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The Clinton Budget: Will It Do?

A Vision of Change for America

by President Bill Clinton
US Government Printing Office, 145 pp., $7.50 (paper)

Budget of the United States Government Fiscal Year 1994

US Government Printing Office, 1,310 pp., $43.00 (paper)

Perhaps if people were told of their dangers,” Churchill suggested to Britain’s war cabinet in 1940, “they would consent to make the necessary sacrifices.” Economic dangers differ from wartime peril, of course, but over much of the past year the American political system looked as if it were about to apply Churchill’s maxim in just that context.

The 1992 election campaign did not initially focus on the dangers inherent in the trajectory of mounting debts and deficits charted by Presidents Reagan and Bush, but it certainly did so once Ross Perot reentered the contest. Both Mr. Perot in his televised “infomercials” and Bill Clinton in his own campaign appearances repeatedly emphasized the economic damage done when a nation persistently lives beyond its means.

The two challengers also repeatedly made the case that the real burden of this excess falls primarily on Americans who are too young to vote, or not yet born, and on that ground they questioned not only the Reagan-Bush policy’s economic wisdom but also its moral probity. And while they differed over concrete matters like which government programs to cut and whether or not to impose a fifty cents per gallon tax on gasoline, both men were plain that Americans can and should make sacrifices, by forgoing some of what government now does as well as by paying more for it, to prevent those dangers from becoming realities.

Just after the election, Mr. Clinton used the Little Rock economic conference to focus public attention yet more fully on what is wrong with the government’s tax and spending policies and what will happen over time if it isn’t fixed. With the President-elect sitting close at hand, some of the country’s most distinguished economists explained why today’s huge excess of spending over revenues causes the US government to drain away the bulk of what Americans save, why that loss of saving restricts what the nation can invest, and why without adequate investment the standard of living cannot rise. Other speakers, including many who have since assumed responsible positions in the new administration, explored potential ways of addressing these problems, again including solutions that would require real public sacrifice.

Finally, the new President himself took up the message, beginning right from his first day in office. In his Inaugural Address, President Clinton observed that “most people are working more for less” already, and argued that to reverse this creeping decline,

we must invest more in our own people, in their jobs, and in their future, and at the same time cut our massive debt.… It will require sacrifice, but it can be done and done fairly, not choosing sacrifice for its own sake but for our sake.

Four weeks later, in his State of the Union speech, the President was even more explicit. The problem, as he put it, is “two decades of low productivity, growth, and stagnant wages; persistent unemployment and underemployment; years of huge Government deficits and declining investment in our future.” The solution? In blunt terms, “spending must be cut, and taxes must be raised.”

In the wake of this forceful and sustained effort to tell the people of their dangers, the subsequent call for sacrifice has been somewhat disappointing. Over the next five fiscal years, beginning this October, President Clinton’s initial budget proposals called for $328 billion of tax increases, partially offset by $77 billion of tax reductions, together with $375 billion of spending cuts compared to current policies, partially offset by $153 billion of increased spending on other programs. The resulting $473 billion of net deficit reduction represented about one third of what the administration estimates that the government would have to borrow over the next five years if it simply carried on under today’s tax and spending policies. The administration predicted that the combination of a recovering economy and these proposed tougher fiscal measures would narrow the deficit from last year’s record $290 billion, and probably well over $300 billion this year, to $206 billion by 1997 (after which the deficit will begin to widen once again, even with these policy changes). With just the economic recovery, but no change in policy, the deficit would instead widen to $346 billion in 1997.

The budget package recently passed by the House of Representatives, and now pending before the Senate, is very close to what the President originally proposed and, as I write, still pending before the Senate. The House version calls for $496 billion of deficit reduction over five years, to be achieved through $273 billion of tax increases, net of tax cuts, and $223 of spending cuts, net of proposed new spending. The Senate will probably introduce some further changes, primarily ones that will enlarge the total of spending cuts and reduce the total tax increase, but most of the major elements of the program are likely to remain intact and the overall projected net deficit reduction is likely to remain close to the half-billion dollar benchmark.

All this may look like a big change, and in a sense it is. President Clinton has clearly called for a change of fiscal direction, especially compared to the chronic inattention to fiscal responsibility that marked the approach of Presidents Reagan and Bush. But Americans are also entitled to ask whether the change Mr. Clinton has proposed is big enough to address the genuine dangers about which he has so energetically warned. More basically, does it represent a call to sacrifice consonant with what the President, Mr. Perot, and others have prepared people for by repeatedly highlighting those dangers?

The main reason for wanting to reduce the government’s deficit in the first place is that the borrowing it forces the Treasury to do absorbs private saving, saving that the financial markets would otherwise make available to businesses undertaking investment in new factories and machines or to families building new houses. The most immediate question that arises about any deficit reduction plan, therefore, is whether it frees up enough saving to enable the private sector to increase the economy’s overall investment rate to a level consistent with reasonable objectives for rising living standards and enhanced international competitiveness.

Despite several favorable developments that should have boosted US productivity growth and therefore real wage growth in the 1980s—a more experienced work force and generally declining energy prices, to cite just two examples—productivity growth has continued to be disappointing and real wages have stagnated. Accounting for such shortfalls in any precise way is impossible, but inadequate capital formation is clearly one of the central elements in the story. After allowance for replacement of buildings and machines that wore out or became obsolete, business investment in new productive facilities averaged 3.6 percent of US national income in the 1960s and 3.7 percent in the 1970s. Since 1980 the average net investment rate has been just 2.6 percent. Investment inclusive of needed replacement has declined even more precipitously in recent years. Gross investment in new factories and equipment was 13.5 percent of national income in 1981. By 1989, the last year before the latest recession, the gross investment rate had fallen to 10.8 percent. Last year it was just 9.2 percent.

Not investing adequately means not providing workers with the tools they need to do their jobs productively and competitively. Not surprisingly, periods of rapid growth in the total amount of capital per worker in the US economy have also seen rapid growth in productivity, and vice versa. If business had invested during the 1980s at the same pace that prevailed on average over the previous three decades, by 1990 there would have been $65,700 in capital behind each American worker. But because business invested less, the actual amount was $57,600. Just last month the Federal Reserve Board reduced substantially its estimate of the US economy’s potential capacity for further expansion, underscoring the directly practical consequences of a decade of inadequate investment.

When the economy is at or near full employment, as it was during much of the 1980s, the principal factor limiting its investment is the amount of saving available to finance it. On average throughout the Reagan-Bush years, all American families and businesses together saved 5.9 percent of national income on a net basis. (Broader measures, which count household purchases of durable goods like refrigerators and VCRs as “investments,” naturally lead to higher estimated saving rates. But the “saving” that is “invested” in these items is not available to finance new factories or new machines, and no one thinks that putting bigger refrigerators and more VCRs in Americans’ houses will enhance their productivity or competitiveness.) The federal deficit during these years absorbed 3.8 percent of national income, or nearly two thirds of that saving. How much better will the Clinton program do?

For 1997, the year in which the deficit hits bottom under the Clinton plan, US national income will probably reach the neighborhood of $7.6 trillion. (This level, predicted by both the administration and the Congressional Budget Office, would represent a five-year average growth of 5.1 percent per year—slightly more than half of it real, the rest merely inflation—from last year’s level of just under $6 trillion.) The administration’s projected deficit of $206 billion in 1997, under the assumption that Congress adopts the President’s proposals in full, would represent 2.7 percent of that year’s national income. If the private sector’s saving rate remains near the 5.9 percent level of the past dozen years, therefore, borrowing by the Treasury will still be absorbing almost half of the economy’s already meager saving. An improvement over the Reagan-Bush years? Yes. But satisfactory? Of course not.

As always, it is easy to imagine any number of reasons for optimistically supposing that novel developments may rescue the situation despite a deficit that continues to be so large when compared to the available saving. Perhaps families will save more as the members of the baby boom generation grow older. Perhaps the advance of the information age will finally begin to make possible gains in productivity, and therefore rising real wages, without requiring much investment by business. Perhaps the current economic problems in Europe and Japan will so worsen that Americans will at least be able to think of themselves as gaining on the competition, even if developments at home are still disappointing.

Sadly, imagining does not make it so. Each of these tantalizing possibilities has been around at least since the beginning of Ronald Reagan’s presidency. Like the theory that Elvis will one day turn up alive and well somewhere in South America, each such prediction is impossible to disprove in advance. But none provides any real basis for confidence in this nation’s economic future, or solid ground for disregarding the genuinely likely prospect of continuing to dissipate the nation’s saving instead of investing it. A government deficit that still absorbs half of America’s net saving is just too big.

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