Fix the Federal Spending Baseline First

Of late there has been controversy among budget wonks as to whether lawmakers should use a “current law” or “current policy” baseline to score the effects of tax reform in the budget process.  Though this is a prototypically arcane procedural fight, it bears enormous implications for federal finances.  The Committee for a Responsible Federal Budget (CRFB) has sounded an alarm against the possible use of a current tax policy baseline, calling it a “gimmick” that would add enormously to federal debt.  The competing argument is typified by a recent column from Manhattan’s own Brian Riedl, who finds that a current tax policy baseline is necessary for consistent treatment of taxes and spending.

I usually strive in my columns to provide a high ratio of factual information relative to interpretation and opinion.  However, it is difficult to enter this dispute without resort to significant interpretation and value judgments, so I want to be especially transparent here about my own subjective views.  In sum, I agree with CRFB that the use of current policy baselines is dangerously likely to lead to worse fiscal outcomes, for reasons I will detail later in this piece.  On the other hand, Riedl is correct to observe that using a current policy baseline for taxes would be a step toward more consistent, balanced treatment of taxes and spending.

First, the factual background.  As Riedl covers well in his piece, Congress’s scorekeeping rules (by which the Congressional Budget Office abides) exhibit significant inconsistencies.  Many areas of legislation, most especially tax law, are scored against a literal current law baseline, even if that current law would produce a sudden policy change.  So for example, if a particular existing tax provision is set to expire by a date certain, CBO assumes it will in fact do so, even if this would result in a sudden increase in tax assessments that most observers do not believe lawmakers will allow.  Accordingly, pending bills to extend current tax policies are typically scored as adding to the federal deficit. This reflects the (in my opinion, reasonable) view that CBO should score current law as it is, and not make speculative judgments as to the actions legislators will take to change the law.

This approach is not taken, however, with many areas of federal spending.  CBO assumes that discretionary appropriations will continue indefinitely even if under law they would expire at the end of the fiscal year.  And in perhaps the single most significant departure from current-law baselining, CBO is instructed to assume that Social Security and Medicare will make full benefit and insurance payments far beyond the amounts the programs are permitted by law to spend from their limited trust fund resources.  In other words, with respect to Social Security and Medicare, CBO is directed to assume that lawmakers will pass future legislation to effectuate large spending increases in those programs, far beyond what is authorized in current law.  Thus, there is no procedural barrier to increasing spending as long as it doesn’t exceed the spending increase assumed in the baseline, in which case lawmakers are not charged with adding to the deficit.

I first wrote about this phenomenon when explaining the finances of the Affordable Care Act (ACA): that it would improve federal finances only relative to Congress’s scoring baseline (with its assumption of future Medicare spending increases) while it was unambiguously a fiscal worsening relative to previous law.  At that time, my purpose was purely explanatory; I was agnostic as to whether the scorekeeping rules should change.  Since then I have come to believe that they should.  As Riedl explains, the rules are inconsistent and bias federal budget policy toward higher spending and higher taxes.  They create a host of other problems as well, about which I have written before but will not repeat here.   It was encouraging to see House Budget Committee then-Chairman Tom Price introduce legislation to address this problem before assuming the position of HHS Secretary.Over the years various justifications have been offered for the scorekeeping baseline’s quirky treatment of Social Security and Medicare spending.  One suggestion is that this treatment is necessary to provide lawmakers with appropriate positive incentives.  Changing to literal current-law scoring for Social Security and Medicare would always show those programs being prevented from falling into the red, due to the curtailment of their spending authorities upon depletion of their trust funds. It is feared that incorporating this fail-safe assumption into the baseline would eliminate the credit lawmakers receive for legislating to align those programs’ benefit and tax schedules (because the baseline would already show them to remain in balance regardless).  I was once receptive to this belief, but the empirical evidence has shown it to be incorrect.

The currently-used spending baseline actually doesn’t create an effective incentive for lawmakers to address Social Security and Medicare financing gaps.  Instead of a stick (e.g., penalizing them for financing Social Security and Medicare shortfalls with debt) it offers a carrot (rewarding them for balancing program finances).   The relative incentive of the carrot is no stronger than the stick would be and in any case, does not justify treating entitlement spending differently from taxes.  The same rationale could be employed to argue that lawmakers should get a spendable scorekeeping credit simply for allowing current tax policies to expire, rather than being penalized for extending them. 

Lawmakers respond much more to the negative incentive of being penalized for exacerbating deficits, than to the positive incentive of producing budget savings.  For example, Congress’s budget procedures erect barriers to adding to the federal deficit; they do not provide significant rewards for net improvements to the fiscal outlook.  The fiscal results are predictable, and were manifested most damagingly in the ACA.  Lawmakers didn’t seek credit for improving the fiscal outlook via the ACA’s Medicare cost-containment provisions – instead they concurrently spent those illusory savings on a massive new health entitlement.  This could not have happened if the budget rules had recognized lawmakers’ pre-existing statutory obligation to maintain balance in the Medicare HI trust fund, which would have accurately shown the ACA adding to federal deficits

In fact, lawmakers are actually under great pressure to demonstrate that they are not balancing the budget on the backs of Social Security and Medicare.  Thus, they do not reap political benefits from the current scorekeeping practice of crediting them with large budgetary savings simply for upholding pre-existing Social Security and Medicare law.  Consequently, the advantaged treatment given to these programs in the budget rules is not an inducement for good fiscal behavior but rather an invitation to fiscal irresponsibility – an invitation that lawmakers have accepted in the past and almost certainly will again. 

As CRFB correctly notes, the best fiscal behavior will occur if the budget baseline makes it harder, not easier, for lawmakers to add to the federal deficit. But to be both effective and fair, this principle needs to be applied with equal force on the spending side. It is fruitless to apply the principle only selectively – for example, by blocking the use of a current-policy baseline for taxes, while its equivalent on the spending side continues to permit the passage of large spending expansions such as the ACA.

With all this said, let’s examine the three scorekeeping alternatives on the table:

  1. Continue current-law scorekeeping for taxes, but make the rules consistent by applying it also to entitlement spending.
  2. Continue current-policy scorekeeping for entitlement spending, but make the rules consistent by applying it also to tax policy.
  3. Continue to use current-law scorekeeping for taxes and current-policy scorekeeping for entitlement spending.

#3, where we are now, is clearly bad.  It is inconsistent, incorrect and biases policy in the direction of higher spending and higher taxes, which is the essence of our budget problem. #1 is by contrast methodologically consistent and would produce the best fiscal outcomes.

Which of #2 or #3 is better/worse is a value judgment and a tough call.  #2 opens the door wider to higher deficits, while #3 opens the door wider to higher taxes.  Assuming spending policies are the same either way, this basically comes down to whether you are more concerned about higher taxes or higher debt.  This is largely a function of whether you believe today’s or tomorrow’s taxpayers should be stuck with increased tax burdens.  I have an opinion on that question but it’s just that -- an opinion, with which others could reasonably disagree.  A true deficit hawk would favor choice #1 – consistently applying current-law scorekeeping to both the mandatory spending and tax sides, while strengthening safeguards against additional deficit spending. 

Hence, choosing between options #2 and #3 for the tax baseline bypasses the central scorekeeping question, while not offering either side an unassailably correct position.  Because of this, and given both legislative history and current projections, budget watchdogs should prioritize getting the spending baseline right first and foremost.