CBO Makes the Case for Strict Pay-As-You-Go (PAYGO) Rules

In their recent Long Term Outlook, CBO shows the nation to be on an unsustainable fiscal path if we continue our current policies. Under its Alternative Fiscal Scenario, debt reaches 100 percent of GDP by the end of the decade and 200 percent by 2037.

However, some have rightfully pointed out that the situation looks much better under their current law scenario -- that is, if politicians allowed everything scheduled into law actually occur. As Ezra Klein wrote on the matter, last week:

We have a congress problem, not a deficit problem. The deficit only explodes if the next few congresses vote to detonate it. Congress doesn't have to extend the Bush tax cuts without offering offsets, or put off the Medicare cuts without paying for them in other ways, or do the easy parts of the health-care law without doing the hard parts.

And indeed he is correct. We ran the numbers on a scenario in which policymakers kept to current law on mandatory spending and revenue, held regular discretionary spending growth to inflation, and allowed for a gradual drawdown of troops in Iraq and Afghanistan, and in this scenario found that debt would fall to 67 percent of GDP by 2020 and continue to fall toward 55 percent by 2050.

A major reason for this improved debt situation has to do with the expirations of the 2001/2003 tax cuts at the end of 2013 (the Alternative Fiscal Scenario assumes the cuts are continued through 2021 and then revenue is frozen as a percent of GDP). However, other factors also weigh heavily. For example, if policymakers allowed the tax cuts to expire but continued to enact AMT patches and Doc Fixes as they always have, debt would fall to only 71 percent of GDP in 2020, and would grow after that reaching 100 percent by 2050. If the recently-passed health reform legislation were unsuccessful in controlling costs after 2021 -- as many experts suspect they may be -- debt would rise to 120 percent by 2050.

Compared to current policy (as reflected in the Alternative Fiscal Scenario), of course, all these scenarios are a major improvement. That doesn't mean that sticking to current law would be desirable, though. If politicians continued to abide by current law, it would mean the following:

• Marginal income tax rates would go up across-the-board, ranging from 15% to 39.6% instead of 10% to 35%. The average effective marginal rate would increase from 25% today to 35% by 2035.
• Revenue as a whole would rise from the historical average of about 18 percent of GDP to about 23 percent in 2035 and 26 percent by 2050.
• Physicians payments under Medicare would drop immediately by 30% and continue to fall thereafter.
• The Alternative Minimum Tax would no longer be patched, and so instead of impacting less than 3 percent of families as it does today, it would impact 11 percent of families in 2013, 22 percent by 2020, and nearly 50 percent by 2035.

An observer could make the case that these policy changes are undesirably sudden, will weaken the economy, and represent a departure from where we have been historically. More to the point, they are unrealistic -- and most will never happen.

But there is a solution. If current law (with a war drawdown) leads to sufficient debt levels, but not necessarily the right policies, then budget process can be used to keep the country on a sustainable path. Strict Pay-As-You-Go (PAYGO) rules, which call for every tax cut and spending increase to be fully offset, could help to put the country back on track.

Want to renew the tax cuts? Fine, identify tax expenditure and/or spending cuts to offset the cost. Want to avoid cutting physician payments? OK, make other policy adjustments to make the make up the difference. Can't find offsets you are willing to make? Then the policy was probably not important enough to continue in the first place.

Simply offsetting policies on a one-off basis might not necessarily be the best strategy to achieve the goal of getting the debt under control, since it might make it more difficult to focus on long-term entitlement growth (or on discretionary caps and Social Security, which are not technically covered under PAYGO). But the principle of paying for everything we do, including expiring provisions, should be there.

And while we are at it, PAYGO has been biased in how it treats taxes and spending for too long. Extensions of entitlement programs such as the Farm Bill must also be subject to the same budgetary hurdle.

If we can make rational tax and spending choices with the current law debt path as a starting point, it would go a long way to bringing our debt under control. If we can't even stop ourselves from making things worse, the prospects for making things better seem grim.