Red Ink Page 2

  The $700 billion bank bailout didn’t cost taxpayers nearly as much as initially feared.

  The financial crisis was an economic calamity. It provoked the worst recession since the Great Depression, the cost of which went far beyond the boundaries of the federal budget. The Great Recession, as it became known, wiped out $7 trillion in home equity. Two and a half years after the economy had resumed growing, nearly 13 million Americans were still out of work. The United States faced significant deficits even before the recession, but the size of today’s record-busting budget deficits are, in large measure, the consequence of revenues lost, taxes cut, and spending increased because of the recession.

  In rescuing the banks, the big insurance company American International Group (AIG), money market mutual funds, and automakers General Motors and Chrysler, the government—that is, the taxpayers—took enormous risks. “At one point, the federal government guaranteed or insured $4.4 trillion in face value of financial assets. If the financial system had suffered another shock on the road to recovery, taxpayers would have faced staggering losses,” the bailout’s Congressional Oversight Panel concluded in its final report. Indeed, private investors who risked their money to shore up big financial institutions—Warren Buffett, for one—demanded much better returns than the government did.

  But actual direct cost to taxpayers for the much-maligned bailout of the banks proved to be a lot lower than expected. The sticker price on the Troubled Asset Relief Program (TARP) was $700 billion, the mind-blowing sum that George W. Bush and his Treasury secretary, Hank Paulson, got from Congress in October 2008. As of the end of March 2012, the Treasury said it had disbursed or promised only $470 billion of the $700 billion. In the end, it turned out, the banks didn’t need all the money that Congress authorized, and the government didn’t spend all $50 billion Congress originally earmarked for beleaguered homeowners.

  By early 2012, about 67 percent of the money that went out had been paid back with interest, another $12 billion had been written off, and much of the remainder looked likely to be recouped. The biggest losses to taxpayers are expected to come not from the banks but from AIG and GM; the ultimate cost depends on the price of the AIG and GM shares the government holds. At last tally, the CBO and the White House Office of Management and Budget projected the ultimate cost of the program will be between $32 billion (CBO) and $60 billion (OMB). But the headline is the same: the cost is significantly less than the hundreds of billions the agencies—and the media—anticipated in the darkest days of the financial crisis.

  The biggest direct hit to taxpayers from the financial crisis, so far, isn’t from TARP, but from the bailouts of Fannie Mae and Freddie Mac, the mortgage giants that were created by the government, later turned into private companies, and effectively nationalized in 2008. As of December 2011, the government had pumped a net of $151 billion into them and they weren’t close to standing on their own. The ultimate cost depends on housing prices.

  The share of income most American families pay in federal taxes has been falling for more than thirty years. Today, Americans pay less of their income in taxes than citizens of nearly every other developed country.

  There are a dozen ways to measure the slice of income that the government takes in taxes, and most point in the same direction. One meaningful metric: the CBO estimates that for families in the very middle of the middle class, the federal government took an average of 19.2 percent of their gross (before deductions) income in 1981 in income, payroll, and all other federal taxes. State and local taxes have risen for some since then, but the federal tax bite has eased. In 2007, just before the recession hit, according to the CBO, the tax take for these Americans was 14.3 percent—and it has fallen since. The Tax Policy Center, a joint venture of two Washington think tanks, the Urban Institute and the Brookings Institution, estimates that the folks in the middle of the middle paid 12.4 percent of their income in taxes in 2011.

  Nearly half of American households—46 percent—didn’t pay any federal income taxes at all in 2011. It’s not that they all cheated, though some did. Rather, the vast majority didn’t make enough money to owe taxes, or they took advantage of tax breaks that Congress has created to help the working poor, the elderly, and students, or to reward investors who put money into municipal bonds or other favored investments. About half of those who didn’t owe federal income taxes were hit by payroll taxes levied on wages to finance Social Security and Medicare.

  Americans turn over less of their income to local, state, and federal governments than citizens of almost any other rich country, even when taking into account that budgets of foreign governments often include the cost of providing health care for all, and in the United States less than a third of the populace gets health insurance through the government. The Organization for Economic Cooperation and Development, a Paris-based consortium of developed-country governments that makes apples-to-apples comparisons, says government at all levels in the United States took in taxes about 25 percent of the income in the economy in 2010. Twenty-seven countries took more, including Japan (27 percent), Canada (31 percent), the United Kingdom (35 percent), Germany (36 percent), and France (43 percent).

  The federal government gives up almost as much money from tax loopholes, deductions, credits, and all other tax breaks as it collects in individual and corporate income tax.

  The U.S. tax code is like a big piece of Swiss cheese. It has a lot of holes. Over time, Congress and presidents have cut new holes and expanded old ones. Taxpayers and their clever lawyers and accountants have also enlarged the holes, sometimes with help from the courts. More holes means the government has to get more money from somewhere else. All these tax breaks added up to about $1.1 trillion in 2011. That is approaching the total take of $1.3 trillion from the individual and corporate income tax.

  When “tax cuts” are politically popular and “government spending” is not, politicians favor new or bigger tax breaks over spending increases—to help college kids meet tuition bills, to encourage energy companies to develop alternatives to fossil fuels, you name it. This “spending through the tax code,” as it is sometimes called, is cherished by those who benefit and pushes up tax rates needed to finance the government. Hence, the growing enthusiasm for “tax reform” that would eliminate some of these tax breaks and bring down tax rates. But—and there’s always a but in these conversations—the bigger income tax breaks are by far the most popular: allowing homeowners to deduct mortgage interest payments and excluding employer-paid health insurance premiums from workers’ taxable income.

  For every dollar the U.S. government spent in 2011, it borrowed 36 cents, much of it from China, where the income per person is about one-sixth of that in the United States.

  Except for four unusual years at the end of the 1990s and the beginning of the 2000s, the federal government has spent more than it took in every year for the past four decades. It borrows the difference, essentially promising that taxpayers in the future will pick up the tab for government spending today. The U.S. government is by far the world’s biggest borrower even though the United States is by far the world’s biggest and richest economy, a historical anomaly. By any yardstick, its borrowing in recent years has been huge. Part of this was automatic: when people are out of work, they pay less in taxes, and government spending on unemployment benefits and food stamps goes up because more people qualify. Part of this was deliberate policy: Congress increased spending and cut taxes.

  The bottom line is that the U.S. government borrowed $3.6 billion a day in 2011, holidays and weekends included, or about $11,500 for every man, woman, and child in the country. About half of that borrowing came from overseas. The net interest tab on the government debt was about $230 billion last year, which exceeded the budgets of the departments of Commerce, Education, Energy, Homeland Security, Interior, Justice, and State, plus the federal courts, combined. As deficits persist and interest rates rise from recent very low levels, as they inevitably will, interest payments will c
laim an increasing slice of the federal budget, crowding out spending on other things.

  Today’s budget deficit is not an economic problem—tomorrow’s is.

  For all the dire rhetoric about the dangers of debt, all the scares about the United States becoming another (albeit far larger) Greece, big U.S. government deficits have not been an economic problem—at least not yet.

  The deficits have been big. Measured against the value of all the goods and services produced in the United States, known as the gross domestic product (GDP), deficits in the Ronald Reagan years peaked at 6 percent. In the past three years, they came in at 10 percent of GDP in 2009 (the fiscal year that spans the end of the George W. Bush presidency and the beginning of Barack Obama’s) and at 9 percent and 8.7 percent in the two subsequent years.

  Running bigger deficits in a deep recession and sluggish recovery is still Economics 101—even if one can get a good debate going among serious people about how best to do that and how well the medicine works. Running deficits means the government has to borrow the difference between income and outgo. The sum of all that borrowing is the government debt. Borrowing by government, banks, business, and consumers soared so much during the 2000s that at the end of 2008 the U.S. economy as a whole owed twice as much as it did in 1975, measured against the size of the economy. Since then, private borrowing has come down, but government borrowing has gone up—a lot—in a deliberate effort to cushion the economy from the pain caused when so many lenders pull back and so many borrowers try to pay off loans or walk away from them.

  Despite the anxiety about the capacity of a paralyzed political system to grapple with deficits projected for the future—and despite the headline-making move by ratings agency Standard & Poor’s to strip the U.S. Treasury of the prized AAA credit rating that signifies the safest risks—savers, investors, and governments around the world still view U.S. Treasury bonds as the most secure place to put their money. For now. The only other big government bond markets—Europe and Japan—are in places that have big problems of their own, which makes the United States the world’s tallest midget. What’s more, the flood of money from all over the world has pushed down the interest rate that the U.S. Treasury pays to fifty-year lows. But this ability to borrow enormous sums at incredibly low interest rates cannot and will not last forever, even if no one can say exactly when the day of reckoning will arrive.

  “A lot of us … didn’t see this last crisis as it came upon us. This one is really easy to see,” says Erskine Bowles, a former investment banker who was Bill Clinton’s chief of staff, later cochairman of an Obama-appointed commission on the deficit, and now an unlikely itinerant preacher on the urgency of dealing with the deficit. “The fiscal path we are on today is simply not sustainable. These deficits that we are incurring on an annual basis are like a cancer, and they are truly going to destroy this country from within unless we have the common sense to do something about it.

  “We face the most predictable economic crisis in history.”

  CHAPTER 2

  HOW WE GOT HERE

  At seventy-four years old, Leon Panetta is one of the few American politicians who can give a truly emotional speech about the federal deficit. Maybe that’s because he is one of a generation of thrifty Americans who elected politicians unwilling to fund many of the benefits they promised. Or maybe it’s because he has spent so much of his adult life in the belly of government—from the House of Representatives to the White House to, now, the top job at the Pentagon. “This country cannot continue to run trillion-dollar deficits and expect that we can remain a powerful nation,” Panetta has said, meshing a little old-time deficit religion with his current job. “When you run those size deficits … the borrowing we have to do around the world … makes us more dependent on those countries that are purchasing our securities. It deprives the country of the resources we need regardless of your priorities. Worst of all, it raises the most regressive tax of all: the tax on our children who have to ultimately pay the interest on that debt.”

  In textbooks, the chief governmental actors are the president, along with an amorphous institution called Congress, represented by the familiar profile of the Capitol. In the case of the budget, this simple model holds true—to a point. The president and the top leaders of Congress ultimately do make the big calls. But below decks is a squad of people who spend most of their careers contemplating, framing, influencing, negotiating, measuring, and executing decisions about spending and taxes.

  Panetta has been one of them. His life spans three-quarters of a century of evolving American fiscal policy, from Franklin D. Roosevelt to Barack Obama. He was born in June 1938 to Italian immigrants, owners of a small Northern California restaurant called Carmelo’s Café. At the time, Roosevelt’s New Deal was expanding the federal government dramatically. By the time Panetta came to Washington, in the mid-1960s, Lyndon Johnson’s Great Society was expanding it further, promising benefits in old age to then young baby boomers (including two of Panetta’s three children). As a Democratic congressman from California in the 1980s, Panetta voted for Ronald Reagan’s big 1981 tax cut, though he later condemned it as “a dangerous experiment” and a “riverboat gamble.”

  A decade later, Panetta was among a handful of congressional leaders who cut a deal in 1990 with President George H. W. Bush to raise taxes and cut spending, a move still controversial twenty years later. He was in Bill Clinton’s White House when the government ran its first budget surplus in nearly thirty years. And after a twelve-year hiatus in California, Panetta returned to Washington in 2009 as Obama’s CIA director, among those overseeing the killing of Osama bin Laden. In 2011, he became defense secretary, supervising a $700 billion budget, a sum so large that the Pentagon would be among the world’s twenty biggest economies if it were a nation. In 2012, the veteran of decades of deficit wars was warning of irreparable damage to U.S. national security if Congress didn’t undo legislation that would cut the defense budget in 2013 and beyond. “I’ve become very eclectic,” he says. A natural politician with an easygoing manner, Panetta has a disarming habit of launching a deep belly laugh at his own jokes. He laughs at this line.

  In 1938, Panetta’s birth year, federal spending came to 7.7 percent of the gross domestic product, or GDP, the value of all the goods and services produced in the United States that year. That simple ratio—the government spent almost 8 cents for every dollar of goods and services produced in America—prevents us from being confused by the changes that occur over time, such as the effects of inflation or the simple fact that America is not the same place it was three-quarters of a century ago.

  In 1938, for example, you could buy a pair of denim overalls out of the Sears catalog for 95 cents; in 2012, the same overalls cost $39.99, roughly forty times more. Adjusted only for inflation, federal spending has increased nearly thirtyfold since 1938. But the United States today has twice as many people as it did in 1938, which increases the cost of government the same way having more kids increases a family’s grocery bills. Every week, for example, thirty-two thousand more people enroll in Medicare, the government’s health insurance for the elderly.

  The United States is also far richer than it was in those Depression years. It can afford more of everything—cars, electronics, massages, restaurant meals, and government. Back then, the entire output of the U.S. economy was about $86 billion at 1938 prices, which is $1.1 trillion in current dollars. Since then the economy has grown to $15.1 trillion. That’s a much bigger pie. And the federal government is also spending a far larger share of it, roughly a quarter for every dollar of output, 24.1 percent last year versus 7.7 percent in 1938.

  Each decade of the fiscal history of the United States has been the subject of dozens of books. The Fiscal Revolution in America, by the late Herbert Stein, an economic adviser to Richard Nixon, ran to over six hundred pages—and that takes the story only through 1994. With budgets, as with so much of life, it’s hard to know where you’re headed until you know where you’v
e been.

  So here’s a quick history of the federal budget in six pieces.

  THE NEW DEAL: THE BEGINNING OF “BIG GOVERNMENT”

  From the end of World War I through the early years of the Great Depression, a “balanced budget” was regarded as an unquestioned virtue, and the U.S. government consistently ran surpluses. Until Congress created a Bureau of the Budget inside the Treasury in 1921, the president didn’t even submit an annual budget to Congress. At the end of 1931, Herbert Hoover, committed to the “balance the budget” orthodoxy of the day and determined to maintain the gold standard after the British abandoned it, proposed a tax increase. In words that echo those uttered in the halls of Congress today, Hoover told Congress in December 1931: “The first requirement of confidence and of economic recovery is financial stability of the United States Government. Even with increased taxation, the Government will reach the utmost safe limit of its borrowing capacity.” Taxes were raised and the Federal Reserve kept credit too tight. The federal government was smaller—4.3 percent of GDP in 1931—and narrower. About 70 percent of the spending went for three things: defense, veterans’ benefits, and interest payments on the national debt. “The federal budget was not then, as it later became, a machine constantly generating new programs and expansions of old ones,” Herbert Stein wrote.

  The Great Depression was well entrenched when Franklin Delano Roosevelt took office in March 1933. Six days after his inauguration, he picked up the “balanced budget” banner, telling Congress that the federal government was on the road to bankruptcy. “Too often in recent history, liberal governments have been wrecked on the rocks of loose fiscal policy,” he said. Roosevelt asked for emergency powers to cut spending and vowed that if they were granted, there was “a reasonable prospect” that within a year, the government’s income would be sufficient to cover its spending. He got the power he sought, but the budget wouldn’t be balanced until 1947.