History of the Federal Budget Impasse

7/30/2019 History of the Federal Budget Impasse

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Historical Sources of the Federal Budget Impasse

Eddie VanBogaertMonday, May 23, 2011


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Historical Sources of the Federal Budget Impasse

A budget in a lot of ways is like a checkbook. A checkbook tells us about an individuals priorities. This is our national checkbook. It tells us where we are and where we want to go

as a nation.SENATOR JOHN THUNE (2007)

Most of the people here, youve got a family budget. If less money is coming in, you end upmaking cuts. Maybe you dont go out to dinner as much. Maybe you put off buying a new car.Thats not what happens in Washington.SENATOR BARACK OBAMA (2008)

Comparisons between household spending and the budget of the FederalGovernment are abundant. For decades, the analogy has been an effectiverhetorical vehicle for connecting with voters on fiscal issues. Its widespread use is

understandable: few Americans have backgrounds in budgetary policy, while mosthave had to manage personal finances. The checkbook comparison appears to maketaxing and spending issues more accessible, even relatable. Unfortunately, thisconceptualization oversimplifies the problem, misplacing political pressure throughthe false dichotomies of ideological purity.

It is true that there is a structural deficit in the Federal budget that must beresolved. In time, the obligations of government debt can leech funding from publicservices and crowd out private investment. Unfortunately, recovery strategies formulti-trillion dollar economies are recent and without controlled testing. Acceptingthat the Federal Government ought to be involved in pursuing economic stability forthe sake of public welfare, it remains understandably difficult to settle on aconsistent macroeconomic approach when the historical precedents only looselyapply. In simplifying fiscal concepts for campaigns, partisan interests have nothelped the publics lack of understanding.

There is no reason why Federal budgetary policy must be a zero-sum strugglebetween the two main economic philosophies. In a medium-term revenueframework, it should be possible for Congress to harness the benefits of bothdemand-side and supply-side strategies, albeit in separate circumstances, whilebeing disciplined enough to meet the responsibilities of each. It does not seem to bepresently appreciated that the strengths of these orientations are quite specific. Theflat and continuous application of a single policy without respect to its historical

record is not very informed decision-making.One source of the problem is a broken system of campaign finance. Specialinterests (corporations, large unions, industry groups) often ones created orsustained by the public sector since the Second World War have made theircontributions so important to elected officials that reductions in spending arepolitically difficult. Tax issues have been won by the wealthy, a fraction of thepopulation who have secured massive victories on income and estate taxes duringthe last thirty years. Combined, we have an irrational budgetary policy that has


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starved education in the name of the health care industry and ignoredinfrastructure for Big Oil.

Too many candidates and voters are still talking about checkbooks, drawingmicroeconomic conclusions for macroeconomic questions. This essay examines theevolution of budgetary strategy in recent American history, beginning with the

birth of demand-side orientation in the 1930s, and moving through the rise of analternative strategy in the 1970s. Here in 2011, faced with operational impassesand ideological conflict, past budgetary policies are extremely relevant, but alsodeserving of careful scrutiny.

What is the deficit?

Consider broadly how the government operates. Incoming funds (mostly taxes)finance government operations (mostly public programs). The range of dynamicsthat affect both revenues and expenditures complicate what would ordinarily beconsidered a fairly simple exchange. This is the failure of the checkbook comparison:the character of the variables that affect personal incomes are often quite differentthan the economic systems that determine public tax receipts. Likewise, thegovernment has a set of spending tools that are not comparable to those availablefor average consumers.

The amount of revenue generated is primarily dependent upon the rate of taxation and the performance of the economy being taxed. The latter isdemonstrated in a comparison of Federal receipts from 2008 and 2009 (see Figure1). While tax rates remained largely the same across this period, the size of the

American economy (measured by Gross Domestic Product) contracted by 3.7%. 1

Figure 1.Summary of Federal Tax Receipts, 2008-2009

in billions of dollars 2

Revenue Sources 2008 Receipts 2009 ReceiptsIndividual Income 1,146 972Corporate Income 304 180Payroll Taxes 901 898Other Sources 173 165Total Receipts 2,524 2,215

Source: Office of Management and Budget, 2010

1 Organisation for Economic Co-Operation and Development (OECD), Quarterly National Accounts: Quarterly Grow Rates of Real GDP, Change Over Previous Quarter , accessed onMarch 15, 2011 at: stats.oecd.org (National Accounts).2 Office of Management and Budget, Budget of the Federal Government for Fiscal Year 2010 (Washington, D.C., 2010), 117 (Summary Tables). Table adapted from Table S-3.


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This highlights the contrast between the two main categories of deficits:structural and cyclical. A structural deficit occurs when public expenditures exceedthe full potential of tax revenues, or what could be taxed from a fully performingeconomy. Cyclical deficits refer to revenue shortfalls that are products of economicdecline. 3 Federal budget deficits usually reflect a combination of both conditions.

Because solutions to cyclical deficits incorporate disaggregated estimates (imperfectestimations of economic performance), the structural deficit is usually discoveredfirst (from flat budget figures), and then used to calculate the portion of the deficitthat is cyclical. 4

Virtually all industrialized nations have medium-term expenditure frameworksthat set taxing and spending targets for the decade ahead. These targets can beflexible (as they are in the United States, with annual appropriations by Congress)or set in place permanently (fixed). The overall framework is intended to fosterstability through consistency in budgetary policy. In the last century, it has favoredtwo strategies: demand-side orientation and supply-side orientation. 5

Supply-side orientation attempts to stimulate economic growth through taxrelief. Expenditure targets and the size of the structural deficit (if any) in thebudgetary framework are dictated by the goal of lowering taxes. The hope of policymakers pursuing this strategy is that the money saved by taxpayers will bereinvested into the economy, yielding growth. Demand-side orientation tries tostimulate growth by putting money into the hands of consumers, often throughpublic spending on government programs, but also by cutting tax rates for theconsumer classes of the economy. In the United States, the popularity of thesestrategies is linked to successes of different political ideologies and has developedthrough the maturation of the American economy since the Great Depression.

The Rise of Demand-SideThose supporting Franklin Roosevelts New Deal proposals in 1932 had no idea

that they were voting for the installation of demand-side orientation. The completeacademic theory on how the government could become involved in stimulatingaggregate demand was not formalized until John Maynard Keynes The GeneralTheory of Employment, Interest, and Money in 1936. 6 Additionally, the public was,as they are now, generally delayed in their reactions to the economic environmentcreated by the Great Crash of 1929. Few had easy access to information about the

3 Organisation for Economic Co-Operation and Development (OECD), Reallocation: TheRole of Budget Institutions (Paris, France: OECD Publications, 2005), 55.4 Pierre-Richard Agnor, The Economics of Adjustment and Growth (Boston, MA: HarvardUniversity Press, 2004), 88.5 OECD, 56.6 N. Gregory Mankiw, Principles of Economics (Mason, OH: South-Western Publishing,2009), 770. Note: Aggregate demand refers to the total demand for goods and serviceswithin an economy.


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budgetary policymaking system. 7 Public perception was limited to observableindicators like unemployment and the cost of consumer goods, which lag behind theoverall performance of the economy. The debate in Congress was over whether thegovernment should become involved at all, since it had not been responsible for thecrash in the first place. 8

After deferring to Congress for some time, the levels of unemploymentnecessitated that President Hoover act, or face electoral consequences. 9 Hisresponse began with appeals to the business community, and eventually includedencouragement to the Federal Reserve for loosened credit. Some demand-side toolswere engaged public spending was expanded with the Agriculture Relief Act butthe Hoover Administration did not demonstrate decisive command of any strategy. 10

The Smoot-Hawley Act, an isolationist reaction that raised tariffs on imports,was countervailing to both supply-side and demand-side notions. It slowed foreigninvestment in many industries and created shortages of commodities, which raisedprices. 11 Hoover is often associated with supply-side theory because his economicplatform in the election of 1928 was focused on tax relief, but this analysis seemsincomplete because the platform also promoted the import tariffs that wereunsuccessfully enacted in 1930. 12 Again, these actions were more populist andpatronizing of select constituencies than they were aligned with a particularstrategy for budgetary maneuvering. Still, Hoover defended government passivityat several moments during his term, and such insistence became definitive of hispresidency. 13

President Roosevelt was elected in 1932 on the promise of more directintervention. His campaign aimed to draw contrast between the alleged inaction of the Republican incumbents and the aggressive New Deal proposals. Said Rooseveltat the Democratic National Convention in July of 1932:

Our Republican leaders tell us economic laws sacred, inviolable, unchangeable that these laws cause panics, which no one could prevent. But while they prateof economic laws, men and women are starving. We must lay hold of the fact thateconomic laws are not made by nature. They are made by human beings

7 William Edward Leuchtenberg, The FDR Years: On Roosevelt and His Legacy (New York,

NY: Columbia University Press, 1995), 43.8 Matthew C. Price, Justice Between Generations: The Growing Power of the Elderly in America (Westport, CT: Greenwood Publishing Group, 1997), 23.9 Ibid , 23.10 Ibid , 24.11 Bernard Beaudreau, Making Sense of Smoot-Hawley: Technology and Tariffs (Lincoln,NE: iUniverse, 2005), 79-85.12 Ibid , 82-32. (Hoovers platform: The Kansas City Platform.)13 Price, Justice Between Generations , 25.


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Throughout the nation, men and women, forgotten in the political philosophy of the government of the last years look to us here for guidance and for moreequitable distribution of national wealth.

These appeals implied demand-side policy, but leaned more heavily on the social

justice of redistribution than its approach for recovery. Regardless, the rhetoric wasphenomenally successful. Roosevelt defeated President Hoover nearly 60/40 andushered in a decade and a half of strong Democratic gains across the country. 14 These victories were construed as a mandate for the expansion of the public sector,something that political realignment would echo for decades to come. 15

The severity of the crisis demanded solutions that were further reaching thanthe public works projects that are emblematic of the New Deal. While publicemployment tactics like the Works Progress Administration had some effect on thestaggering unemployment figures, instability in monetary policy was too great topermit full recovery during Roosevelts first term. 16 To an extent, this was fatedbefore he took office. A sharp rise in money supply in 1932, followed by a deepcontraction between January and March of 1933, set off a liquidity crisis. Banks,uncertain about extreme volatility in the value of the Dollar, greatly reducedlending. Outstanding investments failed outright, forcing some banks to close,creating the public panic that led many Americans to withdraw the deposits thatcapitalized the lenders. Public infrastructure projects put some money into theeconomy, but did not restore the confidence in the banks that was necessary toenergize private investment. 17 Compounded by a 90% drop in stock prices thatcrushed household wealth, the US economy suffered the consequences of rapidlydeclining demand for goods and services. 18

The utilization of public policy tools to catalyze resurgence in aggregate demand

is a very inexact science. Because the effects of recovery measures cannot be testedin a controlled environment, the extent to which actions have succeeded is always

14 William C. Binning, Larry E. Esterly and Paul A. Sracic, Encyclopedia of American Parties, Campaigns, and Elections (Westport, CT: Greenwood Publishing Group, 1999), 136.15 David W. Brady, Critical Elections and Congressional Policy Making (Stanford, CA:Stanford University Press, 1988), 84-105.16 Jason Scott Smith, Building New Deal Liberalism: The Political Economy of PublicWorks, 1933-1956 (New York, NY: Cambridge University Press, 1970), 87-88.17 Lawrence J. Christiano, Roberto Motto, Massimo Rostagno, National Bureau of EconomicResearch, The Great Depression and the Friedman-Schwartz Hypothesis (Washington, D.C.,

2004), 9; Smith, Building New Deal Liberalism , 88-89; Harold G. Vatter and John F.Walker, Real Public Sector Employment Growth, Wagners Law, and Economic Growth inthe United States, History of the U.S. Economy Since World War II (Armonk, NY: M.E.Sharpe, Inc., 1996), 269-273.18 Christiano, The Great Depression and the Friedman-Schwartz Hypothesis , 1; Edwin

Amenta and Bruce G. Carruthers, The Formative Years of US Social Spending Policies:Theories of the Welfare State and the American States During the Great Depression,

American Sociological Review , vol. 53 (1988), 661; Mankiw, N. Gregory, Principles of Economics , 766.


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unclear. It may take years for results to be manifested, and the efficacy of approaches may be exaggerated or understated, because of interference fromoutside variables. Given this, and the multitude of factors that contributed to thescale and complexity of the Great Depression, there is a lot of disagreement amongeconomists and historians about what actions were responsible for recovery. 19

Public spending on infrastructure investment and World War II are primarilycredited, albeit to differing degrees. Both approaches (and their respectivedrawbacks) are relevant to our contemporary budget debate.

Military-Industrial Complex

In Keynes establishment of demand-side orientation, he theorized that demandhas four sources: individual domestic consumers, domestic businesses, exports, andpublic spending. 20 Policymakers employing demand-side orientation usegovernment spending to fortify aggregate demand against the decreases of privatesources. 21 Left unchecked, these decreases can devalue products and impactprofitability. Reduced supply necessitates fewer workers, prompting layoffs. 22 Bysupporting aggregate demand during recessions, demand-side orientation aims torestrain unemployment and shorten recovery time.

Government spending on the military operations of World War II was the largestexpansion of the public sector, by percentage of Gross Domestic Product, in thehistory of the United States. 23 A disconnect between politics and economics (orsimply political bias) seems evident in the public memory of this matter. Forinstance, one might expect a political liberal and Keynesian to embrace the evidenceof World War II as a validation of the demand-side strategy. Strangely, though, in azero-sum debate that pits the achievements of the New Deal against the stimulus of

war, many modern progressives continue to downplay the consequences of 1940smilitary spending. 24 Conversely, numerous conservatives and avowed supply-siderswho reject demand-side orientation are quick to point out that World War II was

19 N. Gregory Mankiw, Principles of Economics , 769.20 Peter Kennedy, Macroeconomic Essentials: Understanding Economics in the News (Boston, MA: Massachusetts Institute of Technology, 2000), 52.21 Mankiw, Principles of Economics , 769; Kennedy, Macroeconomic Essentials , 52-53.22 Kennedy, Macroeconomic Essentials , 52-53.23

United States Census Bureau, United States Department of Commerce, Chapter Y:Government Employment and Finances, The Statistical Abstract of the United States (Washington, DC: United States Census Bureau, Government Printing Office, 2011), 1104-1114. Available online at: http://1.usa.gov/fy6j4K.24 Smith, Building New Deal Liberalism: The Political Economy of Public Works, 1-10, 190-192; Edward P. OConnor, DBQ Theme: The Great Depression and the New Deal,Teaching and Using Document-Based Questions for Middle School (Portsmouth, NH: ReedElsheiver, 2004), 119-122; Edward Sidlow and Beth Henschen, America at Odds (Belmont,CA: Cengage Learning, 2009), 59.


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more responsible for recovery than the New Deal. 25 That appears to conflict withtheir contention that expansions of the public sector are not effective recoverymeasures. 26 Liberals, meanwhile, discard or overlook one of the more convincinginstances of their budgetary strategy in action.

Figure 2. Annual Defense Appropriations and GDP (1925-1950)

in billions of dollars 27

25 Glenn Beck, The Glenn Beck Show, (radio broadcast, July 10, 2010), transcript availableonline: http://bit.ly/a6OHd2.26 Megan McArdle, Did World War II End the Great Depression, The Atlantic (February2009), available online at: http://bit.ly/b0ZsoL; Lawrence White and David C. Rose (CATOInstitute), We Cant Spend Our Way Out of This Quagmire, St. Louis Post-Dispatch (January 21, 2009), available online at: http://bit.ly/bdMVC.27 United States Census Bureau, The Statistical Abstract of the United States , 1104-1114.

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The data sets for this chart are adapted from tables in the United States Census Bureaus Statistical Abstract of the United States (which adjusts for inflation) and rounded to the nearest hundredmillion dollars (see Appendix, Figure B). The hashed line marks the beginning of World War II-

focused policy. Defense spending, like many appropriations, is a f igure often adjusted throughout the year to match the needs of government. The Departments of Army, Navy, and Air Force (following 1948 creation) are reflected above and below.

Figure 3. Data Table of GDP, Federal Revenues/Expenditures,

Defense Appropriations, and Individual Incomes (1925-1950) in billions of dollars

Year GDP Total FederalReceipts

Total FederalOutlays

Total Defense Appropriations

Adjusted GrossIncome

(Individuals)

1925 90.6 3.6 2.9 0.7 25.31926 97.0 3.8 2.9 0.7 25.5

1927 95.5 4.0 2.9 0.7 26.21928 97.4 3.9 3.0 0.7 29.01929 103.6 3.9 3.1 0.8 22.81930 91.2 4.1 3.3 0.8 22.31931 76.5 3.1 3.6 0.8 17.31932 58.7 1.9 4.7 0.8 14.41933 56.4 2.0 4.6 0.8 13.41934 66.0 3.0 6.6 0.7 15.11935 73.3 3.7 6.5 0.7 17.31936 83.8 4.0 8.4 0.9 21.91937 91.9 5.0 7.7 1.2 23.91938 86.1 5.6 6.8 1.2 21.6

1939 92.2 5.0 8.8 1.4 25.81940 101.4 6.9 9.6 1.8 40.31941 126.7 9.2 14.0 6.3 63.81942 161.9 15.1 34.5 22.9 85.91943 198.6 25.1 79.0 63.4 106.61944 219.8 47.8 94.0 76.0 116.71945 223.0 50.2 95.2 80.5 120.31946 222.2 43.5 61.7 43.2 134.31947 244.1 43.5 36.9 14.8 150.31948 269.1 45.4 36.5 12.0 164.21949 262.2 41.6 40.6 13.9 161.41950 293.7 40.9 43.1 13.4 179.9

Consider annual estimations of Gross Domestic Product from 1925 to 1950,contrasted against the Federal Governments revenues and expenditures (seeFigures 2 and 3, above). GDP, a leading indicator, hits its floor in 1930. Two yearslater, tax revenues bottom out at less than half of their 1927 levels. The adjusted


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gross income of individuals (aggregate take-home incomes) falls last in 1934. 28 Thepersonal incomes figure reflects long-term unemployment and a 300% increase inthe top marginal tax rate. 29 A budget surplus of 20% of total outlays in 1930 becamea deficit of almost 60% during the same term, as the public earned less taxableincome and recovery-focused spending programs launched.

This comparison turns in the run-up to World War II. Even before formal American involvement, new allied exports began driving demand for militaryproducts. 30 Between the spring of 1940 and Pearl Harbor in 1941, non-farmemployment and wages increased by about 20%. 31 The full commencement of combat operations in early 1942 expanded defense appropriations to two-thirds of all federal spending in that year. 32 This was a staggering 84.5% of all expenses bythe end of the war in 1945. 33 By leveraging a significant amount of money raisedthrough higher taxes and bond sales, the Federal Government was producing athird of all economic activity by 1943. 34

Demand-side orientation is dependent upon the eventual stimulation of privatedemand. Spending by individuals, businesses, and foreign sources within aneconomy must replace temporary, deficit-funded efforts to relieve the continuedissuance of public debt. Otherwise, the interest obligations would restrain a publicgovernments capacity in the longer term, for services or stimulative measures.Competing for increasingly scarce debt purchasers, bonds have to offer higher ratesof return, which is more expensive for the government. Even if these buyers arefound, public issuers risk slowing growth by crowding out private industry in themarket for investors. 35

28 United States Census Bureau, The Statistical Abstract of the United States , 1104-1114.29 William F. Shughart, II, and Robert D. Tollison, eds., Policy Challenges and PoliticalResponses: Public Choice Perspectives on the Post-9/11 World (The Netherlands: Springer,2005), 100.30 Nathan Grundstein, Presidential Delegation of Authority in Wartime (Pittsburgh, PA:University of Pittsburgh Press, 1961), 91, note 5. Note: This increase even promptedPresident Roosevelt to begin regulating who could become trading partners of the rapidly-growing defense industry.31 James B. Atleson, The Mobilizing Period: Dress Rehearsal for Wartime, Labor and theWartime State: Labor Relations and Law During World War II (Champaign, IL: Universityof Illinois Press, 1995), 20-22.32

Bureau of National Affairs, Doing Business Under the Defense Program: A Handbook of the Laws Governing Business Practices During Rearmament (Washington, DC: Bureau of National Affairs, Inc., 1940); National War Labor Board, War Labor Reports: Salary andWage Stabilization (Washington, DC: National War Labor Board, 1943).33 United States Census Bureau, The Statistical Abstract of the United States , 1104-1114.34 Ibid .35 Marcus Miller, Robert Skidelsky, and Paul Weller, Fear of Deficit Financing: Is ItRational? Public Debt Management: Theory and History (New York, NY: CambridgeUniversity Press, 1990), 296-197.


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The nature of World War II, a personnel-heavy overseas military operation,worked to the favor of the public investment. 36 Active servicemen saved more of their earnings, unable to spend much of it while deployed. Rationing and resourcescarcity forced many Americans to postpone capital purchases. An influx of womeninto the workforce increased national productivity. 37 Increased savings and pent-up

demand replaced and surpassed the public sector contraction caused by the postwarspending drawdown. 38 There is also some limited evidence that favorable tradeconditions benefitted the American economy in the wake of the Second World Warsdestruction, which (mostly) spared the United States. 39 Whether it had intended toor not, the United States was poised to complete the demand-side scheme astheorized.

It may be impossible to separate the merits of the strategy from theadvantageous postwar economic conditions, but the position of the United Stateswould have undoubtedly been worse without the marked expansion of militaryappropriations. Manufacturing for allied forces might have provided sufficientprivate growth to end the 15% unemployment of 1940, but the rate of increase was afraction of the eventual government-led demand. 40 There might not have even beena choice if security vulnerabilities necessitated a greater national defense.Subsequent foreign attacks were expected after Pearl Harbor, and would havedemanded a response at some point, confronted with the prospects of incrediblecollateral cost. 41 Still, this range in function is more a feature of demand-sideorientation than a dilution of this evidence: the subject of public sector spending inthe pursuit of economic stimulus can serve alternative policy objectives if appliedcorrectly.

Accepting that dynamic, the sustainment of the postwar military-industrialcomplex remains a reminder that economic strategy is not the sole political

motivator in budgetary policy. Public demands, pushing in the late 1940s and early1950s for interests related to the Cold War, kept military spending elevated throughthe immediate postwar decade. 42 Defense appropriations in 1950 were at 250% of their 1940 levels (as a percentage of GDP), bolstered by a war in Korea thatinterrupted the defense cool-down. Technologies refined in World War II, especially

36 John W. Kendrick, Productivity Trends in the United States (New York: National Bureauof Economic Research, Princeton University Press, 1961), Xxxvii-xxxviii, 61-76.37 Clair Brown, and Joseph A. Pechman, eds., Consumption, Work, and Growth, Gender inthe Workplace (Washington, DC: The Brookings Institution, 1987), 71-72, 172, 254, 297.38 Earl A. Thompson and Charles Robert Hickson, Ideology and the Evolution of Vital

Economic Institutions: Guilds, the Gold Standard, and Modern International Cooperation (Norwell, MA: Kluwer Academic Publishers, 200), 347.39 RM Auty, ed., Resource Abundance and Economic Development (Oxford, UK: OxfordUniversity Press, 2001), 5-9.40 United States Census Bureau, The Statistical Abstract of the United States , 1104-1114.41 Donald M. Goldstein and Katherine V. Dillon, The Pearl Harbor Papers: Inside theJapanese Plans (Dulles, VA: Brasseys Publishing, 1993), 157.42 Tony Shaw, Hollywoods Cold War (United Kingdom: Edinburgh University Press, 2007),202-203.


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in aviation, were more expensive to service, but were perceived as necessary tocompete with the Soviet Union in the new international paradigm. 43

In discussing these budgetary consequences, it is important to separatedisagreements about the wisdom of defense investments from their sheerquantitative impact. Military spending pursuits may have been foolish, irrelevant,

or necessary from the standpoint of foreign or social policy, but inasmuch as theinstitution affects economic strategies, consistency is more vital than the purpose of the funding. If public revenues cover the outlays, new debt obligations do not poserisks to the functions of government. The higher taxes necessary to support largerdefense operations take money out of the private sector (from the taxed) and bringthe productive capacities of that wealth under the public umbrella. Certaindiversifications in demand sources are arguably more ideal, but a shift within thescope of the Cold Wars military investments (5-7% of GDP, versus 1-3% in the1930s) is not really a radical policy alteration as long as the expenses areaddressed. 44

The fulcrum of the policy debate and the rhetorical challenge to strategicconsistency surrounds an argument about where wealth is best advanced withinan economy. Upon leaving office in January of 1961, President Eisenhowercautioned against the sustained expansion of defense industries. 45 The income taxessupporting the military-industrial complex, he said, were diverting too much moneyaway from investment in private development, where greater productivity could beachieved. 46 This supply-side perspective became politically prominent immediatelyupon demand-sides time of weakness.

The Rise of Supply-Side

Despite being strongly associated with the 1980s and the policies of PresidentRonald Reagan, events of the 1970s are actually the origins of supply-sidedominance. By the 1960s, recovery from the Great Depression had installedKeynesianism as the favored strategy, but 1973 brought a new recession fueled byrising energy prices and increased global competition. 47 Demand-side no longerseemed unassailable, and conservative economists like Milton Friedman framed acounter-movement. Some Republican politicians, in response to President LyndonJohnsons expansion of social entitlement programs, championed the approach.

43 Charles J. Gross, American Military Aviation: The Indispensible Arm (College Station,TX: Texas A&M Press, 2002), 183-186.44 United States Census Bureau, The Statistical Abstract of the United States , 1104-1114.45 Sterling Michael Pavelec , The Military-Industrial Complex and American Society (SantaBarbara, CA: ABC-CLIO, 2010), 95.46 Ibid , 95-96.47 Rhona Free, 21 st Century Economics: A Reference Handbook, Volume 1 (Thousand Oaks,CA: SAGE Publications, 2010), 351.


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These advances were not largely demonstrated until the Eighties because of political setbacks for Republicans. 48

Central to the momentum shift were a few critical public sector errors. Steepmilitary deficits from the war in Vietnam were not balanced in the medium-termwindow as the debts from World War II and Korea had been. 49 A strong consumer

market had pushed the 1950s economy to raise the tax dollars needed to cover costs.The same was not true in the Seventies. Stagflation, a term coined in the decadesearly half, described a combination of side-by-side currency devaluation and highunemployment. 50 The condition made goods more expensive for households thatwere making less income. Oil prices rose in October of 1973, halfway through a two-year market sell-off that shed more than 40% of the Dow Jones Industrial

Average. 51 President Richard Nixon was elected in 1968 as a supply-side supporter. Backed

by Friedman, William F. Buckley, and others, Nixon sought free-market answers tothe economic contractions caused by withdrawals of service personnel from

Vietnam. 52 Inflation and unemployment overwhelmed any peace dividend fromreturning members of the military. 53 Nixons New Economic Policy (1971) wasaggressive, freezing wages for 90 days, raising tariffs on imports, and ending theGold Standard for currency valuation. The first two were short-lived, but the latterbrought down the existing system for monetary policy. 54

Early in his first term, Nixon argued that late-Sixties cyclical deficits were theproducts of high unemployment and that the structural deficits were results of balance-to-payment shortfalls from creditor nations calling in aggressive dollar-to-gold guarantees. 55 Under the Bretton-Woods system of international finance, U.S.Dollars were promised for gold, which had been set by international accord at $35per ounce in 1944. Some flexible controls were featured, but interest was largely

48 Edwin C. Sims, Capitalism: In Spite of It All (Amsterdam, The Netherlands: OPA,Gordon and Breach Science Publishers, 1989), 101.49 Anthony S. Campagna, The Economic Consequences of the Vietnam War (New York, NY:Praeger Publishers, 1991), 141-145; Gardner, Lloyd C., and Ted Gittinger, eds., The Search

for Peace in Vietnam: 1964-1968 (United States: Lloyd C. Gardner and Ted Gittinger,Lyndon B. Johnson Foundation, 2004), 102-104.50 Free, 21 st Century Economics , 351.51 Council of Economic Advisors, Economic Report for the President (Washington, DC, 1975),

20, 128.52 Lynn Turgeon, Bastard Keynesianism: The Evolution of Economic Thinking and Policy-Making Since World War II (Westport, CT: Greenwood Publishing Group, 1997), 24;William F. Buckley, Op Ed: The Watergate Moment, The New York Times , Letters(August 8, 1994), available online at: http://nyti.ms/kNDsVN.53 Turgeon, Bastard Keynesianism , 24-25.54 Ibid , 25.55 Catherine R. Schenk, The Decline of Sterling: Managing the Retreat of an InternationalCurrency (New York, NY: Cambridge University Press, 2010), 317.


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fixed. 56 This structure collapsed with the Nixon Shock in 1971, when on August16, the administration announced that the Federal Government would no longer behonoring gold transactions. 57

The politics of the Gold Standard aside, the sharp devaluation increasedinflation on all fronts. A dollar that was worth less eroded domestic purchasing

power and the Organization of Petroleum Exporting Countries (OPEC) raised pricesto repair a trade position that was lost in August 1971. The run-up in energy pricesthat was borne from the new trade and currency dynamics had a commandingimpact on the use of domestic budgetary tools, since fuel costs weakened consumersand made government services more expensive to provide. 58

Nixon pushed forward with considerable deficits, declaring famously in 1971, Iam now a Keynesian. 59 The statement referred more to the cemented overall role of demand management in the practice of macroeconomic analysis, but stilldemonstrated the Presidents fragile allegiance to a single strategy. Nixon rodepublicly driven demand-side expansion into a friendly re-election year economy. 60 A deficit struggle that emerged in 1975 as growth began to wane. This debate alsopublicly acknowledged the convergence of economy strategies. Alan Greenspan, thenew Chairman of the Council of Economic Advisors under President Gerald Ford(replacing one of many advisors who left with Nixon), argued that governmentspending (as a significant portion of aggregate expenditures) outstripped thesustainable growth of the supply of real goods and services. He endorsed the taxcut plan proposed by President Ford in the Economic Report for the President (1975): 61

The tax cut will not prevent a decline in real output from 1974 to 1975 but it willreduce the extent of the year-over-year declineperhaps by one-half of 1 percent to

1 percent in terms of real [Gross National Product]and will contribute to therecovery in the second half of 1975.

The support was tempered by the acknowledgement that a number of factors werecomplicating an assessment of the stimulus programs economic effects, mainly thatthe tax cut will be saved rather than spent.

56 National Bureau of Economic Research, Michael D. Bordo, and Barry Eichengreen, eds., A Retrospective on the Bretton-Woods System: Lessons for International Monetary Reform (Chicago, IL: University of Chicago Press, 1993), 125-128.57

Robert Charles Angel, Explaining Economic Policy Failure: Japan in the 1969-1971International Monetary Crisis (New York, NY: Columbia University Press, 1991), 115-119;Schenk, The Decline of Sterling, 317.58 Turgeon, Bastard Keynesianism , 24-25.59 Bradley Bateman, Toshiaki Hirai, and Maria Christina Marcuzzo, The Return to Keynes (Boston, MA: Harvard University Press, 2010), 12-15.60 Ibid .61 Council of Economic Advisors, Economic Report for the President (Washington, DC, 1975),20, 128.


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spending currently goes toward interest payments on existing debt, andinternational creditors are threatening to make new outlays more expensive.Borrowing from the Social Security trust, a popular financing source over the lastthree decades, has largely been exhausted, raising new concerns about the risks of paying entitlements on an annual basis, after having surpluses in the fund as

recently as 1990. 71 Attempts to stimulate the economy outside of budgetary policyhave produced less than stellar results. The Federal Reserve can no longer lowerinterest rates to encourage lending, having already cut the Federal funds rate tozero. 72 Quantitative easing, a program designed to have the Federal Reservepurchase government bonds, failed to meet expectations. 73

Inflation, the hallmark economic problem of the Carter presidency, is becomingthe primary point of contrast between the recession of the late 1970s and that of thelast few years. The Consumer Price Index (CPI), an estimation of the adjusted risein prices for consumer products, year over year, is a respected inflationary measure.This score has shown that even when energy prices are included, devaluation andthe associated erosion of purchasing power are not the risks that they were in1980. 74 Thus, the advancement of new public spending, at least as it relates toinflationary fears, is probably not as dangerous:

Figure 4. Contrasted Consumer Price Indexes (CPI), 1979, 1980 and 2011

Average of annualized percentage change for all items, seasonally adjusted 75

Affected Period CPI Jun/1979 Dec/1979 12.5%

Dec/1979 Jun/1980 16.3%Jun/1980 Dec/1980 8.9%Jan/2011 Apr/2011 3.2%

71 Carolyn L. Weaver, Social Securitys Looming Surpluses: Prospects and Implications (Lanham, MD: University Press of America, 1990), 114; John Attarian, Social Security:False Consciousness and Crisis (New Brunswick, NJ: Transaction Publishers, 2003), 284-285; David John, Trustees Show Permanent Deficits for Social Security, The Wall StreetJournal , Federation Feature (May 18, 2011), available online at: http://on.wsj.com/jCxkYZ.72 Howard Packowitz, Feds Evans Sees No Feds Fund Rate Increase by Years End,

NASDAQ, Dow Jones Newswires (May 23, 2011), available online at: http://bit.ly/jQkehf.73 The Associated Press, Top Economist Warns of Dangers in U.S. Debt Fight (May 16,2011), available online at: http://bit.ly/jQkehf.74 Becky Yerak, Top C.D. Rates Outpaced by Inflation, The Chicago Tribune (May 23,2011), available online at: http://bit.ly/mGTGNM.75 Norman Frumkin, Recession Prevention Handbook: Eleven Case Studies , 1948-2007(Armonk, NY: M.E. Sharpe, 2010), 223; Bureau of Labor Statistics, News Release:Consumer Price Index: April 2011, (Washington, DC: United States Department of Labor,2011), available online at: http://1.usa.gov/1Vgpf.


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These sorts of differences are why the blanket application of a one-size-fits-allapproach for budgetary policy is not justified when the proper historicalconsiderations are made. In 1980, when rapidly declining purchasing powerchallenged private sector recovery, continued expansion of the public sector throughdemand-side tools was risky. Artificial support of aggregate demand raises prices by

design. This demand-side inflation would have compounded the primary problemin the late Seventies economy. Todays scenario appears closer to the deflationaryclimate of the late 1930s. Both then and now, energizing the lending market is ahigher priority than tamping inflation. This is more suited to demand-side stimulus.

Again, these comparisons should be applied carefully. In his essay The GreatSlump of 1930, John Maynard Keynes wrote about the lack of real controlpolicymakers are able to exert over macroeconomic trends, even with budgetarystrategies:

We have involved ourselves in a colossal muddle, having blundered in thecontrol of a delicate machine, the workings of which we do not understand. Theresult is that our possibilities of wealth may run to waste for a time perhaps fora long time.

Seventy-five years removed, popular fiscal orientations are still exceptionallyhumbled by a lack of controlled testing. Replication of strategic precedent is oftenprevented by differing conditions. The inability of these policies to be generallyapplied and proven is a disturbing strike to these theories credibility, especiallyconsidering how faithfully they are followed by ideologues. Voters do not appear toconsistently align electoral decisions with support for a budgetary approach on its

merits, so these strategies, bound to the political fortunes of partisan figures,haphazardly wax and wane with unrelated political victories.Consider again the climate of the previous two sessions of Congress. Much in the

way that weaknesses in the 1970s economy reflected poorly on demand-sideinstallations, the late-2000s recession brought forward an unexpected Keynesianresurgence as a backlash to recent economic uncertainly. 76 A return to demand-sideorientation in fiscal stimulus was not likely the motivation of many of Obamassupporters (though he did acknowledge the distinction during the campaign), buthis election marked the first turn back to pure demand-side since the theoryssetbacks in the Seventies. 77 Unlike the setting for Carter, Democratic waves in 2006

76 E. Phillip Davis, Comparing Bear Markets: 1973 and 2000, National Institute EconomicReview , vol. 183, no. 1 (January 2003), 78-89; Kent Gilbreath, Business and theEnvironment: Toward Common Ground (Washington, DC: The Conservative Foundation,1984).77 Farrokh Langdana, Macroeconomic Policy: Demystifying Monetary and Fiscal Policy (New York: Springer, 2009), 227-228; Joseph E. Stiglitz, Freefall: America, Free Markets,and the Sinking of the World Economy (New York: W.W. Norton, 2010), 70-71.


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History of the Federal Budget Impasse

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