In mid-December, the Congressional Budget Office (CBO) released its biennial “Options for Reducing the Deficit” report. With the deficit increasing dramatically in 2018, even in a year with strong economic growth, this report is more important than ever. Rising deficits and hence rising national debt will have numerous negative consequences if left unchecked. The government will need to spend a larger and larger share of the budget on interest payments, and more borrowing would raise the investments in US Treasuries, hence reducing private investment. As a consequence, the current rate of growth of the national debt will reduce average income by $4,000 in thirty years.
Given the long-term problems the national debt situation will cause, especially for younger generations, policymakers should use this new CBO report to find a blueprint to bring down the deficit. The report presents 121 policy options for Congress to consider, categorized into three groups: mandatory spending, discretionary spending, and revenue. Here are some of the examples. Click here to read them all: Options for Reducing the Deficit: 2019-2028
Mandatory Spending Option:
Use an Alternative Measure of Inflation to Index Social Security and Other Mandatory Programs
Under current law, spending on federal programs is adjusted for inflation using consumer price index (CPI), which is a measure of inflation calculated by the Bureau of Labor Statistics. However, the current CPI gauges do not take into account changes in consumer behavior, and as such is a flawed measure of the price level most families actually face. Failing to account for changes in consumer behavior means that spending levels rise faster than they need to. If the federal government switched to measuring inflation using the chained CPI – a measure that adjusts for changes in consumer behavior – it would reduce spending by $203 billion over the next decade, predominantly thanks to lower Social Security spending. Notably, the tax code now utilizes the chained-CPI measure for adjusting tax brackets and other inflation-adjusted tax provisions.
With the annual deficit expected to rise past $1 trillion in 2019, the need to reduce spending is more apparent than ever. Social Security is famously the untouchable “third rail” of American politics, but in order to avoid a fiscal crisis, reducing spending on this massive program is a must. Shifting to an arguably more accurate measure of the change in cost of living over time would not only be a reasonable reform in itself, but it might also be more politically palatable than direct benefit cuts.
Discretionary Spending Option:
Reduce Funding for Certain Grants to State and Local Governments
As the CBO notes in the report, the federal government gave state and local governments $675 billion in grants in 2017. These grants are intended to help strengthen the governments and public services of lower-income states and municipalities and finance programs with national implications. Most federal grant money to states goes towards healthcare, education, transportation, environmental protection, and income security programs. The CBO deficit reduction option, however, is limited to a handful of block grants from the Department of Energy, the EPA, the Department of Housing and Urban Development (HUD), and the Department of Justice.
One of the grant programs in need of reforms is the Community Development Block Grant program, run out of HUD. As Politico noted in 2017, the allocation of this block grant is deeply inefficient: many high-income cities, such as San Francisco, receive more money on a per capita basis from this program than much lower-income municipalities, such as Allentown, Pennsylvania. One analysis found that 8 of the top 10 highest-income counties received millions of CDBG dollars while the ten lowest income counties received no CDBG funds.
Trimming down this program, and making CDBG funds contingent on recipients eliminating over-restrictive zoning is an idea that both Republicans and Democrats have expressed interest in. The CBO estimated that reducing spending on this specific block grant by 50 percent would reduce federal outlays by $10.8 billion over the next decade. Reducing all five block grants covered by CBO would save $41.9 billion over the next 10 years.
Eliminate Itemized Deductions
In the US tax code, a tax deduction allows taxpayers to subtract the costs of certain activities or payments from their taxable income. When filing, taxpayers can either take the standard deduction, which offers a fixed amount all taxpayers can deduct, or they can take advantage of itemized deductions, which allow them to deduct certain expenses. The largest itemized deductions are the deductions for mortgage interest and state and local taxes. The Tax Cuts and Jobs Act significantly reduced the value of these deductions and simultaneously doubled the standard deduction, thus making it more likely for a taxpayer to opt for the standard deduction rather than itemizing. However, those changes are scheduled to expire in 2025.
While using the assumption that those reforms will expire, CBO estimates that getting rid of itemized deductions entirely would raise $1.3 trillion in new revenue over the next decade – with a significant portion of the increases coming in the last three years. Working under the assumption that Congress will make the Tax Cuts and Jobs Act permanent, eliminating itemized deductions would raise closer to $1 trillion in new revenue.
Eliminating itemized deductions is a win for deficit reduction, a win for the economy, and a win for tax fairness. Allowing people to deduct certain types of behaviors lead to economic distortions – as an example, the mortgage interest deduction helped fuel the housing crisis leading up to the Great Recession as it over-incentivized home ownership. Furthermore, itemized deductions primarily benefit upper-middle and upper-class taxpayers. Eliminating itemized deductions is a way to raise taxes while avoiding the large, negative economic impact raising marginal tax rates would.
Change the Tax Treatment of Capital Gains from Inherited Assets
When someone buys and then later sells an asset, they pay a tax on their “capital gain,” or the difference between the price they sold the asset for and the price they bought it for. However, this tax treatment changes when an asset is inherited. When an asset is inherited and then later sold, the capital gain is calculated based on the selling price subtracted from the fair market value of the asset at the time it was inherited.
Getting rid of this tax preference, and instead using the method used for all other capital gains, would raise tax revenue by $105 billion over the next decade. It would also likely be a progressive tax change, as capital gains taxes are mostly paid by higher-income households. However, removing a special tax preference that predominantly benefits higher-income earners would have smaller negative economic effects than raising the capital gains tax rate, for example.
These are just a few examples of the 121 options that CBO put forward. All of the options would save at least $10 billion over the next decade and some would yield over $1 trillion in deficit reduction. The federal government is expected to spend $12 trillion more than it takes in over the next decade. CBO’s report provides the new Congress a critical how-to guide on avoiding this disastrous path. Let’s hope they use it.