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Testimony

Hearing on the Proposed Balanced Budget Amendment to the Constitution

Allen Schick

Mr. Chairman, I appreciate the opportunity to discuss the proposed balanced budget amendment to the Constitution. My statement focuses on the political and governmental implications of a constitutional constraint on the power of elected officials to adopt and implement realistic, acceptable budgets.

The case for a balanced budget requirement rests on the argument that in the face of pressure from voters and interest groups to tax less and spend more, politicians cannot maintain fiscal discipline. In this view, democratic politics is the problem, and the remedy should be a constitutional amendment that bars politicians from producing certain budgetary outcomes. My view, however, is that only political action can ensure true budgetary discipline; if politicians want to spend more than they take in, they will find the means to do so, even when the Constitution purports to dictate otherwise. This is the lesson from the many states whose constitutions restrict the borrowing capacity of the government.

Whether in statute or in the Constitution, law is effective when it gives elected leaders incentives and opportunities to make the right decisions, including the decision to manage the nation’s finances prudently. Some laws are effective, others aren’t. The Gramm-Rudman-Hollings law was ineffective because it impelled politicians to lie about the budget; the Budget Enforcement Act has been effective because it has encouraged politicians to produce realistic budgets.

Interfering with the normal interplay of politics through the balanced budget amendment would risk adverse consequences. It might spur politicians to use bookkeeping gimmicks and other tricks to conceal the true condition of the budget; it would risk political deadlock and governmental shutdown when a balanced budget was beyond reach; it would hold the elected majority in Congress hostage to the demands of the minority; it would inject federal courts into political issues and might make judges the final arbiters of budget policy; it might compel Congress to cede much of its constitutional power of the purse to the President; and it might impel Congress to splinter the federal government into numerous quasi-public entities whose finances were excluded from the balanced budget rule. These are enormous political risks that can damage the capacity of government and political leadership in the United States.

Why the Political System Works

Some argue that these risks are worth taking because American politics is biased in favor of big, chronic deficits which cannot be controlled by statutory remedies. The evidence, however, shows that the political system is capable of self-correction and fiscal discipline. How else does one explain the reduction in the budget deficit from $290 billion in FY1992 to $107 billion only four years later? How does one explain the explicit commitment of the President and congressional leaders to adopt budgets that will eliminate the deficit by 2002? How does one explain why the deficit has been reduced from 4.7% of GDP to 1.4%, the lowest rate among major democracies and less than half the deficit permitted by the Maastricht Treaty for countries in the European Monetary Union?

Author

Deficit reduction did not happen by itself. True, the task was aided by the end of the Cold War and by robust economic growth, but these conditions would not have sufficed without strong political will. The deficit has been reduced because Congress passed the Budget Enforcement Act of 1990, because it and the President negotiated budget reconciliation bills in 1990 and 1993, because congressional adherence to the discretionary spending caps has driven annual expenditures in this part of the budget almost $100 billion below what it would have been if spending had grown apace with inflation, and because Congress has complied with the PAYGO rules and has curtailed new entitlement legislation.

Budget policy over the last dozen years has been a laboratory for testing which rules work in a political environment and which rules don’t work. The most apt comparison is between the Gramm-Rudman-Hollings law which did not deliver on its promise to balance the budget and the Budget Enforcement Act which has effectively controlled the deficit. At first glance, these outcomes are anomalous because GRH explicitly capped the deficit while BEA didn’t. Yet it is precisely because GRH targeted the deficit that it failed and because BEA has avoided deficit targets that it has succeeded. Any rule that targets the deficit will prove unworkable because the rule will be in effect both during times that the target is achievable and during times when the target is beyond reach. In every year that GRH was in effect the actual deficit exceeded the deficit permitted by law. This was the outcome in fiscal 1986, the first year covered by GRH; it was the outcome in fiscal 1990, the last year before GRH was superseded, and it was the result every year in between. The only variable was the amount by which the deficit target was violated.

It is generally conceded that deficit targets cannot work during recessions. Supporters of the Balanced Budget Amendment assure us that Congress will be able to waive the requirement during recessions. I will leave to others consideration of whether this safety valve suffices to avert economic trouble, and to a later part of this statement discussion of whether a three-fifths vote is the right rule. For the present, I want to point out that it is not only during recession that a fixed balanced budget rule may be inappropriate. When a recession ends, the impact on the budget lingers for a number of years. According to the latest CBO Economic and Budget Outlook, it would take approximately four years for the budget deficit to return to the baseline level after a recession. Even a relatively mild and short recession, such as the one experienced in 1990, would elevate the budget deficit by about $100 billion in the first year, and by declining, but still substantial, amounts in subsequent years. Not only would a fixed deficit rule be unworkable during a recession, it would continue to be unattainable for several years after the recession ended. In other words, Congress would be pressured to waive the balanced budget requirement for as many as five years (or more) of a normal economic cycle.

I believe that the temptation to play fast and loose with deficit rules will be greatest during the recovery period. When the economy is stagnant, politicians will have little choice but to waive the balanced budget rule. But when growth resumes and economic worries recede, they will be pressured to get rid of the deficit, even if it is extremely difficult or impossible to do so. As the deficit recedes, pressure to balance the budget will escalate.

This is precisely the situation that Congress now faces, but with one very big difference. The economy is now completing its 6th consecutive year of growth and, as a consequence, the budget deficit has been cut by almost two-thirds. Despite this laudable achievement, clamor to balance the budget is rising, as evidenced by the current drive to adopt the balanced budget amendment. In this case, however, there is a political consensus that total elimination of the deficit should be stretched over the next five years. But if the balanced budget rule were inscribed in the Constitution, Congress would not have another five years to complete the job; it would have to eliminate the deficit immediately, unless three-fifths of its members voted otherwise. It is in this type of situation that the President and Congress would most likely conspire to evade the zero deficit rule.

The two-thirds reduction in the deficit occurred during a period when Gramm-Rudman-Holling’s fixed deficit target was replaced by the more flexible rules of the Budget Enforcement Act. BEA shifts the focus of budget control from the budget’s totals to its components, and from the deficit to congressional action. Under BEA, Congress may not appropriate in excess of the discretionary spending caps, and its revenue and direct spending legislation may not cause the deficit to rise. These rules hold Congress accountable for the parts of the budget it controls. Moreover, these rules operate independently of the size of the deficit, even though their net effect has been to reduce the deficit. I will not say that politicians have shown perfect fidelity to the rules; they haven’t, but the breaches have been relatively minor. It would not be difficult to tighten the BEA rules to strengthen budgetary discipline in Congress.

Unlike deficit targets, the BEA rules are not affected by economic cycles. They work in good times and in bad, when the deficit is rising and when it is falling, when government is divided and when it is unified. They do not guarantee that the budget will be balanced, but they guard against legislative actions that add to the deficit.

Lessons from the States

What should be done when political conditions are not conducive to prudent budgeting, when, for example, the President and Congress spend a lot more than the government takes in? Isn’t this the situation for which the balanced budget amendment is needed? Wouldn’t the amendment deter politicians from incurring chronic deficits?

In the short-run, the answer might be “yes.” In the early years after ratification, a balanced budget rule probably would constrain deficit spending. But a constitutional amendment is not just for the short-run; it has to work years after being adopted. The evidence from the states is that over time, as political pressures build up, governments find ways of spending above their revenue even though the constitution prohibits the practice. In fact, many states manage to borrow money while adopting budgets that purport to be in balance. The following are some of the methods used by states; all can be adopted by the federal government, even if H.J. Res 1 were ratified.

The most popular method is for the legislature to establish an entity such as a public authority or corporation, authorize it to borrow money, and provide that its debt shall not be an obligation of the state. When called upon to rule, the courts invariably hold that inasmuch as the public authority is borrowing the money, there is no violation of state constitutional restrictions on indebtedness. Thousands of these quasi-governmental entities have been established in the 50 states; their outstanding debt totals hundreds of billions of dollars, far more than the states owe in “general obligation” bonds. Because the debt incurred by these entities is not backed by the full faith and credit of the state, it typically carries a higher rate of interest, thereby adding significantly to the cost of state government.

The debt of these entities usually is in the form of revenue bonds which are serviced by income earned from business-type operations such as tolls collected on state highways or dormitory fees charged college students. These are “moral obligation” bonds; there is a strong expectation that the state will come to the rescue in case of default. Underwriters take these bonds into account in assessing the state’s financial condition. The federal government also has moral obligation bonds—the more than one trillion dollars of debt owed by government-sponsored enterprises. The volume of this type of debt will soar if a balanced budget rule were inscribed in the Constitution.

Another device used by states to balance their books is to sell assets, record the proceeds as current revenue, and thereby make their financial condition appear better than it actually is. Some states sell assets to their own off-budget corporations. The state can sell anything this way—prisons, highways, loan assets, etc.—whether or not there is a market, and the state can dictate the sales price. Asset sales are part of a larger state practice—using non-recurring revenue (known as “one shots”) to close the revenue-expenditure gap.

How do public entities get money to purchase state assets? Not to worry, for once again budgetary alchemists know the tricks of the trade. In some cases, the state “leases back” the facility, making annual appropriations to service the debt incurred by the entity when it purchased the asset. In other cases, the state enables the off-budget entity to borrow in capital markets by guaranteeing the debt. Either way, the state bears the financial burden, or risk, and the budget shows a more favorable outcome than is warranted.

States also have been adept in passing the buck to Uncle Sam. They lobby for federal assistance, pressure federal agencies to make good on disallowed claims, re-label their expenditure to qualify for matching federal assistance, etc. One of the most inventive schemes was used by states to wrest billions of additional Medicaid dollars from Washington. In this scheme, states pretended to tax hospitals and other providers, used the revenue from these “taxes” to obtain higher Medicaid reimbursements from the Federal Government, and then split some of the “profits” with providers. Both states and providers came out ahead, at the expense of the federal government. It should be noted that this scam peaked in the early 1990s, at a time when federal budget deficits reached record levels.

States often adjust to changing budget conditions by switching from pay-as-you-go financing of capital improvements to debt financing. Many states are adept at shifting money among funds—for example, from the highway fund to the general fund. These and other bookkeeping tactics are most likely to occur when a state (a) is required to maintain a balanced budget or is restricted in the amount it may borrow, and (b) has a budget gap that cannot be closed through politically-acceptable spending cuts or tax increases.

This is the very predicament that will confront the federal budget if it were to operate under a constitutional balanced budget rule. The federal government might end up with balanced budgets and bigger deficits. For an early warning of how federal budgeting might be warped by a balanced budget amendment, one need only look back at the “blue smoke and mirrors” practices that veiled the true deficit during the heyday of Gramm-Rudman-Hollings. Budgetary legerdemain mushroomed in those years because federal policymakers worked under unworkable fixed deficit rules. The gimmickry will be even more inventive if the federal government were compelled to operate under a constitutionally-mandated zero deficit rule.

It is sometimes argued that small evasions of a balanced budget rule, say on the order of $20 or $30 billion a year, would be far better than the mega-deficits that have occurred in the absence of such a rule. This is a specious argument, for there is no reason to believe that the evasions and gimmicks would be small. They are not in the states, and they will not be in Washington. Even if the dollar amount of budget lies were relatively small, their true cost would be much larger, for they would further erode trust in government. Establishing a constitutional rule that would impel politicians to lie would not contribute to good government.

In drawing lessons from state practices, it should be noted that H.J. Res 1 would force Congress to give the President vast new budgetary power in implementing the federal budget. In many states, the governor has carte blanche in withholding funds during the fiscal year to avert a deficit. The governor can rearrange budget priorities to suit his or her preferences and does not have to get legislative approval when appropriated funds are impounded. In some states, the governor’s impoundment power reaches to grants made by the legislature to local governments and to state-funded entitlements. In considering the balanced budget amendment, therefore, one must be mindful of the potential implications for legislative-executive relations and for Congress’ power of the purse. It is highly unlikely that Congress would be able to cope with unplanned deficits by passing new legislation; more likely it would have to vest the President with power to sequester or cancel both appropriated funds and entitlements.

Here, again, the ill-fated Gramm-Rudman-Hollings process offers guidance on what doesn’t work. In GRH, Congress established a formula for sequestering funds in case of an excess deficit. The formula exempted major portions of the budget from sequestration and provided for uniform percentage cutbacks in sequestrable resources. The idea was to prevent the President from imposing his priorities over those of Congress. But the effect of the formula was to thwart deficit reduction. It gave interest groups a strong incentive to pressure Congress for special treatment; in the end, most federal spending was exempted from sequestration. As a result, the percentage that had to be cut from the portions of the budget subject to sequester was unacceptably high.

This is Sophie’s Choice applied to federal budgeting. One choice is to turn budgetary power over to the President and let him do the job as he deems fit, the other is to write a formula that protects Congress’ priorities but results in extremely high percentage cutbacks. Both would damage the legislative capacity of Congress and confidence in our political institutions.

Letting the Courts Do It

There is a third possibility, however: because of constitutional ambiguity or political conflict, the job of bringing federal spending into line with revenues is to be entrusted to the courts. In considering this possibility one must take into account the uncertainty inherent in the balanced budget amendment, and the conflict it is likely to spawn between the President and Congress.

All constitutional provisions require judicial interpretation, but because of its wording and the manner in which federal budgeting operates, the courts might be put in the position of deciding both what the balanced budget amendment means and what federal budget policy should be. Litigation is likely to arise over key words in the amendment: “U.S. Government,” “receipts,” “outlays,” and “limit on the debt.” Federal courts may be brought into play when budget estimates veer off course and the planned balance turns into a projected deficit; when taxpayers challenge the accuracy of the Government’s estimates; when the President and/or Congress refuse, or are unable, to act in the face of a pending deficit; when cutbacks are made in entitlements or other budget commitments. States may be active litigants if they feel short-changed by federal budget actions that leave them with less money than was promised. So, too, would be prison inmates, welfare recipients, health care providers, and the many others on the receiving end of federal payments or services.

The bare words of the balanced budget amendment open the door to judicial activism. The words say that Congress may by a three-fifths vote provide for a “specific excess of outlays over receipts.” Suppose Congress votes for a specific deficit but deteriorating economic conditions propel the deficit even higher? Suppose Congress is unable to muster either majority support for a balanced budget or three-fifths permission for a deficit? Should the courts intervene to break the deadlock and ensure a balanced budget? Another provision requires the President to submit a balanced budget each year. In most years, CBO’s re-estimate of the President’s budget finds that his projections are unduly optimistic. Will Congress sue the President to compel him to submit a realistic budget?

The balanced budget amendment seems to state that funds carried over from previous years cannot be counted in determining whether outlays are in line with revenues. Section 1 of the amendment provides that “total outlays for any fiscal year shall not exceed total receipts for that fiscal year….” This is a much stricter balanced budget rule than most states have. It implies that balances carried over from one year to the next may not be counted as part of federal receipts. The impact can be especially pronounced in Social Security and other trust funds that have accumulated large balances over the years. One can foresee the courts being the decisors of Social Security policy early in the next century when the trust fund begins to run a deficit. Will the courts permit Social Security balances to be used in computing the budget’s receipts, or will it insist on a literal interpretation of Section 1? Nobody can predict how the courts will rule, but one can predict that they will be called upon to rule.

Government by Deadlock

In contemplating the effects of a balanced budget amendment, it is necessary to speculate about how its provisions will be implemented. But there is one danger which requires no speculation. Just one year ago, large portions of the federal government were shut down by unprecedented conflict between the President and Congress over budget policy. The balanced budget amendment would greatly increase the probability of budgetary conflict by requiring a three-fifths vote to raise the public debt limit or to permit spending in excess of receipts. One can foresee many circumstances in which a majority agrees on budget policy but three-fifths support is not forthcoming. The minority will be able to extort concessions from the majority before it agrees to vote for the budget. Negotiations between the two sides are likely to be fractious and lengthy; deals will not be made by the first day of the fiscal year but long afterwards, probably only after the two sides have gone to the brink and beyond.

Government by deadlock is a substitute for politics as usual. In its disdain for politics by majority vote, the balanced budget amendment impedes the normal operation of democratic politics. This in the end would be the most damaging result of the amendment.

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