After the Supercommittee, Fiscal Policy Questions Still Have to be Addressed
December 05, 2011
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The end of the supercommittee doesn’t mean the end of the fiscal policy debate in Washington. There are still many tax and spending issues that Congress has to decide on this month, next year, and beyond. And while each individual decision may not carry a $1.2 trillion price tag, when added together they’ll have a major impact on the long-term budget picture.

The chart below highlights many of these key decisions. They include mandates from last summer’s Budget Control Act (BCA), standard budgeting deadlines, a variety of expiring tax and spending provisions, and the nation’s long-term structural debt challenge.

It’s also important to remember that while the BCA authorized a $2.1 trillion increase in the federal debt limit, the limit could be reached again as soon as the end of 2012 or in 2013, requiring another increase for the government to continue meeting its obligations to creditors.

Implementing Sequestration and Spending Caps

Since the supercommittee failed to agree on a ten-year plan, the BCA calls for $1.2 trillion in savings from sequestration -- or automatic cuts to the amount that Congress and the president can spend -- to be implemented beginning in January 2013. About 15 percent of that amount will come from assumed interest savings. The rest will be divided equally between defense and nondefense spending. Social Security, Medicaid, and some other programs are exempt from sequestration.

In addition to facing automatic cuts through sequestration in January 2013, Congress has to grapple with holding spending within the caps established by the BCA this summer. That task just became more constrained because, as a result of the supercommittee’s inaction, revised spending caps will tighten the amounts allowed for defense spending. The caps, which took effect on October 1st, 2011 -- the beginning of the 2012 fiscal year -- originally applied to a broader category of security programs (defense, international affairs, veterans programs, homeland security, and others). Now, defense is limited by its own caps through 2021.

Although Congress and the President are completing action on fiscal year 2012 appropriations, they have yet to agree on several key issues, including extension of the payroll tax “holiday” beyond its scheduled expiration on December 31. If they don’t reach agreement, employees’ share of the payroll tax will revert to 6.2 percent, up from this year’s reduced rate of 4.2 percent. Other tax provisions are also scheduled to expire, as is the provision that keeps Medicare payment rates for physicians from being cut by about 30 percent beginning in January 2012, as current laws requires.

Why Sequestration Alone Won’t Solve the Long-Term Challenge

If the sequestration process is implemented as planned in the BCA -- which is not assured, given the growing Congressional interest in rolling back the reductions, at least in regard to defense spending -- deficit reduction over the next ten years would total $2.1 trillion ($1.2 trillion from sequestration plus $900 billion from spending caps).

According to analysis by the Peterson Foundation, this would do little to solve the nation’s long-term debt challenge. U.S. federal debt is already at 70 percent of Gross Domestic Product (GDP, the nation’s annual economic output) and if policy isn’t changed, the Congressional Budget Office (CBO) projected in June that federal debt will soar to 187 percent of GDP within 30 years -- well above the 60-90 percent of GDP considered sustainable by most economists. Even if it achieves its objective, the BCA would only reduce projected public debt to between 134 percent and 164 percent of GDP in 2035. Moreover, debt will still reach 187 percent of GDP between 2038 and 2043 -- just 3 to 8 years later. (It is also likely that the U.S. would face a severe financial and economic crisis well before debt reached these stratospheric levels.)

Long-Term Budget Busters: Health Care, Revenues, Interest

Why would the BCA have such little impact? Because the spending caps and sequesters barely touch the biggest drivers of projected long-term deficits -- Medicare, Social Security, and inadequate tax revenues.

According to CBO, all of the long-run increase in noninterest spending relative to the size of the economy will come from entitlements. This is the result of America’s population getting older as the Baby Boomers retire and of health care costs rising sharply. CBO projects that overall U.S. health care spending will double as a percentage of GDP over the next 30 years, to 34 percent.

On the other side of the ledger, deciding whether or not to maintain some or all of the tax cuts passed in the Bush era and extended by President Obama will have a significant impact on budgets. CBO has estimated that it would cost nearly $4 trillion over the next decade to maintain income and estate tax rates at current levels and continue “patching” the Alternative Minimum Tax each year to exempt many middle-class earners.

Unless the long-term imbalance between spending and revenues is fixed, rising debt will require much higher interest payments. The Peterson Institute for International Economics projects that U.S. interest costs will rise from 1.5 percent of GDP today to 13 percent of GDP by 2035 -- roughly four times what the federal government typically spends on research, education, and nondefense infrastructure combined.

Our Fiscal Future Starts Today

Thus, the choices policymakers confront today and in 2012 will begin to set the stage for economic policy stretching decades into the future. The chart draws attention to some of the long-term questions Congress will face, including how to bring down health care costs and make Medicare sustainable -- particularly to protect the most vulnerable Americans -- and how to restructure the tax code to provide needed revenues with as little economic disruption as possible.

Will the United States economy be smothered by debt in future decades, or will it stabilize long-term debt at sustainable levels and ensure that resources are available for public and private sector investments that lead to stronger economic growth? Over the next 13 months, Congress and the president will begin answering that question.

What’s Next on the Fiscal Agenda? 

 

Taxes

Medicare/Health Care

Defense

All other spending

December 2011

  • December 31: Tax provisions expire:
    Payroll tax holiday ends and employee payroll tax rate reverts to 6.2% from 4.2%;
    Alternative minimum tax (AMT) "patch" expires. Number of taxpayers affected by AMT jumps from 4 million to 33 million in 2012;
    Other tax provisions, including the R&D tax credit, expire.
  • December 31: Waiver of sustainable growth rate provision expires, triggering a reduction in Medicare physician payments by 30% compared to 2011 levels.
  • OMB determines whether 2012 appropriations exceed the security discretionary spending cap for 2012, which includes defense, homeland security, veterans, international affairs, and other related programs. Sequestration ordered if they do.
  • December 31: Emergency unemployment benefits expire.

OMB determines whether 2012 appropriations exceed non-security discretionary spending cap for 2012. Sequestration ordered if they do.

2012

October 1: FY 2013 begins. December 31, 2012:
Expiring tax provisions include:
Individual tax cuts enacted in 2001 and 2003, and extended in 2010;
Lower rates for estate and gift taxes, capital gains, and dividends;
Accelerated depreciation provisions for business.
  • OMB and CBO issue sequestration preview reports showing amounts of deficit reduction required for fiscal years 2013-2021.
  • Medicaire spending would be reduced by about $11 billion in 2013, and increasing amounts through 2021 according to preliminary CBO estimates.
  • October 1: FY 2013 begins.
  • January 15: Security spending caps revised downward to reflect only defense activities (removing broader national security functions) for 2013-2021.
  • OMB and CBO issue sequestration preview reports showing cap and spending reductions required for fiscal years 2013-2021 as a result of supercommittee inaction and any appropriations decisions that exceed caps.
  • Enact defense appropriations for 2013.
  • October 1: FY 2013 begins.
  • January 15: Non-security spending caps revised upward to include veterans, homeland security, international affairs, and related programs.
  • OMB and CBO issue sequestration reqports showing cap and spending reductions required for fiscal years 2013-2021 as a result of supercommittee inaction and any appropriations decisions that exceed caps.
  • Enact non-defense appropriations for 2013, with discretionary spending subject to the caps.
  • October 1: FY 2013 begins.

Policy Considerations
Beyond 2012

  • Fundamental tax reform to raise additional revenue while increasing efficiency and reducing complexity, including by eliminating tax spending provisions.
  • January 2, 2013: Sepuestration cuts Medicare spending.
  • Payment and delivery system reforms to overall health care system to bend the cost curve increase health care value.
  • Federal health program reforms to reduce subsidies to higher income beneficiaries while protecting those with lower incomes.
  • January 2, 2013: Sequester cancels about 10% of 2013 defense appropriations and lowers spending caps for 2014-2021.
  • Review defense mission and define national security strategy that fits within the available (capped) funding levels.
  • January 2, 2013: Sequester cancels about 7% in 2013 non-defense discretionary appropriations and lowers caps for 2014-2021. Non-exempt mandatory programs also cut.
  • Review priorities across all programs to eliminate unnecessary and ineffective programs and to provide sufficient resources to fund public investments, as well as core functions of government.

*Social Security, Medicaid, the Children's Health Insurance Program, and other safety net programs are exempt from sequestration. Medicare spending cannot be cut by more than 2 percent.

SOURCES: P.L. 11255, Consolidated and Further Continuing Appropriations Act, 2012; CBO, Estimated Impact of Automatic Budget Enforcement Procedures Specified in the Budget Control Act, https://www.cbo.gov/doc.cfm?index=12414. CBO, The Budget and Economic Outlook: Fiscal Years 2011 to2021, pp. 88-89, January 2011. "How Potential Across-the-Board Cuts in the Debt Limit Deal Would Occur," Center on Budget and Policy Priorities, http://www.cbpp.org/cms/index.cfm?fa=view&id=3557

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