America's Fiscal Constitution (49 page)

Senate Republicans offered the president their own concrete plan to balance the budget. At a White House meeting, Budget Committee Chairman Pete Domenici spoke for the group, which included Majority Leader Baker, Finance Committee Chairman Dole, and the president’s closest political friend, Senator Paul Laxalt of Nevada. Domenici told the president that the budget included money “for feeding babies, for building roads, for cancer research, for the national parks, the FBI. We’ll help you squeeze ’em, but we can’t bleed ’em. You’re just going to have to have some more revenue.”
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He proposed to balance the budget by scaling back tax cuts and imposing new spending cuts split equally between domestic and defense programs. Reagan replied curtly, “We can’t solve it with more of tax and spend.”
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The Reagan administration instead opted to borrow and spend.

Early in 1981, Stockman had projected a balanced budget by 1984. By November he was forecasting a record $146 billion deficit in 1984 and $700 billion over five years.
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In later interviews he acknowledged the flawed early budget projections and the failure to link spending and taxes, but he commented that he stayed on the job “to help correct the enormous fiscal error that I had done so much to bring about. . . . There was no longer any revolution to betray, only a shambles to repair.”
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The American Fiscal Tradition suffered a setback in 1981, though support for its underlying principles had not collapsed. Some of the borrowing during a severe recession that began in late 1981 could be considered
a traditional use of debt. The nation was ready for cuts in personal income tax rates, since many Americans felt that the top marginal tax rate of 70 percent, or a rate of 32 percent that reached those considered to be middle class, was unfair and excessive in the absence of an emergency. After 1981 no prominent federal leader in either party advocated a reversion to the 1980 income tax rates. The fiscal year 1982 budget did, however, sever the tight link between spending and tax policies. The traditional pillar of “pay as you go” budget planning would take years to be rebuilt.

By the end of 1981 Reagan recognized that something had gone wrong. He publicly announced that he was “ready to veto any bill that abuses the limited resources of the taxpayers,” though he rarely vetoed spending bills as the deficit continued to widen.
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In his diary he mused: “We who were going to balance the budget face the biggest budget deficits ever.”
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T
HE
T
RADITION
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URVIVES
, T
HOUGH
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TS
P
ILLARS
E
RODE

1982–1989: Years when deficits exceeded debt service = 8 (1982–1989, higher spending on interest expense and the Cold War)

T
HE
F
IGHT TO
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ESTORE
F
ISCAL
D
ISCIPLINE

For almost two centuries the federal government had borrowed for four clearly understood purposes. After 1981, however, federal leaders negotiated limits on the amount of annual borrowing but could not agree on a rationale for the debt incurred. This shift eroded a critical pillar of the American Fiscal Tradition: explicit congressional authorization of debt for a temporary and defined purpose. Democrats blamed projected deficits on Reagan’s tax cuts and rising military budgets, though many in their party voted for those tax cuts and the Carter administration planned defense spending in line with the amounts Congress appropriated in the 1980s. Reagan blamed the deficits on domestic spending, though most domestic spending programs did not rise as a share of national income and the president never vetoed any formula-based entitlement spending. Both the president and members of Congress tried to avoid the stigma associated with
explicit
debt financing of their favored policies and programs.

President Reagan’s initial speeches on economic policy emphasized fiscal discipline and the need to avoid pushing the nation’s total debt to a
trillion dollars. For example, in his State of the Union address in February 1981 he lamented that a debt of a trillion dollars would be “a stack of thousand-dollar bills 67 miles high.”
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As debt ballooned to over $2 trillion within a few years, the president dropped that illustration. Instead, he referred to a “structural deficit” in the budget.
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Budget commentators adopted the phrase to describe a gap between federal commitments and revenues that would persist even with normal economic growth. The phrase conveniently implied that the budget had a “structure” independent of Congress’s annual votes or bills signed by the president.

By the second year of the Reagan presidency, financial markets—and many senators—recoiled at spiraling federal debt. When Reagan submitted a budget with an estimated $100 billion deficit, the Senate Budget Committee rejected it by a vote of 20 to 0.
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Ways and Means Chairman Dan Rostenkowski waited for presidential leadership to close the budget gap. Instead, Reagan pushed for a constitutional amendment requiring a balanced budget but never submitted a budget to Congress that balanced. Senate Finance Committee Chairman Bob Dole stepped in to fill the budget leadership vacuum.

The Constitution requires that tax legislation originate in the House, an obstacle Dole circumvented by amending a minor House bill to add significant tax increases. He called the tax provisions “revenue enhancement” and lined up every single Republican senator to vote for it.
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Ways and Means Chairman Rostenkowski cooperated with Dole by moving the amended bill directly to a conference committee. Dole and Rostenkowski, with the help of Chief of Staff James Baker, enlisted votes on the House floor for the bill emerging from the conference committee. After delivering a televised address in which he complained about the deficit and applauded “tax reform,” Reagan worked to secure the votes of a majority of House Republicans and agreed to send a letter thanking each Democrat who voted for it.
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Speaker Tip O’Neill and Rostenkowski gathered enough Democratic votes to pass the bill, which the president signed without comment.

The Tax Equity and Fiscal Responsibility Act of 1982 did not quite live up to the promise of its name. Much of the bill’s tax increase resulted from undoing certain corporate tax reductions passed the year before. The law also required that income tax be withheld from dividend and interest payments and raised cigarette taxes and taxes for unemployment insurance. In
late 1982 Congress also doubled gasoline taxes dedicated to the highway and transit fund and imposed strict controls on hospital costs reimbursed by Medicare Part A. Despite these actions to raise revenues, the deficit continued to rise as a result of soaring interest on expense, higher defense costs, and high unemployment. With November 1982 midterm elections looming and the deficit growing, senators sought political cover by passing a constitutional amendment to balance the budget.

The eventual political success of Reagan’s presidency was not apparent in late 1982. Reagan ended the year with a public approval rating of 41 percent, down from 68 percent following the assassination attempt.
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Democrats gained twenty-seven seats in the House in the November midterm election. The remaining Republican House members, largely elected from districts with little Democratic competition, were more intensely partisan than Senate Republicans. An upstart young congressman from Georgia, Newt Gingrich, called Senator Dole the “tax collector for the welfare state” because of the senator’s work to reduce the use of debt to finance routine spending.
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Treasury secretaries have, for the most part, served as guardians of fiscal discipline. Treasury Secretary Donald Regan, however, disparaged Dole’s efforts as being “Keynesian,” a term no economist—including those on the White House Council of Economic Advisers—would have applied to the efforts to reduce deficit spending.

Other members of the senior White House staff, led by James Baker, tried to restore fiscal discipline. Reagan’s staff warned the president that the administration’s “current long-term fiscal policy” would not “generate tax revenues to finance [proposed spending] even under ideal economic performance.”
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Budget Director David Stockman briefed the president on every federal program and asked for direction on where he should cut. Reagan identified annual cuts of less than $1 billion, a small dent in borrowing that had soared to well over $100 billion per year.
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Public support for the tradition of limited borrowing exerted an invisible but powerful pressure on post-1981 budget negotiations. When Reagan was told in early 1983 that the proposed White House budget for the next fiscal year would contain a $188.8 billion deficit, he said that he could not “go to the country with these deficits.”
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Congress responded with bipartisan applause when the president, in his 1983 State of the Union address, asked for a “standby-tax”—a three-year tax raising federal
revenues by 1 percent of national income—combined with limits on federal spending. Later that year the House adopted a Democratic budget resolution with its own $174 billion deficit.
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Neither Reagan’s senior economic advisors nor congressional leaders defended the practice of allowing interest on growing debt to absorb a greater share of future budgets. Conservative economist William A. Niskanen, who served on Reagan’s Council of Economic Advisers, later concluded that “the administration did not have a deficit policy. It had a spending policy and a tax policy, and the deficit was an outcome rather than a target of these policies.”
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The president’s first chairman of the Council of Economic Advisers, Murray Weidenbaum, commented upon his resignation, “On balance, we really haven’t cut the budget. Instead, the much-publicized reduction in non-military programs . . . has been fully offset by the unprecedented growth in military spending. When you add that to the big tax cuts, you get . . . horrendous deficits.”
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His successor, Martin Feldstein, a market-oriented economist, also spoke frankly about the need to reduce annual borrowing. He told reporters that “we can’t grow our way out of these deficits.”
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B
ALANCING THE
S
OCIAL
S
ECURITY
B
UDGET

Two pillars of the American Fiscal Tradition—“pay as you go” budget planning and explicit congressional votes on the purpose of new debt—started to crack in the 1980s. But a third pillar, the use of self-sustaining trust funds, remained strong enough to force hard choices about Social Security pensions.

The post-1972 automatic cost-of-living adjustments to Social Security benefits jeopardized the balance in the program’s trust fund; high inflation and two recessions had caused benefits to rise faster than payroll tax revenues in an economy with both high inflation and sluggish growth. By 1981 Social Security actuaries concluded that the pension system would exhaust its funding within a year. Moreover, Congressman Jake Pickle of Texas, who chaired the Ways and Means Subcommittee on Social Security, warned of the need to prepare for the eventual retirement of Baby Boomers.

Chief of Staff James Baker advised the president to create a bipartisan panel to recommend a plan to restore the actuarial balance to the Social Security system. The National Commission on Social Security Reform included five members selected by Speaker Thomas “Tip” O’Neill, five
by the Senate, and five by the White House. Alan Greenspan, a conservative economist, chaired the commission. As the Greenspan Commission approached the 1982 year-end deadline for its work, its members had agreed on goals and financial projections, but not on a specific legislative solution.
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Baker and Greenspan held daily White House meetings with members of the commission to craft common ground on specific recommendations. Within weeks, twelve of the fifteen Greenspan Commission members agreed on a plan to raise payroll taxes, expand coverage to some public and nonprofit employees, impose income taxes on pensions, reduce benefits for early retirement, and gradually increase the retirement age from sixty-five to sixty-seven. The plan called for a measured rise in taxes for Social Security pensions and Medicare hospitalization to a level of 15.3 percent of covered payroll by 1990.

Despite organized opposition, Congress passed many of the Greenspan Commission’s ambitious reforms in April 1983. President Reagan praised the bipartisan effort and noted that it demonstrated “for all time our nation’s commitment to Social Security.”
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The Social Security Reform Act of 1983 showed that federal leaders could plan a generation ahead. The legislation enabled the pension trust fund to accumulate large pension reserves—a surplus of revenues over expenses—during the working years of Baby Boomers, to finance pensions for that generation.
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A large pension reserve for Baby Boomers placed the Social Security trust fund in actuarial balance, but the continued use of a unified budget disguised the amount of debt and annual borrowing in the federal funds budget, just as Senator Arthur Vandenberg had feared would happen. Since federal accounting included the revenues earmarked for pension reserves in the unified budget, it understated the deficit. The practice of subtracting the debt of trust funds from total debt—leaving a smaller reported “debt held by the public”—obscured the future obligations of the federal funds budget. There was nothing necessarily wrong or misleading about investing trust fund reserves in Treasury debt, which is a common practice of well-managed private firms offering annuities. But that investment should not allow the federal government to reduce its reported level of debt.