San Francisco Chronicle, May 23, 2010

Today's budget problems aren't America's first. High debt levels accompanied our major wars, but they were quickly reduced soon afterward. Federal "deficits as far as the eye can see" in the mid-1980s were followed briefly by surpluses in the late 1990s. State deficits often followed recessions but ended soon thereafter. In all these cases, economic growth helped solve the problem. Today, that's no longer possible.

Failure to understand the causes of today's historic impasse will stymie those budget reformers tempted to believe we can use the traditional pro-growth strategy to get our fiscal house in order. Most of history is on their side: In almost all past federal and state budgets, revenues were scheduled to grow automatically along with the economy, and expenditures were scheduled to grow only if there was new legislation. Thus, revenues in some future year would always exceed that past expense, no matter how high any current deficit.

But under the laws now dominating government budgets, many expenditures essentially are or will be growing faster than both revenues and the rest of the economy. In fact, in many areas of the budget, automatic expenditure growth matches or outstrips revenue growth under almost any conceivable rate of economic growth.

In the budget policy reform discussions I've been part of, this disconnect from the past blocks understanding of our present fiscal situation. Thus, both liberals who want to maintain spending programs and conservatives seeking to keep taxes low seem to think - or, at least, want to think - that economic growth can once again solve our problems. Just what is different now? Today, we are facing two fiscal problems, whereas before we had just one.

In the past, fiscal imbalance was mainly a temporary, current issue only. Yes, legislatures would occasionally spend much more than they collected in taxes, sometimes heedlessly. But as long as revenues over time rose with economic growth and most spending was discretionary, push never came to shove as long as the next legislatures weren't too profligate.

In effect, during the nation's first two centuries, all that was required to get the federal or state fiscal house in order was for future legislatures to limit new spending increases or tax cuts. Because future surpluses were always built into the established law at any one point in time, sound fiscal policy meant not turning those surpluses into unmanageably high deficits year after year.

Jump ahead to today. Now, so much spending growth is built into permanent or mandatory programs that they essentially absorb much or all revenue growth. Meanwhile, we've also cut taxes, widening the gap between available revenues and growing spending levels.

But why won't even higher economic growth do more to solve this problem? If spending growth were limited so it couldn't exceed some fixed rate, then higher economic growth might increase the revenue growth rate enough to help restore balance. Unfortunately, spending growth is not set at a fixed rate. Instead, it generally is scheduled to grow faster when the economy grows faster.

Consider government retirement programs. Most are effectively "wage-indexed" insofar as a 10 percent higher growth rate of wages doesn't just raise taxes on those wages, it also raises the annual benefits of all future retirees by 10 percent. Meanwhile, in most retirement systems, employees stop working at fixed ages, even though for decades Americans have been living longer. When spending rises with both wages and extra years of retirement benefits, extra economic growth just doesn't provide much if any reprieve from fiscal imbalances.

Health care costs - a dominant item at federal and state levels - also tend to grow automatically faster the more that the economy grows. As our income goes up, we demand and get even more.

Today, so much of government spending is devoted to health and retirement programs that their growing costs tend to swamp gains we might achieve in holding down the ever-smaller portion of the budget devoted to discretionary spending. Still other programs add to the problem, such as tax subsidies for employee benefits, the cost of which grows automatically without any new legislation.

Compared to the feds, many states perhaps have more discretion in the budget, in the sense that education is a more dominant spending item. This isn't necessarily good news: Instead of borrowing more from China, as the feds do, states tend to cut back on discretionary education spending when deficit-reduction becomes the order of the day.

California is a great example of a state that further limits discretion by providing constitutional or other protections to selective groups: taxpayers (Proposition 13); primary and secondary schools (Proposition 98); health programs (various earmarked taxes). These rules contort and twist in so many ways that they remind me of Yogi Berra's two rules that 90 percent of baseball is mental and the other half is physical. Can a constitution violate the laws of arithmetic?

Built-in automatic rules for spending more or taxing less means that balancing a budget today is far harder than simply putting the brakes on new tax cuts and spending increases. A do-little legislature can no longer save the day. Our elected officials are in a bind they hate: They must say "No" to many new giveaways and go back on unkeepable spending and tax promises made by past lawmakers.

The thumbnail version: Seek economic growth, but don't expect it to provide the budget slack it did when budgets were largely discretionary. Past legislatures have already spent much of the revenues that economic growth will provide, or put restrictions on revenues in ways that merely force future generations to pay for rising spending levels. Now we need to weed our government's garden as well as water it.