The Great Deformation

by David Stockman

  The equally unassailable fact, however, was that the president and the White House spin machine never took ownership of these legislative actions. Indeed, the Reagan White House hardly even acknowledged that they occurred.

  Consequently, as time passed and the American economy moved into the faux prosperity of the 1990s, a whole generation of Republican politicians grew up without knowing four important truths. The most important was that the 1981 Reagan legislative program had been a fiscal disaster. The huge tax reduction without a matched book of spending cuts caused the structural deficit to literally explode to the then unimaginable level of 6 percent of GDP.

  Secondly, the actual deficit during the second Reagan term was brought down to a still exceedingly high 3.5 percent of GDP average only through a series of major tax increases over 1982–1984. These unavoidable measures had actually been grounded in the old-time Republican doctrine that government should pay its bills.

  Thirdly, these unavoidable tax measures to pay the government’s bills did not block the economic recovery. This was resoundingly affirmed by the 5.4 percent average GDP growth rate during 1983–1985, a three-year expansion rate that was on par with prior recoveries from deep recessions.

  Finally, at the time of the “morning in America” celebration, the weighted average cost of the US debt was still in double digits. Had the 6 percent of GDP structural deficit not been corrected by these tax increases, a “debt trap” would have soon erupted as interest payments spiraled out of control. Save for the “tax grabbers” in the White House and GOP congressional leadership, the Reagan economic legacy would have been in ruins before his second term was complete.

  THE STARVE THE BEAST MYTH:

  NEVER PROCLAIMED BUT INDISPUTEDLY FAILED

  The yawning fiscal gap which made these serial revenue recovery measures necessary also provided a real-world experiment in the “starve the beast” theory of tax cuts. It failed the test completely.

  At that point in fiscal history, the prospect of a 6 percent of GDP structural deficit during peacetime full employment was truly frightening. So if there was ever a circumstance in which politicians could literally be bludgeoned into large-scale spending cuts, this was it.

  Yet notwithstanding the massive outpouring of red ink during the remainder of the Reagan tenure, there was no measureable progress in contracting the welfare state after 1981. This failure to make a dent in the federal spending claim on GDP is evident in the fiscal data for the second Reagan term.

  By then the American economy was in a strong recovery, and counter-cyclical spending for unemployment had largely ceased. Nevertheless, federal outlays still averaged 21.7 percent of GDP—a figure which, as indicated above, is actually higher than the 21.1 percent of GDP average during the four “big spending” Carter years.

  The Reagan defense buildup, of course, did add about 1 percentage point of GDP to total spending compared to the Carter average. Yet the real explanation for the fact that Ronald Reagan presided over the highest peacetime spending share of GDP yet recorded is that the US welfare state simply refused to shrink very much during the second Reagan term, even after the huge mandate of the 1984 election and with the tailwind of a strong economy.

  Specifically, federal spending excluding defense and foreign security assistance during the second Reagan term averaged 15.5 percent of GDP, representing an exceedingly modest improvement from the 15.9 percent average during the Carter years. The threat of massive structural deficits did not drive a contraction of the welfare state during the post-recession Reagan years because politics, not the exigencies of fiscal policy, had already decided the outcome—way back in the spring of 1981.

  THE SCHWEIKER PLAN: REAGAN’S FISCAL WATERLOO

  The referendum on domestic spending that Ronald Reagan promised in the 1980 campaign was short-lived, having reached its high-water mark with the passage of the budget resolution in April 1981. After that, nearly every new spending reduction initiative, such as the May 1981 Social Security reform plan, was dead on arrival on Capitol Hill, while many of the initial budget resolution cuts were watered down or circumvented with the passage of time.

  The demise of the May 12, 1981, Social Security reform plan within ten days of its unveiling powerfully illuminates this deep political resistance to serious welfare state retrenchment. Needless to say, these powerful head-winds arose from all points on the partisan compass, especially from inside the Reagan White House itself.

  There was no real mystery as to why three months after the original Reagan fiscal plan had been launched, and after its apparent triumph in the congressional budget resolution approved in April, that a second sweeping spending cut initiative was being presented to the Congress. The original plan had a big hole in its center; namely, a $44 billion per year spending cut based on additional measures “to be proposed.”

  This huge due bill had been dubbed the “magic asterisk” by Senate Majority Leader Howard Baker. The Senate GOP leaders had reluctantly gone along with this expedient in the budget resolution, since it was only a non-binding fiscal blueprint in the first place; in effect, a list of items “to be enacted” in subsequent tax and spending legislation. Still, the GOP fiscal stalwarts who ran the Senate were not happy about balancing the budget with what appeared to be a large quotient of bottled air.

  Therefore, they expected additional spending cuts from the White House, meaning that there actually wasn’t anything particularly magical about the $44 billion. It most certainly was not some nefarious trick designed to bamboozle the Congress. What Senate GOP leadership had not prepared its rank and file for, however, was that this second installment of spending cuts would inexorably involve a frontal assault on Social Security.

  Indeed, the $44 billion had been an obvious “placeholder” for what I had always intended; namely, a direct assault on the misguided “social insurance” foundation of Social Security which dated all the way back to the New Deal. But just as in the case of the DOD top line, the “placeholder” expedient had been resorted to because there had not been time in the short interval between inauguration and February 18 to delve into the program’s vast complexity.

  Even with the extra time through its May 12 launch, however, the White House Social Security reform plan had been only the opening salvo, not the full measure of retrenchment needed to make the Reagan fiscal plan solvent. Yet the plan did attack an important target; namely, the elimination of some of the more egregious “unearned benefits” which had been added to the program during earlier flush times.

  The most important of these was partially eliminating the huge mistake called “double indexing” that the usual suspect, Richard Nixon, had signed into law on the eve of the 1972 election. In addition to the debatable but understandable provision for automatically increasing the benefits of existing retirees by the annual CPI gain, the 1972 legislation had also made an additional huge fiscal mistake. It effectively indexed the wages of the entire active workforce, reaching all the way down to eighteen-year-olds first entering the job market, to each year’s gain in consumer prices plus national productivity.

  Accordingly, after forty years in the workforce, the benefits of every retiree would now be massively higher than warranted by their own payroll tax contributions, owing to the compounding effect of this wage index kicker. The May 12 White House plan didn’t eliminate but did materially dilute these transparently unearned benefits, along with a number of other like and similar reforms.

  For instance, the penalty for early retirement at age sixty-two was raised from 20 percent 45 percent. Likewise, the unearned “minimum benefit” was phased out, and extraneous payments to student dependents and certain types of disability recipients were also eliminated.

  None of these benefits had been earned and they had not been included in the original scheme. Not only was the principle of reducing unearned benefits eminently sensible, but it also cut about $40 billion from federal spending after a few years of transition, thereby plugging the magic a
sterisk hole.

  Still, these initial reforms amounted to only about 1 percent of GDP. A serious shrinkage of the welfare state would have required a far more extensive and direct attack on social insurance; that is, on the principle of non-means-tested income transfers.

  Nevertheless, this modest “unearned” benefit reform plan had actually been one of the few anti-spending measures that President Reagan had firmly grasped and had enthusiastically embraced. At the White House meeting during which the plan was approved, he had summarized the unearned benefits issue succinctly: “I’ve been warning since 1964 that Social Security was heading for bankruptcy,” he had said, “and this is one of the reasons why.”

  Yet fiscal disaster at some point down the road or not, the White House political staff led by Jim Baker was not about to run the risk of a political disaster in the here and now. It was thus decreed that the plan would not be issued by the White House, but by the secretary of Health and Human Services, Richard Schweiker.

  Instantly, the politicians on Capitol Hill smelled blood, and the speed of the plan’s demise became one for the record books. The OMB notes from the daily White House staff meeting dramatically map the historical inflection point which was at hand. Three days after the plan’s announcement, the staff marching orders were “Social Security—need strong efforts to inform people about the President’s proposal.”

  By the seventh day, the daily talking point had become “We’re not backing off on this, but the President will not lead.” And by May 21, ten days of history had been revised with such alacrity as to make a Soviet historian blush: “Social Security—need to get this off the front page. Only submitted to the Hill in response to a request from a Congressional committee for a position…. No Presidential involvement.”

  Then and there, it was clear that the welfare state would not give ground, and that it was destined to grow inexorably in the years ahead owing to the embedded demographics of the baby boom, and the relentless indexing of unearned benefits. In fact, the complex of non-means-tested social insurance programs including Social Security, Medicare, and unemployment insurance was 6 percent of GDP in 1981 and is 10 percent today—heading for 15 percent by the end of this decade.

  History sometimes kindly provides an exclamation mark to signify the finality or unequivocal nature of an episode. In this case, the political uproar was so deafening that the Senate Republican leadership felt compelled to introduce a resolution condemning the Administration’s package of reforms. It passed the same day by a vote of 96 to 0.

  Not only did that vote permanently bury any prospect for reforming the dense complex of social insurance programs which comprise the core of the welfare state, but it also implanted a fiscal litmus test for the ages: whenever politicians talk about shrinking the size of government and returning the tax burden to pre-1980 levels, they are either indulging in pure pettifoggery or they mean to embrace the “Schweiker plan” at the very least. The fiscal math simply admits of no other alternative.

  Propagators of the myth that Reagan cut domestic spending have attempted to deny this, dismissing the Schweiker plan meltdown as historically insignificant on the grounds that it was flawed and hurried. Yet the historical record proves otherwise.

  There may have been a better plan than the ill-fated Schweiker package, but none has been seriously proposed for three decades now. Indeed, the one episode of major legislative action on Social Security—the 1983 Greenspan Commission solvency plan—proves that the door to significant retrenchment of social insurance had now been slammed shut.

  The Greenspan Commission plan has been hailed as a bipartisan success, and appropriately so. It did the only thing bipartisan plans can do: it raised taxes substantially—through a higher payroll tax rate, a substantial rise in the taxable wage base, and by forcing state and local government employees into the system.

  These measures did keep the mythical “trust funds” solvent in the intermediate term. Additionally, the overall plan attempted to camouflage its front-loaded pile of taxes by means of a well-advertised but modest increase in the retirement age. The latter incepted twenty years from the effective date and did not become fully implemented for forty years, which is to say, not even yet. Thus, in the fiscal here and now the Greenspan plan was a tax increase pure and simple.

  Nor did the core tax-raising piece of the plan have only a minor impact. The payroll tax share of GDP was boosted by nearly a full percentage point. Accordingly, middle-class families were permanently shuffled deeper into the regressive zone of the US taxation system.

  The average payroll tax burden for middle-income families rose from 9.5 percent of earnings in 1980 to 11.8 percent by 1988. By contrast, the income tax share had fallen and by 1988 was down to 6.6 percent of middle-class earnings, reflecting a burden that was now barely half the payroll tax extraction.

  In those days, the bipartisan majority which passed the plan still believed that government had to pay its bills. But in raising taxes on the working class to do so, there was some considerable irony in it.

  RONALD W. REAGAN: TAX COLLECTOR FOR THE WELFARE STATE

  At the time the Schweiker plan had been approved by the White House, President Reagan had stoutly insisted that he would not go the easy route of tax increases to paper over the system’s insolvency for just a while longer. Indeed, he had a deep disdain for the 1977 Carter legislation which did just that: “They gave us the largest tax increase in history and said it would be sound until the year 2030,” the president had remarked. “Now we’re here four years later and it’s already bankrupt.”

  Nevertheless, two years later Ronald Reagan fulsomely praised the bipartisan tax-raising plan, using nearly the identical words that Jimmy Carter had employed about achieving long-term solvency. But in assuring the public that Social Security had (again) been made solvent for a generation, the president had crossed a fiscal Rubicon that has been denied by his hagiographers ever since. The truth is, once he abandoned the Schweiker plan in favor of the bipartisan solvency package, Ronald Reagan became the tax collector for the welfare state—no longer its bête noire.

  In short, the Schweiker plan and the Greenspan plan were bookends in time which captured a turning point in fiscal history. After that, the true issue was how to finance the welfare state efficiently, fairly, and with minimum damage to the American economy.

  To be sure, a minority of junior backbenchers, led by Newt Gingrich, voted against the Greenspan plan in March 1983. For decades thereafter, they denounced any recidivist tendencies within the GOP toward the old-time fiscal religion of balanced budgets as evidence of wanting to do what Ronald Reagan actually did; namely, become tax collectors for the welfare state.

  But the questions that subsequent history has proved they could not answer were strikingly evident even then. There was no alternative to higher taxes except to strike at the social insurance core of the welfare state. If not Ronald Reagan, who? If not in May 1981, when?

  In any event, history rolled along its chosen course and the American welfare state did not shrink. Outlays for domestic programs in 1986 totaled $516 billion, a figure only 9 percent smaller than the $568 billion that would have been spent under the inherited Carter policies.

  The main reason for this tepid reduction is that fully 55 percent of the Welfare State budget even then consisted of social insurance: Medicare, Social Security, unemployment insurance, and other non-means-tested income support programs. Quite evidently, there had been no Reagan Revolution on the social insurance front.

  The modest 7 percent reduction that actually had been realized versus the inherited Carter baseline represented minor benefit tinkering and a one-time three months’ delay of the Social Security cost of living adjustment (COLA). In the main, however, these savings were achieved by the imposition of un-Reagan-like price controls on Medicare hospitals.

  Another sizeable portion of the domestic budget was comprised of spending for veterans and agriculture. These programs were blessed with strong
Republican constituencies, and, in turn, were favored with only a token 2 percent reduction.

  Even out-and-out “welfare” programs like food stamps, Medicaid, and Aid to Families with Dependent Children (AFDC) had been reduced from the Carter level by just 10 percent. There turned out to be fewer welfare queens and more arguably needy participants in these programs than Republican campaign rhetoric had implied.

  At the end of the day, the only deep spending reduction that actually occurred was in a tiny corner of the budget consisting of Great Society employment and community services programs, which were shrunk by 25 percent from the Carter levels. Unfortunately, these savings amounted to just $12 billion annually or hardly 1 percent of the $1 trillion in total federal outlays during 1986.

  And so it went. The Reagan Revolution turned out to be nothing of the kind when it came to domestic spending. It did not even constitute an era of meaningful reform. Instead, a few programs were pruned, no new ones were started, and the vast bulk of federal activities carried on as before.

  In fiscal terms, the domestic welfare state remained at 15.5 percent of GDP. That was just a hair below where the Carter administration had left it and where it remained through the end of Bill Clinton’s second term.

  THE GROWTH CURE FOR DEFICITS: SUPPLY-SIDE FANTASY

  A bastardized variation of supply-side theory has been embraced by Republican politicians in the years since Reagan. They have not explicitly claimed that deficits are harmless—they have just attempted to define the issue away. The argument has been that deficits are essentially the by-product of a weak economy and that the solution, therefore, is to undertake policy actions directed at growing the GDP, not shrinking the budget columns.

  Not surprisingly, the way to get more GDP growth is claimed always and everywhere to be through lower taxes. In due course, fiscal deficits disappear because the economy grows the revenue line back to balance. The trouble with this shibboleth is that it was put to the test and failed a long time ago, during the Reagan-Bush recovery after 1982.