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Federalism and the Federal
Budget:
Today and Tomorrow
North Carolina State Budget Day
October 2007
Vic Miller
[email protected]
Federal Funds Information for States
The Invisible and Visible Hands
• Question: How many free market economists does it
take to screw in a light bulb?
• Answer: None. They sit in the dark and wait for the
invisible hand.
• Moral—When it works, the invisible hand of the market
place is the best mechanism man has ever devised for
allocating resources.
• When it does not, we must turn to the very visible hand
of government. And public finance drives what
government can do.
Fiscal Federalism—Taxes
• Since World War II, the federal government has
been the dominant tax collector.
– State and local governments collect about
10% of Gross Domestic Product (GDP) in
taxes.
– The federal government, until recently,
collected 18-21%.
• Recent tax cuts have reduced the federal share
to 16-18%, probably not sustainable for the long
term unless major reductions are made in
entitlement spending.
Fiscal Federalism—Taxes
(cont.)
• The federal government collects more than three-fourths
of its revenue from direct taxes on persons—income
taxes and social insurance taxes.
• Most unstable are corporate income tax receipts, ranging
from 6-8% in recessions to 14-15% in recent years.
• Many state and some local governments also impose
income taxes, but they collect the bulk of their revenue
from indirect taxes—sales taxes and property.
– In 2005, sales (34%), property (30%) and income
(22%).
– Property taxes heavily for local governments.
• Federal grants-in-aid constituted 21% of state and local
receipts (2005).
Fiscal Federalism—Employment
• However, the federal government is actually quite small.
• State governments employ 13-14% of the domestic
civilian work force --teachers, police, firemen,
economists, etc.
• The federal government employs about 1.5%.
• Remove the civilian employees of the Departments of
Defense and Veterans Affairs, and of the Postal Service,
and the federal share falls to 0.75%.
• Contract employees probably add another 1% to the
total.
• Federal purchases of good and services constitute
slightly more than 25% of the budget; two thirds for
defense.
The Federal Government—Fiscally
Primarily a Transfer Mechanism
• So where does this tax revenue go? It goes to transfers.
• Transfers to individuals for such purposes as Social
Security, military and veterans retirement and pensions,
Food Stamps, unemployment insurance, civilian
retirement, debt service on our growing debt.
• Transfers to the medical industries, for hospital and
doctor care, for prescription drugs and vaccines, for
community health centers, for graduate medical
education, etc.
• Transfers to state and local governments, for grants in
support of federal and state and local interest.
• Transfers to the private sector, for subsidies.
Two Types of Federal Spending
• Mandatory (60%)—Where the basic substantive
legislation provides the legislative authority for
spending (Social Security, Medicare, Medicaid,
TANF, Food Stamps).
• Discretionary (40%)—Where the 12 annual
appropriations bills provide the legislative
authority for program allocations.
Components of Federal
Spending, FY 2006
($ in billions)
Net Interest, $220
Defense, $510
Other Mandatory,
$370
Medicaid & SCHIP,
$198
Domestic
Discretionary, $522
Medicare, $338
Social Security,
$550
Federal Budget Surplus/Deficit
Federal Budget Surplus/Deficit
($ in billions)
Final
2007
2000 2001 2002 2003 2004 2005 2006 2006 February
2008
July Actual Feb
July
Receipts
2,025 1,991 1,853 1,782 1,880 2,140 2,178 2,407
2,540 2,574
2,568 2,662 2,659
Outlays
1,789 1,863 2,011 2,160 2,292 2,472 2,613 2,655
2,784 2,779
2,731 2,902 2,918
Surplus/ Deficit
236
128 -158 -378 -412 -332 -435 -248
-244
-205
-163
-240 -259
Sources: OMB (FY 2008 Midsession Review for FYs 2006-2008, Final Monthly Treasury Statement, FY 2007
Comments on FY 2007 Actuals
• Total expenditures are up 2.8% over FY 2006.
• Given the drag upward of Medicare and defense
(most of the increase), this is not “runaway”
spending.
• Total receipts are up 7%, driven by an 11.5%
increase in personal income taxes and
continued high corporate tax receipts.
• Neither is sustainable for FY 2008. Withholding
from salaries and wages will continue growing at
its 7% rate, but unearned income and corporate
profits will decline.
Comments on FY 2007 Actuals
(cont)
• The deficit of $163 billion is substantially better
than the deficit of $318 billion two years earlier.
But it is $400 billion worse than the surplus of FY
2000.
• Lower revenue growth and increased
entitlement, debt service and defense spending
mean that deficits will grow in FY 2008 and
beyond under current law.
In sum
• In sum, the federal government collects
taxes for far more than supporting its own
household.
• Its finances underlie the finances of
essentially all sectors of society—state
and local governments, the consumer,
private enterprise, etc.
• This is especially true when the economy
turns soft, and the automatic stabilizers of
the federal fiscal machine kick in.
• This is happening now. The questions are,
how soft and for how long.
Budget Concepts
• Budget authority (BA). The authority to obligate
the federal government to spend money.
• Obligation. A formal legal commitment by the
federal government to spend money.
• Outlay (OL). Same in federal parlance as
expenditure or spending; flow of cash or checks
issued.
• Cost. Generally, the program level, the timing of
which may differ from any of the above.
• BA and OL are the concepts you usually see—
Ols frequently lag BA, sometimes substantially.
Federal Budget Timetable
• Federal fiscal year begins October 1. President’s budget
for that year is transmitted to Congress the previous
February.
• Congress passes a concurrent budget resolution by April
15th--not a law, but an exercise in congressional
rulemaking—what spending and tax legislation is in
order in each house, what laws must amended to
reconcile their fiscal impacts to the budget assumptions.
• The budget resolution sets totals for discretionary
spending; establishes rules for possible tax and
mandatory spending changes.
Federal Budget Timetable (cont)
• July 15—President transmits mid-session update;
updates budget assumptions, changes in policy, new
requirements.
• Budget reconciliation act—timing varies—forces
changes in tax law or cuts in mandatory spending
(entitlements). Requirements for any reconciliation bills
are placed in budget resolutions; the source of most
changes in tax law and mandatory spending.
• September 30—Need to pass new appropriations,
extend lapsing entitlements (e.g., SCHIP).
Continuing Resolution
• If new appropriations action is not finished by October 1,
Congress enacts a continuing resolution (CR) to
continue funding.
• A CR is a joint resolution—president signs, becomes
appropriations act.
• May be part of a year, or a full year; different rules (e.g.,
continue last year’s spending level, continue but at the
lower of last year or this year’s action to date).
• For FY 2008, the first CR is for 47 days—through
November 16, 2007—continuing FY 2007 levels.
Ongoing Tax Revenue Shifts
• At the federal level, the corporate profits tax will decline
substantially this fiscal year.
– Corporate profits increase will fall from double digit to
close to zero this quarter—HEADLINES!!!
– It is not this bad. Corporations try to push all the bad
news into the same quarter. But FY 2008 federal
corporate receipts will fall.
• Direct taxes should continue to grow, as wage and salary
increases finally kick in, but perhaps somewhat slower.
• There will be no substantial federal tax legislation this
year. Overall, tax revenue increases will be modest,
perhaps only equal to inflation.
Ongoing Tax Revenue Shifts
(cont.)
• At the state level, sales and property transfer tax
revenues have already taken a hit.
• Direct taxes continue fairly strong.
• At the local level, foreclosures and tax
delinquencies are reducing receipts for most
local governments, who will now look to their
states.
• Excise tax yields (e.g., transportation) continue
weak; trust and special funds that rely on them
will experience stress.
Sources of Major Federal
Program Changes this Year—
Not Many
• Social Security—No immediate need for change this
year, no changes.
• Reconciliation—The only budget reconciliation
instruction for FY 2008 was for higher education; that bill,
which cut subsidies to lenders, has already passed.
• Medicare—The Medicare changes in the House-passed
SCHIP bill will be deleted for now, but not forgotten.
– Reductions for Medicare Advantage
– Eliminating reductions for doctors reimbursements.
• Medicare growing fast—growth from 2004-2112 greater
than total projected federal costs for Medicaid in 2012.
Medicare/Medicaid Comparison
Medicare and Medicaid Payments for Individuals, 2004-2012
(federal fiscal years; dollars in billions)
Medicare
Part A
Other
Medicaid
SCHIP
2004
$295.9
164.1
131.8
176.2
4.6
2008
$454.2
211.6
242.6
201.9
6.6
Source: FY 2008 Federal Budget; Historical Tables.
2012
$574.2
257.7
316.6
270.2
6.6
Change
2004-08
2004-12
$158.2
$278.3
47.5
93.6
110.7
184.7
25.7
94.0
2.0
2.0
Medicaid
• Medicaid is 42% of federal grants to states. Enrollment is
falling nationwide, for a variety of reasons.
• Federal Medicaid spending grew 5.5% in FY 2007 after
falling in FY 2006
– Impact of the creation of Medicare Part D.
– Impact of many other events—DRA shifts, citizenship
documentation, changes in state eligibility, benefit and
reimbursement structures, intense federal oversight, new
federal regulatory shifts,
• States receive open-ended reimbursements based on
their federal medical assistance percentage (FMAP).
These changes are the biggest changes states will
face—they will move hundreds of millions of dollars.
North Carolina’s FMAP declines in FY 2008, costing the
state about $50 million; it will increase about the same
amount in FY 2009.
Medicaid (cont.)
• The administration is attempting to reduce
Medicaid programs cost by a variety of
regulatory changes—citizenship requirements,
graduate medical education, handicapped
education reimbursement, rehabilitation
services, provider tax limits, etc.
• There will be no substantial legislated Medicaid
changes this year; Congress has placed
moratoria on some.
• Long-term, Medicaid is a fiscal problem for both
federal and state governments. Short term, it is
not a major contributor to spending growth.
SCHIP
• SCHIP entitlement/ appropriation are provided for the
first ten years of the program (1998-2007) in Title XXI of
the Social Security Act.
• Unlike Medicaid, this entitlement is capped, with
allocations based on a formula.
– Data feeding the SCHIP formula variable/uncertain.
– In 1999, when these data were upgraded, constraints
were put on changes. North Carolina loses the most
from these constraints (-$16 million in FY 2008 under
current law structures).
• States reimbursed based on enhanced FMAP.
• SCHIP spending is now larger than its annual new BA;
states using prior year allotments. Over 5 years, an
increase of about $17 billion is necessary just to provide
for inflation for the current program.
SCHIP (cont.)
• Congress passed a five-year SCHIP
extension; the president vetoed it.
• Major questions—who is to be served,
how much to spend? (Note that potential
increase is $7 billion annually vs. much
larger growth for Medicare.)
• Important question for North Carolina—
need to move away from the constraints of
the current formula.
• Projection—SCHIP expansion passes just
before Christmas, but it will require further
changes—perhaps different FMAPs.
Social Services Block Grant
• SSBG is established under Title XX of the Social
Security Act; a set of state entitlements totaling $1.7
billion annually.
• Level was cut from $2.2 billion in late 1990s to offset
costs of highway legislation.
• The President proposed reducing this amount to $1.2
billion for FY 2007, and has repeated the proposal for
FY 2008.
• The administering agency refuses to publish state
entitlement amounts promptly, as required by Title XX,
listing state shares of $1.2 billion.
• There is almost no chance that the program will be cut.
Other Mandatory Spending
• Much federal mandatory spending remains tied to
FY1996 eligibility and allocation levels, when the
Temporary Assistance for Needy Families (TANF) block
grant replaced the Aid to Families with Dependent
Children (AFDC) program. Costs are being shifted to the
states.
• These levels were relatively generous initially, and states
managed through early 1990s economic downturn.
• These levels will have to be revisited if our current
economic softening is protracted.
The Clawback
• The clawback was designed to make states pay part of
the cost of the Medicare Modernization Act, that created
Medicare Part D, expanded Medicare Advantage, etc.
• Parameters for calculating the clawback are far from
definitive. Though it is clear that CMS overestimated for
the 2007 calculation, no change was made; States are
overpaying for 2007.
• North Carolina will have paid about $225 million for
2007; may on net have saved money.
• Clawback multipliers will decline 0.23% for 2008; federal
government repaying overpayment?
• The clawback may be revisited next year per a Medicare
“cost containment” requirement.
Focus on Discretionary
Appropriations
• Most discretionary grants received level funding in FY
2007; the major exception was funding through many
programs for hurricane relief.
• The President’s proposed cuts in FY 2008 domestic
discretionary spending will not be enacted; the President
has threatened to veto levels assumed in the budget
resolution. It will not be an easy fall in Washington
(Projection—final action just before Christmas).
• Under the current FY 2008 continuing resolution (thru
Nov 16), programs receive level funding.
• Elementary and secondary education will not experience
the president’s proposed cuts. Overall, the increase
should be 5-10%, with increases for compensatory
education and special education offset by reductions
elsewhere.
Focus on Discretionary
Appropriations (cont.)
• Low Income Home Energy Assistance (LIHEAP) should
get an increase, as will Community Health Centers and
Ryan White AIDS grants.
• HUD programs should receive some of the larger
increases, both for Section 8 housing and for community
development programs.
• A few Justice and Homeland Security programs will also
receive increases.
• Overall, however, these will be modest increases in FY
2008 following a year of level funding in FY 2007.
Transportation
• Highway spending has continued a slow growth
through the decade, with FY 2007 spending $8.8
billion higher (35%) than the $24.9 higher than
for FY 2000.
• At least half the increase is either for earmarks
or for emergency highway reconstruction.
• At the same time, Americans are driving less.
Receipts into the highway trust fund grew only
2% in FY 2007.
Transportation (cont.)
• It is now projected that the highway account of the trust
fund will be $4 billion in deficit in FY 2009; the mass
transit account somewhat later; legal implications are
unclear.
• It is clear that without more revenues states will wait
longer for reimbursement of valid expenditures.
• Mass transit spending has grown somewhat more.
• Airport construction grants, also funded through a trust
fund, have more than doubled since FY 2000. FY 2007
receipts increased 10%.
In sum—the Federal
Government
• Federal revenues continued a second year of strong
growth in FY 2007, up 7% after a 12% gain in FY
2006. This is primarily growth in capital gains and the
corporate income tax. These levels are not
sustainable for the long haul unless additional
unearned income is redefined as capital gains.
• Withholding is up about 6-7%; that is an
improvement. That will be sustained.
• FY 2007 federal spending was up only $77 billion
over last year (2.8%). Social Security, Medicare and
Defense were up over $100 billion; the balance of the
budget shrunk over $30 billion.
• Congress will attempt to add discretionary spending
for FY 2008; the administration will oppose it. Total
FY 2008 domestic discretionary spending will not be
much above FY 2006.
In Sum—the States
• Unlike the federal government, most state and
local governments cannot borrow for current
expenditures, only for capital expenditures.
• State revenues increased with the economy; the
growth is now softening with the economy.
• Sales taxes have leveled off, property tax yields
are beginning to level off or shrink with the end
of the housing bubble. Will the federal
government have the resources to assist?
Next Year
• As a country, we need to come to grips with our budget
situation. We cannot continue forever our expenditures
with the revenue structure we have established.
• Any major changes will probably wait until 2009. They
will not happen in a presidential election year.
• Medicare amendments, if not achieved this year, will be
revisited next year.
• With a potential softening of the economy, we may see
efforts to expand Medicaid and/or SCHIP to reduce state
costs, or to provide fiscal relief.
• The administration will continue its pressure on domestic
discretionary spending while attempting to maximize
appropriations for national defense in its last year. This
will permit expansion of defense procurement
expenditures regardless of who is elected to Congress
and the presidency.
Take Aways
• Bad News: The budget process is highly contentious
this year; expect more vetoes, expect delays.
• Good News: The outcome will almost certainly result
in increased funding for some grants. LIHEAP will
almost certainly receive an increase.
• Bad News: The cost of the war will continue to put
pressure on the federal budget, as will the rising
costs of Medicare. The problems of the Highway
Trust Fund may result in a retreat from federal-aid
highway collaboration.
• Good news: SCHIP will be reauthorized and
expanded--eventually.
Take Aways (cont.)
• No news: There will be no sustained action from either
the Administration or the Congress to address the issues
that are driving our fiscal deficits.
• Next Year’s News: Medicare cost containment legislation
will be presented with the President’s budget, and
considered in Congress.
• Bad News: The rules keep changing; program planning
becomes difficult.
• Bad news: The economy is soft; federal and state
receipts are leveling off, service demands are increasing.
Will the visible hand be visible?