A Budget Deal That Did Reduce the Deficit
Policy + Politics

A Budget Deal That Did Reduce the Deficit


There is a dogmatic belief that permeates Republican circles which says that budget deals never reduce budget deficits. Republican strategist Grover Norquist recently said that those that do cut the deficit are as real as unicorns. This is factually untrue. The record shows that the 1990 budget deal was extremely effective in reducing deficits; the budget surpluses of the late 1990s owe much to the policies put in place by George H.W. Bush that his son and party later repudiated.

Bush had, of course, been Ronald Reagan’s vice president for eight years and knew firsthand how difficult it was to bring the federal budget deficit down from 6 percent of GDP in 1983 to 2.8 percent in Reagan’s last budget. Bush knew that the many budget deals of the 1980s had been hard fought and always involved higher taxes as part of the deficit reduction. According to a table in his last budget, Reagan signed into law 11 major tax increases that raised taxes by $133 billion in 1988 or 2.7 percent of GDP.

Unfortunately, Bush was hit by the savings and loan crisis almost the minute he took office in 1989. This required a massive federal outlay to protect deposits that were threatened by the collapse of an earlier housing bubble.  Moreover, by 1990 the economic situation was deteriorating, causing estimates of future budget deficits to rise at a time when inflation was still a problem and interest rates were far higher than they are today. In early 1990, the federal funds rate was well above 8 percent versus close to zero today.

Bush administration economists believed that an easier monetary policy was the key to stimulating growth. But Federal Reserve Board chairman Alan Greenspan made it unmistakably clear that inflation was his prime concern and he would not ease monetary policy until he saw some improvement in the budget deficit, which Greenspan viewed as inflationary. Therefore, a budget deal was the price that had to be paid for lower interest rates, an easier monetary policy and faster growth. (Greenspan imposed the same conditionality on Bill Clinton three years later.)

Democrats controlled both houses of Congress in 1990 and there was obviously no possibility of doing a budget deal without them. And their price for coming to the table was that higher taxes had to be part of the discussion. But Bush was constrained by a promise he made at the Republican Convention in 1988 never to raise taxes. Abandonment of that solemn “read my lips, no new taxes” promise was certain to unleash a firestorm of attacks from the GOP’s right wing.

Nevertheless, Bush agreed to negotiate in early May on the Democrats’ terms. Although Republican negotiators were willing to discuss taxes, Democrats were wary of a trap. They feared being hung out to dry unless Bush himself made a public commitment to put taxes on the table. He did so on June 26, 1990, saying, “It is clear to me that both the size of the deficit problem and the need for a package that can be enacted require all of the following: entitlement and mandatory program reform; tax revenue increases; growth incentives; discretionary spending reductions; orderly reductions in defense expenditures; and budget process reform—to assure that any bipartisan agreement is enforceable and that the deficit problem is brought under responsible control.”

Not surprisingly, right-wingers instantly seized upon “tax revenue increases” as representing abandonment of Bush’s no-new taxes pledge and launched a concerted attack on him for his apostasy. But it did get the budget negotiations going in earnest.

Work went on all summer as the situation in the Middle East reached a crisis when Iraq invaded Kuwait on August 2, 1990. I believe that a key reason why Bush supported the budget negotiations is because he knew we were almost certainly going to war shortly and believed that it ought to be paid for. Today, Republicans laugh at such an old fashioned idea and believe that wars should just be put on the national credit card.

Budget negotiations finally concluded in late September. The final deal cut spending by $324 billion over five years and raised revenues by $159 billion. The most politically toxic part of the deal, as far as congressional Republicans were concerned, involved an increase in the top statutory income tax rate to 31 percent from 28 percent, which had been established by the Tax Reform Act of 1986. The top rate had been 50 percent from 1981 to 1986 and 70 percent from 1965 to 1980.

More importantly, the deal contained powerful mechanisms for controlling future deficits. In particular, a strong pay-as-you-go (PAYGO) rule required that new spending or tax cuts had to be offset by spending cuts or tax increases. There were also caps on discretionary spending that were to be enforced by automatic spending cuts.

Right-wingers were totally apoplectic about the budget deal and made outrageously extravagant claims about how it would destroy the economy. The most extreme forecast came from the National Center for Policy Analysis. In an October 16, 1990, study it predicted that the deal would reduce employment by 408 thousand jobs by 1995 and that GDP would be lower by precisely $168.6 billion between 1990 and 1995. Even 10 years later GDP would be $65.6 billion per year lower, the study said.

Admittedly, the budget deal didn’t occur at the most opportune moment in time from a macroeconomic point of view. But according to the National Bureau of Economic Research, a recession began in July 1990, long before any provisions of the budget deal took effect, ending in March 1991.

Economists generally agree that the recession resulted primarily from a tight monetary policy. (See this study by Federal Reserve Bank of San Francisco economist Carl Walsh.) Stanford economist Robert Hall looked at whether higher taxes contributed to the recession in a May 1993 study and concluded that it was “farfetched” to think so.

The political implications of the 1990 budget deal are much more straightforward. In the House of Representatives, 163 Republicans voted against it and only 10 supported it. In the Senate, only half of Republicans voted for the deal. More significantly, Bush’s abandonment of his no-new-taxes pledge dogged him all through the 1992 election campaign and contributed heavily to his defeat by Bill Clinton. Ironically, Ross Perot also contributed to his defeat by arguing that Bush had not done nearly enough to reduce the deficit.

Budget experts now agree that the Budget Enforcement Act of 1990, which was strengthened in 1993 by another budget deal that was opposed by all Republicans, deserves much of the credit for the subsequent improvement in the deficit, which shrank from 4.7 percent of GDP in 1992 to virtual balance in 1997 and gave us budget surpluses from 1998 to 2001. Economist Robert Reischauer, director of the Congressional Budget Office when the 1990 budget deal was enacted, told me it was “the foundation upon which the surpluses of the 1998 to 2001 period were built.”

But in 2002, Republicans abandoned the budget rules put in place in 1990 so that they could cut taxes without constraint. The result was a continuous string of budget deficits throughout the George W. Bush years.

Twenty years ago, the last serious Republican effort to reduce the budget deficit took place when George H.W. Bush agreed to negotiate with congressional Democrats on a budget deal. As a consequence, many Republicans disowned his efforts and abandoned him in 1992, leading to his defeat. Today, the idea of cooperating with Democrats on deficit reduction is viewed as a total loser by all Republicans.  Until that perspective changes, the elder Bush will remain the last Republican who took fiscal responsibility seriously.