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  Whatever the reasons—Darman later (and characteristically) offered a ten-point explanation—the result was the 1981 tax cut without the hoped-for spending cuts. Stockman famously predicted deficits of “$200 billion a year as far as the eye can see,” numbers that sounded huge at the time. He was prescient. The 1980s broke a pattern in which the federal government ran big deficits only in wartime. The deficits topped $200 billion a year from 1983 through 1992. They would have been even bigger if Reagan hadn’t flinched on taxes, accepting significant tax increases in 1982 and 1984.

  Reagan enjoyed many victories as president. But starving the beast was not one of them. When he left office, federal spending was 20 percent higher, adjusted for inflation, than it had been when he arrived, and he never found a way to pay for it. In the twenty years before Reagan became president—under Kennedy, Johnson, Nixon, and Carter—the budget deficit averaged well under 1 percent of GDP. In Reagan’s eight years, it averaged 4.25 percent of GDP.

  Panetta summed up Reaganomics in a single sentence: “A significant tax cut was enacted at the same time that defense spending went up and … entitlement programs were also expanding.” When Reagan turned the presidency over to George H. W. Bush, the deficit was 2.8 percent of GDP—and rising.

  THE ARRIVAL OF SURPLUSES: READING GEORGE H. W. BUSH’s LIPS

  Bush was elected in 1988 with one memorable promise: “Read my lips, no new taxes.” Republican pollster Richard Wirthlin once called them “the six most destructive words in the history of presidential politics.”

  When Bush assumed the presidency, Panetta was chairman of the House Budget Committee, the panel created in the 1974 reforms of the budget process. From that perch, he decried “a borrow, bailout, and buy-out binger that pervades our society and puts our future economic security at risk,” warning further—in phrases that are heard again today—that “our capacity to govern” was being tested.

  “Both Democrats and Republicans talked about reducing this deficit, but neither wanted an approach to touch their favorite programs,” he recalled years later. “The Republicans said they would balance the budget, but they did not want to raise taxes, and they did not want to cut defense. The Democrats, on the other hand, said, ‘We want to balance the budget, but we don’t want to cut domestic programs, we don’t want to reduce any entitlement programs. What we want to do is reduce defense and raise taxes.’

  “So,” Panetta went on, “the very areas that had to be part of a solution were the areas that both parties staked out as holy territory that couldn’t be touched. That created the dilemma.” He was talking about 1990, but he could just as easily have been talking about 2012.

  About eighteen months after taking the oath of office, George H. W. Bush ate his words. In June 1990, after a two-hour breakfast at the White House with congressional leaders from both parties, Bush’s press office issued a statement: “It is clear to me”—the last two words were inserted at the insistence of the Senate Democratic leader, George Mitchell—“that both the size of the deficit problem and the need for a package that can be enacted require all of the following.…” The laundry list that followed included the politically salient phrase “tax revenue increases.”

  After three torturous months of negotiations, much of it at Andrews Air Force Base outside Washington, Richard Darman and the president’s other advisers cut a deal with Panetta and the congressional Democrats, who had a majority in Congress. Newt Gingrich, then the number two House Republican, led a rebellion—and the deal was rejected by the House. After three weeks, a new deal was cut. To woo more Democratic votes, tax rates on the rich were pushed higher than in the original agreement.

  “The American people have had enough of [being told] that somehow we can confront the deficit and it doesn’t involve pain,” Panetta told a reporter at the time. “The fact is that it does.” The final deal cut spending by $2 for every $1 of tax increases and, to the consternation of some Republicans, raised the top marginal income tax rate (the levy on each additional dollar of income) to 31 percent from 28 percent, the level to which it had been lowered in the Tax Reform Act of 1986.

  The vote tally for the 1990 deal underscores just how much Congress has changed. A Republican president relied on a majority of House Democrats (181 yes and 47 no) to overcome the opposition of a majority of House Republicans (74 yes and 126 no) to raise taxes and cut spending. Today, the idea that a president could appeal to a mixed-party center to win approval of any measure seems as quaint as a typewriter.

  “For Democrats during that period, with Republican presidents, we made the fundamental decision that governing was good politics for us [in terms of] maintaining our power,” Panetta recalled recently with the hindsight of more than twenty years. “I don’t get a sense today that either side thinks that governing is necessarily good politics.”

  The law did cut the deficit from what it otherwise would have been—a concept always easier for economists to grasp than the public—but still the deficit grew. The economy deteriorated, revenues fell short of projections, and spending on Medicare and Medicaid rose faster than anticipated. Rising deficits tarnished the image of a compromise born of a broken presidential promise. Bush later told TV interviewer Barbara Walters that the deal was “a mistake because it undermined to some degree my credibility with the American people.” But he insisted it hadn’t hurt the economy. Republicans often suggest otherwise and even today blame the deal for triggering a recession that began three months before it passed Congress. Darman, who died in 2008, blamed the recession on the Fed for not cutting interest rates quickly enough.

  From the vantage point of twenty years, the evidence favors those who say the deal restrained deficits from what they otherwise would have been. “The record shows that the 1990 budget deal was extremely effective in reducing deficits; the budget surpluses of the late 1990s owe much to the policies put in place by George H. W. Bush that his son and party later repudiated,” says Bruce Bartlett, a veteran of the Reagan and first Bush administrations who has become a critic of Republican fiscal policy.

  Beyond the important details of spending and taxes, the 1990 deal made two significant changes:

  It established a pay-as-you-go rule that made it hard for Congress to cut taxes or increase benefits without offsetting tax increases or spending cuts. For more than a decade, this rule restrained Congress from significant expansion of government benefits. A decade later, when this rule lapsed, Congress and the president did exactly what the rule sought to avoid: expanded Medicare to cover prescription drugs without funding the new program.

  After bumping up spending in the first year to buy congressional backing for the deal, the 1990 agreement also set multiyear caps on annual appropriations for the first time. Congress was, essentially, tying its own hands, or at least promising to do so. In one sense, the caps held. Adjusted for inflation, annually appropriated spending in 1996 was 13 percent below the 1990 level. But the total masks a key factor: “The Soviet Union fell apart, and there was no justification for such a huge military,” says Bob Reischauer. In 1990, outlays for defense were $300 billion, and outlays for domestic programs subject to annual appropriations were $200 billion. Six years later, they were even at $266 billion each.

  The 1990 deal was only a down payment, though. Debate over how much the government should spend and on what continued. “I think the most dangerous threat to our national security right now is debt, very heavy debt, that we confront in this country,” Panetta, then House Budget Committee chairman, lectured then defense secretary Richard B. Cheney and General Colin L. Powell, the chairman of the Joint Chiefs of Staff, at a 1992 hearing. “I don’t question anything you’re saying in terms of the role that this country ought to perform. My problem is how the hell are we going to pay for it?”

  Shortly after Bill Clinton was elected, he invited Panetta to Little Rock, Arkansas, where the president-elect was organizing his administration. “We talked a long time about the deficit, and, frankly, the campa
ign in ’92. Ross Perot [the Texas businessman who ran as a third-party candidate] had made the deficit a major issue of that campaign, which helped a great deal, ultimately, in trying to confront it.” Clinton’s advisers were split between those who wanted to reduce the deficit first and those who wanted to deliver on the campaign’s promise of increasing federal investments. The cut-the-deficit-first crowd won. Among its members were Panetta, who became Clinton’s budget director, and Rivlin, who became Panetta’s deputy and later his successor, and Robert Rubin, who would become Clinton’s White House economic-policy coordinator and later Treasury secretary. They convinced Clinton to ditch his campaign promises to cut taxes for the middle class and sharply increase government investment spending and, instead, to focus on bringing down the deficit.

  After substantial haggling—and an energy tax that was abandoned by the White House—Clinton’s deficit-reduction bill, heavier on tax increases than spending cuts, got through Congress. In striking contrast to 1990, every Republican in the House and Senate opposed it. Vice President Al Gore broke a tie in the Senate, and last-minute pressure on reluctant Democrats produced a 218–216 vote in the House in 1993. One of the last Democrats to vote for the bill was Marjorie Margolies-Mezvinsky, a first-term congresswoman from Philadelphia’s suburbs who had previously said she would oppose the bill. Her vote was later blamed for her defeat in 1994. (Clinton’s daughter later married her son.)

  The deal extended the 1990 limits on annual appropriated spending through 1998, squeezed payments to health care providers, and raised taxes, primarily on upper-income taxpayers. This time the deficit-reduction effort worked as promised. The deficit came down even faster than the CBO projected as the economy picked up momentum and incomes of the rich—whose taxes had been raised by the law—rose sharply. In 1995, the IRS counted 87,000 returns with incomes of more than $1 million, up from 66,500 in 1993. These millionaires saw their incomes rise by $57 billion over those two years, and they paid $18 billion more income taxes.

  Republicans gave Clinton no credit for the shrinking deficit. At one unusually testy appearance before the House committee he had once chaired, Panetta, then White House budget director, exploded under questioning from Olympia Snowe, a moderate and mild-mannered Republican from Maine. “You know,” he said, “does it really hurt that much to admit that we are impacting on the deficit? Does it really hurt that much to say that we are going in the right direction? Does it really hurt that much to give us a little credit for what we are trying to do …?” Even for those familiar with Panetta’s behind-the-scenes outbursts, the harsh words were startling, a display of frustration and a reminder that partisanship over budgets is hardly a recent phenomenon. A few minutes later, Panetta apologized: “Sometimes the Italian part of me gets in control of my emotions.”

  In the 1994 elections, Republicans took the House for the first time in four decades, their campaign aided by their attacks on Democrats for raising taxes in 1993. Newt Gingrich became the speaker. Emboldened Republicans confronted Clinton over spending, producing two government shutdowns before agreement was reached. After a couple of years as Clinton’s chief of staff, Panetta went home. He sounded bitter. “In the time that I’ve been in Washington politics has gotten meaner … where instead of spending time talking about the broader issues—on education, welfare reform, health care, and what have you … it’s become much, much more of a political temptation … to grab that 30-second spot on the evening news to engage in this kind of attack politics.” Referring to Republicans, he said, “I honestly think they’re losing points with the American public, but … there’s still a mentality that if they can score the first punch, that somehow that benefits them.”

  Two years after Gingrich led the Republican takeover of the House, Bill Clinton went to Capitol Hill to deliver his 1996 State of the Union address, and sounded a Reaganesque theme: “We know big government does not have all the answers. We know there’s not a program for every problem.… The era of big government is over.” Republicans cheered. Clinton and Gingrich had economic winds at their back—a strengthening economy, a rising stock market, soaring incomes in the top tax brackets. Suddenly, a balanced budget appeared to be within reach. In 1997, Gingrich and Clinton—with Panetta’s successor as chief of staff, Erskine Bowles, doing much of the negotiating—reached a deal to cut taxes but restrain spending more, at least on paper. One money saver would later become a headache, though. The deal legislated unrealistically large cuts to fees Medicare pays doctors in the future; in later years, Congress would waive the cuts regularly.

  The pact marked a high-water mark in recent cooperation on budgets between Republicans and Democrats. From the Obama White House in 2012, Jack Lew reflected almost wistfully on the 1990s: “Leon [Panetta] and John Kasich [the Ohio congressman who was the senior Republican on the House Budget Committee] would get in a room and scream at each other. It was awkward to be in the room sometimes. But at the end of the day, they could do business together. You go through that, and you do business together.”

  Emboldened by their success, Clinton and Gingrich flirted with a once-in-a-generation fix to Social Security so its finances could withstand the retirement of the baby boomers. But Clinton’s dalliance with intern Monica Lewinsky and the impeachment trial that followed destroyed any chance of a grand bargain between the president and Congress. “Gingrich wanted to do it; Clinton wanted to do it. It was a real missed opportunity,” Bowles says. “Monica changed everything.”

  Lew and the deficit-fearing contingents in both parties look at the Reagan tax increases of the 1980s and the Bush deficit deal of 1990 as the good old days, and keep searching for ways to re-create the politics that spawned those compromises. Paul Ryan and the small-government, antitax slice of the Republican Party see them as evils to be avoided because they reduced the deficit without permanently shrinking the government. “Why would we go back to the ’82 and ’90 deals where we put taxes on the table, and we didn’t get spending cuts?” says Grover Norquist, the influential antitax crusader and strategist.

  THE RETURN OF DEFICITS: TAX CUTS, WARS, AND PRESCRIPTION DRUGS

  For four years, 1998 through 2001, the federal government ran surpluses, a remarkable development that put deficit worrywarts nearly out of business and made all the warnings about rising health care costs and the approaching retirement of the baby boomers much less threatening. As a presidential candidate, George W. Bush promised to tap the surpluses to cut taxes. Federal Reserve chairman Alan Greenspan, at the time the most credible economist in the country, widely hailed as the voice of fiscal rectitude, was called to the Senate Budget Committee in January 2001 to testify. As is the custom, the Fed sent an advance copy of the written testimony to the committee. Kent Conrad, the fiscally conservative Democrat who chaired the committee, read it—and winced. “[T]he highly desirable goal of paying off the federal debt is in reach before the end of the decade,” Greenspan said. The money would burn a hole in the government’s pocket: if taxes weren’t cut, it would be spent. Greenspan favored tax cuts, and said so, with carefully worded qualifications that he could point to later but few heard at the time.

  Conrad called Greenspan to his office and told him his words would trigger “a feeding frenzy.” He made no headway and asked Bob Rubin, the former Treasury secretary, to call. Rubin was no more successful. Greenspan delivered the testimony as written and got precisely the reaction that Conrad and Rubin had foreseen. The headline in the next morning’s Wall Street Journal said, “Greenspan, in About-Face, Backs Tax Cuts.” In his 2007 memoir, Greenspan allowed that he had “misjudged the emotions of the moment.” The most prescient part of his testimony was little noted at the time: an admonition against “policies that could readily resurrect the deficits of the past.” Indeed, 2001 would be the last year that Washington ran a surplus.

  WHERE DID THE SURPLUSES GO?

  In January 2001, the CBO, then headed by Dan Crippen, a burly, bearded former aide to Ronald Reagan, issued the annual
ten-year budget projections to which Greenspan referred. If current policies continued and the economy, which was weakening at the time, rebounded as anticipated, the United States would run budget surpluses each year from 2002 through 2011. Collectively, these surpluses would total $5.6 trillion, enough to pay off the entire federal debt, according to the CBO.

  In January 2012, the CBO, now headed by a slender, bearded economist who had worked for Bill Clinton, Doug Elmendorf, issued another ten-year update. The tables in the back showed that from 2002 to 2011, the government had run deficits each year. The total: $6.1 trillion worth of deficits over ten years.

  How did those surpluses turn into deficits? How could the CBO be off by nearly $12 trillion, an astounding sum? The short answers: a lousier than anticipated economy, some big tax cuts, two wars that weren’t paid for, an expansion of Medicare to cover prescription drugs that wasn’t paid for, and—later—the damage done by the worst recession since the Great Depression.

  Let’s take them one at a time.

  First, the economy did worse than the CBO and most other forecasters anticipated. The dot-com bubble burst, precipitating the recession of the early 2000s, which was compounded by the shock of the September 2001 terrorist attacks. The recession was mild and the economy recovered. But the hits kept coming: first the housing bubble burst, then the financial crisis hit, and the Great Recession was on. That hurt revenues—fewer capital gains, fewer profits, and fewer jobs mean less tax revenue to the Treasury. And it increased spending because more people were eligible for government unemployment, food stamps, and health benefits.