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The Perils of Automatic Budgeting

The Perils of Automatic Budgeting

By Philip Wallach - March 27, 2013

In the fall of 1978, the United States Congress finally solved the federal government's budget problems. While the Senate debated a bill making some technical revisions to the Bretton Woods Agreement, Virginia senator Harry Byrd, Jr., offered an amendment that read, in its entirety: "Beginning with fiscal year 1981, the total budget outlays of the Federal Government shall not exceed its receipts." The amendment passed, and the bill was eventually signed into law.

The next year, in a bill increasing the debt ceiling, the overwhelmingly Democratic Congress again enacted essentially the same requirement for balanced budgets beginning in 1981. It did so again in 1980, and then in 1982 struck the reference to fiscal year 1981 but reiterated its "commitment" to balanced budgets. To this day, Title 31, Section 1103, of the United States Code reads: "Congress reaffirms its commitment that budget outlays of the United States Government for a fiscal year may be not more than the receipts of the Government for that year."

Of course, in all but four of the 30 years since, the federal government has indeed spent more than it has taken in — running an average annual deficit of more than $340 billion (adjusted for inflation) and well over a trillion dollars in more recent years. The debt held by the public has grown by more than $10 trillion in that time. Not surprisingly, promising to be fiscally responsible in the future has done nothing to mitigate the government's fiscal recklessness in the present.

And yet precisely that practice remains the essence of our fiscal policy today, as Congress and the president struggle to get the federal deficit under control. Now as then, their prayer is: Lord, make our budget sustainable — but not yet.

Our lawmakers contend that today's budget mechanisms are more effective than Senator Byrd's commitment to balanced budgets because they impose specific (if broad) spending cuts that will occur automatically unless Congress undoes them. There has been little recognition of the irony involved in continuing to make this argument even as lawmakers spent the past several months trying to avoid and then mitigate the consequences of a previously enacted mechanism of exactly the same sort: the sequester adopted as part of the 2011 debt-ceiling fight.

The automatic budget mechanism has long held Washington under its spell. But again and again it has disappointed, and for precisely the same reason that Byrd's balanced-budget language was meaningless: As a people no less sovereign than we, future voters (and, more to the point, their representatives) may not feel obligated to respect decisions made in years gone by.

At first glance, this inability to bind the future — which political scientists call the "commitment problem" — would seem to preclude the very possibility of responsible representative government, at least on matters that require sustained discipline (such as the management of the public debt). If representatives today can always put off hard choices until tomorrow — and especially if their voting constituents want them to — it is hard to see how any sacrifices will ever be made. And yet we know that responsible choices are possible, because our predecessors often made them. Balanced budgets in peacetime were the norm for most of our country's history until after the Second World War. Even in the aftermath of the New Deal and Great Society expansions, the polity has managed a few impressive moments of self-control — reining in runaway spending and reducing the growth of entitlement costs.

So why do most of our attempts to achieve such results through automatic budget mechanisms fail? And what has enabled those occasional fiscal successes? To answer these questions, we must first examine the automatic budget mechanisms employed over the past few decades, seeking to distinguish effective recipes for long-term balance from willful acts of self-delusion.

AUTOMATIC FOR THE PEOPLE

While scholars may be able to design rules that would help discipline out-of-control budget growth, it is Congress that must ultimately pass legislation. In making the compromises needed to secure passage, lawmakers are likely to settle on incoherent or politically unsustainable devices — procedures that sound good to the average voter but are not necessarily well suited to the realities of budgeting. And even if the mechanisms actually enacted could succeed, preventing a future Congress from undoing them is no simple matter. Voters naturally want to put off any pain, so the promise of delay is always powerful. In the absence of genuine public outrage over undoing a past budget commitment, Congress would have to rely on some external "enforcer" capable of compelling adherence to past rules — and there are few institutions with such power in our constitutional system.

Congress attempted to create an external budget enforcer in what may have been its most ambitious budget mechanism of the past 30 years: the Gramm-Rudman-Hollings Act of 1985. Enacted as part of a debt-ceiling increase, the law mandated steadily declining deficits until the budget reached balance in fiscal year 1991. In the event the targets for each year were not achieved, Congress delegated to the comptroller general (the head of the General Accounting Office, which reports to Congress) the ability to sequester spending until the deficit was brought down to the level permitted by the statute.

In 1986, the Supreme Court struck down this arrangement as a violation of the separation of powers, since the comptroller, a legislative-branch official, had been assigned the essentially executive function of enforcing the law. Congress, however, was undeterred, and changed the language of the law in 1987 to give the sequestration power to the director of the Office of Management and Budget, safely in the executive branch. For a time, this mechanism seemed to work: As the deficit targets became increasingly demanding in the late 1980s, it appeared that an enforcer had finally been equipped with a powerful tool to impose budget discipline.

In reality, however, Gramm-Rudman-Hollings brought about little more than a boom in accounting shenanigans resulting from the law's design defects. For example, a $10 billion "margin of error" allowance built into the law was effectively used to revise target deficits upward by $10 billion each year. Meanwhile, other budget gimmicks, such as sales of government loans, were used to generate "savings" to manipulate the targets.

More significant was the fact that several of the largest federal programs — including Medicaid and Aid to Families with Dependent Children — were exempted from sequestration, a concession that was the price of passage in the Democratic House. This meant that sequesters had an even more severe effect on the remaining programs, and especially on defense spending. Moreover, while sequestration (which consists of a simple across-the-board reduction in a spending category) sounds easy to implement, it in fact creates an administrative nightmare for agencies, especially those bound by legal relationships with contractors.

Although Gramm-Rudman-Hollings likely did bring about modest reductions in deficit spending at first, over time, the law was increasingly twisted and manipulated to enable greater spending. Various exceptions were legislated into annual spending bills; federal agencies became increasingly adept at fudging their ledgers in ways that avoided budget cuts. And when the demands imposed by the law's framework became too great to be manipulated, Congress simply did away with Gramm-Rudman-Hollings in 1990. As University of Rochester political scientist David Primo points out, this is the general pattern with automatic cutting mechanisms: When the choice is between obedience to the rule and staying safely within the realm of the politically comfortable, the rule is not long for this world.

Intuitively, it would seem like this problem could be solved through incremental budget trimming: Though large, sudden cuts mobilize political opposition, small and gradual ones may be more palatable. But while striving for modesty in budget rules is a sound practice (as we shall see), incrementalism is no guarantee of success. If a particular group bears most of the burden of cuts over time, its members will become highly motivated advocates for "fixing" the reform. They will, in their rhetoric, seek to turn the automatic cuts themselves into a "problem" that needs to be "solved" through bipartisan cooperation.

The classic example of this phenomenon is the Medicare Sustainable Growth Rate, a cost-capping device adopted by Congress as a way of controlling Medicare costs and reaching the desired spending targets in the Balanced Budget Act of 1997. Although the mechanics of the Sustainable Growth Rate calculation are somewhat complex, the basic idea is simple: The growth of Medicare costs per enrollee should not exceed the growth of the nation's per-capita gross domestic product each year, lest health spending consume an ever larger portion of our national resources. Under the law, should Medicare spending exceed GDP growth, the rates at which Medicare pays physicians and other providers of health care must be reduced the following year to compensate for the difference.

But what was thought to be a modest tweak to Medicare's funding formula has, over time, become just one more of the program's fiscal woes. The people subject to the annual spending reduction — especially physicians, a sympathetic and politically potent group — have a powerful incentive to petition Congress for relief each year; the original coalition behind the particular formula enacted in 1997, meanwhile, cannot be reconstituted. And rather than embrace this form of automatic budget discipline as a politically safe way of cutting expenditures, both parties have instead shown great consistency in denouncing the potential cuts to physician payments as grave threats to Medicare. As a result, the so-called "doc fix," in which the Sustainable Growth Rate requirements are waived for a time, has become a staple of our budget process. Thus, rather than providing a solution to our budget problem, the Sustainable Growth Rate rule has become one "problem" that Democrats and Republicans can unite to "fix."

To make matters worse, putting the Sustainable Growth Rate requirement off for one year means that reinstating it the following year would require a more severe reduction in payments to bring Medicare spending back into line with GDP growth. Since the cuts have been put off almost every year since the requirement was enacted, if the Sustainable Growth Rate formula were applied today, it would require an almost 25% reduction in physician fees all at once. To institute these cuts would be politically disastrous, which of course makes the annual "doc fix" even more likely, and the original formula even more meaningless.

If mandating blanket cuts — be they sudden or gradual — is an unworkable budget mechanism, what about procedural requirements that compel Congress or the president to propose new plans for budget savings in the event of overspending? The vagueness of this approach means that, in adopting it, lawmakers do not commit themselves to politically impossible remedies; in this sense, the "come up with a plan in the future" requirement should be more workable than painful automatic cuts. But this same vagueness also makes such mechanisms highly unlikely to have any meaningful effect.

Here, too, the best example comes from Medicare, in this case from the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (known primarily for creating Medicare Part D, the program's prescription-drug benefit). In yet another attempt to restrain the growth of Medicare spending, the law included a device known as the "Medicare Trigger." The trigger requires Medicare's trustees to assess whether Medicare's spending is growing so quickly that it can no longer be adequately funded with Medicare's dedicated payroll tax and must therefore draw heavily on general-fund revenues. (Such a shift in the program's funding sources would mean Medicare was growing more quickly than wages, and therefore more quickly than the economy.) If the trustees observe such rapid growth for two consecutive years, they are required to issue a formal warning to Congress and the president, who in turn are required to propose cost-control legislation within a few months.

Formal warnings under this provision began in 2006 and have followed every year since. The program's projected fiscal course gives no reason to expect that they will ever cease. But far from generating specific legislation to curb costs, the legal trigger has failed even to generate the required proposals. The Bush administration offered only one, in 2008, and the Obama administration has taken the position (previously staked out in a Bush-administration signing statement) that the president cannot be constitutionally required to submit legislation. When it comes to obeying its own rule, Congress has been little better: The 110th Congress waived the requirement that cost-cutting legislation be given fast-track consideration; the 111th Congress suspended the trigger entirely; and, in spite of the apparent opportunity for politically advantageous posturing, the 112th Congress did not even bother to waive the requirement, and instead simply failed to offer a plan. With no penalties for non-compliance specified, the law is now routinely ignored.

Many of the cost-control devices built into Obamacare have a similar feel, and they are likely to meet a similar fate. The Independent Payment Advisory Board, hailed by its defenders as the secret weapon in the battle against Medicare overspending and denounced by its opponents as a "death panel," is a prime example. For all the talk about IPAB's unprecedented power, the design limitations that were imposed on the board in the effort to get Obamacare passed are profound. It is true that the board's recommendations are to be given fast-track consideration in Congress, and if Congress does not replace those recommendations with equivalent cost savings, IPAB's proposals can be implemented by the secretary of Health and Human Services. But these procedures will kick in only if health-care spending growth exceeds a specified cap that is set quite high (at the average of the overall inflation rate and its health-inflation component) through 2018. Moreover, the substance of the recommendations IPAB may offer is tightly circumscribed by the statute: Many different types of health-care providers are wholly exempted from cost cuts, and the board is explicitly prohibited from rationing, raising revenues, raising premiums, imposing greater cost-sharing, or otherwise restricting benefits or eligibility. What the board actually can do is still a matter of speculation, but CBO's scoring of the cost savings that IPAB is supposed to produce speaks volumes: It predicts that the board will provide zero savings through 2022.

The failures of automatic budgeting gimmicks are not confined to health-care spending (or to spending cuts more generally); the revenue side can be problematic, too. Indeed, a nearly identical story can be told about the Alternative Minimum Tax. Designed in 1982 as a way to make sure that high earners could not use various deductions to bring their tax liabilities all the way down to zero, the AMT has gradually encompassed an ever growing number of taxpayers, because the minimum amount of income subject to the tax was not indexed for inflation. As a result, although it wasn't intended to serve as a budget-balancing mechanism, the AMT offered a path toward higher revenues by means of simple legislative inaction. Yet just as with Medicare's Sustainable Growth Rate, this automatic revenue increase came to be seen not as a path to smaller deficits but as a problem to be solved. With great regularity, congressional budgets have included "patches" that set higher income thresholds for AMT applicability, limiting the number of taxpayers forced to pay the levy.

As a part of this January's "fiscal cliff" compromise, the AMT was permanently "patched" — meaning that the income level at which it kicks in is now indexed to inflation. There were legitimate reasons for thinking that allowing the AMT to expand would be bad policy, and millions of households that value their deductions were unlikely to comply meekly. Still, in an era of severe political polarization, the bipartisanship that the effort to avert the expansion of the AMT has inspired is noteworthy. It shows that, even amid cries from both parties about a looming fiscal crisis, embracing an unpopular policy (like allowing the AMT to expand) is worse politically than letting our debt continue to grow out of control.

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This article is reprinted with permission from the Brookings Institution.

Philip Wallach

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