Budget Bunk: The Old Pox on Both Your Houses Game

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Dean Baker

Dean Baker is co-director of the Center for Economic and Policy Research

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May 1st, 2012 4:02 PM

Budget Bunk: The Old Pox on Both Your Houses Game

In Washington all serious people routinely write columns in which they set themselves above the political fray and pronounce the Republicans and Democrats equally to blame for political gridlock and all that they see wrong with the world. Today, it is my turn.

Of course beating up on the Republicans is pretty easy these days; you mostly just have to repeat what they say. Their standard bearer, House Budget Committee Chairman Paul Ryan, has proposed a budget that eliminates the national park system, the Justice Department and federal courts, the Food and Drug Administration and most other areas of the federal budget over the next four decades.

According to the analysis done by the Congressional Budget Office, the Ryan budget, which was endorsed by the Republican House and Governor Mitt Romney, shrinks non-Social Security and non-health care spending to 4.75 percent of GDP by 2040 and to 3.75 percent of GDP by 2050. With the military budget taking up 3-4 percent of GDP, everything else goes to zero somewhere in this period.

Ryan also proposes massive tax increases on the middle class to finance tax cuts to the wealthy. He wants to reduce the top tax rate on high-income earners by more than one-third compared with its baseline level. He proposes to maintain revenue neutrality be eliminating tax deductions that benefit the middle class, like the mortgage interest tax deduction and the deduction for employer-provided health insurance.

How many people will feel good about a budget that eliminates most of the governmental functions that we take for granted -- drug safety, courts, a State Department and passport office? How will people feel about paying higher taxes so that Mitt Romney can pay less? These are the questions raised by the Republican budget. Hopefully they will be presented clearly in the campaign so that the public can make an informed choice.

While beating up on the Republicans is pretty much child's play, it is necessary to do a little homework for the demolition of the Democrats. The Democrats rely on their great myth: Bill Clinton made the hard choices, cutting spending and raising taxes. This led not only to a balanced budget, but to large surpluses. As former Treasury Secretary Larry Summers said, he had the privilege as Treasury Secretary to be buying back federal debt. In this story, the economy was rewarded with strong growth, low unemployment, and a declining national debt, all by virtue of President Clinton's courage in reducing the budget deficit.

It's a nice story, but it's long past time that we put this fairy tale to rest. In 1996, after all the "hard choices" had been made (subsequent changes on net raised the budget deficit), the Congressional Budget Office (CBO) was still projecting a deficit of 2.5 percent of GDP (@$460 billion in today's economy) for 2000. The reason that we ended up with a surplus of $240 billion instead of a deficit of approximately the same size was that the economy grew much more rapidly than had been expected, pushing the unemployment rate down to 4.0 percent in 2000, rather than the 6.0 percent projected .

There were two reasons that the economy grew so rapidly over this four-year period. First, Alan Greenspan allowed it to grow. The conventional wisdom in the economics profession at the time was that the rate of inflation would increase dangerously if the unemployment rate fell below 6.0 percent. This view implied that the Fed should raise interest rates to slow the economy and keep people from getting jobs once the unemployment rate was near 6.0 percent.

Greenspan was not an orthodox economist. As a result, he was prepared to allow the unemployment rate to continue to drop through the late 90s, over-riding the objections of the Clinton appointees to the Fed.

The other reason that the economy grew so rapidly and the deficit flipped to a surplus was the stock market bubble. This bubble propelled growth both directly by allowing Internet start-ups to finance half-baked schemes. The investment from these projects generated demand, just like any make-work project, even if the companies never had a prayer of making a profit.

The other way the bubble boosted the economy was by creating a consumption boom. People spent based on their newly generated stock wealth, pushing the saving rate to what were at the time record lows.

In short, the real story of the balanced budget in the '90s had little to do with Clinton's hard choices. It was attributable on the one hand to an eclectic Fed chairman who was prepared to ignore the orthodoxy within the economics profession and allow the unemployment rate to fall to levels generally thought impossible to attain by economists. On the other hand, it was driven by an unsustainable asset bubble.

This is key part that people want to remember going forward. The prosperity at the end of the Clinton years was unsustainable because it rested on a bubble that was destined to burst. And it did burst exactly as President Clinton was making his plans to leave the White House. The economy did not regain the jobs lost in the 2001 recession until 2005, and even then it was on the back of another unsustainable bubble, this one in the housing market. And we know how that one ended.

So the Democrats' morality tale of hard budget choices and virtuous austerity turns out not to hold water. If this myth is exposed perhaps they can be prodded into talking more seriously about the economy in the months leading up to the election.