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January 10, 2013
Failed Discipline and Planned Disasters
Joseph J. Thorndike

Full Text Published by Tax AnalystsTM

This article is drawn from remarks to the conference "Explaining Fiscal Performance: An International Study," held January 6 and 7 at Keio University in Tokyo.


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Fiscal nostalgia is endemic among U.S. politicians of a certain age. In the face of today's large and unaddressed long-term fiscal gap -- not to mention the late and unlamented fiscal cliff -- aging politicos have invoked the lessons of an earlier, more disciplined budgetary era. They insist that once upon a time, lawmakers refused to tolerate oceans of red ink; faced with an unsustainable fiscal future, they made hard decisions in the political present.

That nostalgic narrative casts today's political leaders in a poor light. "Where have the heroes gone in the fiscal cliff debate?" bemoaned one out-of-office veteran recently.1 By implication, real heroes make real compromises. Of course, ideological intransigence pays political dividends, especially in an era of hotly contested primaries and uncompetitive general elections. But the United States won't solve its budget problems until politicians relearn the lost art of bipartisan compromise, according to fiscal oldsters.

There is an element of truth to this fiscal storytelling, at least as far as the issue of fiscal declension is concerned. Over time, U.S. budgets have grown less "responsible," if responsibility can be measured by the size of a nation's annual budget deficit. Between 1950 and 1968, the United States ran an average deficit of 0.6 percent of GDP; from 1970 to 2011, the shortfall averaged 2.9 percent of GDP. Even excluding the extraordinary deficits associated with the 2008 recession, the deficit averaged 2.4 percent of GDP between 1970 and 2007 -- quite a bit more than the early postwar decades.2

But averages can obscure more than they illuminate. In U.S. fiscal history, deficit averages can hide significant policy shifts, with short periods of shrinking deficits overwhelmed by long periods of growing ones. In fact, since 1970 the overall growth in deficit finance has been punctuated by at least two distinct periods of shrinking shortfalls or even budgetary surpluses, the first running from 1985 to 1989 and the second from 1993 to 2001.3

These episodes of fiscal consolidation -- to use the term popular among fiscal analysts these days -- were the product of both economic growth and intentional policy reform. There may, moreover, be a causal link connection between these two phenomena, with economies growing smartly in response to wise policy adjustments. Or there may be no real connection at all. Cycling economies have a way of making politicians look smart, at least some of the time.

What is certain, however, is that economic performance has been a key factor in prompting fiscal consolidation. Both periods of post-1970 fiscal improvement have come in the wake of a recession, as shrinking revenues have created large and growing budget deficits.

More specifically, fiscal consolidation has been triggered when annual budget deficits have exceeded 3 percent of GDP, and they have intensified when shortfalls have reached 4 percent of GDP. The fiscal consolidation of the mid- to late-1980s, for instance, developed after a run of deficits averaging just under 5 percent of GDP. Similarly, the fiscal consolidation of the mid- to late-1990s developed after a string of annual deficits that averaged 4.4 percent over a three-year period.4

If the past can give us clues to the future, then the United States may again be heading for a period of fiscal consolidation, or at least attempts at budgetary reform. The recession pushed annual deficits to extraordinary heights (with some help from deliberate programs of fiscal stimulus) -- between 2008 and 2011, deficits averaged 7.8 percent of GDP. To date, these deficits have not produced meaningful improvements in annual budgetary shortfalls or long-term fiscal projections. But they have encouraged a crisis atmosphere, which in turn has put fiscal consolidation at the center of political debate.

The recent debate, moreover, has prompted a search by policymakers for some sort of structural budgetary reform. Discouraged by the political stalemate over fiscal policy, politicians have been looking for new means to break the legislative logjam. The crisis over the fiscal cliff is only the most recent example. For several years, policymakers have experimented with a series of legislative expedients -- including both special commissions and a few planned disasters -- designed to serve as sources of budgetary discipline.

Indeed, the search for mechanisms of fiscal discipline has been a recurring feature of U.S. fiscal policy since 1970, especially during periods of fiscal consolidation. The 1980s, for instance, gave birth to the Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Control Act of 1985 (GRH) -- an ambitious effort to change the political dynamics of deficit reduction that dominated fiscal policymaking through the early 1990s.

Similarly, the fiscal consolidation of the 1990s brought still another attempt at budgetary innovation, enacted principally in the Omnibus Budget Reconciliation Act of 1990. Both GRH and OBRA 1990 played a vital political role in these two episodes of fiscal consolidation, although the actual efficacy of either measure as a deficit control device is unclear.

Do They Work?

By most accounts, GRH was a failure. Between fiscal 1986 and fiscal 1990, Congress missed deficit targets every year. The overages ranged from $5 billion to $205 billion, getting much worse over time. Critics argued that even the law's modest improvements were essentially illusory, the product of budget gimmickry rather than genuine fiscal reform.5

Indeed, even one of the law's original sponsors despaired of its efficacy. "I'm filing for divorce on grounds of infidelity and irreconcilable differences," declared former Sen. Ernest F. Hollings.6 A key Republican staffer from the era recently gave a more specific diagnosis of the ills plaguing the law. "Gramm-Rudman-Hollings was so contrary to the culture and the Constitution and whole flow of legislative history, the first thing we did was to ignore it," he said.7

Still, some observers have credited GRH with improving the nation's fiscal politics. A leading budget official of the Obama administration, who was also present at the creation of GRH while working as a congressional staffer, suggested that it focused political attention in useful ways. "I don't know that we ever would have been able to accomplish the deficit reduction that we did in 1990, 1993, and 1997, without an environment that had been shaped by having that collection of enforcement mechanisms in place," he said recently.8

That claim for the success of GRH is plausible but weak. Boiled down to its essentials, it simply asserts that GRH got people talking seriously about fiscal reform. That's fine, as far as that goes. Which is not very far.

But what about the deficit reductions of the 1990s -- the ostensible payoff of GRH and its artificial crises? In fact, these improvements are better assigned to the second landmark of post-1970 fiscal consolidation, OBRA 1990. What distinguished this second attempt at creating a mechanism of fiscal discipline was its relative flexibility. OBRA 1990 replaced the inflexible, aggregate deficit targets of GRH with a set of flexible, category-specific targets that gave Congress and the president more room to work. If budget enforcement mechanisms of any sort are inherently alien to the culture of Congress, flexible mechanisms are at least less alienating.

Indeed, that may be the most important lesson drawn from our post-1970 history of budget process reform. New mechanisms work best when they are less dramatic, less novel, and less foreign to the norms and mores of U.S. lawmaking.

Our recent experiment with the fiscal cliff was, perhaps, a bit too much like GRH and not enough like OBRA 1990. In many respects, the cliff was quite different from either of these predecessors. In particular, its use of expiring tax provisions as a prod to action was unprecedented, at least in terms of scope and size.

But the cliff resembled GRH in its unrealistic targets and draconian penalties. The spending reduction targets in the 2011 budget agreement were never going to happen, and the penalties for failure were far too large -- and therefore unlikely -- to serve as a meaningful guide for legislative progress. The cliff, in other words, had all the drama of GRH, with a nicely vast and unattainable fiscal goal. And none of the political flexibility of OBRA 1990.

Ultimately, the most important part of OBRA 1990 was probably not its revised, more flexible, and more attainable deficit targets. Rather, it was the much more mundane introduction of "pay as you go" budgetary rules. Pay-go was a form of budgetary discipline that Congress could live with, because it followed most of the normal procedures of fiscal policymaking. Indeed, pay-go was really just the formalization of unwritten budget norms that governed fiscal policy through the 1970s.

Some years ago, conservative economist William Niskanen described the post-1970 breakdown of fiscal discipline as a "moral problem" rather than an economic one. By spending too much and taxing too little, adult Americans of the late 20th century were saddling their children with too much outstanding debt.9

Niskanen traced the origins of this moral failure to a change in the nation's written and unwritten fiscal constitution. For the first 140 years of U.S. history, federal borrowing was constrained by formal constitutional restrictions on the government's authority to spend, as well as by an informal political agreement that limited borrowing to wars and recessions, he contended. Formal restrictions were vitiated by the Supreme Court in the 1930s, as it signed off on New Deal spending and regulatory programs of unprecedented ambition.

But the more interesting story, at least for today's policymakers, may be the demise of informal restrictions on deficit finance. To some extent, the unspoken agreement to limit the size of peacetime deficits to manageable levels fell prey to the Keynesian revolution in economic thought (and the quasi-legitimacy it gave to deficits).10 But it also succumbed to a slowdown in economic growth that made such norms increasingly painful to enforce.

OBRA 1990 and its pay-go rules represented an effort to revive the disappearing norms of fiscal responsibility -- to give them legal, rather than simply moral, force. And as such, pay-go proved modestly successful. In conjunction with brisk economic growth during the 1990s, pay-go brought real and meaningful fiscal improvement to the United States -- for the first and last time since Niskanen's moral breakdown of the 1970s.

OBRA 1990 worked because it was both less and more specific than GRH. Less specific in the sense that its deficit targets were less ambitious and more flexible. More specific in that it provided guidelines for how to reach these targets. OBRA 1990 told lawmakers not simply where to go, but how to get there.

Pay-go, of course, didn't last. It soon succumbed to antitax ideology as lawmakers revised it to focus only on spending increases, rather than both sides of the fiscal equation. But it provides a good lesson to lawmakers eager for a new structural fix to the nation's broken budget process.

Less, it turns out, is often more. Not just when it comes to deficits, but also to the budget reforms that might actually achieve them.


FOOTNOTES

1 Bill Frenzel, "Where Have the Heroes Gone in the Fiscal Cliff Debate?" Real Clear Markets, Dec. 11, 2012, available at http://www.brookings.edu/research/opinions/2012/12/11-fiscal-cliff-heroes-frenzel.

2 Office of Management and Budget, "Budget of the United States Government, Fiscal Year 2013: Historical Tables" (Washington: Government Printing Office, 2012), 24-25.

3 Id.

4 Id.

5 Id. at 51.

6 Jackie Calmes, "Idea Rebounds: Automatic Cuts to Curb Deficits," The New York Times, May 15, 2011.

7 Id.

8 Id.

9 William A. Niskanen, "The Case for a New Fiscal Constitution," The Journal of Economic Perspectives 6, no. 2 (1992): 20.

10 Id. at 13-16.


END OF FOOTNOTES