March 15, 2004

March 15, 2004 | WebMemo on Federal Budget

Restoring PAYGO Would Mean Tax Increases and High Spending

Senators voted on March 10 to incorporate Pay-As-You-Go (PAYGO) rules into the FY2005 budget resolution. The House of Representatives is considering a similar PAYGO provision among its budget process options. PAYGO, which requires that any new tax cuts or mandatory spending expansions be balanced by equal tax increases or mandatory spending cuts, would do little to address federal spending while laying the groundwork for future tax increases and economic disaster. The House should steer clear of the Senate's PAYGO provision.

The Problems with PAYGO

  1. PAYGO Would Not Decrease the Growth of Federal Spending. PAYGO rules are not designed to reduce federal spending. They aren't even designed to reduce spending increases relative to the baseline. They only limit the creation of new entitlement programs above the baseline. Because lawmakers are not currently looking to create any major new entitlement programs, such as those enacted in 2002 and 2003, this new restriction would not make a big difference in the short run. In fact, mandatory spending grew faster under PAYGO rules in the 1990s than without them. Mandatory spending levels will likely look no different over the next few years with PAYGO in place.
  2. PAYGO Would Not Affect Current Entitlement Programs. The nation's financial challenges do not stem from any future entitlements that may be created. The real danger is from the current entitlement programs (which PAYGO does not affect) that are growing 7 percent per year. In short, PAYGO:

    Consider the case of the Medicare drug bill. Had PAYGO been in place in 2003, it likely would have prevented this unaffordable expansion of government. Instead, lawmakers demanded no offsets to the expensive Medicare drug benefit. The year before, they demanded no offsets to the budget-busting farm bill. Now that the spending damage has been done and the debate has turned to taxes, some of these same lawmakers have suddenly discovered budget deficits - and are calling for strict PAYGO rules that would raise taxes.
    • Would not prevent Social Security from growing 5 percent annually;
    • Would not prevent Medicare from growing 9 percent annually;
    • Would not prevent the new Medicare drug law from costing $2 trillion over the next twenty years;
    • Would not prevent Medicaid from growing 7 percent annually; and
    • Would not prevent total mandatory spending from nearly doubling over the next decade.
  3. PAYGO Would Force Massive Tax Increases. While PAYGO allows current entitlement programs to grow on autopilot, it would likely lead to the expiration of the current tax cuts. Merely retaining the tax relief that Americans now enjoy would, under PAYGO, require 60 votes in the Senate and a waiver in the House. To avoid this supermajority requirement, lawmakers seeking to prevent tax increases would have to either: A) raise other taxes; or B) reduce mandatory spending by a larger amount than has ever been enacted. Option A is still a net tax increase (raising one tax to avoid raising another), and Option B is probably politically unrealistic. It is possible that the entire 2001 and 2003 tax cut packages could expire and the unadjusted Alternative Minimum Tax could raise taxes even higher for millions of households.

A Better Way

Lawmakers in the House seeking deficit reduction should instead focus on reducing spending that threatens the nation's future. Options for better budget process reforms include:

  1. Good: Exempt The 2001 And 2003 Tax Cuts From PAYGO. PAYGO was never intended to force tax increases, but rather to limit new tax cuts. Exempting the 2001 and 2003 tax cuts will protect the current policies that are benefiting families and businesses.
  2. Better: PAYGO For Mandatory Spending, Not Tax Cuts. This policy would limit the creation of new entitlements without jeopardizing the current tax cuts or any additional tax cuts that may be needed to jump-start the economy. This reform should be accompanied by reforms in current entitlement programs.
  3. Best: Mandatory Spending Caps. Discretionary spending caps, which are also being considered by lawmakers, serve as an effective tool to cut spending.[1] Extending spending caps to mandatory spending would address the real problem - the 7 percent annual growth rate in current entitlement programs - by forcing lawmakers to put all mandatory spending on the table and set priorities. Cap levels could be set by lawmakers every few years, or determined by a formula, such as inflation plus population growth.

The House's eagerness to reform the budget process is encouraging. However, PAYGO, in the form passed by the Senate, will not rein in federal spending, but will likely lead to higher taxes.

Brian Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

About the Author

Brian M. Riedl Grover Hermann Fellow in Federal Budgetary Affairs
Thomas A. Roe Institute for Economic Policy Studies

Related Issues: Federal Budget

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[1]For specific spending cut recommendations, see Brian M. Riedl, "How to Get Federal Spending Under Control' Heritage Foundation Backgrounder No. 1733, March 10, 2004, online at http://www.heritage.org/Research/Budget/bg1733.cfm.