The Battle of the Budget

This predicament was not caused by President Carter, or by any one president. It will not be corrected by one president. It took fifty years to reach this pass.

Five years from now the deficit, counted honestly, could range between $100 billion and $150 billion. Federal spending could rise to 25 percent of GNP from the present 22.5 percent, tax burdens to almost 24 percent from about 21 percent at the end of 1980. These may seem to be small changes; they are not. A one-point increase in spending or taxes as percentage of GNP represents--in five years--a shift of $50 billion from the private to the public sector. Such shifts could well mean the difference between an economy beginning to recover from the shocks of the 1970s and one spiraling through an experience of alternating high interest rates, high unemployment, and low growth--with double-digit inflation as a constant.

Ronald Reagan is caught in the same trap that snared Jimmy Carter. The federal budget's basic structure was established in the twenty-five years immediately after World War II, a period of extraordinary performance on the part of the U.S. economy. In such a period of sustained real growth, low unemployment, and low inflation, the public sector could steadily expand without any apparent harm to the private sector. Between 1950 and 1980, the budget grew by over 1000 percent, and in the course of that growth established a momentum inconsistent with the limits posed by today's economy. Moreover, despite the budget's huge size, there is no obvious "room." The programs in the budget are extremely hard to reduce or even slow down. But without such reductions, the impending deficits will not allow the tax cuts or the defense increases Ronald Reagan promised, and which he believes the country needs.

The fact is we are overcommitted. Fifty years of automatic resort to the public purse--indulged in with equal enthusiasm by Democrats and Republicans--have led to a budget with an almost unstoppable momentum whose premises were set in better times. We have an emerging structural deficit (one that persists in good and bad times) the nation cannot afford. We spend too much on income transfers--or at least we spend it without sufficient thought. Believe it or not, we underspend in significant areas. And no party to the process by which we decide on public spending has sufficient power to initiate and sustain a purposeful long-term policy of change.

THE SAD STORY OF THE FISCAL 1980 BUDGET

In early 1978, barely one year into his presidency, Jimmy Carter and his principal advisers were deeply concerned about the rising level of inflation and the force of its momentum. At the same time, the managers of the federal budget had become worried about a surge in spending and an impending deficit that was much too large. By March of 1978, my OMB (Office of Management and Budget) staff had predicted that the 1980 deficit would be at least $55 billion if we did not act, approximately the same level as the deficit forecast for the 1979 budget. To allow another deficit in the neighborhood of $60 billion in a time of accelerating inflation seemed profoundly wrong--wrong in strictly economic terms, wrong politically, wrong given the President's public commitments to budget control.

In a long set of discussions in May and June 1978, the President was told in detail what a substantial reduction in the deficit would entail. We would have to reduce the tax cut the administration had already proposed--requiring immediate discussions with congressional leaders. His promise to provide growth above the rate of inflation for the defense budget had to mean even worse prospects for the domestic budget. No new programs of any significant size could be proposed. Existing programs for the cities, for transportation, for the environment--programs that already provided benefits, and had clients and constituents (most of them Democrats)--had to be held down or cut back. Legal changes would have to be proposed to Congress to permit reductions in such untouchables as Social Security and Medicare. Federal operating costs would be reduced, federal salary increases would be limited, federal hiring would be restricted.

No one was under any illusions about the difficulty of this effort for this President. In June 1978, Jimmy Carter was not particularly popular. But any President would have had an extremely tough sale on his hands. Conservatives would be pleased with the direction the President was taking, but displeased with its moderate quality, its necessary concessions to other points of view. On the other hand, much of the Democratic party--where the President had to look for support--would despise the entire effort. The President had to convince one set of skeptics that a policy of restraint was acceptable and appropriate while he persuaded another that too much restraint was inequitable and unfair to those who depended upon federal programs. Despite the obstacles, the President decided at the end of these spring discussions upon a major turn toward restraint.

A policy of restraint, even if applied absolutely evenly, would have been difficult enough. But as President, Jimmy Carter had to make choices between programs, and the choices he felt compelled to make ran against the grain of his party. He was in the process of concluding that the defense budget had to be increased.

The President's evolving attitude toward defense spending had been a source of muted displeasure among many Democrats for more than a year. In his 1976 campaign, he had argued that the defense budget could be reduced by more efficient management. But within six months of taking office, in June 1977, he had permitted Secretary of Defense Harold Brown to announce an administration decision to increase defense by 3 percent in real terms, 3 percent above the rate of inflation. Now it was obvious he was considering extending that defense commitment for a second budget year. A defense spending increase would, of course, mean disproportionate pressure on the rest of the budget; the "rest of the budget" consisted largely of domestic, "Democratic" programs.

For the remainder of 1978, planning for the 1980 budget was a central aspect of the President's domestic policy. By late fall, the 1980 budget had become an issue of considerable prominence. Its general direction was widely known. The standard Washington game of leaking the OMB's budget "marks" prior to budget publication flourished with more than normal intenseness. Meetings with the President were requested by the leadership of every group that felt its programs were threatened.

In December the Democratic party's second midterm convention was held in Memphis, Tennessee. Midterm conventions are always tough on incumbent Democratic presidents. The party believes deeply in a positive government--one that searches out social problems and defines programmatic solutions. But a president has to balance problems, solutions, resources, and opportunities.

This convention had not only the normal, built-in dissatisfactions but also the issue of President Carter's budget directions and priorities to chew on. In his speech to the convention on December 9, 1978, Senator Edward Kennedy tore into President Carter's budget policies.

"I support the fight against inflation. But no such fight can be effective or successful unless the fight is fair. The party that tore itself apart over Vietnam in the 1960's cannot afford to tear itself apart today over budget cuts in basic social programs.

"There could be few more divisive issues for America and for our party than a Democratic policy for drastic slashes in the federal budget at the expense of the elderly, the poor, the black, the sick, the cities, and the unemployed."

In commenting on the speech, Adam Clymer of the New York Times wrote, "Senator Edward M. Kennedy today confronted President Carter over the spirit that should guide the Democratic party.

"In a ringing speech to a cheering audience of 2,500, the Massachusetts Democrat seized a building mood at the conference, where unhappiness about budget proposals was heard again and again at workshops on the cities, inflation, arms control and health insurance."

If it accomplished nothing else, the convention made clear that if President Carter continued to pursue his stated budget policies, he was risking major problems with an important part of the Democratic party. The party was not ready to embrace budget restraint.

But President Carter's 1980 budget was tougher than that of any other Democratic president in modern history. In January 1979, he announced a budget for fiscal year 1980 of $532 billion in spending and $503 billion in receipts. The deficit of $29 billion hit the mark he had set publicly the previous November. The domestic budget fell in real terms; grants to state and local governments fell in real terms. Reductions of $600 million in Medicare and Social Security were recommended. Defense spending was proposed to grow 3 percent in real terms. The President had made his choice.

BUT WAS IT REALLY? AND WHAT DID IT GET HIM?

Much federal spending is tied directly to economic conditions: if conditions change, federal spending changes. Therefore, when a president proposes a budget, he is also providing, explicitly, an economic forecast upon which that budget depends.

President Carter's 1980 budget had forecast economic growth of 3.2 percent, inflation of 6.3 percent, and unemployment of 6.2 percent. A year later, in January 1980, the new forecast for 1980 was dramatically different: economic growth of -1.0 percent, inflation of 10.4 percent, unemployment of 7.5 percent. Jimmy Carter was hit at the same time with three of the four factors that force spending up automatically: lower economic growth, higher inflation, higher unemployment. (The fourth factor is high interest rates; in two months he'd have those also.) This time, his 1980 budget was for $564 billion in spending--an increase of $32 billion. The predicted deficit had grown from $30 billion to $40 billion.

The financial community went crazy. In the intervening year, times and needs had changed. The fall of the shah had precipitated another oil shortage; oil prices had doubled. Inflation had risen to a markedly high level and, more important, had become a matter of national concern and anxiety. It was a fact--but clearly a politically trivial one--that virtually all of the $32 billion spending increase now forecast was due either to drastically changed economic circumstances--which no president can control--or to defense increases--which the financial world by and large approved of. The 1980 budget no longer represented a policy of restraint; rather, it now seemed symptomatic of the uncontrolled appetite of the federal monster.

After a period of intense turmoil in the markets, the President announced that officials of his administration would begin immediate meetings with the Democratic congressional leadership about the budgets he had proposed only six weeks earlier. In effect, events had forced the President to withdraw and reconsider his budgets. After an eleven-day series of all-day meetings with members of Congress, President Carter at the end of March 1980 presented revised and reduced 1980 and 1981 budgets.

But events continued to grind on. In late October 1980, shortly after the end of fiscal year 1980 and approximately one week before the presidential elections, final federal spending figures for the fiscal year were released. Fiscal year 1980 spending was $579 billion and the deficit was $59 billion. Spending had grown by $47 billion from the time the budget was proposed to the end of the fiscal year; it had grown by $85 billion over the previous year; the deficit had doubled from the limit President Carter had publicly established. The restrained budget of 1980, upon which Jimmy Carter had spent so much political capital, ended up as a symbol of his profligacy and loss of control.

THE "REAL" BUDGET

One of the small cruelties of American politics is the peculiar requirement that defeated presidents must prepare and propose a budget for a time beginning well after their departure from office. The requirement imposes an enormous amount of melancholy, largely useless work. A defeated president has to review his past dreams; decide upon the course of a defense policy he can influence for, at most, thirty more days; consider with his economic advisers fiscal policy for a future he will not affect; adjudicate disputes between his OMB and his Cabinet, knowing that no one will care. It is bitter medicine, but President Carter carried out this painful responsibility with grace, dignity, and humor.

I spent those months working the normal awful hours budget-making requires, but this time there was a difference. From my northeast corner office in the Old Executive Office Building--that magnificent baroque structure next to the White House that once housed all of the State, War, and Navy departments--I could see the excited, intense movement across the street at Blair House when Ronald Reagan came or left, and down the street a bit I could watch the construction of the Inaugural review stands. They were forming a government. We were carrying out the required forms of one that had been dissolved. It was not a task that held much joy, but it forced a great deal of thought about the nature of my work for the past four years.

If, at least in part, politics is about who gets what, then a budget is a statement of a given year's results in that competition. But it is also an explicit or implicit statement about a number of other, more fundamental questions--the appropriate size of government, the value and impact of federal programs, the role of government vis-a-vis the private sector.

The budget process encompasses every major actor in the political system. The budget that emerges annually from this process is an extraordinarily complex crystallization of agreements among institutions, competitors, interests, and philosophies. I believe that its current size and built-in rate of growth raise serious problems; its structure is inappropriate; its allocations of resources are increasingly wrong; and the process that determines it yields self-canceling decisions. But having managed the preparation of five budgets, I'm disturbed by a tendency to underestimate its complexity and to depict changing it as relatively easy. To listen to most political discussions of economics or the budget is to come away with the sense that the federal budget can be changed easily by cutting fraud, waste, and bureaucrats, and that our current situation is one a malevolent government created against the will of the American people.

Reality is different. The budget represents commitments made over decades. Those commitments will not be changed without significant conflict. Of course, some fraud and waste occur in federal spending. But normally the term "waste" denotes someone else's program. As a senior Defense Department official once said about the defense budget, "At least we don't piss it away on welfare." And finally, despite public mythology, the budget achieved its present state with the knowledge and active connivance of the American people.

Every federal program has numerous supporters, is passed by Congress, and is signed by a president. Very few are repealed. The OMB and the Treasury do not work overtime receiving remittances from citizens giving back federal benefits.

The very scale of the federal budget ($740 billion in the recently introduced 1982 budget--almost one quarter of the GNP--with 2000 to 4000 programs, depending on definitions, and 1.9 million civilian employees) allows the presumption that change is easy to achieve. Candidates, presidents, and presidents-elect always believe that the "base"--that part of the budget they do not understand--can be cut. Jimmy Carter ran for office on the claim that a new technique--zerobased budgeting--would provide a means to cut that mythical base, make room for new programs, and still allow budget restraint. For four years he was puzzled and irritated by the fact that the choices were so brutal. He grew to hate the budget process.

Even Ronald Reagan--who ran against the federal government--followed the same pattern. During his campaign he committed himself to expenditures and tax cuts as if he were a liberal Democrat. He supported bilingual education, guaranteed loans for the Chrysler Corporation and New York City, increased Social Security, federal employee pensions indexed to inflation twice a year, increased support for the National Maritime Administration, and the largest tax cuts in history. But he chose, predictably, not to identify the programs he would cut, relying instead on the familiar promise to cut waste.

In fact, most general discussions of the budget proceed with virtually no understanding of the structure of the budget. Political leaders, senior business executives, the press, even most public officials intuitively think of a budget structure in a way something like the following:

Table 1: 1980 Budget

Defense $135.9 billion

Education 13.8 billion

Energy 6.3 billion

Health & Human Services 194.7 billion

NASA 4.8 billion

Treasury--interest 74.8 billion

The Rest 149.3 billion

Total $579.6 billion

This budget (the actual figures from the 1980 fiscal year, which ended September 30, 1980) shows what the nation buys with its money and suggests, implicitly, how these funding decisions could be changed. A budget organized this way virtually demands certain questions: Why not add $10 billion to Defense and take it from Health & Human Services (a 5 percent reduction)? or reduce the entire total by $25 billion (only 4 percent)? This is the budget new presidents believe they face, the one Congress must have in mind when it periodically tries to reduce every agency by 2 percent or 5 percent. This is the budget business leaders think of when they demand austerity. But this is not the budget that has developed over the past thirty years; it is not the budget that drives presidents crazy.

The "real" budget looks like this:

Table II: 1980 Budget

Billions

A. Required spending

Payments for individuals $255.7

Military pensions 11.9

Other (interest on the national

debt, long-term contracts) 172.0

Total 439.6

B. Personnel (largely discretionary)

Military 30 3

Civilian 38.9

Total 69.2

C. Discretionary spending

Defense 57.0

Domestic 13.8

Total 70.8

Total $579.6

About 45 percent of the total budget consists of required payments to individuals--Social Security, Medicare, military pensions; 30 percent consists of interest payments and long-term contract commitments--water projects, naval ships, solar energy demonstrations or public buildings; and all annual discretionary spending--funds that could actually be reduced in any particular year--makes up the final 24 percent. Salaries for government workers, the Beekeepers Indemnity Fund, public service jobs, foreign aid, the urban gardening program, mass transit subsidies, solvent-refined coal demonstration plants, consulting contracts good and bad, the homeownership assistance program, production costs for nuclear bombs, the Edward Hebert Medical College of the Armed Forces, and anything else one can imagine fit into one quarter of the budget.

This structure means that many intuitive judgments about federal budget policy are wrong. Programs and dollars are not interchangeable or fungible. In the "real" budget, Medicaid expenditures, federal salaries, and HUD planning funds are authorized by different laws; they have different histories and legal bases; and they occur over different time periods. In practice, a president finds that a dollar in one program is different from a dollar in another program.

In 1978, HEW Secretary Joseph Califano offered Jimmy Carter a deal. If the President would increase certain discretionary programs in the "restrained" 1980 budget by a few hundred million dollars, he would return to the President more than that amount in savings--by proposing a number of sensible and small reductions in Social Security. Secretary Califano's offer, in the larger scheme of things, made a great deal of sense. But he was offering to trade uncontrollables for discretionary dollars. The President agreed. Secretary Califano got his budget increases for 1980. Congress never gave the President his savings.

Over time, this structure virtually forces the wrong allocative decisions on presidents and Congress. That part of the budget now taken up by direct payments of income--income transfers--is so large a percentage of the total that it virtually determines the entire budget. Income transfers have a momentum of their own, unrelated to the limits of the economy or the needs of other programs. First, these programs are entitlements: they are assured by law to qualifying individuals; they do not pass through the appropriations process. It is much harder procedurally and vastly harder politically to constrain these programs than it is to constrain any others. Second, income transfers compose a structure of programs erected over fifty years with little attention paid to its internal cohesion. Today, we have Social Security, Medicare, Medicaid, food stamps, supplementary security income (SSI), and aid to families with dependent children. We also have housing programs, training and employment programs, education programs, energy grants, low-income weatherization programs, and nutrition programs. These programs were conceived, passed, and implemented at different times and they are not changed as new programs are established. I'm glad we have them. But I believe that the taxpayer deserves a more cohesive structure, a rationalization, a careful trimming of overlaps and redundancies. Finally, these programs are virtually all indexed to the Consumer Price Index. That is why spending surged so much in the 1980 budget. That's wonderful for the beneficiary, terrible for the budget, and probably unfair to the taxpayer. For the past two or three years, increases in the Consumer Price Index have run far ahead of wage increases. In effect, indexation--in the form we have it now--requires wage earners to pay taxes funding a larger annual increase in income than they themselves receive.

The effect of this structure of programs is either to force increases in spending that will not always be consistent with sound economic policy or to force other, equally valuable programs out of the budget. Both consequences occur. The truly discretionary spending in the budget is steadily squeezed because it is not legally required. We underfund the investment programs in the budget. We do not sufficiently maintain the government's own facilities and capital investments. I believe, totally contrary to current notions, that we spend too little on federal operations--on such functions as program oversight, or debt management. At the same time, because cuts in these discretionary expenditures cannot compensate for increases in less discretionary areas, the budget grows in an unacceptable manner. It has become increasingly obvious that if we cannot take a long and searching look at the current structure of uncontrollable income-transfer programs, we cannot solve the problems of the budget.

Last fall, in the middle of a long and difficult discussion of one agency with an entirely discretionary budget, the agency head finally hit the table with his fist and said, "When are you sons of bitches in OMB going to do something about Wilbur Cohen's money machine? It's killing the rest of us."[See endnote].

Between 1980 and 1981, the federal budget will increase by $86 billion, or 15 percent. It is commonplace to observe that budget restraint could be easily achieved by limiting these multibillion annual increases. But this completely ignores the real structure of the budget and the source of most of the increased spending.

Table III: 1980-1981

Source of Changes

Billions $ Percent

1. Total change 86.7 100

2. Required non-defense

spending 61.1 7

3. Defense spending 20.0 23

4. Discretionary non-defense 5.8 7

5. Salaries 6.8 8

6. Asset sales and other

revenues --7.0 --8

As the table shows, virtually all of the year-to-year increases in the budget are either mandatory or the result of policy commitments with which most of the nation agrees. Of the total increase from 1980 to 1981, 93 percent goes either for payments that are required by law--Social Security, Medicare, Medicaid--or to meet President Carter's pledge to increase defense spending by 5 percent annually: a commitment that the new administration believes to be insufficient.

If all the rest of the budget were held constant, the nation could save $12.6 billion, not enough to fund President Reagan's defense commitment or his tax cut promises. But in fact, the budget is even less flexible. Much of the $5.8 billion non-defense increase, for example, consists of projects under construction. To avoid the increase, if we legally could, we would have to leave highways, bridges, dams, and major energy projects partially constructed. Denying the almost $7 billion in salary increases may, at first, seem reasonable, even attractive--after all, who likes bureaucrats?--until it is recognized that almost 50 percent of these pay increases are for the military. They are intended to improve our forces by increasing recruitment and by slowing the loss of trained men and women. Moreover, I believe it is unfair to deny salary increases to men and women who have made the government civil service their career because we cannot cope with the difficulties posed by other possible forms of constraint.

Nonetheless, if we (1) funded all required programs, (2) continued defense budget increases, and (3) held every other program in the federal budget constant--no pay increases for civilian federal employees, no budget increases of any kind for energy, or veterans' programs, or highways, or parks--we could save $9.4 billion, or 1.4 percent of the federal budget.

It is a simple but rarely understood fact that the basic structure of the federal budget allows for very little change. To achieve even marginal restraint in its rate of growth requires a president to take on important interests who have good cases to make. It is almost impossible to explain to a columnist or an angry constituent why a $10 million reduction matters in a $700 billion budget. Such a reduction seems nonpresidential, shortsighted, arbitrary. Moreover, this same budget structure guarantees high rates of increase--rates the nation cannot sustain--into the indefinite future.

THE BUDGET PROCESS AND THE PRESIDENT

President Reagan will quickly discover that for truly important issues, such as the budget, his power is extraordinarily limited. I believe that presidential power is far too limited for the system's own good.

It is understandable that it is so. The budget involves the basic stuff of modern government, the issues of resource allocation the political system really cares about. How much does the Department of Defense get? What water project is built, or park bought? Will Congressman X get a federal building in his district? Should funds go to Social Security increases, for solar power, or for foreign aid? How much does the federal government owe the states, and why? These are the issues local congressional districts, single-issue political groups, major blocs in our society, focus on. They are the issues the system handles best when resources are abundant; they will tie the system--presidents, congress, constituencies, the media--into knots in the 1980s.

The fact that these issues matter to the political system means that all the principal institutions and actors in the system are part of the budget process. Budget-making has become the organizing core of the political-economic structure. It encompasses the President and the executive branch (only in theory on the same side of most issues); Congress: its leadership, its members, its committees (not even in theory on the same side); other levels of government concerned about resources, and turf; major interest groups operating with defiantly single-minded tunnel vision; and the media, as unable as any other force to gain perspective on this overall process. The President, in other words, has competition.

The President may believe to his core that falling productivity requires more private investment and that that requires federal spending restraint. But every interest group in the country will tell the world that, on the contrary, declining productivity requires Import Bank, job training, and health care.

No one who was there will forget the moment in early 1977, after President Carter had made a brief statement to a gathering of senators about his plans to eliminate eighteen water projects, when Senator Russell Long, whose state stood to lose two of these projects, stood up. "I," he said, "am Russell Long, chairman of the Senate Finance Committee." His message was not difficult to understand.

The budget process is one of Washington's central rituals. It is a task of immense scale and complexity, involving some of the most important questions the political system faces. But, as Ronald Reagan will discover, it is not a process that easily permits steady, consistent change. However, steady, consistent change is exactly what we now require. The momentum an earlier economy imparted to the budget cannot, and should not, be sustained today.

By every relevant measure, the economy performs less well today than it did from 1950 to 1970. Productivity growth is down. Growth in the capital stock is down. Unemployment is up. Inflation is up. GNP growth is lower. These trends began to become apparent in the early 1970s. They are deep-rooted and systemic, and they limit the policy choices available to any administration. They make the costs of error much higher; they narrow the room for maneuver; they impose enormous caution. At unemployment and inflation rates of 7.5 percent and 12 percent, there are no good choices available to economic policy; what alternatives do exist are fewer and riskier than when both rates are substantially lower. Ronald Reagan will discover that a policy of marginal change is forced upon him. There are no magic buttons.

But the same trends that require so much caution also demand that change begin. At some point we must choose between particular programmatic solutions to particular problems and the health of the system as a whole. No one knows precisely where that point is, but we are certainly closer to it today than we were two decades ago. No one knows if a federal budget of 19 percent of GNP is reasonable; one using 23 percent of GNP is not. No one knows at what point tax burdens truly affect investment and productivity. From now on, presidents must balance the benefits of specific actions against the effects of higher deficits, or higher tax burdens, on the entire system.

I believe that the budget is the fundamental domestic problem the presidents of the 1980s will encounter. The President is the only figure in our political system in a position to consider the most general choices. And if we are to solve the problems posed by the budget, the President will have to explain them to the American people, and spend a term correcting them.

The stakes are enormous. Today's economy delivers less income and more inflation to the average citizen than he expects, it subjects him more often to the threat of unemployment, and it is more vulnerable to the outside shocks that wars, revolutions, or oil markets can impose. If unchanged, the narrowing economic and budgetary choices we face will alter prevailing views about government and society.

Sometime in the 1980s, the President must (1) recognize that the performance of our economy imposes limits upon the government's use of the nation's resources, (2) understand that the underlying, already committed momentum of federal spending is inconsistent with desired economic performance, (3) develop a policy that is compassionate about our ends but rigorous about our resources, and (4) conceive a long-term strategy that brings about the necessary change despite the weaknesses of the present process. Such a president will come to terms with the internal contradictions of modern government, and will redefine the modern presidency. He might well consolidate political power for a very long time.

[Endnote: Wilbur Cohen was one of the founding drafters of the Social Security Act. In the late 1960s, as a senior official (briefly secretary of HEW), he played a major role in the initiation of the Medicare and Medicaid programs. All are uncontrollable, entitlement, income-transfer programs, totaling about $225 billion today.]