PRESIDENT

BUDGET UPDATE
CO-CHAIRMEN MAY 3, 2005
At the beginning of this year there were some indications that the era of
“deficits don’t matter” rhetoric was being replaced by a renewed
DIRECTORS concern about deficits, at least rhetorically. Unfortunately, the actions
since then have shown no indication that policymakers have the stomach
to match that rhetoric with actions.

The budget resolution conference agreement leads to higher deficits than

current law in each of the next five years, with the costs of additional tax
!!! cuts and increased spending for defense and homeland security assumed
" in the resolution exceeding the savings called for in non-defense
# # discretionary spending and mandatory spending programs. Meanwhile,
$ the House didn’t even wait for the budget resolution to pass to start
# passing tax cuts and Congress is moving forward with expensive
# ! #% highway and water infrastructure bills that are loaded with special
& ' projects.
() #%
# (*
+
Senate action on the budget resolution was particularly discouraging for
advocates of fiscal responsibility. Amendments (supported by the
Committee for a Responsible Federal Budget) to reinstate Paygo rules
) for all mandatory spending or revenue legislation that would increase the
& deficit and strike the reconciliation protections for tax cuts which would
# , increase the deficit were defeated. Meanwhile, the Senate approved
%, amendments nearly doubling the size of the tax cuts in the resolution and
& , - cutting in half the amount of mandatory savings called for in the
. -
resolution. The Senate also approved several smaller amendments
/
# ' #%
providing for increases in discretionary spending on health care,
education and veterans programs.
SENIOR ADVISORS
" The fact that the House and Senate were able to agree on a budget
0 , resolution conference report is an important accomplishment, since
) , Congress failed to adopt a budget resolution in two of the last three
years. A failure to adopt a budget resolution again this year would have
further undermined the credibility of the budget process.

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The budget resolution conference agreement is closer to the President’s budget than
many observers, including the Committee, expected. The tax cut number in the
budget resolution is large enough to accommodate most of the tax cuts proposed by
the President and the budget adopts the discretionary spending limits proposed by
the President for fiscal year 2006. The agreement calls for $30.5 billion in
entitlement savings, $15 billion less than the President’s budget would achieve
under CBO scoring.

Despite this, the deficit would actually increase by $167 billion above current law
over the next five years. The declining deficits in the conference report are purely a
function of the improvements in the underlying near-term budget outlook. The
domestic spending cuts in the resolution are more than offset by the increases above
baseline for defense and new tax cuts. It is hard to justify sacrifices in entitlement
programs as part of a budget that actually increases the deficit. We are concerned
that making cuts in entitlement spending without achieving deficit reduction will
make it even harder to reach agreement on a balanced deficit reduction plan in
future years.

IMPACT OF BUDGET RESOLUTION CONFERENCE ON THE DEFICIT

(Deficit increases (+) or reductions (-) compared to CBO March baseline in billions of dollars)

1 Including reserve for additional war supplemental in fiscal year 2006

Note: Numbers may not add due to rounding

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COMPARISON OF THE PRESIDENT’S BUDGET, THE HOUSE-PASSED BUDGET
RESOLUTION, THE SENATE-PASSED BUDGET RESOLUTION & THE CONFERENCE
AGREEMENT

1 All numbers are from the CBO re-estimate of the President’s budget
2 Excludes outlay effects of refundable tax credits
3 Excluding costs of operations in Iraq and Afghanistan
4 Includes outlays from refundable tax credits

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Tax cuts

The budget resolution will allow Congress to pass tax cut legislation for the fifth
year in a row. The budget allows tax cuts of $106 billion, $70 billion through
reconciliation. The tax cut reconciliation instructions could accommodate an
extension of major expiring tax provisions such as the capital gains and dividend
tax cut and small business expensing, the research and experimentation tax credit, a
one year extension of AMT relief and deductibility of state and local sales taxes.

The decision to set aside $36 billion for tax cuts outside of reconciliation will allow
the Senate to move tax cut extensions that will have costs within the five year
budget window, most notably the lower rates for capital gains and dividends and
estate tax. The Byrd rule in the Senate prohibits the inclusion of provisions that
would increase the budget deficit outside the budget window. Consequently,
reconciliation legislation cannot extend tax cuts beyond 2010.

These restrictions would not apply to tax cut legislation moved through the regular
legislative process. Although the budget process limits the amount of tax cuts
within the budget window to the levels set forth in the budget resolution, there are
no limits on the costs of tax cut or spending legislation beyond the budget window
considered through the regular legislative process. As a result, the most expensive
parts of the President’s budgetary agenda, extension of the income tax rate
reductions, marriage penalty relief, child tax credit and other provisions expiring in
2010 will effectively be exempted from any budgetary restraints.

Mandatory spending reductions

For the first time since the 1997 Balanced Budget Agreement, the budget resolution
conference report contains reconciliation instructions to reduce mandatory
spending. Although the real challenge remains when Congress has to agree on
policies to achieve these savings, it is encouraging that this budget recognizes that
budgeting involves sacrifices and not just promising more goodies. While
reconciliation bills containing spending cuts and revenue increases for deficit
reduction were a nearly annual occurrence in the 1980s and early 1990s, nearly half
of the current Members of Congress have never voted on a reconciliation bill that
cuts spending.

The budget contains reconciliation instructions to achieve savings in mandatory

spending programs of $1.5 billion in 2006 and $35 billion over five years. The
budget calls for savings in agriculture and nutrition programs, student loans,
Medicaid, oil drilling in ANWR and increases fees paid by businesses to the
Pension Benefit Guarantee Corporation, among other areas. The largest source of
savings and consequently most controversial items in the conference agreement are
Medicaid and increased PBGC fees.

The House budget resolution contained instructions requiring the Ways and Means
Committee to achieve savings of $18.7 billion without any indication of where
those savings would be achieved other than assurances that none of the savings
would come from Medicare. Other major programs within the jurisdiction of the

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Ways and Means Committee include the EITC, Trade Adjustment Assistance,
Unemployment Compensation, the TANF (welfare) and child care block grants and
Supplemental Security Income. Although the budget negotiators initially agreed to
instruct the Ways and Means and Finance Committees to achieve $5 billion in
unspecified savings in these programs, those instructions were dropped after facing
resistance from Senators. In addition, the conference report did not include the
savings in veterans programs that were in the President’s budget and the House-
passed budget resolution.

Although the budget resolution sets out instructions for the amount of savings that
must be achieved, the real challenge comes when the committees try to find policies
to achieve the required savings. Each authorizing committee must set priorities and
make tradeoffs for programs within its jurisdiction. The authorizing committees are
not bound by the policy assumptions in the budget resolution, so the actual policy
changes made in reconciliation could be very different than the resolution assumes.
For example, the Finance Committee could reduce Medicaid spending less than the
resolution assumes by making reductions in Medicare or other programs within its
jurisdiction. There may be efforts within the Agriculture Committees to limit the
reduction in farm programs by making greater reductions in nutrition programs.
Similarly, there could be pressure to achieve greater savings in student loans or
other programs within the jurisdiction of the House Education and Workforce
Committee and Senate HELP Committee to limit the amount PBGC fees need to be
increased to meet the reconciliation instructions.

Drafting legislative language that CBO estimates will achieve the required savings
is much more difficult than assuming those savings in a budget resolution. This is
particularly true with regard to the Medicaid savings called for in the budget. This
was made evident when CBO analyzed the proposed Medicaid changes contained in
the President’s budget and estimated lower savings than the administration, in part
because CBO did not have enough information about several provisions to
determine whether they would succeed in reducing spending. Although the
President’s budget called for Medicaid savings of $12 billion over five years and
$45 billion over ten years, more than enough to meet the reconciliation target, CBO
estimated that those policies would only achieve $9 billion in savings over five
years and $27 billion over ten years.

Prior to the vote on the conference report there were reports that the Governors had
agreed on a package of Medicaid reforms that would achieve more than $8 billion
in savings, but the governors quickly clarified that the reported agreement was just
a discussion draft that had not been approved. Even if the policies contained in the
discussion draft were endorsed by the governors, it is not clear whether those
policies would actually achieve the amount of savings claimed.

Reconciliation

Budget reconciliation legislation has special procedural protections intended to help

Congress take actions that are responsible but politically difficult, not politically
popular actions that are fiscally irresponsible. When the budget went into surplus,
Congress began to use reconciliation protections to make it easier to cut taxes and

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make projected budgets worse, the exact opposite of the way reconciliation was
intended to be used. This was a bad precedent to set in a period of surpluses, and is
even worse now that the budget is back into deficit.

On a more positive note, the conference report followed the Senate position calling
for consideration of spending cut reconciliation legislation before tax cut
reconciliation. That is the approach that was taken in implementing the 1997
Balanced Budget Agreement, the previous time that Congress considered both a
spending cut and tax cut reconciliation bill. Requiring Congress to eat its spinach
by passing the spending cuts before getting to the dessert of tax cuts is a positive
step, although the budget still allows a large helping of dessert and only a modest
portion of vegetables.

Ways and Means Chairman Bill Thomas raised the intriguing possibility that he
might attempt to achieve mandatory savings greater than the budget resolution
requires. In a press conference the day after the budget resolution passed, Thomas
told reporters “The numbers in the budget are minimums, not maximums. And the
number in the tax reductions are maximums, not minimums. And I think you' ll find
in dealing with minimums and maximums, the House wants to make a far bolder
statement than the budget act legislation looks like right now.” Other House
Committees may also consider mandatory savings greater than required by the
budget resolution. Passing a reconciliation bill with mandatory savings greater than
the budget requires could give the House a stronger negotiating position going into
a reconciliation conference with the Senate.

Discretionary spending

The budget generally follows the President’s overall funding levels for domestic
discretionary program. Total discretionary spending for 2006 would be $843
billion – a 2.1% increase over 2005. The conference agreement dropped increases
in total discretionary spending in fiscal year 2006 added by Senate amendments
increasing funding for education, health care, veterans and other discretionary
programs.

After 2006 the budget calls for modest increases for homeland security programs
and essentially freezing all other domestic discretionary programs through 2010.
This would result in savings of $216 billion below the CBO baseline over five
years. Put another way, domestic discretionary spending over the next five years
would be $216 billion lower than necessary to keep pace with inflation.

The budget fully funds the President’s level of defense funding for 2006 through
2010, including the costs of the $81.9 billion Iraq supplemental the President
requested. It also contains a reserve fund of $50 billion for ongoing military
operations for 2006 which was not included in the President’s budget. It does not
include any costs for military operations after 2006.

We are somewhat concerned that the budget resolution could repeat the mistakes of
the late 1990s when Congress and the administration set unrealistic budget limits
and then disregarded them. The conference report relies heavily on large,

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unspecified saving in discretionary spending after FY2006 to achieve its deficit
targets. A responsible budget sets limits and enforces those limits. If Congress is
unwilling to live within the constraints it sets for itself and actual spending is much
higher than the limits, the credibility of the budget process will be further damaged.

Budget enforcement

The budget includes several budget enforcement provisions which would apply to
the Senate. It establishes discretionary spending limits at the levels contained in the
resolution for 2006 through 2008. The budget ostensibly retains paygo rules in the
Senate for taxes as well as spending, but all tax cuts assumed in the budget
resolution would be exempt. Both the discretionary spending limits and paygo
exemption would apply to subsequent budget resolutions. The budget would also
establish a new 60 vote point of order against legislation that would increase
mandatory spending by $5 billion or more in any of the four 10-year periods from
2015 through 2055. This point of order would not apply to tax cuts that would
substantially increase the deficit in future years.

The rule for the budget resolution conference report codified the agreement reached
with conservative Republicans in the House to establish a new point of order
against spending bills which exceed budget limits. The point of order would apply
after the House has considered the bill and voted on amendments. This is intended
to address the issue of spending bills which were within budget limits when they
came to the floor being loaded down with amendments which would cause the
legislation to exceed budget limits. This point of order does not apply to conference
reports, where spending above budget limits is often added.

Conclusion

Despite the renewed talk about fiscal restraint, the budget resolution conference
agreement allows deficits to continue as far as the eye can see and actually makes
the deficit hole deeper. The fact that Congress is willing to go forward with modest
savings in mandatory spending is a positive development, but proposing savings in
a budget resolution is not the same as actually enacting policy changes. The
proposed savings in mandatory spending programs and cuts in discretionary
programs have created considerable controversy without achieving any deficit
reduction, and it is uncertain at best whether the discretionary spending cuts will be
achieved in the outyears. This could actually make it harder to reach agreement on
a deficit reduction package in the future because spending cuts that could have been
included as part of a balanced deficit reduction package will no longer be available.

We need to develop a specific and realistic plan to put the country on a sustainable
fiscal path. Congress should consider holding a Budget Summit, where everything
including, defense, discretionary spending, entitlement programs, and taxes are on
the table. The Committee is growing increasingly concerned that if Congress and
the President fail to act, financial markets will force our hand.