What is PAYGO?
A budget rule requiring that new legislation affecting revenues and spending on entitlement programs, taken as a whole, does not increase projected budget deficits.
PAYGO, which stands for “pay-as-you-go,” is a budget rule requiring that (using current law as the baseline) tax cuts as well as increases in entitlement and other mandatory spending must be covered by tax increases or cuts in mandatory spending. It does not apply to discretionary spending (spending that is controlled through the appropriations process).
The original PAYGO was part of the Budget Enforcement Act of 1990. In that year, President George H. W. Bush and congressional leaders painfully negotiated a large deficit reduction package combining spending cuts and tax increases. Having accomplished so much, Congress became concerned that future Congresses would reverse the agreement bit by bit. PAYGO helped prevent this, supplemented by caps on appropriations and outlays for discretionary spending programs. Budget experts generally agree that PAYGO worked extremely well from 1990 through 1997. In 1998, an unexpected budget surplus emerged and the discipline driven by PAYGO began to wane. The law officially expired at the end of fiscal 2002.
The most recent version of the PAYGO rule was established in 2010: To the extent that legislation does not pay for increases in mandatory spending or for tax cuts, the cumulative amount of the projected increase in the deficit is averaged over two periods—5 years and 10 years. (Budget imbalances in the current budget year are included, so in practice the averaging is over six and 11 years.) To prevent manipulation of the pay-go rules, legislation subject to PAYGO cannot move costs outside the budget window (i.e., after 10 years) or move saving into the budget window from later years.
If the Office of Management and Budget determines that either the 5- or 10-year average cost is great then zero when Congress adjourns, the President must sequester (apply an across-the-board spending cut) certain mandatory spending programs. The higher of the two averages determine the sequestered amount. Spending for each program is reduced by the same percentage for one year to offset the average projected deficit. Unless Congress acts to reduce or eliminate the project deficit increase, there is another sequestration the following year.
Some programs are exempt from sequestration. Social Security and the postal service are exempt because they are classified as “off-budget” programs (although they are included in consideration of the unified budget). Moreover, numerous welfare and other safety net programs, such as Medicaid, the Supplemental Nutrition Assistance Program (SNAP) and unemployment insurance, also are exempt. Medicare is subject to sequestration, but the spending reduction for Medicare is limited to 4 percent. If sequestration calls for an across-the-board reduction of more than 4 percent, the additional amount that would have come from Medicare is allocated proportionally to other programs.
The PAYGO rule has not been enforced consistently. For example, the 1997 Budget Act put in place a method, known as the SGR (the sustainable growth rate), for determining Medicare payments to physicians. Application of that formula threatened huge cuts in Medicare physician reimbursements. Congress prevented the payment rates determined by SGR from taking effect, but only for one year at a time. While Congress did pay for these one-year fixes, by limiting the fix to one year it did not need to pay the cost of the fix over the full budget window. When the Medicare Access and CHIP Reauthorization Act of 2015 replaced the SGR formula with a new system in 2015, Congress waived the PAYGO rules, exempting itself from paying for the entire cost of the new legislation.
Congressional Budget Office. 2015. “H.R. 2, Medicare Access and CHIP Reauthorization Act of 2015.”
Keith, Robert. 2010. “The Statutory Pay-As-You-Go Act of 2010: Summary and Legislative History.” Report R41157, Washington, DC: Congressional Research Service.