Tag: Debt

Treasury Takes Step 1 in Avoiding the Debt Ceiling

As expected, Treasury has announced that it will allow the $200 billion Supplemental Financing Program to run down to only $5 billion; that will save $195 billion of borrowing authority under the current debt ceiling:

Treasury Issues Debt Management Guidance on the Supplementary Financing Program
1/27/2011
WASHINGTON – The U.S. Department of the Treasury’s Assistant Secretary for Financial Markets, Mary Miller, today issued the following statement on the Supplementary Financing Program:
“Beginning on February 3, 2011, the balance in the Treasury’s Supplementary Financing Account will gradually decrease to $5 billion, as outstanding Supplementary Financing Program bills mature and are not rolled over. This action is being taken to preserve flexibility in the conduct of debt management policy.”​

Treasury created the SFP in order to help the Fed expand its balance sheet without “printing money” (or, more accurately, “printing reserves”). Under the program, Treasury issues bonds, as usual, but it deposits the proceeds in an account at the Federal Reserve, rather than using them to pay the nation’s bills. The Fed then uses those deposits to purchase assets. Since the money ultimately comes from investors who own the new Treasury bonds, the SFP allows the Fed to expand its balance sheet without creating reserves out of thin air.

With the program winding down — at least until the debt ceiling gets raised — the Fed will have to ask its electronic printing press for another $195 billion if it wants to maintain its targeted portfolio.

 

 

Geithner Won’t Default on the Public Debt

In a guest column at CNN Money, I argue that Treasury Secretary Timothy Geithner won’t allow us to default on the public debt even if Congress fails to increase the debt ceiling:

America reached two dubious milestones in recent weeks.

Our national debt, including Social Security obligations, has run up to nearly $14 trillion. That’s a lot of money, even in Washington.

And our Treasury Secretary started using the d-word. Writing to congressional leaders, Timothy Geithner warned that failing to increase America’s debt ceiling, currently $14.3 trillion, “would precipitate a default by the United States.”

“Default” is not a word that Treasury secretaries use lightly. For more than two centuries, the United States has paid its debts on time. That’s why U.S. Treasuries have historically been considered the safest investment in the world.

When Geithner was sworn into office, he took responsibility for defending the full faith and credit of the United States.

So why is he openly discussing the possibility of default? Because of the peculiar political theater of the debt limit.

Alone among developed nations, our country separates the legislative decisions that govern spending and taxes from those that govern debt.

As a result, America must periodically watch its elected leaders try to avoid voting for higher debt, even though most of them happily voted for higher spending, lower taxes or both.

During these spells of political brinkmanship, the Treasury secretary’s job is to prod Congress into action.

Given today’s political divisiveness, Geithner understandably decided — as did his predecessors in similar circumstances — that the best way to defend America’s credit worthiness is, paradoxically, to warn of potential default if Congress fails to act.

Geithner is correct that the debt limit must increase. With monthly deficits running more than $100 billion, it’s simply unthinkable that Congress could cut spending or increase revenue enough to avoid borrowing more. America’s daunting fiscal challenges require bold action, but it must be thoughtful and deliberate, not arbitrary and sudden.

Still, I am troubled by any suggestion that the United States might willingly default on its public debt. Doing so would have absolutely no upside. That’s why I’m confident that Geithner won’t let it happen.

If Congress somehow fails to increase the ceiling in time, Geithner would do everything in his power to avoid going down in history as the first Treasury secretary to miss a debt payment.

To do so, he would use the same tactics as any stressed debtor.

Squirrel it away: First, Geithner would hold on to his cash and what little credit he has left. Among other things, he would eliminate unneeded borrowing associated with certain obscure programs such as the Exchange Stabilization Fund and a state and local debt program.

Turn to family for help: He would call in money from his relatives, in this case the Federal Reserve. During the financial crisis, Treasury created a special program to borrow money on the Fed’s behalf; that borrowing now totals $200 billion. Treasury temporarily wound this program down the last time we got close to the debt ceiling. Expect the same this time.

Promise to pay later:He would issue IOUs (which don’t officially count as debt) to friendly creditors who have no choice but to accept them. Geithner’s predecessors did this with two retirement funds for government employees, both of which were later made whole. In his recent letter to Congress, Geithner said he’d do the same.

Sell stuff: Lastly, Geithner would look for assets that are easy to sell. Thanks to the financial crisis, Treasury now owns a sizeable investment portfolio, including stakes in auto companies, banks and other financial institutions. Don’t be surprised if Treasury cashes in some of these positions to raise cash in coming months.

Those tactics would give Congress time to work through its differences and raise the debt limit.

If lawmakers fail to act on time, however, Geithner would face starker choices: Our monthly bills average about $300 billion, while revenues are about $180 billion. If we hit the debt limit, the federal government would be able to pay only 60 cents of every dollar it should be paying.

But even that does not mean that we will default on the public debt. Geithner would then choose which creditors to pay promptly and which to defer.

As the heir to Alexander Hamilton, Geithner would undoubtedly keep making payments on the public debt, rolling over the outstanding principal and paying interest. Interest payments are relatively small, averaging about $20 billion per month, and paying them on time is essential to America’s enviable position in world capital markets. To miss even one is and should be unthinkable.

Other creditors would have to wait in line. Treasury would defer payments to some groups of creditors, perhaps including Social Security beneficiaries, Medicare providers, military personnel, weapons vendors or taxpayers expecting refunds.

Missing such payments would be another dubious milestone in America’s fiscal journey — so dubious, in fact, that the resulting constituent outrage would likely force Congress to increase the debt ceiling immediately.

Here’s to hoping that Congress doesn’t let things go that far and get that bad.

P.S. Stan Collender, Greg Ip, and Felix Salmon have also made the point that hitting the debt limit might cause the the government to delay some payments to some creditors (technically a type of default), but will not and should not default on the public debt.

Handicapping the Debt Limit Debate

Sometime this spring, Congress will vote to increase the debt ceiling. That vote won’t come easy. Newly ascendant House Republicans will threaten to withhold needed votes unless significant spending cuts or budget process reforms are attached to the measure. Democrats will denounce Republicans for threatening the government’s ability to pay its bills. And Treasury Secretary Tim Geithner will be forced into creative financing moves to buy Congressional leaders enough time to strike a deal.

But strike a deal they will. With monthly deficits running around $100 billion, the United States can’t cut spending or increase tax revenues enough to avoid further borrowing this year. It is equally inconceivable (I hope) that our elected leaders will decide to withhold payments from Social Security beneficiaries, our military, and our creditors.

So the debt ceiling will go up. And that means that at least 50 senators and more than 200 House members will cast a politically toxic yea vote.

Which lucky members will they be? The answer may well depend on what other budget provisions accompany the debt limit measure. That’s impossible to handicap today. In the meantime, though, we can look at past votes. They tell a clear story: debt limit votes are about politics, not principle.

Consider, for example, Senate votes on stand-alone debt limit measures over the past decade:

When Republicans held both the Senate and the White House (2003, 2004, 2006), they provided virtually all the yea votes, while almost all Democrats voted no. When the Democrats were in power (2009, 2010), the roles reversed: the Democrats provided all but one of the yea votes, while Republicans voted no. Only when government was divided – with a Democratic Senate and a Republican president (2002, 2007) – has the vote to lift the debt limit been bipartisan.

The House has taken fewer stand-alone votes than the Senate (because of the so-called Gephardt rule, which the Republicans abolished last week), but they show the same pattern: the party in power votes to increase the debt limit:

History thus suggests that Democrats will bear the burden of lifting the debt limit in the Senate; expect at least 50 yea votes. The only interesting question is whether individual Republicans filibuster the increase; if so, a 60-vote cloture measure would require at least 7 Republican votes as well.

Handicapping the House is more difficult since we’ve had no recent experience with divided government. If the Senate provides any guide, roughly equal numbers of Republicans and Democrats will ultimately vote for an increase. That would allow many Tea Party-backed Republicans to vote no without affecting the outcome. And other members might simply skip the vote. That’s what 21 members did in 2004, when it took just 208 votes to raise the debt ceiling.

Note: Congress increased the debt limit three other times during the past decade as part of larger bills: the 2008 housing act, the 2008 TARP act, and the 2009 stimulus. For simplicity, I have included all votes by Independents with the Democrats, since that’s how those members caucused during this period.

Bowles-Simpson, Health Insurance, Social Security, and Payroll Taxes

The other day I discussed the Tax Policy Center’s distributional analysis of the Bowles-Simpson tax proposal. As you may recall, a key feature of the proposal we considered (“Option 1”) is that it eliminates almost all existing tax breaks and reduces tax rates on most types of income (but raises them on capital gains and dividends).

We subsequently learned that we misinterpreted one aspect of the Bowles-Simpson proposal. As a result, we posted an updated distributional analysis yesterday. Let me turn the mike over to Howard Gleckman at TaxVox:

One of the most dramatic elements of the tax reform plan offered by the chairs of President Obama’s deficit commission, Erskine Bowles and Alan Simpson, was their proposal to eliminate tax breaks for employer-sponsored health insurance, contributions to retirement plans, and other employee benefits. When the Tax Policy Center did its first analysis of that proposal on November 16, our modelers assumed (perfectly reasonably) that if these benefits were now subject to income tax, workers would have to pay Social Security and Medicare payroll taxes on them as well.

Because these tax subsidies are so generous, a payroll tax on their value would generate a lot of money—more than $100 billion a year. And that extra levy would have a noticeable impact on the how taxes would be distributed among various earners under the plan. But after we published our analysis, the Bowles-Simpson staff told us they did not intend to hit workers with payroll tax on this income as well.

So TPC has run a new distributional analysis for the Bowles-Simpson plan without those extra payroll taxes. It turns out that everyone still pays more tax on average, but less, of course, than if they were hit with bigger payroll taxes. The lowest 20 percent of earners (who will make an average of about $12,000 in 2015 and who pay far more in payroll tax than in income tax) would pay about $200 more than they do today, instead of an average of $400 if they took a payroll tax hit as well. Their typical after-tax income would be cut by 2 percent, instead of 3.4 percent if they had to pay that extra payroll tax.

Middle-income earners (who’ll make about $60,000) will pay about $1,000 more instead of $1,900. Their after-tax income would be cut by about 2.2 percent instead of 4 percent. People at the top 0.1 percent of the economic food chain would also save about $1,000. But when you’re making an average of $9 million, and paying a half a million in new taxes, an additional thousand bucks is easily lost in the sofa cushions.

You can also see the importance of the payroll tax effect in the debt reduction proposal released on Wednesday by a Bipartisan Policy Center task force on which I served. In that proposal, the rollback affects both payroll taxes and income taxes. The extra Social Security revenues from phasing out the tax exemption for employer-sponsored health insurance account for about one-third of the plan’s overall improvement in Social Security solvency.

Bottom line: When you are cutting tax breaks, it’s a big deal whether you do that for payroll taxes as well as income taxes.

The Distributional Effects of the Bowles-Simpson Tax Proposal

Today Eric Toder and Daniel Baneman of the Tax Policy Center released a preliminary analysis of the tax proposal put forward by the fiscal commission’s co-chairs Erskine Bowles and Alan Simpson. The centerpiece of their proposal is to eliminate almost all tax expenditures* except the earned income tax credit and the child tax credit and use the resulting revenues for a mix of deficit reduction and tax rate cuts (they also consider other options that would retain more tax expenditures). The proposal would also increase the fraction of wages subject to the Social Security tax, increase the gasoline tax by 15 cents per gallon, and make a few other changes.

The distributional impacts of the proposal depend greatly on what baseline you compare against. As my TPC colleague Howard Gleckman notes, if you use current policy (in which the 2001 and 2003 tax cuts remain in place and the alternative minimum tax is patched), then the Bowles-Simpson plan raises taxes on everybody:

The Bowles-Simpson proposal is indeed an across-the-board tax increase– and a fairly progressive one at that. In 2015, the lowest earners would face an average cut in their after-tax income of 3.4 percent or about $400. Middle-income households (those earning an average of about $60,000) would see their after-tax incomes fall by 4 percent or about $1,900. On the other end of the economic food chain, the top one percent of earners (who earn an average of about $2 million) would lose about $77,000 (5.3 percent) while the top 0.1 percent would see their after-tax incomes cut by nearly 8 percent, or close to $500,000.

Things look different if your baseline is current law–in which all the 2001 and 2003 tax cuts expire and the AMT remains unpatched. In that case:

[T]he distributional impact of the Bowles-Simpson plan would be quite different: While low-income households and the top one percent of earners would be hit with a tax increase, the upper middle class would enjoy a small tax cut averaging about 1 percent.

You can find all the details here.

* Added 11/17: As noted in a previous post, the concept of tax expenditures officially includes the lower tax rates paid on capital gains and dividends. So whenever you hear the phrase “eliminate tax expenditures”, that means not only eliminating deductions, credits, etc., but also taxing capital gains and dividends as ordinary income.

Cleaning Up the Tax Code and 15 Other Ways to Cut the Deficit

In conjunction with its new deficit option game, the New York Times asked 16 budgeteers to write-up ideas for reducing the deficit. My assignment was to explain the rationale for reducing tax expenditures–the exclusions, exemptions, deductions, and credits that complicate the code and dramatically reduce the revenue that it raises:

The Office of Management and Budget has identified more than 170 such tax expenditures (these provisions are called “expenditures” because they essentially run spending programs through the tax code). The deductibility of state and local taxes, for example, runs almost $70 billion each year. Favorable tax treatment for life insurance savings is about $23 billion. Credits for alcohol-based fuels total almost $9 billion. And dozens of rifle-shot provisions benefit narrow interests, such as special tax rules for NASCAR venues.

In total, individual and corporate tax expenditures reduce revenues by more than $1 trillion each year. Congress should revisit each tax break to see if it produces sufficient economic and social benefits to justify its budgetary cost. Some provisions should make the grade (the earned income tax credit, for example). But many others should be restructured or cast into the dustbin of history.

Such housecleaning would help close the deficit, reduce wasteful spending disguised as tax cuts, simplify tax preparation for millions of households, and potentially make the tax code more progressive (since many tax expenditures are worth most to households in high tax brackets) – all without raising rates.

You may have noticed that the co-chairs of the President’s fiscal commission recently made tax expenditures a centerpiece of their proposal for both deficit reduction and tax reform. Tax expenditures are so expansive that the co-chairs decided an aggressive roll-back could both raise more revenue and finance substantial reductions in tax rates on wages, salaries, and other ordinary income (tax rates on capital gains and dividends would increase since their lower rates are counted as tax expenditures, a topic I will return to at a later date).

For the other 15 ideas for deficit reduction, see here.

Investors Should Be Prepared to Face Financial Oppression

That’s the conclusion of a new report by Morgan Stanley analyst Arnaud Mares.

And what, you may ask, is financial oppression? Speaking from the perspective of investors in sovereign debt, Mares defines it as “imposing on creditors real rates of return that are negative or artificially low.” Which doesn’t require outright default. Instead, it

[C]an take other forms: repaying debt in devalued money (e.g., through unanticipated inflation), taxation or regulatory incentives on institutions to purchase government debt at uneconomic prices.

Mares sees sovereign creditors as tempting targets when over-indebted governments decide which of their many fiscal promises they can’t keep.  After all, elderly pensioners cast more votes than coupon-clipping bond holders. And he thinks current low yields provide little protection against that threat.

His piece is definitely worth a read if you want to consider a bearish view on U.S. and European sovereign credit.

How Bad is the Budget Outlook?

The Congressional Budget Office offers two visions of the future in its new long-run budget outlook.

The first imagines a world in which lawmakers take pay-as-you-go budgeting really seriously. The budget baseline assumes that existing laws execute exactly as written: all the 2001 and 2003 tax cuts expire, the alternative minimum tax hits millions more families, real bracket creep drives taxes far above historical norms, Medicare payments to doctors are cut by more than 20%, discretionary spending grows only with inflation, and all the offsets in the recent health legislation – taxes on “Cadillac” health plans, cuts in provider payments, etc. – happen as scheduled. If Congress tries to avoid any of those changes, it would have to pay for them through offsetting spending cuts or tax increases.

In that strict—and unrealistic—PAYGO world, our debt would continue to increase faster than the economy, rising from about 60% of gross domestic product today to about 80% in 2035. That’s far above where we want to be. PAYGO policymaking cannot fix the budget pressures of an aging population and rising health costs. But you have to give PAYGO some credit. If Congress really acted that way on every future budget decision, it’s unlikely that we would have a fiscal crisis in the next decade or more.

Of course, no one believes that Congress will really be that disciplined. That’s why CBO offers a second vision, in which lawmakers give in to temptation. They extend most of the tax cuts, patch the AMT, limit bracket creep, increase payments to Medicare docs, allow discretionary spending to rise with GDP, and turn off some of the health legislation offsets after 2020.

If policymakers give in to all those temptations, the debt skyrockets, rising from about 60% of GDP today to 185% by 2035. And that’s assuming no negative effects on the economy. As my colleagues Len Burman, Jeff Rohaly, Joe Rosenberg, and Katie Lim have pointed out, out-of-control deficits would weaken the economy by crowding out investment and driving up interest rates, so the debt-to-GDP ratio would actually grow even faster.

CBO doesn’t include those economic effects in its official long-run projections. However, it does separately examine what would happen to the economy because of reduced investment. The results aren’t pretty. When CBO runs the giving-in-to-temptation world through its model, it discovers that the U.S. economy ceases to exist after 2027.

OK, maybe that’s a bit strong. What happens is that crowding out gets so severe that CBO’s model breaks down, overwhelmed by the debt explosion.

These findings provide ammunition to both sides of the great deficit debate. Budget hawks will point to the temptation scenario as further evidence that we are on a reckless fiscal path that threatens our economic well-being. Budget doves will emphasize the PAYGO scenario as evidence that we can muddle along for years without needing to fear an economic backlash.

I think the hawks have the better of this argument. Even under perfect PAYGO, our fiscal condition would deteriorate in coming years. Moreover, the odds that lawmakers will show that much discipline in the near term are nil. For example, the PAYGO law enacted earlier this year allows Congress to extend most of the 2001 and 2003 tax cuts and to avoid cuts to Medicare doctor payments without finding any offsets. Real life PAYGO doesn’t come close to the rigorous standards of CBO’s PAYGO scenario.

Nevertheless, I don’t really think that the U.S. economy will blink out of existence in 2027. We will find a way a muddle through. But to do so, we need to face up to CBO’s bleak vision of our fiscal future and the temptations that lawmakers will face. Now is not the time for sudden austerity—the G-20 bandwagon non-withstanding—but it is the time to develop a plausible plan to bring taxes and spending into long-run balance.

This post first appeared on TaxVox, the blog of the Urban-Brookings Tax Policy Center. 

Edited (7/6/10): Added “most of” in fourth paragraph (CBO’s alternative fiscal scenario extends most of the 2001 and 2003 tax cuts, but it allows the rates reductions for high-income taxpayers to expire).

How Would You Tame the Debt?

Show of hands, please: Do you think you can do a better job with the federal budget than our leaders in Washington?

OK everyone, put your hands down. And put that confidence to the test by clicking over to the new Stabilize the Debt exercise from the Committee for a Responsible Federal Budget.

The exercise gives you a goal–getting the federal debt down to 60% of GDP by the end of 2018–and a lengthy menu of policy options that you can use to get there.

How tough is this? Pretty hard. The CRFB’s baseline has the debt at 66% of GDP in 2018, implying that we need $1.3 trillion in spending cuts and tax increases to hit the 60% target. But that’s assuming that all the 2001 and 2003 tax cuts expire at the end of the year and that discretionary spending will grow only at the rate of inflation over the next decade.

As a political matter, a more plausible baseline might be to assume that the tax cuts get extended except for high-income folks and that Congress enacts the President’s proposed levels of discretionary spending. In that case, the debt would be 82% of GDP in 2018. And you, the beneficent budget dictator, would have to find $4.6 trillion in spending cuts and tax increases.

Just for fun, here’s one way you might get there:

  • Reduce the number of troops in Iraq and Afghanistan to 30,000 by 2013
  • Make a variety of other defense spending reductions
  • Raise the Social Security normal retirement age to 68
  • Gradually reduce scheduled Social Security benefits through 2080
  • Use an alternate (i.e., lower) measure of inflation for Social Security COLAs
  • Include all new state and local workers in Social Security
  • Increase Medicare cost-sharing and premiums
  • Reduce spending on graduate medical education through Medicare
  • Enact medical malpractice reform
  • Increase the Medicare eligibility age to 67
  • Reduce Medicaid spending to higher-income states
  • Reduce farm subsidies
  • Cut assorted other spending (is anyone not going to cut “certain outdated programs”?)
  • Enact a carbon tax
  • Increase the gas tax by 10 cents [I was surprised CRFB didn’t have an option to raise it more]
  • Raise the Social Security tax cap to cover 90% of earnings
  • Index the tax code to an alternate (i.e., lower) measure of inflation
  • Sell government assets
  • Reduce the tax “gap”
  • Replace the mortgage interest deduction with a flat credit
  • Curtail the state and local tax deduction
  • Replace the exclusion for employer-provided health insurance with a flat credit
  • Limit itemized deductions for taxpayers with high incomes
  • Eliminate subsidies for biofuels

And that doesn’t leave room for any spending increases or tax reductions that you might want.

Good luck.

Financing Needs of Advanced Economies Remain Exceptionally High

The International Monetary Fund released its latest Fiscal Monitor last week. As expected, the headline message was quite grim for the advanced economies, many of which face grueling fiscal adjustments in coming years.

One of the IMF’s most important findings is that the government financing needs of many advanced economies “remain exceptionally high.” As illustrated in the following chart, Japan will have to sell debt equivalent to 64% of GDP this year in order to rollover maturing debt (54% of GDP) and finance new deficits (10% of GDP):

The United States comes in second, needing to sell debt equivalent to 32% of GDP in order to rollover maturing debt (21% of GDP) and cover new deficits (11% of GDP).

Why does the USA come in ahead of more troubled economies such as the UK and the PIIGS? Because our debt has a much shorter average maturity. According to the IMF, the average maturity of US debt is only 4.4 years. Portugal, Italy, Ireland, and Spain have maturities that are about 50% greater (from 6.2 to 7.4 years), and the UK is almost three times as long at 12.8 years.

The short maturity of US debt is a blessing in the short run, since we can benefit from lower interest rates. But it is also poses two risks in the long-run: greater exposure to interest rate increases (if and when they materialize) and a relentless need to ask capital markets to rollover existing debts. Both good reasons why Treasury should continue to gradually extend the maturity of federal borrowing.