Rudolph G. Penner is an Institute fellow at the Urban Institute and holds the Arjay and Frances Miller Chair in Public Policy. Previously, he was a managing director of the Barents Group, a KPMG Company. He was director of the Congressional Budget Office from 1983 to 1987. From 1977 to 1983, he was a resident scholar at the American Enterprise Institute. Previous posts in government include assistant director for economic policy at the Office of Management and Budget, deputy assistant secretary for economic affairs at the Department of Housing and Urban Development, and senior staff economist at the Council of Economic Advisors. Before 1975, Dr. Penner was a professor of economics at the University of Rochester.
Thanks to artificially low interest rates, the United States has been able to finance deficits exceeding $1 trillion every year from 2009 through 2012 at very low cost. Throughout the period, the ratio of interest to the GDP has remained almost stable and is not expected to start rising until 2015. Some argue that this has encouraged the Congress to be fiscally irresponsible, although others believe that deficits have not been large enough given the severity of the recession.
But low interest rates will not last. In June, Federal Reserve Chairman Ben Bernanke gave the impression – apparently unintentionally — that the Fed would soon reduce its purchases of Treasury debt and mortgage-related securities. That helped propel a major increase in bond yields. The 10-year Treasury rate rose from under 2.0 percent to over 2.8 percent in a matter of days.
The Congressional Budget Office (CBO) baseline assumes rates will gradually rise over the next few years until the 10-year rate stabilizes at a more normal 5.2 percent in 2018 and thereafter. The implications for federal interest payments are alarming. The bill is assumed to rise almost four-fold between 2013 and 2023 or at a rate of 14 percent per year. Interest would become the fastest growing expenditure item in the budget by far, leaving health costs in the dust.
CBO’s baseline must assume that current law does not change. For example, numerous tax reductions, such as the research and experimentation tax credit, are temporary under current law and the CBO must assume that they expire, even though Congress has routinely extended them over the years.
CBO provides an alternative fiscal scenario that incorporates more realistic policy assumptions. Before the fiscal cliff deal that made most of the “temporary” Bush tax cuts permanent, the alternative fiscal scenario and the baseline were very different. They have come together recently, but the alternative is still more pessimistic than the baseline, implying a debt-GDP ratio of 83 percent at the end of 2023 compared to the baseline’s 74 percent. That would make interest costs grow even faster than 14 percent per year, though the difference is small relative to the usual error in forecasting interest rates.
Countries are often pushed into a sovereign debt crisis because of growing interest payments. It becomes politically impossible for them to increase taxes or reduce noninterest spending fast enough to keep up with rising interest costs. The debt-GDP ratio begins to explode. A debt crisis is sure to follow.
Today, it is hard to see that happening in the U.S. over the next 10 years. But throw in another recession and/or an increase in interest rates above normal levels and the risks grow. Recent good news on the fiscal front has caused CBO to project a fall in the baseline debt-GDP ratio from 75 percent in 2013 to 71 percent in 2017. However, it begins to rise after that at an increasing rate. Given these downside risks, a growing interest bill would severely limit government flexibility. And no one should be happy with that.
Rudolph G. Penner is an Institute Fellow at the Urban Institute.
In one of the more dangerous fiscal developments of recent months, some on the left are defining successful deficit reduction as merely stabilizing the federal debt at about 70 percent of Gross Domestic Product by 2022. While there is no magic target, this one is far too modest and threatens to leave future fiscal policy perilously constrained.
Under current assumptions this goal can be achieved with combined reductions in spending growth and/or increases in taxes of $1.4 trillion over the 2014-2022 period, far less than the total deficit reduction provided by the 2011 Budget Control Act (BCA), which resolved the 2011 debt ceiling debate, and the American Taxpayer Relief Act of 2013 (ATRA), which recently avoided the fiscal cliff.
Richard Kogan of the Center on Budget and Policy Priorities, supported by Martin Wolf of the Financial Times makes the case for more modest deficit reduction. The editorial page of the Washington Post shares my concern that their goals are dangerously modest.
Imagine facing the next recession with a debt-GDP ratio already above 70 percent. It is almost certain that we shall have another slump before 2022. If not, it will be the longest period without a decline in the recorded history of U. S. business cycles. Add a modest stimulus to the recession-driven reduction in tax revenues and increases in social spending and the debt-GDP ratio would top 100 percent in the blink of an eye. But it is harder to argue for a stimulus with the debt already soaring, and without one, a future recession would be more severe than necessary.
However, let us say that for some period before or after 2022 the economy is cruising along a full-employment path at a steady rate of growth. The deficit associated with stabilizing the debt-GDP ratio at 70 percent of GDP is more than 10 percent higher than that consistent with a 60 percent ratio – the limit chosen by the drafters of the Maastricht treaty that created the Euro. That is a significant increase in the rate at which we are depleting our nation’s wealth. The damage to the standard of living cumulates over time and that does no favor to our children and grandchildren.
Kogan and Wolf assume that the discretionary spending caps imposed by the BCA through 2021 will be enforced successfully (Kogan assumes that the BCA’s spending sequester will be cancelled.) The caps imply that discretionary spending will fall to the lowest level relative to GDP since World War II. They would also require both defense and nondefense outlays to grow less than the rate of inflation from 2014 to 2021, after already falling considerably from the levels inflated by the stimulus and the recession.
The biggest risk is that it will be impossible to maintain defense at such low levels. Mali shows that the war on terror is far from over. While the Chinese defense budget is now only about one-quarter of ours, it is growing explosively. Is it reasonable to expect ours to continue to decline in real terms, even if theirs approaches ours by 2021?
In nondefense, population growth will be putting upward pressure on spending for programs like education, infrastructure, national parks, etc, etc. Although nothing is irreversible in the budget, true reforms in Social Security, Medicare, and Medicaid have a better chance of lasting than arbitrary caps on discretionary spending that do not specify individual program cuts. The BCA, however, excludes Social Security and Medicaid from cuts and includes only modest reduction in payments to Medicare providers.
I would think the left would back more aggressive deficit reduction, if only to lower the risk of a sovereign debt crisis. It is, after all, the poor who are being most devastated by high unemployment in Ireland, Portugal, Spain and Greece and by arbitrary cuts in public pensions and social programs.
Sovereign debt crises occur at all manner of debt-GDP ratios and are impossible to predict, but it is hard to believe that a higher ratio does not increase the risk to some degree. It is sobering to note that in 2008, just before their crises, the net debt to GDP ratio in Spain was less than 31 percent and in Ireland less than 25 percent.
Rudolph G. Penner is an Institute Fellow at the Urban Institute and a former director of the Congressional Budget Office from 1983 to 1987.
Yesterday, I described President Eisenhower’s remarkable success in turning a large deficit in fiscal 1959 into a balanced budget in 1960. It was one of the biggest fiscal consolidations since World War II.
Although it was a very different time, there are lessons relevant to today’s fiscal challenges. One is that a president need not lose popularity just because he fights hard to impose a responsible, austere budget. Another is that Congress and the president can have intense ideological battles without paralyzing government.
Admittedly, this was easier when both Democrats and Republicans were more diverse ideologically and some of the most intense philosophical battles raged within the parties, not between them.
But the biggest difference may be in the nature of government spending. In 1959, Medicare and Medicaid did not exist. Today, nearly half of noninterest spending is in just two areas: Social Security and health. Almost all this spending is on entitlements.
Entitlement programs are not subjected to a budget in the same way discretionary programs face spending limits imposed annual appropriations. Entitlements define an eligible population and describe the benefits to which they are entitled. Then we pay for anyone who shows up to make claims. The spending is on automatic pilot.
Somehow we must find ways to gain control over what are often called “uncontrollables.” If and when we can, the budget will look more like that of 1960 when the bulk of spending was under the direct control of annual congressional appropriations. It may seem impossible, but it can be done.
Countries like Canada and the United Kingdom subject their national health programs to a budget, and the system must live within it. A Medicare budget would be imposed by the “premium support” plans advocated by the Domenici-Rivlin debt reduction commission, and House Budget Committee Chairman Paul Ryan (R-WI) and Senator Ron Wyden (D-OR).
Under such a system, Congress would allocate a fixed amount of money each year to finance income-related subsidies that enable Medicare enrollees to buy health insurance. The hospital and physician insurance parts of Medicare would look very much like Medicare’s prescription drug program and the new health insurance exchanges created by the recent health reform, but with stricter controls over the amounts budgeted.
An alternative approach would subject programs to triggers that would be pulled if the programs become financially unsustainable. For example, a Social Security trigger might gradually and automatically raise the normal retirement age and raise payroll tax revenues whenever the program faces financial problems.
Such triggers have not been very effective in the United States, but more appealing designs in Sweden, Canada, and Germany are worth studying. It is not exactly like imposing a strict budget, but it imposes some discipline where there is now very little.
We cannot exactly emulate the past, and there is no doubt that budgeting used to be easier. But it is also true that the will to govern was much stronger in the past. That will must be renewed. The stakes are high and time is running out.
Rudolph G. Penner, an Institute fellow at the Urban Institute, directed the Congressional Budget Office from 1983 to 1987.
The election results did not change the political status quo, and the status quo has not been conducive to solving the nation’s festering fiscal problems. In his victory speech President Obama pledged to seek bipartisan cooperation in solving problems, though it is not going so well so far. But we better hope that in the end he succeeds. That is the only way to avoid the fiscal cliff and cure the long-run fiscal imbalances that threaten our economic wellbeing.
Given the challenges faced by the president and Congress, it is instructive to look back almost 60 years to a time when divided government did not mean gridlock and intense ideological battles did not lead to paralysis. Unlike most presidents who followed him, Dwight Eisenhower truly believed that budgets should be balanced. Consequently, he was embarrassed when by early 1959 the budget deficit was heading toward $13 billion.
Today, that seems very small but it was the largest deficit since the aftermath of World War II. Eisenhower was determined to attain balance, and his 1960 budget incorporated severe spending restraint and only minor tax increases.
But budget balancing would not be easy. Democrats had won a landslide victory in the 1958 midterm elections and held large majorities in both the House and the Senate.
The composition of the political parties and the budget were very different in 1959 than today. The Democratic Party contained extreme conservatives from the South like Richard Russell and John Stennis and liberals like Hubert Humphrey and William Proxmire. Republicans ranged from “Mr. Conservative” Barry Goldwater to Jacob Javits, who might now be considered a liberal Democrat.
Defense constituted about half of federal spending, compared with 18 percent in 2012. Social Security amounted to only 11 percent, compared with 22 percent today. Medicare and Medicaid, which have been growing very rapidly for decades, did not exist.
Foreshadowing his farewell warning about the military-industrial complex, Eisenhower had been hard on defense throughout his presidency. He was especially tough on the Army, believing that large armies created a temptation to get into ground wars.
Yet, the Cold War was raging, the Soviet Union’s Nikita Khrushchev was bellicose, and there was much discussion of a missile gap. Early in 1959 it appeared as though Congress, prodded mainly by conservative Southern Democrats, would significantly exceed Eisenhower’s defense request. But the president held firm and Congress agreed to an aggregate figure almost equal to his request.
The most interesting budget battle of the year involved a major housing bill. First, Congress passed a version that greatly exceeded the president’s request. But Democrats were very sensitive to being labeled “big spenders,” so they pared the bill back. Eisenhower vetoed it anyway, arguing it would add to spending in future years. Lawmakers upheld his veto.
Congress then sent the bill back to the Oval Office with several changes aimed at satisfying the president. Surprisingly, Eisenhower vetoed it again, and yet again Congress upheld his veto. Congress revised the bill a third time, and finally the president signed it, although it still contained some items he opposed.
What explains Eisenhower’s great success contending with a Congress controlled by the opposing party, especially given recent history of presidential budgets being labeled “dead on arrival”?
There are two reasons. First, Eisenhower was amazingly popular. Over the eight years of his presidency, his approval rating averaged 64 percent. No subsequent president has come close to that. Congress took him on at its peril. Second, Eisenhower’s budgets were serious documents, and he was willing to strongly defend them in speeches and frequent news conferences, and by wielding the veto pen if necessary.
Recent budgets are often forgotten by the presidents who present them. Eisenhower issued 181 regular and pocket vetoes over his eight years to back his budget and other policies. George W. Bush issued 12, and until now Barack Obama has issued 2.
Even Eisenhower did not always succeed. He twice vetoed a public works bill that he thought started too many projects. His second veto was overridden—the only veto battle he lost in the first 6-1/2 years of his presidency—proving that even a popular president better not come between a politician and pork.
Nevertheless, the final 1960 budget was balanced. Admittedly, it was aided by a bit of luck and one big gimmick. The good fortune: The recovery from the 1958 recession turned out to be more vigorous than expected. The gimmick: A large contribution to the International Monetary Fund was artificially moved forward into 1959 so it would not count against the 1960 budget.
But none of that detracts from Eisenhower’s enormous success working with a heavily Democratic Congress. Lyndon Johnson, the majority leader of the Senate, and Sam Rayburn, the speaker of the House, deserve some credit as well. They knew when to fight and when to give in. Are there lessons that might help to resolve today’s fiscal gridlock? I’ll explore that question in tomorrow’s blog.
Rudolph G. Penner is an Institute Fellow at the Urban Institute. He was director of the Congressional Budget Office from 1983 to 1987.
A constitutional amendment that would require a balanced federal budget has again gained favor, especially among Republicans. The proponents should be forced to answer an important question, “What is a budget?”
Forty nine states have constitutions or strong legislative language requiring budgets to balance. An unfortunate effect has been to push many state activities “off-budget”. There are independent authorities that run turnpikes, hospitals, etc. and a plethora of other off-budget accounts whose main purpose is to avoid balanced budget requirements. It has made the typical state budget very hard to read and understand.
Some efforts to limit the reach of balanced budget rules seem more legitimate. Often, for instance, only operating budgets must be balanced, and jurisdictions may borrow to finance capital investment. However, politicians then have an incentive to define almost any activity as being a capital investment. It was said that during the financial crisis facing New York City in the 1970s even janitors’ salaries became capital investments. After all, they did have something to do with buildings.
A federal balanced budget amendment has the added disadvantage of making it difficult to run a countercyclical policy or finance wars and other emergencies unless there are escape clauses. But every escape clause creates another loophole. In order to avoid certain budget rules in the late 1990s, the Congress declared the 2000 census to be an emergency, even though we have known since 1789 that we would have to have one.
It is ironic that a balanced budget amendment is being discussed just as House Republicans passed a budget that would not be balanced until the 2030s. The president’s fiscal commission’s recommendations did not balance the budget until 2035. As hard as it will be, it may be easier to put a balanced budget requirement in the constitution than actually to balance a real budget.
My blog on “How the Budget Baseline Favors Spending” stimulated numerous thoughtful comments. Some implied that my proposal would reward those who wish to make the Bush tax cuts permanent and ignore the fact that dubious accounting was used to get them passed in the first place. Those arguing this point did not pay sufficient attention to my last paragraph which implied that baseline reform would have to await the disposition of the Bush cuts. Further, I alluded to the possibility that whatever portions of the Bush policy are extended, the extension will again be temporary, thus making it difficult to finally settle the point.
The most challenging point was raised by Blue Dog. It was argued that if the baseline assumes that temporary tax cuts are permanent, should they not also be scored using the same assumption? I think that follows logically. The problem is that there are tax cuts that are clearly meant to be temporary and probably will be. The tax cuts in the recent stimulus package are an example.
There are two possible solutions to this problem. One approach would deal with it by attempting to differentiate tax cuts that were clearly meant to be sunset from those really intended to be permanent. Blue Dog noted that we do that with entitlements, but there are obvious difficulties and the necessary language would complicate a budget process that has already become so complex that only a few people in the world understand it all. (I am not one of them.)
The other approach would be to ignore the problem. The budget process contains many illogical features, and perhaps, we should accept one more. Currently, there is no attempt to differentiate appropriations that are almost as permanent as entitlements, e.g. financing the Bureau of Labor Statistics, from those that we fervently hope will be shorter lasting, e.g. funding the wars in Iraq and Afghanistan. Since almost all of the many temporary tax cuts are meant to be permanent, it may not be too inaccurate to regard all as permanent, even those few that are clearly temporary. The downside of this approach is obvious. Legislators would not get any reward for making certain tax cuts truly temporary when that is the fiscally responsible thing to do.
Moreover, ignoring the problem raises another issue. The Byrd rule does not allow reconciliation procedures to be used for legislation that increases the deficit beyond the budget horizon. This provides a very strong incentive to claim that all tax cuts and entitlement increases are temporary. Scoring them as permanent would have ruled out the stimulus package, although it must also be remembered that rules can be waived and points of order defeated. Many have argued that in any case, reconciliation should not be allowed for any deficit increasing measure and that would solve this problem. The counterargument is that it is so easy to block policy changes in the Senate that it is necessary to keep the option of using reconciliation for both deficit increasing and reducing policies.
This discussion shows how incredibly complicated the budget process has become. The needed debate about reforming the baseline probably has to be extended to reforming the whole thing.
The Congressional Budget Office’s expenditure and revenue baseline is supposed to illustrate the budget implications of extending current policy. Few may care how the baseline is actually constructed, but since all policy changes are measured “from the baseline,” the arcane definitions that describe current policy can have a profound effect on Congressional decisions.
Current policy is not current law. If it were, almost all baseline spending would disappear in a very few years, because most appropriations are good for one year only, and programs such as highway spending and agricultural subsidies must be reauthorized from time to time. Instead of rigorously following current law, the baseline assumes that the Congress will pass new laws that extend such programs. Spending on appropriated discretionary programs is assumed to grow at the rate of inflation, while entitlements are assumed to be reauthorized at current levels.
Oddly enough, the tax side is not treated symmetrically. With a few exceptions, temporary tax provisions are assumed to expire as in current law. Thus, the research and experimentation tax credit, which has been renewed for one year eleven years in a row, disappears from the baseline.
The curious result of this asymmetry is that a renewal of a temporary entitlement at current levels, such as food stamps, is not considered to be a spending increase, but a renewal of temporary tax relief is considered to be a tax cut. This has important consequences if the Congress is applying a pay-as-you-go rule (PAYGO) that requires that any tax “cut” or entitlement “increase” must be paid for with some other tax increase or entitlement cut. Reauthorizing agricultural subsidies at current levels does not have to be paid for whereas extending temporary relief from the alternative minimum tax does require raising another tax or cutting an entitlement. Even if PAYGO is not applied, the definitions used in the baseline tilt the playing field in favor of spending, because the extension of a temporary tax cut is said to “increase” the deficit whereas the extension of a temporary entitlement does not.
A more sensible approach would regard all temporary spending tax policies to be permanent. In addition to leveling the playing field, it would make the baseline a more accurate predictor of future spending and revenues, because almost all temporary tax and spending provisions are, in fact, routinely extended.
Unfortunately, sensible reforms are unlikely at this time. They would require bipartisan compromise and that is implausible because sensible reforms would make it easier to extend the Bush tax cuts for upper income groups. Those tax cuts are hated by liberals and loved by conservatives and rational discourse is almost impossible. I would like to think that we can return to the issue of reforming the baseline once the Bush tax cuts are finally dealt with, but alas, current rules suggest that whatever the Congress does will again be temporary, thus continuing the fight for another day.