Posts Tagged ‘Federal Deficit’

Debt Ceiling-Deficit Reduction Talks

July 10, 2011

President Obama needs to start explaining to the American people what is at stake in the current negotiations between the Administration and the Congress on raising the debt ceiling.  Unless Congress raises the federal debt ceiling, the U.S. federal government will soon run out of money to pay its operating expenses and service its debt.  August 2 is the date, according to Treasury Secretary Timothy Geithner.  Republicans have been demanding drastic reductions in federal spending, with no increase in taxes of any kind, before they will approve an increase in the debt ceiling.

Last week, Congressional Republicans walked out of deficit reduction talks hosted by Vice President Biden.  Now President Obama has increased his participation by inviting Congressional leaders to discuss how to break the impasse.  During a Thursday meeting at the White House, the President proposed three options for reducing the deficit over a ten year period – a $2 trillion option, a $3 trillion option, and a $4 trillion option.  The Wall Street Journal gave a general idea of what was included in the $4 trillion option, but we do not have any specifics.  Initially, both President Obama and Speaker John Boehner were described as being in favor of a $4 trillion deal.  However, on Saturday night, Speaker Boehner issued a statement saying that he no longer favored a $4 trillion deal because that would have included “tax increases”, as Republicans call elimination of tax loopholes that favor the rich.

Recent polls indicate that a majority of Americans oppose raising the debt ceiling, but they also oppose any cuts to Social Security or Medicare.  In response to the intransigence of the Congressional Republicans, President Obama needs to explain to the American people that maintaining the full faith and credit of the U.S. government is paramount.  He needs to explain the impact that Republican demands will have on the lives of ordinary Americans. The President also needs to report to his own supporters what options he laid out for the Congressional leaders, and what the impact of those options would be.

The following four options are illustrative of what is at stake for positions of the Obama Administration, the Bowles-Simpson Deficit Reduction Commission, the Congressional Republicans, and the TEA party.  (Since we do not have the advantage of a large staff of economists like OMB or the Congressional Budget Office to score the options, I cannot give precise numbers for the size of the budget savings.)

Debt Ceiling/Deficit Reduction Options

Option I outlines the main features of a proposal that the President laid out in a speech on  April 13, 2011.  President Obama has emphasized some of the points in this list at various times during the first six months of 2011.

I. Increase Debt Ceiling, Invest in Infrastructure and Jobs

  • Must pay interest on debt.
  • Fund Infrastructure Investments
    • Roads, bridges, ports;
    • Maintain sewers and sewage treatment plants;
    • National electrical power grid.
  • Green energy technology development
  • Manufacturing innovation laboratories
  • Cap defense spending.
  • Implement the Affordable Care Act, including support for Medicaid.
  • Support states in school improvement projects.
  • Eliminate farm subsidies and ethanol production subsidies.
  • Eliminate tax breaks for oil companies.
  • Eliminate tax loopholes while cutting top corporate tax rate.
  • Let Bush-era tax cuts expire as scheduled.
  • Tax hedge fund manager fees as ordinary income.
  • Tax dividends as ordinary income.

II. Increase the Debt Ceiling, Gradually Reduce Spending, Increase Revenues

Option II outlines the main implications of adopting the recommendations of the President’s Deficit Commission, co-chaired by Erskine Bowles and Alan Simpson.[i] See http://www.taxpolicycenter.org/taxtopics/Bowles_Simpson_Brief.cfm.

  • Pay interest on debt.
  • Gradually reduce defense and discretionary spending.
  • Maintain current levels of green energy development.
  • Maintain social security payments at current levels.
  • Maintain Medicare benefits at current levels, but aggressively seek ways to reduce health care cost increases.
  • Eliminate farm subsidies, ethanol subsidies, and tax breaks for oil companies.
  • Eliminate corporate tax loopholes while cutting top corporate tax rate.
  • Tax hedge fund manager fees as ordinary income.
  • Adopt the Bowles-Simpson Zero Plan to reduce the federal deficit to zero:
  1. Eliminate all tax expenditures—for both income and payroll taxes—except for the child credit, the earned income tax credit, foreign tax credits, and a few less common preferences.
  2. Eliminate the alternative minimum tax (AMT).
  3. Retain personal exemptions (no phase-out).
  4. Replace the current six-bracket individual tax rate schedule with a three-bracket schedule of 12, 20, and 27 %.
  5. Tax capital gains and dividends as ordinary income.
  6. Index tax parameters using the chained Consumer Price Index.
  7. Increase the Social Security wage base by 2 percent per year more than the growth in the average wage (making the FICA cap $140,100 in 2015).
  8. Phase in an increase in the federal excise tax on gasoline of 15 cents per gallon (13.5 cents per gallon on average in 2015).
  9. Eliminate corporate tax expenditures and reduce the corporate tax rate to 27 percent.

We do not have enough details from the Thursday White House meeting to know whether all of these Bowles-Simpson proposals were included in the options presented by President Obama.  The Wall Street Journal reported in a separate story[ii] that the President suggested the adoption of the chained Consumer Price Index as the basis for Social Security Cost of Living (COLA) adjustments and federal pension adjustments as well as for indexing tax parameters.  It is not clear why the President suggested this instead of raising the cap on salaries and wages subject to FICA.

Some economists favor the adoption of a chained Consumer Price Index because it takes into account changes in the quantities of goods and services that consumers buy as relative prices change.  For example, if the prices of French wines go up and the prices of smart phones go down, consumers may buy more smart phones but less French wine.  At present, some tax parameters are adjusted by the CPI-U, which does not take into account changes in quantity preferences as relative prices change.  Social Security benefits and federal pensions are adjusted using CPI-W, which is based on the increase in average wages.  However, over the past decade CPI-U and CPI-W have tracked very closely, whereas the chained CPI increased more slowly.

If someone were to retire now at age 62, the future benefits would be less using the chained CPI than using the current formula – 4% less at age 75, 6.5% less at age 85, and 9.2% at age 95.[iii]  The changes would be even worse for younger Americans.  If the chained CPI were really a better formula for showing the cost of living, there might be some justification for adopting it.  However, health care costs are rising faster than general living costs, and seniors are the largest consumers of health care.  None of the proposed CPI formulae take into account the higher costs that seniors incur for health care and long term care.

Increasing the FICA cap is a better way to ensure the solvency of the Social Security System.  There is no reason to stop at $140,000 annual salary.  If FICA applied to wages and salaries up to $200,000 annual income, the Social Security System could remain solvent for the rest of the century.

III. Raise the Debt Ceiling, Reduce Spending, Reduce Taxes on the Wealthy, Eliminate Social Security and Medicare

Option III reflects the mood of Congressional Republicans, including a lot of Republican proposals.   Republicans say repeatedly that the United States does not have a revenue problem, it has a spending problem, and many Republicans in Congress would vote for Option III.

  • Pay interest on debt.
  • Maintain defense budget.
  • Drastically reduce discretionary spending.
  • Eliminate Department of Education and drastically reduce Pell Grants (student aid for college education); states are responsible.
  • Eliminate spending on green energy development; private sector is responsible.
  • Eliminate food stamps and Women, Infants and Children programs.
  • Cut 50% of funding for the Securities and Exchange Commission and the Commodity Futures Trading Commission.
  • Cut 30% from funding for Food and Drug Administration (FDA).
  • Privatize social security for those under 55; individual’s accounts would be invested in the stock market.
  • Repeal the Affordable Care Act.
  • Privatize Medicare, but with a Federal voucher system; current retirees would keep their current benefits.
  • Make Bush-era tax cuts permanent.
  • No tax increases:  maintain farm subsidies, ethanol subsidies, and tax breaks for oil companies; hedge fund managers continue 15% tax on their fees; dividend rates are 0% or 15%.
  • Cut top corporate tax rate to 27%.
  • Eliminate the alternative minimum tax.

IV. No Increase in the Debt Ceiling

The U.S. government reached its statutory debt limit on May 16, 2011.  The Treasury has been using “extraordinary measures” that will allow the government to extend its borrowing authority until August 2.  There is a large amount of debt coming due on August 4, and there will be no way to roll over the debt or pay the interest due unless the debt limit is increased.  Standard & Poors has stated that any U.S. Treasury bond that has a payment due on August 4, 2011 will be downgraded from AAA to D if Congress does not increase the debt limit.  The results of such a debt default would be catastrophic, and many Congressional leaders have stated that it will not happen.

Option IV assumes that Congress fails to come to a long-term deficit reduction deal but enacts a temporary and small increase in the debt ceiling on August 2, 2011.  Clearly, Option IV is not a long-term solution to the problem of balancing the budget, but it would cause so much economic pain that it would quickly get the attention of an apathetic public.

  • Government is allowed to spend only its current revenues.
  • Must pay interest on the debt as well as fund current operations.
  • Drastic reductions in government expenditures until debt ceiling increased
    • Government salaries are cut 50%.
    • Social Security payments are cut 50%.
    • Government retirement pensions are cut 50%.
    • No Medicare payments until debt ceiling is increased
    • All National Parks are closed.
    • FEMA suspends operations.  Reponses to natural disasters, such as hurricanes, earthquakes, floods, fires, and tornadoes, will be the responsibility of the states.
    • Staff positions at foreign embassies are cut 50%.
    • All consular offices are closed.
    • U.S. Passport Office is closed until debt ceiling is increased.
    • Subsidies to the U.S. Postal Service are eliminated.
  • Start to sell stored commodities such as gold in Fort Knox and oil in the Strategic Petroleum Reserve.

It should be clear that Option IV would create quite a stir, and if implemented for very long would result to riots in the streets just like in Athens. People need to see where the TEA party recommendations would lead.  It is unlikely that Republicans in Congress could “hang tough” in the face of the public outcry if Option IV were forced on the President.

We should add what the consequences of Option III would be. If the Republican agenda were adopted quickly, if Option III were implemented within a year, it would lead to a new recession.  IMF studies show that a budget cut of 1% of GDP typically reduces demand by about 1%, and increases the unemployment rate by 0.3%.[iv]

Since the Federal Budget Deficit is about 10% of GDP, an immediate or short-term cut in Federal spending to try to balance the budget with no revenue enhancements (as the Republicans demand) would result in a reduction of 10% in domestic demand and a rise in the unemployment rate of 3% to 12.2% This would be worse than the recent recession that officially ended in 2009. The Federal Budget would not in fact be balanced because ensuing recession would result in lower tax revenues.

President Obama should not cave in to Republican demands.  He should explain in a lengthy televised address to the American people what the three options are that he suggested to the Congressional leadership, and what the consequences would be if the Republicans were to force a solution like Option III above.  Then he should make it clear that unless the Republicans compromise, the outcome will be Option IV, which will be a disaster.


[ii] “How Tweaking Benefits Would Work,” Wall Street Journal, July 8, 2011, p. A4.

[iv] World Economic Outlook, October 2010, Chapter 3, “Will It Hurt? Macroeconomic Effects of Fiscal Consolidation,” p.113.

Medicare Changes in the Ryan Budget

May 5, 2011

On April 15, 2011 Republicans in the U.S. House of Representatives passed the Ryan Budget (all Democrats voted no) and sent it to the Senate.  Then they went back to their home districts and faced some criticism from their constituents, especially on the plan to privatize Medicare.  Rep. Paul Ryan and his colleagues explained disingenuously that people over the age of 55 would not be affected by the proposed changes.

While it is true that the voucher-like healthcare system would not start until 2022, the following changes would affect people over 55 immediately on passage:

The proposal would repeal the ACA provision that expanded subsidies for the “coverage gap” in Medicare Part D (a range of spending in which many enrollees have to pay all of their drug costs, sometimes called the doughnut hole).

The proposal would repeal the Community Living Assistance Services and Supports (CLASS) program for long-term care insurance, as well as a number of mandatory grant programs including funds for so-called high-risk pools, reinsurance for early retirees, and prevention and public health activities.[i]

Republicans also say that after taking effect, the proposed legislation would create a healthcare insurance system for seniors like the current healthcare insurance system for federal employees.  This is not true, either.  Federal employees pay a fixed portion of their healthcare insurance costs, but that would not be true for the new Republican Medicare substitute.

Under the House Republican proposal, starting in 2022 new Medicare beneficiaries would receive coverage through private insurance plans, and Medicare would subsidize the cost.   The federal payment for a typical 65-year-old would be set at $8,000 a year in 2022, about the same as what Medicare is expected to spend under current law.

The eligible age for federal benefits would increase two months per year until the eligible age would reach 67 in the year 2034.  Presumably, Ryan expects people between the ages of 65 and 67 to get healthcare insurance from their employers or in the private market.  The CBO did not analyze the extent to which additional people would apply for disability insurance benefits or Medicaid because of the increased eligibility age for privatized Medicare.

Beneficiary costs under the Ryan plan would be higher than under traditional Medicare.  Administrative costs are higher for private healthcare insurance than for Medicare, but that is only the beginning.  The premium support payment would be adjusted for age, health status, income of the beneficiary, as well as general inflation, measured by the Consumer Price Index.  But healthcare costs and insurance premiums have, for years, been rising faster than consumer prices in general.[ii]  So, under the Republican plan, Medicare would pay a shrinking share of beneficiaries’ total health costs, and seniors would pay a growing share. For a typical 67-year-old, that share would be 68% in 2030 versus 25% under current law, the Congressional Budget Office said.  

There is nothing in the Republican plan to reduce the rate of growth of healthcare costs per enrolled beneficiary (“bend the curve”).  Indeed, the House legislation would repeal the parts of the Affordable Care Act that initiate several proposals to try to reduce that rate of growth.  The net result is that the Ryan Plan increases beneficiary costs more than it reduces government costs.  Part of the reduction in overall healthcare costs to the federal government is particularly insidious.  Since the beneficiary share of the total healthcare insurance costs would be higher under the Ryan budget, participation rates for eligible elderly persons would be lower than under traditional Medicare.

The Ryan plan includes rules that would govern the Medicare exchange—including requiring insurers to issue insurance to all people eligible for Medicare who apply, requiring that each insurer charges the same premium for all enrollees of the same age, and using a risk-adjustment mechanism. However, the Ryan plan would allow insurance companies to increase premiums with beneficiary age.  Ryan says that the support payments would be greater for the poor, but it is not clear that the increase in federal healthcare support payments would be enough to prevent participants from dropping out of the federal plan as they got older.

Healthcare experts agree that the primary problem with healthcare is health care inflation. The secondary problem is the long-term Medicare deficit.  For decades, the United States has relied on a private healthcare insurance for people under 65, and fee-for-service government healthcare insurance for people over 65.   Neither system has helped to rein in healthcare inflation.  Republicans want to scrap Medicare and revert to a private healthcare insurance system for everyone. However, the free market for healthcare insurance has failed to rein in healthcare inflation for people under 65, just as Medicare has failed to control healthcare costs for the elderly.   Despite the lack of supporting evidence, the Ryan plan would repeal all federal pilot programs designed to reduce the rate of growth of healthcare costs, relying on blind faith in free markets to control costs.  It is foolish to suppose that a solution that has failed repeatedly to control healthcare costs will succeed in the future if we solve the secondary problem of the long-term Medicare deficit.

The Ryan Plan would end traditional Medicare to solve the secondary problem of the long-term Medicare deficit, and substitute a system that would increase the burden on the elderly to pay their own healthcare costs and increase the number of uninsured elderly.  James Kwak, who calls the Ryan Plan “ just one bad idea dressed up with the false precision of lots of numbers” has suggested a better and simpler way:  “Index the Medicare payroll tax to actual health care costs. This should automatically solve the Medicare deficit because as Medicare’s costs go up, its funding will go up at the same rate.*

“This may sound like just raising taxes whenever the government wants to spend more. But the key is that the more taxes you pay, the more you get back. To see this, assume for now that Medicare is a pure price taker: it has no impact on health care costs but just has to pay what the market charges. Then, if health care costs go up by 5 percent, your taxes go up by 5 percent, but the expected value of your future Medicare benefits also goes up by 5 percent. You get all the insurance benefits of traditional Medicare, but now that insurance is worth 5 percent more, so you should be willing to pay 5 percent more.**

“Raising taxes can have macroeconomic effects, but anything that solves the Medicare deficit problem will have macroeconomic effects: any solution involves either higher revenues or lower spending. Furthermore, increasing payroll taxes in line with health care costs is no different in substance than increasing premiums for employer-sponsored plans in line with health care costs, which has been going on every year for decades.”[iii]

With that solution in mind, we can reject the Ryan Plan and let healthcare experts discuss various ways to bring healthcare cost inflation under control.


Causes of Current Federal Deficit

October 3, 2010

An article in the June 24 issue of the Westport Minuteman described Dan Debicella as saying “Jim Himes voting record has led to the $1.4 trillion [federal budget] deficit.”  Debicella also said the $800 billion stimulus package (American Recovery and Reinvestment Act) enacted in February 2009 was both unnecessary and ineffective, and Congressman Himes committed a grave error in voting for it.  Mr. Debicella proposes to repeal the act.  In blaming President Obama and Mr. Himes for the current deficit, Mr. Debicella apparently has a poor memory and a poor understanding of economics.

The article did not mention that President George W. Bush handed Barack Obama a federal budget deficit of $1.2 trillion in January 2009 as well as an economy declining more rapidly that at any time since the 1930s.  Economic stimulus was needed to stop the downward spiral caused by the impending collapse of the financial sector as well as the housing sector, which had not been adequately regulated during Republican control of all three branches of government, as well as the Federal Reserve.

The Great Recession started in December 2007, more than a year before Barack Obama and Jim Himes took office.  This recession was caused by failed Republican policies of deregulation and unfunded war.  (Remember how Bush saved us from Iraq’s weapons of mass destruction that did not exist?)  Congress funded TARP at the request of President Bush.  Hank Paulson, Treasury Secretary until 2009, has said that if Bush had not reversed course and funded the bank bailout and initiated the bailout of the auto industry, we would have had 20% unemployment.  President Obama and Jim Himes have been working tirelessly to fix the mess left by the Republicans.

It should be noted that it was a Democratic Administration that produced the only balanced federal budgets in a generation.  President Clinton inherited a large (for those days) budget deficit from President George H.W. Bush.  Proper Democratic Administration fiscal policy and Congressional Paygo rules produced budget surpluses during the last three years of Clinton’s second term, and there was serious talk of paying down the national debt to very low levels in preparation for the retirement of the baby boomer generation.  Although the recession of 2002-2003 would probably have led to a temporary budget deficit, we should have had a federal budget surplus again by 2005 if President George W. Bush had followed equally sound fiscal policies.  However, he was influenced by V.P. Dick Cheney, who said deficits did not matter.

Republican deregulatory policies wrecked the U.S. economy.  Alan Greenspan, appointed to the chairmanship of the Federal Reserve by President Reagan, followed the Republican deregulatory philosophy and urged people to take adjustable rate mortgages instead of fixed-rate mortgages with payments they could be sure they could afford.  When no down payment mortgages and liar loans were offered by mortgage brokers, Greenspan looked the other way and the Bush Administration asserted federal jurisdiction to prevent five state attorneys general from investigating the use of fraudulent and deceptive sales tactics by mortgage brokers.  This fueled the pipeline to Wall Street firms that created collateralized debt obligations and sold the CDOs to foreign banks, pension funds, etc., obscuring the risk involved in the inevitable downturn of the housing market.

In a June 2008 speech, President and CEO of the NY Federal Reserve Bank Timothy Geithner — who in 2009 became Secretary of the United States Treasury — placed significant blame for the freezing of credit markets on a “run” on the entities in the shadow banking system. These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls as banks. Further, these entities were vulnerable because of maturity mismatch, meaning that they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term assets at depressed prices.

Paul Krugman, winner of the 1999 Nobel Prize in Economics, described the run on the shadow banking system as the “core of what happened” to cause the crisis.  A sudden drop in liquidity led to a sharp downward spiral in aggregate demand, and we started seeing 700,000 jobs lost every month.  It is well documented that the $800 billion stimulus package has created or saved between 2 million to 3 million jobs.  However, Prof. Krugman said in February 2009 that an $800 billion stimulus was not enough, and recent developments indicate that he may have been right.

In testimony to a Congressional committee investigating the causes of the financial crisis, Alan Greenspan admitted that there had been a flaw in his philosophy of financial market deregulation.  Essentially, the flaw was that financial markets do not regulate themselves as efficiently as he had assumed.

One of the lessons that we should have learned from the Great Depression is that early attempts to balance the budget will not work.  In general, premature attempts to balance a national budget will lead to an economic downturn.  The resulting downturn will reduce tax revenues, making it harder to balance the budget.  This is what happened in 1937, when political pressure forced President Roosevelt to reduce federal spending.  The net federal deficit was reduced almost 90% from 1936 to 1937.  The result was another severe recession.  In 1938, the deficit rebounded to 60% of its 1936 peak, not because of increased spending but because of reduced tax revenues.  Other countries have had similar experiences.

Joseph Stiglitz, another Nobel Prize-winning economist, has said that one of the many ironies that have marked the crisis is that Greenspan’s and Bush’s attempt to reduce the role of government has resulted in a large temporary increase in the government’s role in the economy.  Barack Obama and Jim Himes, like the main stream of the Democratic Party, are in favor of a well-regulated market economy.  As the economy recovers, the government will sell its stakes in CitiGroup, AIG, and General Motors.  Indeed, this has already started.  The Government will get most of its money back.

What we will not get back is the trillions of dollars of lost output from the idle capacity and millions of unemployed people.  That lost output is the result of the failed Republican policies, and a return to those laissez faire policies of the past 25 years would be a tragic mistake leading to even more lost output and misery for people who are out of work due to no fault of their own.  This tragic situation can only be remedied by increasing aggregate demand, and government will have to do its part.