America's Fiscal Constitution (34 page)

The Committee on Economic Security concluded that it would be a bureaucratic nightmare to require each state to track the work histories
and payroll tax payments of everyone employed within its borders. As a result, few saw any alternative to a national organization capable of assigning each worker a unique identifying number and compiling the information needed to determine each person’s eligibility and benefits.

Secretary of Labor Frances Perkins, who chaired the Committee on Economic Security, hoped to use some amount of general revenues to supplement payroll taxation as a means for financing the pension system. General revenues could provide some capacity to give pensions to older Americans who would have little or no chance to earn a pension based on payroll contributions. Roosevelt and Morgenthau disagreed. The president insisted that actuaries design a system that was fully funded by a dedicated new tax. When Perkins explained that it would be many decades before the pension fund might need general revenues to offset the cost of early benefits, Roosevelt curtly told her that it would be “dishonest to build up an accumulated deficit for the Congress of the United States to meet in 1980.” The president referred to any reliance on general revenues as “the same old dole under another name.”
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No one even considered borrowing to pay for pensions, since the very purpose of a pension system was to save, rather than borrow, in order to defray the future costs associated with an aging population.

Doughton convinced the president to bless the bill’s assignment to his Ways and Means Committee. With advice from Morgenthau, Doughton’s committee drafted the bill in a manner designed to maintain actuarial balance. That is, the estimated future stream of income from payroll taxes plus interest earned on trust would have to cover the cost of future benefits. The Ways and Means Committee excluded agricultural and domestic workers, whose wages Morgenthau said would be hard to track. Though payroll withholding began on January 1, 1937, the first benefit payments would not be made until five years later. A reserve would accumulate as workers earned the right to participate.

The Social Security Act—passed by Congress in August 1935 by an overwhelming, bipartisan majority—included a plan for state-administered unemployment insurance, a national old-age pension program, and state-administered matching grants for public assistance supporting impoverished older Americans, blind people, and single mothers with young children.

Most workers subject to the payroll tax had never before paid directly to the federal government a tax that was based on their earnings. Even though the average income of many Depression-era workers covered little more
than subsistence, the program for minimum Social Security pensions was enormously popular from the outset. Future amendments to the Social Security Act—adopted in 1939, 1950, 1965, 1972, 1983, and 2003—would authorize much of federal domestic spending by the twenty-first century.

A
CCOUNTING FOR
S
OCIAL
I
NSURANCE

Almost immediately the new federal pension system posed a challenge to clear budget accounting, one of the pillars of the American Fiscal Tradition. Jefferson had “hope[d] to see the finances of the Union as clear and intelligible as merchants’ books, so that . . . every man of any mind . . . should be able to comprehend them, to investigate abuses, and consequently to control them.”
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Proper actuarial accounting for social insurance required both economic and demographic projections reflecting the valuation of future streams of revenues and outlays. Traditional accounting would be misleading to the extent it failed to account for future liabilities related to present contributions.

President Roosevelt and Senator Arthur Vandenberg developed well-reasoned but starkly different solutions to the problem of accounting for future pension assets and liabilities. Roosevelt, a former insurance executive, believed that established principles used by actuaries in accounting for annuities should be used to link future liabilities with current payroll contributions. Independent trustees could be charged with maintaining the trust fund—held apart from the federal budget—in actuarial balance. Trustees could invest any reserve in interest-bearing Treasury obligations. Banks, private life insurers, and pension funds bought most federal bonds from 1933 through 1936. By 1936 bank investments in federal debt began to exceed the amount of their private loans. Between 1936 and 1940, debt held by federal trust funds increased from $2.3 billion to $7.1 billion, representing about half of the net increase in debt during this period.
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Senator Vandenberg, who voted for the Social Security Act, was troubled by the potential size of the pension reserves. Vandenberg noted that Social Security reserves could grow to an estimated $47 billion by 1980. He feared that the federal government sometime in the future might use that reserve to disguise the size and annual expense of federal debt.
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The conservative Vandenberg dismissed the alternative of investing reserves in corporate bonds as “socialism.” He preferred a pension system operating on a “pay-as-you-go basis, with only a modest contingent reserve.”
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A
smaller initial reserve would also allow the trust fund to begin distributions earlier and include benefits to surviving spouses.

Vandenberg’s position largely prevailed when Congress passed the Social Security Act Amendments of 1939. The legislation did, however, salvage some of the private sector insurance practices favored by Roosevelt. The bill more explicitly linked eligibility, benefit levels, and contributions; moved Social Security accounts from the Treasury to an independent trust fund; and required trustees to monitor and report the actuarial balance between projected obligations and revenues.

For thirty years after the 1939 amendments, Congress avoided the danger of misleading pension accounting that had so troubled Roosevelt and Vandenberg. The trust fund remained apart from the federal budget and was not used to conceal the amount of federal debt or annual borrowing. The fifty-year actuarial balance remained sound, even without a large reserve, because of the slow rise in benefits until the late 1960s and rapid growth in the workforce. Then, in 1969, the threats of unfunded liabilities (Roosevelt’s concern) and the use of reserves to disguise borrowing (Vandenberg’s concern) became more concrete. That year the federal government consolidated the Social Security trust fund with the administrative or federal funds budget. Muddled and opaque accounting for the Social Security and Medicare trust funds would eventually create an illusion of surplus that facilitated the collapse of the American Fiscal Tradition.

R
EELECTION AND
A
NOTHER
D
OWNTURN

Roosevelt was reelected in 1936 in a landslide so large that many Republicans—including Vandenberg and the other twelve remaining GOP senators—began to question the future survival of their party. No one had predicted such a lopsided outcome just a year earlier, when polls showed that Roosevelt’s public approval ratings, once sky high, had dipped to 50 percent. Even many Democrats cringed at Roosevelt’s National Recovery Administration, which attempted to restore corporate profits using price fixing. Left-wing populists had also criticized Roosevelt for being too cautious with his legislative agenda.

The president managed his 1936 campaign brilliantly. He largely ignored his progressive Republican opponent, Kansas Governor Alf Landon, and aimed his attacks on the well-funded American Liberty League, which accused Roosevelt of encouraging class warfare.

Roosevelt relished the opportunity to voice the concerns of the millions of Americans who had lost their life savings or worked for low wages. He labeled his opponents “economic royalists” and courted former Theodore Roosevelt Progressives. Roosevelt, in a radio broadcast, asked voters to cast their ballots based on whether they thought things were better than they had been four years earlier, when the unemployment rate was far higher.

Democrats won control of all but eight state houses in the 1936 election. Landon, who had picked one of Theodore Roosevelt’s friends as his running mate, blamed his defeat on the GOP’s failure to showcase his “really liberal stand on many questions.”
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Hoover agreed with Landon and blamed the American Liberty League for highlighting Roosevelt’s popular willingness to stand up to big business.

Though the president showed respect for the American Fiscal Tradition, he lost much of his political capital with Congress by threatening another part of the nation’s unwritten constitution. The Constitution did not confine the Supreme Court to the nine positions established by statute in 1869, but the size and independence of the court had since evolved into a sacrosanct tradition. In 1937 Roosevelt proposed to expand the size of the Supreme Court that had invalidated parts of his New Deal legislative program, a ploy that quickly became known as the “court-packing scheme.”

The Republican Party was so weak in 1937 that its leaders kept quiet in order to allow Democrats in Congress to lead the assault on the court-packing scheme. Even Vice President Garner expressed his unease with such a challenge to the traditional balance of power. Roosevelt’s brash proposal may have accomplished one of his purposes, as the court subsequently became less aggressive in restraining New Deal legislation. However, the president’s defiance of the nation’s traditional constitution permanently alienated many conservative Democrats in Congress, who developed an effective partnership with congressional Republicans during the remainder of Roosevelt’s presidency.

The president never underestimated the power of the American Fiscal Tradition. He submitted a budget for fiscal year 1938 that projected a surplus apart from the cost of work relief programs.
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Roosevelt assured Vice President Garner of his continued commitment to balancing the budget and told him that he would say so publicly “fifty times.”
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In the calendar
year 1937 estimated revenues would have exceeded spending had they been calculated based on normal levels of employment, a measure used by economists later in the century.

The economy’s steady recovery ended in late 1937. After the nation’s money supply shrank between 1929 and 1933, it expanded from 1933 to 1936. The Federal Reserve nurtured this trend. Then—in 1937—it tightened credit in order to avoid inflation.

The president persisted in emphasizing the theme of budget discipline even as employment continued to decline in early 1938. Though many commentators now blame that recession on the drive to balance the federal budget, the fault clearly lay with the 1937 monetary contraction. When the Federal Reserve relaxed credit and the Treasury stopped purchasing gold flowing in from Europe, the economy began to grow again. The president explained to the public that the federal government would borrow only an amount equivalent to its investment in durable public works projects or sound loans made by the RFC.

The American people clearly supported traditional limits on federal debt. A Roper poll in 1939 asked: “If you were a member of the incoming Congress, would you vote yes or no on a bill to reduce federal spending to a point where the national budget is balanced?” An overwhelming 61.3 percent said yes; only 17.4 percent replied no.
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Budget cutters had a three-to-one margin in every income group.

The economy had fully recovered from the 1938 downturn by the time Germany invaded Poland in September 1939. Unmonetized federal debt had grown to 40 percent of national income, a level only 9 percent higher than that of two decades earlier.
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Presidents Hoover and Roosevelt, who served as icons of opposing political philosophies, had articulated similar principles for limiting debt during downturns. They both supported debt-financed spending on public works that had a clear benefit to posterity. Though they approved some debt-financed emergency relief to prevent starvation and homelessness, they both opposed longer-term programs that might encourage dependency. Both favored pensions and temporary unemployment insurance financed by self-sustaining trust funds.

Unlike federal leaders in the twenty-first century, Hoover and Roosevelt tried to preserve traditional limits on debt by articulating clearly what borrowed funds should and should not pay for. Senior federal officials in
the 1930s never lost sight of the ceiling on debt authorized during World War I.

By the late 1930s some economists came to believe that federal fiscal restraint had prolonged the Great Depression. In hindsight, however, it seems implausible that several billions of dollars in additional borrowing in an economy with an annual income of $55 billion to $75 billion would have cured unemployment.

Twentieth-century labor markets had changed in a manner not easily altered by debt-financed federal spending. The productivity and real wages (wages and salaries adjusted for purchasing power) of Americans with full time jobs
rose
during most of the Great Depression. The gap widened between incomes of workers with specialized skills and all others. By 1939 national output and income had been restored to 1928 levels, though unemployment was far higher than before. The issue of jobless recoveries from downturns would haunt the economy in the wake of many future downturns. For example, the number of private sector jobs grew more slowly in the twenty-first century than at any time since the Depression, despite massive federal borrowing and credit expansion.

The fact that full employment levels returned during World War II does not justify the conclusion that the federal government should have borrowed more aggressively in the 1930s. World War II was no picnic, and wartime employment came at a high price. The nation did not relish sending much of its young population off to war or coping with shortages of civilian goods.