What Are Pay-Go Rules and How Do They Work?

The Pay-As-You-Go (PAYGO) rule is a fiscal principle of budget neutrality, re-established by the Statutory Pay-As-You-Go Act of 2010. The rule requires that new legislation projected to increase spending on mandatory programs or decrease government revenues must be offset. This offset must come from a corresponding cut in other mandatory spending or an increase in revenues, preventing the new law from adding to the federal deficit.

PAYGO applies to direct spending, also called mandatory spending, which includes programs like Medicare and federal retirement that operate without needing annual legislative approval. The rule does not apply to discretionary spending, which is the funding Congress allocates each year through the appropriations process.

The PAYGO Scorecard

The official accounting for the PAYGO rule is managed by the Office of Management and Budget (OMB) through the PAYGO scorecard. This scorecard is a formal ledger, tracking the cumulative budgetary effects of all qualifying laws enacted during a congressional session. The OMB maintains two separate scorecards: one that tracks the net financial impact over a five-year period and another that covers a ten-year period.

When new legislation is considered, the Congressional Budget Office (CBO) provides the initial estimate of its budgetary impact, which determines the amounts recorded on the OMB’s scorecards. The scorecard records the average annual effect of a law over the five- and ten-year windows. For example, a law projected to increase the deficit by $100 billion over ten years would be recorded as a $10 billion annual increase on the ten-year scorecard.

Only legislation affecting direct spending or revenues is entered onto the scorecard, including changes to entitlement programs and tax laws. Certain budgetary effects are excluded, such as those designated by Congress as an emergency requirement or changes to off-budget items like Social Security. The scorecard maintains a running tally of the deficit impacts from laws passed.

Triggering Sequestration

The enforcement mechanism of the PAYGO Act is a process known as sequestration. This action is triggered if, at the end of a session of Congress, either the five-year or ten-year PAYGO scorecard shows a net positive balance, indicating an increase in the deficit. Within 14 business days of Congress adjourning, the OMB issues an annual PAYGO report. If that report confirms a deficit increase, the President must issue a sequestration order.

Sequestration involves automatic, across-the-board spending cuts to a range of non-exempt federal programs. The total amount of the spending reduction is determined by the higher of the two deficit-increasing averages shown on the five- and ten-year scorecards. For instance, if the five-year scorecard shows an average annual deficit increase of $10 billion and the ten-year scorecard shows an average of $8 billion, sequestration would be ordered to cut $10 billion.

These cuts are applied as a uniform percentage reduction across all affected programs to achieve the required savings. The threat of sequestration serves as the penalty for failing to adhere to the PAYGO principle, creating an incentive for lawmakers to address potential scorecard balances before they trigger cuts.

Exemptions and Waivers

The impact of a potential sequestration is limited by two primary mechanisms: statutory exemptions and procedural waivers. A significant number of federal programs are legally exempt from any spending cuts that would occur under a sequestration order, shielding major programs from being affected.

Key exempt programs include:

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

While Medicare is subject to sequestration, the reduction in its spending is legally capped at 4 percent. This means that even if a larger across-the-board cut is required, Medicare payments cannot be reduced by more than that percentage. Because so many large programs are protected, the burden of sequestration falls on a much smaller subset of government spending.

Beyond these permanent exemptions, Congress can proactively waive the PAYGO rules for a specific piece of legislation. This is a procedural action where language in a bill directs the OMB not to record its budgetary effects on the PAYGO scorecards, preventing a costly law from triggering sequestration. Waiving the PAYGO rules in the Senate requires 60 votes.

Even if deficit-increasing legislation is passed without a waiver, Congress has historically taken action to prevent a pending sequestration. This is done by passing a separate law to erase the scorecard balances, resetting them to zero and averting the automatic cuts.