Process Reform As Deficit Reduction: A First Step, But No Substitute for Policy

Tuesday, May 3, 2011

Issue Briefs

As the President and Congress consider deficit reduction options and an increase in the debt limit, budget process proposals have recently become popular on Capitol Hill.

As the President and Congress consider deficit reduction options and an increase in the debt limit, budget process proposals have recently become popular on Capitol Hill. In the last several months, President Obama has proposed a “debt failsafe” trigger, The Bipartisan Policy Center proposed a “Save as You Go” rule, and Senators McCaskill (D-MO) and Corker (R-TN), as well as House Budget Committee Chairman Paul Ryan (R-WI) have proposed a cap on overall spending. Additional proposals are likely in the days ahead as Vice President Biden convenes a new working group requested by President Obama and the bipartisan “Gang of Six” senators continue work on their proposal.

The proposals have key differences, though each attempts to reduce the deficit by setting specific spending, revenue or deficit targets. The targets are generally enforced using some variation of a trigger or sequestration procedure requiring automatic spending cuts or revenue increases if the targets are missed.

Process proposals such as caps, commissions, points of order and constitutional amendments are often appealing solutions for politicians because they frequently leave out the specifics of politically difficult decisions necessary to meet the targets. For elected officials, it is far easier to discuss a cap than it is to tell voters that their Social Security or Medicare benefits will be cut or a favorite tax deduction will be eliminated.

As a means of actually reducing deficits, the benefits of process proposals are less clear. In the past, similar proposals have had a mixed track record because they have frequently been poorly designed and weakened with exemptions. For a process proposal to have a meaningful effect on trillion-dollar deficits and our $14 trillion debt, these mistakes of the past must be avoided. An effective budget process proposal should limit exemptions, consider the entire federal budget to be on the table for deficit reduction, include realistic targets, and be accompanied by a bipartisan commitment both to enforce the targets and support the specific spending and revenue policies necessary to meet them.

McCaskill-Corker CAP Act

Senators McCaskill and Corker have introduced legislation (S. 245– The Commitment to American Prosperity Act) to limit total federal spending to the historical average of 20.6 percent of gross domestic product (GDP). Beginning in 2013, the bill would gradually phase in the cap over a 10-year period until it reaches the 20.6 percent target. Each year’s cap would be determined using the average GDP of the first three of the four previous years.

Compliance with the cap would require significant cuts to current spending levels. Without a cap, 2021 spending is projected to reach 24 percent of GDP in CBO’s baseline and 26 percent of GDP in The Concord Coalition’s plausible baseline. Based on existing GDP estimates, the bill’s sponsors project that over the first three years the cap is in effect, spending would be limited to the levels included in the table below:

The Office of Management and Budget (OMB) would be responsible for calculating the annual cap and providing updates throughout the year. If OMB determines that the cap will be exceeded, the Budget Committees could report resolutions directing the other committees to produce legislation to comply with the cap. If spending is not reduced below the cap, OMB would eventually be required to conduct a sequestration imposing cuts to eliminate the excess spending. The sequestration process would apply to virtually every federal program. The single exemption permitted is for interest payments on the debt. The caps would also be enforced with a new budget point of order that could be raised against legislation that would cause the cap to be exceeded. Waiving the point of order would require a two-thirds vote in both the House and the Senate.

House Budget Committee Chairman Paul Ryan’s Proposal

House Budget Committee Chairman Paul Ryan (R-WI) has also expressed support for a cap on total spending. In his budget resolution proposal, Ryan called for a binding cap on total spending as a percentage of the economy that would be linked to the assumptions in the budget resolution. In the case of the House budget resolution, spending would average 20.5 percent of GDP over ten years and decline to 19.9 percent of GDP by 2021. If spending did not meet the budget resolution’s targets, they would be enforced with a sequestration process that requires automatic spending cuts, but does not apply to revenues. Ryan has also called for similar caps on discretionary spending.

President Obama’s Debt Failsafe Trigger

In a speech last month, President Obama set a goal of reducing the deficit by $4 trillion in 12 years or less using cuts to discretionary spending, health care savings, tax reform, and other proposals. Obama has appointed Vice President Biden to lead a group of congressional leaders in negotiations over the details. According to the administration, the framework announced by the President would have the goals of reducing deficits to 2.5 percent of GDP in 2015 while placing deficits on a declining path that gets closer to 2.0 percent of GDP by the end of the decade.

The deficit targets would be enforced using a “debt failsafe” trigger that would go into effect by 2014 if projections show that the debt-to-GDP ratio has not stabilized and will not be declining in the second half of the decade. If deficits as a percentage of GDP are projected to average more than 2.8 percent during the second half of the decade, the trigger would require an across-the-board spending reduction. The proposal would exempt Social Security, low-income programs and Medicare benefits from the trigger.

In a report released last December, the President’s National Commission on Fiscal Responsibility and Reform, chaired by former Republican Senator Alan Simpson and former Clinton Administration Chief of Staff Erskine Bowles, recommended a similar “automatic failsafe” mechanism to ensure that the budget remains on a path to fiscal sustainability. The commission also called for an expedited legislative process to consider deficit reduction proposals.

Bipartisan Policy Center’s SAVEGO Proposal

The Bipartisan Policy Center’s Debt Reduction Task Force, co-chaired by former Senate Budget Committee Chairman Pete Domenici and former Office of Management and Budget Director Alice Rivlin, proposed a new Save As You Go rule (SAVEGO). Under SAVEGO, Congress would set annual savings targets necessary to meet a specific deficit reduction goal. The BPC has recommended reducing debt to 60 percent of GDP by 2021, which would require savings of approximately $4 trillion compared to CBO’s baseline.

Instead of setting an overall deficit target to reach the goal, SAVEGO would establish three annual targets for savings from specific portions of the budget, including:

A cap on discretionary spending
Savings from health care programs
Savings from other mandatory spending, reductions in tax expenditures, and other revenue increases

If the targets are not reached, SAVEGO would require automatic spending cuts, reductions in tax expenditures, or other revenue increases. In many respects, SAVEGO is a more fiscally responsible approach than prior Pay As You Go (PAYGO) proposals. While PAYGO rules have generally focused on offsetting new legislation to avoid increasing the deficit, SAVEGO would set savings targets intended to begin reducing the deficit. SAVEGO also restricts some of the costly exemptions which have limited the effectiveness of PAYGO. The BPC recommends that health care programs only be exempt from a sequestration if the required health care savings target is achieved. Social Security would only be exempt if a law is enacted that achieves sustainable solvency in the program.

Peterson-Pew Commission on Budget Reform

Last year, the Peterson-Pew Commission on Budget Reform also released a plan that called for stabilizing the debt at 60 percent of GDP. Like the President’s proposal, the plan recommends establishing specific deficit targets that would be enforced using a trigger that would require automatic spending cuts if the targets are missed.

The commission concluded that past triggers have failed, in part, because the number of exemptions limited their effectiveness. The commission’s proposal attempts to address this by recommending that the trigger apply to all discretionary programs, mandatory programs, and revenues. Specific cuts would be evenly divided between spending cuts and revenue increases. The impact of the automatic cuts would also be limited so that cuts do not exceed 1.0 percent of GDP in any given year. Separate caps would also apply for discretionary spending.

Budget Process Reforms Have Had a Mixed Track Record

The budget process proposals making their way around Capitol Hill continue what has been a long and often frustrating history of attempting to reduce the deficit using caps, triggers, and related budget enforcement mechanisms. Unfortunately, the path to our $14 trillion debt has been paved with failed caps, points of order and similar devices. This mixed record raises the question: How will these proposals succeed?

In 1985, the Gramm-Rudman-Hollings Act (GRH) began the process by establishing deficit targets and a sequestration process requiring cuts if the limits were exceeded. As the Senate Budget Committee’s history of the budget process recounts, GRH is widely viewed as unsuccessful because it failed to reduce the deficit. While the law was intended to balance the budget by FY 1991, during FY 1986-1990 the actual deficit exceeded the target in every year. The sequestration process was also criticized after Congress proceeded to add a long list of exemptions and other gimmicks.^[1]

Eventually, the Budget Enforcement Act of 1990 replaced the GRH deficit targets with two new budget enforcement mechanisms: a PAYGO law requiring offsets for direct spending or revenue legislation and caps restricting annual appropriations. These mechanisms were generally considered to be successful in the 1990s when deficits were briefly replaced with projected surpluses. The two statutory mechanisms were subsequently revised over the years, though versions of them remained in effect until they expired in 2002. After statutory PAYGO expired, the House and Senate relied on internal PAYGO rules which did not have the force of law or include sequestration procedures. A new version of statutory PAYGO was signed into law by President Obama in 2009.

At the beginning of the 112th Congress, the House replaced its internal PAYGO rule with a new CUTGO rule that excludes revenue effects from the offset requirement and prevents revenue increases from being used to offset spending.

Today, budget enforcement is provided using budget points of order, the House rules and the new PAYGO law requiring revenue or direct spending legislation to be offset in cases where no exemptions apply. All of these mechanisms have been largely ineffective in limiting spending and reducing deficits that now exceed a trillion dollars. From 2001 to 2010, discretionary spending more than doubled and OMB has concluded that loopholes in the PAYGO law have been used to add hundreds of billions of dollars to the deficit.

The mixed track record that budget enforcement rules have had in recent years suggests that a budget process proposal in itself may not be enough to effectively reduce deficits. To be effective, improvements must be made to the previous efforts.

Everything Must Be on The Table

Last December, the President’s Commission on Fiscal Responsibility and Reform released recommendations based on the principle that “everything must be on the table” for deficit reduction. Other commissions that have reviewed the fiscal challenges facing our nation have also concluded that both revenues and spending must be on the table. This principle must also apply to budget process proposals.

The fiscal challenges facing our nation are serious enough and our debt is large enough that the entire federal budget must be considered, including domestic discretionary spending, defense spending, revenues, and entitlement programs. Proposals to tinker around the edges of the budget by focusing only on non-security discretionary spending (about an eighth of the budget) or ignoring revenues are not enough.

It is encouraging that the proposals offered by President Obama, the Bipartisan Policy Center, the Peterson-Pew commission, and the President’s fiscal commission generally consider everything to be on the table. To the sponsors’ credit, the McCaskill/ Corker and Ryan spending cap proposals apply to all federal spending — including the budgets of all federal agencies as well as entitlement programs such as Social Security and Medicare.

Unfortunately, the effectiveness of the McCaskill-Corker cap as a deficit reduction measure is significantly weakened by its failure to explicitly address revenues. For one thing, many spending programs can be disguised as tax policies, encouraging politicians to get around the spending caps by increasing the loopholes and deductions that make our tax code inefficient.

Additionally, in the absence of a revenue component, it is unlikely that the spending caps alone will result in a fiscally sustainable path. Even limiting spending to 20.6 percent of GDP would still result in significant deficits when revenues in 2021 are projected to be only 18.3 percent of GDP in the House Budget Resolution.

The Concord Coalition has long argued that a sustainable fiscal policy must include fundamental changes to both spending and revenue policy. The recent bipartisan deficit commissions both proposed reforms to broaden the tax base and lower rates by scaling back deductions and loopholes. The McCaskill-Corker bill would be more effective if it included similar proposals. Ryan’s budget proposal makes some progress by supporting a proposal to close loopholes and broaden the revenue base, but misses an opportunity by failing to provide details and declining to use any of the assumed savings from base broadening to reduce the deficit.

The Targets Must Be Realistic and Bipartisan

Process proposals that apply far into the future have often proven to be ineffective. In order to claim future savings, the targets are frequently set at unrealistic levels with the assurance that Congress can easily manipulate or alter them before they go into effect. For a process proposal to succeed where similar proposals have failed, there must be a bipartisan agreement that the caps are realistic and should be strictly enforced as soon as feasible.

Caps based on historical averages, such the McCaskill-Corker proposal, are a reasonable place to begin a discussion about spending limits and fiscal sustainability. However, it is important to recognize that historical averages for revenue or spending are numbers that have no policy rationale behind them. Averages have little relevance in determining future spending needs in a nation where an aging population and rapidly increasing health care expenditures will require additional funding that far exceeds prior funding levels.

Both the Congressional Budget Office (CBO) and the Government Accountability Office (GAO) regularly project that the long-term spending needs of our entitlement programs remain unchanged. GAO projects that spending will rise to 27.4 percent of GDP by 2021 and exceed 50 percent of GDP by 2054. CBO’s alternative fiscal scenario projects that spending will rise to 25.9 percent of GDP in 2020 and to 35.2 percent of GDP by 2035. Compared to the McCaskill-Corker bill’s 20.6 percent cap, these projections are a stark reminder that addressing our nation’s fiscal challenges will require more than simply imposing a cap based on the historical average. Even the tough austerity measures proposed by the President’s fiscal commission and the Bipartisan Policy Center’s Debt Reduction Task Force fail to reduce spending by enough to get under the cap within 10 years.

Complying with targets that fall short of the funding necessary to continue programs such as Social Security and Medicare as they currently exist will require significant reforms and politically difficult decisions. Unlike discretionary spending that is designed to be reviewed annually and can easily be adjusted, mandatory spending is on automatic pilot. Entitlement programs are more difficult to adjust because outlays are based on formulas and change based on demographic and economic trends largely beyond the control of policymakers.

If a budget process proposal relying on savings from entitlement programs is to be effective, it must be accompanied by a bipartisan commitment to make the substantive policy decision needed to meet the target. Policymakers should be honest about the trade-offs involved and educate voters about the sacrifices that will be required. Simply saying that benefits may be cut because spending exceeded a cap and OMB sequestered the funds is not enough.

If a budget process proposal were to be enacted without this understanding, it would risk creating a dynamic similar to the current debate over increasing the debt limit — a debate that is unfortunately happening long after fiscal policy decisions have already been made. In the case of limits on both debt and spending, the fiscally responsible approach is to consider limits in the same context as the policy decisions needed to meet them.

Avoid Exemptions and Loopholes

An effective budget process proposal should also avoid the exemptions, loopholes, and gimmicks that have been used in the past to enable additional deficit spending.

A significant weakness of GRH and similar budget enforcement proposals has been the pages of exemptions that frequently accompany the sequestration procedures. While some exemptions may be justified, as soon as one is approved, additional ideas for exemptions never seem to be far behind. The end result has usually been an ineffective sequestration process that covers only a small portion of federal spending. For a trigger or sequestration process to be effective, it must apply to a substantial portion of the spending that is driving deficit spending in the first place. If exemptions are included, they should be limited and rare.

Given the previous history of exemptions, it is discouraging that President Obama’s trigger proposal contains costly exemptions such as Social Security, low-income programs, and benefits for Medicare enrollees. Because programs such as Social Security, Medicare, Medicaid and other low-income programs are projected to account for well over 90 percent of all mandatory spending over 2012-21, this is a significant loophole that could cause the trigger to be an ineffective means of enforcing the deficit target.

A more responsible approach to exemptions is the McCaskill-Corker proposal to subject almost all federal programs to sequestration by eliminating the long list of exemptions that has been included in prior budget process laws. The single exception is for interest payments on the debt.

The 2010 PAYGO law offers a recent example of what can happen when too many exemptions manage to find a home in a budget enforcement proposal. The law was intended to require new legislation to be offset, but it included costly exemptions for several popular revenue and spending priorities. The end result was that exemptions were used for legislation adding hundreds of billions of dollars to the deficit. According to a January OMB report, when the exemptions were taken into account, laws subject to PAYGO would increase the deficit by $899.4 billion over 2010-2015 and by $820.1 billion over 2010-2020.

In the case of discretionary appropriations, the recent history of emergency spending is another example of what can go wrong with exemptions. Because emergency spending is exempt from budget allocations, bills intended to fund legitimate emergencies have routinely attracted extraneous items. In a review of emergency-designation provisions enacted from fiscal years 1997 through 2006, GAO identified $31 billion in emergency spending that was either not consistent with the commonly accepted criteria for emergency spending or did not include enough detail to make a determination.

The Concord Coalition has raised concerns that the growing misuse of the emergency designation has weakened budget discipline and increased deficit spending. The McCaskill-Corker CAP Act attempts to address this by taking the fiscally responsible step of establishing a legal definition for “emergency spending.” If the definition were used in conjunction with stricter budget enforcement mechanisms, it would be more difficult to use emergency spending as a gimmick and caps on discretionary spending could be more effective. Budget process bills should have some exceptions for emergencies, but they should be reserved for legitimate emergencies clearly defined by statute.

Both parties are guilty of weakening budget enforcement mechanisms with gimmicks, whether it is emergency spending, sequestration exemptions or PAYGO loopholes. These exemptions and loopholes have frequently added to deficits that are already unsustainable. Given the fiscal challenges facing our nation, this irresponsible practice should be abandoned in a new budget enforcement proposal.

A First Step, But No Substitute for Policy

At a time when our debt has exceeded $14 trillion, we need credible proposals to place our nation on a fiscally sustainable path. The most responsible course of action would be for Congress and the President to agree on the specific spending and revenue policies needed to reach fiscal sustainability.

If such an agreement were reached, a budget process proposal would be useful for enforcement and to ensure that the intended savings materialize.

If policymakers are unable to agree on the policy details, a process proposal that limits exemptions, considers the entire federal budget to be on the table for deficit reduction, and includes realistic targets backed by a bipartisan commitment to enforcement could establish a framework for a future agreement.

Of the process proposals on the table, the SAVEGO proposal and the Peterson-Pew Commission proposal represent the most complete and thoughtful alternatives with the greatest chance for success. However, to be effective, a process proposal must still be accompanied by an honest discussion of the policy changes that will be necessary to comply with the targets.

Budget process reform is a useful starting point, but it is no substitute for these difficult choices. Whether it is the existing budget process or a new process, deficit reduction requires elected officials to lead by saying which programs will be cut and which taxes will be raised.

Notes

^[1] Committee on the Budget: 1974-2006,Committee on the Budget, United States Senate, 2006. Available at: http://budget.senate.gov/republican/pressarchive/2007/BudgetCommittee.pdf

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