Postscript:
The Budget Truce of 1990

We all agree: "Let's get something responsible." We still haven't decided what "responsible" is .
AN ADMINISTRATION OFFICIAL WHO WISHED NOT TO BE NAMED, MAY 24, 1990^[1]

The tricky part is getting all of the parties to get from where they are at the moment to what they might agree on without getting themselves in such an argument that the thing falls through .
RICHARD DARMAN, MAY 13, 1990^[2]

We would like to take credit, but are sure we cannot. The budget deal of 1990 was very similar in size and purpose to the approach we recommended in our final chapter. It set a reasonable goal of a deficit, on the unified accounts, of 1 percent of GNP five years down the road (by the time the president and Congress did this, that meant FY95). It pursued that goal by enacting all the necessary legislation at once, and then altered Gramm-Rudman to eliminate the perversities of the hostage game. Instead, GRH procedures were adapted to protect the terms of the agreement that had been made.

Throughout the year's struggle, its protagonists, especially in the administration, proclaimed their intent to fix the deficit once and for all. Its five-year term and enforcement procedures mean that it is to be the last deal for a while. In 1981 Richard Darman, worried about the tax bill's cost, told Stockman, "We win it now, we fix it later." 1990 was "later"—though "the thought never crossed my mind, and I don't think it ever crossed Stockman's mind," he admitted, "that we would wait a decade."^[3] President Bush proclaimed a deal would "at last put this budget crisis behind us."^[4] And in a nice indication of the Washington policy community's judgment, CBO chose, at the beginning of 1991, not to publish its annual volume, Reducing the Deficit: Spending and Revenue Options .

While they made the choice we thought best, however, the politicians did not admit they had changed the target. To show their dedication to savings they removed social security from the deficit calculations; having so increased the published deficit, they brought it back down with a highly suspect economic forecast. These twin distortions allowed caustic commentary that compared the size of the package to its ostensible goal

and concluded it was a failure. Even Senator Dole, one of the major architects, proclaimed, "We've only taken the first step."^[5]

Our readers deserve an explanation, and will prefer a short one, of what was done in 1990. What was done, how was it achieved, and what does that say about our original analysis?

A Five-Year Budget Package

The Budget Reconciliation Act of 1990 raised the Gramm-Rudman deficit targets from $64 billion in FY91, $28 billion in FY92, and zero in FY93 to $327 billion in FY91, $317 billion in FY92, $236 billion in FY93, $102 billion in FY94, and $83 billion in FY95. Table A shows how the administration's baseline forecast grew from barely $100 billion at the beginning of the year to $367 billion at the end. Of that difference, $103 billion, the change from January to September forecasts on line 5, was due to the change in economic projections on lines 1 and 2; a 4 percent difference in economic growth in FY90–91 is a lot of money. As the CBO figure shows, some of this misestimate was optimism, and some was really news.

Taking social security's surplus out of the calculations increased the deficit by $74 billion (see lines 6 and 7)—a change in accounting only.

A big real change was the $90 billion rise in expected costs of bailing out insolvent thrift institutions. Deposit insurance, however, was a onetime (we hope) megadisaster, and so its costs would go away on their own. In fact, as the government moved from buying thrifts to selling their assets, its cash flow would move from very negative to positive. Table B, showing how the deficit was supposed to fall under the final plan, shows that between FY91 and FY94 the shift in projected deposit insurance flows would reduce the deficit by $150 billion!

This table is based on figures put together by the Republican staff of the Senate Budget Committee, and it should be no surprise that the Democratic staff at House Budget measure the package somewhat differently. They claimed only $137 billion in extra revenue, and $99 billion cut from entitlements. The major difference was whether to treat tax

credits for the poor as a spending increase (Republican) or a tax cut (Democratic).^[6]

Table B also excludes, because no such thing exists, a reliable breakdown between defense and domestic discretionary savings. Since these accounts are annually appropriated, the savings were not enacted in advance. Instead, the Budget Reconciliation Act created caps on spending that would be enforced by automatic sequesters, no matter what the deficit. For the first three years, FY91–93, there are separate caps on defense, domestic, and international affairs spending. If Congress enacts more than the cap in either category, then there will be an immediate sequester within that category . In FY94 and FY95 the categories are combined, so in theory Congress could cut defense more and domestic less, or vice versa.

The table's discretionary savings line is the difference between the caps and a very slippery baseline. The negotiators excluded the costs of a number of immediate emergencies, such as the Iraqi invasion of Kuwait. The law allowed technical adjustments, such as in scoring a new credit budgeting system, which will add another few billion dollars a year to the domestic base. The baseline was also rigged, in a way generally seen as a deal between Director Darman and the appropriators, to hide a domestic increase. In early December House Appropriations staff estimated that increase at about $40 billion in BA and $20 billion in outlays total. Since the BA and outlays don't fit, and the numbers are tighter in FY94–95, we guess the spending gain is closer to $30 billion overall.^[7]

The big discretionary cuts therefore all come from defense. They were made possible by the collapse of the Warsaw Pact military alliance in 1989, symbolized by the dismantling of the Berlin Wall. Only that good luck makes the package look larger than our suggestion; without the defense cuts there are $49 billion in policy savings in FY92, the second year of the deal. The defense windfall makes up for lower growth and the long-term interest costs from the deposit insurance expense over the course of the agreement. Due to social security accounting and strange economic estimates, official figures were at best confusing.^[8] Yet in talking to budget experts around Washington, and in our own rough calculations, we found a consensus that the real figure, including a goodly amount of bad economic news, was a unified budget deficit of $75 billion, about 1 percent of GNP, in 1995.^[9]

On its face, the package was a bad deal for Republicans: by their scorekeeping, less than 20 percent of the savings came in domestic spending. It was perhaps made worse—and for Democrats clearly improved—by its distributional tilt. Although the tax package included regressive excises, it is progressive overall. The increase in the Earned

Income Tax Credit helped the poor. A total of $67.1 billion was raised from the well-to-do by increasing the alternative minimum tax, limiting itemized deductions for taxpayers with adjusted gross income over $100,000, phasing out the tax benefit from personal exemptions, replacing the "bubble" with a flat 31 percent top rate, and increasing the cap on wages taxable for Medicare from $53,400 to $125,000.^[10] Ways and Means Committee Majority staff estimated that, as a result, the package would: raise the income of the poorest fifth of the population by 1.5 percent; lower the income of the richest 1 percent by 2.2 percent; and lower the income of those in between by around 1 percent.^[11] These may not seem like big changes, but the Democrats seemed proud and the administration had fought long and hard for a different distribution.

Last but not least, the agreement in essence abolished the deficit sequester. It did so by requiring, in FY92–93, and allowing, in FY94–95, the president to adjust the targets for changes in economic and technical assumptions when issuing the budget each year. Then the deficit sequester would be calculated on the basis of those same economic assumptions, even if they were wrong! Since the targets and estimates are based on the same economy, the economy can't cause a sequester. And laws to raise spending or lower revenues are inhibited by both the points of order that had worked well for a few years and a new layer of targeted sequesters. Tax cuts or entitlement increases must be paid for as done; otherwise a "PayGo" sequester lies against certain entitlement programs. Increases in a program that raise an appropriated category above its cap will trigger an across-the-board cut within that category.

A lot can go wrong. The deposit insurance mess, or costs from the war and subsequent relief efforts in Iraq, could increase interest costs in FY95. Yet even with such losses, the deal should get the deficit to a reasonable level by then, and decisions to bust the agreement will require a consensus among the president and Congress (including 60 percent of the Senate). The odds of those sides agreeing on how to bust the deal significantly seem, to us, quite slim. It might happen if a united government is elected in 1992—but, then, the people will have voted for it, and we could hardly object.

Getting There

The budgeting events of 1989, described well in Lawrence J. Haas's aptly titled Running on Empty,^[12] bred only bitterness and mistrust. The president's FY91 budget offered no new prospects for a solution.

In early April, however, OMB Director Darman began to dribble out bad news on the estimates. At first he said they were off by only $6 billion

to $15 billion, but the numbers grew steadily.^[13] Now, nothing had really happened, yet, in the economy. The final quarter of 1989 had been bad, but no worse than already estimated when the FY91 budget was made.^[14] Bad news was coming on the thrifts, but the administration had all sorts of scorekeeping options, like spending the money in FY90 instead of FY91. No economic reestimate was required until June. It seems clear that Darman chose to begin releasing bad news in order to influence other players—perhaps including the president or perhaps with his approval. He worried publicly about a capital shortage as the Japanese and Germans turned inward, and supporters of a deal within the administration began to argue that it was in the president's interest to fix the deficit immediately rather than face a recession closer to the 1992 election.^[15] By May 8 the president was telling legislators, "What's at stake here is the overall economy."^[16] George Bush had decided it was time to confront the deficit.

House Democrats on May 1 passed a Budget Resolution that presumed big defense cuts and some domestic increases, while ducking the question on taxes. Amid a great deal of mutual suspicion, leaders of the administration and Congress began a desultory summit on May 9. The administration backed and filled on the meaning of the president's claim that "everything is on the table." Even conservative Democrats suggested the different sides communicate in writing. The administration and Republicans emphasized their need for new enforcement provisions, which in their strong form were anathema to Democrats and especially appropriators. A great deal of time was spent trying to agree on a target for the package. At one point, "Mr. Darman outlined 11 different ways to measure the deficit and projected the gap six years into the future under each definition. The summit negotiators reached no agreement on how to measure the deficit."^[17] There was a quiet agreement among the economic officials to say that any more than about $50 billion, or 1 percent of GNP, would hurt the economy. The big issue was the size of deficit reduction over five years. Some Republicans wanted to keep it to $400 billion because then there would be some chance of doing the job without taxes. Democrats pushed for $600 billion in order to ensure $500 billion—which they were sure could not be done without taxes!^[18]

The talks broke down. Finally, to get them moving again, the president agreed on June 26 to issue a statement explicitly accepting "tax revenue increases." The statement had a lot of conditions, and the language might even be strictly interpreted as endorsing not rate increases but the capital gains cut that the administration kept insisting would increase revenues. The president may have hoped to have his cake and eat it too, getting the Democrats more seriously involved yet convincing his allies that he had not really given in. He clearly hoped to play his

concession down, by issuing it as a written statement, avoiding oral comment, and doing it on a day when much else was going on, including South African black leader Nelson Mandela's address to a joint session of Congress. Instead he got banner headlines. The Democrats said they would not gloat but did claim victory, his allies screamed, and the press took the free shot at him for abandoning his campaign pledge.^[19]

Negotiations resumed, but were stymied by a wide range of disagreements. Even in May it had been obvious, as David Wessel of the Wall Street Journal wrote, that they would get no money from the domestic discretionary category because "that includes everything that Congress and President Bush want to increase. Whatever cuts negotiators find in this category are likely to be offset by increases elsewhere."^[20] On defense, the administration's best hope was to ally with Chairman Sam Nunn of the Senate Armed Services Committee on a package that still cut more than the Pentagon wished. The president's insistence on a capital gains cut allowed the Democrats to use populist rhetoric, including attacks on the "bubble," which all wings of the party approved. The House Republican Conference endorsed, by a wide margin, a resolution that no taxes should be increased. And Senator Byrd made clear that he would accept no enforcement procedures which he felt infringed on the appropriators', and Congress's, institutional role. As a Republican aide paraphrased Byrd's line, "You will get an agreement with my support; you may not get an agreement without me."

When the administration came up with a tax proposal, leaks of its contents showed that it would lower taxes for the rich and raise them on Joe Sixpack. The Democrats avoided criticism by being too divided to come up with a package that could be leaked.^[21] Talks were suspended, amid much harsh rhetoric, as Congress went home for August.

Negotiations resumed on September 7, at Andrews Air Force Base outside of Washington. Some, but not all, of the gap on defense had closed when the administration settled its internal disagreements and announced plans for a cut in military personnel by half a million over five years.^[22] The Iraqi invasion of Kuwait, by putting the country closer to recession, encouraged a less ambitious first year target.^[23] Our sources report that Darman told the appropriators that he would get them a domestic increase, but he would have to hide it in the baseline so Congressional Republicans wouldn't object. Sin taxes would obviously be included. But arguments about the other taxes, entitlements, and the distributional effects prevented further agreement. Hoping the talks would be easier with fewer participants, the negotiators terminated the Andrews phase on September 17, and resumed, with only the party and administration leaders, at the Capitol on September 19.

The end of the fiscal year, and then Gramm-Rudman, loomed. With

deposit insurance costs now acknowledged, a $230 billion sequester threatened. Domestic accounts faced 32.5 percent cuts; defense 34.5 percent. OMB ordered agencies to begin planning extensive furloughs of their staff, and the president talked tough about allowing no CR without a deal.^[24] As the pressure built, alternative proposals were circulated as if in a game of musical chairs. When the music stopped, what would be left?

The administration wanted a capital gains cut, the Democrats wanted higher marginal income tax rates, and neither side was quite willing to make a trade. The Democrats suggested various surcharges on very high incomes; Republicans suggested various capital gains options; both sides looked for ways to minimize deductions, with the administration emphasizing state and local taxes and the Democrats objecting strenuously. The true budget controllers, like Senator Dole, began to get fed up; on September 19 he suggested that everybody's giveaways, to rich and poor, be put in a separate bill, with offsets. On September 20 he went public: "We'd have one pure deficit-reduction package and one pay-as-you-go package," he explained.^[25] On September 25 Bob Michel joined him. But House Republicans like Bill Frenzel of Minnesota still insisted on the need for "growth incentives."^[26]

There was still a major spending problem, too. Up until the very last, negotiators leaned, because they thought it was a good idea, toward taking some money from the better-off elderly by increasing the taxation of social security benefits.^[27] The trouble was, as one Democratic pollster put it, "The two things the voters still give us credit for are standing up for the middle class and protecting Social Security."^[28] If the elderly pay, the bargainers on both sides in the end decided, it would have to be in some other way.

The music stopped, but only for the first time, on Sunday morning, September 30. The White House and Congressional leadership announced a "Budget Summit Agreement," providing $40.1 billion in deficit reduction in FY91 and $500 billion through FY95. For our purposes, the following provisions of the 47-page document are primary:

The deal made sense in the Washington policy community, where its most politically egregious provisions, like the gas tax, could be defended as good for us. "It's a consumer package," Alice Rivlin of the Brookings Institution explained. "It's a very special kind of consumer package, a series of taxes on things we would like to discourage the consumption of: gasoline, alcohol, cigarettes."^[31] But it was not a package any Democrat could love. The "growth incentives" were swiftly tagged by many analysts as potentially easily abused tax shelters.^[32] Analyses by Democratic tax staffs showed that the package would hit hardest at people with incomes between $30,000 and $50,000, who would pay an average of 3.3 percent more in taxes, while those with incomes between $100,000 and $200,000 paid only 1.5 percent more, and those with incomes above $200,000 paid only 0.3 percent more. Senator Wyche Fowler (D-Ga.) reported that his party colleagues reacted to those numbers with "something between a deep swallow and a gag"; Dan Rostenkowski said the growth incentives would "just muck up the [tax] code again." Pete Stark (D-Calif.), whose subcommittee of Ways and Means would-have to mark up the Medicare provisions, said he would oppose them.^[33] Yet Republicans didn't like it either. The right objected because there were too many taxes, and moderate Republicans, as they had been back in 1982 on the "Oakar Amendment," were especially leery of Medicare. Marge Roukema of New Jersey expressed their reaction: "If they're savaging Medicare, it's going nowhere. Deficit reduction on the back of the elderly sick? This is madness." Charles Schumer (D-N.Y.) summed up the reactions of, it turned out, a majority of the House when he observed, "Democrats think it's a Republican budget and Republicans think it's a Democratic budget."^[34]

Most of all, it was a politically unpopular budget. Polling data for decades had shown gas taxes were less popular than almost any alternative. 1990 was no exception.^[35] Efforts to cut Medicare by hitting the

elderly, not the providers, had failed for years, crisis or no crisis. Therefore, in spite of grudging endorsements in major newspapers, a defense by Federal Reserve chairman Alan Greenspan, national television appeals by the president and Senator Mitchell, and what some people felt were heavy-handed tactics by the president's men, the House on October 4 handily defeated the package, 254 to 179. Minority Whip Newt Gingrich led the revolt within the Republican caucus, rallying colleagues who objected either on principle or as a matter of political tactics to the tax figures. The Democrats could not have such a public defection, because it would look like they were breaking an agreement. But the leadership backpedaled, and soft-pedaled, and reminded everyone that if the Republicans didn't vote for the deal, the Democrats didn't have to, either. Had a majority of Republicans supported the budget deal, it is likely that Democrats would have swallowed hard and voted for it. When word got out about its conservative character, however, the Democratic leadership might have been in big trouble with its troops. The leaders were fortunate, and both parties voted no.^[36]

Three more weeks of musical chairs followed, with continual maneuvers and permutations. For our purposes, what mattered was:

Thus on October 27, 1990, the budget deficit truce of 1990 was signed.

What Does It Mean?

Why was this agreement made in 1990, and not before? The most obvious reason is the target. George Bush obviously told himself that he would break the tax promise only once, and long before the next election. The Democratic leaders could end, at least for a while, the budget battle that had been making their lives miserable—and, given the fall of the Berlin Wall, most of the package had to be in a form they would like.

A second obvious reason is George Bush. The argument for a "responsible" deal always had a subtext: one side would have to attack its own core constituency. Bush did it, or at least so the Gingrich faction believed, by accepting extensive tax increases. As a traditional Republican, we should add, the president presumably cared more about who got taxed than avoiding taxes altogether. From that standpoint the summit agreement was a good deal for Bush, and his right wing screwed it up. Put another way, it "shared the pain"—so both left and right opposed it.

We also must admit that Gramm-Rudman helped. As we have argued, it never made any sense to think that a threatened sequester of, say, $40 billion would force other action of the same size, for the items subject to sequester were those with least political support. A $230 billion sequester is another matter; in the face of that one might find $30 billion of something else to do. Once Darman chose not to mask the deficit—and then it became too large to mask—the artificial crisis did have some impact.

Changing the target and doing much less than Gramm-Rudman was possible because, after years of battle, notions of responsibility had begun to shift again. It is hard to continually hold the system to an impossible

standard, especially when that standard is based on predictions of a disaster that doesn't occur. By 1990 a number of respected commentators, such as the editorial board of the New York Times and economist Herbert Stein, were urging what we called balance.^[39] Yet many deficit-reducers would not say publicly that a balanced budget was unnecessary because they wanted to maximize the pressure for action.

This desire to maintain the pressure was most evident in one of 1990's non-events. By September it seemed that an assessment of economic performance during the second and third quarters of 1990 would show two successive quarters of less than 1 percent real growth in GNP. Under the law, such a report would automatically trigger a vote on whether to suspend Gramm-Rudman, and under the circumstances of late October many politicians might have seized the opportunity. The budgeteers who understood this angle chose not to ask for a report, and CBO had no interest in volunteering one. Once the deal was made, however, the same players took the pressure off. Economists' demands for more savings were conspicuous by their absence. The deficit is still huge and savings low, but with the policy community's shift to feeling that what has been done is all right, the drumbeat from the editorial pages, and of politicians against themselves, has ceased.

We therefore are as convinced as before that the budget battle has been defined by elites and constrained by masses. The elite provided the panic, and the masses constrained the solutions. The 1990 deal, like all its predecessors, moved continually closer to the public's priorities at the time. On the other hand, the public paid most attention to the deficit when the politicians and media worried about it most.^[40] In the end, or so we hope, the elites adjusted their panic to the masses' constraints.

The final question, then, is what the battle tells us about the future of American politics. Does the distributional tilt of the final package mean that the long-awaited revival of the Democrats is at hand? Is the long swing to the right about to be reversed?

Perhaps, but we are more impressed by what the battle has accomplished. The success of populist rhetoric on taxes in 1990 is deceptive. Once the public is told, "There will be a tax increase; you have a choice between a gas tax and taxing the rich," it is easy to sell taxing the rich. When the public hears about taxing the rich in isolation, however, the common thought is, "I'm next." There is no evidence from 1990 that the public is demanding higher top rates to pay for social programs.

The era of less-is-better is over. Domestic discretionary spending was increased in this deal because of an elite near-consensus that they wanted to spend some money for general government. The Appropriations Committees get to fund their programs in peace, without worrying about

the rest of the budget process. Yet under the new agreement there can be no expansion above the new baseline; more is not better quite yet.

The Republican right viewed the 1990 agreement as an abomination. And so it would have been had Ronald Reagan been president. With George Bush in the White House, however, the summit was the best the party's economic conservatives could expect. To a traditional Republican with a long memory, like Bush, even the final agreement should not look so bad at all. What, one wonders, would Gerald Ford or Richard Nixon have said if you had told them that in 1991 the top income tax rate would be 31 percent, and there would be budget rules so even extra revenues from economic growth could not be used for more domestic spending? We suspect they would have thought you were abusing an illegal substance.

Our readers can decide for themselves what they think of this conclusion to our story of political economy. We believe the public interest is not what is in nobody's interest, but rather resides in meeting public preferences by compromising between the party positions, and so the agreement of 1990 is an example of the government serving the public interest.