March 19, 1999
The Lock-Box Proposal and the Economy
by Robert Greenstein
Table of Contents
The Republican leadership is proposing the establishment of a "Social Security lock-box" that has been described as preserving and protecting Social Security by ensuring that Social Security surpluses are saved and used to pay down the debt, rather than used for other purposes. Senator Spencer Abraham unveiled this legislation this week on behalf of the Senate leadership.
A separate Center on Budget and Policy Priorities analysis explains why this lock-box proposal would not actually require Social Security surpluses to be used to reduce the debt. That analysis, "The Republican Budget Proposals," shows that due to a major loophole in the proposal, it could result in little debt reduction and has, in fact, been designed to facilitate the passage of proposals to convert part of Social Security to individual accounts.
This analysis examines several other issues related to the Abraham lock-box proposal, including its likely effects in exacerbating future economic downturns and its potential to trigger a government default. The shortcomings of this proposal do not mean, however, that proposals to lock away surplus Social Security reserves are unwise, but rather that such proposals need to be designed in a fashion that avoids the pitfalls of the Abraham approach.
How the Lock-box Would Work
The proposal would establish steadily declining statutory limits on the debt held by the public. These limits would essentially equal the current Congressional Budget Office projections of what the debt levels would be in the next 10 years if the non-Social Security budget is balanced and all of the Social Security surpluses are used to pay down debt.
Except for automatic adjustments that would be made in these debt limits to reflect changes in the size of the Social Security surpluses as well as the effects of Social Security reform legislation,(1) these debt limits could be raised only by a three-fifths vote in the Senate and a majority in the House. This means that if the non-Social Security budget threatened to fall out of balance and consequently needed to borrow some funds, this borrowing would be prohibited unless a super-majority could be assembled in the Senate to pass legislation specifically allowing it.
Until now, it has taken a simple majority of Congress to raise the debt limit. On numerous occasions, it has been difficult to amass a simple majority for this purpose, even when the debt limit clearly had to be raised and there was no feasible alternative. Votes to raise the debt limit typically are surrounded by high-stakes political maneuvering. Securing a three-fifths vote in the Senate to raise the debt limit could prove exceedingly difficult.
The idea behind the legislation is that if the non-Social Security budget threatened to fall out of balance, Congress and the President would have to reach agreement on ways to reduce government expenditures or increase tax collections to keep the non-Social Security budget in balance. But it is possible that such an agreement could not be reached, and a super-majority in the Senate would not vote for legislation to raise the debt limit. It that occurred, the Secretary of the Treasury would have to default on financial obligations of the U.S. Government an unprecedented step that could have substantial costs or withhold government payments, including payments to beneficiaries of government programs, government contractors, and Medicare providers. The payments affected could include Social Security checks and benefits for poor children and families. The Secretary would have to take these actions even if the unified budget (i.e., the total budget, including Social Security) remained in surplus.
Why the Non-Social Security Budget Could Fall Out of Balance For Reasons Beyond Policymakers' Control
Congress and the President are likely to enact legislation this year that uses most or all of the projected non-Social Security surpluses for tax cuts and government programs. Not much, if any, of the projected non-Social Security surpluses is likely to remain. The Republican budget resolution proposes using most of the projected non-Social Security surpluses for tax cuts, and some tax cuts are likely to pass this year. The Administration and a number of Members of Congress of both parties have called for using a portion of these surpluses to ease the current, tight caps on discretionary spending; some easing of these caps appears likely, especially in light of the bipartisan support for defense spending increases.
If Congress and the President pass legislation this year that is projected to result in balance or modest surpluses in the non-Social Security budget but the economy later weakens and grows more slowly than CBO has forecast, the non-Social Security budget will likely slide back into deficit. The resulting deficits could be substantial. CBO estimates that a downturn of the size of the recession of the early 1990s, which was not a severe recession as recessions go, would increase the budget deficit (or reduce surpluses) by approximately $85 billion a year after the recession hits bottom.
CBO cautions that its surplus forecasts could be off by even larger amounts if revenues grow more slowly than forecast. Analysts do not fully understand why revenues have grown more rapidly than projected in recent years, and they do not know the extent to which the factors that have caused this unexpected revenue growth are temporary or permanent. Revenue growth in future years could be significantly lower or higher than CBO currently projects. If it is significantly lower (and legislation using most of the non-Social Security surpluses currently projected has been enacted), deficits in the non-Social Security budget are likely to return.
A drop in the stock market also would result in lower-than-expected revenue collections, since less capital gains tax would be collected. That, too, could push the non-Social Security budget back into deficit.
CBO this year devoted a full chapter of its annual report on the budget and the economy to the uncertainty of its budget projections. CBO warned that "considerable uncertainty" surrounds its budget estimates "because the U.S. economy and the federal budget are highly complex and are affected by many economic and technical factors that are difficult to predict. Consequently, actual budget outcomes almost certainly will differ from the baseline projections..." (2) CBO reported that if its estimate of the surplus for 2004 proves to be off by the average amount that CBO projections made five years in advance have proven wrong over the past decade, the forecast for 2004 could be too high or too low by $300 billion.
Even if the budget forecast proved accurate and the budget was in balance for a fiscal year, the Treasury still could need to borrow additional amounts during certain months of the year and to exceed the debt limit temporarily. Expenditures and revenue collections do not precisely match each other on a month-to-month basis. The non-Social Security budget can be in deficit for part of the year but in balance for the year as a whole.
The lock-box provision would not permit any such deficits, however, unless three-fifths of the Senate and a majority of the House voted to allow them. In the absence of such Congressional approval, the Treasury would be barred from borrowing any funds in excess of debt limits that had been set with the assumption that the non-Social Security budget would be in balance at all times throughout the next 10 years.
The Dangers to the Economy
In years when economic growth is sluggish, revenues rise more slowly while costs for programs like unemployment insurance increase. Forecasts that the budget will be in balance are overtaken by events, and deficits emerge. Under the lock-box proposal, such deficits would not be permitted.
Fiscal retrenchment in the form of program cuts or tax increases consequently would be required in periods of slow growth and recession. The slower the growth, the larger the expenditure cuts or tax increases required to keep the debt limits the lock-box legislation has established from being exceeded.
This is the reverse of how fiscal policy should function when the economy falters and recession threatens. The lock-box proposal carries a sizeable risk of making recessions more frequent and deeper, as a result.
The economic problems the nation faced in the 1930s were far more severe than anything likely to develop in the years ahead. Nevertheless, the policy mistakes made in that era are instructive. From 1930 to 1933, Congress repeatedly cut federal spending and raised taxes, trying to offset the decline in revenues that occurred after the crash of 1929. These spending cuts and tax increases removed purchasing power from the economy and helped make the downturn still deeper. They occurred at precisely the wrong time in the business cycle.
This is why proposals such as the lock-box measure are called "pro-cyclical" they exacerbate the natural business cycle, making downturns more severe. This also is why most economists who favor strong debt-reduction measures oppose legislative requirements which mandate that the budget be balanced each year as the Republican lock-box proposal would do.
In testimony before the House Budget Committee in 1992, one of the nation's most respected economists, then-Congressional Budget Office director Robert Reischauer, made a number of these points. Reischauer was referring then to a constitutional balanced budget requirement, but the issue is essentially the same as the one the lock-box proposal raises. "[I]f it worked," Reischauer warned, "[a balanced budget amendment] would undermine the stabilizing role of the federal government." He explained that the automatic stabilizing that occurs when the economy is weak "temporarily lowers revenues and increases spending on unemployment insurance and welfare programs. This automatic stabilizing occurs quickly and is self-limiting it goes away as the economy revives but it temporarily increases the deficit. It is an important factor that dampens the amplitude of our economic cycles." Under a balanced budget requirement, Reischauer observed, these stabilizers would no longer operate automatically and hence would be less effective.(3)
Proponents of the lock-box proposal respond that the proposal would allow the debt limits to be raised for a fiscal year if three-fifths of the Senate and a majority of the House voted to allow that. But this is not a sufficient response. It is unlikely a three-fifths majority would materialize until after the economy was already in a recession and considerable economic damage had been done. The Office of Management and Budget and the Congressional Budget Office have rarely, if ever, forecast a recession before one started. We usually do not know we are in a recession until the downturn is at least several months old.
As a result, the lock-box proposal would likely lead to the stiffest austerity measures being taken in years when the economy was weakening but not yet in recession. Such actions could tip a faltering economy into recession and make an ensuing recession deeper.
Adding to this problem, a three-fifths majority could be particularly difficult to garner if a recession were regional rather than national, as is usually the case at least at the start of economic downturns. It might not be possible to obtain a three-fifths majority until a recession had spread to a substantial majority of states.
Past recessions generally have started in some regions and taken time to spread; they also have hit some regions much harder than others. In the last recession, for example, New England and the mid-Atlantic states began experiencing declines in employment by the second quarter of 1989, a full year before employment turned down in most of the rest of the country. If rising unemployment insurance costs and falling revenues in several regions threatened to push the federal budget out of balance, would enough Members of Congress from states where economic problems were not yet evident be willing to raise the debt limit and allow the non-Social Security budget to run a deficit? If not, not only would fiscal retrenchment be required that could make the downturn deeper, but regions needing federal recession relief might find it was not forthcoming.
Economic downturns also tend to last longer in some regions than others. In the last recession, employment losses lasted two to four years in California and much of New England and the mid-Atlantic states, while a number of other states recouped their employment losses in a matter of months. This pattern was reversed in the recession of the early 1980s; that downturn was sharpest and lasted longest in the Midwest and South. The regional patterns that characterize economic downturns raise questions about the wisdom of enacting legislation that prohibits deficits in the non-Social Security budget and allows this structure to be relaxed only if three-fifths of the Senate so approves.
Increasing the Risk of Government Default
The proposal also is likely to make crises in which a government default threatens more frequent and to heighten the risk that such a default actually could occur.
As noted above, it now takes a simple majority of both houses of Congress to raise the debt limit. On a number of occasions, it has proved difficult to secure such a majority to raise the debt limit. Securing a three-fifths vote in the Senate to raise the debt limit, as the lock-box proposal would require, could prove excruciating.
As explained above, a non-Social Security budget balanced at the start of a year could easily slip out of balance during the year for a number of reasons beyond policymakers' control, such as slower-than-expected economic growth, smaller-than-expected revenue collections, or a natural disaster. If such a development occurred with part of the fiscal year gone, the budget cuts or tax increases required to avert a need to borrow, even on a temporary basis, might be unattainable. Enacting and implementing measures to produce budget savings would generally take some time; such savings would not begin appearing instantaneously upon enactment of the deficit-reduction measures. Yet only a limited number of months might remain in the fiscal year. Budget cuts or tax increases sufficiently deep to secure the necessary savings in a few months could be extremely difficult if not impossible to pass.
Suppose, for example, non-Social Security outlays turned out to be a modest one percent higher than CBO estimated at the start of the year, while revenues (other than Social Security payroll taxes) turned out one percent lower. A budget initially thought to be in balance would develop a deficit of close to $30 billion. If this potential deficit was recognized part way into a fiscal year, it could be difficult to address in that year. The highly controversial balanced budget plan embodied in the budget resolution that the hard-charging 104th Congress passed in 1995 would have achieved less than $30 billion in savings (in today's dollars) in the first fiscal year it was in effect. Yet that budget would have had a full 12 months in which to realize those savings.
It may prove impossible in such circumstances to secure agreement by Congress and the President on budget cuts or tax increases large enough to restore balance to the non-Social Security budget, especially if such measures would slow an already-weakening economy. Yet the alternative allowing a deficit in the non-Social Security budget and borrowing the funds to cover it would require a three-fifths Senate vote. If a three-fifths majority could not be secured to raise the debt limit, a default crisis would loom.
The Consequences of a Default
CBO has warned that even a default lasting only a few days could have lasting consequences, because it could erode confidence in the binding nature of the financial obligations of the U.S. Government and raise government costs as a result. The national debt is financed at relatively low interest rates because those who purchase government securities are confident they will be repaid in full and on time. Similarly, federal defense and highway contracts are less costly than they would be if contractors lacked confidence of being paid in full and on time. If a default occurred, even if only for a brief period, confidence in the U.S. Government's ability to make payment in full and on time could be shaken. The interest rates the government must pay on securities that the Treasury issues could rise, as could the costs of government contracts. These increased costs could last for years. A default also could lead to a lowering of the U.S. Government's credit rating and to a lessening of our effectiveness internationally in prodding other countries to avoid defaults.
Giving Minority Factions Power to Disrupt the Economy
Finally, the requirement that the debt must shrink in line with pre-determined debt targets unless three-fifths of the Senate (and a majority of the House) agree to raise the debt limits would have another important consequence. It would confer upon minority factions in the Senate an unprecedented degree of leverage over national economic and fiscal policy.
Due to the supermajority requirement, minority factions could withhold support for an increase in the debt limit when a recession loomed, threatening to plunge the government and the economy into turmoil (and the Treasury into default) unless they were granted major policy concessions. Minorities willing to threaten turmoil and disruption to achieve their ends could gain unprecedented power.
One can, for example, envision a minority insisting on large tax cuts that do not expire when a recession ends as its price for agreeing to raise the debt limit during a downturn. The minority might use supply-side arguments and claim the permanent tax cuts would ignite long-term economic growth. Still-deeper cuts in basic programs could then be needed in subsequent years to offset the ongoing revenue losses resulting from the permanent tax reductions.
Measures to prevent inappropriate uses of Social Security surpluses can represent sound policy if carefully designed. Using debt limits enforced by supermajority voting requirements and backed up by threats of default, however, are an unwise way to achieve this goal.
Since 1990, the nation has used other mechanisms to enforce fiscal discipline rules requiring that the costs of tax cuts and entitlement increases be offset, and rules imposing caps on discretionary spending. These mechanisms have been highly effective. They have operated without threatening budget cuts or tax increases when the economy weakened and without creating risks of government defaults. Mechanisms can be fashioned to enforce fiscal discipline and prevent inappropriate uses of Social Security surpluses, building on the successes of the past decade's budget enforcement mechanisms, without posing the unacceptable risks that the Senate leadership's legislation carries.
1. The debt limits would be decreased or increased automatically to the extent that annual Social Security surpluses proved to be larger or smaller than the current CBO forecast assumes. The debts limits also would be adjusted automatically to reflect the impact of Social Security reform legislation on the debt held by the public. These adjustments are discussed in the Center analysis, "The Republican Budget Proposals."
2. Congressional Budget Office, The Economic and Budget Outlook: Fiscal years 2000-2009, January 1999, p. 81.
3. Statement of Robert D. Reischauer, Director, Congressional Budget Office, before the House Budget Committee, May 6, 1992.