They Called It ‘Rubinomics’
Robert Rubin, Ex-Treasury Chief's new book, excerpt:
NEWSWEEK

Nov. 17 issue — After being somewhat involved in the 2000 election, I didn’t give much thought to what role, if any, I would have in the policy debate going forward. But more than anything else, it was my deeply troubled reaction to the administration’s tax cut proposals that led me to reengage.

The Tax Bil, debated and passed in the first half of 2001, began a period in which tax cut advocates dismissed mainstream views about the direct and indirect effects of large tax cuts on the government’s fiscal position, the value of sound fiscal policy, and the harm caused by large, long-term structural deficits.

Conservatives often framed the debate over Bush’s proposals as a question of lower taxes versus more spending. If government didn’t give back the surpluses to the public in the form of a tax cut, leading conservatives argued, “Washington” would find a way to spend the money. Another version was that the surpluses were the people’s money and should be returned to them. These formulations are as politically shrewd as they are simplistic. Nobody likes what government does when it’s described as “spending.” Yet the major programs that make up the vast preponderance of government spending—from Social Security and Medicare to defense, law enforcement, education and environmental protection—command widespread public support.

The Bush administration’s approach to tax cuts framed a new stage in the Great Fiscal Debate, an ongoing clash about the effects of fiscal discipline and of tax cuts on economic growth. This argument first affected policy in a significant way during the 1980 presidential campaign, when a group of conservative “supply-siders” attained prominence. The core of the supply-side theory was that lower marginal tax rates would cause people to “supply” more labor, working more and harder, which would increase growth—and the positive effect on growth would be so large that government tax revenue would actually increase rather than decrease in response to the tax cut.
Interview: Not Out of the Woods

George H.W. Bush, Ronald Reagan’s opponent for the Republican nomination in the 1980 election, referred to this as “voodoo economics.” And not all of Reagan’s advisers believed this theory. Some committed conservatives understood that reducing the size of government is difficult because of the popularity of most spending programs of significant size. Tax cuts seemed to offer a way around this problem. If government’s revenues were squeezed, this line of reasoning went, spending could no longer grow and might even be forced to shrink. Despite that theory, spending throughout the 1980s consistently and significantly exceeded levels —necessary to offset the tax cuts. The result was large deficits that kept increasing during the early 1990s and were projected by the outgoing administration in 1992 to grow even more in the years ahead.

To run a cyclical deficit—a short-term and temporary deficit in conjunction with a recession or slowdown—isn’t necessarily bad and at times may be entirely sensible. But the Reagan tax cuts, combined with defense spending increases, created something different: large and long-term structural deficits, which persisted even when economic conditions were good.

After Clinton took office, the Great Fiscal Debate mutated. In 1993, the debate was between supporters of Clinton’s economic plan—which included revenue increases, principally an income tax increase on the top 1.2 percent of taxpayers and a small gas tax—and opponents who argued that tax increases of any kind would harm the economy. “I believe this will lead to a recession next year,” Newt Gingrich said at the time. “This is the Democratic machine’s recession and each one of them will be held personally accountable.”

The 1993 deficit reduction program was a test for supply-side theory. Instead of the job losses, increased deficits, and recession the supply-siders predicted, the economy had a remarkable eight years—the longest period of continuous economic expansion yet recorded. That success created an immense anger on the part of some conservatives, who saw a policy they decried led to conditions they said wouldn’t occur.

As the deficits diminished and a surplus emerged during Clinton’s second term, the debate evolved again. Conservatives now argued for “giving back” the large projected surpluses to taxpayers in the form of a tax cut. We felt that continued fiscal discipline—in this case, beginning to pay down the federal debt—would best promote growth. What’s more, Social Security and Medicare were facing huge deficits once the baby-boom generation began to retire.

All of this argued against massive tax cuts. But the surplus left the Democrats in a tricky situation. Most voters don’t even understand the difference between the government’s annual deficit and its accumulated debt. So it was almost impossible to explain why entitlement obligations we faced decades down the road meant that a government that was running a surplus should use the money to pay down its long-term debt instead of refunding it to taxpayers. Preserving the surplus as savings and using that to pay down debt would contribute to lower interest rates, greater job creation, and higher standards of living.

In January 2001, the nonpartisan Congressional Budget Office projected a ten-year federal government surplus of $5.6 trillion. By September 2003, after two rounds of tax cuts, Goldman Sachs estimated a ten-year deficit of $5.5 trillion. That’s a swing of $11.1 trillion, but adjusting for methodological differences the better number to use is $9 trillion. Though many factors contributed, the tax cuts of June 2001 and May 2003 were central to this reversal.

The Great Fiscal Debate now moved to the question of whether these projected deficits mattered. The proponents of tax cuts had to argue that they didn’t matter—or at least didn’t matter much—because large tax cuts and a sound fiscal position could not be reconciled. And tax cut advocates pointed to me as the symbol of the position that deficits have a significant effect on interest rates and therefore on economic activity, job creation, and growth. The Wall Street Journal editorial page dismissed the theory that deficits affect interest rates as “Rubinomics.” Flattered as I was, I didn’t think this position could possibly get traction. But it was loudly trumpeted, and the countervailing view wasn’t. What seemed to me arrant nonsense came to be treated as a serious point of view.

The first thing you learn in Introductory Economics is that supply and demand determine price. It’s curious that people whose credo is that markets explain everything don’t think that an important factor in the supply and demand for debt financing—the government’s fiscal position—has any effect on interest rates. Put another way, it’s an even more obvious point: when the government borrows, the pool of savings available for private purposes shrinks and the price of capital—the interest rate—rises.

Interest rates are only part of the picture. An unsound long-term fiscal situation can also damage business and consumer confidence—as was evident before the 1992 election. Large structural deficits can also diminish confidence in our economy and currency abroad, impair the ability of the federal government to serve the purposes the American people wish it to serve, and undermine our resilience in dealing with future recessions or emergencies.

One major impediment to serious discussion of our fiscal morass is that it immediately raises the question of whether the country now needs to raise taxes to deal with the deficit. My view is that the fiscal deterioration caused by the current fiscal policy will inevitably mean shared sacrifice, as it did in 1993, and will involve both spending and tax measures. But whatever the eventual solution, the president and congressional leaders of both parties should get together—sooner rather than later—to deal with what has become a serious threat to our future well-being.

Robert Reischauer, a former head of the CBO and one of the wisest budget experts I know, thinks that our nation’s leaders may well be unwilling to repair our long-term fiscal mess until we reach an inevitable day of reckoning. When that crisis arrives, we will either make the decision to increase revenues substantially—at what may well be an inopportune time—or face severe and prolonged economic tribulations. Then the American people will look back with dismay at what happened. Unfortunately, no one who is now concerned about deficits has yet found a way to explain these future costs in a way that has political resonance while these problems are being created and can still be prevented.

Leaving aside debates about whether deficits matter and about whether the supply-side effects are real, tax cuts and spending increases often seem attractive in the short term to politicians—and voters—who either don’t focus on the long term or perhaps recognize the potential problems but feel that they will fall on somebody else’s watch.
--------------------------------------------------------------------------------
From “In an Uncertain World” by Robert E. Rubin and Jacob Weisberg. To be published by Random House Publishing Group, a division of Random House, Inc. © 2003 by Robert E Rubin and Jacob Weisberg.