Yellen Trashes GOP Plan to Prioritize Debt Payments

Good Thursday evening! March Madness is in full swing as No. 15 Princeton just beat No. 2 Arizona, following an upset of Virginia by 13th-seeded Furman. Is your bracket busted yet?

Here’s what we were watching while keeping one eye on the hoops.

Yellen Trashes GOP Plan to Prioritize Debt Payments

Appearing before the Senate Finance Committee Thursday, Treasury Secretary Janet Yellen said in no uncertain terms that she does not think a Republican proposal for the U.S. to prioritize its debt payments in the event of a default is viable.

The U.S. bumped up against the federal debt limit in January, forcing the Treasury to start taking “extraordinary measures” to make its payments. Absent an increase or suspension in the federal debt limit, the Treasury could be unable to meet its obligations at some point this summer or early fall — an outcome that Yellen and many economists have warned could lead to a global financial catastrophe.

Some Republicans, however, think that the U.S. can avoid a technical default by prioritizing its debt payments, even if other obligations such as paying salaries at government agencies go unpaid. A bill taken up last week by the House Ways and Means Committee would instruct the Treasury Department on how to prioritize its payments in the event that the debt limit makes it impossible to meet all federal obligations in full.

The “Default Prevention Act” would require the Treasury to first pay all principal and interest on the national debt and all Social Security and Medicare benefits. After those payments are made, the Treasury would be required to prioritize defense and veterans’ benefits. It would also be forbidden from paying for government travel and salaries for the executive branch and Congress until all other obligations have been met.

Yellen stated plainly that she doesn’t think such a plan would work. “The government on average makes millions of payments each day, and our systems are built to pay all of our bills on time and not to pick and choose which ones to pay,” she told the committee. “It’s simply a recipe for economic and financial catastrophe to think we can pay some of our bills and not all of them.”

Yellen also said that she “cannot give any assurances about the technical feasibility of such a plan. It would be an exceptionally risky, untested, and radical departure from normal payment practices of agencies across the federal government.”

Calling debt prioritization “default by just another name,” Yellen called on Congress to skip the disaster contingency planning and to instead “come together to recognize that raising the debt ceiling is their responsibility to protect the full faith and credit of the United States.”

The bottom line: Republicans have announced their intention to use the need to raise the debt ceiling as leverage in their campaign to slash federal spending. Though they have yet to provide a detailed budgetary plan, the fact that they are discussing contingency plans suggests that at least some GOP lawmakers are locked into their game of debt-limit chicken with the White House.

The Fed’s Rate-Hiking Campaign Turns 1 Year Old

On this date one year ago, the Federal Reserve announced a 0.25 percentage point increase in its benchmark interest rate, the first in a rapid series of eight hikes that have totaled 4.5 percentage points thus far.

The Fed’s efforts to curb inflation under Chairman Jerome Powell have suddenly become clouded by fears of a financial crisis given the collapse of Silicon Valley Bank last week and the turmoil now swirling around the banking sector. The Fed might raise rates again next week, or it may pause for fear of exacerbating the banking concerns.

But as Bloomberg’s Simon Kennedy reminds us, few if any analysts predicted the Fed’s path over the last year: “The median forecast of economists surveyed by Bloomberg was for the Fed’s main rate to reach 1.75% at the end of this quarter and for it to be at 2.25% a year later. Not one economist of the 56 analysts who responded anticipated that rates would be where they are now.”

The Fed’s own policymakers saw the benchmark interest rate below 2% by the end of 2022 and below 3% at the end of this year, based on their median projections.

That is, Kennedy writes, “a reminder of how tricky it’s been to forecast monetary policy just as Powell faces another tough call next week.”

Number of the Day: 35%

Goldman Sachs economists raised their estimate of the likelihood that the United States will fall into a recession over the next 12 months to 35%, up from 25%. The change, they said, reflects “increased near-term uncertainty around the economic effects of small bank stress.” The new estimate remains well below the 60% median of economists surveyed by Bloomberg.

Taxpayer Advocate Says $80 Billion IRS Funding Boost Strikes Wrong Balance

The National Taxpayer Advocate on Thursday weighed in on the controversial $80 billion, 10-year funding boost provided to the Internal Revenue Service by Democrats last year, writing that the money would be better directed to help taxpayers rather than ramp up enforcement.

In a blog post, National Taxpayer Advocate Erin M. Collins argues that too little of the additional IRS funding by the Inflation Reduction Act (IRA) went toward taxpayer services and modernizing the agency’s systems. “[T]he additional funding provided by the IRA, while appreciated and welcomed, is disproportionately allocated for enforcement activities and should be reallocated to achieve a better balance with taxpayer service needs and IT modernization,” Collins wrote, arguing that the top tax administration priority should be to improve customer service. “We need to put taxpayers first.”

Of the $80 billion provided by last year’s Inflation Reduction Act, $45.6 billion went for stepped-up enforcement meant to improve tax collection and close the tax gap, or the amount of owed taxes that goes unpaid each year. Another $25.3 billion went to general operational support, while $4.8 billion was allocated to tech systems upgrades and $3.2 billion was dedicated toward service improvements.

The IRS funding infusion has come under attack by Republicans who have focused most of their denunciations on misleading warnings that the money would pay for an army of 87,000 auditors who will target average taxpayers. Some in the party have also criticized the balance of funding provided for customer service improvements.

Collins argues that service improvements would improve tax collections, calling it a “no-brainer” that the agency’s biggest areas of need are service and technology.

“I don’t mean to downplay the IRS’s important role in enforcing the tax laws that Congress has written. Enforcement is an essential IRS function and an important component of tax compliance when applied fairly and equitably,” she writes. “But enforcement is just one component of an effective compliance strategy. The most efficient way to improve compliance is by encouraging and helping taxpayers to do the right thing on the front end. That is much cheaper and more effective than trying to audit our way out of the tax gap one taxpayer at a time on the back end.”

The counterargument: Collins writes that her goal is to ensure that taxpayer needs are met, and she urges Congress to provide greater funding for taxpayer services and IT modernization. But as Tobias Burns writes at The Hill, Democrats directed more than half the new funding for the IRS to enforcement because most of the tax money that goes uncollected each year “is stashed away in individual business income accounts that require well-trained auditors to be able to collect.”

The IRS’s tax gap report last year said that 80% of the projected $540 billion average annual tax gap for 2017 through 2019 was due to underreporting, with 70% of that underreporting done by individuals. Another 12% of the gap was the result of underpayments and 8% was due to individuals or businesses simply not filing taxes. A separate 2021 working paper by IRS researchers and economists at the London School of Economics and the University of California found that the top 1% of taxpayers fail to report more than one fifth of their income to the IRS.

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