Budget Special Report
Navigation Bar
Navigation Bar

 Key Stories
 Links &

Budget Graphic
blue line
Despite Shortcomings, Deficit Effort Really Is 'a Big Deal'

By Steven Pearlstein
Washington Post Staff Writer
Wednesday, July 30 1997; Page A13

It took two presidents, four Congresses, an accommodating Federal Reserve Board and a booming economy. But now, after a fitful seven-year effort, the runaway federal budget may finally be brought into balance.

The process has been so contentious and complex that most Americans have long since stopped paying attention. And now, even before the ink is dry on this third installment in deficit reduction, critics are pointing to its shortcomings – how it complicates the tax code, tilts in favor of the rich, ducks the difficult issues facing Medicare and Medicaid and creates a whole new set of entitlements and tax loopholes that could bust the budget all over again.

But economists yesterday were quick to note what would have happened if, in a search for a more perfect fiscal policy, nothing had been done to bring government revenue and expenses into balance.

"If we had kept on the track we were on, interest rates would be higher, there would be fewer jobs and more inflation and we would never have had the stock market we've had," said Lawrence Chimerine of the Economic Policy Institute in Washington.

"It's really a marvelous thing," agreed Robert Solow, the Nobel-prize winning economist at the Massachusetts Institute of Technology. "We not only reduced the government's persistent overspending, but we did it without inducing a recession."

Benjamin Friedman, a Harvard University economist who issued a book-length jeremiad against budget deficits in 1988, notes that the big payoffs from deficit reduction will come in the long term.

According to Friedman, for every dollar that the government doesn't have to borrow, there's an extra 50 cents invested in new plant and equipment by American businesses. And experience shows that investment eventually raises profits, wages and the U.S. standard of living.

"This balancing the budget is a big deal," Friedman said. "It's one of those things that makes a country more productive and prosperous."

To get a sense of how big a deal it is, MIT's Solow suggests looking across the Atlantic, where major European countries "are all fighting, lying and fiddling with their statistics" just to get their government budget deficits below 3 percent of economic output – the requirement to switch to the new European-wide currency.

"We've already got it to zero, and did it with relative ease," said Solow, noting that in the mid-1980s, the U.S. budget deficit exceeded 5 percent of gross domestic product.

Cynics already have concluded that it was only the good economy – not difficult decisions made by politicians – that really balanced the budget. That may be somewhat true of this last installment, with its big tax cuts. But the Congressional Budget Office has estimated that nearly two-thirds of the deficit reduction since 1990 came as a result of tax increases or spending cuts.

Back in 1990, for example, President Bush and the Democratic Congress raised the gasoline, tobacco, telephone and aviation taxes while increasing the tax rate for high income earners to 31 percent. Those tax increases amounted to $30 billion a year when fully phased in and were matched with equal amounts of spending cuts.

Then, in 1993, President Clinton pushed through a second deficit reduction package with still further cuts in discretionary spending and another increase in the top tax rate to 38 percent.

Those first two budget deals not only had the direct effect of shrinking the deficit but also, according to Bruce Steinberg, chief economist at Merrill Lynch & Co., gave the Federal Reserve and private investors the confidence to lower interest rates, providing additional fuel to the current economic expansion.

"Lowering the deficit generated higher economic growth, and higher economic growth leads to more tax revenue and a lower deficit," Steinberg explained. "There's a virtuous circle at work here."

That process also disproved two notions that once had greater political currency.

The first, dating to the first Reagan administration, was that cutting tax rates would generate so much economic growth that the government would not suffer any reduction in its revenue. The ballooning deficits of the 1980s seemed to give the lie to that bedrock notion of supply-side economics. And it was further called into question after 1993 when the economy began to take off, despite the 1993 Clinton tax increase that Republicans had predicted would send the country into a recession.

At the same time, the performance of the economy also called into question the notion – embraced by a number of key congressional Democrats – that budget deficits don't really affect it.

While applauding the sustained effort to balance the budget, however, economists were quick to note that this latest budget deal likely will have only a modest short-term impact on the overall economy. A few Wall Street analysts have predicted a small additional decrease in long-term interest rates. And others predict the middle-class tax cuts could add a bit to consumer spending next spring.

Finally, if truth be told, not even this week's budget agreement will really bring the government's operating deficit to zero. That's because the government's unified budget includes billions of dollars in Social Security taxes that are meant to be building up in the Social Security Trust Fund, anticipating the day when the baby boom generation retires and benefits paid out to the elderly will be greater than worker contributions coming in. This year, that Social Security surplus amounts to $79 billion.

It's for that reason that many economists argue that balancing the budget by the year 2002 is fine as far as it goes, but it doesn't go far enough. They say that with the economy performing so well, and with Social Security and Medicare spending set to explode after the year 2010, the government really should be showing a surplus right now.

© Copyright 1997 The Washington Post Company

Back to the top

Navigation Bar
Navigation Bar
yellow pages