America's Fiscal Constitution (57 page)

On November 22, 2003, a majority in the House voted against the conference committee bill during the time regularly allotted for a record vote. Speaker Hastert and Majority Leader DeLay kept the final vote count open for hours, during which time they convinced several members to switch their positions. Within two months of the passage of the Medicare Prescription Drug Improvement and Modernization Act, the ten-year cost estimates for the new drug benefit, Medicare Part D, increased to $536 billion.
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Medicare’s actuary later admitted that he had believed that the legislation would cost more than estimates published at the time the bill was passed, and that he had been threatened with termination if he shared his conclusions with Congress.
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By 2005 the Medicare actuary predicted that the ten-year cost would exceed $1 trillion and that the present value of its cost (the amount of current dollars that would have to be reserved and invested in Treasury debt to fund general revenue costs) would be $8.7 trillion, more than the total federal debt at the time.
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In 2013 the Medicare Trustees estimated that $164 billion will be paid for prescription drug benefits in 2022, an amount significantly greater than the total of $104 billion expected to be paid to physicians under Medicare Part B.
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Other than premiums covering 25 percent of costs, there was no funding—other than debt—for the prescription drug benefit. Budget experts had repeatedly warned the White House and Congress that Medicare spending would sharply increase after the first of the Baby Boomers reached age sixty-five in 2010. The decade from 2001 to 2010, when many Baby Boomers were in their prime earning years, represented the last good opportunity to reserve funds for their medical costs. During that decade the increase in population between the ages of forty-five to sixty-five was two times greater than the growth in the population in all other age brackets combined.
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Congressman John Boehner of Ohio, who then chaired the Republican House Policy Committee, tried to overcome doubts of House Republicans about the direction of their party after its expansion of Medicare. He argued that “the American people did not want a major reduction in government.”
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Majority Leader DeLay declared that there simply was no “fat left to cut in the federal budget.”
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The debt-financed spending binge in 2003 culminated in congressional approval that September of the administration’s request for $87 billion to reconstruct and fund military operations in Iraq and Afghanistan.
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Most Democrats supported an amendment that would have reversed a portion of the 2001 tax cuts in order to finance part of that request. Senator Conrad, the ranking Democrat on the Senate Budget Committee, explained to his colleagues that the federal funds budget was already borrowing at a rate of $700 billion a year, the highest level “as a percentage of GDP . . . since World War II.”
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The Senate tabled the amendment by a vote of 57 to 42. Not a single Republican voted in support of raising taxes to pay for the war’s continuing costs. When the nation went to war after Pearl Harbor, Congress passed the Revenue Act of 1942 with only two dissenting votes.

Supplemental requests—apart from the initial budget—were typical during the first year of wars, though it was unprecedented for an administration to make its largest funding request months after announcing the end of combat. By the second year of other conflicts, prior administrations included estimates of war-related costs in their annual budgets. Although initial war costs were uncertain, members of Congress had always expected officials to at least have some military plan that could be used to estimate war-related spending. Until his last year in office, however, President Bush
consistently excluded such estimates from his annual budget submissions and, instead, made emergency requests for war spending weeks or months after Congress began reviewing all other parts of the budget.
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This practice undermined the congressional process for setting budget priorities and made any attempt at “pay as you go” budget planning impossible.

In the fiscal year ending September 30, 2003—even before passage of the legislation expanding Medicare and the appropriation of funds for the reconstruction of Iraq—federal tax revenues apart from dedicated trust funds equaled 9.2 percent of national income.
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That level of federal funds revenues as a share of national income was lower than at any time since the attack on Pearl Harbor. These revenues could only support two-thirds of the federal funds spending, which amounted to 14.2 percent of national income.
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The gap rose the following fiscal year. Using the balanced budget of 2000 as a benchmark, wars in Iraq and Afghanistan accounted for a quarter of the 2004–2005 deficit.
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Debt-financed tax reduction and military spending apart from war were responsible for most of the new debt.

Bush was the fourth Republican president to face a massive potential budget deficit during his third year of office. The first, Abraham Lincoln, asked for a massive tax increase to reduce federal borrowing. The second, Herbert Hoover, also asked for higher taxes. The third, Ronald Reagan, asked for a standby tax surcharge combined with spending limits to curb further borrowing. In contrast, when faced with massive deficits in 2003, President Bush asked Congress to pass debt-financed tax cuts, an expansion of Medicare, and substantial funding for the reconstruction of two nations occupied by American forces.

Without the traditional link between spending and tax policies, federal politicians found it harder to say no to spending requests. In fiscal years 1996 and 1997, when federal leaders worked hard to balance budgets, action on appropriations bills had been highly contentious. From 2001 to 2006, however, appropriations bills sailed through Congress with lopsided bipartisan majorities and no threat of a presidential veto.
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After the demise of the traditional fiscal constitution, voters began asking congressional candidates variations of the basic question: “If Congress can find money to reconstruct Iraq, why can’t it find any money for domestic needs?” The absence of a defined limit on borrowing made that question difficult to answer.

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The traditional taboo against mortgaging large amounts of US tax revenues to foreign creditors no longer constrained federal borrowing. No massive bond drives, like those during prior wars, reminded Americans of the cost and sacrifices required for the War on Terror and the occupation of two nations. Foreign creditors, federal trust funds, and the Federal Reserve absorbed the additional federal debt incurred during the initial years of the Bush administration. In President Clinton’s last term, foreign ownership of federal debt had declined from $1.231 trillion to $992 billion; by the end of fiscal year 2004, foreign creditors held $1.795 trillion of that debt.
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Easy access to credit did not give rise to the borrowing binge, since credit had been readily available to the federal government since at least 1879. The laws of supply and demand could not be repealed, so obviously the sharp rise in federal borrowing raised interest rates to a level higher than they would have been otherwise. One 2003 study concluded that the sharp swing from projected surplus to deficit in 2001–2003 raised interest rates by 99 basis points.
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Federal officials had balanced budgets throughout history and, as recently as the 1990s, tried to balance budgets in order to impart greater confidence in financial markets. But neither the plunge in equity markets in 2002 and 2003 nor the decline in bond prices in 2005 and 2006 restrained the use of debt to finance even routine government operations.

Incumbents were naturally reluctant to explain to the public that foreign trade competitors purchased federal debt in order to suppress the value of their currencies and thereby reduce the prices of goods exported to the United States. China used the dollars it accumulated through a rising trade surplus to invest in Treasury debt. Master investor Warren Buffett compared the use of capital inflows to offset a chronic trade deficit to the circumstance of a family of farmers who sold off land to maintain income until they eventually became sharecroppers. The American trade balance deteriorated after 2000. Domestic manufacturing employment—which from 1966 to 2000 had remained in a stable range of 16.6 million (June 1966) to 19.5 million (June 1979)—fell to 13.8 million in 2007. By 2013, after the Great Recession, only 11.9 million American manufacturing jobs were left.
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The collapse of traditional fiscal limits opened the door to ideas that would once have been considered radical. The poorly understood proposal to borrow more than a trillion dollars to reform Social Security, sometimes referred to as “privatization,” is a prime example. This initiative began when the president appointed a commission in May 2001 and noted that “large budget surpluses over the next ten years” would “provide an opportunity to move to a stronger Social Security system.”
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The notion of Social Security reform sounded prudent in 2001, since the long-run actuarial balance of the Social Security Old-Age and Survivors Insurance Trust Fund had deteriorated. Actuaries calculated that the gap, largest in the later years of a seventy-five-year projection, could be closed by an additional tax or a reduction in the value of benefits between 1 to 1.9 percent of covered payroll, an amount equal to 1 percent or less of national income. The size of that potential shortfall was dwarfed by the growing deficit in the federal funds budget.
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Though the president asserted that the longer lives of Americans posed risks to Social Security, the demographic trends had actually improved relative to the assumptions used as the basis for the Greenspan Commission’s 1983 reforms.
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Bush had requested that his Commission to Strengthen Social Security present policy options for funding a new system of personal retirement accounts that would supplement the current pension system. A group of Republican activists rallied in support of a plan to incur over a trillion dollars in debt to fund “private accounts.” After his reelection in 2004, President Bush toured the nation to promote the concept of personal accounts. In his State of the Union address in January 2005, Bush claimed that the existing system was “headed toward bankruptcy.”
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He dramatized his claim by visiting a Social Security office, where he claimed that the amount invested in Treasury bonds was only a ledger entry. He asserted during his visit that “there is no ‘trust fund.’” In fact most holdings of Treasury bonds, like checking accounts, are electronic ledger entries and federal law required the payment of all amounts owed.

Proponents of private accounts did not, of course, publicize the extensive use of debt to finance their plan. Because the Social Security trust fund had no actuarial surplus, any diversion of dedicated payroll tax revenues would inevitably require the use of debt—directly or indirectly—to fund future benefits at existing levels. That is why Federal Reserve Chairman Greenspan and Treasury Secretary O’Neill had earlier warned the White House that any plan to reduce pension obligations through the funding of
private accounts—which both favored—would require a large surplus in the federal funds budget.

In 2004, “almost two-thirds of U.S. retirees relied on Social Security for most of their income, largely due to the decline in traditional pensions in recent decades.”
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To allay public suspicions about the risk of stock market investment, Republican congressional leaders insisted that the new personal accounts would not reduce future guaranteed benefits. Contrary to the perceptions of many traditional conservatives and liberal critics, the reform or privatization plan as described by the president did not entail a significant reduction in future benefits. In March 2006 a bill to fund personal accounts with Social Security reserves held for the retirement of Baby Boomers died with a perfunctory vote, 46 to 53, in the Senate. That bill, had it passed, would have resulted in more than a trillion dollars in additional federal debt—about $10,000 per working American. In hindsight, that defeat was a blessing for the Republican Party. If the Social Security trust fund had been depleted to fund personal accounts holding stocks or various stock index funds, the GOP might have been struggling for its very survival during the stock market crash that accompanied the Great Recession of 2008.

The majority of midterm voters in 2006 held Republicans accountable for the mismanaged wars and domestic failures such as the chaotic response to Hurricane Katrina in 2005. Record deficits incurred during the Bush administration made it difficult for Republicans to cast themselves as guardians of the Treasury. The massive borrowing by the Bush administration invited obvious comparisons with the reduction in annual borrowing during the Clinton administration. Echoing a powerful and traditional theme, one of the Democrats’ rising stars, Senator Barack Obama, tried to make the case for budget discipline: “We are mortgaging our future. We’re taking a credit card for our children, in our children’s name and our grandchildren’s, and we’re running up the card and being completely irresponsible.”
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Democrats controlled the House for the first time in a dozen years after the 2006 election. Democratic leaders would soon be tested on the strength of their commitment to restore traditional fiscal discipline.

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