Chapter

3 Why the Deficit Persists as a Budget Problem: Role of Political Institutions

Editor(s):
A. Premchand
Published Date:
June 1990
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Author(s)
ALLEN SCHICK

Most democratic countries entered the 1980s with their public finances in disarray. Two oil shocks, low growth, high inflation, and high unemployment had destabilized the postwar relationship between the economy and the budget and had left large, seemingly intractable deficits. As the 1980s draw to a close, the fiscal pattern appears to be more favorable and more varied. Almost all industrialized democracies now have deficits well below the peaks experienced earlier in the decade, and a few have run budget (or public sector) surpluses in the last year or two. In contrast to the despair and confusion that beset democratic governments at the start of the decade, there is today widespread—not universal—confidence that both national economies and budgets can be stabilized.

This paper takes the position that the accolades and self-confidence may be premature. The turnaround in public finance has been accomplished during a period of sustained economic growth. The true test of fiscal balance will come when the economies of industrialized democracies undergo cyclical weakness. The concern that deficits persist as a budget problem is predicated on the notion that fiscal stability depends as much on political actions as it does on economic conditions. To illustrate this point, I will review an extreme case: the deficit trend in the U.S. Government. My selection of the United States is based on two considerations: first, I am more familiar with its budget policy than with the policies undertaken in other countries; second, the United States is a country whose deficit-reduction objectives have been impeded by peculiar governing arrangements, in particular the division of power between the legislative and the executive branches. As such, the U.S. Government is an atypical but informative case study of the role of political institutions in setting and implementing fiscal policy.

FISCAL POLICY: FROM KEYNESIAN EXPANSION TO FISCAL RESTRAINT

The first oil shock in 1973–74 transformed budgeting in industrialized democracies from an engine of government expansion into a process for restraining growth in the public sector. The postwar era was characterized by high economic growth, widespread improvements in productivity and the overall standard of living, and low rates of inflation and unemployment. Economic expansion begot incremental budgeting, which concentrated governmental attention and policy decisions on the size and allocation of spending increases. Although public sector growth generally outpaced the trend in the economy, it was deemed appropriate during the expansive postwar years to allot a rising share of national output to public programs. Accordingly, total government outlays in the Organization for Economic Cooperation and Development (OECD) community averaged about 35 percent of GDP in 1974, compared with only 28 percent in 1960. One reason for this progressive enlargement in the relative size of the public sector was that fiscal policy was geared to the potential of the economy, and it seemed proper that the public share rise (because of built-in stabilizers and discretionary stimulus) during cyclical bouts of weakness. Actual budgetary balance was abandoned as an operative norm in most OECD countries, as it was deemed more important to balance the economy than to balance the budget. Nevertheless, economic vigor ensured that deficits (when they occurred) were modest and manageable.

Economic growth was accompanied by political stability. Even in countries (such as Italy) in which elections and government turnover were frequent, policies remained in place for extended periods. A broad consensus on the role of government in combating unemployment and in ameliorating the financial distress of old age, disability, unemployment, and other obstacles to productive labor led to increased social expenditure and to steep escalation in transfer payments. As governments became more confident of their capacity to sustain economic well-being and promote the public welfare, their budgetary machinery was oriented from spending control to program expansion. Program budgeting and multiyear analysis—two prominent postwar innovations—were not simply rearrangements in budgetary technique; rather they were adaptations to the realpolitik of government expansion. Multiyear budgeting enabled governments to plan for long-term growth; program budgeting enabled them to select the policy initiatives that would do the most good.

Economic and political stability was jarred, however, by the first oil crisis, which brought in its wake stagnation, soaring inflation, and unemployment, and a slowdown (or halt, in some countries) in the productivity gains that had previously made it possible for both public expenditure and private disposable incomes to rise. Some industrialized countries responded to the first oil shock as if it was a conventional cyclical downturn. They tried to reflate their economies through job-creation schemes and tax relief, and they accepted the upsurge in deficits as the normal countercyclical response. But recovery generally was short-lived and sluggish. Caught in the grip of stagflation, various governments found that policies aimed at combating unemployment worsened inflation and added to the budget deficit without accomplishing their objectives. They came to see high unemployment as a structural problem that could not be significantly remedied through short-term interventions.

In a weakened economic condition, most OECD countries concluded that they could not close their budget deficits through tax increases. But they recognized that unless they changed course, the weight of past decisions—such as indexed transfer payments and other commitments—would compel high and chronic deficits and would impel continued enlargement in the relative size of the public sector. Owing to widespread entitlements, public sector prices rose at a faster rate than the general price level (Baumol’s relative price effect); owing to demographic trends, the public sector would continue to expand relative to the overall economy, even if no new programs were initiated.

This realization began to solidify into government policy in the late 1970s when the second oil shock unsettled national economies. Still reeling from the aftereffects of the previous tremor only five years earlier, industrialized countries quickly came to the conclusion that they could not respond this time with textbook countercyclical prescriptions. Instead, they began to shift gears from incremental to decremental behavior. This shift in budgetary and fiscal orientation had a number of characteristics: (1) the establishment of cutback norms and guidelines; (2) the separation of budgetary and economic policy; and (3) the translation of cutback norms into operational budget objectives.

NORMS AND GUIDELINES FOR FISCAL RESTRAINT

Canada was one of the first developed countries officially to adopt constrictive budget norms. Its 1975 White Paper, “Attack on Inflation,” declared that “The federal government shares the view that the trend of total spending by all governments in Canada should not rise more quickly than the trend of the gross national product.” It is important to note that the stated objective was to stabilize—not to reduce—the relative size of the public sector. In Canada, as in other industrialized countries, it was feared that without new restraints, the public sector would continue to expand its share in GNP, causing either a progressive rise in tax burdens or a chronic budget deficit.

To avert this undesired state of affairs, many OECD countries moved in the late 1970s or early 1980s to policies that, they hoped, would restore budgetary balance by moderating the rise in expenditure while lowering or stabilizing the tax burden. In the Netherlands, this policy shift meant abandonment of the structural budget norm that had guided fiscal policy during most of the postwar period. This norm pegged public expenditure to the potential of the economy; in application, it permitted a steady rise in the relative size of the public sector. In the 1970s, however, the utility of this norm was vitiated by actual deficits that were almost double the amount allowed by the structural policy. As a consequence, late in the decade, the Government shifted to a fiscal rule predicated on expected performance of the economy rather than on structural capacity. Moreover, to reduce the deficit and stabilize the collective burden, it adopted a policy that would have limited the annual rise in public expenditure to no more than 1 percent of net national income (NNI). But inasmuch as this norm would have permitted continued enlargement of the public sector’s share in GNP, within a few years it was discarded in favor of a rule that permitted no rise in the expenditure/NNI ratio.

While the targeting of fiscal objectives was an exceptional practice a decade ago, it is today conventional practice. Thus, a 1987 OECD report, The Control and Management of Government Expenditure, noted

The last ten years may be summarised as the decade when “top-down” constraints were gradually imposed much more effectively on the “bottom-up” demands of spenders, their clients and supporters…. All countries taking part in the study now publish some form of summary objectives or targets for fiscal policy. These usually include a target for expenditure. Many governments publish their budgetary targets to stimulate public discussion. Often this is seen as a way to further build consensus about fiscal policy goals and means to meet them. (p. 21)

As the OECD report noted, in virtually all of its member countries, budgetary objectives are expressed in quantitative terms for a number of years ahead. These specific targets are intended to provide a strong message, especially to spending agencies and interest groups, concerning the government’s fiscal objectives and its determination to implement them.

Contemporary fiscal norms come in many varieties, but they can be classified into three main forms: (1) a relative standard in which one or more of the fiscal aggregates (total revenue, outlays, deficit, or the public debt) is to be stabilized or reduced relative to GNP or some other measure of economic activity; (2) a standard pertaining to the rate of change in spending or another fiscal aggregate, such as a rule prescribing zero real growth in spending or a decline in the budget deficit; and (3) an absolute value for the fiscal aggregate to be achieved at some time in the future, such as a rule that the deficit two years hence shall not exceed some stated amount.

Some examples drawn from published and unpublished OECD material will illustrate how these norms have been applied in practice. The following paragraphs review the fiscal norms embraced in the major OECD countries.

Australia. In 1985, the Federal Government adopted a medium-term strategy to stabilize outlays, revenue, and the deficit as a proportion of GDP. This “trilogy” policy was subsequently modified by a commitment to reduce the size of the deficit in nominal terms.

Canada. The fiscal target established in the 1975 White Paper was refined in the next decade to curtail the growth in public expenditure so that it would decline relative to GNP. To accomplish this, the Government recognized, would require the year-to-year growth in expenditure to be below the rate of inflation. If this were accomplished, it was expected that the debt/GNP ratio would decline to a more acceptable level.

Denmark. A strategy calling for zero real growth in public expenditure and the gradual elimination of the deficit was adopted in the early 1980s.

France. Following a brief period of expansion when the Mitterand Government took office, the Government made a “U-turn” and moved to a more restrictive posture. By the mid-1980s, preparation of the national budget was guided by two principal constraints: that the central government deficit not exceed 3 percent of GDP and that the tax burden be lowered by 1 percent a year.

Federal Republic of Germany. Throughout the 1980s, formulation of the federal budget was influenced by efforts to curtail the deficit, restrict the growth in expenditure to approximately the growth rate of GDP, and restrain public consumption while increasing investment-related expenditure. The 1984 medium-term financial plan was based on a “consolidation strategy” that would restrict the growth of federal expenditures to 3 percent a year in current prices and cut net borrowing in half.

Italy. Owing to the massive public deficit, emphasis was placed on stabilizing the public sector borrowing requirement (PSBR) that covers all levels of governments. However, the PSBR often overran its target in the 1980s, forcing frequent adjustments in this fiscal norm.

Japan. The 1982 report of the Administrative Reform Commission urged that the ratio of general expenditure to GNP (excluding interest payments) be stabilized. The Commission noted that although the tax burden would have to rise, it should be kept much lower than that of European countries. The Government’s “Outlook and Guidelines for the Economy and Society in the 1980s,” presented in 1983, called for phasing out deficit-financing bonds.

Sweden. With central government budget deficits exceeding 10 percent of GNP, the Government adopted a medium-term strategy in 1984 to reduce the deficit to no more than 4–5 percent by the end of the decade while keeping the tax/GNP ratio approximately constant. This norm implied a reduction in public expenditure relative to GNP.

United Kingdom. In the 1980s, the medium-term financial strategy, which accompanies the annual budget, has established objectives for the PSBR. The PSBR covers central government, local authorities, and the net lending of public enterprises. In general, the medium-term financial strategy indicated a PSBR that declined from more than 5 percent of GDP at the start of the decade to only 2 percent in 1985/86.

DIVORCING BUDGET AND ECONOMIC POLICY

The policy norms outlined in the preceding paragraphs represent much more than a determination to stabilize or reduce public expenditure and the deficit. They also reflect a fundamental reorientation in the budget’s role in economic policy. In lieu of the use of the budget to steer the economy as was paramount during postwar Keynesianism, the budget reverted in the 1980s to its old-fashioned task of balancing revenues and expenditures and determining the amounts to be spent by public programs and agencies. This reorientation has inevitably meant less attention to active fiscal policy as a means of influencing short-term economic conditions. Part of the reason for deemphasizing short-term results is that the large automatic component in the budget (principally, mandatory transfer payments) makes it exceedingly difficult to adjust budget policy to cyclical swings in the economy.

Governments in the 1980s lost confidence in interventionist fiscal policy. The prevailing attitude came to be that the national budget cannot effectively remedy economic ills unless it is first restored to health, that is, unless the deficit and expenditure growth are reduced to more acceptable levels. Budget norms have thus become more insular and limited: the primary objective of the budget process should be to manage expenditures within fixed targets. Of course, both revenue and expenditure remain highly sensitive to changes in economic conditions; hence, contemporary governments cannot be completely indifferent to the impacts of their budget actions on the economy.

It should be noted that targets infiltrated monetary policy some years before they became common in fiscal policy, but that the motives were similar. In both developments there was a pervasive belief that governments and politicians could no longer be left to their own discretion, either because they lacked sufficient information with which to intervene in an effective manner, or because they could not be trusted to do the right thing. In the absence of fixed targets, they would respond to political crisis by easing fiscal policy or inflating the money supply. They could not be relied on to do the right thing when tough action was called for.

The shift to budget targets was accompanied by a recognition that today’s cyclical crisis is tomorrow’s structural difficulty. That is, it was recognized that the deficits incurred in response to cyclical weakness add to the future debt burden, and hence to future interest charges. As these charges became an increasingly prominent portion of public expenditure in the late 1970s and early 1980s, industrialized democracies turned away from short-term policies to longer-term concerns.

As budgeting became more oriented to spending control, it gave more attention to the actual (or expected) performance of the economy, rather than to its potential. Performance was more important than potential because the key budgetary objective was to curtail the deficit and expenditures relative to GNP.

TRANSLATING THE FISCAL NORMS INTO BUDGET POLICY

Budgetary norms are effective only to the extent they influence financial decisions. When governments seek restraint, they must translate these policies into concrete actions, and they must be able to assess particular decisions in the light of their budgetary objectives.

Table 1 indicates that few industrialized democracies have succeeded in stabilizing public expenditure. The data reveal that only 2 of the 12 countries shown had lower relative expenditures in 1987 than in 1980. The two success stories were Germany and Sweden, and each had a special explanation of its performance. Germany’s historic apprehension about the resurgence of inflation led it to adopt more austere policies than were acceptable in other countries; Sweden’s status as the country with the highest tax burden and the largest public sector led it to recognize that the incessant rise in public spending must be contained.

Table 1.Total Outlays of Government as Percentage of GDP
Country19801987Increase (or Decrease) in

Outlays as Percentage of GDP
Australia34.038.314.3
Canada40.545.65.1
Denmark56.258.32.1
France46.158.35.7
Germany, Fed. Rep. of48.346.8(1.5)
Italy41.950.78.8
Japan32.633.20.6
Netherlands57.560.12.6
Norway48.351.63.3
Sweden61.659.9(1.7)
United Kingdom44.945.911.0
United States33.736.73.0

1987 figures not available; 1986 figures used instead.

1987 figures not available; 1986 figures used instead.

Despite the general lack of success in curbing public expenditure, half of the OECD countries now have smaller budget deficits than they had at the beginning of the decade. Table 2 shows that 3 of the countries had budget surpluses in the most recent year for which data are available, 4 had smaller deficits, and 5 had bigger deficits. The trend in government receipts explains how some countries have managed to curtail their deficits without taking strong steps to retrench public expenditure. All but one of the major OECD countries had higher current receipts (relative to GNP) in the most recent year than they did in 1980. In other words, pressure to trim the deficit has led to an updrift in government receipts, either through specific policy actions such as tax increases or by allowing economic expansion, inflation, or other factors to generate higher tax burdens.

Table 2.General Government Financial Balances(Surplus (+) or Deficit (-) as Percentage of Nominal GNP/GDP)
Country19801987Increase (or Decrease) in

Financial Balances
Australia-1.6-0.61.0
Canada-2.8-4.6(1.8)
Denmark-3.3+2.05.3
France-0.1-2.0(1.9)
Germany, Fed. Rep. of-2.9-1.81.1
Italy-8.5-10.5(2.0)
Japan-4.4+0.65.0
Netherlands-4.0-6.1(2.1)
Norway+5.7+4.6(1.1)
Sweden-2.8-2.20.6
United Kingdom-3.4-1.51.9
United States-1.3-2.3(1.0)

The plain fact is that industrialized democracies have not done very much to curb the upward spiral in public expenditure. Most have squeezed public consumption and investment (the two principal categories of discretionary expenditure), but they have not been willing to challenge the built-in entitlements that mandate higher expenditures for pensions, health care, and other transfer payments. Some countries have trimmed these payments at the margins, but they have not been able to launch a frontal attack on the welfare state.

The slowdown in the growth of spending relative to GNP has occurred during an extended period of economic expansion. While economic growth has been somewhat less vigorous in the 1980s than in previous decades, it nevertheless has channeled more resources to government treasuries and has enabled them to moderate public expenditure without making severe cutbacks.

Do the actions taken thus far in the 1980s suffice to arrest the progressive rise in public spending and the deficit problem? The title of this paper suggests that the answer is no. In view of the failure of democratic governments to restructure the demands on their budgets, one should not be surprised if big deficits recur the next time the economy turns downward. Moreover, the deficit problem is likely to worsen over time, as populations age, health care costs soar, and other demands on the public purse persist.

The failure to rein in public expenditure is primarily a political—not an economic—problem. Cutting expenditures means trimming services, taking away benefits, curtailing rights to payments, and allocating losses. None of these are easy for democratic politicians to do. An OECD study of 11 macroeconomic interventions, Why Economic Policies Change Course, concluded that political leaders did “not seriously tackle the root causes of their problems until the situation approached crisis conditions and the need for remedial action, on the internal as well as on the external side, became evident and broadly accepted by … the population at large.” (p. 9). In short, only when the existing course of action became “unsustainable” did democratic governments, reluctantly and with a lot of foot-dragging, alter course.

One of the lessons of the 1980s is that failure to achieve fiscal norms is not sufficient cause for altering policy, nor is the persistence of budget deficits or the continuing upward creep in public expenditure relative to GNP.

PATHOLOGY OF DEFICIT BUDGETING IN THE UNITED STATES

The budget deficit has dominated national politics in the United States throughout the 1980s. During the 1980 presidential campaign, then-candidate Ronald Reagan announced a target of far lower taxes and spending relative to GNP and a balanced budget by 1984. He reaffirmed these objectives in an economic program presented shortly after taking office. However, it proved much easier to reduce taxes than to curtail spending or the deficit. Table 3 shows the trend in the budget deficit, in nominal terms and relative to GNP during the 1980s.

Table 3.Federal Finances and GNP, 1980–89(In billions of dollars)
Fiscal

Year
GNPDeficitDeficit as a

Percentage

of GNP
19802,670.6-73.8-2.8
19812,986.4-78.9-2.6
19823,139.1-127.9-4.1
19833,321.9-207.8-6.3
19843,687.7-185.3-5.0
19853,952.4-212.3-5.4
19864,186.8-221.2-5.3
19874,433.8-149.7-3.4
19884,780.0-155.1-3.2
1989 (estimate)5,119.7-161.5-3.2

The failure to control the deficit has spawned a lively debate concerning the true objectives of President Reagan. Some say that he wanted high deficits as a means of constraining public expenditures; others argue, however, that the President accepted deficits as a necessary evil only when he realized the high cost of eradicating them. A plausible view is that while the White House did not engineer the deficit, it exploited this condition once it became entrenched. President Reagan clearly preferred a smaller government with a bigger deficit than a bigger government with a smaller deficit. To him, this trade-off was inevitable, for he firmly believed that any tax increase legislated to ameliorate the deficit would lead instead to higher spending.

Regardless of the President’s motives, protracted conflict with Congress precluded decisive action on the deficit. Through the 1980s, the United States had divided government, not only in the sense that the Republicans controlled the presidency and the Democrats controlled one or both houses of Congress, but also in the sense that the two branches warred over budget policies and priorities. The President was determined to downsize domestic government, but after initial success in 1981, he faced a Congress determined to maintain social programs against presidential attack. The result was a protracted impasse, with Congress unable to get the President to agree to sizable tax increases (though he signed a series of modest increases during 1982–87) and the President unable to get congressional approval of further cuts in domestic spending.

As the impasse persisted, the deficit worsened, peaking at $221 billion during the 1986 fiscal year. This condition led to enactment of the Gramm-Rudman-Hollings law (GRH), a measure that promised to restore budgetary balance through annual deficit targets. If the estimated deficit exceeded the target, funds would be automatically canceled from both defense and domestic programs through a process known as sequestration. Inasmuch as the cutbacks would be automatic, they would occur without the consent of politicians and even if the President and Congress could not agree on their composition.

At least this was the expectation. In practice, it has not quite turned out this way, and in each of the years that the GRH process has been in effect, the actual deficit has exceeded the targeted deficit. In fact, the gap between performance and promise became so wide that it was necessary in 1987, as Table 4 shows, to stretch out the targets and lower the amount of deficit reduction that had to be achieved each year. During the 1986–89 fiscal years, the actual deficit has totaled some $230 billion more than the amount allowed in the original GRH law.

Table 4.Comparison of Targets and Actual Deficits(In billions of dollars)
Fiscal

Year
Original

Target
Revised

Target
Actual

Deficit
1986171.9221.2
1987144.0149.7
1988108.0144155.1
198972.0136152.01
199036.0100
199164
199228
1993

Estimated.

Estimated.

Why has a process established to eradicate the deficit allowed it to persist? Supporters of the GRH process, and there are many in Congress, insist that although the deficit targets have not been met, there has been a pronounced slowdown in the growth of federal spending and the deficit is smaller than it would have been in the absence of the GRH controls. Some comfort can be taken from the fact that relative to GNP, the deficit now is only about half the size it was in 1983 when it reached a peacetime record of 6.3 percent of GNP.

This modest success notwithstanding, this writer is of the view that GRH has not brought much deficit reduction but has encouraged a great deal of deception about the budget. The budget deficit for the most recently completed fiscal year (1989) indicates that it was above $150 billion. As shown in Table 4, this figure is above the GRH target for the fiscal year but almost $70 billion below the peak reached three years earlier. While this may seem to be a considerable accomplishment, it is quite modest when two factors—the sustained economic expansion and the enormous buildup in social security reserves—are taken into account. It is astounding how difficult it has been to make inroads into the deficit during the longest peacetime expansion in U.S. history. When Gramm-Rudman-Hollings was enacted in 1985, the United States had just commenced the fourth consecutive year of growth; now, the economy is about to start the eighth consecutive year of uninterrupted expansion. Nevertheless, the deficit is still very large in nominal terms and relative to GNP. In the past, there was a simple and reliable correlation between the performance of the economy and the trend in the deficit. Recovery almost always brought quick and substantial curtailment of the deficit. For example, the budget deficit receded from 4.3 percent of GNP during the recession year of 1976 to only 1.6 percent during the 1979 fiscal year, a decline of almost two thirds relative to GNP. In dollar terms, the deficit declined from $74 billion to $40 billion, a reduction of almost 50 percent. During the current expansion, by comparison, the deficit has dropped from 5.3 percent of GNP in fiscal 1986 (the first GRH year) to approximately 3.3 percent in the 1989 fiscal year. This indicates, both relative to GNP and in absolute terms, that the percentage drop in the deficit was greater before the Government was armed with GRH controls than it was afterward.

The record looks even worse when social security is taken into consideration. Fully two thirds of the abatement in the budget deficit has been due to a buildup in social security reserves. The social security funds (which are excluded from the budget except for computation of the GRH deficit) had an annual surplus of less than $17 billion in fiscal 1986; during the 1989 fiscal year, the annual surplus was about $55 billion. In other words, without the offset from the social security funds, the federal deficit would still be above the $200 billion mark, not much less than it was before GRH.

Why hasn’t GRH brought much amelioration of the deficit? On its face, GRH seems to be the right prescription: a precise fiscal norm coupled with tough enforcement procedures. Cuts are automatic if the projected deficit exceeds the target, and the law spells out detailed rules as to how the calculations are to be made. Nevertheless, certain features of GRH have thwarted the capacity of the Government to deal effectively with the problem.

The bill of particulars against GRH includes the incentive it gives harassed politicians to manipulate budget data and to exploit the process to their advantage. Beyond this, GRH is a weak deficit-reduction process because it shortens the time horizon of budgeting, induces budget officials to take timid steps and places more substantial improvement beyond reach, encourages the President and congressional leaders to conspire to avoid sequestration, and provides incentives to shift deficit-increasing actions to future budgets. Collectively, these shortcomings have turned a deficit-reduction law into a deficit-protection act. Let us consider these problems and their impact on the budget.

GRH promotes deceptive budget practices. Deception is not a newcomer to government budgeting, but nowadays it is practiced on a scale and with a brazenness that was unthinkable a few years ago. As recently as the mid-1980s, budgetary legerdemain was only a small part of each year’s deficit-reduction package. Perhaps four or five dollars of genuine spending cutbacks and/or revenue increases were achieved for each dollar of faked savings. At the time, the tricks were seen as an appropriate price to pay for coming to grips with the deficit. Now, however, the ratio has been reversed, and the gimmicks far outweigh the legitimate savings. Rather than easing the path to deficit reduction, budget tricks have become a substitute for them.

This pattern suggests that key participants in the budget process have learned how to exploit the GRH rules to their advantage. Ironically, despite the consistent failure to meet the deficit targets, neither the President nor Congress wants to repeal this legislation. Politicians like GRH because it conveys the impression that the Government is taking decisive action to deal with the deficit. Fortunately for them, however, GRH has not yet required that they do very much.

GRH has shortened the time horizon of budgeting. On paper, GRH is a multiyear process for eliminating the deficit. In practice, it is a one-year-at-a-time process that impels politicians to narrow their attention to the year immediately ahead. All that matters for them is whether the threatened sequester will be implemented. Anything that averts a sequester is welcomed, even if it worsens future deficits. As each budget cycle begins, politicians compute (using highly questionable assumptions) the amount by which the deficit has to be curtailed in order to put off the day of reckoning. If the “excess” deficit is projected to $20 billion, this is the number targeted in negotiations between Congress and the President. No one cares whether it is the right number for the economy, only that it be achieved.

GRH encourages timid actions. For the reason just mentioned, GRH limits the amount of deficit reduction sought each year. Imagine a world without GRH in which an embattled government was pressured to come to grips with the deficit. Instead of settling for $10–20 billion in contrived cuts (an amount equal to less than 1 percent of combined revenue and expenditure), politicians might be spurred to take truly effective action.

A look at the GRH targets for future years (see Table 4) suggests that more forceful action may be necessary to avert future sequesters. More total deficit reduction is called for in the 1991–93 fiscal years than was achieved in the previous five years. Perhaps the United States is on the brink of substantial abatement in the deficit. But it is also possible that the targets will be diluted or suspended if achieving them becomes too onerous.

GRH encourages the President and Congress to conspire to avoid a sequester. Nowadays budgeting operates according to a simple rule: anything is true if the President and Congress say it is. For example, if the President and Congress claim that the deficit has been reduced some $2 billion by removing the Postal Service from the budget, then $2 billion has been saved. GRH invites this type of conspiracy because of the timetable under which it operates. Without going into all the technical details, we may note that after October 15 (when 359 days remain in the fiscal year) nothing done by the President or Congress can provoke sequestration, regardless of the amount it adds to the deficit.

IS THE UNITED STATES AN ANOMALY?

The Gramm-Rudman-Hollings law is a peculiarly American invention. It serves as a treaty between two politically independent and warring branches of government. This type of arrangement would be unthinkable in countries governed by parliamentary arrangements. Yet, some important lessons can be learned from U.S. experience, with application to some advanced democracies.

The first lesson is that budgetary norms are not self implementing. It is one thing to announce a fiscal norm, quite another to achieve it. The gap between promise and results is wide in many countries, as evidenced by the persistence of high deficits and the continuing rise in public spending.

A second lesson is that the political capacity of government affects budgetary outcomes. A recent paper published in the United States by the National Bureau of Economic Research correlated the debt/GNP ratio of democratic countries with various measures of political strength. The not-so-surprising conclusion was that strong governments have lower ratios than weak ones. While political weakness in the United States derives from the separation of power between the legislative and executive branches, in other countries it may be due to unstable coalitions, minority government, or frequent elections.

Finally, budget control cannot be effective if it fails to deal with the growth in transfer payments. Almost all such payments were exempted from the Gramm-Rudman-Hollings process. In fact, during the current (1990) fiscal year, approximately $650 billion in nondefense expenditures were excluded from the sequester and another $125 billion were subjected to only a limited sequester. Less than one fifth of total nondefense spending was fully subjected to the GRH process.

For the United States and other developed democracies, the test of whether they have purged the deficit problem lies ahead. In my view, they have not.

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