Policy Documents

Bast: American Prosperity: From Clinton to Obama

Joseph L. Bast –
February 1, 2011

This is the second half of an essay that sets out to answer the question, “Who has the best plan to restore American prosperity?” The answer to this question could determine the outcome of many elections in 2012.

Part one, which reviewed the policies of presidents from Kennedy to Reagan, appeared in the November-December 2010 Heartlander. In this essay I start with President Bill Clinton and end with some observations on President Barack Obama’s first two years in office.

Bill Clinton

The Reagan Revolution ended in 1990 when George H.W. Bush, midway through serving Reagan’s “third term,” broke his no new taxes pledge. Two years later he lost his reelection bid to Bill Clinton who, very much like Barack Obama, ran as a moderate and emphasized the theme of change rather than promising any specific policy changes.

Once elected, Clinton governed as an activist liberal in his first two years in office, including putting his wife in charge of an effort to nationalize the nation’s health care system. In 1993, he ushered through Congress a package of tax reforms that increased the individual income tax rate to 36 percent and added a 10 percent surcharge for the highest earners, raised the corporate income tax rate to 35 percent, repealed the income cap on Medicare taxes, and more.

Due to his over-reaching, Clinton lost his mandate and Democrats lost the House in 1994. Nevertheless, the economy did well and the federal budget, after years of deficits, was balanced. Why?

In the narrative provided by Laffer, Moore, and Tanous in their 2008 book, The End of Prosperity, the economic recovery that began with the election of Ronald Reagan in 1980 had enough momentum to survive the Clinton tax hike, though its effect was felt: Real growth was 4.5 percent in the 12 months before Clinton/Gore were elected, and only 2 to 3 percent in 1993 and 1994.

The turning points for interest rates and the stock market were not 1993, but November 1994, when Republicans took control of Congress. Also working in Clinton’s favor was the “peace dividend” that came with the end of the cold war, accounting for about one-third of the deficit reduction from 1995 to 2000.

Republican opposition to Democrat spending initiatives reduced spending to well below what Clinton and the Democrats intended. In 1995, the Democrat-controlled Congressional Budget Office forecast deficits of $200 billion every year from 1995 to 1999. The actual deficits were smaller, and the budget turned to surplus in 1998 ($69 billion) and 1999 ($126 billion).

The tech bubble burst in 2000, the stock market collapsed, tax revenues fell, and the economy slid into another recession. The next year, the terrorist attacks on September 11, 2001 signaled the end of the “peace dividend” and the start of another massive build-up of military spending.

George W. Bush

George W. Bush did not inherit a good economy or a balanced budget. In 2001, he got Congress to enact a tax cut providing $400 to $600 tax rebates to mostly lower- and middle-income workers and tax filers. The effect on the economy was probably negative, but other tax cuts being phased in would start to make a difference. The economy recovered in 2002 but was limping.

In 2003, Bush fought Democrats in Congress for more tax cuts that once again would speed up the nation’s economic engine. The dividend tax was cut from 39.6 percent to 15 percent, the capital gains tax was cut from 20 percent to 15 percent, the highest income tax rate was cut from 39.6 percent to 35 percent, and taxes on business investments in plant, machinery, and equipment were lowered.

Over the next four years, according to Laffer, Moore, and Tanous, those tax cuts generated $15 trillion in new wealth. Business investment, which had fallen 4.8 percent in 2001 and 6.1 percent in 2002, rose by 7.4 percent in 2004 and 9.5 percent in 2005. Households increased their wealth by some $6 trillion between 2003 and 2007, and the median household increased its wealth by almost $20,000 in real terms.

Unlike Reagan and even Clinton when faced with Republican majorities in Congress, Bush allowed spending to grow out of control. The budget rose 41 percent – from $2.2 trillion to $3.1 trillion – during his eight years as president. Still, the annual deficit fell from $401 billion 2002 to $158 billion in 2007, evidence that some small progress toward fiscal discipline was being achieved.

Barack Obama

Prosperity was lost again in 2008 when the end of a housing bubble triggered a banking crisis and a cascading financial crisis that eventually touched every business and every consumer in the country. The Great Recession of 2008–2009 was long (18 months) and the recovery slow. While Barack Obama cannot take the blame for initiating the economic disaster, he richly deserved blame for slowing the recovery.

Like George H.W. Bush, Obama campaigned on a “no new taxes” pledge and broke his promise when in office. Unlike Bush, he did not wait two years. Obama signed into law the State Children’s Health Insurance Program (SCHIP), which Bush had twice vetoed, less than a week after entering office. The law raised taxes on a pack of cigarettes by $0.62 and was expected to raise $11 billion a year.

The average annual income of smokers in the United States is about $36,000.

The cigarette tax hike was the beginning of an orgy of spending and tax hikes. Obama championed and signed into law a massive $787 billion debt-financed “stimulus” act, a government takeover of health care, and government bailouts of banks, car manufacturers, and insurers. Average spending for federal agencies rose by more than 50 percent between 2008 and 2010.

The result of Obama’s policies was economic ruin. Unemployment worsened following the official end of the “Great Recession,” rising from 7.6 percent when Obama took office to 9.4 percent today. A monthly poll conducted by Gallup puts the unemployment rate even higher, over 10 percent. The African-American unemployment rate is a staggering 15.8 percent.

The Republican victories in 2010 prevented Obama from allowing the Bush-era tax cuts to expire. Had that happened, according to the Tax Foundation, a two-income family earning $120,000 with two kids would have seen their “income taxes go up $4,499 next year, even before any potential Alternative Minimum Tax penalty, which could add several thousand dollars to their tax bill.”

Obama still thinks the country can tax and spend its way out of recession. In February, he unveiled a $3.73 trillion spending plan for 2012 with a projected deficit of $1.5 trillion. The massive spending hikes and deficits of the previous two years are now, if Obama has his way, the baseline against which future budget hikes and cuts are to be measured.

Republicans have a different plan in mind. In 2010, the Republican Study Committee presented a budget that would have reduced federal borrowing from the Obama baseline by $6.4 trillion over 10 years by reducing spending on discretionary programs to their 2008 levels, taking back the money given to banks and auto companies during the bailouts, and cutting spending on hundreds of specific programs. The plan forecast reduced budget deficits every year and then surpluses in 2019 and 2020.

Looking Back, Looking Ahead

Looking back, it seems clear that American prosperity was greatest when tax rates were reduced or kept low and when government spending and regulation were held in check. Ronald Reagan re-discovered the formula in the early 1980s, and subsequent presidents have only weakly or unwillingly embraced it.

Looking ahead, it is difficult to know how far to the middle Obama will move or how committed Republicans are to the winning formula. Shocks to the economy are inevitable, and an unbroken string of positive-growth quarters may be a pipe dream. But history shows clearly that politicians can facilitate or hamper economic recoveries by the policies they choose to adopt.

In 2012, the politicians who embrace lower taxes and less government spending are the ones who are most likely to return America to prosperity.

Joseph Bast (jbast@heartland.org) is president of The Heartland Institute.