PAYGO

PAYGO (pay-as-you-go) is a term used to refer to financing where budgetary restrictions demand paying for expenditures with funds that are made available as the program is in progress.

Budgeting

In budgeting, the term PAYGO refers to the requirement that newly proposed expenditures or tax cuts must be accompanied by commensurate increases in revenue or a reduction elsewhere in the budget. The goal of this is to require those in control of the budget to engage in the diligence of prioritizing expenses and exercising fiscal restraint.

U.S. Congress

An important example of such a PAYGO system in this first sense is the use of PAYGO rules in the United States Congress. First enacted as part of the Budget Enforcement Act of 1990 (which was incorporated as Title XIII of the Omnibus Budget Reconciliation Act of 1990), PAYGO required all increases in direct spending or revenue decreases to be offset by other spending decreases or revenue increases. It was thought that this would control deficit spending. Direct spending largely comprises "entitlement spending," which means that a group of beneficiaries are entitled to a benefit and, without further legislative action, the government must provide that benefit -- hence it is considered to be "mandatory." Only by legislative action can the benefit be either expanded or reduced. In terms of revenue, PAYGO largely is designed to control tax reductions. If revenue is estimated to be reduced through a reduction in tax rates of any kind, that effect on the deficit must be offset either through increased revenue collection elsewhere, or spending reductions of the same amount.

In the initial PAYGO regimen, enacted in the Omnibus Budget Reconciliation Act of 1990 (OBRA '90), by statutory requirement, any increases in the deficit were to be offset by an across the board "sequestration" of programs. This means an automatic cut in non-exempt mandatory spending programs -- this was calculated by the Office of Management and Budget at the end of the year.

These rules were in effect from 1990-2002 and are widely seen as having assisted the US Congress in maintaining budget discipline. "Those rules were allowed to lapse in the House and watered down in the Senate, which made it easier for lawmakers to approve President George W. Bush's tax cuts and a Medicare prescription drug plan". The system was reestablished in January of 2007 by the 110th Congress:

It shall not be in order to consider any bill, joint resolution, amendment, or conference report if the provisions of such measure affecting direct spending and revenues have the net effect of increasing the deficit or reducing the surplus for either the period comprising the current fiscal year and the five fiscal years beginning with the fiscal year that ends in the following calendar year or the period comprising the current fiscal year and the ten fiscal years beginning with the fiscal year that ends in the following calendar year.

Social Insurance

In social insurance, PAYGO refers to an unfunded system in which current contributors to the system pay the expenses for the current recipients. In a pure PAYGO system, no reserves are accumulated and all contributions are paid out in the same period. The opposite of a PAYGO system is a funded system, in which contributions are accumulated and paid out later (together with the interest on it) when eligibility requirements are met.

U.S. Social Security

An important example of such a PAYGO system in this second sense is Social Security in the U.S. In that system, contributions are paid by the currently employed population in the form of a payroll tax (also called Social Security tax), while recipients are mostly individuals of at least 62 years of age. Social Security is not a pure PAYGO system, because it accumulates excess revenue in so-called trust funds.

Explanation

These kind of PAYGO systems can be implemented quickly, because no reserves are necessary to finance the expenses of the first generation of recipients. However, these windfall gains of the first generation have to be financed by following generations. By paying the expenses of generation t, the following generation t+1 relies on future contributions of generation t+2 to cover its expenses. In this fashion, the windfall gains of the first generations are passed along over generations and, hypothetically, the last generation would have to finance its own expenses and that of the preceding generation. That is why some economists have called PAYGO systems equivalent to (or even worse than) Ponzi schemes, which is albeit a mistaken classification, since PAYGO systems are far from being fraudulent investment schemes.

Controversy

Opponents to PAYGO argue that too little attention is given to fiscal restraint and tax rate reduction, and too much attention is given to raising taxes by increasing percentage tax rates. This opposition is rooted in the belief that lower tax rates raise capital investment, which would lead to higher productivity, higher GNP, and higher tax revenues. (Citation needed)

Some believe that rather than view tax rate reductions as an expense to Government, tax rate reductions should be viewed as an investment in economic growth. Deficit reduction, according to this logic, should be achieved through a reduction in spending (welfare programs and pork barrel legislation, etc.) and a reduction in taxes.

There is also much controversy about the way a social insurance PAYGO system (especially one as large as U.S. Social Security) may affect private and national saving. Another issue is the return on contributions to the system, which - depending of the system's design - changes from being extremely large for the first generation of recipients to numbers close to the growth rate of the population in a mature PAYGO system. In the 2007-2007 Congress, Republicans argue that the version of PAYGO promoted by Democrats would lead to higher taxes by making renewal of the 2001 and 2003 tax cuts much more difficult while providing no real spending restraint. PAYGO does not limit the automatic spending increases each year of entitlement programs, emergency spending on issues such as the Iraq war, or even discretionary spending increases on items such as education and agriculture as long as those spending levels fall within the budget. PAYGO only limits the creation of new entitlements and spending that exceeds the budget. However, Congress can increase the budget by any arbitrary amount each year regardless of revenue levels or PAYGO rules. Sen. Judd Gregg (R-NH) has criticized PAYGO, calling it "Swiss-Cheese-Go" due to the "holes" in the process.