Issue Summary: Budget Process updated 6/7/2004
Detailed Issue Summaries contain a quick reference to Centrists.Org policy ideas. They will be revised and updated periodically for clarity and usefulness, and as events and policy ideas change. Questions or comments? Please contact us at information@centrists.org .
Budget and Tax (Basics) Issue Summary
Outline:
Brief History of Balanced Budget Politics
How Gimmicks Distort Budget and Tax Policy -- Good Budget Rules Gone Bad
New Rules for Offsets -- Pay-As-You-Go for Consumption, Save-As-You-Go
A Brief History of Balanced Budget Politics: Serious budget progress began with the Budget Enforcement Act of 1990, under which Congress discarded unenforceable budget targets in favor of a new approach: pay-as-you-go rules for taxes and entitlements, and caps on so-called discretionary spending (for domestic and defense programs for which funds are appropriated each year).
The grand budget targets of the 1980s (Gramm-Rudman-Hollings and the like) had failed to prevent large federal deficits.
The new 1990 budget rules, by contrast, were at once more modest and more powerful. The 1990 rules required that laws cutting taxes or raising entitlement spending be offset by equivalent tax hikes or spending reductions elsewhere in the budget. Rather than mandating unachievable goals, the new framework suppressed laws that would make the deficit worse. That held the line on an important preventable cause of deficit spending: congressional action to expand entitlements or cut taxes without budgetary offsets.
The reasonableness of the offset rule appealed to members of Congress, and the new approach to fiscal discipline stuck. For each new bill, members of Congress scrutinized cost estimates from the Congressional Budget Office (CBO). Bills that were not offset, or "paid for," by CBO's reckoning were subject to additional procedural hurdles that required a supermajority to clear. Such bills often failed to pass, and under the new approach, major deficit reducing measures were enacted in the budget and tax agreement of 1990, and the Omnibus Budget Reconciliation Act of 1993. The 1990 and 1993 laws included spending cuts and tax hikes to reduce the deficit.
The cultural change in Washington spread from taxes and entitlements to discretionary spending. In order to fund high-priority programs under the caps on discretionary outlays, congressional appropriators made an extra push to identify and restrain the funding for lower-priority items. Although offsets were not required procedurally in allocating funds for discretionary programs, the mentality took hold among the appropriators.
In the mid- and late-1990s, however, as deficits swung toward surplus, a confluence of pressures made changes in fiscal policy inevitable.
Congressional self-restraint is the ultimate cause of fiscal discipline, and Congress was reluctant to hold to budget rules that were originally designed to reduce the federal deficit. Sound budget rules can help Congress restrain itself, but in the end tough budget decisions result from political will, not rules. Large projected surpluses clearly eroded that will.
Moreover, the 1997 budget bills relied too heavily on trimming discretionary spending and Medicare costs. The Balanced Budget Act of 1997 and the Taxpayer Relief Act of 1997 were intended to provide further budget discipline, but in fact set the stage for its collapse. The 1997 bills actually cut taxes but theoretically reduced the deficit by cutting projected spending by an even greater amount. However, the 1997 bills' budget caps on discretionary spending were too strict and did not hold. Likewise, the Medicare cuts in payment rates to health providers (doctors, hospitals etc.) were reinstated in subsequent legislation or by administrative action.
A surge of discretionary spending for domestic programs started in 1999. Defense outlays followed with a large uptick in 2000, and Medicare spending surged in 2001. Since then, spending in all categories has continued at a very rapid pace. Some of that acceleration of spending is related to post 9/11 anti-terrorism and security programs -- spending in those areas will probably remain high, but will not grow as rapidly in upcoming years.
However, much of the post-2001 spending bubble is not related to security, and there is no indication Congress will be willing to cut back anytime soon. The omnibus appropriations bill enacted in January 2004 will maintain the free-spending trend.
Combined with large tax cuts, the federal budget has swung from surpluses back into deep deficits. Although the economy has been growing since the last quarter of 2001, there is no indication yet that economic growth will come close to bringing revenues back in line with spending, especially since tax rates on dividends, capital gains, and high incomes -- the first components of the income tax base likely to jump as the economy recovers -- have been cut sharply in recent years.
Link:
Congressional Budget Office The Expiration of Budget Enforcement Procedures: Issues and Options in The Economic and Budget Outlook: Fiscal Years 2004-2013 (January 2003). This is the best succinct technical description of budget law since the 1980s, and it contains a clear explanation of pay-as-you-go and budget cap procedures, including tables showing how well those procedures worked.
How Gimmicks Distort Budget and Tax Policy -- Good Budget Rules Gone Bad: The Congressional Budget Office (CBO) released new projections of federal spending and revenues in late January 2004. The President’s budget was released shortly thereafter, on February 2nd.
The headline CBO projections of the budget understated the likely budget deficits for the next ten years for three reasons:
1. Tax Cut “Sunset” Provisions
2. Understated Growth of Discretionary Spending
3. Major Omissions or “Other Considerations”
Sunset Provisions in the Tax Code. The largest sunset provision in the tax code is the 2001 tax cut, which is scheduled to sunset entirely in 2010. Of course, the sunset provisions in current law won’t actually take effect. Congress would not allow tax rates to suddenly snap back to their 2000 levels -- that would be economically disruptive.
The sunset provisions in the 2001 tax cut, as well as the sunset provisions in several elements of the tax cuts passed in 2002 and 2003, represent an extreme of politically cynical and generationally irresponsible policymaking.
The sunset provisions were designed to understate the future size of the tax cuts, confound budget projections, and deceive voters. Congress knew full well when enacting those tax cuts that the sunset provisions would not be allowed to take effect and disrupt the economy.
However, CBO’s main projections assume the tax cuts do sunset on schedule. Therefore the “headline” budget deficit figures dramatically overstate likely future tax revenues and understate future deficits.
Understated Growth in Discretionary Spending. CBO’s projections are also required to use the assumption that discretionary spending -- defense and domestic spending that is appropriated by Congress each year -- grows at the rate of inflation.
During periods of fiscal austerity, such as the mid-1990s, this assumption may have seemed reasonable. However, it is an overly optimistic projection on a forward-looking basis. Non-defense discretionary spending has grown at twice the rate of inflation (or faster) since 1998. Defense spending is growing at double-digit rates.
There is no indication of a slowdown in appropriations for non-defense spending. In fact, Congress seems to be moving in the opposite direction, making it a competition to top previous records in funding levels and pork-barrel appropriations.
And although some of the defense and homeland security spending since 2001 represents one-time outlays that may not need to be added to the budget on a permanent basis, it seems unlikely that defense spending will slow toward the rate of inflation anytime soon.
Moreover, as defense needs gradually shift toward personnel, services, retirement and health costs, and away from purchases of military hardware, the natural growth rates of defense spending -- required to maintain a constant level of military readiness -- will probably exceed the rate of inflation anyway.
Major Omissions or “Other Considerations.” The largest omission in the budget is the future cost of preventing millions of middle-class taxpayers from being hit by the Alternative Minimum Tax (AMT), which was originally intended only to ensure that high-income taxpayers paid a fair amount. Leaving the transition costs of Social Security reform out of the budget is also a huge omission, assuming the Administration really wants to enact a reform program. Finally, there is the "out-year" cost of proposals designed to reduce the tax base outside of the usual 10-year budget window.
The revenue loss from the 2001 tax cut was understated by hundreds of billions of dollars (over the 10-year budget period) because revenue estimators at the Joint Committee on Taxation (JCT) computed that the AMT would negate the tax cuts of millions of taxpayers. However, Congress is not likely to allow this to happen. But fixing the AMT could cost as much at $1 trillion over the next 10 years.
The transition costs of Social Security reform have not been included in any of President Bush's budgets. That is OK if we are not serious about actually reforming the program, and all indications are, the Administration will not push this issue very hard (if at all). However, to the extent the Administration wants to tout the long-term benefits of reform, it should either produce a legislative proposal or encourage Congress to develop one, and it should include the transition costs in its budget.
Finally, the Administration has made a subtle but steady pursuit of reducing the tax rates on retirement savings and investments, like IRAs and 401ks. Under current law, redemptions from most of those accounts (except Roth IRAs) are taxed. If, over time, Congress allows those redemptions to escape taxation, then the long-term budget outlook would be considerably worse.
The largest "other consideration" in the current budget is the future cost of Medicare.
The Medicare drug benefit was created after a long process of give-and-take between the Congressional committees and CBO. CBO wasn’t duped. But it was maneuvered into assuming that the drug benefit would work -- actuarially and politically -- as drafted in the law.
However, many health experts believe Congress will need to add hundreds of billions to the budget to make the drug program work at a politically acceptable level. This may amount to an omission in the budget. Past CBO estimates of health bills that were probably unworkable or would need additional funding or legislation were accompanied by a CBO discussion of those problems up front.
Links:
Centrists.Org No-BS Long-Term Budget Baseline Homepage
Centrists.Org The Fourth Entitlement: Interest (December 1, 2003)
Congressional Budget Office The Expiration of Budget Enforcement Procedures: Issues and Options in The Economic and Budget Outlook: Fiscal Years 2004-2013 (January 2003). This is the best succinct technical description of budget law since the 1980s, and it contains a clear explanation of pay-as-you-go and budget cap procedures, including tables showing how well those procedures worked.
New Rules for Offsets -- Pay-As-You-Go for Consumption, Save-As-You-Go: Budget process rules are generally only as strong as the political willpower of the lawmakers who abide by them. Nevertheless here are several steps that could greatly help lawmakers understand the budgetary consequences of their actions (or inactions):
1. A High-Profile Budget and Tax Reform Commission. It's time. In the mid-1990s, budget issues were all the rage. The House Republicans' "Contract With America," President Clinton's pledge to balance the budget, the tough spending cuts and tax increases in 1993, and the tight appropriations limits after the Republican take-over of Congress in 1994.
Now, budget issues are completely forgotten. The surpluses of the late 1990s are shrugged off as a historical accident (not the result of much hard work and political pain). The Bush administration says deficits don't matter. Right-wing ideologues like Grover Norquist say that tax levels matter and that spending levels matter, but the resulting deficits or surpluses do not. Congress is competing with itself to spend as much as possible before the party stops. Some principled Democrats and Republicans complain, but many have rushed to join the party too.
Forcing the heads of the Congressional budget, tax, entitlement, and appropriations committees to sit on a high-profile budget and tax reform commission with the Administration's top economic and budget policy analysts might be just the ticket to getting a saner budgetary perspective in Washington. It would give the press a solid framework to describe the issues, and the public would be better able to learn which politicians or political parties are telling the truth and which are lying about the budget numbers and their consequences.
2. Transition Costs of Entitlement Reforms in the President's Budget. One of the largest shortcomings of the Bush Administration has been its capitulation on entitlement reform. That may change, but the signs so far are clear: Medicare reform? No, the Administration wanted a politically popular drug benefit, but flinched in the face of long-term reforms. Social Security reform? Not even close. The Bush Administration not only hasn't produced a plan, but also hasn't included even a rough number for the transition costs of reform in its budgets. In both cases, the Administration has signaled that it could live just fine without entitlement reforms that actually save money for the next generations of taxpayers.
Putting the cost of Social Security reform into the President's Budget would be an honest first step. Instead, we see gimmicky long-term savings proposals -- like Retirement Savings Accounts (RSAs) and Lifetime Savings Accounts (LSAs) -- which sound good, but would have huge deficit-increasing effects in the long run.
3. CBO Long-Term Narrative on Major Spending or Tax Bills. Large tax or entitlement bills should get more than the normal 10-year cost table from the Joint Committee on Taxation (JCT) or the Congressional Budget Office (CBO). First, CBO should be required to classify all introduced bills, at every stage in the legislative process, into two categories: those likely to have large, long-term budgetary impacts, and those which would not. The criteria for bills with large budgetary impacts would be:
a. Proposals likely to have a $100 billion cumulative budgetary impact over ensuing 10 years
b. Proposals having abrupt policy changes -- like sunset provisions of major tax proposals -- which could have economic repercussions, or
c. Proposals with delayed effects, such as proposals not scheduled to begin until near or after the end of the 10-year budget period.
These criteria would not need to be objectively proved. CBO would only be asked to quickly assess the rough likelihood of a bill's crossing the threshold at its introduction or at subsequent points in the legislative process where the bill was modified.
Having classified a bill as having significant long-term budgetary impact, CBO would then attach an added narrative to its regular cost estimates describing those consequences. CBO need not perform extra estimates, or extend its regular estimates outside of the 10-year budget window. But it would be required to describe the likely economic and budgetary impact in the longer time period, so that lawmakers would have additional information on which to base judgments.
4. CBO Discussion of Economic Shocks Associated With Abrupt Tax or Policy Changes. One major area where CBO needs to improve its estimates is the evaluation of proposals that include abrupt policy changes, such as large tax increases or sudden spending cuts. To downplay the long-term cost of their proposals, policymakers can be tempted to create legislation that raises spending or cuts taxes now, but then takes away the spending or tax cut at some point in the future. The most common use of this practice in recent years has been the "sunset" provision, in which tax rates or policies would revert to their pre-tax cut levels in a distant year.
This practice is unreasonable, because large, sudden tax changes or spending cuts would have adverse economic consequences. CBO should add a narrative discussion to its regular estimates of proposals with these sorts of sudden changes describing the possible economic impacts of such sudden changes, or the budgetary cost of allowing the tax cuts or spending programs to continue past their expiration dates.
5. Sunshine on the Appropriations Process. CBO's analysis of appropriations bills is just too legalistic and perfunctory. Occasionally you will see an appendix to an old CBO report describing a "sequestration procedure" or other such technical calculations regarding federal spending. But in the main, Congress passes appropriation bills without providing a clear explanation of how the money is to be used, and why. In fact the secrecy and opaqueness is a very important part of the current appropriations process -- without it, the public would hardly approve of many spending programs.
The combination of secrecy and "ear-marks" makes ever-higher appropriations almost inevitable. Members of Congress know that if they don't go along with the process, they won't get any extra spending in their districts. And now that ear-marked spending has grown to such high levels, speaking out against the bloated appropriations process can be a real political disadvantage.
CBO should shed light on the appropriations process by posting regular reports on its website concerning the process of appropriations bills: what's in them, where the ear-marks would likely go, how the funding levels compare with past trends, and so on. Any member of Congress should have the right to demand a CBO evaluation statement on an appropriation bill ahead of final votes. Most importantly, final conference agreements -- where conflicting bills from the House and Senate are reconciled -- should receive detailed CBO statements.
6. CBO Discussion of National Savings on Social Security Reform and Certain Tax Bills. Most spending and tax bills would directly increase or decrease U.S. consumption. For example, most spending bills would put more money in the private sector's pocket (either through direct purchasing or compensation of employees) -- which would mostly stimulate new consumption. Likewise, most of the recent tax bills have been attempts to stimulate consumption by giving taxpayers -- individual or corporate -- money they can spend.
However, there may be ways to cut taxes that are more likely to induce private savings than consumption. For example, payroll tax "carve-outs" (shunting a portion of payroll taxes to individual savings accounts) and "add-ons" (adding a tax that funds individual savings accounts) would increase private savings. If people viewed funds from a Social Security carve-out or add-on as a substitute for traditional Social Security benefits down the road, they would not view the accounts as a windfall and change their consumption patterns. Therefore, even if the funds for carve-out or add-on accounts added to the federal deficit, the reduction in public savings would be largely matched by the increase in private savings.
It makes sense to consider tax cuts that would flow through to private savings in a slightly different manner than ordinary tax cuts or spending increases that would mostly induce consumption. Where it might be appropriate to fully offset the long-term cost of a proposal that would cut taxes and increase private consumption, a less stringent offset or pay-as-you-go rule might apply to tax cuts that would proportionately increase private savings.
Of course, it is hard to know how various types of proposals would impact national savings. Economists might disagree in many cases, and the evidence might be thin on others. Nevertheless, it would be helpful if CBO could analyze the most significant proposals on that score, and at least summarize the main areas of disagreement if necessary.
Link:
Congressional Budget Office The Expiration of Budget Enforcement Procedures: Issues and Options in The Economic and Budget Outlook: Fiscal Years 2004-2013 (January 2003). This is the best succinct technical description of budget law since the 1980s, and it contains a clear explanation of pay-as-you-go and budget cap procedures, including tables showing how well those procedures worked.
