The Federal Debt, the Fiscal Cliff, and the Federal Debt Limit STEVE BELL SENIOR DIRECTOR, ECONOMIC POLICY PROJECT BIPARTISAN POLICY CENTER

FY 2012 Budget 2

Absent reforms, debt is set to skyrocket in the coming decades % of GDP Note: Unlike current law, the Bipartisan Policy Center’s Plausible Baseline assumes that the 2001, 2003, and 2010 tax cuts are extended, the AMT is indexed to inflation, Medicare’s physician payment rates are maintained at their current rate (the “doc fix”), the looming sequester from the Budget Control Act of 2011 is lifted, and troops stationed overseas decline to 45,000 by 2015 Debt breaches 100% of GDP in 2027 Sources: Congressional Budget Office (January 2012) and Bipartisan Policy Center extrapolations 3

Health care costs are the primary driver of the debt % of GDP Sources: Congressional Budget Office’s Alternative Fiscal Scenario (January 2012), additionally assuming that troops overseas decline to 45,000 by 2015; Bipartisan Policy Center extrapolations 4

Fantasy 1: We can save enough in the rest of the budget to pay for the projected growth in entitlements. 5

Fantasy 2: We can raise taxes enough to pay for the projected growth in entitlements. 6

How did we get here? 7 Debt Ceiling Budget Control Act (BCA) Super committee failure Sequester

Massive Fiscal Contraction is scheduled to occur in Bush Tax Cuts + AMT$235 b Payroll Tax Cut$90 b Unemployment Insurance$25 b Tax Extenders & Business Depreciation$80 b The Sequester$60 b The Debt Ceiling !?!?!? TOTAL:$525 b Upcoming Current Law Changes: Affordable Care Act Taxes$25 b Doc Fix$10 b

What is a sequester? 9 Automatic reduction to federal government spending for a given fiscal year Gramm-Rudman-Hollings – Balanced Budget and Emergency Deficit Control Act of 1985 Phil Gramm: “It was never the objective of [GRH] to trigger the sequester; the objective of [GRH] was to have the threat of the sequester force compromise and action.” ‘80s and ‘90s sequesters were rarely carried out, but pushed Congress to achieve fiscal goals in ‘90s

FY 2013 Sequester Cuts Fall on The Smallest Pieces of the Budget 10 Mandatory $2,160B Tax Expenditures $1,343B Defense Discretionary* $729B Domestic Discretionary* $504B $55B – 50% of Sequester$39B – 35% of Sequester$16B Non-Defense – 50%Defense – 50% Sources: Congressional Budget Office, Donald Marron and Tax Policy Center using data from the Office of Management and Budget and Treasury * These amounts include all discretionary budgetary resources for the duration of FY 2013, not solely the non-exempt monies that are subject to sequester. Additionally, the figures assume that a continuing resolution at FY 2012 levels is enacted for FY 2013, that war funding (Overseas Contingency Operations funds) is provided at the level requested by the president. Defense discretionary funds include unobligated balances from prior years, which are subject to sequester. Cuts

Sequester delays Federal debt reaching 100% of GDP by only 2 years Note: The Bipartisan Policy Center’s (BPC) January 2012 Plausible Baseline assumes that the 2001, 2003, and 2010 tax cuts are extended permanently, Medicare physician payments are frozen (the “doc fix”), the AMT is indexed to inflation, and overseas combat operations wind down. Sources: Congressional Budget Office; Bipartisan Policy Center projections 11

10 Largest Individual Tax Expenditures, Cost in Fiscal Year 2014 ProvisionAmount (billions of $) Exclusion of Employer Health Insurance164 Exclusion of Employer Pensions163 Mortgage Interest Deduction100 Exclusion of Medicare76 Capital Gains Rates71 Earned Income Credit58 Deduction of State & Local Income Taxes54 Gains: Exclusion at Death/Gift Carryover52 Deduction of Charitable Contributions52 Employer Benefits under Cafeteria Plans44 Source: Congressional Research Service calculations based on Joint Committee on Taxation revenue estimates 12

Domenici-Rivlin: An Overview 13 The consensus, bipartisan plan will: Create a simple, pro-growth tax system that broadens the base, reduces rates, makes America more competitive, and raises revenue to reduce the debt – while making the tax system more progressive. Reduce the unsustainable rate of growth in health care costs. Strengthen Social Security to ensure that it will pay benefits for 75 years and beyond, while protecting the most vulnerable elderly and maintaining the current retirement age. Freeze domestic and defense discretionary spending (already achieved by means of the Budget Control Act). Cut other spending, including farm and government retirement programs.

Debt Drops Dramatically Under Bipartisan Plan % of GDP Note: Unlike current law, the Bipartisan Policy Center’s Plausible Baseline assumes that the 2001, 2003, and 2010 tax cuts are extended, the AMT is indexed to inflation, Medicare’s physician payment rates are maintained at 2011 levels (the “doc fix”), the looming sequester from the Budget Control Act of 2011 is lifted, and troops stationed overseas decline to 45,000 by 2015 Sources: Congressional Budget Office (January 2012) and Bipartisan Policy Center extrapolations 14

Debt Limit: Key Questions When will the federal government next reach its statutory borrowing limit? 2. At that point, what legal actions does Treasury have at its disposal for continued funding of government operations? 3. What is the date after which Treasury will not have sufficient cash to pay ALL of its bills (the “X Date”)?

Reaching the debt limit – What it means 16 Layers of Defense Against Default The Treasury Department has multiple means that can be used to pay the nation’s bills. If the debt limit is reached and Congress does not act in time, however, all of these layers of defense will be breached and the nation will default on its obligations. ISSUE NEW DEBT TO THE PUBLIC IN TRADITIONAL MANNER EXTRAORDINARY MEASURES DAILY REVENUE AND CASH ON HAND DEFAULT ON FINANCIAL OBLIGATIONS Debt Limit Reached EM Exhausted The X Date

Reaching the debt limit 17 BPC estimates that the debt limit will be reached and Extraordinary Measures will begin in the last week of December Substantial interest on intra-governmental debt (including the Social Security and Medicare trust funds) is due on 12/31/2012

Extraordinary measures 18 EXTRAORDINARY MEASURES AVAILABLEBPC ESTIMATE Do not reinvest the Federal Employees’ Retirement System G- Fund $154 billion Do not reinvest the Exchange Stabilization Fund$23 billion Do not reinvest interest payments and cash receipts to Civil Service Fund and Postal Fund $21 billion Do not reinvest maturing securities in the Civil Service Fund and Postal Fund Not Applicable in Dec Total$197 billion Note: The totals indicate available measures. Treasury may not employ all available measures. Treasury also has measures available (not listed) that assist with cash flow and debt management, but do not extend the date after which Treasury would default on federal obligations absent an increase in the debt limit (the “X Date”). Column does not add due to rounding. Sources: Government Accountability Office, Congressional Research Service

Extraordinary measures Won’t Last As Long 19 In 2011, Extraordinary Measures lasted from May 16 until August 1 They won’t buy as much time as they did last summer February is a “bad” month for the federal government’s finances Fewer measures available

The “X Date” 20 BPC defines the “X Date” as the date after which Extraordinary Measures have been exhausted and cash on hand is insufficient to pay all of the federal government’s bills in full and on time In other words, without an increase in the debt limit, the federal government will begin defaulting on some of its financial obligations on the day after the X Date BPC estimates that the X Date will occur in February 2013

What happens once we reach the “X Date”? 21 Monthly Inflows Monthly Outflows Treasury Cash Flow: February 2012 Monthly Cash Deficit: $261 b Note: This past February’s cash flows provide a rough estimate of the challenge of meeting the federal government’s obligations in February 2013 without the ability to issue net new debt to the public. Numbers may not add due to rounding. $202 Billion in revenues $464 Billion in spending: $112b IRS Tax Refunds $62bMedicare and Medicaid $55bSocial Security Benefits $33bInterest on Debt $27bDefense Vendor Payments $26b Education Programs $14bFederal Salaries $125b Other Spending Source: Daily Treasury Statements

“Wild cards” 22 Fiscal Cliff Income tax withholding Expiration of Alternative Minimum Tax “patch” Delayed filing season Additional Deficit Spending? Disaster relief funds “Growth measures” in fiscal cliff deal Economic Uncertainty Strengthening/weakening economy Monthly fluctuations in spending and revenues

Size of the DEBT LIMIT Increase 23 How much would the debt limit need to be increased to get through 2013 or 2014? High Estimate = $2,200 B Note: All estimates are based on Congressional Budget Office data. The “low estimate” reflects current law except for freezing physician payments at 2012 levels (“Doc Fix”), indexing the AMT to inflation, and applying the scheduled decline in overseas combat operations (OCO) spending. The “high estimate” assumes that the 2001, 2003, 2009, and 2010 tax cuts are extended along with most of the usual tax extenders, the “Doc Fix” and AMT “patch” are applied, OCO spending declines as scheduled, the sequester does not take effect, and the payroll tax holiday and extended unemployment insurance benefits are continued. High Estimate = $1,250 B Low Estimate = $730 B Low Estimate = $1,300 B