Understanding Cut, Cap, and Balance

Understanding Cut, Cap, and Balance

Sometime this week the House of Representatives will consider Rep. Jason Chaffetz’ H.R. 2560, the “Cut, Cap & Balance Act.”

We are entering the arcane world of budget process, so this could be tough sledding. I will do my best to distill the essential elements and simplify it.

The key to understanding this bill is that it focuses on government spending, rather than on taxes or deficits. The bill would achieve significant deficit reduction through cutting and limiting spending, and all of its mechanisms use spending rather than deficit targets.

Surprise, surprise: the bill consists of three parts.

  1. Cut – The bill provides specific numbers to limit both discretionary and mandatory spending for FY12. These numbers would drive further Congressional action this year or else force a Presidential sequester. (I explain a sequester below.) The intent of this section is to force Congress and the President to cut spending immediately.
  2. Cap – The bill would establish a new enforceable limit on total federal spending as a share of the economy. The new caps are designed to phase federal spending down to just below 20% of GDP by FY17 and then hold it there through the end of a 10-year budget window in FY21. Put more simply, this is a new enforceable aggregate spending cap.
  3. Balance – The bill would increase the debt limit by $2.4 trillion after the House and Senate have passed a Balanced Budget Amendment (of a certain type).

What is a sequester?

A sequester is an automatic across-the-board proportional spending cut written into law and implemented by the Office of Management and Budget (OMB). It is usually combined with some kind of budget target and designed as a backup measure to force legislative action to hit that target.

Example

Imagine there are 10 government programs that spend $50 each. Congress passes and the President signs a law that includes a spending target of $490, a deadline of December 31st, and an across-the-board sequester.

If new laws are not enacted by December 31 to reducing spending to $490, then the sequester kicks in. OMB cuts all 10 programs by whatever percentage is needed to hit the target. In this case, each $50 program is cut by 2%, to $49, to hit the aggregate spending target.

If the new law were to exempt five of the 10 programs from the sequester, then the remaining programs would be subject to a 4% cut to hit the same spending target.

If Congress doesn’t like the results of an anticipated sequester, they can and should enact a new law before December 31 which hits $490 in a different way. They could cut one program by 20% ($10) and leave the other 49 programs untouched, for example.

Types of sequesters

There are discretionary sequesters which apply to programs that face annual appropriations.

There is a mandatory sequester, which is designed to apply to mandatory/entitlement spending.

Or you could do a spending sequester which applies to both discretionary and mandatory spending.

In March the President floated the idea of a sequester that would raise taxes as well as increase spending.

The challenge: exemptions

The hard part of designing a sequester mechanism is rounding up the votes for a bill that includes an automatic across-the-board cut. Members of Congress will say, “I support your spending target, and I support the hammer of creating a sequester, but I can’t vote for it if the sequester would cut X. Give X an exemption from the sequester and I’ll vote for your bill.”

The exemptions to the sequester are the key that shapes subsequent Congressional negotiations. If your spending priorities are exempted from the sequester, then you have less incentive to cut a deal after this new law is in effect. You have leverage in the negotiations.

In addition, Members expose themselves to political risk when they vote for the creation of an across-the-board sequester. This is why all mandatory sequesters enacted so far have exempted Social Security, even though Social Security is the largest component of mandatory spending.

The spending limits in Cut and Cap

I support the numeric spending targets in the Cup and Cap sections. For me the most important number is “below 20% of GDP” in the cap section. I think that’s the right target, and it is the primary reason I support this bill.

For comparison:

  • Federal spending in the 50 years preceding the Obama Administration averaged 20.2% of GDP.
  • Federal spending in 2009 hit an all-time post-WWII high of 24.7% 28.5% of GDP.
  • Under the President’s original budget, it would be 23.6% this year, 22.7% in 2013, and then begin a steady climb to 24.5% of GDP at the end of the decade in 2021. Since the President didn’t provide detail with his second round budget, I can’t provide parallel figures for that.
  • The 23.6% figures means federal spending will be 15% larger, measured as a share of the economy, then it has historically been.

Those extreme spending shares are the result of several factors: higher automatic stabilizer payments in a weak economy, government actions like stimulus laws and ObamaCare, and long-term entitlement spending trends that build gradually over time.

Anticipating the replies from my left-of-center friends, yes, I am willing to make whatever changes are needed to the big 3 entitlements to stay within this cap. I would rather change the nature of future government benefit promises than see the private sector shrink.

The sequesters in Cut and Cap

Most Members of Congress complain that automatic sequester mechanisms include programs they don’t want to cut. I have the opposite complaint – the sequesters in this bill exempt too much. In particular, both the mandatory sequester in the Cut section and the across-the-board sequester in the Cap section exclude Social Security, Medicare, military personnel, and interest costs. While military personnel costs would rank high on my list of spending priorities, I think the best sequester mechanisms apply to all non-interest spending.

In particular, we need to address spending trends in the big three entitlements. By exempting Social Security and Medicare from the sequester, this bill makes it that much harder for Congress to bite the bullet and make needed changes in both programs. It is easy to understand the legislative necessity that drove this decision, but it’s a big policy mistake nonetheless.

At the same time, these sequester mechanisms are much better than past ones enacted into law, which exempted hundreds of programs from the across-the-board cut. A well-designed sequester is not supposed to be the mechanism that cuts spending. It is supposed to be the forcing mechanism that convinces Congress to make decisions to cut spending. If you exempt too much, then the incentive placed on Congress is even weaker.

Debt limit – Balanced Budget Amendment

It is important to understand that the debt limit increase in this bill is not just tied to any Balanced Budget Amendment to the Constitution, but to one which meets certain parameters. The BBA must not just guarantee a balanced budget. It must also limit spending as a percent of GDP as in the Cap section of this bill, and it must raise the legislative bar for tax increases to a two-thirds vote of both the House and Senate.

It might therefore be more appropriate to think of this as a “Balanced Budget through Spending Cuts Amendment.”

I support balancing the budget through cutting spending rather than raising taxes. I don’t feel strongly either way about whether or not this should be enshrined in the Constitution. I lean a little against, because I hate messing with the Constitution.

All that is irrelevant, however, because even if this kind of BBA did pass both Houses of Congress, it would take many years for three-fifths three-fourths of the States to ratify it as an amendment to the Constitution. Federal budget problems are upon us now – we can’t wait for a Balanced Budget Amendment to be ratified. While this part of the bill is useful to make a point, I fear it serves as a distraction from actually cutting spending.

Since Congress will not pass a Balanced Budget Amendment through both Houses in the next two weeks, and since this section makes a debt limit increase contingent upon such passage, I have a big problem here. That problem is solved as long as some other bill becomes law soon to increase the debt limit.

Summary of my views on Cut, Cap, and Balance

I recommend supporting this bill even with its significant imperfections. I place enormous value on the creation of an enforceable cap on total government spending.

Good

  • Focuses on the problem I think needs to be solved: too high and too rapidly growing government spending;
  • Cuts spending 2012 and creates a sequester to enforce those cuts;
  • Caps federal spending below 20% of GDP and phases down to that over a few years;
  • Creates a sequester mechanism to force spending cuts to hit those levels;
  • The mandatory spending sequesters are far broader and therefore superior to those enacted in the past; and
  • The form of the Balanced Budget Amendment, which would drive spending cuts rather than tax increases, is good.

Bad

  • The sequester exempts too much, and in particular it exempts the two largest entitlement spending programs, Social Security and Medicare. If enacted, this bill might make it legislatively harder to reform these two programs. That’s a huge problem.
  • While it appears to increase the debt limit, it sets conditions that won’t be met in time. This problem is solved as long as some other bill becomes law soon to increase the debt limit.
  • I lean against amending the Constitution, even for a Balanced Budget Amendment whose form I like. And the legislative reality means time spent on a BBA could be better spent trying to cut spending.

No bill is perfect. In my view, the good far outweighs the bad in this bill.

(photo credit: Alan Bedenko)

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