A Budget Deal That Did Reduce the Deficit
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The Fiscal Times
February 3, 2011

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.

Bruce Bartlett’s columns focus on the intersection of politics and economics. The author of seven books, he worked in government for many years and was senior policy analyst in the Reagan White House.