Copyright 2002 Federal News Service, Inc. Federal News Service
January 29, 2002, Tuesday
SECTION: PREPARED TESTIMONY
LENGTH: 3582 words
HEADLINE:
PREPARED TESTIMONY OF ROBERT D. REISCHAUER*
BEFORE THE SENATE BUDGET COMMITTEE
SUBJECT - FRAMING THE BUDGET DEBATE FOR THE FUTURE
JANUARY 29, 2002
BODY: Mr. Chairman and Members of the Committee, I
appreciate this opportunity to discuss with you some of the challenges facing
the Congress this year as it makes its decisions about the fiscal 2003 budget.
This statement:
- reviews the latest baseline budget
projections and suggests that the baseline may be outside the range of
politically attainable paths;
- draws some
straightforward lessons from the sharp and unexpected deterioration in the
budget outlook over the past twelve months;
- argues
that fiscal discipline remains important and that Congress should revise and
extend the procedures and mechanisms that facilitated budgetary restraint during
the 1990s; and
- makes the case for augmenting the
fiscal flexibility available to future lawmakers by modifying the provisions of
the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). What a
difference a year can make!
When the Congressional
Budget Office(CBO) released its baseline budget projections a year ago, they
showed growing surpluses over the 2002-11 period in both the unified budget and
the onbudget accounts, surpluses that cumulated to $5.611 trillion and $3.122
trillion, respectively, over the ten years (see Chart 1). For many who had
struggled through the dark decades of large and seemingly intractable deficits,
CBO's January 2001 projections were like passing through the pearly gates to the
promised land of fiscal plenty. Resources appeared to be available to address
many of the nation's priorities simultaneously--to reduce tax burdens,
strengthen defense, modernize Medicare, expand aid to education, reduce the
ranks of uninsured, help farmers, boost national saving and so on. Spirited
debates even developed over the maximum feasible pace at which debt held by the
public could be retired and the investment dilemma Treasury would face when
government ran surpluses after all of the public debt had been retired.
Last week, CBO released its latest baseline projections
before this Committee. In sharp contrast to those of a year ago, they showed
unified budget deficits for 2002 and 2003 and deficits in the on- budget
accounts through 2009 (see Charts 2 and 3). The cumulative unified budget
surplus for the 2002-11 period had shrunk to $1.601 trillion and the on-budget
accounts were projected to have a cumulative deficit of $742 billion over the
period (see Chart 1).
(NOTE: GRAPHS IS NOT
TRANSMITTABLE)
CBO carefully enumerated the factors
behind the sharp deterioration in the baseline outlook. Over the short run--2002
and 2003--the changed economic forecast is the dominant explanation, accounting
for 40 percent of the deterioration (see Chart 4). In the later years, the
revenue loss attributable to EGTRRA and the associated debt service dominate,
accounting for half of the total deterioration in the baseline budget outlook in
the 2009-11 subperiod.
While CBO's more pessimistic
projections of January 2002 represent a sharp contrast to those it made a year
earlier, they need to be kept in perspective. Notwithstanding the wailing of
those who would like to convey a sense of extreme fiscal crisis, the new
projections do not foretell a return to the budget dynamic of the 1980s and
early 1990s when, unless Congress took steps to curb the growth of spending or
raise revenues, already large deficits would grow inexorably. Under the baseline
scenario, relatively small deficits, which should cause little concern while the
economy remains weak, turn into surpluses as the economy strengthens. This means
that, if the economy unfolds along the path expected by most economists, the
budget will not get mired in large deficits again unless the 107th Congress and
its successors pass legislation that reduces revenues or increases spending
above baseline levels. However, as you know better than I do, it will be very
difficult to adhere to the fiscal restraint implicit in the baseline and so the
baseline projections may prove to be a somewhat misleading indicator of the
attainable, let alone the likely, future budget outlook. Rarely have the
policies underlying the baseline projections been as disconnected from the
policy makers' agendas as they are today. The rules and conventions that govern
the construction of the baseline budget appropriately do not take into account
the partially completed business before the Congress, provisions of the tax code
that expire but are likely to be extended, or initiatives with bipartisan
support that seem highly likely to be enacted soon. A short list of such items
before the 107th Congress would include the farm bill, a fiscal 2002
supplemental for defense and homeland security, extension of expiring provisions
of the tax code, and adequate resources to cope with natural disasters. The
rather sanguine picture that the CBO baseline portrays for the second half of
the decade deteriorates moderately if one adds to the CBO baseline reasonable
amounts for these priorities. This scenario is portrayed, in a very rough
fashion, in Charts 1 through 3 by the bars and lines labeled "more realistic"
projection. While the non-Social Security accounts remain in deficit throughout
the projection period, small unified budget surpluses still characterize the
second half of the ten-year projection period.
Abstracting from the uncertainty surrounding budget projections, even
this picture is probably too optimistic. It does not encompass an economic
stimulus package, the possibility that Congress might increase payments to
Medicare providers above baseline levels as MedPAC has recommended, a Medicare prescription drug benefit, or added resources for
defense, NIH, Amtrak, those without health insurance, and other perceived
priorities. Of course, above- baseline spending in these areas could be financed
by restraining spending in other programs below baseline levels and by closing
so called tax loopholes. However, such tradeoffs are likely to be difficult in
the current political environment where majorities are narrow and bipartisan
consensus on policy matters elusive. In short, even without considering the
unforeseen needs that inevitably will emerge as the decade unfolds, it will be a
challenge just to maintain balance in the unified budget after the economy
recovers from the recession.
Lessons from 2001
The experience of the past 12 months provides a textbook
example of the uncertainties inherent in budget projections and underscores why
such projections should be used with utmost caution when pushing forward
legislative agendas.
The budget outlook changed
dramatically from that assumed in the January 2001 CBO baseline for three
reasons. First, there was a deliberate, major policy change--the enactment of
the Economic Growth and Tax Relief Reconciliation Act of 2001--in June. This
legislation reduced revenues and increased debt service costs by some $1.7
trillion over the 2002-11 period. It also preemptively provided beneficial
fiscal stimulus to an economy that was sliding into recession and introduced
considerable uncertainty in the future fiscal picture.
This uncertainty derived from the act's failure to extend the many
provisions of the tax code that expire between 2002 and 2010, its creation of
two new provisions (AMT relief and a deduction for education expenses) that
terminate at the end of 2004 and 2005, respectively, and its "Cinderella's
coach" provision which has the tax code revert, not to a pumpkin, but to its
pre-EGTRRA structure at midnight on December 31, 2010.
Second, contrary to the expectations of CBO, OMB and most economists in
January 2001, the economy slid into a recession that the NBER has determined
started in April 2001. The recession reduced the growth rate of nominal GDP for
2001 by 1.5 percentage points below CBO's expectations and caused a sharp drop
in corporate profits. The continued slide in stock market values reduced capital
gains realizations and the value of stock options. These developments depressed
revenue growth.
In July, when the Bureau of Economic
Analysis issued revised national income and product account figures, it lowered
its estimates of nominal and real GDP growth, investment, productivity increases
and corporate profits for the 1998-2000 period. These revisions have cause some
economists, CBO included, to dampen a bit their expectations about the economy's
long-run growth potential. Less robust growth in the short and long run has
reduced projected levels of nominal GDP and future budget surpluses.
Finally, the terrorist attacks of September 11 caused a
sharp shift in the nation's priorities. The needs associated with an active
military engagement abroad, the destruction and loss of life in New York, the
Pentagon, and Pennsylvania, and increased homeland security and antibioterrorism
measures became paramount. The president and Congress responded by appropriating
for fiscal 2001 and 2002 tens of billions of dollars above baseline levels to
meet these new priorities. And these amounts were viewed as only a down payment
on a longer-term commitment.
One clear lesson that can
be drawn from the experience of 2001 is that there is no way to predict with
certainty today the nature or magnitude of tomorrow's priorities. This suggests
that, in long-run budget planning, Congress should leave a considerable margin
of fiscal flexibility for future lawmakers. A second lesson is that the strength
of the economy, which has such a crucial impact on the budget, is not only
impossible to predict with any certainty over the long run but also can be
difficult to forecast accurately even in the short run. This second bitter pill
suggests that Congress should exercise caution in its budgetary decisions,
especially when the economy seems to be approaching a peak or trough in the
business cycle.ablishing a framework for the budget debate
Not only has the budget outlook changed dramatically over the past
year, but the consensus framework in which budget issues were debated has
dissipated and some of the procedures that restrained profligate behavior during
the 1990s have expired. These developments will make it more difficult to
maintain fiscal discipline in the future. Nevertheless, for several reasons,
fiscal restraint should remain an important, if not paramount, goal of policy
makers. First, healthy growth and economic stability are more likely if the
federal government is not running large and persistent budget deficits. Second,
the nation will be better able to cope with the unavoidable challenges posed by
the aging of the population if fiscal discipline is maintained and the
government is not saddled with large and growing debt service obligations when
the baby boomers begin to retire. Third, policy choices tend to be more rational
and debate less contentious when fiscal discipline prevails. In an environment
of persistent deficits, policies designed to address the nation's problems often
are constrained or distorted and, therefore, less effective. Symbolic rather
than substantive responses to problems are too often adopted. Finally, policy
makers are less likely to resort to procedural gimmickry--such as Constitutional
amendments requiring a balanced budget and lock box prescriptions--if fiscal
discipline is maintained.
The first step policy makers
need to take to reestablish a framework for the budget debate is to agree on an
appropriate fiscal goal for the nation. From the end of World War II through the
early 1960s, the consensus fiscal goal of policy makers was to balance the
administrative budget, a target attained in 6 of the 16 years from 1947 through
1962. From the mid 1960s through the late 1970s, the goal was refined to be
balancing the unified budget over the business cycle. In other words, deficits
would be tolerated when the economy was operating significantly below its
capacity but surpluses would be expected when the economy's resources were fully
utilized. Only once during this period was the target achieved. As deficits
persisted and grew, the goal became balancing the unified budget no matter what
the state of the economy, a goal that was finally achieved, quite unexpectedly,
in fiscal 1998.
When rapid economic growth, a soaring
stock market and political gridlock combined to generate surpluses in the
government's non-Social Security accounts in fiscal 1999, policy makers began to
consider raising the bar. By January of 2001, a broad bipartisan consensus had
developed around the notion that, at a minimum, the nation's fiscal goal should
be to balance or maintain small surpluses in the non Social Security accounts
while devoting Social Security's surpluses to debt retirement or structural
program reform. Some wanted to go farther and wall off the Medicare Hospital
Insurance surpluses for debt reduction or Medicare reform. Lock box proposals,
which the sponsors claimed would realize these goals, proliferated.
After September 11 discussions about the appropriate
fiscal goal for the nation ceased. Nevertheless, the Budget Committees should,
as part of their consideration of the fiscal 2003 budget resolution, attempt to
develop a consensus around a long-run fiscal goal for the nation. It could be to
balance the unified budget, achieve balance in the non Social Security accounts,
or meet some other target. Of course, no single goal is analytically right or
economically optimal. The choice of a target depends on judgments--how one
values present versus future needs, how one values public versus private goods,
and what one thinks is politically sustainable. What may be the appropriate goal
for the current decade may be quite different from that which makes the most
sense for the next ten years. While the CBO projections suggest that Congress
will find it challenging just to sustain balance in the unified budget, I would
urge you to set your sights higher and strive to maintain unified budget
surpluses of 1 percent to 1.5 percent of GDP during good economic times.
Maintaining balance in the non-Social Security budget would be a slightly more
ambitious goal, but one with more political appeal.
Once a fiscal goal is agreed to, procedures must be established to
achieve and sustain fiscal discipline. During the 1990s, this was accomplished
through enactment every few years of multi year deficit reduction packages whose
terms were enforced by discretionary spending caps and pay-as-you-go (PAYGO)
restraints on mandatory spending and revenue measures. The system worked fairly
well from fiscal 1991 through fiscal 1998 because the spending caps were
achievable in the post Cold War environment, fear of deficits loomed large, the
economy was strong, and political gridlock prevailed. After 1998, the
effectiveness of this approach deteriorated. The spending caps established by
the 1997 Balanced Budget Act, which called for real reductions in discretionary
spending of roughly 10 percent between 1998 and 2002, were politically
unsustainable in an era of growing surpluses. The payment reductions imposed on
Medicare providers were too deep for many to absorb at a time when their costs
were beginning to rise rapidly and payments from other sources were constrained.
And so Congress flouted the restraints of the Budget Enforcement Act.
Nevertheless, gridlock on major initiatives and a strong economy kept the
surpluses growing through fiscal 2000.
Notwithstanding
the record of the past three years, experience suggests that multi-year
discretionary spending caps and PAYGO restraints can serve useful roles if
Congress wishes to adopt procedures that lead to the attainment of a specific
fiscal goal sometime in the future. Prospectively establishing caps on
discretionary spending several years in advance would almost certainly restrain
spending below the levels that would result from a process in which limits were
set annually through the budget resolution. To be effective, however, spending
caps and PAYGO restraints must be realistic-they must reflect the overall budget
situation, the fiscal goal, and changes in the political consensus. Both
restraints must be flexible enough to accommodate the vicissitudes of the
budget--they must be able to bend, but not too much.
Should the budget outlook improve markedly to the point where the
fiscal goal was likely to be exceeded--the situation Congress faced in early
2001--some more sophisticated process than that of the Budget Enforcement Act
would be more appropriate.
Elsewhere I have suggested
that, under such circumstances, it would be prudent to limit each Congress'
ability to encumber future surpluses that were projected to exceed the fiscal
goal. For example, if the goal were to maintain balance in the non Social
Security portion of the budget and CBO's baseline projections showed large and
growing on-budget surpluses, the budget resolution would be required to place
limits on spending and revenue legislation so that new initiatives absorbed no
more than 80 percent of the surpluses projected for the next two years, 70
percent of the surpluses projected for the following two years---on down to 40
percent of the surpluses projected for years nine and ten. Such a calibrated
system recognizes that the uncertainty that surrounds budget projections
increases the farther in the future one projects. It also reflects the reality
that today's lawmakers may not be the best judges of the nation's needs five or
ten years hence. If future legislators are left with some significant fiscal
flexibility, they will be able to address the nation's problems without raising
taxes, reducing spending on necessary programs, or increasing the deficit.
Developing fiscal flexibility for the future
Realistic estimates of the budget outlook, such as those
discussed earlier in this statement, suggest that it will be a challenge to
attain and then maintain balance in the unified budget if lawmakers complete the
unfinished business before the 107th Congress. In other words, little if any of
Social Security's surpluses will be available to pay down debt or invest in
structural entitlement reforms over the next ten years. And nothing will be
available for emerging priorities. In short, taxes will have to be raised,
program spending cut, or unified budget deficits tolerated to address future
problems.
Congress could avoid placing future policy
makers in this painful predicament by adopting measures now that create greater
fiscal flexibility in the future. The most straightforward approach would be to
modify the provisions of the EGTRRA. From its enactment, this legislation was
incomplete and required further action. The provisions that provide AMT relief
and deductions for educational expenses terminate in mid-stream, and the entire
act sunsets after 2010. With the deterioration in the long-run budget outlook
and the emergence of new priorities, the uncertainty surrounding the level of
tax relief that the nation will conider prudent after 2010 has increased. To
eliminate this uncertainty, consolidate the tax cuts that have already been
implemented, and create greater fiscal flexibility for the future, it would be
judicious to index and make permanent all of the currently effective provisions
of EGTRRA and put the provisions that are not yet implemented on hold. As
Congress debates the disposition of any future surpluses that exceed the
agreed-upon fiscal goal, it would be free to activate the various frozen
provisions. But they would have to compete with other national priorities for
the available resources.
Very rough estimates suggest
that this proposal would provide well over $300 billion in increased fiscal
flexibility over the 2003-12 period relative to the CBO baseline. Compared to a
scenario in which the AMT relief and education expense deductions are extended
and EGTRRA is made permanent after 2010, the savings could well exceed $600
billion. A very rough idea of how this proposal would change the non-Social
Security budget outlook is provided in Chart 5. Rather than facing continued
budget deficits as depicted in the "more realistic" baseline scenario, on budget
surplus would reemerge after 2010. These surpluses could be used for further tax
cuts or other national priorities.
Some will
characterize this proposal as a tax "increase." In fact, for both for 2003 and
for the period after 2010, it represents a reduction in tax burdens imposed by
current law. In addition, throughout the whole period, indexing the bottom
bracket would provide tax relief, relative to current law, to the majority of
taxpayers who face the bottom two marginal rates.
Conclusion
The budget outlook is not as rosy
as it was 12 months ago. Notwithstanding the deterioration that we have already
seen, the nation is in a far stronger fiscal position than it was anytime from
the late 1970s through the mid 1990s. If the nation slips back into serious
budget difficulties, it will be because of decisions yet to be made. With so
many outstanding promises, however, it will be difficult to make the tough
decisions needed to keep out of such difficulties. To strengthen its resolve and
structure its actions, the Congress needs to lay out a clear fiscal goal for the
nation and revise the budget process so that it can help attain that
objective.(NOTE:GRAPHS IS NOT TRANSMITTABLE.)
FOOTNOTES:
* President of The Urban Institute.
The views expressed in this statement should not be attributed to the Urban
Institute, its sponsors, staff, or trustees.
Document 97 of 223. 