This Way to the Egress? Maybe

If all goes well – a frightening thought – Washington is about to kick the can down the road yet another time.  This would be a good outcome because Washington seems just as likely to miss a mighty swing at the can and fall on its bum in the mud.

There is no realistic alternative to another can kick, after all.  This is October.  The fiscal year has already begun.  The federal government has been shut down for two weeks.  The Treasury is just about out of borrowing ability, and on the brink of default (to use the stark term).  This is a drain-the-swamp-versus-fend-off-the-alligators moment.  The Congress is not going to reform the nation’s tax code, Medicare and Social Security before the end-of-the-year holidays, as anyone who has watched our legislators work even at their finest knows all too well.  Think of 1981-1982 on Social Security, and in 1981-1986 on the income tax – and note that these were separate, multi-year efforts.  It is time for damage avoidance; that is the best we can hope for.

So if we are going to kick the can, we might as well kick it strategically.  Let’s think about our situation – what we must accomplish, and when.

What do we need to accomplish?

We have a long-term budget crisis – truly, even though “long-term” and “crisis” don’t usually fit well together.  If the nation’s debt trajectory is not turned back downward (expressed as a percentage of the GDP), sooner or later some bad news from whatever direction will spook the markets, spike interest rates, and squash the dollar.  The legislature that could not lumber its way to reduce the budget deficit will be forced by the markets to do so at a sprint.  It won’t be pretty to watch, or to endure as a part of this economy.

So we need to reduce the budget deficit, enough to slow the rate of growth of our collective debt to less than the pace of growth of our collective income – in other words, to make the burden of the debt gradually more manageable over time.  The bottom line is that this is a big job, and that it will involve virtually every part of the budget.  It is so big that our policymaking process quite possibly cannot swallow it all in one gulp.  That may require some careful strategic thinking.  Let’s analyze and elucidate.

As you understand, but many Americans do not, accomplishing this budgetary trick will require “bending the healthcare cost curve.”  There is nothing we can do about the growing number of elderly who are becoming eligible for Medicare (and for long-term care under Medicaid).  Therefore we must do something about the growing cost of treating each individual elderly person.  We at CED have our own idea for how to accomplish that, and we believe that our approach merits a careful look.  But whatever approach the Congress and the White House take, we will need a major rethinking and restructuring of the status quo.  As it stands, healthcare costs will grow exponentially.  There is no feasible exponential reduction of reimbursement rates for doctors and hospitals to offset that.  We need to change the way medicine is practiced in a fundamental way.

But the U.S. healthcare industry – about the size of the entire economy of France – is not a speedboat, but a supertanker.  Healthcare spending will not turn on a figurative dime.  In the meantime, to keep our debt from getting out of control, we will need deficit savings elsewhere in the budget.

Social Security is another essential, because it already is contributing to our nation’s borrowing needs and will continue to do so at an accelerating rate.  There are political sensitivities, of course, and to have a prayer of building a bipartisan consensus it will be necessary to explain that the program is being strengthened for its own sake, not primarily for the budget as a whole.

But Social Security cannot turn on a dime any more than Medicare can.  There is quite reasonable resistance to reducing benefits for today’s retirees, who have only the most limited ability to work longer or to save more to prepare for their future years of retirement on lower benefits than they were led to expect.  So Social Security, though a key component of the long-term budget problem, will not be a significant part of the short-term solution either (except to the extent that a Social Security refinance includes near-term tax increases on today’s working-age population).

So even though the budget problem is largely long-term, resting on Medicare and (to a lesser extent) Social Security, those two programs cannot yield a complete solution.  In addition, we will need savings in the other spending categories of the budget – the smaller entitlement programs and annual appropriations for defense and non-defense agencies, although appropriations arguably already have been cut enough or even too much (witness the bipartisan unhappiness with the “sequester”), and revenues.  Even though the deficit is waning for a few years, the problem that remains is massive, and will require enormous effort throughout the budget.

When do we need action?  Here is where there is some limited good news.

The good news is that we have been given a brief reprieve, coming from two sources.  The first is that economic recovery, as it often does, has put an unexpected bounce in the budget.  That, along with some expiring tax cuts that actually were allowed to expire, now have produced an anticipated three years of deficit decline, leading to four years in which the debt-to-GDP burden is projected to fall.  It is foolish to interpret this respite as peace in our time.  But it would be almost as foolish to ignore it.

The second source of “good” news actually is a mixed blessing at best.  The economy remains weak, meaning that the current large (even though somewhat reduced) federal budget deficits pose no risk of inflation.  The Federal Reserve’s Open Market Committee has made clear that it expects to need to maintain an accommodative monetary policy for some time into the future.  Again, this is hardly unalloyed good news, but it does mean that we can address the budget problem on the budget’s own schedule, in terms of standards of fiscal responsibility, rather than within additional constraints imposed by macroeconomic-stabilization-policy needs.

In sum, immediate deficit reduction is not only unnecessary but actually undesirable, given the weakness of the economy.  Early legislation to achieve savings later would be the best arrangement, given the need for confidence in the financial markets to keep interest rates low.  So if the Congress could hatch a plan now to reduce the deficit later, it would be the best conceivable tonic for both the budget and the economy.

Building on that background, here is one possible way to proceed:

The United States has some time to execute a deficit reduction plan, as was just explained.  And even if we do not actually impose budget restraint now, it would encourage the financial markets if the legislation to achieve the savings was put in place soon.

Realistically, though, if the goal is a truly comprehensive solution, “soon” does not mean before the holidays, or even by early next year.  There simply isn’t enough time for fundamental reform of taxation, and Medicare, and Social Security – all of which, incidentally, are in the primary jurisdiction of the same two Committees, House Ways & Means and Senate Finance – plus action in every other nook and cranny of the budget.  The Congress has simply procrastinated itself into a corner in this legislative cycle.  We aren’t going to finish all of this work in the winter holiday season.  Instead, we need to set in motion a process to complete that task over an appropriate time horizon.  And we need to create options for future Congresses and Presidents to finish the work in stages if necessary, as will be explained in a moment.

One path that has been advocated by some this time around is to create another “supercommittee.”  I think this would be to repeat bad history.  The first supercommittee failed in 2011 largely because the regular congressional committees of jurisdiction did not want to yield their authority; and truth be told, those committees do have essential institutional memory and expertise.

Instead, we should look back for a budget process that worked.  Arguably, the most successful period of the budget-challenged last three decades was the 1990s.  In the bipartisan 1990 budget deal, a Republican White House and a Democratic Congress collaborated to create a budget process called “pay as you go,” or “paygo” for short.  Paygo actually was a two-part system.  The annual appropriations for defense, international and domestic agencies were constrained by statutory annual dollar caps.  If the appropriators overspent their caps, their appropriations were cut across the board in a “sequester” (first putting that odd word to practical budgetary use).  This established two principles:  First, the target for the appropriators was clearly and unmistakably established.  And second, if the appropriators transgressed, the appropriators and their programs (and not other legislators and their programs) were punished.

Which leads us to the system’s part two, which is “paygo” proper.  Paygo applied collectively to both revenues and entitlements – in other words, to all of the budget except the annual appropriations (and interest on the debt, which of course is truly uncontrollable in the short run).  The rule here was “pay as you go” – that is, if you want to change an entitlement or a tax program in a way that increases the deficit, you must change another entitlement or a tax program to “pay” for it, and undo that adverse deficit impact.  You must “pay as you go.”

Paygo remained in full effect from 1990 through 2000.  It was a success story.  The deficit rose immediately after 1990, which some argued was a failure of paygo.  However, it became clear with the wisdom of hindsight that the economy had fallen into recession in 1990, and that was the source of the budget deficit expansion.  Were it not for the paygo system, the budget would have been far worse.

Then, later in the 1990s, as paygo was followed scrupulously, the budget turned around.  Former Federal Reserve Board Chairman Alan Greenspan, originally a skeptic, later revised his tune and cited paygo as an important advance. By the end of the decade, the budget had improved for eight consecutive years, culminating in three budget surpluses, the last being the largest in history before or since.  In 2001, paygo was waived in the legislative process to enact a large tax cut, the economy fell into recession, and the surplus declined and then morphed back into the deficits that we have endured ever since.  In 2002, paygo was allowed to expire.

So the record indicates that paygo, if obeyed, can work.  Still, you will hear one basic criticism of paygo for the current context.

Back in 1990, the budget was out of balance, but not fundamentally out of control.  Given the up-front savings included in the 1990 deal, if the Congress and President truly did just “pay as you go,” all of the budget projections did indicate that the debt burden would gradually erode.  It was merely a question of establishing and maintaining a standard of deficit-neutral behavior – and paygo did just that.

However, we have fallen much farther from grace today.  If we merely pay as we go, the debt will continue to accumulate faster than our collective income, just as it already is projected to do.  That has led some to conclude that paygo is insufficient and irrelevant, and must yield to another supercommittee.

However, reports of the death of paygo are exaggerated.  I formulated a variation in which the Congress and the President would be required to “pay more than you go,” or in a new name, “save as you go,” or “savego.”  The Congress and the President would be required to enact legislation that would on net cut entitlement spending and / or increase revenues by a specified dollar amount in each future year, not merely achieve a net zero.  Savego was recommended by the Bipartisan Policy Center, and received some attention back in 2011.  Unfortunately, it did not win over the supercommittee, before the supercommittee failed.

Here is how savego could be implemented today:

First, the Congress and the President could agree on a target debt-to-GDP-reduction path.  Actual policy changes could begin two or three years from now, after the economy has time to recover, and after the first years of already-anticipated deficit reduction.

Second, the Congress and the President could choose the path of annual appropriations that they believe is adequate.  That might entail a partial (or even a total) undoing of the unpopular sequester.

Then, third, determined by that target debt-reduction path and target appropriations path would be the necessary amount of savings from the revenue and entitlement categories of the budget – that is, the necessary “savego” savings.  The Congress might well iterate among the debt, appropriations, and “savego” target paths until it found a combination that both political parties would be willing to accept.  All of these amounts of savings would be specified in dollars, and would not change over time.  The Congress needs predictability to be able to make sound policy, and should not be forced to change its targets, up or down, with every wiggle of the economy.

At this late hour, I would not advise the Congress to debate defense versus domestic appropriations levels, or tax increases versus entitlement spending cuts.  Those fights could be fought later, among the committees of jurisdiction, when legislation would be written following the “regular order” – just as legislation was written, year by year, in the 1990s.

As was argued earlier, the budget savings needed truly to solve the long-run budget problem will be a tall order.  There would be important advantages to attacking those problems all at once in a comprehensive package of reform in the income tax, Medicare and Social Security – the major pillars of the budget.  However, that might be more than the Congress can swallow.  Savego would give the Congress a way to attack the problem in installments, without losing sight of the final goal.

So, for example, Savego would schedule required amounts of budget savings year-by-year out into the future.  Suppose that as that schedule of future required savings reached out into future years, the required savings would grow such that the scheduled amount for 2019 equaled $400 billion (a purely hypothetical but not unreasonable number – which likely would follow smaller scheduled savings in earlier years, and greater numbers in succeeding years).  Perhaps the Congress could achieve all of its required future savings in one “grand bargain.”  If so, huzzah.  But suppose instead that next year the Congress were to act, but that it achieved only $250 billion of those $400 billion of 2019 savings.  The savego “scorecard” would be revised to show that there was $250 billion achieved, but another $150 billion left to go.  Thus, the Congress officially could pat itself on the back, but not declare victory and go home.  This is precisely the outcome that we should want.  The financial markets could see that the program was underway, the Congress would have an incentive to do what it could accomplish, and as progress became visible, all would be encouraged to complete the job.

Savego is perfectly compatible with CED’s earlier suggestion to start the deficit-reduction process by refinancing Social Security.  The budget savings from such a step would apply against the savego scorecard, and thereby reduce the targets for further action later on.

The atmosphere in Washington right now is rotten.  Nothing and no one might break the gridlock.  If anything is to succeed, it most likely will be a plan that sets clear targets for responsible authorities in the Congress to do the jobs that they were elected to do.  Savego is one way to do that, building on the paygo system that balanced the budget in the 1990s.  I don’t know of anything that is more likely to succeed in this toxic environment.  It is worth a try.

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