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.

Key Budget Changes in the Senate Health Bill

Majority Leader Harry Reid released his revised health care bill today; the Congressional Budget Office followed shortly thereafter with its cost estimate.

Leader Reid has made many changes to his original bill. The one you will hear the most about, just because it is amusing, is that the tax on cosmetic surgery (the “bo-tax”) has been replaced with a tax on indoor tanning services. (I’m not sure of the politics here, but I presume this tax will be justified by pointing out that indoor tanning is the equivalent of cigarette smoking for your skin.)

From a budget perspective, CBO identifies the following as among the most important changes:

• The tax credit for small businesses would be made available to firms paying somewhat higher average wages, and it would first take effect in 2010 rather than 2011.

• The penalty for not having insurance would be the greater of a flat dollar amount per person or a percentage of the individual’s income, which would increase the amount of penalties collected.

• The provision establishing a public plan that would be run by HHS was replaced with a provision for multi-state plans that would be offered under contract with OPM.

• Certain workers would have the option of obtaining tax-free vouchers from their employers equal in value to the contributions their employers would make to their health insurance plans. The value of vouchers would be adjusted for age, and the vouchers would be used in the exchanges to purchase coverage that would otherwise be unsubsidized. (CBO and JCT estimate that about 100,000 workers would take advantage of that option.)

• Several provisions regulating insurers were added, including a requirement for an insurer to provide rebates if its share of premiums going to administrative costs exceeds specified levels and a general prohibition on imposing annual limits on the amount of benefits that would be covered.

• Additional federal funding for CHIP would be provided to states in 2014 and 2015.

• A provision that would increase Medicare’s payment rates for physicians’ services by 0.5 percent for 2010 was eliminated. Instead, the 21 percent reduction in those payment rates that is scheduled to occur in 2010 under current law would take effect. [In other words, the previous bill had a one-year doctor fix; the new bill has none.]

• The measure of Medicare spending that would be used to set savings targets for the Independent Payment Advisory Board was modified. [As I will discuss in a later post, this is a big deal.]

• The increment to the Hospital Insurance portion of the payroll tax rate for individuals with income above $200,000 and for families with income above $250,000 was raised from 0.5 percent to 0.9 percent.

• The 5 percent excise tax on cosmetic surgery was eliminated, and a 10 percent excise tax on indoor tanning services was added.

• Community health centers and the National Health Service Corps would receive an additional $10 billion in mandatory funding.

• Revisions to and extensions of the Indian Health Care Improvement Act were added.

Taxes Are Not Created Equal

I’ve been working on a paper about America’s looming fiscal crisis. Earlier today I drafted a short (and as-yet-unfinished) section about tax policy that goes as follows:

Three decades ago, supply-side economists first argued that high marginal tax rates would discourage work, saving, and investment, and that well-crafted reductions in those tax rates could help boost long-run economic growth. Those observations have since become part of the fabric of mainstream economics. Meanwhile supply-side economics transformed into a doctrine that endorsed any tax cut at any time and that peddled the idea that tax cuts would inevitably pay for themselves.

Both of those notions are nonsense. Tax cuts rarely, if ever, pay for themselves, and they can do more damage than good.

As policymakers begin to confront our budget challenges and the conversation shifts from tax cuts to tax increases, it is essential that they understand the now-mainstream insight that taxes are not created equal. Taxes on income, for example, are usually worse for the economy than taxes on consumption. That’s why there’s a rising chorus of economists recommending the introduction of a value-added tax, rather than higher income taxes, if our nation decides it wants to support substantially higher government spending. High tax rates similarly tend to be worse for the economy than low rates. That’s why economists usually favor broad tax bases and low rates, rather than narrow tax bases and high rates. Finally, it’s preferable to levy taxes on bads rather than goods. Where appropriate, taxes on pollution (e.g., emissions of greenhouse gases) should thus be preferred over taxes on working, saving, or investing.

Little did I know that I have a subconscious ESP link with Bruce Bartlett over at Capital Gains and Games. In a long post setting out some of the themes in his new book, Bruce writes:

Everything that was true about [supply-side economics has] been fully incorporated into mainstream economic thinking and all that was left was a caricature.

All economists now accept the importance of marginal tax rates to economic decisionmaking, and organizations like the National Bureau of Economic Research publish vast numbers of papers on this topic.

During the George W. Bush years, however, I think [supply-side economics] became distorted into something that is, frankly, nuts–the ideas that there is no economic problem that cannot be cured with more and bigger tax cuts, that all tax cuts are equally beneficial, and that all tax cuts raise revenue.

Looking Back at Fiscal 2009

A few days ago, CBO released its latest snapshot on the federal budget, documenting the remarkable challenges of fiscal 2009, which ended on September 30. The key phrase in the report is “in over 50 years” as in:

  • At $1.4 trillion, the budget deficit was 9.9% of gross domestic product, the largest, relative to the economy, in over 50 years.
  • At $3.5 trillion, spending was almost 25% of GDP, the largest, relative to the economy, in over 50 years.
  • At $2.1 trillion, tax revenues were about 15% of GDP,  the lowest, relative to the economy, in over 50 years. (I get the sense that this point is less well-known than the other two.)

Other highlights from the report:

  • As expected, CBO estimates that the 2009 deficit was about $1.4 trillion, below the $1.58 trillion estimate in the Administration’s August budget forecasts. Assuming CBO is right, that means that next week, when the official Treasury figures are released, the Administration will be able to put a good news spin on the results, saying the deficit was less than it anticipated.  (As noted in an earlier post, CBO’s summer update, released on the same day as the Administration’s, predicted a $1.4 trillion full-year deficit, when calculated on an apples-to-apples basis. The report was a bit complicated to interpret, however, because its headline deficit estimate used different accounting for Fannie Mae and Freddie Mac, which resulted in a higher figure of about $1.6 trillion.)
  • As shown in the following chart, the deficit exploded in 2009 for three main reasons:

Budget Deficit Fiscal 2009

  • Tax revenues fell off a cliff (down 17% or $419 billion relative to fiscal 2008). The sharpest declines were in corporate income taxes (down 54%) and individual income taxes (down 20%). The declines reflect both the weak economy and, to a lesser extent, efforts to provide stimulus.
  • The financial rescue required $245 billion in new spending. TARP accounted for $154 billion, while cash injections into Fannie Mae and Freddie Mac accounted for $91 billion.
  • Other spending increased (up 13% or $347 billion relative to last year). These increases were spread across many spending programs, but were most pronounced for unemployment insurance (up 156%) and Medicaid (up 25%).

In addition:

  • Interest payments provided a sliver of good news. Interest payments fell by 23% (or $61 billion) thanks to low interest rates and small inflation adjustments on indexed bonds.
  • CBO estimates that the budget impact of the stimulus totaled about $200 billion by the end of September.

Answer: When It’s a Fine

Readers have provided many thoughtful comments on yesterday’s post about whether we should use the word “taxes” to characterize the financial penalties that would be used to enforce an individual health insurance mandate. Based on those comments, and some further reflection, I have several additional thoughts:

  • I discovered that some people think the individual mandate itself should be characterized as a tax. I don’t agree. As long as individuals are free to choose among private insurance plans in satisfying the mandate, there is no need for the President (or anyone else) to refer to the mandate as a tax. The distinction between regulation and taxation can sometimes be blurry, but it’s still a useful distinction. And an individual mandate is clearly a form of regulation. (However, I also won’t object if opponents characterize the mandate as a tax; that’s well within the norm of political economic rhetoric on both sides of the aisle. My point is simply that proponents of the mandate don’t need to use the “t” word in characterizing it.)

Note: The situation would be different if individuals were forced to purchase a specific government insurance plan. That would be a tax. (For a related discussion, see this brief from the Congressional Budget Office that discusses how it decides whether regulations are so intrusive that the regulated activities should be reflected in the budget; as I noted in one of my first posts, that was a key issue during the debate over the Clinton health proposals.)

  • My ruminations were focused on the question of what you should call the financial penalties that would be applied to individuals who didn’t satisfy the mandate. Following the CBO, I am firmly of the belief that the resulting cash inflow to the government should be characterized as revenues.
  • Most revenues are the result of taxes, but not all. And, on reflection, it seems rhetorically defensible to refer to the penalties as “fines” rather than “taxes” if their purpose is to enforce the individual mandate and not to generate revenue. (This is similar to, but somewhat different from, my earlier thoughts about the penalty acting like a Pigouvian tax, which is what I took the President to be saying on Sunday.)

So, here’s my revised suggestion for rhetoric that the President can use next time he’s interviewed by George Stephanopoulos: “If my plan is enacted, I believe that all responsible Americans should have health insurance. If they don’t they should face a penalty because they are imposing costs on others who may have to pick up the tab for their future health costs. And that penalty is a fine, George, not a tax.”

When is a Tax Not a Tax?

A critique–and, if you read far enough, a partial defense–of the President’s rhetoric about the definition of a tax.

Be sure to read my follow-up post: “Answer: When It’s a Fine

President Obama has walked into a rhetorical box on taxes. On the one hand, he campaigned on a promise not to raise taxes on Americans who earn less than $250,000 per year. On the other hand, he has endorsed policies that look a lot like taxes on those people. They include:

  • A $0.62 per pack increase in the federal cigarette tax. President Obama signed this into law to help finance an expansion in health programs for children; the increase went into effect on April 1.
  • Proposals to tax insurers who offer “Cadillac health insurance plans.” As many commentators have noted – and as I taught my students on Monday – some of that tax (perhaps much of it) would ultimately be passed on to consumers in higher insurance premiums. So insurers may be the ones writing checks to the government, but, in reality, consumers will be paying higher taxes.
  • Penalties to enforce an individual mandate in the health bills now pending in Congress.  For example, the draft Baucus bill (from a few days ago; it may have since changed) would impose a penalty of up to $3,800 per year for families that could afford health insurance but do not purchase it.

The President’s supporters have argued that the first two tax increases are consistent with his pledge. The increased cigarette tax, for example, isn’t an increase in income taxes.  And the tax on insurance companies isn’t a direct tax on individuals and, even if it’s partially passed through, it would not increase individual income taxes.

Such hairsplitting has no economic content – some of both tax increases really would fall on families that earn less than $250,000 – but may provide enough political cover to defend what I presume the President actually meant on the campaign trail: “I will not raise income taxes directly on American families who earn less than $250,000.”

Unfortunately for the President, that hairsplitting apparently won’t work with the third proposal which involves a direct tax on individuals who don’t get qualifying health insurance. Those individuals would have to write a check to the government as a penalty for this lack of coverage.

There would seem to be no wiggle room to enable the President to call this anything but a tax (albeit not an income tax). Yet, when asked about this by George Stephanopoulos on Sunday, the President tried to deny that such penalties are taxes. Stephanopoulos and Merriam-Webster, however, were having none of it:

The President’s argument fails, on its face, if you take the view that a tax is any money that the government takes from you through exercise of its sovereign power. Purchasing a souvenir at a National Park? Not a tax since it’s a voluntary, market-like transaction. But paying a penalty because you haven’t purchased government-approved health insurance? That’s a tax. And, indeed, it is treated as such by the Congressional Budget Office in its evaluation of health proposals.

I think CBO is correct: for federal budget purposes, the penalty on the uninsured would indeed be a tax, since it reflects the exercise of the government’s sovereign power.

However, and this may surprise you, I also think the President has an important point which he tried, with only limited success, to articulate. I would describe it as follows: A well-meaning government levies taxes for two different reasons:

Continue reading “When is a Tax Not a Tax?”

Baucus Bill: Four Steps in the Right Direction

From a budget perspective, the Baucus bill is a major step forward from the earlier HELP and House bills. There remains lots of room for improvement, and I am certainly not endorsing the bill at this point. But I do believe that Chairman Baucus and his team deserve credit for improvements on at least four important fronts: overall budget impact, doctor payment rates in Medicare, tax increases, and communications.

1. On paper, at least, the bill satisfies three key budget tests. It doesn’t add to the deficit over the ten-year budget window, it doesn’t add to the deficit in the tenth year of the window, and it doesn’t add to the deficit in years beyond the window. Indeed, it appears to reduce the deficit over each of those periods.

As CBO hinted in its cost estimate and Greg Mankiw discusses on his blog, there are reasons to doubt whether some proposed spending reductions and tax increases would actually materialize. Thus, the actual budget effects may not be as rosy. That’s a huge issue. But even with that caveat, the Baucus bill is a major improvement over proposals that didn’t even try to hit these budget targets.

Continue reading “Baucus Bill: Four Steps in the Right Direction”

The Exploding Deficit Reaches $1.4 Trillion

Earlier today, CBO released its latest monthly snapshot on the federal budget. The key things you should know are:

  • CBO estimates that the government ran a deficit of almost $1.4 trillion during the first eleven months of the fiscal year (up from $501 billion at this point last year).
  • CBO reiterated its forecast that the full year’s deficit will also come in around $1.4 trillion (September is usually a month of surplus because of strong tax receipts, but CBO apparently thinks this September will be close to break-even.)
  • CBO’s estimate is noticeably lower than the administration’s most recent deficit forecast of $1.58 trillion. If the final numbers next month are in line with CBO’s projections, some commentators will thus spin the full year deficit as good news (“the deficit came in lower than the administration expected”), while others will spin it as bad news (“yikes, the deficit was $1.4 trillion”). (As noted in an earlier post, CBO’s summer update was a bit complicated to interpret because its headline deficit estimate used different accounting for Fannie Mae and Freddie Mac than the administration used; on an apples-to-apples basis, however, CBO then forecast a deficit of $1.41 trillion.)
  • As shown in the following chart, the deficit has exploded for three main reasons:

Budget Deficit August

Continue reading “The Exploding Deficit Reaches $1.4 Trillion”

2009 Budget Deficit: $1.58 Trillion

Next Tuesday is a big day for budget watchers. The Congressional Budget Office will release its updated budget and economic projections in the morning, and the Office of Management and Budget will release its projections later in the day.

CBO isn’t a fan of leaks, so we probably won’t know much about its updated projections until Tuesday. The Obama administration, on the other hand, will likely allow select tidbits out early, as have previous administrations.

Indeed, Bloomberg is already reporting that an administration official told them that this year’s deficit will come in at “$1.58 trillion, about $262 billion less than forecast in May.”

There are several things you should know about this estimate:

  • The $262 billion difference is largely explained by a single factor: no TARP II. The administration’s original budget included a $250 billion placeholder for additional financial stabilization efforts. Happily, that never happened.
  • A second big factor, as reported by Bloomberg, is that spending on bank failures has come in $78 billion lower than originally forecast.
  • That good news is partly offset by the fact that tax revenues are projected to be about $83 billion less than originally forecast (presumably because of the weak economy). All other spending is forecast to be about $17 billion less than originally projected.

In short, the cost of fighting the financial crisis has been much lower than forecast in May, while the rest of the budget has done slightly worse than forecast.

This being Washington, there will be some debate about whether the $1.84 trillion figure from May is the right benchmark for evaluating whether the deficit is lower than forecast. That figure (the “policy deficit”) reflected not only the administration’s expectations about how the economy was affecting the budget, but also the budget impacts of its policy proposals, including the potential TARP II. At the time, the administration also made a second forecast that did not include any policy changes. That “baseline deficit” was $1.62 trillion, almost identical to the new estimate. Folks who use the baseline as a benchmark will thus conclude that the deficit is essentially in line with earlier expectations.

Note: The estimates of this year’s budget deficit will get lots of press (and blog) attention, but they are by no means the most important information in the new projections. The real question is what 2010, 2011, and subsequent years look like. We know the deficits will be scary-looking, but we will have to wait until Tuesday to find out just how scary.

Latest Data on Transfers and Income

In a series of posts (most recent here), I’ve documented that Americans are getting an increasing portion of their income from the government.

BEA released new data on incomes a couple weeks ago, including revisions back to 1995. These data reinforce the story I’ve described in my previous posts:

  • Transfers accounted for 17.3% of personal income in June. That’s the second highest in history, topped only by the 18.2% recorded in May, when transfers were boosted by one-time payments from this year’s stimulus act:

Transfers June 2009

  • The increasing importance of transfers reflects both short-run developments and long-run trends. In the past year, the importance of transfers has grown because of (a) weakness in other forms of income, (b) the natural expansion of transfers due to economic weakness (e.g., increases in unemployment insurance payments), and (c) policies to expand benefits (e.g., as an attempt at stimulus). Over the longer run, however, the growth of transfers has been driven by the expansion of entitlement programs.

Continue reading “Latest Data on Transfers and Income”