America's Fiscal Constitution (56 page)

Though the president claimed to keep Social Security trust funds “off limits,” the Bush administration—like previous administrations—relied heavily on the trust funds to finance federal borrowing. This fact was eventually conceded by Bush’s senior assistant on economic policy.
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Nothing exemplified the brave new world of federal budget policy better than the Treasury’s distribution of checks to about ninety million households in August and September 2001.
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Federal leaders called the
payments, which ranged from $300 to $600, “tax rebates,” when in fact they were financed using debt.

On September 26, 2001, the Congressional Budget Office reported that tax revenues for the fiscal year ending four days later would be far less than estimated during the final consideration of the tax bill passed a few months earlier. Ordinarily that announcement would have been big news, since the president had referred to his proposed tax cut as a “demand for a refund” from a surplus. Yet late September 2001 was far from ordinary. Americans grieved and expressed their anger in response to terrorist attacks on the World Trade Center and the Pentagon.

Defense Secretary Donald Rumsfeld warned of an impending War on Terror that would require Americans to “forget about ‘exit strategies’” because the country was “looking at a sustained engagement” without “deadlines.”
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On October 7, 2001, the United States deployed troops to Afghanistan for the purposes of replacing the government of the tribal nation, expelling the terrorist organization al-Qaeda, and capturing al-Qaeda’s leader, Osama bin Laden. By then Congress had also voted unanimously to appropriate $40 billion for new antiterrorism and homeland security activities.
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F
INANCING
W
AR WITH
L
OWER
T
AXES

President Bush’s public approval ratings soared in the wake of the 9/11 attacks. Americans applauded his earnest resolve to retaliate against al-Qaeda and its sponsors. The president did not, however, ask Americans to demonstrate their resolve to adversaries by financing the War on Terror with higher tax revenues. After the House quickly passed a tax cut, White House staff reprimanded Treasury Secretary O’Neill for referring to it pejoratively as “show business.”
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The Senate hesitated to lower tax revenues again in light of the rising deficit, leading Bush to demand a “stimulus bill on my desk by the end of November.”
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When Democratic Senate Majority Leader Tom Daschle of South Dakota criticized the rising budget deficits, Bush—according to a principal White House speechwriter—“was only too delighted to play Roosevelt to Daschle’s Hoover.”
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Of course, Roosevelt had actually criticized Hoover for borrowing
too much
and prodded Congress to raise taxes when the nation went to war. In early 2002 a bipartisan majority in Congress complied
with the president’s demand by enacting debt-financed tax breaks and higher spending on health benefits for unemployed Americans.

The slide into debt accelerated. Bush applauded the passage of “compassionate” legislation that raised farm subsidies by $90 billion over five years.
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The Farm Security and Rural Investment Act of 2002 reversed the phased reduction in those farm subsidies, a reduction that was considered a triumph of fiscal restraint by Republican congressional leadership in 1996. The administration asked for a 12 percent increase in Department of Defense spending, plus another $10 billion for “contingencies.”
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By the end of fiscal year 2003, national security spending had increased by more than one-third, or $104 billion, from the level it had been when Bush took office.
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The 2002 spending binge took place in spite of the further deterioration of federal finances. In early 2002 the CBO estimated that the federal funds deficit would be $1.811 trillion over ten years, before rising even more with the retirement of Baby Boomers.
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Any extension of the 2001 tax cuts past their planned December 2010 expiration would require increased borrowing thereafter. Compared to its projections in January 2001, the CBO projected $4 trillion in lower revenues and higher spending—an amount equivalent to almost four full years of personal income tax revenues.
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The CBO attributed 29 percent of the estimated drop in forecasted revenues to a weaker economy; tax cuts, higher spending, and various mistaken revenue assumptions accounted for the balance of the $4 trillion change in the budget outlook.
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Federal Reserve Chairman Greenspan and Secretary of the Treasury Paul O’Neill, whose predecessors had used their offices to defend fiscal discipline, seemed helpless to stem the rising tide of red ink. In September 2002 Greenspan pleaded with Congress to extend spending caps and the “pay as you go” rules imposed by the 1990 Budget Enforcement Act. When Congress allowed the Budget Enforcement Act to expire in the fall of 2002, Greenspan made a note that “budget discipline in Washington” had “[given] up the ghost.”
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Secretary O’Neill warned the president that growing deficits would preclude any new debt-financed initiatives.

Political strategist Karl Rove encouraged Republicans to frame the 2002 midterm election as a referendum on the defense against terrorist attacks. Republicans picked up a few seats in the House and two Senate seats. The day after the election, senior economic officials met in Vice President Cheney’s office to discuss cutting tax rates on corporate dividends.
When O’Neill referred to the mounting deficits, the vice president asserted that “Reagan proved deficits don’t matter.”
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Cheney claimed that the election—in which popular vote for Republican candidates exceeded the Democratic vote by 4 percent—had given Congress a mandate for further tax cuts.
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The administration’s senior economic and political advisors met days later to discuss next year’s budget with the president. O’Neill and Budget Director Mitch Daniels reminded the group that large budget deficits already stretched as far as the eye could see. Then the direction of the conversation veered far outside the boundaries of “pay as you go” budget planning. The group did not address how to offset the costs of the expected war in Iraq or their plans to expand Medicare to cover prescription drugs. Instead, the conversation turned toward cutting taxes on investment income. The president decided to press for lower taxes on dividends and capital gains, and Rove advised him to scale up the size of the requested tax cut because Congress—which then had a Republican majority—might try to reduce its overall size. O’Neill, who had long questioned the wisdom of debt-financed tax cuts, was asked to resign.

Years later Bush blamed terrorism for the collapse of budget discipline: “And then 9/11 hit, which required more tax cuts to stimulate the private sector.”
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D
EBT
W
ITHOUT
L
IMIT
: 2003

In January 2003 the president asked Congress for a tax cut estimated to cost $2.7 trillion in debt, or more than $20,000 of additional debt for every household.
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Even greater amounts of debt would accumulate if the tax cut was extended beyond 2010. The concept of lower taxes on investment was not radical; for decades many tax experts had observed that the US corporate income tax discouraged investment and resulted in double taxation of corporate income used to pay dividends. Workers ultimately bear much of the burden of the corporate income tax, since it limits investments that contribute to productivity. There was, in fact, only one good reason to continue to tax corporate income: to pay the government’s bills.

The House, then led by Majority Leader Tom DeLay, quickly passed the requested tax cuts. The potential cost of a war in Afghanistan and the planned invasion of Iraq did not slow Congress down. In fact, DeLay asserted that “nothing is more important in the face of war than cutting
taxes.”
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Fiscal conservatives worked to reduce the size of the tax cut in order to lower the deficit.

Senator John McCain argued against considering a tax bill until Congress had a better understanding of the full cost of the war in Iraq, which had begun on March 20, 2003. McCain, who had been a prisoner of war for nearly six years in Vietnam, knew of the historic tendency to underestimate costs early in military conflicts. McCain was one of only four Republicans in the House or Senate who voted against the massive tax cut, the first to be enacted during war in American history.

Paul O’Neill’s replacement as treasury secretary, Jack Snow, assured lawmakers that the nation could “afford the war.”
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Wartime taxes and public bond drives had historically been used as a means for showing the public support for war and enlisting civilians in the war effort. However, when the fiscally conservative Senator Fritz Hollings of South Carolina introduced legislation authorizing a wartime 2 percent value added tax—a kind of sales tax—he could not find a Senate cosponsor.

Prior to the Bush administration, the Pentagon relied on what some called the Weinberger Doctrine to guide recommendations on whether to commit the nation’s armed forces to combat. Named for Reagan’s defense secretary, Caspar Weinberger, this doctrine’s criteria for military intervention included a clear statement of the mission, a prior definition of the result that would trigger troop withdrawal, and—thanks to a later modification from General Colin Powell—the availability of overwhelming force. President Bush, Vice President Cheney, and Secretary of Defense Rumsfeld did not feel bound by the Weinberger Doctrine.

Rather than using overwhelming force, Rumsfeld sought to exploit the Pentagon’s advantages in mobility, information technology, and communications. Though Iraqi dictator Saddam Hussein was forced into hiding, the United States lacked a viable strategy for preventing the emergence of hostile unconventional forces or the collapse of civil institutions within Iraq. Newly unemployed Sunni Muslim soldiers, who had been dismissed without pay, reorganized as a resistance movement. Shiite Iraqis established their own militia.
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Nonetheless, on May 1, 2003, Bush and Rumsfeld proclaimed the end of combat operations in Iraq and Afghanistan. For months after that announcement, the Bush administration did not ask Congress for funding to continue those wars.

Instead, the administration requested the largest expansion of Medicare since 1972. In early 2003 Congress had already increased the cost
of Medicare by loosening limits on the reimbursement rates imposed by the Balanced Budget Act of 1997. The Sustainable Growth Rate would have required a drop of 4.8 percent in the average medical reimbursement in 2003. The budget resolution H.J. Res. 2 suspended that ceiling after passing with a large bipartisan margin. Rarely has a fiscal shift with such long-term budgetary consequences occurred with so little fanfare. Congress routinely suspended the applicable annual ceiling in the following fiscal years.

In June 2003 House Speaker Dennis Hastert introduced the administration’s bill to require the federal government to pay for most of the expense of prescription drugs for Medicare recipients. A quarter of the cost of the proposed benefit would, like Medicare Part B, be financed with premiums paid by beneficiaries. Federal debt—described by some Medicare officials with the misleading phrase “general revenues”—would cover the rest of the cost.

The idea of subsidized insurance coverage of prescription drugs was nothing new. It made little sense to providers and beneficiaries that Medicare covered expensive hospitalization and drugs used in hospitals, but not drugs that could keep patients with chronic conditions out of the hospital. There was one good reason to exclude Medicare coverage of the cost of prescription drugs: there was no money to pay for it. Eventually, of course, debt itself would have to be repaid with tax revenues. Like Medicare Part A and B, the cost of any new Medicare coverage would soar when the massive Baby Boom generation reached the age of eligibility for Medicare.

Since before taking office, President Bush had consistently made the case for “modernizing” Medicare with prescription drug coverage and more “choices” for Medicare beneficiaries. His argument for greater “choice” gained little traction, since Medicare already allowed patients to choose their own providers or managed care policies. In contrast, public interest in prescription drug coverage was high. The consumption and cost of prescription drugs had grown faster than had the level of Social Security pensions, which remained the principal source of income for most Americans over sixty-five. In 2003 the White House called for a Medicare prescription drug benefit that would cost $400 billion over ten years. Some Democrats advocated a more expensive program.
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Democratic Senator Ted Kennedy, a longtime champion of federal medical services, worked with the White House to obtain Senate passage of prescription drug coverage. In June 2003 the Senate Finance Committee sent
a bill to the floor with a bipartisan 16–5 vote. The House passed Speaker Hastert’s bill with a margin of one vote, and that occurred only after House leaders bolstered Republican support by passing a parallel bill that reduced taxes on income placed in medical savings accounts. That tax benefit was estimated to require an additional debt of $174 billion over ten years.
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Another feature of the House bill provides an important lesson for people considering proposals that require all Medicare beneficiaries to use privately administered insurance plans. The House bill limited the prescription drug benefit to privately administered plans covering all Medicare services. Beneficiaries, however, did not want to be forced into a relationship with an insurer, and there was scant proof—based on the experience with Medicare vouchers after 1997—that privately administered plans reduced costs. The conference committee, with approval by the White House, dropped the House bill’s expensive tax break as well as the requirement that beneficiaries be forced to participate in private Medicare plans in order to receive the prescription benefits. But the conference committee did agree to subsidize Medicare private plans at a higher—not lower—level than the average cost per beneficiary of the traditional program of direct payment to providers.