Brookings: Experts - Allen Schick

The Federal Budget, Third Edition : Politics, Policies, Process

Allen Schick — Wed, 01 Aug 2007 00:00:00 -0400

Brookings Institution Press 2007 320pp.

The federal budget impacts American policies both at home and abroad, and recent concern over the exploding budgetary deficit has experts calling our nation's policies "unsustainable" and "system-dooming." As the deficit continues to grow, will America be fully able to fund its priorities, such as an effective military and looking after its aging population?

In this third edition of his classic book The Federal Budget, Allen Schick examines how surpluses projected during the final years of the Clinton presidency turned into oversized deficits under George W. Bush. In his detailed analysis of the politics and practices surrounding the federal budget, Schick addresses issues such as the collapse of the congressional budgetary process and the threat posed by the termination of discretionary spending caps. This edition updates and expands his assessment of the long-term budgetary outlook, and it concludes with a look at how the nation's deficit will affect America now and in the future.

"A clear explanation of the federal budget. . . [Allen Schick] has captured the politics of federal budgeting from the original lofty goals to the stark realities of today." —Pete V. Domenici, U.S. Senate

ABOUT THE AUTHOR

Allen Schick

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Can the U.S. Government Live Within Its Means? Lessons from Abroad

Allen Schick — Sun, 19 Jun 2005 00:00:00 -0400

When George W. Bush leaves office in 2009, the federal government will owe at least $15,000 more for every American than it did when he became president eight years earlier. This unprecedented build-up of public debt will result from budget deficits projected to average more than $250 billion a year during the Bush presidency, plus more than one trillion dollars borrowed from social security trust funds. Although this budget projection may be high, there is far greater risk that actual deficits will exceed current estimates than that they will be lower.

The enormous accumulation of debt has been an inevitable by-product of the tax and spending policies promoted by the Bush administration and approved by Congress. The absence of fiscal rules promotes this behavior. This policy brief argues that fiscal rules are an essential instrument for governments determined to stay on a prudent, sustainable fiscal course, and the federal government should reimpose them in order to correct the imbalances that threaten the economic health of the United States.

The United States can learn from the experiences of other countries, including New Zealand, that have successfully implemented fiscal rules by assuring that fiscal restraint laws are supported politically.

POLICY BRIEF #141

Fiscal rules are laws or regulations that set targets for budget aggregates (total revenue, spending, deficit or debt) or bar government actions that would breach preset limits. As this broad definition suggests, fiscal rules come in various forms. Some are indicative, others are binding; some cover a single fiscal year, others extend to the medium-term or longer. During the past two decades, the federal government has had considerable experience with fiscal rules. The Gramm-Rudman-Hollings laws (GRH) enacted in 1985 and 1987 purported to limit annual budget deficits; the 1990 Budget Enforcement Act (BEA) capped annual appropriations and required that any legislation increasing the deficit—or decreasing the surplus—be offset. BEA expired at the end of fiscal 2002, but some of its rules have been reimposed in congressional budget resolutions. These have not been effective.

The Case For Fiscal Rules

When modern budgeting emerged during the nineteenth century in Europe and the early twentieth century in the United States, it was assumed that a comprehensive process that pits claims on government finances against each other in competition for scarce public resources would suffice to produce favorable outcomes. Today, however, there is broad recognition that political biases push governments to spend more and tax less. These biases come in several forms: the benefits of spending are concentrated among program recipients but the costs are dispersed among current or future taxpayers; most current beneficiaries are eligible to vote, but future payers are not yet eligible; politicians are opportunistic agents driven by self-interest rather than the interests of those who elect them; as a common resource, the budget gives claimants incentive to draw more than is prudently available; and the spread of mandatory entitlements has made public expenditure stickier while increasing the political cost of stabilizing the budget.

At one time, virtually all democratic regimes embraced balanced budget norms. The operative rule was that spending during a fiscal year should not exceed that year's revenue. In some countries, such as Germany and Japan, budgetary balance was inscribed in law; in others, including the United States, it was inscribed in behavior. The norm did not distinguish between periods of economic growth and stagnation, nor did its time horizon extend beyond a single year. Because it was rigid, the norm was not always adhered to. Few countries managed to keep total spending within revenues during wartime or recession; some even had difficulty during good times. Although the norm was often dishonored in practice, governments paid it lip service as the right thing to do. Even when their budgets were unbalanced, governments used the norm to constrain spending demands or win approval of tax increases.

The rigid balance norm was superseded after World War II by norms that allowed budget aggregates to accommodate cyclical changes in economic conditions. Policymakers applied active fiscal management in a variety of ways. One version called for government to maintain balance over an economic cycle; another dictated that total spending should not exceed the revenues the government would take in if the economy were at full employment. Governments also differed in the extent to which dynamic fiscal response relied on built-in stabilizers—such as the automatic fall in revenue when the economy weakens—or discretionary policy changes. Over time, dynamic fiscal policy came to mean that government should strive to close the gap between actual and potential output.

The shift in norms changed the way governments budgeted. With fiscal constraints loosened, claimants had a stronger hand in demanding more from government. In most democratic countries, the composition of the budget changed, with much more spent on transfers driven by statutory formulas rather than on consumption and investment determined by discretionary budget decisions. Fiscal discipline was a casualty of these changes. Government outlays soared in virtually all democratic countries. In industrialized countries, they averaged 28 percent of Gross Domestic Product (GDP) in 1960, and about 40 percent two decades later—a growth rate of more than one half percentage point a year.

This accommodating fiscal posture was called into question by deteriorating economic performance after the oil shocks of the 1970s. Chronically high deficits were viewed as structural problems that persist even when the economy recovers, not as cyclical responses to short-term disturbances. National governments in many developed countries, including the United States, concluded that stabilizing the budget requires adopting aggregate constraints before spending bids are considered.

To strengthen fiscal discipline, governments devised new approaches that differ from both the balanced budget rule and accommodative fiscal policy. A strict balanced budget rule was deemed unworkable because the budget is hostage to economic fluctuations—enforcing it when output falls and unemployment rises would worsen the country's economic woes. Accommodating fiscal policy was regarded as imprudent because it impelled the relentless expansion of government and produced deficits that may be justified in bad times but are not liquidated in good times.

Contemporary fiscal rules are hybrids: like the balanced budget norms, they rely on preset constraints; like dynamic fiscal policy, they are set by governments, not by unbending doctrine. In most cases, these rules are made and enforced by the affected government, though there are notable cases, such as International Monetary Fund conditionalities and the European Union's Stability Pact, which limits annual budget deficits of member countries to 3 percent of GDP and public debt to 60 percent.

First-generation fiscal rules (in the late 1980s and early 1990s) generally favored the restrictive approach; more recent rules have taken the "responsibility" route.

When they are determined by the government, the rules may have strong political commitment. Externally imposed rules, by contrast, may lack domestic political support, thereby easing the path to violate them when the constraints are regarded by political leaders as overly restrictive.

Experience With Fiscal Rules

Contemporary fiscal rules have branched in two directions. One path assumes that good budget outcomes depend on preventing politicians from behaving in a fiscally irresponsible manner; the other assumes that favorable budget outcomes depend on giving politicians incentives to adopt responsible policies. The first ties their hands, the second holds them politically accountable for their actions.

The EU's Stability Pact exemplifies the first approach; New Zealand's Fiscal Responsibility Act, which requires the government to announce fiscal targets and to explain any deviation from them, exemplifies the second.

The early rules were influenced by research that found that fiscal institutions strongly affect budget policy. The most prominent of these studies, by Jorgen von Hagen for the European Commission, concluded that centralized institutions—such as when the finance minister or prime minister sets and enforces fiscal targets and the legislature is barred from amending the budget or increasing total expenditure—produce more disciplined budget outcomes than do fragmented arrangements.

A decade of experience with fixed, unbending rules and recent research have provided a more nuanced understanding of the conditions required to sustain fiscal prudence. For one thing, rigid rules have the same flaw as the balanced budget rule; they focus on a single fiscal year and fail to distinguish between periods of economic vigor and weakness. For another, while these rules have generated some fiscal constraint—as evidenced by the actions taken by various countries in the run-up to the introduction of the Euro—they also give beleaguered politicians incentive to lie about the budget's true condition. Recent country performance, which has deviated significantly from expectations generated by von Hagen and similar models, have prompted observers to question the rigid rules.

The death knell for rigid rules may have been sounded by the European Union in March 2005, when it voted to modify the Stability Pact to exempt "special" costs, such as the unification of Germany and reconstructing pensions and social security, as well as some investments, international development, and military expenditure. The fiscal targets were not changed, but enforcement of them has been vitiated by the exceptions. This artful compromise—retaining the rules while rewriting them—enabled both prudent and profligate countries to claim victory.

The second approach, which assigns political responsibility for the government's fiscal performance, is exemplified by the Netherlands, an unlikely candidate for fiscal probity. Throughout its democratic history, the government has been formed by coalition parties, making it impractical to entrust the finance minister with authority to override the budget demands of sectoral ministers. Fiscal discipline is further weakened by the fragmentation of the budget into twenty-three separate bills, each of which may be amended by Parliament. Nevertheless, the Dutch Government has managed to steer a prudent fiscal course since the early 1980s by fashioning the coalition agreements negotiated after each election into detailed policy roadmaps that cover the next four years, the new government's full term.

Recent coalition agreements have not targeted the deficit; rather, they cap expenditure in each major budget sector—the core budget, health care, and social security. The caps are set in real terms and are adjusted each year for inflation. Coalition agreements also establish "firewalls" between revenue and expenditure, as well as rules for adjusting the budget for significant windfalls or shortfalls. When the economy performs better than was projected, preset percentages of the surplus are allocated to tax cuts and deficit reduction. In the case of overruns, the Netherlands assigns responsibility to the relevant minister to keep spending on course.

Although coalition agreements have been effective in stabilizing the government's fiscal position, there have been some strains, especially during expansionary times when revenues have outrun budget estimates. But enforcement of the agreement has been taken seriously. Today, the main budget task of the finance minister and the Cabinet is to police and adjust the agreements. Detailed budget matters have been devolved to the spending ministries, which have broad discretion in managing their finances.

The New Zealand Model

In contrast to the Netherlands, New Zealand has anchored the process for setting and changing fiscal targets in law. Its 1994 Fiscal Responsibility Act has been a model for a growing number of countries, including Australia, Britain, Brazil, and India, which have adopted similar arrangements during the past decade.

New Zealand's version sets forth principles to guide fiscal policy, and requires the government to announce medium, and long-term fiscal objectives and to explain both changes in its objectives and variances from them. New Zealand's principles of responsible fiscal management are: reducing public debt to a prudent level, maintaining the Crown's net worth at a level that buffers the country against adverse shocks, managing financial risks, and maintaining a reasonable degree of stability and predictability on tax rates.

New Zealand's principles are operationalized in a series of reports issued by the government each year, principally an annual budget policy statement that discusses the long-term consequences of current policy and a fiscal strategy report that analyzes progress in implementing the principles and provides long-term economic and budget projections. During the period immediately prior to national elections, which occur every three years, the government must account for the future budget implications of campaign pledges.

In New Zealand and other countries that have embraced the fiscal responsibility model, the rules do not tie the hands of government or dictate budget outcomes; instead they require that the government be open and honest about the impact of its policies on public debt, the tax burden, future deficits, and spending levels. Government is free to act, but it must be accountable.

During the decade that the rules have been in place, New Zealand has maintained operating budget surpluses and has improved the Crown's net worth while reducing the public debt ratio. However, the government has failed to reduce public expenditure and has boosted the expenditure/GDP target from 30 percent to 35 percent. The government has established a process for measuring the budget impact of policy initiatives and assuring they do not exceed the level set in the fiscal framework. Coalition agreements and fiscal responsibility rules have been more effective in protecting surpluses or controlling deficits than in limiting public expenditure. This pattern may be due more to strong economic performance, which enables the government to spend more money and still reduce the deficit, than to the rules themselves.

Recent U.S. Experience

Both the fiscal constraint and the fiscal responsibility models have been tried in the United States. Fiscal responsibility was the basis for the Congressional Budget Act of 1974 (CBA), which empowered Congress to take whatever budget action it prefers, provided it does so within the framework of the budget resolution process. The CBA did not prescribe surpluses or deficits, nor did it limit spending or revenue legislation. Although soaring deficits were due more to economic weakness at the time than to legislative profligacy, deteriorating budgeting conditions undermined confidence in the notion that Congress would behave in a responsible manner if it were accountable for its action.

Barely a decade after CBA, Congress embraced fiscal constraint in the Gramm- Rudman-Hollings laws (GRH) which prescribed maximum deficit levels and sequestration procedures to hold the deficit within the legislated levels. The 1990 Budget Enforcement Act (BEA) also hewed to the fiscal constraint model, though it shifted from directly constraining the deficit to limiting congressional action on revenue and spending legislation.

The prevailing assessment of GRH is that it was a failure. Its deficit targets were breached every year (1986-1990) that the law was in effect, but the deficit did decline (from 5.1 percent of GDP in 1985 to 2.8 percent in 1989). Most of the improvement was due to an economic upswing and the end of the Reagan-era defense build-up. GRH was not a fair test of fiscal constraint, for it had serious design flaws that spurred politicians to behave irresponsibly. One flaw was that it targeted projected, not actual, deficits; another was that the decisive projection was issued fifteen days into the fiscal year. Nothing that happened afterwards was relevant to calculation of the excess deficit. GRH encouraged politicians to lie about the budget at the start of the fiscal year and to be forthright the remaining 350 days.

BEA has been appraised much more favorably, but it was not uniformly effective throughout the dozen years it was applied. It went through three distinct phases. At the outset, BEA was accepted by Congress because it was accompanied by a significant, upfront boost in appropriations. During its middle years (1993-98), BEA restrained tax and spending policy, and a $290 billion deficit was turned into a $70 billion surplus. Finally, the promise of growing surpluses loosened fiscal discipline and gave the president and Congress license to waive or breach rules. Commitment to fiscal prudence evaporated with projections of mega-surpluses.

The three rules all concentrated on legislative action. CBA created a new congressional budget process, GRH empowered the president to sequester funds when congressional action (or inaction) resulted in an excess deficit, and BEA limited spending and revenues legislation. The clear implication is that Congress is culpable when the federal government produces unwanted deficits. However, a full accounting of the government's difficulty in maintaining fiscal discipline must reckon with the president's critical role in budget policy. During the past half century, most presidents have been drivers of government expansion, as well as the main proponents of major changes in tax policy. Fiscal rules cannot effectively constrain Congress if they do not rein in the president's budget ambitions.

U.S. fiscal rules have been impaired by their short-term perspective. GRH was predicated on a snapshot of the next (or new) year's budget deficit; BEA operated through annual spending caps and a fiveyear scorecard for revenue and direct spending legislation. Neither addressed the long-term imbalances that face the country. Some glimpses of these imbalances appear in the thirty- to fifty-year scenarios produced by the Congressional Budget Office, the seventy-five-year actuarial reports issued by the social security and Medicare trustees, the federal balance sheet published in annual budget documents, and the generational accounts constructed by academic researchers. These adverse projections have been ignored in making budget decisions that adversely affect the longrun outlook. Congress and the president have been informed by the various projections, but they have not been constrained or induced to behave more responsibly.

Can Anything Work Here?

U.S. and foreign experience suggests that fiscal rules work only when they are fortified by political commitment to behave in a responsible manner. If this conclusion is valid, the fiscal responsibility model may yield more favorable outcomes than arrangements that seek to constrain political action. But if good behavior depends on the willingness of politicians to take unpopular actions, why are the rules needed at all? What discipline do they add to budgeting?

Rules work in two ways: by tying the hands of budget makers so that they are impeded from acting in ways that do not improve the government's budget discipline; and by raising the political cost of failing to maintain budget discipline. The first corresponds to fiscal constraint rules, the second to fiscal responsibility rules.

The federal government lacks meaningful enforcement because it is bereft of strict accounting standards and its budget actions are not independently audited. One can conjecture that budgeting would be more prudent if the comptroller general (or some other authority) was empowered to restate the budget so that it complies with generally accepted accounting principles. Budget discipline would certainly be strengthened if the various loopholes for emergencies and other purposes were tightened, and if revenue and spending actions were scored to show their adverse effects on future budgets.

Fiscal responsibility rules rely principally on self-enforcement. For these to be effective, politicians have to make "credible commitments," a term introduced by the economist Oliver Williamson. In the context of fiscal rules, a commitment is credible if the target is realistic, the government takes appropriate steps to achieve it, and politicians believe that it will be costly for them to breach it. To be credible, fiscal commitments also need accounting rules to assure transparency and inhibit political opportunism, but the key factor is the determination of politicians to fulfill their promises.

In the Netherlands, coalition agreements became social contracts because the government of the day resolved to live by their terms. In New Zealand, the fiscal responsibility law was invested with political stature because the government used it as a guidepost for budget policy.

All fiscal rules decay over time. The 1990 Budget Enforcement Act, for example, succeeded only until surpluses emerged.

It is necessary to periodically review fiscal rules, to give them new credibility and support. It may be that fiscal responsibility works better than fiscal constraint because it is freshened by new commitments. Given the dire fiscal prospects of the United States, policymakers should try both paths, so that constraints can be fortified by commitments.

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Allen Schick

The Deficit That Didn't Just Happen: A Sober Perspective on the Budget

Allen Schick — Fri, 01 Mar 2002 00:00:00 -0500

It took the federal government 28 years (1970-98) to produce a budget surplus, but only 4 years to return to deficit. President Bush's 2003 budget promises that the government will have a surplus in 2005, but the revenue and spending policies it pursues risk another long spell of red ink that may extend well into the next decade, when the front edge of the baby boom generation reaches retirement age and both health and pension costs escalate.

Why the asymmetry in budget cycles? Why is the vicious circle of deficits so much longer than the virtuous circle of balanced budgets? If economic weakness impels government to spend more than it takes in, shouldn't the reverse also occur, that economic good times rescue the budget from red ink?

Part of the answer is that adverse budgetary effects of recession linger after the economy recovers. Recession lowers the trend line of economic growth, and it therefore takes a number of years to recover the lost output. Just a 1 percent drop-off in the 2002 growth rate would add $50 billion to the deficit a decade later, even if full growth were to resume in 2003.

This is the no-fault part of the deficit story that the Bush budget emphasizes. But it is far from the whole picture. In fact, the Congressional Budget Office has estimated that less than one-quarter of the $4 trillion in lost surpluses over the next decade is due to current economic difficulties. Most of the remainder is the result of political decisions to spend more and tax less. Two years ago in these pages, in "A Surplus, If We Can Keep It," I argued that policy mistakes caused the deficit surge in the 1980s and policy corrections stabilized federal finances in the 1990s. Critical turning points in budgeting don't just happen; they are the products of sound or flawed policies. No less than in the past, policy matters in budgeting. And policy mistakes are the reason why the fiscal outlook has rapidly deteriorated.

Policy mistakes are not simply matters of disagreement. They are inconsistent actions that cannot achieve purported objectives. Cutting taxes while steeply boosting defense spending in the early 1980s was mistaken because it generated huge deficits. Raising taxes in the early 1990s while constraining spending growth was sound policy because it enabled the government to successfully implement its deficit elimination strategy.

The government may now be at the cusp of another major policy error. It is not yet as big as the error two decades ago, but it risks becoming more damaging. The Bush budget story has three interlocking chapters: spending decisions, tax legislation, and White House attitudes concerning surpluses.

Spending Our Way Out of the Surplus

The arrival of a surplus a few years ago triggered a spending frenzy that vitiated the discretionary spending caps established by the 1990 Budget Enforcement Act and made a mockery of the BEA requirement that increased spending be offset by cuts in other spending or by revenue increases. In 2000 and 2001, discretionary spending soared more than $200 billion above the legal limits on annual appropriations. The caps expire at the end of 2002—which will at least enable politicians to be more honest about what they are doing. They no longer have to pretend that the census and other ongoing operations of government are national emergencies.

Defense is leading the spending parade, but it is not the only winner. In a replay of the policies of Ronald Reagan, Bush proposes to boost defense spending by $85 billion over three years, with additional tens of billions for homeland security. In dollar terms, this defense buildup is bigger than the one undertaken in the early 1980s, but it is a significantly smaller share of GDP or of total federal spending. The odds are, however, that defense costs are understated in the budget. On the one hand, the president's State of the Union Address declares that "our nation is at war . . . and the civilized world faces unprecedented dangers." On the other hand, his budget projects that defense spending will decline by mid-decade as a share of GDP. Military leaders have already complained that the additional money is insufficient; they will not have to wait long to get more.

Bush has not proposed the wholesale elimination of domestic programs, preferring instead to hold many to approximately the previous year's spending level. This way, inflation does the cutting and the president can claim credit for some well-publicized increases. But the discretionary budget may be tighter than it appears, for it includes billions for homeland security and for the health care and pensions of federal employees, which have been shifted from the mandatory to the discretionary budget. The CBO's baseline, which shows domestic spending keeping pace with GDP, would eat up most of the budget surplus promised by the president for the next decade.

Entitlements are also likely to add to budget pressures. Congress must reenact welfare and agriculture legislation during the 2002 session, and advocates are demanding hefty increases. The president's Medicare numbers are $300 billion (over the next 10 years) below CBO's baseline. He expects the rise in Medicare spending to decelerate despite the increase in the number of older Americans covered by Medicare.

Summing up the expenditure story, in the next decade the government will spend more than it did in the recent past and more than the president has projected in the budget. The era of big government may be over; the era of big spending is not. The question is, will government have the money to pay for it?

The Power Not to Tax

Judging from the Bush budget, the clear answer is "no." George W. Bush may be the first president in American history to declare war and demand tax cuts. He wants almost $700 billion in tax cuts over the next 10 years, on top of the $1.3 trillion cut enacted last year. The true size of that cut was masked by artfully placed phase-ins and phase-outs. Some cuts were scheduled to take effect near the end of the 10-year period; most would phase out during or at the end of it. Fully implemented, over the course of a decade the cuts would subtract almost $2 trillion from federal revenue.

Despite its search and destroy mission to find and liquidate provisions of the tax code, the administration would allow the alternative minimum tax (AMT), which may be the most disliked feature of the tax code, to ensnare millions of Americans in coming years. The AMT was originally designed to curb aggressive tax avoidance, but because it is not indexed for inflation, increasing numbers of people will face the AMT in future years for reasons completely unrelated to tax sheltering. Last year's tax cut granted taxpayers a temporary reprieve from the AMT, but that relief expires in 2004. Apparently, even the White House could not afford the $500 billion (over 10 years) price tag of fixing the AMT problem. An alternative take is that the president knows Congress will be pressured to act and that if he gets his additional tax cuts and Congress fixes AMT, the combined revenue loss would be even higher. A final spin on the administration's oversight is that once millions of taxpayers have to pay AMT, they will be so angry as to undermine public support for taxes. Whatever the true motive, the downstream loss in revenue may be even higher than the administration has forecast.

One need not wait long to see the effects. The 2003 budget shows two consecutive years—2001 and 2002—of decline in federal revenues, the first time that has happened since the end of World War II, when the United States shifted from full mobilization to peacetime. Even if no new tax cuts are enacted beyond those already adopted, the federal government faces a structural imbalance that is being masked in the short run by Social Security surpluses but will become apparent less than a decade from now. The administration has ignored the dire future by departing from past budget practice and shortening the budget's time horizon from 10 years to 5. Of course, this does not stop it from promoting permanent tax cuts whose budget impact will be fully felt after the foreshortened 5-year period has ended

The Political Logic of Unbalanced Budgets

The White House is not clueless as to the fiscal course it has charted. This is not a case of ignorance aforethought. The administration knows what it wants and is setting out to get it.

During the Reagan era, when serious policy mistakes led to a fivefold escalation in public debt from $700 billion to $3.5 trillion, Senator Daniel Patrick Moynihan accused the administration of creating the deficit to starve the government of revenue. Moynihan did not have a smoking gun to confirm his hypothesis, but George W. Bush has supplied one. Several weeks after taking office, the Bush White House published A Blueprint for a New Beginning, with a chart titled "Budget Surpluses Lead to Bigger Government." If this is so, the prudent thing to do is to get rid of surpluses; otherwise, government will grow bigger. Many conservatives have accepted as an article of faith that government spends any money it has and that the only effective way to constrain spending is to take away the surplus. In their mind, it is better to have a smaller government with a bigger deficit than a bigger government with a smaller deficit.

The problem with this point of view is that even if the government is broke, it will spend more. One reason is that big government includes big defense. In an age of terrorism, the Pentagon will not spend less because the government has red ink. Another is that, as David Stockman, Reagan's budget director, discovered two decades ago, Republicans also beat the drums for more spending. Stockman labeled this phenomenon "the triumph of politics," which became the title of his surly memoirs on his service in the U.S. government.

The third, most compelling reason for more government spending is that higher spending is built into the demographics of American life. We are now two decades closer in time, but no closer in solution, to the baby boom surge. These costs will have to be faced, regardless of the government's financial position. Some cynics think that the White House understands the mammoth costs that lie only a few years ahead, but that it is driven by the conviction that only a full-blown financial crisis will build support for privatizing all or a big portion of Social Security and Medicare. It believes that as long as Uncle Sam can afford to pick up the tab, there will be no pressure to fundamentally restructure these retirement programs.

We may, however, get only the crisis part of this scenario, in which case the administration is taking truly enormous risks with the future well-being of the United States. As the title of this article says, this deficit didn't have to happen. And it shouldn't.

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Allen Schick

A Surplus, If We Can Keep It: How the Federal Budget Surplus Happened

Allen Schick — Fri, 01 Dec 2000 00:00:00 -0500

"It?s the economy, stupid." The battle cry of Bill Clinton?s 1992 presidential campaign has been recycled to explain how a $290 billion budget deficit has been transformed into a $100 billion surplus that is expected to quadruple in the decade ahead. I would argue, however, that the hand of Washington has had as much to do with liquidating the deficit as the economy?s invisible hand. Policies matter. Wrong decisions in the 1980s condemned the nation to a decade of high deficits; right ones in the 1990s have liberated it from past budgetary misdeeds.

Liquidating the deficit ranks as one of the supreme budgetary accomplishments in American history. In 1993, the Office of Management and Budget projected that the fiscal 1998 deficit would be $339 billion; the Congressional Budget Office projected $357 billion. That was not the only year for which budget experts were wide of the mark. In both their five-year projections and their annual budget estimates, OMB and CBO persistently overestimated the deficit. In 1993, CBO projected that policies then in place would yield cumulative deficits of $1.5 trillion over the next five years. Actual deficits totaled less than a third that.

An analysis of economic performance, spending policies, and revenue trends during the 1980s and 1990s makes clear how the federal budget was balanced. Whether it will still be balanced a decade from now when the first wave of baby boomers reaches retirement is much less certain.

The Economic Boom

Every budget is hostage to the economy. Congress and the president cannot balance the budget when national output is declining and unemployment is soaring. Budget receipts are highly sensitive to changes in economic conditions, spending less so, but even a small shortfall in economic performance can affect the budget in a big way. CBO has estimated that if the annual real growth rate over the next decade were just 0.1 of a percentage point less than it has assumed, the fiscal 2010 budget surplus would be $40 billion below current projections.

When the deficit peaked in 1992, the United States was emerging from a brief recession. When the budget was balanced in 1998, the economy was completing the seventh consecutive year of growth, during which 13 million jobs were added and inflation averaged less than 3 percent. The budget was the beneficiary of economic success. Revenues escalated as corporate profits and personal incomes rose; spending dropped as welfare rolls declined, the crisis in the banking sector was resolved, and inflation in the health care sector moderated.

But economic good times alone do not account for the budget?s unexpected turnaround. Measured in terms of growth rates, the eight consecutive years of expansion during the 1980s (from the end of the Reagan-era recession in 1982 to the onset of the Bush-era recession in 1990) outperformed the boom of the 1990s (see table 1). The two expansions were structured differently, which may partly explain their different revenue impacts. During the 1980s expansion, which followed a decade of "stagflation," growth began at a high rate and tapered off. The 1990s expansion, which followed a long period of growth that was briefly interrupted by the 1990?91 recession, began with low growth that accelerated as the expansion continued.

Spending Policies

Although a cooperative economy made the budget surplus possible, the surplus would not have materialized if budget policy in the 1990s had repeated the mistakes of the 1980s. Differences between the revenue and spending paths taken during the two decades led to quite different budgetary outcomes.

On the spending side of the ledger, the key differences were in budget enforcement rules, defense spending, discretionary appropriations, and entitlements.

During the 1980s, Washington postured against deficits with futile gestures that reflected the inability of a Republican president and Democratic Congress to agree on tough budget measures. The 1985 Gramm-Rudman-Hollings (GRH) law promised annual cuts in the deficit and a balanced budget within six years. Although the law threatened the automatic cancellation of budget resources if the projected deficit exceeded the target, the actual deficit was above the statutory limit every year. With clumsy and unworkable sequestration procedures, GRH induced Congress and the president to lie about the deficit by substituting illusory cuts for real ones and by pretending that the budget picture was better than it actually was.

In 1990, with the projected deficit spiraling out of control, the warring branches replaced GRH with the Budget Enforcement Act (BEA), a law that focuses on revenue and spending rather than the size of the deficit. Almost a decade later, BEA remains in effect, and although it has not always been strictly enforced, it has helped improve the budget condition. It has two principal rules?a limit on annual appropriations and a requirement that any revenue or spending legislation that would increase the deficit (or decrease the surplus) must be offset. In sharp contrast to GRH, it does not regulate changes in the budget caused by fluctuations in economic conditions or in the cost of existing entitlement programs. It controls only the parts of the budget that the president and Congress directly influence?and thus holds politicians accountable only for the things they control.

Congress and the president have had a complicated budgetary relationship under BEA. At times, one branch has deterred the other from violating the rules; at other times, both have conspired to evade the rules by designating routine expenditures as emergencies, manipulating the effective dates of tax legislation to hide the full budgetary impact, and using a bewildering variety of bookkeeping tricks. BEA has elevated "scoring" (measuring the budgetary impact of legislation) to a valued political art, but it also has dampened the ability of vote-seeking politicians to cut taxes or boost spending. As with other budget rules, its effectiveness has weakened over time as claimants for federal money have devised means to outwit the process or disable its controls. Hefty surpluses have also weakened BEA. Budget controllers cannot enforce the rules with the same zeal when money is abundant as they can when resources are tight.

Discretionary Spending

It is difficult to separate the impact of BEA from the conditions under which it has operated. Had there been no discretionary caps, defense spending still would have been held down by changes in world affairs, domestic spending pressures, and oversize deficits.

The 1980s began with a steep boost in defense spending; the 1990s, with the collapse of the Soviet empire and the end of the Cold War. Defense spending, which began to level off during the second half of the 1980s, continued to fall through most of the 1990s. Adjusted for inflation, defense outlays were almost $100 billion less in 1998 than they had been a decade earlier. If the Cold War were still raging, there probably would be no surplus.

As after past wars, some defense savings were reallocated to domestic programs. Because the budget enforcement rules built a "firewall" between discretionary appropriations and direct spending, domestic appropriations reaped most of the savings. These programs, which fell more than 15 percent during the 1980s, grew more than 25 percent during the next decade. In fact, real discretionary domestic spending is much higher today than it was when Ronald Reagan launched his campaign to roll back social programs. As a share of gross domestic product, however, discretionary domestic spending has fallen?from 4.5 percent in 1981 to 3.2 percent in 1999.

During the 1990s, the president and Congress exploited BEA spending caps to demonstrate their commitment to control the budget and to reduce the size of the government while spending somewhat more than the BEA rules intended. Led by Clinton, the Democrats came out ahead in this contest; they got credit for fiscal prudence while securing more money for popular programs. Outmaneuvered, congressional Republicans reluctantly approved the increases, sometimes after getting billions more for defense. But the marginal growth in discretionary appropriations was too small to derail the march to a balanced budget.

Direct Spending

Spending growth in entitlements was held down during the 1990s by the BEA pay-as-you-go rule requiring legislated increases in these programs to be offset by cuts in other direct spending or by revenue increases. But even in the absence of PAYGO, big deficits would probably have inhibited the president and Congress from establishing new entitlements and impelled them to seek savings in old ones. After all, few initiatives made it though Congress during the pre-BEA 1980s. And despite PAYGO, Clinton won some new entitlements, such as the children?s health insurance program enacted late in the 1990s.

The PAYGO decade did see some publicized cutbacks, though their net effect on federal spending has probably been small. Medicare was nicked repeatedly, with some of the claimed savings used to offset the cost of benefit enhancements. At the century?s end, Clinton transformed the Medicare debate from worrying about the coming retirement boom to adding prescription drugs to the list of eligible benefits. Welfare was converted from an open-ended entitlement to a fixed block grant to states, and changes were made in eligibility rules and program benefits to move recipients from welfare to work. When the reforms were enacted in 1996, a six-year savings of $54 billion was projected. Steep, largely unexpected declines in welfare rolls?6.5 million fewer recipients in 1998 than 1993?boosted short-term federal spending above what it might have been had the old AFDC program continued. Nevertheless, over the longer term, welfare spending will decline if the reforms endure. Congress also overhauled farm price supports in 1996, but the projected savings will probably not materialize. Whenever farmers run into trouble, politicians pour in billions of dollars of emergency money.

All told, the 1990s were a fiscally static period in entitlement policy. Leaving aside deposit insurance, mandatory spending was a higher share of GDP in 1999 than in 1990. Means-tested entitlements grew the most, both because of new legislation (such as increases in the earned income tax credit) and because of built-in growth in old programs.

Tax Policy

If the economy and spending changes do not adequately account for the surplus, the only other place to look is on the revenue side of the budget. During the 1990s, tax policy largely reversed actions of the previous decade. During the 1980s, the highest marginal tax rate (50 percent on earned income and 70 percent on unearned income?interest and dividends) was reduced to 28 percent (or 31 percent if a "bubble" in the rates is included). But in the 1990s, the rate was boosted to 39.6 percent, and with various phase-outs of exemptions and deductions included, the effective rate is now above 40 percent. The first tax increase was enacted in 1990 when George Bush was president; the second in 1993 when Bill Clinton was in the White House. The first deprived Bush of reelection; the second helped the Republicans take over Congress in 1994 but ultimately aided Clinton?s reelection. While politically risky, the tax increases pumped up federal revenues. Federal receipts rose from 18.2 percent of GDP in 1990 to 20.5 percent in 1998, adding $190 billion in revenue. If the 1989 tax structure were still in place, there would be no surplus to discuss.

The targets of the 1990 and 1993 rate hikes were upper-income taxpayers. By contrast, during the 1990s the income tax burden on low-income Americans was greatly eased. Because of the widened income gap between low and high earners, the government took in much more revenue than it would have if the tax increases had been spread evenly across income brackets. The government taxed the winners during the 1990s, redistributing income while boosting its revenues. By design or accident, sound social policy coincided with responsible budget policy.

Will the Surplus Persist?

Anyone who has made or used budget projections during the 1990s should be exceedingly guarded in forecasting the budget future. Although the medium-term (five to ten years) outlook is cloudy, the longer-term forecast is clear. Under current policy, the budget will incur large and growing deficits when the surge in the over-65 population forces the Social Security fund to draw down the trillions of dollars of accumulated surpluses.

The sure prospect of resurgent deficits makes it urgent that policy mistakes not imperil the surpluses projected for the first decade of the new millennium. Last July CBO estimated that annual budget surpluses would rise from $161 billion in 2000 to $413 billion in 2009. If the forecasts are right, Washington would accumulate almost $3 trillion in surpluses during the next decade?two-thirds in Social Security funds, the rest in the general fund. Although the projected surpluses are enormous, the economic and revenue assumptions on which they are based are modest. The CBO does not build a recession into its forecast, but it assumes that the economy will grow only 2.4 percent a year over the next decade?much more slowly than it has in the recent past. It also expects federal revenues to rise only $75 billion a year during the next five years, as opposed to the almost $115 billion averaged during 1993?98.

The weakest part of the CBO projection is the assumption that discretionary spending (capped through fiscal 2002) will remain tightly in check. The recent actions of Congress in evading the caps for fiscal 2000 appropriations make it highly unlikely that this part of the budget scenario will play out according to the CBO script. Responding to real and imagined emergencies, boosting defense spending (something Democrats and Republicans alike support, though they differ as to how much), raising discretionary domestic appropriations in line with price increases, and adding billions here and there for national priorities such as education would consume almost three-quarters of the projected non?Social Security surpluses. If, as is likely, taxes are also cut, the remainder of the surplus would be at risk.

These possibilities counsel two prudent steps on the part of Washington politicians: do not spend the surplus before it is earned and do not repeat the policy mistakes of the early 1980s. Prudence in fiscal management cannot ensure that surpluses will persist, but it can guard against a return of runaway deficits.

The 2000 election may have much to say about the future budget health of the nation. Divided government has blocked Republican ambitions for large tax cuts and deterred Democrats from big increases in social spending. If either party were to win all the national political sweepstakes in 2000, it would have a clear field to pursue its pent-up budgetary agenda. Perhaps the surprising lesson of the conversion of deficits into surpluses is that fiscal prudence can reign when neither party can achieve its budgetary vision.

Authors

Allen Schick

The Federal Budget: Revised Edition : Politics, Policy, Process

Allen Schick and Felix LoStracco — Mon, 26 Jun 2000 00:00:00 -0400

Brookings Institution Press 2000 320pp.

The U.S. government takes in and spends almost $2 trillion annually, and setting the budget that guides federal spending is an enormously complex undertaking. The federal budget entails the active participation of the president, key advisers, and many members of Congress, the efforts of thousands of staff in the executive and legislative branches, and the attention of numerous interest groups. It consists of thousands of big and small decisions, complicated rules and procedures, and debate over the composition and amount of public revenue and spending. With so much at stake, it is not surprising that budgeting is often a difficult, conflict-laden process. As big as the budget is, there is never enough money to satisfy all demands. As the budget has grown and become more prominent in U.S. political and economic life, the scope for conflict has expanded. In some years the budget is the centerpiece of the president's agenda as well as the vehicle for enacting much of Congress's legislative output. This revised and significantly expanded edition of The Federal Budget concerns the politics and processes of federal budgeting and the policies that emerge from them. It describes how budgeting works at each stage of executive and legislative action-from preparation of the president's budget through the appropriation and expenditure of funds-and assesses the impact of budget rules on policy decisions. It explains how the budget was transformed from deficit to surplus over the past five years and discusses various proposals to change the rules. It analyzes the changes in the appropriations process, friction between the president and Congress, and the reliance on omnibus legislation to resolve budget impasses. In addition to vital statistics and extracts from important documents, the book also features case studies that dramatize contemporary budgetary politics, providing readers with a "you are there" appreciation of how budgeting decisions are made in Washington.

ABOUT THE AUTHORS

Allen Schick

Felix LoStracco

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After the Line Item Veto: Tools for Controlling Spending

Allen Schick — Fri, 30 Jul 1999 00:00:00 -0400

Mr. Chairman, I appreciate the opportunity to discuss proposals to strengthen the rescissions process as an instrument of spending control. In assessing proposed changes, it is important to look back at how the process has evolved, and why the original presidentially-originated rescissions process has been largely displaced by one centered in and controlled by Congress. The discussion must be framed in the context of prolonged friction between the President and Congress over budget policy, as well as in the context of the caps on discretionary spending that have been in place since 1991. Rescission would be a very different process today if instead of fighting over budget policies and priorities, Congress and the President were of the same mind on budget issues. Rescission also would work very differently if instead of the spending caps, Congress were free to appropriate at whatever level the House and Senate majorities wanted.

The table below, drawn from data prepared by the General Accounting Office, summarizes the history of rescissions by presidential administration, beginning with President Gerald Ford, the first President to exercise the power to propose rescissions under the Impoundment Control Act of 1974. Each President's record on rescissions is a measure of his budgetary policy and of his influence in Congress. Between 1974 and 1997, presidents submitted more than $75 billion in rescissions to Congress, but almost 60% of total rescissions were initiated by President Ronald Reagan. The high-water mark for rescissions came during the first two years of the Reagan presidency, in 1981 and 1982, when the new President proposed more than $23 billion in cancellations and Congress rescinded more than $15 billion. Excluding the Reagan Administration, presidents have proposed an average of only $2 billion in rescissions a year. Over the years, Congress has enacted only one-third of the rescissions proposed by the President. With 1981 and 1982 excluded, the rescission approval rate would drop below 20 percent. With these years excluded, Congress has rescinded less than $500 million a year on presidential initiative. Clearly, presidential rescissions now play an insignificant role in controlling federal spending.

Rescission Trends, by President (dollars in millions)

President	Fiscal Years	Amount Proposed for Rescission	Amount Rescinded	Percent Rescided	Amount Rescinded
		Presidential Initiative			Congressional Initiative
Ford	1974-77	$7,935	$1,252	16	$1,405
Carter	1977-81	$4,608	$2,116	46	$3,526
Regean	1981-89	$43,437	$15,657	36	$33,400
Bush	1989-93	$13,293	$2,354	18	$26,821
Clinton	1993-97	$6,561	$3,594	55	$35,561
Total	1974-97	$75,834	$24,973	33	$100,713

But the data presented here show another side to the rescission story. Congress frequently rescinds funds on its own initiative-without waiting for a presidential request-simply by passing a bill canceling previous appropriations. These rescissions are often enacted in regular or supplemental appropriations acts. In fact, for every dollar rescinded by Congress pursuant to the President's impoundment request, it has rescinded four dollars by initiating legislation. Although congressional procedures vary, once enacted, there is no legal distinction between a rescission implemented in a special rescission law or in a regular appropriations act.

At first glance, Congress' behavior appears to be puzzling. Why would Congress take the initiative and rescind funds it had previously appropriated? Why, if it does not like rescissions initiated by the President, has it been so active on its own? The puzzle evaporates when we recognize that Congress initiates rescissions either to thwart the President or to make room within the discretionary spending caps for other expenditures.

Rescissions stir conflict between the President and Congress. Every rescission requested by the White House is a demand that Congress cancel resources that it previously appropriated. By implication, and sometimes by press release as well, proposed rescissions make the point that Congress erred when it appropriated the money. This is not a message that appeals to legislators, especially when it comes from a President from the other party who has different budget priorities. In this contest, Congress has the advantage because the President must release the money if it refuses to pass a rescission bill. Over the past quarter of a century, presidents have been compelled more than $50 billion of the $75 billion they wanted rescinded.

Some have argued that expedited budget procedures which ensure an up or down vote on each proposed rescission would provide for a more effective and balanced rescission process. While I favor an expedited rescissions, I doubt this change would breathe much new life into the moribund presidential budget process. As long as government is divided, as it has been for 26 of the past 31 years, and as long as budget priorities divide the two parties, as has been the case throughout the 1980s and 1990s, the rescission process will languish. Strengthening his rescission power would not do much to control federal spending, but it might give the President a club which to verbally beat up on Congress when the two branches are warring over budget policy.

Although it has not followed the President's lead on rescissions, Congress has incentive to cancel some old appropriations when the budget appears tight and it wants to make room for additional spending. In some years, Congress has rescinded funds to pay for supplemental spending without exceeding the discretionary caps; on others, it has used rescissions as "earnest money" to show that even though it has appropriated more than the President requested, the additional amount has been offset by canceling some old money. Understandably, the tighter the discretionary caps, and the greater the pressure to spend, the greater the incentive to find offsets. The best offsets have been of dormant or inactive funds, such as for weapons systems that have been delayed by technical problems or housing funds that have been reserved for future use. Depending on one's preferences, these offsets can be viewed as escape hatches which weaken spending control or as safety valves that enable Congress and the President to continue to operate within the spending caps.

Current practices raise two issues concerning both the presidentally and congressionally initiated rescissions. One is whether the funds saved by canceling past appropriations should be locked away for debt reduction, the other is whether rules governing spending offsets should be tightened. Both questions are relevant to the issues before the Subcommittee because the extent to which Congress rescinds funds depends on how the savings are treated.

The line item veto law which was ruled unconstitutional by the Supreme Court had a lockbox provision. In effect, the discretionary caps were reduced dollar for dollar by the amount rescinded. It is not clear to me, however, that combining lockbox with expedited rescission procedures would build support in Congress for more rescissions. Clearly, some Members might be more favorably disposed to vote for rescission is they knew the savings were applied exclusively to reduce the public debt. Other Members, however, might support more active rescission only if the savings enabled more spending on other programs.

In my view, budget rules work best when they are supple, and when they can accommodate different fiscal conditions and changes in the relationship between Congress and the President. On this basis, I would prefer a flexible rule which would have the initiator of a rescission proposal specify how the savings were to be applied. Both the President and Congress would have the option of providing for rescinded funds to be locked up or to be spent on other programs. In voting on rescissions, Members would allow their preferences on these matters to influence their vote.

A fair assessment of the use of rescissions (and other resources) as spending offsets suggests that there has been some stretching of the rules to accommodate additional spending. When money which will be spent substitutes for money that will not be spent (at least not this year or next) the ploy should be scored as a spending increase. While I subscribe to this view, it must be recognized that scoring has come under enormous pressure, and this pressure is likely to escalate the longer the caps are in place. I do not like some of the gimmicks used as offsets, but it is not certain that enacting elaborate rules would help much. My preference is for two rules changes that would ease the pressure on politicians to evade the caps. One would make clear that emergency spending does not have to be offset; the other would introduce criteria for determining whether spending is indeed emergency. Together, the two rules changes would reduce the incentive to fabricate rescissions in order to spend more.

I would like to conclude by urging the Subcommittee to assess these and other rules changes affecting rescissions in the light of congressional-presidential relations. What is at stake here is not just the amount spent but the power balance between the two political institutions of national government. For generations, impoundment has been a battleground between the President and Congress. Pretending that the issue is only one of budgetary procedure will not diminish hostilities, nor will it buy budgetary peace. Because the current rescission rules were devised during the Watergate-Vietnam era, they rein in presidential power. Some have argued that the President's hand should be strengthened by forcing Congress to vote up or down on every requested rescission. Congress still would have the last word, but in contrast to the current arrangement, it would not be able to prevail by inaction. But inasmuch as the prevailing rules favor Congress, it may be unwilling to alter the rescission procedures. Perhaps we will have to wait until Congress and the President are controlled by the same party before this issue is addressed.

Authors

Allen Schick

Publication: House Committee on Rules, Subcommittee on Legislative and Budget Process

Hearing on the Proposed Balanced Budget Amendment to the Constitution

Allen Schick — Wed, 05 Feb 1997 00:00:00 -0500

Mr. Chairman, I appreciate the opportunity to discuss the proposed balanced budget amendment to the Constitution. My statement focuses on the political and governmental implications of a constitutional constraint on the power of elected officials to adopt and implement realistic, acceptable budgets.

The case for a balanced budget requirement rests on the argument that in the face of pressure from voters and interest groups to tax less and spend more, politicians cannot maintain fiscal discipline. In this view, democratic politics is the problem, and the remedy should be a constitutional amendment that bars politicians from producing certain budgetary outcomes. My view, however, is that only political action can ensure true budgetary discipline; if politicians want to spend more than they take in, they will find the means to do so, even when the Constitution purports to dictate otherwise. This is the lesson from the many states whose constitutions restrict the borrowing capacity of the government.

Whether in statute or in the Constitution, law is effective when it gives elected leaders incentives and opportunities to make the right decisions, including the decision to manage the nation's finances prudently. Some laws are effective, others aren't. The Gramm-Rudman-Hollings law was ineffective because it impelled politicians to lie about the budget; the Budget Enforcement Act has been effective because it has encouraged politicians to produce realistic budgets.

Interfering with the normal interplay of politics through the balanced budget amendment would risk adverse consequences. It might spur politicians to use bookkeeping gimmicks and other tricks to conceal the true condition of the budget; it would risk political deadlock and governmental shutdown when a balanced budget was beyond reach; it would hold the elected majority in Congress hostage to the demands of the minority; it would inject federal courts into political issues and might make judges the final arbiters of budget policy; it might compel Congress to cede much of its constitutional power of the purse to the President; and it might impel Congress to splinter the federal government into numerous quasi-public entities whose finances were excluded from the balanced budget rule. These are enormous political risks that can damage the capacity of government and political leadership in the United States.

Why the Political System Works

Some argue that these risks are worth taking because American politics is biased in favor of big, chronic deficits which cannot be controlled by statutory remedies. The evidence, however, shows that the political system is capable of self-correction and fiscal discipline. How else does one explain the reduction in the budget deficit from $290 billion in FY1992 to $107 billion only four years later? How does one explain the explicit commitment of the President and congressional leaders to adopt budgets that will eliminate the deficit by 2002? How does one explain why the deficit has been reduced from 4.7% of GDP to 1.4%, the lowest rate among major democracies and less than half the deficit permitted by the Maastricht Treaty for countries in the European Monetary Union?

Deficit reduction did not happen by itself. True, the task was aided by the end of the Cold War and by robust economic growth, but these conditions would not have sufficed without strong political will. The deficit has been reduced because Congress passed the Budget Enforcement Act of 1990, because it and the President negotiated budget reconciliation bills in 1990 and 1993, because congressional adherence to the discretionary spending caps has driven annual expenditures in this part of the budget almost $100 billion below what it would have been if spending had grown apace with inflation, and because Congress has complied with the PAYGO rules and has curtailed new entitlement legislation.

Budget policy over the last dozen years has been a laboratory for testing which rules work in a political environment and which rules don't work. The most apt comparison is between the Gramm-Rudman-Hollings law which did not deliver on its promise to balance the budget and the Budget Enforcement Act which has effectively controlled the deficit. At first glance, these outcomes are anomalous because GRH explicitly capped the deficit while BEA didn't. Yet it is precisely because GRH targeted the deficit that it failed and because BEA has avoided deficit targets that it has succeeded. Any rule that targets the deficit will prove unworkable because the rule will be in effect both during times that the target is achievable and during times when the target is beyond reach. In every year that GRH was in effect the actual deficit exceeded the deficit permitted by law. This was the outcome in fiscal 1986, the first year covered by GRH; it was the outcome in fiscal 1990, the last year before GRH was superseded, and it was the result every year in between. The only variable was the amount by which the deficit target was violated.

It is generally conceded that deficit targets cannot work during recessions. Supporters of the Balanced Budget Amendment assure us that Congress will be able to waive the requirement during recessions. I will leave to others consideration of whether this safety valve suffices to avert economic trouble, and to a later part of this statement discussion of whether a three-fifths vote is the right rule. For the present, I want to point out that it is not only during recession that a fixed balanced budget rule may be inappropriate. When a recession ends, the impact on the budget lingers for a number of years. According to the latest CBO Economic and Budget Outlook, it would take approximately four years for the budget deficit to return to the baseline level after a recession. Even a relatively mild and short recession, such as the one experienced in 1990, would elevate the budget deficit by about $100 billion in the first year, and by declining, but still substantial, amounts in subsequent years. Not only would a fixed deficit rule be unworkable during a recession, it would continue to be unattainable for several years after the recession ended. In other words, Congress would be pressured to waive the balanced budget requirement for as many as five years (or more) of a normal economic cycle.

I believe that the temptation to play fast and loose with deficit rules will be greatest during the recovery period. When the economy is stagnant, politicians will have little choice but to waive the balanced budget rule. But when growth resumes and economic worries recede, they will be pressured to get rid of the deficit, even if it is extremely difficult or impossible to do so. As the deficit recedes, pressure to balance the budget will escalate.

This is precisely the situation that Congress now faces, but with one very big difference. The economy is now completing its 6th consecutive year of growth and, as a consequence, the budget deficit has been cut by almost two-thirds. Despite this laudable achievement, clamor to balance the budget is rising, as evidenced by the current drive to adopt the balanced budget amendment. In this case, however, there is a political consensus that total elimination of the deficit should be stretched over the next five years. But if the balanced budget rule were inscribed in the Constitution, Congress would not have another five years to complete the job; it would have to eliminate the deficit immediately, unless three-fifths of its members voted otherwise. It is in this type of situation that the President and Congress would most likely conspire to evade the zero deficit rule.

The two-thirds reduction in the deficit occurred during a period when Gramm-Rudman-Holling's fixed deficit target was replaced by the more flexible rules of the Budget Enforcement Act. BEA shifts the focus of budget control from the budget's totals to its components, and from the deficit to congressional action. Under BEA, Congress may not appropriate in excess of the discretionary spending caps, and its revenue and direct spending legislation may not cause the deficit to rise. These rules hold Congress accountable for the parts of the budget it controls. Moreover, these rules operate independently of the size of the deficit, even though their net effect has been to reduce the deficit. I will not say that politicians have shown perfect fidelity to the rules; they haven't, but the breaches have been relatively minor. It would not be difficult to tighten the BEA rules to strengthen budgetary discipline in Congress.

Unlike deficit targets, the BEA rules are not affected by economic cycles. They work in good times and in bad, when the deficit is rising and when it is falling, when government is divided and when it is unified. They do not guarantee that the budget will be balanced, but they guard against legislative actions that add to the deficit.

Lessons from the States

What should be done when political conditions are not conducive to prudent budgeting, when, for example, the President and Congress spend a lot more than the government takes in? Isn't this the situation for which the balanced budget amendment is needed? Wouldn't the amendment deter politicians from incurring chronic deficits?

In the short-run, the answer might be "yes." In the early years after ratification, a balanced budget rule probably would constrain deficit spending. But a constitutional amendment is not just for the short-run; it has to work years after being adopted. The evidence from the states is that over time, as political pressures build up, governments find ways of spending above their revenue even though the constitution prohibits the practice. In fact, many states manage to borrow money while adopting budgets that purport to be in balance. The following are some of the methods used by states; all can be adopted by the federal government, even if H.J. Res 1 were ratified.

The most popular method is for the legislature to establish an entity such as a public authority or corporation, authorize it to borrow money, and provide that its debt shall not be an obligation of the state. When called upon to rule, the courts invariably hold that inasmuch as the public authority is borrowing the money, there is no violation of state constitutional restrictions on indebtedness. Thousands of these quasi-governmental entities have been established in the 50 states; their outstanding debt totals hundreds of billions of dollars, far more than the states owe in "general obligation" bonds. Because the debt incurred by these entities is not backed by the full faith and credit of the state, it typically carries a higher rate of interest, thereby adding significantly to the cost of state government.

The debt of these entities usually is in the form of revenue bonds which are serviced by income earned from business-type operations such as tolls collected on state highways or dormitory fees charged college students. These are "moral obligation" bonds; there is a strong expectation that the state will come to the rescue in case of default. Underwriters take these bonds into account in assessing the state's financial condition. The federal government also has moral obligation bonds—the more than one trillion dollars of debt owed by government-sponsored enterprises. The volume of this type of debt will soar if a balanced budget rule were inscribed in the Constitution.

Another device used by states to balance their books is to sell assets, record the proceeds as current revenue, and thereby make their financial condition appear better than it actually is. Some states sell assets to their own off-budget corporations. The state can sell anything this way—prisons, highways, loan assets, etc.—whether or not there is a market, and the state can dictate the sales price. Asset sales are part of a larger state practice—using non-recurring revenue (known as "one shots") to close the revenue-expenditure gap.

How do public entities get money to purchase state assets? Not to worry, for once again budgetary alchemists know the tricks of the trade. In some cases, the state "leases back" the facility, making annual appropriations to service the debt incurred by the entity when it purchased the asset. In other cases, the state enables the off-budget entity to borrow in capital markets by guaranteeing the debt. Either way, the state bears the financial burden, or risk, and the budget shows a more favorable outcome than is warranted.

States also have been adept in passing the buck to Uncle Sam. They lobby for federal assistance, pressure federal agencies to make good on disallowed claims, re-label their expenditure to qualify for matching federal assistance, etc. One of the most inventive schemes was used by states to wrest billions of additional Medicaid dollars from Washington. In this scheme, states pretended to tax hospitals and other providers, used the revenue from these "taxes" to obtain higher Medicaid reimbursements from the Federal Government, and then split some of the "profits" with providers. Both states and providers came out ahead, at the expense of the federal government. It should be noted that this scam peaked in the early 1990s, at a time when federal budget deficits reached record levels.

States often adjust to changing budget conditions by switching from pay-as-you-go financing of capital improvements to debt financing. Many states are adept at shifting money among funds—for example, from the highway fund to the general fund. These and other bookkeeping tactics are most likely to occur when a state (a) is required to maintain a balanced budget or is restricted in the amount it may borrow, and (b) has a budget gap that cannot be closed through politically-acceptable spending cuts or tax increases.

This is the very predicament that will confront the federal budget if it were to operate under a constitutional balanced budget rule. The federal government might end up with balanced budgets and bigger deficits. For an early warning of how federal budgeting might be warped by a balanced budget amendment, one need only look back at the "blue smoke and mirrors" practices that veiled the true deficit during the heyday of Gramm-Rudman-Hollings. Budgetary legerdemain mushroomed in those years because federal policymakers worked under unworkable fixed deficit rules. The gimmickry will be even more inventive if the federal government were compelled to operate under a constitutionally-mandated zero deficit rule.

It is sometimes argued that small evasions of a balanced budget rule, say on the order of $20 or $30 billion a year, would be far better than the mega-deficits that have occurred in the absence of such a rule. This is a specious argument, for there is no reason to believe that the evasions and gimmicks would be small. They are not in the states, and they will not be in Washington. Even if the dollar amount of budget lies were relatively small, their true cost would be much larger, for they would further erode trust in government. Establishing a constitutional rule that would impel politicians to lie would not contribute to good government.

In drawing lessons from state practices, it should be noted that H.J. Res 1 would force Congress to give the President vast new budgetary power in implementing the federal budget. In many states, the governor has carte blanche in withholding funds during the fiscal year to avert a deficit. The governor can rearrange budget priorities to suit his or her preferences and does not have to get legislative approval when appropriated funds are impounded. In some states, the governor's impoundment power reaches to grants made by the legislature to local governments and to state-funded entitlements. In considering the balanced budget amendment, therefore, one must be mindful of the potential implications for legislative-executive relations and for Congress' power of the purse. It is highly unlikely that Congress would be able to cope with unplanned deficits by passing new legislation; more likely it would have to vest the President with power to sequester or cancel both appropriated funds and entitlements.

Here, again, the ill-fated Gramm-Rudman-Hollings process offers guidance on what doesn't work. In GRH, Congress established a formula for sequestering funds in case of an excess deficit. The formula exempted major portions of the budget from sequestration and provided for uniform percentage cutbacks in sequestrable resources. The idea was to prevent the President from imposing his priorities over those of Congress. But the effect of the formula was to thwart deficit reduction. It gave interest groups a strong incentive to pressure Congress for special treatment; in the end, most federal spending was exempted from sequestration. As a result, the percentage that had to be cut from the portions of the budget subject to sequester was unacceptably high.

This is Sophie's Choice applied to federal budgeting. One choice is to turn budgetary power over to the President and let him do the job as he deems fit, the other is to write a formula that protects Congress' priorities but results in extremely high percentage cutbacks. Both would damage the legislative capacity of Congress and confidence in our political institutions.

Letting the Courts Do It

There is a third possibility, however: because of constitutional ambiguity or political conflict, the job of bringing federal spending into line with revenues is to be entrusted to the courts. In considering this possibility one must take into account the uncertainty inherent in the balanced budget amendment, and the conflict it is likely to spawn between the President and Congress.

All constitutional provisions require judicial interpretation, but because of its wording and the manner in which federal budgeting operates, the courts might be put in the position of deciding both what the balanced budget amendment means and what federal budget policy should be. Litigation is likely to arise over key words in the amendment: "U.S. Government," "receipts," "outlays," and "limit on the debt." Federal courts may be brought into play when budget estimates veer off course and the planned balance turns into a projected deficit; when taxpayers challenge the accuracy of the Government's estimates; when the President and/or Congress refuse, or are unable, to act in the face of a pending deficit; when cutbacks are made in entitlements or other budget commitments. States may be active litigants if they feel short-changed by federal budget actions that leave them with less money than was promised. So, too, would be prison inmates, welfare recipients, health care providers, and the many others on the receiving end of federal payments or services.

The bare words of the balanced budget amendment open the door to judicial activism. The words say that Congress may by a three-fifths vote provide for a "specific excess of outlays over receipts." Suppose Congress votes for a specific deficit but deteriorating economic conditions propel the deficit even higher? Suppose Congress is unable to muster either majority support for a balanced budget or three-fifths permission for a deficit? Should the courts intervene to break the deadlock and ensure a balanced budget? Another provision requires the President to submit a balanced budget each year. In most years, CBO's re-estimate of the President's budget finds that his projections are unduly optimistic. Will Congress sue the President to compel him to submit a realistic budget?

The balanced budget amendment seems to state that funds carried over from previous years cannot be counted in determining whether outlays are in line with revenues. Section 1 of the amendment provides that "total outlays for any fiscal year shall not exceed total receipts for that fiscal year...." This is a much stricter balanced budget rule than most states have. It implies that balances carried over from one year to the next may not be counted as part of federal receipts. The impact can be especially pronounced in Social Security and other trust funds that have accumulated large balances over the years. One can foresee the courts being the decisors of Social Security policy early in the next century when the trust fund begins to run a deficit. Will the courts permit Social Security balances to be used in computing the budget's receipts, or will it insist on a literal interpretation of Section 1? Nobody can predict how the courts will rule, but one can predict that they will be called upon to rule.

Government by Deadlock

In contemplating the effects of a balanced budget amendment, it is necessary to speculate about how its provisions will be implemented. But there is one danger which requires no speculation. Just one year ago, large portions of the federal government were shut down by unprecedented conflict between the President and Congress over budget policy. The balanced budget amendment would greatly increase the probability of budgetary conflict by requiring a three-fifths vote to raise the public debt limit or to permit spending in excess of receipts. One can foresee many circumstances in which a majority agrees on budget policy but three-fifths support is not forthcoming. The minority will be able to extort concessions from the majority before it agrees to vote for the budget. Negotiations between the two sides are likely to be fractious and lengthy; deals will not be made by the first day of the fiscal year but long afterwards, probably only after the two sides have gone to the brink and beyond.

Government by deadlock is a substitute for politics as usual. In its disdain for politics by majority vote, the balanced budget amendment impedes the normal operation of democratic politics. This in the end would be the most damaging result of the amendment.

Authors

Allen Schick

Publication: House Committee on the Budget

The Federal Budget : Politics, Policy, Process

Allen Schick — Mon, 12 Dec 1994 00:00:00 -0500

Brookings Institution Press 1994 242pp.

An essential guide to the federal budget process, this book brings together three critical elements of budget strategy: the political tactics and relationships that determine budgetary success or failure; the policy objectives pursued through the budget's revenue and spending proposals; and the rules and procedures that govern congressional and presidential action on these proposals. Documents used in federal budgeting are highlighted to show how the process affects policy outcomes.

ABOUT THE AUTHOR

Allen Schick

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