The Federal Budget and Legislation in 2006 Bob Greenstein Center on Budget and Policies Priorities January 25, 2006.

The Federal Budget and Legislation in 2006

Bob GreensteinCenter on Budget and Policies Priorities

January 25, 2006

I. Background on the Federal Budget and the Return of Budget Deficits

FROM LARGE SURPLUSES TO LARGE DEFICITS IN JUST 4 YEARS

Note: The January 2001 projection is the Congressional Budget Office baseline from that time. CBPP’s August 2005 projection adds to the current CBO baseline a number of new likely costs, such as the extension of the Bush tax cuts, AMT relief, and funding of the President’s budget request for defense. We also adjust the baseline to reflect a continuation and gradual phase-down of operations in Iraq and Afghanistan.

At the start of 2001, the federal government was projected to amass $5.6 trillion in surpluses over the 2002-2011 period. Due mainly to over-optimistic revenue projections, large tax cuts, and increases in defense spending, the government is now projected to amass $3.5 trillion in deficits during that period – a negative swing of more than $ 9 trillion (or more than $900 billion per year).

$5.6

-$3.5

-$4

-$2

$0

$2

$4

$6

$8

Jan. 2001 Projection August 2005 projection

Tri

llio

ns

of

do

llars

Cumulative Surpluses/Deficits, 2002-2011

15

16

17

18

19

20

21

22

23

24

1975 1980 1985 1990 1995 2000 2005 2010

Ou

tlay

s as

Per

cen

t o

f G

DP

1975

-201

0

Federal expenditureswith Katrina

Pre-Katrinaexpenditures

Average expenditures(1975-2005)

Even with Katrina, Federal Spending as a Share of the Economy Is Below the 30 Year Average

$1.77 Trillion

$240 Billion

$200 Billion in Katrina Costs (plusinterest costs)

Cost of Bush Tax Cuts if Extended(including interest costs)

Cost of Katrina Expenditures and Administration Tax Cuts, 2005-2010(includes cost of interest payments on the debt)

LEGISLATION ADDING TO DEFICITS:MOSTLY TAX CUTS AND DEFENSE

Cost in 2005 of legislation enacted since January 2001

CBPP calculations from Congressional Budget Office data. Reflects costs in 2005 above a CBO January 2001 current services baseline projection for 2005. May not add to 100% due to rounding.

70 percent of the deterioration in the budget in 2005 has resulted from legislation enacted by Congress and the President. And 85 percent of the cost of that legislation stems from tax cuts or increases in defense, international aid, and homeland security – not domestic spending.

48%

37%

8%8%

Tax Cuts

Defense, Homeland Security and International

Entitlements

Domestic Discretionary (except Homeland Security)

48%

37%

8%

8%

WHAT WOULD IT TAKE TO BALANCE THE BUDGET WHILE PRESERVING THE TAX CUTS?

Cut Social Security benefits by.................................. 46%

Cut defense spending by ............................................ 70%

Cut Medicare by……………………………….…....….... 64%

Cut every other program except Social Security, Medicare, defense, and homeland security by…......

32%

To balance the budget by 2015 while making the tax cuts permanent, policy makers would have to:

To balance the budget in the next decade while extending the tax cuts enacted since 2001 would require cutting Social Security benefits by nearly half, cutting Medicare or the Pentagon by roughly two-thirds, or cutting practically everything else by one-third.

-20%

-15%

-10%

-5%

0%

5%

2000 2010 2020 2030 2040 2050

Under Current Policy, Deficits Would Grow Deeper in Future Decades

(Surplus (+)/Deficit(-) as a Percent of GDP)

Source: CBPP long-term deficit estimates assuming continuation of current policy including extension of the tax cuts and continuation of AMT relief.

Center on Budget and Policy Priorities; last revised March 2, 2005

II. Drivers of the Long-term Fiscal Problem

• Rising health care costs in the private and public sectors alike

• Tax cuts

• The aging of the population

MAKING THE TAX CUTS PERMANENT WOULD COST TRILLIONS

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

2001 2006 2011 2016 2021

billi

ons

cost of already enacted tax cuts

cost of making the tax cuts permanent

Source: CBPP calculations from Congressional Budget Office data

Cost of tax cuts with interest, adjusted for inflation

Medicaid per-person costs are growing more slowly than private sector insurance premiums

6.9%

12.6%

0%

2%

4%

6%

8%

10%

12%

14%

Medicaid Private SectorAve

rag

e A

nn

ual

Per

cen

tag

e C

han

ge

(200

0-20

03)

Source: Holahan and Ghosh, 2005 and Kaiser/HRET surveys

MEDICAID COSTS LESS THAN PRIVATE HEALTH INSURANCE

$3,145

$719

$4,410

$795

Adults Children

Medicaid Private Insurance

Source: Hadley and Holahan, Inquiry, 2004

Estimated 2001 per capita costs of serving Medicaid enrollees with Medicaid vs. private insurance, after adjusting for health differences.

The Tax Cuts and Social Security:Costs through the next 75 years

Note: The figure for the tax cuts represents the costs of the 2001 (EGTRRA) and 2003 (JGTRRA) tax bills. Estimates of the tax cuts assume that the tax cuts are extended as proposed by the Administration and include the additional cost of Alternative Minimum Tax relief attributable to the 2001 and 2003 tax bills. The cost of the tax cuts is assumed to grow only with the economy after 2015. The Social Security estimate comes from the 2005 Trustees’ Report. All figures are “net present values” of costs from inception through 2079.

Center on Budget and Policy Priorities; last revised May 26, 2005.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Per

cent

of

GD

P

Tax cuts if made permanent

75-year shortfall in Social Security

III. The Decisions that Congress and the President Now Are Making, and the Bigger Policy Choices that Lie Ahead

BUDGET CUTS ENACTED IN 2005 OR NEARING ENACTMENT

Cuts in “domestic discretionary” programs – the part of the budget that includes K-12 education, housing, environmental protection, and other areas – of $17 billion in 2006 alone (as compared to the 2005 level adjusted for inflation).

Cuts of $40 billion in “entitlement” programs over five years, such as: Medicaid, which provides health care to low-income and elderly people, children, and people with disabilities; children’s programs, including child support enforcement and foster care; and student loans.

But Congress also is expected to complete action in early 2006 on close to $100 billion in tax cuts over five years, so the deficit will further increase.

Even though tax cuts and defense increases are overwhelmingly the causes of current deficits, Congress’s budgetary efforts in 2005 have concentrated on cutting domestic spending. At the same time, Congress’s current budget plan would worsen the deficit by enacting additional tax cuts that are more costly than the planned budget cuts.

BUDGET RECONCILIATION BILL NEARING ENACTMENT

Analysis by the Congressional Budget Office indicates the bill would:

• Cause many low-income people eligible for Medicaid to forgo needed health care because of increased co-payments and premiums

• Result in $8 bill in child support going uncollected due to cuts in child support enforcement

• Shift billions of dollars in welfare reform and child care costs to the states

• Raise charges for many student loans

Health

VeteransBenefits Domestic

Discretionary (Outside Defense & International)

Environment

Education,Training

IncomeSecurity

-25%

-20%

-15%

-10%

-5%

0%

CUTS IN “DOMESTIC DISCRETIONARY” PROGRAMS AFFECT MOST PROGRAM AREAS

Proposed real cuts in funding for discretionary programs in FY 2010 in the congressional budget resolution

Note: To calculate funding cuts, the FY 2010 proposed funding levels are compared to the FY 2005 funding levels adjusted for inflation. The official CBO baseline is adjusted to take out the continuation of emergency funding enacted in 2005.

Under Congress’s current budget plan, cuts in domestic discretionary programs would grow over time, reaching very substantial levels by 2010.

-13%

-21%

-12% -13%

-15%

-11%

$18 $742

$103,086

$4,845

$34,948

$0

$25,000

$50,000

$75,000

$100,000

$125,000

Lowest 20Percent

Middle 20Percent

Top 20Percent

Top 1Percent

Millionaires

Average Value of Tax Cuts, 2005

Source: Tax Policy Center

WHO GAINS FROM THE TWO NEW TAX CUTS THAT TOOK EFFECT JANUARY 1?

Source: Tax Policy Center

$0 $1

$4,141

$19,234

$558$25$0

$5,000

$10,000

$15,000

$20,000

$0 -$75,000

$75,000 -$100,000

$100,000 -$200,000

$200,000 -$500,000

$500,000 -$1 million

Over $1million

Income class

Average tax cuts in 2010, when these tax cuts are fully in effect

HOW MUCH DO THE TAX CUTS COST?

All tax cuts

Veterans Housing & Urban Development

Environmental Protection

Tax cuts for the top 1%

Education

$0

$50

$100

$150

$200

$250

Bill

ion

s o

f d

olla

rs

Note: The figure for the tax cuts represent the annual cost when fully effective (including AMT relief) of the 2001 and 2003 tax bills, scaled to the size of the economy in 2005. Agency budgets represent outlays in 2005.

When the tax cuts take full effect in 2010, the top 1 percent of households will receive tax cuts that total about as much as the federal government spends on education, and nearly eight times what it spends on environmental protection.

Annual cost of the tax cuts compared with federal agency budgets

Likely Consequences of Unbalanced Approach to Deficit Reduction

• Large cuts over time in programs for the poor

• Increases in number of uninsured Americans

• Federal government may be unable to fulfill some core functions

• More cost shifts to states

The Goal: Balanced Approach to Deficit Reduction

• Balanced approach would include revenue increases and spending cuts, especially since a main reason we have deficits is because of recent tax cuts.

• Cuts would not fall disproportionately on low-income programs.

• Balanced approach was taken in 1990 and 1993 by Presidents Bush and Clinton.

Center on Budget and Policy Priorities; last revised Nov. 2, 2004

Studies Find Recent Tax Cuts As Likely to Reduce Economic Growth as to

Increase It“tax legislation will probably have a net negative effect on saving, investment, and capital accumulation over the next 10 years.” -- Congressional Budget Office

“making the 2001 and 2003 tax cuts permanent would raise the cost of capital for new investments, reduce long-term investment, and reduce economic growth.”

--Brookings Institution economists

Studies by Federal Reserve economists, the Joint Committee on Taxation, and other noted experts have produced similar findings.

Sources: Congressional Budget Office, The Budget and Economic Outlook: An Update, Aug. 2003, p. 45; Gale & Orszag, "Budget Deficits, National Saving, and Interest Rates," prepared for the Brookings Panel on Economic Activity, September 2004, p. 34; Elmendorf & Reischneider (Federal Reserve economists), “Short-Run Effects of Fiscal Policy with Forward-Looking Financial Markets,” National Tax Journal, Sept. 2002, pp. 357-86; Joint Committee on Taxation, “Macroeconomic Analysis of HR 2,” Congressional Record, May 8, 2003, pp. H3829-32.

Some First Steps Under a Balanced Approach to Deficit Reduction

• Restore “Pay As You Go” rules

• Shelve tax cuts not yet in effect; do not extend expiring tax cuts without paying for them

• Adopt Medicare commission’s recommendations to curb excessive Medicare provider payments

• Adopt President’s reforms in farm subsidies

• Pare back earmarks in appropriations bills

• Adopt Joint Tax Committee proposals to curb unproductive tax breaks and shelters and reduce tax avoidance

• Use better inflation measure for everything from Social Security COLAs to indexing of tax code