Commentary | Budget, Taxes, and Public Investment

An 18% spending cap is not just bad policy, it’s simply not feasible

On March 31, EPI published the following commentary based on a GOP one-pager summarizing a balanced budget amendment that “limits outlays to 18 percent of GDP.” As explained in the original commentary piece, we thought this was both terrible budgetary policy and infeasible. But the Consensus Balanced Budget Amendment is significantly worse than we had first thought. As Bruce Bartlett has pointed out, the legislative text of the proposal would actually cap spending for a given fiscal year at 18% of GDP for the calendar year ended before the start of the current fiscal year. Consequently, if the balanced budget amendment became effective at the start of fiscal year 2016 (October 1, 2015), spending would be capped at 18% of GDP for calendar year 2014. Based on CBO projections, this would translate to an average effective cap of 16.6% of GDP over 2016-21, so the spending cuts we crunched last week ($8.3 trillion over 2016-21, assuming current tax policies are continued) significantly underestimated the magnitude of the cuts needed to comply with this proposal. Instead of rolling back outlays to the lowest level since 1966, the constitutional amendment would cut government back to the smallest size since 1956. The numbers in this commentary have been revised to reflect this even less plausible assault on the Great Society and New Deal legislation.

Senate Republicans are lining up behind what they call a Consensus Balanced Budget Amendment. It would limit federal spending to 18% of recent economic activity and require a two-thirds supermajority vote of both chambers to pass any tax increase or run a budget deficit (with lower parliamentary hurdles set for times of war and military conflict, but not recessions). The proposal is deeply flawed. Parliamentary restrictions on tax increases and budget deficits would amplify political gridlock, handicap fiscal policy, and undoubtedly intensify economic downturns by ruling out effective responses to both cyclical events and unforeseen emergencies. And notions of effectively reducing government spending to around 16.6% of economy activity for the current fiscal year, as explained above, are in the realm of the delusional.

The United States faces an aging population, spiraling health care costs, and the legacy of two unfunded foreign wars and a decade’s worth of sweeping tax cuts. What would a balanced budget amendment that constrains federal spending to its lowest level since 1956 (prior to enactment of Medicare and Medicaid) mean in this environment?

Based on a barebones extension of current policy, projected government spending over 2016–21 would average 23.9% of GDP (assuming a scheduled reduction in Medicare physician payments is prevented and the alternative minimum tax is patched, reflections of current policy not built into the Congressional Budget Office baseline). Under this current policy baseline, projected revenue would average 20.1% annually over 2016–21, so the effective 16.6% spending cap would not only cut spending by 30.5% ($9.4 trillion), but cut significantly more than needed to balance the budget entirely on the spending side of the ledger. (If enacted this fiscal year, the balanced budget amendment would become effective in fiscal 2016.) This proposed cap is not about deficit reduction; this is about locking in the unfair and costly Bush-era tax cuts, and then some.

Under an alternative scenario in which all the Bush tax cuts were extended, baseline revenue would fall to 18.3% of GDP and spending would jump to 24.4% of GDP over this same period (pushing deficits up by $3.0 trillion over 2016-21). Measured against this baseline, the balanced budget amendment would slash noninterest spending by $10.0 trillion over 2016-21, with annual cuts escalating from $1.4 trillion in 2016 to $2.0 trillion in 2021. Total outlays would fall 31.9% over 2016-21, and primary outlays (excluding net interest) would face much larger across the board cuts if everything were immediately on the chopping block (including sacrosanct items like veterans’ pay—also highly unlikely). By 2017, the requisite cut to noninterest spending would exceed the entire discretionary budget (including emergency supplemental appropriations for overseas contingency operations). Entire cabinet agencies, such as the departments of Education and Energy, and all of their programs, would have to be abolished.

The federal budget is a slow ship to turn. Changes to the major entitlement programs (Social Security, Medicare, Medicaid, and other health programs) would take years to generate savings, particularly if individuals over the age of 55 were protected from any changes to taxes or benefits (in order to allow those approaching retirement to plan accordingly).

Eliminating all other mandatory spending—including veterans’ benefits, federal and military retirement pay, and all income security programs—would reduce primary spending by only $3.6 trillion over 2016-21—covering less than half of the necessary savings, even if the Bush tax cuts are allowed to expire on schedule (the “barebones” current policy extension). Defaulting on interest payments, the remaining category of spending, is not an option.

It is unclear if anyone has given serious thought to how annual spending cuts ranging from $1.4 trillion to $2.0 trillion could be achieved. The balanced budget amendment itself does not detail any savings.

The most specific Republican long-term budget proposal, House Budget Committee Chairman Paul Ryan’s Roadmap for America’s future—which like the balanced budget amendment also places the entire burden of deficit reduction on spending cuts—would not come close to meeting this spending cap for at least half a century.

Ryan’s Roadmap—a draconian but detailed plan to partially privatize Social Security, voucherize Medicare, block grant Medicaid, and eliminate the Children’s Health Insurance Program—would not meet the effective 16.6% of GDP spending cap for more than half a century. According to CBO, primary spending under the Ryan Roadmap would total 19.3% in 2040, with total spending at 23.5%. (This CBO calculation assumes that the accompanying tax policies would generate revenue of 19.0% of GDP, whereas the Tax Policy Center estimates that revenue under the Ryan Roadmap would average only 16.3% of GDP over 2011-20). Again ignoring the regressive, budget-breaking tax policies in the Ryan Roadmap, total spending would equal 19.5% of GDP by 2060—a full 1.5 percentage points above an 18% global spending cap and roughly three percentage points above the effective cap, assuming similar rates of trend GDP growth. The 16.6% average effective spending cap over 2016-21, if somehow met, would almost balance budgets with the Ryan Roadmap tax cuts, including elimination of all investment income taxation and replacing corporate income taxation with a consumption tax that would be passed along to consumers.

In short, not even eviscerating Medicare, Medicaid, and Social Security would generate adequate savings to meet the balanced budget amendment global spending cap within 50 years.

Put differently, the balanced budget amendment would require more than twice the deficit reduction proposed in the Bowles-Simpson Fiscal Commission report, but over a considerably shorter time horizon and with all deficit reduction placed on spending cuts. (The Bowles-Simpson report was widely criticized at the time for cutting roughly $2 in spending for every $1 in revenue raised). Again, this cap is a political non-starter.

This plan moves the g
oal post for the coming debt ceiling debate so far to the right that Republicans have left the stadium. Short of eliminating every cabinet agency (the entire discretionary budget), drastically defaulting on our obligations to our citizens (Social Security, Medicare, and Medicaid), or defaulting on our obligations to our creditors, this plan simply is not feasible. Even if it were feasible, cutting $1.4 trillion in federal spending by 2016—when the economy is projected to just be returning to potential output and full employment—would be economically devastating. Budget process proposals are much easier to generate than budgets, but this one is totally detached from reality.  

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