Obama-Congress U.S. Budget Battle Benefits From No Grand Bargain

Photographer: Pete Marovich/Bloomberg

U.S. President Barack Obama after speaking about the budget on Dec. 28, 2012. Republicans are now pressing Obama to revamp entitlement programs before they’ll raise the country’s $16.4 trillion borrowing limit. Close

U.S. President Barack Obama after speaking about the budget on Dec. 28, 2012.... Read More

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Photographer: Pete Marovich/Bloomberg

U.S. President Barack Obama after speaking about the budget on Dec. 28, 2012. Republicans are now pressing Obama to revamp entitlement programs before they’ll raise the country’s $16.4 trillion borrowing limit.

Twice in less than two years, President Barack Obama and U.S. House Speaker John Boehner failed to negotiate a sweeping solution to the nation’s financial challenges. That may not be such a bad thing.

From the establishment of Medicare to across-the-board tax cuts, history shows that presidents’ most ambitious ventures often create as many problems as they solve.

“Presidents act first and think later about the long-term consequences,” says Barbara Perry, an expert on the presidency at the University of Virginia’s Miller Center. “Then 50 years from now, or even 10 years from now, we’ll say: ‘Oh, why didn’t he see that this wasn’t going to work properly?’”

Republicans are now pressing Obama to revamp entitlement programs before they’ll raise the country’s $16.4 trillion borrowing limit, with both sides agreeing that costs must be contained. A comprehensive rewrite of the 4 million words in the U.S. tax code is also on the 2013 agenda.

For Obama, who came to office vowing to be a transformational chief executive, the risks of unintended consequences are greater than most. Already, he has pushed through Congress a health-care plan that will alter an industry that makes up about 18 percent of the economy as well as the broadest rewrite of financial-industry regulations since the 1930s.

Tangible Risks

The president and his senior aides were aware of the risks of bold action, according to Jared Bernstein, a former economic adviser to Vice President Joe Biden who participated in White House debates on both initiatives. Such dangers were outweighed by the tangible risks of inaction, with health-care spending consuming an ever larger share of economic output and the financial system vulnerable to a repeat of the 2008 credit crisis, he says.

“It’s pretty hard to protect against things you can’t foresee,” says Bernstein. “Leadership means tackling the most important problems without being frozen in fear by things you can’t know about the future.”

Some of the potential fallout from Obama’s lack of action on curbing costly entitlement programs is already apparent. Even as he vows to stabilize the national balance sheet, his long-run budget forecasts call for exploding deficits beyond the customary 10-year planning period. By 2040, debt held by the public is expected to exceed 103 percent of gross domestic product, according to the White House.

Hurting Neediest

In the recent negotiations to avert more than $600 billion in automatic tax increases and spending cuts, the president’s initial consideration of a new formula for calculating cost-of- living adjustments for Social Security had activists such as the Campaign for America’s Future warning that the needy may suffer. Still to come in a second term is possible action on issues from immigration to gun control.

White House spokesman Jay Carney declined to comment for this story.

Historian H.W. Brands, the author of books on five Oval Office occupants, says presidents as different as Harry S. Truman and Ronald Reagan contributed to the nation’s current fiscal woes. Truman responded to communist challenges in Europe and Korea by putting the U.S. on a permanent war footing, and Reagan effectively made chronic budget deficits palatable to conservatives, he says.

LBJ, Bush

Two presidents from Texas, one Democrat and one Republican, made Texas-sized miscalculations that ultimately helped lead U.S. lawmakers to the current impasse.

Lyndon Johnson wanted doctors and hospitals to support his effort to expand health insurance to the elderly. He figured that controlling costs could wait.

George W. Bush said the government was taking in so much money that he could cut taxes and reduce the national debt at the same time. He couldn’t.

Years later, those errors left the government with too much spending and not enough cash.

By 1965, Democrats had been trying for decades to expand health-insurance coverage when Johnson, fresh from a landslide election victory, pressured U.S. lawmakers to approve Medicare.

As the legislation moved through the House, it grew to cover physicians’ bills along with hospital expenses. Johnson confronted opposition from the American Medical Association, resisting what it saw as “socialized medicine,” and cost- conscious members of Congress from both parties.

He leaned on supporters to keep long-term cost projections under wraps. In a Jan. 9, 1965, conversation with then-Senator Edward Kennedy, recorded by the White House, Johnson complained that “the fools had to go projecting it down the road five or six years” risking the wrath of powerful figures such as Senator Richard Russell of Georgia. “We don’t want to stir up any more hornets than we have to,” Johnson told Kennedy.

‘Reasonable’ Fees

The compromises required to defuse the program’s most virulent opposition laid the seeds for later cost escalation. To win the backing of doctors, Johnson agreed to have Medicare reimburse them for “usual, customary and reasonable” fees. In effect, doctors could name their own price.

Hospitals got an even better deal, with Medicare paying them on a “cost-plus” basis. That system, which lasted until 1983, left bills to be determined after medical services had been rendered.

Johnson signed Medicare into law on July 30, 1965, with Truman, enrolled as the first beneficiary, by his side. The program took effect one year later, an accelerated schedule that emphasized speed of implementation rather than cost- effectiveness, says James Morone, co-author of “The Heart of Power: Health and Politics in the Oval Office” and a Brown University political scientist.

Ballooning Cost

In its first five years, Medicare drove hospital spending up by 23 percent and encouraged widespread usage of new technologies, including open-heart surgery and cardiac intensive-care facilities, according to a 2005 paper by Amy Finkelstein, a Massachusetts Institute of Technology economist.

Medicare’s hospital spending of $67 billion in 1990 was more than seven times the $9.1 billion forecast for that year in 1965. Last year, the program served more than 49 million Americans at a total cost of $560 billion, more than double the 2003 figure.

Former Johnson aides today say that political needs trumped cost concerns. The Medicare bill was “deeply flawed. There were too few cost controls,” wrote Bill Moyers, his onetime spokesman, in the Huffington Post in August. “Even as he signed the bill, we still weren’t sure what all was in it.”

Tax Miscalculation

If presidents have erred on spending, they have been far from flawless raising money to pay for government programs.

Bush took office in 2001 with the federal government, flush from the technology boom of the 1990s, running a record budget surplus the previous year. The $236.9 billion surplus in 2000 was the third consecutive following 28 straight deficits.

As he was sworn in, the Congressional Budget Office projected additional surpluses of $5.6 trillion over the 2002- 2011 period. The new president’s Feb. 27, 2001, budget speech to a joint session of Congress boasted of increased discretionary spending of 4 percent above inflation, plans to double Medicare spending over 10 years to encompass a new prescription-drug benefit, and a $2 trillion reduction in the national debt.

“The growing surplus exists because taxes are too high and government is charging more than it needs,” Bush said. “The people of America have been overcharged, and on their behalf, I am here asking for a refund.”

He also sought sweeping tax cuts to reduce marginal rates, lower taxes for some married couples, and the eventual elimination of the estate tax.

Wrong Projection

Even as the president spoke, the economy was shrinking. His plans were predicated upon annual growth over the next decade of 3.1 percent, almost twice what actually occurred. Employment peaked at about 132 million during his first full month in the White House and then sank until August 2003.

On June 7, 2001, Bush signed the first of two major tax cuts. The next year, following the Sept. 11 terrorist attacks, the government was back in the red, with a $158 billion deficit.

In 2003, a second tax cut lowering capital gains and dividend levies was enacted. By the following year, the twin reductions accounted for $255 billion of the $413 billion federal deficit, according to the budget office.

Over the decade 2002-2011, the Bush tax cuts cost the Treasury more than $1.7 trillion -- or almost 30 percent of the $6.1 trillion in deficits, the CBO says.

Half Right

Phillip Swagel, who served as chief of staff of the president’s Council of Economic Advisers from 2002 to 2005, says the administration was counting on enacting entitlement-program changes to lower future spending.

“We had in mind doing both, changes to revenue and spending,” he says. “And, of course, the second half didn’t get done.”

Obama, who once praised Reagan for altering “the trajectory of America,” wants to leave a similar lasting impression. He bills his economic policies, especially increased spending on education and energy efficiency, as designed to produce benefits years from now.

“Except in the last year when so many of his decisions were about getting re-elected, most of what he focuses on is long-term,” says Jonathan Alter, author of “The Promise” and an occasional columnist for Bloomberg View. “He didn’t run for president just to be the first African-American president; he wanted to do big things.”

Big things risk big headaches for his successors. Deep within the laws that overhauled the financial-regulation and health-insurance systems are provisions that some experts worry could hamstring future chief executives.

Getting Bigger

Though Obama in 2010 promised to “prevent the further consolidation of our financial system,” the nation’s big banks have grown bigger. At the end of the third quarter, more than two years after he signed the Dodd-Frank financial regulation act, the five largest banks held $8.7 trillion in assets, equal to more than 55 percent of the economy, according to Federal Reserve data. That’s up from 43 percent before the crisis.

Dodd-Frank also prohibits the Fed from rescuing individual financial firms during a crisis -- a power that helped stabilize the system in 2008 -- and further restricts the central bank’s ability to act in a crisis. That concerns experts such as Donald Kohn, former Fed vice chairman, John Dugan, former comptroller of the currency, and John Williams, president of the Federal Reserve Bank of San Francisco.

“The Dodd-Frank Act restricts the Fed’s ability to provide liquidity” to nonbank financial institutions, Williams warned in a 2011 speech.

Boosting Subsidies

Flaws may also appear once Obama’s health-insurance legislation is fully implemented in 2014. One example: More people may end up on government-run exchanges than the plan’s architects projected, making the plan more costly to the federal government by boosting subsidies.

A March report by the Congressional Budget Office concluded that low-wage employees who have insurance through their employer may be better off if they were able to buy coverage through their state’s exchanges instead.

For the head of a family of four with up to $74,000 in adjusted gross income in 2016, obtaining insurance through the subsidized exchanges could mean a net gain of $3,000, CBO says.

Yet under the Affordable Care Act, individuals who get insurance through their employers aren’t eligible to use the exchanges. As people realize the potential savings, a future Congress may come under pressure to change that. If it does, the cost of providing additional subsidies to these individuals could prove expensive, says James Capretta, a health-care specialist at the Ethics and Public Policy Center in Washington.

“I don’t think there’s ever been a sweeping piece of legislation that didn’t have unintended consequences,” says economist Alan Viard of the American Enterprise Institute. “There’s no reason for this to be any different.”

To contact the reporter on this story: David J. Lynch in Washington at dlynch27@bloomberg.net

To contact the editor responsible for this story: Cesca Antonelli at fantonelli@bloomberg.net

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