December 19, 2014

The Budget Conference: Low Expectations But Great Opportunities

Given the acrimonious political environment and the wide discrepancy between the House and Senate budgets, the conference committee now scheduled to report by Dec.13 begins its work with low expectations. However, if the committee approaches its task with flexibility and a commitment to achieving results, it has an opportunity to put in place a framework for making substantial progress toward solving our nation’s fiscal challenges.

The most immediate concern will be to agree on an overall spending level for Fiscal Year 2014 appropriations. That would avert another government shutdown on Jan. 15, when current funding expires. An agreement should also allow a debt ceiling increase through the end of 2014 since funding levels under either the House or Senate budget would require it. 

It is important for the panel to produce a result -- whether the committee reaches a mini-bargain that simply keeps the lights on and the bills paid for the coming year, or something closer to a grand bargain. The budgetary gridlock that has led to one crisis moment after another has weakened the economy, disgusted the public and damaged our standing in the world. And it has left the nation’s major fiscal challenges largely untouched. 

Yet, there is a path toward that larger “grand bargain.” Relieving the pressure that sequestration is putting on discretionary programs means finding cuts in mandatory programs (entitlements) -- a key Republican objective. But if mandatory spending cuts are in play, Democrats will insist on new revenues as well. The issues are so intertwined that a comprehensive grand bargain is still the best way to resolve them.

The question is whether there is enough political will on the part of the committee to go beyond crisis management and tackle long-term sustainability. If so, the committee will need to look at two of the most contentious issues that have stymied past attempts at a “grand bargain”: health care and taxes. 

Sequestration

A logical starting point for the committee’s work is “sequestration” - the lower discretionary spending caps for 2014 through 2021 that were included in the Budget Control Act of 2011 (BCA). Funding for 2014 cannot be determined without deciding whether and how to alter the current caps. 

Sequestration is a fitting symbol of all that has gone wrong with the budget process. It is misdirected, cutting the part of the budget that is least threatening to our fiscal future. Sequestration is also ill-timed, forcing immediate cuts despite a fragile economic recovery even though the more serious deficit problem is over the medium- and long-term. And sequestration makes cuts in a mindless, across-the-board manner that negates the whole concept of congressional priority-setting. 

At a minimum, the conference committee on the budget should find a way to adjust this policy in a deficit-neutral manner.

Committee members begin with a $91 billion gap between the House and Senate discretionary spending allotments in their budgets for Fiscal Year 2014, which began Oct. 1. Essentially, this is the difference between sticking with the original caps agreed to in the BCA and the lower caps (sequestration) that were imposed automatically because the 2011 “super committee” failed to agree on a broader budget deal.

Sequestration was the Sword of Damocles that was supposed to be so threatening and irrational that neither party would allow it to go into effect. That hope proved overly optimistic. The sequestration caps are now in force and are projected to cut $995 billion in spending in the 2014-2023 budget window. 

Since those savings are counted in the more favorable deficit projections that both sides want to preserve, altering the sequester will require corresponding cuts in mandatory spending programs or increased revenues. The amount of such alternatives will depend on how much of the sequester the committee wants to change. For example, shutting off sequestration in 2014 alone would require $89 billion of offsets. Shutting it off for two years would require $188 billion. Repealing it through 2021, when the sequester expires, would require $995 billion.

The first-year savings are modest enough that offsets could probably be found with some minor combination of mandatory spending cuts and user fees, which are scored as “negative outlays” in the budget rather than as new revenues or taxes. That type of short-term patch would not solve much but would at least avoid another budget crisis in January.

The more ambitious the committee wants to be, the more likely it will have to get into health care savings and revenue-raising tax reform. While there are deep divisions between the parties in these two areas, there is also a surprising amount of consensus on the direction that policy reforms should take. 

It is generally acknowledged, for example, that additional health care savings can be found in delivery reforms that move away from rewarding quantity of services provided and towards the quality of care.

And on revenues, it is generally acknowledged that the tax code needs an overhaul to scale back wasteful and unnecessary “tax expenditures” that act as subsidies for favored activities or industries. 

The desire on the part of both parties to adjust sequestration could serve as a springboard for negotiations on these more fundamental issues and produce greater, smarter deficit reduction.

Health Care

Perhaps the most encouraging news on the fiscal front is a developing consensus among fiscal and health care policy experts about the steps needed to move the nation towards a less costly, more effective and more patient-centered system. 

In addition, health care cost growth has at least temporarily slowed -- providing further encouragement for policymakers to get legislative changes right.

There have been numerous reports from think tanks and bipartisan commissions over the last few years, and nearly every group developed plans that would accomplish two very important but distinct goals. 

First, they found scorable savings within the 10-year budget window -- important because that is what will get them into the conference committee discussion. And second, they chose reforms that would spur a longer-term transformation in the health care system -- making it better while having savings grow even more beyond the budget window. The plans anticipate that because of the federal government’s market power through Medicare and the tax code, the changes would filter through to the private sector, transforming the health care system as a whole. 

These groups also developed their plans with a keen understanding of the political difficulties inherent in getting health care reform legislation passed. The fact that they ended up producing such similar plans offers hope that if the legislative process were to provide an opening, the groundwork would be there for effective, bipartisan solutions. 

The similarities among the key parts of these proposals and the proposals in the President’s budget -- as well as, to some degree, the House Republican and Senate Democratic budgets -- add to this hope. That is why there is a chance to achieve health care savings, and in the right way, from the conference committee discussions.

The basic agreement is that the most politically acceptable and orderly way for the U.S. to transform its health care system is by nudging it to become more efficient, less costly and more effective. Policymakers need to shift how providers practice medicine by changing how they get paid. They also need to alter patients’ sensitivity to health care costs.

The first change, and the one with the most adherents, involves a shift away from fee-for-service medicine -- which encourages maximal resource use -- towards a value-based system, which would reward effectiveness and efficiency. This shift could be achieved through Medicare provider payment reforms, building in part on the experiments and pilot projects from the Affordable Care Act (ACA).

Many bipartisan plans also envision a new and comprehensive “value-based” insurance product within Medicare, designed to pay providers for outcomes instead of per service. 

The ACA attempts to set up outcome-based payments through a hodge-podge of initiatives. One such attempt is “payment bundling,” in which a group of providers is paid a single amount based on a set of services or an episode of care -- such as a procedure payment including follow-up with a nurse, or a payment for managing a chronic disease like diabetes. 

Care coordination is another promising area of experimentation. This calls for a group of providers to receive extra funding to manage the full care of a patient -- through professionals dedicated specifically to the task, through a reorganization of practice norms, or perhaps as part of a program to transition patients between the hospital and home.

The second piece of reform involves altering the behavior of patients by making them more sensitive to health care costs. The most consequential means through which most think tank plans attempt this shift is by changing the tax treatment of health insurance. However, there are  smaller options that the conference committee might find more amenable, including increasing cost-sharing, reducing premium subsidies for upper-income beneficiaries or introducing a universal deductible in Medicare. Increasing the use of competition in government insurance programs could also lead to patient-driven cost reductions.

Congress also needs to fix the Sustainable Growth Rate (SGR) mechanism -- which determines doctor payments in Medicare -- by the end of the year. This will provide another opportunity to enact some changes in the health care system. There are already bipartisan efforts underway in Congress to permanently end the need for annual “doc fixes” and replace the flawed SGR with a doctor payment system that encourages care coordination and value-based payments. Ideally, the budget conference can pave the way for agreement on a new mechanism to end the annual SGR charade.

Tax Expenditures

On the surface, the split over spending cuts and tax increases in the House and Senate budgets seems stark. Lost in the rhetoric, however, is that the basic case for eliminating or scaling back tax expenditures fits the agenda of both sides. In fact, both budgets actually call for such a reduction, albeit with different consequences for the deficit.

Tax expenditures are a major problem. They are large and growing. Because many deductions are reserved for the only 30 percent or so of taxpayers who itemize, they are regressive and primarily benefit wealthier taxpayers. They misallocate economic resources. And they typically serve no legitimate social purpose that couldn't be better served at far lower cost through other means.

Basically, tax expenditures are economically identical to entitlement spending programs, and inefficient ones at that. Recognizing that reductions in tax expenditures are the same as spending cuts, actually reducing the size and scope of government, is one major piece on the road towards bipartisan agreement.

Furthermore, the fiscal cliff deal of Jan. 1, 2013, which allowed tax cuts to expire for households with $400,000 of annual income and above, ended any realistic discussion of tax rate increases for the present -- which should also pave the way closer to agreement.

Yet the door should not close on revenue increases as part of a long-term budget plan. Ample room exists to raise revenues by eliminating or scaling back the roughly $1 trillion a year in tax expenditures through credits, deductions, exemptions and exclusions. 

Indeed, such base-broadening and deficit-reducing tax reform was a major part of the bipartisan Simpson-Bowles and Domenici-Rivlin budget recommendations.

House Ways and Means Committee Chairman Dave Camp (R-MI) has been holding hearings on base-broadening ideas all year. Last summer, the concept was given a further boost in a letter from the Senate Finance Committee’s chairman and ranking member  -- Max Baucus (D-MT) and Orrin Hatch (R-UT) – to their colleagues.

The letter explicitly embraced the tax reform strategy of creating a “blank slate.” It would begin with the elimination of all tax expenditures and then add back only those that could be justified by helping to grow the economy, making the tax code fairer, or effectively promoting other important policy objectives.

The tax reform discussion may seem easier politically if the revenue goal and desired rate structure are set aside in advance. However, this puts the cart before the horse. As we have seen in multiple attempts to reach a grand bargain, determining these levels has been a major impediment. But without agreement on them first, there is no context for further discussion, and the likelihood of tax reform resulting in fiscal sustainability is diminished. Ultimately, taxes and spending cannot be considered in separate silos.

The largest tax expenditures include the exclusion from income of employer-provided health insurance ($132 billion a year), the home mortgage interest deduction ($70 billion), the Earned Income Tax Credit ($61 billion), the Child Credit ($57 billion), and the charitable contribution deduction ($39 billion).

Policymakers must be honest about which tax benefits would be lost and what the payoffs would be. Changing the definition of what constitutes a spending cut versus a tax increase would not bridge all the policy differences or produce all of the deficit reduction needed to put the budget on a sustainable path. It would, however, be a more useful way of assessing the true impact of various policies. 

Suppose, for example, that the two sides agreed to find $600 billion of tax expenditure cuts. The economic effect would actually be the same as a spending cut, not a tax increase, and should be treated accordingly in assessing the balance of any budget deal. It would also mean that the two parties are not as far apart as a traditional view of budget scoring makes them appear.

Overall Criteria For a Budget Deal

The conference committee budget should strive for a deficit path that trends downward over the 10-year budget window -- at a minimum, stabilizing the debt by the end of the period. The plan should produce a cumulative deficit within the budget window that is smaller than what is projected under current law, and it should not include a “cliff effect” – an explosion in the deficit just beyond the budget window. 

This budget path must be based on realistic assumptions and reject the use of procedural tricks and gimmicks to hide costs or circumvent budgetary limits. Clever accounting does not fool the economy. 

Stabilizing the debt over the short term is only the first step in meeting a far greater fiscal challenge. A sound budget plan must lay the foundation for dealing with the fiscal consequences of an aging population. Policy changes are needed to ensure that benefits are sustainable and affordable, so that both beneficiaries and taxpayers can know what to expect in decades to come. 

Since all Americans would enjoy the fruits of sound fiscal policy, no group except for the very needy should be exempt from contributing to a sustainability plan. Those Americans who can more readily shoulder some of the burden should be asked to do so. Narrowly targeted tax breaks or spending provisions for businesses or individuals do not belong in a deficit reduction plan. Even if fully offset, such political pork diverts resources from more pressing needs and increases public cynicism about the fairness of the federal budget process. 

Moreover, no generation should be exempt from shouldering some responsibility for this national problem. Programs and benefits for senior citizens comprise more than one-third of total outlays. Exempting them would place an even greater burden on our children and grandchildren. Everything must be on the table.

A successful plan must be capable of resisting pressure to undo the tough choices it contains. The best way to ensure that a plan can stand up over time is to infuse it with broad bipartisan support from the beginning. This requires that priorities be set and compromises made. Starkly partisan budget proposals may appeal to true believers and party loyalists, but a credible plan to reduce the deficit and replace sequestration is unlikely to succeed over the long term without sufficient political will to enforce it.

Conclusion

Expectations may be low for the budget conference committee, but this need not become a self-fulfilling prophecy. A clear consensus exists that current fiscal policies are unsustainable. Short-term patches may be adequate to avoid another crisis immediately but they cannot postpone forever the fundamental choices that must be made. If the conference committee can get beyond tired partisan talking points, it has a valuable opportunity to break the gridlock. It is not a “super committee” but can do super work by reaching consensus on a way forward that can be filled in by the appropriate committees of jurisdiction through regular order. 

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