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Home Publications Blogs Beat the Press The Stock Bubble Created the Budget Surplus: Not Bill Clinton's Tax and Spending Policies

The Stock Bubble Created the Budget Surplus: Not Bill Clinton's Tax and Spending Policies

Tuesday, 12 June 2012 05:22

Bruce Bartlett is a decent person and an honest economist. A former Reagan and Bush I administration official, he now regularly berates Republican politicians for making nonsensical assertions about the economy. However in his NYT blogpost today he may go a bit overboard in telling readers:

"The projected surplus was primarily the result of two factors. First was a big tax increase in 1993 that every Republican in Congress voted against, saying that it would tank the economy. This belief was wrong. The economy boomed in 1994, growing 4.1 percent that year and strongly throughout the Clinton administration.

The second major contributor to budget surpluses that emerged in 1998 was tough budget controls that were part of the 1990 and 1993 budget deals."

This leaves out the main cause of the budget surpluses at the end of the decade, the stock bubble.

This point can be easily seen from examining the Congressional Budget Office (CBO) projections from May of 1996 for the 2000 fiscal year. At that time, the Clinton tax increases were all passed into law, so these were fully incorporated into the budget projects. So were the spending restraints.

So what did CBO tell us? Its projections show that in the spending constraint scenario (discretionary spending would only rise in step with inflation) the deficit would be equal to 2.7 percent of GDP in 2000 (Summary Table 3). Instead we had a budget surplus of 2.4 percent of GDP (Table 1-1), a shift of 5.1 percentage points.

In today's economy this would be equivalent to an unexpected drop in the annual deficit of $780 billion. This shift $780 billion drop was not due to policy changes but rather to the extra growth and tax collections spurred by the stock bubble. 

On the tax side, we see that CBO projected that revenue would be equal to 18.6 percent of GDP in 1996 (Table 2-3). It turned out that revenue in 2000 was equal to 20.6 percent of GDP (Table 1-2). This differences of 2 percentages of GDP was not due to any change in tax policy, it was due to faster than expected growth and the large amount of capital gains taxes collected as a result of the bubble. (It is likely that some of the capital gains showed up as ordinary income and were taxed as ordinary income. This could explain the jump in the statistical discrepancy at the end of the 90s and the unexplained rise in tax collections in those years.) 

On the spending side, non-interest outlays ended up being 15.9 percent of GDP (Table 1-2), they had been projected at 18.2 percent of GDP in 1996 (Table 2-5). While there were some factors that lead to lower than expected spending, most notably slower than projected growth in health care costs, by far the biggest reason for the drop in spending as a share of GDP was the faster than projected growth in GDP.

In 1996, GDP was projected to be $9,094 billion in 2000 (Table 1-2). It ended up being $9,828 billion (Table 1-2). With GDP 8.1 percent higher than projected, the same level of nominal spending would be 8.1 percent less measured as a share of GDP. This means that if we spent exactly the same number of dollars projected in 1996, then spending would have ended up as 16.4 percent of GDP in 2000 rather than the 18.2 percent projected.

The remaining factor was the lower than projected interest payments. Because deficits were lower than projected in the years 1996-1999, interest on the debt only cost us 2.3 percent of GDP rather than the 3.1 percent projected in 1996.

In short, the hero of the budget surplus story was the stock bubble, not President Clinton's tax cuts and budget restraint. This is important not only in dishing out praise for the surplus, it is also essential to a proper understanding of the economy. 

Bubbles are not sustainable, by definition. The stock bubble began to burst in 2000. By the summer of 2002 stocks had fallen to roughly half of their peak values destroying $10 trillion in wealth. This gave us a recession which, although officially short and mild, led to the longest period without net job creation since the Great Depression (until the current downturn).

The ending of this bubble was the biggest factor turning the surplus into a deficit. The Bush tax cuts were very much secondary in this picture, as were his wars and the Medicare drug plan. The Bush administration might deserve serious grief for all three of these, but they were not the story of the end of the Clinton era surpluses. The end of the stock bubble was the end of the budget surpluses and that one cannot be blamed on President Bush. 


[Addendum: I see from the comments that I may have to do some real Clinton bashing. A few simple points here.


1) The 1996 projections took account of all the steps Clinton took to balance the budget. All the deficit reduction beyond this was due to the bubble.

2) The pick up in productivity growth, which began in the middle of 1995 (long before balanced budget glory), continued all through the Bush years. Anyone who wants to claim Clinton's balanced budgets spurred the surge in productivity, which was then destroyed by Bush deficits has a really big quarrel with the data. The story doesn't fit at all.

3) The deficit did fall sharply under President Bush as the economy recovered from the 2001 recession, until the collapse of the housing bubble brought on the recession in 2008. Yes, the deficit was brought down by housing bubble driven growth. On the other hand, in the absence of this bubble, the downturn from the collapse of the Clinton era stock bubble would have lasted longer. Blame who you like on that one, but them's the facts.

Anyhow, I'm not getting paid by either side in this story. I have been using the same analysis of the economy for the last 15 years. If that proves inconvenient for supporters of President Obama or Clinton that is their problem.]

Comments (19)Add Comment
Even the progressive Dean Baker, Low-rated comment [Show]
Not Proven
written by reflectionephemeral, June 12, 2012 9:00
You show here that the surpluses were the result of stronger-than-expected GDP growth; but you don't show that the stronger-than-expected GDP growth was entirely the result of the stock market bubble.

You may be right, but there's more work to do to establish it.
Bubble Impact on the Economy
written by Dean, June 12, 2012 9:13

Sorry, I've written about the connections between the bubble and the economy so many times, I just assume that everyone has heard my spiel. There are two channels through which it lead to more rapid growth.

The first and more important channel was through the wealth effect on consumption. This is usually estimated at 3-4 cents on the dollar. With the value of the bubble wealth reaching around $10 trillion at the peak in 2000, this would correspond to around $300-$400 billion in additional annual consumption or 3-4 percentage points of GDP. This is keeping with the plunge in the saving rate over that period.

The other channel was the investment boom of the late 90s. Ordinarily stock prices have little impact on investment, but when you could issue shares in dot.garbage and instantly raise hundreds of millions of dollars, the story is different. We saw a lot of junk investment in loon tune start-ups at the peak of the bubble. This was probably on the order of 1-2 percent of GDP. (Not all the start-ups were loon tune.)

Anyhow, when the bubble burst, these sources of demand went away. There was no easy way to replace them. Eventually the housing bubble filled the gap.


you're on to me -- the Romney campaign is paying me millions to repeat the things I have been saying for the last 15 years.
written by skeptonomist, June 12, 2012 10:09
Why oversimplify this so grossly, one way or another? Yes, the stock-market bubble was important in producing "surpluses", but so were the tax increases and other measures taken early on. At that time there were some genuine Republican budget hawks in Congress (e.g. Gramm), not just people whose only concerns are reducing taxes and political attacks. Would it have been better if the Clinton administration had advocated big tax cuts as a means to get out of the recession of 2001? Or had expanded military spending instead of contracting it? Federal outlays as a percentage of GDP actually declined 1991-2000, yet this did not seem to impede recovery from the recession of 1991. The surpluses of 1999 and 2000 were actually pretty small ($2B and $86B respectively) if you correctly count the money going into the SS Trust Fund, and given the existence of the bubble and the general prosperity should have been much larger - that is tax rates should have been (and should be) even higher to prevent debt/GDP from rising in the long-term.

There are no simple stories for what went on (or what is going on now), and neither Clinton nor Congress were heros. Economics is not really the story of clashes of heros and villains (nor is it the story of good Maestros and evil Maestros).
written by Ed Ericson, June 12, 2012 10:48
Also, the tax collections from the stock market bubble were in large part the result of Clinton's income tax policies, which Bush reversed. One reason the housing bubble did not generate the same (or more) tax receipts.
its worse than you think
written by pete, June 12, 2012 11:00
because of the huge increase in equity values, pension plans were flush, and folks like California vastly increased future payouts based on unrealistic expected returns. Yet Angelides who headed Calpers was put in charge of investigating the real estate bubble...amazing fox/hen house
thanks for your reply
written by reflectionephemeral, June 12, 2012 11:16
Thanks for setting out the explanation. I see, it's something you've spent a lot of time on in the past, and I walked in afterward.

So, you're of the view that it's because there was more consumer spending due to the bubble, and because of the illusory gains of IPOs. I'd want to look more deeply into who had that $10 trillion of bubble wealth-- were they the sort of folks who were likely to consume at that rate? Or did that bubble wealth sit in accounts before it disappeared?

"when the bubble burst, these sources of demand went away. There was no easy way to replace them. Eventually the housing bubble filled the gap."

When people try to argue that "Paul Krugman caused the housing bubble!", they point to a column he wrote around 2002 saying something like, "there aren't any prospects for a recovery in demand; what can Greenspan do but keep rates low enough to fuel housing construction?" But it wasn't a recommendation, it was a diagnosis of how bleak the economy looked.
written by Roger Waller, June 12, 2012 11:55
Clinton was like the character in 'Being there'. He showed up at exactly the right moment: the Cold War was over so he could get away with trimming down the military budget. He inherited a simultaneous bull market in stocks, and just as important for him, was a bear market in commodities, which bottomed out in 1998 with $12 oil. Paying .99c for regular freed up alot of cash.
He also engaged in slight of hand accounting trickery as far as calculating the rate of inflation to contain entitlement cost of living increases and tweeked the calculations for unemployment. Refer to Shadow Stats on this. He presided over the dismantel of Glass-Stegall and saw the peak of the Tech Bubble in March, 2000 and managed to pass off the hot potato to Bush.
keep oversimplifying
written by rootless_e, June 12, 2012 12:09
Your economic mistakes and the "progressive" "Obama sux" consensus are explanation enough, I don't need to imagine you are being paid by Romney.

On economics, you seem unwilling to think beyond gross aggregate numbers but where money gets spent makes a big difference. During the Clinton boom, a lot of that "dot.garbage" investment you deride went into purchase of durable industrial development that increased the base wealth. For example, the dot.com companies financed construction of processor chip factories, internet wires, and even Sili Valley office space that emptied in 2000, but was full again by 2005. So a lot of the economic growth of the Clinton years was actual growth, not just stock speculation. Cisco's market cap was $200million in 1990 and was a ridiculous $500billion in 2000, but that increase in value was not all bubble, it reflected huge real growth. On the other hand, Bush's policies destroyed manufacturing and diverted investment into real-estate speculation, war costs, and rentier payments to owners of US bonds. The difference between Bush's housing bubble and Clinton's dot.com bubble is stark. And that difference, plus the irresponsible tax and war policies of the Bush administration do explain why the budget deficit did not decrease (far from it) during the Bush boom.

So Keynes Was Correct Again?
written by Paul, June 12, 2012 1:06
The .com bubble of the late 90s spurred consumer demand enough to create full employment for 4 years and balance the federal budget. Then consumer demand for housing revived the economy after 9/11 and pushed unemployment again under 5% until the Wall Street casino crashed the economy in 2008.

But now, because of the "balance sheet" recession, stimulating consumer demand to spur growth is wrong despite Cash-for-Clunkers reviving sales in the auto industry. Keynes would have been dumbfounded by today's economic conventions.
written by Paul R, June 12, 2012 2:48
I have always known that the stock bubble was part of the story of Clinton balancing the budget and you make a good case that it is a bigger part of the picture then I realized. I still feel you are downplaying Clinton's contribution. First, there wasn't a stock bubble the first couple of years of the Clinton administration and yet the deficit went down. Secondly you are not giving Clinton any credit for not spending the extra revenue. It isn't like he couldn't have found plenty of ways to spend the money.

It also bothers me that you are poking a hole in the Clinton myth but when people make comments about W. and the deficit you will say that the deficit was not that large and dropping before the recession when that was just the housing bubble.
Rubin & Low Interest Rates
written by St. Juste, June 12, 2012 7:04
As I recall Rubin's argument to Clinton was that a balanced budget would keep interest rates low. It was correct and fueled not only economic activity but the stock bubble that you note. The reason that the bubble defied ordinary economic parameters was not so much the policies of the administration but Greenspan margin requirements and the Fed's monetary policy. Look there for the problems rather than what were basically sound economic policies absent the repeal of Glass Stegal which represented unanimous establishment narrow mindedness at the time.
written by David, June 12, 2012 11:02
I loved a lot of things about Bill Clinton. He certainly had charisma. But he wasn't afraid to 'take some shine' off fortuitous events. And his economic decisions were for the most part Republican in flavor. NAFTA and Glass-Steagall 'reform' were disasters, for many reasons.
deep trends
written by Peter K., June 13, 2012 10:24
My view is that people defend Clinton out of misplaced loyalty and well-placed antipathy towards Republicans and conservatives.

Clinton's success was largely due to Greenspan and the stock market bubble which happened because of Greenspan.

Clinton also deregulated. The creation of deregulated, bubble-boom-bust economy is the result of work by both Democrats and Republicans.

Bush did waste budget surpluses with tax cuts and two unfunded wars.
written by kharris, June 13, 2012 10:52
There is another way to slice this question. If fiscal policy accounts for the change in the budget balance, then we should see revenue rising in proportion with economic activity. If the stock bubble accounts for the change in the budget balance, we should see the impact in a disproportionate rise in capital gains tax revenues. (This ignores the wealth effect, by the way. This view is based only on where revenue comes from, not on interaction between wealth and activity. It also ignores the spending side, which had a substantial impact.) I don't have the data in front of me, but I did have once upon a time. There was a substantial rise in tax revenues across nearly every category, but the biggest rise by far was in capital gains taxes. So the low jobless rate and decent income growth account for some of the improvement in the fiscal balance, but the bubble was important too.

The only hitch with Dean's presentation is the title. The title presents a false dichotomy, and is factually wrong. His text is correct, whether you think like an budget accountant (revenue sources), or think like an economist (wealth effect).
Confused on one point
written by Andrew Burday, June 13, 2012 6:40
Believe me, I have no axe to grind on behalf of any President since FDR. (Well, maybe LBJ. But only to say he wasn't as awful as people sometimes make out.) But I'm confused by part of this sentence:

This differences of 2 percentages of GDP was not due to any change in tax policy, it was due to faster than expected growth and the large amount of capital gains taxes collected as a result of the bubble.

I understand the increase in capital gains taxes. But "faster than expected growth" in what? If in GDP, that's growth in the denominator. Is it redundant, i.e. faster than expected growth in capital gains taxes? Again, no axe to grind, but I'd appreciate it if you could clarify this.
Both faster than expected GDP growth and growth in tax share
written by Dean, June 14, 2012 7:00

GDP grew much faster than projected. This was both the stock bubble propelling growth and Greenspan's decision not to stop it by raising rates. In addition, taxes roses as a share of GDP. This was due to high capital gains taxes and also a rise in tax collections for unknown reasons. My guess is that many people got short-term capital gains and, since they are taxed at the same rate as normal income, just wrote them down on their tax returns as normal income. That's just a guess.
written by RRaccoon, June 14, 2012 8:13
Clinton was indeed very fortunate to have the stock market bubble occur during his admin but for the simple comparison of his policies vs Bush2's the country as a whole was better off with his budget.
And that's why you're my favorite left wing (for a mainstream economist anyway) economist
written by Erik L, June 14, 2012 8:27
The cognitive bias associated with group identity is extremely difficult to overcome. It makes most economic discussions worthless as problem solving exercises. I have to applaud your unusual ability to overcome this bias.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.