominal GDP will grow about 4.5% annually in the latter part of this decade (the earliest the amendment could go into effect). Over 21 months, that works out to roughly 8% growth. The amendment would thus limit federal spending in those years to about 16.7% of each year’s GDP (16.7% = 18% / 1.08) not the advertised 18%. In 2020 alone that amounts to a difference of more than $300 billion in spending.

That’s a big error.

I doubt that Senate Republicans really want to limit spending to only 18% of GDP. Even the House Republican budget calls for spending of more than 20% of GDP for at least two decades. But if the Senate Republicans are serious, their first step should be to fix the drafting error in their amendment.

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In October 2013, a slightly updated version of this post appeared here.

Since the day of Alexander Hamilton, the United States has never defaulted on the federal debt.

That’s what we budget-watchers always say. It’s a great talking point. One that helps bolster the argument that default should not be an option in Washington’s ongoing debt limit slowdown.

There’s just one teensy problem: it isn’t true. As Jason Zweig of the Wall Street Journal recently noted, the United States defaulted on some Treasury bills in 1979. And it paid a steep price for stiffing bondholders.

Terry Zivney and Richard Marcus describe the default in The Financial Review (sorry, I can’t find an ungated version):

Investors in T-bills maturing April 26, 1979 were told that the U.S. Treasury could not make its payments on maturing securities to individual investors. The Treasury was also late in redeeming T-bills which become due on May 3 and May 10, 1979. The Treasury blamed this delay on an unprecedented volume of participation by small investors, on failure of Congress to act in a timely fashion on the debt ceiling legislation in April, and on an unanticipated failure of word processing equipment used to prepare check schedules.

The United States thus defaulted because Treasury’s back office was on the fritz.

This default was, of course, temporary. Treasury did pay these T-bills after a short delay. But it balked at paying additional interest to cover the period of delay. According to Zivney and Marcus, it required both legal arm twisting and new legislation before Treasury made all investors whole for that additional interest.

Some may quibble about whether this constitutes default. After all, the United States did eventually make its payments. And the disruption applied to only a sliver of its debt – certain T-bills owned by individual investors.

But I think it’s unambiguous. A debt default occurs anytime a creditor fails to make a timely interest or principal payment. By that standard, the United States did default. It was small. It was unintentional. But it was indeed a default.

And the nation still stands. But that hardly means we should run the experiment again and at larger scale. Zivney and Marcus examined what happened to T-bill interest rates as a result of this small, temporary default. They find a surprisingly large effect. As best they can tell, T-bill interest rates increased about 60 basis points after the first default and remained elevated for at least several months thereafter. A simple way to see that is to look at daily changes in T-bill yields:

T-bill rates spiked upwards four times in the months around the default. In November 1978, Henry “Dr. Doom” Kaufman predicted that interest rates would rise. They did. Turn-of-the-year cash management caused rates to fall and then rise as 1978 became 1979. And rates spiked and fell in October 1979 when Paul Volcker announced that the Fed would target monetary aggregates rather than interest rates (the “Saturday night special”).

The fourth big move was the day of the first default, when T-bill rates rose almost 0.6 percentage points (i.e., 60 basis points).There’s no indication this increase reversed in the days that followed (the vertical line on the chart is just a marker for the day of default). Indeed, using more sophisticated means, including comparing T-bill rates to interest on commercial paper, the authors conclude that default led to a persistent increase in T-bill rates and, therefore, higher borrowing costs for the federal government.

The financial world has changed dramatically in the intervening decades. T-bill rates hover near zero compared to the 9-10 percent range of the late 1970s; that means a temporary delay in payments would be less costly for creditors. Treasury’s IT systems are, one hopes, more reliable that 1970s vintage word processors. And one should take care not to make too much of a single data point.

But it’s the only data point we have on a U.S. default. Not surprisingly it shows that even temporary default is a bad idea.

P.S. Some observers believe the United States also defaulted in 1933 when it abrogated the gold clause. The United States made its payments on time in dollars, but eliminated the option to take payment in gold. For a quick overview of this and related issues, see this blog post by Catherine Rampell at the New York Times and the associated comments.

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My latest column at the Christian Science Monitor argues that we can cut spending by raising taxes:

Here’s a shocker: America can cut government spending by eliminating tax breaks.

I know that sounds crazy. Everyone usually talks as if spending and tax breaks are distinct. Spending is what the government gives out or uses for purchases; tax breaks reduce how much revenue it collects.

Reality, however, is a lot blurrier. Hundreds of billions of dollars of spending are disguised as tax cuts.

It’s not hard to see why. Voters like tax cuts more than spending increases. Politicians understand that, so they convert spending into tax breaks.

The ethanol tax credit is a perfect example. Fuel producers qualify for a 45-cent tax credit for each gallon of ethanol they blend into gasoline. Blenders calculate their income taxes like other businesses, then deduct the value of the credit before they send their check to the Internal Revenue Service (IRS).

The ethanol subsidy thus looks like a tax cut, but it’s really government spending in disguise. The Department of Energy could accomplish the same thing by sending out subsidy checks. The same is true for dozens of other tax provisions, such as the business credit for research and development and personal tax breaks for mortgage interest, health insurance, and charitable giving.

Politicians act as if those provisions are tax cuts. That seems plausible. Businesses and families send less money to the IRS because of them.

But think about it. These tax breaks don’t let you keep your money. They pay you for doing what government wants, whether that’s taking out a mortgage, giving to charity, or investing in R&D. What you pay the IRS equals the taxes you owe minus the payments for which you’ve qualified. Those payments are no different from spending; they just happen to be netted against your tax bill.

That doesn’t mean all tax preferences are bad policy. Some support important goals, and the tax system is sometimes the best way to administer a program. The income tax, for example, provides a natural structure for benefits like the earned income tax credit that should vary with income.

It does mean, however, that these provisions should get the same scrutiny as traditional spending programs. Social Security, health care, defense, and domestic spending must all go under the budget knife if we want to avoid unsustainable debts. The middle-class entitlements, business incentives, and social programs embedded in the tax code shouldn’t escape that surgery just because they’re designed as tax breaks.

That’s why many budget hawks believe that cutting these preferences is essential to deficit reduction. The president’s fiscal commission, for example, proposed dramatic cuts to “spending-like” tax preferences as a way to reduce future deficits while lowering – not raising – income tax rates.

That approach has great merit, but has not yet been universally embraced. When Sen. Tom Coburn, a conservative Republican and budget hawk from Oklahoma, recently introduced legislation to eliminate the ethanol tax credit, he drew fierce opposition from some advocacy groups that favor lower taxes. Both Senator Coburn and the advocates favor smaller government. Where they differ is that Coburn recognizes that spending can hide in the tax code.

Trimming tax preferences won’t be painless – many businesses and families would send more to the IRS. But the result would be a fairer, more honest tax code and a broader, more solid base of revenue to pay for government services.

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ht: Bruce Bartlett

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Over at the Moment of Truth project (a continuation of the president’s fiscal commission), Adam Rosenberg and Marc Goldwein make a compelling case that the government should use a different inflation measure when calculating cost of living increases and indexing the tax code:

Maintaining purchasing power in spending programs and indexing various parts of the tax code is an important policy goal. However, policymakers should ensure that the most accurate measure of inflation is being used.

To correct the problem of over-indexation, many have proposed switching to the chained CPI [consumer price index] to provide a more accurate measure of inflation for indexed provisions in the federal budget. This switch was recommended by the National Commission on Fiscal Responsibility and Reform (“Fiscal Commission”) and the Bipartisan Policy Center ‘s Debt Reduction Task Force (“Domenici-Rivlin”). It has been incorporated into a large number of other plans, including from the Heritage Foundation on the right and the Center for American Progress on the left. An overwhelming majority of economists from both parties agree that the chained CPI is far more accurate measure of inflation than the CPI measurements currently in use.

In addition to improving technical accuracy, switching to chained CPI would have the secondary benefit of reducing the deficit – by about $300 billion over the next decade alone.

For the reasons they mention, I endorse this change and predict it will be part of any “grand bargain” on America’s budget.

With apologies to Aretha Franklin (and any of you with sensitive music sensibiities), let me suggest a theme song for the effort:

Chain, Chain, Chain, Chain CPI

Chain, chain, chain, chain, chain, chain

Chain, chain, chain, chain CPI

For these long years, we have indexed all wrong

We pay too much, that leads to fiscal pain

And now money’s getting tight

But we have no need to cry

We know what to do, oh a better measure we can try

Chain, chain, chain, chain CPI

P.S. To my readers who believe that the regular CPI understates inflation, rather than overstating it: Yes, Aretha’s song is “Chain of Fools”. And yes, that makes it easy for you to make up lyrics that mock the chain CPI rather than endorse it. Have fun.

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A few hours after attending the “Attention Deficit” panel at the Milken Global Conference, I spoke on a panel about another deficit you may have heard about: “The Federal Deficit: What Options Are Really on the Table?”
 
My fellow panelists were:

Charles Blahous, Research Fellow, Hoover Institution

Peter Passell, Senior Fellow, Milken Institute; Editor, The Milken Institute Review (pinch-hitting for budget guru Alice Rivlin, whose flight from Washington didn’t cooperate)

Andy Stern, Senior Fellow, Georgetown Public Policy Institute; former President, SEIU

Moderator, Jim McCaughan, CEO, Principal Global Investors

Here’s a link to video of our panel; a bit more than an hour.

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1. Over at Third Way, Bill Rapp used my data on debt limit votes to make a great graphic showing that those votes are about politics, not principle.

2. Over at the Tax Policy Center, Eric Toder pushes back against the idea that tax expenditures — spending in the tax code — are loopholes and earmarks:

The House Budget resolution promises an individual tax reform that “simplifies the broken tax code, lowering rates and clearing out the burdensome tangle of loopholes that distort economic activity.” The Fact sheet describing President Obama’s new budget framework calls for “individual tax reform that closes loopholes and produces a system which is simpler, fairer, and not rigged in favor of those who can afford lawyers and accountants to game it.” The bipartisan National Commission on Fiscal Responsibility and Reform notes that the tax system is riddled with tax expenditures and adds, “These earmarks not only increase the deficit, but cause tax rates to be too high.”

But the largest tax expenditures are not loopholes or earmarks snuck into the law in the dead of night to benefit a shadowy handful of super-wealthy individuals or well-connected corporations. Rather, they benefit tens of millions of taxpayers. Among the biggest: itemized deductions for home mortgage interest, charitable contributions, and state and local taxes, exemption of income accrued within tax-preferred retirement saving accounts, and the exemption from tax of employer contributions to health insurance plans. IRS data show that 39 million taxpayers claimed deductions for home mortgage interest and charitable contributions in 2008, and 35 million deducted state and local income taxes.

3. The Committee for a Responsible Federal Budget offers a helpful side-by-side comparison of four leading budget plans:

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My latest column at the Christian Science Monitor makes the case that defense spending deserves close scrutiny as America evaluates its fiscal priorities. Excerpt:

This year the US will spend about $110 billion in Afghanistan and $44 billion in Iraq. Regular defense spending is even larger, at about $550 billion. Military spending will total more than $700 billion this year.

That spending gets far less scrutiny than it deserves. Discussions of our long-run budget challenges usually emphasize the big entitlement programs – Medicare, Medicaid, and Social Security – and the need for new revenues. Congressional budget debates, meanwhile, have bogged down on the sliver of spending that goes to domestic discretionary programs [written before the 2011 budget deal].

Defense should be on the table as well. Military spending has more than doubled over the past decade. Some of that increase has been necessary to respond to the 9/11 attacks and the new challenges they revealed. But not all. Some of the increase has simply been excess.

Adm. Mike Mullen, chairman of the Joint Chiefs of Staff, made this clear in remarks in January. Because of the dramatic expansion of the Pentagon budget, he said, “We’ve lost our ability to prioritize, to make hard decisions, to do tough analysis, to make trades.”

We also have embarrassingly little ability to track that spending. When the Government Accountability Office recently audited the government’s finances, it concluded – as it has for many years – that the Defense Department’s books are so poorly kept that they can’t be audited. Taxpayers are thus giving $700 billion a year to an organization that can’t prioritize and can’t tell us where the money is going. That’s unacceptable.

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You may have noticed a flurry of letters lately calling on our elected leaders to do something about America’s growing debt. First up were 64 senators. Then 10 former chairs of the Council of Economic Advisers. And today, 68 budget experts including yours truly.

Our message to President Obama and congressional leaders Boehner, Pelosi, Reid, and McConnell:

As you continue to work on our current budget situation, we are writing to let you know that we join with the 64 Senators who recently wrote that comprehensive deficit reduction measures are imperative, and to urge you to work together in support of a broad approach to solving the nation’s fiscal problems. As they said in their letter to President Obama:

“As you know, a bipartisan group of Senators has been working to craft a comprehensive deficit reduction package based upon the recommendations of the Fiscal Commission. While we may not agree with every aspect of the Commission’s recommendations, we believe that its work represents an important foundation to achieve meaningful progress on our debt. The Commission’s work also underscored the scope and breadth of our nation’s long-term fiscal challenges.

Beyond FY2011 funding decisions, we urge you to engage in a broader discussion about a comprehensive deficit reduction package. Specifically, we hope that the discussion will include discretionary spending cuts, entitlement changes and tax reform.”

You may also have noticed that final phrase is decidedly non-specific. As my TPC colleague Howard Gleckman noted, there’s a lot of euphemizing going on.

That’s understandable and, frankly, necessary at this point of the process. Step 1 is to demonstrate that folks with a broad range of views agree that something must be done about our building debt. Getting that consensus requires some vagueness about the eventual policy solutions. Hence such elliptical phrases as “tax reform” and “entitlement changes.”

I usually use the phrase “tax reform” to mean structural changes — improvements, one hopes — to the tax code independent of revenue levels. For purposes of this letter, however, I interpret it as meaning revenue increases as well. As regular readers know, I think the best way to do that is to attack spending-like provisions that are structured as tax preferences.

I interpret “entitlement changes” to be reductions in the biggest entitlement programs — Medicare, Medicaid, and Social Security – relative to the spending scheduled under current law. That qualifying phrase is important, since there’s plenty of room to reduce the growth rate of these programs without cutting below today’s benefit levels. Some smaller entitlements like farm subsidies, however, should be cut from today’s levels.

Finally, I believe the “discretionary spending cuts” should include security spending, not just non-security.

So that’s what I mean by the euphemisms.

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Ten former chairs of the President’s Council of Economic Advisers joined together for a call to action on America’s unsustainable budget. In an op-ed at Politico, they write:

As former chairmen and chairwomen of the Council of Economic Advisers, who have served in Republican and Democratic administrations, we urge that the Bowles-Simpson report, “The Moment of Truth,” be the starting point of an active legislative process that involves intense negotiations between both parties.

There are many issues on which we don’t agree. Yet we find ourselves in remarkable unanimity about the long-run federal budget deficit: It is a severe threat that calls for serious and prompt attention.

To be sure, we don’t all support every proposal here. Each one of us could probably come up with a deficit reduction plan we like better. Some of us already have. Many of us might prefer one of the comprehensive alternative proposals offered in recent months.

Yet we all strongly support prompt consideration of the commission’s proposals. The unsustainable long-run budget outlook is a growing threat to our well-being. Further stalemate and inaction would be irresponsible.

We know the measures to deal with the long-run deficit are politically difficult. The only way to accomplish them is for members of both parties to accept the political risks together. That is what the Republicans and Democrats on the commission who voted for the bipartisan proposal did.

We urge Congress and the president to do the same.

I agree.

P.S. The signatories are Martin N. Baily, Martin S. Feldstein, R. Glenn Hubbard, Edward P. Lazear, N. Gregory Mankiw, Christina D. Romer, Harvey S. Rosen, Charles L. Schultze, Laura D. Tyson, and Murray L. Weidenbaum

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