Tuesday , September 17 2019
Home / Jeffrey Frankel's Blog / The Lesson from George H.W. Bush’s Tax Reversal

The Lesson from George H.W. Bush’s Tax Reversal

Summary:
Dec. 13, 2018 —  When President George H.W. Bush was laid to rest earlier this month, the remembrances appropriately remarked on his general decency and competence.  In public commentary, the encomiums tend to be followed by a “but.”  For journalists and historians, it is “but he was only a one-term president.”  He lost the election of 1992, in part because of the recession of 1990-91.  For members of his own political party, the “but” is, “but he broke with the legacy of Ronald Reagan and with his own ‘no new taxes’ pledge.”  They have always blamed his failure to win re-election on that perceived betrayal. But President Bush’s mistake was making the anti-tax pledge in 1988 in the first place and sticking to it in the first part of his presidency. The 1990 reversal on fiscal policy

Topics:
Jeffrey Frankel considers the following as important: , ,

This could be interesting, too:

Eric Crampton writes Around the budget traps

Eric Crampton writes Oh Treasury … again

Menzie Chinn writes Why Is the Structural Budget Deficit Blowing Up Since Trump?

Menzie Chinn writes When the Textbook Is Right: Implications of the Trump Fiscal/Trade Regime

Dec. 13, 2018 —  When President George H.W. Bush was laid to rest earlier this month, the remembrances appropriately remarked on his general decency and competence.  In public commentary, the encomiums tend to be followed by a “but.”  For journalists and historians, it is “but he was only a one-term president.”  He lost the election of 1992, in part because of the recession of 1990-91.  For members of his own political party, the “but” is, “but he broke with the legacy of Ronald Reagan and with his own ‘no new taxes’ pledge.”  They have always blamed his failure to win re-election on that perceived betrayal.

But President Bush’s mistake was making the anti-tax pledge in 1988 in the first place and sticking to it in the first part of his presidency. The 1990 reversal on fiscal policy set the stage for a decade of economic growth that eventually achieved budget surpluses.

The budget deal that Bush reached with Congressional Democrats in 1990 may indeed have contributed to his failure to win re-election in 1992. There is no question that the timing of this otherwise-impressive achievement was terrible.  The move to fiscal discipline came just as the recession was hitting. (The economy peaked in July 1990 and reached its trough in March 1991.) This instance of pro-cyclical fiscal policy probably made the recession worse than it would otherwise have been and slowed the subsequent recovery.

Did the broken tax pledge cost Bush re-election?

But it is not as clear as some believe that the tax reversal is what cost him re-election. Another drama ran simultaneously with the budget negotiations and the recession: Iraqi forces invaded Kuwait on August 2, 1990.  (This reckless act was arguably attributable to the coddling of Saddam Hussein, another misguided policy that Bush had inherited from Reagan.)  The invasion sent oil prices higher and may well have caused the recession.

In any case, President Bush’s prosecution of the campaign to push Iraq out of Kuwait was skillful, both diplomatically and militarily.  Project Desert Storm achieved its aims on 28 February, 1991. Consequently, his job approval rating reached a sky-high 89 per cent.  It was only in the fourth year of his term that the poll rating sank miserably (hitting its low-point of 29% in July 1992.  Anger at the reversal of the tax promise can’t directly explain the 29 percent poll rating, because the 89 per cent rating came in between.

Bush during the Reagan Administration

George H.S. Bush actually had known better than to support the claim that Reagan’s 1981-83 tax rate cuts would boost the US economy so much as to reduce the budget deficit.  When he had run against Reagan for the Republican nomination in 1980, at one point he had famously called such claims “Voodoo economics.”  But he put his doubts aside when he accepted the position as Reagan’s vice president.  Even more famously, when Reagan’s second term was ending and Bush was nominated to be his successor in August 1988, his acceptance speech at the Republican National Convention predicted that Democrats would repeatedly ask him to raise taxes. He promised that he would forever refuse: “read my lips, no new taxes.”

The economy at the end of the 1980s was at the peak of the business cycle.  This was an appropriate time to begin to address the long-term budget deficit problem.  As Keynes said, “The boom, not the slump, is the right time for austerity at the Treasury .”  But Bush agreed to double-down on the Reagan policies that had produced the record deficits in the first place.  And the ploy worked, in the sense that the pledge helped him not only get the Republican nomination but also win the election in November 1988.

Bush’s historic reversal

After a year and a half in office, the 41st president courageously (though belatedly) decided to address the long-postponed budget deficit problem that he had inherited.  He entered into difficult negotiations with the Congressional leadership.  The Democrats had the majority in both houses of Congress and they refused to agree to restrain domestic spending unless taxes also contributed to the budget package.  Thus in June 1990 Bush admitted that any agreement to cut the deficit would require not just spending restraint but also tax increases.  This was universally viewed as a retraction of his “no new taxes” pledge.  The taxes that were raised were in fact old taxes, but that was considered just a technicality.  On October 8, the House and Senate finally agreed on a budget plan (narrowly avoiding a government shutdown).

The Budget Enforcement Act of 1990 legislated caps on discretionary spending and created constraints known as “pay-as-you-go” (PAYGO) rules which essentially said that if Congress wanted to cut a tax or increase entitlement spending it had to pay for the cost in some other part of the budget.  When Bill Clinton became President in January 1993 and was persuaded to prioritize the budget balance by his Treasury Secretary, Robert Rubin, he sent to Congress legislation to renew the system of spending caps and PAYGO.  It passed, though without a single Republican vote.  (The Democrats controlled Congress then — until, in the mid-term elections of November 1994, Newt Gingrich successfully marshaled Republican anger at what had effectively been four years of fiscally responsible legislation and re-took the House.)

The fiscal system remained in place throughout the remainder of the Clinton Administration.  The budget policy, together with good economic growth, steadily reduced the deficit and converted it to rising surpluses in 1998, 1999 and 2000.  But in January 2001, the second Bush assumed office. The Republicans allowed the budget caps and PAYGO rule to lapse. They cut taxes and rapidly raised spending, with the results that record deficits soon returned.

Lesson: Avoid pro-cyclical fiscal policy

This is not irrelevant ancient history.  George H.W. Bush showed a “profile in courage” when he decided to meet the Democrats halfway in order to achieve fiscal responsibility; it is the last time any Republican president has tried to live up to the label of fiscal conservative.  But the timing of the 1990 switch was pro-cyclical.  Republicans repeated the economic mistake of pro-cyclicality when they engaged in fiscal expansion during the recovery of 2001-2007 and then fought President Obama’s attempts to respond to the 2007-09 recession with fiscal stimulus after he arrived at the White House in January 2009.  As a result of this fiscal pro-cyclicality, the recovery from the Great Recession was slower than it had to be, just as had been the case with the 1990-91 recession.

Over the last year, President Trump has pursued an even more flagrantly pro-cyclical fiscal expansion, with ill-timed tax cuts and spending increases at the peak of the business cycle.  It too will end badly.

[A appeared at Dec. 10, 2018. the site.]

Jeffrey Frankel
Jeffrey Frankel, a professor at Harvard University's Kennedy School of Government, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He directs the Program in International Finance and Macroeconomics at the US National Bureau of Economic Research, where he is a member of the Business Cycle Dating Committee, the official US arbiter of recession and recovery.

Leave a Reply

Your email address will not be published. Required fields are marked *