Rubinomics Redux

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MAY 24, 2004

Rubinomics Redux

One of the more bizarre rhetorical strategies employed by economic
conservatives in recent years has been to tar their opponents as
advocates of "Rubinomics." It's bizarre, first, because, if you
want to discredit your adversaries by identifying them with a
person, you wouldn't usually choose the Treasury secretary who
presided over the longest expansion in U.S. history. The second
reason it's bizarre is that the specific notion conservatives wish
to discredit--that large and sustained budget deficits harm the
economy--is by no means peculiar to Robert Rubin. Nonetheless, a
fierce anti-Rubin revisionism has emerged on the right, and the
debate over Rubin is understood by both sides to be, in part, a
proxy debate over the economic policies of George W. Bush.In a recent 9,000-word cover story in this magazine (see "What the
Boom Forgot," May 3), Robert J. Samuelson gives expression--and, to
some extent, lends The New Republic's imprimatur--to this
anti-Rubin (which is to say, anti- anti-deficit) revisionism.
Samuelson is not a habitual repeater of Republican talking points,
and, on the surface, his essay appears more credible than most
anti-Clinton or pro-Bush pseudo-economic screeds. But he employs
misleading arguments and tries to pass off his own ideological
preferences as settled fact, and ultimately his essay is no more
convincing than GOP spin.

To the extent that Rubin introduced a new idea, it was that deficit-
reduction, at least under certain conditions (such as those when
Clinton took office) can help spark short-term economic growth.
This idea is worth debating. Alas, Samuelson does not address it.
Instead, he takes issue with the broader notion that deficits harm
the economy over the long run. Not only did Rubin not invent that
idea, it's not even controversial among economists. In other words,
while Samuelson purports to be debunking Rubinomics, his real
quarrel is with economics.

The heart of Samuelson's argument is a series of contrasts between
what he labels "myth" and "reality." One "myth" is that "[b]udget
deficits raise interest rates." "Reality," Samuelson writes, is
that "[d]eficits are only one of many influences on interest rates,
and at present a minor one." This is baffling, because the two
statements do not contradict each other: Higher deficits put upward
pressure on long-term interest rates, but they're not the only
factor. It's as if Samuelson wrote, "Myth: Eating more food makes
you gain weight. Reality: Food consumption is only one factor in
weight gain."

The relationship between deficits and long-term interest rates is a
truism among economists. As former Harvard economist and current
Bush Council of Economic Advisers Chairman Greg Mankiw observed in
a textbook he wrote in 1997, "When the government reduces national
saving by running a budget deficit, the interest rate rises, and
investment falls." The reason is simple. Interest rates are the
price of borrowing money. There's a finite amount of money to be
borrowed. When the government enters the market looking to borrow
money at any price--which is what happens when it runs a
deficit--then there's less money available for everybody else to
borrow. The supply drops, and therefore the price rises.

To be sure, the relationship between deficits and interest rates is
not always apparent, because there are a number of factors that
affect interest rates in contradictory ways and all operate at
once. During an economic boom, for instance, deficits will tend to
fall, which puts downward pressure on interest rates. But booms
also cause the Federal Reserve to hike overnight interest rates,
which cause long-term rates to rise.

Samuelson cites rising rates during the '90s (when deficits fell)
and falling rates since 2001 (when deficits skyrocketed) to show
that there's no link between the two. But this doesn't show that
deficits don't affect interest rates. It only shows that other
factors can sometimes have a larger effect. If we hadn't reduced
the deficit during the '90s, long-term interest rates would have
been higher than they were. Return for a moment to the food/weight
analogy. Suppose you started consuming far more calories at the
same time you began training for a marathon and, as a result, lost
weight. Would this prove that the relationship between calories and
weight is a myth? Of course not.

In one breath, Samuelson acknowledges this logic and then dismisses
it. "All other things being equal, interest rates should rise [if
deficits rise]," he asserts. "But other things are rarely equal,
and actual interest rates reflect many forces." As a matter of
fact, other things are never equal. That's not the point.
Economists use that phrase because, in a world with myriad factors,
it's the only way to think about the effects of a single one. To
reject that analysis on the grounds that "other things are rarely
equal" is to reject all economic analysis--indeed, all social

Samuelson's next "myth" is that "[b]ig budget deficits depress
private investment and thereby hurt future wages and living
standards." This "myth," unfortunately for Samuelson, is another
economic truism. Deficits soak up private capital that could be
used for productive investment and divert it into government debt.

Samuelson doesn't refute this logic. He simply points to other
effects that deficits have and other factors that affect
investment. For instance, he argues, "It's not just how much a
country invests, but how well." OK, sure. But how well a country
invests is independent of how much it invests. Again, there may be
several factors affecting private investment and future income, but
focusing on those other factors doesn't change the fact that
deficits are one of them.

Deficits also depress future incomes in a more straightforward way:
The more debt we bequeath to future taxpayers, the more taxes
they'll have to spend paying off interest on our debt. Samuelson
doesn't even mention this--odd, given that, in other contexts, the
burden of debt on future generations is a major theme of his. In
one column on Medicare last December, he wrote (accurately), "Who's
going to pay? Well, tomorrow's workers." Another earlier this year,
on the prescription-drug benefit, was titled "our kids will pay the

Why would Samuelson fixate on the evils of higher debt in some
contexts while dismissing them in others? His inconsistency is best
understood as a product of his particular brand of small-government
conservatism. Samuelson's core belief is that we must reduce
Medicare and Social Security payments. Thus his criticism of Rubin,
who recommended in the late '90s--while liberals and conservatives
clamored to divide up newfound budget surpluses for spending or tax
cuts--that the surpluses should be reserved to pay down the national
debt. The Clinton administration sold this frugal policy by arguing
that the less debt we leave to future taxpayers, the easier time
they'll have handling deficits in Social Security. Samuelson, in
his review, decries President Clinton's move as "a plug for the
status quo: preserving all future benefits of Social Security and

But Samuelson not only dismisses the benefits of deficit-reduction,
he denies that Clinton's policies enabled deficit-reduction in the
first place. According to Samuelson, another "myth" is that "fiscal
responsibility ... led to budget surpluses in the late 1990s."
Reality, he tells us, is that "the economic boom and the end of the
cold war were the basic causes of the surpluses." To be sure,
there's a germ of a point here--external factors had a lot to do
with the improving budget picture under Clinton, as well as with
the subsequent deterioration under Bush. But Samuelson stretches
that point beyond all plausibility.

First, Samuelson treats the boom as a pure windfall. But respectable
Democratic economists, such as former Clinton Treasury Secretary
Lawrence Summers, make a plausible case that the boom came in large
part because of the deficit-reduction that preceded it. Yes,
productive new technologies emerged during the '90s. If we were
still running 1980s-scale deficits when they emerged, though, much
of the investment capital that funded those technologies would have
instead gone into financing government debt. To some extent,
deficit- reduction begat more investment, which begat more
productivity, which begat stronger growth, which begat even lower
deficits. Now, it's impossible to tell whether deficit-reduction
played a major role or a minor role in producing that virtuous
cycle. But assigning fiscal responsibility zero role in the boom
simply strains credulity.

Even if we assume that deficit-reduction had absolutely nothing to
do with the '90s boom, however, Samuelson still underplays the role
that good policy-- as opposed to lucky external factors--played in
reducing the deficit. He quantifies the fiscal benefits of the boom
and lower post-coldwar defense costs, pointing out that they were
very large. Which they were. But, astonishingly, he doesn't compare
those numbers with the savings brought about by deficitreduction.
In fact, he doesn't bring up those savings at all.

Here's a fair side-by-side comparison. In 2000, non-defense-related
savings from Clinton's 1993 budget accounted for 2.4 percent of
gross domestic product (GDP). Lower defense spending accounted for
2.2 percent, and higher revenue from the boom another 3 percent.
The 1990 deficit-reduction deal--the tax hike and budget cuts
passed by the first President Bush, which in many ways presaged
Clinton's own approach--accounted for another 1.8 percent of GDP.
Samuelson asserts that "good luck, more than good policy, produced
the surpluses." Yet even by Samuelson's own definition, "good luck"
accounted for not much more (5. 2 percent of GDP) than good policy
(4.2 percent of GDP). It's hard to think of any reason why he
omitted these numbers except that doing so would have undercut his

On top of all that, Samuelson piles on one more misleading omission.
He assumes the surpluses that appeared in the late '90s would have
appeared no matter who held office at the time. But only Clinton's
insistence on reserving the surpluses for deficit-reduction--the
very insistence Samuelson so derides-- kept the surpluses from
quickly being carved up for spending and tax cuts. That is to say,
even if we grant all of Samuelson's other arguments and assume that
fiscal responsibility had nothing whatsoever to do with the
surpluses at the end of his term, Clinton still deserves credit for
using that money to pay down the national debt, rather than
spending it. The $236 billion devoted to paying down the debt in
2000 is still around $236 billion more than it would have been if a
less frugal president had held office.

The essential flaw in Samuelson's argument can be seen in his final
"myth." After denying that "[t]he central budget problem is
eliminating stubborn budget deficits," he instructs us that "[t]he
true problem is federal spending, driven by higher retirement
benefits for aging baby-boomers." Samuelson is conflating the
problem with his preferred solution. By any objective standard, the
true problem is that the government is on course to spend far more
than it takes in, and rising costs in Medicare and Social Security
are a part of the problem. We could solve this problem with higher
revenue. Alternatively, as Samuelson hopes, we could do it through
benefit cuts. Or we could do some combination. To state
authoritatively that the "true problem" is high spending is no more
valid than asserting that the true problem is low revenue.

Samuelson occasionally falls into the habit of burying his own
preferences behind authoritative-sounding empirical statements
about the economy. Thus, he is unmoved by the effects of deficits
caused by tax cuts but panic-stricken about the effects of deficits
brought about by growing Social Security and Medicare costs. In the
same tnr essay dismissing the effects of deficits, he warns that,
as a result of the entitlement crisis, "interest rates might rise,
choking off investment and promoting stagnation. Worse, huge
deficits could trigger a financial crisis." This might be
intellectually consistent if the future entitlement deficits were
bigger than the tax-cut deficits. But they're not. The present
value of deficits in the Social Security and Medicare trust funds
combined over the next 75 years amounts to 2.2 percent of GDP. The
present value of the revenue loss caused by Bush's tax cuts over the
same period also equals 2.2 percent. If we repeal the Bush tax
cuts, we could, if we wanted to, solve the Medicare and Social
Security trust-fund deficits. That doesn't mean we should do that,
and Samuelson could argue that cutting benefits makes the most
sense (as he has in other contexts). But his tnr essay circumvents
that argument altogether.

Samuelson's gambit is best understood in the context of recent
fiscal debates. His desire to starve entitlement programs no doubt
helped drive his support for the Bush tax cut in 2001. "I think
Bush is correct on the central issue of government's size," he
wrote. He also accused this magazine and other critics of the tax
cut of throwing a "tantrum." When critics questioned Bush's claim
that he could easily pay for his tax cut, new spending on the
military, and prescription drugs--and still pay off the national
debt--Samuelson replied that "the critics' case is wildly
overstated." As we now know, the critics' case was wildly
under-stated. We figured Bush wouldn't really pay off the debt, we
suspected he might bring deficits, but nobody predicted half a
trillion dollars' worth of red ink per year.

Rather than directly concede error, Samuelson simply waves the point
away. "It's true that Bush's tax cuts have created the prospect of
endless deficits," he conceded in a column last year. "But this is
not the real issue; the real issue is future government spending."
This is a fairly galling argument. (Try telling your spouse, "OK,
maybe borrowing $50,000 to buy that sports car was a bad idea, but
the real issue is all the money we're spending on that retirement
community for your mother.") But, since it's getting harder and
harder to defend Bush's fiscal policies, perhaps the only remaining
tactic is to change the subject. Samuelson tries to persuade tnr's
readers that Clinton's economic policy didn't work--and, by
implication, cannot work in the future. But that isn't his real
objection. His real objection is that he doesn't want it to work. ;
Robert J. Samuelson's response...

Robert J. Samuelson Responds:

For decades, economic ideas have been merchandized for political
purposes-- by economists who have peddled their pet theories as a
way of gaining public prominence or political appointment and by
politicians who have advertised economic doctrines as solutions to
the nation's social problems. In the 1960s, there was
"Keynesianism," the notion that manipulation of budget deficits and
surpluses could eliminate recessions. "Monetarism," which emerged in
the late '70s, promised that slavish control of the money supply
could eradicate inflation and stabilize the economy. In the '80s,
"supply-side economics" contended that low marginal tax rates--the
tax on the last dollar of income-- could dramatically increase
economic growth. Each of these doctrines contained some truth, but
each was exaggerated to enhance its political appeal. The
inevitable result was disillusion, because none could live up to its

The obsession with government budget deficits is the latest of these
simplistic fads. According to fashionable theory, low deficits (or
better, surpluses) promote strong, sustained economic growth
through, among other things, low interest rates that stimulate
investment. Conversely, large deficits are supposed to discourage
economic growth through, among other things, high interest rates.
But, in the real world, the economy doesn't respond to deficits or
surpluses as the theory implies, and formulating budget policy
requires answering other questions beyond whether there's a surplus
or a deficit. How high should government spending and taxes go?
What programs are in the national interest--and why? Who deserves
help--and why?

I am in an awkward position. In general, I have favored balanced
budgets-- when the country is not in or near a recession or
fighting a major war--as a crude political discipline. If extra
government spending is worth having, it should be worth paying for
with higher taxes. I've called this view "the folk wisdom," and it
prevailed until the '60s, when Keynesian economists dismissed it as
old-fashioned. But, although I dislike deficits, I think their
adverse economic effects have been (so far) exaggerated. Similarly,
I think the benefits of surpluses have been overstated.

One point of my tnr review, which covered former Treasury Secretary
Robert Rubin's memoir and four other books, was to question the
single-minded focus on budget deficits. The review was not a
personal attack on Rubin. Indeed, it praised his role in addressing
the Asian financial crisis of 1997-'98, and his performance there
will (I think) deservedly secure his reputation. But, to the extent
that Rubin has popularized the obsession with budget deficits, he is
a fair target for criticism. If Rubin were alone in holding these
views, it wouldn't matter much. But the truth is that there are
many in both parties-- including many economists--who have bought
into this theory.

Jonathan Chait has taken strident exception to my analysis. I could
answer his critique point for point, but that would be tedious and,
for all but dedicated economic policy wonks, fairly opaque. The
better course, I think, is to respond to Chait's three broad
arguments: that Clinton's "deficit-reduction" program primed the
'90s recovery; that Clinton's policies were decisive in restoring
budget surpluses; and that a return to his policies will solve the
nation's future budget problems. Each is exaggerated.

First, declining budget deficits didn't cause the economic expansion
of the '90s. If Chait were correct, Clinton and Rubin would be
responsible for the '90s boom--and the subsequent bust. Happily for
them, Chait is wrong. Two economic surprises propelled the
prolonged expansion: Inflation was lower than expected, and
productivity growth was higher than expected. As a result, optimism
increased, and people spent more because their "real" (inflation-
adjusted) wages and salaries rose. Higher profits contributed to an
improving stock market and greater business investment. Dampened
inflation meant the Federal Reserve didn't have to raise interest
rates to prevent an "overheating" economy from triggering a
wage-price spiral. But diminishing budget deficits didn't cause
either lower inflation or higher productivity.

Inflationary expectations had gradually subsided since the early
'80s because the Federal Reserve--first under Paul Volcker and then
under Alan Greenspan--had indicated that it would no longer
tolerate high and rising inflation through easy-money policies. By
the early '90s, other factors may also have helped: Intensified
competition from imports limited companies' ability to raise prices
(greater domestic competition had a similar effect), new computer
technologies held down costs, and the expansion of "managed care"
temporarily restrained health costs. At the same time,
productivity--the measure of how efficiently workers work and
companies use their machinery, factories, et cetera--increased. But
that increase was mainly a function of better management and
technology. There was no short-run connection with lower budget
deficits. Consider: From 1995 to 2000, as the budget swung from
deficit to surplus, productivity growth averaged 2.6 percent
annually. From 2000 to 2003, the budget returned to big deficits,
but productivity growth averaged 3.9 percent.

As for the impact of deficits on interest rates, Chait says I'm
confused and inconsistent. Not so. All I've said is that, in the
past, the effects of deficits have been modest and usually
overwhelmed by other factors: inflation, the state of the economy,
and Federal Reserve policy. Had inflation jumped in the early '90s,
for example, interest rates would also have jumped--regardless of
the budget deficit. After all, investors won't buy bonds at 6
percent if inflation is 7 percent--they'd be losing money.

Second, President Clinton's budget policies didn't create the
surpluses of the late '90s--the economic boom and the end of the
cold war did. When Clinton took office early in 1993, the economy
was still suffering from the 1990-'91 recession, and such slumps
automatically shift the budget toward deficits. Tax revenue weakens
because wages, salaries, and profits weaken. Government spending
grows for unemployment benefits, food stamps, and other "safety
net" programs. In fiscal year 1992--George H.W. Bush's last
year--the budget deficit was $290 billion, or 4.7 percent of GDP.
By 1995--when Clinton's budget plan had taken effect--the deficit
had dropped to $164 billion, or 2.2 percent of GDP. About one-third
of the decline reflected the recovering economy, according to
estimates by the Congressional Budget Office (CBO). Clinton's higher
taxes and spending restraint could be credited with the rest. But a
big part of the drop in the deficit was lower post-cold-war defense
spending, which declined from 4.8 percent of GDP in 1992 to 3.7
percent in 1995.

Almost no one anticipated the subsequent surpluses in early 1995.
Both the Clinton administration and the CBO projected continuing
deficits. Nor did Clinton advocate balancing the budget. What
happened? The economic boom caused tax revenue to surge. In 1995,
federal tax revenue was 18.5 percent of GDP. By 2000, it was 20.9
percent of GDP, the highest since 1944, even though Congress had
actually cut taxes in 1997. Wages and salaries increased. Profits
rose. Bonuses proliferated. Capital gains (stock profits, mostly)
exploded. At 20.9 percent of GDP, taxes were $229 billion higher
than they would have been at 18. 5 percent of GDP. The actual
surplus in 2000 was $236 billion. (Once the boom ended, this flood
tide of revenue receded.) Defense spending also continued to
decline, the boom reduced "safety net" outlays, and interest
payments dropped.

Finally, the major budget problem is not the deficit, but federal
spending-- dominated by spending for retirement programs. The
reason is this: Government spending must be financed either by
taxes or borrowing (deficits). Too much of either could hurt the
economy. Just because deficits haven't done much harm in the past
doesn't mean they might not in the future. The same is true of much
higher taxes. You don't have to be a "supply-side" zealot (I'm not)
to think that high taxes can discourage work, investment, or
risk-taking. Even if high taxes weren't an economic danger, we
might not want to overtax younger and poorer workers to subsidize
older and richer retirees.

Chait's statement that, "[i]f we repeal the Bush tax cuts, we could,
if we wanted to, solve the Medicare and Social Security trust-fund
deficits" is--over any relevant time horizon--rhetorical
make-believe. Here is the basic arithmetic. In 2003, the federal
government spent about 20 percent of GDP. Social Security,
Medicare, and Medicaid (which covers some nursing-home care)
accounted for 8 percent of GDP, or about 40 percent of federal
spending. Under plausible assumptions, the CBO projects that Social
Security, Medicare, and Medicaid will cost 14 percent of GDP in
2030. Suppose the budget were now balanced at 20 percent of GDP.
That would put taxes near historic highs and would equal levels
achieved in the boom-affected years of 1998 and 1999. Still,
covering all the projected retirement spending--assuming all other
federal spending remains the same as a share of GDP--would require
a tax increase equal to 6 percent of GDP. That would be almost a
one-third tax increase; in today's dollars, it's about $660 billion
annually. That dwarfs Bush's tax cuts.

You can fiddle with assumptions, but the point remains: Unless we
curb retirement benefits, future pressures to cut other spending or
raise taxes will be enormous. It's true that, if we try to deny the
pressures by borrowing, the ever-larger deficits will ultimately
become unsustainable. Still, the underlying problem is the
trajectory of spending. I am not a "small-government conservative"
(Chait's label) in the sense that I think government can be made
smaller. Given the pressures of aging, it must get bigger. But I
have consistently advocated eliminating less-needed programs
(examples: farm subsidies, Amtrak) and trimming retirement benefits
(raising eligibility ages, making benefits more income-related) to
prevent government's growth from becoming burdensome. Future taxes
will have to go up. The important question is: How much? The Bush
administration's deficits were justifiable as stimulus for a weak
economy. But they should not be perpetuated. I have never said

In an era when economic theories are routinely marketed for
political advantage, I have thought it part of the job of
journalists to punch through self-serving myths and convenient
delusions. I have never said that deficits don't matter; what I
have said is that they don't matter as much as many supposed
authorities assert. It's great politics to claim you have a simple
formula that will automatically deliver economic success. It is
rarely that simple. Focusing relentlessly on deficits is mostly a
form of escapism. It justifies skipping over the contentious
questions of retirement spending and the messy process--including
proper government incentives--that actually leads to healthy
economic growth.

Because the attack on me is so uncompromising, let me end on a
personal note. The notion that I have formulated my views mainly to
discredit Robert Rubin is preposterous and demonstrably false. My
views on deficits and retirement programs have been aired in many
places for many years: in columns dating back to the early '80s; in
my 1995 book, The Good Life and Its Discontents (see chapters 10
and 14); in a talk I gave in 1996 at the University of Virginia
that was published in a collection by the Miller Center (The Budget
Deficit and the National Debt). Of course, my views have evolved;
but they have long emphasized the need to curb retirement spending
and have long disputed the central economic importance of budget
deficits. Rubin was a good Treasury secretary. I said that in my
review and elsewhere. But he's not infallible. Chait's excited
defense of indefensible simplicities does not make them any more
defensible or less simplistic.

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