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Time to End "Temporary" Tax and Spending Policies

Charles Blahous | 02/06/2012 |

No matter who is elected president this November, he would do himself, both political parties and the nation an enormous service if he began his term with a successful bipartisan effort to end the multitude of “temporary” tax and spending policies under current law. The artificial statutory “sunsets” of many such provisions cripple the efforts of lawmakers – on both sides of the aisle -- to craft sensible solutions to our fiscal problems. Without such sweeping reform, we should expect an indefinite continuation of the economic policy paralysis that has so infuriated the public in recent years.

Late last year I wrote a piece entitled “Why There is No Bipartisan Budget Deal,” in which I explained various substantive factors that render a comprehensive fiscal bargain so elusive. Too often the public and press are told that such a deal would be possible if only those on the other side of the aisle were not so intransigent. The reality is more complex; certain elements of current budget law make it very difficult for lawmakers of good faith -- but of different economic policy views -- to reach even modest compromises. The result is an impasse that serves neither side’s vision of optimal economic policy.

Under current law, various budgetary policies are scheduled either to change dramatically or to expire altogether within the next few years. The parties will often disagree on how exactly these policies should be extended going forward, while generally agreeing that the expiration threatened under law should not be allowed to occur.

Both parties agree, for example, that tax rates should not rise for all income taxpayers at the end of 2012. Yet under current law, they would. Our “current law” forecasts, therefore, show a much smaller deficit than we will almost certainly have. And at the same time, someone who advocates changing the law simply to reflect what both parties agree upon is accused of proposing to increase the deficit. This leads to grandstanding, brinksmanship, higher deficits, and economic uncertainty. It’s the worst of all policy worlds.

The situation has become so perverse that the Congressional Budget Office (CBO) now routinely publishes two alternative scenarios for the government’s fiscal outlook. One, the “extended baseline” scenario, reflects current law and shows relatively smaller deficits, but bears almost no relationship to what is likely to happen. The other projection -- the “alternative fiscal scenario” -- assumes that various current policies are not allowed to expire and shows disastrously high deficits. This latter scenario is closer to where we are actually headed, but puts scorekeepers in the awkward position of making predictions of how lawmakers will choose to override various current-law provisions.

The problems with employing “temporary” policies go beyond the understatement of likely deficits. They exert a crippling effect upon budget negotiations. A quick glance at CBO’s two fiscal scenarios shows why.

The disjuncture between “current tax law” (in which tax rates rise for all taxpayers after 2012) and “current policy” (in which current rates are extended and Alternative Minimum Tax income thresholds rise gradually over time so that total tax burdens rise no faster than GDP) creates tax policy paralysis. Conservatives see the “current law” baseline rising in the future to unprecedented highs and refuse to raise it any higher. Progressives look at the “current policy” baseline, at the size of the constraints required to keep spending close to historical norms, and argue that revenues need to be raised.

Both sides, therefore, get an outcome that they do not want. For conservatives, the continual uncertainty about the pending expiration of current rates undoes many of the incentive benefits of keeping them low. Progressives meanwhile are subject to the charge of wanting to raise taxes every time a pending rate expiration nears. Meanwhile the public is repeatedly shown a falsely optimistic fiscal picture.

The economic policy dynamic would be far better for both sides if ongoing tax rates were permanent. Henceforth both sides could argue for their respective policy visions without being held to the other side’s exploitation of their pending expiration. From a budget process standpoint, the permanence of existing rates may actually matter more than what those specific rates are. We can only have a sensible conversation about our fiscal future if it is not distorted by pending expirations that no one believes will (or should) actually occur.

In recent years this dynamic has grown out of control, with a whole host of new “temporary” policies put into place. In December, 2010, lawmakers adopted a shortsighted policy of temporarily cutting the Social Security payroll tax and funneling general revenues (i.e., income taxes) into the program’s Trust Fund to make up the lost revenues. Originally supposed to be a one-year policy in 2011, it has already been extended for the first two months of 2012 and is likely to be extended through the end of the year at least. Though few believe it is sound policy to convert Social Security piecemeal into an income-tax-financed program, no one wants to be accused of raising the payroll tax, and so the policy continues.

Not one year into the payroll tax cut there came a forceful push for its extension, now likely to lead to greater fiscal pressures than were disclosed at the time of its original enactment. Indeed, many advocates already believe that they should be able to count on the tax cut’s extension as a given. In one recent Washington Post article, an economist was quoted as saying (of the payroll tax cut’s pending expiration), “This is just ridiculous. I never thought as an economist I would have to spend so much time doing political analysis. It's hard to plan ahead when every policy decision waits until the last possible minute.” But it is folly to believe that temporary policies can ever come unaccompanied by political uncertainty.

On the spending side perhaps the most glaring example of this phenomenon is the Medicare physician payment Sustainable Growth Rate formula, the subject of periodic “doc fix” legislation. Under literal current law, payments to Medicare physicians would be suddenly cut by over 27% in the near future. Neither party expects or wants this to happen. So while CBO includes this sharp outlay reduction in its “extended baseline” scenario, its “alternative fiscal scenario” assumes that the physician payment cuts will be overridden.

In its first 2009 budget, the Obama White House included the cost of a permanent doc fix in its baseline budget projection. They mishandled the issue by in effect proposing to add the doc fix to the deficit without accepting responsibility for that policy choice -- a position they have since modified. But the status quo treatment of the doc fix clearly isn’t working either; neither side is yet willing either to budget for a permanent doc fix or to add it to the deficit. We thus instead get a series of short-term legislative patches, doling out the doc fix costs piecemeal, creating payment uncertainty for physicians and undermining federal budget transparency.

The current list of such “temporary” policies is now practically endless; it includes current income tax rates, AMT thresholds, Medicare physician payments, unemployment insurance extensions, a host of spending reauthorizations, and various individual tax incentives known as the “tax extenders.”

The annual rush to pass the array of “tax extenders” benefits few outside of an army of lobbyists whose job is to get them temporarily extended. Recent legislative practice with the “extenders” has often been to pass them belatedly, well after the affected entities have made the decisions that determine their eligibility for it, shifting the costs of these decisions to the federal government after the fact. This practice undercuts the likelihood that the extenders offer the positive behavioral incentives attributed to them.

For the indefinite future, it will be very difficult for the two political parties to reconcile their conflicting visions for the federal government’s future reach. There is indeed a great divide on the question of what proportion of our national economic resources the federal government should command and reallocate. That debate is unavoidable.

The corruption of that discussion by the proliferation of temporary policies is, however, correctible. Both sides would benefit enormously by starting fresh at the earliest possible time – by aligning “current law” and “current policy,” eliminating the need for dueling budget baselines, and looking realistically at our likely fiscal future. What is needed for this is to scrap a host of so-called temporary policies under current law and replace them with permanent ones. (Such a negotiation, of course, would not prohibit lawmakers from allowing some truly temporary policies).

If the two sides could gloss over their long-term policy differences just long enough to agree to do away with the array of pseudo-temporary policies, both would benefit enormously. It would also become far easier for the two sides to negotiate adjustments to current policies going forward than it is in the current environment. The next president, whoever he is, could improve our fiscal practices enormously simply by leading a frontal, bipartisan assault on the various “temporary” tax and spending polices of the federal government.

Charles Blahous is a research fellow with the Hoover Institution, a senior research fellow with the Mercatus Center, and the author of Social Security: The Unfinished Work.


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