March 14, 2005

March 14, 2005 | WebMemo on Federal Budget

PAYGO: A Recipe for Steep Tax Increases and Runaway Spending

The Senate is once again considering incorporating Pay-As-You-Go (PAYGO) rules into its budget resolution. PAYGO, which requires that any new tax cuts or mandatory 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. It is the wrong answer to runaway spending and budget deficits.

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 Senate 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 and Building Unfunded Obligations into the Budget. 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.[2] And as the budget process current stands, the federal budget includes no measure of entitlement obligations, giving Congress every incentive to increase future commitments for these programs and no incentive to provide for their payment. Lawmakers concerned about long-term deficit reduction should push for budget process reform that would include unfunded liabilities in the budget process.[3]

Lawmakers' eagerness to reform the budget process is encouraging. However, PAYGO will not rein in federal spending, but will likely lead to steeply 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

Show references in this report

[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.

[2] A Federal Taxpayers' Bill of Rights would cap total spending increases at the inflation rate plus population growth. See Brian M. Riedl, "Restrain Runaway Spending with a Federal Taxpayers' Bill of Rights," Heritage Foundation Backgrounder No. 1793, August 27, 2004, at www.heritage.org/Research/Budget/bg1793.cfm.

[3] See Alison Acosta Fraser, "Time for the Federal Budget Process to Include Unfunded Entitlement Obligations," Heritage Foundation Backgrounder No. 1818, February 3, 2005, at http://www.heritage.org/Research/Budget/bg1818.cfm.