United States of America: Selected Issues

This Selected Issues paper presents updated IMF staff estimates of potential output growth for the United States, using data through 2001 that incorporates the full cyclical upswing of the 1990s and the subsequent mild recession, as well as taking into account the revisions to the national accounts released in July 2000. The paper also reviews recent investment trends and provides estimates of the extent to which the capital stock has deviated from its long-term equilibrium.

Abstract

This Selected Issues paper presents updated IMF staff estimates of potential output growth for the United States, using data through 2001 that incorporates the full cyclical upswing of the 1990s and the subsequent mild recession, as well as taking into account the revisions to the national accounts released in July 2000. The paper also reviews recent investment trends and provides estimates of the extent to which the capital stock has deviated from its long-term equilibrium.

VIII. The Effectiveness of the Fiscal Rules Under the Budget Enforcement Act and Options for Reform1

A. Introduction

1. Eliminating the U.S. federal budget deficit during the 1990s marked a significant fiscal milestone. The unified budget surplus in FY 1998 was the first in nearly 30 years, and the surplus in the following year was the largest relative to GDP since 1951 (Figure 1). Although the prolonged period of economic growth and legislative initiatives during the 1990s undoubtedly played important roles in achieving this fiscal turn around, a key factor was also the Budget Enforcement Act of 1990 (BEA) which introduced caps on discretionary spending and a “pay-as-you-go” (PAYGO) requirement for new legislation affecting mandatory spending and tax receipts.

Figure 1.
Figure 1.

United States: Federal Budget Deficit 1962-2001

(In percent of GDP)

Citation: IMF Staff Country Reports 2002, 165; 10.5089/9781451839548.002.A008

Source: Congressional Budget Office.

2. More recently, however, there has been a deterioration in the fiscal position, which appears to have partly reflected an erosion in the effectiveness of the BEA mechanisms. The apparent weakening of budget discipline and the expiration of the BEA rules at the end of FY 2002 raises the issue of how, or whether, to reform its enforcement procedures. This chapter reviews evidence on the effectiveness of the BEA mechanisms, and briefly discusses some of the principal options.

B. Background

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

  • The Balanced Budget and Emergency Deficit Control Act of 1985—widely known as Gramm-Rudman-Hollings (GRH)—specified declining nominal targets for the deficit, culminating in a balanced budget in FY 1991. Uniform percentage cuts 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, the President and the Congress amended GRH, relaxing the deficit target and postponing a balanced budget until FY 1993. These revised targets were never met, in part because of the financial burden associated with resolving the savings and loan crisis.

  • The Budget Enforcement Act of 1990 took a different approach by replacing the deficit targets of GRH with mechanisms to enforce agreed levels of discretionary spending, and to ensure the budget neutrality of new spending and taxation laws (Box 1). The original Act covered FY 1991-FY 1995, but the Act was extended in 1993 and 1997 and currently applies through the end of FY 2002.2

The 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. Presently, 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-year period. 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.

C. Assessing the BEA Rules

4. Deficit reduction during the 1990s was the result of both rising tax revenues and falling expenditures (Figure 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, this section reviews the effectiveness of the BEA rules from a variety of different perspectives: the design of the BEA’s rules compared to those of the GRH; trends in spending; accounting for the role of economic growth in reducing the deficit; and enforcement and budget transparency issues.

Figure 2.
Figure 2.

United States: Federal Outlays and Revenues

(In percent of GDP)

Citation: IMF Staff Country Reports 2002, 165; 10.5089/9781451839548.002.A008

BEA design improvements

5. The design of the BEA enforcement mechanisms are widely viewed as a significant improvement over the GRH procedures, in at least three respects.3 First, the BEA rules apply to outturns, while the GRH provisions applied only to deficit targets and thereby encouraged budgets to be based on overly optimistic macroeconomic assumptions. Second, the BEA applies to spending and tax laws, over which the government has direct control, and thus it has held lawmakers accountable for the costs of the laws they enact. In contrast, the deficit targets under GRH were subject to many factors beyond government control. Third, the combination of overoptimistic assumptions and a focus on the deficit made the amounts subject to sequestration under GRH so large as to lose 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 the caps, as discussed below.

Trends in discretionary and mandatory spending

6. During FY 1991-FY 1998, discretionary spending outlays were within the BEA ceilings (with only minor adjustments to the original caps), and discretionary spending fell as a share of GDP (Table 1 and Figure 3). However, substantial reductions in defense spending over this period made room for additional nondefense discretionary spending (after separate defense and nondefense caps expired at the end of FY 1993). Moreover, seen in a longer-term perspective, nondefense discretionary spending as a share of GDP increased steadily during the 1960s and 1970s, fell in the 1980s, and remained broadly constant during the 1990s. This suggests that the BEA discretionary spending ceilings served to lock in spending reductions achieved in the 1980s rather than precipitate a major reduction in discretionary expenditure. Since FY 1999, with the emergence of actual and prospective budget surpluses, spending caps were exceeded by classifying large amounts of expenditure as emergency spending, and by adjusting upward the 1997 ceilings for 2001 and 2002 (see Table 1).

Table 1.

United States: Adjustments to Discretionary Spending Caps

(In billions of dollars)

article image
Source: Office of Management and Budgeting.

As amended in 1993 and 1997.

Numerous smaller adjustments not shown.

2002 figure is an estimate, as of January 2002.

Figure 3.
Figure 3.

United States: Discretionary Spending

(In percent of GDP)

Citation: IMF Staff Country Reports 2002, 165; 10.5089/9781451839548.002.A008

7. Mandatory spending has fallen slightly as a share of GDP since 1991 (Figure 4). Although PAYGO did not completely halt the enactment of new spending initiatives—e.g., the children’s health insurance program 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, emphasize the relative lack of tax cuts and spending increases in the face of large surpluses at the end of the 1990s.4 In addition, Schick (2000) argues that the PAYGO rules may have encouraged some reforms of the welfare system, such as converting Aid to Families with Dependent Children from an open-ended entitlement to a fixed block grant.

Figure 4.
Figure 4.

United States: Mandatory Spending

(In percent of GDP)

Citation: IMF Staff Country Reports 2002, 165; 10.5089/9781451839548.002.A008

Source: Congressional Budget Office.

The role of economic growth

8. In achieving fiscal consolidation, the importance of the BEA relative to strong economic growth during the 1990s remains an open question. Anderson (1999) notes that while discretionary spending outturns were close to the BEA limits between FY 1993 and FY 1998, 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 5, which shows the CBO’s one-year-ahead forecast errors for revenues and expenditure that can be ascribed to economic factors. Significant and prolonged underprediction of the effect of economic growth on revenues and on some mandatory spending programs apparently played an important role in assisting deficit reduction.

Figure 5.
Figure 5.

United States: Projection Errors Due to Economic Factors1/

Citation: IMF Staff Country Reports 2002, 165; 10.5089/9781451839548.002.A008

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

9. In contrast, comparisons of structural and actual budget balances suggest that economic growth played a more limited role in fiscal consolidation. Removing the impact of cyclical factors from changes in the budget balance indicates the extent to which structural factors—including the budget rules—contributed to consolidation. Table 2 shows three different estimates of the contribution of cyclical factors to fiscal consolidation between FY 1992 and FY 2000. These estimates suggest that structural factors played a more important role in the overall improvement in the budget balance.5 By implication, the BEA enforcement mechanisms, as well as other structural factors, including the tax increases of 1990 and 1993 and lower defense expenditures following the end of the Cold War, contributed to the improvement in the fiscal position.

Table 2.

United States: Cyclical Contribution to Fiscal Consolidation

(In percent of GDP)

article image
Sources: OECD (2001); IMF (2002); and CBO (2002).

General government financial balance.

General government fiscal balance.

Federal government.

Adjusted for cyclical and other factors.

Includes deposit insurance, receipts from spectrum licenses, timing adjustments, and contributions for Desert Storm.

Enforcement and budget transparency

10. With the emergence of fiscal surpluses beginning in FY 1998, the spending caps and PAYGO were routinely circumvented using a range of devices.6

  • Emergency appropriations are exempt from BEA rules, and the specific criteria for defining an emergency have not been codified. This exemption was used infrequently between FY 1991 and FY 1998, when annual adjustments to the caps for emergency requirements averaged less than $7 billion. However, during FY 1999 and FY 2000 annual emergency appropriations increased to over $30 billion, including appropriations for the long-anticipated 2000 census and for farm subsidies.

  • Advance appropriations occur when Congress appropriates funds for spending in a future year. Under BEA scoring, these appropriations are scored against the caps in the later year. Advance appropriations were increasingly used from FY 1999 as a means of increasing pressure on subsequent budgets to either raise the ceilings or engage in other accounting mechanisms to augment spending.

  • Rescissions of previous appropriations can also be used to make room for additional spending under the caps. For example, Congress cancelled dormant funds for weapons systems that had not been spent for technical reasons, and used the room to appropriate additional spending under the caps.

  • Structuring measures to reduce costs during the budget period that is subject to scoring. Examples include: (i) extensions to Medicaid in the late 1980s and early 1990s that were phased in so that the first year of spending increases occurred beyond the scoring period; by the time that year was incorporated into the baseline, the increase was already authorized by law; (ii) the 2001 tax reforms included a “sunset” provision to repeal all measures at the end of 2010, and thereby reduced the cost of the measures during the FY 2002-FY 2011 budget window.

  • Repeatedly extending an expiring tax. 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 can only be scored once.

  • Resetting the PAYGO scorecard balance to zero. The CBO and OMB maintain a “scorecard” of the cumulative effect on the budget balance of legislated changes during a congressional year. Under normal application of the PAYGO rules, if the calculated net change is negative, then offsets have to be made elsewhere. However, this requirement has been circumvented by setting the PAYGO scorecard to zero. For example, although legislation enacted by the 107th Congress—including the June 2001 tax cuts—reduced the overall budget surplus, offsetting actions were not required because Congress enacted other legislation that instructed the OMB to change the PAYGO balances for 2001 and 2002 to zero.

11. More generally, the BEA enforcement mechanisms, and the subsequent devices used to circumvent them, have added complexity to the federal budget process. It has also been suggested that the BEA rules have encouraged increased recourse to extra-budgetary devices including regulatory instruments and unfunded mandates. Nonetheless, the BEA has 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, and the scorekeeping period was extended from five to ten years, in an attempt to reduce the scope for timing shifts. Finally, where all budget rules and processes are subject to abuse, several studies have concluded that the BEA has resulted in less gimmickry than occurred under GRH.7

D. Options for Reform

12. Given the recent erosion of the U.S. fiscal position and the longer-term fiscal pressures that demographic trends are likely to imply, there is an evident need for strengthened budget discipline. International experience clearly suggests 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.8 If the political commitment is present, the U.S. experience between 1990 and 1998 suggests that BEA-type rules can play a useful role in bolstering budget discipline.

13. At the same time, however, the erosion of the effectiveness of the BEA’s rules during the more recent period indicates the need for reform. Some of the specific options under discussion include the following:9

  • Limit discretionary spending caps to budget authority only. Some argue that separate caps on budget authority and outlays created incentives for delaying obligations, and favor slower spend-out programs over those with faster 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 FY 2002 defines 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 five or ten 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 a “look back” procedures: Congress would specify targets for mandatory programs several years into the future; if these targets seem likely (or turn out) to be exceeded, the President could recommend in his budget that some or all of the overage 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 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 therefore subject to PAYGO requirements) and which as user fees (which can be used to offset discretionary spending).

List of References

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  • Leidy, M., 1998, “A Postmortem on the Achievement of Federal Fiscal Balance,United States—Selected Issues, SM/98/188 (Washington, D.C.: IMF).

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  • Penner, R., 2002, Repairing the Congressional Budget Process (Washington, D.C.: The Urban Institute).

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  • Reischauer, R., 2002, “Framing the Budget Debate for the Future,Testimony before the Committee on the Budget, Washington, D.C., January 29.

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  • Schick, A., 2000, The Federal Budget: Politics, Policy, Process (Washington, D.C.: The Brookings Institution Press).

1

Prepared by Michael Kell.

2

The fiscal year runs from October 1 to September 30.

6

For further discussion, see Schick (2000).

7

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

9

See GAO (2002) and other recent submissions to the House Committee on the Budget. Note, however, that the Administration’s FY 2003 Budget includes some proposals besides refining the caps and PAYGO provisions, such as replacing the 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.

United States: Selected Issues
Author: International Monetary Fund