[I’m finishing a chapter on how fiscal policy went wrong, from which I’ve been spinning off a few posts.  Here’s one on the (d)evolution of how policy makers think about fiscal policy.  What can the recent history of ideas teach us about the damaging ascent of austerity and descent of Keynesian countercyclical policy?]

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I identify three reasons why fiscal policy became so backwards in recent years.  First, a strategy by Democrats to block the GW Bush tax cuts morphed from strategy to ideology.  Second, a misunderstanding of the Clinton surpluses in ways explained below.  And third, the use of deficit fear-mongering to achieve the goal of significantly shrinking the government sector.

During the early years of the GW Bush administration, the President proposed and Congress passed two tax-cut packages that quite sharply lowered the revenues flowing to the Treasury.  During those debates, opponents of the cuts raised their negative impact on deficits and debt as a major concern.  Such concerns proved to be justified.  As Ruffing and Friedman show (2013), instead of its actual slowly rising path, the debt ratio would have been falling in the latter 2000s but for the Bush tax cuts (war spending played a much smaller role).  In my terminology, GW Bush fiscal policy was that of an SD (structural dove), adding to the debt ratio throughout the expansion of the 2000s.

Many who were making those anti-tax-cut arguments cited the Clinton years as an instructive counter-example.  The lesson of those years, they argued, was that by increasing taxes and restraining spending, the Clinton budgets both led to surpluses and assuaged bond markets leading to lowering borrowing costs, more investment, and faster growth. In fact, while fiscal policy in Clinton’s first budget did lower projected deficits, as discussed above [earlier in the paper I point out that if you track the swing from deficit to surplus from 1993-2000, Clinton fiscal policies explain one-third of the change; even once these changes were in the baseline, in 1996, CBO still projected deficits a few years later, when in fact the budget went into surplus, so Clinton fiscal policy cannot get credit for that part of the swing], economic growth was far the larger factor (the fact that much of this growth was a function of a dot.com bubble is a separate issue).

Together, this line of attack against the Bush tax cuts in tandem with the over-emphasis on Clinton fiscal policy as the factor that led to surpluses, raised the budget deficit to a new level in the national debate.  Deficit hawkish pundits, editorial pages, and policy makers knew two things: Clinton raised taxes, cut spending, and balanced the budget; Bush cut taxes, failed to restrain spending, and added to the debt ratio.

Again, reality was more complex.  Economic growth was the major factor behind the Clinton surpluses, and while GW Bush’s tax cuts clearly added to the deficit and debt, even under his quite profligate fiscal policy, the deficit-to-GDP ratio fell to about 1% in 2007 (below primary balance).  To be clear, this is no endorsement of his structural dovishness.  That was the last year of that business cycle expansion, and as I argue later in the paper, it’s important to get the debt ratio on a downward path much sooner than that.  But the collision of these two different approaches to fiscal policy in two back-to-back decades helped to construct a conventional wisdom about budget deficits as a national scourge that had more to do with cursory observation than economic analysis.

Another important factor, perhaps the most consequential, in the evolution of these wrong-headed ideas was the partisan ideology that government should be much smaller as a share of the economy.  For conservatives who shared this vision, elevating the issue of the budget deficit as a major national problem was and remains a highly effective strategy.  If they could convince the public and their representatives that deficits had to be reduced no matter what, than cutting the federal budget should be a short step away.

Of course, at least in terms of arithmetic, it is not at all obvious that balancing budgets requires spending cuts; it could also be achieved by raising taxes.  So, part of the conservative strategy has been to take higher tax revenues off the table.  Similarly, some—though by no means all—in the conservative caucus aim to protect defense spending.  That leaves the non-defense discretionary budget and the mandatory entitlement programs, and these are in fact the targets of conservatives who continue to cite the threat of budget deficits—even as they fall sharply.

An illuminating set of documents to see these dynamics in action are the recent budgets passed by House Republicans.  These budgets have proposed to cut taxes sharply for those at the top of the income scale, slash food support and Medicaid, turn Medicare into a voucher program, and cut non-defense discretionary spending to historically unforeseen low levels.

This analysis of the House 2010 budget, from budget expert Robert Greenstein, provides some extensive detail of this goal of shrinking government (Greenstein is referring to CBO analysis of the House budget authored by Rep. Paul Ryan, a noted deficit hawk).

“The CBO report, prepared at Chairman Ryan’s request, shows that Ryan’s budget path would shrink federal expenditures for everything other than Social Security, Medicare, Medicaid, the Children’s Health Insurance Program (CHIP), and interest payments to just 3¾ percent of the gross domestic product (GDP) by 2050.  Since, as CBO notes, “spending for defense alone has not been lower than 3 percent of GDP in any year [since World War II]” and Ryan seeks a high level of defense spending — he increases defense funding by $228 billion over the next ten years above the pre-sequestration baseline — the rest of government would largely have to disappear.  That includes everything from veterans’ programs to medical and scientific research, highways, education, nearly all programs for low-income families and individuals other than Medicaid, national parks, border patrols, protection of food safety and the water supply, law enforcement, and the like.  (In the same vein, CBO also notes that spending for everything other than Social Security, Medicare, Medicaid, and interest “has exceeded 8 percent of GDP in every year since World War II.”

Another interesting example comes from a recent policy suggestion by conservative economists Glenn Hubbard and Tim Kane.  They begin by citing an Admiral from the Joint Chiefs of Staff claiming that the national debt is the “single biggest threat to our national security.”  They then call for an amendment to the US Constitution that they call a balanced budget amendment but is really a spending cap: “Congress shall spend no more in the current year than it collected, on average, over the previous seven years.”

Though they explicitly note that Congress can override the amendment in “national emergencies,” such a rule seems clearly motivated by the desire to reduce the size of government and preclude Keynesian measures in downturn.

In sum, the over-interpretation of fiscal rectitude in the Clinton years, the “structural dovishness” of the GW Bush years, and the ideological drive to shrink the size of government have contributed to our current predicament, where despite evidence to the contrary, austerity measures dominate fiscal policy.