The Federal Budget Outlook Matt Fiedler Center on Budget and Policy Priorities March 1, 2007

Outline Recent budget trends The President’s budget proposals This year’s Congressional debate Dealing with the long-term fiscal problem

I. Recent Budget Trends

From Large Surpluses to Large Deficits in Just 6 Years Cumulative Surpluses/Deficits, Source: CBPP calculations based on Congressional Budget Office data. Surplus Deficit

Legislation Adding to Deficits: Mostly Tax Cuts and Defense, Not Domestic Programs Cost, , of policy changes since January 2001 Tax Cuts Defense, Homeland Security, and International Entitlements Domestic Discretionary (except Homeland Security) 49% 36% 10% 5% Source: CBPP calculations based on CBO data. Assumes extension of the President’s tax cuts, continuation of AMT relief, a gradual phasedown of operations in Iraq and Afghanistan, and defense spending in line with the President’s FY 2007 budget.

Tax Cuts Cost More Than Most Agency Budgets Source: CBPP calculations based on Treasury Department, Congressional Budget Office, Joint Committee on Taxation, and Urban-Brookings Tax Policy Center data Agency Budgets, Tax Cuts if Fully in Effect in 2006

Since 2001, Funding for Domestic Discretionary Programs Has Fallen as a Share of the Economy Source: CBPP calculations based on CBO data. To avoid distortions, figures do not include funding for homeland security or hurricane relief. 0.0% Domestic Discretionary Funding as a Share of the Economy

The Current Path of Federal Revenues and Program Spending Is Unsustainable Source: CBPP projections based on CBO data.

Last 25 Years Have Seen Rapid Income Growth at the Top, Virtually No Growth at the Bottom Source: CBPP calculations based on Congressional Budget Office data. Growth in average real pre-tax income,

II. The President’s Budget Proposals

Key Components of the President’s Fiscal Year 2008 Budget Proposal Permanent extension of the 2001 and 2003 tax cuts Large cuts in domestic discretionary programs that grow deeper over time; large increases in security spending Cuts in Medicaid that shift significant costs to states Proposed funding levels for the State Children’s Health Insurance Program that would likely force states to drop children from the program Misses the opportunity to use this year’s reauthorization to invest in the Food Stamps Program

Overall Effects of the President’s Fiscal Year 2008 Budget Proposal According to OMB’s own documents, the budget would increase deficits in each of the next five years Deficits increase despite domestic cuts due to the defense increases and large tax cuts included in the budget Combination of large tax cuts and domestic cuts would worsen recent trends toward increased income inequality

Average Value of the 2001 and 2003 Tax Cuts for Households in Pennsylvania, 2007 Source: Citizens for Tax Justice Lowest 20 Percent (Avg. Income $11,000) Middle 20 Percent (Avg. Income $41,000) Top 20 Percent (Avg. Income $175,000) Top 1 Percent (Avg. Income $1.0 Million)

Cuts in Domestic Discretionary Programs Would Hit Pennsylvania Hard Source: CBPP calculations based on OMB documents. Cuts in Pennsylvania in 2012 (millions of dollars)

President’s Medicaid Proposals, : Budget Proposals Shift Federal Costs to States Proposals that shift costs to states = $21.0 billion in federal reductions Proposals that reduce both federal and state costs = $3.4 billion in federal reductions and $2.6 billion in state reductions Source: OMB and HHS budget documents.

III. This Year’s Congressional Debate

The Outlook for Discretionary Programs President proposed a big increase in security spending, and he is likely to get much of what he asked for There appears to be growing support for making substantial investments in domestic programs To accommodate both, the ceiling for discretionary funding set in the budget resolution must be well above baseline Without a high enough ceiling for overall discretionary, crucial investments in low-income housing, education, environment, etc. will be squeezed out

A Major Change From Prior Years: PAYGO Rules PAYGO requires offsets for tax cuts or entitlement increases; “if something is worth doing, it’s worth paying for” Means that investments in SCHIP, Food Stamps, and other areas will require offsets But PAYGO is the best defense against extension of the President’s tax cuts (at a cost $3.0 trillion ) Tax cuts of that size would starve programs of the revenue they need to survive; maintaining a strong PAYGO rule is a top priority

Even Extending Just “Middle-Class” Tax Cuts Is Costly 10 percent bracket$312 billion Child tax credit$219 billion Marriage penalty relief$53 billion “Middle Class” Tax Cuts Subtotal$585 billion Extend AMT relief (not repeal)$569 billion TOTAL, “Middle Class” and AMT$1.15 trillion Source: Joint Committee on Taxation, CBO Cost of Extending Tax Cuts,

Extending Higher-Income Tax Cuts Adds Substantially to Costs “Middle Class” and AMT Subtotal$1.15 trillion Extend Remaining 2001 and 2003 Tax Cuts $1.35 trillion Accompanying AMT Relief$472 billion TOTAL, 2001 and 2003 Tax Cuts and AMT Relief $3.0 trillion Cost of Extending Tax Cuts, Source: Joint Committee on Taxation, CBO

Debt With and Without Unpaid for Extension of Recent Tax Cuts Debt as a Share of the Economy Additional debt if tax cuts are extended Debt if tax cuts expire Source: CBPP projections based on CBO data.

Cost of AMT Repeal Dwarfs Cost of Maintaining Current Funding Levels for Important Programs Source: Tax Policy Center, CBO. Costs shown are 2006 discretionary funding adjusted for inflation. Cost in Billions, 2010

More Than Half the Cost of AMT Repeal Goes to Shield Highest-Income Households From Tax Source: Urban-Brookings Tax Policy Center Cost in Billions, 2010 Cost of Excluding Households With Incomes Below $100,000 Cost of Excluding Households With Incomes Below $200,000 Cost of Repeal

Goals for Tax Policy This Year Core Goal Make sure that budget resolution and all tax legislation (including AMT reform) adhere to PAYGO Major Challenges Budget resolution may show large surpluses after 2010, creating tremendous pressure for unpaid for tax cuts in Senate AMT “patch” may be under consideration at the end of the year; some will want to waive PAYGO

The President’s SCHIP Proposals Reauthorizes SCHIP for five years at baseline levels of $5.04 billion per year. Provides additional $4.8 billion to states, above the baseline funding levels, starting in 2009; presumably distributed to shortfall states. Accelerates the redistribution of unspent SCHIP funds, reducing from 3 years to 1 year the time states have to spend their annual allotments. This helps to maximize use of available SCHIP funds, partially addressing federal funding shortfalls. Reduces the federal match for certain beneficiaries in SCHIP – namely, parents and children above 200 percent of poverty – to the regular Medicaid match. Leaves states with a $7 billion shortfall over five years.

Goals for SCHIP Reauthorization Growing bipartisan support for: Covering immediate (FY 07) and the 5 year federal funding shortfall ($13.4 billion) affecting most states by Providing funding to states to cover, at a minimum, those children who are eligible for SCHIP and Medicaid but not enrolled (7 of 10 uninsured children). Preserving current state flexibility in determining income limits for SCHIP. Provide financial support, as resources allow, to support states’ (e.g. PA’s) use of this flexibility to cover more kids.

IV. Dealing with the Long-Term Fiscal Problem

Likely Consequences of Unbalanced Approach to Deficit Reduction (in Which Large Parts of the Budget Are Off the Table) Large cuts over time in programs for the poor. Increases in the number of uninsured Americans. Federal government may be unable to fulfill some core functions. More costs shifted to states.

The Goal: Balanced Approach To Deficit Reduction (in Which All of the Budget Is On the Table) Balanced approach would include revenue increases as well as spending cuts. Deficit-reduction measures would focus on “weak claims,” not “weak clients.” Balanced approach was taken in 1990 and 1993 by Presidents Bush and Clinton.

Rising Health Costs are the Main Driver of Growth in the “Big Three” Demographic changes Health cost growth faster than economic growth Sources of cost growth in the “Big Three” as a share of GDP MedicareMedicaidSocial Security Source: CBPP calculations based on CBO data.

The Big Enchilada: The U.S. Health Care System The largest factor behind the grim budget forecast is the rising cost of Medicare and Medicaid. The rising costs of these programs essentially reflect the rapidly rising costs in the entire U.S. health care system. To cut future costs in Medicare and Medicaid sharply without restraining costs in the health care system as a whole would necessitate draconian cuts in these programs. Thus, the key to addressing the future implosion of the budget is to reform the U.S. health care system, a daunting task given the powerful economic interests involved.