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Jacob J. Lew - May 20, 1999

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May 20, 1999

Mr. Chairman, Representative Spratt, and Members of the Committee:

Thank you for the opportunity to appear before your committee today to discuss H.R. 853, the "Comprehensive Budget Process Reform Act of 1999," as introduced by Representatives Nussle and Cardin on February 25, 1999.

I would like to begin by emphasizing that the Budget Enforcement Act (BEA) has worked. The BEA has imposed an essential discipline on discretionary spending by means of enforceable discretionary spending caps. And the statutory pay-as-you-go (PAYGO) requirements have ensured that new mandatory spending and new tax cuts are paid for with offsetting spending reductions and revenue increases.

In short, the BEA's spending caps and PAYGO requirements have, over the last decade, helped reduce and eliminate the deficit and produce a surplus for the first time in 29 years. These tools for fiscal discipline, together with the 1993 and 1997 Budget Reconciliation Acts, have been key to our success.

Moreover, it should be noted that the PAYGO rules have been instrumental in the President's commitments to "save Social Security first" and to strengthen Medicare. By requiring that new spending and tax cuts be fully paid for, PAYGO has effectively prevented the spending of projected surpluses before the solvency of Social Security and Medicare have been secured. In addition, PAYGO has started us down the road toward substantial debt reduction.

We have a process that has worked. Before we make any changes to the current budget rules, we need to ask why the changes are needed, and to consider very carefully all of their consequences.

H.R. 853 would make several far-reaching changes to the current budget process. Transforming the Concurrent Budget Resolution into a Joint Budget Resolution presented to the President for signature, is a concept which this Administration has in the past supported.

However, as I will explain, the Administration is strongly opposed to the bill's serious weakening of the PAYGO rules and its establishment of an automatic continuing resolution. In addition, we have concerns about changes to the emergency procedures, the appropriations "lockbox" and other provisions in the bill.

I. Repealing PAYGO in an Era of Surpluses.

H.R. 853 would effectively repeal PAYGO in an era of surpluses. It would amend the BEA to permit on-budget surpluses to be spent on tax cuts or mandatory spending increases, without pay-as-you-go offsets. To understand fully the implications of this change, a brief review of the PAYGO rules will be useful.

Background.--The Budget Enforcement Act of 1990 set up separate enforcement mechanisms for: (1) discretionary spending; and (2) revenues and direct spending. These mechanisms -- annual caps on discretionary spending and a pay-as-you-go requirement for revenues and direct spending -- replaced the largely ineffective Gramm-Rudman-Hollings regime of declining annual deficit targets.

The PAYGO process originally required that changes in direct spending and revenues, combined, not increase the deficit in any year through FY 1995. The Budget Reconciliation Act of 1993 (OBRA-93) extended this requirement through FY 1998, and the 1997 Balanced Budget Act (BBA) further extended PAYGO for all legislation enacted through 2002.

PAYGO applies not to each new law individually, but to the cumulative effect of all new laws enacted since a designated starting point. The original starting point was all legislation enacted subsequent to the 1990 BEA. The current starting point for PAYGO calculations is legislation enacted since the BBA in 1997. OMB is required to maintain a "PAYGO scorecard" of both deficit and savings effects from all direct spending and revenue legislation enacted since the BBA and through 2002. Deficit effects of such legislation are calculated for the budget year and each of the ensuing four years (so that PAYGO will be enforced through 2006, for legislation which is enacted in 2002.)

OMB enforces the PAYGO requirements through "sequestration." If at the end of a congressional session, the scorecard shows a combined net deficit increase (or surplus reduction) for the fiscal years just-beginning and just-ended, OMB is required to implement across-the-board cuts in all non-exempt direct spending programs in amounts sufficient to eliminate the deficit increase (or restore the surplus). These across-the-board cuts are called sequestration. About 80 percent of outlays associated with direct spending programs are statutorily exempt from automatic sequestration cuts. Exempt programs include Social Security, Federal retirement and disability programs, net interest, certain low-income programs, veterans' compensation and pensions, and regular State unemployment insurance benefits.

Under the automatic sequestration of non-exempt programs, the sequester calculations are made so that two programs with automatic spending increases (COLAs) -- the special milk program and vocational rehabilitation -- are cut first, followed by two special-rule programs (Stafford loans, formerly called guaranteed student loans, and foster care and adoption assistance), and then Medicare and the remaining non-exempt direct spending programs. Automatic cuts in Medicare under PAYGO are limited to four percent, but there is no limit to the cuts which can be imposed on non-exempt direct spending programs.

The PAYGO requirements apply only to new legislation, not to changes in spending levels under existing law. For example, the estimated increase in mandatory spending resulting from a new law that broadened a beneficiary population would have to be offset, or it would trigger a sequester. However, if a beneficiary population as defined under existing law simply grew, the increased spending would not have to be offset. This is the key to PAYGO's success: it holds people responsible for legislative changes they can control - not for economic changes beyond their direct control.

Under current law, PAYGO applies whether the Federal government is running a deficit or a surplus. Therefore, tax cuts or direct spending increases that would cause a reduction in on-budget surpluses must be fully offset, just as legislation causing or increasing on-budget deficits must be offset.

Title VII of H.R. 853 would fundamentally change current law by permitting tax cuts or new direct spending legislation to be enacted without offsets -- up to the amount of projected on-budget surpluses. For example, the bill would permit a large tax cut or more spending to be enacted without any offsets, as long as the amount of the tax cuts does not cause or increase an on-budget deficit. This effectively repeals the pay-as-you-go requirement in an era of surpluses.

The Administration strongly opposes this repeal of the PAYGO rules. The Administration has proposed a framework for allocating projected budget surpluses over the next 15 years, but strongly believes that after Social Security and Medicare have been strengthened the pay-as-you-go disciplines should continue - as they did following OBRA-93 and the BBA of '97. H.R. 853, however, would set into permanent law the principle that any amount of projected on-budget surpluses could be spent on new tax cuts or new direct spending programs without offsets.

To understand the dangers of this approach, consider this year's Congressional Budget Resolution, H.Con.Res. 68 (Budget Resolution). The Budget Resolution calls for a tax cut of $778 billion over the next ten fiscal years -- which amounts to nearly all of the currently projected on-budget surpluses for that period. The PAYGO repeal called for in H.R. 853 would permit enactment of these permanent, and very expensive, tax cuts without any offsetting revenues or spending cuts. The tax cut would create large negative balances on the PAYGO scorecard for each of the subsequent years on the assumption that these negative balances will be offset by the actual surpluses when the time comes.

Now consider what would happen if the economy grows a bit more slowly than is currently projected, and the on-budget surpluses over the next 10 years, in the absence of legislation, turn out to be half of what is currently projected. The tax cuts would already be in permanent law, but the surpluses which were supposed to finance the tax cuts would not have materialized. We could face a net deficit big enough to trigger a 100 percent PAYGO sequestration. That means that Medicare spending would be automatically cut by 4 percent; spending for all of the non-exempt mandatory spending programs--child support enforcement, social services block grants, veterans education and readjustment benefits, CCC, crop insurance, and others would be eliminated; and there might still be some deficit remaining. Or, to avoid such a sequestration, Congress and the Administration would be forced to slash selected mandatory and discretionary spending programs. One of the principal reasons we need to maintain the fiscal discipline of the PAYGO rules during a time of surplus, as well as during deficit periods, is the relative uncertainty of budget forecasting.

The PAYGO rules have been and continue to be a pillar of fiscal discipline. They have saved the surpluses for Social Security and Medicare, and have reduced our public debt. We urge the Committee to maintain this discipline.

II. Automatic Continuing Resolution.

Title VI of H.R. 853 would establish an automatic continuing resolution (auto-CR) which would continue funding at the previous year's levels, in the absence of regular appropriations. Similar proposals have been under discussion in the past, particularly since the government shutdowns of 1995. The government shutdowns during the 104th Congress were unnecessary and very costly, and -- as the President has said -- should never happen again.

However, an auto-CR is an irrational and unworkable response. Congress should not undermine the ability to respond to a changing world by substituting an automatic funding mechanism for the hard work and judgment that results from bicameral action and presidential approval.

In addition, under this bill, auto-CRs would last for the whole year, unless replaced by regular appropriations. Full year CRs could therefore trigger a sequester if they result in spending levels greater than the caps of that year.

An auto-CR could disrupt the funding of government programs in other ways. For example, an auto-CR could be a powerful incentive for filibusters in the Senate. A minority of 41 in the Senate could impose a freeze on selected programs - defense or non-defense -- simply by filibustering the relevant appropriations bills. Alternatively, a minority of 41 could prevent program reductions, where the savings are needed to fund higher priorities. In fact, such a minority could perpetuate programs with no review or reform whatsoever.

In short, it is the Congress' constitutional responsibility to make decisions about appropriate funding levels for the government's activities. Putting appropriations on auto-pilot would be a mistake.

I would remind the Committee that in 1997, the President vetoed an emergency flood supplemental because it attempted to enact an auto-CR that would have undermined the appropriations process.

III. Emergency Spending.

Title II of H.R. 853 would repeal the BEA "emergency" procedures. Those procedures currently provide for the upward adjustment of the discretionary spending caps to accommodate emergency spending. For this purpose, spending is deemed an "emergency" when it is jointly designated as such by the President and the Congress. (Though seldom used, the BEA also permits designation of direct spending and revenue provisions as emergencies; in such cases, the costs of such legislation are not placed on the PAYGO scorecard.)

H.R. 853 would replace the current-law emergency procedures with a requirement that both the President's Budget and the Congressional Budget Resolution include a "reserve" for emergencies that is not less than the average for emergency spending in the preceding five years.

Use of the reserve fund is made contingent upon the Budget Committee Chairmen certifying that the spending meets a new statutory definition of "emergency." "Emergency" is defined in the bill as a "situation that requires new BA and outlays...for the prevention or mitigation of, or response to, loss of life or property, or a threat to national security; and is unanticipated"; the bill defines "unanticipated" as "sudden,...urgent,...unforeseen,...and temporary."

In addition, under H.R. 853, any legislation which proposes emergency spending that would exceed the emergency reserve would be automatically referred to the Budget Committees for not more than 3 days. The Budget Committees would determine whether to report an amendment exempting the emergency spending from the discretionary caps or PAYGO requirement, as appropriate.

H.R. 853, as introduced, does not address the issue of whether the discretionary spending caps would be adjusted upward to levels sufficient to accommodate inclusion of an "emergency reserve." If there is an insufficient upward adjustment, the fencing off of funds for this emergency reserve would make already extremely tight spending caps that much tighter. The Administration would strongly oppose a significant tightening of the discretionary caps.

But even if there is an intention to fully adjust the caps for such a reserve, the Administration would still have concerns about the advisability of this proposal in its current form. Consider Table 1, which shows emergency spending in each year since enactment of the BEA. As the table shows, emergency spending is by its very nature inherently unpredictable. If an emergency reserve is created, based on a five-year average, it could end up being too little to cover emergencies in some years; while in other years, it would end up being too much, which would divert scarce resources from other needs.

Moreover, the President, the Congress, and the Nation need to be able to respond quickly to emergencies - whether it is for military and humanitarian needs in Kosovo, aid to victims of tornadoes, farmers struggling with low prices, or assistance desperately needed by hurricane or earthquake victims. The current process, which permits emergency spending only when it is jointly designated, in law, by the President and the Congress, can already take months. H.R. 853, by contrast, would further encumber the process by requiring the Budget Committees to determine whether particular emergencies meet a rigid statutory definition. This additional encumbrance is unnecessary and could have very negative consequences when emergency relief is urgently needed.

IV. Putting the Squeeze on Appropriations: the Lockbox and Baselines.

Title VI of the bill would establish procedures to give Members offering Floor amendments cutting appropriations the option to allocate the savings either as offsets for other spending, or as savings to go into a "lockbox." The lockbox savings would automatically reduce the Appropriations Committees' 302 allocations; and by operation of language to be included in the appropriations bills, would also reduce the statutory caps.

The Administration has concerns about this proposal because it has the potential to further reduce already tight discretionary spending caps. In an era of very tight discretionary spending limits, savings from lower priority appropriations should continue to be available for higher priorities.

In addition, the lockbox mechanism itself, is unworkable. For example, a Senator could offer an amendment to reduce funding in a particular appropriation bill and direct all of the savings to the lockbox. Even if the House cuts nothing from that bill, H.R. 853 requires that one-half of the Senate's cut would remain in the lockbox -- automatically reducing the 302(a) allocations in the Senate and in the House. So you could end up with a circumstance where a Senate amendment has lowered the House Appropriations Committee's 302(a) allocation -- contrary to the levels the House had adopted in the Budget Resolution.

In addition to appropriations being squeezed by a lockbox mechanism, H.R. 853 purports to mandate that the Congressional Budget Office (CBO) and OMB use the prior fiscal year's level without adjustment for inflation as their baselines for projections of discretionary spending in future years. The results would be that when estimating future surpluses or deficits, the Congress would be assuming a hard freeze on discretionary programs, rather than estimating the inflation-adjusted costs of continuing current services. The result would be a substantial under-estimate of what it would cost to continue current government operations and services - resulting in more pressure on discretionary appropriations.

V. Accrual budget for Federal insurance programs.

Title VI of the bill mandates budgeting for Federal insurance programs on the basis of the net present value of the risk assumed in a given year, instead of the traditional cash basis of payouts minus premium collections. This approach is generally analogous to budgeting for credit programs under the Federal Credit Reform Act. The requirements would apply to deposit insurance, pension guarantees, flood and crop insurance, the Overseas Private Investment Corporation's insurance program, and other insurance programs. The bill provides for several years of experimentation, publication of advisory estimates, and transparency for the models and data used. In addition, it would require reports by OMB, CBO, and GAO on the feasibility of risk-assumed budgeting for insurance programs. It would require the President actually to base the budgets for insurance programs on risk-assumed estimates beginning with the FY 2006 budget.

We agree that risk-assumed estimates -- if they are reliable and well understood -- would have considerable merit for scoring insurance programs in the budget. However, the use of this methodology, outside of the comparatively ordered world of contractual arrangements between lenders and borrowers, is sufficiently difficult that OMB would oppose a statutory deadline for its implementation. Estimates for some programs could change substantially from year to year with shifts in interest rates and other long-range assumptions. Producing the estimates would require highly sophisticated estimating models that neither we nor the private sector have now or are likely to have any time soon. Whether such models could be developed in time to meet the requirements of the bill is highly uncertain. While we understand the bill sponsors' desire to set a firm target date for implementing this change, we donot believe it is realistic at this time.

VI. Ten-year Limits on Program Authorizations and Entitlements.

Title IV of H.R. 853 requires committees to submit schedules for reauthorizing, within 10 years, all programs in their jurisdiction, including entitlements. It also prohibits the consideration of new direct spending programs unless their duration is limited to 10 or fewer years. And it guarantees Members the right to offer amendments subjecting proposed entitlements to the appropriations process.

The apparent objective of this title is to limit the enactment of new entitlement benefits. The Administration believes the right approach is not to put arbitrary roadblocks in the way of new direct spending, but to maintain the current law PAYGO rules so that new direct spending is paid for, and must compete against alternative uses of available funds. It is highly ironic that H.R. 853 on the one hand seeks to rein in the creation of new entitlement authority, at the same time that it repeals the pay-as-you-go requirements when surpluses exist.

I want to thank the Committee for this opportunity to present the Administration's views on H.R. 853 and would be happy to answer any questions you may have.

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