In the wake of midterm elections, how should politicians evaluate future policy proposals?
Consideration of which policy proposals to support and how to fund these policies is a complex process that requires one balance competing interests. To simplify the due diligence required, I recommend that one first evaluate policy proposals along four dimensions: (1) Impact; (2) Feasibility; (3) Equity; and (4) Time.
The systematic assessment of policy proposals using these four dimensions allows for both an absolute measure of the policy and a comparison across policies. Once a policy has been deemed ready to move forward, one can utilize a benefit-cost analysis to confirm that the total benefits outweigh the total costs as well as to understand how the funding of the policy will impact the national deficit.
At a minimum, all newly elected members must support policies that address the fundamental challenges to the American economy and way of life in a fiscally responsible way. Too often Congress has crafted and then passed legislation with the best intentions in mind, yet the high cost of these programs has contributed to an already overburdened national deficit — now estimated at $22 trillion.
Thus, for all new regulation in the short-term, the total benefits must not only outweigh the costs, but also the policy must adhere to the pay-as-you-go (PAYGO) standard. In the long-term, policymakers must continue to adhere PAYGO, prioritize balanced budgets, and reduce the national deficit in such a manner that does not sacrifice economic growth or equity / fairness.
WHAT CRITERIA SHOULD BE USED TO EVALUATE POLICY PROPOSALS?
Policy-making is a dynamic, not static, process. Therefore, the frameworks used to assess policy proposals must be flexible in its design. While the weightings given to the criteria can be adjusted as needed, the overall methodological approach should still hold. Therefore, I recommend that one evaluate policy proposals along four key dimensions:
- Impact: What will be the result of the policy proposal? What is expected revenue / cost?
- Feasibility: Is this proposal doable? Is the necessary support in place? Who will execute it once passed?
- Equity: Who will be impacted and to what extent? Who will be excluded / left out?
- Time: Over what period / horizon will the proposal have an impact? Short-term / Long-term?
By assessing how each policy proposal scores on these dimensions, one can more effectively grasp the true cumulative effects of the policy. With an absolute assessment of the policy, one can then benchmark policies against one another, facilitating a meaningful discussion over which policies to prioritize or potentially combine, before deciding which policies to move forward.
However, assessment along these criteria and comparison across policies alone is not sufficient. As a legislative body, policymakers cannot continue to ignore the effects of policies on the growing national deficit.
Historically, the US has run an annual budget deficit — a fiscal year in which federal government spending exceeds government revenue. To close the funding gap, the US government issues treasury bills, notes, and bonds, which allow the government to collect capital inflows today in exchange for the promised payment of future capital outflows. Over the last 20 years, the US has seen an unprecedented expansion of deficit spending, with each year’s deficit adding to the cumulative national debt.
To combat the rising deficit, I recommend that newly elected members of Congress take a standby only supporting public policy proposals that adhere to the PAYGO standard. With PAYGO, expenditures are only financed with currently available funds rather than through continued issuance of treasury securities. For ways in which to enact PAYGO standards to reduce deficit spending, see Exhibit 1: PAYGO Working Models below.
FACTORS TO DETERMINE THE RIGHT MIX OF EXPENDITURE VS. REVENUE GENERATION
Despite the call for the PAYGO standard, such a standard is unlikely to receive immediate, universal adoption in Washington even if the OMB requires it (i.e. there are always loopholes or savings don’t materialize). Inevitably, the federal government will have to balance the tension between spending reductions and generating revenue, or — alternatively — watch as the national deficit increases.
If the goal is to ultimately move towards a more balanced budget and reduce the deficit in the long-term, the government can either (A) raise more revenue or (B) decrease spending (or perhaps both).
First, the government can raise more revenue. Doing so inevitably means an increase to existing taxes or the creation of new taxes. As Exhibit 2: Sources of Total Federal Tax Revenue below illustrates, ~90% of government revenue comes from individual income taxes (~47%), payroll taxes (~34%), and corporate income taxes (~9%) while other taxes constitute the balance.
Alternatively, the government can reduce spending, which can be segmented into three categories:
- Mandatory Spending: Accounts for roughly 62% of government expenditures. Social Security (33% of total) and Medicaid / Medicare (29% of total) are the primary drivers.
- Discretionary Spending: Accounts for roughly 30% of government expenditures. Discretionary spending can be segmented into defense and nondefense spending, with both receiving roughly an equal share. Funding for the military (16% of total) is the largest driver of discretionary spending,
- Interest Payments: Accounts for roughly 8% of government expenditures. With continued budget deficits, this expenditure is expected to increase quickly over the next several years.
An inherent tension exists between raising taxes versus cutting expenditures. The debate over which to do centers on one’s perspective on the role of government.
For example, those who support a larger, more socialist state will likely prefer an increase to taxes to cover the expenditures that the federal government deems necessary. Although a marginal tax increase spread out over a large base can increase revenue substantially, raising taxes is a political quagmire that is likely unfeasible.
Conversely, those who prefer a smaller, free market state will prefer to cut spending, most notably to entitlement programs such as Medicare, Medicaid, and Social Security. Brian Riedl of The Economist sums up the expected impact best, writing “Over the next 30 years…Medicare will run a $40 Trillion cash deficit, Social Security will run a $19 Trillion cash deficit, and the interest on the resulting program debt will be $23 Trillion.”
Thus, any attempts to balance the budget and reduce the national deficit most likely must include some entitlement reform.
SHORT-TERM VS. LONG-TERM CONSIDERATIONS
In the short-term, a couple of factors must be considered.
- First, policymakers must adopt a more systematic approach to policy-making to ensure that policymakers are promoting the most effective and feasible policy proposals.
- Second, policymakers must ensure that policy proposals adhere to the PAYGO standard whenever possible.
Adhering to these recommendations will mitigate the need to make deep spending cuts, likely to entitlement spending, or to raise taxes. While the former will affect distributional or equity concerns, the latter could potentially retard economic growth.
One must balance these tensions if necessitated. Finally, policymakers must also recognize that politics do not happen in a silo. How policies affect one’s reelection chances must always be a concern at least in the short-term.
In the long-term, reductions to the national deficit must be prioritized but not the extent that future economic growth and distributional / equity concerns will be meaningfully negatively impacted.
However, if federal spending is not checked, the rising debt overhang threatens to slow down growth and push the US economy headfirst into a recession. Thus, US policy-makers must embrace the PAYGO standard and the larger policy of balanced budgets.
The consequences of not acting — sequestration and austerity or even recession — in the long-term are too dire to ignore.