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Controlling our structural budget deficits will require major changes in budget policy. Congress and the President will have to make hard decisions about spending as well as taxes. To help better understand those choices, we need to look at the key elements of the budget

The 2011 Federal Budget

Data from CBO, The Budget and Economic Outlook: Fiscal Years 2012 to 2022, January 2012. Compiled by PGPF.

Federal spending is divided into two large categories: discretionary spending and mandatory spending. Discretionary spending covers some of the federal government’s major activities, such as defense and homeland security, education, transportation, research, food safety, science and space programs, disaster assistance, environmental protection, federal law enforcement and the courts, and a host of other priorities. Each year, Congress and the President set spending levels for individual discretionary programs through the appropriations process. If lawmakers do not enact appropriations in a given year, these programs have no funding to operate.

Mandatory spending includes programs such as Social Security, Medicare, Medicaid, unemployment insurance, and food stamps. Unlike discretionary spending, lawmakers do not provide specific funding levels for mandatory spending. Instead, they specify who is eligible for benefits as well as the type and level of benefits that they can receive. But total spending on those programs depends on how many people actually claim benefits. For example, the unemployment insurance program has eligibility criteria that, once met, entitle an individual to a certain level of benefits. But, the total amount of spending on the program depends on the number of people who file for unemployment. Moreover, most mandatory programs continue indefinitely without action by lawmakers. For that reason, spending on nearly all mandatory programs is considered to be on "automatic pilot."

Sources of Financing for Medicare

Data from the Centers for Medicare and Medicaid Services, 2011 Medicare Trustees Report, May 2011. Compiled by PGPF.

The term "mandatory" doesn't mean that lawmakers are powerless to alter this spending, however. Elected officials can at any time adjust the eligibility criteria and benefit formulas that determine spending on mandatory programs, as they did with Social Security in 1983. However, if Congress and the President take no action, the current formulas remain in place year after year, and the spending flows without interruption.

Interest on the debt is another category of mandatory spending. When the federal government issues debt, it agrees to make payments to bondholders at predetermined intervals. The amount of money the federal government spends on interest in any given year is determined by the amount of debt outstanding and the interest rates at which the government borrowed. The interest rates reflect judgments by creditors about the creditworthiness of the U.S. government.

Tax policies also have an impact on budget deficits and debt. Congress and the President enact tax laws that allow the federal government to collect revenue in multiple ways. The largest source of revenue is the individual income tax. Payroll taxes are the second largest source of revenues for the federal government. They are paid by both employees and employers and are collected to fund Social Security and Medicare. Corporate income taxes are the third largest revenue source and contribute about 9 percent of federal revenues.

While it is important to keep in mind that thousands of policy decisions come into play with each year’s budget, four programs represent a disproportionate amount of spending, and therefore offer the most significant opportunities for change on the spending side of the budget: the two major health care programs (Medicare and Medicaid), Social Security, and defense. These four spending areas alone account for 60 percent of the federal budget. Given their size, addressing the fiscal challenge cannot be successful without reforming commitments in these areas. At the same time, given the aging population and the growth in overall health care costs, stabilizing the debt will be very difficult through spending changes alone. Taxes should also be on the table.

THE FEDERAL GOVERNMENT AND HEALTH CARE

Here are some of the various programs run and funded by the government:

Medicare — A program of health insurance for Americans over 65 and for certain individuals who are disabled.

Medicaid — A program for low-income individuals that is jointly funded by the federal government and the states. Under the provisions of the Patient Protection and Affordable Care Act of 2010, Medicaid coverage will expand.

TRICARE — The health care program for military personnel, their families, and military retirees.

Federal Employee Health Benefit Program — The health care program for federal employees and their families.

Veterans Health Administration — The health care system for eligible veterans. Health Exchanges — A new program, authorized by the Affordable Care Act, which is to begin in 2014. Exchanges will be administered by the states and offer health insurance policies to individuals and their families. The federal government will provide subsidies to certain low-income individuals who are receiving insurance through the exchanges.

Tax Exclusion of Employer-Provided Health Insurance — Provision in the tax code that enables employers to provide tax-free health insurance to their workers. The provision subsidizes employees' health insurance by treating employer payments for their employees’ health care as a deductible cost of doing business and excluding those payments from employees’ taxable income. By insulating workers from the full cost of the insurance, this tax subsidy encourages them to choose more expensive health insurance plans.

Why are health care costs growing so rapidly? There are many reasons. A major factor is that a significant portion of health care in the United States is financed through "fee for service" payments. This type of system pays health providers for services they deliver but not necessarily for quality of health achieved. Because providing more services produces more payments, fee-for-service can encourage unnecessary, ineffective, or even harmful care. Reducing health care costs will require reforming the incentives so that only necessary and effective services are delivered, while wasteful and ineffective care is reduced or eliminated. Accomplishing that task will not be easy.

Annual Per Capita Health Care Costs

Data from the OECD. Compiled by PGPF. NOTE: Per capita health expenditures in 2009, except Japan and Australia data which are from 2008. Foreign health spending was converted into U.S. dollars using purchasing power parity.

To control its health care program costs, the federal government can increase beneficiary premiums, cut payments to doctors or hospitals, reduce benefits, or limit eligibility for subsidies. These measures are difficult to implement because Medicare and Medicaid are popular programs that benefit vulnerable populations. Moreover, controlling federal costs does not necessarily reduce health spending overall. Cuts to federal spending may “shift” costs onto other payers, such as private insurance and individuals, as providers try to make up lost revenue.

Health care reform needs to balance a set of legitimate concerns. Patients want to protect their access to care. Providers and hospitals must meet their own costs. The government needs to watch its bottom line. And taxpayers want their money to be spent responsibly. These goals are not always aligned, and the push and pull of the democratic process makes balance difficult to achieve. But we cannot avoid the fact that health care costs will overwhelm the federal budget at some point in the future and that something must be done. Most would agree that it would be better to eliminate wasteful spending than to reduce access to necessary and effective care.

In 2010, total national spending on health care (public and private) was $2.6 trillion, or 18 percent of GDP. Yet, even though we spend proportionately more on health care than other developed countries, some health outcomes are often no better. For this reason, health experts believe that we can increase the quality of our care while also reducing our costs.

Looking forward, the outlook for health care costs is daunting. According to government projections, total health care expenditures could climb to 27 percent of GDP by 2035. Over the same period, federal spending on health care is projected nearly to double.

Allocation of Medicare Benefits, 2010

Data from the Centers for Medicare and Medicaid Services, Medicare and Medicaid Research Review, 2011 Statistical Supplement, December 2011. Compiled by PGPF.
NOTE: Figures reflect data on Medicare patients in calendar year 2010

SOLUTIONS

Because of the large size of health care spending relative to the American economy, an enormous amount of time, energy, and research is under way to support cost-containment efforts and increase incentives to improve health care value. Private reforms have already begun: Integrated health care delivery systems are leading to better coordinated care among hospitals, physicians, and other outpatient care providers; government and private insurers are experimenting with new payment systems, such as tying physician and hospital payments to patient outcomes, and employers and insurance companies are incentivizing preventive care and healthier lifestyles.

Initial solutions have focused on these goals:

• Improved coordination of care to address the needs of the whole patient and increase the quality of care delivered
• Promotion of best practices and the consistent delivery of care that is demonstrated to be the most effective, and elimination of known bad or ineffective practices
• More transparency in the payment system, so that health care purchasers and consumers can better evaluate questions related to performance and cost
• Better decision-making about the allocation of scarce health care resources.

Medicare, because it has access to extraordinarily detailed data on cost, volume, and the quality of patient care, is in a very good position to reward good performance and penalize bad performance. Several pilot programs are under way to improve health care value, and more are planned as a result of the 2010 Patient Protection and Affordable Care Act. In addition, the ACA created the Independent Payment Advisory Board to make recommendations to improve Medicare's efficiency.

Changing the way health care is delivered and financed will require changes to the way our whole society — families, the elderly, employers, insurance companies, providers, the legal system, and, of course, governments — thinks about health care. Policymakers and the public must also show greater willingness to adopt measures to reduce the estimated 30 percent of care delivered that is deemed ineffective, unnecessary, wasteful, or outright harmful.

WHY ARE HEALTH COSTS SO HIGH?

Public and private health care costs in the United States are high for many reasons. Here are some of the important ones:

Insurance and provider payments — One of the most defining characteristics of the health care market is the widespread prevalence of insurance. As a result, treatment costs are largely borne by third parties and not patients themselves. Moreover, physicians and other health care providers are usually paid for the quantity of services they perform. These features create an incentive to provide more care regardless of costs.

Subsidies for coverage — Employees do not pay taxes on employer-provided health insurance. That tax subsidy hides the full cost of care, and encourages the overutilization of health services, which results in higher spending.

Technology — Insurance, fee-for-service payment, and subsidies for coverage create incentives for the development and expansion of expensive medical technologies whose benefits may not be worth the additional costs. According to CBO, the proliferation of these high-cost technologies is the single largest contributor to the growth of health care costs.

Fragmentation in the delivery system — Health care delivery in the United States is fragmented, which results in poor coordination of care among patients, providers, and insurers. This fragmentation creates costly inefficiencies in our system and exposes patients to the risk of inappropriate care.

Medical malpractice — The legal system encourages the proliferation of malpractice and liability lawsuits, which prompts physicians to over-treat and over-prescribe — a practice known as "defensive medicine." This drives up overall spending and creates a culture of overuse.

Increasing incidence of chronic conditions — Chronic conditions — such as hypertension, diabetes, and obesity — are on the rise in the United States. When these ailments are not managed carefully, they increase health care spending.

Income — Higher income countries tend to spend more on health care, and the United States has one of the highest per capita national incomes in the world.

National Health Care Costs, 1960–2035

Data from the Centers for Medicare and Medicaid Services, National Health Expenditure Data, Historical and Projected, January 2012; and the Congressional Budget Office, The Long-Term Budget Outlook, June 2011. Compiled by PGPF.

SOCIAL SECURITY

Social Security accounts for more than 20 percent of total federal spending. In 2012, Social Security paid benefits to about 54 million people, or about 1 in 6 Americans.

Data from the Social Security Administration, Social Security Beneficiary Statistics, January 2012. Compiled by PGPF.

Of these beneficiaries, 37 million were retirees and their dependents, 10 million were disabled Americans and their dependents, and an additional 6 million were the survivors of deceased workers. As the number of beneficiaries grows, Social Security’s costs under current law will increase by about 20 percent over the next 25 years — from 5 percent of GDP in 2012 to 6.2 percent of GDP in 2035.

Social Security has been financed chiefly on a pay-as-you-go basis, which means that current workers pay for current beneficiaries. This arrangement worked well as long as there was a consistently high ratio of workers to beneficiaries. But, as the population ages, this ratio will decline from 3 workers for 1 beneficiary now, to about 2 to 1 in 2035.

The main source of Social Security funding is the payroll tax. The Social Security portion of that tax is 12.4 percent of the first $110,100 of 2012 wages, with half paid by the employee and half paid by the employer. To help stimulate the economy, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 reduced the employee share of the payroll tax by 2 percentage points through the end of 2011, to 4.2 percent. That payroll tax cut was extended through the end of 2012 by the Middle Class Tax Relief and Job Creation Act of 2012.

Workers per Social Security Beneficiary

Data from the Social Security Administration, The 2011 OASDI Trustees Report, May 2011. Compiled by PGPF.

According to the latest government estimates, Social Security has begun a period of permanent cash-flow deficits, paying out more in benefits than the combined revenue it will bring in each year. Absent significant reform, Social Security will lack the budgetary authority to pay full scheduled benefits after 2036. At that time, projections by the Social Security actuary indicate that benefits will have to be cut by about 23 percent if laws are not changed.

The existence of the Social Security Trust Fund has given rise to the notion that Social Security is a self-sustaining program that poses no threat to the broader fiscal outlook. The reality, however, is that Social Security is part of the federal government. Although Social Security payroll taxes exceeded benefit costs and contributed to an accumulation of a Trust Fund balance (often referred to as a "surplus") for the past 25 years, those surplus funds were spent on other programs. To keep track of the Social Security's surplus, the federal government provided special-purpose Treasury bonds, which represent promises to provide funds to the program when needed in the future. Once Social Security’s benefit costs exceed its annual income — an event that is expected to occur in 2023 — it will begin redeeming those Treasury securities in the Trust Fund and use the proceeds, raised from other federal revenues or borrowing from the public, to pay benefits. Therefore, Social Security Trust Fund balances represent a commitment of the federal government to the program that could increase federal debt held by the public.

Social Security Cash Surpluses and Deficits

Data from the Social Security Administration, The 2011 OASDI Trustees Report, May 2011. Compiled by PGPF.

SOLUTIONS

Despite many challenges, there is still time to make changes to Social Security that will improve the financial position of the program while protecting the most vulnerable beneficiaries. Options for reforming Social Security are relatively well-defined. Most solutions can be classified into one of the following two categories.

Options that would increase Social Security's income:

• Increase the payroll tax rate above its current level of 12.4%
• Raise or eliminate the taxable maximum for Social Security, which is $110,100 in 2012, and index that tax cap for inflation in subsequent years. Under this policy, a larger share of total wages will be subject to the payroll tax
• Increase taxes on benefits of more affluent retirees.

Options that would decrease Social Security's expenses:

• Use a more accurate measure of inflation to calculate cost-of-living adjustments for Social Security benefits
• Change the formula for calculating benefits for new retirees, including options that reduce benefits for high earners, such as progressive price indexing
• Phase in an increase in the retirement age for future beneficiaries or encourage later retirement through higher benefits.

Many of these possible solutions would affect different age cohorts and yield different savings depending on the date the reforms are phased in. Considering the role that Social Security plays in providing basic income to elderly Americans, changes to benefits could be delayed until 2022 to avoid affecting workers aged 55 and older and who are close to retirement. Young workers would have time to adjust their retirement plans.

DEFENSE

Defense spending accounts for about 20 percent of all federal spending — nearly as much as Social Security, or the combined spending for Medicare and Medicaid. It is also more than the combined defense budgets of the next 17 highest-spending countries. Over the past 10 years, defense spending has increased 42 percent (from 3.3 percent of GDP to 4.7 percent of GDP), to $680 billion in 2012, primarily reflecting continuing commitments in Afghanistan and Iraq. In December 2011, the last U.S. combat forces left Iraq, and the administration plans to wind down engagement in Afghanistan beginning in 2013; we can expect a gradual reduction in defense spending in coming years. Even so, our defense spending will remain substantially higher than the roughly 2 percent spent by many other developed countries.

The growth of our nation’s debt is a threat to our national security, and, given the sheer size of the defense budget, reduced defense spending can help address that threat. In face of spending limits imposed by the Budget Control Act and the end of the conflicts in Iraq and Afghanistan, the Department of Defense has initiated changes in its strategic framework, but spending for national security continues to use assumptions inherited from the Cold War. The global security environment has changed over the past few decades and provides an opportunity to align the defense budget more closely with current and probable future security requirements.

Defense Spending By the Next 17 Highest-Spending Countries

Data from Stockholm International Peace Research Institute, SIPRI Military Expenditure Database. Compiled by PGPF.

SOLUTIONS

To operate within a transformed security environment, the Pentagon should conduct a broad review of the nation's interests, threats to those interests, and strategies to meet those threats. An updated strategic framework will guide defense policymakers' efforts to align force structures, defense investments, and budgets to reflect today's international challenges and current U.S. priorities. Revising our strategic framework will lead planners to scale back some legacies of the Cold War — such as our nuclear weapons program and some overseas commitments — and reevaluate threats to the U.S. and our citizens, our allies, and the global commons (shared resources such as sea lanes, electronic networks, the earth's atmosphere and space). It may also reduce the need for expensive, outmoded equipment and align the size and mix of our military personnel to meet the challenges of the 21st century.

Components of the Defense Budget

Once agreement is reached about national security interests, threats, strategies and missions, the defense budget must be redesigned to fulfill those requirements. All aspects of the budget, including personnel costs, operations and equipment purchases, must be examined so that national security objectives are fulfilled efficiently without incurring undue risk to our nation.

Making changes to the defense budget will be difficult. There is general agreement that the U.S. military should continue to play a significant role internationally, but there are questions about how to best fulfill those commitments. Many ideas to reduce defense spending have already been suggested, and there is recognition that the Department of Defense should be subject to close review when it comes to budget-making.

Foreign Aid and the Rest of the Federal Budget, 2011

Data from CBO, The Budget and Economic Outlook: Fiscal Years 2012 to 2022, January 2012; and OMB, The Budget of the United States Government for Fiscal Year 2013, February 2012. Compiled by PGPF.

ALL OTHER SPENDING

Although the major health care programs (i.e., Medicare, Medicaid, CHIP, and subsidies for the health insurance exchanges created by the ACA), Social Security, and defense account for substantial portions of the federal budget, the rest of the budget also funds many important national priorities. Programs such as education, research and development, veterans’ health care, transportation, environmental protection, diplomatic activities, and public housing fall into this category. Some are discretionary programs funded each year through annual appropriations. Others are mandatory programs that are not part of the annual appropriations process, such as subsidies for agriculture, flood insurance, loans to undergraduate and graduate students, and federal pension programs.

All other non-interest spending has accounted for about one third of all spending in the last three decades. However, these programs are not responsible for the projected growth of our nation's debt over the next 25 years: Looking forward, spending on these programs is projected to remain at a roughly stable percentage of GDP and become an increasingly smaller share of the budget as other categories — especially health care — grow. We will not solve the problem simply through eliminating foreign aid and getting rid of earmarks. In 2010, Congress ended the practice of earmarking, which totaled less than 1 percent of the budget. Many argue that eliminating earmarks will not "save" anything because members can still direct funds at different stages of the budget process. But, to address the long-term fiscal challenge, policymakers will need to take a hard look at every program in the budget, and programs in this category are no exception. But, to address the long-term fiscal challenge, policymakers will need to take a hard look at every program in the budget, and programs in this category are no exception. Although the fiscal problem cannot be solved through reducing spending in this area of the budget alone, such reductions could play a role in putting the budget on a sustainable path.

SOLUTIONS

This category of the budget can be reduced through across-the-board cuts or, with more precision, by establishing and enforcing priorities, eliminating ineffective programs, merging duplicative programs, and streamlining the work of federal agencies.

However, some programs in this category of the budget can promote economic growth. For instance, this category includes programs that make investments in education, research and development, and infrastructure. Those activities offer the promise of long-term dividends by creating a better-trained, more highly skilled workforce, laying the groundwork for growth-enhancing innovation, and improving the U.S. business climate. Both the public and private sectors play an important role in driving U.S. competitiveness; determining the most effective role for the federal government will be critical to the long-term health of our economy.

TAXES

Although revenues fluctuate with the economy, in the post-World War II era the federal government has collected an average of 18 percent of GDP in annual revenues. During the recent recession, revenues plunged to 15 percent of GDP. Once the economy has fully recovered, the Congressional Budget Office expects revenues to rise gradually to 21 percent of GDP in 2022 under current law. However, those current-law projections assume that many popular tax cuts will expire at the end of 2012. Since those tax cuts have been extended in the past, many observers expect that policymakers will do so again, especially given the weak economy. If those tax cuts are permanently extended, the CBO projects that revenue as a proportion of GDP will hover around 18 percent once the economy recovers. However, this level of revenue will not be sufficient to meet future spending, which will be pushed up by higher spending on Medicare, Medicaid, and Social Security. By the CBO’s estimates, spending will rise to 24 percent of GDP in 2022 under current policies — well above the current policy ratio for revenue of 18 percent of GDP.

Portion of Income Earned and Federal Tax Paid

*A quintile is one fifth of the distribution. The top quintile is the richest 20% of households, while the bottom is the poorest 20%. Data from the Tax Policy Center, "Baseline Distribution of Cash Income and Federal Taxes Under Current Law by Cash Income Percentile, 2011," April 2011. Compiled by PGPF. NOTE: Data for cash income in 2011 dollars.

The greatest proportion of the federal government's revenue comes from three sources: the individual income tax, the corporate income tax, and the payroll tax. Other taxes collectively generate a relatively small amount of revenue.

The federal income tax system is in many ways intended to be "progressive" — that is, the amount of taxes owed increases with the amount of income earned. As shown in Figure 15, the top 20 percent of households receives a disproportionate amount of total income (55 percent), but also pays a disproportionate amount of federal taxes (70 percent).

Top 5 categories of tax expenditures

Tax Expenditures

Tax expenditures are often referred to as hidden spending, because Congress uses the tax code to direct subsidies to specific constituencies and activities. Tax expenditures — exemptions, deductions, credits, and other special provisions — allow households and qualifying corporations to reduce their tax liabilities. They also are expensive and cost about $1.3 trillion each year, more than any agency or spending program in the budget, including Social Security and the Department of Defense. Because high-earning taxpayers pay the most taxes, they also receive the bulk of the subsidies through the tax system.

Policymakers use tax expenditures to influence consumer and business behavior and to achieve economic outcomes. For example, the mortgage-interest deduction encourages taxpayers to buy homes instead of renting, the exclusion of employer-provided health insurance from taxable income encourages businesses to offer employees better health insurance benefits instead of providing wage increases, and depreciation provisions encourage new purchases of equipment. In all, there are more than 150 tax expenditures written into the individual and corporate tax codes.

SOLUTIONS

How can the federal government increase revenue? There are three broad classes of options.

• Raise current tax rates
• Introduce a new type of tax to supplement or replace the existing system. Carbon taxes are often highlighted as a way to raise revenue and discourage emissions. Others have proposed progressive consumption taxes to encourage savings
• Broaden the tax base by eliminating tax expenditures. This could apply to both the individual and corporate tax codes. Some, including the Bowles-Simpson commission, have recommended broadening the base (or increasing the amount of income that is subject to tax), and using some of the revenue gained to lower marginal tax rates and some to reduce the deficit.

INEQUALITY

Income inequality has grown considerably in recent decades. The most recent data from the Congressional Budget Office show that the average income of a household in the top 1 percent (the top 110,000 households) is 17 times more than that of the average household. In 1980, the average household in the top 1 percent earned 7 times more than the average household did. Many observers worry that this large and growing disparity in income could undermine the social cohesion of our democracy.

The progressive nature of our tax system is intended to offset some of these differences because taxpayers with higher incomes face higher tax rates. As a result, tax payments by the top 1 percent make up 26 percent of total federal revenue, while the bottom 20 percent of households contribute 0.2 percent to revenue.

Given the large number of deductions and benefits contained in the tax code, special interests across the political spectrum make fundamental reform of the system difficult. For an individual taxpayer, the loss of a tax benefit is very noticeable, while the overall gain to the economy is easy to overlook. But momentum is building for some action on taxes. Ideally, the path chosen should increase tax efficiency, reduce complexity, and raise enough revenue to improve the nation's fiscal outlook.

A BETTER BUDGET PROCESS

The annual federal budget process makes the budget picture harder to understand and encourages members of Congress and the executive branch to neglect long-term planning. Reforming the budget process could shift the focus to long-term issues, improve budgetary decisionmaking, and make the budget more transparent.

Budget process reforms can also be particularly valuable in helping to enforce budget deals to reduce the deficit once agreement has been reached. By making it more difficult for future Congresses to undermine those agreements, reforms can help reinforce and perpetuate a consensus among policymakers about the continuing need to maintain policies that reduce the deficit over the long run.

Several potential reforms could address shortcomings with the current budget process.

KEY PLAYERS IN THE BUDGET PROCESS

Federal agencies — The federal budget process begins in the spring when federal agencies start preparing budget proposals for the fiscal year that will commence 18 months later.

Office of Management and Budget — OMB coordinates the budget process in the executive branch for the White House. It reviews the agencies' proposals and negotiates modifications to reflect the spending and revenue priorities of the President. Once those proposals have been finalized, OMB prepares the President’s budget, which is usually released in early February following the State of the Union address.

House and Senate Budget Committees — Using the President’s budget as a guideline, these two standing committees of Congress work to create a congressional plan, known as the concurrent budget resolution. Although this resolution is not law, it sets aggregate levels for spending and revenue for the subsequent budget-related legislation. The deadline for passing the resolution is April 15, but it is rarely met. Congress is not required to produce a budget resolution each year, and in many recent years it has failed to pass one.

Congressional Authorization Committees — The House and Senate authorizing committees draft legislation that shapes the design of federal programs. Authorizing legislation is needed to create new federal programs and modify or terminate existing programs. For mandatory programs, authorizing legislation sets the eligibility criteria and benefit levels that play a large role in how much the program will cost.

House and Senate Appropriations Committees – The appropriations committees establish the annual funding level for discretionary programs. They write legislation allocating the total level of discretionary spending as provided by the budget resolution among various subcommittees, which produce 12 separate appropriations bills.

Congressional Budget Office — The Congressional Budget Office estimates the budgetary costs of every piece of legislation that is reported out of committee or otherwise subject to debate on the floor of the House or Senate. CBO also prepares a 10-year budget baseline of spending, revenues, and deficits under current law. The baseline is used as a benchmark against which legislative proposals can be measured. In addition, CBO analyzes the President’s budget each year, prepares an annual report on the long-term (75-year) outlook for the budget, and prepares other analyses on economic and fiscal topics.

Government Accountability Office — GAO is a congressional agency that audits the operations of federal agencies, investigates allegations of illegal or improper government activities, reports on whether government programs have met their objectives, performs analyses of selected policy issues, and issues legal opinions on agency rules.

Long-Term Focus

The long-term impact of federal policies is disconnected from that annual budget process. Although the President's budget submission includes information about the long-term impact of proposed policy, that information is buried in a technical appendix. To be sure, the Congressional Budget Office publishes a long-term budget outlook annually, and the Government Accountability Office issues its analyses twice a year. But the official estimates of the budgetary impact of legislation — the only ones that truly matter in legislative debate — generally cover only a 10-year period, which discourages reforms that would involve short-term political costs but produce improvements to the budget's long-term outlook.

Simple measures to provide more information about the long-term budget outlook could help to overcome the short-term focus of the current process. One approach would be to require the budget agencies to provide a long-term baseline at the beginning of the budget process. Another would be to require the President and Congress to evaluate the impact of their proposed policies on the long-term structural deficits and to report annually on the progress made toward fiscal sustainability. Official cost estimates, which are prepared when the Congress considers legislation, could also be extended beyond 10 years when policy proposals would have a significant impact on long-term deficits and debt.

Fiscal Targets

Despite the projected level of our deficits and debt, there are no overall goals or targets incorporated into the budget process to guide decision-making. Without a consensus about overall budget goals, it is more difficult to maintain fiscal discipline. To address this problem, Congress and the President could, for example, establish statutory medium-term targets for the national debt (such as a long-run stabilization of debt at 60 percent of GDP, as the Peterson-Pew Commission on Budget Reform has recommended), or require the budget to be in balance over the business cycle (that is, run surpluses when the economy is growing and allow deficits when the economy is weak).

Budget Enforcement Rules

Statutory pay-as-you-go rules, commonly known as PAYGO, mandate that lawmakers offset any mandatory spending increase or new tax cut with an equal reduction in mandatory spending or a tax increase. In the 1990s, PAYGO rules were particularly helpful in enforcing the deficit reduction that had been achieved with the 1990 budget deal. Those rules have been credited with helping to bring the federal budget into surplus in the late 1990s. However, these rules expired in 2002.

In 2010, Congress and the President enacted a new PAYGO statute. The new statute is less restrictive than the earlier PAYGO law because it exempts some policies (such as the extension of expiring middle-class tax cuts) from the PAYGO requirement. The PAYGO rules could be strengthened by scaling back or eliminating those exemptions.

Accounting for Budgetary Performance

Lawmakers could require the Congressional Budget Office to publish an annual report at the end of each session of Congress that details the progress made (or lost) during the year toward closing the gap between long-term promises and projected revenues. If the Congress passed a budget resolution (which sets a blueprint for spending and revenues for the year), the CBO report could also analyze the extent to which the Congress actually adhered to the resolution during the year. If the Congress adopts a set of fiscal targets, the report could also assess the performance of the Congress in meeting those targets. Such a report would increase transparency in the budget process and would hold the Congress accountable if it failed to meet its own targets.

Similarly, lawmakers could require the President to report annually to the Congress on actions taken that have improved or worsened the nation’s long-term fiscal outlook.