September 28, 2010

Making Budget Rules Work

Key materials
Contact us
To speak with a scholar or learn more on this topic, visit our contact page.

The United States faces severe fiscal challenges that can no longer be ignored.  Entitlement spending, especially Medicare, is a ticking time bomb that must be defused. Increasing deficits and a growing debt burden place the country‘s pristine debt rating in jeopardy, as ballooning deficits and debts raise concerns about the government‘s ability to pay back debt without strangling economic growth or causing significant inflation. These threats reflect the inability of legislators and the president to make the hard choices needed to restore fiscal responsibility to the U.S. system.

Legislators on both sides of the aisle are aware of this problem. House Majority Leader Steny Hoyer (D-MD) writes, "The course we‘re on will lead to public debt that will exceed the size of our entire economy, and a government that will eventually exist to do only two things: fund entitlement programs and make interest payments." Senate Minority Leader Mitch McConnell has called the national debt an "emergency," arguing,  "the time is long since past to reverse this dangerous trend [of increased debt]." Legislators have proposed several solutions, ranging from Rep. Paul Ryan‘s (R-WI) alternative budget proposal that requires significant spending cuts and ultimately leads to a federal budget surplus (albeit not for decades) to a spending cap proposed by Reps. Jeb Hensarling (R-TX), Mike Pence (R-IN), and John Campbell (R-CA).

Meanwhile, President Barack Obama has pledged to put the country on "a fiscally sustainable path." To do so, the president has promised to freeze non-security discretionary spending for three years, a move he claims "will require a level of discipline with Americans‘ tax dollars and a number of hard choices and painful tradeoffs not seen in Washington for many years." The president also signed into law a budget rule that prevents legislators from creating new programs unless taxes are increased accordingly or cuts are made elsewhere (known as a pay-as-you-go, or PAYGO, rule), and he recently proposed a line-item veto that permits the president to propose specific cuts to bills, subject to congressional approval. Finally, the president has created a National Commission on Fiscal Responsibility and Reform to "improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run;" the commission‘s proposals are non-binding.

Unfortunately, Rep. Ryan‘s alternative budget proposal and Reps. Hensarling, Pence, and Campbell‘s spending cap have not gained traction, and the president‘s proposals are largely smokescreens that distract attention from the truly hard choices that have to be made. (If the president believes that simply not increasing spending will be anguishing, the prospects for sticking to his pledge to halve the deficit by the end of his first term in office seem dim.)

Even before stimulus spending began in the wake of the economic downturn, the United States government faced a precarious financial situation that politicians made little progress in improving. Why is such progress so difficult to achieve? The short answer is that Congress faces two sets of problems, a commitment problem and an enforcement problem, that prevent well-meaning legislators from effecting change. In this paper, I argue that budget rules are one mechanism for addressing both of these problems, but not all rules are created equal. Some, like the president‘s line-item veto proposal, will do little and may even be counterproductive. Others, like a spending cap that limits increases in spending, are excellent starting points for reform.

This paper proceeds as follows. First, I discuss the nature of the looming fiscal crisis facing the country. Then, I show why Congress is having such difficulty implementing meaningful budget reforms. Next, I propose a set of principles that should guide rule designers at the federal level. I conclude by discussing the potential risks of implementing rules that satisfy those principles.