Deficit – Page 4 – Donald Marron

The Looming Budget Battle over the Bank Tax

Treasury Secretary Tim Geithner appeared before the Senate Finance Committee today to push the Administration’s proposal for a Financial Crisis Responsibility Fee, more commonly known as the Bank Tax. The purpose of the fee is to

[M]ake sure that the direct costs of TARP are paid for by the major financial institutions, not by the taxpayer. Assessments on these institutions will be determined by the risks they pose to the financial system. These risks, the combination of high levels of riskier assets and less stable sources of funding, were key contributors to the financial crisis.

The fee would be applied over a period of at least ten years, and set at a level to ensure that the costs of TARP do not add to our national debt. One year ago we estimated those costs could exceed half a trillion dollars. However, we have been successful in repairing the financial system at a fraction of those initial estimates. The estimated impact on the deficit varies from $109 billion according to CBO to $117 billion according to the Administration. We anticipate that our fee would raise about $90 billion over 10 years, and believe it should stay in place longer, if necessary, to ensure that the cost of TARP is fully recouped.

As noted by other participants in today’s hearing, the bank tax raises a host of questions: Is it possible to design the tax so that it is ultimately paid by major financial institutions (by which I presume Geithner means their shareholders and top management), or will it get passed through to their customers? How much, if at all, would the tax reduce bank lending? Is it fair to target the banks even though the bank part of TARP actually made money for taxpayers? Would the tax reduce risks in the financial system?

Those are all interesting questions, but today I’d like to highlight another one: Can Congress embrace the idea of a bank tax that would be used to “ensure the costs of TARP do not add to our national debt”?

As described by the Administration, the bank tax would be used to reduce the deficit, thus offsetting budget costs of TARP. Congress, however, is hungry for revenues that it can use to offset the budget costs of new legislation, e.g., extending the ever popular research-and-experimentation tax credit or limiting the upcoming increase in dividend taxes. With PAYGO now the law of the land (for many legislative proposals), some members are looking at the $90 billion of potential bank tax revenues as the answer to their PAYGO prayers.

All of which points to a looming budget battle: Will the bank tax be used to pay off the costs of TARP, as the President has proposed, or will it be used to pay for other initiatives?

Can Greece Cut Its Deficit by 10% of GDP?

Greece needs money fast. The International Monetary Fund (IMF) and members of the Euro-zone have that money. But before they lend it to Greece (at very favorable interest rates), they are demanding that Greece get its fiscal house in order.

As a result, Greece is proposing an austerity plan that would reduce its out-of-control budget deficits (currently standing at more than 13% of GDP) by at least 10-11% of GDP.

You might wonder whether that’s possible. History suggests the answer is yes, at least in principle. Indeed, several countries have achieved even larger deficit reductions.

According to an IMF study that I discussed a few months ago, the past three decades have witnessed at least nine instances in which developed nations have cut their structural deficits by at least 10% of GDP:

Ireland (20%, 1978-89)
Sweden (13%, 1993-2000)
Finland (13%, 1993-2000)
Sweden (13%, 1980-87)
Denmark (12%, 1982-86)
Greece (12%, 1989-95)
Israel (11%, 1980-83)
Belgium (11%, 1983-1998)
Canada (10%, 1985-99)

This list demonstrates that large-scale budget improvements are possible. But they don’t always stick. Sweden, for example, makes two appearances in the top nine. Its gains in the 1980s were undone in the financial crisis of the early 1990s, so it had to undertake a second round of austerity. And Greece itself is a repeat offender, as its gains from the early 1990s have all been lost.

Greece faces enormous practical and political challenges in its austerity efforts, and success is hardly guaranteed. The nation can take some encouragement, however, from the fact that other nations have addressed even larger budget holes.

With some hard work and luck, perhaps Greece will join Sweden as a two-time member of the Large Deficit Reduction Club.

America in the Red, AOL Version

Responding to all the recent talk of a value-added tax, AOL News poses the following question today: “Do we need a new way to tax citizens?”

In response, AOL posts several pieces about the pros and cons of a VAT (by Henry Aaron and Isabel Sawhill, Ira Stoll, and Veronique de Rugy). In addition, it also includes an abridged version of my National Affairs piece, “America in the Red,” which they titled “Don’t Take Anything Off the Table.”

If you haven’t found time for the full length version, with charts, you might want to try AOL’s abridged one. (Please note that they did the abridging.)

America in the Red

The new issue of National Affairs includes an essay in which I summarize my thinking about our nation’s fiscal challenges.

In “America in the Red” (pdf version), I describe our fiscal challenge, explain how deficits and debts may undermine our prosperity, and emphasize the importance of setting clear budget goals.

I also argue that everything should be on the table in thinking about our budget future. Growth alone won’t set us free. Spending cuts alone won’t be enough. And tax increases alone won’t work either. We need to pull on all the levers–reducing spending, increasing revenues, and promoting growth–if we want to get our fiscal house in order.

Talking About Our Budget Woes

On Thursday, I appeared on Canada’s Business News Network to discuss our budget woes. Also on the show were Joe Minarik of the Committee for Economic Development and Bill Beach of the Heritage Foundation.

The first part of the interview focused on taxes. In a nutshell, my view is that spending restraint won’t be enough to get our budget under control, and therefore tax revenues will have to rise above their historical level (of about 18 – 18.5% of GDP). But our existing tax system is inefficient and will not scale well to higher levels of revenue. Thus any effort to raise more revenues must be coupled with fundamental tax reform. For example, we ought to re-examine how tax expenditures have made swiss cheese of our tax system.

The second part focused on the risks of our growing debt. I view that debt as a serious problem (no surprise). But I remain optimistic that the United States will eventually get its act together to deal with it. I am just not sure when.

Budget Thoughts from Steny Hoyer

House Majority Leader Steny Hoyer is building a reputation as one of our most thoughtful leaders when it comes to budget matters. Thus I commend to you the speech on fiscal responsibility he gave at the Brookings Institution today.

Highlights include his criticism of “selfish” budget choices:

[W]hen it comes to budgeting, what is politically easy is often fiscally deadly. It is easier to pay for tax cuts with borrowed money than with lower spending; easier to hide the true costs of war than to lay those costs before the people; easier to promise special cost-of-living adjustments than explain why an increase is not justified under the formula in law; easier to promise 95% of Americans that we won’t consider raising their taxes than to ask all Americans to contribute for the common good. Those kinds of easy choices are so often selfish choices—because they leave the chore of cleaning up to someone else. Easy choices may be popular—but the popularity is bought on credit.

And his discussion of budget options:

On the side of entitlement spending, an agreement might recognize that Americans are living longer lives and raise the retirement age over a period of years, or even peg the retirement age to lifespan. Another option is to make Social Security and Medicare benefits more progressive, while strengthening the safety net for low-income Americans. That could preserve those programs as a central part of our social compact, while protecting their ability to help those of us in the greatest need.

On the side of revenues, President Obama was correct in refusing to take any options off of the commission’s table. No one likes raising revenue, and understandably so. But if you’re going to buy, you need to pay. … If need be, I am hopeful that both parties will agree to look at revenues as part of the solution—not as a gateway to higher spending, but as part of a compromise that cuts spending and balances the budget.

I don’t agree with everything Leader Hoyer has to say in his speech (e.g., I am much more concerned about the budget impacts of the pending health bills, and I view the recent PAYGO bill less favorably because of its many exceptions). But I appreciate how seriously he takes these issues.

P.S. Bruce Bartlett also recommends the speech.

The Lost Budget Decade

Budget aficionados have long warned that the U.S. budget is on an unsustainable path. That’s old news (but important).

The new news, which I hope you’ve noticed, is that those warnings have become more urgent over the past year or so. Why? Because our future problems have moved much closer.

Over at the Committee for Economic Development, Joe Minarik has a nice chart that illustrates how rapidly the budget outlook deteriorated:

Joe’s chart shows two projections of the U.S. publicly-held debt. The blue line shows the history of the debt (measured relative to the size of the economy), as well as a projection of the future debt based on analyses by the Congressional Budget Office released in late 2007. The red line shows a similar projection, but based on CBO budget analyses released in January of this year.

As you can see, the day of debt reckoning has moved much closer. For example, our debt will hit 60% of GDP twelve years earlier than forecast (which Joe rounds down to a decade). And, of course, it will keep rising thereafter.

Bottom line: The warnings of budget experts have become much more urgent because our room for maneuver has gotten much smaller.

The Spectre of Creative Bookkeeping

A spectre is haunting Europe — the spectre of creative bookkeeping.

In an article in this morning’s Wall Street Journal (“Debt Deals Haunt Europe“), Charles Forelle and Susanne Craig provide more examples of the “aggressive” bookkeeping that European nations have deployed to satisfy the deficit and debt targets of the Growth and Stability Pact.

Greece, of course, takes honors in the field, not just for its recent use of derivatives to hide liabilities (see my earlier post), but also for other creative moves in the past. For example, the authors report that Greece:

insisted to the Eurostat statistics authority that large portions of its military spending were “confidential” and thus excluded from deficit calculations. In 2000, Greece reported that it spent €828 million ($1.13 billion) on the military—about a fourth of the €3.17 billion it later said it spent. Greece admitted to underreporting military spending by €8.7 billion between 1997 and 2003.

Such shenanigans are hardly unique to the Greeks. Other players include:

Portugal, which “classified subsidies to the Lisbon subway and other state enterprises as equity purchases” in 2001, and

France, which “arranged a deal with the soon-to-be privatized France Telecom in 1997 under which the company paid the government a lump sum of more than €5 billion. In return, France agreed to assume pension liabilities for France Telecom workers. The billions from France Telecom helped narrow France’s budget gap.”

Although dated, these examples illustrate some basic strategies that governments use to conceal the size of their deficits and debts: pretend the spending does not exist (Greece), pretend that spending is really an investment (Portugal), or pretend the future pension liabilities aren’t real (France).

A topic for another day is how these strategies may have been used in the United States. Suffice it to say that strategy three–ignoring future pension costs–is widespread both in governments and the private sector.

Crisis and Aftermath: The Economy and the Budget

Most of official Washington was closed today in the wake of Snowmageddon. But not the Senate Budget Committee, which went ahead as planned with its hearing “Crisis and Aftermath: The Economic Outlook and Risks for the Federal Budget and Debt.”

The three witnesses were Carmen Reinhart of the University of Maryland (famous for her work with Ken Rogoff on the history of financial crises), Simon Johnson of MIT (famous for his blog, The Baseline Scenario), and yours truly.

You can find my written testimony here. You can watch the hearing from a link on the website.

The gist of my message was:

Our nation is on an unsustainable fiscal path. If current policies continue, we will run trillion-dollar deficits in the years ahead—even after the economy recovers—and the public debt will rise faster than our ability to pay it. Persistent deficits and rising debt will undermine American prosperity, threaten beneficial social programs, and weaken our position in the world.

Those threats deserve immediate attention but our economy remains fragile. Payroll employment has fallen by 8.4 million jobs since the start of the recession, and long-term unemployment is at record levels. Recent data have provided some glimmers of hope—strong GDP in the fourth quarter and a decline in the unemployment rate in January—but our economy has a very long way to go.

Policymakers thus face a difficult challenge of balancing concern about current economic conditions with a meaningful response to our looming fiscal crisis. In thinking about that balance, they should keep five points in mind:

1. Don’t expect a rapid recovery. The recession does appear to be behind us, but the economy has much healing ahead of it.

2. Uncertainty has been holding the economy back. Uncertainty discourages investment and hiring and therefore undermines growth. The good news is that economic uncertainty has declined sharply over the past year, creating an environment more conducive to growth. The bad news, however, is that policy uncertainties are enormous. From expiring tax provisions, to uncertainty about the rules-of-the-road in the financial sector, to major policy initiatives on health insurance, climate change, etc., businesses and families are uncertain about the future policy environment. That discourages investment and hiring. Some of these uncertainties are unavoidable as Congress deals with important issues. But lawmakers should look for opportunities to reduce unnecessary policy uncertainty.

3. Persistent deficits and rising debts pose a serious risk to long-term economic growth. Concerns about the near-term economic outlook should not deter Congress from taking steps to strengthen our fiscal position over the next decade. Although major steps toward fiscal consolidation should not take effect in 2010 and 2011, Congress should begin to plan now for deficit reduction and debt stabilization in later years. That plan should include clear goals (e.g., a target trajectory for the debt-to-GDP ratio) and credible means for achieving them. President Obama outlined some steps in this direction in his budget, but I believe they fall far short of what is required. Under his official budget the debt would grow faster than the economy in every single year. That’s unacceptable.

The President has proposed that a fiscal commission be tasked with stabilizing the debt-to-GDP in 2015 and beyond. That proposal is worth serious consideration. However, I believe any commission should have a more ambitious goal–e.g., reducing the debt-to-GDP ratio to 60% by the end of the budget window. In addition, I wonder whether a commission created by executive order will have sufficient political legitimacy and power to have much effect.

4. A credible plan to reduce future deficits would help keep long-term interest rates low, thus strengthening the current recovery.

5. In the long-term, bringing our deficits under control will require both spending restraint and increased revenues. Spending restraint should receive greater emphasis both because spending is the primary driver of our long-run budget imbalances and because higher government spending may slow economic growth. Given the government’s existing commitments, however, it is unlikely that spending restraint alone can put our nation on a sustainable fiscal trajectory. As policymakers consider how to finance a larger government, they should therefore give special attention to making our tax system more efficient. That means thinking about ways to tax consumption rather than income, ways to broaden the tax base rather than increase rates, and, ways to tax undesirable things like pollution rather than desirable things like working, saving, and investing.

The Problem with Tax Expenditures

Last week, Len Burman published a provocative op-ed suggesting that President’s Obama idea of freezing non-security discretionary spending amounts to “chump change” and that if he wants to make real budget improvements the President should propose to freeze tax expenditures (i.e., all the various preferences in our famously complex tax code). By Len’s calculations, such a freeze would increase tax revenues by $3.5 trillion over the budget window, 14 times as much as the $250 billion in spending reductions from the narrow spending freeze.

Over at the National Journal, John Maggs interviewed Len about his proposal and then asked various experts for their reactions. Here’s what I wrote:

Len is right to focus attention on tax expenditures. They involve big money, distort our conception of the size of government, often disproportionately favor the affluent, and receive too little oversight.

He’s also right that they deserve special attention when Congress decides that it wants to increase tax revenues. As Len says in the interview: “Cutting tax expenditures is a much better way to do this than raising marginal tax rates since the former tends to improve economic efficiency by reducing economic distortions — for example, among different kinds of investments — while the latter increases the economic cost of taxation.”

Of course, there are some complications. In addition to the obvious political challenges, tax expenditure cutters face another problem: agreeing on what provisions should actually be characterized as tax expenditures. One could, of course, just use whatever definitions the Treasury and the Joint Committee on Taxation use. But analysts do not agree on which provisions are really spending programs in disguise.

Some cases are easy. Tax credits for using ethanol-blended motor fuels are clearly spending programs run through the tax code. But then there are items like the 15% tax rate on capital gains and dividends. That rate is scored as a tax expenditure in the current system because 15% is lower than the rates on ordinary income. It wouldn’t be viewed as a tax expenditure, however, by analysts who believe that a consumption tax, rather than an income tax, should be the lodestar for judging tax policies. My point is not to take sides on that issue, but just to point out that there is sincere debate about which items labeled as tax expenditures should be viewed as hidden spending programs and which as good tax policy.

In response to one question, Len raises the idea of subjecting all tax expenditures to annual reauthorization as one way to rein them in. I appreciate the desire for greater oversight, but I find this idea worrisome. We are already cursed with a tax system in which an enormous number of provisions are scheduled to expire. That creates needless uncertainty, placing a real burden on businesses and families and often undermining the very intent of the tax provisions. As a case in point, consider the research and experimentation tax credit, which Congress extends every year or two. That’s absurd. If the credit is good policy, it should be enacted on a permanent (or, at least, prolonged) basis so that it provides a clear signal to firms that engage in R&E. Conversely, if it’s bad policy, we should kill it. Revisiting it every year will just enrich lobbyists, distract legislators from more important issues, and weaken any incentives it might create.

I expect that the same holds true for many other tax expenditures. Some deserve to be enacted for prolonged periods to accomplish their goals. Some deserve annual review. And many deserve to be killed.