Economics: Deficit Delusions

Clinton can't take credit for temporary good budget news.

President Clinton's crowing over the apparent progress made in reducing the federal deficit since he took office is reaching near thunderous proportions.

"The decline in the deficit since 1992 is the largest two-year decline in our history, and the first time in 20 years the deficit has gone down for two years in a row," Clinton said in a speech October 24 in Cleveland, where he announced that the deficit was now $203 billion. "If we hadn't passed the deficit reduction plan last year, the deficit would have been off the charts, up here at $305 billion."

A problem with Clinton's conclusion: It isn't true. A wide range of evidence suggests that the deficit's temporary decline—it is scheduled to resume climbing next year—had little to do with the administration's 1993 budget package. That package of $433 billion in deficit reduction over a five-year period wasn't even passed until August 1993, less than two months before the end of fiscal 1993. Thus, it could only have had minimal effect on that year.

Also, most of the spending cuts that made up about half of the so-called deficit reduction were aimed at the "out" years of the five-year period. For the most part, they haven't happened yet. And some decline in the deficit had already been predicted by the Congressional Budget Office in January 1993, a month before Clinton took office.

The truth is that most of the so-called deficit reduction over the past two fiscal years would have happened no matter who was in the White House. Fortunately for Bill Clinton, he was in the right place at the right time.

In January 1993, the CBO projected that the deficit would hit $310 billion at the end of that fiscal year (on September 30) and then drop to $291 billion for 1994. Instead, the deficit dropped to $255 billion in 1993 and $203 billion in 1994. What accounts for the $144 billion decline over the two years?

"The deficit reduction has been generated by a reversal of the earlier cash-flow outlays for the savings and loan bailouts, legislated tax hikes and stronger economic growth," writes economist Mickey Levy of NationsBanc Capital Markets Inc. In a September paper for the Shadow Open Market Committee, a group of monetarist-oriented Federal Reserve watchers, Levy notes that progress in reducing the deficit has been largely "illusory" because the basic structural problems with the budget remain intact.

According to an analysis by Sen. Pete Domenici (N.M.), ranking Republican member of the Senate Budget Committee, the administration can probably claim credit for about 12 percent of the deficit reduction that occurred in fiscal years 1993 and 1994.

"Of the $144 billion reduction in the cumulative deficit over the last two years, nearly three quarters (73 percent) or $107 billion results from 'technical re-estimates.' These technical factors are completely unrelated to any specific policy proposed, legislation enacted by the 103rd Congress, or any action taken by the president," he contends.

The biggest technical re-estimate was the downward revision of the cost of the savings & loan bailout—some $45 billion worth. That came about because analysts overestimated the number of thrifts that would be taken over in 1993, partly because improved economic conditions kept more of them from falling into receivership. In addition, outlays for the thrift bailout peaked at $66.1 billion in 1991 and then abruptly changed direction when the Resolution Trust Corporation, the government agency charged with cleaning up the mess, sold S&L assets.

Medical costs have also dropped faster than expected, which led to a $22-billion technical re-estimate in projected Medicare and Medicaid costs. Some of that drop may be attributed to presidential jawboning, but more of it came from natural forces at work in the marketplace as health maintenance organizations began lowering costs. Analysts had also overestimated interest costs.

Revenue from new estimates unrelated to any tax law changes or economic changes, such as higher-than-expected corporate profits, increased $24 billion, according to Domenici. Another $22 billion is explained by stronger economic conditions.

The sole administration action that contributed to the reduction of the deficit was raising $28 billion in new taxes and user fees in 1994—but spending on the Los Angeles earthquake and the Midwest floods ate up an unplanned $11 billion. That spending was added to the deficit under current budget rules, giving the administration a net of $17 billion in deficit reduction because of policy changes, under Domenici's analysis.

In short, the drop in the deficit was largely because of the surging economic recovery, which saw two strong quarters of growth just before Bill Clinton took office, and from overestimates of the cost of cleaning up the S&L debacle.

The Office of Management and Budget, headed by Alice Rivlin, now sees the deficit bottoming out at $168 billion in 1995 and then rising to $184 billion in 1996 and $194 billion in 1997, according to the now-famous memo by Rivlin. By the turn of the century, it will reach $235 billion. (The CBO estimate at this point is even higher—$257 billion.)

From there, OMB estimates that the deficit will climb to $285 billion in the year 2004. (The CBO says $397 billion). OMB then projects a deficit of $456 billion in the year 2010, $1.5 trillion in 2020, and $4.1 trillion in 2030.

As a share of gross domestic product, OMB projects that the deficit will remain in the 2.5 percent range through the year 2004 but then begin to climb out of sight, reaching 2.9 percent by 2010 and 5.9 percent by 2020. It then will double to 10.4 percent of GDP in 2030.

Those projections are why the administration is closely watching the Bipartisan Commission on Entitlements. Its report, due out December 15, is expected to call for a number of tough measures to stem the rising tide of entitlement spending. (See "Retirement Wrangle," November 1994.)

The pre-election hullabaloo inside the Beltway over the leaked secret memo by Rivlin merely reinforces the problems surrounding Clinton's claim that his administration was responsible for the two years of lower deficits. Although the White House spin was that the 11-page memo was a mere "catalog" of proposals that have been floated by Republicans and various think tanks, any reasonably intelligent observer would understand it was a set of talking points for the immediate future. "Decisions must be made soon about the policies to be articulated in the FY 1996 budget, the State of the Union, and our response to the Kerry-Danforth Commission report," Rivlin wrote in the October 3 memorandum.

Levy, in his paper for the Shadow Open Market Committee, complained that policy makers have "left untouched" the structural flaws that "are the sources of the fastest growing spending programs." He found that from 1990 to 1994, spending on entitlements and other mandatory programs rose at an 8.8 percent annual rate—even faster than in the 1980s, in part because of an increase in welfare recipients during the recession and the slow-starting recovery.

Tax revenue growth accelerated dramatically in 1994, increasing nearly 10 percent, he added, reflecting both the 1993 budget deal hikes as well as stronger economic growth. He also hints that taxpayers could be forced to pick up the cost of the administration's decision last year to alter the Treasury Department's debt management strategy and shorten the duration of government debt. In effect, the administration purchased more short-term securities because interest rates had dropped. With interest rates now rising, that could "prove costly to taxpayers," Levy wrote.

"The administration has raised its projections of net interest outlays, and uncertainty about future costs have [sic] heightened, particularly as the Federal Reserve pursues a disinflationary monetary policy," wrote Levy. If Clinton is around to preside over the possible deficit ballooning to come, his crowing may have to give way to eating crow.

Robert G. Robinson Jr. reports on politics, budget, and trade matters for Market News Service.