Why Retirement Plan Tax Preferences are Not as Expensive as You Might Think

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Dec 13, 2012

Retirement plans such as the 401(k) receive favorable tax treatment under the U.S. income tax system.  Historically, this favorable tax treatment was provided to increase individual saving.  Recent research has called the efficacy of this approach into question, suggesting that individual saving rates may not be all that responsive to marginal tax rates.

Last week, I wrote about the danger of drawing the conclusion that tax incentives do not matter and that we should therefore look to eliminate the tax preference for retirement saving.  My focus was on the role that tax preferences play in providing an incentive for employers to offer plans, and to design them in a way that uses behavioral nudges to increase saving.

This week, I want to focus on a different aspect of this issue, the public discussion of which has been misleading – how much this tax preference costs the U.S. Treasury.  My contention is that the cost figures being bandied about (including my own use of the $100 billion figure in last week’s post) are substantially overstated.  The point of today’s post is to note that the amount of revenue that the government would receive by eliminating the preferential tax treatment for retirement saving would be much less than what it might appear.

To understand this, one must understand (1) how retirement plans are treated under U.S. tax law, (2) how the government actually accounts for the foregone revenue, and (3) how the government ought to account for the foregone revenue.  These are complex topics, but some simple exposition is sufficient for seeing the main point.

(1)   How are retirement plans treated under U.S. tax law?  In a nutshell, the income tax on retirement plan contributions is deferred, not eliminated.  This is an important distinction.  If I receive an additional $1000 in cash salary, and I am in a 35% tax bracket, I owe the government an additional $350 in taxes.  If, however, I receive this additional $1,000 in the form of a contribution to a 401(k) plan, I owe no taxes today.  However, I will owe taxes on the money when I withdraw it during retirement.  Of course, there is financial value to deferring my taxes (what we economists call tax free “inside build-up”), but it is not as if the initial contribution escapes the tax system entirely.

(2)   How does the government account for the foregone revenue?  The U.S. Department of Treasury and the Congressional Joint Committee on Taxation prepare annual estimates of what they label “tax expenditures.”  These tax expenditures are basically just an estimate of how much additional tax would be collected if a particular activity went from being untaxed to being taxed, assuming no behavioral response to the tax.  (As an aside, the fact that they do not account for a behavioral response is why they are careful to always note that “a tax expenditure estimate is not the same as a revenue estimate.”)  In the case of retirement plan contributions, they roughly calculate the amount of money being deferred, apply the relevant marginal tax rates to it, and obtain a rough estimate of how much revenue is not being collected as a result of this tax preference.  However, a key point is that they do not estimate this over the entire life of the account, but rather use an arbitrarily truncated time horizon to estimate the effects.

Going back to my simple example: suppose I contribute an additional $1,000 today to a 401(k) plan.  That saves me $350 in taxes today, and costs the government $350 in foregone revenue in the current tax year (assuming I would save the same amount either way).  So far, so good.  But suppose that I plan to pull the money out in 20 years.  I will pay income taxes on the amount I withdraw.  The present discounted value of the tax that I pay in 20 years will likely be less than $350, but it will be much greater than zero.  For the sake of example, suppose it is worth $150 in present value.  If so, then the net gain to me (and the net cost to government) over my lifetime is $200.  The problem is that the government does not use a present value method.  Instead, it looks at just the front end, and thus overstates the value of the deduction.

(3)   How should the government account for tax expenditures?  Ideally, the government would compute these tax expenditures using the “present value” concept just explained.  A number of experts have made this suggestion.  For example, a paper by the American Society of Pension Professionals and Actuaries (ASPPA) boldly states “tax expenditure estimates for retirement savings provisions should be prepared on a present-value basis” because this “would allow an ‘apples to apples’ comparison” with other tax deductions.

What does all this imply?  A paper written by two Treasury Department officials and published in the December 2011 National Tax Journal found that “the long-run NPV cost can be dramatically different if measured using relatively short time horizons.”  The calculations are a bit tricky because one must make assumptions about rates of return, the appropriate discount rate, current and future marginal tax rates, and so on.  And the extent to which estimates differ depends on the time horizon being examined.

But, these caveats aside, the ASPPA study concludes that “the present-value tax expenditure estimates of contributions made in the first five years are 55 percent lower than the JCT five-year estimates and 75 percent lower than the Treasury five-year estimates.”  That is a huge wedge.

How does all this matter for policy?  The fiscal cliff has DC policymakers scouring the four corners of the earth looking for ways to boost revenue without raising marginal tax rates.  One way to do this is to eliminate tax expenditures.  However, some of those tax expenditures exist for good economic reasons, and the provision of favorable tax treatment for retirement saving is one of them.

As noted last week, the elimination of this provision could have serious unintended consequences for the availability of retirement savings programs through employers.  Now add to that the fact that any revenue implications of such a policy change are substantially overstated and what you get is the potential for good intentions (closing the fiscal gap) to lead to bad policy.

Relevant Disclosures:  I serve as a trustee for TIAA, a provider of retirement plans to the not-for-profit sector.  I have also received compensation as a consultant or speaker for a wide range of other financial services institutions.  The opinions expressed in this blog (and any errors) are my own.


Negative Leakage

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Apr 20, 2012

What is that, a gastrointestinal disorder?   No, it’s the title of one of my recent research papers  (joint with Dan Karney and Kathy Baylis) about unilateral efforts to reduce emissions of greenhouse gases (GHG).   When worldwide agreement is not possible, then the question is whether GHG abatement policy might be implemented by only one country, or bloc of countries (or region or sector).   The fear of any one country or bloc is that they would only raise their own cost of production, make themselves less competitive, and lose business to firms in other countries that may increase production and emissions.  When only one country limits their emissions, any positive effect on emissions elsewhere is called “leakage”.

Yes, that’s a word in economics, see http://en.wikipedia.org/wiki/Leakage .

In efforts to “abate” or to reduce GHG emissions, the fear of lost business has pretty much deterred any attempt at unilateral climate policy.  That positive leakage might be called a “terms of trade effect” (TTE), because unilateral policy raises the price of exports and reduces the price of imports.   But our recent research paper points out a major effect that could offset part of that positive leakage.  The “negative leakage” term in the equation might be called an “abatement resource effect” (ARE).   That is, one additional thing happening is that the domestic firms face higher costs of their emissions, and so they want to substitute away from GHG emissions and instead use other resources for abatement – such as windmills, solar cells, energy efficient machinery, hybrids, electric cars, and even “carbon capture and sequestration” (CCS).  Thus they have at least SOME incentive to draw resources AWAY from other sectors or other countries.  If that effect is large, the result might shrink those other sectors’ operations overall, and thus possibly SHRINK emissions elsewhere.

I don’t mean to oversell this idea, because it probably does not completely offset the usual  positive “terms of trade effect”.  But in some circumstances it COULD be large, and it COULD result in net negative leakage.  The best example is probably to think about a tax or permit price for carbon emissions only in the electricity generating sector, within one country.  For simplicity, suppose there’s no trade with any other countries, so the only choice for consumers in this country is how much to spend on “electricity” and how much to spend on “all other goods”.   Demand for electricity is usually thought to be inelastic, which means consumers buy almost the same amount even as the price rises.  If firms need to produce almost as much electricity, while substantially reducing their GHG emissions, they must invest a lot of labor AND capital into windmills, solar panels, and CCS.  With any given total number of workers and investment dollars in the economy, then fewer resources are used to produce “all other goods”.

The ability of consumers to substitute between the two goods (electricity vs “all other”) is called the “elasticity of substitution in utility.”  The ability of firms to substitute between GHG emissions and those OTHER inputs is called the “elasticity of substitution in production”.  If the former is bigger than the latter, then net leakage is positive.  If the latter is bigger than the former, then net leakage can be negative.

Okay, too technical.  But the point is that other researchers have missed this “abatement resource effect” and overstated the likely positive effect on leakage.  And that omission has led to overstated fears about the bad effects of unilateral carbon policy.  What we show is that those fears are overstated, in some cases, where leakage may not be that bad.  With some concentration on those favorable cases, one country might be able to undertake some good for the world without fear that they just lose business to other sectors.

Privatize, Privatize, Privatize!

Filed Under (Environmental Policy, Finance, Other Topics, U.S. Fiscal Policy) by Don Fullerton on Apr 6, 2012

Many advocates of small government have many ideas for how to move activities out of the public sector and into the private sector.  Social Security can be privatized, using fully-funded private retirement investment accounts.  Education can be privatized, with vouchers that can be used by parents to choose the best private school or charter school.  All could save money for the federal budget, by taking advantage of the more efficient operations of the private sector.

In this blog, I’ll describe my new idea for privatization.  Why not privatize the military!  Many rich Republicans want more military spending, and I can imagine that they might well be willing to pay for it.   Why not let them?  Now, they are probably not willing to simply donate money to the federal government, with no recognition, nor any private return on their investment.  But, we could provide the same kind of naming rights as many private operations: FedEx Field is the home of the Washington Redskins, because FedEx paid for the naming rights and they get PR advantages of doing so.  The name of the business school at the University of Texas is the “McCombs School of business”, because Red McCombs paid for the naming rights, and he gets PR advantages of doing so.  The J. Paul Getty Museum is the name of a major art museum in Los Angeles, presumably because somebody in the Getty family or foundation paid for the naming rights and gets PR advantages of doing so.

So, the idea is to write the name of any major donor on any piece of military equipment for which that donor covers at least half the cost.  Pay for half a tank, and it will be the “Your Name Here” Army Battle Tank, with the name engraved on the equipment.  You can even visit it, at certain times of year under certain conditions, and have your picture taken with it.  If you are willing to pay a little more, half the cost of a cruise missile, you can have your name on that instead.

Now I’m not suggesting that the donor ought to be allowed to decide when to push the button.  Nor even make any decisions at all.  The payment is just to help out the U.S. Federal Budget deficit, with recognition for doing so.  I’d bet that a good number of millionaires would really be willing to pay, for that kind of prestige.  It might even be greater recognition if the missile were actually used!  The well-heeled U.S. businessman might even get more U.S. business activity, after the newspaper announces that the “Your Name Here” cruise missile was launched at Tehran, killing 137 innocent civilians, but successfully deterring the Iranian government from pursuing a nuclear weapon that might kill even more.

Cheaper Gasoline, or Energy Independence: You Can’t Have Both

Filed Under (Environmental Policy, Finance, U.S. Fiscal Policy) by Don Fullerton on Mar 23, 2012

Politicians like to say they want the U.S. to produce at least as much energy as it consumes – “energy independence”.  And they certainly want to reassure consumers that they are doing something about the high price of gasoline.  But the two goals are inconsistent.  You can’t have both.  Indeed, the current high price of oil is exactly what is now REDUCING our dependence on foreign oil!

We all know the price of gasoline has been increasing lately, now well over $4 per gallon in some locations.  Five-dollar gas is predicted by Summer.  In addition, the New York Times just reported that our dependence on foreign oil is falling.  “In 2011, the country imported just 45 percent of the liquid fuels it used, down from a record high of 60 percent in 2005.”  The article points out that this strong new trend is based BOTH on the increase of U.S. production of oil AND on the decreased U.S. consumption of it.  And both of those factors are based on the recent increases in oil and gasoline prices.  Those higher prices are enough to induce producers to revisit old oil wells and to use new more-expensive technology to extract more oil from those same wells.  The higher prices also are enough to induce consumers to conserve.  Purchases of large cars and SUVs are down.  Many people are driving less, even in their existing cars.  A different article on the same day’s New York Times, on the same front page, also reports that “many young consumers today just do not care that much about cars.”

Decreased dependence on foreign oil does sound like good news.   Actually, it is good for a number of reasons. (1)  It is good for business in oil-producing states, helping raise them out of the current economic slow-growth period.  (2) It is good for national energy security, not to have to depend on unstable governments around the rest of the world.  (3)  It reduces the overall U.S. trade deficit, of which the net import of oil was a big component.  And (4) the reduced consumption of gasoline is good for the environment. 

On the other hand, the increased U.S. production of oil is not good for the environment, as discussed in the same newspaper article just mentioned.   As an aside, I would prefer to do more to decrease U.S. consumption of oil – not only from increased fuel efficiency but also by the use of alternative non-fossil fuels – and perhaps less from increased U.S. production of oil from dirty sources such as shale or tar sands.  But that’s not the point for the moment.

The point for the moment is just that maybe the higher price of gasoline is a GOOD thing!  We can’t take even small steps toward decreasing U.S. dependence on foreign oil UNLESS oil and gas prices rise.  Any politician who tells you otherwise is pandering for your vote.  It is the high price of oil that is both increasing U.S. production and decreasing U.S. Consumption.



Expensive Houses for Low-Income Families?

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Feb 3, 2012

A recent NY Times has an article about SOL Austin, an acronym for Solutions Oriented Living.  This housing development is interesting for at least two reasons.  First, the designs and materials are intended to be “sustainable” (whatever that means), but also “net zero” (which I gather means that it will produce all the energy consumed).  The houses have solar panels and geothermal wells.

Second, however, it is interesting because it is in east Austin, the low-income part of town.  In fact, a 1928 “city plan” decided that east Austin would be “designated African-American”.  The 1962 construction of Interstate I-35 further divided east from west.  The relatively flat east side of Austin had all the industrial blight, pollution, and low-income housing.  In fact, it was quite cheap!  The hilly west side of Austin had the fancy new upscale houses with views of the Hill Country.

One would think that the intellectual-academic, left-leaning, high-income households of west Austin might be more interested in sustainable housing that could go “off the grid.”  Why then are these developers building super-energy-efficient houses in east Austin?

Well, for one thing, the 2010 census showed a 40% increase in east Austin’s white population and a drop in minority population.  In correlated fashion, land prices in east Austin have risen considerably.  In fact, a different article in the NY Times tells about a study based on the 2010 census finding that all residential segregation in U.S. cities has fallen significantly.  Cities are more racially integrated than at any time since 1910.  It finds that all-white enclaves “are effectively extinct”.  Black urban ghettos are shrinking. “An influx of immigrants and the gentrification of black neighborhoods contributed to the change, the study said, but suburbanization by blacks was even more instrumental.”

Since I’m visiting here in Austin, Texas, it is easy enough to go see the new development.  As you can see in the snapshot below, the houses have a modern box-like style.  They range from 1,000 to 1,800 square feet.  That explains the article’s reference to “matchbox” houses.    But the roofs are sloped enough to hold photovoltaic arrays and to channel rainwater into barrels.  

The developers said they wanted to “examine sustainability on a more holistic level, that would not just look at green buildings, but in our interest in affordability, in the economic and social components of sustainability as well.”  As stated in the NY Times article, the developers “hammered out a plan with … the nonprofit Guadalupe Neighborhood Development Corporation, to sell 16 of the 40 homes to the organization.  The group, in turn, sold eight of the houses at a subsidized rate to low-income buyers (who typically were able to buy a house valued at more than $200,000 for half price).”  Each of those 16 subsidized homes has a photovoltaic array on the roof, though not necessarily large enough to produce all of the needed power for the house.

Of the “market-rate” houses, all sold at prices in the low $200,000’s.  Eleven have been sold, and thirteen have yet to be built.  Because of the financial and housing crisis, however, the “holistic” development ideas have not worked perfectly.  Homeowners got rebates from Austin Energy and tax credits from the federal government. So far, however, only four market-rate house owners paid the extra $24,000 for photovoltaic arrays substantial enough to fully power a house.  Only one is also heated and cooled by a geothermal well.  But they all have thermally efficient windows, foam insulation, and Energy Star appliances.

So far, only one couple paid to install the geothermal well and the extra energy monitoring system:  a systems engineer and a microbiologist.  So, “sustainability” in low-income neighborhoods might still require some gentrification.

Nothing Good about Cheaters

Filed Under (U.S. Fiscal Policy) by Don Fullerton on Jan 13, 2012

Taxes are bad, on that we can agree.  So not paying taxes must be good, right? 

Wrong.  A reform to cut taxes for everybody might be a good idea (or not).  But having millions of individuals cheat to reduce their own taxes is never a good idea.  It is a tax cut without reason, without fairness, and without the incentive or cost advantages of a cut in tax rates.

Just to focus on that last point, note that some people have to go to a lot of trouble to re-arrange their affairs to be able to cheat on their taxes, and they have to take on extra risk to do so – the risk of getting caught.  So their net “advantage” from cheating is much less than their dollars of tax savings. That cost of tax cheating does not apply to the case where Congress and the President agree to cut taxes for everybody, because then all those dollars stay in the private sector instead of being wasted.

The IRS has just released new numbers on the “tax gap” in the United States, the amount of U.S. tax liability that goes unpaid.  From 2001 to 2006, as you can see in the table below, the tax gap increased from $290 billion to $385 billion.  Just to reverse the increase in unpaid tax would gain the much-discussed and much-needed $100 billion revenue per year, or $1 trillion over ten years.  The percent of tax voluntarily paid has fallen from 83.7% to 83.1%.  After expected small amounts are recovered by our meager enforcement efforts, the “overall net compliance rate” has fallen from 86.3% to 85.5%. 

The average taxpayer cheats on about 15% of their tax liability, but almost nobody is “average.”  Rather, the huge majority of Americans earn wages and salaries that are reported by their employers to the IRS, on which tax withholding is paid by the employer to the IRS.  Workers cannot cheat on that income, and so the huge majority of Americans pay all of their tax due.  The cheating is highly concentrated among other Americans, especially those who are self-employed and get paid in cash that is never even reported to the IRS.   In fact, the IRS estimates that noncompliance or misreporting is 1% of  wages and salaries, but a huge 56% of proprietor income!

This issue is covered nicely in the blog by Bruce Bartlett, who also points out that “The number of IRS employees fell to 84,711 in 2010 from 116,673 in 1992 despite an increase in the population of the United States of 53 million over that period.” Fewer auditors chase large numbers of tax cheaters, so of course compliance falls.  When I worked at the U.S. Treasury Department, in the Office of Tax Analysis, I used to hear about revenue/cost ratios of ten to one!  That is, one additional dollar spent on enforcement could generate an additional ten dollars of revenue.  And the problem has only gotten worse since then.

We don’t want a huge number of IRS enforcement agents to strike fear into the hearts of average law-abiding Americans who do pay their taxes on time.  But a lot of us might feel better about our country if a few more IRS agents struck some fear into the hearts of those who are supposed to pay their taxes and don’t!  And those cheaters don’t have to bear extra cost of getting caught, if they just paid taxes instead of cheating.


Social Security Funding

Filed Under (Finance, U.S. Fiscal Policy) by Don Fullerton on Dec 30, 2011

Here is an interesting article, in the Washington Post, entitled “Payroll tax cut raises worries about Social Security’s future funding“.  It points out that the recent payroll tax cuts are intended for short term stimulus, but they muck with the way that social security benefits are funded.  Instead of coming frm payroll taxes, that money now will haveto come from general revenue. 

As it points out: “For the first time in the program’s history, tens of billions of dollars from the government’s general pool of revenue are being funneled to the Social Security trust fund to make up for the revenue lost to the tax cut. Roughly $110 billion will be automatically shifted from the Treasury to the trust fund to cover this year’s cut, according to the Social Security Board of Trustees. An additional $19 billion, it is estimated, will be necessary to pay for the two-month extension.” 

As it goes on to say, “The payroll tax cut changes that. Instead being a protected program with its own stream of funding, Social Security, by taking money from general revenue, becomes more akin to other government initiatives such as Pentagon spending or clean-air regulation — programs that rely on income taxes and political jockeying for support.”

Energy Independence?

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Dec 19, 2011

With crude oil prices hovering near $100 per barrel, the issue of energy independence is sure to be a frequent topic in the upcoming presidential election. Don Fullerton, a finance professor and energy policy expert at Illinois, spoke with News Bureau Business and Law editor Phil Ciciora about whether the goal of energy independence is a viable one or just another pipe dream.

Is energy independence a realistic goal for the U.S.?

It seems like it’s mostly senators from oil-rich states who want to talk about oil and energy independence, because they want subsidies for the oil industry. So it’s really only for political reasons that energy independence has been hyped as an important or worthwhile goal.

If we really are concerned about reducing our dependence on foreign oil, then the implication is to tax oil, not to subsidize it! A tax on oil would discourage its use, which would have three good effects. First, it would discourage imports. Second, it would reduce drilling in the U.S., and thus help keep more oil in the ground for future contingencies. Third, it would encourage the development of other energy technologies such as biofuel, solar power, wind power and better battery technology. Those other technologies are the only realistic route to true energy independence.

Plus, there’s absolutely no way we’re going to achieve energy independence through oil because we’ve basically used up most of our oil. For all practical purposes, we don’t have much more oil. That’s why we either have to rely on other countries or switch to new technologies.

An attempt to achieve energy independence would also be a bad move for energy security, because it just says, “Let’s drain America first.” If so, we’ll be in an even worse situation later. Whatever we still have in reserve should be left there for its option value. If we did have another serious war where we really needed oil that we couldn’t import, those reserves might be good to have.

Do the new sources of domestic energy in the Dakotas and the Gulf of Mexico hold much promise for solving our energy problems?

Sure, there are some new sources of energy in the U.S. – really, natural gas and shale oil – but however much we have won’t bring us any closer to energy independence. Even if we do discover a few new fields of crude oil, it’s not going to make much of a difference.

As the price of crude rises even higher, the oil companies can go back to old and existing fields and drill a little deeper. That extraction is expensive, but it’s worthwhile if the price of oil is back near $100 per barrel. It wasn’t worthwhile earlier because the extra drilling cost was more than the oil was worth. But now that the price of crude is high enough, they can make money if they drill deeper on these old wells.

What happens to energy prices if the European economy continues to sputter?

If Europe experienced, say, a 10- to 20-percent drop in gross national product, then you might actually notice a dip in the price of oil in the U.S. But economic growth in the U.S. would also slow. So just because the price of oil might fall a little bit doesn’t make their troubles good for us, since we would be affected, too. We certainly don’t want to hope for a recession in Europe to make oil cheaper. First of all, the price wouldn’t fall that much. Second, there would be a whole host of negative implications for the U.S.

What (if anything) will bring the price of oil down again?

The only ways to get a significant change in the price of oil would be through a major recession, a major technological breakthrough, or huge policy changes. If the whole world got together and agreed to a new, stringent version of the Kyoto Protocol to reduce carbon emissions, that would have an impact. If the whole world were to reduce the burning of fossil fuels by 20 percent – that would also have an effect. But we don’t want another recession, nor will all nations agree to such a treaty.

The WSJ is “Wrong”: The U.S. is NOT a Net Exporter of Petroleum

Filed Under (Environmental Policy, Finance, Other Topics, U.S. Fiscal Policy) by Don Fullerton on Dec 2, 2011

Just a couple days ago, the Wall Street Journal reported that “U.S. exports of gasoline, diesel and other oil-based fuels are soaring, putting the nation on track to be a net exporter of petroleum products in 2011 for the first time in 62 years.”  Taken literally, this fact is strictly “correct”, but it is misleading.  It is therefore very poor reporting.  The authors either don’t understand the words they use, or they are deliberately trying to mislead readers.

The reason it is misleading is because the article implies the U.S. is headed toward “energy independence”, and that implication is wrong.  It goes on to say:  “As recently as 2005, the U.S. imported nearly 900 million barrels more of petroleum products than it exported.  Since then the deficit has been steadily shrinking until finally disappearing last fall, and analysts say the country will not lose its ‘net exporter’ tag anytime soon.”  That statement and several expert quotes in the article clearly imply the U.S. is headed toward “energy independence”.   

Strictly speaking, the WSJ is correct that the U.S. exports more “petroleum products” than it imports, … but “petroleum products” do not include crude oil!!  “Petroleum products” include only refined products like gasoline, diesel fuel, or jet fuel.  The implication is only that the U.S. has a large refinery capacity!

The U.S. is a huge net importer of crude oil, and a huge net importer of all “crude oil and petroleum products” taken together, as you can see from the chart  below (provided by the U.S. Energy Information Administration).   In other words, we import boatloads of crude oil, we refine it, and then we export slightly more refined petroleum products than we import of refined petroleum products.  Big deal.

If the WSJ reporters knew what they were talking about, or if they were not trying to mislead readers, then they should have just stated that the U.S. is a huge net importer of all “crude oil and petroleum products” taken together.  They didn’t.  That is why I conclude they do not understand the point, or that they are trying to misrepresent it. Neither conclusion is good for the Wall Street Journal.

They are simply wrong when they say:  “The reversal raises the prospect of the U.S. becoming a major provider of various types of energy to the rest of the world, a status that was once virtually unthinkable.”  Just look at the figure!


Nothing is Wrong with a “Do-Nothing” Congress!

Filed Under (Finance, Retirement Policy, U.S. Fiscal Policy) by Don Fullerton on Nov 18, 2011

The Budget Control Act of 2011 established a joint congressional committee (the “Super Committee”) and charged it with the responsibility of reducing the deficit by $1.2 trillion over 10 years.  If the Super Committee fails to reach an agreement, automatic cuts of $1.2 trillion over 10 years are triggered, starting in January 2013.  These are said to be “across the board”, but they are not.   They would apply $600 billion to Defense, and $600 to other spending.  Entitlements are exempt, including the Supplemental Nutrition Assistance Program (SNAP, formerly food stamps) and refundable tax credits such as the Earned Income Tax Credit and child tax credit.  These entitlements are exempt from the cuts because anyone who qualifies can participate (that spending is determined by participation, not by Congress).

In addition, the Bush-era tax cuts are set to expire at the end of 2012, so doing nothing means that tax rates would jump back to pre-2001 levels.  That combination might be the best thing yet for our huge budget deficit.

The Federal government’s annual deficit has been more than $1 trillion since 2009.  Continuation of that excess spending might create a debt crisis similar than the one now in Europe.

The Center on Budget and Policy Priorities estimates that the trigger would cut $54.7 billion annually in both defense and non-defense spending from 2013 through 2021.  Meanwhile, U.S. defense spending is around $700 billion per year, with cuts of about $35 billion per year already enacted, so the automatic trigger would reduce defense spending from about $665 billion to about $610 billion.  Some may view that 10% cut as draconian, but the simple fact is that the U.S. needs to wind down its spending on two wars.  Congress and voters are fooling themselves if they think the U.S. can continue to spend the same level on defense, not raise taxes, and make any major dent in the huge annual deficit.

The same point can be made for automatic cuts in Social Security, which in its current form is unsustainable.  Since it was enacted in 1935, life expectancy has increased dramatically, which means more payouts than anticipated.  Birth rates have declined, which means fewer workers and less payroll tax than anticipated.  The system will run out of money in 2037.  Congress either needs to raise taxes or cut spending.  But they won’t do either!  The only solution might be the automatic course, without action by Congress!

For further reading, see “Why doing nothing yields $7.1 trillion in deficit cuts”.