on a $700 billion tax reduction.
In the context of a major ongoing surplus, a tax cut of some sort was a
sensible idea, O'Neill and I agreed. As he pointed out, taxes now accounted
for more than 20 percent of GDP versus a historic average of 18 percent.
But there were competing uses for the surplus to consider. Paying down
government debt, most importantly—Al Gore had that right. Federal debt
to the public, as it is technically called, now stood at $3.4 trillion; more
than $2.5 trillion of this was considered "reducible," or readily paid off (irreducible
debt includes savings bonds and other securities that investors
would decline to sell).
Another major item on our wish list was Social Security and Medicare
reform. I'd long hoped to see Social Security transformed into a system of
private accounts; to launch such a change while meeting the obligations already
on the books for today's workers and retirees would probably require
$1 trillion of additional funds as a down payment. And the nation hadn't
even begun to reckon with the ballooning costs of Medicare. We'd taken
that issue off the table when I'd run the Social Security reform commission
for President Reagan almost twenty years before, but with the aging of the
baby boomers, the challenge was becoming urgent. I pointed out that the
statisticians were counting an awful lot of unhatched chickens by forecasting
surpluses ten years ahead. What would happen if those surpluses failed
to materialize?
O'Neill took as dim a view of deficits as I did. His answer was
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"triggers"—provisions added to any new spending and tax legislation that
would put off or reduce the cuts if the surplus disappeared. Some sort of
capping mechanism might work, I agreed. One of the most important
achievements of Congress and the last two administrations had been to
make budget balancing the law of the land. The government now operated
under so-called pay-go rules, whereby if you added a program you had to
come up with a source of funds for it, either by raising taxes or cutting
other spending. "We are not going back into the red," I declared.
E
E
vents in January moved very quickly indeed. The preparations for a
new administration and a new Congress are always hectic, and that
year they were doubly so—because of the prolonged dispute over the outcome
of the presidential race, Bush and his transition team had just six
weeks instead of the usual ten to gear up for inauguration day.
Taxes were, as expected, the front-burner issue. In a private conversation
in mid-January, Cheney told O'Neill and me that, after the disputed election,
Bush felt that a clean victory on his tax cut was crucial. This echoed the uncompromising
note I'd heard Cheney strike in a Sunday-morning TV interview
a few weeks before: "As President-elect Bush has made very clear, he ran
on a particular platform that was very carefully developed; it's his program
and it's his agenda and we have no intention at all of backing off of it."
Having been around Washington a long time, I thought I recognized a
familiar pattern. Campaign promises are the starting point of every new
presidency. Each administration, as it takes office, puts out budget proposals
and other plans identical to those in the campaign. The problem with
turning such promises into policy, however, is that platforms are written for
political perception, not optimal effect. The campaign agenda is a hastily
constructed road map based on conditions at the time; by definition, it
cannot be a fully vetted policy for operating government. Invariably other
forces in government—in Congress and the executive branch—act as a reality
check, testing and tempering the plans. I knew this from experience;
I'd worked for Nixon in his campaign of 1968 and for Reagan in 1980, and
in no instance had the policy mix or forecast survived the early weeks of a
new administration.
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I did not foresee how different the Bush White House would be. Their
stance was "This is what we promised; this is what we'll deliver/' and they
meant it quite literally. Little value was placed on rigorous economic policy
debate or the weighing of long-term consequences. As the president himself
put it to O'Neill a couple of months later, in rejecting a suggestion on
how the administration's plan for Social Security reform might be improved:
"I didn't go with that approach in the campaign." My friend soon
found himself the odd man out; much to my disappointment, economic
policymaking in the Bush administration remained firmly in the hands of
White House staff.
T
T
he surplus was the first issue the Senate Budget Committee took up
when the new Congress convened. That is how I found myself sitting
under the bright lights of a hearing room on the morning of Thursday, Jan
uary 25, about to touch off a political furor.
The key questions, as committee chairman Pete Domenici noted in
welcoming me, were whether the projected long-term surplus would be
transitory or permanent, and, if it did continue to rise, "What do we do
about it?" My response in previous years had always been simply "Pay off
the debt." But now the projected surpluses were so large that debt repay
ment would be completed within a very few years. Yet the surplus would
continue. The CBO statisticians now envisioned the surpluses under cur
rent policy at $281 billion in 2001, $313 billion in 2002, $359 billion in
2003, and so on. Assuming no major shift in fiscal policy, the CBO ex
pected the reducible debt to be fully paid off by 2006; any surpluses there
after would have to be held in some form of nonfederal assets. In 2006 the
surplus would break $500 billion. Thereafter, more than a half trillion extra
dollars would flow into Uncle Sam's coffers each year.
As I contemplated this prospect, I felt a bit stunned: $500 billion is an
almost unimaginable accumulation, roughly equivalent to the combined
assets of America's five largest pension funds, piling up each year. What
would the Treasury do with all that money? Where would it invest?
The only private markets large enough to absorb such sums are in stocks,
bonds, and real estate, in the United States and abroad. I found myself
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picturing American government officials becoming the world's largest investors.
I'd encountered this prospect once before and found the idea truly
scary. Two years earlier, President Clinton had proposed investing $700 billion
of Social Security funds in the stock market. To prevent political meddling
with investment decisions, he suggested creating a privately managed
mechanism to oversee the funds. But with such financial leverage at the
government's disposal, I could readily envision the abuses that might occur
under a Richard Nixon or a Lyndon Johnson. As I told the House Ways
and Means Committee, I didn't believe it was "politically feasible to insulate
such huge funds from government direction." To my relief, Clinton
dropped the idea soon after. Yet now it would very likely arise again.
Taking all this into account, I came to a stark realization: chronic surpluses
could be almost as destabilizing as chronic deficits. Paying off the debt
was not enough. I decided to propose a way for Uncle Sam to pay off his
debts while leaving little or no additional surplus to invest once the debt
reached zero. Spending would have to be raised or taxes cut, and to me the
preferable course seemed clear. I have always worried that once spending is
notched up, it is difficult to rein in. The same is less true about tax cuts.*
Moreover, lowering taxes eases the burden on private business, potentially
raising the tax base. We could, alternatively, wait a couple of years and then,
if the surpluses continued, reduce taxes sharply to eliminate them. But there
was no way to know whether that would be a prudent option at the time; if
inflation was pressing, tax cuts would end up stimulating an already overheated
economy. The only course that did appeal to me was to act now to
put fiscal policy on what I called a "glide path" to a balanced budget. This
would involve phasing out the surpluses over the next several years, through
a combination of tax cuts and Social Security reform.
Two pieces of tax-cut legislation were already on the table. On the first
day of the new Congress, Senators Phil Gramm and Zell Miller had introduced
a bill embodying the $1.6 trillion plan from Bush's campaign, and
Senate minority leader Tom Daschle had introduced a more modest $700
billion plan. Either tax cut would serve my objective of scaling down the
surplus while leaving enough money for Social Security reform.
*There is no upper limit to spending, but tax revenues cannot go below zero.
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Of course, I still had the fear in the back of my mind that Congress and
the White House might again go overboard on spending, or that revenues
would unexpectedly flag, either of which would cause deficits to come
back with a vengeance. So in writing my testimony, I was careful to include
Paul O'Neill's notion of making the tax cuts conditional. I asked Congress
to consider "provisions that limit surplus-reducing actions if specified targets
for the budget surplus and federal debt were not satisfied." If chronic
surpluses did not develop as forecast, then the tax cuts or newly enacted
spending increases should be curtailed.
I could not shake a conviction of many decades that the biases in our
political system favor deficits. So I made sure to end the statement on a
strong note of caution: "With today's euphoria surrounding the surpluses,"
I wrote, "it is not difficult to imagine the hard-earned fiscal restraint developed
in recent years rapidly dissipating. We need to resist those policies
that could readily resurrect the deficits of the past and the fiscal imbalances
that followed in their wake."
My office provided the Budget Committee leaders with a copy of my
remarks a day in advance, as we often did with complex testimony that had
no direct bearing on the financial markets. I was surprised on Wednesday
afternoon to get a call from the committee's ranking Democrat, Kent Conrad
of North Dakota. He asked if I could stop by his office to talk. A former
tax commissioner, Conrad had been in the Senate as long as I'd been chairman,
and had a reputation as a fiscal conservative. After thanking me for
taking the time to see him, the senator went straight to the point. "You're
going to create a feeding frenzy," he said. "Why are you backing the Bush
tax cut?" He predicted that my testimony would not only ensure the passage
of the White House proposals but also encourage Congress to jettison
the fragile consensus on fiscal discipline it had built up over the years.
"That is not what I'm saying at all," I told him, pointing out that my
testimony endorsed a tax cut of some kind to remove the surplus, but not
necessarily the president's. My ultimate goals were still debt reduction and
zero deficits. I went over my assessment of how dramatically the outlook on
the surplus had changed, explaining how productivity growth, according
to virtually all analysts, seemed on a permanently higher path—or on a
higher path at least for the years immediately ahead. That had fundamentally
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THE AGE OF TURBULENCE
altered the outlook for revenues. Finally, I agreed that it remained crucial
to emphasize fiscal restraint, and volunteered to expand on the need for a
safety mechanism like O'Neill's triggers if the senator would ask me about
it during the Q&A.
When I left, I could see that Senator Conrad wasn't entirely satisfied
with this response, but I didn't buy the idea that Congress would act on my
say-so. Politicians had never hesitated to discount or ignore my recommendations
in the past as it served their convenience. I do not recall my turning
the tide when I advocated cuts in Social Security benefits. I had no intention
of taking sides on whose tax cut was better; as I would tell Senator
Domenici the following morning at the hearing when he asked me to endorse
the Bush plan, that was a fundamentally political question. I was an
analyst, not a politician; the job would be no fun if I had to worry about the
political implications of everything I said. I was offering what I thought was
a novel insight and hoped my testimony would add an important dimension
to the debate.
I went back to the Fed and hadn't been at my desk for even an hour
when Bob Rubin phoned. "Kent Conrad called me," he said. "He said I
needed to talk to you before you testify." Bob hadn't read my statement but
Conrad had filled him in, and he told me he shared some of the senator's
concerns. With a big tax cut, said Bob, "the risk is, you lose the political
mind-set of fiscal discipline."
He and I had labored for years to promote that consensus, so I asked if
he knew that I was still presenting debt reduction as the ultimate goal. "I
understand that," he said. Then what was the problem? I asked. "Bob, where
in my testimony do you disagree?"
There was silence. Finally he replied, "The issue isn't so much what
you're saying. It's how it's going to be perceived."
"I can't be in charge of people's perceptions," I responded wearily. "I
don't function that way. I can't function that way."
It turned out that Conrad and Rubin were right. The tax-cut testimony
proved to be politically explosive. The hubbub began even before I reached
Capitol Hill: copies of my statement had leaked, and USA Today that morning
