The Emerging Debt Ceiling Deal

August 1, 2011

The emerging deal between congressional leaders and President Obama on the debt ceiling is nothing if not confusing. We’ll try and give you the basics here.

Stage 1: Effective Immediately

-The debt ceiling is raised by $900 billion dollars. That’s only enough to finance the cost of government until sometime next summer.

-Spending cuts go into effect that save $1 trillion dollars (or $1,000 billion dollars) over ten years, for an average of $100 billion in savings per year.

Stage 2: The next few months

Here’s where things get interesting. Pretty much everyone agrees that $1 trillion dollars in savings over ten years isn’t going to put much of a dent in the deficit (which currently stands at around one and a half trillion dollars per year), so the deal essentially leverages the urgency of the current situation (the treasury runs out of cash literally tomorrow) to force additional cuts to be decided later on. Here’s how that works.

By November, a bipartisan congressional committee must come up with recommendations for additional deficit reductions of $1.5 trillion dollars over ten years (or an average of $150 billion per year), and Congress must pass them. If it fails in this task, then automatic “triggers” kick in, which force cuts in defense spending (which Republicans will hate) and in Medicare (which Democrats will hate). If it succeeds, the debt ceiling gets automatically increased by a further $1.5 trillion (which is enough to last until 2013). The idea here is that the prospect of such unattractive cuts, combined with the desire to avoid another fight over the debt ceiling next year, will force the bipartisan committee to make a deal.

The $1.5 trillion that the bipartisan committee is tasked with finding is subject to certain restrictions, most notably that it must be scored relative to “current law” (as opposed to “current policy”). The distinction between current law and current policy is at the root of an incredible quantity of confusion over what counts as a tax cut or tax increase.

In a nutshell, under “current law,” any law which is scheduled to automatically expire is assumed to do so, whereas under “current policy,” policies are assumed to exist in their current incarnations in perpetuity, even if it takes congressional action to maintain that status quo. For fiscal policy, some particularly relevant laws are the Medicare “doc fix,” the Bush-era tax cuts, and the AMT (the Alternative Minimum Tax—an alternate way of calculating one’s income tax). Under “current law,” the Bush-era tax cuts expire at the end of next year, and certain AMT parameters revert to levels which substantially increase the number of taxpayers subject to the AMT.

The practical effect of this is that the bipartisan committee will be unable to make any recommendations regarding the Bush-era tax cuts. For example, let’s say the committee proposes, among other things, raising the top marginal tax rate three percentage points, from 35% to 38%, which would bring in some amount of revenue that counts towards their $1.5 trillion assignment. “Hold on,” says the Congressional Budget Office, “According to our current law baseline, that rate is set to go up to 39.6% in 2013 when the Bush-era tax cuts expire, so this is actually a tax cut, and it makes the deficit worse.”

The bipartisan committee is therefore unlikely to touch any aspect of tax law that is directly affected by the Bush-era tax cuts (which includes marginal rates, the child tax credit, and various other credits and deductions), or any parameters that are routinely changed by AMT patches. If the committee wants to reduce the deficit by, say, increasing the top marginal rate by three percentage points, it has to explicitly say, “We’ll make the rate 38% (35+3) in 2012, and 42.6% (39.6+3) in 2013 and beyond.” That’s not likely to be a popular move, and that’s why Boehner said in his presentation to his caucus that the current law requirement “effectively [makes] it impossible for the Joint Committee to increase taxes.” (For similar reasons, the committee will find it difficult to touch physician reimbursements under Medicare because they have to assume the end of “doc fix” patches for any change to count as deficit reduction.)

It should be said, however, that this doesn’t preclude the bipartisan committee from recommending other kinds of tax increases (such as a national VAT or tax expenditure reductions) nor does it preclude Congress from extending the Bush-era tax cuts separately from the bipartisan committee. It simply means that any deficit reduction measure recommended by the bipartisan committee that raises taxes by changing rates and parameters associated with the Bush-era tax cuts has to explicitly assume their expiration (and thus a substantial tax increase) in order to score as reducing the deficit. As a result, the committee is unlikely to pursue any such changes.

In any event, in order to prevent the triggered defense and Medicare cuts, the bipartisan committee must come up with $1.5 trillion in deficit reduction, which Congress must then pass, by November. The only other way to prevent the unpopular “trigger” from taking effect is for Congress to pass a balanced budget amendment to the U.S. Constitution and send it off to the states. It’s not entirely clear how likely this is. Constitutional amendments require two-thirds support in both the House and Senate to pass, and it’s hard to see Senate Democrats voting for it. However, if the bipartisan committee is unable to reach its $1.5 trillion goal, and the alternative is triggered unpalatable Medicare cuts, Democrats may vote to pass the amendment despite their dislike of it, knowing that it would never get ratified by 38 state legislatures.

[Correction 11/21/11: Passing a Balanced Budget Amendment would not, by itself, prevent the “trigger” from being enacted, although it would allow for the full additional $1.5 trillion debt ceiling increase, instead of a reduced $1.2 trillion increase, which is the most allowed if the bipartisan committee fails.]

It was inevitable that the final compromise was going to have all sorts of complicated political maneuvering, though the intricacies of this particular deal are confusing even to those of us who observe Congress on a regular basis. We can at least be glad that the U.S. has, for now, avoided defaulting on its debt.

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