Yet it did not include funding for the looming war in Iraq. (If that occurred,
the administration would have to seek a special appropriation, which would
push the deficit still higher.)
The budget's centerpiece was a second major round of tax cuts, which
President Bush had initially proposed a few weeks before. Of these, the
most costly was the partial elimination of the double taxation of dividends.
For years, I have advocated the full elimination of the double taxation of
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corporate dividends as an incentive to capital investment. The new plan
also accelerated Bush's across-the-board income tax reductions so that they
would take effect right away, and made permanent the repeal of the estate
tax. Bottom line, the tax package was projected to add $670 billion (or
more than $ 1 trillion, if the cuts were made permanent) over ten years to
the $1.35 trillion cost of Bush's first round of tax relief.
Mitch Daniels, the director of the Office of Management and Budget,
was quick to point out that a $300 billion budget deficit was the equivalent
of only 2.7 percent of GDP, relatively modest by historical standards. True,
but my main concern was the failure to address the longer-term path of
promised benefits that are going to leave a very large hole in future budgets.
We should be preparing ourselves for the retirement of the baby boomers
with balanced budgets or surpluses for the difficult years ahead.*
There was talk that additional tax cuts would revitalize economic
growth. But in the Fed's analysis, the lingering lethargy reflected anxiety
and uncertainty about war, not a need for more stimulus. Iraq dominated
the news. On February 5, Colin Powell had given his United Nations speech
accusing Iraq of hiding weapons of mass destruction; ten days later there
were antiwar marches in cities around the world. Until the situation in Iraq
was resolved, there was no way to know whether more tax cuts made sense.
I told the Senate Banking Committee on February 11, "I am one of the few
people who still are not as yet convinced that stimulus is a desirable policy
at this particular point."
Far more urgent than tax cuts, I said, was the need to address the threat
posed by the soaring new deficits. Bring back statutory spending caps and
pay-go rules, I urged the senators. "I am concerned that, should the enforcement
mechanism governing the budget process not be restored, the resulting
lack of clear direction and constructive goals would allow . .. budget
deficits to again become entrenched." That, in turn, would beget problems
no amount of stimulus would solve. The supply-side argument that faster
economic growth would make deficits easier to contain was doubtless true,
*Surpluses no longer pose the threat of an accumulation of private assets that they did in 2001.
The level of debt is now substantially higher than contemplated in 2001.
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I said. Except in the unlikely event that a tax cut is wholly saved, the part
that is spent raises GDP and the tax base and hence tax receipts. Thus, the
gross tax cut is larger than the loss in receipts. But there is still a loss. Given
the size of the shortfalls we faced, I warned, "Economic growth cannot be
safely counted upon to eliminate deficits and the difficult choices that will
be required to restore fiscal discipline."
The fact that I was openly challenging the administration's plan caused
a stir. "No, Mr. President: Greenspan Delivers a Stern Rebuke on Rising
Deficits" was a headline the next morning in the Financial Times. But the
headlines in U.S. papers showed that I had failed to shift the debate to
where it belonged. I was trying to get people to see the need for fiscal restraint,
encompassing not just taxes but more important, spending. Yet all
anyone focused on was taxes. The Washington Post wrote, "Greenspan Says
Tax Cuts Are Premature; War Fears Blamed for Stagnation." "Greenspan
Advises Putting Tax Cuts on Hold," said USA Today. Nor did anyone in the
congressional leadership take up the cause of budgetary controls.
The tax-cuts issue briefly became a media circus. That week, more than
450 economists, including ten Nobel laureates, published a letter arguing
that the tax cuts proposed by Bush would drive up the deficits without
much helping the economy; the White House countered with a letter,
signed by 250 economists, supporting its plan. I knew many of the names—
the 450 were mainly Keynesians and the 250 were mainly supply-siders.
The entire debate shed less light than heat, and was quickly eclipsed by the
war in Iraq. By May, when Congress gave the president the tax cut he
wanted and he signed it into law, the need for budgetary discipline was nowhere
on the priority list. I knew how Cassandra must have felt.
D
D
uring the Bush administration, particularly after 9/11, I spent more
time at the White House than ever before in my Fed career. At least
once a week, I'd make the short walk from my office to the elevator that
took me to the Fed garage for the half-mile drive to the southwest gate.
These trips sometimes involved routine meetings with National Economic
Council chief Steve Friedman, his successor Al Hubbard, or other senior
economic officials. Periodically I would visit with Dick Cheney, Condo
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THE NATION CHALLENGED
leezza Rice; Andy Card; or any of a number of other officials. And sometimes,
of course, I'd be there to see the president.
I was back to being a consultant. The agendas of these meetings covered
international economics, the global dynamics of energy and oil, the future
of Social Security, deregulation, accounting fraud, problems with Fannie
Mae and Freddie Mac, and, when appropriate, monetary policy. Many of
the ideas I worked hardest to convey appear in the chapters that follow.
The Bush administration turned out to be very different from the reincarnation
of the Ford administration that I had imagined. Now, the political
operation was far more dominant. As Fed chairman I was an independent
force, and I'd been around for quite a long while, but I certainly did not
qualify as part of the inner circle, nor did I want to be.
It quickly became clear that there was no room in the administration
for an outspoken deficit hawk like Paul O'Neill. Initiatives he and I spent
many hours planning—the transition to Social Security private accounts,
for example, and a strict new law to govern CEO accountability—got no
better reception than the triggers we'd advocated during the first round of
tax cuts. Paul's outspokenness put him at odds with the administration,
which emphasized loyalty and staying on message. Paul spent much of his
two years as treasury secretary feuding with the Bush economists, especially
Larry Lindsey, the primary architect of the tax cuts. After the 2002
election, the White House obtained both men's resignations. It replaced
Paul with another former CEO, John Snow, who had headed the giant railroad
company CSX. John proved to be a better administrator than Paul
and a smoother, much more effective spokesman for economic policy, which
was all that the White House wanted its treasury secretary to be.
The president and I continued to relate much as we had that first
morning at the Madison Hotel. Several times each year, he would invite me
to lunch in his private dining room, usually with Vice President Cheney,
Andy Card, and one of the economic advisers. In these meetings, as in the
first, I would do most of the talking, about global economic trends and
problems. I talked so much that I don't recall ever having time to eat. I
would end up grabbing a bite back at my office.
For the five years we overlapped, President Bush honored his commitment
to the autonomy of the Fed. Of course, during most of that time we
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THE AGE OF TURBULENCE
kept short-term interest rates extremely low, so there wasn't much to complain
about. Yet even in 2004, after economic growth returned and the
FOMC began ratcheting up rates, the White House did not comment.
Meanwhile the president remained tolerant of; if not receptive to, my criticism
of his fiscal policy. Barely a month after I countered his argument for
the urgency of another tax cut, for instance, he announced he intended to
nominate me for a fifth term as chairman. This caught me by surprise; my
fourth term wasn't even due to expire for another year.
The administration also took the Fed's advice on policies we thought
were essential for the health of the financial markets. Most important was
the effort that began in 2003 to curb excesses at Fannie Mae and Freddie
Mac, the companies chartered by Congress to help underwrite home mortgages.
They are granted a de facto subsidy by financial markets in the form
of interest rates with very low credit-risk premiums on their debt—the
markets presume Uncle Sam will bail them out in the event of default. Fannie
and Freddie had been using this subsidy to pad their profits and grow.
But their dealings had begun to distort and endanger the markets and
seemed likely to become a bigger and bigger problem. The companies employed
skillful lobbyists and had powerful advocates in Congress. President
Bush had very little to gain politically by supporting a crackdown. Yet he
backed the Fed through a two-year struggle that resulted in crucial
reforms.
My biggest frustration remained the president's unwillingness to wield
his veto against out-of-control spending. Not long ago I had occasion to assess
the change in fiscal status of the United States since January 2001, when the
administration took office. I compared the budget outlook through September
2006, under the then current policy (existing law and budget conventions)
as estimated by the Congressional Budget Office, with the actual
outcomes through 2006. Debt to the public outstanding projected for the
end of September 2006 was $1.2 trillion. The actual outcome was $4.8 trillion.
That is a rather large miss. To be sure, a significant part of the shortfall
in receipts owed to the CBO's failure to judge adequately the looming shortfall
in capital gains and other taxes related to the stock-market decline. But
by 2002, that was already known to the administration and the Congress—
and they altered their policy approach very little.
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The rest of the shortfall owes to policy: tax cuts and spending increases.
The costs of the Iraq war and antiterrorism measures do not explain the gap.
Appropriations for both totaled $120 billion in fiscal year 2006, the Congressional
Budget Office estimated. This is a large sum, but in a $13 trillion
economy, it's readily absorbable. Federal outlays on national defense, which
in fiscal 2000 hit a sixty-year low of 3 percent of GDP, jumped back to
around 4 percent in 2004 and have since flattened out—they were 4.1 percent
in 2006. (By comparison, national defense spending at the height of the
Vietnam War absorbed 9.5 percent of GDP, and during the Korean War,
more than 14 percent.)
But spending in the civilian sector, so-called nondefense discretionary
outlays, has soared past the projections made in the surplus-rich days of the
new millennium. Most dispiriting to me was the enactment in late 2003 of
the prescription drug act. Instead of incorporating much-needed Medicare
reforms, it was estimated to add more than $500 billion over ten years to
the system's vast and intractable costs. While it allowed the president to
check off another of his campaign promises, it provided no way to come up
with the needed funds.
This wasn't an isolated event. As the administration and Congress set a
course toward a federal deficit of more than $400 billion in 2004, Republicans
actually tried to rationalize the abandonment of the libertarian small-
government ideal. "It turned out the American people did not want a major
reduction of government," wrote Congressman John Boehner of Ohio in a
position paper just after the drug bill passed. Boehner had been an architect
of the Republican takeover of the House nine years before, but now the
party was facing "new political realities," he said. Rather than shrinking the
size of government, the best that could be hoped for was slowing its growth.
"Republicans have accepted such realities as the burdens of majority governance,"
he wrote. Bigger but more efficient government should be the
new goal, he and other party leaders argued. They achieved the former, but
not the latter.
The reality was even uglier. For many party leaders, altering the electoral
process to create a permanent Republican-led government became a
major goal. House Speaker Hastert and House majority leader Tom DeLay
seemed readily inclined to loosen the federal purse strings any time it might
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help add a few more seats to the Republican majority. The Senate leadership
proved only somewhat better. Majority leader Bill Frist, an exceptionally
intelligent physician who favored fiscal discipline, lacked the force of
personality to do the necessary head-knocking. Conservatives like Phil
Gramm, John McCain, Chuck Hagel, and John Sununu usually found their
warnings unheard.
Congress was too busy feeding at the trough. The abuse of "earmarks"
became extreme, as politicians exercised this power to direct government
spending to particular projects, leading to lobbying and corruption scandals
in 2005. The Pork Barrel Reduction Act, introduced afterward by a bipartisan
group led by McCain, observed that earmarks in congressional appropriations
had proliferated from 3,023 in 1996, at the end of Clinton's first term,
to nearly 16,000 in 2005, the start of Bush's second. The total dollar amount
of the pork was harder to gauge—some earmarks are legitimate—but by
