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Bill Clinton
Bill Clinton
The Republican Party, and in particular the anti-government radical fringe known as the Freedom Caucus, promotes a disproven hypothesis about economic growth that comes in two parts. First, tax cuts, particularly cuts to the income of the donor class, will stimulate economic growth. A more extreme version of this nostrum is that economic growth would be so robust as to increase total tax revenue despite lower tax rates. Part two of this belief is its mirror image: tax increases will dampen economic growth, and worse, force a stable economy into recession.
It is a testable hypothesis, and one of the most powerful tests came in 1993 with the first economic policy move of the Clinton administration: a tax increase imposed primarily on the highest income taxpayers. It disproved the Republican prediction; the tax increase did not result in a recession but rather initiated greater growth and turned a string of deficits into surpluses.
The explanation begins with the debt-financed tax cuts of the Reagan-Bush years that ushered in several years of large and increasing deficits. By 1992, the Congressional Budget Office (CBO) projected the 1993 deficit to be $310 billion, roughly 5% of GDP. Their one-word descriptor: “Grim.” In 1992, Bill Clinton campaigned in part on a pledge on to bring the deficit down.
Early in 1993, just after his inauguration, Clinton proposed the Omnibus Budget Reconciliation Act (OBRA), which had as its central feature an increase in taxes, particularly on upper income taxpayers. In the face of a policy so severely at variance with their treasured hypothesis, republicans predicted that the tax increase would cause a recession. Newt Gingrich claimed that OBRA would bring on the worst recession since the great depression. Not a single Republican senator voted for the bill. In fact, the vote in the U.S. Senate was a tie, with the tie-breaking vote cast by Vice President Al Gore.
Instead of causing a recession, OBRA did what Clinton predicted: the policy set in motion rapid economic growth. This was a big win for demand-side economics; a big loss for supply-side advocates. Rather than cause the deficit to rise, the deficit began to shrink during 1993. OBRA passed in August 1993 and, within a month, the CBO’s deficit projection (expressed as a negative number) was revised downward to -$200 billion. For comparison, the deficit for 1992 was $327 Billion. The deficits declined year after year through 1997, followed in 1998 by the first surplus is in 30 years. The actual deficit and then surplus numbers for the years up to 2000 were:
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- 1993 -226.3 B
- 1994 -185.0 B
- 1995 -146.5 B
- 1996 -110.9 B
- 1997 -2.4 B
- 1998 +54.4 B
- 1999 +158.6 B
- 2000 +254.8 B
To see the scope of the turnaround from deficits to surpluses, note that in 1993 the CBO had forecast a deficit for the year 1998 of -$357 billion. Put another way, a shift from a projected deficit of -$357 billion to an actual surplus of +$54.4 billion is a turnaround of $411 billion, or roughly 5.5% of GDP.
How can a tax increase on rich people increase economic activity? The explanation provided by the CBO tells the story in a series of steps. First, the 1993 Clinton economic policy was to create another testable hypothesis: a believable effort to get control of the budget deficit. Investors around the world demonstrated by their investment patterns that they believed the dramatic policy shift away from supply side economics would bring the deficit under greater control. Knowing that fewer federal bonds would be on the market, investors very quickly shifted their U.S. bond-demand to private sector bonds, e.g., public utility bonds, municipal bonds, insurance companies and so forth. The reduced supply of U.S. bonds offered for sale to finance deficits in turn reduced the “crowding out effect,” i.e., making more room for private sector investment. In other words, this projected decrease in borrowing drove down interest rates, making investment in the private sector cheaper.
There is no question that the Clinton economic policy that began in 1993 got the ball rolling toward a budget surplus by 1998. What was a supply-sider to do in the face of this debunking of the supply-side theory? Answer: take credit for the results! That’s right: Newt Gingrich claimed that it was Republican policies in 1998 that created the surplus, claiming further that Clinton fought their deficit reduction/balanced-budget policies. Not quite. Clinton objected to their proposed cuts in domestic spending and their proposed increases in military spending. Clinton did not object to balancing the budget and stimulating growth; those were among his major campaign promises. He simply had, unlike the Republicans, a coherent way to achieve those goals.
An earlier version of this article was posted on Econ4Voters at grassrootsnorthshore.com.
