Why Most Tax Extenders Should Not Be Permanent

This post originally appeared on TaxVox.

What to do about the tax extenders—or, as my colleague Donald Marron calls them, the “tax expirers”? Restoring the current crop (most of which expired on December 31) for 10 years would add about $900 billion to the deficit. House Ways & Means Committee Chair Dave Camp (R-MI) and Senate Finance Committee Chair Ron Wyden (D-OR) have pledged to address these extenders, though in very different ways.

Camp would take them on one by one this year, making some permanent and killing others.  Wyden (and senior panel Republican Orrin Hatch of Utah) would restore nearly all of them but only through 2015.

Clearly, as my colleague Howard Gleckman suggests, we need to rigorously examine the merits of each one. But after paring out those we don’t want, should we make the rest permanent as Camp and many lawyers and accountants favor? Or should we keep them on temporarily?

Making them permanent would reduce complexity and uncertainty. But keeping them temporary would allow Congress to regularly review them on their merits. I believe that, with a few exceptions, most should not be made permanent. However, I’d extend most of them for a more than a year at a time according to the purpose they are meant to serve.

Why not make them permanent?  As Professor George Yin of the University of Virginia School of Law has argued, most of these provisions really look more like spending than taxes.  We must distinguish, therefore, between those items that legitimately adjust the income tax base, and those that, like direct expenditures, subsidize particular activities or persons, or respond to a temporary need.

In my forthcoming book, Dead Men Ruling, I lay out the many complications that arise when elected officials make too many subsidies permanent. Over many decades, lawmakers have effectively destroyed the very flexibility government needs to adapt to new needs and demands over time.  Making the extenders permanent would tie even tighter the fiscal straightjacket we have placed on ourselves.

Fiscal reform demands retrenchment, not expansion, of the extraordinary power of permanent programs to drive up our debt and override the ability of today’s and tomorrow’s voters to make their own political choices.

Now onto a more complicated but related issue.  The way Congress handles tax subsidies such as extenders should be treated similarly to the way it handles direct spending subsidies. But doing this requires addressing some tricky budget accounting problems.

Direct expenditures can be divided into two categories: mandatory spending, often called entitlements, and discretionary spending.  Discretionary spending, in turn, has multiyear and single-year spending programs.  Both must be appropriated occasionally.   To simplify, let’s call permanent tax subsidies “tax entitlements” and tax extenders “tax appropriations.”

The Congressional Budget Office (CBO) treats direct entitlements and tax entitlements similarly, projecting them perpetually into the future. If legislation enacted decades ago requires those entitlements to grow, CBO will treat that growth as part of the baseline of what the public is promised by “current law.”

But CBO does not treat direct appropriations and tax appropriations similarly.  It assumes that direct appropriations will be extended either according to the program rules in effect (as in the case of most multi-year appropriations) or in aggregate (as in the case of most annual expenditures).  In contrast, CBO assumes that tax extenders or tax appropriations expire at the end of each year. Continuing temporary tax extenders would be scored as adding significantly to the deficit, whereas extending many or most appropriations at current levels would not.

These inconsistent budget accounting rules mean we need to rethink how Congress treats temporary tax subsidies. If they are not going to be made into permanent tax entitlements, then, as far as practical, they should be treated closer to multiyear or annual tax appropriations.    Multiyear often makes more sense for planning purposes.  Of course, subsidies that are truly meant to be temporary, such as anti-recession relief, should be treated as if they end at a fixed date.  The net result would be that when most “tax appropriations” other than those clearly meant to be temporary meet the end of some arbitrary extension period, CBO would no longer project their future costs at zero.

However one slices it, Congress needs to avoid making permanent or converting into entitlements even more subsidy programs, whether hidden in the tax code or not.  At the same time, it must address its inconsistent budget accounting rules for direct appropriations and those extenders that are really little more than appropriations made by the tax-writing committees.

Austerity, Stimulus, and Hidden Agendas

Nothing better exemplifies our gridlock over the future of 21st century government, as well as how to recover from the Great Recession, than the false dichotomy of austerity versus stimulus.

The austerity thesis, reduced to its simplest form, suggests that government has been living beyond its means for some time, only exacerbated by the actions that accompanied the recent economic downturn. Sequesters, tax increases, and spending cuts become the order of the day.

The stimulus hypothesis, reduced also to simplest form, suggests that more government spending and lower taxes puts money in people’s pockets and helps cure a country’s economic doldrums. Once the economy is doing better, government spending will naturally fall and taxes rise.

The debate then plays out largely over deficits: do you want larger or smaller ones?

But reduced to this form, the debate is a fallacy, for several reasons.

First, one must define larger or smaller relative to something. Last year’s spending or taxes or deficits? What’s scheduled automatically in the law? The public debate often glosses over these issues. Which is more expansionary when keeping taxes at the same level: an economy whose growth in spending is cut from 6 to 4 percent or one whose growth is increased from 1 to 3 percent?

Second, a country’s ability to run deficits depends on its level of debt. A recent debate over whether at some point higher debt starts to slow economic growth doesn’t change the fact that lenders want to be repaid. People won’t loan to Greece now, but they still find the U.S. Treasury securities a safe haven for their money.

Third, and by far the most important, what timeframe is involved? Is the Congressional Budget Office pro-austerity or pro-stimulus when it concludes that sequestration hurts the economy in the short run, but is better in the long run than doing nothing about deficits? No one on either side suggests that debt can grow forever faster than the economy. Everyone implicitly or explicitly believes that to accommodate recessions when debt grows faster there are times when debt must grow slower.

So where’s the rub? Here you must understand the emotional systems, usually veiled, that lie behind those on both sides trying to force the problem to an either/or solution.

Start with hardline austerity advocates. Many of them don’t just want smaller deficits. They want smaller government—or, at the very least, they want to prevent the government from taking ever larger shares of the economy, even given changing demographics. Essentially, austerity advocates don’t trust their pro-stimulus adversaries, some of whom can almost always find an economy going into a recession, in a recession, coming out of a recession, or attaining a lower-than-average growth rate and, therefore, needing some form of stimulus. Austerity advocates have learned from long experience that once government spending is increased, it’s hard to reduce. So they feel they have to get what deficit reduction they can now that the public’s attention to recent large debt accumulations is creating pressure to act.

Now for many the hardline stimulus advocates, their support for additional temporary government intervention cannot be entirely disentangled from their sympathy for a larger future government. Else why not agree to cut back now on the scheduled acceleration of entitlement programs, particularly fast-growing health and retirement programs? That would bring the long-run budget, at least as currently scheduled, back toward balance. It would simultaneously please many of their austerity opponents and allow for more current stimulus.

The hidden agendas are complicated further by inconsistencies on both sides. Many hardline austerity advocates, at least in the United States, don’t want cuts to apply to defense spending. For their part, many hardline stimulus advocates would be glad to pare growth in tax subsidies.

Regardless, the dichotomy falls apart once one realizes that a solution can involve a slowdown in scheduled growth rates in spending and a higher rate of growth of taxes, accompanied by less short-run deficit reduction and an abandonment of poorly targeted mechanisms such as sequesters.

Consider the buildup of debt during World War II, the last time we saw U.S. levels above where they are today. Debt-to-GDP fell fairly rapidly after the war all the way until the mid-1970s. While the growing economy certainly helped, tax rates that were raised substantially during the war were largely maintained afterward, and spending had essentially no built-in growth (actually huge declines when the troops came home). Just the opposite holds now even with recovery: there are limited tax increases to pay for past accumulations of debt or wartime spending, and spending is scheduled to grow long-term, even after temporary recession-led spending and defense spending on Afghanistan declines.

Both sides—pro-austerity and pro-stimulus—want desperately to control an unknown future, either by not paying our current bills with adequate taxes or by maintaining built-in growth rates in various programs, mainly in health and retirement. The false dichotomy between austerity versus stimulus has fallen by the wayside, and what we see through the veil are two sides in mutual embrace trying to control our future, whatever the cost to the present.

Our Imperfect Work

“We must act, knowing that our work will be imperfect,” Barack Obama proclaimed in his second inaugural address. Interestingly, the Washington Post blazoned its front page with the first three words without noting the succeeding dependent clause. Yet within this clause, I believe, lies the means by which the president—and Congress—and we—can move past so many of our conflicts and face up to the problems that confront us. The solution lies not in acting, but in recognizing the imperfection of what we do. If our budgets are to be vehicles for change, then we cannot enact so many laws as if the priorities of one time and place must endure forever.

More than ever before, our recent fights carry with them the implication that victory must be complete and total, setting in stone the institutions that will rule over our successors for decades and centuries to come. “We must act,” each political party seems to say, “as if our work will be perfect, else our opponents may someday slow down or even reverse our course.” Permanent monuments must be made to some liberal or conservative agenda, regardless of whether that monument rests upon unstable ground, employs an architecture glued together from incongruous designs, or fails to leave room for the improvements that only future knowledge may reveal.

Today, if we favor Social Security, it must be maintained permanently in its ancient design. For all generations of ever-expanding life expectancies, we must allow beneficiaries to retire as early as 65, or, when feeling temporarily richer, at 62. We must even accept its 1940s stereotype of the two-parent family, with abandoned mothers required to pay taxes to support spousal benefits for which they are ineligible. Similarly, if we favor less government, we can’t just work toward that goal by reducing spending. No, we have to create permanent tax cuts even if that means running economically disastrous deficits.

If we favor helping the poor, then we can never give up support for benefits like SNAP or food stamps. These programs must be etched in the law as superior to any alternative use of those funds, including ones that might provide better opportunities to people in need. If we subsidize an industry, whether oil or alternative fuel or agriculture or manufacturing, then we must enshrine that subsidy in the tax code.

Now, of course, there’s good reason for using legislation to try to provide some certainty or security. With perfect foreknowledge, we can plan for the future. But what if that future remains uncertain? Planning for it then requires creating a way to respond to its surprises, good and bad.

Unfortunately, we’ve gone long past the point where our federal budget could be flexible. A fiscal democracy index I developed with Tim Roeper shows that the combination of entitlement growth and low revenues means that today most revenues are already committed to permanent spending programs. Almost every congressional decision to adjust national priorities has to be paid for out of a deficit, or by overturning some past “permanent” enactment.

Earlier, before entitlements became so prevalent and dominant, spending was largely discretionary. Congress also felt that we should pay our bills on time, so it didn’t finance tax cuts for today’s generations by passing those liabilities onto future generations. Though many programs survived for decades, most still had to receive new votes of support. Even more important, almost none had any built-in growth. That made it easy to let some ideas languish as others came into prominence, leaving room for new choices or reconsideration over time.

Compromise is much easier when one side or the other isn’t forced into reneging on past promises to the public. It’s easier when it’s possible down the road to proceed on the same course, pursue the same objective via a different course, or decide on both a new objective and course. It’s easier when we’re not asking our opponents to keep funding some permanent monument we want erected to ourselves.

“But we have always understood that when times change, so must we; that fidelity to our founding principles requires new responses to new challenges…We understand that outworn programs are inadequate to the needs of our time…Let us answer the call of history, and carry into an uncertain future that precious light of freedom.” (Barack Obama, January 21, 2013; emphasis mine).

The Decline of Fiscal Democracy in America: A New Video Series by Eugene Steuerle

On January 3, 2013, the 113th session of the U.S. Congress opened with a fiscal cliff averted, but a country still stuck in a less-recognized fiscal bind.

In the first video of a three-part series, I explore one of the major reasons recent Congresses have been so dysfunctional: all, or almost all, the revenue to be collected by the Treasury Department was spent before lawmakers walked in the door.

I further discuss how spending and tax subsidy programs on autopilot, along with a tax system inadequate to pay our bills and rife with gaping holes, handicap lawmakers’ and the public’s ability to set new goals for solving today’s and tomorrow’s problems.

The Budget Crunch for Children—An Update

The Urban Institute recently released Kids’ Share 2012: Report on Federal Expenditures on Children through 2011, by Julia Isaacs, Katherine Toran, Heather Hahn, Karina Fortuny, and myself. It looks comprehensively at trends in federal spending and tax expenditures on children over the past 50 years. This sixth annual report is well worth a look if you are at all interested in how children fare in the federal budget.

In 2011, federal outlays on children fell by $2 billion, dropping from $378 billion in 2010 to $376 billion in 2011. This is the first time spending on children has fallen since the early 1980s.

However, children’s share of the spending has gone up and down over the last fifty years. Federal budget outlays on children as a percent of the domestic budget have declined from 20 percent in 1960 to 15 percent in 2011. Spending on children has not kept pace with growth in government spending over the last fifty years.

In the future, spending on children is expected to further decline, driven by budget pressures, which are strongest on the very types of programs on which kids rely: domestic discretionary programs like education that, unlike entitlements, do not grow automatically but require congressional funding each year. From 2011 to 2022, federal outlays are projected to grow by almost $1 trillion, but children gain almost nothing from this growth. In comparison, the nonchild portions of Social Security, Medicare, and Medicaid are projected to claim 91 percent of the increase.

As a result, children’s spending is projected to fall sharply as a share of the economy, from 2.5 percent of GDP in 2011 to 1.9 percent in 2022, below pre-recession levels. In 2017, Washington will start spending more on interest payments than on children.

Future decreased investment in children can be compared to increased investment on seniors. Their starting points are also different: in per-person terms in 2008, the federal government spent $3,822 on children and $26,355 on the elderly (in 2011 dollars). Take into account state and local spending, and a child on average still only gets about 45 percent as much as an elderly person.

The decrease in emphasis on children is part of a broader worrying trend that increasingly crimps investment, budgetary flexibility, and choices for the future.

Fiscal Democracy Index: An Update

This chart provides an update on percent of federal revenue available for discretionary spending over time.

Eugene Steuerle and his colleague, Tim Roeper, have developed a “fiscal democracy index” to document the fall in the fiscal freedom of our policymakers in recent years and into the future. To calculate the index, Steuerle and Roeper measured the extent to which past and future projected revenues are already claimed by the permanent programs already in place (including interest payments on the debt). The fiscal democracy index is neutral politically, favoring neither a liberal or conservative agenda, in the sense that it falls with both rising commitments from the past and reduced revenues.  It fell into negative territory for the first time in history in 2009 – meaning that revenues were already falling short of the built-in spending of permanent programs – and it will return to negative territory soon if Congress does not change current entitlement and tax policies. Even reducing annual non-entitlement spending to zero – thus, ending education, transportation, housing, defense, and most other general government programs – will do little to alter the downward path of the index other than reduce some interest costs temporarily. That means that future generations will have no additional revenues to finance their own new priorities, and they will actually have to raise new revenues or cut other spending just to finance the expected growth in existing programs.

Fiscal democracy will be a central concept of Gene’s forthcoming book with Larry Haas.

Why Economic Growth Isn’t Enough

Today’s budget problems aren’t America’s first. High debt levels accompanied our major wars, but they were quickly reduced soon after. “Deficits as far as the eye can see” in the mid-1980s were followed briefly by surpluses in the late 1990s. In all these cases, economic growth helped solve the problem. Today, that’s no longer possible.

Failure to understand the causes of today’s historic impasse will stymie those budget reformers tempted to believe we can use the traditional pro-growth strategy to get our fiscal house in order. Most of history is on their side: in almost all past U.S. budgets—indeed, the budgets of most nations—revenues were scheduled to grow automatically along with the economy, and expenditures were scheduled to grow only if there was new legislation. Thus, revenues in some future year would always exceed that past expense, no matter how high any current deficit. But under the laws now dominating the budget, expenditures essentially are or will be growing faster than both revenues and the rest of the economy. In fact, we’re now locked into automatic expenditure hikes that will outstrip revenues under almost any conceivable rate of economic growth.

In the many budget policy reform discussions I’ve been part of, this disconnect from the past blocks understanding of our present fiscal situation. Thus, both liberals who want to maintain spending programs and conservatives seeking to keep taxes low seem to think—or, at least, want to think—that economic growth can once again solve our problems.

Just what is different now? Today, we are facing two fiscal problems, while before we had just one. In the past, fiscal imbalance was mainly a temporary, current issue only. Yes, Congresses would occasionally spend much more than they collected in taxes, sometimes heedlessly. But as long as revenues over time rose with economic growth and most spending was discretionary, push never came to shove as long as the next Congresses weren’t too profligate

In effect, during the nation’s first two centuries, all that was required to get the nation’s house in order was for future Congresses to limit new spending increases or tax cuts. Since future surpluses were always built into the established law at any one point in time, sound fiscal policy meant not turning those surpluses into unmanageably high deficits year after year.

Take the case of World War II, when our national debt ballooned. It’s usually cited as the great example of successful fiscal policy overcoming a depression. If in 1942 Congress had developed ten-year estimates of the deficit under “current law” on the books, the estimates would have shown massive surpluses. Spending was scheduled to drop dramatically in absolute terms and as a percentage of the economy or GDP once the war was over. Meanwhile, higher tax rates imposed to support war spending would stay in place until future Congresses saw fit to reduce them.

Jump ahead to today. Now, so much spending growth is built into law in permanent or mandatory programs that these programs essentially absorb all future revenues. Meanwhile, we’ve also cut taxes—widening the gap between available revenues and growing spending levels.

But why won’t even higher economic growth solve the problem? If spending growth were limited so it couldn’t exceed some fixed rate, then higher economic growth might increase the revenue growth rate enough to help restore balance. Unfortunately, spending growth is not set at a fixed rate. Instead, it generally is scheduled to grow faster when the economy grows faster.

Consider government retirement programs, such as Social Security. Most are wage indexed insofar as a 10 percent higher growth rate of wages doesn’t just raise taxes on those wages, it also raises the annual benefits of all future retirees by 10 percent. The same doesn’t hold for discretionary programs such as education, even though we might expect that teachers’ salaries would need to rise with economic growth. Instead, teachers’ raises must be appropriated every year. Meanwhile, in most retirement systems employees stop working at fixed ages, even though for decades Americans have been living longer. When spending rises with both wages and extra years of retirement benefits, extra economic growth just doesn’t provide much if any reprieve from fiscal imbalances.

Health care is a bit more complicated. Health costs tend to rise more than proportionately with incomes. If our incomes rise by 10 percent over the next few years, we tend to demand at least 10 percent more health care. With 20 percent income growth, we want even more than 20 percent increases in health goods and services. Of course, it’s not just a demand phenomenon. The higher economic growth may reflect improvements in health technology, along with its higher costs.

Today, so much of government spending is devoted to health and retirement programs that their growing costs tend to swamp gains we might achieve in holding down the ever-smaller portion of the budget devoted to discretionary spending. Some other programs add to the problem, since they, too, tend to grow with the economy: mortgage interest deductions as we demand more housing, subsidized pension contributions and other employee benefits as our wages go up.

Built-in automatic spending growth like I’ve just described means that balancing the budget today is far harder than simply putting the brakes on new tax cuts and spending increases. A do-little Congress can no longer save the day. Our elected officials are in a bind they hate: they must both say “No” to many new give-aways AND go back on unkeepable spending and tax promises made by past lawmakers…

The thumbnail version: seek economic growth, but don’t expect it to provide the budget slack it did when most spending was discretionary. Congress has already spent the revenues that economic growth will provide, so we need to weed our government’s garden as well as water it.

From Deficit to Surplus: How Budget Projections Used to Look under Current Law

How Budget Projections Look Today under Current Law: With and Without Additional Economic Growth

Broken Government

The Obama Administration faces not one but several dilemmas. First is the huge issue of preventing the current downturn from turning into a very deep and long-lasting worldwide recession. State governors are running to Washington for help with their own budget crises, while Democratic supporters are clamoring for the spending increases and tax cuts they were promised during the campaign. Unfortunately, the long-term federal budget is so unbalanced that even if the nation were experiencing good times, able to avoid more tax cuts or spending increases, and in a position to enact the types of budget reforms that President Clinton did in 1993, it would still be way behind the fiscal eight-ball.

That’s just the money side of the equation. Many government programs are in disarray: they cannot be administered as currently structured, and cannot prove or measure their effectiveness. Many were designed for a different era but retain strong constituencies opposed to change. Yet few elected officials have ever undertaken systemic reform of any major program (I don’t count simply raising benefits or lowering taxes as systemic reform). And not for a very long time has Congress seriously weighed significant legislation that asks citizens to make even a modest sacrifice.

There is one way, and probably only one way, to confront these issues. President Obama must treat them as symptomatic of an even larger problem—that government is broken. As one of his very first actions, he should convey to the nation that these problems permeate government from top to bottom, that we are going to need multiple reforms, and that tackling them will take hard work and often shared sacrifice for the common good. This would not be an attack on government but an attempt to restore confidence in it.

He must then propose a series of processes—actual proposals for quick enactment in some cases, commissions and white papers in others, and complete departmental reviews in yet others. These will lead, he must promise, to a series of proposed reforms and definite proposals—a few immediate, but others after a fuller assessment of the issues.

Simultaneously, he must get Congress on board—not just to vote for a stimulus but to figure out how it can organize to deal with the inevitable: asking the public to give something back. Most of today’s representatives have never had to do this!

Here’s what is going on among Obama’s advisors right now. The dilemmas the new Administration faces—I have only mentioned a few—are voluminous. They have led to fierce internal struggles to determine what its all-important first message to the nation might be. Anytime someone suggests picking one, multiple advisors offer sound reasons why it should be another.

I think it would be a drastic mistake to pick only one of these battles to fight, no matter how important it might be viewed in isolation. I know there are those who suggest trying only for the easier first victory—generally on the give-away side of the budget (tax cuts or spending increases)—and gradually picking up momentum. And certainly fiscal stimulus in isolation fits that bill. That approach looks good at first because it allows the President to hold onto the popularity that comes from continuing to be a Santa Claus who doesn’t really ask for much.

Unfortunately, that type of thinking has put us in the mess we are in today, and it really doesn’t work well for a President over a four- or eight-year cycle, anyway. Look at President George W. Bush’s popularity rating after presiding over some of the largest give-aways on both the tax and spending side of the budget in our nation’s history. Even if this approach has worked in the past, it’s like proposing to run at 5 miles an hour on a treadmill that is running backward at 20.

In dealing with the most pressing issue, the recession, the President will of course need to support some tax cuts and spending increases. However, he must not let those easier political tasks take him away from his larger task of starting to fix this broken government. For instance, he should indicate that he wants to tackle not simply the effects of the recession but some of its causes, so that the same mistakes are not repeated again.

I also suggest that the President avoid getting into the weeds on these issues. He should boldly empower others to draft the proposals, conveying in each area a few broad goals that he wants to achieve. He could even empower some independent, nonprofit, or nonpartisan groups to keep an eye out as to whether the process, especially as it winds to and through Congress, strays too far from broad principles to be followed.

Remember that both Clinton health care reform and Bush Social Security reform failed in many ways because those Presidents were too engaged, made too many political decisions that went against what was technically achievable, and tried to wiggle their way around dilemmas for which there were no easy answers. Contrast their “success,” if you will, with that of tax reform in 1986, where the Treasury led the way despite a lot of sniping from the White House personnel, or with Social Security reform in 1983, where President Ronald Reagan generally stood behind the commission’s recommendations, some of which violated stands he had taken earlier in his career (e.g., taxation of Social Security benefits). The President’s role is to keep his—and our—eyes on the prize.

Consider the alternative. The President expends a lot of chits getting behind some stimulus or energy reform or health care reform or infrastructure investment. He lets the other matters slide. But some of these ideas don’t work, or aren’t sufficient, or face huge opposition. The recession continues or is followed by slow growth, the energy proposals end up distributing a lot of benefits and costs unfairly because property rights to pollute and taxes are hard to allocate, the health care reform doesn’t meet all expectations, and the infrastructure investment is allocated by Congress in a way that overlooks too many dangerous bridges or levies.

If the President is viewed as in charge of the naval force that is trying to turn the tide of battle, people will forgive him when his captains make mistakes. If he starts taking charge of each of his battleships and cruisers, trying to claim success for every maneuver, he will never gain full command of the fleet or gain the full confidence of a public counting on him to lead.