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BUDGET SCENARIOS
Smead.
FLEX-I-VISION® HANGING FOLDER
HASTINGS, MN
LOS ANGELES-CHICAGO LOGAN, ON
MoGREGOR, TX-LOCUST GROVE, GA
PHOTOCOPY
PRESERVATION
PHOTOCOPY
PRESERVATION
BUDGET SCENARIOS 105
ARGUMENTS FOR BUDGET SCENARIO 1
IT IS DESIRABLE
SCENARIO 1 GENERATES SUBSTANTIALLY MORE DEFICIT REDUCTION THAN
SCENARIO 3 - $196 BILLION OVER THE PERIOD 1996-2000 VERSUS $70 BILLION.
EVEN UNDER THE AGGRESSIVE COST CONTAINMENT ASSUMED IN SCENARIO 1,
HEALTH CARE SPENDING WOULD STILL RISE TO 17% OF GDP BY THE YEAR 2000.
THE LOOSER BUDGET IN SCENARIO 3 WOULD ALLOW SPENDING TO RISE TO 18.7%
OF GDP.
THERE IS LITTLE REASON TO BELIEVE HEALTH OUTCOMES WILL BE ANY BETTER AT
18.7% OF GDP THAN AT 17%, YET THE ADDITIONAL SPENDING WOULD LEAVE
MUCH LESS FOR OTHER INVESTMENTS.
A TIGHT BUDGET WILL BRING DISCIPLINE TO A SYSTEM THAT HAS BEEN OPERAT-
ING FOR MANY YEARS WITHOUT RESTRAINT.
IT IS DOABLE
TIGHT BUDGET CONSTRAINTS MUST BE VIEWED IN THE CONTEXT OF INVEST-
MENTS BEING MADE IN THE FIRST YEAR OF THE NEW SYSTEM. NEW RESOURCES
WILL BE ADDED TO COMPENSATE PROVIDERS FOR NEW SERVICES DELIVERED TO
THE CURRENTLY UNINSURED.
GIVEN THE RELATIVELY FIXED SUPPLY OF SOME HEALTH CARE RESOURCES IN THE
SHORT TERM, THIS MAY PROVIDE A CUSHION FOR MEETING STRINGENT BUDGET
CONSTRAINTS, BOTH UNDER MEDICARE AND IN THE PRIVATE SECTOR.
OTHER INDUSTRIALIZED COUNTRIES, SUCH AS GERMANY AND JAPAN, HAVE
RESTRAINED GROWTH IN HEALTH CARE COSTS TO APPROXIMATELY GDP OVER
THE LAST DECADE. FOR SHORTER PERIODS, GROWTH IN GERMANY, FOR EXAM-
PLE, HAS REMAINED BELOW GDP.
THERE IS BROAD AGREEMENT THAT PRIVATE SECTOR SAVINGS FROM
ELIMINATING THE SMALL GROUP MARKET AND ADMINISTRATIVE SIMPLIFICATION
)
COULD MEET SCENARIO 1 BUDGET CONSTRAINTS DURING THE FIRST YEAR OF
IMPLEMENTATION.
MID-RANGE ESTIMATES OF SAVINGS FROM CONSUMERS SWITCHING TO LOWER
COST PLANS GENERATE SUFFICIENT ADDITIONAL SPENDING REDUCTIONS TO
MEET THE BUDGET IN THE SECOND YEAR OF THE NEW SYSTEM.
ONLY IN THE THIRD YEAR AND BEYOND ARE BEHAVIOR CHANGES BY PROVIDERS
NECESSARY TO MEET THE SCENARIO 1 BUDGET. THE EXTENT AND NATURE OF
THESE CHANGES ARE ADMITTEDLY SUBJECT TO MORE UNCERTAINTY THAN
OTHER SOURCES OF SAVINGS.
THERE IS SUBSTANTIAL WASTE IN THE SYSTEM. WE SPEND MORE THAN OTHER
INDUSTRIALIZED COUNTRIES DO BY A LARGE MARGIN. MANY STUDIES OF
HEALTH CARE PROVIDED IN THE UNITED STATES HAVE SHOWN THAT COMMON
AND EXPENSIVE MEDICAL THERAPIES ARE FREQUENTLY USED WHEN UNNEC-
ESSARY AND EVEN INAPPROPRIATE.
IT IS POLITICALLY ACCEPTABLE AND CREDIBLE
WHILE SOME HEALTH CARE ECONOMISTS MAY VIEW SCENARIO 1 AS OVERLY
CONSTRAINED, THE PUBLIC IS LIKELY TO VIEW AGGRESSIVE RESTRAINT OF
HEALTH INSURANCE PREMIUMS AND PROVIDER PRICES AS DESIRABLE.
GIVEN THE INEVITABLE PRESSURE FROM STAKEHOLDERS TO ALLOW A LOOSER
BUDGET, WE SHOULD BEGIN FROM A POSITION OF AGGRESSIVE COST CONTAIN-
MENT.
ARGUMENTS FOR BUDGET SCENARIO 3
IT IS DESIRABLE
SCENARIO 3 INCREASES THE LIKELIHOOD THAT
COMPETITION WILL DRIVE THE SYSTEM NOT
REGULATION.
SCENARIO 1 MAY DESTROY INCENTIVES FOR MARKET
ENTRY, ESPECIALLY NEW COMMUNITY BASED PLANS,
REDUCING CHOICE.
SCENARIO 3 PROVIDES AN INCENTIVE FOR
AGGRESSIVE BIDDING BY PROVIDING A CUSHION FOR
UNCERTAINTY.
IT IS DOABLE
SCENARIO 3 REDUCES THE RISK OF NEGATIVE HEALTH
EFFECTS AS THE MEANS OF ADJUSTING TO BUDGETS.
EVEN ASSUMING WASTE IN THE SYSTEM, THERE IS A
LARGER CHANCE UNDER SCENARIO 1 THAT IN SUCH A
SHORT TIME FRAME THE REDUCTIONS MAY EFFECT
REAL AND NECESSARY CARE, AND ENCOURAGE SHORT
TERM MAXIMIZATION AT THE EXPENSE OF LONG TERM
MAXIMIZATION.
SCENARIO 3 REDUCES THE LIKELIHOOD THAT THE
REDUCTIONS WILL BE ACHIEVED THROUGH RATIONING.
THE MEDICARE REDUCTIONS UNDER SCENARIO 3 ARE
ACHIEVABLE.
UNDER SCENARIO 1, THE REDUCTIONS THREATEN
ACCESS AND QUALITY OF CARE.
ARGUMENTS FOR BUDGET SCENARIO 3
IT IS POLITICALLY ACCEPTABLE AND CREDIBLE.
NO BILL ON THE HILL IS AS LOW AS SCENARIO 1, AND A
FINANCING SCHEME BASED ON AN UNREALISTICALLY
LOW LEVEL OF BUDGET GROWTH MAY THREATEN THE
CREDIBILITY OF THE ENTIRE PLAN
TALK OF LARGE MEDICARE CUTS MAY SCARE SENIORS.
HAS A BETTER CHANCE OF ACHIEVING SOME
PROVIDER SUPPORT.
SCENARIO 3 WILL STILL BE VIEWED AS AN AGGRESSIVE
PLAN WITH CONSIDERABLE DEFICIT REDUCTION.
SCENARIO 1 IS VERY SUBJECT TO THE CHARGES OF
EXCESSIVE GOVERNMENT INTERVENTION,
REGULATION, AND RATIONING.
ALTERNATIVE
THE CONCERNS ABOUT BUDGET SCENARIO I COULD BE
SUBSTANTIALLY REDUCED, WHILE RETAINING THE
PREPONDERANCE OF DEFICIT REDUCTION AND HEALTH
CARE/GDP RATIO ADVANTAGES THROUGH MORE
GRADUAL PHASING OF THE BASIC HEALTH CARE PLAN,
LONG TERM CARE AND DRUG BENEFITS, AND/OR
REDUCING THE SIZE OF THESE PROGRAMS.
ARGUMENTS FOR BUDGET SCENARIO 3
IT IS DESIRABLE
SCENARIO 3 INCREASES THE LIKELIHOOD THAT COMPETITION WILL DRIVE THE
SYSTEM NOT REGULATION.
SCENARIO 1 MAY DESTROY INCENTIVES FOR MARKET ENTRY, ESPECIALLY NEW
COMMUNITY BASED PLANS, REDUCING CHOICE.
SCENARIO 3 PROVIDES AN INCENTIVE FOR AGGRESSIVE BIDDING BY PROVIDING A
CUSHION FOR UNCERTAINTY.
IT IS DOABLE
SCENARIO 3 REDUCES THE RISK OF NEGATIVE HEALTH EFFECTS. EVEN ASSUMING
WASTE IN THE SYSTEM, THERE IS A LARGER CHANCE UNDER SCENARIO 1 THAT IN
SUCH A SHORT TIME FRAME THE REDUCTIONS MAY EFFECT REAL AND
NECESSARY CARE.
SCENARIO 3 REDUCES THE LIKELIHOOD THAT THE REDUCTIONS WILL BE ACHIEVED
THROUGH RATIONING.
THE MEDICARE REDUCTIONS UNDER SCENARIO 3 ARE ACHIEVABLE.
UNDER SCENARIO 1, THE REDUCTIONS THREATEN ACCESS AND QUALITY OF
CARE.
ARGUMENTS FOR BUDGET SCENARIO 3
IT IS POLITICALLY ACCEPTABLE AND CREDIBLE.
NO BILL ON THE HILL IS AS LOW AS SCENARIO 1, AND A FINANCING SCHEME
BASED ON AN UNREALISTICALLY LOW LEVEL OF BUDGET GROWTH MAY
THREATEN THE CREDIBILITY OF THE ENTIRE PLAN
TALK OF LARGE MEDICARE CUTS MAY SCARE SENIORS.
HAS A BETTER CHANCE OF ACHIEVING SOME PROVIDER SUPPORT.
SCENARIO 3 WILL STILL BE VIEWED AS AN AGGRESSIVE PLAN WITH
CONSIDERABLE DEFICIT REDUCTION.
SCENARIO 1 IS VERY SUBJECT TO THE CHARGES OF EXCESSIVE GOVERNMENT
INTERVENTION, REGULATION, AND RATIONING.
BUDGET ENFORCEMENT IN THE FIRST YEAR
EXAMPLE
NATIONAL HEALTH BOARD ESTABLISHES A NATIONAL PREMIUM TARGET BASED ON
PROJECTED COST OF THE GUARANTEED BENEFITS WITH A REDUCTION IN CURRENTLY
UNCOMPENSATED CARE.
NATIONAL PREMIUM TARGET:
$1,900
NATIONAL HEALTH BOARD ADJUSTS THE NATIONAL TARGET FOR REGIONAL
VARIATIONS IN HEALTH SPENDING AND RATE OF UNINSURANCE/UNDER-INSURANCE.
SAMPLE ALLIANCE TARGET:
$2,000
HEALTH PLANS SUBMIT BIDS TO THE ALLIANCE (WITH OR WITHOUT KNOWLEDGE OF
THE TARGET). ALLIANCE NEGOTIATES WITH HEALTH PLANS AND SUBMITS FINAL BIDS
TO THE NATIONAL HEALTH BOARD FOR REVIEW.
HEALTH PLAN 1 FINAL BID:
$1,800
HEALTH PLAN 2 FINAL BID:
$2,200
USING PROJECTED ENROLLMENT AND BIDS, THE NATIONAL HEALTH BOARD
CALCULATES THE WEIGHTED AVERAGE PREMIUM.
HEALTH PLAN 1 ENROLLMENT:
40%
HEALTH PLAN 2 ENROLLMENT:
60%
EXPECTED WEIGHTED AVERAGE:
$2,040 ($40 OVER BUDGET)
IF THE EXPECTED WEIGHTED AVERAGE PREMIUM EXCEEDS THE ALLIANCE'S TARGET,
EACH PLAN WHOSE PREMIUM INCREASE EXCEEDS THE ALLIANCE'S ALLOWABLE
PREMIUM INCREASE IS ASSESSED FOR THE DIFFERENCE BETWEEN ITS INCREASE AND
THE ALLOWABLE INCREASE. IN EFFECT, THE ALLIANCE'S ALLOWABLE PREMIUM
INCREASE BECOMES A CAP.
THE PLAN ALSO ASSESSES ITS PROVIDERS AN EQUAL AMOUNT.
HEALTH PLAN 1 HAS NO ASSESSMENT (IT'S PREMIUM INCREASE IS LESS THAN 5%)
HEALTH PLAN 2 IS ASSESSED:
1.9%
HEALTH PLAN 2 NET PREMIUM:
$2,310 (5% INCREASE)
[NOTE: ALTERNATIVE ASSESSMENT MECHANISMS ARE POSSIBLE, AND ARE BEING
REVIEWED.]
IF ACTUAL ENROLLMENT DURING THE OPEN ENROLLMENT PERIOD PRODUCES A
WEIGHTED AVERAGE PREMIUM IN EXCESS OF THE ALLIANCE'S TARGET, THEN THE
ALLIANCE'S ALLOWABLE PREMIUM INCREASE FOR THE SUBSEQUENT TWO YEARS IS
REDUCED TO RECOUP THE OVERAGE.
HEALTH PLAN 1 1998 ENROLLMENT: 40%
HEALTH PLAN 2 1998 ENROLLMENT: 60%
ACTUAL AVERAGE PREMIUM:
$2,135
AMOUNT OF OVERAGE:
$35
BUDGET ENFORCEMENT AFTER THE FIRST YEAR
EXAMPLE (1998)
NATIONAL HEALTH BOARD PROVIDES EACH ALLIANCE WITH ITS ALLOWABLE PREMIUM
INCREASE AND ITS NEW PREMIUM TARGET.
1997 PREMIUM TARGET:
$2,000
1998 PREMIUM TARGET:
$2,100 (5% INCREASE)
ALLIANCES ACCEPT PREMIUM BIDS FROM HEALTH PLANS.
EACH ALLIANCE NEGOTIATES WITH HEALTH PLANS - KNOWING WHETHER OR NOT IT
IS IN LINE WITH BUDGET - AND SUBMITS FINAL BIDS TO THE NATIONAL HEALTH
BOARD FOR REVIEW.
HEALTH PLAN 1 FINAL BID:
$1,872 (4% INCREASE)
HEALTH PLAN 2 FINAL BID:
$2,354 (7% INCREASE)
NATIONAL HEALTH BOARD CALCULATES THE EXPECTED WEIGHTED AVERAGE PREMIUM
FOR THE ALLIANCE BASED ON THE PREVIOUS YEAR'S ENROLLMENT AND THE NEW
PREMIUMS.
HEALTH PLAN 1 1997 ENROLLMENT: 50%
HEALTH PLAN 2 1997 ENROLLMENT: 50%
EXPECTED WEIGHTED AVERAGE: $2,113 ($13 OVER BUDGET)
IF THE EXPECTED WEIGHTED AVERAGE PREMIUM IS LESS THAN THE ALLIANCE'S
TARGET, THEN NO ENFORCEMENT ACTION IS TAKEN PRIOR TO ENROLLMENT.
OTHERWISE, THE ALLIANCE IS NOTIFIED THAT IT IS OUT OF LINE WITH THE BUDGET
TARGET AND IS GIVEN AN OPPORTUNITY TO RE-NEGOTIATE PREMIUMS WITH PLANS.
IF THE WEIGHTED AVERAGE OF THE FINAL BIDS STILL EXCEEDS THE ALLIANCE'S
TARGET, THEN EACH PLAN ABOVE THE TARGET IS ASSESSED THE DIFFERENCE
BETWEEN ITS BID AND THE ALLIANCE'S TARGET. IN EFFECT, THE ALLIANCE'S TARGET
BECOMES A CAP.
THE PLAN ALSO ASSESSES ITS PROVIDERS AN EQUAL AMOUNT.
HEALTH PLAN 1 HAS NO ASSESSMENT (BID IS BELOW THE ALLIANCE'S TARGET)
HEALTH PLAN 2 ASSESSMENT:
9.1% (DIFFERENCE BETWEEN BID & TARGET)
HEALTH PLAN 2 NET PREMIUM:
$2,000 (AFTER ASSESSMENT)
NEW AVERAGE PREMIUM:
$1,920
[NOTE: ALTERNATIVE ASSESSMENT MECHANISMS ARE POSSIBLE, AND ARE BEING
REVIEWED.]
IF ACTUAL ENROLLMENT DURING THE OPEN ENROLLMENT PERIOD PRODUCES A
WEIGHTED AVERAGE PREMIUM IN EXCESS OF THE ALLIANCE'S TARGET, THEN THE
ALLOWABLE PREMIUM INCREASE FOR THE SUBSEQUENT TWO YEARS IS REDUCED TO
RECOUP THE OVERAGE.
09-Aug-93
SUMMARY OF ALTERNATIVE PATHS
GROWTH RATES IN PERCENT
Calendar Years
1994
1995
1996
1997
1998
1999
2000
Growth Rate 1
8.9
9.2
5.1
4.7
3.4
3.1
3.2
Growth Rate 2
8.9
9.2
6.1
5.7
4.4
4.1
4.2
Growth Rate 3
8.9
9.2
7.1
6.7
5.4
5.1
5.2
Growth Rate 4
8.9
9.2
8.1
7.7
7.4
6.1
6.2
Growth Rate 5
8.9
7.3
6.1
5.7
4.4
4.1
4.2
Growth Rate 1
baseline
baseline
gdp
gdp
gdp 1
gdp 1
gdp 1
Growth Rate 2
baseline
baseline
gdp + 1
gdp +1
gdp
gdp
gdp
Growth Rate 3
baseline
baseline
gdp + 2
gdp + 2
gdp + 1
gdp + 1
gdp + 1
Growth Rate 4
baseline
baseline
gdp + 3
gdp + 3
gdp + 3
gdp + 2
gdp + 2
Growth Rate 5
baseline
gdp +2
gdp + 1
gdp +1
gdp
gdp
gdp
Nominal GDP Growth Rate
5.4
5.3
5.1
4.7
4.4
4.1
4.2
CPI Inflation Rate
2.7
2.7
2.7
2.7
2.7
2.7
2.7
Population Growth Rate
1.0
1.0
0.9
0.8
0.8
0.8
0.8
Net Deficit Impact
Fiscal Years
1994
1995
1996
1997
1998
1999
2000 1994-1998
1996-2000
Scenario 1
-8
-11
-1
-15
-36
-59
-85
-70
-196
Scenario 2
-8
-11
3
-7
-23
-43
-64
-46
-133
Scenario 3
-8
-11
7
2
-11
-26
-42
-21
-70
Scenario 4
-8
-11
11
10
4
-5
-16
6
4
Scenario 5
-8
-21
-6
-17
-34
-54
-75
-86
-186
Additional Deficit Reduction Possibilities
Fiscal Years
1994
1995
1996
1997
1998
1999
2000
1994-1998
1996-2000
FUTA wage base increase
0
0
-8
-11
-11
-12
-12
-29
-54
1% Corporate Assessment
0
0
-9
-8
-8
-9
-9
-25
-43
Tax Cap
0
0
0
-14
-21
-22
-24
-35
-81
Reduce Mental Health Benefits
-
-
-
-
-
-
-
-
-
Defer Pediatric Dental Benefits
-
-
-
-
-
-
-
I
-
Copy re-sent
to Nancy
Sylvester
CENTER ON BUDGET
AND POLICY PRIORITIES
December 7, 1994
THE NEW FISCAL AGENDA:
WHAT WILL IT MEAN AND HOW WILL IT BE ACCOMPLISHED?
I.
Overview
In coming months, the new Republican Congress will consider a fiscal agenda
that would cause a virtual revolution in American government. The most momentous
changes since the creation of the New Deal 60 years ago may be in the offing. Like the
New Deal, these changes could establish a framework within which the federal
government operated for decades thereafter.
This new framework would begin to change radically the purpose of
government in this country - through dismantling much of the federal social safety
net and redistributing substantial amounts of income from low- and middle-income
households to upper-income Americans. But the way in which this would be
accomplished is far from obvious or straightforward. The new fiscal agenda is made
up of a number of intertwined proposals and strategies, the long-term consequences of
which may not be immediately apparent. Unless the new proposals are subjected to
careful analysis and widespread discussion, the public is unlikely to understand the
way in which the agenda will affect them, their families, and the communities in which
they live.
At the core of the new fiscal strategy is the establishment of a constitutional
requirement for a balanced federal budget each year, starting in fiscal year 2002,
accompanied by a series of statutory and procedural changes that "wall off" defense
and Social Security from budget reductions, cut taxes heavily, and make it difficult to
raise taxes in the future. Balancing the budget without raising taxes or touching Social
Security or defense — and while cutting taxes as well — is a formidable undertaking.
It would necessitate dismantling substantial parts of the federal government over the
coming decade.
More than $1.3 trillion in non-defense, non-Social Security program cuts
would be required over the next seven years.
All federal expenditures other than Social Security and defense (and the
required interest on the national debt) would have to be cut by more than
one dollar out of every four compared to spending projected under current
law for fiscal year 2002.
777 North Capitol Street, NE, Suite 705, Washington, DC 20002 Tel: 202-408-1080 Fax: 202-408-1056
Iris J. Lav and Isaac Shapiro, Acting Co-Directors
If this fiscal framework is put into place by mid-1995, it is likely to lead to four
noteworthy outcomes:
Programs that are weak politically would stand to be cut especially
severely during the coming decade. Much of the federal safety net for the
poor could consequently come to an end.
The middle class, despite receiving an initial tax cut, could ultimately lose
more in government benefits than it gained in tax reductions.
State and local governments will bear a disproportionate share of the
budget cutting, which likely will lead to further reductions in the safety
net and increased state and local taxes on low- and middle-income
households.
High-income households, who will benefit from generous tax subsidies
for investors, are the only clear beneficiaries of the new agenda.
Safety Net Programs
The first indication that the safety net is in jeopardy is found in the Contract with
America, a platform that was signed this fall by most House Republican Members and
that incoming Speaker Newt Gingrich has vowed to try to push through the House of
Representatives by mid-April. The Contract calls for balancing the budget, protecting
defense spending, and cutting taxes. (The less-detailed Senate Republican campaign
document - Seven More in '94: An Agenda for the Republican Majority in the 104th
Congress - also calls for balancing the budget, increasing defense spending, shielding
Social Security and defense from budget cuts, lowering taxes, and providing generous
tax breaks for wealthy investors.) Massive budget cuts in domestic programs would be
needed as a result.
The Contract's authors shied away from endorsing specific budget cuts before
the election in most areas except one - programs targeted on the poor. Virtually all of
the budget savings proposed in the Contract consist of reductions in basic food, cash,
housing, medical, child care and other benefits for poor families and individuals.
The cuts in low-income programs identified in the Contract also stand out for
another reason - they are unprecedented in their severity. For example, if the AFDC
changes were fully in effect today, more than five million fewer children - over half of
the children now on AFDC - would be receiving this cash assistance. Overall, the
benefit cuts in means-tested entitlement programs the Contract calls for are almost
2
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three times as large as the benefit cuts in such programs that were enacted in 1981 and
1982 under President Ronald Reagan.
The Contract calls for ending all federal food assistance programs as separate
programs - including food stamps, WIC, and the school lunch program - and
merging them into a block grant to states. The block grant would be funded at levels
several billion dollars below what these programs would cost under current law and
would be structured so that food stamp assistance would likely to be reduced about $4
billion a year. Other low-income programs - including Supplemental Security Income
(SSI) benefits for the elderly and disabled poor, AFDC, low-income housing, the child
support enforcement program, and child care support for working poor families not on
welfare - would be placed under a separate cap that would require program cuts of
$26 billion over four years. The entitlement status of these progams also would be
ended. In addition, the Contract calls for making most legal immigrants ineligible for
60 different health, education, job training, nutrition, housing, cash assistance, and
social service programs.
Despite the severity of these reductions, the Contract's deep cuts in poverty
programs would constitute about 10 percent of the total spending cuts needed to
balance the budget by fiscal year 2002 without touching Social Security or defense and
while cutting taxes; these cuts would only be the "tip of the iceberg." This suggests
that prospects for a significant federal safety net surviving a decade from now will be
bleak if the Republican strategy is adopted, since programs for the poor are likely to
remain more susceptible to cuts in the years ahead than most other programs.
The Middle Class
A second likely outcome would be that the middle class, despite receiving an
initial tax cut, would ultimately lose more in benefits than it gained in tax reductions.
To some extent, such a result is an inevitable outcome of most plans to eliminate the
deficit. Large-scale deficit reduction essentially means that the middle class must
undergo some sacrifice now in order to secure the long-term economic benefits that
smaller deficits are thought to bring. The degree of middle-class sacrifice required,
however, would be increased under the emerging Republican plan because budget cuts
would be needed not only to balance the budget but also to finance an array of
extremely generous tax cuts primarily benefiting upper-income Americans and large
corporations.
The tax cuts in the Contract are presented as losing $192 billion in revenue over
the first five years, but that cost explodes to over $400 billion in subsequent five-year
3
periods.¹ That does not mean, however, that tax relief for the middle class will
increase over time. The cost of the major provision that will benefit middle class
households, a tax credit for children, will remain relatively constant over time -
costing approximately $107 billion over the first five-years and over subsequent five
year periods as well. But those tax cuts contained in the Contract that principally
benefit high-income households and corporations are designed so their costs remain
small - approximately $31 billion - during the first five years after enactment, and
then rise to more than $260 billion in subsequent five-year periods.² Thus, less than
one-third of the expected revenue losses from the proposed tax cuts after the initial five
years will be targeted on middle-class families.
Moreover, a significant proportion of the budget cuts that will be necessary to
compensate for the revenue loss are likely to fall on the middle class. To reach and stay
at budget balance while these revenue losses continue to mount will entail steadily
increasing reductions in discretionary programs important to the middle class, such as
funding for education and transportation.
In addition, the large entitlement programs that will have to be reduced are
primarily programs that principally benefit the middle class. If many of the poverty
programs were abolished, the savings would fall short of what was needed to balance
the budget and pay for the tax cuts. Significant reductions in middle-class benefits
such as Medicare, student loans, school lunches, and the like would be inescapable,
with such reductions growing as the revenue losses increased.
State and Local Governments
A third likely outcome is that state and local governments would be hit hard.
This is true regardless of whether legislation - or even a constitutional amendment -
passes that bars "unfunded mandates." Grants to state and local governments
constitute about one-third of what remains in the federal budget when Social Security,
defense, and interest payments on the debt are excluded. In addition, some other parts
of what remains in the budget constitute essential federal functions such as protecting
the borders, maintaining embassies overseas, fighting forest fires, constructing and
1
Under federal budget laws, the first five years' losses from a tax cut must be offset either by
entitlement cuts or tax increases. This rule that has led some Members of Congress - and especially the
authors of the Contract --- to design tax breaks so their full revenue-losing effects are delayed until after the
five-year point passes.
2 This includes the cost of three provisions benefiting upper-income individuals or corporations:
the new type of Individual Retirement Account, the capital gains tax reduction, and the more generous
depreciation allowances. Other provisions, such as the increased estate and gift tax exclusion also would
primarily benefit upper-income households.
4
operating federal prisons, operating the Internal Revenue Service and Social Security
offices, and providing benefits to veterans; these programs are not likely to be cut
much. As a result, grants to state and local governments will have to bear a
disproportionate share of the budget-cutting.
One other factor would heighten the adverse fiscal impact on states. Most states
incorporate the federal definition of adjusted gross income and corporate net income
into their tax codes. Hence, the proposed tax cuts benefitting upper-income individuals
and corporations would result in tax cuts - and revenue losses - in many states. State
revenues would decline at the same time that federal grants to states were being cut
deeply. The resulting impact on states would, in turn, likely lead to further reductions
both in assistance to low-income households and in aid to local governments, as well as
to some state and local tax increases.
Virtually all states have regressive tax systems. Lowering taxes at the federal
level and raising them at state and local levels would tend to transfer income from the
poor and the middle class to the wealthy. The Urban Institute found evidence of such a
chain of events after the Reagan tax and budget cuts of the early 1980s.
Upward Redistribution of Income
Upper-income households would be the only large winners under the new
agenda. While these households would receive the lion's share of the tax cuts, they
secure a much smaller percentage of their income from government benefits than
average families at middle- and lower-income levels do. Upper-income families would
be affected the least by the required budget cuts.
These developments would come at a time when Census data show the gap
between rich and poor, as well as the gap between the wealthy and the middle class,
are greater than at any time since the end of World War II. The proposals in the
Contract, as well as the similar provisions in the less-detailed Senate Republican
campaign document, would widen these disparities further.
II.
The Emerging Republican Budget Plan
The emerging plan includes four key changes in the nation's fiscal structure and
procedures. Once in place, these changes would set federal budget policy on a fixed
path. The four changes are:
A constitutional balanced budget amendment. The House is expected to
consider the amendment on January 19, while the Senate will take it up
sometime after that (probably in February). At the current time, approval
5
in both the House and Senate by the requisite two-thirds majority appears
likely. If the amendment passes in Congress and three-quarters of the
state legislatures approve it, it will become part of the U.S. Constitution.
Neither the President nor governors can veto the amendment. Congress
and state legislatures are the actors here.
An entitlement cap. A new budget device whose importance cannot be
overstated - an "entitlement cap" - would be established, probably in a
"budget reconciliation" bill that Congress would pass in the first half of
1995. A binding cap would be placed on the total amount the federal
government can spend each fiscal year on entitlements other than Social
Security. The cap would be set at levels that are well below what
entitlements would cost under current law. With each passing year, the
amount that the cap falls below what entitlements would otherwise cost
would grow. If Congress and the President failed to cut entitlements
enough to fit within the cap for a given year, all entitlements except Social
Security would be cut across-the-board by the amount needed to comply
with the cap.
Tighter discretionary spending caps. The establishment of an entitlement cap
would be accompanied by a measure extending the current stringent caps
on non-entitlement (or "discretionary") spending through fiscal year 2002
and lowering these caps sharply. As part of this measure, defense
spending would be "walled off" so all of the steep cuts needed to meet the
tightened discretionary caps would come from non-defense programs.
Defense spending also is highly likely to be increased over time, making
the required cuts in domestic discretionary programs still greater.
A supermajority requirement for tax increases. Of importance as well is a new
House rule that soon-to-be Speaker Newt Gingrich will establish (on a
party-line vote) when Congress convenes in January. The rule will
stipulate that any measure coming to the House floor which contains an
increase in tax rates (and possibly increases in certain other tax measures)
must secure the votes of three-fifths of the full House membership to pass.
This rule is likely to drive Congress to cut domestic programs even more
deeply in coming years in order to offset those new tax cuts that Congress
wishes to provide.
The Contract with America even calls for writing into the forthcoming
balanced budget amendment a constitutional requirement that any tax-
raising measure (including measures ending special-interest tax breaks)
must secure the votes of three-fifths of the membership of both houses to
6
pass. It is less clear whether the votes are there in either the House or the
Senate to make such a requirement part of the U.S. Constitution.
The two spending caps just described - the entitlement cap and the
discretionary spending cap - are integral to the new fiscal structure the Republican
leadership would erect. These caps would be set at levels so stringent that, by
themselves, they reduce the deficit to zero by fiscal year 2002. Since Social Security
would not be affected by the entitlement cap and defense spending would be walled
off, the two caps would require spending on areas other than Social Security and
defense to be cut sufficiently to reach budget balance.³ A recent report prepared by the
Senate Budget Committee Repbulican staff notes that "nearly 50 percent of spending
programs have been removed from Republican deficit reduction — Social Security,
defense, and net interest."
In any year in which a spending cap would otherwise be breached, across-the-
board cuts would automatically occur. The two caps, especially if backed by a
constitutional amendment requiring budget balance by 2002, would lock in the new
fiscal requirements and lead to the dismantling of substantial parts of the federal
government - most likely including large elements of the safety net - in the years
ahead.
There are a number of probable scenarios under which this radical, sweeping
agenda could be accomplished despite the countervailing power of a presidential veto.
For example, the legislation that is likely to include the provisions establishing
entitlement caps and tightening the discretionary caps - the budget reconciliation bill
- also would contain the tax cuts the Republican leadership is proposing and some
cuts in entitlement programs to help pay for the tax cuts. In addition, the bill is likely
to include another important element - a provision raising the debt ceiling under
which the federal government may borrow funds. If the debt ceiling is not raised by
this summer, the federal government will go into default.
The likely inclusion of these elements in one bill appears to be a shrewd strategy.
If President Clinton vetoes the bill, Republicans would charge him with blocking a
middle-class tax cut, frustrating deficit reduction, and risking a default on the part of
the U.S. Government.
3
Under such an arrangement, if Social Security and defense were cut or taxes were raised, those
actions would have no effect on meeting the caps.
7
How Much Would Have to Be Cut?
Based on the latest Congressional Budget Office projections, balancing the
budget by fiscal year 2002 without raising taxes would require expenditure cuts of
about $1 trillion over the next seven years. This excludes savings in interest payments
on the debt. It entails $1 trillion in program cuts.⁴
By fiscal year 2002, the cuts would exceed $260 billion a year. This equals
between 20 percent and 25 percent of all expenditures on areas other than Social
Security, defense, and interest payments on the debt. The cuts made under President
Ronald Reagan were tiny compared to this.
Moreover, these figures significantly understate the degree of cutting that would
be required. Cuts in programs would need to be large enough not only to balance the
budget, but also to offset the costs of the tax cuts. Balancing the budget and offsetting
the cost of the tax cuts proposed in the Contract with America would raise the amount
of budget cuts needed over the next seven years to about $1.3 trillion. It would increase
the level of budget cuts needed on an annual basis to well above $260 billion a year by
fiscal year 2002 and still more in years after that.
III.
The New Tax Cuts
The tax cuts being proposed by the Republican leadership - especially those
included in the Contract with America - are of particular note. While the middle-class
tax cut in the Contract has received the most attention, it accounts for only a minority
share of the revenue loss that would occur beyond the first five-year period. Over the
long-term, the tax reductions proposed for wealthy individuals and corporations are
substantially larger than the middle-class tax cut. They include deep cuts in taxes on
capital gains income, Individual Retirement Account tax breaks for higher-income
taxpayers who lost them in the Tax Reform Act of 1986, and new depreciation
provisions that will sharply reduce the taxable income of corporations.5
4
These figures assume a plan to ratchet down the deficit each year between now and fiscal year
2002.
5
For additional information on the revenue provisions on the Contract, see the Center's report The
Contract with America Proposal: Assessing the Long-Term Impact.
8
Capital Gains Taxes
The Contract's proposals regarding capital gains taxes are especially striking.
Currently, investors who buy assets such as stocks or bonds and later sell these assets
pay taxes on their profit - that is, on the amount by which their sale price exceeds
their purchase price. The Contract, however, proposes adjusting the purchase price to
reflect inflation between the time of purchase and the time of sale, which would
substantially reduce the taxable profit in most cases. The Contract would make half of
the remaining profit tax-free as well. The result would be the elimination of taxes on
most capital gains profits.
While profits from stocks, bonds, real estate speculation, and the like - which
accrue overwhelmingly to those at high income levels - would be largely exempt from
taxation, no changes would be made in the treatment of interest income from the
savings accounts that ordinary middle-class Americans hold. For interest earnings, no
adjustment for inflation or exclusion from taxation would be provided.
In addition, wealthy investors would be able to borrow large sums to purchase
stocks or bonds, deduct all of the interest payments on these loans when figuring their
taxes, and then sell the asset and pay tax on only half the profit remaining after the
purchase price is adjusted for inflation. This would create lucrative tax shelters for
wealthy investors and skew investments toward investment opportunities that yield
capital gains.
For example, Herbert Stein, Senior Fellow at the American Enterprise Institute
and chair of the Council of Economic Advisors under President Nixon, has written that
capital gains tax cuts are not likely to promote savings but will result in inefficiencies
and tax-avoidance schemes:
Unless cutting the capital gains tax increases the rate of saving, it will only divert
investments to projects that can be structured to yield capital gains away from
projects that cannot. I see no reason to want such a diversion. On the question
whether cutting the capital gains tax would increase saving you can get as many
different answers as you can find econometricians. My own view is that the
effect would be extremely small, and not worth betting on... I think the only
economic consequence we can confidently expect from reducing the capital gains
tax is increased activity by lawyers and accountants in converting other income
into capital gains.6
6
Summary of the Statement of Herbert Stein, Senior Fellow, American Enterprise Institute, to the
House Ways and Means Committee, December 17, 1991.
9
In the past, Republican supply-side tax-cutters have tended to call either for
indexing capital gains or for excluding 30 percent to 50 percent of capital gains profits
from taxation. The Contract calls for instituting both measures, each of which
constitutes a massive tax cut for wealthy investors by itself.
Past analyses by the Joint Committee on Taxation have indicated that under
proposals for more modest capital gains tax cuts, more than 50 percent of the tax
benefits would go to the wealthiest one percent of Americans, those with incomes
exceeding $200,000 a year. About 70 percent of the benefits from the capital gains tax
cuts appear to go to those with incomes exceeding $100,000, who constitute about the
top five percent of households. An analysis of a more modest proposal which excluded
from income a portion of capital gains income (but which did not allow indexing)
found that individuals in the top one percent of the population who benefit from these
tax breaks would receive tax cuts averaging more than $8,500 per year.
Individual Retirements Accounts
In addition to the capital gains tax cuts, the Contract would create a new, more
generous type of Individual Retirement Account tax break that would be available to
taxpayers at all income levels, including upper-income taxpayers who enjoy private
pension coverage. IRA tax breaks are currently available to single individuals with
incomes below $35,000 and married couples with incomes below $50,000 who are not
covered by a private pension plan. The Contract would extend tax breaks to
households above these income levels who already benefit from other tax-favored
pension or retirement plans.
Wealthy households are more likely to have the funds to deposit in an IRA than
middle-class households. In addition, IRA tax breaks are worth the most to those in
the top income tax brackets. Thus an estimated 95 percent of the tax benefits from
proposals such as this would accrue to the wealthiest fifth of U.S. households.
Taxation of Social Security Benefits
The Contract also would repeal the provision enacted in 1993 that raised the
proportion of Social Security benefits treated as taxable income for the one-eighth of
beneficiaries with the highest incomes. Repealing this provision would lose revenue
and provide another tax cut tilted toward those at higher income levels. It also would
weaken the Medicare program. The 1993 budget law stipulates that the revenue raised
by this provision be deposited in the Medicare hospital insurance trust fund, an
important step since the trust fund is in deep financial trouble and faces insolvency in
2001. Repealing this provision would make Medicare's financial hole deeper.
10
Business Depreciation
Finally, but hardly least important, the Contract calls for sweeping changes in
the tax rules that businesses use to claim deductions for the depreciation of equipment,
machinery, and buildings. These proposed changes would constitute a massive
corporate tax break. Currently, if a corporation buys a building for $1 million, it can
take depreciation deductions on its tax returns that total $1 million over a number of
years. Under the Contract, the amount taken in depreciation deductions would exceed
the amount the corporation paid for the building and do so by a large amount. For
example, for a building purchased for $1 million, the total amount of depreciation a
corporation could deduct from its taxes over time would increase from $1 million to
approximately $4.2 million.⁷ This proposal would have the effect of sharply reducing
or eliminating taxable income for a significant number of firms.
Passage of these provisions would make something of a mockery of the widely
heralded Tax Reform Act of 1986. That Act sharply lowered income tax rates on
wealthy individuals and corporations in return for scaling back the tax breaks provided
for such things as capital gains, IRAs, and depreciation. Under the Contract, the tax
rates faced by those in the top brackets would remain far below the rates such
taxpayers encountered prior to the 1986 Act. But capital gains, IRA, and depreciation
tax breaks would not only be restored, but they would be made more generous than
they were before 1986. The result would be massive windfalls for wealthy investors
and large corporations. This would occur while benefits for millions of poor children
were being withdrawn and much of the safety net likely was being taken down to meet
the balanced budget requirement and pay for these tax cuts.
The data cited above showing that the tax cuts would heavily benefit high-
income Americans come from CBO and Joint Tax Committee analyses conducted in
recent years. This type of analysis may not, however, be available in the future. For
more than a decade, the highly respected non-partisan Congressional Budget Office
and the equally well-respected and non-partisan Joint Committee on Taxation have
provided analyses of the effects of various tax proposals on different income groups.
The Republican Congressional leadership plans to name a new CBO director and a new
director of the Joint Tax Committee. It is widely feared that under the new regime,
these institutions will cease producing analyses showing the impacts on different
income groups of various tax measures under consideration. Without such distribution
tables, information that has helped illuminate policy debates on these issues in the past
7
The exact amount that could be taken in depreciation deductions would depend in part on the
inflation rate. The $4.2 million figure noted here assumes a modest inflation rate of three percent. If
inflation were higher, the deductions would be still greater.
11
- and also has helped to prevent passage of certain tax policies skewed to the wealthy
- will be gone.
The Fiscal Impact of the Tax Cuts
The tax cuts aimed at wealthy individuals and corporations will have major
fiscal impacts. They are structured so their full revenue impacts do not appear until
after the end of the five-year period that is used to measure the budgetary effect of
proposed changes in taxes and entitlements.
The House Republican Conference has estimated that the tax cuts in the Contract
will lose about $190 billion in revenue over the next five years. Past Joint Tax
Committee and Congressional Research Service estimates of tax provisions similar to
those in the Contract indicate that the cost of these provisions would exceed $400 billion
over subsequent five-year periods. (See box on page 13.)
The ballooning of the revenue losses after the five-year mark is not accidental.
As noted, federal budget rules require tax cuts to be "paid for" through offsetting
entitlement cuts or tax increases for their first five years. This has led some Members of
Congress from both parties to design provisions in recent years whose true fiscal
impacts do not emerge until after the five-year point passes. Never before, however,
have a set of tax provisions advanced by leaders of either party contained so many
devices to postpone and camouflage so much of the full cost of the tax cuts they were
proposing.
Interestingly, devices of this nature are not employed for the Contract's middle-
class tax cut; its costs do not swell after the five-year period ends. The devices are used
only for tax cuts heavily benefitting upper-income households and corporations. The
cost of the tax credit for children that benefits middle class households will remain
relatively constant over time - costing approximately $107 billion over the first five
years and over subsequent five-year periods. But the capital gains, IRA, and
depreciation provisions described above that principally benefit high-income
households and corporations are designed so their costs remain relatively small -
approximately $31 billion - during the first five years after enactment but rise to more
than $260 billion in subsequent five-year periods.
The mounting revenue losses from these tax cuts would have profound
ramifications. As noted, the tax cuts in the Contract would raise the total cuts needed
to balance the budget by fiscal year 2002 - as the proposed constitutional amendment
would require - to about $1.3 trillion over the next seven years. By fiscal year 2002,
more than one-quarter of federal expenditures in areas other than Social Security and
defense would have to be eliminated. In years after that, as the revenue losses
12
Revenue Loss From Proposed Tax Cuts Grows over Time
The Contract with America calls for federal tax changes that the House Budget
Committee minority staff estimate would reduce federal revenues by about $190 billion over
the next five years. The revenue proposals include a new tax credit for children, a new type
of Individual Retirement Account, reductions in the rate of taxation of capital gains income
for individuals and corporations, a reduction in taxes for businesses that invest in buildings,
machinery, and equipment, and a reduction in the extent to which Social Security income is
taxable for higher-income taxpayers.
The revenue loss from these tax proposals would rise dramatically after five years.
The IRA, capital gains, business depreciation, and Social Security provisions in the Contract
are designed so they lose smaller amounts or even raise revenue over the next five years -
but then lose much larger amounts of revenue after the five-year budget period ends. In
subsequent five-year periods, the federal revenue loss is likely to exceed $400 billion.
The IRA proposal is said to raise $5 billion over the next five years. Short-term
revenue gains come from incentives for holders of current-law IRAs to pay taxes
on those holdings now, rather than at retirement, and roll over the funds to the
new, more generous, and more flexible IRAs. After the rollover window
expires, however, the revenue losses mount. Past analyses of similar proposals
show they eventually lose as much as $50 billion over subsequent five-year
periods.
The Contract puts the cost of the capital gains proposal at $56 billion over its
first five years. The proposal includes both an adjustment of the gain for
inflation and an exclusion from taxation of half the remaining gain. In the years
immediately after implementation, revenues are assumed to be boosted by an
increase in asset sales to take advantage of the new provisions. Over time,
however, asset sales level off and the cost of inflation indexing increases. The
Joint Committee on Taxation has estimated that the cost of such a provision in
the second five-year period after enactment would exceed $160 billion.
The Contract lists the depreciation proposal as raising $20 billion over the first
five years. This costly proposal is turned into a revenue gainer for this initial
five-year period by decreasing, in the first few years, depreciation allowances for
equipment that turn over frequently, such as computers and vehicles. But
depreciation for longer-lived assets is made much more generous, and the long-
term costs of this proposal are large. Past analyses of similar proposals suggest
the revenue loss in subsequent five-year periods could reach $58 million.
Just these three proposals in the Contract, which are said to have a net cost of $31 billion
in their first five years, could have a combined cost in subsequent five-year periods of more
than $260 billion. As a result, even if the cost of all other tax provisions in the Contract
remained constant at $159 billion, the cost in subsequent five-year periods would exceed $400
billion.
13
continued to mount and Social Security costs continued climbing with the aging of the
population, still more of the government would have to be dismantled.
IV.
Impacts on Poor Households, the Middle Class, and State and Local
Governments
To grasp the type and impact of the budget cuts that are likely to occur, it is
useful to understand the stringency of the entitlement cap and the discretionary
spending caps needed to achieve a balanced budget. A plausible design of entitlement
and discretionary caps designed to reach a balanced budget by fiscal year 2002 - while
cutting taxes - could require non-Social Security entitlement spending to be cut by 20
percent and non-defense discretionary spending to be cut by 40 percent to 50 percent.
An entitlement cap is likely to be constructed in a more severe fashion than most
Republican entitlement cap proposals that have been offered in the past. For example,
overall non-Social Security entitlement spending could be capped permanently at the
cost of entitlements in fiscal year 1995 with adjustments in the spending cap allowed
only for inflation and changes in entitlement program caseloads. No adjustments
would be allowed for rising health care costs, a significant omission since Medicare and
Medicaid are projected to make up 65 percent of non-Social Security entitlement
spending by 2002. An analysis based on Congressional Budget Office data shows that
under this type of entitlement cap more than $600 billion in entitlement cuts would be
required between now and fiscal year 2002. By fiscal year 2002, entitlements other than
Social Security would have to be sliced about one-fifth to meet the requirements of the
entitlement cap; entitlement spending in fiscal year 2002 would have to be about $165
billion less than projected under current law.
It is difficult to imagine where Congress would find $600 billion in entitlement
reductions. As noted above, Medicare and Medicaid are projected to constitute about
65 percent of all non-Social Security entitlement spending by fiscal year 2002; there are
limits to how severely they can be cut. Congressional Budget Office director Robert
Reischauer told the bipartisan Entitlement Commission last summer that if deep cuts
are made in Medicare and Medicaid but are not accompanied by major health care
reforms in the private sector, substantial cost-shifting to the private sector will result,
with employers affected significantly. (Other costs would be shifted to state and local
government.) In the aftermath of this year's health care debates, major reform of
private sector health care appears largely moribund. Instituting deep Medicare and
Medicaid cuts in the absence of system-wide health care reform would likely cause
premiums charged to other purchasers of health insurance - principally employers -
to mount more rapidly. That, in turn, would likely induce more employers to drop
coverage for their employees or drive employers to push down wages to make up for
their escalating health care costs. The depth of the cuts that can be made in Medicare
14
and Medicaid is also limited by a second factor - the strength of doctors, hospitals,
and organizations representing the elderly.
This does not mean, however, that an entitlement cap of this nature would be
rejected as being too severe. An entitlement cap such as this would still leave the
government far short of budget balance if Social Security and defense were taken off
the table and taxes could not be raised as part of the budget-balancing effort.
Even if an entitlement cap were this stringent, expenditures for non-defense
discretionary programs would have to be cut nearly 30 percent below fiscal year 1994
levels, after adjusting for inflation, by 2002 to achieve a balanced budget that year.
And that is if no tax cuts are instituted. When the tax cuts envisioned in the Contract
are factored in, expenditures for non-defense discretionary programs would have to be
cut 40 percent to 50 percent in real terms by fiscal year 2002 to produce a balanced
budget, in conjunction with the stringent entitlement cap described here.
(Alternatively, entitlements could be cut more severely and domestic discretionary
programs reduced less than 40 percent to 50 percent, but that would likely necessitate
even larger Medicare cuts.) These figures indicate why large parts of the government
would have to be dismantled.
Impact on Poor Families and Individuals
The implications of this budget strategy for poor families are profound. By fiscal
year 2002, Medicare alone will constitute more than 40 percent of all non-Social
Security entitlement spending. While the Republican budget framework ultimately
would lead to major Medicare cuts, there are - as just noted - limits to the depth that
such reductions could reach. In fact, Rep. Bill Archer, who will be the new chairman of
the House Ways and Means Committee, recently expressed a desire to make Medicare
as well as Social Security off-limits to cuts this year.
Certain other entitlements not targeted on the poor are unlikely to be cut much
either. Benefits for disabled veterans are one such example.
This leads to an inescapable conclusion - to meet the stringent entitlement caps
likely to be imposed, benefits for low-income families and individuals are likely to be
slashed severely.
Developments to date point strongly in this direction. Of the more than $1.3
trillion in spending reductions needed to balance the budget by fiscal year 2002 and
pay for the tax cuts they propose, the authors of the Contract found it prudent to
identify only about $59 billion in specific reductions (measured over four years) before
15
the elections. Nearly all of the cuts they identified would come in means-tested
benefits for low-income families.
The cuts in low-income programs identified in the Contract are unprecedented
in their severity. Overall, the benefit cuts the Contract calls for in means-tested
entitlement programs are three times as large as the benefit cuts in such programs that
were enacted in 1981 and 1982 under President Ronald Reagan. For example, if the
AFDC changes were fully in effect today, more than five million fewer children - over
half of the children now on AFDC - would not be receiving this cash assistance. (See
box on p. 17.)
The Contract also calls for ending all federal food assistance programs as
separate programs - including food stamps, the school lunch program, and WIC -
and merging them into a block grant. The block grant would be funded at levels
several billion dollars a year below what these programs would cost under current law.
The block grant is constructed in such a manner that food stamp assistance would
likely be reduced about $4 billion a year. Furthermore, programs like food stamps and
school lunches would lose their entitlement status.
Loss of entitlement status would be particularly problematic when recessions hit
and the number of poor families needing food stamps and the number of poor children
needing free school lunches increased. For example, from June 1990 to June 1992,
civilian unemployment rose from 5.1 percent to 7.7 percent. During this time, food
stamp participation rose from 20.3 million to 25.7 million people. The average number
of children receiving free school lunches rose from 9.9 million in fiscal year 1990 school
year to 11.1 million in fiscal year 1992. Under the Contract plan, increased additional
federal resources to meet the mounting needs would no longer be forthcoming. States
would have to cut benefits across-the-board, eliminate benefits for categories of poor
households, or put needy applicants on waiting lists unless they were willing to cut
other programs or raise state taxes in a recession.
8
The authors of the Contract (the House Republican Conference) estimated that the provisions in
the Contract's Personal Responsibility Act would save $40 billion over fiscal years 1995 through 1999
(although the provisions do not take effect until 1996). The Center on Budget and Policy Priorities finds
that the effect of the PRA would be a net reduction of about $59 billion over the four-year period from 1996
to 1999, with the cuts escalating over time. For additional information, see the Center's report The Personal
Responsibility Act: An Analysis.
9 The spending on the proposed new work program for AFDC recipients is not considered in this
calculation. This spending is for administrtative and child care costs for those in the new mandatory work
slots, while this calculation attempts to measure changes in benefits to low-income people that affect their
standard-of-living. If the spending on the work program was included, then the cuts identified in the
Contract would still be twice the size of the cuts in the early 1980s.
16
PRA Would Begin to Dismantle Key Features of the Safety Net, and
Deny AFDC to Five Million Children
A new proposal affecting low-income programs, the Personal Responsibility Act
(PRA), is part of the "Contract with America" unveiled in September 1994 by Republican
members of the House of Representatives and congressional candidates. The PRA differs in
important ways from recent welfare reform plans. Key elements of the bill include the
following:
The PRA proposes deep cuts in a broad range of programs for low-income
households and eliminates the entitlement status of most major low-income
benefit programs, including the Supplemental Security Income program for
the elderly and disabled poor and the food stamp program. The effect would
be a net reduction in low-income programs of about $59 billion over the four-
year period from 1996 to 1999, with the cuts escalating over time.
The bill would deny Aid to Families with Dependent Children and housing
benefits to many poor children born to young unmarried mothers for their
entire childhood, diverting these funds to support programs such as
orphanages for poor children. In addition, the "child portion" of AFDC
benefits would be denied for children whose paternity has not been
established - 29 percent of all children currently receiving AFDC - even if
their mothers were fully cooperating with state efforts to track down absent
fathers and establish paternity.
The bill would establish extremely stringent time limits and work
requirements. States would be required to terminate both cash assistance and
work opportunities for families who had received AFDC for a total of five
years; regardless of their circumstances, these families could never receive
assistance again. States would have the option of ending welfare assistance
for families after they receive aid for a total of two years. The PRA would not
provide work opportunities for parents who reach these time limits and are
unable to find jobs even if the parents fully complied with work requirements
while on assistance and made faithful efforts to find employment. During the
period in which they would receive aid, a large fraction of recipients would be
required to work their AFDC benefits off at "wages" that would equal $2.42 an
hour for a family of three in the typical state.
In combination, PRA provisions that would bar certain categories of children
from receiving AFDC benefits and the PRA's mandatory time limit would
ultimately deny assistance to a substantial majority of the children who would
be eligible for AFDC under current law. If the provisions were fully in effect
today, more than five million children would be denied AFDC. At least 2.5
million fewer families would receive AFDC benefits.
17
Still another provision in the Contract would place a cap on total annual
expenditures for an array of low-income programs, including Supplemental Security
Income (SSI) benefits for the elderly and disabled poor, AFDC, low-income housing,
the child support enforcement program, and child care support for working poor
families not on welfare. The cap would require that these programs be cut more than
$26 billion over four years. Here, also, entitlement status would be ended for all
programs that are now entitlements. This would mean that additional federal AFDC
funds would no longer become available automatically if a recession temporarily
increased the numbers applying for assistance. Nor would additional SSI resources
automatically become available if the number of elderly poor applying for benefits rose
as the number of elderly people climbed.
Still another provision of the Contract would make most legal immigrants
ineligible for 60 different health, education, job training, housing, cash aid, and social
service programs. Legal immigrant children could not be screened for lead poisoning
and would be barred from immunization programs. Pregnant women who are legal
immigrants would be barred from WIC. Legal immigrants who became disabled on
the job in the United States would be shut out of SSI.
As noted, these low-income benefit cuts would be much larger than those in
low-income entitlements secured by President Reagan in his first two years in office,
when nearly all of the cuts in low-income benefits during his term were passed. Yet if
all of the low-income cuts listed in the Contract were enacted, only about 10 percent of
the cuts needed to balance the budget and pay for the tax cuts would have been
secured. Severe as the Contract's proposed cuts in benefits for the poor are, they would
be but the tip of the iceberg, just the first installment of much deeper cuts in programs
for the poor that would follow.
There also is another lesson in the low-income cuts included in the Contract.
The fact that the specific cuts House Republicans felt comfortable endorsing before the
election consisted overwhelmingly of reductions in benefits for the poor speaks
volumes about the weakness of programs for the less fortunate in the current political
atmosphere.
In short, the chances are high that the new budget structures and tax cuts that
seem likely to be put in place in the first half of 1995 would lead to the dismantling of
much of the safety net in the decade ahead.
Impact on the Middle Class
Eviscerating the safety net would not, by itself, provide the level of cuts needed
to balance the budget and pay for the tax cuts. Hundreds of billions of dollars in
additional cuts would still be needed. Non-means-tested entitlements also would have
18
to be reduced to meet the requirements of the entitlement cap, and appropriations for
many discretionary programs primarily serving the middle class would have to be
sliced to comply with the discretionary caps. To be sure, various special interest
expenditures can and should be targeted, although the extent to which such
expenditures can actually be reduced (due to the power of the interests that protect
them) remains to be seen. But the arithmetic dictates that programs providing benefits
and services for the middle class be cut substantially as well.
A scaling back of various programs benefitting the middle class is, of course, a
likely result of any effort to eliminate most or all of the deficit. To reach budget balance
will entail steadily increasing reductions in discretionary programs important to the
middle class, such as funding for education and transportation. In addition, the large
entitlement programs that ultimately will have to be reduced are primarily programs
that principally benefit the middle class. If many of the poverty programs were
abolished, the savings would fall short of what was needed to balance the budget and
pay for the tax cuts. While reductions in middle-class benefits such as Medicare might
not be as deep as 20 percent (because of concern for cost-shifting, as noted above),
substantial cuts would be inescapable.
The budget reductions affecting the middle class will be larger than otherwise
would be the case, due to the need to pay for the upper-income and corporate tax cuts.
In the absence of tax cuts, it is likely that low-income programs would be cut to the
maximum extent politically possible and then budget cuts affecting the middle class
would make up much of the remainder of the cuts necessary to achieve budget balance.
Few additional low-income cuts would be available to pay for tax cuts on top of
budget balancing, so additional cuts in middle-income programs in a sense will have to
pay for the tax provisions that primarily benefit upper-income households and
corporations.
The losses in benefits and services borne by middle-class households are likely
to outweigh by a significant margin the tax cuts these households would receive. As
noted above, the middle-class tax cut in the Contract accounts for less than one-third of
the revenue loss generated by the Contract's tax reductions when their full revenue
losses are felt. From reductions in student aid for middle-class college students to hikes
in school lunch prices to sizeable increases in the out-of-pocket health care costs that
elderly Medicare beneficiaries are required to pay, middle-class households would be
likely to have their incomes reduced or their expenses raised in various ways.
Middle-class households also would likely face sizeable increases in state and
local taxes to help fill the hole created by large-scale retrenchment in federal aid to state
and local governments (see below). Virtually every state has a regressive tax system,
under which poor and middle-class households pay a larger share of their incomes in
taxes than higher-income households do. The process of shifting tax burdens from the
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federal to state and local levels would tend to redistribute disposable income from low-
and moderate-income families to those at higher income levels.
Effects on State and Local Governments
The arithmetic of achieving a balanced budget without cutting Social Security or
defense or raising revenues - and while cutting taxes - virtually assures that states
and localities will absorb large hits. Grants to state and local governments make up
one-third of what remains in the federal budget when Social Security, defense, and
interest payments on the debt are excluded.
If overall expenditures other than those for Social Security and defense must be
cut sufficiently both to balance the budget and pay for the Contract's tax cuts, between
one-quarter and one-third of non-Social Security, non-defense costs must be eliminated
by fiscal year 2002. Grants to state and local governments, however, almost certainly
will be cut by a larger percentage than this. Significant parts of the budget that would
remain "on the table" after Social Security and defense were removed consist of
programs that either cannot or will not be cut very much, which would make the cuts
in other areas such as grants to state and local governments still deeper.
For example, funds for federal functions such as protecting the borders,
maintaining embassies overseas, fighting forest fires, constructing and operating
federal prisons, operating the Internal Revenue Service and Social Security offices, and
making pension and disability payments to veterans are unlikely to suffer more than
modest cuts. These and other tasks tend to be viewed as essential federal functions. As
discussed, Medicare is likely to be reduced less than its proportionate share. To the
extent that large portions of the budget other than Social Security and defense spending
are reduced significantly less than one dollar in four, the likelihood increases that
grants to states and localities will be cut by a substantially larger proportion.
This problem will be aggravated because most of the tax cuts called for in the
Contract would generate revenue losses for many states as well. Most states conform
the definition of individual adjusted gross income and corporate net income used in
their income tax codes to the federal definitions of such income. Several of the major
tax cuts proposed by the Republican leadership - such as the cuts in capital gains tax,
the expansion of Individual Retirement Accounts, and the much more generous
depreciation schedules - would be incorporated into many state tax codes if these
measures were enacted at the federal level. The result would be narrower state tax
bases and some loss of state revenue. The revenue loss would occur at the same time
that the federal government was sharply scaling back grants to states and localities,
placing state and local governments in a double bind.
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An Unfunded Mandate Ban Does Not Address These Problems
Some state and local officials believe passage of either legislation or a
constitutional amendment barring unfunded mandates would address these problems.
Such a belief is mistaken. Unfunded mandate protection would affect only those
situations where the federal government requires other levels of government to perform
certain tasks without paying the cost of those tasks. Unfunded mandate measures do
not prevent highly disproportionate cuts in aid to states and local governments that
result from large parts of the federal budget being placed off-limits while the budget is
being balanced and taxes are cut. Nor would an unfunded mandate measure forestall
federal decisions to shed functions that some level of government must perform,
thereby leaving other levels of government little choice but to pick up the pieces
without any federal funds to undertake the work.
An unfunded mandate ban would not, for example, protect against increases in
Medicare cost-sharing requirements that drive up state Medicaid costs under
"medically needy" programs. It would not protect against cuts in child care programs
that increase the load on public schools which operate pre-school programs with state
or local funds. Nor would unfunded mandate protection replace lost federal funding
for primarily state-local functions, such as mass transit, education, or economic
development.
Local governments could be hit particularly hard. In addition to large cuts in
federal aid, they would likely be saddled with deep reductions in state aid as states
passed on part of the pain caused by the withdrawal of billions of dollars in federal
grants. The consequent reduction in both federal and state support for cities would
occur at the same time the safety net was being severely weakened, a mix that could
spell deep trouble for some cities.
V.
Can This Really Occur?
Some who read this paper may think such radical changes will never occur. But
if the Republican budget strategy is passed essentially intact in the next few months,
such changes will be difficult to avoid.
If the balanced budget amendment is enshrined in the Constitution and the
entitlement cap and stricter discretionary caps are enacted, along with large tax cuts,
the die will essentially have been cast. Most developments described here are logical
outgrowths of such events.
This raises the question of whether the balanced budget amendment, the two
caps, and the tax cuts can pass? At the present time, all of them seem likely to pass,
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with the details of the tax cuts to be worked out. Indeed, the balanced budget
amendment and the two caps share a common characteristic that facilitates their
passage - they come without specifics, so their consequences are largely hidden from
view at the time they are voted on. Most of the blanks would get filled in later, after the
amendment is in the Constitution and the caps are in law. Similarly, the full extent of
the revenue losses caused by the tax cuts will not become apparent until five years
down the road. And if the Congressional Budget Office and Joint Tax Committee cease
conducting analyses of the impacts of policy changes on different groups, as is likely
under the new Republican leadership, the extent to which these proposals would
transfer income up the income scale - from low- and moderate-income families to the
well-to-do - will be obscured as well.
The changes described here would represent the most radical changes in federal
policy and in the role of the federal government in more than half a century. They
warrant careful, thoughtful debate and thorough examination of their implications.
Policymakers, journalists, foundations, non-profit organizations, and ordinary citizens
ought to endeavor to ensure that a full debate takes place.
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