Reducing the federal government deficit: an update.

Wakefield, Joseph C.

Reducing the Federal Government Deficit: An Update SINCE 1981, Congress has enacted several pieces of legislation that were designed to reduce the unified budget deficit. This legislation included:

* The Omnibus Budget Reconciliation Act of 1981, designed to reduce outlays $130.6 billion over fiscal years 1981-84.

* The Omnibus Budget Reconciliation Act of 1982, designed to reduce outlays $13.3 billion over fiscal years 1983-85.

* The Tax Equity and Fiscal Responsibility Act of 1982, designed to increase receipts $98.3 billion and reduce outlays $17.5 billion over fiscal years 1983-85.

* The Omnibus Budget Reconciliation Act of 1983, designed to reduce outlays $8.0 billion over fiscal years 1984-87.

* The Deficit Reduction Act of 1984, designed to increase receipts $50.0 billion and reduce outlays $13.0 billion over fiscal years 1984-87.

The combined effect of these legislative actions was expected to increase receipts almost $150 billion, reduce outlays just over $180 billion, and reduce the deficit $330 billion over the fiscal year 1981-87 period. In addition, other legislative and administrative actions, particularly actions to lower outlays for national defense, were taken to reduce the unified budget deficit.

Despite these actions, the unified budget deficit increased substantially. In fiscal 1981, the deficit was $78.9 billion; in fiscal 1985, $212.3 billion. The reasons for this increase are many, but three stand out. First, the Economic Recovery Tax Act of 1981, which was signed into law on the same day as the Omnibus Budget Reconciliation Act of 1981, reduced receipts $748.9 billion over fiscal years 1981-86 (according to estimates made at the time of enactment). Second, unfavorable economic conditions--the severe economic recession of 1981-82, high interest rates, and high unemployment--resulted in either lower receipts or higher outlays than expected when the deficit reduction measures were enacted. High interest rates were particularly significant: Coupled with large and growing deficits, they pushed interest paid on the Federal debt from $95.5 billion in fiscal 1981 to $179.1 billion in fiscal 1985. Over this period, interest paid on the debt increased at an average annual rate of 17.0 percent, compared with an average rate of 7.1 percent for all other outlays. Third, although Congress held down the administration's requests for national defense spending, it increased considerably: From fiscal 1981 to fiscal 1985, it increased 60.0 percent, for an average annual increase of 12-1/2 percent.

The molding of the Federal budget has been complex and confrontational. Congressional and administration compromises have been difficult, especially when the issues of tax increases and defense spending were concerned. Further, little concensus has been reached on the manner in which nondefense spending can be curtailed. The administration's policies call for increases in the defense budget, large cuts in nondefense spending, and no increases in taxes. On the other side, many in Congress believe that the deficit-reduction legislation has, by its successive cuts, pared nondefense spending (except for social security) enough, that defense spending is too high, and that a tax increase is needed to reduce the deficit.

It was with this historical background, and with a sense of frustration over the inability to change course to prevent continuing large deficits, that Congress enacted the Balanced Budget and Emergency Deficit Control Act of 1985 in mid-December 1985. The act, on which the final drafting was done under pressure to raise the federal debt limit to avoid default, is better known as the Gramm-Rudman-Hollings Act for its principal sponsors in Congress. It requires that the Federal Government deficit be eliminated by fiscal 1991 through legislative actions or, failing such actions, through automatic cuts in budget outlays. (The act does not provide for tax increases to reduce the deficit.) The act mandates maximum unified budget deficits as follows: For fiscal 1986, $171.9 billion; fiscal 1987, $144.0 billion; fiscal 1988, $108.0 billion; fiscal 1989, $72.0 billion; fiscal 1990, $36.0 billion; and for fiscal 1991, a balanced budget.

The act also radically revises the budget process. The act establishes a new, accelerated timetable for presidential budget submissions, for congressional budget resolutions and reconciliation instructions, and for the enactment of appropriations legislation. The act requires the President to submit annual budgets, according to the new timetable, in which the projected deficits do not exceed the deficit limits. The President's budget can achieve the stipulated deficits by any combination of proposals to increase taxes or reduce outlays. If the proposals are not acceptable to Congress and not enacted into appropriate legislation, or if Congress cannot design a deficit reduction program acceptable to the President, the process to reduce outlays automatically becomes effective.

The remainder of this article discusses the implementation of the act for the current fiscal year, which has a special timetable, as well as discusses in more detail the major provisions of the act as they apply to both this fiscal year and the 1987-91 period.

Fiscal year 1986 implementation

The process leading up to the automatic spending reductions, or sequestration, began on January 10, when the Congressional Budget Office (CBO) and the Office of Management and Budget (OMB) completed economic assumptions and a base-line budget for fiscal 1986. (The act specifies that the economic assumptions include estimates of real GNP growth for each quarter of the fiscal year.) Table 1 shows the economic assumptions, and table 2 shows the base-line budget for fiscal 1986.

The base-line budget, with certain exceptions, is to assume that Federal receipts and outlays will continue at levels provided under laws in effect as of the date the economic assumptions were made and that expiring laws will not be in effect. Spending or tax changes in a proposed reconciliation are not to be assumed. Expiring excise taxes dedicated to a trust fund are to be assumed to be extended through the fiscal year at current rates, as are farm programs operated by the Commodity Credit Corporation (CCC). The base-line budget for fiscal year 1986 also assumes the most recent medicare payment regulations for impatient hospital payment rates and the Presidential recommendations for Federal employee pay increases. If CBO and OMB differ in their estimates of the base-line budget, averages of the two are to be used.

The sequestration report

When the base-line budget was prepared, it was determined that the base-line deficit ($220.5 billion) exceeded the deficit limit ($171.9 billion) and that automatic spending reductions, therefore, were required for fiscal year 1986. (The act stipulated, however, that the fiscal year 1986 cuts were not to exceed $11.7 billion.) A sequestration report was prepared and submitted jointly by CBO and OMB to the General Accounting Office (GAO) on January 15. This report includes the economic assumptions, the base-line budget, and a uniform percentage by which spending is to be cut to reduce the deficit.

The spending cuts are to be divided equally between defense programs and nondefense programs not explicitly exempted by the act (table 2). Defense programs consist of all military accounts plus one-half of all Federal retirement cost-of living adjustments (COLA's); nondefense programs consist of all expenditures, with exemptions, plus the remaining COLA's. The cuts are applied at the uniform percentage to all programs, projects, and activities as set forth in the most recently enacted applicable appropriation acts and accompanying committee reports, including joint resolutions providing continuing appropriations.

Exemptions and special provisions

The act exempts the following from automatic cuts in outlays: Social Security benefits; interest on the Federal debt; nondefense spending obligated in prior years; major programs to assist low-income persons (medicaid; aid to families with dependent children; special supplemental feeding program for women, infants, and children; supplemental security income; food stamps; and child nutrition); State unemployment benefits, veterans compensation and pensions; Federal payments to retirement funds; and the earned income tax credit.

The act has special provisions to allow reductions by less than the uniform percentage. These are for defense spending obligated in prior years; for medicare, veterans medical care, and other health programs; for the CCC; and for retirement programs with COLA's. Defense spending obligated in prior years can be cut or modified at Presidential discretion. Medicare and the other health programs cannot be cut automatically more than 1 percent in fiscal year 1986 and 2 percent thereafter. For retirement programs, only the COLA is subject to automatic cuts; the base program is exempt. CCC contracts in effect at the time of a sequester order (discussed later) cannot be cut, but the required cut would be applied to new contracts signed in the following year. Special rules also apply to various other programs, such as guaranteed student loans and assistance for foster care and adoption. Table 3 shows fiscal year 1986 outlays subject to the exemptions, special provisions, and sequestration.

Although the act exempts Social Security benefits from sequestration by placing the program "off-budget," effective October 1, 1986, the program is included in the budget for purposes of estimating the base-line deficit. When the amount of the deficit reduction is determined, the Social Security trust funds--old-age and survivors insurance trust fund and the disability trust fund--are then moved off-budget and not subject to sequestration.

The sequestration report cannot eliminate any programs, change program eligibility standards, change congressionally mandated spending priorities, or, in fiscal year 1986, close military bases.

The act provides special rules relating to the national defense reductions in fiscal year 1986 only. These rules allow sequestration to depart, within limits, from uniform percentage reductions in defense accounts and subaccounts. This flexibility allows the President to shield uniformed military personnel--both numbers and salaries--from the automatic cuts, but only if the percentage reduction from those accounts is allocated elsewhere in defense spending. (The President used this flexibility for 1986.)

Upon receipt of the sequestration report, the Comptroller General at the GAO verified the report and used his authority to revise certain uniform reductions and to revise the real quarterly economic growth assumptions to 3 percent (annual rate) for each of the remaining quarters of the fiscal year. He then forwarded the report to the President on January 20.

The sequester order

If the sequestration report calls for spending reductions, as it did for fiscal 1986, the President is required to issue an emergency sequester order reducing Federal spending, with the exemptions, by the uniform percentage specified in the report. This sequester order was issued on February 1, to be effective March 1. A compliance report is to be issued by GAO on April 1. Congress has the month of March to respond to the order by legislating an alternative deficit-reduction measure. So far, the House leadership has decided to make no attempt to avoid the cuts for this fiscal year.

Suspension of sequestration

The sequestration process can be suspended in the case of war or recession. If CBO and OMB, when preparing the economic assumptions for the sequestration report, forecast real GNP to decline for any two consecutive quarters in the fiscal year, the sequestration process is suspended for the current and next fiscal year. Similarly, if the Bureau of Economic Analysis reports that actual real GNP growth is less than 1 percent (annual rate) for any two consecutive quarters, the process is suspended.

The act also provides that if the President, citing his constitutional responsibilities as commander-in-chief, does not include defense spending in the sequester order, and that claim is upheld by the Supreme Court, the entire sequester order will be invalid.

The act further provides that if a court nullifies the use of a joint CBO-OMB-GAO sequestration report to trigger the sequester order, the report would be forwarded to a special budget committee, comprised of members of the Senate and House budget committees. The sequester order would then be reported by the special committee within 5 days as a joint resolution, which would have to pass both chambers and be signed by the President (or be passed again over a veto) in order to take effect.

On February 7, a special Federal judicial panel ruled that the automatic budget-cutting provision of the act is unconstitutional. However, the panel stayed the effect of the ruling until the Supreme Court reviews it. Thus, the ruling leaves undisturbed, until that review takes place (probably not before July), the spending-reduction process already put in motion on March 1.

If the act is not declared unconstitutional and if Congress and the President cannot compromise on a package of a tax increase and cuts in national defense and nondefense spending--including entitlements, such as social security--for the fiscal 1987 budget now under consideration, then the sequestration process would be implemented again in 1987. Table 4 shows the timetable for the fiscal year 1987-91 period.