We don’t usually involve ourselves in spending debates but the President’s budget proposal came out this morning and, given the sea of red ink ahead, we thought a quick overview of the budget process and challenges ahead might be in order.
The President’s budget would reduce the deficit by $1.1 trillion over the next decade b- two-thirds from spending cuts and one-third from tax increases. The proposed budget would trim or terminate 200 federal programs within the next year, reduce Pentagon spending by $78 billion, freeze non-security discretionary spending for 5 years, and increase spending in education, transportation and energy and medical research.
The budget also offers a 3-year paid-for patch for the Alternative Minimum Tax and calls on Congress to work with the Administration on budget-neutral corporate tax reform. Tax increases include allowing the 2001 and 2003 tax cuts for high-income earners to expire beyond 2012 and limiting the value of the itemized deduction for those same earners. Importantly, the budget does not include specifics on the President’s corporate tax reform proposal or any entitlement spending reforms. You can view the entire budget here.
The budget comes during a week when House Republicans are preparing to debate spending cuts included in the Continuing Resolution (CR) to cover government funding for the rest of the current fiscal year. These cuts are far below what was projected in the past - $100 billion below the President’s FY2011 request and $61 billion below FY2010 spending levels - and their success or failure will strongly signal how much deficit reduction is possible this year.
The debate itself should be lively as they will consider the CR in an “open rule” process where members will be able to introduce amendments on the House floor without getting them pre-approved. Considering the high level of interest from the freshman class and other conservative Republicans on this issue, we expect even more spending cuts proposed on the House floor through the amendment process.
Next up on the budget, House Budget Chairman Paul Ryan is expected to begin working on his budget resolution due in April. The rolling-out of the budget should overlap with the CR debate, as Senate Democrats have vowed to block the controversial cuts included in the House Republicans’ CR placing at risk a potential government shutdown if a deal isn’t struck by March 4th when the current-law CR expires.
Most likely, short-term CR extensions will continue to pass until negotiators strike a deal. Further complicating the FY2012 budget process is the fact that we’re running up against the debt ceiling. Conservative Republicans are insisting on structural budget reforms, and potentially additional spending cuts as their price for support raising the ceiling, if they support it at all.
That debate is scheduled to take place in the April/May time frame, and while there’s a lot of random speculation about possible government shutdowns and defaulting on the debt, the simple fact is that Treasury has numerous tools at its disposal to keep things running until the Congress takes action, so we expect a negotiated compromise coming out of this process, not a budget crisis.
Back to the President’s budget, several folks have observed that the Administration chose not to follow the recommendations made by his Deficit Commission late last year, but that doesn’t mean the policies put forward by that group are dead. Senators Mark Warner (D-VA) and Saxby Chambliss (R-GA) are working diligently to advance the Commission’s blueprint. They are working with a broad group of 31 senators (including those who served on the Commission) Durbin (D-IL), Crapo (R-ID), Coburn (R-OK), and Conrad (D-ND). The group is shooting to put together legislation along the lines of the Commission report and have it ready by the debt-ceiling debate.
So we have lots of movement on spending and deficits, and we have three significant budget events overlapping in the next couple months – the CR funding the government for the remainder of this year, the budget resolution setting the spending and tax outline for next year and beyond, and the debt ceiling increase.
All of which suggests that by the time June rolls around, we’re going to have a really good idea whether Congress and the President are going to take real action and make progress to address the record deficits and fiscal crisis we face, or if, instead, gridlock will prevail and these issues will be pushed off until the 2012 elections. We’re voting for progress, but we’ll see.
Taxes in Budget and Rate Debate Ahead
We will spend the next year debating the details of the President’s tax policies included in the budget today, but here are some of the highlights that jumped out at us today:
- The budget calls for revenues over the 2012-21 time frame to total $38.7 trillion, or about $1.3 trillion less than the CBO baseline. The difference is just about the same as the cost for extending the middle-class tax relief from the Bush tax cuts beyond 2012. Which means all the other tax cuts in the budget (the AMT patch, for example) are offset by revenues increases someplace else (curbing deferral for US multinationals, etc.)
- The President is sticking with past positions and arguing for higher tax rates on upper income taxpayers, beginning 2013, where the top rate on those families and businesses will rise from 35 percent to 43.4 percent. (Remember, that’s the year the health reform bill’s 3.8 percent investment tax and .9 percent Medicare tax take effect.) All of which suggests we’re going to relive the rate debate of last fall in less than two years.
- The President continues to press for taxing capital gains and dividends at 20 percent for upper income taxpayers. They are both at 15 percent for the next two years, with the dividend rate scheduled to return to 39.6 percent while the capital gains would revert to 20 percent in 2013. Again, this income would be subject to the new 3.8 percent investment tax, too, so the real rate for dividends and capital gains would be 23.8 percent.
- On the estate tax front, the President calls for returning to the 2009 rules of a $3.5 million exemption and a 45 percent top rate rather than either the current policy ($5 million and 35 percent) or the current law in 2013 ($1 million and 55 percent.) In an ongoing oddity, the budget again assumes the 2009 rules as part of the baseline, despite the fact that those rules are neither current law nor current policy.
- As noted above, the budget mentions corporate tax reform as something they would like to pursue, but does not include any details on how they might approach this, beyond that the reform should be budget neutral. Combined with the large increase in corporate taxes from reducing deferral and other provisions, it’s clear the President’s budget reflects a significant tax increase for both C corporations and S corporations compared to current policies.
- LIFO accounting is one of the “loopholes” to be closed under this budget. As Washington Wire readers know, we have been LIFO advocates for years and reject the idea that LIFO is a tax expenditure or a loophole. Nonetheless, it continues to be on the short list of provisions proposed by the President to be repealed in the future, either as part of corporate reform or outside of it. LIFO companies beware.