America's Fiscal Constitution (46 page)

R
ISING
I
NTEREST
E
XPENSE

Jimmy Carter’s status as a Washington outsider was a campaign asset that became a liability when he had to prepare a budget within weeks of taking office. His staff’s lack of experience with budgets and Congress made his task difficult.

Carter searched for wasteful spending and decided to cut nineteen hydroelectric power projects. Members of Congress in both parties objected to the potential loss of those infrastructure investments, which had been planned for years. Some members also objected to the president’s deferral of investments in several new weapons systems. Carter’s tax proposal—a one-time tax rebate of $50 per taxpayer—was slow to gain traction, and the administration dropped its initiative after only a few months in office.
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From then on, Carter later reflected, his “major economic battle would be against inflation,” a fight in which he tried to “stay on the side of fiscal prudence, restricted budgets.”
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The emphasis on fiscal discipline limited the Carter administration’s ability to undertake new domestic initiatives. Carter’s annual budgets—like
those of his predecessor, Gerald Ford—contained few new programs apart from those intended to enhance energy security.

Rising interest expense made it even harder to balance the budget. When Carter took office in January 1977, the Treasury sold long-term bonds at an effective interest rate of 7.63 percent. By 1979 Treasury bonds were sold at a yield of 10.44 percent, a level reached previously only during the War of 1812 and the Civil War.
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Higher interest rates soaked up revenues that otherwise could have been used to fund expanded medical services, tax reduction, or more robust Cold War military budgets.

Consumer prices increased 13 percent in 1979.
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Monetarist economists marshaled persuasive evidence showing price levels rose principally to the extent that the supply of money grew faster than did the output of the economy. Carter’s appointee as chairman of the Federal Reserve, Paul Volcker, began throttling back growth in the money supply in October 1979. The combination of restricted credit and inflationary expectations propelled the prime lending rate offered by banks to an unprecedented level of 21 percent.
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For all that, however, by the end of fiscal year 1979, the deficit in the federal funds budget had fallen to 2.3 percent of national income, almost half the level of the deficit in the last full fiscal year in the Ford administration.
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The budget probably would have satisfied the criterion of balance at “reasonably full employment.” Nonetheless, the public grew impatient with the seeming inability of elected officials to restore traditional fiscal discipline.

By 1979 a majority of state legislatures had passed resolutions calling for a constitutional amendment that required a balanced federal budget. According to polls, more than 70 percent of Americans supported such an amendment.
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B
UDGET
C
HAOS IN
1980

Carter sought to balance the budget by the end of his term. There was more at stake than fulfilling a campaign promise or securing his legacy. The Federal Reserve had been contracting the supply of credit in order to curb inflation. Democratic and Republican leaders in Washington believed that the federal government should assist that effort by reducing its demand on credit.

In January 1980 Carter submitted a budget with a projected deficit of $15 billion, the lowest in years.
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Days later budget experts raised the
estimate of required federal borrowing. The bond market began to crash. The market value of long-term Treasury bonds fell by more than 20 percent in the first seven weeks of 1980, and interest rates on Treasury debt soared to 12 percent.
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The Dow Jones Industrial Average fell to its lowest level in eighteen years.

In March 1980 Carter invited congressional leaders from both parties, the administration’s senior economic officials, and Federal Reserve Chairman Paul Volcker to daily White House meetings convened for the purpose of rewriting the administration’s budget. Volcker described Carter during those meetings as “a president with basically conservative instincts making preliminary decisions challenged by advisors sensitive to both particular interests and to the more liberal traditions of his party.”
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Most of the group agreed to cut federal grants, withhold estimated taxes on interest and dividends, and levy a new tax on oil imports. Volcker’s Federal Reserve restricted credit card lending in an attempt to curb price inflation, triggering an abrupt fall in consumer spending and economic output. The harsh monetary medicine resulted in a slow but steady reduction in price inflation.

Shortly after the White House meetings, bipartisan budget cooperation ended. Members of Congress nervously eyed the November election, and Congress refused to authorize a fee on imported oil that bipartisan leadership had endorsed just weeks earlier. Senate Republicans even endorsed a 10 percent reduction in income tax rates. Gridlock ensued. Procedures enacted in 1974 required Congress to pass a budget resolution by the spring
before
the fiscal year that began each October. In 1980 Congress missed that deadline and was unable to pass a budget resolution until October 1—the first day of fiscal year 1981—just as the administration prepared to shut down the government due to lack of funding.

The belated budget resolution included a feature that offered some solace for advocates of traditional “pay as you go” budget planning. Congress revised its budget procedures to give a voting majority the power to order committees to amend legislation affecting taxes and spending so as to fit within—be “reconciled with”—the annual budget resolution’s spending ceiling and revenues estimates. Congressional leaders hoped that this broad “reconciliation” power would be used to restrain formula-based spending.

The budget resolution adopted on October 1, 1980, also projected a lower operating deficit—federal funds outlays minus receipts before
counting the interest expense—than any budget since the recession from 1974 to 1975. No one had quite figured out how to pay for those rising interest rates. By the end of fiscal year 1981, gross interest expense rose to $95 billion, more than double the amount paid in the year Carter had taken office.
¹¹

Even the apparent discipline—before interest expense—for fiscal year 1981 would turn out to be an illusion, however. Revenue projections assumed that rapid economic growth and high rates of inflation would push taxpayers into higher tax brackets, and that the resulting flood of revenues would allow Congress to raise future defense spending and still balance the budget.

The budget prepared in 1980 did, however, include two hard choices. The Carter administration beat back an attempt by some Democratic leaders to expand federal medical services, and ended a signature Democratic jobs initiative.

After his election in 1976, Carter had asked for time to consider how to deal with Senator Ted Kennedy’s proposal to expand access to medical insurance with an employer mandate and some premium subsidies, an approach endorsed earlier by President Nixon and later by President Clinton. Carter could not find room for the new program within a balanced budget, especially after Congress defeated his initiative to cap the annual rise in costs for Medicare hospitalization. Senator Kennedy proceeded—without the White House—to line up support for his plan. Polling showed that about 60 percent of Americans in the 1970s said “too little” was spent on health programs, a percentage much higher than those who felt “too little” was spent on defense.
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Senate Finance Committee Chairman Russell Long and House Ways and Means Committee Chairman Al Ullman blocked action on the insurance legislation, prompting Kennedy’s supporters to organize a challenge to Carter’s renomination.

The drive to balance the budget also forced cuts in a Democratic jobs program. In 1977 Congress had increased funding for public service jobs administered under the Comprehensive Employment and Assistance Act, known as CETA, enacted during the Nixon administration.
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Congress required more than four hundred grant recipients, principally local governments, to create hundreds of thousands of jobs by the spring of 1978. The number of subsidized jobs grew from 300,000 in May 1977 to 725,000 in March 1978.
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Local governments hired unemployed people
to fill temporary jobs in schools and parks and to perform street maintenance. Occasionally they shifted parts of their existing workforce to CETA grants. Under media scrutiny, Congress blamed grant recipients for mismanagement, while local governments recoiled at new CETA mandates and audits.

In fiscal years 1977–1979, Congress appropriated more than $27 billion for employment and training programs.
¹⁵
In 1980 Congress pared down the program, over the objection of Senator Kennedy.

T
HE
C
OLD
W
AR
D
ILEMMA

The years following the withdrawal from Vietnam, unlike those after other major wars, evinced no drop in military spending. The end of conscription raised personnel costs. At the same time, the Ford administration endorsed an expensive five-year plan of investments to modernize military hardware. Carter delayed that plan’s contemplated outlays for new nuclear delivery systems. He and Secretary of Defense Harold Brown placed more emphasis on upgrading conventional forces with improved technology and precision-guided missiles. Carter and Brown challenged NATO allies to share the burden of Cold War expense by making a multiyear commitment to increase military spending by 3 percent annually after inflation—a level the president hoped would serve as a ceiling as well as a floor on US defense costs.
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Senator Henry “Scoop” Jackson demanded substantially higher military outlays. Jackson had never agreed with Nixon and Ford’s policy of détente with the Soviet Union. Jackson was an unapologetic Truman Democrat who had served in Congress since World War II. The Soviet Union’s economy appeared vulnerable. For that reason, the down-to-earth liberal senator from Washington opposed popular nuclear arms control treaties. Jackson believed that Americans should be willing to pay the tax rates sufficient to challenge the Soviet Union’s brutal suppression of human rights and control of Eastern European nations.

In 1978 Carter vetoed a military spending resolution crafted by Jackson and Senator Sam Nunn of Georgia, another vocal critic of the administration’s defense budgets. In 1979 Carter vetoed another resolution calling for defense spending to increase at an annual rate of at least 5 percent plus inflation.
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Jackson’s hawkish view on military preparation gained ground when a new regime in Iran took American diplomats hostage on November 4, 1979. Shortly thereafter, to obtain Senate ratification of a treaty with the Soviet Union limiting certain kinds of nuclear weapons, Carter agreed to back a sustained 6 percent after-inflation increase in defense spending.
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Then, on Christmas Eve 1979, the Soviet Union invaded Afghanistan, initiating a new phase of the Cold War.

Jackson’s efforts were backed by the influential Committee on the Present Danger. That organization included Ronald Reagan, who later would appoint more than thirty of its members to positions in his administration. Several leaders of the committee, including Donald Rumsfeld and Jackson staff member Paul Wolfowitz, would help shape military policy well into the twenty-first century.

In the last fiscal year of Carter’s administration, the federal government spent $157 billion for national security—$60 billion more than in the final year of the Ford administration from four years earlier.
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Jackson and Reagan sought to spend even more.

F
ROM
T
AX
R
EFORM TO
T
AX
R
EVOLT

The federal tax system inherited from World War II no longer produced revenues sufficient to pay for both higher Cold War spending and other existing bipartisan federal commitments, such as Medicare, within a balanced budget. In 1979 House Ways and Means Committee Chairman Ullman and Senate Finance Committee Chairman Long called for a radical overhaul of the federal tax system. They proposed a value-added tax—a form of sales tax—in order to broaden the federal tax base. Many tax experts and most businesses favored a shift to greater taxation of consumption rather than income from production.

By 1980 federal taxation of corporate income yielded revenues of only 2.4 percent of national income, down from 6 percent in 1952.
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In the mid-1950s corporate taxes provided 30 cents out of every dollar spent in the federal funds budget; in 1980 those revenues covered only ten cents of each federal dollar spent, the lowest relative contribution of the corporate tax since before World War I.
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Declining corporate tax revenues were principally the result of international competition, though some elected officials instead blamed deductions that they called “loopholes.” Rules on the deduction of
business outlays often were intended to bring the taxable income of capital-intensive industry in line with their actual cash flows and the cost of equity financing.
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The challenge of international competition became more visible in the 1970s, when Japan flourished as American productivity and trade balances deteriorated. Productivity rose alongside greater educational achievement and capital investment per worker. Nations such as Japan, Korea, and Taiwan improved the skills of their workforces, and devoted a larger share of their national income to business investment than did the United States. Foreign nations used tax systems that weighed more heavily on consumption than investment as a means to encourage growth.