July 16, 2012
Nov 2012 - Putting the federal budget on a more sustainable path is likely to require a combination of policies, many of which may stand in stark contrast to policies now in place.
- March 10, 2011
Reducing the Deficit: Spending and Revenue Options
March 10, 2011
The Congressional Budget Office (CBO) regularly issues a compendium of budget options to help inform federal lawmakers about the implications of possible policy choices. This volume—one of several reports that CBO produces regularly for the House and Senate Committees on the Budget—presents more than 100 options for altering federal spending and revenues. Nearly all of the options would reduce federal budget deficits. The report begins with an introductory chapter that describes the current budgetary picture and the uses and limitations of this volume. Chapters 2 and 3 present options that would reduce mandatory and discretionary spending, respectively. Chapter 4 contains options that would increase revenues from various kinds of taxes and fees.
Federal budget deficits will total $7 trillion over the next decade if current laws remain unchanged, the Congressional Budget Office (CBO) projects. If certain policies that are scheduled to expire under current law are extended instead, deficits may be much larger. Beyond the coming decade, the aging of the U.S. population and rising health care costs will put increasing pressure on the budget. If federal debt continues to expand faster than the economy—as it has since 2007—the growth of people's income will slow, the share of federal spending devoted to paying interest on the debt will rise, and the risk of a fiscal crisis will increase.
This report presents 105 illustrative options that would reduce projected budget deficits. As in past reports, the options cover an array of policy areas—from defense to energy to entitlement programs to provisions of the tax code. The budgetary effects shown for most options span the 10 years from 2012 to 2021 (the period covered by CBO's January 2011 baseline budget projections), although many options would have longer-term effects as well. The options are grouped into three major budget categories: mandatory spending, discretionary spending, and revenues. In most cases, the table accompanying an option shows the option's estimated budgetary effects in each of the next 10 years, as well as 5- and 10-year totals.
The options in this volume come from legislative proposals, various Administrations' budget proposals, Congressional staff, other government entities, and private groups, among others. Because the spending options in this volume are intended to help lawmakers review individual programs, they do not include large-scale budget initiatives, such as eliminating entire departments or agencies. The options are intended to reflect a range of possibilities, not a ranking of priorities, and the report does not provide an exhaustive list of policy alternatives. The inclusion or exclusion of a particular policy change does not represent an endorsement or rejection by CBO. In keeping with CBO's mandate to provide objective, impartial analysis, this report makes no recommendations.
Budget Decisions: The Current Context
Over the past 40 years, federal debt held by the public has averaged 35 percent of the country's annual economic output (gross domestic product, or GDP). Because of massive deficits during the past few years, that ratio climbed to 62 percent by the end of last year, the highest level since shortly after World War II.
In CBO's current-law baseline, the deficit is projected to equal 9.8 percent of GDP in 2011, shrink to 4.3 percent of GDP by 2013 (after certain tax provisions are scheduled to expire and the economy has recovered further from the recession), and then range between 2.9 percent and 3.4 percent of GDP through 2021—close to the average of 2.8 percent seen over the past 40 years. Those deficits would push total debt held by the public to 77 percent of GDP by 2021.
Moreover, CBO's baseline projections are predicated on the assumption that many policies now in place are allowed to expire over the next decade, as scheduled under current law. Those expiring policies include the major reductions in individual income taxes originally enacted in 2001 and 2003 and recently extended through 2012, as well as the higher exemption amounts for the alternative minimum tax. If those policies and others were extended, budget deficits would be much larger than in that baseline.
Over the longer term, the continued aging of the population and growth in health care costs will almost certainly push up federal spending significantly relative to GDP under current law. Without changes in law, spending on Social Security and the government's major mandatory health care programs (Medicare, Medicaid, the Children's Health Insurance Program, and health insurance subsidies to be provided through insurance exchanges) will increase from roughly 10 percent of GDP today to about 16 percent over the next 25 years. If revenues stay close to their average share of GDP for the past 40 years, that rise in spending will lead to rapidly growing budget deficits and surging federal debt.
To prevent federal debt from becoming unsupportable, lawmakers will have to restrain the growth of spending substantially, raise revenues significantly above their historical share of GDP, or pursue some combination of those two approaches.
Options for Reducing Mandatory Spending
Mandatory spending includes spending for entitlement programs and certain other payments to people, businesses, nonprofit institutions, and state and local governments. For mandatory spending programs, funding levels are generally determined not by annual appropriations but by eligibility rules, benefit formulas, and other parameters set by Congress in authorizing legislation.
The largest programs in this category are Social Security, Medicare, and Medicaid, which together accounted for 74 percent of mandatory spending in 2010 and are projected to account for 81 percent by 2021, under current law.
The options in this section encompass a broad range of mandatory spending programs. Although the options are grouped by program, some of the options for different programs are conceptually similar. For instance, two options address the effects of applying different inflation factors to the benefit formulas for certain programs. Other options would alter the balance of spending between the government and program participants or between the federal government and the states.
Of the 32 options in the mandatory spending chapter:
- Fifteen deal with spending for health care programs.
- Seven would make changes to Social Security or other retirement programs.
- Ten focus on Fannie Mae, Freddie Mac, and programs that deal with education, energy, or agriculture.
Options for Reducing Discretionary Spending
Spending governed by the Congress's annual appropriation acts—which is labeled discretionary spending—accounts for nearly 40 percent of federal outlays. In 2010, roughly half of discretionary spending went for defense. The other half paid for a wide range of federal activities, including law enforcement, homeland security, transportation, national parks, disaster relief, scientific research, and foreign aid. CBO's baseline projections reflect the assumption that discretionary spending will grow at the rate of inflation and will thus decline to 28 percent of total spending by 2021.
Of the 38 options in the discretionary spending chapter:
- Two options, one for defense spending and one for nondefense spending, present broad alternatives for freezing or reducing discretionary spending.
- Twelve other options deal with defense spending.
- The other 24 options cover a broad array of nondefense programs.
Most of the options show savings calculated relative to CBO's baseline projections—that is, the 2011 appropriation annualized, adjusted for projected inflation in later years. The budgetary effects of several options that involve spending for defense procurement were estimated on a different basis—they were measured relative to the Department of Defense's (DoD's) 2011 Future Years Defense Program (FYDP). CBO determined that it would be more informative to estimate the effects of procurement options relative to DoD's published plan because CBO's baseline for defense procurement is not based on detailed plans for weapon systems. Because the 2011 FYDP extends for only five years, however, CBO's estimates for procurement options are presented with tables that show just five years of costs or savings. The text of each procurement option discusses the effect of the option on DoD's long-term acquisition plans.
Options for Increasing Revenues
Federal revenues come from taxes on individual and corporate income, payroll taxes for social insurance programs (such as Social Security and unemployment compensation), excise taxes, estate and gift taxes, remittances from the Federal Reserve System, customs duties, and miscellaneous fees and fines. The two largest sources are individual income taxes and social insurance taxes, which together produce more than 80 percent of the government's revenues.
The revenue chapter presents 35 options to increase revenues. The options are grouped in a number of broad categories according to the part of the tax system they would target:
- Individual income tax rates
- The individual income tax base
- Individual income tax credits
- The Social Security tax base
- Corporate income tax rates
- Taxation of income from businesses and other entities
- Taxation of income from worldwide business activity
- Consumption and excise taxes
- Health care provisions
- Other taxes and fees
Nearly all the estimates for the revenue options were prepared by the staff of the Joint Committee on Taxation (JCT). If combined, the options might interact with one another in ways that could alter their revenue effects as well as their impact on households and the economy. For simplicity in presentation, some of the changes in revenues shown in the tables represent the net effects of an option on both revenues and outlays combined.
Caveats About This Report
The estimates shown in this volume could differ from any later cost estimates by CBO or revenue estimates by JCT for legislative proposals that resemble these options. One reason is that the policy proposals on which those later estimates would be based might not precisely match the options presented here. Another reason is that the baseline budget projections against which such proposals would ultimately be measured might have been updated and thus would differ from the projections used for this report.
The estimated budgetary effects of options do not reflect the extent to which a policy change would affect interest payments on federal debt.
CBO's analyses do not attempt to quantify the impact of options on state spending. Some options that would affect other levels of governments or the private sector might involve federal mandates. The discussions of the options in this volume do not address the costs of potential mandates.
Social Security Policy Options
July 1, 2010
Social Security is the federal government's largest single program, and as the U.S. population grows older in the coming decades, its cost is projected to increase more rapidly than its revenues. As a result, under current law, resources dedicated to the programs will become insufficient to pay full benefits in 2039, the Congressional Budget Office (CBO) projects. Long-run sustainability for the program could be attained through various combinations of raising taxes and cutting benefits; such changes would also affect the Social Security taxes paid and the benefits received by various groups of people. This CBO study examines a variety of approaches to changing Social Security, updating an earlier work, Menu of Social Security Options, which CBO published in May 2005. In keeping with CBO's mandate to provide objective, impartial analysis, the current study makes no recommendations.
Social Security, the federal government's largest single program, provides benefits to retired workers (through Old-Age and Survivors Insurance, OASI), to people with disabilities (through Disability Insurance, DI) and to their families as well as to some survivors of deceased workers. Those benefits are financed primarily by payroll taxes collected on people's earnings. In 2010, for the first time since the enactment of the Social Security Amendments of 1983, Social Security's annual outlays will exceed its annual tax revenues, the Congressional Budget Office (CBO) projects. If the economy continues to recover from the recent recession, those tax revenues will again exceed outlays, but only for a few years. CBO anticipates that starting in 2016, if current laws remain in place, the program's annual spending will regularly exceed its tax revenues.
Social Security's dedicated revenue stream sets it apart from most other federal programs in that the dedicated revenues are credited to trust funds that are used to finance the program's activities. Interest on the balances of those funds also is credited to the funds (which often are treated collectively as the OASDI trust funds). CBO estimates that, unless changes are made to the system, the trust funds combined will be exhausted in 2039. At that point, the resources available to the Social Security program will be insufficient to pay full benefits as they are currently structured.
This CBO study first provides an overview of Social Security and discusses some criteria for evaluating proposals to change the system. It then presents a variety of options for changing the Social Security system and analyzes the financial and distributional effects of those options- that is, how they would affect Social Security's finances and how they would alter the benefits paid to people in various earnings categories and people born in various decades.
The Outlook for Social Security's Finances
As the population of the United States continues to grow older, the number of Social Security beneficiaries will continue to rise, and the program's outlays will increase faster than its revenues. Long-term projections are unavoidably uncertain but, under a broad range of assumptions, benefits that are scheduled under current law will consistently exceed revenues.
CBO projects that beginning in 2039 the Social Security Administration will not be able to pay those scheduled benefits, however. If revenues were not increased, benefits would need to be cut by about 20 percent in 2040 to equalize outlays and revenues. Those proportionately lower payments, which would be made to all Social Security recipients once the trust funds were exhausted, are known as payable benefits.
A commonly used summary measure of the system's long-term financial conditions is the 75-year actuarial balance- a figure that measures the long-term difference between the resources dedicated to Social Security and the program's costs under current law. The actuarial balance is the value of Social Security's revenues over the 75-year period, discounted to their value in current dollars, plus the current balance in the OASDI trust funds, minus the present value of future Social Security outlays, minus the value of a year's worth of benefits as a reserve at the end of the period. CBO estimates the 75-year actuarial balance to be -0.6 percent of gross domestic product (GDP); that is, under current law, the resources dedicated to financing the program over the next 75 years fall short of the benefits that will be owed to beneficiaries by about 0.6 percent of GDP. That figure is the amount by which the Social Security payroll tax would have to be raised or scheduled benefits reduced for the system's revenues to be sufficient to cover scheduled benefits. In other words, to bring the program into actuarial balance over the 75 years, payroll taxes would have to be increased immediately by 0.6 percent of GDP and kept at that higher rate, or scheduled benefits would have to be reduced by an equivalent amount, or some combination of those changes and others would have to be implemented.
The actuarial balance averages the smaller deficits that would occur near the beginning of the projection period and the larger ones that would occur near the end. In 2084, scheduled outlays would exceed revenues by 1.4 percent of GDP.
In this study, CBO analyzes 30 options that are among those that have been considered by various analysts and policymakers as possible components of proposals to provide long-term financial stability for Social Security. The options follow the convention of not reducing initial benefits for people who are currently older than 55, and all would directly affect outlays for benefits or federal revenues dedicated to Social Security.
The options fall into five categories:
- Increases in the Social Security payroll tax,
- Reductions in people's initial benefits,
- Increases in benefits for law earners,
- Increases in the full retirement age, and
- Reductions in the cost-of-living adjustments that are applied to continuing benefits.
Each option is analyzed in isolation, although most proposals to make substantial changes to Social Security combine several provisions. Many options would interact with one another, so combining them might cause changes to the overall finances of the system that are larger or smaller than would be produced by a simple sum of the effects of several discrete options.
This list of options is far from exhaustive. It does not include changes that would draw on general government revenues, create individual accounts, or change the trust funds' investments. Other than an increase in the Social Security payroll tax, changes to federal tax policy are not considered. The options do not include any that apply only to people who receive DI benefits, although some of the options would affect OASI and DI beneficiaries alike.
Effects of the Options
This study analyzes the overall effect of each option on the finances of the Social Security system. Some options, such as those that would apply the payroll tax rate to all earnings or those that would index initial benefits to prices, would more than eliminate Social Security's actuarial deficit; others would have far smaller financial effects (see Summary Figure 1).
This study also analyzes the options' effects on taxes that would be paid and benefits that would be received by various groups of program participants. For that distributional analysis, participants are grouped by the amount of their lifetime household earnings and by their birth cohort (that is, by the decade in which they were born). Those distributional effects of the options are measured relative to the outcomes that would result both from scheduled benefits and from payable benefits under current law.
Some options, such as an across-the-board increase in the payroll tax rate or a flat reduction in benefits, would affect all participants proportionately, but some options would have disparate effects on people in different earnings groups with higher lifetime earnings by placing an additional tax on earnings above a threshold or by increasing the progressivity of the Social Security benefit formula.
Many options with similar financial effects in the aggregate would affect older and younger generations differently. In particular, the timing of the changes would affect their impact on different generations (as well as the magnitude of the change necessary to bring the system into balance). Some options, such as one that would reduce benefits by a flat 15 percent, would take effect in a single year and would affect all future beneficiaries the same way. Others would be phased in and, initially, would have only small effects. For example, a policy that gradually reduced benefits would have a much larger effect on people whose benefits began in 2040 than it would on those whose benefits began in 2020. Raising tax rates would increase the amounts paid by younger people but make little difference in the sum of taxes paid over a lifetime by people who already have left or are about to leave the workforce.