Tag: Budget

The President Caves on Climate Policy

At a time of unsustainable deficits, deficit neutrality is a remarkably lame vision for climate policy.

Last year, President Obama proposed to raise $500 billion over ten years through a cap-and-trade system that would limit carbon emissions. This year his climate policy raises nothing.

The president still backs cap-and-trade, but he has caved into congressional pressure to give away or spend all that potential revenue rather than use it to help taxpayers. Cap-and-trade has thus become cap-and-spend.

The new policy is described as follows in a footnote to Table S-2 of the budget:

A comprehensive market-based climate change policy will be deficit neutral because proceeds from emissions allowances will be used to compensate vulnerable families, communities, and businesses during the transition to a clean energy economy. Receipts will also be reserved for investments to reduce greenhouse gas emissions, including support of clean energy technologies, and in adapting to the impacts of climate change, both domestically and in developing countries.

I am sympathetic to the idea that the value of some emission allowances should be used to compensate some families, communities, and businesses as the system ramps up. But studies have repeatedly found that such compensation would require only a fraction of the overall value of the allowances. There should still be plenty of room for allowances that are ear-marked for deficit reduction.

Proponents of the bills currently pending in Congress counter by pointing out that allowance giveaways would get smaller in later decades, helping cut future deficits.

I wouldn’t bet on it. In my experience, these dessert-now-spinach-later policies usually get renegotiated just as the spinach course is about to begin. The alternative minimum tax is about to hit more taxpayers? Let’s patch it for a year. Doctors are about to get their Medicare payments cut? Let’s put that off for another year. Terrorism risk insurance is about to phase out of existence? Let’s extend it for a few more years until we are ready. And on and on.

If we are serious about using some allowances for deficit reduction, we are better off doing it immediately, not creating beneficiary groups who will lobby for extensions when their free dessert is coming to an end.

And faced with $10 trillion or more in deficits over the next decade, we could really use the money.

Note: In his 2010 budget, the president proposed to raise $624 billion in revenues from a cap-and-trade program. $120 billion was earmarked for investing in clean energy technologies, so I netted it out in calculating the $500 billion figure above. The president proposed using those funds to pay for a permanent extension of the making work pay tax program, but they could also have been used to reduce the deficit. (See Table  S-2 from last year’s budget)

Initial Thoughts on the President’s Budget

1. Big deficits. Under the President’s specific proposals, deficits will total $10 trillion from 2010-2020. Oh, and if existing policies (as defined by the administration) run their course, those deficits would actually be $12 trillion. Those are gigantic numbers. Under either scenario, our debt would grow faster than the economy every single year. That’s simply not sustainable.

2. The Fiscal Commission warning label. Budget-watchers know Table S-1 as the place to go for budget totals. In today’s budget, however, Table S-1 had a new feature: a box describing the President’s Fiscal Commission:

The Administration supports the creation of a Fiscal Commission. The Fiscal Commission is charged with identifying policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run.  Specifically, the Commission is charged with balancing the budget excluding interest payments on the debt by 2015. The result is projected to stabilize the debt-to-GDP ratio at an acceptable level once the economy recovers.  The magnitude and timing of the policy measures necessary to achieve this goal are subject to considerable uncertainty and will depend on the evolution of the economy.  In addition, the Commission will examine policies to meaningfully improve the long-run fiscal outlook, including changes to address the growth of entitlement spending and the gap between the projected revenues and expenditures of the Federal Government.

I think of this as a warning label because it’s trying to warn readers that the official deficit forecasts are too pessimistic if, and some would say this is a big if, the commission has an impact.

I think the commission is a step in the right direction, and I welcome the President’s willingness to set an intermediate fiscal goal, even as I might quibble about some details. In addition, I wish he had gone further and specified a target for reducing the debt-to-GDP ratio by, say, 2020.

3. The freeze on non-security discretionary spending. When this was announced last week, I was stunned by heat it generated in the blogosphere. Folks on the left decried it as harmful budget cutting in the face of a weak economy, and folks on the right decried is a sham that would have no effect. I spent about an hour trying to figure it out and decided I couldn’t find enough information to have an informed view one way or the other.

Now that the budget is out, I feel vindicated in that view. To fully understand the trajectory of non-security discretionary spending, you need to consider such obscure bits of budget arcana as the obligation limitations used for transportation funding (ob lims, to the initiated), the proposed conversion of Pell grants from discretionary to mandatory spending, the reassignment of bioshield from security to non-security spending, and the fact that Census spending is particularly high in fiscal 2010 because of the decennial census. I haven’t actually crunched the numbers, but that’s not my point tonight. Instead, my point is simply how hard it can sometimes be to match budget reality to budget communications.

More tomorrow.

Will Illinois Go Bankrupt Because of Scott Brown?

A sharp reader offers the following hypothesis (which I have edited):

Illinois is fundamentally bankrupt. It has less than $1 million in cash, pays vendors net 90, and owes its state university $450 million that it cannot pay. Oh, and it also has $60 billion in unfunded pension liabilities.

Now that the Republicans have 41 votes in the Senate, Illinois can’t count on any federal aid. The President’s home state will thus become insolvent.

(For some background on Illinois’s budget woes, see this link.)

My reader expresses similar concerns about California (where Governor Schwarzenegger’s budget assumes $6.9 billion in federal aid) and New York.

All of which raises a question for policymakers and municipal bond investors. Does the election of Scott Brown mean that the Senate will be unwilling to give federal aid to the states? The $862 billion stimulus bill last year (formerly known as the $787 billion stimulus bill) included substantial state aid, and it squeaked through the Senate with exactly 60 votes. Now the Democrats (and the Independents who caucus with them) account for only 59 votes.

Does that bode ill for struggling states and the investors who own their debt? Only time will tell. But I wouldn’t count the states out just yet.

The stimulus bill could have had 62 votes, but Senator Kennedy didn’t vote and Senator Franken hadn’t yet been seated. If the Senate majority can coordinate the same coalition–including Republican Senators Snowe and Collins of Maine–they will have one vote to spare for any new jobs bill (formerly known as a stimulus bill). In addition, with his paean to tax cuts in the State of the Union, the President was signaling that he wants to find enough common ground with congressional Republicans to get a jobs bill passed.

In the short run, then, I wouldn’t be surprised if substantial state aid finds its way into the jobs bill. That may buy Illinois and other struggling states some time.

In the long run, however, the reader is probably right that fiscally-strapped states will find the Senate less welcoming.

Legalistic answer to the title question: No. States can’t seek protection in bankruptcy court, so Illinois can’t technically go bankrupt.

The Debt Limit is a Tax on the Majority

Today the Senate voted 60-39 to increase the federal debt limit from $12.4 trillion to $14.3 trillion. No one is happy that we need to borrow another $1.9 trillion in the next year or two, but the alternative–default–is unthinkable. So let’s hope that the House follows suit when it votes next week.

As expected, today’s vote was entirely party line: 60 Democrats (including the two Independents who caucus with them) voted yea, while 39 Republicans voted nay; one R didn’t vote.

You might be tempted to look at these results and try to read into them some larger ideas about fiscal politics. Perhaps Democrats all voted to increase the debt limit because they are big spenders? Perhaps Republicans will recklessly risk default in their anti-government zeal?

I will leave to you, dear reader, to decide whether such claims have any merit. But please understand that the debt limit vote tells us absolutely nothing about them.

With rare exceptions, votes to increase the debt limit do not involve any real substance. Defaulting remains unthinkable, so the debt limit has to go up. The horse-trading before the final vote may have plenty of substance–this round included a welcome amendment bringing back statutory PAYGO rules as well as an almost-successful effort to create a budget commission–but the final vote is pure politics. The Senate has to deliver a debt limit increase. And that means that the Senate majority has to deliver the votes.

As a matter of politics, then, debt limit votes are a tax on the majority. The majority has to take the hit for increasing the limit, while the minority gets a free ride.

To test this view, I looked at Senate votes on the last five stand-alone increases in the debt limit (three other increases were part of the housing, TARP, and stimulus bills that passed in 2008 and 2009). The chart above shows the fraction of senators in each party who voted to increase the limit.

The results are striking: Back in 2004 and 2006, the Republicans (in red, but do I really need to say that?) controlled the Senate and thus bore the political tax of increasing the debt limit. In those two votes, the Rs accounted for 102 of 104 yeas. In 2009 and 2010, the situation was reversed, as the majority Democrats (yes, in blue) bore the political burden. In those two votes, the Ds (including the Is) accounted for 119 of 120 yeas.

And then there’s 2007, when the two parties shared the burden of boosting the debt ceiling. What explains that rare outburst of bipartisanship? Divided government. In 2007, President Bush had to work with a Democratic Congress to get the debt limit passed. With divided government, the pain had to be shared. In the other four years, however, the President was the same party as the Senate majority.

Bottom line: Sometimes it hurts to be in charge.

For a good summary of past debt limit increases, see this CRS report. For information on Senate votes, start here.

Wondering who the three aisle-crossers were? In 2004, Democrats John Breaux and Zell Miller voted yea. In 2009, Republican George Voinovich voted yea.

A New Price Tag for Stimulus: $862 billion, not $787 billion

Amongst its usual cracker jack budget projections yesterday, the Congressional Budget Office provided a few toy surprises for budget watchers. One is an updated estimate of the direct budget costs of the 2009 stimulus bill, officially known as the American Recovery and Reinvestment Act (ARRA).

CBO originally estimated that ARRA would cost $787 billion from 2009 through 2019. Its new estimate is $862 billion, about $75 billion higher.

Key changes to the estimate:

  • Food stamps (officially known as the Supplemental Nutrition Assistance Program): $34 billion more than expected
  • Build America Bond program: $26 billion more
  • Unemployment compensation: $21 billion more
  • Medicaid: $3 billion less than expected
  • Other spending: $3 billion less

(CBO did not make any updates for the tax provisions in ARRA.)

For an earlier discussion of the stimulus being bigger than expected, see this post.

For a discussion of why the $862 billion figure (formerly known as the $787 billion figure) is not really the right measure of stimulus, see this post.

Note: CBO provides many details about ARRA in Appendix A of yesterday’s report.

Deficits As Far as the Eye Can See

Today the Congressional Budget Office released its much-anticipated projections for the budget. As usual, the headline figure is CBO’s estimate of the budget deficit, now projected to be $1.35 trillion for the fiscal year, about 9.2% of GDP.

That’s slightly better than last year–when $1.4 trillion deficits amounted to 9.9% of GDP–but is still the second-worst since World War II. And, as CBO notes, new legislation could easily lift the 2010 figure higher. For example, Congress will likely consider further extensions to unemployment benefits and more war spending, not to mention a possible jobs bill.

CBO also projected deficits for the next decade. They are large and persistent:

The blue line shows CBO’s official budget baseline. That baseline shows persistent deficits over the next decade. They fall below 3% of GDP by 2014 and then increase somewhat in later years. I would characterize that trajectory as unwelcome but not a crisis.

It’s also completely unrealistic given Washington’s current policy predilections.

The official baseline is built upon two key assumptions: that existing laws execute exactly as written and that discretionary spending increases with inflation in future years. Those assumptions make sense for constructing a baseline that will be used to score the budget impacts of new legislation. But, as CBO itself notes, they are unrealistic if your goal to make predictions of where current policy is leading:

  • Under current tax law, a remarkable number of tax reductions will expire in the near future. These include the 2001 and 2003 tax cuts (EGTRRA and JGTRRA, often known as the Bush tax cuts), the annual patch to the dreaded alternative minimum tax (which prevent the AMT from hitting more and more families), the Making Work Pay tax credit (enacted as part of the stimulus), expanded net operating loss carrybacks (enacted as part of another, smaller stimulus bill in the summer), and a panoply of other, smaller provisions (e.g., the research and experimentation tax credit). It is unthinkable that Washington will allow all these to expire.
  • In recent years, discretionary spending has grown faster than inflation. As yet, there is no reason to believe that will stop.
  • On the other hand, the current baseline assumes that spending on the wars in Afghanistan and Iraq will continue at their 2009 pace, adjusted for inflation, over the next decade. One hopes that assumption is unrealistically high.

To help outside analysts construct alternative baselines that better show existing policy, rather than existing law, CBO provides estimates for several policy alternatives. Analysts differ on which of these alternatives they use to build a policy alternative (and, given more time, they may also use other estimates).

As rough justice I made the following assumptions for the chart above: (1) that regular discretionary spending grows at the same pace as nominal GDP in coming years (closer to recent history than the baseline assumption of growth with inflation), (2) that spending on the wars in Iraq and Afghanistan moderates somewhat in coming years (CBO’s 60,000 troop scenario), (3) that the 2001 and 2003 tax cuts are permanently extended, and (4) that the AMT is indexed for inflation.

Under these assumptions, the budget picture is much scarier: deficits never get lower than 5.5% of GDP and they are 7.5% by 2020.

Bottom line: Current policy is unsustainable.

Note: You should view my adjusted baseline as a quick-and-dirty, back-of-the-envelope of existing policy. For example, it doesn’t include any adjustments for other expiring tax provisions (which are substantial) or the infamous Medicare doctor payment problem; if you made adjustments for those, the deficit outlook would look worse. On the other hand, many political leaders, including President Obama, want to scale back the 2001 and 2003 tax cuts; if you did that, the deficit outlook would look better.

Joining the “Announcement Effect Club”

Inspired by the popularity of Greg Mankiw’s Pigou Club, which favors using taxes (or auctioned permits) to address pollution problems, the Committee for a Responsible Federal Budget has created its own: the “Announcement Effect Club.”

To become a member, you need to endorse the idea that it would help the U.S. economy if our elected leaders could develop a credible plan to bring our deficits and skyrocketing debt under control. In CRFB’s phrasing:

While aggressive debt reduction in the short term might imperil the fragile recovery, the announcement of future deficit reduction can actually strengthen it.

I’m happy to be a member (based on this post last October).

Key Readings on America’s Fiscal Plight

It remains to be seen whether our elected leaders have much enthusiasm for dealing with America’s troubling fiscal trajectory. But the policy commentariat has embraced the issue with relish.

If you have a few hours (or days) to ponder these issues, let me recommend the following:

  • Train Wreck: A Conference on America’s Looming Fiscal Crisis, held last Friday at the USC Law School. Conference papers addressed a host of issues, including the need to pay attention to tax expenditures, the burden of state pensions, the potential for catastrophic budget failure, and the arithmetic impossibility of solving our budget woes by raising income taxes on the highest earners. I had an unusual role in the conference, presenting a paper by Joyce Manchester and Jonathan Schwabish of the Congressional Budget Office about the role of health spending in our long-term budget challenges. I didn’t play any role in preparing the paper, but was happy to present the findings when neither of the authors could attend. My presentation is near the end of the afternoon session (video here). Bottom line? Our fiscal trajectory is unsustainable thanks to population aging and rising health spending.
  • Choosing the Nation’s Fiscal Future, released last week by the National Research Council and the National Academy of Public Administration. Weighing in at a hefty 360 pages (including appendices), this report provides a comprehensive overview of our budget challenges. More important, it then lays out strategies for addressing them. And it makes very clear the most important decisions we face: how big a government do we want and how should it balance the interests of older and younger generations?
  • Red Ink Rising: A Call to Action to Stem the Mounting Federal Debt, released last month by the Pew-Peterson Commission on Budget Reform. This report  reviews our fiscal prospects and makes six big picture recommendations: (1) Commit immediately to stabilize the debt at 60 percent of GDP by 2018; (2) Develop a specific and credible debt stabilization package in 2010; (3) Begin to phase in policy changes in 2012; (4) Review progress annually and implement an enforcement regime to stay on track; (5) Stabilize the debt by 2018; and (6) Continue to reduce the debt as a share of the economy over the longer term. This framework strikes me as reasonable, although one can always debate the exact numbers (e.g., would 60% in 2018 be that much better than 60% in 2020?).
  • The Right Target: Stabilize the Federal Debt, released last week by the Center on Budget and Policy Priorities. Another excellent overview of the budget challenge, this report agrees with the Pew-Peterson report in many qualitative ways, but disagrees on tempo: “Pew-Peterson Commission endorses sounds ideas but overly ambitious target.” The authors would like to see deficits reduced to 3% of GDP or lower by 2019. (A goal that OMB Director Peter Orszag has also mentioned.)
  • A Path to Balance: A Strategy for Realigning the Federal Budget, released last month by the Center for American Progress. This report takes a slightly different approach from the others, focusing on achieving primary budget balance (i.e., balancing revenues with spending excluding interest payments) rather than a debt-to-GDP target. Those concepts are closely related in analytic terms (each of the reports explains why), but as Stan Collender over at Capital Gains and Games notes, the concept of achieving primary budget balance may be a better talking point than stabilizing the debt-to-GDP ratio. Because CAP has close ties to the Obama Administration, Stan also suggests that its budget thoughts may offer a “sneak peek” about what to expect in the President’s upcoming budget.

Federal Reserve Earns $46 Billion for Taxpayers

The Federal Reserve system is doing its part to cut the budget deficit (at least for now). Treasury will receive $46.1 billion of profits from the Federal Reserve profits for fiscal 2009. That’s about a third higher than the amount remitted for 2008.

According to the Fed’s news release this morning, the following items drove profits:

$46.1 billion in earnings on securities acquired through open market operations (U.S. Treasury securities, government-sponsored enterprise (GSE) debt securities, and federal agency and GSE mortgage-backed securities) [Profits on traditional open market operations plus the new credit easing operations]

$5.5 billion in net earnings from consolidated limited liability companies (LLCs), which were created in response to the financial crisis [Profits on the Maiden Lane partnerships etc.]

$2.9 billion in earnings on loans extended to depository institutions, primary dealers, and others [Profits on the new loan facilities]

[$2.6 billion in] net earnings from currency swap arrangements, which have been established with 14 central banks, and investments denominated in foreign currencies

Additional net earnings of $1.5 billion were derived primarily from fees of $0.7 billion for the provision of priced services to depository institutions

Those $58.6 in gross earnings were slightly offset by the following expenses:

[$3.4 billion for] operating expenses of the twelve Reserve Banks, net of amounts reimbursed by the U.S. Treasury and other entities for services the Reserve Banks provided as fiscal agents

[$2.2 billion in] interest paid to depository institutions on reserve balances [As noted previously, the Fed’s still-new ability to pay interest on reserves is a big deal for monetary policy; this is the cost side]

[$0.9 billion in] Board expenditures, including the cost of new currency

The resulting $52.1 billion in new profits were then distributed as follows: $46.1 billion to the Treasury, $1.4 billion as dividends to member banks, and $4.6 billion retained to “equate surplus with paid-in capital.”

Treasury is Issuing More TIPS

As noted by the Wall Street Journal this morning (“U.S., in Nod to Creditors, Is Adding TIPS Issues“), Treasury is issuing more Treasury Inflation-Protected Securities (TIPS). Today’s auction involves $10 billion 10-year notes; one estimate suggest that total TIPS issuance this year will be $80-85 billion. Still small compared to our nation’s overall borrowing needs (somewhere in the $1 trillion range, not including rolling over existing debt), but a real boost to the TIPS world.

As I discussed in two earlier posts (here and here), many observers have recommended that Treasury increase TIPS issuance. The WSJ piece emphasizes one particular set of advocates: our creditors who are beginning to worry about inflation:

TIPS, which account for less than 10% of the $7 trillion Treasury market, offer investors a way to hedge against inflation as their value rises along with the increase in consumer prices. The fixed returns on nominal Treasurys, in contrast, can be eroded over time by inflation, which especially affects long-term bonds.

…

The small size of the market for inflation-protected securities means many large investors who want to be able to sell easily still prefer other ways to hedge against inflation risk, such as commodities.

But in the past year, China and other large foreign investors have become vocal about their concerns that the large U.S. fiscal deficits and the Federal Reserve’s ultra-loose monetary policy will lead to a spike in inflation. That would hurt the value of their large holdings of nominal Treasurys.

U.S. officials reassured China in late July that the Treasury remained committed to its TIPS program and would take investors’ views into account when drawing up its issuance plans. That pledge was seen as a commitment to increasing TIPS sales.