America's Fiscal Constitution (50 page)

To prevent such abuse, the Greenspan Commission recommended that the trust funds be removed from the normal federal budget. Congress and the White House, however, were not anxious to highlight increasing debt. The legislation addressed the problem by requiring that trust funds for
Social Security and Medicare hospitalization be removed from the budget beginning ten years later. A few years later even that requirement was quietly dropped.
¹⁸

The Greenspan Commission used reasonable assumptions in its actuarial projections, though one of them—concerning future income distribution—would prove to be inaccurate. The commission forecasted that the trust fund would continue to be in balance as long as the annual wage base subject to payroll taxes rose at the same rate as the liability for future benefits. The commission assessed payroll taxes at a level covering 90 percent of overall payroll in 1983 and indexed the annual increase in the wage ceiling to the average—rather than the median—rise in annual income from wages and salaries.
¹⁹
Before 1983 median income in America had risen in line with average income, and the Greenspan Commission’s actuaries assumed that this historical linkage would continue. After 1983, however, total wages grew significantly faster than average wages. Incomes of Americans with at least one four-year college degree grew faster than the incomes of other employees, so average wages did not rise as much as incomes of workers above the ceiling on payroll taxes. As a result, by 2005 the Social Security wage base represented only 85 percent of wages and salaries, not the 90 percent the Greenspan Commission had assumed.
²⁰
Much of the existing actuarial imbalance in the Social Security trust fund could be fixed using an adjustment of either the wage ceiling or benefits to compensate for that difference.

Contrary to popular belief, the commission accurately forecasted the ratio of retirees to workers. It also addressed a common criticism that wealthy Americans received pensions that they did not need. Workers with high incomes already received benefits at far lower levels in proportion to their contributions than others, and the 1983 reform applied a high tax rate to those Social Security benefits.

Social Security pensions had lifted many elderly citizens out of poverty. People can judge for themselves whether the pensions are too generous: the average Social Security pension in 2013 was about $1,100 a month, an amount that provided the principal source of income for many older Americans.
²¹

Today it is common to hear that the “real problem” with balancing the budget is the growth of “entitlements,” including Social Security. In fact, the balance between revenues and spending in the Social Security trust fund is far better than in the federal funds budget, which excludes trust funds.

B
UDGET
B
LAME AND
S
EQUESTRATIONS

Though the economy grew during the third through fifth fiscal years of the Reagan administration, taxes paid for only $1.354 trillion of the $2.121 trillion in federal funds spending.
²²
In short, the United States borrowed to pay for one out of every three dollars it spent apart from trust fund revenues. This gap represented about 5.5 percent of national income, a level of borrowing comparable to that during the Great Depression.
²³
In the words of Federal Reserve Chairman Paul Volcker, “the deficit ate up a lot of our private savings, which were awfully low to start with by world standards and even by our own past performance.”
²⁴

Reagan’s budgets—like those during the New Deal—spawned partisan myths. Contrary to the view of some “supply side” analysts, President Reagan and his most senior advisors never believed that the tax cuts would somehow “pay for themselves” through increased economic growth. During his January 1983 State of the Union address, Reagan proposed a “standby” tax—not a new tax cut—to reduce deficits.
²⁵

A second pervasive myth is that the Reagan administration made significant cuts in New Deal and Great Society programs. The largest of these programs—Social Security pensions and Medicare—grew rapidly. As expressed by Reagan loyalist and principal domestic policy advisor Martin Anderson: “On the whole, President Reagan set spending records right and left.”
²⁶
The Reagan administration, however, did succeed in reducing spending in four much smaller programs: development of alternative energy technologies (a Ford and Carter initiative), community and regional development (a Johnson and Nixon initiative), training and employment (largely a Democratic congressional initiative), and general revenue sharing (a Nixon initiative).
²⁷
Federal funds outlays during the eight fiscal years of the Reagan administration amounted to about 16.5 percent of total national income, while the average during Carter’s four years was 15.5 percent.
²⁸
During the Reagan administration federal funds spending as a share of national income far exceeded the level during the Clinton administration.

House Democratic leadership declined to force the president and the nation to choose between cutting back on popular domestic programs such as Medicare Part B or imposing higher taxes to pay for them. In one of the most unusual episodes in budget history, the House defeated seven different proposed budget resolutions in early 1983. Three of them attempted
to balance the budget: one from moderate Democrats that cut all spending and raised revenues in equal amounts, one from “small government” Republicans that slashed domestic spending, and one from the Black Caucus that raised taxes and cut defense spending. The House finally adopted a budget that included less borrowing, more domestic spending, and lower military appropriations than did Reagan’s budget. That budget allowed Democrats to highlight their domestic priorities but abdicated the high ground of a budget that actually balanced.

Former vice president Walter Mondale, in his televised speech accepting the Democratic presidential nomination in 1984, proclaimed that chronic borrowing would “hike interest rates, clobber exports, starve investment, [and] kill jobs.”
²⁹
He then proposed to cut the deficit by two-thirds in four years, in part by raising taxes. The idea of only gradually tapering off debt-financing belied the urgency and moral imperative of avoiding routine borrowing. If mortgaging future taxes to pay today’s bills was so bad, why not immediately balance the budget?

As economic growth revived in 1984, so did the president’s public approval rating. Yet Reagan’s large reelection margin that year was hardly a partisan victory. Democratic candidates received a substantial majority of all votes cast for Congress. In the absence of a concrete plan by either party to immediately balance the budget, there was no clear mandate on how to do so.

The president and members of Congress had, however, heard public concerns about rising debt. In 1985 Republican senators, with some Democratic support, fought to restore budget discipline. The Senate failed by only one vote to pass a constitutional amendment—subject to state ratification—that required a balanced budget. Senate Appropriations Committee Chairman Mark Hatfield, a Republican, voted against it, explaining that Congress could always balance the budget by simply cutting spending.

Senators Pete Domenici and Bob Dole then crafted a budget resolution that limited the growth in defense spending and froze most other federal spending for a year, a freeze that eliminated the next annual inflation adjustment for Social Security pensions. Senate Republican leaders designed their plan to cut the budget deficits projected during Reagan’s second term by at least half, a goal that had been embraced by both Reagan and Mondale during the 1984 presidential campaign. The Senate budget resolution
reduced growth in future spending by more than any budget proposal adopted by the House or Senate since 1964.

The Democratic House responded with its own plan, which retained the inflation adjustment for Social Security while cutting military spending by a larger amount than did the Senate’s. Reagan and Defense Secretary Caspar Weinberger bridled at congressional limits on defense spending. After the president and House Speaker O’Neill compromised by eliminating cuts to defense and pensions, an angry and frustrated Senate majority delayed action on the White House’s request to raise the statutory debt ceiling above $2 trillion.
³⁰

This impasse led Congress to adopt the new budget procedures, in the form of the Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Act. The legislation, passed in late 1985, set annual limits on new debt that could be incurred in each of the next five years. That limit dropped by $36 billion a year until it reached zero.
³¹
Amounts borrowed from trust funds were excluded from that annual limit on debt.
³²
The act included a distinctive enforcement mechanism: the controller—an unelected officeholder—was directed to “sequester,” or not spend, certain amounts Congress had already appropriated in order to comply with the annual ceilings on debt. (Later, the sequestration authority was transferred to the White House.) The Gramm-Rudman-Hollings Act passed by lopsided margins in both the House and the Senate.
³³
Those debt ceiling targets triggered potential sequestrations during five of the next six fiscal years. In each case, Congress and the White House reached some compromise that reduced the amounts scheduled to be sequestered and raised the limit on the debt ceiling.

In preparation for the 1985 budget, virtually all of the president’s senior White House staff and economic advisors sought to shrink the administration’s annual requests for military spending. Secretary Weinberger defended his proposed budget by showing the president two posters: one depicting a muscular G. I. Joe and the other a scrawny, shabbily clothed soldier. Weinberger prevailed with the president but not members of Congress, who slowed the growth in military spending.

Interest on the debt was the fastest growing component of federal spending in the late 1980s. Annual interest expense grew by $50 billion from 1986 through 1989.
³⁴
In 1989 interest expenses were equal to half of the total amount of all federal funds spending in 1980.
³⁵

R
EFORMING THE
W
ORLD
W
AR
II T
AX
S
YSTEM

In 1986 the Treasury Department and Congress completed the most ambitious reform of the income tax system since World War II. While that effort did not address the deferred tax bill accumulating as debt, but it did remove significant economic distortions that had resulted from high marginal rates of taxation on earned (noninvestment) income. The initiative was the brainchild of Senator Bill Bradley of New Jersey, a moderate Democrat who cast the lone vote in the Senate Finance Committee against the massive tax cut bill in 1981. The thoughtful Bradley was a former professional basketball player who had observed firsthand how attempts to shelter income from high tax rates skewed economic decisions. Professional athletes and others with high salaries could lower their net income subject to taxes by making investments that generated early losses while building asset value. Despite almost annual changes in the tax code, for decades the average tax rate paid on the top line of personal income tax returns had been about 13.5 percent.
³⁶
In theory, personal income tax revenues could remain the same if Congress lowered tax rates while eliminating an adequate amount of exclusions and deductions.

Bradley’s bill dropped the top tax rate from 50 percent to 30 percent and made up the lost revenue by raising the tax rate on capital gains and limiting the ability to lower taxable income with deductions for investment-related expense.
³⁷
For many years senators considered Bradley’s proposal to be naïve. The concept of broadening the tax base seemed easy in theory, but income after deductions would have to double in order to offset the loss in revenues from a one-third cut in tax rates. Moreover, most of the provisions referred to as loopholes had once been enacted as beneficial incentives.

President Reagan called for tax reform in his 1984 State of the Union address. Members of Congress responded with laughter, however, when the president promised to recommend reforms only
after
the election eleven months later. Reagan’s 1981 tax initiative had, however, changed the politics of federal income taxation. Many elected officials in both parties openly acknowledged that a top rate of 50 percent inevitably led to attempts to shelter taxable income.

Following the 1984 election Secretary Regan and his Treasury Department staff presented their plan to lower personal tax rates and reduce deductions that had been designed as investment incentives. The Treasury
plan faltered after the president publicly questioned its net increase in corporate taxation. Republican Senate Finance Committee Chairman Bob Packwood believed that it did not “make sense” to pass tax legislation “without a dime’s dent in the deficit.”
³⁸

After White House Chief of Staff James Baker switched jobs with Treasury Secretary Regan in early 1985, he and Deputy Treasury Secretary Richard Darman prepared a new plan for tax reform. It did not close the budget gap but at least preserved the level of revenues projected under existing law while lowering personal tax rates on earned (noninvestment) income. Half the members of the Senate signed a letter opposing the consideration of such a revenue neutral tax reform until the federal government reduced its planned borrowing.
³⁹

Televised speeches by the president and the House Ways and Means Committee’s Rostenkowski in May 1986 revived the prospects of tax reform. Rostenkowski crafted a plan that limited deductions and dropped the top tax rate from 50 to 38 percent.
⁴⁰
With support from House Democrats and the White House, Rostenkowski’s bill passed the House on a voice vote. Senate Finance Committee Chairman Packwood then reversed course and embraced the House initiative with certain changes.
⁴¹
Packwood and Rostenkowski personally negotiated a compromise that passed Congress with large bipartisan margins. The Tax Reform Act of 1986 lowered the top tax rate on personal income to 28 percent, though a phase-out of deductions for people with higher incomes made the top effective rate 33 percent.