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

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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.]