Washington: Fiscal Folly


Last May, Richard Darman, director of the Office of Management and Budget, convinced the President that he had to renege on his no-new-taxes pledge and enter a budget summit with the Democrats. The stated reasons for this abrupt reversal were to reduce the deficit and strengthen the economy. At the time, the 1991 deficit was projected to be about $200 billion, and the annual rate of economic growth had slipped to less than 2 percent.

After a torturous process lasting nearly six months, Darman and the Democrats got their deal, which they claimed would reduce budget deficits by $500 billion over five years, shrink federal spending to 18.2 percent of the gross national product by 1995, double the annual rate of economic growth in 1991, impose binding caps on annual appropriations, and maintain the integrity of the Gramm-Rudman deficit reduction law. Last but not least, the budget deal would produce a budget surplus by 1994.

Not everyone believed Darman's assertions. Rank-and-file Republican legislators, business groups, taxpayer organizations, and the editorial page of the Wall Street Journal, among others, raised objections to the budget deal. Some pointed out that Washington raised taxes in 1982, 1984, 1987, and 1989 as part of budget summit agreements designed to reduce the deficit, but in every single instance the deficit was higher the following year. Was there any reason to expect that higher taxes would reduce the deficit in 1990, they asked? Others wondered what economic theory suggested raising taxes was the way to strengthen an economy. Notwithstanding these and other objections, however, Congress and the president approved the agreement.

Unfortunately for Darman, even though barely five months have passed since Bush signed his cherished budget into law, it appears that the skeptics were right, and he was wrong. By every conceivable standard, Darman's budget was a disaster.

The major reason for the budget summit, of course, was to reduce the budget deficit, which the OMB had estimated last May would be as much as $206 billion in the absence of a deficit reduction deal. Because of their professed concern over rising deficit projections, combined with fear that inaction would result in automatic budget cuts under the sequestration provision of Gramm-Rudman, policy makers decided to cut a deal, which they claimed would solve the deficit problem once and for all. The result was not what we were led to believe it would be. The Congressional Budget Office recently estimated that the 1991 deficit will be $298 billion. The Administration now projects this year's deficit will climb to more than $318 billion.

To be fair, Darman never claimed the budget agreement would reduce the deficit in 1991. Even he understood that a budget that allowed domestic discretionary spending to climb by 9.1 percent and entitlement spending to soar by 12.5 percent in just one year would not reduce the deficit no matter how much he raised taxes. Darman's major claim was that the budget deficit would reduce the sum of projected deficits over five years by $500 billion and generate a budget surplus by 1994.

Once again, Darman's claims and reality collide. In July 1990, the CBO projected baseline deficits between 1991 and 1995 would total $949 billion. But the CBO's January 1991 estimate, which includes Darman's deal, says deficits for this period will be $1.158 trillion, an increase of $209 billion. Even if Congress produces the additional $144 billion of spending cuts (actually reductions in spending increases built into the baseline) promised in the agreement, the five-year deficit will still be $65 billion higher than it was before the budget deal, not $500 billion lower as Darman claimed. Of course, the chances that Congress will actually produce the extra $144 billion of savings are slim; Ronald Reagan is still waiting for the $3.00 of spending cuts per $1.00 of higher taxes Congress promised in 1982.

What about the goal of a budget surplus by 1994? The CBO now says the deficit that year will be $211 billion. The OMB, using more optimistic assumptions, projects the deficit will be $67.5 billion.

Darman's other major goal for the budget summit was to strengthen the economy, and once again he failed. To make the numbers look good last fall, Darman had predicted that enactment of the budget deal would cause the annual rate of economic growth to almost double in 1991 and nearly triple in 1992. As any Economics 101 student could have predicted, though, higher taxes hurt the economy. As a result, the longest peacetime economic expansion in America's history has come to a crashing halt.

Of course, higher taxes were just one cause of the current downturn. Record increases in federal spending, expensive new regulatory burdens such as the Clean Air Act, and higher minimum wages all contributed to the recession. There is little doubt, however, that both the expectation of higher taxes—which slowed economic activity as investors waited to see what new taxes the budget summiteers would propose—and the actual imposition of the largest tax increase in our nation's history were the final blow to an already weak economy.

If nothing else, Darman has vindicated supply-siders such as Housing Secretary Jack Kemp and Chamber of Commerce Vice President Richard Rahn who have argued that higher taxes would increase the deficit by slowing economic growth. The CBO, which certainly cannot be accused of using a supply-side model, estimates that a weaker economy will cause tax collections to be $206 billion lower over the 1991–95 period, completely offsetting the $170 billion of higher taxes contained in the agreement.

Unwilling to admit his mistake, Darman maintains that the tax increase had nothing to do with the recession. Evoking images of a spoiled little boy blaming the family dog for the broken vase, Darman shifts responsibility for the economic downturn to Saddam Hussein and monetary policy.

Darman's other claims prove equally groundless. The budget deal was supposed to reduce federal spending to 18.2 percent of GNP by 1995, but both the OMB and the CBO now project that 1995 spending will exceed 20 percent of our nation's output, and even that estimate is exceedingly optimistic. The one fact we know for sure is that federal spending this year will consume more than 25 percent of GNP, the highest level since World War II. Darman continues to tout the spending "caps" in the budget agreement as a great achievement, but the administration's own budget, prepared by Darman, reveals that domestic discretionary spending will climb faster than the rate of inflation.

The fastest-growing part of the budget, entitlements, have no caps whatsoever, and will grow at nearly twice the rate of inflation. The "new and improved" Gramm-Rudman, which supposedly enforces the agreement, is a joke. The new law allows spending and deficit targets to be adjusted when technical and economic assumptions are revealed to have been overly optimistic, meaning the minimal level of spending restraint in the current agreement will quickly evaporate. January's CBO report revealed the magnitude of this loophole, as technical "re-estimates" added $215 billion to five-year deficits and economic "re-estimates" lumped on an additional $325 billion. Unlike the old Gramm-Rudman, the new law does not force Congress to pass deficit reduction legislation. Thus it creates a huge incentive to constantly manipulate underlying assumptions to avoid fiscal discipline.

As a result of Darman's poor advice and weak performance, the Bush administration has dug itself into a deep hole. Higher taxes, more spending, and larger deficits are hardly a recipe for economic growth. Unfortunately, Darman hasn't learned from his mistakes and is lobbying inside the administration against the Social Security payroll tax cut and is resisting empowerment proposals to free individuals from the web of government dependence.

By diverting more of the nation's resources into the public trough and continuing to oppose a pro-growth agenda, Dick Darman has earned the gratitude of the Washington establishment. The taxpayers, however, will be the ones to pick up the check for Darman's binge.

Daniel J. Mitchell is the John M. Olin Senior Fellow in Political Economy at the Heritage Foundation. Andrew F. Quinlan, a freelance writer and economist, formerly served as senior economic analyst at the Republican National Committee.