Strategic analysis of the Budget Control Act

Strategic analysis of the Budget Control Act

This is the third of three posts on the Budget Control Act.

The other two posts are:

  1. Quick summary of the Budget Control Act; and
  2. Understanding the Budget Control Act.

I cover three topics in this post: what important players won in this deal, the core concepts and tradeoffs within the deal, and what the different strategies might be this Fall under this bill if (when?) it becomes law.

The President’s priorities

The President knows he will get debt limit increases through early 2013 no matter what House conservatives/Tea Party members do. Those Members can no longer “hold a debt limit increase hostage” before the 2012 election.

We could also describe this as eliminating liquidity risk through 2012.

Assuming someone doesn’t find a way out of the enforcement mechanisms in the bill (1 in 3 chance), there will be at least $2.1 T in deficit reduction over the next 10 years as a result. While I think that’s a big policy benefit, I’m not sure how important that is substantively to the President. (Is he for stimulus? Austerity? Who knows at this point.)

But given his recent public conversion to deficit hawk, the President will undoubtedly stress it publicly over the next 18 months and began doing so last night. At a minimum, the President will benefit politically with deficit hawk centrists, both for the policy result and the achievement of a bipartisan agreement. Prepare to watch the President seize political credit for spending cuts he fought.

The President also has an opportunity to push for tax increases as part of the Joint Committee deficit reduction process this fall. You will hear the corporate jets & Big Oil riffs ad nauseam.

Republican / conservative / Tea Party priorities

The Speaker set a goal for House Republicans of at least a dollar of spending cuts for each dollar of debt limit increase. This law guarantees at least a dollar of deficit reduction for each dollar of debt limit increase. Thus this law guarantees at least $2.1 T in deficit reduction over the next 10 years. That’s not $4 T but it’s not bad in a balanced Washington.

Of that deficit reduction, at least $917 B of it is from spending cuts and discretionary spending caps, and House Republicans can guarantee that it all comes from spending cuts and caps if they are willing to threaten to cut defense a lot (which is different than actually cutting defense a lot). Through this law Republicans have the opportunity to lock in at least $2.1 T in spending cuts over the next 10 years. The spending caps will be in law and enforced with a sequester, meaning they are not gimmicks. Yes, a future Congress can change the law and undo those caps, but the same is true for any policy change.

While the Joint Committee process does not preclude tax increases cuts, it is tilted pretty heavily against them and toward spending cuts. That is huge.

The tax rate and cap gains & dividends fights probably shift to outside this Joint Committee process. I expect a recurrence of the 2010 fight in 2012, this time with the President threatening a veto. The use of a current law baseline for revenues in this fight is a rhetorical but not a procedural concession. My money remains on another extension of current rates and no tax rate increases in 2013. The underlying political pressures are unchanged.

The Balanced Budget Act will get a vote this fall in the Senate, and there is a modest financial incentive (a higher debt limit increase) for the Senate to pass it. I still think it’s unlikely this will be sent to the States, but this is a process improvement relative to where they are now on a BBA.

Congressional Democrats’ priorities

In addition to the goals listed above for the President, Senate Democrats get to punt this year and next on passing a budget resolution and making any politically difficult choices in the open. This is for me the only unequivocally bad part of this bill. It is process abuse, in which Senate Democrats are avoiding taking responsibility for proposing solutions to America’s biggest economic policy problems.

Core concepts & tradeoffs

  • The President avoids another debt limit battle before his election. (Hey, he framed it this way.)
  • Republicans get >$2T of deficit reduction and the ability to block tax increases and force spending cuts.
  • This fall Democrats will face a hard choice: cut the big entitlements or cut domestic discretionary spending even further?
  • This fall Republicans will face a hard decision: are you willing to taking the chance that defense discretionary will be cut even more deeply to avoid tax increases?

The new trigger mechanism is the key to this new deal and the fall battle.  The trigger makes tax increases quite difficult (should make Rs happy), provides no benefit to raising tax rates (Rs even happier) but doesn’t rule out targeted tax increases (should minimally satisfy Ds). The trigger cuts defense spending more deeply than nondefense spending, in theory creating greater pressure on Republicans than on Democrats to want the Joint Committee process to succeed.

I think Team Obama thinks, because a failed Joint Committee would cause the trigger to cut defense spending an additional 10% and nondefense discretionary spending “only” an additional 8%, that Republicans will pay anything to get a new law, including agreeing to tax increases. I think Congressional Republicans think this judgment is wrong, and this difference of opinion allows both sides to agree to this trigger and this new law.

The President’s strategy for the fall Joint Committee battle

The President is telegraphing his strategy. He will threaten to oppose (veto?) any product of the Joint Committee that does not raise taxes on his favorite targets (“balance”). In doing so, he will be threatening something valuable to most Republicans: defense spending. While last spring Tea Party conservatives took a debt limit increase hostage to force Democrats to cut spending, this fall the President will take national security spending hostage to (try to) force Republicans to raise taxes on politically unpopular constituencies.

A Republican counter-strategy

There is a simple Republican counter strategy available:

  • Speaker Boehner and Leader McConnell appoint to the Joint Committee six Members who will not raise taxes.
  • These six Republicans call the President’s bluff, and tell their Democratic counterparts they are willing to reject a deal that includes tax increases, even if that deal means the trigger will cut defense deeply. They deny the six Democratic Members of the Committee negotiating leverage from the difference between a triggered 10% cut in defense and an 8% cut in nondefense discretionary spending. “This is going to hurt you almost as much as it’s going to hurt me, so I’m not giving you anything to avoid it.”
  • These six Republicans encourage everyone to cooperate to get most (all?) of the $1.5 T in deficit reduction from the Big 3 entitlement programs: Social Security, Medicare, and Medicaid. They are the cause of our long-term fiscal problems and they are so big and growing so rapidly that you can save lots by changing them.

I am reminded of the familiar scene in an action movie. The bad guy holds a hostage and a hand grenade while our hero, five feet away, points a gun at the bad guy. The bad guy threatens to pull the grenade pin and kill himself, the hostage, and our hero. He points out that the hero may not care about himself, but surely he doesn’t want to risk the life of this innocent young girl.

The hero, who we know is a kind and compassionate man, looks the bad guy straight in the eye and says, “Go ahead. Blow us all up. I don’t care about her, and I don’t care about myself, as long as you’re killed in the process as well. We both know you won’t pull that pin because you won’t kill yourself. So let her go and let’s end this peacefully.” The bad guy backs down because the hero has demonstrated the threat provides no relative advantage. As long as the exploding grenade would do sufficient damage to the bad guy (death), it doesn’t matter that the hero suffers a greater loss (death X 2). The bad guy doesn’t want to carry through with his threat any more than the hero does.

(I am not suggesting the President is a bad guy with a grenade.  It is just a metaphor to illustrate a negotiating concept.)

The same is true here. An additional 10% cut to defense discretionary is deep, and many Republicans will intensely want to avoid it. At the same time, an additional 8% cut in nondefense discretionary will freak out many Congressional Democrats and the White House, and they will intensely want to avoid it. I think the depth of both cuts are so deep, and the difference between -10% and -8% is small enough, that it confers no relative advantage in the Joint Committee. Democratic negotiators will be just as desperate to avoid 8% domestic discretionary cuts as Republicans will be to avoid 10% defense cuts.

This means that all Republicans need to do is call the President’s/Democrats’ bluff on tax increases, threaten to allow the pain of the trigger hit both sides, offer $1.5 T of entitlement spending cuts, and wait.

$2 trillion of spending cuts is big for Congress but small relative to our underlying fiscal problems. If this bill becomes law and if the fall Joint Committee process is successful, the remaining spending problem will be more than an order of magnitude larger than this accomplishment. If you think this summer has been painful or dread the battle of this fall, you ain’t seen nothin’ yet. Wait until Congress wrestles with the big stuff.

Three times in the past year Congressional Republicans have played brinksmanship with the President and come out ahead:  the December 2010 tax rate fight, the Spring 2011 CR fight, and now the Summer 2011 debt limit fight. They have a game plan that has delivered multiple incremental wins so far, and a playing field that favors them for the Fall 2011 Joint Committee fight. In a balanced Washington they have successfully leveraged a debt limit increase to cut spending and not raise taxes.

For these reasons I am fairly optimistic this bill provides an opportunity for another incremental win this fall. If I’m right, it also establishes a pattern for when the debt limit expires in 2013.

(photo credit: Andrew Magill)

Understanding the Budget Control Act

Understanding the Budget Control Act

This is the second of three posts on the bill agreed to by the President and the bipartisan bicameral leaders of Congress (Speaker Boehner and Leaders Reid, McConnell, and Pelosi).

The other two posts are:

  1. Quick summary of the Budget Control Act; and
  2. Strategic analysis of the Budget Control Act.

If you have not read my quick summary post, please do so before reading this one. I cover three topics in this post:  how taxes are treated in the Joint Committee, how the spending cut trigger works, and the intentional imbalance of triggered spending cuts.  All three are critical to the strategic analysis.

How taxes are treated in the Joint Committee

This bill does not raise taxes.

The $917 B of spending cuts that immediately take effect are just that, spending cuts. No tax increases there.

The Balanced Budget Amendment might or might not have a 2/3 voting requirement to raise taxes. That’s up to the House and Senate to decide when they vote on a BBA.

It gets complex when you look at the new Joint Committee. I think it’s easier if I break it into four questions:

  1. If the Joint Committee process fails, could the automatic sequester mechanism raise taxes?
  2. Is the Joint Committee allowed to raise taxes?
  3. Can the Joint Committee count tax increases toward hitting its deficit reduction target?
  4. What does the bill do to efforts to raise taxes outside of this process?

As I read the bill text, the answers are:

  1. No.  The automatic triggered sequester cuts spending. It cannot raise taxes.
  2. Yes, the Joint Committee is allowed to raise taxes. Nothing forbids the Committee from including any tax increase they like, if they have 7 or more votes to do so. But to become law that bill would also need the support of a majority of the House.
  3. No for any taxes already scheduled to increase in the next 10 years under current law (e.g., the Bush-Obama tax rates, AMT, or any expiring tax extenders). Yes for any other proposed tax increase (e.g., corporate jets, Big Oil, carried interest, LIFO, capping itemized deductions for high income tax filers, or any other “new” tax increase). See below for more details.
  4. The bill creates a 60 vote Senate budget point of order against legislation that would extend any of the Bush-Obama tax rates or patch the Alternative Minimum Tax. Then again, those bills already face a 60 vote filibuster threshold, and last year such a point of order existed against extending the top tax rates, so practically speaking, this isn’t a new or higher hurdle.

Details on #2 and #3

The Joint Committee can choose to raise taxes if a majority of the 12 members agree. This would require at least one of Speaker Boehner’s three or Leader McConnell’s three appointees to agree to raise taxes. The more important question is: would such tax increases count toward the Committee’s $1.5 T deficit reduction target?

The key technical detail is that the Committee’s recommendations on taxes will be measured against a current law baseline for taxes. Under current law, certain taxes are scheduled to go up in 2013, most notably the individual income tax rates and rates on capital gains and dividends. Normally Republicans dislike a current law baseline on taxes, but in this case it helps them.

Here’s what that means for the Joint Committee:

  • If the Committee allows tax rates to increase in 2013 (aka “raise tax rates in 2013,” or “let the Bush-Obama tax cuts expire,” depending on your point of view), the additional revenues raised will not count toward the Joint Committee’s target since this is already current law. So raising these tax rates doesn’t help the Committee meet their $1.5 T deficit target.  That doesn’t mean they can’t include them in their legislation (they can), just that they can’t get any numeric benefit for doing so. That is incredibly important.
  • The same is true for capital gains and dividends. While a majority of the Committee could agree to allow those rates to increase, they won’t get any numeric benefit from doing so (unless they were to go above the 20% scheduled for current law starting in 2013).
  • The same would be true for the alternative minimum tax. If the Committee were to decide to let the AMT bite a lot more people, they wouldn’t be scored with any additional revenues raised to meet their deficit reduction target, since that is already scheduled to happen under current law.
  • The same would be true for any tax extender-like provisions scheduled to expire under current law (e.g., the ethanol tax credit).  Allowing them to expire (or scaling them back) won’t get scored as deficit reduction for the Joint Committee because they are already scheduled to expire under current law. It won’t move them any closer to their goal.
  • But other “new” tax increases would count toward the Joint Committee’s deficit reduction target.  If the Committee eliminates depreciation for corporate jets, for instance, or or repeals or scales back carried interest or LIFO, or caps itemized deductions for high-income tax filers, those would score as tax increases relative to current law, and the Committee would get credit for deficit reduction for including those tax increases.

Therefore, if the six committee Democrats can convince one of the Republicans to raise taxes, they have an incentive to raise new taxes rather than tax rates on income, capital gains, or dividends. The tax rate fights are most likely to occur outside this process.

In any case, if 218 House Republicans don’t want to raise taxes, they can kill the Joint Committee’s recommendations, triggering the automatic spending cuts. There is, however, a downside to that for Republicans …

How the spending cut trigger works

First, it’s a spending cut trigger. It does not and cannot trigger any tax increases.

Second, the trigger kicks in only if the Joint Committee process fails to result in a new law enacting deficit reduction of at least $1.2 T over the next 10 years.

The trigger would cut spending by ($1.2 T minus the amount of deficit reduction enacted into law through the Joint Committee process).

The trigger would cut all discretionary spending, Medicare, farm subsidies, mandatory housing subsidies, and a few smaller mandatory spending programs. Social Security, veterans’ benefits, civilian and military retirement, and all low-income subsidies including Medicaid and the “welfare” programs (food stamps, SSI, etc.) would be exempt from the trigger. Net Interest payments would also be exempt.

The spending cuts are split evenly (measured in dollars) between two pots:

  1. defense discretionary;
  2. nondefense discretionary + covered entitlements.

As in the 1997 budget law, the cut to Medicare is capped at 2%.

The imbalance of triggered spending cuts

If the Committee fails altogether or comes up short of its $1.2 T deficit reduction target, the triggered spending cuts kick in. The automatically triggered spending cuts are designed to cut defense discretionary spending by a greater percentage than nondefense discretionary spending.  Since the dollar amount of the cuts are allocated 50/50, and the nondefense discretionary spending also has Medicare and about $50 B of other annual entitlement spending in its base, the cuts to nondefense discretionary spending are diluted by the cuts to the included entitlements.

Example:  Suppose the Joint Committee process fails completely and no law enacts new deficit reduction this fall. Just s’pose.

The trigger then must cut spending by $1.2 T over ten (actually, nine) years.  Here are the mechanics of how those spending cuts are allocated.

  • First back out interest savings (18% of the total, or $216 B). That leaves $984 B of spending cuts.
  • Spread that out evenly over nine years. That means cut spending by $109 B per year for each of FY13 – FY21.
  • Split that $109 B evenly between (defense) and (nondefense + some mandatory). So each category takes about a $55 B hit in each of the next nine years.
  • That would result in about a $54 B cut in defense discretionary spending in FY13.
  • The other $55 B in spending cuts gets applied to (nondefense discretionary + Medicare + some other entitlements). But the cut to Medicare is capped at 2%.
  • The result of this is that nondefense discretionary and these other entitlements would take about an 8% cut.

Therefore:

  • Defense discretionary spending would be $546 B if the Committee hits its target, and about $492 B if the Committee fails entirely. That’s 10% less, a $54 B cut in defense discretionary spending in 2013.
  • Nondefense discretionary spending would be $501 B if the Committee hits its target, and about $461 B if the Committee fails entirely. That’s 8% less, a $40 B cut in nondefense discretionary spending in 2013.
  • Medicare spending would be cut 2% in 2013.
  • Farm programs and a few other entitlements would be cut 8% in 2013.

Note that in both cases, the discretionary percentage cuts are on top of the 2013 share of the $917 B of discretionary spending cuts enacted when the Budget Control Act is signed.  Discretionary spenders will correctly argue that they are paying once up front to offset the initial $900 B debt limit increases, and then again to offset almost all of the $1.2 T debt limit increase if the Joint Committee process fails.

A key strategic point is the relative pain applied to the two parties’ spending priorities. In this example where the Joint Committee process fails, defense takes a 10% cut on top of its share of the initial $917 B cut, while nondefense takes an additional 8% cut and Medicare takes a 2% cut.

This imbalance is intentional and was key to reaching agreement on the Budget Control Act.  It’s also critical to how the Joint Committee might work.

To understand why, please see Strategic analysis of the Budget Control Act, the last post in this series.

(photo credit: David Beyer)

Quick summary of the Budget Control Act

Quick summary of the Budget Control Act

This is the first of three posts on the bill agreed to by the President and the bipartisan bicameral leaders of Congress (Speaker Boehner, and Leaders Reid, McConnell, and Pelosi). The bill is called the Budget Control Act of 2011.

The two other posts are:

  1. Understanding the Budget Control Act; and
  2. Strategic analysis of the Budget Control Act.

The “understanding” post covers in some detail a few critical details for insiders and experts. The strategic analysis post tries examine how this deal came together and what might result from it this fall.

Preliminary sources:

Everything below assumes the new Budget Control Act of 2011 bill passes the House and Senate and is signed into law by the President.

I’m going to try to be neutral in this description and put my analysis in a separate post.

Debt limit

  • The debt limit will be increased by $2.1 T no matter what Congress does.
  • The debt limit can be increased up to an additional $300 B depending on what Congress does on deficit reduction and a Balanced Budget Amendment (BBA).
  • The debt limit increase will happen in three steps: $400 B immediately, then +$500 B, then the remainder after Congress tries to enact further deficit reduction and pass a BBA.
  • Assuming the economy doesn’t go into the tank, this should eliminate the risk of another cash flow crisis for about 18 months, into early 2013. (No, it was never a “default” crisis.)

Spending cuts, tax increases, and deficit reduction

  • Whether or not Congress successfully enacts another deficit reduction law in the fall, the total deficit reduction will exceed the debt limit increase available to the President. If Congress fails this fall, some of that deficit reduction will happen through automatically triggered spending cuts.
  • As soon as the Budget Control Act becomes law, discretionary spending (aka annual appropriations) will be cut and capped, with projected savings of $917 B over 10 years, more than the initial $900 B of debt limit increase allowed the President. This is measured relative to a traditional inflation baseline for discretionary spending, without using the “Iraq/Afghanistan war baseline gimmick.”
  • In addition to these immediately enacted spending cuts from the cut and spending caps, a complex process will lead to additional deficit reduction of $1.2 – $1.5 T (or in theory more) over the next 10 years. That additional deficit reduction will result either from a new law enacted by the end of 2011, or from automatically triggered spending cuts written into the Budget Control Act (or from a combination of the two). The last leg of the President’s debt limit increase is tied to this additional deficit reduction.
  • How that additional deficit reduction is achieved is uncertain:
    • The bill creates a new Joint Committee of 12 Members of Congress (6 R, 6 D), whose goal is to produce a bill that would reduce the deficit by $1.5 T over 10 years. If 7 or more Members of that Committee approve a bill by November 23rd, it is guaranteed a straight up-or-down vote in the House and Senate by December 23rd.  No amendments and no Senate filibuster are allowed of this bill. It’s take-it-or-leave-it to everyone.
    • If this new Joint Committee legislative process fails to result in a law, then there will be no tax increases and there will be triggered $1.2 T of across-the-board spending cuts in discretionary spending, Medicare, farm subsidies, and a few smaller entitlements. These triggered spending cuts would hit defense more deeply than other types of spending.
    • The additional deficit reduction could include tax increases, but only if:
      • 7 of 12 Members of a new Joint Committee of Congress agree to raise taxes, including at least one Republican Member of the Committee;
      • and a majority of the House and Senate vote for the Committee’s recommendations;
      • and the President signs the bill into law.
    • For more details on tax increases in the Joint Committee process, please see my other two posts today.

Assuming the language has been tightly drafted enough, this process should result in $1.2 T – $1.5 T of additional deficit reduction no matter what. There are four possible outcomes from this process to produce that deficit reduction:

  1. across-the-board spending cuts automatically happen in defense and non-defense discretionary spending (deeper in defense), Medicare, farm and housing subsidies and a few smaller entitlements; or
  2. a bill becomes law that cuts spending only, with the makeup of the spending cuts determined entirely by the new Joint Committee (and including any spending the Committee wants); or
  3. a bill that cuts spending and raises taxes comes out of the Joint Committee and becomes law; or
  4. some combination of (1) with (2) or (3).

As stated above, the President gets $900 B of debt limit increase effectively immediately.  The amount of the President’s last “leg” of debt limit increase depends on what happens with this Joint Committee and a Balanced Budget Amendment:

  • If the Joint Committee process implodes or produces less than $1.2 T of deficit reduction, then the President can get a final debt limit increase of $1.2 T;
  • If the Joint Committee process results in a law that reduces the deficit between $1.2 T and $1.5 T, then the President can get a debt limit increase of the same amount;
  • If the Joint Committee process results in a law that reduces the deficit by more than $1.5 T (don’t hold your breath) or if a Balanced Budget Amendment passes the House and Senate and is sent to the States, then the President can get a final debt limit increase of $1.5 T.

Balanced Budget Amendment

The House and Senate will each vote on a Balanced Budget Amendment between October 1 and December 31 of this year. If the House passes a version of the BBA, the Senate must “consider” that version.

Senate budget resolution deemed

The Senate, which has not passed a budget resolution in two years, will be “deemed” to have passed a budget resolution for this year and next year. In other words, for the purpose of budget points of order on the Senate floor, it will be as if the Senate had done a budget resolution. This will apply to both FY12 (this year) and FY13 (next year), meaning there will be no pressure for the Senate to consider a budget resolution on the floor before 2013.

Senate Budget Committee Chairman Conrad will reportedly commit to at least a committee markup of next year’s budget resolution.

That’s your quick summary of this bill.  If you’d like to learn more, I have two additional posts:

  1. Understanding the Budget Control Act of 2011. (This is an advanced topics post, not for the faint of heart.)
  2. Strategic analysis of the Budget Control Act of 2011.
(photo credit: Dustin Moore)

Understanding vetoes, veto threats & SAPs

Understanding vetoes, veto threats & SAPs

In this background post, I explain how vetoes and veto threats work and what a SAP is. It is a companion post to one on the current situation: Senior advisors veto threat on the Boehner bill.

Before we get to veto threats, we need to understand what a SAP is.

SAP: Statement of Administration Policy

A Statement of Administration Policy, or SAP, is a formal document produced by the Office of Management and Budget that expresses the Administration’s official views on a bill.

  • A SAP can be a few sentences or several pages long.
  • A SAP applies to a particular version of a particular bill.
  • A SAP applies to a bill being considered on the floor of the House or Senate. When the Administration provide formal written input on a bill earlier in the process (like when it’s in committee), that input usually takes the form of a letter from a senior Administration official (e..g, a Cabinet secretary or senior White House aide) to the relevant Committee chairman.
  • OMB releases the SAP just before the bill comes to the House or Senate floor.
  • A SAP is unsigned and written “to the world,” sort of like a press release. There is no “From:” or “To:” field in a SAP.
  • A letter, for example from the Assistant Secretary of Tax Policy to the House Ways & Means Committee Chairman, would probably only apply to a portion on the bill (in this case, the tax part). While such a letter would be “cleared” through OMB and therefore represent the whole Administration’s views, it is formally treated as the views of the particular official who sends it. In contrast, the SAP always formally represents the entire Administration’s views, on the entire bill, and the SAP speaks to the substance of the entire bill, not just one part.
  • SAPs emphasize the President’s top policy priorities, but they also get into levels of detail in which a President would almost never directly engage. The Administration often uses a SAP to communicate precise or nuanced positions on complex policy issues in a bill.

A SAP, especially a long and detailed one on a big bill, can be the result of discussions and debates among 5-30ish senior officials in the White House, OMB, and Cabinet agencies. Usually OMB and White House policy staff do the initial draft. OMB Legislative Affairs staff take comments from throughout the Administration and play an honest broker role to resolve them as best they can. White House policy council staff sometimes help this process when the differences of opinion among Administration officials are important enough to be debated in the West Wing. This can be a painful process for those involved, because the letter ends up signaling not just the Administration’s substantive views, but what’s important and what’s less so. Individual Administration officials may care only about a portion of a bill, and they will often argue forcefully that their views on a part of a bill should be the Administration’s top priority in a SAP.

SAPs are aimed at Congress – the Members and senior staff who draft, debate, and vote on bills. The language of a SAP is therefore drafted for those who are intimately familiar both with the substantive issues involved and with the legislative process. Like other technical forms of communication, it can sometimes read strangely to a layman.  Hill Members and staff will parse the language in a SAP very finely, and the drafters know that. When you’re drafting a SAP you want to be precise and forceful. It’s not really an advocacy piece, but more of a blunt “Here’s where we stand on this bill.”

OMB staff release SAPs by email anywhere from a few minutes to a few days before a bill comes to the House or Senate floor. A short while later they post them on a section of OMB’s website. If you care a lot about a bill, you should read the SAPs on it, one each for the House and Senate floor.

The American Presidency Project at UCSB has a great collection of all SAPs going back to 1997.

A stylistic comment: the Obama Administration’s SAPs tend to be a bit more message-y than were ours in the Bush Administration. An Obama Administration SAP is more likely to include text that sounds like the Administration’s talking points, in addition to the detailed substantive policy feedback on the bill.

The spectrum of support or opposition

The first thing you should look for in a SAP is the core (usually underlined) sentence that summarizes the Administration position on the bill. Let’s assume an imaginary bill H.R. 1234 and look at the spectrum of summary sentences you might find in a SAP.

  1. The Administration strongly supports H.R. 1234.
  2. The Administration supports H.R. 1234.
  3. The Administration supports passage of H.R. 1234.
  4. (list specific good and bad things in H.R. 1234, but don’t make a statement on the bill as a whole)
  5. The Administration opposes H.R. 1234 [optional: …in its present form].
  6. The Administration strongly opposes H.R. 1234 [optional: …in its present form].
  7. If the President were presented this bill for signature, Secretary _______ (or White House Advisor ________) would recommend that he veto it.
  8. If the President were presented this bill for signature, the President’s senior advisors would recommend he veto it.
  9. If the President were presented this bill for signature, he would veto it.
  10. If the President is presented this bill for signature, he will veto it.
  11. (not in a SAP) If this bill makes it to my desk, I will veto it.

If you can’t find this sentence, you’re in that fourth version in which they’re not taking an overall position on the bill.  This means the Administration is conflicted or for some other reason doesn’t want to take a summary position, positive or negative.

Notice the slightly weaker support in (3) compared to (2). In (2) the Administration supports the substance of the bill. In (3) the Administration isn’t excited about the substance of the bill, but hopes they can improve it later in the process, so they “support passage” to keep the process moving.

In (5) and (6) you can weaken the opposition signal by adding “in its present form.” This is signaling to Congress “fix things we address elsewhere in this SAP and we won’t oppose it.”

Note also the addition of “strongly” between (1) and (2), and between (5) and (6). In everyday conversation most people wouldn’t think it’s a big difference to say “I oppose X” versus “I strongly oppose X.” in the world of SAPs and formal communications between the Administration and the Congress, this difference matters. The White House is usually working quite hard to kill a bill that it strongly opposes.

How the President vetoes a bill

The House and Senate pass the same legislative text.

The House or Senate Clerk (based on in which House the bill originated) enrolls the bill and transmits it to the President. A Clerk’s office staffer drives the bill to the White House and hands it to the President’s Executive Clerk.  They usually do this in batches.

The President has 10 days (excluding Sundays) to sign the bill or veto it:

  • If he signs it, it is law.
  • If he returns it to the house of Congress that sent it to him with “his message of disapproval,” he has vetoed the bill.
  • If he neither signs nor returns it, after 10 days (excluding Sundays) it becomes law.

The President does not write anything on the bill to be vetoed. Instead, he sends a “veto message,” which looks like a letter, back to the House that originated the bill. He signs the veto message, but that is not technically required by the Constitution. The bill is technically vetoed when it arrives back at the House or Senate. And there is no veto stamp. Sorry to disappoint you.

Congress can then attempt to override the President’s veto. To do this at least two-thirds of the House and two-thirds of the Senate must vote to override the veto.

Therefore to sustain a veto, the President needs more than one-third of the Senate or one-third of the House to stick with him and vote against overriding the veto. That’s 34 or more Senators or 146 or more House members (145 or more today since there are three vacancies in the House at the moment).

How veto threats are issued

Veto threats can be issued in several different ways:

  • the President can make the threat publicly, on camera, in a public statement, or in a letter to Congress;
  • a Cabinet secretary or top White House aide could make a public statement or send a letter to Congress;
  • a veto threat could be included in a Statement of Administration Policy.

The first two of these are somewhat ad hoc. The most common form of a veto threat is a written threat in a SAP. This allows the President and his team to have precise control over the language of the threat.

Presidential threat vs. senior advisors threat vs. single advisor threat

The SAP on H.R. 2560, the Cut, Cap and Balance Act of 2011 contained a Presidential veto threat:

If the President were presented this bill for signature, he would veto it.

Since it is made by the President, this is a strong veto threat. In May 2008, President Bush issued a written statement (not a SAP) on a bad farm bill with the strongest form:

If this bill makes it to my desk, I will veto it.

The difference between these two is fairly small, and the Presidential veto threat on CCB was a big deal and a serious threat. Let’s compare that to the veto threat on Speaker Boehner’s version of the debt limit bill.

If S. 627 is presented to the President, the President’s senior advisors would recommend that he veto this bill.

Senior advisors is a technical term used to mean “all the relevant Cabinet officials and senior White House aides.” A recommendation from the President’s senior advisors is implied to be a consensus recommendation and is therefore stronger than a recommendation from any particular Cabinet secretary or White House aide. Presidents very rarely take a different path than one recommended by a consensus of their senior advisors. When he does there’s a big question about why these people are advising him if he is ignoring advice from all of them.

So a senior advisors veto threat in a SAP is stronger than, for instance, the following threat from a single Presidential advisor:

If H.R. XXX is presented to the President, Secretary YYY would recommend that he veto this bill.

A senior advisors veto threat is a very big deal and a serious threat.

In the Bush White House we almost never issued veto threats in their Presidential form. We treated a senior advisors veto threat as if it were a Presidential veto threat, just one with downgraded phrasing. We cleared every senior advisors veto threat with the President, and never issued one without his approval.

That allowed the President to save the Presidential veto threat language for those cases in which he wanted to send an extra strong negative signal to Congress.

I hope this post has been helpful.  You can now apply your newfound understanding to the current situation here: Senior advisors veto threat on the Boehner bill.

(photo credit: DonkeyHotey)

Understanding the Gang of Six plan

Understanding the Gang of Six plan

In this post I will try to describe and explain the Gang of Six plan. In a separate post (coming soon) I will describe my views on the plan. I can’t explain the plan without incorporating some judgment, but I’ll try to separate most of my personal policy views into the follow-up post.

The Original Gang of Six consists of Democratic Senators Conrad (ND), Durbin (IL), and Mark Warner (VA), and Republican Senators Chambliss (GA), Coburn (OK), and Crapo (ID). Senator Conrad is Chairman of the Senate Budget Committee. Senator Durbin is the #2 Senate Democrat, the Whip.

Press coverage of the Gang’s plan has been substantively weak. Most of it covers only the Gang’s top line substantive message and the political back-and-forth surrounding it. I’m going to try to supplement that by putting some meat on the bone.

Friendly warning: this is somewhat of a monster post. It is both longer and more detailed than I would like it to be, but I’m aiming it primarily at policy insiders who I think want that additional detail and analysis. Lay readers may find a few parts of it to be tough sledding. The mainstream press is giving you not enough detail. Here I’m erring on the other side. I will, in my follow-up post, provide a shorter and far more judgmental summary of what’s going on in this plan.

To their credit, the Gang of Six (G6) released three documents that provide significant descriptive detail and numbers. I will therefore begin by giving you what the Washington insiders already have: the Gang of Six’s documents, so you can see for yourself.

  1. Gang of Six summary;
  2. Gang of Six slides; and
  3. Gang of Six charts.

The Gang of Six plan is designed in three legislative parts. Part 1 is “a $500 B down payment” that would presumably be implemented quickly/immediately through a bill. Part 2 contains the bulk of the plan’s deficit reduction, and would require enactment of at least two more pieces of legislation, a budget resolution followed by a reconciliation bill. Part 3 is a process for considering Social Security legislation that would, if successful, be combined with the reconciliation bill from Part 2 after both had passed the Senate.

The Gang’s plan says nothing about increasing the debt limit. It would be natural to package Part 1 with a debt limit increase, but they stay silent on that point. I think that ambiguity is reasonable in the current legislative context — it allows them flexibility and keeps the issues somewhat separate. This is a deficit reduction plan, not a debt limit increase plan.

Part 1 of the Gang’s plan consists of several components:

  • Caps on discretionary spending at unspecified levels through FY15 (that’s for four fiscal years, FY12-FY15, but without any actual numbers);
  • A significant technical correction to the way inflation is measured through the Consumer Price Index;
  • Two Social Security spending increases to partially mitigate the effects of the CPI change on low-income beneficiaries;
  • repeal of the CLASS Act, a new long-term health care benefit created in the Affordable Care Act (aka it’s part of “ObamaCare”);
  • some knicks and knacks like freezing Congressional pay and selling some government assets; and
  • unspecified budget process reforms.

As I describe in further detail below, the absence of numbers for proposed discretionary spending is a huge gaping hole. It’s impossible to evaluate a budget plan if you don’t know what it’s proposing for spending that comprises 30% of the federal budget.

The CPI correction is a big deal — it would result in slower spending growth, mostly with reduced Social Security Cost of Living Adjustments (COLAs), as well as higher taxes, resulting from a slower indexation of income tax brackets. CBO says the technical change (moving to “a chained CPI”) would on average reduce measured inflation by about 0.25 percentage points. There’s a debate about whether the higher revenues constitute a “tax increase” or not. I fall on the “not” side as long as the technical correction is applied to everything, but this is a judgment call.

The Social Security spending increases are clearly a legislative bargain with someone on the Left who was concerned about the effects the correction would have on lower-income Social Security recipients.

Repeal of the CLASS act is a big deal. This is the little-discussed but hotly disputed new long-term care insurance benefit in the Affordable Care Act. Spending hawks are concerned the cost of this benefit will explode in the long run. Repeal is a big deal fiscally, as a health policy matter, and politically.

Part 2 of the Gang’s plan describes a budget resolution. This is unsurprising given that Gang member Conrad is Senate Budget Committee Chairman. Minor note: all three documents use the same language and presentation formats as Chairman Conrad’s traditional presentations, strongly suggesting that he controlled the paper. Like a budget resolution, the Gang’s plan sets numeric targets for categories of spending and sets up legislative processes that would govern the development of legislation dealing with specific policy details. In this respect, the Gang’s outline is traditional and fits within the normal confines of the regular budget process, albeit 4-5 months later than normal. If there were a broad consensus supporting the Gang’s plan, it would be normal process to turn it into a budget resolution and then a reconciliation bill.

I think of Part 2 in three subparts: numbers, recommended tax policies, and process changes.

Part 2A: Numbers

  • Mandatory spending would be cut by either $328 B over 10 years, or $445 B over the same timeframe. The $117 B difference is confusing — the document provides two different numbers for savings from Medicare and Medicaid that differ by that much. Sen. Coburn has been quoted as saying the Gang “added another $115 B in health savings” in recent days. I think that’s this figure, but the document includes both numbers. That suggests to me the document is trying to have it both ways — include the higher figure that Sen. Coburn likes, and the lower figure that I presume Democrats prefer. One of the graphs shows the additional $117 B in health savings, but lightly shaded, again allowing the Gang to sell it both ways to different constituencies. This ambiguity detracts from the plan’s credibility and is important.
  • A significant policy detail is that the Judiciary Committee would have to get savings from medical malpractice reform.
  • Revenues would be set at a level that over the next ten years is $1.5 trillion lower than current law, but $2.3 trillion higher than current policy. I will explain this in further detail below.

There are a couple of significant little phrases in the document: Medicare and Medicaid would be reformed “while maintaining the basic structure of these critical programs,” and the plan “would maintain the essential health care services the poor and elderly rely upon.” The first is a rejection of structural reforms like those proposed in the House Budget plan or in Ryan/Rivlin, as well as a rejection of block granting Medicaid or converting it into a low-income voucher program. The second is vague and could be interpreted to mean almost anything. Since Democrats are in the Senate majority, they would be the ones interpreting both sets of language as legislation implementing the Gang’s plan is drafted.

In effect, you should think of this language as meaning the Gang’s plan commits to achieving Medicare and Medicaid savings through incremental programmatic changes rather than structural reforms.

You can compare the $328 B or $445 B of proposed mandatory savings to the Biden group’s $423 B figure. Democrats in the Biden group were willing to go higher if taxes were increased, as they are in the Gang’s plan.

Part 2B: Recommended tax policies

The plan would require the Senate Finance Committee to report tax reform legislation within six months. That tax reform legislation would have to hit the revenue levels described above, and would also have the following tax reform policy parameters (with a caveat):

  • Individual rates would be in three brackets: 8-12%, 14-22%, and 23-29%;
  • AMT would be repealed
  • “Reform, not eliminate, tax expenditures for health, charitable giving, homeownership and retirement, and retain support for low-income workers and families;”
  • “Retain the Earned Income Tax Credit and the Child Tax Credit, or provide at least the same level of support for qualified beneficiaries;”
  • Corporate income would be taxed at a single rate between 23 and 29%;
  • Corporate income earned overseas would operate under a “competitive territorial tax system.”

There’s an important process point here. It’s pretty clear to me that the Gang’s plan is written to be implemented through a traditional budget resolution process. If I’m right, then the above tax reform parameters are non-biding and close to meaningless. A budget resolution cannot constrain the Senate Finance Committee and force it to change taxes in a particular way. Its only power is to set the numeric total for how much revenue is collected. A budget resolution could include all the above conditions, but the Finance Committee could ignore them without consequence (and traditionally has). Procedurally the Senate would first commit to the new revenue levels, and then later work on the details of tax reform.

That means that either the Gang would have to find another way to commit the Finance Committee to abiding by these principles, or risk the committee doing different tax policies that would collect the total amount of revenue required by the budget resolution. Several members of the Gang are also Finance Committee members, but if Chairman Baucus decided he wanted higher marginal income tax rates than described above, for instance, I don’t see how this plan could prevent him from doing so.

Another important detail left unspecified is the capital gains & dividend tax rate. Back channel conversations suggest the Gang agreed on 20% for both, up from 15% now, although this is left unspecified in the Gang’s plan.

Part 2C: Process changes

  • Part 1 of the plan would establish discretionary spending caps for four years, through FY15. Part 2 would set caps through the end of the 10-year budget window in FY21, but again the numbers aren’t specified.
  • The Gang’s plan would create an unspecified “trigger” mechanism if debt-to-GDP does not stabilize after 2015. The language makes it sound like a fast-track legislative process rather than an automatic sequester.
  • The plan also creates a process to “require action by the Congress and the President” if total federal health care spending per beneficiary grows faster than GDP + 1%. The details of this process are similarly unspecified.

The triggers are important but not super-strong. If you want to guarantee a fiscal outcome like stable debt-to-GDP or health spending growth slower than some rate, you need to put an automatic mechanism into law that forces that outcome whether or not Congress acts. Creating an expedited legislative process to encourage Congress to fix it still relies on Congress to do the right thing in the future. That’s often an uncertain bet.

This has an important consequence. I understand the “$3.7 trillion in savings” cited by the Gang is based in part on this second health care trigger. In other words, they assume that total federal health care spending per beneficiary will grow no faster than GDP + 1%. But they don’t specify the policies to achieve that goal, and they set up an unspecified legislative process to make hitting that target a little easier but far from certain. This means that a significant share of the $3.7 trillion savings are not real. If you want to claim savings from capping government health spending growth, you either have to make the policy changes now or actually cap it. You can’t just say “We’ll set a goal for Congress to hit in the future.” You don’t get to count that as saving money, and the Gang does.

Part 3: Social Security process

  • The Gang’s plan would “consider Social Security reform, if and only if the comprehensive deficit reduction bill has already received [60 votes].” While the Gang describes this as including Social Security reform in their plan, the “only if” means it is instead a new procedural barrier to reform. In effect, it says that SS reform may not be considered until and unless Part 2 has passed the Senate.
  • It sets “75-year actuarial balance” as the test for measuring Social Security reform. This is a significant policy choice I will describe below.
  • It would set a 60-vote threshold for passing Social Security reform in the Senate. While there is in practice already a 60-vote threshold since a minority could filibuster a Social Security bill they didn’t like, this slightly raises the bar by requiring 60 votes not just to vote to shut down a filibuster, but also to vote aye on final passage. This is therefore another new procedural hurdle to passing Social Security reform.
  • If the Senate completes Part 2 and Part 3, the two bills would be combined and sent to the House as a single bill.

The big question here is what the Gang can legitimately claim on Social Security reform. Unlike both the House-passed budget, the President’s February budget, and the President’s late-Spring budget speech, the Gang’s plan actually talks about Social Security. But they are counting a technical correction to CPI, plus Social Security spending increases, plus the above process, as moving forward on Social Security reform. That is an unusual claim to say the least.

Deficit reduction

The Gang says their plan would reduce deficits by $3.7 trillion (or maybe $3.6 trillion, depending on that ambiguous additional $115 B of health savings) over 10 years “under CBO’s March baseline.” To be blunt, I don’t believe this number. The Gang’s documents use three different baselines as bases for comparison for different elements of the plan. They don’t specify how much they want to spend on 30% of the budget, and they count savings from a weak legislative process change on health care. To me these are flashing red lights suggesting someone is trying to hide the ball. The Gang’s charts purport to compare the Gang’s plan with the Bowles-Simpson recommendations, but they leave out the Social Security portions of Bowles-Simpson, distorting the comparison.

Until more numbers or detail are provided I suggest treating this number as an assertion rather than a fact. A reporter who writes “The Gang of Six plan would reduce the deficit by $3.7 trillion” is being insufficiently skeptical.

The discretionary holes

  • The Gang’s plan proposes $866 B in savings from “security” (aka defense) discretionary spending. They don’t say compared to what. This is a particular challenge right now, because how you measure the savings depends on what you assume as a starting point for expenditures in Iraq and Afghanistan. This baseline measurement question is not particular to the Gang’s plan. Everyone faces it.
  • More importantly, the Gang’s plan specifies neither discretionary spending totals nor how much would be spent (or saved) from nondefense discretionary spending. The traditional battle is that Republicans want to cut nondefense and increase defense, and Democrats the reverse. The Gang’s plan provides some detail on defense (with the above caveat), but says nothing about total discretionary spending or whether the Gang’s plan would increase or cut non defense appropriations.

The first of these could be pretty easily clarified. The second is more of a gaping maw than a hole. It is a critical area of ambiguity in one of the most hotly disputed questions in any budget plan. I don’t see how a Member of Congress could make a judgment about a plan without knowing how much it’s going to spend on appropriations, as well as the defense/nondefense balance.

Tax cut or tax increase?

The “Bush tax rates” have been in effect since 2001. Congress has “patched” the Alternative Minimum Tax every year for a long time so that it doesn’t suddenly hit millions more tax filers. But the Bush tax rates are scheduled to expire January 1, 2013, and the AMT again needs to be patched. This creates a massive difference between current law on taxes and current policy on taxes.

  • Current law: Income tax rates increase January 1, 2013, with significantly higher revenue coming into the government from that point on. The AMT patch expires as well, affecting millions more taxpayers and adding another huge chunk of revenue for the government. The same is true for the estate tax.
  • Current policy: The tax rates now in effect (aka “the Bush tax cuts,” or maybe now “the Bush-Obama tax cuts” since President Obama extended them last December) stay where they are forever, and the AMT continues to be patched. These principal components of tax policy do not change in 2013 or thereafter. Future government revenues collected will be roughly the same as they are this year, accounting for differences in economic growth.

Congressional Republicans have been using a current policy baseline to describe tax policy changes. Congressional Democrats have been using a current law baseline. The White House has used a hybrid (don’t ask).

CBO says the difference between current law taxes and current policy taxes over the next decade is about $3.8 trillion over the next decade. Interest effects are another $750 B more.

The Gang’s plan would result in revenues that would be greater than current policy but less than current law. So whether this is a tax cut or a tax increase depends on your “baseline” (starting point) for comparison.

  • The Gang says “If CBO scored this plan, it would find net tax relief of approximately $1.5 trillion.” CBO scores relative to current law, and this phrase is key.
  • That means the Gang’s plan is a $2.3 trillion tax increase relative to current policy.
  • House Budget Chairman Paul Ryan measures current policy a little differently than CBO, I think, so he comes up with a $2.0 trillion tax increase relative to current policy.

This tax baseline question also critically affects the “ratio” measurement commonly used to describe deficit reduction plans. The Gang is claiming most of the deficit reduction comes from spending cuts. That’s using a current law baseline for taxes. If you instead use current policy, the Gang’s plan relies principally on tax increases for its deficit reduction. I can’t tell you that ratio because I don’t believe their aggregate deficit reduction number, nor do I have sufficient detail to understand their discretionary spending numbers.

Social Security measurement

There are two commonly discussed ways to measure a Social Security reform plan. They are called “75-year actuarial balance” and “cash flow balance.” The first test is easier to meet and tilts the reform playing field toward tax increases. The Bowles-Simpson framework said Social Security reform had to meet both tests, including the harder cash flow balance test. The Gang’s plan sets 75-year actuarial balance as the metric for measuring reform.

Congratulations. You made it through a heavy post and now, I hope, understand the Gang of Six’s budget plan. Thanks for reading.

(photo credit: Kinya Hanada)

Understanding Cut, Cap, and Balance

Understanding Cut, Cap, and Balance

Sometime this week the House of Representatives will consider Rep. Jason Chaffetz’ H.R. 2560, the “Cut, Cap & Balance Act.”

We are entering the arcane world of budget process, so this could be tough sledding. I will do my best to distill the essential elements and simplify it.

The key to understanding this bill is that it focuses on government spending, rather than on taxes or deficits. The bill would achieve significant deficit reduction through cutting and limiting spending, and all of its mechanisms use spending rather than deficit targets.

Surprise, surprise: the bill consists of three parts.

  1. Cut – The bill provides specific numbers to limit both discretionary and mandatory spending for FY12. These numbers would drive further Congressional action this year or else force a Presidential sequester. (I explain a sequester below.) The intent of this section is to force Congress and the President to cut spending immediately.
  2. Cap – The bill would establish a new enforceable limit on total federal spending as a share of the economy. The new caps are designed to phase federal spending down to just below 20% of GDP by FY17 and then hold it there through the end of a 10-year budget window in FY21. Put more simply, this is a new enforceable aggregate spending cap.
  3. Balance – The bill would increase the debt limit by $2.4 trillion after the House and Senate have passed a Balanced Budget Amendment (of a certain type).

What is a sequester?

A sequester is an automatic across-the-board proportional spending cut written into law and implemented by the Office of Management and Budget (OMB). It is usually combined with some kind of budget target and designed as a backup measure to force legislative action to hit that target.

Example

Imagine there are 10 government programs that spend $50 each. Congress passes and the President signs a law that includes a spending target of $490, a deadline of December 31st, and an across-the-board sequester.

If new laws are not enacted by December 31 to reducing spending to $490, then the sequester kicks in. OMB cuts all 10 programs by whatever percentage is needed to hit the target. In this case, each $50 program is cut by 2%, to $49, to hit the aggregate spending target.

If the new law were to exempt five of the 10 programs from the sequester, then the remaining programs would be subject to a 4% cut to hit the same spending target.

If Congress doesn’t like the results of an anticipated sequester, they can and should enact a new law before December 31 which hits $490 in a different way. They could cut one program by 20% ($10) and leave the other 49 programs untouched, for example.

Types of sequesters

There are discretionary sequesters which apply to programs that face annual appropriations.

There is a mandatory sequester, which is designed to apply to mandatory/entitlement spending.

Or you could do a spending sequester which applies to both discretionary and mandatory spending.

In March the President floated the idea of a sequester that would raise taxes as well as increase spending.

The challenge: exemptions

The hard part of designing a sequester mechanism is rounding up the votes for a bill that includes an automatic across-the-board cut. Members of Congress will say, “I support your spending target, and I support the hammer of creating a sequester, but I can’t vote for it if the sequester would cut X. Give X an exemption from the sequester and I’ll vote for your bill.”

The exemptions to the sequester are the key that shapes subsequent Congressional negotiations. If your spending priorities are exempted from the sequester, then you have less incentive to cut a deal after this new law is in effect. You have leverage in the negotiations.

In addition, Members expose themselves to political risk when they vote for the creation of an across-the-board sequester. This is why all mandatory sequesters enacted so far have exempted Social Security, even though Social Security is the largest component of mandatory spending.

The spending limits in Cut and Cap

I support the numeric spending targets in the Cup and Cap sections. For me the most important number is “below 20% of GDP” in the cap section. I think that’s the right target, and it is the primary reason I support this bill.

For comparison:

  • Federal spending in the 50 years preceding the Obama Administration averaged 20.2% of GDP.
  • Federal spending in 2009 hit an all-time post-WWII high of 24.7% 28.5% of GDP.
  • Under the President’s original budget, it would be 23.6% this year, 22.7% in 2013, and then begin a steady climb to 24.5% of GDP at the end of the decade in 2021. Since the President didn’t provide detail with his second round budget, I can’t provide parallel figures for that.
  • The 23.6% figures means federal spending will be 15% larger, measured as a share of the economy, then it has historically been.

Those extreme spending shares are the result of several factors: higher automatic stabilizer payments in a weak economy, government actions like stimulus laws and ObamaCare, and long-term entitlement spending trends that build gradually over time.

Anticipating the replies from my left-of-center friends, yes, I am willing to make whatever changes are needed to the big 3 entitlements to stay within this cap. I would rather change the nature of future government benefit promises than see the private sector shrink.

The sequesters in Cut and Cap

Most Members of Congress complain that automatic sequester mechanisms include programs they don’t want to cut. I have the opposite complaint – the sequesters in this bill exempt too much. In particular, both the mandatory sequester in the Cut section and the across-the-board sequester in the Cap section exclude Social Security, Medicare, military personnel, and interest costs. While military personnel costs would rank high on my list of spending priorities, I think the best sequester mechanisms apply to all non-interest spending.

In particular, we need to address spending trends in the big three entitlements. By exempting Social Security and Medicare from the sequester, this bill makes it that much harder for Congress to bite the bullet and make needed changes in both programs. It is easy to understand the legislative necessity that drove this decision, but it’s a big policy mistake nonetheless.

At the same time, these sequester mechanisms are much better than past ones enacted into law, which exempted hundreds of programs from the across-the-board cut. A well-designed sequester is not supposed to be the mechanism that cuts spending. It is supposed to be the forcing mechanism that convinces Congress to make decisions to cut spending. If you exempt too much, then the incentive placed on Congress is even weaker.

Debt limit – Balanced Budget Amendment

It is important to understand that the debt limit increase in this bill is not just tied to any Balanced Budget Amendment to the Constitution, but to one which meets certain parameters. The BBA must not just guarantee a balanced budget. It must also limit spending as a percent of GDP as in the Cap section of this bill, and it must raise the legislative bar for tax increases to a two-thirds vote of both the House and Senate.

It might therefore be more appropriate to think of this as a “Balanced Budget through Spending Cuts Amendment.”

I support balancing the budget through cutting spending rather than raising taxes. I don’t feel strongly either way about whether or not this should be enshrined in the Constitution. I lean a little against, because I hate messing with the Constitution.

All that is irrelevant, however, because even if this kind of BBA did pass both Houses of Congress, it would take many years for three-fifths three-fourths of the States to ratify it as an amendment to the Constitution. Federal budget problems are upon us now – we can’t wait for a Balanced Budget Amendment to be ratified. While this part of the bill is useful to make a point, I fear it serves as a distraction from actually cutting spending.

Since Congress will not pass a Balanced Budget Amendment through both Houses in the next two weeks, and since this section makes a debt limit increase contingent upon such passage, I have a big problem here. That problem is solved as long as some other bill becomes law soon to increase the debt limit.

Summary of my views on Cut, Cap, and Balance

I recommend supporting this bill even with its significant imperfections. I place enormous value on the creation of an enforceable cap on total government spending.

Good

  • Focuses on the problem I think needs to be solved: too high and too rapidly growing government spending;
  • Cuts spending 2012 and creates a sequester to enforce those cuts;
  • Caps federal spending below 20% of GDP and phases down to that over a few years;
  • Creates a sequester mechanism to force spending cuts to hit those levels;
  • The mandatory spending sequesters are far broader and therefore superior to those enacted in the past; and
  • The form of the Balanced Budget Amendment, which would drive spending cuts rather than tax increases, is good.

Bad

  • The sequester exempts too much, and in particular it exempts the two largest entitlement spending programs, Social Security and Medicare. If enacted, this bill might make it legislatively harder to reform these two programs. That’s a huge problem.
  • While it appears to increase the debt limit, it sets conditions that won’t be met in time. This problem is solved as long as some other bill becomes law soon to increase the debt limit.
  • I lean against amending the Constitution, even for a Balanced Budget Amendment whose form I like. And the legislative reality means time spent on a BBA could be better spent trying to cut spending.

No bill is perfect. In my view, the good far outweighs the bad in this bill.

(photo credit: Alan Bedenko)

Understanding the McConnell debt limit proposal

Understanding the McConnell debt limit proposal

Coming two full days after Leader McConnell released his proposal, this post may be too late to do much good. Most of Washington seems to have processed the idea and is now fiercely debating it. Still, I found the press coverage of the Leader’s proposal to be generally confusing and inadequate, so I hope this helps clarify things for anyone who was confused by other explanations.

I will try to stay neutral as best I can in this post.

The core concept

The debt limit now works as an only if proposition: the debt limit is increased only if Congress votes affirmatively to authorize an increase. Increasing the debt limit therefore requires a majority of the House and Senate to cast a difficult aye vote, plus a Presidential signature. The McConnell proposal would invert this into an unless proposition: the debt limit would automatically be increased unless Congress voted to stop it. And by changing the key vote to a veto override, you would need only 1/3 of either the House or Senate to take a tough vote to allow the debt limit to increase.

In exchange for this significant increase in Presidential authority, the President would take most of the political heat for the debt limit increase, and he would be required to propose difficult spending cuts of an equal or greater amount.

How it would work

  • Before August recess, the House and Senate would pass the McConnell proposal and the President would sign it into law.
  • As soon as it became law, the President could ask Congress to increase the debt limit by $700 B.
  • The President would have to simultaneously submit a plan to cut spending by more than $700 B.
  • The Presidential request and submission would trigger an immediate $100 B increase in the debt limit, thus giving the Administration the ability to make it into September without having to slow down cash outlays for benefit checks or anything else.
  • The President’s $700 B debt limit increase request would be automatically approved unless Congress blocked it. To block it, a majority of the House and Senate would vote to disapprove. That resolution of disapproval would go to the President, who would presumably veto it. If more than 2/3 of the House and Senate overrode the President’s veto, then the $700 B request would be denied and the original $100 B authorization rescinded. This resolution of disapproval would be governed by “fast track” legislative procedures so it couldn’t be delayed, amended, or filibustered.
  • If either the House or Senate voted down the resolution of disapproval, or if 1/3 or more of the House or the Senate sustained a Presidential veto, then the $700 B would be automatically authorized. In other words, the President knows he will get his $700 B as long as (a) he submits his spending cuts and (b) he knows he can get 1/3 of the House or the Senate to sustain his veto, should it be necessary.
  • This process would be repeated in the fall of 2011 and again in the summer of 2012, with the President authorized to ask for an additional $900 B each time, again matched by a greater amount of spending cuts. The President could begin this process only when Treasury was within $100 B of the debt limit.
  • The authority would expire in early 2013, around the end of this Presidential term.

The biggest area of confusion

The McConnell proposal does not guarantee that spending will be cut. Congress would consider the debt limit resolution of disapproval and the President’s proposed spending cuts separately. The process is designed to bring the debt limit resolution of disapproval to a rapid vote. Congress could, however, do anything it wants (or nothing) with the President’s proposed spending cuts. The McConnell proposal guarantees that spending cuts will be proposed, and it guarantees a swift resolution to the debt limit increase. It does not guarantee any legislative conclusion on spending cuts.

Likely results

If the McConnell proposal were to become law, I would expect the following results:

  • All four debt limit increases would happen: $100 B in late July / early August, another $600 B in September, another $900 B in the fall of 2011, and another $900 B in mid-2012, for a total of $2.5 trillion between now and the end of 2012. If revenue forecasts hold up, that should get through the remainder of this Presidential term.
  • Press attention would initially focus on the President’s request. He would bear much of the political responsibility for the debt increases, as intended by the McConnell proposal.
  • Most Members of Congress, from both parties, would vote for the resolutions of disapproval (i.e., to disapprove the debt limit increase) each time. There is a high likelihood the President would have to veto each resolution of disapproval, then muster 1/3 of the House or Senate to sustain each veto. I assume he would be able to find the votes to sustain, possibly from both parties.
  • The President would, as “required” (see below), make his three spending cut proposals. There would be lots of back-and-forth over whether his proposals were real and/or legitimate.
  • Congressional action on the spending cut proposals is difficult to predict, but I wouldn’t hold out high hopes for these proposals to provoke significant legislative action. They would, however, create pressure for the President to be more specific than he has been up until now.

Nuances

  • The McConnell bill does not increase the debt limit. It authorizes the President to increase the debt limit, as long as Congress doesn’t prevent him from doing so. Thus, you as a Member of Congress could vote for the McConnell bill, then vote for the subsequent resolutions of disapproval, and honestly say that you never voted to raise the debt limit.  Yet the debt limit is much more likely to be increased, given the lower success hurdle of just sustaining a veto. This political logic is core to the proposal.
  • This mechanism would work exactly like the TARP funding mechanism enacted in September, 2008. That TARP funding mechanism was modeled after a longstanding provision in law that governs Congress’ ability to disapprove regulations implemented by the President with a resolution of disapproval. If you are familiar with either the Congressional Review Act process (for regs) or the TARP “tranche” process, this is close to an exact copy.

Legislative & political logic behind the proposal

Under current law the debt limit does not increase unless enough Members of Congress votes “aye.” Under McConnell, the debt limit increases as long as not too many Members vote “no.” In a strange way, Members of Congress would like this vote – it would be a “free” opportunity to demonstrate they are opposed to a debt limit increase by voting no. The President (and Congressional leaders who feel a responsibility for the result) would only have to find 1/3 of the House or the Senate to take a tough vote, rather than now, where they have to find a majority in both the House and the Senate.

More fundamentally, the McConnell amendment would shift authority, power, and responsibility for a debt limit increase from the Legislative Branch to the Executive Branch. Usually the two branches of government fight to maximize their power relative to the other. Here, the Congress would be saying, “Too hot for us – you deal with it.”

This is a time-limited proposal with a specific partisan configuration in mind. All $2.5 T of debt limit increases would technically be the result of Presidential action, not Congressional action. This may explain why Democratic leaders are saying nice things about McConnell’s idea – it lets their Members off the hook just as it lets Republicans off the hook. President Obama would politically “own” the debt limit increases.

In addition, it would require (with a caveat) the President to make specific legislative proposals to cut spending deeply (note that McConnell requires “spending cuts,” rather than “deficit reduction”), something he has so far been unwilling to do. The President and his team assert that his spring budget speech and his recent closed-door negotiations constitute specific and credible proposals, while Republicans (including me) argue he has been vague and has been claiming credit for more deficit reduction than he has actually proposed. The McConnell amendment would force the President to propose spending cuts to get his debt limit increase, creating a more level playing field in an environment in which House Republicans have voted for specific pain while everyone else has basically ducked. At the same time, it’s difficult to limit the President’s ability to propose gimmicks and call them spending cuts.

The economy is weak and President Obama is taking the brunt of the blame for that. I think Leader McConnell is concerned that if the debt limit is not increased, the President will attempt to assign responsibility for that Congressional inaction and any subsequent economic bad news to Republicans. He could argue that Republicans’ irresponsibility on the debt limit is the cause of economic weakness. The McConnell proposal would preclude this scenario.

An important detail

It is difficult to draft a Constitutionally acceptable provision to require the President to make a proposal to Congress. In the past, the Executive Branch has argued that similar provisions are not legally enforceable, so there could be a concern that the President would ignore this requirement and fight it in court.

I think this could be rectified by a separate Presidential letter committing him to abide by this provision whether or not he’s required to do so. Since the McConnell proposal will pass the Senate and become law only if the President finds it acceptable, such a letter could be negotiated as a suspenders to the belt of the legislative language.

Initial reactions

This is the fascinating part. The New York Times and Wall Street Journal editorial pages both endorsed the McConnell proposal, for different reasons. That is astonishing.

POLITICO reports that many House Republicans were furious with the proposal, and that some Senate conservatives are also not onboard. The proposal could not pass the House today, but then I don’t think any debt limit proposal could pass the House today.

The National Review editorial board opposes it, preferring a debt limit increase be packaged with spending cuts. At the Weekly Standard, Bill Kristol and Stephen Hayes oppose it, while Fred Barnes supports it (I think). Leader McConnell should be pleased, in that he has support from a number of outside conservatives who, for instance, attacked Republican leaders during the spring Continuing Resolution battles.

Key Democrats, including Senate Majority Leader Reid and Senator Schumer, are signaling that they are open to Leader McConnell’s idea. It is unlikely they would be doing so without at least a private nod from the White House.

Evaluating the plan

Key to understanding the McConnell proposal is the current legislative context. Leader McConnell emphasizes that he intends this proposal as a backup plan, to be pursued only if everything else fails. Congressional Democrats are reportedly open to the idea, which means it has at least a moderate chance of becoming law. This means that, at the moment, it is the only plan that can make that claim. The question is not, then, whether or not you like the proposal. Instead, I think the relevant questions are:

  1. Are you willing to allow the Congress to recess for August without the debt limit being increased?
  2. If not, what other alternative can become law?

Those conservatives who answer the first question yes will probably be unsatisfied by any proposal, I think. If you are not afraid of the effects (policy or political) of Congressional inaction, you have no incentive to consider any compromise.

The other obvious alternative, assuming there is no big deal, would be to package a small, short-term debt limit increase with a similarly-sized package of spending cuts (say, $200-$300 B). I won’t be surprised if that idea starts to gain traction soon as an alternative to McConnell’s proposal

(photo credit: Gage Skidmore)

Understanding the S&P report

Understanding the S&P report

Yesterday’s report by Standard & Poor’s on the U.S. government’s credit rating is driving headlines. You can learn a lot more from reading the primary source document than from news coverage of it.

Here is what S&P did:

On April 18, 2011, Standard & Poor’s Ratings Services affirmed its ‘AAA’ long-term and ‘A-1+’ short-term sovereign credit ratings on the United States of America and revised its outlook on the long-term rating to negative from stable.

The news is in the latter part: S&P downgraded its “outlook on the long-term [credit] rating [of the U.S. government].” This is a warning sign.

S&P told us why they downgraded their outlook:

We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns.

… Despite these exceptional strengths, we note the U.S.’s fiscal profile has deteriorated steadily during the past decade and, in our view, has worsened further as a result of the recent financial crisis and ensuing recession. Moreover, more than two years after the beginning of the recent crisis, U.S. policymakers have still not agreed on a strategy to reverse recent fiscal deterioration or address longer-term fiscal pressures.

In 2003-2008, the U.S.’s general (total) government deficit fluctuated between 2% and 5% of GDP. Already noticeably larger than that of most ‘AAA’ rated sovereigns, it ballooned to more than 11% in 2009 and has yet to recover.

The S&P analysts base their outlook downgrade on a legislative assessment that I think is accurate:

We view President Obama’s and Congressman Ryan’s proposals as the starting point of a process aimed at broader engagement, which could result in substantial and lasting U.S. government fiscal consolidation. That said, we see the path to agreement as challenging because the gap between the parties remains wide. We believe there is a significant risk that Congressional negotiations could result in no agreement on a medium-term fiscal strategy until after the fall 2012 Congressional and Presidential elections. If so, the first budget proposal that could include related measures would be Budget 2014 (for the fiscal year beginning Oct. 1, 2013), and we believe a delay beyond that time is possible.

Standard & Poor’s takes no position on the mix of spending and revenue measures the Congress and the Administration might conclude are appropriate. But for any plan to be credible, we believe that it would need to secure support from a cross-section of leaders in both political parties.

If U.S. policymakers do agree on a fiscal consolidation strategy, we believe the experience of other countries highlights that implementation could take time. It could also generate significant political controversy, not just within Congress or between Congress and the Administration, but throughout the country. We therefore think that, assuming an agreement between Congress and the President, there is a reasonable chance that it would still take a number of years before the government reaches a fiscal position that stabilizes its debt burden. In addition, even if such measures are eventually put in place, the initiating policymakers or subsequently elected ones could decide to at least partially reverse fiscal consolidation.

Let’s tease this apart.  S&P describes three distinct but related risks:

  1. The risk of no agreement on a medium-term fiscal strategy before the 2012 election;
  2. The risk that, if there is an agreement, it will be phased in too slowly;
  3. The risk that delay plus a slow phase-in allows enough time for future policymakers to partially undo an agreement.

I think all three are valid concerns, and I share their skepticism.

They describe other short-term fiscal risks that worry them as well:

  • the risk of further financial bailouts;
  • the potential cost of “relaunching” Fannie Mae and Freddie Mac, which they estimate at “as much as 3.5% of GDP (!!!);
  • the risk of losses on federal loans (they single out student loans).

The first bullet here is scary, and they emphasize it: “Most importantly, we believe the risks from the U.S. financial sector are higher than we considered them to be before 2008.”

S&P comments on three elements of recent deficit reduction proposals: income tax rates, entitlement reform, and the President’s new trigger.

On income tax rates:

Revenue [in the President’s new proposal] would be increased via both tax reform and allowing the 2001 and 2003 income and estate tax cuts to expire in 2012 as currently scheduled—though only for high-income households. We note that the President advocated the latter proposal last year before agreeing with Republicans to extend the cuts beyond their previously scheduled 2011 expiration. The compromise agreed upon in December likely provides short-term support for the economic recovery, but we believe it also weakens the U.S.’s fiscal outlook and, in our view, reduces the likelihood that Congress will allow these tax cuts to expire in the near future.

Note that they are commenting on both the fiscal effects of the deal, and how it affects their assessment of the legislative viability of the President’s recent proposal.

On the President’s new trigger proposal:

We also note that previously enacted legislative mechanisms meant to enforce budgetary discipline on future Congresses have not always succeeded.

This is a poke at the credibility of the President’s trigger mechanism.

On entitlement reform:

Beyond the short-term and medium-term fiscal challenges, we view the U.S.’s unfunded entitlement programs (Social Security, Medicare, and Medicaid) to be the main source of fiscal pressure.

Note that they agree with Chairman Ryan (and me) that entitlement spending is “the main source of fiscal pressure.”

S&P scolds American policymakers by comparing them to their counterparts in other countries.  The U.K., France, Germany, and Canada have all begun implementing austerity programs, even while they suffered recessions comparable to or larger than what we had here in the U.S.

S&P concludes with a concrete probability assessment:

The negative outlook on our rating on the U.S. sovereign signals that we believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years. The outlook reflects our view of the increased risk that the political negotiations over when and how to address both the medium- and long-term fiscal challenges will persist until at least after national elections in 2012.

They also tell policymakers the standard against which they will be judged:

Some compromise that achieves agreement on a comprehensive budgetary consolidation program—containing deficit reduction measured in amounts near those recently proposed, and combined with meaningful steps toward implementation by 2013—is our baseline assumption and could lead us to revise the outlook back to stable. Alternatively, the lack of such an agreement or a significant further fiscal deterioration for any reason could lead us to lower the rating.

S&P is telling Washington, that to avoid a possible downgrade, they need to do a deal “in amounts near [$3-4 trillion over the next decade]” and “with meaningful steps toward implementation by 2013.”

In yesterday’s press briefing, White House Press Secretary Jay Carney disagreed with S&P’s skepticism about a deal:

As for its political analysis, we simply believe that the prospects are better. We think the political process will outperform S&P expectations. The President is committed, as he made clear in his speech on Wednesday, to moving forward in a bipartisan way to reach common ground on this important issue of fiscal reform.  And he believes that the fact that Republicans — that he and the Republicans agree on a target — $4 trillion in deficit reduction over 10 to 12 years — is an enormously positive development.  They also agree that the problem exists.  So the third part is the hard part, which is reaching a bipartisan agreement.  But two out of three is important.  And it demonstrates progress.

My view

There is a high probability of incremental spending cuts being enacted this year and next as part of debt limit legislative struggles.  I’ll make a wild guess of $100B – $300B over 10 year range.

There is a moderate chance (1 in 3) of an incremental, slightly bigger (maybe $300B – $500B over 10 years) deficit reduction deal before the 2012 election. The President would trumpet such a deal as a good first step, but it appears this would fall far short of what S&P says is needed.

Given the President’s apparent budget strategy, there is at the moment a vanishingly small chance of a big medium-term or long-term deal like that described by S&P as necessary to avoid a possible downgrade, ($3-4 trillion over 10 years, with even bigger long-term changes to Social Security, Medicare, and Medicaid).

The greatest obstacle to constructive negotiations is the President’s attack rhetoric, in which he today accused Congressional Republicans of “doing away with health insurance for … an autistic child” and potentially causing future bridge collapses like the one in Minnesota that killed 13 people.

Maybe the S&P report will scare the President’s team into treating the long-term problem seriously rather than using it as a campaign weapon. I’m not holding my breath.

(photo credit: Marjie Kennedy)

Understanding the President’s new budget proposal

Understanding the President’s new budget proposal

I will describe in some detail the President’s new budget proposal, then provide a few big picture reactions to it.

I have been keeping my recent posts fairly short. This one is instead more of a reference post, and it is not for the faint of heart. I hope it is useful, I know it is long. Consider yourself warned.

Today the President proposed:

  1. a negotiating process;
  2. deficit and debt targets;
  3. a new budget process trigger mechanism;
  4. and new spending cuts in Medicare, Medicaid, other entitlements, and defense.

Compared to the budget he proposed in February, he offers no new proposals in non-security discretionary spending (I think), taxes, or Social Security.

Process

The President proposes a 16-person bicameral bipartisan Congressional budget negotiation, led by VP Biden, beginning in early May. Each Congressional leader (Boehner, Pelosi, Reid and McConnell) would name four Members. The group’s goal would be “to agree on a legislative framework for comprehensive deficit reduction.”

The President’s timeframe could foul up the normal budget calendar. This is a consequence of him waiting to go second.

Deficit & debt targets

The President proposes a budget deficit “of about 2.5% in 2015” and that is “on a declining path toward close to 2.0% toward the end of the decade.” (That second test is a mess.) Compared to what he argues he proposed in February (using OMB scoring), that’s only 0.7 percentage points lower in 2015 and only 1 percentage point lower in 2021.

He proposes that debt/GDP be “on a declining path … by the second half of the decade.”

Budget credibility:  Quite low, for three reasons.

  1. Several of the largest specific proposals described below have very low credibility (they’re almost gimmicks).
  2. All proposals of this nature phase in their changes over time, but these proposals push that farther than most. The later the pain begins, the more time there is for Congress to undo it. The President’s proposal backloads the savings so much that they talk about a 12-year window rather than the traditional 10 years. That’s a sign of a weak proposal.
  3. OMB says the President’s February budget reduces the 2021 deficit to 3.1% of GDP. CBO said the same policies would result in a 4.9% deficit in that year. That’s a big gap, and the same will likely be true here. CBO is likely to say that the President’s specific policies don’t come close to hitting his stated deficit targets. If they’re right, the trigger would not be a failsafe and would kick in with big tax increases.

Taxes

While the President reiterates two big tax proposals from his February budget, he does not propose explicit new tax increases.

Despite having signed a law last December that prevented income, capital gains, or dividend tax increases for all Americans, the President stresses that next time he will insist that tax rates on “the rich” should go up. Next time begins in 2013.  Small business owners, this means you.

He also reiterates his proposal to limit itemized deductions for high-income taxpayers. The lion’s share of revenue loss from individual tax expenditures comes from broad-based and wildly popular preferences: the deductibility or exclusion of home mortgage interest, of retirement plan contributions, of charitable contributions, of state and local income and property taxes, of employer-provided health insurance, and of capital gains. The last two times he proposed this he had almost zero Congressional support, including from his own party.

While he is not proposing new explicit tax increases beyond those he proposed in February, his new trigger proposal would likely result in big tax increases.

The Trigger (“Failsafe”)

The President proposes a new debt trigger, similar to policies in place a couple of decades ago. (The most well known is called “Gramm-Rudman-Hollings.”) The trigger is new and important.

The President’s proposal is structured as an if … then … proposition.

If, by 2014, the debt/GDP ratio is not (stabilized and projected to decline by the end of the decade)

… then certain mandatory spending programs are cut across-the-board, and certain taxes are increased, by enough to ensure the debt meets the “if” test.

It’s unprecedented (but not crazy) to structure this as a debt test rather than a deficit test. As a rule of thumb, a deficit of 3% of GDP roughly keeps debt/GDP stable, so the President’s test is roughly equivalent to:

If, by 2014, the deficit/GDP is not 3%, and below 3% by the end of the decade…

The President’s team thinks that his specific policy proposals would reduce the deficit enough that the trigger would never kick in. He therefore calls it a “failsafe.” In past years the term “backstop” has been used for similar triggers. Under this logic the trigger is not used to force cuts, it’s used to ensure them.

If, however, the President’s scoring is wrong and too optimistic, or if the trigger becomes law but the specific policy changes don’t, then this proposal serves a new purpose: it would be a mechanism that automatically changes policy unless Congress acts to stop it. That’s a big distinction. As a general rule, a backstop trigger has a much better chance of being sustainably implemented than an action-forcing trigger.

Trigger proposals like this pop up every few years. Two big questions about any such proposal are:

  • What happens if the trigger kicks in?
  • How does this affect Congress’ incentive to legislate?

What happens if the trigger kicks in?

The President’s proposal is similar to past triggers in that it exempts all discretionary spending, Social Security, and interest on the debt. While past triggers limited the amounts that Medicare and Medicaid could be cut, the President’s trigger appears to exempt them entirely. The White House fact sheet says the trigger “should not apply to Social Security, low-income programs, or Medicare benefits.” Elsewhere it says the trigger applies only to mandatory spending.

Assuming that “low-income programs” includes Medicaid, this means the trigger appears to apply to at most about $300 B (if triggered this year) in “other mandatory” spending. Half of that would hit federal retiree payments, a quarter would hit veterans’ benefits (if not defined as “low income”), and the rest would hit smaller things like farm subsidies.

It therefore appears that the President’s trigger would exempt more than 90% of government spending from the automatic across-the-board cut.

The trigger would also raise taxes by implementing “across-the-board spending reductions … [in] spending through the tax code.” In other words, the trigger would somehow (how??) automatically reduce tax expenditures across-the-board (rather than raising rates, it appears). No past trigger has included a tax increase. This is new.

The fog lifts. The across-the-board trigger would apply to less than 10% of federal spending and would also raise taxes. And since it would apply only to itemized deductions, it’s only going to hit a portion of those paying income taxes, which is only a portion of all Americans.

The trigger is, in effect, a tax increase trigger on those who itemize deductions, with a little other mandatory spending thrown in for good measure.

The overwhelming impact of the trigger would be to raise taxes on those who itemize.  A much smaller portion of triggered deficit reduction would come from automatic spending cuts.

When you combine the automatic nature of this policy with the absence of specific policies needed to sufficiently reduce spending in the long run, the effect of this trigger would be to shift the burden of future entitlement spending increases away from deficits and onto higher income taxpayers. The future default would be that entitlement spending would grow at an unsustainable rate, and taxes on “the rich” would grow to hold deficits below 3% of GDP.

How does this affect Congress’ incentive to legislate?

Since the overwhelming burden of the trigger would be through tax increases, it would significantly advantage the Left in future fiscal policy battles. Big spenders/taxers would know that, if no future legislation were enacted, automatic tax increases would kick in. They would therefore be better able to walk away from what they think is a bad deal. This is incredibly dangerous if your goal, like mine, is to cut government spending.

Spending

The President proposes specific changes (“cuts”) to Medicare and Medicaid, but it’s questionable how real most of them are. He sets numeric goals for additional savings in discretionary spending, both for defense and nondefense, as well as for “other mandatory” programs, but he does not offer specific spending cut proposals in any of these areas. In some cases that’s legit, in others it’s not.

He once again punts on the largest component of federal spending, Social Security ($727 B this year).

Medicare

The President proposes incremental changes to Medicare that would slow its growth in the short run. These changes focus on cuts to provider payment rates. Doctors, hospitals, and other providers of medical goods and services would receive fewer dollars per service.

The easiest way to think about government Medicare spending is that it’s the product of three factors: the number of people eligible for benefits, times the amount of services each person receives, times the government payment per service. The President focuses entirely on the third factor: government dollars per service. The President contrasts his approach to Paul Ryan’s, in that Ryan tries to get at all three factors. More on this in a later post.

The President singles out drug manufacturers as a specific target for budgetary savings, and otherwise relies almost entirely on the so-called IPAB (Independent Payment Advisory Board) that was created by the health care laws last year. The IPAB is a bunch of appointed officials who, under current law, have authority to recommend changes in Medicare provider payment rates. The President would dial up the budget savings target for the IPAB and give them the authority to force those changes if Congress did not act. A Democratic majority Congress last year rejected giving IPAB this forcing authority, and Congressional Republicans hate it even more.

Giving the IPAB forcing authority is a Medicare parallel to the President’s tax trigger. He thus has a trigger backed up by a trigger.

Budget credibility:  The drug savings proposals are real. The IPAB savings are at best highly questionable. The President gets the overwhelming majority of his proposed savings from the latter. Since Medicare savings are the largest component of the President’s proposed new spending “cuts,” reliance on the untested IPAB as a backdoor procedural mechanism is a key budgetary weakness in the President’s plan.

Medicaid & Children’s Health Insurance

The President proposes establishing a consistent federal “match rate” across Medicaid and the Children’s Health Insurance Program (CHIP). Both are shared federal-state programs, in which the Feds pay a portion of each dollar spent and the State pays the rest. Each State has a different federal “match rate,” and these match rates vary within and across programs for different types of services. This is potentially a good reform, but it’s not clear whether the overall effect would be to increase or cut overall federal spending on these programs. That is super important.

He dings Medicaid reimbursement for drugs, but his big Medicaid savings will come from cracking down on States’ attempts to gimmick their accounting to draw down more federal matching dollars for each State dollar spent. While I want to wait for the specifics, as a general matter this is very good policy, especially for federal taxpayers. Governors will hate it and push back hard, because several of them use these gimmicks to solve their State budget problems.

He’s also got some “reforms” to address high-cost beneficiaries and users of prescription drugs.

Budget credibility: The match rate, drug reimbursement provisions, and State gimmick provisions are real and would save money. I am skeptical that the high-cost beneficiary/drug provisions would actually reduce spending by any significant amount.

Other mandatory spending programs

“Other mandatory spending” excludes the Big 3 entitlements: Social Security, Medicare, and Medicaid. For comparison, in FY2011 those three programs combined will spend $1,493 B, while all other mandatory programs combined will spend $615 B. So while other mandatory is a whole lot of money, it’s small relative to the Big 3. And the Big 3 are the source of future spending growth, not other mandatory.

Under current law the biggest components of other mandatory spending are the low-income support programs (aka “welfare”, $280 B this year combined): cash welfare, food stamps, earned income tax credits, etc.  Federal employees’ retirement is big ($146 B this year), and this year unemployment insurance payments are huge ($129 B). Other big chunks are veterans’ benefits ($78 B) and agriculture subsidies ($16 B).

The President provides a savings target for the other mandatory category but offers no specifics, other than to say proposals from the Bowles-Simpson Commission “and other bipartisan efforts … should be considered.”

Budget credibility:  Zero. Without specifics, or at least per program targets (e.g., $X B from farm subsidies, $Y B from federal retirees), this is just pulling numbers out of thin air.

Discretionary spending

He is proposing additional cuts to defense and security discretionary spending.  Details are TBD.

On the non-security side it appears he simply takes the new appropriations deal and extends it for ten years. But while he claims $200 B in non-security discretionary savings over 10 years in addition to the $400 B in savings from the President’s budget, it appears that he is relabeling what has already been decided in the recent appropriations deal.

As a policy matter this is smaller and therefore less important than the other changes listed above, but it’s a political flashpoint. Reporters should ask the Administration and CBO how the President’s new non-security discretionary spending proposal compares to a straight extension of the new FY11 appropriations soon-to-be-law. It’s even possible that he is proposing to increase spending and, in effect, “undo” some of this year’s deal in future years. We can’t tell until we see this comparison.

Budget credibility:  Since discretionary spending totals can be enforced by spending caps that have a long history of enforceability, credibility here is fairly high. Unlike for “other mandatory” spending, you don’t really need to propose specifics to establish a credible and enforceable path for future discretionary spending.  At the same time, you should be very skeptical of the presentation of the claimed non-security “savings.” This appears to be a misleading presentation. It looks like they are cutting only defense/security discretionary.

Analysis

Here are four broad reactions to the new proposal.

First, this is a short-term budget, not a long-term budget. There are three forces driving our long-run government spending and deficit problem:

  1. demographics;
  2. unsustainable growth in per capita health spending; and
  3. unsustainable promises made by past elected officials, enshrined in entitlement benefit formulas.

The President’s proposal addresses none of these forces. It instead spends most of its effort on everything but those factors. His proposed Medicare and Medicaid savings, while large in aggregate dollars, are quite small relative to the total amount to be spent on those programs, and he lets the largest program in the federal budget (Social Security) grow unchecked. While Bowles and Simpson focused their efforts on the major entitlements and also addressed other spending areas and taxes, the President’s proposal does the reverse, focusing on other mandatory spending, taxes, and defense. That’s a short-term focus.

Second, this proposal “feels” to me like the recently concluded discretionary spending deal. It’s the size of a typical deficit reduction bill that Congress usually does every five or so years. I’m sure the affected interest groups are even now preparing to invade Washington to explain how a 3-5% cut will devastate them. The problem is that our fiscal problems are now so big that they require much larger policy changes.

Third, while framed as a centrist proposal, the substance leans pretty far left. It’s deficit reduction through (triggered) tax increases on the rich, plus defense cuts, plus unspecified other mandatory cuts and process mechanisms that might cut Medicare provider payments. Centrist Democrat proposals do all of these things, but they also reform Social Security and Medicare, usually through a combination of raising the eligibility age, means-testing, and raising taxes.

Fourth, the President’s speech was campaign-like in its characterization of and attacks on the Ryan plan.

The President’s proposal could be the opening bid in a negotiation with Congressional Republicans. When you combine this substance with the President’s aggressive partisan attacks and framing of the Ryan budget, however, it’s hard to see how this leads to a big fiscal deal this year or next. A small incremental bill, which “cuts” spending by a couple hundred billion dollars over the next decade, is possible. But the chances of a long-term grand bargain in the next two years just plummeted from an already low starting point.

What is the Strategic Petroleum Reserve (SPR)?

What is the Strategic Petroleum Reserve (SPR)?

Yesterday Meet the Press host David Gregory asked White House Chief of Staff Bill Daley if the President was considering releasing oil from the Strategic Petroleum Reserve (SPR):

MR. GREGORY: But what about the shorter term? Does the president—there’s calls to tap the strategic petroleum reserve, which comes up during these spikes. Is the president considering doing something that can arrest that spike?

MR. DALEY: Well, we’re looking at the options. There’s—there—the spike—the, the issue of, of, of the reserves is one we’re considering. It is something that only is done—has been done in very rare occasions. There’s a bunch of factors that have to be looked at, and it is just not the price. Again, the uncertainty—I think there’s no one who doubts that the uncertainty in the Middle East right now has caused this tremendous increase in the last number of weeks.

MR. GREGORY: But it’s on the table, which I think is the significant development.

MR. DALEY: Well, I think all consider—all matters have to be on the table when you go through—when you see the difficulty coming out of this economic crisis we’re in and the fragility of it.

Let’s look at the Strategic Petroleum Reserve and the President’s option to release oil from it.

What is the Strategic Petroleum Reserve?

The SPR is a bunch of holes in the ground. The Strategic Petroleum Reserve is a collection of salt caverns at four locations in Louisiana and Texas along the Gulf Coast.  Those salt caverns hold 727 million barrels of oil, managed by the Department of Energy.

The SPR is a national insurance policy. Specifically, it insures the U.S. against a severe oil supply disruption. Without this insurance, our economy could be even more sensitive to a big oil supply shock than it already is.

Created in 1975 after the Arab oil embargo, the SPR is designed to be an emergency reserve.  If Venezuela’s Hugo Chavez suddenly were to decide he is no longer going to sell oil to the U.S., we would face a short-term supply disruption while we waited for supplies to arrive from other producer nations.  President Bush (41) released oil from the SPR when Operation Desert Storm began in January 1991, in anticipation of supply disruptions in the Middle East.  When Hurricane Katrina damaged much of the Gulf of Mexico oil infrastructure, we suddenly lost about 25% of domestic production and President Bush (43) released oil from the SPR.  If terrorists were to blow up major elements of the global or domestic oil supply chain, that could cause a severe supply disruption.  The SPR is not a backup supply to be used frequently when gasoline gets expensive, it’s an emergency strategic supply to be used only in a crisis.

Releasing oil from the SPR is a Presidential decision, based principally on the advice of the Secretary of Energy.  The President’s White House economic and national security advisors are usually involved in the decision as well.

The U.S. relies more heavily on government stocks than private reserves.  The same is true for the Japanese.  The Europeans rely more on privately held commercial stocks.  Since their governments don’t own that oil, the Europeans mandate that commercial storage facilities hold a certain amount of emergency reserves.  Also, you can’t drain your stocks down to zero; you have to leave some oil in the tanks and especially the pipes to make the hydraulics work.

The U.S., Japan, and Germany have the biggest reserves.  Then there are the Chinese, who so far have not been full participants in the international coordination system run by the International Energy Agency (IEA).  Reserve withdrawals are more effective when they are coordinated among the countries with the largest reserves.

The U.S. government fills the SPR in two ways.  They buy oil on the open market, and they receive oil as payments in kind for drilling leases granted by the government (called Royalty-in-Kind).

How big is the SPR?

The Strategic Petroleum Reserve can hold 727 million barrels of oil.  At the moment it’s full, at 726.6 million barrels.

Here are some figures for comparison:

  • The global oil market is about 86 million barrels per day (bpd).
  • The U.S. consumes about 19-20 million bpd of oil and petroleum products.  We import about half that.
  • The Desert Storm SPR release totaled 21 million barrels.
  • The Katrina SPR release coincidentally also totaled 21 million barrels.
  • There are 42 gallons of oil in a barrel.
  • A barrel of oil results in about 44 gallons of products, including about 19 gallons of gasoline, 10 gallons of diesel, 4 gallons of jet fuel, and 11ish gallons of other stuff.  This means you get a gallon of gasoline from about 2.1 gallons of oil.

As the economy grows, any fixed-size SPR gets effectively smaller. Insurance is measured in “days of import protection”: take the average number of barrels per day that we import, and divide it into the oil we have, and that’s how many days of import protection we have.

The U.S. imports (net) about 10-11 million barrels of oil each day.  At the moment the SPR is full:  there are 726.6 million barrels of oil stored in these salt caverns.  Divide 726.6 M by 10-11 M and you get 66-73 days.

Since you won’t replace lost imports barrel-for-barrel, the number is more of a relative than an absolute measure of how much your insurance is worth.  A significant SPR release might be 100,000 bpd.

We don’t worry about losing all of our imports simultaneously.  Almost one-quarter of our imports come from Canada.  Our next biggest suppliers are Venezuela (11%), Saudi Arabia (10%), Mexico (9%), and Nigeria (8%).  There are risks to each of these (much less so for Canada and Mexico).

A 2005 law requires the SPR to be increased to 1 billion barrels.  President Bush (43) proposed doubling the current SPR to 1.5 billion barrels and increasing the size of our insurance policy.  Congress has not provided significant funding for either expansion.

When should the President release oil from the SPR?

The Saudis are the first line of defense when there is a disruption in global supply.  If that worries you, then figure out ways to use less oil, because the Saudis will always have the largest and lowest cost marginal supply in the world.  The Saudis often/usually have spare production capacity that they hold in reserve.  They appear to have dialed up their production in recent weeks, offsetting most of the recently lost production in Libya.

The phrase severe supply disruption is the key to the President’s decision about an SPR release.  Oil is expensive right now for four reasons:

  1. Fundamentals — The global economy is recovering and demanding more oil.  Global supply and demand are tight.
  2. Some Libyan supply has recently gone offline – maybe 850K – 1M bpd.
  3. Oil market participants are worried that events in Tunisia, Egypt, Libya, and Bahrain could spread to other oil-producing nations in the Middle East and North Africa, further disrupting supply.
  4. Nobody is quite sure how much unused capacity the Saudis have available.

It’s hard to conclusively tease out the price effects of each factor, but policymakers need to try.  High gasoline prices alone are insufficient to justify an SPR release.  You have to look at why prices are increasing.  One expert recently surmised that about $100 of the current $115/barrel world price (Brent) results from tight fundamentals, and the other $15-ish is from actual and feared supply disruptions.

If global economic growth accelerates (oh please oh please), then global demand will increase and the price of oil will continue to climb.  That’s unfortunate and a medium-term economic problem.  It’s not a reason to tap the strategic reserve.

If supplies are further disrupted, for instance by geopolitical events, then that is a viable reason for an SPR release, if the President thinks it is severe enough to justify tapping our emergency reserve.

You also shouldn’t expect an SPR release to have a huge effect on the pump price of gasoline.    With oil around $100/barrel, if the President were to release 100,000 b/d from the SPR, that would probably lower the price of oil by about $2/barrel initially.  That’s about ten cents per gallon of gasoline, maybe a bit more if the release were coordinated with other nations and reduced the fear premium in global oil markets.  The effect would wear off over time as markets adjust to the increased supply.

Should President Obama release oil from the SPR now?

Mr. Gregory asked Chief of Staff Daley if the President is considering releasing the SPR because the price of gasoline has spiked.  He further asked if the President is “considering doing something to arrest that spike.”

The President should consider a release only if he determines there’s a severe supply disruption, not just because the price of gasoline has increased.  And if he does approve a release, it will not “arrest” the price increase at the pump.

The U.S. imports almost no oil directly from Libya – they supply about 0.6% of all our imports.  Most Libyan oil goes to Europe, and some to China.  Still, it’s best to think of oil as if it were a single big global pool.  If more Libyan production were to go offline, prices in Europe would jump.  Oil tankers in the Atlantic headed west for the U.S. might turn around and head east seeking out those higher prices, causing prices to rise in the U.S.  (The reverse happened after Hurricane Katrina – tankers headed for Europe turned around and headed for the Southeastern U.S. after prices jumped from lost Gulf of Mexico supply.)

So far it appears the Saudis are mitigating much of the lost Libyan production.  Based on public information, I think it’s hard to justify an SPR release now.  If a lot more supply goes offline (in Libya or elsewhere), and if the Saudis lack the spare capacity to offset that additional loss, then the President will have a tough call to make.

(photo credit: Department of Energy, Office of Fossil Energy)

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