Prepared for the
Public Policy Conference
Rebuilding America's Foundation:
Prosperity, Personal Freedom, and Private Enterprise
Federal Reserve Bank of Dallas
June 23, 1995
My subject today is bringing accountability to the federal budget process. Just what is accountability, and what we are to do to those who are held accountable when they fail? When they fail to do what? Holding people accountable--responsible for their actions--implies knowing who is responsible. It also implies having a standard against which to judge their performance.
Is the President responsible for federal spending? Certainly he--or perhaps sometime she--proposes a budget to the Congress. But according to Article I, Section 9 of the Constitution, "No money shall be drawn from the treasury, but in consequence of appropriations made by law." Ultimately, then, the executive branch cannot spend a dime that has not been voted on by the U.S. Congress.
And yet the Congress is amorphous. It is difficult to blame any particular representative or senator for the spending on any particular program. The amount of spending brought to a particular Congressional district or state by its elected representatives and senators is relatively minor in the context of the total federal budget. And single members of Congress are seldom considered responsible--or accountable--for the really big-items: retirement and health programs.
There was a long period of time when the President was more eager to spend money than the Congress: the Congress was the watchdog of federal spending. Some time after World War II this relationship shifted, and the Congress began to vote for more spending than the President proposed. Until 1974 the President had the power to withhold from spending funds the Congress had appropriated. With the November 1994 elections, we may have seen a shift back to the watchdog role of the Congress; but in fact it is too soon to tell.
In any event the federal budget has been growing relentlessly in relation to the U.S. economy--that is, as a percentage of Gross Domestic Product. In 1940 it was less than 10 percent of GDP. By 1950 it was 16.0 percent, 18.3 percent by 1960, 19.9 by 1970, 22.3 by 1980, 22.9 by 1990, and is estimated at 21.9 for this fiscal year, a reduction achieved mainly by cutting national defense expenditures.
The growth in budget outlays accelerated with the advent of the Great Society--the poverty and middle class entitlement programs of the 1960s. Social security, a 1930s depression program, expanded as well. During this time the defense budget bounced around a good deal, increasing during times of war and declining during peacetime. From the World War II high of 39.2 percent of GDP in 1944, it declined to 3.7 percent in 1948, rose to 14.5 percent during the Korean war, declined to 7.5 percent by 1965, increase to a 1968 high of 9.7 percent during the Vietnam war, hit a 4.8 percent post-Vietnam low, a cold-war high in the Reagan years of 6.5 percent in 1986, and has since declined to this year's 3.9 percent. Since the Korean War high the trend overall has been downward, and the decline in the defense budget has been used to finance social programs.
The current cycle of defense cut-backs has been used, in the Bush and Clinton presidencies, to finance social spending. As I have pointed out, the defense budget has its ups and downs. But even the Reagan peak of 6.5 percent of GDP was not unusual by post-World War II standards. What has been unusual, and is the major issue in the federal budget, is the growth of social spending--the overall category called "human resources." "Human resources" includes welfare, housing and food assistance, education, social security, Medicare, Medicaid, and much more.
Human resources absorbed 5.2 percent of GDP in 1960. In 1995 it will be 13.2 percent, an increase of 8 percentage points. It is this category above all that is responsible for the increase in federal spending and the deficits we have been running.
One of the major problems with the federal budget is, then, what we expect--and permit--of the federal government. What is considered an acceptable role for the federal government has expanded enormously. One of my ancestors--and I am sure many of you could tell similar stories--immigrated to the United States in 1850 as the new bride of a back-woods minister in Michigan. She had eleven children, three of whom died in infancy. There was no program for feeding pregnant women and their infant children. There was no Head Start. There was no Aid to Families with Dependent Children. There was no housing assistance or farm subsidies, no home heating assistance, no Medicaid, no Medicare, no social security.
Today all these programs exist, not only for citizens but for immigrants--and sometimes even illegal immigrants--as well. Constitutional decisions require that the states provide to immigrants all the benefits they provide to citizens; the federal government has legislated most benefits to immigrants that are provided to citizens, and mandates the states to pay the costs of emergency medical care and schooling for even illegal immigrants.
It is not only the entitlements. One of the things I learned as associate director of the Office of Management and Budget is that the federal government does virtually everything. A run-up in world oil prices produces a new program for subsidizing the home heating costs of the poor. The federal government tries to encourage exports and tourism. It not only finances research on health and science, it researches the fighting of fires and the processing of fish. Human beings have been processing fish for 5000 years--and in most of these years we did it tolerably well without federal assistance.
The greatly expanded role of the federal government--and, indeed, of state governments as well--is the major reason for the increased spending of governments and especially the federal government.
The second reason is the gradual erosion of the standard of a balanced budget. It used to be that a period of deficits--usually due to war--was followed by a return to balanced and even surplus budgets and the paying off of accumulated debt. World War I was followed by an entire decade of surplus budgets in the 1920s. In the 15 years following World War II, the budget was in surplus about half the time, with deficits about equal to surpluses in dollar amounts.
But since 1960 the federal budget has been in deficit in every year except 1969, when the surplus was a mere $3 billion. Ignoring 1969 that is 35 years of deficits--almost two generations--with no end in sight.
We need to continue to review, evaluate, and decide about the proper role of the federal government, and by doing so to strengthen the federal system not by delegating responsibility to the states, but by deciding to remove the federal government from some responsibilities, for example for welfare. And we need to re-establish the fiscal standard of a balanced budget as a fundamental standard of fiscal responsibility.
The most important change we can make in re-examining and limiting the scope of the federal government and restoring the standard of fiscal responsibility is to pass, in the Congress, a balanced budget/tax limitation amendment. The most recent draft of the amendment failed in the Senate by one vote; and the requirement for a three-fifths majority vote to raise taxes failed in the House. It was not a perfect amendment, and it is possible to argue that it is good that it failed--it gives us a chance at a better amendment in the future, one that does require an extraordinary majority to raise taxes.
It is not the Congressional passage of the amendment itself that will restore fiscal morality to the federal government and limit its scope. Nor will the existence of the words in the Constitution accomplish this purpose. Our Constitution has worked as well as it has because it reflects principles of government shared widely by the people. The most important part of a balanced budget amendment--especially one including tax limitation--is the process of ratification, in which people in the 50 states and the country as a whole debate the issues involved and re-establish an understanding of what it is the federal government is supposed to do and not do and how Congress is to keep the fiscal house in order.
[Election of 104th Congress changed the standards in one important respect: it nationalized the issues and established the keeping of promises as a fundamental standard in politics. In fact the American public has always expected promises to be kept, and has held politicians who failed to keep them accountable, unless they had very good reasons for reversing their course. George Bush paid dearly for his defaulted promise not to raise taxes.]
One of the reasons the balanced budget amendment has been so contentious is that it will require substantial change in what the government does. Every program beneficiary--and most of the most interested beneficiaries are the middle-men who deliver the goods and services, not those who ultimately receive them--is concerned about cut-backs in particular programs, and certainly everything would come under scrutiny.
But the basic structural problem with the budget cannot be solved without addressing the two areas that have grown the fastest and will continue to grow in the coming years--health and retirement. Medicare and social security, to be more specific.
If we look at the growth in the federal budget, the programmatic growth is entirely in the area of social programs. Between 1960 and 1995, the "human resources" category of the budget increased by 8 percentage points of GDP. All other programmatic areas--national defense, physical resources, other--declined. (Net interest went up by 2 percentage points.)
What is even worse, the major social programs, under current law, will continue to grow as a percentage of the Gross Domestic Product in the twenty-first century. There are two reasons. One is the demographic crisis--the retirement of the baby-boomers beginning in the year 2008. The second is the inflation in the costs of medical care.
Here are some estimates of the increase in social security and Medicare in the next century--this is, over the next 35 years, as a percentage of the Gross Domestic Product. Surely one could argue about them. I could complicate the issue by giving ranges. But the numbers are so large that even a low estimate forces the issue.
But first I want to emphasize that one percentage point of the Gross Domestic Product is a very large amount. It is one percent of everything--all final goods and services--produced in the United States. It is today about $70 billion--over $250 for every man, woman, and child in the United States. Another way I like to look at it is with this rule of thumb, which stands up pretty well over time: every increase in spending of one percentage point of the GDP would require, if financed with the current income tax on individuals and corporations, an income tax surcharge of 10 percent. I like this rule of thumb because we generally know what our income tax bill is for the year, and we can readily imagine what it would mean to pay 10 percent more in income tax than we now pay. Thus--an increase of 5 percentage points in federal spending--say, from 22 percent to 27 percent--would require a 50 percent surcharge on income taxes for all individuals and corporations.
Estimates of increases in social security (Old Age, Survivors and Disability Insurance) and Medicare (including the Hospital Insurance program and Supplementary Medical Insurance programs) as a percentage of GDP are very large, even under mid-range estimates. By the year 2010 the increase in outlays is over 2 percentage points of GDP. By 2020 it is 4.67 percentage points. If financed by a surcharge on income taxes, the rule of thumb says that this would require a surcharge of almost 50 percent. By the year 2030 the increase in these programs is almost 7 percent of GDP, for a 70 percent surcharge. And by the year 2070 it's over 8 percentage points, for an 80 percent surcharge.
In other words we are looking at an increase in taxes from the current level of a little over 19 percent of GDP to 27 percent of GDP, without even eliminating the deficit--which would require another 3 percentage points. This is a 50 percent increase in the proportion of the economy that is taken by the government.
Clearly the issue of responsibility to future generations is involved here. The people who will be paying the taxes are the children and young people of today. Meanwhile the time horizon of politicians tends to extend not much beyond the next election. The passage of a balanced budget/tax limitation amendment would go a long way toward encouraging the debate on the long-term structural problems of the federal budget and the appropriate role of the federal government.
Of the increase in the costs of federal retirement and health programs, the increase in the number of old folks--the demographic crisis--is responsible for a good portion of it. But inflation in medical care costs is also important. The most important action the Congress can take with respect to medical care costs is to get the individual back into the decision-making process by reducing the enormous tax incentives for comprehensive medical insurance policies.
Sources: Budget of the United States Government, Fiscal Year 1996: Historical Tables. U.S. Government Printing Office, Washington, D.C., 1995.
The 1995 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Trust Funds, April 3, 1995. 104th Congress, 1st Session. House Document 104-57. U.S. Government Printing Office, Washington, D.C., 1995.
The 1995 Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust Fund, April 3, 1995. 104th Congress, 1st Session. House Document 104-56. U.S. Government Printing Office, Washington, D.C., 1995.
The 1995 Annual Report of the Board of Trustees of the Federal Supplementary Medical Insurance Trust Fund, April 3, 1995. 104th Congress, 1st Session. House Document 104-55. U.S. Government Printing Office, Washington, D.C., 1995.