John Edward, a resident of Chelmsford who earned his master’s degree at UMass Lowell and who teaches economics at Bentley University and UMass Lowell, contributes the following column:
Last month I explained why Reaganomics was a dismal failure. Now I will focus on lessons that Clintonomics have to offer.
President Clinton said, “The era of big government is over.” That was not true. His saying that was a reflection of his political talent, not his economic policies.
What Clinton did achieve was a temporary end to an era of budget deficits. What he accomplished did more for the supply side of the economy than any of the failed supply-side policies of President Reagan.
Economic textbooks describe a “crowding out” effect. If the government runs a large deficit, it might drive up interest rates. Higher rates will discourage investment. Government spending is said to crowd out investment. With today’s low interest rates, crowding out is not a concern.
Some textbooks suggest the possibility of a “crowding in” effect. Investors see the government is willing to spend public funds to stimulate the economy and invest in the future. If they expect the policy will be successful, it will encourage private investment.
We saw some crowding in with President Obama’s stimulus package. However, there is a limit to how much and for how long deficit spending can crowd in investment.
There is evidence that Clintonomics demonstrated a very different crowding in effect. Textbooks seldom discuss it.
When William Clinton took the oath of office the federal budget deficit was $290 billion, or 5 percent of Gross Domestic Product (GDP). It took a while, but by the final years of his Presidency we were running a budget surplus – the federal government was spending less than revenue. We were actually paying down the national debt.
For four years in a row, starting in 1998, the official budget was in surplus. Two of those years were a surplus only because of money going into the social security trust fund. In any case, if you look at the history of federal budgets both before and after, these surpluses were remarkable.
Clearly, something was crowding in investment. In 1992, investment was 13.6 percent of GDP. By 2000, it was up to 17.8 percent. Investment more than doubled during the Clinton administration. As compared to the Reagan-Bush era, worker productivity, corporate profits, and price stability all improved under Clinton.
A mix of fiscal discipline and fiscal reality may have encouraged investors. Investors want the government to manage its budget – in particular to have a long-range plan, and the discipline, to bring it into balance.
However, smart investors also acknowledge the reality that “big government” can help our economy grow. In the short run, it may provide a necessary stimulus. In the long run, no one other than the government will make adequate investments in infrastructure, education, public health, public safety, national security, and environmental stewardship.
In 1992, government spending was 20.1 percent of GDP. By 2000, it was down to 17.4 percent. During those eight years, government spending grew by only 1 percent per year, adjusted for inflation. The President worked with Republicans and Democrats in Congress to reach compromises on spending and taxes.
In 1993, Clinton and Congress agreed to a modest increase in personal income taxes. The top tax rate rose to 39.6 percent. To put that in context, it was 70 percent when Reagan took office.
As a result of the tax increase, government revenue increased significantly. Without the rate hike, there would not have been a budget surplus.
Supply-siders predicted tax increases would slow economic growth. They were wrong.
During the eight years Reagan was in office, Real (adjusted for inflation) GDP grew by 30 percent. During the Clinton administration, it grew by 35 percent. Without the healthy economic growth, there would not have been a budget surplus.
Today we have sluggish economic growth, high unemployment, and a very large budget deficit. The national debt is over 100 percent of GDP. However, it was over 120 percent of GDP after World War II and we recovered nicely. The 1950s and 60’s were decades of excellent economic growth.
We also have companies sitting on about $2 trillion in cash. For now, the government must continue serving as the investor of last resort.
A dramatic reduction in government spending right now would jeopardize the recovery. Trying to balance the budget now could drive us into a recession worse than the one we are still trying to recover from.
However, we need a credible plan to eventually bring the budget into balance. At some point, interest rates will go up and may crowd out investment. We need to crowd in some of that $2 trillion waiting to be invested by demonstrating long run fiscal discipline not seen before or after the Clinton era.
In his Macroeconomics textbook, MIT Professor Olivier Blanchard has the right formula. First, he describes the rationale for crowding in via long run budget discipline. Then he suggests the most effective policy: “backloading the deficit reduction program toward the future, with small cuts today and larger cuts in the future, is more likely to lead to an increase in output.”
Blanchard also advocates revenue increases through broadening the tax base. We spend excessively on low tax rates for the rich and generous tax exemptions for corporations that do little to stimulate investment.
Arguing that we need a long-term plan to balance the budget is not anti-Keynesian. In fact, it is pro-Keynesian because our large national debt limits the flexibility of government to respond, as necessary, to economic crises.
Arguing for a modest tax increase is not a call for bigger government. It is a plea for better government – a more fiscally responsible government.
President Obama is calling for the “Buffet Rule” – a minimum tax for people earning a million dollars or more. According to the White House “For the 98 percent of American families who make less than $250,000, taxes should not go up.” That position should appeal to the Occupy movement but it would only reduce the deficit by about 1 percent.
In a recent Wall Street Journal opinion piece New York Mayor Michael Bloomberg called the Buffet Rule class warfare. Bloomberg suggested the two major parties “should commit to a reasonable and responsible goal – closing the deficit in 10 years.” The goal is a good one. However, Bloomberg’s recommendation that we “allow the Bush tax cuts to expire for all income levels” (my emphasis) is neither reasonable nor responsible.
What would Clinton do? He would triangulate of course.
What should Obama or the next President do? More on that in an upcoming column.