Fiscal Crisis Renders a Reform Opportunity: In Pursuit of More Sophisticated Economic and Fiscal Policy

Fellow, RIETI

Every time the U.S. president and the Congress get entangled in conflict, voices are heard in Washington to envy a parliamentary cabinet system in Japan and elsewhere. Japan and the United States differ greatly in their political and administrative systems, thus, we cannot make simple comparison. But if both countries are to pursue the improvement of people's life through the further maturing of democracy, the two have lots to learn from each other.

Political Power Games

Fiscal policy is nothing but politics. Plagued by economic stalemate and huge fiscal deficits, Japan has already entered an era of drastic changes in budgetary priorities. The creation of the Council on Economic and Fiscal Policy stands evidence to Japan's recognition of the need to make changes. Because the council basically has to rely on man-governing principle, rather than being in a new budget formation system, it understandably has been taunted by political power games within the existing framework of decision making system and rules. In general, political power games are a necessary factor in the process of formulating fiscal policy. Any institutional changes that underestimate the premise of political power games would bring little effect in reform. Like in Japan, such power games are everyday events in the U.S. and as long as legal, every imaginable means is taken. The U.S., despite such power games, however, was able to eliminate fiscal deficits in 1998. And after the rosy prospect for expanding fiscal surplus, Sept. 11 terror attacks and economic stagnation, the U.S. once again finds itself in deficits. In this column, I would like to take up the 1990 Budget Summit which led to the Budget Enforcement Act of 1990 (BEA), a major contributor to the reduction of the U.S. fiscal deficit, and introduce the painful but fruitful experience of the U.S. in restoring fiscal discipline, an achievement that has been made possible by the very quagmire the U.S. was in.

U.S. Experience

The U.S. had years of fight against the growing fiscal deficits before it saw the first surplus in 29 years in 1998. The U.S. deficit peaked at $290 billion, or 4.7 percent of the gross domestic product, in fiscal 1992. In the process reaching there, the U.S. tried various budgetary process reforms in an attempt to bring back fiscal discipline but failed to produce any tangible results. Some positive outcome began to emerge only after 1990 when the Omnibus Budget Reconciliation Act of 1990 (OBRA90) and the BEA were enacted.

The year of 1990 brought out the worst of many things in the U.S. The Gram-Rudman-Hollings Act of 1985 and 87 that imposed a mandatory deficit target ended in failure and the problem of bad loans held by savings and loans (S&L) credit unions aggravated. At the time, Republican President George Bush was at the helm of the government, while the Democrats dominated both chambers of the Congress. Since the very beginning of the year, the administration and the Congress clashed over every piece of policy. In his presidential campaign, Bush had said, "Read my lips, no new taxes," and that was the promise the president could not break easily. In November that year, however, President Bush signed the OBRA90 into the law, paving the way for substantial tax hikes.

Budget Summit

Uniform expenditure cuts worth $85 billion imposed under the GRH Act translated into an unrealistic 32 percent cut in defense spending and 35 percent cut in non-defense discretionary spending. In May 1990, the president decided to negotiate with the Democrats, the controlling power in the Congress. Thus, the Budget Summit was held as a peace-seeking conference to resolve conflicts with the congressional members including the Republicans. With all the participants bound up in political power games, the conference made zero progress in its initial stage. But since the negotiations were being held on the summit level, it was quite visible to the general public. In the face of worsening economy and fiscal conditions, President Bush opted for a minimum compromise with the Democrats. The president had a range of pressing fiscal issues far more important than keeping his campaign pledge, i.e., bringing quick solution to the S&L problem, avoiding gigantic cuts in discretionary spending, and establishing a new fiscal discipline system by replacing the GRH Act with the BEA (that calls for somewhat more realistic caps on discretionary spending and PAYGO rule to find offsets if there are legislations that increase mandatory spending). The summit ended the night before Oct. 1, the starting date of a new fiscal year. It tells us the extent of attritional nature of the negotiation.

OBRA90 included major hikes, reflecting the president's rather major compromise to the Democrats. Rules devised by this legislation, however, worked positively to the congressional system driven by political power games and helped bring stricter fiscal discipline among politicians. President Bush later recalled the Budget Summit agreement as a compromise with merit. The subsequent fate of the president himself, however, was quite painful; he broke his campaign promise less than one year into office, damaged Republican unity in the Congress, and was defeated in the 1992 presidential election. In the face of faltering economy, the spectacular success in the Gulf War had a hollow ring. Also, there always is a time lag between any defiant reform decision and its outcome to appear. President Bush surely paid his price for reform.

Chance for Reform

What Japan can learn from the U.S. is its persistency in reforming existing system to find more sophisticated economic and fiscal policy making system in the context of evolving democracy. The OBRA90, by incorporating BEA, brought impact on fiscal discipline. If Japan's fiscal and economic policy is also formulated on political power games and procedural mechanisms, a series of U.S. successes and failures in attempt to improve the budget making process and rules - as seen in BEA, the Congressional Budget Act of 1974, the GRH Act, and the Government Performance and Results Act (GPRA) of 1993 - provide useful lessons for Japan which has yet to come up with effective system reform. It should be noted that the three key factors - policy, decision making process and political power games - all came into scope of fiscal discipline in the U.S. only after its budget deficit was perceived serious enough. Now that Japan faces a fiscal crisis right in front, it has a chance to launch measure reforms to create a system to facilitate the evolution of democracy and turn out effective economic and fiscal policy. When fiscal discipline is to be materialized in the future because of implementation of credible process reforms, the young and middle age generations should begin projecting brighter future for themselves, knowing their future tax burden would not be ski-rocketed. This psychological change will help stimulate consumption and lift economy, eventually leading to the restoration of public confidence in the government and democracy.

June 25, 2002

June 25, 2002

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