The PAYGO Rule and Its Impact on Tax Reform

The Pay-As-You-Go rule, or PAYGO, is a fiscal principle designed to instill budget discipline. It requires that new laws affecting government revenues or mandatory spending do not collectively increase the projected federal deficit. Any proposed tax cut or increase in entitlement spending must be offset by a corresponding tax increase or a cut in other spending.

The purpose of PAYGO is to act as a procedural checkpoint for the financial consequences of new policies. By requiring fiscal neutrality, the rule aims to prevent legislation that would worsen the long-term budget outlook, making it a factor in major tax reform.

The PAYGO Mechanism

The modern framework is the Statutory Pay-As-You-Go Act of 2010, which established a formal accounting system managed by the Office of Management and Budget (OMB). The OMB acts as the official scorekeeper, maintaining two PAYGO “scorecards.” These ledgers record the estimated deficit effects of every new law altering revenues or mandatory spending over five-year and ten-year periods.

When Congress enacts a law with a fiscal impact, the OMB calculates the projected net cost and adds it to the scorecards, creating a running tally. The estimates for a bill’s impact are often provided by the Congressional Budget Office (CBO) and included in the legislation itself. This process ensures that every relevant piece of legislation is accounted for.

Consequences of a PAYGO Violation

If a PAYGO scorecard shows a net deficit increase at the end of a congressional session, an enforcement action called sequestration is triggered. Within 14 days of adjournment, the OMB issues a final report on the scorecard’s status. If that report confirms a debit, the President is required by law to issue a sequestration order.

This order mandates automatic, across-the-board spending reductions to certain federal programs to offset the deficit increase. The cuts are calculated as a uniform percentage necessary to eliminate the debit on the scorecard. However, many of the largest government programs are legally protected from these cuts.

A significant number of programs are exempt from sequestration, including:

• Social Security
• Medicaid
• Veterans’ benefits
• The Supplemental Nutrition Assistance Program (SNAP)
• Federal retirement programs

Programs subject to these automatic reductions include certain payments to Medicare providers, agricultural subsidies, and various social services block grants. For programs that are not fully exempt, special rules can apply; for instance, cuts to Medicare are capped at four percent.

Bypassing PAYGO Requirements

Despite the automatic nature of sequestration, Congress has several tools to prevent these spending cuts from taking effect. These procedural maneuvers are frequently employed for legislation with significant budgetary costs. The most direct method is for Congress to pass a separate law that explicitly waives the PAYGO rules for a specific bill, instructing the OMB not to record its deficit impact on the scorecards.

Another common approach is for Congress to enact legislation that resets the PAYGO scorecard balances to zero. This has been done to clear large debits that have accumulated from prior laws, such as the American Rescue Plan Act, thereby preventing a sequestration order at the end of the session. This gives Congress a clean slate to pass new measures.

A more complex method for avoiding PAYGO is the budget reconciliation process. This is a special legislative pathway established by the Congressional Budget Act of 1974 that is exempt from the threat of a Senate filibuster. Bills considered under reconciliation can pass the Senate with a simple majority rather than the 60 votes typically needed. This process is specifically designed for legislation that changes federal spending, revenues, and the debt limit.

Because of its privileged status, budget reconciliation has become a preferred vehicle for enacting major tax and spending legislation. While a reconciliation bill itself is still subject to the Statutory PAYGO Act, Congress can include language in the budget resolution that provides for a waiver. It can also pass a separate bill to waive the PAYGO requirements for the reconciliation measure.

PAYGO’s Role in Major Tax Legislation

The passage of the Tax Cuts and Jobs Act of 2017 (TCJA) serves as a clear example of these procedural tools in use. The TCJA enacted significant changes to the U.S. tax code, including a large reduction in the corporate tax rate and broad cuts to individual income taxes. The Congressional Budget Office projected the law would increase the deficit by approximately $1.46 trillion over ten years, a clear violation of the PAYGO principle.

To pass this legislation without 60 votes in the Senate, Congress utilized the budget reconciliation process. By including reconciliation instructions in its annual budget resolution, the majority party advanced the TCJA through the Senate with only a simple majority vote.

Although using reconciliation allowed the TCJA to pass, it did not automatically solve the PAYGO problem. The cost of the tax cuts was still slated to be recorded on the OMB scorecard, which would have triggered sequestration. To prevent this, Congress passed a separate piece of legislation that explicitly waived the PAYGO rules, directing the OMB not to count the law’s deficit impact. This action neutralized the enforcement mechanism of the PAYGO Act.