When President Clinton came out this June for a balanced budget within ten years, he returned to the economic approach that brought him significant support from many business leaders and economists in 1992. That approach included reducing the deficit in order to achieve lower interest rates and higher rates of capital investment; and it also included encouraging greater US productivity and competitiveness and support for free trade. In putting forward his ten-year program, the President joined congressional Republicans in advocating the principle of fiscal balance, despite their obvious differences on how to achieve it.

The President’s position provoked criticism from both his Democratic supporters and his Republican opponents. The opposition of many Democrats was understandable. Clinton’s position, they said, would inevitably require cuts in the rate of growth of many popular and largely Democratic programs, such as Medicare and Medicaid. These cuts would create political problems for the Democrats that otherwise would have remained the sole responsibility of the Republicans. Clinton’s plan genuinely offended the convictions of many Democrats. As a Democrat, I understand those views; but I believe Clinton was essentially right in what he did. If it is to have a leading part in the country in the twenty-first century, the Democratic Party must show that it can combine fiscal responsibility with social progress. I believe the President showed political courage as well as economic realism in taking his position; if he made a mistake it was in not taking it earlier, and in not sticking to his 1992 plan.

The Republicans have criticized Clinton’s plan to balance the budget for lacking financial credibility and convincing statistics to support it. Their argument can be divided into two categories, both of which are questionable in my judgment:

1) The Republican plan balances the budget in seven years; the Clinton plan would take ten years. In reality, it makes very little difference whether the budget is balanced by 2002, 2004, or 2005. What is important is (a) to have a believable commitment to balancing the budget over a reasonable period, and (b) that the budget be balanced in ways that have defensible social consequences. There is no decisive argument to be made for balancing the budget in seven years instead of in ten; as a practical matter, if a bipartisan budget agreement is reached, it will probably set a date somewhere between seven and ten years.

2) More important, Republican criticism of the Clinton plan attacks the accuracy of the administration’s forecasts of revenue and growth. The administration was accused of sponsoring a Democratic version of David Stockman’s “rosy scenario” in order to appear to balance the budget with considerably less fiscal pain than the Republican plan would entail. The Clinton plan projected growth in GDP at 2.5 percent a year, while the Congressional Budget Office (CBO) predicted a 2.3 percent rate; and the CBO’s assumptions with respect to future Medicare and Medicaid costs were higher than Clinton’s. Over the ten-year period of these forecasts, the cumulative difference was inevitably significant. If the CBO’s estimates turned out to be accurate, the so-called Clinton balanced budget would apparently be in deficit by about $200 billion by 2005.

The credibility of all such predictions is, however, doubtful. No one with any experience with economic forecasting and economic reality believes in the accuracy of three- to five-year forecasts, much less seven- to ten-year ones. Such skepticism simply reflects the unpredictability of economic growth and government expenditures. Most major companies in this country are run on the basis of a one-year forecast and a five-year plan, and for a simple reason. One needs a five-year plan to set objectives, but it is imprudent to try to make hard-and-fast forecasts beyond a single year. To reflect changing conditions, a five-year plan has to be adjusted each year, and the new forecast for the following year is used as the basis for the company’s planning. The same process should be built into any long-term plan to balance the federal budget; but so far I have seen no plausible attempt to do so.

Meanwhile the debate over the budget, which will be the central political issue for the rest of the year, will turn on a seemingly arcane question: the validity and credibility of long-term economic projections. For example, Republican legislation for a $245 billion tax cut requires the CBO to certify this year that reduced taxes will not impair the plan to balance the budget in seven years. But any certification to this effect made in 1995 provides no guarantee whatever that the deficit will be lowered to the point the plan specifies for the year 2000 or 2002.

The assumptions in the Clinton plan should also be treated with caution, but they are no less credible than those of the Republicans. A difference of 0.1 percent or 0.2 percent in expected annual GDP growth rates is within normal limits, and the growth rates in the Clinton plan actually coincide more closely with most of the private economic forecasts I have seen. The Clinton estimates of future Medicare and Medicaid costs are more optimistic than the CBO estimates, but they are not necessarily less credible. Large changes are occurring in the healthcare market as a result both of the pressures on prices exerted by managed care and of the cuts being made by state and local governments. The marketplace is driving costs down dramatically. Clinton’s projections of medical costs may be less conservative than some others, but they could well turn out in the long run to be more accurate.


The real issue here is not the accuracy of the projections, since no long-term projections are accurate. The issue is whether the administration’s commitment to balancing the budget is convincing and whether its fiscal assumptions are reasonable. The Clinton plan’s assumptions, in my view, are just as reasonable as those of House and Senate Republicans; the credibility of the commitment on either side will depend on creating some type of control mechanism that will measure each year’s actual deficit against the amounts that were forecast and will quickly make adjustments that will resolve any discrepancy.

The need for such a mechanism is obvious. For instance, it is one thing to have to make a $21 billion adjustment in the third year of either the Clinton or the Republican plan because changes in the economy have created a $190 billion deficit instead of the forecast $169 billion; that is painful but feasible. It is quite another to wake up seven or ten years from now to try to deal with an accumulated deficit of $200 to $300 billion. A legislated commitment to keep deficit reduction on an agreed-upon annual schedule, leading to balance by a certain date, has to be part of any long-term budget plan if such a plan by either party is to carry conviction.

The mechanism for annual adjustment could consist of a three-step process. First the CBO would determine the actual deficit as opposed to the projected one. Second, the President and the legislative leaders would agree on measures to resolve differences between the predicted reduction and the real deficit; this could include additional cuts or new taxes, or a combination of the two. The agreement would be subject to ratification by Congress. Third, if no agreement is reached, automatic across-the-board cuts in the budget would come into effect to comply with the forecast (with the exception of interest on the debt). Provisions would have to be made to defer cuts in case of a serious recession or a national emergency. Times have changed since the Gramm-Rudman legislation of the 1980s, which set limits on the deficit that were successfully evaded by keeping expenditures out of the budget and by other devices. The financial markets will be the ultimate arbiters of the credibility of any new plan; they are now far more powerful than they were when the Gramm-Rudman bill was passed and their reaction to any appearance of evasion will be harsh. The political pressures on the President and the legislative leaders to arrive at a negotiated settlement will be very strong.*

Establishing a mechanism for such continuous, year-by-year adjustments would be a more effective fiscal measure than the dramatic cuts in expenditures—based on what may be excessively conservative forecasts—that the Republicans now want to make. I do not myself favor any tax cuts at present, because I do not think the resulting losses of revenue can be justified. But the current Republican plans call for tax reductions so large that they are particularly troubling. One of their many negative consequences would be to cut back support programs for the poor, and particularly for poor children. As Senator Moynihan has said, such legislation may not be tolerable socially.

In all of the discussions of the budget, several important issues should be kept in mind:

1) Balancing the budget is not an end in itself. Its goals are to create more economic growth, to lower the cost of capital, to increase investment, to create jobs, to strengthen the value of the dollar, and to finance the basic public spending required by an advanced industrial democracy. To some extent, the financial markets have already given credence to the commitment to an eventual balanced budget on the part of both the Republicans and the administration. The recent rise in the securities markets is the direct result of this expectation, and has created tens of billions of new wealth without increased inflation. The markets did not wait for the cuts in the capital gains tax that many Republicans claimed were necessary to stimulate investment; market investors wanted to see evidence of deficit reduction. That bodes well for capital investment and private job creation as long as deficit reduction continues.


2) However, what is striking about the recent economic projections of the Congressional Budget Office and the Office of Management and Budget is that both agencies forecast modest growth for the rest of the decade—annual rates of 2.3 or 2.5 percent, which are historically low and not adequate for a strong economy. Yet there has been hardly any discussion about what would be an acceptable rate of growth for a country such as the US, which requires huge investments in both the private and the public sectors. In a global economy, the US cannot initiate a strong policy to achieve higher growth—particularly by lowering interest rates—without the cooperation of Europe and Japan, because of the risks to the dollar.

But the entire question of the economy’s failure to grow more vigorously deserves much more attention than it is now getting. During the 1960s and the early 1970s, when global competition was less severe and our social problems less daunting, the US economy needed a growth rate of between 3 percent and 3.5 percent to generate sufficient jobs and sufficient revenues for productive investment. A deliberate, coordinated policy among the G-7 nations to stimulate higher growth and to lower interest rates has now become an economic necessity if we are to realize higher national growth and higher personal incomes. This would also be consistent with Clinton’s original emphasis on higher levels of public as well as private investment.

3) We should take advantage of the debate on the budget to understand more clearly what the budget really consists of. The federal budget is a grotesque document that reflects neither accounting nor economic reality. As opposed to state and local budgets, and corporate financial statements, it does not differentiate between capital investment and ordinary expenses. So far as the federal budget accounts are concerned, a welfare payment is treated in exactly the same way as a payment to build a school or a bridge. The budget also does not take account of future liabilities or of expenditures whose repayment is guaranteed, such as student loans and certain foreign loans, among other obligations. The budget simply measures cash in and cash out over a twelve-month period.

Lowering the cost of capital as a result of lowering the deficit will certainly stimulate private capital investment; it will do nothing, however, for much-needed public investment. The administration and the Congress should provide for a capital budget that will be quite separate from the expense budget. Borrowing for capital investment by issuing bonds is the traditional way to finance such investment, but it should be subject to two conditions: that the capital project create new assets with a useful life over a defined period, and that it provide for paying back the interest and principal on the bonds. Such repayment can be assured either by designating a particular source of revenue, such as a gasoline tax, to pay off the borrowing, or by limiting total government borrowing to a fixed percentage of GNP. Appropriations for public infrastructure, including schools, roads, airports, and water supplies, need not be seen as filling the “pork barrel.” They can be a vital part of a twenty-first-century advanced economy.

The incremental public investment so created, combined with growing private investment, could do much to generate the additional economic growth and the new jobs that clearly will be needed. It would also offset the potential economic contraction resulting from budget balancing.

The Clinton administration deserves credit for making a difficult political decision to plan for a balanced budget, although it must also be recognized that the movement to limit the deficit was led by the Republicans in Congress. As planning for an eventual balanced budget goes forward, nitpicking about which economic projections are plausible or not will accomplish nothing; the projections are going to be changing constantly anyway. It will be more important for the different sides to agree on a control mechanism that will enable the administration and the Congress to assess whether the reduction of the deficit is on schedule and to make annual adjustments if it is not.

Now that the principle of budget balance has been adopted by both parties, the deeper questions about the economy that have been neglected should be debated. What is the relation between wealth and fairness? What are the respective responsibilities of the states and the federal government in economic matters? What are the actual components of the budget and what is the best way to bring it into balance so far as the country’s economic and social future are concerned? These are the fundamental issues that should be at the center of public discussion and the coming presidential election.

This Issue

August 10, 1995