Abstract

The elimination of the U.S. federal budget deficit during the 1990s marked a significant fiscal milestone at the time. The unified budget surplus in FY1998 was the first surplus in nearly 30 years, and surpluses in the following years were the largest relative to GDP since 1951 (Figure 6.1).1

The elimination of the U.S. federal budget deficit during the 1990s marked a significant fiscal milestone at the time. The unified budget surplus in FY1998 was the first surplus in nearly 30 years, and surpluses in the following years were the largest relative to GDP since 1951 (Figure 6.1).1

Figure 6.1.
Figure 6.1.

Federal Budget Deficit

(In percent of GDP)

Source: Congressional Budget Office.

Although the prolonged economic boom played a major role in turning the fiscal position around, a shift in the direction of policies was also instrumental. In particular, the 1990s were marked by a significant strengthening of budget discipline, codified in the 1990 Budget Enforcement Act (BEA). This legislation included strict caps on discretionary spending—that is, spending subject to annual appropriations—and a “pay-as-you-go” (PAYGO) requirement for new legislation affecting mandatory spending—that is, spending determined by permanent law—and tax receipts.

The recent deterioration in the fiscal position also appears to have reflected both cyclical and policy weaknesses. In addition to the effects of the collapse of the stock market, geopolitical events, and the onset of the 2001 recession, budget discipline weakened considerably, culminating in the expiration of the BEA at the end of FY2002. These developments, and the growing awareness of the need to reestablish a more sustainable fiscal position, have spurred questions about how, or whether, to reintroduce and reform budget enforcement procedures. This section discusses some of the principal reform options.

Background

Rising deficits during the 1980s prompted a series of reforms of budgetary legislation and procedures. Of these, the most significant were

  • The Balanced Budget and Emergency Deficit Control Act of 1985, widely known as Grarnm-Rudman-Hollings (GRH), which specified declining nominal targets for the deficit, culminating in a balanced budget in FY1991. Uniform percentage cuts—termed sequestration—were supposed to be triggered in selected mandatory and most discretionary spending programs if the projected (rather than actual) deficits exceeded the targets.

  • Faced with the prospect of huge spending cuts in 1987, Congress amended GRH by relaxing the deficit target and postponing a balanced budget until FY1993. These revised targets were never met, in part because of the financial burden associated with resolving the savings and loan crisis.

  • The 1990 Budget Enforcement Act took a different approach by replacing the deficit targets of GRH with mechanisms to enforce agreed-upon levels of discretionary spending, and to ensure the budget neutrality of new spending and taxation laws (Box 6.1). The original Act covered FY1991-FY1995, but it was extended in 1993 and 1997 and remained in force until its expiration at the end of FY2002.

Main Provisions of the BEA

The BEA has three main features:

Caps on discretionary spending: Discretionary spending consists of outlays not covered by permanent law and represents roughly one-third of total federal outlays, including almost all defense expenditure, salaries and other operating expenses of government, and many grant programs. The BEA defines limits, or “caps,” in nominal terms for specific discretionary spending categories for each fiscal year over a five-year period, with separate caps set for budget authority and actual outlays. At present, there is a cap for overall discretionary spending, as well as separate caps for highway, mass transit, and conservation spending, but at different times during the 1990s, either a single cap for all discretionary spending or separate caps for different spending categories have applied. The legislation allows for breaches of the caps in the case of “emergencies.”

Pay-as-you-go (PAYGO): The PAYGO requirement covers tax receipts and mandatory, or direct, spending. Mandatory spending is controlled by permanent laws and includes Medicare, Medicaid, unemployment benefits, and farm price supports. Under PAYGO, any legislation that increases mandatory spending or reduces revenues must be accompanied by legislation that specifies offsetting mandatory spending reductions or tax increases over a five-yearperiod. PAYGO rules do not apply to changes in mandatory spending and receipts that are not the result of new laws, such as the effects of cost-of-living increases, interest rate changes, or demographic changes. PAYGO does not apply to Social Security.

Sequestration: Sequestration procedures are used to enforce the BEA. For discretionary spending, if the amount of budget authority specified in an appropriation act, or the outlays in a particular year, exceed the corresponding caps, the BEA requires a reduction in spending in the relevant category by a uniform percentage. Special rules are specified for reducing some programs, and others are exempt from sequestration entirely. For mandatory spending and revenues, the Office of Management and Budget is required to estimate whether the new laws enacted meet the PAYGO requirements. If they do not, a uniform reduction is required across all mandatory spending programs that are not exempt or subject to special rules. These latter categories cover Social Security, interest on public debt, Medicaid, and Medicare, leaving only 3 percent of mandatory spending subject to sequestration. Sequestration procedures have been enacted only once—in 1991.

Assessing the BEA Rules

Deficit reduction during the 1990s reflected the effects of both buoyant tax revenues and expenditure restraint (Figure 6.2). It is impossible to say with certainty how much the BEA rules contributed to this fiscal consolidation, not least because the counterfactual—that is, what the deficit would have been in the absence of these rules—is not known. Nonetheless, the effectiveness of BEA rules is reviewed below from a variety of different perspectives: the design of the BEA’s enforcement mechanism compared with those of GRH; trends in spending; accounting for the role of economic growth in reducing the deficit; and enforcement and budget transparency issues.

Figure 6.2.
Figure 6.2.

Federal Outlays and Revenues

(in percent of GOP)

Source: Congressional Budget Office.

BEA Design Improvements

The BEA’s enforcement mechanisms were widely viewed as a significant improvement over those in the GRH in at least three ways:2

  • First, BEA rules applied to outturns, while GRH simply imposed constraints on deficit projections and thereby encouraged budgets to be based on overly optimistic macroeconomic assumptions.

  • Second, the deficit targets under GRH were subject to many factors beyond government control, including fluctuations in mandatory spending. By contrast, the BEA caps applied to discretionary spending, over which the government has more direct control, while a pay-as-you-go provision required that legislated changes to mandatory spending programs or tax provisions had to be budget neutral over a 5-year (later 10-year) period, introducing greater accountability into the budget process.

  • Third, under GRH, the combination of overoptimistic macroeconomic assumptions and nominal deficit targets rendered the amounts of budgetary funds subject to sequestration so large that the enforcement process lost credibility. Sequestration under the BEA, although only applied once in 1991, has been a more credible deterrent—at least until the late 1990s when it was circumvented by large emergency appropriations and adjustments to spending caps, as discussed below.

Assessing BEA’s Effectiveness

Deficit reduction through most of the 1990s rested in part on a massive decline in defense expenditure following the end of the Cold War, and a leveling off in other discretionary outlays. During FY1991-FY1998, discretionary spending outlays remained within the BEA ceilings (with only minor adjustments to the original caps), and consequently declined relative to GDP (Table 6.1; Figure 6.3). Underlying this trend were substantial reductions in defense spending, which provided some room for nondefense spending to increase after separate defense and nondefense caps expired at the end of FY1993. From a longer-term perspective, however, nondefense discretionary spending increased steadily relative to GDP during the 1960s and 1970s, fell in the 1980s, and remained broadly constant during the 1990s. This suggests that BEA spending ceilings largely served to lock in spending reductions achieved in the 1980s rather than precipitating a major reduction in discretionary outlays.

Table 6.1.

Adjustments to Discretionary Spending Caps

(In billions of U.S. dollars)

article image
Source: Office of Management and Budget.

Budget Enforcement Act (BEA) as amended in 1993 and 1997.

Numerous smaller adjustments not shown.

2002 figure is an estimate, as of January 2002.

Figure 6.3.
Figure 6.3.

Discretionary Spending

(In percent of GDP)

Source: Congressional Budget Office.

The BEA also appears to have had a noticeable impact on mandatory spending. Mandatory spending fell slightly as a share of GDP between FY1991 and FY2002 (Figure 6.4). Although PAYGO did not completely halt the enactment of new spending initiatives—for example, the children’s health insurance program was enacted in the late 1990s—several studies have argued that the PAYGO requirement was effective in discouraging new mandatory spending initiatives and tax cuts. Elmendorf, Liebman, and Wilcox (2001), for example, emphasized the relative lack of tax cuts and spending increases in the face of large surpluses at the end of the 1990s.3 In addition, Schick (2000) argued that the PAYGO rules may have encouraged some reforms of the welfare system, such as converting Aid to Families with Dependent Children (AFDC) from an open-ended entitlement to a fixed block grant.

Figure 6.4.
Figure 6.4.

Mandatory Spending

(In percent of GDP)

Source: Congressional Budget Office.

In achieving fiscal consolidation, however, the effectiveness of BEA rules was likely enhanced by the economic boom of the 1990s. Anderson (1999) notes that while discretionary spending outturns were close to the BEA limits between FY1993 and FY1998, outturns for mandatory spending and revenues were very different from the projections made in January 1993. He argues, therefore, that the effects of unexpectedly strong growth on revenues and mandatory spending were more important than the limits on discretionary spending in achieving deficit reduction. This is illustrated in Figure 6.5, which shows the rise in the Congressional Budget Office’s one-year-ahead forecast error for revenues and expenditure that can be ascribed to economic factors in the late 1990s.

Figure 6.5.
Figure 6.5.

Projection Errors Due to Economic Factors1

(In billions of U.S. dollars)

Source: Congressional Budget Office.1No data available for 1999.

BEA Circumvention and Fiscal Complexity

Budget discipline eroded significantly with the emergence of actual and prospective budget surpluses beginning in FY1999. Spending caps and PAYGO, which had remained notionally in place, were routinely circumvented, and expenditure ceilings for 2001 and 2002 were adjusted upward in 1997 (see Table 6.1). As a result of this—as well as reflecting additional outlays enacted following the September 11 attacks—federal outlays as a share of GDP increased by about ¾ percent between FY1999 and FY2002.

The devices used to circumvent BEA rules included the following:4

  • Emergency appropriations were exempt from BEA rules, and the specific criteria for defining an emergency were not codified. This exemption was used infrequently between FY1991 and FY1998, when annual adjustments to the caps for emergency requirements averaged less than $7 billion. During FY1999 and FY2000, however, annual emergency appropriations increased to over $30 billion, including appropriations for the long-anticipated 2000 census and farm subsidies.

  • Advance appropriations occur when Congress appropriates funds for spending in a future year. Although advance appropriations were to be counted toward spending caps in future years, they were increasingly used from FY1999, increasing pressure on subsequent budgets to either raise the ceilings or engage in other accounting mechanisms to augment spending.

  • Budgetary measures could be structured in a way to reduce costs during the budget period that was subject to scoring. For example, extensions to Medicaid in the late 1980s and early 1990s were phased in such a way that the spending increase took place only after the current scoring period. Once the next year’s expenditure baseline was established, the increase was already authorized by law. Alternatively, the 2001 tax cuts included a “sunset” provision to repeal all measures at the end of 2010, thereby reducing the cost of the measures during the FY2002–FY2011 budget window.

  • An expiring tax could be extended repeatedly. For example, the federal tax on airline tickets expired in 1996 but was renewed in 1997 and 1998, allowing revenue gains to be scored as offsets to other measures. In contrast, a permanent tax increase could only be scored once.

  • The CBO and the Office of Management and Budget (OMB) maintained a “scorecard” of the cumulative effect of legislated changes on the budget balance during a congressional year. Under normal application of the PAYGO rules, if the calculated net change was negative, then offsets had to be found. However, this requirement could be circumvented by setting the PAYGO scorecard to zero. For example, legislation enacted by the 107th Congress, including the June 2001 tax cuts, reduced the overall budget surplus, but offsetting actions were not required because Congress enacted other legislation that instructed OMB to change the PAYGO balances for 2001 and 2002 to zero.

The BEA’s impact on budget transparency was also mixed. On the one hand, the above list suggests that the BEA encouraged using complex accounting devices to circumvent budget rules, and some analysts have also suggested that the BEA constraints may also have encouraged Congress to resort to extrabudgetary policy instruments, including regulations and unfunded mandates. Nonetheless, the BEA arguably improved fiscal transparency in many respects, including by requiring full listings, cost estimates, and intensified scrutiny of all tax expenditures. In addition, the scorekeeping guidelines were codified and published in the 1997 Balanced Budget Act. At the same time, the scorekeeping period was extended from 5 to 10 years, in an attempt to reduce the scope for timing shifts. Finally, several studies have concluded that the BEA has resulted in less gimmickry than occurred under GRH.5

Options for Reform

Given the recent erosion of the U.S. fiscal position and the longer-term fiscal pressures implied by demographic trends, there is an evident need for strengthening budget discipline. Both U.S. and international experience have amply demonstrated that fiscal rules cannot substitute for an underlying political commitment to fiscal discipline and longer-term fiscal sustainability, and the revenue and expenditure policies that would be required.6 Nonetheless, the U.S. experience between 1990 and 1998 suggests that, with political commitment, BEA-type rules can play a useful role in bolstering budget discipline.

At the same time, however, the erosion of the effectiveness of BEA rules during the more recent period indicates the need for reform. Some of the specific options under discussion include the following:7

  • Limit discretionary spending caps to budget authority only. Some argue that separate caps on budget authority and outlays created incentives for delaying obligations and favored programs with slower spend-out rates. Focusing the caps simply on appropriations would also improve accountability, given that Congress has more control in a given year over budget appropriations as opposed to outlays.

  • Clarify and codify into law the criteria for emergency spending. For example, the House Budget Resolution for FY2002 defined an emergency as a situation (other than a threat to national security) that requires new budget authority to prevent the imminent loss of life or property, and is sudden, urgent, unforeseen, and temporary. This more stringent definition could be combined with the introduction of a contingency reserve for emergencies, which would be included in the spending cap, possibly calculated as an average of emergency/disaster spending over the past 5 or 10 years.

  • Redesign PAYGO to trigger examination of the “base.” Under the current rules, cost increases of existing mandatory programs are exempt from the PAYGO requirement. This provision favors existing policies over possible new programs and constrains the budget from reflecting current priorities. Recent suggestions have included the introduction of “look back” procedures: Congress would specify targets for mandatory programs several years into the future; if these targets are or seem likely to be exceeded, the President could recommend in his budget that some or all of the average be recouped.

  • Make the PAYGO requirement contingent on a level or forecast of the debt-to-GDP ratio. Under this approach, additional spending or tax cuts would be permitted without offsetting measures if the debt ratio is below some key level, or projected to decline by a certain amount. This would help prevent PAYGO from becoming overly restrictive if fiscal outturns are better than expected.

  • Clarify and refine the scorekeeping guidelines. One option would be to require all tax and spending programs to be scored as fully phased in within, say, five years, preventing the use of a gradual phasing of measures to reduce their scorecard cost below the true long-term cost. A second possibility would be to codify criteria for deciding which receipts are classified as revenue, and are therefore subject to PAYGO requirements, and which ones as user fees that can be used to offset discretionary spending.

Conclusion

As discussed in Section I, impending demographic and other pressures on the federal budget make it increasingly urgent to establish a framework for achieving long-term fiscal sustainability. The U.S. experience of the 1990s under the Budget Enforcement Act, and the international experience with fiscal responsibility legislations, illustrate that budget rules, if properly defined, can help discipline policies and provide the appropriate context for weighing tax and expenditure policy options. Reintroducing strengthened versions of the BEA’s budget rules could help provide the necessary framework for achieving the fiscal adjustment that is needed in the period ahead, especially if it is accompanied by a strong underlying political commitment to fiscal discipline and balanced budgets.

References

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  • Auerbach, A.J., 1994, “The U.S. Fiscal Problem: Where We Are, How We Got Here and Where We Are Going,” in NBER Macroeconomics Manual, Vol. 9, edited S. Fischer and Rotemberg J. (Cambridge, Massachusetts: MIT Press).

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  • Blinder, A., and J. Yellen, 2001, The Fabulous Decade: Macroeconomic Lessons from the 1990s (Washington: Century Foundation Press).

  • Congressional Budget Office (CBO), 2002, Budget and Economic Outlook, Fiscal Years 2003–12 (Washington: U.S. Government Printing Office).

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  • Elmendorf, D., J. Liebman, and D. Wilcox, 2001, “Fiscal Policy and Social Security Policy During the 1990s,NBER Working Paper No. 8488 (Cambridge, Massachusetts: National Bureau of Economic Research).

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  • General Accounting Office (GAO), 2002, “Budget Process: Extending Budget Controls,” Testimony Before the Committee on the Budget, Washington, April 25.

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  • Hemming, R., Kell, M. 2001, “Promoting Fiscal Responsibility: Transparency, Rules, and Independent Fiscal Authorities,” paper presented at the Bank of Italy Fiscal Rules Workshop, Perugia, 2001.

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  • Joyce, P., 1996, “Congressional Budget Reform: The Unanticipated Implications for Federal Policy Making,Public Administration Review, Vol. 56, No. 4, pp. 31724.

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  • Penner, R., 2002, “Repairing the Congressional Budget Process,Research Report (Washington: Urban Institute). www.urban.org.

  • Reischauer, R., 1997, “The Unfulfillable Promise,in Setting National Priorities: Budget Choices for the Next Century, edited R. Reischauer (Washington: Brookings Institution).

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  • Schick, A., and F. Lostracco, 2000, The Federal Budget: Politics, Policy, Process, rev. ed. (Washington: Brookings Institution).

1

The fiscal year runs from October 1 to September 30.

4

For further discussion, see Schick (2000).

5

See, for example, Auerbach (1994) and Joyce (1996).

7

See GAO (2002) and other submissions to the House Committee on the Budget. The administration’s FY2003 and FY2004 budgets also included some proposals that went beyond simply refining the caps and PAYGO provisions, such as replacing Congress’s Concurrent Resolution with a Joint Budget Resolution, approved by the Congress and signed by the President, that would have the force of law; correcting the constitutional flaw in the Line Item Veto Act, and linking the caps to debt reduction; and introducing biennial budgeting. The FY2004 budget proposed to extend BEA’s PAYGO provisions and caps on discretionary spending, which expired at the end of FY2002, for two years.

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