The best time economically to take serious action against large, persistent structural budget deficits is when the economy is strong—for example, the late 1980s or currently. The cyclical deficit rises as tax revenues decline and social spending increases as unemployment rises. The public, political, and media discussion focuses on the actual deficit, whereas economists tend to focus on cyclically adjusted budget deficits, sometimes called structural deficits.
Despite the conventional wisdom, taxes as a share of the gross domestic product were not cut during the Reagan administration; they stabilized around 19 percent of GDP. The deficits were a result of spending rising relative to GDP. Thus, President Bush strongly committed in the 1988 campaign to do something serious about the budget deficit by controlling spending—that is, imposing a real spending flexible freeze. He was quite aware that this would require a serious whack at defense and entitlements, especially the latter, relative to projected baseline budget growth.
Unfortunately, it was decided for political reasons not to press for these budget priorities in the first year of the Bush administration. This was a major mistake, because the economy was sure to soften over the coming year—the Fed had raised interest rates 300 basis points in the ten months prior to his inauguration—and because the president received over 400 electoral votes running on this fiscal program. It made lots of sense economically as well as politically. But the feedback was that under no circumstances would the Democrats agree to any serious control over spending unless the president would go along with a major tax increase, and the president and most of his advisors—including myself—were strongly opposed to considering such an outcome for both economic and political reasons.
Meanwhile, the second round of disinflation ensued, the economy slowed, and budget projections were way off for technical reasons, such as the enormous growth of Medicare and Medicaid expenditures above previous trends. The cost of the savings-and-loan resolution, including temporary working capital and a variety of regulatory problems, were worsening the credit crunch in financial institutions. The president wound up in serious budget negotiations the following year in a much weaker economy. Contrary to popular belief and numerous press statements, the president was quite aware of what was going on in the economy. This was no secret. The economy performed very closely to the administration’s officially published economic forecasts.
I had always taken President Bush’s “no new tax” pledge seriously. I also believed that it would be difficult to get the Democrats in the Congress to go along, and that the president would have to either get a close-enough approximation, having prepared the public for what was finally negotiated, or blame the Democrats for failure to reach a budget agreement and run against them in the midterm election.