FY 2018 Budget: Major Clashes Expected on Appropriations, Tax Cuts, Entitlement Cuts

Administration will release the President’s FY 2018 Budget on Tuesday, May 23, launching a contentious and consequential debate over America’s priorities.  OMB Director Mulvaney will testify at House Budget Committee on 5/24 and Senate Budget Committee on 5/25.

Five Major Pieces to this Year’s Contentious Budget Debate:

  1. Appropriations Impasse or a New Bipartisan Budget Deal?
  2. Cutting Entitlements $500 – $800 billion over 10 Years
  3. Individual and Business Tax Cuts, Reforms
  4. Balancing the Budget vs. Investment & Infrastructure
  5. Debt Ceiling

1. Appropriations Impasse or a New Bipartisan Budget Deal?  

The Budget divides all spending into two broad categories. About 30%of federal spending is “discretionary spending,” because the amount of spending flows from annual funding decisions by Congress’ Appropriations Committees. (The other 70% of the budget is “mandatory spending” — because outlays flow from mandatory federal obligations in statute — mostly entitlement programs.)

About half of discretionary spending is defense; the other half is
non-defense (mostly domestic programs, and a small percentage for international obligations).

On March 16, the Trump Administration released an FY 2018 spending outline (“skinny budget”) that calls for (i) keeping total appropriations flat, and (ii) shifting $54 billion from domestic and other non-defense programs into the defense budget — the result being a 10% increase in defense spending, and major cuts in non-defenseprograms.

The Trump spending plan would scale back federal support for health research, environmental protection, job training, education, rural programs, low-income energy and housing assistance.  See our 3/16 blog: Trump Budget Outline Calls for Massive Shift in Spending Priorities

Appropriations bills require 60 votes in the Senate (unlike filibuster-proof budget reconciliation bills for tax and entitlement changes). Therefore, Senate Democrats can block the proposed cuts in domestic and other non-defense programs, and insist on equal increases in defense and non-defense programs — similar to the
2-year bipartisan deal that was struck in 2013 (following a government shutdown) and again in 2015.

The FY 2018 spending caps were set by the Budget Control Act of 2011 at $549 billion for defense and $515 billion for non-defense — a $5 billion decrease from the combined FY 2017 caps.

Outlook — Shutdown Possible: another shutdown is quite possible — even likely — this October with two eventual outcomes: (1) another bipartisan budget deal (similar to 2013 and 2015) that raises both defense and non-defense spending for FY 2018 and 2019; or (2) an ongoing series of continuing resolutions that maintain defense and non-defense programs at current levels of spending.

Consider the following recent statements: House Appropriations Ranking Democrat Nita Lowey told Congressional Quarterly referring to the proposed $54 billion in non-defense cuts: “I want to make that clear: no chance this could happen,” Lowey said. “So if you want to shut the government down, keep talking about this skinny budget”; May 17 letter from Senate Appropriations Democrats seeking parity in defense and non-defense cap increases; and OMB Director Mulvaney telling Face the Nation, “the appropriations, the spending process, Congress using the power of the purse has been broken here in Washington for more than 10 years. And I think a `good shutdown’ would be one that could help fix that.”

2. Cutting Entitlements $500 – $800 billion over 10 years 

Congressional Quarterly reports that both the Administration and the House GOP will call for big cuts in entitlement programs. The President’s Budget may include $800 billion in cuts over 10 years, with the House Budget Committee looking at up to $500 billion in entitlement cuts.

The largest entitlements are Social Security, Medicare, and Medicaid, which together comprise nearly half of the federal budget. President Trump during his campaign pledged to “save Medicare, Medicaid and Social Security without cuts. Have to do it.” However, last month the President endorsed the House ACA repeal-and-replace bill that calls for major cuts in Medicaid of $880 billion over 10 years (as initially estimated by CBO).

It remains to be seen, which entitlement programs may be targeted for cuts. Other major entitlement programs in the federal budget include: military and civilian retirement, SNAP (food stamps), the refundable portions of Earned Income Tax Credit and Child Tax Credit, the mandatory portion of Pell Grants for low-income college students, Supplemental Security Income, unemployment compensation, Temporary Assistance for Needy Families, farm payments, child nutrition, and veterans’ compensation and pensions (although veterans benefits are unlikely to be cut). Background on Entitlements.

Filibuster-proof Budget Procedures Face Timing Challenge: As a procedural matter, entitlement cuts and tax cuts can be advanced as part of filibuster-proof Budget Reconciliation legislation — a procedure that can be launched by Congress’ FY 2018 Budget Resolution.

However, Congressional Quarterly reports that Senate Budget Committee Chairman Enzi has been advised that the FY 2017 ACA repeal-and-replace reconciliation bill may have to be completed before the FY 2018 Budget Resolution can proceed.

In plain English: an FY 2018 budget reconciliation bill to cut taxes and entitlements may have to wait until ACA repeal-and-replace has been completed–and that faces an uphill battle.

Highly Contentious: As a political matter, cuts in entitlement programs will be highly controversial and securing even 50 votes in the Senate could be difficult. In addition to Democratic and moderate Republican opposition, some GOP governors may oppose cuts to low-income entitlements.  See House Budget Committee minority analysis of means-tested entitlements.

3. Individual and Business Tax Cuts, Reforms

A filibuster-proof Budget Reconciliation bill is also likely to incorporate Administration tax cuts.  The Administration released on April 26, 2017 a one-page skeletal outline of “2017 Tax Reform for Economic Growth and American Jobs” proposing major individual and business tax cuts and reforms.

Individual tax reforms in the Trump outline include major tax cuts for upper income taxpayers: cutting the top rate from 39.6% to 35% (about $1.5 tr), and repealing the 3.8% Net Investment Income Tax ($145 b), the Estate Tax ($174 b), and the Alternative Minimum Tax ($413 b).  (Only an estimated 80 small farms and closely held businesses will pay any estate tax in 2017.) 

Provisions with broader taxpayer impact would double the standard deduction and provide unspecified tax relief for families with child and dependent care expenses.

According to Treasury Secretary Mnuchin, most itemized deductions would be eliminated except for mortgage interest and charitable contributions.

Business tax reforms in the April tax outline aim to reduce the corporate rate from 35% to 15%; and shift to a “territorial tax system” where only domestic profits would be taxed while profits from offshore would be tax-free, unlike the current system where taxes on off-shore profits are deferred, but taxed when brought back to the U.S. The outline proposes to tax “trillions of dollars held overseas” but offers no details and makes no mention of using repatriation tax revenues for infrastructure–a trial balloon floated earlier in the year. Reduction of the corporate rate to 15% has been estimated by Tax Policy Center to cost $2.4 trillion in the first 10 years and $3.5 trillion in the second 10 years.

Tax Cuts Likely to Expire after 10 Years: A major consequence of using the filibuster-proof Budget Reconciliation process is the Senate’s “Byrd Rule” — which prohibits Reconciliation legislation increasing deficits in the out-years (i.e., years beyond the 10-year budget window). Under the Byrd Rule, either the tax cuts will have to be fully paid for by eliminating existing deductions and credits, or the tax cuts will have to expire at the end of 10 years (like the Bush tax cuts enacted in 2001, PL 107-16and 2003, PL 108-27).

House Speaker Ryan has said he wants the bill permanent and paid for — but coming up with trillions of dollars from repealing deductions and credits would be challenging, and Senate Majority Whip John Cornyn told CQ Rollcall in early May, tax cuts “probably won’t be as comprehensive, and certainly not permanent.”

BAT: Also receiving attention in Congress is a form of Border Adjustment Tax (BAT) called a “destination-based cash flow tax (DBCFT) advocated by House Speaker Paul Ryan and Ways & Means Chairman Kevin Brady. The proposal would transform the corporate income tax into a consumption tax, under which goods and services destined for domestic consumption (including imports) are taxed, interest payments are no longer deductible, and goods and services destined for other countries (exports) are not taxed. One objective is to raise revenue by taxing imports and using the revenues to reduce corporate rates; another objective is to remove the incentive for corporate inversions (moving overseas) because taxation would be based on where goods and services are consumed, not where they are produced. However, the proposal has drawn strong opposition from various sectors, especially importers and retailers.

“Dynamic Scoring”:  Anticipate a robust debate over how tax cut estimates are scored, with pressure on the Treasury Dept. and Joint Committee on Taxation to estimate economic growth effects of proposed tax cuts.  Link to Tax Reform WebPage.

4. Balancing the Budget vs. Investment & Infrastructure

Budget hawks in the House are calling for the FY 2018 Budget Resolution to balance the budget over 10 years.

There is broad disagreement on whether a “balanced annual federal budget” is the correct prescription for the economy. Many analysts argue that stabilizing accumulated Federal debt as a percentage of GDP is the more appropriate metric for fiscal stability, although there is little agreement on what level of debt would yield long-term stability.

While deficit hawks like to point out that most States require a “balanced budget,” State budgets are fundamentally different from the Federal budget.  States typically require balanced “operating budgets,” but have separate “capital budgets” that are permitted to borrow funds (i.e. deficit-spend) for long-term investments.

By contrast, the Federal government, has a unified budget that includes all current operations and capital investments, lumped together.

Requiring an annual, balanced federal budget that includes all long-term investments (as well as current operations) would place severe limitations on the nation’s ability to invest in infrastructure, R&D and other vital areas.

Imagine the devastating impact on U.S. public and private investment if States, localities, and businesses were barred from issuing debt in order to finance long-term investments.  That is essentially what an annual balanced budget requirement seeks to impose at the federal level.

Impossible Math: If the House GOP decides to press for annual balanced federal budgets within 10 years, the math is daunting, if not impossible.

Annual federal deficits, under current policies, are projected by CBO to increase from nearly $500 billion in FY 2018, to $1 trillion in 2022, to $1.4 trillion in 2027.

Reversing the rapidly rising deficits, and getting on a downward trajectory to achieve a balanced budget within 10 years, would require $8 trillion of deficit reduction over 10 years (spending cuts and/or tax increases).

The proposed $500 – $800 billion in entitlement cuts would barely make a dent in projected deficits.

The math gets even more challenging if trillions of dollars in new tax cuts, $1 trillion for infrastructure investment; a 10% increase in defense, and at least $20 billion for a border wall are added to the mix.

5. Raising the Debt Ceiling

On March 15, 2017, the Statutory Limit on the Public Debt was automatically re-set at current debt levels (on that day) as prescribed by a previous law.

Despite the new debt ceiling, through this summer, Treasury can meet legal requirements for redemption of bonds, payment of benefits, and payment of contractors by managing cash flow and dis-investing certain Federal trust funds.

By late summer or early fall, Congress will have to raise the debt ceiling to avoid a U.S. default that would cause economic chaos.  Treasury Secretary Mnuchin has promised action in sufficient time to avoid last minute jitters.

However, when a contentious budget debate is under way, raising the debt ceiling typically becomes part of the larger budget negotiations.  Link to Debt Ceiling Webpage.