Who Really Balanced the Budget?
By Stephen Moore

Until very recently, the idea of Congress spending only as much as it takes in was a hopelessly elusive dream--like visions of the Berlin Wall coming down, or Northwestern going to the Rose Bowl. But with the federal budget deficit now well below 1 percent of national output, we have achieved a de facto balanced budget for the first time in more than a quarter-century. If the economy continues to surge, the federal budget may even end up in surplus in 1998. [For more on that subject, see the article immediately following this one.]

Not surprisingly, Congress and the White House are falling over each other to take credit for this turn of events. Bill Clinton recently boasted that "discarding the failed supply-side economics of the 1980s" and instituting his record tax increases of 1993 were the critical steps. Newt Gingrich insists it was the "heroic commitment to a balanced budget" of the Republican Congress that made the balanced budget possible.

And how's this for a rewrite of history: Some media mavens have recently crowned George Bush as the real hero of the balanced budget story for "courageously" breaking his "read my lips" tax pledge back in 1990. Bush "was the man who risked the most and paid the biggest price for cutting the deficit," the New York Times gushed not long ago. "When George Bush was confronted with a deficit crisis, he delivered," political analyst William Schneider recently proclaimed on CNN while Bernard Shaw broke out in applause.

The surprising truth is that they are all wrong. The politician who is most responsible for our current rosy fiscal outlook is not Newt Gingrich, Bill Clinton, or George Bush. Rather it is the man regularly vilified in the press for creating trillions of dollars of debt in the first place: Ronald Reagan.

The most simple-minded and oft-repeated interpretation of budget history is that the Reagan tax cuts caused the deficits to explode, while the Bush and Clinton tax increases erased them. On the surface this is an appealing story line. After all, we had tax cuts in the early 1980s and, subsequently, large deficits. We had tax increases in the 1990s and, presto, falling deficits.

But the dogma about Reagan's tax cuts depleting federal coffers doesn't match reality. Look at Figure 1. It compares the growth of federal revenues in the seven Reagan fiscal years 1982-89 with revenue growth in the seven Bush and Clinton years 1990-97. During the first period, top marginal tax rates were being cut from 70 percent to 28 percent, while during the second the top tax rate was being pushed back up to 42 percent. What these data show is that federal revenues grew at the same pace with falling income tax rates in the '80s as they did with rising rates in the '90s.

Two things explain how this is possible. First: as AEI scholar and former Federal Reserve Board member Lawrence Lindsey has documented, the amount of taxes paid by wealthy Americans soared when tax rates were lowered in the 1980s (because they began producing more income). And second: the economy grew faster in the seven years following the Reagan tax cuts (3.2 percent real GDP growth per year) than it has in 1990-97 period (2.5 percent per year).

So tax cuts are not primarily responsible for the last decade's ballooning of the deficit. Nor did George Bush's 1990 tax-raising "deal of the century" and other fiscal policies "lay the groundwork" for the taming of the deficit in recent years (as Mr. Bush argued not long ago). It is a little-remembered fact that by the end of the Reagan era, the federal deficit was falling rapidly: from 6 percent of GDP in 1985 to 3 percent in 1989. As Reagan left office, the Democrat-controlled Congressional Budget Office projected that deficits were on a path to fall to about 1 percent of GDP by 1993. Instead, the budget deficit during the Bush years ended up some $600 billion higher than the Reagan track.

Why the fiscal deterioration? First, the 1990-91 recession and a middling recovery caused federal revenue growth to slow to a trickle, even with Bush's tax increase. And second, George Bush (with the enthusiastic assistance of a profligate Democratic Congress) was one of this century's biggest-spending presidents. Domestic outlays surged by 28 percent above and beyond inflation during Bush's four years. To somehow fantasize that George Bush and Richard Darman contributed to the current balanced-budget regime is to give historical revisionism a bad name.

Virtually all of the deficit reduction of the past five years (from $255 billion in 1993 to $40 billion in 1997) has happened on Bill Clinton's watch. He was there when it happened and deserves some of the credit. To paraphrase Woody Allen, "90 percent of life is just showing up." Moreover, compared to Bush's spendthrift record, Bill Clinton looks like a fiscal tightwad.

But to attribute the steep decline in the deficit to Clinton's 1993 tax increases is misleading. The '93 tax increases did reduce the budget deficit, but not by nearly as much as the White House is touting. The best evidence of this is to examine where the deficit was heading in early 1995-after a couple years of Clintonism, including his tax hike, but before the reforms of the new Republican Congress began to kick in. Figure 2 shows that the deficit was set to hover at or above $200 billion well into the next millennium under Clintonism prior to the dawn of the Republican Congress. Instead, the cumulative budget deficits from 1994-98 are now expected to total $475 billion less than the Clintonomics baseline.

Newt Gingrich is right that part of this improvement is due to the tighter fiscal restraints imposed by the GOP Congress. Under Republican rule of Capitol Hill, domestic spending is growing at a slower pace than when the Democrats ran Congress. But these savings are much more modest than GOP congressional leaders would have you believe.

The major contribution of the Republican Congress has been in what it hasn't done, more than in what it has. Republicans haven't crippled the economy with costly new domestic regulations (although there may be a severe body blow if they accede to Clinton's proposed new clean-air mandates). Republicans haven't enacted many expensive new entitlement expansions--the glaring exception being this year's child health care program. They have not raised taxes. Our present impressive economic expansion has proceeded because business is contented with a Congress that is committed to doing little harm.

But we still haven't identified the main source of this decade's big drop in federal deficits. Which brings us back to Ronald Reagan. Over the past 25 years, the single factor that has affected the federal budget the most is the Cold War. Although the Reagan administration didn't admit it at the time, the primary explanation for the deficit bulge of the '80s was Reagan's Cold War defense build-up. In the eight Reagan years, the Pentagon budget rose by about one-third above inflation. We spent fully $2 trillion during the decade to defeat the Soviet Union. (And it was arguably the only government "investment" of the past half-century that actually worked.)

Reagan had intended to soften that heavy run-up of defense spending by making some cuts in social spending--but the Democratic Congress refused to go along. The promised Reagan spending reductions on the domestic side never materialized. Instead, Congress funded the military expansion by borrowing. In fact, the deficit rose in the 1980s by almost precisely the amount of the increases in defense spending.

Yes, that debt will have to be paid off by the Generation Xers and their children. But there is a rough fiscal justice to that, because it is those generations who are the biggest beneficiaries of the U.S. Cold War victory. Thanks to Reagan, twenty-first-century Americans will inherit a more peaceful world less threatened by nuclear war. In economic terms alone, the value to future generations of there not being a Soviet Union is orders of magnitude larger than the $2 trillion price tag.

Which brings us to the point where Ronald Reagan's Cold War victory connects with Bill Clinton's vanishing deficit. For just as the Reagan defense build-up caused the deficit to soar in the 1980s, it is primarily the Reagan peace dividend that has caused the deficit to plummet in the late 1990s. The end of the Cold War has generated a half-trillion-dollar budget dividend in just the last eight years, and that gift escalates with every passing season. And this was all dropped like manna from heaven into President Bill Clinton's lap. The fact is, the budget deficit is falling today not primarily because Clinton or Bush raised taxes, not primarily because the congressional Republicans committed themselves to a balanced budget, but rather because the defense budget is now more than $100 billion a year lower than when the Berlin Wall was still standing.

In fact, the post-Cold War peace dividend has been so large it has simultaneously financed a reduction in the budget deficit and a sustained buildup of domestic programs. Contrary to constant interest-group whining about a "neglect of social programs" in Washington, nondefense outlays catapulted in 1997 to their highest levels ever in American history--both in real dollars and as a share of national output. Over the period 1988-97, federal domestic expenditures rose from $622 billion to $1,113 billion. After adjusting for inflation, that's a stark 34 percent rise.

Figures 3 and 4 show (in inflation-adjusted dollars) how U.S. defense spending is contracting while other spending is zooming upward. Representative John Kasich and his fellow Republicans like to defend their record by noting that federal expenditures as a share of the overall economy are now in the process of falling--from 21.1 percent of GDP in 1995 to an estimated 20.6 percent in 1998. But all of that half-a-percentage-point decline is attributable to defense cutbacks. Domestic spending has been growing even faster than today's hot U. S. economy.

Much the same pattern can be seen regarding federal employment. Bill Clinton has bragged repeatedly about the federal workforce being slimmed by 180,000 jobs (6 percent) since January 1993. But here too, virtually all of the reduction has come out of the military. Between 1993 and 1996 the Department of Defense trimmed 160,000 civilian jobs (nearly a fifth of the DoD total). That means nine out of ten federal  jobs eliminated over the past four years came out of the Pentagon, while the rest of the federal bureaucracy has been trimmed by less than 20,000 jobs--or one percent. (Moreover, state and local governments have swollen so fast there are now 1.5 million more Americans working for some level of government than there were in the late 1980s.)

The Bush and Clinton tax hikes paid for a social spending spree. Expenditures at the Department of Health and Human Services have roared upward by a whopping 82 percent after inflation in the 1990s. The Education Department budget has risen by 22 percent; Housing and Urban Development is up 21 percent. Even the Department of Energy--a worthless relic of the OPEC oil crisis of the Jimmy Carter era--has been rewarded with a fatter budget. Only the Department of Agriculture has seen its budget fall in real terms in the post-Reagan era. If domestic spending in the 1990s had simply been restrained to the inflation rate, as it was in the Reagan years, Uncle Sam would have a $200 billion budget surplus today.

In addition to the peace dividend, the Reagan policies of the 1980s had one other profoundly positive effect on the budget in the 1990s. The economic policy regime known as Reaganomics--low tax rates, tight monetary policy, low interest rates, freer international trade, regulatory relief, and a strong dollar--have produced what is now a 15-year low-inflation, high-employment, bull market economy, interrupted only temporarily in the middle Bush years. For all the contempt that Bill Clinton heaps on supply-side economics, most of Reagan's policies have become orthodoxy not only among Republicans, but among New Democrats as well. (Notice Bill Clinton's support of free trade agreements and his continuation of hawkish anti-inflation policies.)

When Reagan took office and the nation found itself in the grips of what Newsweek was calling the most "serious economic crisis since the Great Depression," America's economic resurgence seemed improbable. Left-wing pundits like Lester Thurow moaned in 1982 that "the engines of economic growth have shut down in the U.S.--with no end in sight." Yet over the next decade and a half the U.S. economy would nearly double in size, and American companies would create 30 million new jobs (more than the rest of the industrialized world combined). The inflation rate would fall by two-thirds, the Dow Jones average would rise from 800 to nearly 8,000, and more net new wealth would be created in this short decade-and-a-half than in the nation's previous 200 years combined.

Reagan's policies also ended our long and tense competition with international communism, and our loss of confidence in American leadership. And none of this happened by accident. It was Reagan's determined policies that brought unprecedented global stability, nudging the entire global economy into a higher gear in many subtle and important ways.

Peace and economic growth-not political deal-making-balanced the U.S. budget in 1997. Those are the deepest sources of today's prosperity and sudden federal budget windfall. And that is the enduring legacy Ronald Reagan left to Bill Clinton and Newt Gingrich.

Stephen Moore is director of fiscal policy studies at the Cato Institute.