PAYGO Begone

Main St. Agenda by from The Weekly Standard, June 16, 2014

An arithmetic riddle: How much money would the U.S. government collect if it were to impose a 5 percent tax on the $2 trillion currently parked in offshore accounts to avoid the high U.S. corporate tax rate of 35 percent?

If you multiplied $2 trillion by .05 and arrived at $100 billion as an answer, you get full credit for your math acumen but zero points for political accuracy. The answer is a negative $600 billion, at least in the eyes of the Joint Committee on Taxation and the Congressional Budget Office (CBO).

How can this be? The trouble is that in official calculations of how much a law will change revenue, a counterfactual must be taken into account: How much money would the Treasury have received from those overseas profits if the government did not reduce its tax rate? While common sense and accuracy would put that number somewhere around zero, since most of that money will never be repatriated, the convention is to assume that, eventually, every one of those dollars would be returned to the United States and taxed at the full 35 percent tax rate, bringing in $700 billion.

The arcane rules and conventions followed in official revenue estimates are problematic because the current budget system requires every piece of legislation that would increase the deficit in some way to be “paid for,” typically with a complementary piece of legislation that either raises revenues or lowers spending elsewhere. While it may seem like an admirable way to keep a spendthrift Congress in check, the way that our “pay as you go,” or PAYGO, system actually functions creates a whole host of perverse incentives. Ultimately, its use may cause more problems than it prevents.

In some circumstances it actually blocks policies that would generate revenue. For instance, while the possibility of expanding offshore oil drilling to Virginia and the Carolinas—where it is currently banned—may have lots of passionate advocates on both sides, no one disputes that it would generate more tax revenue.

Except the CBO. As they see it, there is not actually a “permanent” ban on such drilling: It is technically a five-year ban that Congress habitually renews. If the ban were lifted tomorrow, no oil would flow—nor would any tax revenues be realized—for at least five or six years, which is how long it would take for the government to auction lease permits and for companies to begin exploring and then acquire the capital and expertise to actually produce oil there.

So while an honest accounting would forecast tax revenue accruing to the Treasury by year six, CBO reckons that, since technically the ban on drilling will not be in effect six years from now, any tax revenue generated by drilling off the Atlantic coast six years out will not be a result of ending the drilling ban. Thus, CBO is required to forecast that ending the ban would generate no “new” tax revenue.

The PAYGO rule encourages all sorts of sordid games by politicians. For instance, every so often Congress inserts a clause into a tax bill that, five or six years down the road, will require corporations to push forward a quarterly tax payment. It’s a procedure that doesn’t affect firms in the slightest: After Congress duly passes the law containing that provision, it quietly repeals the provision a year or two later. This sleight-of-hand is done solely to plug a budget hole: If Congress can’t quite make a tax bill adhere to the PAYGO rules within the five-year budget window, it simply maneuvers to temporarily borrow from the year after the budget window to square things up, and then quietly undoes this fix a year or two later.

And don’t get me started about black liquor. A tax loophole was created when an IRS bureaucrat decided that a tax break for clean energy production also—contra any actual intent of Congress—applied to the longtime practice by paper companies of burning a byproduct of the paper production process—the aforementioned black liquor—to produce energy. The tax break is worth as much as $7 billion a year to the paper industry, but to the tax-writing committee it represents $70 billion ($7 billion times the 10-year budget window) worth of “pay-fors”: By closing the loophole, legislators can exploit the logic of PAYGO to finance $70 billion in new tax breaks or spending initiatives.

A procedure that can be gamed this egregiously is not worth saving.

What’s the alternative to PAYGO? How about an honest debate over new spending and tax initiatives, or maybe an approach that forces Congress to confront the $100 billion of annual increases in entitlement spending? That’s how the country somehow stumbled along until PAYGO made its first appearance in 1990.

This fake constraint is worse than useless. It allows Congress to pretend it’s being miserly with the budget when its members know perfectly well it’s a sham. It’s time the rest of us realize that as well.

© 2014 Weekly Standard LLC. Reprinted with permission.