Lawmakers Must Abide by PAYGO...Here's Why

In recent weeks, we've used our blog to call for strict adherence to pay-as-you-go (PAYGO) principles for extending emergency unemployment benefits, offering sequester relief, extending the doc fix, and continuing the so-called tax extenders. Some have questioned whether abiding by PAYGO is truly necessary given the potential benefits and worthiness of many of these short-term policy extensions. With the economy still weak and many of these extensions assumed to occur anyway, the argument goes, policymakers should waive PAYGO rules to ease passage of the legislation.

In our view, this would be a huge mistake. In a world where current law budget projections have the debt on an unsustainable upward path, PAYGO is the right policy for the economy, the budget, and the government’s credibility. While putting debt on a downward path should be the ultimate focus, PAYGO at least helps policymakers to maintain fiscal discipline. PAYGO won’t solve our fiscal problems, but at least it can stop them from getting worse. 

The Economic Case for PAYGO

Some advocates have argued for waiving PAYGO in order to enact pro-growth policies. Although its true that some deficit-increasing policies can improve growth -- by providing short-term stimulus or encouraging long-term work and investment -- paying for these policies would strengthen that pro-growth impact. Higher debt levels slow economic growth over the long-run and lack of fiscal sustainability can even sometimes have a negative short-term impact.

Recently, we criticized a plan to repeal 60 percent of the sequester on a deficit financed basis, even though we believe that sequestration represents an "anti-growth" way to reduce the deficit. Though counterintuitive, this is entirely consistent. Repealing 60 percent of the sequester would increase the size of the economy by about $45 billion in 2014 at a budgetary cost of $700 billion through 2023. Thought of another way, deficit-financing this partial sequester repeal would mean increasing debt by 2.6 percent of GDP in order to increase the size of the economy by only 0.3 percent. Moreover, this temporary economic boost will fade and reverse. CBO rules of thumb suggest that by 2023, this partial-sequester repeal would reduce the size of the economy by about 0.3 percent, and that number would grow substantially over time.

^{Source: CBO, CRFB calculations}

The Fiscal Case for PAYGO

Abandoning PAYGO for the extension of current policies would substantially worsen the fiscal situation. Assuming war spending is drawn down and hurricane Sandy spending does not continue, current law would result in debt levels of about 68 percent of GDP by 2023 with debt rising by an average of less than half a percentage point of GDP per year in the early 2020s. If, on the other hand, policymakers violate PAYGO to waive the sequester, SGR, and extend the refundable tax credits (as in the "CRFB Realistic Baseline"), debt will rise to 73 percent of GDP by 2023, an average increase of about 0.8 percent annually in the 2020s.

Of course, because PAYGO does not require all offsets take place in the "same year," the fiscal implications of abiding by PAYGO are not the same as abiding by current law. For example, policymakers could temporarily extend expiring provisions one year at a time and pay for them over the following ten years. In this case, debt would be somewhat lower and grow somewhat more slowly than under the CRFB Realistic Baseline -- though the situation would be worse than if provisions were allowed to expire. We ran one illustrative example, which would extend doc fixes and other expiring provisions, and it would bring debt levels to roughly 71 percent of GDP by 2023, and the debt would be growing by roughly 0.5 percent of GDP annually in the early 2020s.¹

On the flip side, using PAYGO rules to pay for these extensions all at once -- offsetting ten years of front-loaded policies with ten years of more gradual reforms -- could have the potential to actually improve the fiscal situation. We ran one illustrative example, which would replace these policies with a savings path similar to proposals from the President's budget.  Under this scenario, the debt would fall to below 68 percent of GDP by 2023, keeping it roughly flat later in the decade.² 

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^{Source: CBO, CRFB calculations}

The Fiscal Credibility from PAYGO

In addition to the economic and fiscal benefits of PAYGO, this rule helps with our fiscal credibility. This is especially true for repealing the sequester without offsets, which would show that lawmakers cannot even stick to the deficit reduction they have agreed upon.

As we pointed out in June, the rating agencies do not even see the sequester status quo as sufficient to quell concerns about debt. This perception is sensible. Our debt is currently twice its historic average as a share of the economy, the highest it has been since World War II, and projected to keep growing in the coming years and decade. In short, our debt problems are still far from solved.

Despite this, the markets are currently giving us the benefit of the doubt. Interest rates are low, and there is still a belief that the United States will do the right thing before it is too late. It's not clear that perception will last forever, particularly if we continue to violate our fiscal rules. And if the United States loses its fiscal credibility, the economic consequences could be severe.

* * * * *

Policymakers should enact a plan to put the debt on a clear downward path relative to the economy. In the meanwhile, they should at minimum prevent the fiscal situation from getting worse by adhering to strict PAYGO rules relative to current law. Adhering to PAYGO is the right economic policy, the right fiscal policy, and the right thing to do to maintain our country's fiscal credibility.

^{1 Illustrative scenario assumed that annual doc fixes, sequester relief, and expiring tax measures are extended for a year but paid for over the following ten years. The assumed savings are gradual.}

^{2 Illustrative scenario assumed that annual doc fixes, sequester relief, and expiring tax measures are extended for ten years and fully offset over those ten years. The assumed savings take the 28 percent limitation on deductions, the chained CPI, and the health care savings from the President's budget and scale them up to the level of the costs of the extensions.}