BUDGET RULES Rudolph G. Penner and C. Eugene Steuerle The Urban Institute People tend to expect both too much and too little of budget rules. Because they are more art (or perhaps, craft) than science, it is impossible to derive some ideal set of rules through theory. Because they involve many arbitrary elements, they are also easy to disparage. And yet, an orderly decision process requires rules, written or unwritten. We believe that the return of significant deficits after a brief interlude of surpluses will make it inevitable that budget policy will be a prime focus of attention in 2005 or soon thereafter, and that budget rules will receive a significant share of that attention. This article represents an attempt to make some sense out of budget rules and what we might expect from them. Budget rules can be likened to the rules by which a household conducts its financial affairs. No matter how formal or informal, they cannot force rational budget decisions if the parties to the agreement do not want to be rational. By the same token, once there is a political consensus behind a specific goal, like balancing the budget, rules can limit the extent to which the Congress strays from that goal. They can keep nudging legislators in the right direction, even if they do not always prevent moves in the wrong direction. They can also provide a handy excuse when a legislator is forced to make an unpopular decision. A politician can say that he or she would love to give a tax break to a certain industry, but the rules forbid it. Rules may not by themselves force action, but they can have a powerful effect on the types of actions taken. No piece of legislation is drafted without some set of rules, implicit or explicit, as to what will be contained in it and what will not. There are one- time budget rules, like reducing the size of the cumulative deficit over 5 years by $500 billion. That was the budget target for both the 1990 and 1993 budget agreements. The Tax Reform legislation of 1986 had to be “deficit-neutral and revenue-neutral” , and “75- year trust fund balance of roughly zero” was the goal of the 1983 Social Security reform. One-time rules are often, simply agreed to by the leadership. Then there are rules that are meant to apply over time, such as “pay-as-you-go (PAYGO)” and the “Byrd rule” applying to long-term changes in the deficit (see discussion below). Budget rules are frequently associated with numerical targets, such as a zero change in the deficit in any bill enacted over a given period (PAYGO). That these rules have a powerful impact on policy is reflected in the fact that almost all major legislation in recent years has been crafted and restricted under both one-time and more extended rules. Even in recent years, when budget discipline eroded badly, the so-called Byrd rule prevented reconciliation bills from increasing deficits after the end of the budget horizon used in the budget resolution. Often legislation will be crafted under both ongoing budget rules and one-time targets adopted for particular legislation. Thus, Congress in 1993 utilized the 1990 Budget Enforcement Act to enforce its additional $500 billion deficit reduction over 5 years, even though the 1993 package was not anticipated when the 1990 act was passed. Rules are inherently impure. In the effort to set limits that inhibit undesirable actions, rules will sometimes inhibit desirable actions. This is unavoidable. However, this takes us one step further down into the quagmire of rule-making. The very arbitrariness of rules means there must be an escape clause, perhaps allowing a 2 supermajority vote in the Senate or a House Rules Committee decision to waive the rules from time to time. Thus, rules applied to legislation in general, rather than specific legislation like a budget agreement, are generally written to be waived in case of a national emergency. But this opens a major loophole, because it is so difficult to define an “emergency”. Quantitative Targets and Technical Feasibility It must be technically possible to implement whatever rules are designed. That seems self evident, but the Congress is frequently drawn to proposals that are not practical. The Gramm-Rudman-Hollings law of 1985 (GRH) was of this type. It specified a declining path for the deficit that was to culminate in a balanced budget. If the deficit target was not achieved, spending was supposed to be cut or sequestered according to a complex formula. The problem with any quantitative target for the budget balance is that the balance is usually affected much more in any year by the vagaries of the economy and technical factors than it is by legislation. That is to say, GRH forced the Congress to aim at a rapidly moving target. When the economy grew less vigorously than expected, the deficit shot up and the sequester necessary to achieve the target was so politically painful as to be unthinkable. Moreover, GRH was pro-cyclical, with deficit-cutting heaviest in recession and lightest when the economy was expanding rapidly. The original GRH deficit targets were adjusted upward in 1987, and then, abandoned altogether in 1990. The experience with GRH has not prevented the Congress from contemplating similar quantitative targets from time to time. In the brief period of unified budget 3 surpluses at the turn of the century, the Congress considered a “lock box” that would aim for a unified budget surplus that would equal or exceed the surplus in the Social Security trust funds – another numerical target not just for one year, but presumably over time. Similarly, an amendment to the constitution that would require budget balance has often been considered. One can see states and localities wrestle with such constitutional or legislated limits, frequently resorting to outrageous accounting gimmicks (e.g., changing interest assumptions on pension plans; securitizing future tobacco settlement revenues) to balance their budgets on paper when the economy is weaker than expected. The Budget Enforcement Act of 1990 The question of whether the BEA rules that applied throughout much of the 1990s should be re-applied today has frequently been debated since the BEA expired at the end of fiscal 2002. We believe that today’s conditions are very different from those of the 1990-97 period when the rules worked effectively. The brief history that follows suggests that a new BEA would not provide an adequate answer to today’s budgetary quagmire. When it became apparent that GRH was not working, President George H. W. Bush began difficult, bipartisan negotiations with the Democratically-controlled Congress. The result was a significant deficit reduction package. The agreement included significant tax increases and, after an initial flurry of spending increases, severe spending constraints for future years. There was a legitimate fear that the painfully negotiated package would erode over time because the Congress would not have the discipline strictly to adhere to the agreement. The main intent of the BEA was to enforce the 1990 4 agreement by restricting the ability of the Congress to pass legislation that deviated from its goal of deficit reduction. The Budget Enforcement Act of 1990 (BEA) was thus passed mainly to protect the tax increases and spending constraints contained in the original agreement. The rules embodied in the agreement, which were adapted and extended under President Clinton’s 1993 budget agreement worked extremely well through 1997. The BEA had two major elements. First, caps were imposed on discretionary spending for a five-year period. Both budget authority and outlays were limited. The caps had the effect of reducing discretionary spending relative to GDP, which, all else equal, will reduce the deficit in the long run. The spending caps did not apply to entitlements. The modest deficit- reducing entitlement reforms enacted in 1990 and 1993 and the more important tax increases were protected by pay-as-you-go (PAYGO) rules.1 PAYGO stated that any tax cut or entitlement increase had to be paid for with some other tax increase or entitlement cut. In other words, the Congress was not allowed to make any changes in the non- discretionary part of the budget - entitlements or tax laws - that would increase the deficit. If there were new laws, they had to be paid for in the budget year and on average for five years. Later, the time horizon was extended to ten-years. To the extent the rules were violated, a sequester was supposed to occur that automatically reduced spending according to a formula similar to that used in the original Gramm-Rudman law. When President Clinton and the Democrats in Congress negotiated another deficit reduction package in 1993, BEA spending caps were slightly modified and extended. The rules were again reaffirmed in the budget agreement of 1997 between Clinton and the 1 The distinction between the tax changes and the expenditure changes is not entirely clean. Some tax provisions are extended periodically, almost like discretionary programs. These provisions were then caught up in pay-as-you-go rules that called for other tax increases to pay for their further extension. 5 Republican Congress. This was the first deficit reduction agreement of the 1990s that allowed tax cuts. It was the goal of BEA to prevent the tax cuts from being increased unless they were paid for. It ultimately failed to achieve this goal. BEA was allowed to expire at the end of fiscal 2002. There are a number of reasons that the BEA was so successful prior to 1998. First, it was backed by a broad political consensus that it was important to get the deficit under control and that meant adhering to the agreements of 1990 and 1993.