The Heritage Foundation

Executive Memorandum #281 on Federal Budget

September 21, 1990

September 21, 1990 | Executive Memorandum on Federal Budget

The Four Percent Solution to the Deficit Impasse


(Archived document, may contain errors)

9/21/90 281

THE FOUR PERCENT SOLUTION TO THE DEFICIT IMPASSE

Whether the current budget summit yields an agreement on the federal budget deficit or not, the negotiations graphically demonstrate that the federal government's budget process has broken down completely. Congress currently is set to spend the $79 billio n it will receive next year in new revenues - and more - rather than using these funds to reduce the budget deficit. Indeed, over the last decade, every dollar in new revenues has been accompanied by more than a dollar of new spend- ing. And the budget sum m it, which was meant to bring congressional and Bush mini leaders together behind dosed doors to work out an agreement to cut the deficit, has yielded almost nothing but calls for higher taxes. Now the economy is showing disturbing signs of a possible rece s - sion, due in part to the spectacle of a government unable to control its spending but eager to raise taxies. Ritther than taking more money out of productive enterprises and the pockets of American. con- sumers, which could guarantee a recession, many p o licy makers are rallying around a proposal that rejects higher taxes and instead reduces the budget deficit by limiting total annual spending in- creases to 4 percent. With federal revenues already projected to climb by $79 billion next year, and by $373 billion over the next five years, this "Four Percent Solution" would reduce the budget deficit to only $33 billion by 1995, and produce a balanced budget soon after (see table).

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. .................... . ............ ..... ....... ...................... .:::-:19.94, ................... .. ............ ........... ... ..... ........ ... .. .. ... .................... . ............. . Spending* 1,192 1,240 1,289 1,341 1,394 1,450 Rev e nues 1,044 1,123 1,188 1,2M 1,337 1,417 Deflcit 1148 117 101 81 57 33 *Amumes Congress wiD take the costs of the Savings and Loan deposit insurance bailout off-budget. Sourcc Congressional Budget Office Jbi@ cap on spending growth still would allow policy makers to spend more on all programs - or even increase spending well over 4 percent for some programs if they cut back or terminate others.

And perhaps mom important, by precluding how Uw4 the Four Percent Solution will lem more resources in the produc tive private sector Of the economy, makin a recession less likely. Yet this, or any other budget proposal, stflfwffi fail unless there are, stronger - rcement TnWhnni to prevent Congress from violating spending limits - as it. has done routinely. The Four Percent Solution thus should include tough major budget process reforms. in particular, Congress should: 1) Establish Gramm-Rudman Outlay Targets. Under the Gramm-Rudman Deficit Reduction Act, spending Utoinatically is cut across the board, or "sequestere d ," if the projected deficit ex- cce4h the Gramm-Rudman target deficit. Lawmakers, however, can evade the laws intent simply by itb - OvCr-cstirnating projected revenues, thereby permitting even larger spending increases. Once c comes apparent that the rev e nue projections were maccurate, the sequester has already passed. Establishing outlay or spending targets should eliminate this loophole. Under this approach, the current deficit targets would be augmented by Outlay targets. Whenever projected spending in any fiscal year was above the target level permitted in the law, sequestration would be triggered to bring outlays back down to the legally required level. 2) Create a Second, Mid-Year Sequester. Even with outlay targets, however, politicians still would h ave an incentive to underestimate future spending in order to make program expansions and new spending legally possible. Congress could also continue its practice of waiting until after the October 15 sequester deadline passes to enact expensive spending b ills. These loopholes could in large part be closed by creating a second sequester in the middle of the fiscal year. If a mid-year estimate showed that spending was exceeding the new outlay target, auto- matic cuts would reduce spending by the necessary a m otuit. Such-a reform would give Congress less leeway to exceed its own targets. 3) Abolish Cunent So-vices Budgeting. Much of the public confusion surrounding the entire budget debate is caused by Congress's bizarre definition of a budget "cut" - legislat i ng a reduction in a projected increase. Thus according to Congress's version of a cut, ff a businessman raised his prices 15 percent instead of the 25 percent he had intended, that would be a price cut of 10 percent. Ibis phony accounting system, known as the "current services budget," distorts honest debate and builds political pressure for higher spending. Other proposals before Congress would further tighten the budget process. Among them: "pay-as- you-go budgeting," which would require new spending inc r eases to be offset by reductions else- where in the budget; super-majority votes to raise taxes or violate Gramm-Rudman targets; a line- item veto; and a constitutional amendment to limit taxes and maintain a balanced budget. After tightening the Gramm-Ru d man law, Congress should give urgent attention to such proposals. The Four Percent Solution, enforced by budget process reforms, would help reignite strong economic growth by bringin the stubborn budget deficit finally under control. Spending control is t h e tool to curb the deficit. Tax increases are not. Tax increases approved -by budget summits were tried in 1982, 1984, 1987, and 1989. In each case, the budget deficit increased the following year. Tax revenues now consume almost 20 percent of America's g r oss national product (GNP) - a near- record high for peacetime. Ominously, the only two times outside of World War II that tax collec- tions have exceeded 20 percent of GNP, in 1969 and 1981, the economy fell into a recession the fol- lowing yea. The Four Percent Solution, backed up with reforms to tighten the budget process, would avoid the recession tripwire, allowing Americans to look forward to declining federal deficits and robust ecoriontic growth. Daniel J. Mitchell John M. Olin Fellow

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