Seven Signs of Fiscal Sense: What to Look for in the President's Budget

Issue Brief
Friday, February 03, 2006

On Monday February 6, President Bush will unveil his Fiscal Year 2007 budget. A thorough evaluation of how it all adds up must await the details, but based on proposals outlined by the President in his State of the Union Address as well as statements by other administration officials, it is possible to anticipate the broad outlines of the budget and the main arguments that will be used to support it. In addition, previous budgets submitted by President Bush contain proposals and signal issues that may come up again.

This issue brief previews what to look for in the FY 2007 budget based on The Concord Coalition’s Seven Signs of Fiscal Sense. These criteria, which were established to help sort through the strengths and weaknesses of deficit reduction plans, are as follows:

1. Does the budget achieve actual deficit reduction?

2. Does the budget build on realistic assumptions?

3. Does the budget contain offsets for new initiatives?

4. Does the budget achieve a path of sustainable deficit reduction beyond the forecast window?

5. Does the budget share the burden of deficit reduction across generations and income levels?

6. Does the budget establish credible enforcement mechanisms?

7. Is the budget politically viable over the long-term?

A confluence of factors makes the FY 2007 budget significant. This is the first of the Bush administration budgets where the five-year window must account for baby boomers turning 65 and qualifying for both Social Security and Medicare benefits. It is also the first budget that has to account for the cost of extending the 2001 tax cuts beyond their current law expiration date at the end of 2010. Finally, it is an election year—not exactly the best atmosphere for proposing hard choices. These factors make it all the more important to scrutinize the budget for fiscal sense.

1. Does the budget achieve actual deficit reduction?

A true deficit reduction plan should achieve a deficit path that trends downward smoothly over the budget window with progressively smaller deficits year-by-year relative to current law; produces a cumulative deficit within the budget window that is smaller than what is projected under current law; and does not harbor a “cliff effect” – an abrupt explosion in the deficit just beyond the budget window. A budget plan that backloads deficit reduction is suspect since political and economic forces make out year deficit targets less likely to materialize.

Scrutinizing the deficit path

The President’s budget will begin with a deficit that is going up. Administration officials have said that the FY 2007 budget will show a deficit in excess of $400 billion for the current year (FY 2006). This would represent a 25 percent increase over the $318 billion deficit in FY 2005 and rival the FY 2004 deficit of $412 billion for the highest ever in dollar terms. Measured as a percentage of the economy, a $400 billion deficit would be 3.1 percent, up from 2.6 percent in 2005.

The Congressional Budget Office (CBO) has also projected an increase in the deficit this year, ranging from $337 billion to $360 billion depending on what is assumed regarding further supplemental spending.[1] The CBO and administration numbers are not necessarily at odds because the Administration’s deficit projection includes policy proposals that will be contained in the President’s budget. Still, the administration’s higher number may lead to claims in September that the deficit “is coming down” if it comes in at something closer to the CBO number ¾ even though this would constitute a substantial increase over the 2005 deficit.

Administration officials have attributed the FY 2006 deficit increase primarily to relief efforts in the Gulf Coast region following Hurricane Katrina. They have indicated that Katrina-related relief (both spending and tax breaks) will be temporary and that the budget will show the resumption of a downward trend in the deficit. Assuming that Katrina relief is a one-time event with no lingering effect suggests that after the new funding spends out, the deficit should be similar to what the Administration projected in its July 2005 Mid-Session Review, released just a few weeks before the hurricane hit. If so, this would be a very precipitous drop ¾ all the way down to $162 billion in 2008 and 2009.

Prior Bush administration budgets have assumed substantial improvements between the first and third years, but such optimistic projections are hard to turn into reality. For example, the FY 2003 budget showed an $80 billion deficit in FY 2003 turning into a $61 billion surplus by FY 2005. The actual figure in FY 2005 was a deficit of $318 billion. Similarly, the FY 2004 budget showed a deficit of $307 billion that year declining to $201 billion by 2006. As it turns out, the FY 2006 deficit is likely to be about twice that amount. The FY 2005 and FY 2006 budgets also showed dramatic improvements within a short time frame. It remains to be seen how these projections will turn out, but experience suggests that careful scrutiny should be given to projections of a rapidly declining deficit three years into the future.

Thus, the first thing to look for in the new budget is the assumed deficit trajectory. A sure sign of a suspect budget plan is a sudden plunge in the deficit. Such events can occur, as last year’s decline of $94 billion demonstrates, but rarely do they occur as the direct result of policy initiatives (i.e., spending cuts or tax increases). If the President’s budget contains a steep decline in the deficit, it will be important to examine the reasons:

  • Is it because of explicit policy choices recommended in the budget?
  • Is it because of baseline assumptions regarding the economy, revenue growth or discretionary spending?
  • Is it because of scoring technicalities such as assuming a revenue windfall from the Alternative Minimum Tax (AMT) or that no new supplemental funding will be requested for military activities in Iraq and Afghanistan?

Cutting the deficit in half

The overall fiscal policy goal of the Bush administration is to “cut the deficit in half” by 2009.[2] Adherence to this goal is often cited by the administration as evidence of its commitment to fiscal discipline and to ease fears of a rising deficit. It thus deserves careful scrutiny when the budget is presented. Relevant questions include:

  • How much actual deficit reduction is needed to meet the goal?
  • Is the goal realistic given the administration’s policy initiatives?
  • How meaningful is the goal relative to the fiscal challenges we face?

How much actual deficit reduction is needed to meet the goal?

The short answer is: not much. It may come as a surprise to many who have heard the President speak of his progress in “cutting the deficit in half,” but it would be possible for the administration to hit its mark with a deficit as high as $343 billion in 2009 ¾ an amount higher than last year’s $318 billion deficit.


The official goal begins with the 2004 deficit. However, the calculation does not begin with the actual 2004 deficit, but with the 2004 deficit that was projected by the administration in February of that year. The distinction is important because the February deficit projection ($521 billion, 4.5 percent of GDP) was considerably higher than the final result ($412 billion, 3.6 percent of GDP). The table below shows the difference.

Table 1. Deficit Reduction is Relative to the Starting Point

Projected FY 2004 Deficit

Actual FY 2004 Deficit

Billions of $

Percent of GDP

Billions of $

Percent of GDP

Starting point





Cut in half





Establishing deficit reduction as an official goal is a positive thing because it keeps at least some pressure on policymakers, including the administration, to avoid actions that would jeopardize the goal by expanding the deficit ¾ whether through increased spending or lower revenues.

Within the administration’s framework, however, a deficit as high as $343 billion in 2009 (2.25 percent of projected GDP) could be deemed half of the 2004 deficit ¾ even though the actual reduction from 2004 to 2009 would be just 17 percent in dollar terms and 38 percent when measured as a share of GDP.[3]

In short, while the goal of cutting the deficit in half may sound impressive, not much heavy lifting is required to meet the standard the administration has set for itself.

Is the goal realistic given the administration’s policy initiatives?

The goal is very realistic in the abstract. What may make it difficult is the policy proposals contained in the budget, likely costs omitted from the budget (such as war costs) and the absence of likely revenues assumed in the budget (such as AMT receipts).

The best way to assess the budgetary impact of the policy proposals in the President’s FY 2007 budget is to measure them against the non-partisan CBO baseline. As described by CBO, the baseline represents its “best judgment of how the economy and other factors would affect federal revenues and spending if current laws and policies remained the same.” It is not a prediction, but rather “a neutral benchmark against which to measure the effects of proposed changes in tax and spending policies.”[4] The most recent CBO baseline was published on January 26, 2006 in The Budget and Economic Outlook: Fiscal Years 2007-2016 (Table 2).

The CBO baseline shows a steadily downward trend in the deficit with small surpluses emerging by the end of the 10-year forecast period. The deficit falls to $241 billion in 2009, well within the administration’s definition of cutting the deficit in half.

Over the five-year horizon used by the Bush administration, the baseline deficit falls to $114 billion (0.7 percent of GDP) by 2011 assuming that Congress:

  • Funds current programs, including war costs and hurricane relief, at this year’s level adjusted for inflation throughout the next five years;
  • Funds all scheduled benefits;
  • Adds no new spending, and
  • Follows current law for tax provisions, including scheduled sunset provisions.

The cumulative deficit over the next five years under the baseline is $1.1 trillion.

Table 2. CBO Baseline Projections, January 2006






















In billions of dollars


On-Budget Deficit















Off-Budget Surplusa















Total Deficit


















Social Security Surplus















Postal Service Outlays
















As a percentage of GDP


Total Deficit
















Debt Held by the Public
















Source: Congressional Budget Office.


Note: n.a. = not applicable.


Off-budget surpluses comprise surpluses in the Social Security trust funds as well as the net cash flow of the Postal Service.

When the budget is released, it will be important to look at how the CBO baseline compares with the administration’s baseline. In the recent past, the administration has used a unique baseline calculation that assumes permanency of the tax cuts enacted in 2001 and 2003. The sunsets on those tax cuts, which were written into law, are simply assumed to not exist. The effect of this is to minimize the apparent impact of the President’s policy proposals.

This issue will be particularly relevant to the FY 2007 budget because it will be the first of the administration’s budgets to show the bottom line effect of making the 2001 and 2003 tax cuts permanent. Up until now, the five-year budget window used by the administration since enactment of the tax cuts has closed before the legislated tax cut “sunsets” appear in 2011.

Estimates by the Joint Committee on Taxation indicate that the one-year revenue loss of extending the tax cuts in 2009 would be $20 billion. By 2011, however, it would be $154 billion. Preventing the deficit from trending upward in 2011 and beyond will require aggressive spending cuts or a level of economic growth that seems improbable.

How meaningful is the goal relative to the fiscal challenges we face?

The President’s very modest goal of cutting the deficit in half by 2009 is a significant retreat from the bipartisan balanced budget consensus that developed in the late 1990s. It is easy to forget now, but when President Bush took office in 2001 a bipartisan consensus existed that the budget should not just be balanced but should be balanced excluding the “off-budget” Social Security surplus. That goal was actually achieved in 1999 and 2000. It was a responsible fiscal policy goal because it had as its objective a much needed boost in national savings to help prepare the budget and the economy for the challenges of an aging population.

In recent years, we have drifted far from that goal. The deficit in 2005 was $494 billion excluding the Social Security surplus, not the deficit of $318 billion that is the most commonly used measure.

While it is a plus that the President is promising deficit reduction ¾ thereby acknowledging that the deficit is a problem ¾ his halfway goal trivializes the full magnitude of the fiscal challenges ahead. Even if the policies in the budget succeed in halving the deficit by 2009, regardless of how that is defined, what policies will be proposed to prevent deficits from ballooning again after 2009 due to rising entitlement costs and, if enacted, the permanent extension of expiring tax cuts?

The administration’s fiscal policy rhetoric is fixated on a goal that is too modest and a timeframe that is too limited. Analysts of diverse ideological perspectives and nonpartisan officials at CBO and the Government Accountability Office (GAO) have all warned that current fiscal policy is unsustainable over the long-term. Undue focus on whether the President can “cut the deficit in half” by 2009 diverts attention from the more vital and daunting long-term fiscal challenge.

2. Does the budget plan build on realistic assumptions?

A fiscally responsible budget plan must be based on realistic, attainable assumptions, and reject the use of procedural tricks and gimmicks to hide costs or circumvent budgetary limits. Inclusion of such procedural smoke screens is a strong signal that a plan lacks credibility.

In past budgets, the Bush administration has not accounted for some significant ongoing expenses and new initiatives. For example, the FY 2006 budget left out any accounting for Social Security reform even though it was a major presidential priority and policy initiative. The administration has also consistently failed to include funding estimates in their budgets for military operations in Iraq and Afghanistan. And, while the budgets are supposed to be five-year blueprints, they have normally assumed only one year—at the most—of Alternative Minimum Tax (AMT) relief even though the administration supports further extensions. How the administration treats these items in this year’s budget will offer the initial evidence as to whether its plan meets the “realistic assumption” test.

Relevant questions about the assumptions underlying the President’s budget include:

· Does the budget include realistic estimates for continued war costs and hurricane relief?

· Does the budget assume that policies supported by the President will expire to limit their costs on paper?

· Are the estimates about savings in the health care system realistic?

· Are the levels of discretionary spending realistic and attainable in the out years?

· Does the budget rely on overly optimistic assumptions about revenues?

Does the budget include realistic estimates for continued war costs and hurricane relief?

According to CBO, Congress has approved ten supplemental appropriation requests for military operations in Iraq and Afghanistan totaling about $323 billion, none of which were included in the President’s original budget requests. CBO has indicated that at the current rate of approximately $7.5 billion spending per month for military operations in Iraq and Afghanistan, Congress would need to appropriate an additional $40 billion beyond the $50 billion “bridge fund” enacted last December for fiscal year 2006, which would increase outlays in FY 2006 by $20-$25 billion. Indications are that the President will ask for up to $70 billion in FY 2006 supplemental funds in the FY 2007 budget, which would bring total funding for FY 2006 up to $120 billion.

Even if the President’s budget does contain additional funding for this year, the larger issue is what assumptions are made for military operations within the five-year budget window (FY 2007-2011). According to some reports, the President may include a placeholder request of roughly $50 billion for military operations in 2007. This would be better than assuming no additional funding, but it seems clear that more will be needed both in 2007 and beyond. Assuming only $50 billion over five years for military operations in Iraq and Afghanistan would clearly not be an accurate reflection of administration policies or likely expenses.

Another item to watch will be how the budget accounts for Hurricane Katrina relief and rebuilding. Although a substantial amount of rebuilding funds are in the pipeline already, the administration, as well as members of Congress and local leaders, all agree that more funding will be needed. The question is whether there will be some estimate in the budget for these funds, as there should be, or if it will be left for a supplemental request later in the year. Press reports indicate that the President’s budget will assume an additional $18 billion in funding for a hurricane relief supplemental.

Does the budget assume that policies supported by the President will expire to limit their costs on paper?

The administration has consistently expressed support for AMT relief.[5] The AMT is intended to prevent high-income taxpayers from escaping income taxes through extensive use of tax preferences. However, it is capturing more and more taxpayers who weren’t meant to be targeted. Because it is not indexed to inflation, the number of taxpayers subject to the AMT will explode from 4 million in 2005 to nearly 50 million by 2016, if the tax cuts are extended, and 33 million if they are not. The 2003 tax bill contained a provision temporarily increasing the AMT exemption amount to prevent more taxpayers from being subject to the AMT for one year. Congress extended this exemption for one year in 2004 and legislation extending it for another year is likely to be enacted in the coming weeks.

The President’s FY 2005 budget proposed a one-year extension of AMT relief. Last year’s budget did not include any funding for AMT relief based on the stated assumption that AMT relief would be enacted as part of revenue neutral tax reform. Given the broad bipartisan support for AMT relief, it is not realistic to assume that AMT relief will be allowed to expire after being extended for just one year. It is also unrealistic to assume that a permanent AMT fix will be enacted as part of revenue neutral tax reform since the administration and leading members of Congress have already rejected the options recommended by the President’s Tax Reform Commission to offset permanent repeal of the AMT.

A realistic projection of the likely deficit must include the cost of permanently extending AMT relief. According to CBO, extending the AMT relief enacted in 2003 would add $233 billion to the deficit over the next five years — $60 billion in 2009 alone. A full fix of the AMT ¾ to prevent the alternative tax from negating promised tax cuts and becoming the de-facto tax calculation for the upper-middle class ¾ would cost substantially more.

Are the estimates about savings in the health care system realistic?

The principal domestic initiative in the President’s State of the Union Address was a package of proposals intended to improve the availability and affordability of health care. The centerpiece of his proposal is expanding Health Savings Accounts (HSAs) and eliminating all taxes on out-of-pocket spending through HSAs. The administration’s FY 2006 budget included a similar but more modest proposal that CBO estimated would cost $33 billion over five years.

Previous administration budgets relied instead on a “magic asterisk” – an unspecified offset assumed in the numbers -- to offset the costs of refundable health care tax credits. Alternatively, the administration could rely on optimistic feedback assumptions about the savings in the health care system that will occur as a result of its policies.

Supporters of this approach argue that the high deductible insurance policies in Health Savings Accounts will restrain health care costs by reducing unnecessary utilization of care and using market forces to squeeze out inefficiency in the system. However, analysis by the Urban Institute and others have found that the vast majority of health care expenses are related to catastrophic illness or the end of life, which would not be affected by the market forces associated with HSAs since those costs are well in excess of even the high deductibles in HSAs.[6]

The President’s proposal is similar to, although considerably less expansive than, a proposal put forward by economists John Cogan and Glenn Hubbard and law professor Daniel Kessler in the book, Healthy Wealthy and Wise ¾ Five Steps to a Better Health Care System. They estimated that savings in health care costs and other interactions under their proposal would offset more than two thirds of the gross cost, which they estimate at $27 billion a year. The administration may try to limit the projected cost of the President’s initiatives by relying on similarly optimistic assumptions about the savings in health care costs that will result from the HSAs proposal. While the proposals may result in some savings in health care expenditures, there is little hard evidence to prove or disapprove this assumption. It is overly speculative to rely on assumptions that any proposal will substantially pay for itself by reducing health care expenses to offset the costs of expanding the tax advantages of health savings accounts. Are the levels of discretionary spending realistic and attainable in the out years?

It will also be important to pay attention to the assumptions the budget makes about future discretionary spending. Spending restraint is crucial to deficit reduction, but any projection of a five-year freeze, or even a cut in domestic discretionary spending over a multi-year period is unrealistic given the normal rate of spending growth. Between 2001 and 2005, appropriations for domestic spending other than homeland security increased by an average of 4.6 percent a year, from $338 billion in 2001 to $404 billion in 2005 (excluding appropriations for hurricane relief).

While most of the attention will be focused on the specific proposals to reduce domestic discretionary programs in FY 2007, the budget will likely include much larger unspecified savings in discretionary programs in subsequent years. But that assumption must be tempered by the reality that this category of spending has steadily remained at about 3.5 percent of GDP since the late 1980’s. The President’s FY 2006 budget assumed that non-defense discretionary spending would decline to less than 3 percent of GDP by 2010, even with increased spending for homeland security programs. Non-defense discretionary spending has never been below 3 percent of GDP since the statistic was first recorded in 1962. It has grown from 3.4 to 3.8 percent of GDP since 2001.

It is obviously much easier to incorporate assumptions about reductions in discretionary spending in future years than it is to put together specific proposals to keep spending within those limits. Holding non-defense discretionary spending (excluding emergencies) for FY 2007 to the level assumed in last year’s budget will require the administration to reduce spending by $7 billion below the $411 billion appropriated last year. The administration’s ability to follow through on projections of unspecified savings for FY 2007 with specific policies in this years’ budget will provide an indication of their commitment to adhering to the austere discretionary spending assumptions in subsequent years. It will be increasingly difficult to meet this challenge in each subsequent year as the magnitude of the reductions increases.

Previous administration budgets have relied on user fees to offset part of the costs of discretionary spending programs. Most of these proposals have been repeatedly rejected by Congress and are unlikely to fare any better this year.[7] Without these offsetting user fees, the magnitude of the reductions that will be necessary in discretionary appropriations to stay within the overall discretionary spending levels in the President’s budget will be much greater.

Similarly, in the past the administration has assumed considerable savings from the elimination of spending on Congressional earmarks. Not only is it unlikely that Congress would agree to such a thing, but also the administration has had numerous opportunities to veto earmark-laden spending bills or propose to rescind specific earmarks, and has not done so. A sign that the President is serious about his pledge to control earmarks would be to submit a list of proposed earmark rescissions and other low-priority spending approved last year and call on Congress to vote on those rescissions.

Does the budget rely on overly optimistic assumptions about revenues?

The final area to watch is the administration’s projections and discussion of the trends in revenue. On the projection side, it will be important that the administration does not rely on assumptions showing overly large increases in revenues based on the unexpectedly high tax receipts from FY 2005. While these might be helpful in showing lower deficits, past history has shown that longer-term projections based on optimistic estimates are often dramatically wrong.

In 2001, the administration and CBO projected surpluses of $5.6 trillion over the next ten years, based in large part on the assumption that the strong revenue growth in the late 1990s would continue. (Although it should be noted that CBO warned policymakers that the projections were highly uncertain and there were no guarantees that the factors that caused revenues to increase rapidly in the late 1990s would continue.)

The recent increase in revenues has occurred over a much shorter period of time and provides much less evidence to determine whether the trend will continue than the revenue increases of the late 1990s that led to the projections of large surpluses in 2001. Consequently, any assumptions regarding revenue growth in the next few years based on the recent growth in revenues would be even more uncertain than the projections made in 2001. Treasury Secretary John Snow recently acknowledged that the budget forecasts made in 2001 demonstrate the risk in making projections based on the assumption that recent trends will continue.[8] Policymakers should not repeat the mistakes of 2001 by allowing improvements in the budget outlook from higher than expected revenues to serve as an excuse to relax fiscal discipline.

On the administration’s discussion of the recent trends in revenue, it will be important to put the revenue trends in context. FY 2005 saw a large increase in revenue from FY 2004—up by 14.6 percent to $2,154 billion. While this was a record in dollar terms, larger than the previous record of $2,025 billion in 2000—it still represented a much lower percentage of GDP than in 2000—17.5 percent of GDP as opposed to 20.9 percent. Revenues in 2005 were approximately $140 billion lower than 2000 revenues adjusted for inflation.

It is true that total revenues set a record in nominal dollars in 2005 and almost certainly will do so again in 2006. Setting a record for revenues in nominal dollars is not remarkable; revenues almost always set a record in nominal dollars every year as revenues naturally increase with inflation, economic growth and other factors. What is remarkable is that revenues did not set a record in the previous four years and the record set in 2000 was not broken until 2005. Revenues declined in nominal terms for three years in a row between 2001 for the first time since the 1920s. It is also important to note that the $2,473 billion in spending in 2005 was also a record in dollar terms.

While total revenues finally climbed back above 2000 levels in nominal dollars last year, revenues from individual income taxes were still well below 2000 levels. Individual income taxes totaled $927.2 billion last year, roughly 7.5% lower than the $1,004 billion collected in 2000. Adjusted for inflation, revenues from individual income taxes in 2005 were nearly 19% below 2000 levels. Total revenues in 2005 exceeded 2000 levels primarily as a result of the steady growth in social insurance revenues (which have increased from $653 billion in 2000 to $794 billion in 2005) and to a lesser extent the surge in corporate tax collections ($278 billion in 2005 compared to $207 billion in 2000).

Furthermore, the increase in revenue was aided by a one-time jump in corporate tax receipts due to the expiration of a tax break on business equipment depreciation and the one-year amnesty for repatriation of overseas profits. However, the strong economy clearly aided in bringing up corporate receipts as well as substantial increases in personal income taxes and social insurance taxes.

Whether this increase in revenue reflects and depends on the tax policy of the administration is questionable. While short term economic growth can be assisted by lower tax rates under certain conditions — there can be little debate that the tax cuts are net revenue losers, i.e. that they have not paid for themselves.[9] An examination of the administration’s own numbers in Chart 1 illustrates this case well.

In its FY 2004 budget, the administration included a package of tax cuts that sped up some cuts in marginal tax rates they had included in their 2001 tax package, along with cuts in the Capital Gains and Dividend tax rates. They also included two projections—one for what revenues would be if none of their policies were enacted (their baseline)—and one for what revenues would be if their policies were enacted. When these projections are compared to actual revenues, one can see that even under the good economic growth of the last few years, total revenue fell short of both projections.

3. Does the budget plan contain offsets for new initiatives?

The first step in bringing the deficit under control is to stop digging the hole deeper. Rhetoric about deficit reduction will lack credibility if Congress continues to treat rising debt as a viable alternative to spending cuts or tax increases. Deficit reduction plans should only be taken seriously if new or expanded spending initiatives and new or extended tax relief is fully offset with spending reductions or tax increases.

Unlike previous years in which the President proposed tax cuts without proposing corresponding reductions in spending (and in many cases enacting substantial increases in spending such as the Medicare prescription drug benefit), the budget submitted by President Bush last year contained significant savings in mandatory spending programs as well as domestic discretionary spending cuts to accompany tax cuts. Unfortunately, those savings were more than offset by the costs of the President’s tax and spending initiatives. Spending restraint is crucial, but rhetoric about controlling the deficit won’t have much credibility so long as the President goes forward with tax cuts financed by borrowing.

Key questions to ask about the President’s budget include:

  • Are the costs of extending the tax cuts honestly acknowledged and offset?
  • How does the budget handle the issue of tax reform?
  • Does the budget rely on unspecified savings in non-defense discretionary spending to offset specific tax cut and spending increase proposals?

Are the costs of extending the tax cuts honestly acknowledged and offset?

The President reiterated his call to permanently extend all of the expiring tax cuts in the State of the Union Address. If deficit reduction and extending these tax cuts are both high priorities for the President, his budget should identify offsets for the estimated revenue loss. There are plenty of revenue offsets available. The Joint Committee on Taxation has identified over $350 billion worth of options to improve tax compliance and reform tax expenditures.

Supporters of the tax cuts under consideration argue that they are not new tax cuts, but simply an extension of expiring tax cuts previously approved by Congress. In fact, in the budget submitted last year the administration proposed to incorporate extension of the tax cuts into the baseline, which would make the extension appear costless when measured against that adjusted benchmark. This argument ignores the fact that extending these provisions requires legislative action that would result in a greater tax reduction (and higher deficits) than would be the case under current law.

The tax cuts are expiring because Congress included a sunset provision when they were passed to limit the official cost. This was done to fit them within budgetary limits established to gain the support of moderate Republicans concerned about the impact of the tax cuts on the deficit. Between 2001 and 2003, Congress enacted three tax cut packages with an official cost of $1.3 trillion between fiscal years 2004 and 2013. The cost of the tax cuts would have more than doubled -- to $3.1 trillion -- over that period if the tax bills had not included sunsets. Extending these tax cuts without considering their budgetary impact over the long term and exempting the costs from budget enforcement would undo the compromises made to limit the size of the tax cuts when they were originally enacted

The Concord Coalition criticized the use of sunsets to artificially limit the official cost of the tax cuts, but did note that they could serve a useful function as the ultimate trigger, requiring Congress and the President to re-evaluate whether the tax cuts were affordable when they expired. “As events unfold and we see whether future deficits are modest and manageable as the Administration hopes, it may make sense to adjust fiscal policy accordingly – perhaps removing some of the sunsets and allowing others to take effect. Although the sunsets were not designed to be taken seriously, fiscal responsibility may ultimately require that result.”[10]

Circumstances have changed dramatically since the tax cuts were enacted in 2001. Congress is no longer “refunding a surplus” to the taxpayers. The surplus era in which the tax cuts were enacted has been replaced by deficits as far as the eye can see, and the budget faces new demands for the war on terrorism and homeland security. A logical response to the dramatically changed budgetary conditions would be to reassess whether all of the tax cuts enacted during the surplus era should be extended now that we are facing deficits.

In light of the deteriorated fiscal outlook and the fact that we have not taken action to prepare for the costs of the baby boomers’ retirement and health care costs, it makes sense to offset the extension of some tax cuts by delaying, scaling back or rescinding others. Doing so would send a very positive signal that Congress is finally prepared to acknowledge that we can’t have it all and that choices must be made among competing priorities.

How does the budget handle the issue of tax reform?

Last January, the President appointed an advisory panel on tax reform to develop options to fundamentally reform the tax code to make it simpler, fairer, and pro-growth. The White House indicated that tax reform would be the President’s next major domestic policy initiative. As mentioned earlier, the administration relied on the tax reform panel to provide the solution to the problems created by the Alternative Minimum Tax. More broadly, tax reform was expected to be the administration’s avenue for advancing tax policy in the President’s second term following the sweeping tax cuts enacted in the first term.

On November 1, 2005 the President's Advisory Panel on Federal Tax Reform issued a report making several recommendations for reforms of the tax code. It did achieve the administration’s goal of addressing the AMT issue as part of a revenue neutral tax reform package. It also recommended several other proposals supported by the administration, including tax-advantaged savings plans, lower rates on capital gains and dividends and lowering the top marginal rates on individuals and businesses.

However, the panel also proposed to repeal or scale back several existing tax breaks, including limiting the deductibility of employer-provided health care, converting the mortgage interest deduction into a credit but limiting the amount of the mortgage on which the credit can be claimed, and repealing the deductibility of state and local taxes. Not surprisingly, these provisions were received with little enthusiasm from the President and Congress. The White House has distanced itself from these recommendations and has explicitly rejected the proposal to limit the deductibility of employer-provided health insurance.[11]

While the failure to include the proposals of the Advisory Panel on Tax Reform or other tax reform proposals represents a lost opportunity to improve the fairness and efficiency of the tax code, it would be much worse for the President’s budget to include some or all of the more politically popular, expensive elements of the panel’s report without embracing the tradeoffs recommended by the panel or alternative savings to offset those costs. It now appears that the administration will continue to pursue its goals of encouraging savings through tax advantages, reducing taxes on capital gains and dividends and maintaining individual tax relief outside the context of revenue neutral tax reform.

Does the budget rely on unspecified savings in non-defense discretionary spending to offset specific tax cut and spending increase proposals?

It is all too easy to offset tax cuts and spending increases in other areas by assuming unspecified savings in non-defense discretionary spending. As noted earlier, it is much easier to make assumptions about substantial savings in future discretionary spending than it is to identify specific reductions to achieve those savings. Last year, the President’s budget assumed savings of $133 billion in unspecified non-defense discretionary spending between 2007 and 2010. Achieving those savings would require Congress to make progressively larger cuts in non-defense discretionary programs: nearly 5 percent below the CBO baseline in 2007 and 10 percent in 2010. Under the President’s FY 2006 budget, non-defense discretionary spending would be $40 billion below CBO’s baseline by 2010. The inability of Congress and the President to follow through with the substantial savings in discretionary savings in the out years called for in the 1997 budget agreement casts doubt on the likelihood that assumptions of discretionary savings in the future will be realized. Meanwhile, the spending increases and tax cuts enacted with the promise of future savings in discretionary spending will remain in place.

4. Does the budget plan achieve a path of sustainable deficit reduction beyond the forecast window?

A fiscally responsible budget plan is one that achieves a smooth, sustainable path of deficit reduction during and beyond the budget window. Gaining control of the short-term deficit is only the first step in a far greater fiscal challenge. An explosion in entitlement spending associated with the retirement of the baby boom generation lurks just over the horizon. A sound budget plan must lay the foundation for dealing with the fiscal consequences of an aging America.

Although the President has promised to submit a budget plan that cuts the federal deficit in half by 2009, an explosion in entitlement spending just beyond the President’s budget window threatens the economic well-being of future generations.

According to the Congressional Budget Office (CBO), the combination of falling birth rates, increasing longevity and escalating health care costs will drive the projected costs of Social Security, Medicare and Medicaid from 8.4% of GDP today to 15.2% in 2030. The financial demands of these three programs will exert pressures on the budget that economic growth alone is unlikely to alleviate. Lawmakers must look beyond today and address the tough choices that lay just over the horizon.

There are several questions which will determine whether the President’s budget will keep the budget on a sustainable path after the five-year budget window:

  • Are the costs of policies beyond the five-year budget window acknowledged and displayed in the budget?
  • Does the budget address the need for entitlement reform?
  • Does the budget re-examine the Medicare prescription drug benefit?
  • Does the budget contain reforms that will control the rising cost of health care?

Are the costs of policies beyond the five-year budget window acknowledged and displayed in the budget?

In 2002, the Bush administration dropped the established practice of ten-year budgeting in favor of a five-year budget window. The change was instrumental in hiding the growing deficit in the latter half of the decade as the tax cuts were fully implemented. Unfortunately this myopic approach to budgeting has encouraged lawmakers to ignore the looming financial crisis associated with the retirement of the baby boom generation, and has left federal finances ill-equipped to deal with national emergencies (hurricanes, terrorist attacks, and energy price shocks). The fiscal impact of the baby boom retirement will start to show up within the five-year budget window this year, but using a ten-year budget outlook will provide a more complete view. Policymakers should be aware of and consider the budgetary outlook after 2011 when making decisions about whether or not we can afford certain tax or spending policies in the short term.

Does the budget address the need for entitlement reform?

In 2008, the leading edge of 70 million baby boomers will be eligible for Social Security; and in 2011, Medicare. Already the retirement costs of baby boom generation are emerging in the budget baseline. According to CBO’s most recent Budget and Economic Outlook, spending on Medicare and Social Security will increase from $941 billion to $1.85 trillion between 2006 and 2016. Already Medicare relies on general revenue transfers to keep the program afloat and by 2017, so too will Social Security. Left unchecked, these two programs will require significant tax increases, drastic cuts in discretionary spending, or both. The longer lawmakers wait to address the significant shortfalls in these programs, the harder it will be to protect current and near retirees from any changes. In the State of the Union the President highlighted these challenges and called for a bipartisan commission to address the impact that the baby boomers’ retirement will have on entitlement programs. It is now incumbent on him to follow through on this rhetoric.

Does the budget re-examine the Medicare prescription drug benefit?

Proposals to establish a prescription drug benefit first entered the political debate in the surplus era, but the proposals and price tag were not adjusted to reflect the return to deficits. In the face of such daunting budget deficits, it was irresponsible for Congress and the President to exacerbate the entitlement crisis with yet another expensive benefit for seniors. According to CBO, the new prescription drug benefit will add $30 billion to the FY 2006 deficit alone. Congress and the President should begin to look for ways to make the benefit more efficient, better targeted and less expensive.

Will the policies in the budget help control the rising cost of health care?

Today, Medicare and Medicaid comprise 21% of all federal spending ($515 billion). Spending for these health programs is projected to grow briskly over the next 10 years and by 2016, CBO estimates that the two programs will cost $1.3 trillion, or more than 30% of all federal spending. As long as the cost of delivering health care routinely exceeds economic growth (as it has since 1960), the federal government will have no other recourse but to continually ration care through benefit reductions and greater cost sharing while the ranks of the uninsured will soar. Clearly, resolving the financial crisis in Medicare and Medicaid requires reigning in rising health care costs. As discussed earlier, the administration’s health care plan relies primarily on Health Savings Accounts to control the costs of health care through market forces. The evidence is at best mixed as to whether this approach will have a significant impact on health care costs.

5. Does the budget plan share the burden of deficit reduction across generations and income levels?

All Americans will enjoy the fruits of a balanced budget. Thus, no economic group except for the very needy should be exempt from contributing to eliminating the federal budget deficit. Those who can more readily shoulder the burden should be asked to do so. 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, and exempting them would place an even greater burden on our children and grandchildren.

The “deficit reduction” efforts last year disproportionately affected low-income populations through cuts in Medicaid, Supplemental Security Income and other income support programs. Meanwhile, middle class entitlements and corporate subsidies were largely spared from the budget ax, and middle and upper income individuals benefited from yet another tax cut.

A disproportionately large share of current federal resources is devoted to the elderly while investments in future generations are held to a disproportionately small share. Yet, on the current policy path, future generations face the prospect of far higher tax burdens and substantially lower real benefits than enjoyed by today's adults.

Questions to ask about how the President’s budget addresses issues of fairness and generational equity include:

  • Does the budget spread the burden of deficit reduction between revenues and spending?
  • Does the budget call for savings in middle class entitlements and corporate subsidies, or do the proposals for entitlement savings disproportionately affect programs that serve low-income populations?
  • Does the budget address the burdens that will be placed on future generations by growing debt and the unfunded liabilities facing Social Security and Medicare?

Does the budget spread the burden of deficit reduction between revenues and spending?

Federal revenues at 17.5 percent of GDP are well below the level they have averaged as a percentage of GDP over the past 25 years (18.3 percent). Meanwhile, spending is at 20.1 percent of GDP, which is below the average over the past 25 years (21 percent). This suggests that it is revenues, and not spending, that have deviated from recent norms. However, the administration’s budget policies have relied exclusively on cuts in non-defense discretionary spending and entitlement programs to reduce the deficit while continuing to pass tax cuts. Relying on cuts in domestic spending programs to achieve deficit reduction puts greater burden on lower-income populations, while tax cuts inherently benefit higher income populations.

Does the budget call for savings in middle class entitlements and corporate subsidies, or do the proposals for entitlement savings disproportionately affect programs that serve low-income populations?

The entitlement savings proposed by the President in previous budgets have tended to affect lower income programs more heavily, while the administration has opposed mandatory savings proposals, which would affect insurance companies and the pharmaceutical industry. Many of the entitlement savings contained in the President’s budget last year that Congress rejected in putting together the spending reconciliation bill affected low-income programs.

Does the budget address the burdens that will be placed on future generations by growing debt and the unfunded liabilities facing Social Security and Medicare?

If the current generation fails to control the growth of our national debt and address the looming challenges facing Social Security and Medicare, future generations will face ever higher tax burdens simply to cover increasing interest payments instead of addressing other needs such as keeping our military the strongest in the world, protecting our domestic security, providing health care and investing in our education system. Our current policy course assumes that we can fight two wars, fund homeland security, rebuild the Gulf Coast, maintain full promised benefit levels for entitlement programs and keep cutting taxes, because we are going to send the bill to future generations. That is irresponsible and immoral. As the political process sorts out the individual winners and losers in the budget debate, policymakers should not lose sight of the gains or losses that will accrue to future generations.

6. Does the plan establish credible enforcement mechanisms?

Although process alone will never be able to solve the nation’s fiscal problems, budget mechanisms can bring greater accountability to the budget process and help provide Members of Congress with the political cover to make the tough choices necessary to reduce the deficit.

When Congress and the President were struggling with large and growing deficits in the 1990’s, the budget process was primarily aimed at reining in the deficit. The Budget Enforcement Act of 1990 established caps on discretionary spending and Pay-As-You-Go (PAYGO) limitations requiring offsets for new entitlement spending and tax cuts. The PAYGO rule helped to rein in deficits during the 1990’s by requiring anyone proposing entitlement expansions or tax cuts to answer the question: “How do you pay for it?” These mechanisms were extended with bipartisan support as part of the 1997 Balanced Budget Agreement, but Congress and the President allowed them to expire in 2002, and have failed to renew them or replace them with a new enforcement regime despite support from bipartisan majorities in both chambers.

Key questions to ask about any budget enforcement proposals in the President’s budget include:

  • Do budget enforcement rules apply equally to tax cuts and spending increases?
  • Do budget enforcement rules apply to all legislation, or are policies proposed by the President exempt from budget discipline?
  • Are discretionary spending limits set at reasonable levels?
  • Does the budget contain enforcement mechanisms to address long-term fiscal challenges?
Do budget enforcement rules apply equally to tax cuts and spending increases?

In previous budgets the President has proposed reinstating budget enforcement mechanisms establishing discretionary spending limits and PAYGO rules but exempt tax legislation from these rules. The only common sense way to restore fiscal discipline is to apply budget rules to all legislation that would increase the deficit. Since spending and tax decisions both have consequences for the budget, there is no good reason to exempt either from enforcement rules. Moreover, exempting tax cuts from PAYGO would encourage an expansion of so-called ‘tax entitlements’ where benefits are funneled through the tax code rather than by direct spending, a far less efficient approach. In addition, prohibiting tax increases from being used to pay for entitlement spending increases under PAYGO rules would create the notion that debt is a painless alternative to raising revenues necessary to pay for entitlement benefits.

The concept of applying PAYGO rules to all legislation which would increase the deficit, both spending and revenues, has received support from both sides of the aisle since it was originally enacted. “Two-sided” PAYGO was originally enacted in the bipartisan budget agreement of 1990 and extended in the bipartisan balanced budget agreement of 1997. Furthermore, it was included in the budget passed by the Republican Congress in 1995.

Applying PAYGO rules to tax cuts does not prevent Congress from passing more tax cuts. All it would require is that Congress must identify another source of revenue or reduce spending if it wants to enact or extend a tax cut.

Do budget enforcement rules apply to all legislation, or are policies proposed by the President exempt from budget discipline?

The other approach to watering down budget enforcement rules that has been included in previous administration budgets is to establish a “post-policy” PAYGO rule that only applies to legislation which would increase the deficit beyond the levels assumed in the President’s budget. This approach effectively exempts any initiatives proposed by the President from budget enforcement. This rule has limited value in imposing fiscal discipline because it essentially allows Congress to enact fiscally irresponsible policies as long as they were included in the President’s budget.

Are discretionary spending limits set at reasonable levels?

Previous experience has demonstrated that discretionary spending limits can be an effective tool for fiscal discipline if they are set at reasonable levels, but can actually work against fiscal discipline if they are set at unrealistic levels. The discretionary spending limits enacted in 1990 and extended in 1993 were quite successful in restraining discretionary spending. By contrast, the much more restrictive spending caps enacted as part of the 1997 budget agreement proved to be unrealistic and were effectively ignored, leaving no credible restraint on discretionary spending in place. As noted earlier, the President’s FY 2006 budget assumed substantial and growing reductions in non-defense discretionary spending that would result in spending far below historical norms.

Does the budget contain enforcement mechanisms to address long-term fiscal challenges?

The budget submitted by the President last year proposed a budget enforcement tool which would take a modest step toward acknowledging the long term fiscal problems by restricting the ability of Congress to enact legislation which would increase long term liabilities. This rule would only apply to legislation increasing entitlement spending and would not apply to tax cuts that would substantially increase the deficit in future years. The budget resolution adopted by Congress last year incorporated this proposal as part of Senate rules, establishing a new 60 vote point of order legislation that would increase mandatory spending by $5 billion or more in any of the four 10-year periods from 2015 through 2055. The Medicare prescription drug plan contained a provision requiring action by the President and Congress if general revenue spending for Medicare exceeded a certain threshold. The President’s budget should strengthen and build upon these proposals and extend the discipline to tax cuts with an impact on the long-term fiscal outlook as well.

7. Is the plan politically viable over the long-term?

A plan to reduce the deficit is unlikely to succeed over the long-term without sufficient political will to enforce it. 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, in turn, requires that priorities be set and compromises be made. Everything must be on the table.

In his State of the Union Address, President Bush acknowledged the “unprecedented strains on the federal government” that the growth of entitlement programs will place on the budget in the future, forcing future Congresses to confront, “impossible choices: staggering tax increases, immense deficits or deep cuts in every area of spending.”

His answer was to propose a bipartisan commission to examine the impact of the baby boom retirement on Social Security, Medicare and Medicaid and come up with bipartisan solutions, saying: “We need to put aside partisan politics and work together and get this problem solved.” The Concord Coalition agrees and has long maintained that only through bipartisan effort can these enormous long-term challenges be met.

However, there is a disconnect between this rhetoric and the President’s budget plans. His budget further increases the deficit and makes those long-term problems harder to solve. One reason it does so is because it only puts very narrow areas of the budget on the table for fiscal scrutiny, a problem in itself as mentioned above, but also a surefire recipe towards inciting partisan strife.

It is neither fiscally responsible nor politically viable to make cutbacks in limited areas of the budget while exempting most areas from scrutiny. It will be extremely difficult to justify maintaining tough choices on spending while continuing to go forward with every tax cut. The recent experience in Congress with the budget reconciliation package demonstrates exactly this difficulty.

Not only were the reconciliation spending cuts extremely difficult to pass, both numerically and politically, but the end result was a “deficit reduction package” that, when combined with the imminent passage of the reconciliation tax cuts, will wind up increasing the deficit. The particular cuts in mandatory spending (where much cutting will be needed in the future) were very unpopular—driving up opposition and creating leverage for individual members of Congress to pass provisions favorable to their specific constituencies but harmful to the overall deficit.

The better way to confront fiscal imbalance is to follow the example of the past three presidential administrations. Following his initial tax cuts and defense spending increases, President Reagan signed several tax increases and held the line on new spending, even for the military, once it became clear that deficits were on the rise. President George H. W. Bush negotiated a deficit reduction plan with a Democratic Congress that achieved $482 billion in savings; roughly 63 percent from spending cuts and 37 percent from new revenues. And in 1997, President Clinton and the Republican Congress negotiated an actual balanced budget plan that produced the nation’s first surpluses in 29 years.

As The Concord Coalition board said in a recent New York Times Ad: “If everyone insists on only cutting someone else’s priorities, talk about deficit reduction will remain just that. The best way to end this standoff is to agree on the common goal of deficit reduction, put everything on the table—including entitlement cuts and tax increases—and negotiate the necessary trade-offs…Unfortunately, actions have been wanting. Leaders must put the national interests ahead of partisan or parochial interests and develop a specific and realistic plan to put the country on a sustainable long-term fiscal path.”

[1] The higher figure assumes likely supplemental spending, primarily for military operations in Iraq and Afghanistan. CBO, The Budget and Economic Outlook: Fiscal Years 2007-2016, January 2006.

[2] For example, at his January 26 press conference President Bush said that the budget would be “one that says we can cut our deficit in half by 2009 and make sure the American people still get their tax relief.”

[3] This formulation was used by Treasury Secretary John Snow when he told the National Chamber Foundation on January 5 that, “[D]eficits matter and one of our highest priorities is to achieve the President’s goal of reducing our deficit in half to below 2.3 percent of GDP by 2009. (emphasis added).

[4] CBO, The Budget and Economic Outlook Fiscal Years 2007-2016, January 2006 p.5.

[5] For example, in his December 7, 2005 press briefing, White House Press Secretary Scott McClellan stated “The President wants to make sure that more middle-income Americans are not being hit by the alternative minimum tax, and that the tax relief we provided to those Americans, all Americans, is not taken away because of the alternative minimum tax.”

[6] See, Linda J. Blumberg, Lisa Clemans-Cope, and Fredric Blavin, “Lowering Financial Burdens and Increasing Health Insurance Coverage for Those with High Medical Costs,” Urban Institute, December 2005.

[7] The President's FY 2006 budget proposed more than $2 billion in new user fees to offset discretionary spending which were rejected by Congress, including an increase in airline passenger security fees, charging some veterans enrollment fees for medical care, explosives regulatory fees and Food Safety Inspection Service user fees.

[8] On the January 6, 2006 edition of CNBC’s Squawkbox, Snow responded to a question about revenues falling well below the projections in the administration’s FY 2002 budget by stating “all of us who do economic forecasting need to…be humble. Because this was a cataclysmic mistake. This was a classic mistake of forecasters building a forecast precisely on the past.”

[9] The White House Council of Economic Advisers concluded in its 2003 Economic Report of The President that “Although the economy grows in response to tax reductions (because of higher consumption in the short run and improved incentives in the long run), it is unlikely to grow so much that lost revenue is completely recovered by the higher level of economic activity.”

[10] May 28, 2003 Concord Coalition Issue Brief: “Sunsets Hide More Than Half of the Revenue Loss From Recent Tax Cuts.”

[11] “Bush Rejects Proposal to Tax Health-Care Benefits, Hubbard Says.” Bloomberg News, January 12, 2006.