Rosy Scenarios and Red Realities: Ronald Reagan, George W. Bush and the Deficit

Elephants are supposed to have long memories but the Republican variety patently does not, judging by the fury over the ‘Obama deficits.’ In the GOP universe, these are the outcome of big-government spending and the only hope of fiscal restoration is to cut taxes.  The Republicans appear to have forgotten that this was tried before by Ronald Reagan and George W. Bush, with the main effect of sending the deficit skyrocketing.

            The deficit explosion on his watch was a nasty surprise for Ronald Reagan not a deliberate strategy to reduce government.  In his rosy interpretation of Laffer curve theory, the personal tax cuts he promoted in 1981 would deliver higher not lower revenues through their boost to economic growth.  However Reagan quickly came to terms with the red reality so long as deficit expansion did not provoke the Fed into raising interest rates to safeguard against inflation, thereby putting him under inexorable pressure to surrender his core objectives of low personal taxes and big defense.  Reagan’s animus in reality was against big government not big deficits.  As he put it to reporters in 1982, “the cost of government, not just necessarily the deficit, was the problem.” As elaboration, he cited Milton Friedman’s dictum that an unbalanced budget with only $200 billion spending was preferable to a balanced one with $400 billion outlays.  Reagan continued to rail against deficits while doing everything he could to protect his tax and defense programs that were their primary cause.  In 1985 he adroitly outmaneuvered GOP Senate leader Bob Dole’s efforts to cut a deficit-reduction deal with House Democratic Speaker Tip O’Neill that included tax increases and defense cuts in return for entitlement economies.  Moreover, Reagan colluded with the now entirely Democrat-led Congress of 1987-88 to circumvent the deficit reduction schedule mandated by the 1985 Gramm-Rudman-Hollings (GRH) initiative, thereby protecting his defense program at cost of soft-peddling domestic economies.            

            Realizing that the financial markets would not tolerate such legerdemain for long and anxious to avoid draconian spending sequestrations required by the GRH schedule, George H. W. Bush took the deficit more seriously than his predecessor.  This was why he reluctantly accepted the 1990 budget compromise with congressional Democrats that included higher taxes in return for a spending control formula.  Seen as a betrayal by Reaganite Republicans, this first step in the restoration of fiscal responsibility split Bush’s party and helped make him a one-term president.    Led by Newt Gingrich and abetted by Bob Dole in the interests of his presidential ambitions, the increasingly dominant conservatives sought payback when the GOP gained control of both houses of Congress in 1994.  To preserve and expand the Reagan legacy, they demanded huge tax cuts and a balanced budget paid for with massive domestic retrenchment. Bill Clinton’s unexpected resilience and the public’s disgust at the government shutdowns of 1995-96 ended this strategy.  The GOP consequently accepted a more moderate and bipartisan five-year balanced-budget plan in 1997.  Within a year, however, the economic boom primarily created by the Federal Reserve’s monetary relaxation eliminated the deficit problem.  The main budget issue became what to do with the massive surpluses now being projected for years to come – invest them in the Social Security trust fund to guarantee its long-term solvency (the Clinton-Gore plan) or in tax cuts (the Republican preference).

Enter George W. Bush who pushed through the largest tax cut in US history in 2001 and the second largest tax cut in 2003.  The trouble was that the budgetary situation had undergone massive deterioration – the dot.com bust and the consequent recession of 2001 had blown away the surplus and restored huge deficits.  Bush’s response was to insist that his tax cuts would be the fertilizer for budget-restoring economic growth.  The deficit did shrink from a current dollar record of $412 billion in FY 2004 to $162 billion in FY2007 (3.6 percent to 1.2 percent of GDP).  In 2006 Bush exulted, ‘Some in Washington said we had to choose between cutting taxes and cutting the deficit…. that was a false choice.  The economic growth fuelled by tax relief has helped send our tax revenues soaring.’ This was wishful thinking.  Even conservative economists like Bruce Bartlett thought that monetary relaxation was the principal agency of economic recovery. The main effect of Bush’s program was to lose revenue.  According to the congressional Joint Committee on Taxation, the tax cuts enacted since 2001 cost $251 billion revenue in FY2006, when the deficit was $248 billion.  In other words, absent them and the US could have paid for its Iraqi and Afghan operations and post-Hurricane Katrina reconstruction within a balanced budget.  

Faced with a Democratic Congress instead of a Republican one in 2007, Bush became a born-again budget balancer, but his plan to eliminate the deficit by 2012 only featured domestic economies and unrealistic revenue estimates.  The economic crisis that blighted his final year in office ended all hope of fiscal recovery.  In a desperate effort to prevent financial system meltdown, Bush promoted rescue initiatives – notably the Troubled Assets Recovery Program – that expanded gross federal liabilities by over $1 trillion, more than the combined cost to date of the Afghan and Iraq wars. Nevertheless, he resisted an Obama-style stimulus package out of opposition to spending solutions.  True to his party’s credo, Bush insisted in his final press conference that making his 2001 and 2003 tax cuts permanent was the surest route to sustainable economic and fiscal recovery.

During a White House meeting in early 1984, Ronald Reagan shocked economic adviser Martin Feldman in insisting that no tax increase in US history had raised revenue.  The eminent Harvard economist penned him a memo proving that every increase in tax rates from 1917 to 1969 had actually done so.  Arguably the contemporary GOP needs to absorb this lesson and the corollary one that tax cuts cost revenue before it can play a constructive and bipartisan role in the solution of America’s increasingly grim twenty-first century deficit problem.    

Related Links

Iwan Morgan: Seeing Red: The Budget Deficit - Past, Present and Future