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The Future, The Deficit and the Federal Budget

Financial Executive...September 2010

When Rep. Bart Gordon (D-TN) introduced his America COMPETES reauthorization bill (H.R. 5116) on April 22, 2010, he had high hopes for the bill's trouble- free passage through the House. The bill jacked up spending on research programs at three federal agencies and departments, and was designated a "key vote" by at least three business groups, including the Chamber of Commerce, who hoped it would eventually add up to new jobs and new products for American companies.

Gordon thought his bill threaded the political needle; business support meant Republicans would fall into line, increased federal spending meant Democratic support.
Instead of threading that needle, however, Gordon jabbed himself with it.

Republicans and even some Democrats took immediate issue with the cost of the brimming $96 billion bill at a time when the federal deficit was projected to hit $1.3 trillion. Gordon's reauthorization bill pumped up budgets for programs at the Departments of Energy, Commerce and the National Science Foundation at a rate of 8-10 percent a year over a five-year period. He topped that off with dollops of new spending on new programs, some of them seemingly duplicative of existing programs in each place. The annual cost for Gordon's bill was $17.2 billion a year, compared to $8 billion a year for the original bill passed in 2007 in response to a 2005 National Academy of Sciences (NAS) committee report called Rising Above the Gathering Storm, which said the U.S. industrial/exporting/high-paying job sector "appears to be on a losing path."

Three years later, not much had changed. "There is disturbing evidence that our overall innovation lead has not only been lost, but that we are continuing to rapidly lose ground," says Robert D. Atkinson, president, ITIF. Information Technology and Innovation Foundation (ITIF).

But here was Gordon, back with the same basic bill, only fatter. The big budget increases for existing programs during fiscal 2011-2015 seemed particularly irresponsible since Congress had not appropriated funds at the authorization levels for those programs during fiscal 2008-2010. So why even suggest higher authorizations? It was as if Gordon, who is retiring at the end of this session, was sending a message that the deficit be damned. The new programs Gordon insisted on authorizing such as Energy Innovation Hubs and Energy Frontier Research Centers seemed especially excessive given that the marquee new energy program authorized in the 2007 bill-- an Advanced Research Projects Agency-Energy, meant to reproduce the kind of results that the Defense version, called DARPA--had barely gotten off the ground because of Congress's refusal to appropriate funds for it.

The deficit headwinds forced Gordon a month after introduction of the bill to cut its $96 billion, five -year price tag by 10.2 percent. But when that $86 billion bill went to the House floor on May 19, Republicans offered what is called a "motion to recommit" which lopped $40 billion off the bill's price tag by cutting some new programs and freezing spending. It passed by a vote of 292 to 126, the margin in part reflecting inclusion of an amendment--which would have been hard to vote against-- authorizing firing of federal employees who look at pornography on taxpayers' time. The Democratic House leadership then pulled the bill off the floor, found a parliamentary way around the pornography amendment, and brought the $86 billion bill back to the House floor on May 28 when it passed by a vote of 262-150 with some GOP support.

Sen. Jay Rockefeller (D-W. Va.), chairman of the Senate Commerce Committee, and sponsor of the Senate version of America COMPETES, has made it clear that the House bill is unaffordable.
The debate in the House and now the Senate over the America COMPETES reauthorization illustrates how concern over the federal budget deficit is strewing rocks in front of all sorts of key business-favored legislation which would have had a smooth ride through Congress just a few years before. But business groups are responsible for some of the bumps. On the one hand, groups like the Chamber and National Association of Manufacturers (NAM) press legislators such as Gordon to authorize new programs like the Energy Innovation Hubs, Energy Frontier Research Centers and loan guarantees for small- and medium-sized manufacturers included in the America COMPETES reauthorization while at the same time calling for federal spending discipline to reduce the $1.3 trillion deficit.

Asked to reconcile higher federal spending and deficit reduction, Jeff Ostermayer, senior media strategist for the NAM, says, "We have always held the position that the federal government has a role to play to help spur investment and foster economic growth. With our economy still recovering we have supported policies that will help stimulate economic growth and create jobs."
But how to reconcile spending with deficit reduction, that is the question.

President Obama and other world leaders took up that question a month after the House passed the expensive America COMPETES reauthorization during the Group of 20 meeting in Toronto. The agenda there focused on how the world's biggest economies could coordinate to defeat both the global economic slowdown and the looming worldwide deficit debacle. The final G20 communiqué pledged the signatories to a goal of cutting government deficits in half by 2013 and stabilizing the ratio of public debt to gross domestic product by 2016. Although Obama insisted emphatically that there was “violent agreement” on the need to reduce debt over time, the final communiqué included a delicately worded call for deficit reduction “tailored to national circumstances.”

The U.S. national debt stands at $12.88 trillion and the Congressional Budget Office (CBO) expects the nation to add another $1 trillion a year for another decade. Obama, though, hopes to put the debt on a diet; the White House has forecast the projected 2010 deficit of $1.3 trillion will be reduced to $700 billion by 2013.The CBO has given credence to that Obama prediction, prophesying that the deficit will shrink from 10 percent of the economy today to about 4.5 percent in 2013 under Obama's long-range budget blueprint. But reaching that short-term goal depends on Obama's projected budget cuts and tax increases coming to fruition. Moreover, the CBO's June 2010 report The Long Term Budget Outlook calls the long-term budget outlook "daunting."

Obama's big push is toward 2015 when he wants to have a balanced budget excluding interest on the national debt. He has set up a bipartisan National Commission on Fiscal Responsibility and Reform to make recommendations on how that balanced budget can be achieved. Fourteen of the 18 members would have to agree on a package of domestic spending cuts and tax increases for Obama to then submit the recommendations to Congress for approval. Matt Miller, senior director for government affairs at FEI, expects the commission to engage in some good, open-ended dialogue focused on entitlement programs and revenue and tax policy. "A lot of times in these kinds of exercises you will see tight parameters for discussion," he explains. "This is a good inquiry. But it will be extremely difficult for the commission to put forth numerous serious recommendations."

Marty Sullivan, a contributing editor at Tax Analysts, a non-profit publisher of tax information and publications, explains just how extremely difficult it will be for the Commission to prescribe a palatable deficit Rx. "The changes needed to get to a balanced budget in 2015 excluding interest on the debt are earth shaking," Sullivan avers. What might be possible, he says, is to reduce the ratio of U.S. debt to gross domestic product (GDP) from today's level of 65-70 percent. To do that would mean reducing the deficit from its current 10 percent of GDP last year to three percent in 2015. Sullivan estimates that reduction would mean the U.S. would have to cut the federal budget by about $500 billion by 2015. Sullivan posits seven options for performing that gastric surgery:

1) raising all personal income taxes by 30 percent
2) raising all taxes, personal and corporate income taxes, estate taxes, Social Security taxes, etc. by 15 percent
3) cutting Medicare, Medicaid and Social Security spending by 25 percent
4) cutting all discretionary spending by 40 per, including defense, (but not "entitlement" spending such as Medicare, Medicaid and Social Security)
5) cutting all spending, entitlement and discretionary by 13 percent
6) cutting all taxes by 8 percent and all spending by 7 percent
7) imposing a new value added tax at 8 percent

" The current deficit is unsustainable and unprecedented." states Sullivan. "Congress is just taking baby steps. It needs to think outside the box just to get to a minimum level of sustainability."

Of course, the dimensions of the expanding federal deficit and needed solutions were pretty clear before the creation of the National Commission on Fiscal Responsibility and Reform. The long term outlook as viewed by the non-partisan CBO resembles nothing more than the blackening skies in the Wizard of Oz before the tornado swept Dorothy to Oz. And it is going to take more than some short guy with a booming voice behind a curtain to significantly reduce the deficit. The June 2010 CBO report looked at spending trends for Medicare, Medicaid, the Children’s Health Insurance Program (CHIP), and insurance subsidies that will be provided through the exchanges created by the recently enacted health care legislation. Under both of CBO’s scenarios, total outlays for those health programs would roughly double as a share of GDP over the next 25 years, from 5.5 percent in 2010 to about 10 percent or 11 percent in 2035. Spending on Social Security would rise much more slowly, from almost 5 percent of GDP in 2009 to about 6 percent in the 2030s and beyond.

Some of the ways of cutting spending on those programs are obvious. J.D. Foster, Norman B. Ture Senior Fellow in the Economics of Fiscal Policy, The Heritage Foundation, says there is agreement "right to left" on the need for Medicare reform. "On the benefit side, every beneficiary is getting a federal subsidy of $6000," he states. " It makes sense to subsidize the health care of low- or middle-income seniors but does it make sense to subsidize Medicare for rich seniors?"

Maya MacGuineas, president, Committee for a Responsible Federal Budget and director, fiscal program policy, New America Foundation, suggests even more radical solutions. "Over time, it would be advisable to fundamentally restructure Medicare to provide a voucher program, which would introduce more cost consciousness and cost controls. Given the progress in creating exchanges in the recent health reforms, this is now more of a possibility. Broad spending controls will have to be introduced to federal health care spending, including a cap on spending growth and triggers to ensure that projected health care savings are realized."

The CBO estimates that these kinds of spending reductions would stabilize the debt-to-GDP ratio at 67 percent for the next decade only if the Bush tax cuts approved in 2001 and 2003 are allowed to expire, if provisions designed to limit the reach of the alternative minimum tax (AMT) are allowed to expire and if annual appropriations drop below the pace of growth of GDP. If some or all of those things don't happen, the public debt would reach almost 90 percent of GDP in 2020. Experts like MacGuineas say the debt ratio should be at 40 percent.

A failure to tame the federal deficit would have myriad unappetizing implications. Most obviously, bills such as America COMPETES will not pass Congress and even if they do appropriators won't approve annual budgets up to the authorization levels. It is interesting to note that when Sen. Jay Rockefeller (D-W. Va.) introduced his version of the America COMPETES reauthorization in mid-July, the bill had a three-year authorization--not five years as in the House--as a way of cutting the bill's cost.

On the tax side, an out-of-control deficit means Congress won't even consider a reduction in the corporate income tax, which even many Democrats support. Nearly everyone with an eye on the global competitive situation understands that American companies are at a severe disadvantage when the U.S. corporate rate is at 39 percent, where it has remained for two decades, compared to the average rate of 26 percent for countries in the Organization for Economic Cooperation and Development (OECD). The only OECD country with a higher rate than the U.S., Japan at 40 percent, recently announced a planned, phased reduction in its corporate income tax as one way of jolting Japan out of its long-term economic malaise, although those plans are somewhat indistinct. But at least the recognition is there.

Not only does a yawning deficit mitigate against corporate tax cuts and an ensuing expansion of capital spending and investment, it also insures expanded borrowing by the U.S. Treasury. That leads to lower national saving which also leads to lower domestic investment. Then there is the whole suite of unappetizing "Greece-like" scenarios revolving around investor confidence and interest rates.

Some Democrats and Republicans in Congress have paid lip service to the need to cut federal spending and, to a much lesser extent, to raise taxes. It didn't go unnoticed in June when House majority Leader Rep. Steny Hoyer (D-MD) raised the possibility of raising the retirement age for Social Security as well as breaking President Obama's presidential campaign promise not to raise taxes on those earning less than $250,000. But even there Hoyer was tentative, saying President Bush's "middle class" tax cuts, which expire at the end of 2010, should be extended but only for one year, which was a way of saying that this Congress didn't have the courage to make that move, but maybe the next Congress would. Then, a week later, Rep. John Boehner (R-Ohio), the House Republican leader, said he favored raising the Social Security retirement age, too, and tying cost-of-living increases to the consumer price index rather than wage inflation and trimming benefits for retirees with substantial non-Social Security income.

But talk has clearly not translated into action, as House passage of the arguably bloated America COMPETES reauthorization proved. Neither the House nor the Senate has considered Obama's "Reduce Unnecessary Spending Act of 2010." The bill would give the president, whomever he or she is, the authority to delete spending from a recently-passed appropriations bill and send that bill back to Congress. The legislation would require the Congress to vote up or down on the presidential cuts. However, a president's spending cuts would be limited to discretionary programs, meaning excluding Social Security, Medicare, Medicaid; tax cut bills would also be off limits. The Obama-proposed authority is far weaker than the line-item veto power a GOP-dominated Congress gave President Clinton in 1996. Under that bill, before it was struck down by the Supreme Court in 1998, Clinton's line-item vetoes automatically went into effect unless overturned by a two-thirds vote of both the House and Senate. It is highly unlikely Congress will pass even Obama's diluted proposal which, as of the end of July, had not moved forward one inch.

Congress's refusal to entertain the Obama bill is just one example of its inability to confront the deficit issue. There are starker examples. In July, it became clear the House would not, for the first time since 1974, introduce, much last pass, a budget resolution. These are annual bills laying out five-year spending and tax plans which serve as a guideline for the Appropriations Committees in both houses. They indicate the size of the federal deficit over that period. The failure of the House to produce a budget resolution was a result of a split within the Democratic caucus. Conservative Blue Dog Democrats wanted a budget resolution which produced, again symbolically, cuts in some federal programs between fiscal 2011 and 2015, showing significant progress toward Obama's goal of a balanced budget minus interest on the federal debt.

Progressive Democrats wanted the resolution to reflect even greater deficits in the short term as a way of jolting the economy out of its continuing doldrums and producing more jobs. House Democrats produced instead what is called a "deeming" resolution which sets targets for only the next fiscal year.
Of course it is not just the Democrats who are hiding from the deficit problem. Republicans resolutely oppose any tax increases. Sullivan argues that the Republicans would be more willing to countenance a tax increase if business groups supported the idea. He notes that the Business Roundtable has at least opened the door to consideration of a value-added tax (VAT) in the U.S. Almost all European countries have one in the area of 15-20 percent. Imposition of a VAT, says Sullivan, would allow Corporate America to demand in return a reduction in the corporate income tax. "Obviously, there have to be spending cuts first," Sullivan notes. "But the second phase has to be broad-based tax increases." He explains that without those tax increases, President Obama and congressional Democrats will continue to look to business for new tax income each year. "It is death by a million cuts," he states. Other countries have recognized the link between lower corporate income taxes and a higher VAT. The new Japanese prime minister has just proposed a cut in that country's 40 percent corporate income tax as part of an increase from 5 to 10 percent in the Japanese VAT.

The new Great Britain government of Prime Minister David Cameron has taken a similar step to address that country's deficit problem. Cameron's plan, agreed to by his coalition of Conservatives and Liberal Democrats, cuts the budgets of most government departments by 25 percent over the next five years. The steps outlined to the House of Commons by George Osborne, the chancellor of the Exchequer, would cut the annual government deficit by nearly $180 billion over the next five years. Great Britain will increase its VAT to 20 percent from 17.5 percent and raise its capital gains tax to a new high of 28 percent. In exchange, the corporate income tax rate will be reduced over a five-year period to 24 percent from 28 percent.
MacGuineas says Great Britain has the formula for austerity about right mixing four pounds in spending cuts for every pound in tax increases. "That is the right model for the U.S." she says. "Although some of the spending cuts have not be specified, what the British government has done is quite remarkable. They are off to a credible start."

She pauses, then adds, " It would be nice if the U.S. were off to any start. It is sort of shameful to watch other countries get their act together while we squabble over petty partisan problems."