America's Fiscal Constitution (43 page)

Mills believed that this financing plan could fit within a balanced budget. He emphasized the value of the traditional link between new services and new revenues: “Whenever you have a program financed by a specific tax, the willingness of people to pay that tax, that specific tax, limits the benefits of that specific program . . . if you put a program, then, into the general fund of the Treasury, there is less likelihood that you control the package of benefits initially enacted.”
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The most costly feature of the program at the time of its enactment—Medicare Part A’s hospitalization insurance—was fully paid for by payroll taxes earmarked for the new Medicare trust fund. By requiring beneficiaries to pay half the cost of Medicare Part B and states to match federal Medicaid grants, the program provided an incentive to restrain the escalation of costs.

Mills described his legislation as “a satisfactory and reasonable solution of the entire problem [of medical insurance], not just a partial solution.”
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To limit upward pressure on costs, Mills rejected coverage of prescription drugs dispensed outside of hospitals, a benefit that had been included in the Republican alternative.

The bill allowed doctors to set their “customary fees,” without a regulated price ceiling, in order to overcome threats of a boycott. Mills countered the emotional charge of “socialized medicine” by making Medicare Part B voluntary for patients and physicians and requiring that fees be paid directly to doctors. The requirement of direct payment to physicians changed the business model of hospitals that had previously employed a variety of specialists.

Mills and House Speaker John McCormack called to brief President Johnson on the potential budget impact of the federal funds subsidy for physician fees, an idea that Johnson said Mills “stole from Byrnes.”
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Mills highlighted the estimated federal funds cost of $450 million for the first year, and the president assured him that it could be offset by savings found in other programs.
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House members gave Mills a standing ovation when he brought the Social Security Act Amendments of 1965 to the floor. It passed the House and Senate with bipartisan backing.

The part of the bill entitled “Grants to the States for Medical Assistance”—Medicaid—generated the least controversy and media attention in 1965. Relatively few states had aggressively pursued grants under the earlier Kerr-Mills Act, and few could argue with the chairman’s desire to help states meet “the medical needs of the aged, blind, and disabled or the mothers and children receiving aid for dependent children.”
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By 2013 Medicaid would become the principal ground of contention between Republican and Democratic budget plans.

Since the adoption of Medicare in 1965, Americans have lived longer. Deaths from heart disease fell by 5 percent between 1963 and 1968, and another 15 percent by 1975.
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Americans with low incomes utilized hospital services more frequently. In the words of President Johnson, young families no longer had to “see their own incomes, and their own hopes, eaten away” because they were committed to “carrying out their deep moral obligations to their parents, to their uncles, and to their aunts.”
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Medicare became immensely popular. Even opposition from the AMA vanished.

The great compromise on medical services orchestrated by Mills in 1965 did not, however, anticipate four trends that would severely strain federal funds budgets in the future.

First, medical costs grew at double digit annual rates rather than the assumed growth rate of slightly more than the rate of inflation. Mills and actuary Robert Myers did not predict the emergence of expensive new outpatient services, the rapid rise in physicians’ fees, or the cost of greater medical specialization.
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By 1969 rising medical costs, in turn, caused Congress to relax the original requirement that beneficiaries pay premiums covering half the annual cost of outpatient services.

Second, states expanded Medicaid services more aggressively than originally projected. A handful of states with Republican governors—California (Ronald Reagan), New York (Nelson Rockefeller), Massachusetts (John Volpe), and Michigan (George Romney)—led the way. New York made Medicaid available to families with incomes of $6,000 or less—fully half of the state’s population.
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Even after Mills amended Medicaid to limit the eligibility of individuals receiving public assistance, costs continued to soar in part because of the sharp rise in the population of nursing homes. Mills had rejected the use of Medicare to pay for nursing home care, which he called “a bottomless budgetary pit.”
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Demographic trends such as greater mobility of family members, climbing divorce rates, increasing employment of women, and growth in the population over age seventy propelled the growth in assisted living facilities. By 2010 Medicaid paid for the services provided to 9.4 million disabled and 4.3 million older Americans, 3.1 million of whom lived in residential facilities.
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Third, complex accounting and funding for Medicare began to undermine two important pillars of the American Fiscal Tradition: the use of clear budgets and self-sufficient trust funds. Unreliable estimates of medical costs confounded budget planning, and the federal funds budget did not account for liabilities related to current payroll contributions. Private insurers annually adjust premiums in an effort to maintain their plans in actuarial balance. The annual ceiling on Social Security payroll taxes rises for that same reason, but Medicare has no such annual adjustment mechanism.

Fourth, federal leaders would not act decisively based on the advice of Medicare actuaries. Two decades of extraordinarily high birth rates preceded the implementation of Medicare. Then, in 1965—the very year
Medicare was enacted—the number of children born in the United States fell below four million for the first time in a decade. That number would not be exceeded again for a quarter of a century.
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Contrary to popular belief, the rising costs of Medicare and Medicaid are unrelated to their status as “entitlements,” a legal concept embodying the commitment to fair and nondiscriminatory decisions concerning eligibility.
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Each session of Congress can prospectively change the criteria for eligibility and scope of services rendered and lower the annual appropriation by a corresponding amount.

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Problems with financing future medical costs were not apparent in the hot summer days in Washington in 1965, when Mills and Senate Finance Chairman Long put the finishing touches on the Medicare bill. The bill’s initial claim on federal funds revenues appeared manageable in light of strong economic growth and tight limits on other spending in the Johnson administration’s first fiscal year. The budget outlook began to change within days of the bill’s final passage, however, when President Johnson agreed to a request from the American field commander in Vietnam to expand his mission and increase the number of American ground forces. The Cold War suddenly became hot and more expensive. The Vietnam War ultimately resulted in direct costs of $111 billion, an amount almost equal to the entire annual federal budget when the escalation began.
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Little more than a month into fiscal year 1966, Secretary of Defense McNamara urged the president to seek a supplemental appropriation for $10 billion and a tax increase to pay for the military costs in Vietnam. Johnson told him to test the waters in Congress, but then decided not to seek additional funds until January 1966. As the administration complied with General William Westmoreland’s requests for more troops in late 1965, some members of Congress became frustrated with the administration’s unwillingness to provide an estimate of the war’s cost.

Except for fiscal years 1953 (the height of Korean War), 1958 (severe recession), and 1962 (the Kennedy defense and space buildup), since World War II the nation had paid more each year in interest on its debt than it had borrowed. By fiscal year 1967, however, debt incurred for war-related costs grew rapidly. The Vietnam War propelled defense
spending from $50 billion in fiscal 1965 to $81 billion in fiscal 1968.
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With federal funds tax revenues increasing from $101 billion to $114 billion, the budget could have balanced without the cost of war.

Mills urged the president to tell the public that he had been forced to choose between paying for the war and domestic spending. Federal Reserve Chairman Martin recommended higher taxes and cuts in domestic spending in order to reduce wartime borrowing. When the administration was slow to respond, Martin raised interest rates.

Almost eighteen months after the decision to escalate combat operations in Vietnam, President Johnson proposed a tax surcharge—an across-the-board tax increase. The budget deficit for fiscal 1968 was projected to be 3 percent of national income, equivalent to the shortfall caused by the recession in 1958 and far lower than those incurred during the post-2000 wars in Afghanistan and Iraq. The president, famous for his strong-armed “Johnson treatment,” began to receive similar treatment from Mills. The Ways and Means chairman had once remarked, “You don’t need the title [of president] to run things in Washington.”
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He made that point by refusing to bring a tax bill to the floor until the president made large, specific commitments to reduce spending. Mills received the backing of most business organizations and House Republicans led by a new minority leader, Gerald Ford.

The impasse between the president and Mills persisted into early 1968. In Johnson’s words, “The issue was never whether the people should like the tax or not. Of course they would not like it; I did not like it either. The issue was whether they would dislike it as much as the consequences of not enacting the tax.”
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Several years earlier Mills had expressed the essence of his position: “You can’t form tax policy in a vacuum. You have to connect it with your spending policy.”
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Matters came to a head at a lunch on March 22, 1968, attended by Mills, House Appropriations Chairman George Mahon, Treasury Secretary Henry Fowler, and Federal Reserve Chairman Martin. Mills expressed disgust at the lack of a more formal process to link total spending and estimated revenues.
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Mahon, a soft-spoken, dignified West Texan who towered over Mills, resented Mills’s attempt to control the entire federal budget.
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Martin once described his job as “taking away the punch bowl just when the party gets going.”
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He would relieve pressure on interest rates only if Congress reduced federal borrowing.

Secretary Fowler had loyally defended the administration’s position that Congress should raise taxes and decide where to cut spending. After the March meeting, however, he informed the president that Congress would not pass the tax bill until Johnson asked for domestic spending cuts. He also told the president that without prompt action on the tax bill, they would have to ask Congress to raise the legal debt ceiling.

Days later, Johnson delivered a nationally televised speech in which he pledged that as “part of fiscal restraint that includes a surcharge” he would “approve appropriations reductions in the January budget.”
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He called on Congress to pass a tax bill “together with expenditure control that Congress may desire and dictate.”
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Then the president stunned the nation, as well as his staff, by concluding his fiscal message with the announcement that he would not seek reelection. Johnson later explained that by sacrificing any political advantage, he hoped to be more effective in breaking the budget impasse.

Although the Constitution required that “money bills” originate in the House, the Senate promptly voted for a tax increase accompanied by a cut in spending. Mills had prevailed. Congress passed the Revenue and Expenditures Control Act of 1968, which imposed a 10 percent surcharge on personal income taxes for most taxpayers and also mandated a $6 billion cut in projected spending.
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By requiring the president to cut spending that had already been appropriated by a majority vote in Congress, that legislation represented a turning point in budget history. When signing the bill Johnson chided Congress for shifting “to the President the responsibility for making reductions in programs which the Congress itself is unwilling to do.”
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Congress would also employ a similar mechanism—a “sequester”—in attempts to control spending that its own majority voted for in the late 1980s and after 2011.

Although the last federal budget in Johnson’s presidency required only very modest borrowing in the administrative or federal funds budget—no more than half of 1 percent of national income—an unheralded change in federal accounting created the illusion of a slight surplus. In fiscal year 1969 the federal government adopted a “unified budget,” which consolidated the federal funds and trust fund budgets. The change reflected advice from economists who sought to shape budget accounting in a manner that could be used to estimate the short-run impact of federal outlays and receipts on the economy as a whole. For that limited purpose, it made
little difference whether federal spending was paid for with taxes dedicated to trust obligations or taxes that could be used to service debt.

The unified budget also had the deceptive allure of simplification, since federal officials had previously used three different versions of the budget, each for distinct purposes. Elected officials and journalists usually referred to the administrative budget—similar to what is now referred to as the federal funds budget—which could be used to compare annual spending appropriations with annual revenues apart from the trust funds. That budget served the traditional purpose of aligning federal commitments and related taxation. Another version of the budget—the “consolidated cash budget”—was used to manage the timing and amount of sales of Treasury debt. The consolidated cash budget included the administrative, or federal funds, budget and all trust fund budgets. Economists relied on yet another budget, the “national income accounts budget,” which was modified to conform with the economic accounting used to estimate national income. If the federal funds budget borrowed $5 billion entirely from trust funds, the net borrowing in the national income accounts budget appeared to be zero since there was no net change in total economic activity resulting from that transaction. The President’s Commission on Budget Concepts recommended that these three disparate versions of the budget be collapsed into one.