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Backgrounder #763 on Federal Budget

April 3, 1990

Save the Gramm-Rudman Sequester

By

(Archived document, may contain errors)

763 April 3,1990 SAW THE GRAMM-RUDMAN SEQUEsI'ER Daniel J. Mitchell John M. Olin Fellow in Political Economy Washington should be celebrating the Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Reduction Act of 1985, popularly known as Gramm-Rudman. Since it was enacted, inflation-adjusted federal spending has grown by only 1.4 percent annually, a dramatic reversal of the runaway federal spending increases of previous periods when it jumped 3.6 percent annually in the 1970s and 4 percent annually between 1980 and 1985 At the same time, the federal budget deficit has fallen from $212 billion in fis cal year 1985 to an estimated $123.8 billion this year. Adjusted for inflation the deficit today is less than half the size it was just five years ago.

Instead of celebrating the success of Gram-Rudman, many in Washington are claiming that it has failed.Thus, while two of the measure's principal spon sors, Republican Senators Phil Gram of Texas and Warren Rudman of New Hampshire, still support the Act, South Carolina's Democratic Senator Ernest Hollings openly disassociates himself from it. Newspaper articles and political commentators routinely assert that Gramm-Rudman is a flop.

Despite the facts that say the opposite, the sheer volume of criticism directed at Gramm-Rudman suggests that federal spending md bxdget deficits con tinue to grow uncontrollably Vast Improvement. Many of those who assert that Gramm-Rudman does not work are mounting a campaign to repeal the law or eliminate its enforce ment mechanism, known as sequestration. If Congress fails to produce a budget that controls deficit spending, sequestration takes effect, automat ically reducing spending by the amount needed to bring the deficit down to the legally-required level. This is a vast and proven improvement over earlier congressionalefforts to control deficit spending.The fact that now a se quester occurs automatically if Congress fails to comply with the deficit-cut ting law guarantees deficit reduction will actually happen. Without the se quester, Gramm-Rudman is almost completely emasculated Rather then discussing ways to weaken Gram-Rudman, Congress should examine proposals to strengthen the law. One reform would be to introduce a second sequester, occurring in mid-year. This would, help prevent Congress from increasing spending after the October 15 sequester deadline, which oc curs just two weeks into the new fiscal year. Another reform, mentioned in the Bush Administrations budget this year, would require a super-majority vote by each House of Congress to rescind a sequester. once it goes into ef fect; currently, a sequester can be-rescinded by legislation passed by simple majority. Another reform would limit such budget gimmicks as taking programs off budget or moving government paydays from one fiscal year to another.These gimmicks do not cut spending but merely hide the size of the deficit THE GRAMM-RUDMAN APPROACH TO DEFICIT REDUCTION In the 1970s, the proponents of higher federal government spending usually had their way. Since there were no objective limits on spending or deficits they could enact new spending programs and increase funding for existing programs with little difficulty. Fiscally-responsible legislators then often had to raise taxes to contain deficits. This pattern of fiscal conservatives raising taxes so advocates of big government could raise spending did little to promote economic growth -or to control the federal debt.

In 1981 Ronald Reagan, with Republicans controlling the Senate, broke with tradition and pushed through comprehensive legislation to lower Americas tax burden. Supporters of tax cuts hoped that reducing disincen tives to work, save, and invest would lead to higher levels of economic growth.This in fact happened. A by-product of cutting tax rates and of the record 88-month economic expansionis that annual federal revenues have in creased by more than $473 billion since 1983, a jump of 79 percent. The prob lem was that the combination of the 1982 recession and continued congres sional overspending pushed the deficit to record high levels. Some thought higher taxes were the only way to lower the deficit; this resulted in large tax increases in 1982,1983, and 1984 As in the past, however, these tax increases were not used for deficit reduction they simply were excuses for more government spending Frustrated Congress. The Gram-Rudman-Hollings Balanced Budget and Emergency Deficit Reduction Act of 1985 changed all this. Enacted by a Con gress frustrated with persistently high deficits the Act set progressively smaller maximum budget deficits for each fiscal year. The original targets sought to balance the budget by fiscpll9

91. Subsequently, Congress shifted the timetable to 1993 (seeTable 1 1 Note: The fscal year begins October 1 and ends September 30 of the following year.The 1990 fscal year, for instance, began October 1,1989, and will end September 30,1990 2 Table 1 Gramm-Rudman Deficit Targets billions Target $loo 64 28 0 that amount.

Source: Budget of the United States Government Gramrn-Rudman requires that the Office of Management and Budget Om) prepare a snapshot estimate of the upcoming fiscal years deficit each August based upon assumptions about economic performance and con gressional actions on that years budget. Since the August snapshot will al most certainly show that the projected deficit is higher than the Gramm-Rud man target, Congress will know how much additional deficit reduction is re quired before the new budget takes effect on October 1 Automatic Reductions. OMB takes a final deficit snapshot on October 15.

If the projected deficit on that day is more than $10 billion over the Gramrn Rudman target, spending for federal programs subject to sequestration is automatically reduced by the percentage necessary to lower the deficit to the required level. Under Gramm-Rudman, 50 percent of the sequester comes from defense and 50 percent from domestic spending. Most entitlement programs are exempt from sequestration.

Should a sequester occur, Congress can simply accept the results, or it may choose to substitute an alternative deficit reduction package. A full sequester has never happened, although partial year sequesters did occur in fiscal 1986 and 1990 DYNAMICS OF THE GRAMM-RUDMAN PROCESS Gramm-Rudman sharply curtails Congresss ability to increase spending.

Under Gramm-Rudman, total spending in any year cannot exceed the sum of anticipated tax revenues plus the maximum allowable deficit. To introduce new programs or to increase spending for existing ones, legislators must either raise taxes or cut spending elsewhere in the budget. This deficit-neutral requirement forces policy makers to make trade offs. This, more than any thing else, fundamentally has altered the dynamics of the budget process.

In the case of catastrophic care, for example, Congress had to include a large tax increase as part of the legislation to pay for the spending provisions of the bill.This sparked a revolt by the elderly asked to pay the higher taxes, leading Congress last year to repeal the catastrophic care pro gram. The lesson: beneficiaries of spending are much less enthusiastic about big government if they have to pay for the programs.

Congress, of course, could trim some existing programs to free up money for new programs. This is a commendable process, for it would require law makers to set priorities. Politically, however, it has been difficult to find off 3setting spending reductions. An attempt to comply with Gramm-Rudman's deficit neutrality requirement, for example, resulted in bitter warfare in the Senate last year over legislation to fund anti-drug programs GRAMM-RUDMAN SUCCESS IN CONTROLLING SPENDING shown inTable 2 federal spending in current dollars increased by an average of more than 9.9 percent annuiilly between 1980 and 1985TSince Gram-Rudman was adopted, however, annual spending increases have averaged about 4.8 percent If federal spending had con tinued to grow at the 9.9 per cent annual rate, both the budget and the deficit for 1990 would be more than 300 billion higher than cur rently projected.

Table 3 shows that after adjusting for inflation, the impact of Gramm-Rudman nding Increase During the 1980s is even more striking.

Federal spending in real terms grew almost three times faster before Gramm Rudman than it has since Gram-Rudman.

More important, Gramm 1 990.3 4.6 Five Year 1003.8 1.4 Average 1064.0 6.0 Growth 1142.6 7.4 1197.2 4.8 4.8 Rudman has helped reduce E the size of government rela tive to the size of the Estimate Bud lget of the United States Government productive sector of the economy. In every year but one'between 1980 and 1985, government spend ing as a percentage of Gross National Product (GNP) was higher than the previous year, with annual increases averaging 0.36 percentage points. Yet as Table 4 shows, government spending as a percentage of GNP has fallen or remained stable every year since Gramm-Rudman was adopted, declining by an average of more than 0.4 percentage points each year GRAMM-RUDMAN'S SUCCESS IN SLASHING THE DEFICIT Gram-Rudman also has reduced the budget deficit. In four of the five years before Gram-Rudman, the deficit increased. AsTable 5 shows, of the five years since Gramm-Rudman was enacted, the deficit has fallen three years. As a percent of GNP, the budget deficit increased in three of the five years before Gram-Rudman; since enactment, the deficit as a percent of GNP has fallen every year. According to current projections, the deficit as a percent of GNP will be at its lowest level in more than a decade. As recently 4 Table 3 Annual Spending Increases During the 1980s 1982 dollars 6YY.l 726.5 3.9 Five Year 745.7 2.6 Average 775.0 3.9 Growth 788.1 1.7 4.0 percent 849.6 7.8 867.5 857.8 879.6 907.1 2.1 1.1 2.5 3.1 Five Year Average Growth 1.4 percent Estimate Source: Budget of the United States Government Table 4 Federal Government Spending as a Percent of GNP 0.6 Five Year 23.8 +0.9 Average 24.3 +oms Growth 036 1.2 0.8 Source: Budget of the United 0.2 Five Year 1.0 Average 0.5 Shrinkage 0.42 0.4 States Government 5 as 1988, total government deficits in the U.S. as a per cent of GNP were the &.me as West Germanys (though West Germany was in better shape than the U.S. last year and for,at least the past half dozen years, the annual U.S government deficit as a per cent of GNP was below the average for all West European countries.

Another way to illustrate how Gram-Rudman has reduced the budget deficit is to compare what the Congres sional Budget Office (CBO projected the deficit in 1989 and 1990 before be Source: B.udget of the United States Government Historical Tables Gram-Rudman was enacted. In 1985, CBO es timated that the 1989 deficit would be $272 billion and consume 5.2 percent of GNP. For 1990, CBO also predicted in 1985 that the 1990 deficit would climb to $296 billion and 5.3 percent of GNP. In reality, owing largely to the Gram-Rudman law, the 1989 deficit was $152 billion 120 billion below the estimate. If the 1990 budget deficit estimate of $123.8 billion is even close, the deficit will be less than half the amount CBO projected Table 5 Deficits During the 1980s THE FLAWED CASE AGAINST GRAMM-RUDMAN Opponents raise several arguments against the Gramm-Rudman approach to fiscal policy. If the case were that Gramm-Rudman is far from perfect then the critics would be correct. Gram-Rudman offers considerable room for improvement. But this is not where the congressional critics focus Slipping Targets. Opponents point out that Gramm-Rudman originally called for a balanced budget for fiscal 19

91. Now the target is fiscal 1993.

Thus, it might be said the law lacks credibility. But this is an indictment not of Gram-Rudman but of Congress, which pushed the target forward two years. Congress was unwilling to reduce the deficit as quickly as Gramm-Rud man originally demanded. The weakness of Congress in dealing with over spending underscores the importance of preserving the automatic Gramm Rudman mechanism for meeting deficit targets.

Gramm-Rudmans critics claim that the law does not work because actual deficits at the end of each fiscal year consistently have exceeded the Gramm Rudman target.The deficit in fiscal 1989, for instance, was $152 billion 16 billion above the $136 billion target. Furthermore, the Bush Administration 6 projects that the fiscal 1990 budget deficit will be $123 billion 23 billion over target Loopholes. This overshooting of the target results from loopholes in the Gram-Rudman 1aw:One loophole is that Gram-Rudman does not re quire .that the actual deficit equal the deficit target. Instead, it mandates that the deficit projected as of October 15, two'weeks into the new fiscal year, be no more than 10 billion over the target If the economic assumptions underlying the deficit projection are too op timistic (for example, projecting a stronger economy and more resulting tax revenues the actual deficit will be higher than the target. And it is Congress not the White House, which typically usually adopts the rosiest forecasts be cause better economic assumptions mean that less spending restraint is needed to meet projected deficit targets.

A second loophole is that once the October 15 sequester deadline passes Congress can increase spending for that fiscal year without triggering a sub sequent sequester. The only significant barrier against such midyear spending increases is the 60 votes required in the Senate to waive the budget act and consider legislation which would increase the deficit. While the 60-vote re quirement makes it more difficult to increase spending, it is still possible for Congress to approve such increases. Every dollar of added spending after October 15 causes the actual deficit to be that much higher than the deficit target Meat-Ax Budgeting. Critics assert that Gram-Rudman is an arbitrary meat-ax approach to budget cutting, since those programs vulnerable to se quester all are penalized, while almost all entitlement programs are exempt from automatic cuts. Indeed, there is no doubt that Gramm-Rudman dis criminates The defense budget, for instance,,must account for 50 percent of the total sequester even though defense is barely one-fourth of the total budget If Congress finds the current sequester formula unfair, however, legis lators can change the law to increase the number of programs which are af fected THE PROBLEM OF BUDGET GIMMICKS Congress, often in cooperation with the Administration, can get around Gram-Rudman restrictions with budgetary gimmicks and sleights of hand.

Congress, for example, has shifted government paydays and Medicare and farm-price-support payment dates from one fiscal year to another. Thus if projected spending for 1991 appears too high, Congress could move a payday from October 1, the first day of the 1991 fiscal year, back to September 30 the last day of the 1990 fiscal year. Spending will increase for the current year, but Congress will not be subject to sanctions since the sequester dead line passed nearly a year before, on October 15,1989 programs off budget. Last year, for instance, Congress took the Postal Service Another gimmick used by Congress to evade deficit limits is to takeoff budget so that its deficit no longer is counted in the general federal deficit calculation. Congress claimed to save $1.7 billion by doing this, even though theTreasury Department still must borrow just as much money to cover off-budget as on-budget debts. And once the Postal Service was off budget and its deficits no longer counted, Congress required the Postal Ser vice to make a one-time $400 million payment to an on-budget part of the government. This created.the illusion of an additional $AOO.million of deficit reduction. The Farm Credit system was also taken off budget, a move that 1 generated another $400 million of phony savings SOCIAL SECURITY AND THE BUDGET DEFICIT The issue of deficit reduction has been confused by constant claims that the Social Security surplus masks the true size of the deficit. It is true that So cial Security tax revenues have begun exceeding Social Security outlays. The overall federal budget deficit, however, is supposed to measure how much money the government will borrow from private credit markets. As such, all government spending and taxes, including Social Security, should be counted.

Any other measurement would misrepresent the true extent of government borrowing. The Social Security system thus belongs where it is, in the unified budget.

When Social Security tax revenues exceed outlays, the Social Security sys tem takes its excess to theTreasury and exchanges the cash for U.S. govern ment bonds or IOUs; these are deposited in the Trust Fund. When Social Security outlays begin to exceed revenues, as they will early next century, the Social Security system will return to theTreasury to redeem these bonds for the cash to pay retirement benefits. At that time, to get the cash to redeem the Social Security systems bonds, the Treasury either will have to raise taxes or issue new debt, just as would be the case with a pay-as-you-go system. If it does not do so, then it will not be able to redeem the bonds; the Social Security system then will have to reduce benefits to retired Americans RECOMMENDATIONS Gramm-Rudman has helped slow federal spending and reduce the budget deficit. Legislators concerned about its weaknesses shoUM slqgthenthejaw ra&er<_h26_>

In reality, many of Gram-Rudmans critics object to the law because it has worked. Many legislators resent having to choose which programs will receive scarce funds. Special interest groups are having a much harder time getting access to taxpayers wallets, forcing them to compete against one another.

Change for the Better. The passage of Gramm-Rudman thus marked a turning point in the battle of the budget. With the right strategy, refusal to capitulate on taxes and willingness to use the sequester if necessary, George Bush can assure that spending and deficits are brought under control.These benefits, however, will vanish if the Gram-Rudman sequester is repealed.

The deficit reduction law has dramatically changed the way Congress budgets for the better.

Indeed, the only shortcoming is that Gramm-Rudman will end in 1993.

There is always a possibility that politicians will slip the targets again and extend the balanced budget goal forward a year or two, but at some point Gram-Rudman will accomplish its immediate goal of balancing the budget.

At that point, advocates of economic growth need to be ready with tax-cut proposals, accompanied by new deficit reduction requirements. Gramm-Rud man has succeeded in reducing the relative size of government, but only con stant vigilance will keep leviathan under control 9

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