The Real Problem With PAYGO

Practically every fiscal conservative supports the concept of PAYGO (short for pay-as-you-go), the idea that new spending programs or tax cuts should be paid for with spending cuts or tax increases so as to keep from making our budget deficit problem worse.

Most would probably say that the biggest problem with PAYGO is that it isn’t enforced rigidly enough–Congress routinely exempts itself from it by declaring an emergency and suspending PAYGO rules. While this is indeed a problem, it isn’t really a problem with PAYGO but with Congress’s lack of budgetary discipline and overeagerness to ignore its constraints when it suits itself to do so.

What I am concerned about is something different, a problem that is inherent in the nature of PAYGO itself. That is the idea that particular pieces of legislation need to be matched dollar-for-dollar with particular budgetary offsets, whether tax increases or budget cuts.

This we see the ridiculously-named “American Jobs and Closing Tax Loopholes Act of 2010,” whose technical explanation runs to 317 pages and makes a number of very important changes to the Tax Code. These include fundamental changes in the way the foreign tax credit is calculated that look more like punishment of multinational corporations for engaging in outsourcing than elimination an unjustified tax loophole.

The basic purpose of the foreign tax credit is to prevent double taxation by the US and a foreign country on income generated in a foreign country. It does this by giving US-based companies a credit for foreign taxes paid against their US tax liability. This is not in any way a tax loophole with no economic basis.

I don’t know whether the particular foreign tax provisions of the current legislation are justified by abuse or not. What concerns me is that these tax changes are being driven by the need to raise a target amount of revenue just to meet a PAYGO requirement. The result is ad hoc tax policymaking that risks imposing arbitrary tax increases just because they raise an amount of revenue that just happens to fit a particular budgetary need.

I think it is very unwise to make tax policy in this way. It will create unfairness by picking on industries or taxpayers who are politically unpopular at the moment PAYGO demands a certain amount of new revenue. Such ad hoc tax changes will also inevitably lead to greater tax complexity at a time when the Tax Code is crying out for simplification.

Expecting every new spending programs to be paid for with specific offsets looks very much like a fallacy well known in the trade area. Even those who think it would be desirable for our trade accounts to be balanced in the aggregate know that it would be stupid to expect that our trade with each individual country should be in balance. We necessarily are going to need to import things from countries that we aren’t going to be able to sell enough goods and services to in return. But there will also be countries with which the reverse will be true. It’s the aggregate trade balance that matters, to the extent that it matters at all, not the bilateral balance with each country.

I think the same is true of the budget. We should be looking at aggregate revenues with reference to aggregate spending. If aggregate revenues are too low then they should be raised as sensibly as possible so as to minimize unfairness and economic distortion. PAYGO works against that goal even though it is motivated by a reasonable desire to avoid increasing the deficit more than necessary.

Instead of PAYGO, I think it would make more sense for Congress to stop ignoring the Budget Act of 1974 and adhere to its rules and procedures. It should set an aggregate target for revenues and expenditures, and pass a budget resolution that enforces caps on spending and floors on revenues. Then there will be no need for PAYGO.

• Become A Funded Futures Trader