When Bill Clinton told Americans in February that the budget deficit was so serious that it demanded tax increases and "deep cuts in existing government programs," something strange happened. People believed him. The budget deficit became a serious national issue, at least for a few weeks. And, even on Capitol Hill, people started demanding more spending cuts.
By late March, the president was back-pedaling, suggesting that more cuts might not be such a good idea. But the seed has been sown. The deficit remains an issue (as Ross Perot pops up every now and then to remind us).
What's still missing, however, is serious talk about where the deficit came from and how we might really get the federal budget under control. To provide that talk, REASON asked four noted budget analysts to spend the afternoon discussing the subject.
Our roundtable included:
• Martha Phillips, executive director of the Concord Coalition, a grass-roots educational group chaired by former Sens. Warren Rudman and Paul Tsongas. Phillips is the former Republican staff director for the House Budget Committee.
• Norman Ture, president of the Institute for Research on the Economics of Taxation. Ture was undersecretary of the Treasury in the early Reagan administration.
• Daniel Mitchell, the John M. Olin Senior Fellow in Political Economy at the Heritage Foundation.
• William Niskanen, chairman of the Cato Institute and editor of Regulation magazine. He was a member of the Council of Economic Advisers from 1981 to 1985.
The roundtable was moderated by REASON Editor Virginia Postrel.
Virginia Postrel: Is the budget deficit a problem? If so, why?
Martha Phillips: The Concord Coalition was formed because we believe that the deficit is a problem, particularly for the long term. The country cannot continue indefinitely spending 23, 24, sometimes even 25 percent of GDP, while taxing itself 18.5 percent. The deficit has to be brought under control, so that we can increase net savings, so that there will be funds from America available for investment in this country's economic future.
Norman Ture: I think the deficit is a problem for an entirely different reason. The deficit deceives us about what the government is extracting from us. Its alleged adverse economic effects are really attributable to government spending. When the government spends, it removes our resources or directs their use, and that raises the cost of resources in the private sector. When the government taxes, it distorts our decision making. That's costly.
Daniel Mitchell: Federal spending is the problem, not the deficit. I don't ever lose sleep about the budget deficit. Federal spending is what measures the resources the government is pulling out of the economy, at least in terms of fiscal policy. If you finance that spending by taxes, that has ill effects; if you finance it with the deficit, it has ill effects.
William Niskanen: The deficit is primarily a moral problem. It leads to a redistribution of tax obligations away from the current generation toward the future generation. That would be appropriate if the budget were financing a major system-threatening war or a major temporary increase in public investment activity, but for the most part we are financing current public and private consumption by borrowing from our children without their consent.
Postrel: So what is to be done?
Niskanen: Well, arithmetically, the deficit can always be reduced either by constraining spending or by increasing taxes. The choice depends on how much the current level of federal spending is valued. The American public has no general comprehension of two conditions. One is that the total government spending in the United States is now over $20,000 per household.
The second is that it costs a good bit to increase taxes. [Harvard economist] Dale Jorgensen estimates, for example, that on average the last dollar of federal revenue costs about $1.50 in resources displaced from other uses. We should ask then whether there are any federal programs for which the last dollar of spending is worth a buck fifty.
Phillips: By and large, most people somehow have the idea that somebody else is paying for government programs. Congressmen who have been working on the health-reform issue say they've sadly had to conclude after reading all their mail that what their constituents want is every medical service that could possibly benefit them that somebody else would pay for.
So I would have to say that Norm Ture has a point. You've got to get your spending and your taxes calibrated in some way. If people want the services, they have to be willing to pay for them.
Ture: That's right.
Phillips: And if they're not willing to pay for them, then we'd better look at the services, benefits, income transfers, and what have you—
Niskanen: One major reform that would do more than anything I can think of is to take the Constitution seriously in terms of the limit on enumerated powers. The federal government has taken on functions that have no explicit constitutional authority. That includes many of our largest programs, including Social Security and Medicare, and we provide everything from babysitting to midnight basketball now through the federal budget.
Ture: When I was a sophomore at Ohio State University I had an economics professor who defied his class to name a single type of human activity in which the federal government wasn't involved. And nobody could actually meet his challenge. Now that was when the federal government was a tiny fraction of what it is now—in the days of Jefferson.
Niskanen: One way to make the tax cost of government spending much clearer is to devolve a great many federal functions back to the state and local governments. The primary reason why the states and local governments have been more constrained in their spending is that it is much more obvious who pays if they raise taxes. And, as a consequence, you have much more serious tax revolts and real tax constraints at the state and local level than you do at the federal level.
Postrel: Spending cuts are on the table for the first time in a long time as a good in and of themselves. In discretionary domestic spending, what would you cut?
Niskanen: May I suggest that that's not the place to start? Two-thirds of the federal program outlays are in defense, Social Security, and medical care. And you're never going to get control of the budget unless you're prepared to address those three big programs themselves. You can cut an awful lot out of all this discretionary domestic spending, but in fact it hasn't grown enormously, at least over a longer period of time. It did during the Bush years, but that's unusual.
Ture: What is the focus of the question, though? Is it reducing the aggregate amount or getting rid of things that the government ought not to do, as Bill suggested earlier? If you start from the latter perspective, I would nominate at the top of the list in the discretionary category—let's eliminate the Department of Education and its functions. Those activities ought to simply disappear as a federal function.
In the entitlement area, I think Bill's perfectly correct in saying this is where the big money is. The question here, too, is on substance rather than the number of dollars: Why is the federal government in the business of subsidizing health care for people by the mere fact that they've reached the age of 65?
Phillips: Or subsidizing retirement income for people who have adequate or far better than adequate resources outside of the government?
Ture: Why are they in the retirement income business at all? Why are they in any of the so-called insurance businesses at all? If you look at the performance of the federal government, that is not the insurance company you'd like to pay premiums to for anything.
So what one ought to say is, what's the justification for these activities? And what do we do to eliminate all of that activity for which we cannot find a justification?
I could justify a Medicaid approach to Medicare. There are certainly going to be forevermore people who reach some age and cannot care for themselves. So we'll have a welfare program. Means testing, that's what ought to happen to Medicare. Indeed, that's what is in the process of happening to Social Security, but through the back door. We are striving to means test Social Security by taxing Social Security benefits to everybody who has an income above $25,000.
Phillips: That point of taxation is not indexed, so eventually it really will cover the vast majority of recipients.
Postrel: Is that the best way to get a handle on Social Security?
Niskanen: No, I think that the two proposals that we have made are both better and more politically realistic. One is to gradually increase the age for full retirement benefits by, let's say, two months a year beginning next year. And that would mean that the age for full retirement would go to 66 in the year 2000, 67 in the year 2006, and so forth. And do that indefinitely. If we don't, the ratio of workers to retirees is going to drop to about 2-to-1, and there will be an enormous burden on our children and their children to pay for this huge retired population.
The second reform is the proposal first made in 1976 by the Zschau Report. That would index the benefits of future retirees to prices and not wages. If we implemented the recommendations of the Zschau Report now, it would mean that real benefits of future retirees would roughly double rather than triple by the third or fourth decade of the next century.
Phillips: You're assuming that wages are going to rise faster than prices, which is, of course, greatly to be hoped. But we have been through periods of high inflation where prices were going up much faster than wages.
Postrel: But what are you trying to do? Are you trying to maintain the standard of living? Then index to prices.
Niskanen: The political argument for the approach that we have proposed is that you don't touch the real benefits of those who are retired at the moment. What you do, in effect, is to reduce the growth of real benefits of those people who will retire in the future.
Postrel: What would be the budgetary impact of your Social Security reforms?
Niskanen: Very little in the next half dozen years, but literally hundreds of billions of dollars in the second and third decade of the 21st century.
It's important to start it now, because that will give people time to make their own life adjustments and change their own savings plans. Otherwise, to meet the presumed obligations of Social Security will require a substantial increase in the payroll tax—maybe a payroll tax of 25 to 30 percent instead of what is now about 16 percent.
Postrel: How do you get it beyond the perception that the problem in government is waste, fraud, and abuse?
Phillips: With great difficulty. We run into that the first thing at every meeting. One of our big missions is to inform people and to get them beyond the waste, fraud, and abuse issue. Government waste is terrible; it exists; of course you want to do something about it. But you can only do as much as you can do until you're spending a dollar to save a dollar. Once you've done that, what are you going to do for the rest of the budget deficit or the rest of the excess spending?
Postrel: Do any of you have any estimate of what waste, fraud, and abuse amounts to?
Niskanen: It's not a meaningful distinction. The reason that waste is there is the same reason that programs are there. It's because somebody in authority wants it. Waste is in many ways very much harder to dig out than the programs. The programs tend to have generalized benefits, whereas the waste has very specific, identifiable benefits in particular jurisdictions to particular named people and companies affected by and influenced by particular people in Congress and the Senate—
Ture: Who do not regard it as wasteful at all.
Niskanen: We should recognize that this $1.5-trillion budget is larger than the national economies of all but one or two other countries in the world. The idea somehow that we can run a huge economy almost the size of the Japanese economy out of Washington is a great illusion, and particularly the idea that somehow it could be run efficiently.
Ture: That's the kicker. We can run it, but we'll run it right into the ground year after year after year.
Niskanen: What Martha's organization is trying to do is the ultimate challenge for all of us—to make good politics out of good policy. We shouldn't expect members of Congress or the executive to be angels. We have to make the kinds of actions that are appropriate good politics, and until and unless we do that, then we're going to continue to have the problem.
Ture: What we haven't really come up with yet is a way in which public-policy makers have an incentive to economize. You can't simply dictate to them that they have to put the interest of the country above their own personal interest. They will assure you they have no personal interest; they're only looking out for their constituents, which is substantially true. That's their personal interest.
Phillips: Our Virginia chapter got interested in the question of federal pork, so they're going to go through the budget and identify all the Virginia ham. And then they are going to go back to their own members of Congress and senators and ask them about all this Virginia ham: In terms of our whole country and of our future, do we need this much ham in Virginia? People have to start doing this, defining some of this stuff, even when it's being spent ostensibly for their own benefit.
Postrel: I'd like to get you to react to something the president said recently in Santa Monica. He said, "What has happened is that, because we had a theory of government nonintervention, the deficit has exploded as taxes were lowered on the wealthiest Americans; health-care costs exploded; interest on the debt exploded; the cost of government continued to increase."
Mitchell: Everything in the statement is absolutely wrong, so it's hard to know where to start. "The cost of government is increasing."That in my definition means that there's not a policy of nonintervention.
If you look at real inflation-adjusted revenues to the government, they're up dramatically since 1980. The problem is, you look at spending and it's up even more. And it's actually up more in real dollars on non-defense spending than it is in defense spending, and it all does come back to the fact that the major entitlement programs, particularly health, have been what's driving the budget.
Ture: But don't forget the statement about taxes on the rich.
Postrel: "Taxes were lowered on the wealthiest Americans."
Ture: That indicates that there was a continuing program of tax reductions on the wealthy. There was one tax reduction during the Reagan and Bush years. That was the act of 1981. Every other act increased revenues, even the one that was supposed to be revenue-neutral.
And the 1986 Tax Reform Act had the effect of increasing the marginal tax rates on a huge part of that very narrow part of the population that we used to call the rich. We now have the rich as anybody who's got an income of $30,000 or more. So that's a larger part of the population.
Niskanen: Unfortunately, what President Clinton said is widely repeated—the idea that the revenue base in the federal government was gutted during the 1980s and that the rich made out like bandits. In fact, the federal revenue share of GDP was 19.2 percent of GDP in fiscal '89, and in the prior cyclical peak of fiscal '79 it was 19.1 percent of GDP. So there was no gutting of the federal revenue base.
Ture: Except by the recession.
Niskanen: Right. And of that share, the rich paid a higher share at the end of the period than they did at the beginning of the period. So the whole premise of the liberal attack on the Reagan years is inconsistent with the facts.
Postrel: Why, then, did the Reagan years, the Bush years, leave us with these very large deficits?
Niskanen: It's important to make it clear that the de facto economic policy of the Bush years was a very strong reversal of the policies of the Reagan years. Reagan's policy was to reduce the rate of growth of spending and taxes, regulation and money growth, and Bush's de facto policy was to increase the growth of spending, taxes, and regulation. And so it is quite misleading to talk about the Reagan-Bush era. It is much more meaningful to talk about the Bush-Clinton era, because almost every program that Clinton has proposed to increase in fact increased very sharply during the Bush years.
Now, of course, during the Reagan era the economic outcomes were also very different from the Bush outcomes. We had an unprecedented peacetime recovery. Total economic growth went up. Inflation came way down. Productivity went up substantially relative to the Ford-Carter years.
Ture: If you want to find an approximate explanation for the spurt in the deficit, you have to look at the 1980-82 recession. It's not that the growth rate of revenues thereafter fell; it's just that the level from which they were rising was devastated by the recession.
Phillips: There were two other things going on also. The defense buildup began actually at the end of the Carter administration, but Reagan had campaigned on the need to build up our defenses against what was going on in the Soviet Union. He got elected and then had to carry through his buildup, notwithstanding the fact that a buildup had already begun. So he put a buildup on top of a buildup, and up through 1985-86 we continued just flooding the Defense Department with money. They had everything they could possibly want. Then spending started gradually tapering off after that.
Also, inexorably through the 12 or 13 years that we're talking about, we have had runaway entitlement spending.
Mitchell: A lot of people don't understand that after peaking at 6.3 percent of GDP in 1983, largely due to the recession, the budget deficit did come down substantially, down to 2.9 percent of GDP by 1989. There were several factors in there, one of which was Gramm-Rudman, one of which was economic growth. The two terrible things George Bush did were he got rid of economic growth and he got rid of Gramm-Rudman.
I'm a firm believer that the only way we're really going to get spending under control is by having automatic cuts. I don't think Congress will ever overcome the political problem that Norm was outlining earlier. And now that Congress knows the way Gramm-Rudman works, the chances of them going back to it are slim to none. So what Bush did in 1990 was a real disaster, and I think we'll have a hard time getting on a downward deficit track that we were on in the 1980s—
Phillips: Then you must think that there's a very slim-to-none chance that Congress will pass the constitutional amendment to require a balanced budget.
Mitchell: Slim-to-none is probably a generous estimate.
Ture: There are two dimensions to this problem. One is what would work. The other, of course, is the political dimension. Now if you can escape from that, following up on what Dan suggests, I would commend the Walker-Smith proposal.
Postrel: Explain that.
Ture: The Walker-Smith proposal is the debt buy-down proposal. Individual taxpayers could designate up to 10 percent of their income-tax liabilities each year to be allocated to a trust fund, the sole function of which would be to buy outstanding debt in the hands of the public. And for each dollar of such debt reduction, there would have to be a dollar of current spending reduction. If, in fact, we could have a rule of that sort, it would be extremely effective.
Phillips: What do you think about the new Congress? Most of these new people were elected because they wanted to change; they wanted radical new direction; they weren't running for the same old business as usual. And now that they're here one of the first things they tell President Clinton is, "You didn't cut enough—we want more spending cuts." Is this a sea change?
Niskanen: I think it's much too early to be too enthusiastic, but I'm encouraged. I find a different mood among the new people in Congress, and there are new people on the House Budget Committee, and that's all very encouraging.
Mitchell: Let's not forget, though, that under the Clinton plan, government is going to spend $300 billion more in 1998 than it is spending today, and the supposed deficit hawks at the House Budget Committee were talking about affecting maybe about $10 billion per year of that surging growth. And the Senate, where they're talking about more cuts, they're talking in large part about additional tax increases. Again, we come back to the problem: It's not the deficit that we should be focusing on; it's spending.
Even for those who are concerned about the deficit, higher taxes won't work because we know two things: With the expectation of higher revenue, they're going to spend more money. And, number two, they're not going to get the revenue they project, especially since they're going after taxes where they're going to cause widespread behavioral changes. A lot of the revenue is going to evaporate.
So I'll bet anybody right now that if the Clinton plan goes through in anything resembling its current form, the deficit will be much, much higher—probably by at least $50 or $100 billion—in 1997 than it is today.
Phillips: Well, '97 is only part of the problem. If you look at the next decade under the CBO baseline, you will see that they are projecting, even taking into account the Social Security trust fund surpluses, that by the year 2003, we would have a deficit of $650 billion. The Clinton plan, if fully implemented and carried out for that same 10-year period, using OMB's own projections and figures, takes that down to $400 billion.
But the amount of his deficit reduction does not increase over time. That's why you need things like the Social Security proposal that Bill is making, to have something that comes along in the second half of the decade and produces long-term changes to reduce these costs of entitlements.
If you enact the Clinton plan, you're going to have to come back in another year or two or three and enact another Clinton plan, because this is not going to be enough to solve the long-term problems.
Ture: Martha, is it your understanding that either the House or the Senate Budget Resolution draft includes getting rid of the Clinton investment spending?
Phillips: I don't believe so.
Ture: One good way to start off on an economizing program is persuade the president simply to drop those proposals entirely as a complete package. Just forget them.
Postrel: But from a number of statements that the president has made, it seems his whole concern about the deficit is that he's worried that the combination of interest payments and entitlement commitments will leave Congress and the president with no money to play with for new programs.
He has said a number of times he is afraid that they will only have six or seven cents on the dollar to fund new programs. So the "investment" programs are what the entire thing is about. I don't see much chance that he would drop them.
Ture: You're absolutely right. When I look at his overall budgetary scheme for an extended period of time, through 1998, the thing that comes through to me is that he's using the deficit as a scare device to say we have to raise taxes because spending reductions will never be adequate, for political reasons, and we also need to reduce the deficit because we need to increase investment.
But what kind of investment does he intend to increase? He intends to increase "investment"—I then put quotes around the word—in the public sector, and by virtue of the very stiff tax increases reduce it in the private sector. So the overall thrust of this program is to shift the saving and investment function from the private sector to the public sector.
Niskanen: Virginia, there are two areas now that we should address. One is defense and one is general government management.
The Cold War is over. The United States no longer faces any major threat to our national interest. My own view is that we should be prepared to cut defense a good bit more than Clinton has proposed. Three or four responsible groups around this town have been working on a defense budget for '97 and '98 that will be roughly half in real terms what it was in '92.
At that level of defense spending, you would have a force that would be more than adequate to meet any threats that might arise from short notice and enough of a mobilization base to meet any kinds of threats that would arise over a much longer period of time. That would permit taking out of defense another $60 or $70 billion in 1998 relative to what Clinton himself has proposed. The implications are that we probably could not mount an operation as large as Desert Storm without relying heavily on the Guard and reserve forces.
Phillips: And on other nations, even more than we did.
Niskanen: That's right, and other nations.
Now my own view is that that is a desirable check on our military forces. We are much less likely to commit ourselves to low-priority interventions abroad.
As for federal-government management, we have two areas that we should look at carefully. One is federal pensions. The military pension system is completely unfunded and the civil service pension system is substantially underfunded. Civil service and military pensions are much higher than in the private sector. And they're about the only pensions in this country that are indexed for inflation. We need to change those substantially.
Now, again, that has to be phased in, much the same way as for Social Security, because people who are now retired or near retirement have made their life plans based upon those pension expectations. But we should change the conditions when we recruit new people in the military or into the civil service, so that they don't expect pensions before they're age 65 or maybe after 40 years of service.
In addition, we need to address the structure of federal pay. Federal pay in many cases is too high and in some cases is probably too low, because we don't have a regional pay structure in the white-collar work force. In many parts of this country federal jobs are a prize, and in some parts of the country we have difficulty recruiting qualified people. So we need to permit more variation as a function of skill and of place of work. And on the average, we can probably even reduce federal pay.
Ture: I'm not sure that I fully agree with Bill on the subject of what we ought to do with the defense budget. What we've done is to approach it in terms of how many dollars we can get out of it. The appropriate way to address it, in my judgment, is to say, "By virtue of the change in the world situation, what are the appropriate programs for the Department of Defense?" They need a new mission statement.
Postrel: But there's also the issue of pork. We see this with our would-be deficit-cutting president, so-called. He likes Seawolf—and who else likes Seawolf? People in Connecticut. And we in California are suddenly discovering that even Barbara Boxer may have a good thing or two to say for military spending. At a time where everyone agrees that some substantial cuts in the defense budget are in order, what do you do to get it done in a non-pork-barrel way?
Mitchell: I don't think you can. As a matter of fact, one of the safer predictions about the Clinton plan is that they won't get anywhere near the defense cuts they're showing because even the Democrats in the House have shown a reluctance to follow through on all their chest thumping about cutting defense.
Postrel: On the other hand, there has been some success in base closing by lumping—
Mitchell: The base closing, though, is similar to Gramm-Rudman.
Phillips: They knew they could vote for the package; they couldn't vote for the specifics one by one. The package—
Mitchell: They had to be sure that they couldn't amend it, that it was all a deal. Take it or leave it.
Mitchell: If we could expand upon the base closings commission idea, we could get something similar to Gramm-Rudman, where they could then go to their constituents and say, "I had no choice. This happened in spite of my hard work on your behalf."
Postrel: Perhaps you'd each like to make a closing statement.
Mitchell: The Clinton program is based on the same dubious logic and flawed assumptions of the 1990 budget deal. It's probably going to go through largely intact. It will fail miserably. He's going to come back for a second or third bite of the apple—depending on where you count health care—in 1995, right after the mid-term elections. And we'll get in this downward spiral where we pass bad fiscal-policy laws, which hurts the economy, which drives up the deficit, which encourages more bad fiscal policy.
Probably the only chance we have is that Clinton will set the stage for some as yet unknown, good Republican in 1996, the same way Jimmy Carter set the stage for Ronald Reagan. Hopefully, we'll get a little bit more progress in 1996 than we got out of Reagan. Reagan, I think, just largely held the line.
Phillips: The Concord Coalition was pleasantly surprised and pleased that Clinton put deficit reduction at the top of his list. We hadn't expected that.
But we do not expect that our mission is going to be accomplished over the next four years. Our mission is to eliminate the federal deficit over a reasonable period of time, and it's going to require a lot of educating and energizing of people across the country to make sure that their elected officials understand that we still have a very serious problem.
Niskanen: President Clinton was correct to make deficit reduction a major priority. He was incorrect to focus the deficit reduction almost entirely on the tax side. My own arithmetic suggests that he has proposed something like $6.20 of taxes and fees for every dollar of spending reductions and that the net amount of spending reductions is smaller than the amount that he's taking out of defense alone.
The deficit forecasts are likely to be misleading, because tax increases do not yield the revenues that are projected from a static model. And many of the spending cuts are one-time management reforms that do not affect the long-term programs. So spending and the deficit will grow very rapidly again in the 1998 period and beyond.
Ture:It seems to me that what Mr. Clinton should be about—and it is my judgment that he isn't—is reducing the role of the government's activity in the overall economy. Indeed, he's quite explicit that the government's role should be expanded. That makes the question of deficit reduction for me not even a secondary issue.
If you look at an administration that says the government ought to have a larger scope of responsibility throughout the economy and try to reconcile that with a program for reducing the deficit, it seems to me one could very well raise the question, Why bother to reduce the deficit? If spending is to increase, if that is a basic part of the Clinton program, then it seems to me that's what we should be opposing.
Postrel: Thank you all very much.