America's Fiscal Constitution (54 page)

The administration softened its opposition to a hard limit on annual Medicaid spending when bipartisan leadership in Congress found a new source of revenues to support medical care for impoverished children. Senators Ted Kennedy and Orrin Hatch crafted legislation that would levy higher tobacco taxes to pay for a separate Medicaid grant program for poor children; they fell just short of winning a vote to raise that tax high enough to pay for the entire program.
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In the spring of 1997, the White House and Republican negotiators reached a tentative agreement on a plan to balance the budget within four years. Each side was nervous, however, about whether their compromise would be acceptable to other leaders in each party. Speaker Gingrich wanted some form of tax cut to get his caucus on board, while the White House worried about Democratic opposition to a hard cap on Medicaid
spending. They both remembered that a coalition of liberal Democrats and conservative Republicans had defeated the first version of the 1990 budget agreement.

A special report in May 1997 from the Congressional Budget Office (CBO) facilitated a compromise on the difficult tax and Medicaid issues. Monthly tax collections had been exceeding projections, prompting the CBO to raise its five-year revenue forecasts by more than $200 billion.
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The new projections allowed negotiators to lower the tax rate on capital gains and maintain a more flexible Medicaid ceiling. The Balanced Budget Act of 1997 passed in August with bipartisan support. It capped so-called discretionary spending—appropriations not driven by a legal formula—for five years and extended “pay as you go” procedural rules to enforce those limits.

The legislation’s most remarkable new feature was its restriction on the growth of Medicare reimbursements. That limit—the Sustainable Growth Rate—allowed prices for many medical services to rise no more than the rate of growth in national income. If any large category of federal spending always grows faster than tax revenues, someday it could consume all available revenues. However, the Sustainable Growth Rate would force the rationing of services if providers could not recover their costs or if the demand for their services grew faster than national income.
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Federal leaders appointed a bipartisan commission to outline reforms to develop a long-term plan to contain Medicare costs within the ceilings.

Medicare and Medicaid costs barely rose in the two years following the implementation of the Balanced Budget Act of 1997. Medicare costs actually declined in fiscal year 1998—the first time in the program’s history. That success arose from caps on payment rates rather than from the managed care insurance alternative (Medicare Part C) inserted in the bill by Republicans. By 1999 only six million out of thirty-nine million total Medicare recipients participated in managed care plans, which never produced significant savings for the federal government.
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In fiscal year 1998 the unified budget balanced for the first time since 1969. The federal funds budget did not yet balance, but trends were headed in that direction. The Omnibus Budget Reconciliation Acts of 1990 and 1993, along with the Balanced Budget Act of 1997, had succeeded in restraining routine borrowing. The American Fiscal Tradition had endured.

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URPLUS AND
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CANDAL

In January 1998 the Congressional Budget Office published a ten-year projection that showed large future surpluses, under certain assumptions, in the unified budget. In each biannual report from January 1998 until January 2001, the CBO increased its estimate of the size of a potential ten-year budget surplus. News of this progress weakened the resolve of many in Congress to institutionalize “pay as you go” budget planning. Speaker Gingrich and Senate Majority Leader Trent Lott began to call for cuts in federal funds taxes well before the federal funds budget actually experienced a surplus.

Senator Kent Conrad, a fiscally conservative budget expert from North Dakota, warned of the illusory nature of the surplus created by merging Social Security surpluses with the federal funds budget. Herbert Stein, a traditional fiscal conservative, commented that “we have ahead of us a period of very large deficits as the baby boomers come into their Social Security and Medicare benefits. We shouldn’t dissipate the surpluses for tax cuts or new spending.”
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The willingness of Republican leaders to collaborate with Clinton diminished in the wake of reports in January 1998 that the president had a sexual relationship with a White House intern. Republican House members led by Majority Whip Tom DeLay pressed aggressively for Clinton’s impeachment, a prospect that forced the president to solidify his relationships with Democratic House members. Chief of Staff Bowles later commented that the scandal ended the productive budget collaboration between Clinton and Gingrich. Plans for long-term reforms of Medicare and Social Security yielded to budget issues with more symbolic than financial significance. Clinton obtained an increase of $1.1 billion in spending for public school teachers and environmental programs, while Gingrich raised spending—largely for the military—by $8 billion.
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After Republicans overplayed their hand on impeachment, Democrats picked up five House seats in the 1998 midterm elections. Gingrich lost support for his reelection as Speaker; his farewell speech called his critics within his own party “cannibals.”
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On January 6, 1999, Clinton announced an end to “the era of big deficits.”
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In order to counter a future threat to fiscal discipline, he proposed to remove the Social Security and Medicare trust funds from the unified budget and to pay two-thirds of anticipated federal funds surpluses
into those trust funds in advance of the retirement of the Baby Boomers. The president’s plan—had it succeeded—would have clarified federal accounting.

In the late 1990s Federal Reserve Chairman Greenspan also argued that surplus revenues should be used to pay down debt before the Baby Boomers began to retire. He warned that projections of future surpluses depended on faster economic growth than had actually occurred, on average, since World War II.

In fiscal year 2000, for the first time since Eisenhower’s last budget, the federal funds budget ended with a slight surplus.
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No one can predict what might have happened if the bipartisan drive to balance the budget in 1997 had retained its momentum. Once the federal funds budget balanced in 2000, it would have been much easier to restore traditional budget practices. Budget accounting would have been more transparent if the trust funds had been separated from the rest of the budget as Clinton intended. The Sustainable Growth Rate provided a solid foundation for additional reforms designed to make the Medicare trust funds self-sustaining. Continuation of the “pay as you go” rules in the 1990 Budget Enforcement Act could have restored the historical link between tax and spending policies. Once the federal government had brought annual appropriations in line with its annual commitments to the amount of annual revenues, votes on the debt ceiling could have become a more practical tool for limiting new debt.

Of course, there still would have been heated political battles concerning the level at which spending and taxes balanced. Elections would inevitably shift the balance in one direction or another. But those decisions would have been made within the framework of the unwritten fiscal constitution. The fact that the United States came within reach of restoring traditional budget practices in the late 1990s should give heart to those who still seek to do so today.

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HE
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LLUSION OF
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ARGE
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URPLUSES

In light of changing circumstances, Dwight Eisenhower often commented that planning was indispensable even though plans themselves were worthless. Long-term budget plans demonstrate the value of Eisenhower’s insight. Until recent decades, federal leaders made budget decisions principally based on concrete information about the previous year’s budgets and
revenue estimates for the current budget year. Formula-based federal funds spending for medical services resulted in greater reliance on long-term budget projections. Since 1976 the Congressional Budget Office (CBO) has provided five-year projections, or “baseline” forecasts, evaluating the impact of new legislation.

Those CBO projections had a poor track record in predicting future deficits and surpluses. In 2000, analysts working for the Federal Reserve compared the CBO’s historical projections of deficits and surpluses five years out from a given date with what had actually occurred during those years. That straightforward calculation showed that “there is no relationship between the CBO’s projections and the actual surplus/deficit. . . . [A] large deficit was as likely to occur when the CBO projected a surplus as it was when the CBO projected a deficit.”
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Though flawed, these projections nevertheless played a critical role in the 2000 presidential campaign.

In 1998, when the CBO first projected surpluses in the unified budget, the federal funds budget continued to run a deficit.
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By January 2000 the CBO had begun to project modest and rising surpluses in the federal funds budget. Based on the extension of the 1990 spending caps, higher revenues from the Alternative Minimum Tax, strong economic growth, extraordinary revenue from taxes on investment gains, and the retention of caps on medical reimbursements, CBO projections showed surpluses rising until shortly after 2010—at which point federal spending for Medicare and deficits would soar. Because of those Baby Boom Medicare liabilities, economist Paul Krugman wisely pointed out in 2001 that the use of a ten-year projection was far more misleading than those for either a shorter or a longer time horizon.

The consolidation of trust funds in the unified budget also led to a misleading account of interest expense on federal debt. From 2000 to 2010, rising Social Security trust fund reserves for Baby Boomers would be invested in more federal debt. As a result, the unified budget in some years was projected to incur no “net” interest expense, even though the federal funds budget was borrowing from the trust funds. To understand that dynamic, consider a hypothetical budget of a government that begins with no debt and for ten years spends $50 annually, paid for with $40 in tax revenues and $10 in loans from trust funds. Each year the government borrows more from the trust funds to pay the annual interest due to those same trust funds. At the end of ten years, the $40 in federal funds tax revenues must service a debt of $100 plus the amounts borrowed to pay
interest. But the unified budget for that government would show zero debt and zero interest expense. The official unified budget numbers for fiscal years 1998–2000, still available on the White House website, show a surplus.
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Yet the Treasury borrowed $274 billion during those years.
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The flaw in the unified budget would have been obvious if Congress had voted to authorize specific amounts of debt for defined purposes. Not everyone can master accounting, but most people can understand the questionable nature of a reported surplus when the federal government is forced to borrow to pay its bills. Projections prepared by the White House Office of Management and Budget recognized this problem and in 2000 showed virtually no future surpluses after removing the Social Security Trust Fund from its calculations and allocating additional federal funds after fiscal year 2005 to a “Medicare solvency debt reduction reserve.”
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The CBO did not.

The CBO forecast relied on other questionable assumptions. It assumed no growth beyond inflation in the cost of federal programs. To the extent that some categories of cost—notably for medical expenses and new military technologies—tend to rise faster than inflation, the CBO’s “baseline forecast” implied steadily declining levels of many federal services. In addition, the CBO projected the continuation of high levels of income tax revenues from investment gains. Roughly half of the surge in revenues above the levels originally forecasted for 1997 to 2000 had resulted from higher rates of economic growth, and the other half resulted from sharply higher incomes of the wealthiest Americans. By 2000 the CBO raised the projected rate of annual economic growth after inflation from 2.1 percent to 3 percent per year—a level well above the average long-term growth rate. That assumption contributed to projections of high levels of investment income and related taxes.
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Changes in the American economy had indeed caused federal personal income tax revenue to rise faster than economic growth in the 1990s. Taxpayers with incomes in the top 1 percent, who typically had at least one college degree, did well in the global economy. Their share of the nation’s adjusted total gross income rose from 13.8 percent in 1993 to 20.8 percent in 1998, while their share of personal income taxes had grown from 29 percent to 37.4 percent.
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The relative prosperity of Americans with high incomes was an awkward reality for politicians as well as forecasters. Democrats did not campaign on promises to create more opportunity for the wealthiest
Americans. Republicans found it more difficult to contend that the 1993 tax increases would destroy incentives and investment. Experts who prepared budget forecasts had problems estimating future revenues from investment gains. A bull market in the late 1990s contributed to higher tax collections, including those from taxes paid on the exercise of stock options in the red-hot market for stock in technology-based companies.
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Nonetheless, the CBO forecast in 2000 continued to assume high revenues from investment income even after the tech bubble burst and stock prices began to fall.