811 February 26,1991 WMHINGTOWS NEW DOMESIlC SPENDING SPREE INTRODUCIION The fiscal 1992 budget submitted to Congress early this month by the Bush Administration is noteworthy, not because it lives up to the promis es of last years budget summit, but because it has opened the floodgates to record levels of domestic spending. George Bush may, as a result, be known as the biggest spending President in three decades rather than the President who fiinally balanced the f ederal budget.

The $166.5 billion in new taxes agreed to in last years budget summit did not result in deficit reduction. Rather, eve new tax dollar raised has generated $1.83 in new domestic spending. Thus, instead of a deficit of 155.5 billion, the numbe r originally set by the budget agreement, or even of 64 billion, which would have resulted had automatic Gramm-Rudman-Holl ings cuts been allowed to take effect, the deficit for fiscal 1991 will be at least 206.7 billion.

Huge GNP Bite. With the spending approved by last years budget agree ment, the federal government now consumes over 25 percent of gross nation al product, the highest level since 1946 and up from 223 percent in 19

89. The federal governments bite of GNP has enormous impact on Americas 7 1 December, the Congressional Budget Office revised this total to $158 billion.fhe Presidents budget has reestimated the five-year tax increase at $1665 billion 2 Domestic spending here and below denotes all non-defense spending excluding net interest on t he national debt and the costs of the savings and loan bailout The original budget agreement announced that it raised taxes by Sl372 billion over five.years. In eamomy.The huge bite of this year takes out of the economy billions of dol lars that could be used by consumers to make more purchases or business to make more investments and create more jobs.he current recession is in large part a result of the tax-and-spend policies of Bush and the Congress.

Bush promised in his State of the Union address in Jan uary to hold spend ing increasu in fiscal 1992 below the level of inflation.This is not what his new budget does. When the one-time costs of the savings and loan bailout are removedfrom the..current budget figures, aggregate spending rises at a 5.4 percen t rate, 1.1 percentage points above inflation. What is more telling, non defense domestic spending rises by 82 percent, 3.9 points above inflation. An increase of this pace signals that domestic spending again is out of control.

Program are growing and bur eaucracies are expanding in ways that ensure higher base lines and constituencies for even bigger government programs in the future. As such, the Bush budget not only fails to keep domestic spending below the rate of inflation but nearly guarantees years of government spend ing increases and even deeper deficits.

Spending Caps. The fiscal 1992 budget need not be opening the sluices to new torrents of red ink. Just as strict limits have been placed on defense spending, such hits too could be placed on total domestic spending.The Bush budget should cap domestic spending at a firm four percent annual growth, a rate slightly above the projected rate of inflation. Capping domestic spending growth at four per cent, enforced by an auto matic sequester if Congress exceeds the spending tar gets, would still provide an additional, and predictable 32 billion per year for new spending, while leading to a budget surplus by 19

95. And by assuring the American people that federal spending is under control and that they wi ll not be asked to turn over more of their paychecks for growing and wasteful programs, federal policy makers will help the country climb out of the recession that they helped to create awl 1 Growth In Total Federal Spending ola\{ l 0141 01.4 Old 81s 81.1 nr rltrga DalaClurt Exdudes S&L w8 the wsts of Operations Dewn Shield and Dewn Storm, Md entitlement policy changes recommended by the Rush Administration 2 SPENDING IS OUT OF CONTROL Last years budget sdt originally was convened to solve a short-term proble m .The deficit for fiscal 1991, which began last October 1, was growing so large that the ax of the automatic sequester, required by the Gramm-Rud man-Hollings deficit reduction law, was about to fall. This would have lowered the deficit to the $64 billion level specified in law. Blanching from this, the White House and congressional leaders began looking for new ways to raise revenues to match the higher level of spending.

While budget summiteers last year toiled for six months to find new revenues, they ig nored the fact that Congress was raising total spending for fiscal 1991 by a record $96 billion, or 8.1 percent, over fiscal 1995This in crease did not include the Savings and Loan (S&L) bailout costs. This spend ing spree is built into last years budget accord. If unchecked, it will result in an annual average growth in aggregate spending of 5 percent per year through fiscal 1995, almost one point above the inflation rate.

Supporters of higher taxes defended the 1990 budget agreement by insist ing that it would result in about $2.05 in spending cuts for every new dollar of taxes raised.These cuts, they claimed, combined with strict enforcement rules against new spending, would lead to a $155.5 billion deficit in fscal 1991, a 150 billion deficit in fiscal 1992, and a $23 billion budget surplus by fiscal 1995.

Broken Promises. As critics of the budget accord predicted, the promises of spending cuts have been broken almost immediately. As the proposed 1992 budget released by the Bush Administration reveals, aggregate federal spending, not including the one-time costs of the S&L bailout, increases 1.97 for every new tax dollar raised.This is not obvious from a quick reading of the budget.This is because the fiscal 1992 budget, like the summit agree ment, empl o ys a series of budgetary gimmicks to mask the aggregate spend ing increases. In large part because of these increases, the fiscal 1992 deficit is estimated at $193 billion deficit. In fiscal 1995 alone, nearly $1 trillion of the nations resources will be d edicated just to domestic spending, not counting the net interest on the na tional debt.The only thing holding down overall federal spending at all is the budget summits reduction, in nominal terms, of defense spending by 3 per Domestic spending is entire l y responsible for the rapid growth in the 3 Unless otherwise noted, all totals of spending and deficits in the remainder of this study do not include the highly fluctuating one-time costs of the Savings and Loan bailout. Estimates of these costs have vari e d far too widely to reliably be included in aggregate totals.The confusion generated by the inclusion in budget figures of the S&L numbers will be discussed below 3 cent per year.This defense rollback masks a 7.6 percent annual in crease in non-defense do mestic spending average of 3.4 points above the inflation rate.

Some critics charge that todays budget deficit is the result of Ronald Reagans deter mination to rebuild and modernize Americas defense arsenal. This is not correct and the figures do not support it.

It is, moreover, instruc tive to note that the Bush build-up in domes tic spending will dwarf Reagans defense build up. Chart 2 shows the constant dollar com parison of the first six through fiscal 1995, an awl 2 The Bush Domestic Build-Up vs The Reagan D e fense Build-Up years of defense groqh under Reagan with six years of projected domestic spending under Bush. Cumulatively over six years, the Bush domestic spend ing spree is $590 billion, two-thirds more growth than the $356 billion, six year cumulative g rowth of defense spending under Reagan. If the critics of the Reagan budgets were concerned about high defense spending, they should be even more. concerned about the Bush domestic spending build-up 4 The base year for comparing each presidents build-up i s the constant dollar level of the last year of the previous administration. For example, Carters last defense budget in fd 1981 is held constant for the subsequent six years. Any real growth above this level each year is assumed to be the result of Reagan policy.

Cumulatively over six years, this build-up is $356 billion in constant 1989 dollars.

The Busb domestic spending build-up is likewise compared to the constant dollar level of domestic spending in Reagans last year, fiscal 1989.This sum is held con stant for the subsequent six years and any growth above that level is assumed to be the result of Bush policy 4 REJECI'INGTLIEREAGANSPENDINGRATES The growth trends for domestic spending now projected by the Bush Ad ministration will repeal thoroughly the s pending restraint established by Reagan. Domestic spending rose in nominal terms by 4.75 percent annually during Reagan's eight years, well above the average rate of inflation. Had Bush continued domestic spending at the Reagan growth rate, total federal spcnding for fiscal 1991, the current fiscal year, would stand at $1.2 trillion not $13 trillion, and the deficit wouldp no morelhan $118 billion, not the minimum $206 billion now projected.

Had Bush stuck to Reagan domestic spending growth levels from fis cal 1990, the first Bush budget, through fiscal 1995, the federal budget would have been balanced by early 1994 and shown a $107 billion surplus by 1995 even with the lower revenue estimates. But Bush abandoned the Reagan course. At the present rate of do m estic spending growth, Bush will spend a cumulative $687 billion above the Reagan growth rate through fiscal 1995 See Chart 3) This massive increase amounts to $4.00 in new domestic spending for ewexy new dollar of taxes raised by last year's budget agree ment.

Even after the fast spending pace set by Bush in fiscal 1990, his first budget he could have reversed the trend and gone back to the Reagan growth rate.

Yet it is now clear that the budget summit quickened the spending spree in Chart 3 Domestic Spen ding Growth 5 In fact, were the recession not causing a significant reduction in the estimates of future revenue growth, this year's deficit could have been as low as $87 billion, only $23 billion above the 564 billion deficit target required by Gramm-Rud m an. Before the re&on 30 billion more revenues were expected to come into theTreasury for fiscal 1991 than is now projected.Thtsc projections have been torpedoed by last year's budget agreement's tax and spcnding bikes which are driving the cconomy deeper into a recession. As a result, estimates of future tax revenues have fallen considerably 6 The shaded arm represents the cumulative $667 billion difference between the two trends 5 M.

Bush Policy Recommendations itiated in fiscal 19

90. Belatedly, the Bus h Administration acknowledges this rapid build-up in domestic spending, especially in mandatory programs. To of fset in part what could have been prevented in total, the Administration now seeks to trim roughly $35 billion from the planned entitlement gro wth through 1995.

As Chart 4 shows, this tardy and meager attempt to stem the spending tide will have negligiile results. Even if Congress gives Busb all the cuts he seeks the cumulative six-year increase in domestic spending over the Reagan rate Will stil l total $632 billion 3.80 for every new dollar of taxes raised BUSH OUT-SPENDS FIVE PRESIDENTS Unless the Bush Ad ministration alters its furious domestic spending the record books, outspend ing the first term domestic increases of the last five flation, t he Bush Ad ministration in its current term will boost domestic spending an average of $29 billion per year. Measured in constant dollars (ie: infla tion-adjusted dollars), this average annual growth rate well exceeds the domestic pace, it will be heading for OS0 826 Presidents. Adjusting for in- 820 816 810 86 aa chvl a Average Annual Growth in Domestic Spending nm mnlw) I spending of Richard Nixon I JlW cam 6is twice the growth rate of John Kennedy, nearly twice the growth rates of Iyndon Johnson and Jim m y Carter, and a staggering five times the growth rate of Ronald Reagan BUDGET SLIGHT-OF-HAND The Bush Administration claims that it is holding the fiscal 1992 budget growth of federal spending to 2.6 percent,.well below. the projected 4.3 per cent rate of inflation. The budget summit negotiators similarly have claimed to cut over $280 billion in spending from the budget overthe next five years.

Both claims are false.

The fiscal 1992 budget uses a variety of methods to trick the public into believing that Washington has become fiscally responsible. Most deceptive is the inclusion of the widely fluctuating one-time costs of the S&L bailout in the aggregate of total federal spending. This inclusion gives the false impres sion that aggregate federal spending will grow by a mere $61 billion between fiscal 1991 and fiscal 1995.

Since the time that the soaring costs of bailing out ailing S&Ls first made headlines, there has been considerable debate among policy makers over whether to include theses costs on-budge t and accouIlt for them as any other program expenditure, or to exclude these costs from aggregate account ing because of their short-term, unpredictable nature.

S&L Confusion. Those who favor the uon-budget approach argue that fail ing to include these c osts understates the true size of the federal deficit and thus, the financial problems facing the federal government.Those who favor the off-budget approach argue that the S&L crisis is a short-term, one-time problemTo include this in an aggregate account i ng of federal spending, con tinues the argument, would make it difficult for the public gauge the real growth trend of the federal government. Rather than choose between these two camps, last years budget summit agreement and the fiscal 1992 budget use bo th methods. Technically, the S&L costs are off-budget, but they are included in the aggregate totals of federal spending.

There are two characteristics of the S&L crisis that lead to the confusion when it is viewed in the light of total federal sp ending. First, the S&L crisis will have very high up-front costs in the first few years.These costs will shrink considerably in later years. In fiscal 1991, for instance, it is estimated that the bailout costs will total $111.5 billion.This will drop in f i scal 1992, according to the estimates, to $88 billion; in fiscal 1993 it will drop to $44 billion. As the costs of the bailout drop so will the growth rate of federal spending, even though almost all federal spending accounts may be increasing. Indeed, th i s is exactly what is happening.The Bush White House uses the drop in the cost of the S&L bailout to hide the growth in domestic spending See Chart 6) Such use of a onetime or short-term expenditure violates all accepted accounting practices 7 The second p r oblem is that clurt 6 the government. as it sells the How the S8L Bail-Out Masks ass& that it hi acquired from the failed SBiLs, eventually will realize, in some years, more money coming in than goes out in the S&L operation. In a sense, for that year, th i s is a profit. But because of the peculiar acoounting methods of the federal government, these profits will be recorded not in the revenue column but in the expenditure column as nega tive outlays, or off-setting receipts. The sale of S&L as sets is proje c ted to generate $38 billion in fiscal 1994 and $42 bil lion 1995.The governments accounting practices allow these profits to cover up bil lions in higher federal expendi tures. This furthers the illusion that spending growth is slow ing Real Budget Increa s es Curnnt Dollom Csiiii 81660 81600 81460 81400 81060 81 260 81 200 81 160 Budget Gimmicks. Since the fiscal 1992 budget was released, Administra tion officials have said repeatedly often in the same breath -that total federal, spending growth will be kep t below the inflation rate and that the costs of the S&L bailout are off-budget. Those not familiar with federal ac counting practices and this includes, understandably, almost ail Americans including almost all journalists -will not see through this budge t gimmick.

The truth is that total federal spending is kept below the inflation rate only if the S&L bailout costs are included in aggregate spending totals.This means that the Administration is misleading the public when it claims that domestic spending g rowth now is under control.

Removing the gimmicks, and thus eliminating the S&L bailout costs and eventual profits, total federal spending is growing by an annual average of 5 percent between fiscal 1991 and 19

95. As is shown by the growth line in Chart 6, the fiscal 1992 budget jumps roughly $70 billion over fiscal 1991 levels, an increase of 5.4 percent and a full point (or nearly 25 percent) above the infla tion rate. This increase follows on the heels of a $96 billion total spending hike in fiscal 1 9 91, an increase of 8.0 percent, nearly 3 points above the infla tion rate Oddly enough, though, it is this use of the S&L bailout cost that Budget Director Richard Darman used during the budget summit last year to create the illusion of a budgetary crisis and, according to some observers, to force Bush to support higher taxes. When Darmans Office of Management and Budget released its J

I990 Mid-S&n Review ofthe Bu&et, Dannan had completely changed the terms of the debate up to that time by including the S &L costs in both the deficit and spending calculations. By doing this he depicted the estimated fiscal 1991 deficit as $232 billion, up from the January estimate of 100 billion. This gave the appearance of credence to his argu ment: a huge deficit suddenl y has emerged and it can be reduced only by record high taxes DEFENSE CUTS Changes in defense spending also disguise the true federal spending situa tion. Last years budget agreement cuts defense spending considerably through 1995, calling for a 3 percent r eduction in defense spending per year in nominal terms, that is, below the level spent in previous years. In Washington budget terms, a reduction below a prior years level counts for much more than it may first appear to be.This is because of what is know n as the current services baseline budgeting method The current services baseline method is very confusing. Some veterans of the federal budget process say that the method is deliberately codusing. The current sewices baseline method works as follows: Budg e teers project future spending lewels for programs based upon such criteria as the requirements of current law, estimated inflation rates, and the expectedgowth in demand for the good or service provided.These projections, which are required by the 1974 Bu d get Act, become the baseline with which future real outlays or proposals for outlays are compared. Example: a program that costs $100 mil lion this year could, using the current services system, be projected to cost SllO million next year. If the program d oes cost SllO million, it is said that the program has not increased at all even though the program costs tax payers an extra $10 million. And if the program goes from $100 million only to $105 million, instead of to the projected $1 10 million, it actual ly is said that the program is being cut even though the program costs the taxpayers an extra $5 million.

Apparent Fiscal Responsibility. It is this current services system that al lowed last years summiteers to claim that they were cutting $178 billion fr om discretionary spending over the next five years. Discretionary spending includes most defense programs and any domestic programs for which Con gress must appropriate funds each year. In reality, all they did was trim the discretionary defense spending s lightly each year below the previous year. A slight trim over a previous year is a huge cut from what the projected outlays would be. It is this savings by keeping defense below projections that ac counts for 36 percent of last years summits entire $492 b i llion deficit reduc 9 tion plan. The reduction in defense spending, meanwhile, slows the aggregate growth of spending, which gives the further appearance of fiscal responsibility claimed by the summiteen FAILED ENFORCEMENT PROCEDURES Supporters of last ye a rs budget agreement claim that they have established tough procedures to enforce the. terms.of the accord.These enforcement mechanisms are in the form of caps on discretionary spending and pay-as-you go provisions on entitlement spending. Ostensibly these check federal spend ing growth and force spending priorities to be set by requiring agencies to compete for resources. But the spending spree of the Bush fiscal 1992 budget reveals that these enforcement mechanisms do not check spending growth.

The main reason is that the spending caps on domestic discretionary spend ing were set very high: 95 percent growth in fiscal 1991; 6.1 percent growth in fiscal 1992; and 5.3 percent growth in fiscal 19

93. Each of these rates is well Chart 8 Mandatory Spending NoW Totals exdude nel interest on the national debt md S&L bailout costs 10above the inflation rate and, in fact, above the existing pre-surmit baseline.

The result: last year's budget agreement actually permits vast boosts in discre Another result the caps will prompt no reordering of program priorities.

Any trade-off of funding forced by the spending caps is likely only at the mar gins.The high aggregate level of the caps would suggest that there wil1 be plenty of funding for everyone's favorite programs. nSavings".Washed Away. Since last year's summit, the costs .of entitlement program growth have been revised and reestimated. The resulting new figures completely wash away the ''savings promised by the summiteen. Entitle ments are now projected to grow by Over 85 percent per year on average through 1995,8 cumulative increase of $183 billion over the levels agreed to by the suxnmitcers. Even if Bush's recommended policy changes in this area are adopted by Congress, they only will slow entitlement growth to a n average 83 percent per year. Moreover, the pay-as-you-go provisions to stem new entitlement spending, which require that any new spending proposal be matched by an equal reduction in spending elsewhere or a tax increase, have yet to be tested but this r a pid rate of growth may make them irrelevant tionarywnding TLIE FOUR PERCENT SOLUTION Tbe budget summit's enforcement provisions and spending caps have not slowed domestic spending.This is because they do not force policy makers to weigh the relative value of everyprogramand,thus, trade off lowpriori programs for more important programs.The most effective method for reducing federal spending and forcing such trade ofb is to put a single cap on total domestic spend ing, excluding net interest on the federal d ebt and the S&L costs.This cap should be fixed at four percent, roughly the rate of inflation. Such a Four Percent Solution in itiated in fiscal 1992, and en forced by an automatic se quester if Congress exceeds the established spending caps, would save t h e tax payers $255 billion by 1995 cmlte The Four Percent Solution 11 CONCLU The Four Percent Solution is much like a long-term union contract in which the worker can count on a specific percentage pay increase every year of the contract. Beginning in fisc al 1992, the Four Percent Solution provides the domestic spending pool with an additional $32 billion each year for new spending.This new money can be allocated throughout domestic programs as policy makers see fit.

This is not possible under the current s ystem. Last years budget sum miteers were right to put firewalls between domestic discretionary spend ing and defense spending. Each of these areas is protected by a distinct spend ing cap so that Congress could not cut defense to increase domestic spendi ng.

While this is wise, it was not wise to erect a firewall between domestic discre tionary spending and domestic mandatory spending as the budget agreement has done. Just as all of the programs that comprise the nations defense inter ests should compete e qually for the available funds dedicated toward that pur pose, so too should all of the programs that comprise the domestic interests compete equally for the available domestic resources.

Policy Fiefdoms. The current enforcement system effectively has cre ated two distinct domestic policy fiefdoms in Congress; one fiefdom gets to pass out perks through projects and pork, while the other fiefdom gets to pass out perks through benefits to all who are eligible, be they welfare recipients or large agribusiness es. A single Four Percent Solution cap on total domestic spending would force all of the nations domestic interests to be appraised within a predetermined pool of money.

Because the Four Percent Solution prevents runaway domestic spending growth, it allows the current pace of revenue growth to catch up with spend ing.The Four Percent Solution, thus, honestly balances the budget by 19

95. If tax revenues continue to grow at the current projected rate, the budget could show a surplu s by the end of that year. Chart 9 shows the growth of tax revenues compared to both total federal spending under the Four Percent Solution and the current Bush rate of growth ITON Last year the American people witnessed their federal government in fiscal Crisis, struggling within a budget process that had broken down, unable to define spending priorities, and uncertain from day to day whether or not it would stay open for business. Both supporters and critics of the final budget agreement hoped that this experience never would be repeated, that Con gress and the Administration had learned their lessons and that this year they would strive to avoid past mistakes.

These hopes are to be dashed.TheWhite House and Congress are heading for a tragic replay of las t years tragic budget fiasco. Budget negotiators as sured taxpayers last year that spending would be cut in exchange for higher taxes.They claimed that the budget agreement would control the future 12 growth of spending. And they claimed that all of this w as ne- to avoid a higher budget defiut.This year, the Bush Administration is pledging that fis cal 1992 spending growth is held below the rate of inflation lkgic Replay. Last years promises already have been proved hollow.This years promises arc no better . The truth already is that the federal deficit again is heading for record levels because domestic spending is growing at un precedented ram.The record-high tax increase levied by last years summit already has been squandered on new spending. In fact, for every dollar raised by the new Bush-Congress tax hike, domestic spending will increase by at least $1.83 through 19

95. None of the tax hike has been used to trim the deficit. In fiscal 1991 domestic spending rose by 12 percent over fiscal 1990 levels, 65 points (or about 95 percent) above inflation.The 1992 budget sub mitted by the White House projects a domestic spending increase of 8.2 per cent, 4 points (or about 100 percent) above inflation. If this growth continues the federal budget cannot be balanc ed in the foreseeable future.

Reversing the Trend. Washingtons insatiable big-spenders, as is their habit, will want only higher spending and bigger government once they taste this new money. Before it is too late, Bush should admit that negotiating with t hese big spendera did not wrkThe Washington Establishment got every thing it wanted, higher taxes and much higher spending. Bush can reverse this trend only by confronting Congress with the truth and then submitting a budget plan, like the Four Percent So lution, that slows the rate of govern ment spending growth enougb to allow a growing economy to generate the taxes, as was happening at the end of the 198& to balance the budget.

Scott A. Hodge Grover M. Hermann Fellow in Federal Budgetary Affairs 13