Budget Out of Balance: Are Spending Caps the Way to Go?

Budget Out of Balance? So Put a Lid on Spending, Right?

That might not be the right thing to do—it depends on how you do it. The House is planning votes this week on a bill to “Cut, Cap, and Balance” to put some tight controls on government spending. The Senate may take up similar legislation. The “cap” in this proposal would put a limit on all government spending, ratcheting down gradually from the current level, which is 22.5 percent of the gross domestic product, to 19.5 percent over the next decade. A supermajority in both houses (2/3) would be required to set the cap aside or to raise taxes (by ending tax subsidies, closing loopholes or otherwise.)

First: How low is the limit?
In Ronald Reagan’s time, total federal government spending was about 22 percent of the gross domestic product. Though President Reagan – with Congress’s full acquiescence – raised military spending during that time phenomenally, there were pretty tight controls on other types of spending -- on health care, community programs, education, mass transportation, environmental protection, and programs to support low income people. Now, we have the huge military budget that was inherited from that time and has been increased by generous increments year to year, we have health care costs that have gone up by 1/3 as a share of the economy, we have baby boomers retiring in great numbers and qualifying for both Social Security and Medicare, and we have a whole new agency formed since 9/11/2001 to respond to threats of terrorism. A cap at 19.5 percent of the gross domestic product would be extremely low, given current and anticipated needs.

Second: What does the cap apply to?
The proposals apply the cap to all federal spending, both discretionary and “entitlements.” Entitlements are programs that are available to anyone who qualifies for them. Unless Congress changes the program itself, the funding is assured. By their nature, entitlements often pick up the slack when the economy weakens, directly helping those who are most vulnerable to economic downturns, and indirectly helping local communities by getting more money into circulation to support employment and economic recovery. In this recession, for example, the Food Stamp program (now known as Supplemental Nutrition Assistance Program or SNAP) functioned exactly as it was designed. Surveys before and during the recession show that, while this nation has a much bigger hunger problem than it should have as an advanced nation, there were no more hungry children at the lowest part of the recession than before the recession. Families who lost the job of their breadwinner(s) were able to get help immediately to put food on the table. Food assistance programs, income supports like Unemployment Insurance, Temporary Assistance for Needy Families, and Supplemental Security Income, are designed to be “counter-cyclical.” They counter the effects of a recession, and help both needy families and the communities around them to recover more quickly from the recession. Including them in a cap would mean that, as the economy slows (i.e. the gross domestic product goes down), the amount available to counter the recession would also go down, contributing to a downward economic spiral.

Third: What measure is it hooked to?
Hooking a spending cap to the gross domestic product means that as the economy contracts, the government’s ability to respond to the recession also contracts. In addition to restrictions on the automatically counter-cyclical programs, this kind of cap would also prevent new investments in job creation, supports for state education budgets, incentives for home buying, rental assistance, and other interventions that could help to turn around a weak economy. It also restricts longer term investments in education, training and health care that support a healthy economy in future decades.

Fourth: Are all spending caps bad?
Not necessarily. If the nation’s spending is out of balance, it does need to be reined in to a reasonable level that can be supported by an adequate and fair tax system. Achievable yearly spending caps on discretionary spending could be a very useful part of package that includes attention to fair and adequate revenues.

How should spending caps be applied?
According to the Center on Budget and Policy Priorities, a non-partisan economic group, the current deficit crisis could be met with savings from direct spending and tax expenditures, approximately equally divided. Caps on direct spending should be applied equally and separately to military and non-military programs; without this requirement, experience tells us that most or all of the cuts would come from non-military programs, while the Pentagon budget would continue to grow. On the non-military side of the budget, programs that care for the most vulnerable in our society should be protected from spending cuts. The prevalence of poverty in the U.S. should be a challenge to us as an advanced nation. Until poverty is drastically reduced, the nation has a particular responsibility to those left out of the benefits of the economy. Previous deficit reduction efforts in the 1980s and 1990s exempted the major programs for low income people from the effects of deficit reduction packages. These efforts were generally successful, and poverty was actually reduced as deficit spending went down.

How do taxes come into the picture?
Effective tax rates – the amount actually paid after all deductions and credits are factored in – are at an historic low for both individuals and corporate tax payers. Tax expenditures – which are deductions and credits allowed for some but not all taxpayers – are a way to subsidize certain activities which, ideally, are in the public interest (such as giving to charity, installing “green” appliances and windows, or buying long-term care insurance). Tax expenditures do tend to flow to relatively high income people who (a) have the money to undertake a subsidized activity and (b) itemize their deductions on their tax returns. Also, this kind spending is guaranteed – even more firmly than an “entitlement” – because tax expenditures are provided through the tax code. For example, a parent who pays for child care might be subsidized in one of two ways – through a discretionary program that Congress can choose to fund or not fund from year to year, or through a tax credit, which Congress is always reluctant to end.

Tax expenditures include popular items such as deductions for interest payments on home mortgages and student loans, or credits like the child care tax credit. They also include special treatment for certain kinds of income or expenses that apply to only a very few individuals or corporations. Taken all together, this “indirect” spending totals more than $1 trillion per year. As Congress looks at spending caps, it should also look at capping some of this indirect spending through the tax code.