On Jan. 5, the House took a significant step in the direction of fiscal responsibility, adopting pay-as-you-go (PAYGO) budget rules by a 280-152 margin. PAYGO rules bar consideration of legislation including tax cuts or entitlement expansions that would have the net effect of increasing the deficit. While a necessary step toward putting the country back on the right fiscal path, PAYGO rules may make fulfilling the policy goals of the new Democratic Congress significantly more difficult to achieve. The new PAYGO rules are internal to the House and will create a procedural hurdle called a budget point of order against legislation that violates its terms. Any such violation would not automatically trigger a point of order, and any point of order raised could be waived by a simple majority of the House. The Senate currently has a weaker version of a PAYGO rule, one that exempts tax cuts while requiring new entitlement spending to be offset. In recent years, Republicans have passed numerous sizable tax cuts without offsetting the cost with alternative tax increases or spending cuts. These tax cuts have contributed significantly to the recent fiscal decline of the federal government. Like the House, Sen. Majority Leader Harry Reid (D-NV) and other key Democrats have pledged a return to PAYGO constraints in the new Congress and are likely to enact a true, two-sided PAYGO rule early in the year. This may present a problem for the Democrats' agenda. Assuming that both chambers operate under the new House PAYGO rule or a similar statute and resist temptations to waive the rule or create exceptions, Democrats face serious constraints on many of their campaign promises and policy goals. Some of the more popular items among those goals are:

• "patching" and/or permanently reforming the Alternative Minimum Tax (AMT)
• closing the "doughnut hole" on Medicare prescription drug coverage
• cutting interest rates on student loans by roughly 50 percent
• making permanent the research and development tax credit
• addressing shortfalls in children's and veterans' health benefits

Enacting these goals will involve daunting costs. A mere patch on AMT (i.e. holding those not currently liable under it harmless) would cost $70 billion in FY2008. Full AMT repeal - the reported highest priority of House Ways and Means chair Rep. Charles Rangel (D-NY), and Senate Finance Committee chair Sen. Max Baucus (D-MT) and ranking member Sen. Charles Grassley (R-IA) — could cost up to $1.6 trillion over ten years. To close up the Medicare doughnut hole would cost an estimated $400 billion over ten years. There are certainly more goals, with additional costs, but the picture is clear: PAYGO complicates, if not compromises, the Democratic congressional agenda. There are additional problems with shortfalls in certain "capped entitlement" programs. Under traditional entitlement programs, the baseline grows with demographic and inflationary changes, so funding for these programs continues to grow, even with PAYGO rules. However, for capped entitlements, such as the State Children's Health Insurance Program (S-CHIP), there are no automatic increases due to demographic and inflationary changes. The entitlement is capped at a specific amount. Any increases in spending to keep pace with the number of people served will require new spending and face PAYGO rules. Thus, to continue spending at current levels, PAYGO will require finding offsets to pay for capped entitlements. This is particularly problematic for the S-CHIP program, which, despite a stop-gap measure passed by Congress in December 2006, still faces funding shortfalls that will threaten coverage for children in 17 states this year. Because of these challenges, early on Democrats tried to rein in expectations in a few areas. For instance, senior House Democratic aides said the promise to cut in half interest rates on student loans will have to be phased in over five years instead of being passed immediately in order to minimize the costs. But the enormity of the agenda taken as a whole may imperil the whole PAYGO principle, causing Congress to abandon the fiscally responsible mechanism. Rep. John Spratt (D-SC), the chair of the House Budget Committee, issued this enigmatic statement last week after the House voted to reinstate PAYGO: "That's not to say that you couldn't come back later in a budget resolution and have some sort of a dispensation from the rule for a certain-sized tax cut." This sounds like a potential slippery slope back to the fiscal practices of most of this decade. Some have suggested that only restoring the statutory form of PAYGO, which lapsed in 2001, could bind Congress to follow its own rules. But statutory PAYGO would also constrain Congress' ability to extend the 2001 and 2003 tax cuts President Bush is bent on making permanent, and so might draw his veto. Further complicating matters, Office of Management and Budget director Rob Portman said during a speech in Cleveland last week

"Because spending is the real problem, the Administration supports a stronger version of 'PAYGO' than Democrat leaders have offered. The Administration supports 'PAYGO' for ALL spending, not just so-called mandatory spending. It should also apply to the annually appropriated funds that most of us think of as government spending."

With such divergent views on PAYGO, Congress and the Administration might be headed for statutory stalemate. For all the perils surrounding PAYGO in 2007, its passage reflects an important departure from recent Congress' disregard for the deficit, and a 180-degree turn away from the "Cheney doctrine" that deficits do not matter. No one, whether inside of Congress or out, regards PAYGO as a panacea for the deficit or the country's long-term fiscal problems. The new rule itself will not guarantee that the Congress and the President act in a fiscally responsible manner, or that any deficit reduction will, in fact, occur. But if nothing else, the action taken in the House last week is an important acknowledgement of the serious deficit problems facing the nation and that future legislation ought not exacerbate it.