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  Increased government spending was not the centerpiece of FDR’s initial program to resuscitate the economy. Indeed, the new president’s insistence on personally approving public works projects one by one slowed the flow of money. Instead, FDR sought to thwart a devastating deflation by using government muscle to raise wages and prices, control and plan production and employment, change the price of gold, and expand the supply of credit. “Spending,” Stein wrote, “was the ugly duckling of Roosevelt’s 1933 barnyard, not to become the swan for several years, and then mainly by default”—that is, after other steps didn’t work as hoped or were declared unconstitutional. “Unemployment remained high. Something had to be done, and more spending was left as the only thing that could be done.”

  Roosevelt’s New Deal left an indelible mark on America, some of it physical. The bridges that government-paid workers built back then still punctuate the Merritt Parkway in Connecticut, while Dealey Plaza, scene of John F. Kennedy’s assassination, is still a melancholic swath of green in downtown Dallas. Largely because of the growing scale of the federal government, the population of Washington, D.C., grew more in the 1930s—176,000 new residents, a 36 percent increase—than in the previous two decades combined. Many agencies created then are now permanent fixtures: the Federal Deposit Insurance Corporation, which insures bank deposits; the Federal Housing Administration, which guarantees some mortgages; the Tennessee Valley Authority, which sells electricity; and the Securities and Exchange Commission, which regulates the stock market. In a move with lasting consequences for the power of the presidency, the Bureau of the Budget was moved in 1939 from the Treasury to a new Executive Office of the President, centralizing the preparation of the annual budget in the White House and permanently elevating the president’s role in budgeting.

  The New Deal left other legacies, too. Tough talk about fiscal rectitude and avoiding debt would persist, but, as Stein wrote in the late 1960s, “Never again would there be a serious effort, like Hoover’s of 1932, to balance the budget in a depression or offset the revenue loss caused by the depression itself.” In fact, the big economic lesson to take root as a result of the Great Depression, elaborated by Britain’s John Maynard Keynes, the twentieth-century economic giant, was that the government and the Federal Reserve had been too stingy and that only government spending pulled the U.S. economy out of the ditch. This view informed the economic strategies of presidents through George W. Bush (who successfully proposed a little-remembered tax cut in 2008 intended to give the economy a lift) and Barack Obama.

  Lately, though, Keynesian “truths” have come under attack—in some academic circles first and, more recently, in political circles—as the economy has languished despite massive government efforts to revive it. “In three short years, an unprecedented explosion of spending, with borrowed money, has added trillions to an already unaffordable national debt,” Indiana governor Mitch Daniels said in the Republican response to Obama’s 2012 State of the Union address. “The President’s grand experiment in trickle-down government has held back rather than sped economic recovery. He seems to sincerely believe we can build a middle class out of government jobs paid for with borrowed dollars.”

  With Social Security—the first of the enduring and popular social programs that enlarged the federal government’s role in providing for the poor, sick, and elderly—FDR also planted the seeds of the modern American welfare state and a bigger federal government. When he died in 1945, government spending, swollen by the cost of fighting World War II, exceeded 40 percent of GDP. It fell after the war but would never return to pre-FDR levels.

  “From the mid-1930s to the 1970s, the government made a set of commitments that led to expectations on the part of the American people about what their government owes them,” says Robert Reischauer, a former director of the Congressional Budget Office. “And they’re totally unprepared to go back to a different world.”

  THE GREAT SOCIETY: GUNS, BUTTER, AND MEDICARE

  In the burst of prosperity after World War II, Leon Panetta’s parents sold the restaurant and sunk their profits into a twelve-acre walnut farm in Carmel, where Leon and his wife, Sylvia, now live when he’s not in Washington. “My dad used to have a pole and hook, and shake every one of these branches, and hit the walnuts,” he once said. “And my brother and I used to be underneath collecting the walnuts, putting ’em in sacks. And, you know, my dad often said I was well-trained to go to Washington because I’d been dodging these nuts all my life.” Panetta went to college and law school at Santa Clara University, a Jesuit institution, and then did two years in army intelligence.

  In 1966, he met the nuts face-to-face.

  Rejecting his father’s advice to settle down and practice law, he looked instead toward Washington. “I had read about Joe Califano [an aide to LBJ] so I wrote him and said, ‘I don’t know you. I’m very proud of you as an Italian. I happen to be Italian. Is there a way for me to get involved in government?’ Sure enough, he wrote and set up some appointments.… I went to the Justice Department. I went to the Pentagon. I went to other agencies, and I decided I wanted to go to Capitol Hill. So I walked into [Senator Tom] Kuchel’s office; they had an opening for a legislative assistant. I didn’t know the senator, I didn’t know anybody there. They looked at my background. He liked the fact that I was a lawyer, he liked the fact that I had been in the army, and he hired me.”

  The Congress for which Panetta went to work in 1966 was strikingly different from today’s polarized institution in which one party regularly passes major legislation with few votes from the other, and often none. Party lines were far less predictable, in large part because of a cadre of southern Democrats that was considerably more conservative than a sizable group of liberal Republicans, including Kuchel.

  Still, Democrats dominated the federal government in 1966. Amid the increasingly unpopular Vietnam War, LBJ was completing the domestic agenda that Roosevelt and his successor, Harry Truman, had laid out. Federal spending rose steadily as Johnson refused to choose, in the lingo of the day, between guns and butter, hitting a peak for that era of 20.5 percent of GDP in 1968. But nothing that Johnson did left a fiscal legacy as enduring as the creation of the all-federal Medicare health insurance program for the aged and Medicaid for the poor, the cost of which is split between state and federal governments. Before Medicare, only about half the elderly had any health insurance. Many employers didn’t cover retirees, and much of the available private insurance was lousy. Back then, one in five seniors hadn’t seen a doctor in the previous two years; after Medicare, that figure settled at roughly one in twelve. Columbia University economist Frank Lichtenberg estimates that the typical older American spends about 13 percent fewer days sick in bed because of Medicare and that the program has increased the odds that a sixty-five-year-old will make it to age seventy by about 13 percent.

  But Medicare is a leading example of the law of unintended consequences. It’s a living laboratory. Science moves in unpredictable spurts. Government incentives often do much more or much less than expected. Profit-minded entrepreneurs exploit the government’s largesse. Costs squeezed out of one place pop up elsewhere; save money by discouraging inpatient surgery and outpatient surgery costs skyrocket, for instance. And it is increasingly expensive. Adjusted for inflation, the federal government spent more on Medicare and Medicaid in 2011 than it spent on everything in 1960.

  In 1968, Senator Kuchel was defeated in a primary by a more conservative Republican, and Panetta ended up in the Nixon administration overseeing federal efforts to force southern schools to desegregate in what was then the Department of Health, Education, and Welfare. The job lasted only fourteen months. Nixon’s interest in courting the South conflicted with young Panetta’s aggressiveness in enforcing the law. He was fired and wrote a book about the episode, Bring Us Together. The cover on one of the later printings identified him as “the man who blew the whistle on the Nixon administration two years before Watergate.” After a stint working for Ne
w York mayor John Lindsay, he went home to practice law with his brother.

  NIXON: CONGRESS STRIKES BACK

  Among his other accomplishments (or transgressions), Richard Nixon antagonized Congress by refusing to spend billions of dollars that lawmakers had approved. In 1974, Congress struck back with the Congressional Budget Act, passed over Nixon’s veto a month before he resigned. It created a congressional budget process parallel to the president-centric system created in FDR’s time. New House and Senate budget committees were established to coordinate panels responsible for tax and spending bills, and a series of target dates for action each year was set to impose order on the process. The most durable innovation was the creation of the Congressional Budget Office, or CBO, which freed Congress from relying almost exclusively on economic forecasts and budget analysis from the White House budget office.

  In recent years, the process envisioned in the 1974 law has broken down amid partisan discord. In 2010 and 2011, the two houses of Congress failed to agree on the mandated budget blueprint. Congress hasn’t finished annual spending bills before the October 1 start to the fiscal year since 1998. But in a city riddled with dysfunctional institutions, the CBO has become one of the few organs of Congress that actually work. It is the arbiter of facts, a call-it-as-we-see-it outfit that is viewed as largely immune to political pressure.

  When the CBO was conceived, the Senate imagined a high-powered think tank with a director, as then Senate Budget Committee chairman Ed Muskie said, “who can grasp the dimensions of the global problem that this new committee is going to be struggling with.” The House imagined something quite different. As Robert Reischauer, a former CBO director, once put it: “Congress would have a bill or something, and it would lift up the manhole cover and put the bill down it, and you would hear grinding noises, and 20 minutes later a piece of paper would be handed up with a cost estimate.” It was, he said, “to be non-controversial the way the sewer system is.”

  The Senate won and, over the objections of some in the House, Alice Rivlin became the first director of the agency. Rivlin was a pioneer. Rejected by Harvard’s graduate school of public administration, now the Kennedy School of Government, in the 1950s “on the explicit grounds that a woman of marriageable age was a ‘poor risk,’ ” she turned to economics, then a field in which about 5 percent of Ph.D. students were female. “In retrospect, the amazing thing was that the women were not more outraged,” she says. “I think we thought we were lucky to be there at all.” Outwitting the system was kind of a game. One of the university libraries was closed to women, and its books could not even be borrowed for a female on inter-library loan. “I don’t remember being upset. If I needed a book, I just got a male friend to check it out for me,” she recalls. With academic tenure-track jobs largely closed to women, she spent her early career alternating between government (the Johnson-era Department of Health, Education, and Welfare) and think tanks (the Brookings Institution, which is largely populated by Democrats).

  Rivlin is short in stature, less than five feet, but steely. She was determined to build an institution with influence and independence. At age eighty-one she remains an active and formidable advocate for fiscal rectitude, serving on blue-ribbon panels and appearing on public forums. With Muskie’s backing, she built a staff independent of what she called the “schmoozy, good ol’ boy Hill culture.” While the CBO director job has alternated between Democrats and Republicans, the culture of nonpartisan analysis built by Rivlin and her Republican successor, Rudy Penner, has endured. Rivlin annoyed President Jimmy Carter with skepticism about his energy proposals. Reischauer, a Democrat, resisted Clinton White House pressure to avoid labeling as “taxes” rather than “premiums” the mandatory employer contributions to health insurance in Clinton’s health plan. Douglas Holtz-Eakin disappointed his fellow Republicans who wanted the CBO to count more of the economic benefits of tax cuts when putting a price tag on them. When the current CBO director, Douglas Elmendorf, wouldn’t vouch for Obama White House predictions of big savings from the president’s health care reforms, Peter Orszag—the White House budget director who had preceded Elmendorf in the CBO post—protested publicly that his successor was “overstepping.” For budget geeks, it was like the showdown at the O.K. Corral, albeit by dueling blog posts. “Elmendorf,” businessman-turned-commentator RJ Eskow wrote in the Huffington Post, “is the stone-faced banker who won’t lend the money, while Orszag’s the inventor holding a prototype of the hula hoop.”

  This pressure on the CBO can actually encourage truth telling, says Holtz-Eakin. “In the end, everyone will always complain to you, so it gets easier to just tell the truth,” he says. Congressmen want someone “to kick in public” but most value a scorekeeper that tries to be objective, he says. And even when they don’t like the CBO’s conclusions, members of Congress value the leverage the office gives Congress in its budget dustups with the White House.

  “To a degree that may have been unforeseen when the 1974 act was formulated,” University of Maryland budget maven Allen Schick says, “the new system institutionalized and expanded budgetary conflict.” Eventually, the two branches have to agree on spending bills or the government shuts down. “But first,” says Schick, “they fight … [not] over the details, as was once common, [but] over big policy matters—the size of government, defense versus domestic programs, how much total spending and revenues should rise … whether to cut the deficit by trimming expenditures or by boosting taxes, and so on.”

  THE REAGAN REVOLUTION: THE BEAST IS NOT STARVED

  In 1975, a year after the CBO was created, the budget hit a little-noticed milestone: for the first time, spending on interest, Social Security, Medicare, and other benefits exceeded the defense and domestic spending that Congress must approve annually. A year later, having become a Democrat, Panetta was elected to Congress from his hometown. Four years further on, fellow Californian Ronald Reagan was elected president.

  The Reagan presidency was styled as a turning point in American politics: the end of the New Deal and the beginning of an era in which the government would retreat from the economy. Ronald Reagan made three significant fiscal promises during his campaign for president: cut taxes, rebuild the nation’s defenses, and balance the budget. He delivered on the first two, but not on the third.

  Later, the notion that cutting taxes would lead to compensating cuts in government spending became known as the “starve the beast” strategy, a phrase made famous by Daniel Patrick Moynihan, the late, erudite Democratic senator from New York. In his usual folksy style, Reagan lent credence to this theory in a February 1981 televised speech: “Well, you know, we can lecture our children about extravagance until we run out of voice and breath. Or we can cure their extravagance by simply reducing their allowance.”

  But insider accounts of the Reagan years describe a haphazard, almost chaotic process inside the White House. Some Reagan aides were committed to cutting spending, notably David Stockman, the Paul Ryan of his day. Elected to Congress at age thirty, Stockman left the House of Representatives after four years to become Reagan’s budget director, determined to dismantle vast segments of the welfare state. “If you insisted on a balanced budget but accepted all the illicit welfare-state spending commitments that have been accumulated over the years … you became the tax collector for the welfare state,” Stockman wrote in his memoir. He did not want that role.

  Another group around Reagan, known as the supply-siders, argued that cutting tax rates would unleash a surge of economic activity from the producers in the economy. Within the White House, they derided Stockman and his allies as “root canal” Republicans determined to inflict the pain of spending cuts to pursue a misguided antipathy toward deficits.

  One of the supply-siders, Jude Wanniski, a Wall Street Journal editorial writer, had popularized what he called the “Two Santa Claus Theory” in 1976: “The Democrats, the party of income redistribution, are best suited for the role of Spending Santa Claus. The Republicans, trad
itionally the party of income growth, should be the Santa Claus of Tax Reduction. It has been the failure of the GOP to stick to this traditional role that has caused much of the nation’s economic misery.… It isn’t that Republicans don’t enjoy cutting taxes. They love it. But there is something in the Republican chemistry that causes the GOP to become hypnotized by the prospect of an imbalanced budget.… [T]hey embrace the role of Scrooge, playing into the hands of the Democrats, who know the first rule of successful politics is Never Shoot Santa Claus.”

  On spending, much of the Reagan cabinet and a good chunk of the Republican congressional leadership labored to shield their favorite programs from Stockman’s knife. And they succeeded.

  Even without the spending cuts, the Reagan tax cut passed in 1981. More than half the Democrats in the House voted for the bill, Panetta among them, despite his later criticism of it. He already had voted for a smaller tax cut, a compromise offered by Representative Dan Rostenkowski of Illinois, then the chairman of the tax-writing committee. But that bill had failed. “At that point,” Panetta said in a recent interview, “I thought I’d been fighting [Reagan] on every front, and he was very popular in my district, and I said, you know, having voted for the Rostenkowski tax cut, I just find it very difficult to now turn around and suddenly vote against [the Reagan] tax cut. That’s the scenario.”

  The Reagan tax cut was gigantic: its provisions, the Treasury estimated later, would have slashed federal revenues by 18 percent in the first two years. “If the American political system had acted the way it normally does, it would have lopped off the extremes and forced a compromise within moderate bounds,” Richard Darman, a Reagan White House aide and later George H. W. Bush’s budget director, recalled in his memoir. “But in this case, even as it became absolutely clear that necessary spending control would not be achieved, the system allowed a way-out-of-the-ordinary tax cut to become law.”