President Barack Obama’s $3.8 trillion budget released Wednesday targets the wealthy by closing some tax loopholes and limiting deductions while curbing entitlement spending, an effort that seeks to lower by two thirds the U.S. budget deficit’s share of GDP by 2023.
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The fiscal plan for 2014 contains a mix of tax increases and breaks that the administration has advocated for in the past. But some proposals, particularly the curbed entitlement spending, have some concerned that could translate to increased costs for states and localities.
Among the proposals Obama includes is a 28 percent cap on tax deductions for higher earners, reducing federal subsidies to high-income seniors and changing the inflation calculation to curb Social Security cost-of-living increases. (For a more detailed breakdown, see below.) All three proposals were expected in his budget, which was submitted two months after the federally-mandated deadline.
Combined with the proposed implementation of the so-called Buffet Rule, which mandates that those making $1 million a year or more after gifts to charity would have to pay at least 30 percent of their income in taxes, Obama projects that the budget deficit would be reduced to 2.8 percent of Gross Domestic Product by 2016. By 2023, it would be 1.7 percent of GDP, according to his budget. The deficit currently represents 5.3 percent of the nation’s economic output, according to the nonpartisan Congressional Budget Office.
“When it comes to deficit reduction, I’ve already met Republicans more than halfway so in the coming days and weeks, I hope Republicans will come forward and demonstrate they’re really as serious about [reducing the] debt as they claim to be,” Obama said in a speech outlining the budget prior to its release Wednesday morning.
Roughly ten minutes after the president concluded his remarks in the White House Rose Garden, Rep. Paul Ryan, House Budget Committee Chairman and 2012 Republican vice presidential candidate, issued a statement calling Obama’s proposal a “status quo” budget that increases the total national debt.
“It raises taxes by $1.1 trillion. It increases spending by $964 billion. And it adds $8.2 trillion to our debt,” said Ryan, who has submitted a rival budget in the House that eliminates the deficit entirely by 2023 and transforms Medicare into a voucher system.
Neither budget proposal is expected to remain intact but are seen as starting points in negotiations. For state and local governments, Obama’s proposals regarding capped deductions and retirement spending are causing the most concern.
The hit proposed to Social Security would use the chained Consumer Price Index to lower cost-of-living-adjustments to all but the most vulnerable program recipients. Unlike regular inflation, chained CPI operates on the assumption that when a price increases for an item, demand will decrease and therefore overall spending will not directly correlate to the inflated price. For example, if the cost of beef rises, more consumers theoretically would instead buy more chicken to cut down on their bill.
Neil Bomberg, a program director at the National League of Cities’ Center on Federal Relations, said chained CPI makes sense for more flexible consumer items but doesn’t translate to essentials like medical costs.
“Medical costs are not going down, drug costs are not going down, some of the most important expenditures that seniors have to make are not going down,” Bomberg said. “Those things will continue to increase in price.”
Switching to chained CPI could knock $600 off a senior’s annual income, he said. And that kind of income reduction could have a trickle-down impact to counties and cities that are most likely to pick up the costs of any increased needs among seniors. For example, seniors might decide to skimp on heat or air conditioning, which could put pressure on local warming and cooling centers, or on their emergency services if seniors try to save money by skipping doctor visits.
“These then become city problems [or county [problems],” Bomberg said. “Their conditions of life impact the people around them and impact the city as a whole.”
Localities are also worried about the impact on Obama’s proposed 28 percent cap on tax deductions for higher earners, which would include a cap on the tax-free income allowed for some municipal bond holders. States and localities have lobbied hard against any restrictions regarding the tax exempt status of municipal bonds, including one that would limit the exemptions higher earners could claim. Municipalities have argued that any change to that status would increase their borrowing costs, which would translate to less infrastructure development.
Obama has floated the 28 percent cap in previous years but so far it has not gained steam and many observers believe the proposal won’t survive the budgeting process. However Janney Montgomery Scott analyst Tom Kozlik noted this week he believes the cap will play out as part of larger tax reform negotiations over the next few years and remains a discussion item although not an immediate threat.
“And at this time, anything packaged like a tax break for the rich, remains at risk,” he wrote in his April 9 newsletter.
And in the meantime, an overall cap on deductions could affect spending in localities where the federal tax code helps cover higher costs. For example, the home mortgage interest deduction and local property taxes are all deductable from a filer’s total income.
“In certain places [deductions] compensate for a higher cost of living or higher housing costs,” said Brookings Institution Fellow Tracy Gordon.
Key tax components of President Obama’s 2014 budget:
Raises $580 billion for deficit reduction by limiting high-income tax benefits by:
Implementing the Buffett Rule, requiring that households with incomes over $1 million pay at least 30 percent of their income (after charitable giving) in taxes. Limits the value of tax deductions and other tax benefits for top tax bracket earners to 28 percent. Targets higher earners in closing some tax loopholes:
Ends a loophole that lets wealthy individuals circumvent contribution limits and accumulate millions in tax-preferred retirement accounts. Ends a loophole that lets financial managers pay tax on their carried interest income at the lower capital gains rate. $200 billion in savings from other mandatory programs, such as reductions to farm subsidies and reforms to federal retirement benefits.
$230 billion in savings from using a chained measure of inflation for cost-of-living adjustments throughout the budget, with protections for the most vulnerable.
$210 billion in savings from reduced interest payments on the debt.
Provides a 10 percent tax credit for small businesses that hire new employees or increase wages:
Provides a new tax credit to encourage employers to offer retirement savings plans and expands a tax credit that helps middle-class families afford child care. Makes permanent the American Opportunity Tax Credit, which currently helps about 11 million students and families afford college, as well as improvements to the Earned Income Tax Credit and Child Tax Credit.