America's Fiscal Constitution (38 page)

In 1948 the thirty-six-year-old Milton Friedman, a professor at the University of Chicago with a gift for statistical research, spelled out his approach to balanced budgets in his influential article, “A Monetary and Fiscal Framework for Economic Stability.” Friedman proposed that the federal government should try to balance its budget across each multiyear economic cycle with tax rates set at a level expected to balance the budget in average economic circumstances. He envisioned that the federal government would “keep two budgets: the stable budget, in which all figures refer to the hypothetical [or projected] income [at a normal level of employment], and the actual budget.”
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Since Friedman recommended the reduction of downturn-related debt after the economy recovered, any such could be financed by short-term borrowing supported by the Federal Reserve. As a result, the net burden of unmonetized debt would not increase.

Thirty-three-year-old Paul Samuelson authored the first edition of his influential introductory text,
Economics
, in 1948. Like Friedman, Samuelson had a gift for clear communication in both English and math. His book described the depth of the Great Depression as a “liquidity trap” characterized by high unemployment, increased savings, and excess capacity. In that circumstance, debt-financed public spending or tax cuts could potentially stimulate economic activity that otherwise has stalled at a level accompanied by high unemployment. Debt used for that purpose could either be monetized or financed from unutilized savings. Samuelson agreed with Friedman that debt could be repaid when the economy recovered.

The two economists disagreed about the appropriate limit on federal spending during downturns. Friedman thought borrowing during downturns should be limited to the amount needed to finance the drop in revenues and any rise in downturn-related outlays such as public assistance. Samuelson thought that federal officials could spend even more or tax less to accelerate recovery, though he warned in the first edition of his text
that this prescription was “controversial.” Friedman identified himself as a libertarian; Samuelson referred to himself as a liberal. Each would advise future presidents on budget issues. In reality, very few economists have ever actually changed federal spending and tax decisions, which are typically made by powerful members of congressional committees. After 1945, however, politicians more frequently cited the authority of economists who agreed with them.

The views of the business-oriented and privately funded Committee for Economic Development may have had a greater immediate impact on postwar policy. The committee consisted principally of corporate executives, with the balance made up of prominent bankers and scholars. In 1947 it recommended a rule similar to Friedman’s: budgets should be balanced across each economic cycle, and tax rates should be stable and set at a level designed to produce a slight surplus at normal or full employment.

The Committee for Economic Development considered it impractical to fine-tune spending and tax rates in an attempt to precisely balance each budget, since economic conditions rarely conformed to projections made well before the beginning of each fiscal year. Frequent changes in tax rates also undermined the desirable predictability of taxation. Because expenditures tended to “resist downward change and taxes . . . resist upwards change,” the committee warned that the surpluses needed to retire debt for “compensatory” or stimulus spending during downturns might never materialize—especially because advocates of federal spending for certain programs tended to exaggerate the need for such spending.
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12

C
ONTAINING
D
EBT
W
HILE
F
UNDING
D
EFENSE
, P
ENSIONS
,
AND
H
IGHWAYS

1950–1962: Years when deficits exceeded debt service = 3 (1953, Korean War; 1959, recession; 1962, Cold War)

T
HE
C
OST OF
G
LOBAL
L
EADERSHIP

Harry Truman, Robert Taft, Arthur Vandenberg, and James Forrestal struggled for years to define the new normal level of military spending and income taxes following sixteen years of the Great Depression and World War II. Someone far outside the federal government, Joseph Stalin, ultimately served as a catalyst in forging an American consensus on that balance. In the spring of 1950 Stalin approved Kim Il Sung’s plan to invade the UN protectorate of South Korea. North Korea’s crossing of the thirty-eighth parallel in June 1950 gave rise to a bipartisan commitment to high levels of military spending and taxation to maintain a worldwide security perimeter.

Until that invasion President Truman had persisted in cutting the Pentagon’s spending requests in order to balance the budget within the revenues produced by the tax rates set in Congress. When the Joint Chiefs of Staff warned that America’s military capabilities were “inadequate in light of present commitments,” the president’s chief economic advisor countered that additional debt would weaken the nation’s ability to respond to a future security emergency. Truman’s planned defense budget
for fiscal year of 1951 represented slightly more than 5 percent of national income—a level higher than the 1 percent average before World War II and roughly in line with defense spending in 2013.

As Kim Il Sung prepared for war in the spring of 1950, the National Security Council (NSC) presented its recommendations for defense policy and military budgets to Truman. The NSC, organized several years earlier, counted among its members the secretaries of state and defense departments and the chairman of the Joint Chiefs of Staff. In a classified document designated NSC-68, the high-powered group argued for a “substantial increase” in military spending and military assistance programs. To pay for these initiatives, it suggested “the deferment of certain desirable domestic programs” and “increased taxes.”
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Truman would not sign the recommended policy; he was willing to support higher taxes but understood that Congress would not. His assessment was correct. Taft and his allies in Congress fought to restrain military spending in order to balance the budget with lower tax rates. That spring, before the North Korean invasion, the House blocked $100 million in military assistance to South Korea but ultimately reversed the vote after heavy administration lobbying.
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Then, in the words of Secretary of State Dean Acheson, the June invasion “removed the recommendations of NSC 68 from the realm of theory and made them immediate budget issues.”
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The American-led United Nations force desperately battled to retain a foothold in the Korean peninsula. By September 1950, when the United States and other UN forces reversed North Korea’s initial military gains, Truman signed NSC-68 and approved a rapid buildup of the national security budget: $69.5 billion in fiscal year 1951 and $56 billion in each of the next three fiscal years—a level of spending that was more than half the nominal amount at the height of World War II.
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General Eisenhower accepted Truman’s request that he organize forces within the European-based North American Treaty Organization (NATO). The president agreed to Eisenhower’s request for a sustained financial commitment to an American military presence in Europe.

The financing of the Korean War highlights the influence of traditional fiscal doctrine in striking a balance between spending and taxation. Congress raised taxes three times within eighteen months to pay for the Korean War. Personal and corporate income tax collections rose from $37.8 billion in 1951 to $54.4 billion in 1953.
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During the thirty-six months from fiscal year 1952 through fiscal year 1954, revenues supporting the federal
funds spending rose to 16.6 percent of national income, a higher share than at any time in the nation’s history except the final two years of World War II.
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This level of federal funds taxation was double the average during the three years at the height of the wars in Iraq and Afghanistan in the early twenty-first century. By the end of the war in 1953, federal debt had risen only 3 percent from the amount in 1950, though military outlays had grown by 300 percent.

Truman acknowledged that some Americans were wondering “how high we can push taxes without having serious effects” on economic growth, and opined that such a limit still had not been reached.
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High tax rates, Truman noted, had not prevented rapid economic growth since the end of World War II.

Following Roosevelt’s example during World War II, Truman deferred requests for new domestic spending, remarking that “many of the things we would normally do must be curtailed or postponed.”
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The widespread desire to avoid excessive debt forced both Republican and Democratic leaders to delay legislation dear to their constituents. Americans with high incomes—a wellspring of GOP support—chafed at personal income tax rates that they considered punitive. For decades the cost of the Cold War undermined the ability to lower these rates without risking a loss in tax revenue and corresponding increase in debt.

Meanwhile, the White House and the Democratic congressional majority realized that federal tax revenues were insufficient to pay for both military commitments and Truman’s proposal to provide medical insurance for families without access to employer-based plans. While Truman embraced the vision of federal medical insurance, his administration never offered specific legislation to implement it. Various plans for expanded medical insurance never made it past Truman’s White House Budget Office.

Americans did not enjoy paying higher taxes in the 1950s, and feared high medical bills. Federal officials at the time did not care less about their favored domestic agendas than those in power during the post-2001 wars in Iraq and Afghanistan; they simply subordinated these agendas to the principle of limiting debt in order to avoid mortgaging future tax revenues. Even after the end of the Korean War, the White House and Congress strived to fund major domestic initiatives—like an expansion of Social Security pensions and a new federal program for highway construction—with dedicated taxes paid into trust funds kept apart from the administrative or federal funds budget.

Numerous battles in the Korean War, particularly those against Chinese forces, demonstrated the importance of sustained investment in military technology. It became obvious the United States could not hope to prevail in future wars by simply trading casualties. When North Korean leaders complained about the dearth of Soviet support in 1953, Stalin told Chinese premier Zhou Enlai that the North Koreans “have lost nothing, except for casualties.”
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Elected officials in America could not be so cavalier about the loss of life.

Even though senior federal officials agreed to higher spending and taxes consistent with the new American role in the world, the nation could not afford everything the Pentagon requested. In March 1951, for example, the various military services compiled estimates of their requirements for the next fiscal year totaling $104 billion, an amount that would have absorbed much of the national economy. Within a month, Truman forced them to pare that estimate back to $60.7 billion.
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The post-1950 Cold War ushered in a new era in federal budget history. Before World War II, the United States invested only a small share of national income in its military except during war. For years after 1950 spending for global security, veterans, and interest on the debt dwarfed the cost of all other commitments in the federal funds budget and delayed plans to pay down the remaining debt from World War II.

S
USTAINABLE
S
OCIAL
S
ECURITY
P
ENSIONS

Many Americans who had lost their savings during the Great Depression struggled to make ends meet after their retirement. The erosion of purchasing power as a result of wartime inflation had undermined the value of Social Security pension benefits, which had not increased from the levels set in 1935. The average Social Security pension of $25 a month was too small to survive on.
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As a result, a vast number of older Americans lived on state-administrated public assistance—supported by matching grants authorized in the Social Security Act of 1935—rather than contributory pensions. A fifth of older Americans received Social Security pensions in 1949, while even more were forced to rely on monthly welfare checks. Social Security offered a weak safety net in rural America, where most retirees were ineligible for its benefits. In Louisiana, for example, more than half of the elderly population relied on welfare payments for subsistence. Relatively few retired Americans received employer-funded pensions.

House Ways and Means Chairman Robert Doughton was in a unique position to craft a consensus on the future of Social Security pensions. The eighty-six-year-old dean of the House had worked effectively across party lines to finance World War II. The powerful House Speaker, Sam Rayburn of Texas, respected the chairman and was one of the few who still called him by his old nickname, “Muley.” Doughton still arrived at the Capitol at six a.m. each weekday, and he used those morning hours in 1949 to prepare for hearings on pensions at which more than 250 witnesses testified about the future of the pension system.

A decade earlier, President Roosevelt and Senator Vandenberg had wrestled with the issue of how best to account for pension liabilities far into the future within a federal budget that had historically been managed by comparing of annual revenues and expenses. Estimating the level of benefits that could be sustained for decades required complex calculations based on economics, statistics, and actuarial accounting. Doughton and other House members began to rely heavily on the judgment of Congressman Wilbur Mills of Arkansas, a graduate of Harvard Law and the soft-spoken son of a small-town banker. Mills, forty years old in 1949, had entered Congress a decade earlier and had served on Doughton’s Ways and Means Committee since 1943. The fiscally conservative Mills mastered the details of pension accounting, forming an enduring partnership with Social Security’s actuary, Robert Myers. During the next decades the two would craft modern Social Security, Medicare, and Medicaid, programs that guided the trajectory of much of the federal budget through the present day.