December 5, 2012
When selling his tax hikes to the public, President Obama often advertises the economic gravy train that chugged through the Clinton-era as proof that higher taxes won’t derail growth.
Bill Clinton in 1993 raised top marginal rates on the wealthiest to 39.6 percent, the same level Obama wants to restore them to as part of the fiscal cliff talks with congressional Republicans. The administration’s nuanced argument—backed by a spate of economic studies—is that the economy can easily weather the increase, but statements from Obama and his deputies occasionally insinuate that boom times will return if only patricians paid the IRS more money.
“Remember, that was a time of remarkably good economic growth, in this country—very strong private investment, strong job growth, strong broad-based growth in incomes,” Treasury Secretary Tim Geithner said this week on “Fox News Sunday.” “It was a good time for the American economy. It makes a lot of sense.”
These kinds of comparisons to the 1990s annoy economists like Douglas Holtz-Eakin, who has advised GOP presidential campaigns and now runs the American Action Forum. Affluence during the Clinton era derived in large part from forces that had little to do with changing taxes: demographic trends, the rise of the Internet, the tech stock bubble, and phenomena that are divorced from some of the dominant traits in the economy as it is now.
“The free lunches on productivity from then are all gone now,” Holtz-Eakin said. “I understand the politics of it, but it’s shoddy empirical research. I would flunk a freshman who did that.”
Here are four major reasons to doubt that we’ll relive the 1990s under any of the plans—Obama’s or the Republicans’—that are meant to trim the deficit:
SHRIVELING WORKFORCE – Two major factors steer economic growth: population and productivity. The labor pool essentially exploded under Clinton. Baby boomers hit peak earning years, as their children started climbing the career ladder. When Clinton first took the oath of office in 1993, the employment-to-population ratio was 61.5 percent. It peaked toward the end of his tenure at 64.6 percent—the highest quarterly reading since the Bureau of Labor Statistics began recording this ratio in 1948.
Baby boomers are now retiring after weathering an annihilative financial crisis. The employment-to-population ratio has been flat at 58.5 percent for the past four quarters, even as the unemployment rate improved.
“Labor force participation was still climbing in the 1990s when tax rates were higher,” said Robert Stein, a senior economist at First Trust Advisors, “which means we won't get the same real GDP growth at those tax rates” now.
CHINA BELONGS TO THE WTO – Clinton never had to contend with an industrial behemoth like China. The Asian power exported just $31.5 billion worth of goods and services to the United States in 1993, a figure it now surpasses on a monthly basis by more than $6 billion, according to the Census Bureau.
Americans buy clothing, furniture, laptops, and smart phones from China. Increased trade can help consumers with lower prices, but it also contains hidden costs that unfold over time. The Obama administration filed complaints with the World Trade Organization—an entity China didn’t even belong to during the Clinton administration—for violations on solar panels, wind turbines, raw materials, tires, and auto parts.
The trade deficit with China is on pace to top $330 billion this year, subtracting roughly 2 percent drag from the U.S. Gross Domestic Product. To put that in perspective, the entire economy grew at a 2 percent clip so far this year.
STOCK MARKETS—The S&P 500 surged by about 210 percent under Clinton, as Internet companies like Amazon, Netscape, and Yahoo had epic IPOs. Stocks are up about 60 percent thus far with Obama, in large part because it’s been recovering from the depths of the 2008 financial crisis.
But even with hot IPOs the graying population indicates that it will be extremely tough for Obama to ever match those returns. As more baby boomers retire, they sell their equity holdings to finance their golden years, pulling capital out of the stock market. The San Francisco Federal Reserve issued a paper last year estimating that the price-earnings ratio—a fundamental measure of a stock’s value—will decline as a result of the capital flight, going from a P/E average of 15 in 2010 to 8.3 by 2025.
FALLING PUBLIC INVESTMENT—Not all government spending is wasteful. Taxpayer investments in education, infrastructure and basic research pay off for the economy down the road. A skilled workforce is more productive, just as highways, bridges, railways, and airports can enable daily commerce.
Analysis by Ethan Pollack at the liberal Economic Policy Institute forecasts that public investment will decline over the next four years. These investments initially surged under Obama because of the 2009 stimulus and currently represent 2.3 percent of GDP, but discretionary spending was trimmed last year in the Budget Control Act to reduce the deficit. According to the Obama budget proposal—which is more generous than the GOP alternative—they’ll slide beneath the Clinton-era average of 1.7 percent around 2016.
And because the stimulus supported the fragile economy for the past three years, Pollack expects that “the wind-down in investment as a share of GDP will drag at growth rates.”
Given the historically low interest rates on U.S. Treasurys and the relatively high 7.9 percent unemployment rate, it makes sense to many economists to continue deficit expenditures to help the economy—an option that’s no longer prominent in policy discussions between the White House and congressional leaders. Interest rates were not only higher in 1993, but unemployment was slightly lower when the deficit trimming began under Clinton.
“To me, it’s shocking that we’re devoting less to government capital spending,” said Gary Burtless, a senior fellow at the Brookings Institution. “It’s as though everything we learned from the aftermath of the Great Depression has been forgotten.”