Obama Proposal Could Lead to Bigger Domestic Cuts, Smaller Defense Cuts

February 17, 2012 at 3:43 pm

A provision of the President’s budget would likely lead to even bigger cuts in domestic discretionary programs than the Budget Control Act’s (BCA) spending caps call for, with the savings going to lessen the required cuts in defense spending.

Our new analysis explains why, but here’s the story in brief:

Under current law, separate caps limit total defense discretionary funding and total nondefense discretionary funding for each year from 2013 through 2021.  The President’s budget would replace those caps with a single overall cap on discretionary appropriations starting in 2014, throwing defense and nondefense funding into the same pot.  (Essentially, the President is proposing to return to the BCA’s original cap structure, before the failure of the Supercommittee triggered a reconfiguration of the caps.)

The proposal wouldn’t change the overall amount of discretionary funding that Congress could approve in any year.  But in the current political environment, where advocates of the Pentagon are emphatic, defense contractors employ well-connected lobbyists and make substantial campaign contributions (and, in many cases, are strategically located in key congressional districts), and budgetary savings in defense often are attacked as jeopardizing national security, it would likely lead Congress to cut domestic and international discretionary programs further in order to help protect the military budget.

For 2013, the year before the proposal would take effect, the President’s budget breaches the existing defense cap by about $5 billion, while providing nearly $5 billion less for nondefense programs than the current cap allows.  (This funding shift is possible because the budget would change the caps to cover “security” and “nonsecurity” funding, which include somewhat different programs than the “defense” and “nondefense” categories.)  This modest reallocation may be just a foretaste of much larger reallocations to come in future years, especially on Capitol Hill, if policymakers remove the firewall between defense and nondefense funding.

The Downside of Cutting Taxes at All Costs

February 16, 2012 at 4:19 pm

A new tax plan from leaders in the Kansas House of Representatives is a prime example of how a misguided focus on cutting taxes at all costs can lead to bad fiscal policy that threatens to weaken a state’s economy.

The proposal would:

  • Cut income taxes virtually every year, and eventually repeal the individual and corporate income tax. The bill would require the state to cut income tax rates every year in which nominal revenue growth exceeded 2 percent, which is less than the current rate of inflation, until the individual and corporate income tax disappeared completely.  Income taxes make up over half of Kansas’ general fund, which supports such investments as education, public safety, and health care — key ingredients for economic growth and high-quality jobs over the long term.  Already, transportation officials warn that they will have to delay or cancel highway projects to help pay for the proposed tax cuts.
  • Raise taxes on nearly 200,000 low-income working families with children by cutting the Earned Income Tax Credit in half. Halving the state EITC would leave low-income families with less money to spend in the local economy and dramatically weaken the credit’s antipoverty impact.
  • Grant a huge, unprecedented tax break to corporations and their owners. The bill would abolish the income tax on business income that is “passed through” to owners, rather than taxed at the corporate level. Though proponents present the change as a job creator, much of the benefit would flow to large corporations and to investment funds and other entities that have few or no employees and are unlikely to create jobs, as our analysis explains.
  • Threaten the state’s bond rating and make infrastructure improvements more costly. The bond rating agency Moody’s recently declined to upgrade Oklahoma’s rating in part because of the mere possibility that the state might eliminate its income tax, which Moody’s warned would harm its ability to pay its debts in the future.  Lower bond ratings require a state to pay bondholders more to finance infrastructure investments.  That means either state spending on payments to the (mostly out-of-state) bondholders has to go up, or capital projects have to be scaled back.

Senator Toomey’s Tax Plan Can’t Do Everything That He Says It Does

February 16, 2012 at 3:12 pm

Senator Pat Toomey (R-PA) pounced on CNN’s Soledad O’Brien this week when she raised findings from an analysis that CBPP issued last fall of the tax plan that the Senator proposed to the congressional “Supercommittee.”  Senator Toomey asserted that a finding that O’Brien cited — that his tax plan would raise taxes on people making less than $200,000 — was “factually wrong and ridiculous.”

Really?  Let’s take a look:

In presenting his plan to the Supercommittee, Senator Toomey indicated it would:

  • Cut tax rates below the levels of President Bush’s tax cuts, setting the top rate for high-income households at just 28 percent;
  • Limit “tax expenditures” (credits, deductions, and other tax preferences) using a model developed by leading economist Martin Feldstein;
  • Leave the current preferential tax rate for capital gains in place; and
  • Produce $290 billion in increased revenues for deficit reduction.

It is impossible to do all of these things without raising taxes on people below $200,000.  Consider:

  • The Urban Institute-Brookings Institution Tax Policy Center (TPC) has estimated that the reductions in tax rates that Senator Toomey proposed would cost $268 billion in 2015 alone, with $137 billion of it going to people over $200,000. (These estimates assume a corresponding reduction in the tax rate under the alternative minimum tax, or AMT.  If policymakers do not enact that corresponding reduction, the number of taxpayers subject to the AMT would double to more than 13 million — a result that Senator Toomey surely does not intend.)
  • TPC also has estimated that a Feldstein-like tax-expenditure limit on people making over $250,000 would raise only $48 billion in 2015, meaning that higher-income households would receive a large net tax cut — they would gain much more from the tax-rate reductions than they would lose from the tax-expenditure limit.  (TPC did not provide this estimate for people over $200,000, but the TPC figures make clear that those over $200,000 would receive a substantial net tax reduction.)

The math is irrefutable.  Senator Toomey told O’Brien that, while reducing their deductions and credits, he also would cut tax rates for people below $200,000 so that they would face no net tax increase.  But that can’t be.  If the tax plan is supposed to produce a net increase in revenues, and if it loses revenue from people making over $200,000, then it simply must raise revenue from people making less than $200,000.

Nor would that outcome be terribly surprising.  With regard to tax expenditures, the Toomey plan shields the most lucrative tax expenditure for high-income people — the preferential tax rate on capital gains — while limiting key tax expenditures that lower- and middle-income people use, such as the child tax credit and employer-provided health insurance.  Indeed, Feldstein’s own estimates show that nearly three-fifths (71 percent) of the revenue that his proposal to limit tax expenditures — the model for the Toomey plan — would produce would come from people with incomes under $200,000.

Moreover, the Joint Committee for Taxation (JCT), Congress’ official, impartial “scorekeeper” on tax legislation, examined a plan similar to Senator Toomey’s — one that would cut tax rates to about one-seventh below the Bush tax rates, setting the top rate at 30 percent (Senator Toomey’s top rate is 28 percent), fully offset the costs of cutting tax rates by reducing tax expenditures (the Toomey plan would go further and limit tax expenditures enough to produce $290 billion in net revenue increases for deficit reduction), and retain the current preferential tax rates for capital gains and dividends (as the Toomey plan would do).  JCT found people making more than $200,000 would receive large tax cuts while those making less than $200,000 would, on average, face tax increases.

The only way that Senator Toomey’s plan could avoid raising taxes on people with incomes below $200,000 would be if he designed it in such a way that it lost significant revenue overall and, thus, added significantly to the deficit.  Given its tax cuts for people at high income levels, it must either raise taxes on middle-income families or increase the deficit.  It cannot achieve the conflicting goals that Senator Toomey claims for it.

That would become evident if Senator Toomey turned his proposal, which is still not available on paper, into a specific plan and sent it to JCT for analysis.

An Updated Look at Governor Romney’s Budget Proposals

February 16, 2012 at 1:37 pm

We’ve updated our analysis of Governor Mitt Romney’s budget proposals, which (as we said before) would require cutting nondefense discretionary spending to levels not seen in decades.  Here’s the opening:

Romney Proposals Would Require Massive Cuts in Nondefense Programs Presidential candidate Mitt Romney’s proposals to cap total spending, boost defense spending, cut taxes, and balance the budget would require extraordinarily large cuts in nondefense programs.

For the most part, Governor Romney has not outlined cuts in specific programs. But if policymakers exempted Social Security from the cuts, as Romney has suggested, and then cut Medicare, Medicaid, and all other nondefense programs by the same percentage, balancing the budget and adhering to the Romney spending cap would require cuts of 35 percent in 2016 and 56 percent in 2022. Without the balanced budget requirement, the cuts would be smaller but still massive — 28 percent in 2016 and 38 percent in 2022. These estimated cuts are somewhat larger than those that we published in an earlier version of this paper for reasons that we outline in Box 1 on page 4, including our use of the latest Congressional Budget Office (CBO) budget and economic projections.

For nondefense discretionary programs — those subject to annual appropriation — these cuts would come on top of the 11-percent cut already in law due to the discretionary funding caps of the Budget Control Act (BCA) that Congress enacted last August. Our estimates of the depth of cuts that the Romney proposals would require are consistent with what Governor Romney himself has said about the required cuts.

These cuts are far deeper than those that House Budget Committee Chairman Paul Ryan’s (R-WI) austere budget plan would require. They would shrink nondefense discretionary spending — which, over the past 30 years, has averaged 3.7 percent of gross domestic product (GDP) and never fallen below 3.2 percent — to just 1.7 percent by 2022.

Click here for the full report.

Of Zeno’s Dichotomy Paradox, “Takers,” and Deficit Reduction

February 16, 2012 at 1:05 pm

Do you know Zeno of Elea’s famous Dichotomy Paradox?  More than 2,000 years ago, he noted that if Homer wanted to walk all the way to the market, he would first have to walk halfway there, then half of the remaining difference, then half of the remaining difference again so that, ultimately, he would take ever smaller steps without ever getting there.  Zeno was wrong, of course, as mathematicians and philosophers have long demonstrated.  Homer could get from here to there — as long as he stopped focusing only on the remaining distance.

You might not think Greek philosophy bears much relevance to fiscal policy. But Zeno’s Dichotomy Paradox comes to mind when I think about how some policymakers frame discussions of deficit reduction.

Here’s why:

When I served as a House Budget Committee staffer, a colleague described one particular senator as a “taker.” After one side in a tough budget negotiation offered to split the difference, the senator “took” that offer, called it the new starting point, and insisted on splitting the remaining difference 50-50. He should get three-quarters of what he wanted, he argued, because the other side had already conceded the first half.

Now, let’s think about how “takers” relate to current discussions of fiscal policy.

In late 2010, the release of the Bowles-Simpson and Rivlin-Domenici deficit reduction plans laid the groundwork to start this nation on a fiscal journey.  Those plans each called for trillions of dollars in deficit reduction through a combination of substantial spending cuts and substantial tax increases.  Efforts last year to make major progress on that journey — through negotiations that Vice President Biden chaired in the spring with key lawmakers of both parties, the negotiations between President Obama and House Speaker John Boehner in the summer, and the negotiations by the congressional “Supercommittee” in the fall — all failed.  But policymakers started the journey nonetheless by enacting large budget cuts, primarily through the Budget Control Act, which they enacted in August to resolve the debt limit crisis.

As President Obama’s new budget, which he sent to Congress earlier this week, shows (Summary Table 3 on page 207), the President and Congress cut $1.7 trillion last year from “discretionary” (non-entitlement) spending over the period 2013-2022.  When you count the resulting interest savings, that figure surpasses $2 trillion.  This amount came entirely from budget cuts.  No deficit reduction came from higher taxes.

Now, policymakers are starting to debate the remaining part (or parts) of the journey.  As we have noted, $4.3 trillion in deficit savings would occur over the next ten years through a combination of the savings enacted last year and the new measures in the President’s budget (if Congress enacts them).  About three-fifths of the total (not counting interest savings) would come from spending cuts, with about two-fifths from revenues.

The “takers,” however, are having none of it.  Acting as though the first $2 trillion of the journey no longer count, lawmakers such as Senator Jeff Sessions (R-AL), the Senate Budget Committee’s top Republican, are criticizing Obama’s budget because it secures most of its savings by raising taxes.  The fact that the first $2 trillion of deficit reduction consisted solely of spending cuts, secured through threats by numerous lawmakers last spring to shut down the government and threats last summer to let the nation default, is conveniently swept aside.  For “takers,” the journey is just starting now.

But we must view the journey in its entirety.  Deficit reduction as a whole — irrespective of how many steps it comes in — must be balanced, even though the initial steps of last year were not.