Red Ink (5 page)

In 1975, a year after the CBO was created, the budget hit a little-noticed milestone:
for the first time, spending on interest, Social Security, Medicare, and other benefits exceeded the defense and domestic spending that Congress must approve
annually. A year later, having become a Democrat, Panetta was elected to Congress from his hometown. Four years further on, fellow Californian Ronald Reagan was elected president.

The Reagan presidency was styled as a turning point in American politics: the end of the New Deal and the beginning of an era in which the government would retreat from the economy. Ronald Reagan made three significant fiscal promises during his campaign for president: cut taxes, rebuild the nation’s defenses, and balance the budget. He delivered on the first two, but not on the third.

Later, the notion that cutting taxes would lead to compensating cuts in government spending became known as the “starve the beast” strategy, a phrase made famous by Daniel Patrick Moynihan, the late, erudite Democratic senator from New York. In his usual folksy style, Reagan lent credence to this theory in a February 1981 televised speech: “
Well, you know, we can lecture our children about extravagance until we run out of voice and breath. Or we can cure their extravagance by simply reducing their allowance.”

But insider accounts of the Reagan years describe a haphazard, almost chaotic process inside the White House. Some Reagan aides were committed to cutting spending, notably David Stockman, the Paul Ryan of his day. Elected to Congress at age thirty, Stockman left the House of Representatives after four years to become Reagan’s budget director, determined to dismantle vast segments of the welfare state. “
If you insisted on a balanced budget but accepted all the illicit welfare-state
spending commitments that have been accumulated over the years … you became the tax collector for the welfare state,” Stockman wrote in his memoir. He did not want that role.

Another group around Reagan, known as the supply-siders, argued that cutting tax rates would unleash a surge of economic activity from the producers in the economy. Within the White House, they derided Stockman and his allies as “root canal” Republicans determined to inflict the pain of spending cuts to pursue a misguided antipathy toward deficits.

One of the supply-siders, Jude Wanniski, a
Wall Street Journal
editorial writer, had popularized what he called the “
Two Santa Claus Theory” in 1976: “The Democrats, the party of income redistribution, are best suited for the role of Spending Santa Claus. The Republicans, traditionally the party of income growth, should be the Santa Claus of Tax Reduction. It has been the failure of the GOP to stick to this traditional role that has caused much of the nation’s economic misery.… It isn’t that Republicans don’t enjoy cutting taxes. They love it. But there is something in the Republican chemistry that causes the GOP to become hypnotized by the prospect of an imbalanced budget.… [T]hey embrace the role of Scrooge, playing into the hands of the Democrats, who know the first rule of successful politics is Never Shoot Santa Claus.”

On spending, much of the Reagan cabinet and a good chunk of the Republican congressional leadership labored to shield their favorite programs from Stockman’s knife. And they succeeded.

Even without the spending cuts, the Reagan tax cut passed in 1981. More than half the Democrats in the House voted for the bill, Panetta among them, despite his later criticism of it. He already had voted for a smaller tax cut, a compromise offered by Representative Dan Rostenkowski of Illinois, then the chairman of the tax-writing committee. But that bill had failed. “
At that point,” Panetta said in a recent interview, “I thought I’d been fighting [Reagan] on every front, and he was very popular in my district, and I said, you know, having voted for the Rostenkowski tax cut, I just find it very difficult to now turn around and suddenly vote against [the Reagan] tax cut. That’s the scenario.”

The Reagan tax cut was gigantic: its provisions, the Treasury estimated later, would have slashed federal revenues by 18 percent in the first two years. “
If the American political system had acted the way it normally does, it would have lopped off the extremes and forced a compromise within moderate bounds,” Richard Darman, a Reagan White House aide and later George H. W. Bush’s budget director, recalled in his memoir. “But in this case, even as it became absolutely clear that necessary spending control would not be achieved, the system allowed a way-out-of-the-ordinary tax cut to become law.”

Whatever the reasons—Darman later (and characteristically) offered a ten-point explanation—the result was the 1981 tax cut without the hoped-for spending cuts. Stockman famously predicted deficits of “
$200 billion a year as far as the eye can see,” numbers that sounded huge at the time. He was prescient. The 1980s broke a pattern in which the
federal government ran big deficits only in wartime. The deficits topped $200 billion a year from 1983 through 1992. They would have been even bigger if Reagan hadn’t flinched on taxes, accepting significant tax increases in 1982 and 1984.

Reagan enjoyed many victories as president. But starving the beast was not one of them. When he left office, federal spending was 20 percent higher, adjusted for inflation, than it had been when he arrived, and he never found a way to pay for it. In the twenty years before Reagan became president—under Kennedy, Johnson, Nixon, and Carter—
the budget deficit averaged well under 1 percent of GDP. In Reagan’s eight years, it averaged 4.25 percent of GDP.

Panetta summed up Reaganomics in a single sentence: “
A significant tax cut was enacted at the same time that defense spending went up and … entitlement programs were also expanding.” When Reagan turned the presidency over to George H. W. Bush, the deficit was 2.8 percent of GDP—and rising.

Bush was elected in 1988 with one memorable promise: “Read my lips, no new taxes.” Republican pollster Richard Wirthlin once called them “
the six most destructive words in the history of presidential politics.”

When Bush assumed the presidency, Panetta was chairman
of the House Budget Committee, the panel created in the 1974 reforms of the budget process. From that perch, he decried “
a borrow, bailout, and buy-out binger that pervades our society and puts our future economic security at risk,” warning further—in phrases that are heard again today—that “our capacity to govern” was being tested.

“
Both Democrats and Republicans talked about reducing this deficit, but neither wanted an approach to touch their favorite programs,” he recalled years later. “The Republicans said they would balance the budget, but they did not want to raise taxes, and they did not want to cut defense. The Democrats, on the other hand, said, ‘We want to balance the budget, but we don’t want to cut domestic programs, we don’t want to reduce any entitlement programs. What we want to do is reduce defense and raise taxes.’

“So,” Panetta went on, “the very areas that had to be part of a solution were the areas that both parties staked out as holy territory that couldn’t be touched. That created the dilemma.” He was talking about 1990, but he could just as easily have been talking about 2012.

About eighteen months after taking the oath of office, George H. W. Bush ate his words. In June 1990, after a two-hour breakfast at the White House with congressional leaders from both parties, Bush’s press office issued a statement: “It is clear to me”—the last two words were inserted at the insistence of the Senate Democratic leader, George Mitchell—“that both the size of the deficit problem and the need for a package that
can be enacted require all of the following.…” The laundry list that followed included the politically salient phrase “tax revenue increases.”

After three torturous months of negotiations, much of it at Andrews Air Force Base outside Washington, Richard Darman and the president’s other advisers cut a deal with Panetta and the congressional Democrats, who had a majority in Congress. Newt Gingrich, then the number two House Republican, led a rebellion—and the deal was rejected by the House. After three weeks, a new deal was cut. To woo more Democratic votes, tax rates on the rich were pushed higher than in the original agreement.

“
The American people have had enough of [being told] that somehow we can confront the deficit and it doesn’t involve pain,” Panetta told a reporter at the time. “The fact is that it does.” The final deal cut spending by $2 for every $1 of tax increases and, to the consternation of some Republicans, raised the top marginal income tax rate (the levy on each additional dollar of income) to 31 percent from 28 percent, the level to which it had been lowered in the Tax Reform Act of 1986.

The vote tally for the 1990 deal underscores just how much Congress has changed. A Republican president relied on a majority of House Democrats (181 yes and 47 no) to overcome the opposition of a majority of House Republicans (74 yes and 126 no) to raise taxes and cut spending. Today, the idea that a president could appeal to a mixed-party center to win approval of any measure seems as quaint as a typewriter.

“
For Democrats during that period, with Republican presidents, we made the fundamental decision that governing was good politics for us [in terms of] maintaining our power,” Panetta recalled recently with the hindsight of more than twenty years. “I don’t get a sense today that either side thinks that governing is necessarily good politics.”

The law did cut the deficit from what it otherwise would have been—a concept always easier for economists to grasp than the public—but still the deficit grew. The economy deteriorated, revenues fell short of projections, and spending on Medicare and Medicaid rose faster than anticipated. Rising deficits tarnished the image of a compromise born of a broken presidential promise. Bush later told TV interviewer Barbara Walters that the deal was “a mistake because it
undermined to some degree my credibility with the American people.” But he insisted it hadn’t hurt the economy. Republicans often suggest otherwise and even today blame the deal for triggering a recession that began three months before it passed Congress. Darman, who died in 2008, blamed the recession on the Fed for not cutting interest rates quickly enough.

From the vantage point of twenty years, the evidence favors those who say the deal restrained deficits from what they otherwise would have been. “
The record shows that the 1990 budget deal was extremely effective in reducing deficits; the budget surpluses of the late 1990s owe much to the policies put in place by George H. W. Bush that his son and party later repudiated,” says Bruce Bartlett, a veteran of the Reagan and first
Bush administrations who has become a critic of Republican fiscal policy.

Beyond the important details of spending and taxes, the 1990 deal made two significant changes:

It established a pay-as-you-go rule that made it hard for Congress to cut taxes or increase benefits without offsetting tax increases or spending cuts. For more than a decade, this rule restrained Congress from significant expansion of government benefits. A decade later, when this rule lapsed, Congress and the president did exactly what the rule sought to avoid: expanded Medicare to cover prescription drugs without funding the new program.

After bumping up spending in the first year to buy congressional backing for the deal, the 1990 agreement also set multiyear caps on annual appropriations for the first time. Congress was, essentially, tying its own hands, or at least promising to do so. In one sense, the caps held. Adjusted for inflation, annually appropriated spending in 1996 was 13 percent below the 1990 level. But the total masks a key factor: “
The Soviet Union fell apart, and there was no justification for such a huge military,” says Bob Reischauer. In 1990, outlays for defense were $300 billion, and outlays for domestic programs subject to annual appropriations were $200 billion. Six years later, they were even at $266 billion each.

The 1990 deal was only a down payment, though. Debate over how much the government should spend and on what continued. “
I think the most dangerous threat to our national
security right now is debt, very heavy debt, that we confront in this country,” Panetta, then House Budget Committee chairman, lectured then defense secretary Richard B. Cheney and General Colin L. Powell, the chairman of the Joint Chiefs of Staff, at a 1992 hearing. “I don’t question anything you’re saying in terms of the role that this country ought to perform. My problem is how the hell are we going to pay for it?”

Shortly after Bill Clinton was elected, he invited Panetta to Little Rock, Arkansas, where the president-elect was organizing his administration. “
We talked a long time about the deficit, and, frankly, the campaign in ’92. Ross Perot [the Texas businessman who ran as a third-party candidate] had made the deficit a major issue of that campaign, which helped a great deal, ultimately, in trying to confront it.” Clinton’s advisers were split between those who wanted to reduce the deficit first and those who wanted to deliver on the campaign’s promise of increasing federal investments. The cut-the-deficit-first crowd won. Among its members were Panetta, who became Clinton’s budget director, and Rivlin, who became Panetta’s deputy and later his successor, and Robert Rubin, who would become Clinton’s White House economic-policy coordinator and later Treasury secretary. They convinced Clinton to ditch his campaign promises to cut taxes for the middle class and sharply increase government investment spending and, instead, to focus on bringing down the deficit.

After substantial haggling—and an energy tax that was abandoned by the White House—Clinton’s deficit-reduction
bill, heavier on tax increases than spending cuts, got through Congress. In striking contrast to 1990, every Republican in the House and Senate opposed it. Vice President Al Gore broke a tie in the Senate, and last-minute pressure on reluctant Democrats produced a 218–216 vote in the House in 1993. One of the last Democrats to vote for the bill was Marjorie Margolies-Mezvinsky, a first-term congresswoman from Philadelphia’s suburbs who had previously said she would oppose the bill. Her vote was later blamed for her defeat in 1994. (Clinton’s daughter later married her son.)