Surplus, Deficit, and Recession – Thinking (Not Highly) of Glenn Hubbard and Mitch Daniels

I want to revisit the moment when it became the policy of this administration to lie to the American public about fiscal responsibility. And I want to revisit the point where I decided that Mitch Daniels and Glenn Hubbard were hacks.

Here’s the start of the President’s radio address on August 25, 2001:

Good morning. Congress will shortly return to Washington to make its final spending decisions for 2002. A new budget report, released this past week, shows that despite the economic slowdown that began in the third quarter of last year, the federal budget is strong, healthy and in balance. In fact, the 2002 budget surplus will be the second biggest surplus in American history.

Earlier in the week, then OMB director Mitch Daniels had said:

In 2002, we forecast a growing, a larger surplus, $173 billion. I think it’s very noteworthy that in 2002, we will pass an important landmark — interest costs — the debt burden on the federal Treasury will drop below a dime on the dollar down to 9 cents of each dollar of federal revenue. That’s the lowest interest burden in a quarter century since 1976, and it’s headed down very quickly.

Sounds good, right? Of course, that’s not what happened… OMB Table 1.3 tells us that for FY 2002, there was a deficit of 157 billion.

Put another way… the financial situation was $173 – (-$157) = $330 billion worse than predicted.

Why the difference? Wellllll… a few months later we were told:

The War and Recession — Not the Tax Cuts — Drained the Budget Surplus
# While some in Washington want to blame the tax cut for the declining surplus, the facts tell a different story:

* The Recession Erased Two-Thirds of the Surplus: The recession and declining tax revenues drained roughly two-thirds of the budget surplus.
* Homeland Security and War Spending Used 19% of the Surplus: Immediately following the terrorist attacks, President Bush and Congress rightly passed significant spending increases for the war against terrorism, homeland security, airline security, and emergency response. This necessary spending accounted for approximately 19% of the surplus.
* The Tax Cut Only Used 15% of the Surplus: Despite the claims of some in Washington, the tax cut used less than 15% of the surplus.

Huh? In August 2001, with the recession more than half done, the Bush tells us that there’s going to be the second largest surplus in history. A year later, we’re informed that the recession drained 2/3 of the surplus away? What happened… the last stretch of recession was the tough part?

But let’s do some math, shall we? When the administration tells us that 2/3 of the lost surplus was due to the recession, what they’re telling us is that 2/3 of $330 billion, or $220 billion in reduced income was due to the 2 months of recession in FY 2002.

That year, according to OMB table 1.3, the gubmint collected 17.9% of GDP in taxes. I think its reasonable to assume they were surprised it was this low – so let’s say they figured on 20%, which is higher than they had any right to expect. That means… if taxes were $220 billion lower due to a recession, GDP was about 1.1 trillion lower than it would otherwise be. (If they assumed receipts were equal to 17.9% of GDP, that would mean the recession knocked off 1.235 trillion.)

The administration was basically saying that two months worth of recession removed over a trillion bucks from the GDP!! To understand the magnitude of that statement, consider that according to OMB Table 1.2, GDP at the end of FY 2002 was 10.377 trillion.

Which means that at the end of FY 2002, barring the two months of recession, GDP would have been equal to $1.1 trillion plus $10.377 trillion or about $11.477 trillion. That in turn means the (nominal) growth in GDP from the end of FY 2001 (GDP = 10.058 trillion) to the end of FY 2002 would have been… (11.477 – 10.058)/10.058, or about 14.1%. 14.1% growth??? 14.1% growth??? 14.1%!!!!!

Note… presumably, some percentage of the homeland security and war spending was less efficient than the spending that would otherwise have taken place – which means without that, growth would probably have been even higher than 14.1%… but I’ll ignore this line of inquiry.

Now, let us briefly flitter around reality for a moment, and let me note – while the 14.1% is a nominal figure, you have to go back to the Truman administration – more than 50 years, to find a single year nominal growth rate over 14%. Even during the high inflation period of the 1970s and early 1980s it didn’t happen. But basically… since GW and the boys weren’t forecasting inflation, presumably this 14% would come primarily from, well, real growth. Maybe what, 10% real growth rate? 11%? What sort of real growth did they have to be expecting in order to see 14.1% nominal? How does a sane person with a working knowledge of economics assume such a growth rate?

Before we talk about what this assumption means, I want to talk about the cast of characters involved in this forecast. GW himself… well, I honestly don’t think the coke and the drink left him with as many dendrites as God gave the average toaster in the last year that growth was above 14% a year, but we were constantly assured that he had good advisers – the grownups were in charge, we were told. So who were these advisers? Who were these grownups? Well, one obvious one was Mitch Daniels – then head of the OMB, now governor of Indiana (and up for re-election in 2008). Another was the chair of GW’s Council of Economic Advisers at the time, Glenn Hubbard. He’s now dean of the Columbia Business School, an economic advisor to Mitt Romney, and I believe he’s on some sort of a Fed appointed committee to look into the effects of globalization. Then there was Paul O’Neill, who was Treasury Secretary at the time. I’m sure there were others at the top tier who could claim at least partial credit.

So back to the assumption – a nominal growth rate in excess of 14%, and a real growth rate of somewhere around or above 10% in FY 2002 had there been no recession. Now, its possible I made a mistake somewhere here… I’ve been pretty clear with my steps though… if there’s a mistake, I have little doubt someone will catch it. So under the assumption that I haven’t made a mistake, here’s what’s left in terms of options, as I see it:

1. These guys weren’t able or willing to do the simple arithmetic shown above. From what I can tell, none of the steps shown above is outside the capability of an average 7th grader or a somewhat slow senior in high school with access to a pencil.
2. These guys understood that the administration’s collective position was that growth would have been 14% barring a recession, which in turn implies that:
a. They believed it or
b. They were willing to let it be said to the American public anyway

If there’s another option, I simply don’t see it. And I’m not sure which option is most damning. To me, the first speaks to incompetence on a breath-taking level for folks who are supposed to advise the President on running the economy. Where I sit, the second implies not just incompetence, but an almost incredible level of delusion. I think the third option might be excusable in the old USSR where speaking out could have gotten the entire family of the person speaking out in trouble. It might even work as an excuse for most Americans who are struggling to survive financially, but its hard to imagine that if Glenn Hubbard had gotten himself fired for speaking up he’d have been struggling to pay the bills.

That said, I would be surprised if any of so-called grownups are worse off financially now than they were then. There really are no negative consequences for their behavior… at least not for them. For the rest of us, perhaps, but not for them. And as long as that continues to be true, there will be another Mitch Daniels and another Glenn Hubbard. Many of them, in fact.

Update….

Reader CoRev notes that perhaps when the administration mentions the disappearing surplus, they meant the surplus from 2001. Never mind the surplus they forecasted. OK, fine. My response to him (cut out from comments):

The surplus in 2001 was…128 billion. That mens the turnaround was 285.8 billion. 2/3 of that is 190.5 billion. I’ll round down to 190 billion.

Assuming they were expecting 20% of GDP to be collected in taxes, that means they were assuming an extra $953 billion in GDP, or that they were expecting a GDP of 11.33 trillion for FY 2002.

Since the GDP in FY 2002 was 10.058 trillion, that means they were expecting a growth rate of 12.7% in FY 2002. (Again, note that I’ve gone with an unrealistically high tax collection assumption to make it look better.)

Well, that’s a heck of a lot more realistic. Of course they should have managed to achieve a 12.7% growth rate without a those two months of recession! I’m reassured now.

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