On November 5, 1996, Bill Clinton was elected to a second term as president of the United States. That same night, in congressional races, Republican majorities were returned to both the House of Representatives and the Senate. Lost in the sound and fury of the election campaign was a striking fact. When President Clinton had submitted his budget proposal the previous February, he had effectively surrendered to the policies demanded by the Republican majority in Congress. Though there had been two shutdowns of the federal government and a raucous debate between the president and the majority of Congress, they were merely arguing over the method of achieving a policy on which they had already agreed.1 The agreement was that by 2002 the federal budget deficit would be reduced to zero without raising taxes—in fact, there would be some tax cuts.2 This was not the president’s only surrender. He later “compromised” with the Republican majority in Congress by signing a welfare reform bill that ended a sixty-year federal guarantee of income to poor children in single-parent homes.3
Eight months after the election, on July 30, lopsided majorities in both houses passed a budget and tax agreement that had been crafted by the Clinton administration and the Republican majority in Congress. Due to the strong economic growth that had occurred in 1996 and 1997, the amount of spending reductions necessary to achieve budget balance by 2002 was significantly lower than when Congress had passed a bill with the same goal in 1995. The tax cuts were much less than the Republicans had proposed in 1995.4 Nevertheless, the overall result of this agreement was to complete a revolution in economic policy making.5
To understand the significance of that agreement, compare the policies adopted by the United States government between 1975 and 1979 to the policies followed from 1991 to the present. The years have been chosen because these are the years following recessions, which, by law, the government of the United States must take action to counter.6 After the recession of 1974, economic policy was designed to increase the rate of growth, reduce the level of unemployment, and soften the blow of unemployment and poverty for those unable to find work or earn a decent level of income. After 1990 the policymakers focused on cutting the budget deficit and slowing the economy in order to keep inflation from rearing its ugly head. Making sure the unemployed were receiving unemployment compensation and that the poor could take advantage of governmental assistance were not merely less important than achieving budget balance, they were considered counterproductive.7
The policies followed in response to the 1974 recession were consistent with a general expansion of the role of government in the economy from the Great Depression through 1979.8 The election of Ronald Reagan to the presidency in 1980 signaled the beginning of a serious effort to alter that trend. Though the so-called Reagan Revolution was only partially successful in changing policy and though the effects it had on the economy have been the subject of hot dispute, with the hindsight of history it is clear that those initial efforts finally met success in the bipartisanship before and after the presidential election of 1996.
This book will follow the steps of this revolution. Here, we will merely outline the results. Government tax and spending policy will no longer be used to reduce unemployment. Instead, the Federal Reserve System, the U.S. Central Bank, has been conceded total authority to battle either inflation or unemployment. In practice, the Central Bank has focused more on preventing inflation, so that anytime the unemployment rate gets “too low” they feel it necessary to raise it in order to slow down the economy. The Congress and the president are silent in the face of such action. Thirty—and even twenty—years ago, such actions would routinely produce howls of protest from Congress and even the president.9
Redistribution of income to the nonelderly poor is no longer a federal responsibility. Even redistribution of income to the elderly is to be constrained so as to permit the federal budget to achieve balance. After an expansion of the role of the federal government in redistributing income between 1960 and 1980, the new priority for government, both at the federal and at the state and local levels, is to finance the Defense Department and a growing police and prison industry. / Surrender
Between 1960 and 1979, the Social Security system went from representing 12.6 percent of the federal budget to 20.7 percent. In 1960, Medicare did not exist; by 1979 it covered 5.2 percent of the budget. Redistributing income to the poor (identified as income security) went from 8 percent of the federal budget to 13 percent.10 The “Reagan Revolution” made a strenuous effort to cut this redistribution but mostly succeeded in cutting taxes. In terms of overall spending it was unsuccessful. In 1989, the proportion of the budget covered by Social Security and Income Security had fallen slightly to 32.2 percent (from just over one-third), but Medicare had risen to cover 7.4 percent of the federal budget.11
The 1997 law puts controls on the growth of Medicare spending.12 Looking to the long term, there are proposals in the air to privatize some aspects of Social Security, to automatically reduce cost-of-living increases because the government’s measuring rod for the cost of living has been judged faulty, and otherwise control what the pundits and policymakers have called “runaway entitlement spending.”
Meanwhile, income distribution, which had trended toward more equality between 1945 and 1979, had become more unequal in the period between 1979 and 1993, and it was unclear whether the period after 1993 had merely interrupted a trend or actually reversed it.13 Income distribution is a very important economic-policy issue from a political point of view. During the 1994 congressional election, Demo-crats had criticized the Republicans’ campaign document, called the Contract with America,14 on the basis of “fairness.” The policies advocated by the Republicans would, in the words of Representative Carrie Meek (D.-FL), “produce another tax windfall for the wealthy while leaving the middle class and poor behind.”15
The effect of proposed policy changes on income distribution is one of the major arguments between those who approved of and wanted to extend the Reagan economic legacy and those who wanted to reverse it. Both sides appealed to the principle of fairness. From Representative Meek’s perspective, fairness involved less inequality in the distribution of income. For supporters of the Reagan Revolution, fairness involved avoiding undue burdens on individuals who work, produce, and invest, thereby creating more income for everyone.16 The Republican majority in Congress and not a few Democrats claim that policies that might increase income inequality are acceptable if they have such a positive influence on the rate of growth of income that even the poorest individuals would benefit greatly. In other words, economic growth raising the absolute level of income for the poor would more than make up for increased inequality. This is the key idea behind the statement attributed to President Kennedy, “A rising tide lifts all boats.” Those who agree with Representative Meek argue that the middle class and the poor were hurt by the Reagan economic program, that the economy’s growth did not benefit them.A Revolution in Economic Policy /
The linchpin of the revolution was the drive to balance the federal budget and cut taxes as a means toward shrinking the role of the federal government in the economy. The desire to do this was based on a general view of how the (economic) world functions: a belief that, left to their own devices, individuals pursuing their self-interest and constrained only by competition will interact in such a way as to produce the best of all possible (economic) results. On the theoretical level, this is an argument that government should stay out of the way as much as possible, though it has some clearly important roles, such as enforcing the law and providing for the defense of the nation against foreign enemies.17
On a more practical, political level, the requirement of a balanced budget provides significant support for policymakers who do not wish to expand government spending on programs that might be popular, such as guaranteeing all children equal educational opportunity, repairing every bridge and road that needs it, fixing every leaky roof in a public school, and wiring every public library for the Internet. It also makes it difficult to introduce new spending initiatives such as providing complete cradle-to-grave health coverage for all citizens. In response to felt needs, leaders can exclaim, as President George Bush did in his inaugural address, “We have more will than wallet,” and that ends the argument in favor of such expensive items as guaranteed health care for all Americans.
President Reagan created the first installment of the revolution by pushing through a significant tax cut in 1981. However, he never was able to follow through with the spending cuts necessary to avoid big increases in government borrowing. In 1990, George Bush compromised with Congress on a combination of tax increases and spending cuts that some saw as a betrayal of the Reagan policies, but that in the long run reduced borrowing and constrained spending increases. In 1992, Bill Clinton was elected in part on a promise to reverse Reagan’s policies. His package of tax increases and spending cuts in 1993 supposedly repudiated Reagan’s policies, but except in very minor ways they were consistent with them. More importantly, over the years after 1993, the federal budget deficit declined significantly, and federal spending fell a bit in relation to total income.18 The one effort made by the Clinton administration to move economic policy in a different direction, the full reform of the health care system, was soundly defeated by a coalition of Republicans and conservative Democrats. / Surrender
In 1994, the Republicans gained control of the House and Senate after a campaign where they featured a series of promises in the Contract with America. The economic policies promised in that document included a balanced-budget amendment to the Constitution, a series of tax cuts, and a sweeping reform of the welfare system.19 From the beginning of that congressional campaign, Democrats such as Representative Meek attacked the proposals as trickle-down economics, enriching a few and claiming that the rest of society would benefit from the crumbs. When the Republicans won the election and introduced their proposals as legislation, Democrats blasted them as “extremist.” In 1995 and 1996 the battle was joined between the president and the Republican Congress over budget proposals that were vetoed by the president. As mentioned above, the government actually was shut down twice over these budget battles before Congress and the president reached a compromise in April 1996.20
Hidden in the noise from the “battlefield,” the Clinton administration’s surrender was barely noticed by the public, which was focusing instead on the lead-up to the presidential election campaign and then the campaign itself. But as the compromise emerged during the discussions over the 1998 fiscal year budget, the success of the revolution was no longer in doubt. First had been Reagan’s election, then a decade of change and even more revolutionary proposals thwarted by a Demo-cratic Congress. Then there was the alleged Bush betrayal in 1990. Some saw the election of Bill Clinton as a repudiation of Reaganomics, with the Republican Contract with America as its revival. Clinton’s “tough stand” against Republican “extremism” allegedly blunted that revolution, but in fact when Bill Clinton submitted his budget in February 1996 and signed the welfare reform law in August 1996 he signaled surrender: the Reagan Revolution was going to achieve its major goals.A Revolution in Economic Policy /
With the signing of the budget and tax bills in August 1997, the surrender was complete. Budget balance was an iron-clad pledge from both political parties and both branches of government. As a result of the constraint of budget balance and the (albeit modest) tax cut approved for the 1998–2002 budget years, the impact of government on the economy, which had grown from the Great Depression through the 1970s, was bound to shrink. The reduction of government activity was most obvious in the redistribution of income to the poor.
It is often stated that history is the laboratory of the social sciences. Unlike most of the physical sciences, in which access to a laboratory permits one to conduct controlled experiments, the social sciences must look to human existence, which occurs once and then becomes history. Thus, disciplines in the social sciences must take history as evidence in the search to discover regularities of human existence beyond the biological ones.
To accurately evaluate the recently concluded revolution in economic policy, one must study recent economic history. Economic history involves the use of economic analysis to answer certain historical questions. It also employs the systematic study of historical experience to “test” certain economic propositions. For example, one of the crucial conflicts about economic behavior during the 1980s concerns the incentive effects of reducing the marginal tax rate on individuals and businesses. Lawrence Lindsey devoted his doctoral dissertation to an analysis of taxpayer responses to marginal tax-cuts.21 He argued that the historical experience of the 1980s showed that powerful incentive effects led businesses and individuals to work harder and take more risks as a result of the Reagan tax cuts in 1981. But those who criticize the tax cuts as trickle-down economics (because they gave no tax relief to low-income people, with the lion’s share of reductions going to very high-income people) argue that the negative impact on income distribution actually slowed economic growth.22 Both of these arguments use the historical record in an attempt to validate a particular theoretical conception of “how the world works.”23
This is a good example of how economic history serves both history and economics. Economic theories may be tested against historical experience. Historical interpretation can be revised through economic analysis of the information available. Such a study can help the student, scholar, and citizen learn more about how the world functions, how to live in it and, perhaps, alter the world to suit our ends. This has been the hope of philosophers, scientists, and anyone who has believed in the value of education.
Here are the bare-bones “facts” of recent economic history. In 1979, the Board of Governors of the Federal Reserve System, under the leadership of Paul Volcker, launched a stringent anti-inflation policy. The following year, Ronald Reagan was elected to the presidency; his tax cut and general budget proposals in 1981 precipitating the Reagan Revolution in economic policy. For the decade of the 1980s, the United States economy would be dominated by the impact of both sets of policies—the Volcker-Reagan policies, if you will. In 1990, a recession ended a long economic expansion. A debate about the actual impact of these policies was a major theme of the election campaign of 1992. The presidential election of 1996 continued the debates from 1992 and 1994 in the same contentious vein.24 As Congress and the president collaborate on keeping the federal budget on track to balance by 2002, we will continue to be treated to every politician’s, policymaker’s, and opinion-leader’s interpretation of the meaning of the Volcker-Reagan period.
This study will use the historical experience of the 1979–90 period in order to referee between competing economic interpretations. It will also use economic analysis in an attempt to understand what actually happened to the United States economy and its people during that period and since. Our goal is to not only answer questions about the successes or failures of the Reagan-Volcker changes but to show the essential continuity of policy since 1990 in order to suggest predictions about the future course of the U.S. economy based on what we have learned about the 1979–90 period.
Learning from this information is difficult. The public is inundated with information in our modern age. The citizen, student, or scholar must be a critical analyst in order to make sense of this information. So much information is collected and stored that it is impossible for any one person to be cognizant of it all.
One also has to determine the significance of certain facts. Since we cannot “run” history twice as a controlled experiment, social scientists engage in the process of abstraction. The pieces of economic reality or the “facts” that the investigator considers important are emphasized so as to focus attention on the important causal factor(s). Of course different investigators consider different elements of reality worthy of attention.A Revolution in Economic Policy /
We recognize the truth in this when we analyze the various arguments made by scholars, politicians, and journalists about the economic impact of the Reagan Revolution. Some emphasize the decline in the rate of inflation; others emphasize the rise in the national debt and the budget deficit. Some emphasize the length of the recovery from the 1981–82 recession; still others focus on the depth and severity of that recession. Some emphasize the continued strength in manufacturing-productivity growth; others focus on the minimally impressive increases in overall productivity. Some analysts believe that the distribution of income has become more unequal and perceive this as dangerous for the long-run growth and stability of the nation. Others believe that when we seek to measure well-being, the absolute rise in income for the vast majority of the population is more significant than the distribution of income.25
In an attempt to assess the success or failure of a set of economic policies, we must have a clear view of what constitutes success. To study economic policies and their impact on the economy in the 1980s and since, we need to set up standards of comparison for the “facts” presented by analysts. This work will elucidate the analyses that have defined as successes or failures the economic policies of the 1980s and since. We will subject the competing theories to the relevant data and make every effort to enable the reader to readily see where the arguments and supporting evidence conflict. It is this writer’s task to attempt to convince the reader that the facts and the comparisons I have chosen are appropriate to answer the economic questions that will inevitably arise as Americans live with the results of their leaders’ taxation and spending decisions designed to achieve a balanced budget by the year 2002.
The reason the arguments about the Volcker-Reagan economic program currently resonate is not merely because of the sound and fury generated by the budget battles between President Clinton and Congress in 1995 and the presidential campaign of 1996, and certainly not because of the bipartisan self-congratulations of the budget and tax bill signings in August 1997. In fact, those battles merely obscure the most important reason why an investigation of the successes and failures of that program is essential today. No matter what happens in the congressional election of 1998, the president and Congress are on a bipartisan mission to complete the economic-policy revolution. What the Volcker–Reagan program delivered to the American people be-tween 1981 and 1989, and that program’s non-reversal between 1990 and now, are essential background for all citizens, policymakers, and students of economic policy making as we attempt to cope with economic realities between 1998 and 2002 (when the budget is supposed to be in balance). / Surrender
Our judgment as to how successful the Volcker-Reagan period was and how significant the large budget deficits were for that alleged success or failure will inform our views on whether the governmental consensus in favor of eliminating the federal budget deficit is rational. The stakes are extremely high. If Congress and the president stick to their agreed-upon timetable, the next recession will confront the people and policymakers with an extremely stark choice. We can either continue on the path toward budget balance and hope the recession will cure itself (with help only from the Federal Reserve), as was done in 1990–95, or we can take steps to cure the recession that require abandoning our goal of budget balance, as was done when Congress cut taxes in 1975 to combat the recession. How we confront that choice will depend on which conclusions about the Reagan era and the period since 1990 are accepted by the opinion-leaders and public officials.
Chapter 2 will introduce the important principles and vocabulary of economic analysis that will be necessary for understanding the arguments and evidence presented in the rest of the book. The next two chapters will first flesh out what I have called the conservative economic diagnosis of the unacceptable performance of the American economy through most of the 1970s and then present alternatives from other schools of economic analysis. The following two chapters will present a detailed description of the actual Reagan and Volcker policies between 1979 and 1989. Chapter 7 will introduce a variety of judgments about the impact of those policies, and chapter 8 will attempt to assess the record created by those policies. Chapter 9 will discuss a variety of alleged problems identified by scholars, policymakers, and politicians as stemming from the Reagan-Volcker policies.
Chapter 10 presents an analysis of the Bush administration and the first two years of the Clinton administration with an eye toward determining whether or not there was a reversal of the “Reagan” part of the economic-policy revolution in those years and why the recession of 1990 was followed by such an anemic recovery. Chapter 11 fully develops the argument merely asserted above, namely that after the 1994 congressional elections, the Clinton administration surrendered, completing the policy revolution started by Volcker and Reagan fifteen years previously. Though it may seem churlish in the face of virtually unanimous euphoria about the agreement to balance the budget and about the good economic news of 1996 and 1997, the chapter closes with a strong warning that all the good trends will last only until the next recession, and then we will be faced with the true costs of the recent decisions. The book closes with a short coda that identifies a series of policies alternative to the ones agreed upon by the president and Congress.