Book Review of Red Ink: Inside the High-stakes Politics of the Federal Budget by David Wessel

Genre: Economics
Author: David Wessel
Title: Red Ink: Inside the High-Stakes Politics of the Federal Budget (Buy the Book)

Summary

In Red Ink: Inside the High-Stakes Politics of the Federal Budget, two-time Pulitzer Prize winner and Wall Street Journal economics editor David Wessel details the history, current practices, and future of the Federal budget. This is no small subject since the Federal government spends $3.6 trillion annually – equal to $400 million per hour and more than $30,000 per household.

Early in its history, balanced budgets were revered within the U.S. government. However, the devastating unemployment associated with the Great Depression and the rise of Keynesian economics led to the abandonment of this philosophy. Indeed, the establishment of Social Security forever changed American expectations on the role of the government. Likewise, the 1960s brought about as lasting creations Medicare for the elderly and Medicaid for the poor.

In the 1980s Ronald Reagan vowed to cut taxes, rebuild the nation’s defense, and balance the budget. He was successful on all but the third such that George H.W. Bush inherited skyrocketing deficits, which after a period of fiscal restraint and booming economic growth in the 1990s became surpluses. This situation did not last long due to a weak economy, large tax cuts, two wars, expansion of Medicare to cover prescriptions, and the Great Recession.

Today the sustainability of this ongoing spending spree is being called into question. Medicare and Medicaid together account for 21% of Federal outlays, and health care is growing faster than any other major subset of the budget.

Likewise, though the purpose of Social Security was to keep the elderly from living in poverty, an average life span of 80 calls into question the sustainability of the program. Further, U.S. defense spending is 30% higher today adjusted for inflation than during the height of the Cold War and equal to the entire GDP of Indonesia, the world’s fourth most populous country.

Yet despite this profligacy, taxes have not risen for most Americans over the past couple of decades. Income taxes on individuals and payroll taxes comprise the majority of Federal tax revenue, and the broadest way to measure the tax bite is to examine the average aggregate collections over the past thirty years – 18% of GDP. That number increased in 1981 to 19.6% under Ronald Reagan, and peaked at 20.6% in 2006. In recent years, this figure has hovered around 15.4% due to difficult economic conditions and tax cuts.

Even so, few American taxpayers will defend the current state of the tax code. Critics claim that it rewards companies for moving overseas, and that it restrains saving and growth. Wessel discusses how lawmakers have discovered the simple solution to making constituents and businesses happy: provide a basket of credits, loopholes, and deductions. Indeed, even though the tax code is riddled with inefficiency and illogical exceptions (the IRS defines livestock of different sexes as “not like-kind properties”), changing it is playing with political fire.

Wessel contends that while today’s budget deficit is not an economic problem, tomorrow’s will be. During the Reagan administration the deficit peaked at 6% of GDP, but from 2007-2011 it averaged around 10%. This behavior is rationalized by Keynesian economics, which holds that a country should combat an economic recession via deficit spending. His concern is that the ability to conduct such massive borrowing at rates near 50-year lows will end sooner rather than later.

There is little doubt that President Obama inherited an economy in a tailspin, which required him to use fiscal muscle and assistance from the Federal Reserve to avoid collapse.

That being said, the U.S. government owed $6.3 trillion the day Obama took office in 2009. Three years later, the debt had grown to $10.6 trillion, and today this figure is growing exponentially. Decision makers in Washington can and must make tough decisions to avoid what Erskine Bowles has described as “the most predictable economic crisis in history.”

INTRODUCTION

On a dreary and dim February morning at a Starbucks in Washington, D.C., a White House budget office aide distributes a compact disc to representatives of the major world news outlets. The information inscribed on the disc has the power to change the economic and political outlook of the entire world.

President Barack Obama’s budget plans for the year are on sale for $27 a disc. Every President since Warren Harding has been required to present a budget to Congress, the contents of which represent a numerical description of the government’s role in society and the world abroad.

In Red Ink: Inside the High-Stakes Politics of the Federal Budget, David Wessel, two-time Pulitzer Prize winner and economics editor for the Wall Street Journal, details the history, current practices, and future of the federal budget.

$400 MILLION AN HOUR

In fiscal year 2011, the federal government spent $3.6 trillion dollars. This massive figure translates to $400 million an hour and more than $30,000 per American household. Wessel points out a series of astonishing observations about the spending habits of the U.S. government:

• Nearly 2/3 of annual federal spending is automatic and doesn’t require an annual vote by Congress.
• The U.S. defense budget is greater than the combined defense budgets of the next 17 largest spenders.
• Firing every federal government employee wouldn’t save enough to even cut the deficit in half.
• About $1 of every $4 the federal government spends goes to health care, and that share is rising inexorably.
• The $700 billion bank bailout didn’t cost taxpayers nearly as much as initially feared.
• 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 1/6 of that in the United States.
• 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 share of income most American families pay in federal taxes has been falling for more than 30 years. Today, Americans pay less of their income in taxes than citizens of nearly every other developed country.

Wessel contends today’s budget deficit is not an economic problem; however, tomorrow’s will be.

During the Reagan administration, the deficit, as a percentage of GDP, peaked at 6 percent. In the five years from 2007-2011, the deficits as a percent of GDP averaged around 10%. This increased spending behavior is rationalized by Keynsian economics, which states that a country should run a large spending deficit to combat an economic recession.

The plethora of money flowing in from abroad has pushed U.S. borrowing rates to 50 year lows. The fear is that this massive borrowing at low interest rates will end sooner rather than later, and the “day of reckoning” is approaching. “We face the most predictable economic crisis in history,” said Erskine Bowles, Bill Clinton’s former chief of staff, when describing the current deficit.

HOW WE GOT HERE

THE NEW DEAL: THE BEGINNING OF “BIG GOVERNMENT”

From the end of the first world war until the Great Depression, balanced budgets were revered within the United States government. During this era, the federal government was spending around 4% of its gross domestic product, and 70% of which was limited to defense, veterans’ benefits, and interest payments on the national debt.

Franklin Delano Roosevelt took office in the heart of the great depression in March 1933, and throughout his time as Commander in Chief, dramatically increased that figure. Ironically, FDR’s initial prerogative was not to substansially increase government spending. FDR was quoted as saying, “Too often in recent history, liberal governments have been wrecked on the rocks of loose fiscal policy.”

However, he was forced to create the New Deal in a last ditch effort to curb the devastating unemployment plaguing the country. Lasting establishments created during the New Deal include the Federal Deposit Insurance Corporation, Federal Housing Administration, Tennesee Valley Authority, and the Securities and Exchange Commission.

Paradigm shifts in power and precedent were established as the Bureau of the Budget was moved in 1939 from the Treasury to a new Executive Office of the President. The Executive Branch now lacked motivation to balance the budget and aligned its spending behavior with the theory of economist John Maynard Keynes – spend to alleviate recession. Perhaps the lasting impact of the New Deal was the establishment of Social Security, which forever changed American expectations on the role of the government.

THE GREAT SOCIETY: GUNS, BUTTER, AND MEDICARE

Wessel continues on with commentary from the career politician, Leon Panetta. Panetta describes the 1966 Congress as a meshed, unpolarized institution with unpredictable party lines. With this in mind, President Lyndon B. Johnson built on the spending habits designed by his budget-influential predecessors Roosevelt and Harry Truman.

A popular ultimatum of 60’s politcal lingo was “guns or butter”: depicting the choice between domestic or defense spending.

Johnson refused to choose between the two and increased spending to roughly 21% of gross domestic product. President Johnson’s lasting creation was Medicare for the elderly and Medicaid for the poor. Columbia University economist Frank Lichtenberg estimates a 65 year old has a 13% greater chance of making it to age 70 due to Medicare.

Granted, these programs have been blessings for those in need, but the federal government spent more on Medicare and Medicaid in 2011 than it spent on everything in 1960.

NIXON: CONGRESS STRIKES BACK

In 1974, Congress fought against President Richard Nixon’s refusal to execute on approved spending projects totaling billions. The Congressional Budget Act was passed over a Nixon veto a month before his resignation from office. House and Senate budget committees were established, along with the Congressional Budget Office.

This provided the Legislative Branch the liberty to rely on economic forecasts generated outside of the White House. Even today, the Congressional Budget Office is deemed a nonpartisan institution with honest numerical forecasts. This reputation can be traced to the moxy of the initial CBO director, Alice Rivlin. Despite the efficiency goals of the Congressional Budget Act, Congress hasn’t finished annual spending bills before the start to a fiscal year since 1998.

THE REAGAN REVOLUTION

Ronald Reagan made three significant fiscal promises during his campaign. He vowed to cut taxes, rebuild the nation’s defense, and balance the budget. In retrospect, he was successful on all but the third. Four years following election to the House of Representatives at the age of 30, David Stockman was chosen to be Ronald Reagan’s budget director.

Wessel depicts him as the Paul Ryan of his time, a disciplined fiscal conservative.

He was highly motivated to cut welfare spending programs in conjunction with Reagan’s massive tax cuts. Reagan’s cabinet and a majority of Republican congressional leadership worked laboriously to protect their favorite programs from Stockman’s hatchet. Their efforts were successful, and Stockman never cut spending significantly.

After instituting a massive tax cut in 1981, Reagan had to concede and raise taxes in 1982 and 1984. The lasting impact of the Reagan budget was a 20% (inflation adjusted) increase in spending with the implementation of massive tax cuts. George H.W. Bush inherited an office with skyrocketing deficits as a percent of GDP.

THE ARRIVAL OF SURPLUSES

George Herbert Walker Bush was elected president in 1988. At the time, Leon Panetta was the chairman of the House Budget Committee, a creation of the 1974 Congressional Budget Act. Panetta illustrates a political atmosphere where Democrats and Republicans both wanted to reduce the deficit; however, Democrats refused to cut entitlement and welfare and Republicans refused to cut spending on defense.

In 1990, after lengthy talks with both parties, President Bush relied on a majority of House Democrats to overcome the opposition of a majority of House Republicans to raise taxes and cut spending. This feat appears to be impossible in today’s political arena.

The 1990 deal reduced deficits, but government revenues landed below projection and Medicare/Medicaid expenses exceeded projection.

Bill Clinton was elected president in 1992 and was able to sneak a deficit reduction bill through Congress in 1993 thanks to a last minute swing vote from Philadelphia Congresswoman Marjorie Margolies-Mezvinsky (Clinton’s daughter later married her son.) The country began to run a surplus which could be credited to a booming economy and bipartisan legislation.

Republicans claimed the source of success was the 1990 Bush efforts while Democrats championed Clinton. At the close of the Clinton administration, Speaker of the House Newt Gingrich and President Clinton never were able to remodel Social Security due to disruption from the Monica Lewinsky scandal.

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

In the years 1998 through 2001, the federal government ran a surplus. In 2001, the Congressional Budget Office projected surpluses in the years 2002 through 2011, with total surplus amounting to $5.6 trillion; enough to pay off the national debt.

Instead, the federal government ran deficits each of those years, totaling $6.1 trillion over ten years. How could the estimate be off by $12 trillion dollars? The direct answer is an underperforming economy, large tax cuts, two wars, expansion of Medicare to cover prescription medication, and the Great Recession. A rapidly rising population in conjunction with rising health care costs guaranteed by benefit programs is a recipe for fiscal disaster.

“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 securites. 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.” – Leon Panetta

WHERE THE MONEY GOES

As one could imagine, there are an infinitesimal number of eye-popping statistics involved in the budget process. For example, the White House sends a 972 page instruction packet to agencies for annual budget requests. The supplement of the budget plan detailing the expenditures for the Department of Homeland Security encompasses 3,134 pages.

That is 1 page for every $12.6 million of planned spending. In a 2008 Cornell University poll, 44% of individuals receiving Social Security checks and 40% covered by Medicare believed they had never used a government social program. Gallup polled American citizens on what fraction of each dollar was wasted by Washington.

The result was $0.51 of each dollar. The reality of the situation is most scandals total $300 million wasted – under one hour of total government spending. It is most revealing to assess the outlays of federal expenditure by looking at health care, Social Security, defense, and the “other” category of significant expenditures.

HEALTH CARE

Health care spending is growing faster than any other major subset of the federal budget. First, the number of citizens eligible for health care benefits is on the rise. Second, the number of procedures eligible patients are undergoing is rising.

The third and most painful situation tied to health care expenditure is the fact that costs are dramatically increasing.

This trio of factors is setting up a balloon-like rise in government health care expenditure. Medicare and Medicaid, as of 2011, accounted for about 21% of federal spending. The Congressional Budget Office estimates the Medicare bill will rise 75% over the following decade. An alarming anecdote that accurately illustrates the drivers of Medicare costs is hip replacements.

More people are living a longer life, the number of patients electing the procedure has grown 30%, and the cost of the procedure has dramatically escalated. The Government Accountability Office assessed 40% of the rise in Medicare spending on hip replacements is due to number of procedures, while 60% is tied to the rising costs.

Patients are able to enjoy a mobile life until they require a second hip replacement at a marginally higher cost than their first procedure. It is apparent government health care spending is sprinting uphill.

SOCIAL SECURITY

The principal mission in the creation of Social Security was to keep the elderly from living in poverty. This mission has been a success because it currently keeps the population over 65 from being below the poverty line.

However, the population now averages a life span of 80, and many are questioning the longevity of the program. Social Security accounts for approximately 20% of federal expenditures. Average contributions to a beneficiary of the system is $14,750 a year. In the 1950’s, the number of workers per beneficiary averaged 16.5.

By the year 2029, it is projected there will be only 2.1 workers per beneficiary.

Therein lies the question: Is Social Security a ponzi scheme or a life saver? Many participants of the Social Security system established in the New Deal believe they will receive what they paid into the program. The truth is that current benefit claims are paid by current payroll taxes.

Benefits are calculated using a complex formula tied to the wages the beneficiary earned as a worker. For an extended part of United States history, the program was running a surplus – paying out less than was being paid in.

These surpluses were transferred to the Treasury, which spent the money and granted Social Security Trust Fund IOU’s in form of U.S. Treasury bonds. The Treasury spent the money to create and subsidize government programs. Currently, the program is beginning to flounder due to the baby boomer population exiting the workforce and entering society as senior citizens withdrawing at the “Social Security window.”

Many suggest canceling the government programs created by the Treasury’s spending would help solve the Social Security crisis. Obviously, Social Security is a sensitive program that benefited 55 million people in 2011. Somewhere around 2036, projections suggest incoming tax revenues will only cover 75% of promised benefits. Doug Elmendorf, director of the Congressional Budget Office, contends Social Security payments need to be cut 25% to put the budget on a sustainable path by 2022.

DEFENSE

The Pentagon’s budget in 2011 equaled the goods and services produced by the world’s fourth most populous country, Indonesia. $700 billion, adjusted for inflation, is 30% higher than defense spending during the height of the Cold War. For many decades, the United States has dominated the world landscape in military power and presence. To have this luxury, the price tag is not cheap and possibly no longer sustainable.

In response to deficit concerns, the Obama administration proposed a base defense budget cut for fiscal 2013 of $487 billion over ten years.

Despite Leon Panetta’s liberal political views, he cried out warning that the U.S. would eventually have the smallest ground force since 1940, smallest number of ships since 1915, and the smallest Air Force in history. Panetta’s outcry entices an exploration into the legitimate costs to maintain the world’s largest navy.

Aircraft carriers are deemed the ultimate power in controlling the world, and also are some of the most expensive items on the menu. One aircraft carrier costs approximately $11 billion dollars to commission and $2 billion to decommission after a long service life. Some propose floating only ten carriers instead of the congressional requirement of eleven. Dismissing an entire crew could save $7 billion over a decade.

During a May 2010 speech, defense secretary Robert Gates voiced his discomfort about the health care costs absorbed under the defense budget. Tricare is the health benefits program offered to veterans and tenured officers. Due to astronomically low premiums and wide ranging coverage, many veterans opt for Tricare over their post-service employer’s package. Tricare costs about $11 billion a year, yet is viciously protected by veteran interest groups.

The following is a look at the defense budget over time:

OTHER: FARMERS, VETERANS, NASA, ETC

Roughly 17 cents of every federal dollar spent goes to veterans’ benefits or farm subsidies. The federal government has been paying farmers consistently for over eight decades. FDR and Herbert Hoover began subsidizing farms when crop prices plunged in the 1920’s in an effort to support the 40% of the population that lived in a rural area.

However, today there is fewer than 2% of the population living in a rural area, and the same subsidies are in place. In 1994, the Republican Congress vowed to permanently slash farm subsidies, but only succeeded temporarily.

Farmers still receive $5 billion a year in direct payments

For example, the first congressional district in western Kansas has received the most money in direct payments – $250 million in 2010. On top of direct payment subsidies, the government pays about 60% of premiums to private crop insurance providers on behalf of the farmers.

This tab totals $10 billion a year for taxpayers. In another food related government expenditure, more than 46 million Americans were using food stamps as of 2011. The food stamp program has historical ties back to the Depression era, and is directly correlated with the farm subsidy expenditures. Food stamps cost $78 billion in 2011 – a figure that Paul Ryan suggests should be transferred to the states and away from federal control.

WHERE THE MONEY COMES FROM

Dating back to stories from the Old Testament, taxes have been a pivotal fabric of society. In the Book of Genesis, Joseph required that 20% of every farmer’s crop should go to the Pharaoh. In Hunter Hibler 6 czarist Russia, Peter the Great even rendered a tax on beards.

Fast forward several centuries and the United States federal government receives their funding from taxation and borrowing. In 2011, the federal government collected $2.3 trillion in tax revenue, borrowing another $1.1 trillion placing a burden on future generations’ tax bills.

WHO PAYS? HOW MUCH?

Income taxes on individuals and payroll taxes comprise the majority of federal tax revenue. In 2011, 47% of tax revenue was from individual income taxes, and 36% was collected from payroll taxes on employers and employees. Wessel points out for most Americans, federal taxes have not risen over the past couple of decades.

Although the average taxpayer is essentially only concerned with the amount of money the government takes from them individually, it is economical to observe federal taxes as a percent of GDP over time.

The broadest way to measure the tax bite is to average the percent of GDP over the past thirty years – 18% of GDP. That number increased in 1981 to 19.6% under Ronald Reagan, and peaked at 20.6% in 2006. In recent years, the figure has hovered around 15.4% due to lagging economic conditions and tax cuts.

Payroll taxes are beginning to take larger bites out of American pockets. Employer payroll taxes affect employees just as much, because that money could be paid out in wages. If you combine the employee and employer tax bite, over 60% of households paid more in payroll taxes than income taxes.

The 2011 standard payroll tax rate was 15.3% with 12.4% allocated for Social Security, and 2.9% for Medicare. In President Obama’s Affordable Care Act, Medicare will have an additional 0.9% imposed, and an added 3.8% tax on individual investment income.

The following is a look at the tax mix over time:

CONTROVERSY: TAX RETURNS

During the 2012 presidential campaign, Mitt Romney released his tax return to the public. The results were $3.2 million paid in 2011 federal taxes on $20.9 million in income – roughly 15% of the gross take before deductions. Romney was able to accomplish an advantageous rate through exposure to the lower capital gains tax rate and deductions for charitable contributions.

Many forget the tax return controversy regarding President Richard Nixon.

In the shadows of the Watergate Scandal, it was revealed Nixon only paid $5,100 in combined federal income taxes for 1970-1972 on $795,000 of income. Nixon’s 1970 tax bill amounted to only $792. President Nixon clearly cheated on his taxes by making a number of highly questionable deductions. Every president since has voluntarily released their tax returns. Public outcry over the share prominent Americans pay in taxes questions who takes the actual tax bite.

In 2011:

• The bottom 40% of Americans received 12% of the income and paid 3% of all federal taxes.
• The next 40% of earners deemed the middle class received 33% of the income and paid 27% percent of the taxes.
• The top 20% received 55% of the income and paid 70% of the taxes.

SPENDING THROUGH THE TAX CODE

Very few American taxpayers defend the current state of the tax code. Critics claim the current tax codes reward companies for going overseas, and that it restrains saving and growth.

Wessel discusses how Congress and Presidents have discovered the simple solution to making constituents and businesses happy: provide a basket of credits, loopholes, and deductions. Analyzed in a practical sense, there is no difference in receiving a $1,000 check from the government and a $1,000 voucher to reduce taxes.

politicians have the opportunity to avoid the negative connotation attached to “spending.”

For example, more than 60% of all federal subsidies for energy are routed through the tax system compared to direct spending. Personal credits are given on items such as home-mortgage interest payments and child adoption.

In the corporate tax world, if all tax credits were wiped out, the corporate tax rate could fall from 35% to 28% and still generate the same revenue. An illustrative anecdote of tax code inefficiency is found in the infamous Section 1031. When participating in stock market capital gains, a definitive tax is owed on the profit.

However, the same tax exposure does not apply to “like- kind exchanges” such as real-estate or some animal investments. If structured properly, one could swap a dental office for a vacation property and avoid taxes, but could not swap a bull for a milk cow.

The IRS defines livestock of different sexes as “not like-kind properties.” It becomes clear the tax code is riddled with inefficiency and illogical exceptions, but changing the tax code is playing with political fire.

THE UNSUSTAINABLE PATH

There is no doubt President Obama inherited a collapsing economy and used fiscal muscle with assistance from the Federal Reserve to avoid collapse. That being said, the U.S. government owed $6.3 trillion on January 20, 2009, the day Obama took the oath of office.

On the day Obama submitted his budget on February 13, 2012, the debt had grown to $10.6 trillion. Even to this day, the number is growing exponentially and decision makers in Washington can and must make tough decisions to solve the crisis.

The following is a look at the national debt over time.

CONCLUSION

Red Ink: Inside the High-Stakes Politics of the Federal Budget sheds light on the highly controversial and deeply misunderstood issue of federal fiscal policy. Wessel exumes the most enlightening statistics and anecdotes to reveal truths on the budget.

It is important to understand the magnitude of spending $400 million an hour and how this feat was accomplished. When investigation continues, insight is provided on where the money goes and who it is coming from. Wessel expresses viewpoints and motives from both parties, but vehemently declares the need for bipartisan reform to keep the United States intact.

“I used to tell the students that we are either governed by leadership or crisis, and I always thought that if leadership wasn’t there, then ultimately you rely on crisis to drive decisions. In the last few years, my biggest concern is that crisis doesn’t seem to drive decision either. So there goes my theory.” – Leon Panetta

Britt always taught us Titans that Wisdom is Cheap, and principal can find treasure troves of the good stuff in books. We hope only will also express their thanks to the Titans if the book review brought wisdom into their lives.

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