A GOP Congress and a Democratic president struck an unlikely deal in 1997. It succeeded.
The budget deal between the president, the Democratic House and the Republican Senate eliminated the risk of debt default, government shutdown and a spending sequester for at least two years, and thereby reduced economic uncertainty. Yet it comes at a dreadful price. With publicly held debt at $16.6 trillion and already projected to rise $11.8 trillion over the next decade, breaking the spending caps will add $2 trillion more to the national debt. When the usual emergency spending is included, Americans can expect the debt to surpass 100% of gross domestic product within 10 years. Starting in 2020, the national debt is projected to grow faster in dollars than the economy. It will do so in perpetuity until bankruptcy—unless dramatic action is taken.
One may find hope by looking back to when America last enjoyed fiscal stability, after the 1997 Clinton-Gingrich-Lott Balanced Budget Act (BBA). Its purpose was to cut spending enough to eliminate the deficit by 2002.
It didn’t take that long: Large surpluses arose from 1998 to 2001, driven by unexpectedly strong economic growth. In delivering budget surpluses so large and quickly—but failing to cut spending substantially or sustainably, and thus returning to large deficits just as quickly—the BBA should be the study of all who fear government debt.
The balanced budgets of the late 1990s were the result of budget, tax and appropriations fights between President Clinton and the Republican Congress. Those fights produced welfare reform, tax cuts and the BBA.
The act began as a Republican effort, in which the GOP rejected the “balanced approach” of spending cuts plus tax hikes that had worked politically but failed fiscally for decades. With tax cuts and pro-growth reforms, Republicans placed economic considerations above political accommodation, converting growth from an ancient fiscal nemesis into a formidable ally.
Strong economic growth largely offset the BBA’s failure to cut spending. In January 1995 the Congressional Budget Office projected deficits totaling $1.19 trillion for 1996-2000, but by September 1997 deficits plunged 75%, to $298 billion. Spending cuts enacted during those years amounted to $114 billion—only an eighth of the total deficit reduction.
Early spending cuts, such as the $27 billion reduction in 1996-97 domestic discretionary spending, played a role. But CBO data confirm that economic factors largely balanced the budget. In July 2000 the CBO budget update sought to explain why the fiscal 2000 deficit the agency projected to be $172 billion in 1997 instead became a $232 billion surplus. The report dryly noted “an improvement of $404 billion” in a single year, of which “an estimated $440 billion” came from “changes in economic or technical factors” while “legislation decreased [the surplus] by an estimated $37 billion.” In fact, all legislation from 1997 to 2000 combined increased deficits.
Where the BBA failed to restrain spending, the economy filled the gap. This economic surge was powerful and surprising: Real GDP growth was projected in 1995 to average 2.2% from 1996-2000. Instead it almost doubled, to 4.3%. That added $300 billion in revenue in fiscal 2000 alone—a single-year bonus of 3.1% of GDP, equivalent to $620 billion today.
What changed? Falling federal debt may have liberated capital markets as 10-year Treasury-note rates dropped from 7.8% in November 1994 to 4.4% in September 1998. After the passage of a capital-gains tax cut and welfare work requirements, perhaps new investment and new labor leavened the economy.
The elixir of certainty also deserves credit. Global uncertainty faded after the Cold War, when the Soviet Union vanished and a rising superpower, China, embraced free-market reforms. Republicans blocked Mr. Clinton’s regulatory excesses, and trade stability improved with the North American Free Trade Agreement and similar treaties. The threat that deficits would compel new taxes disappeared. The big monetary worry was how the Federal Reserve might manage without government debt. Democrats and Republicans agreed that growth was paramount. America governed itself well, adding to consumer confidence.
But what an economy can give, it can take away, and the 2001-02 recession cost the country $689 billion in revenue in 2002-03. The resulting deficits exposed the BBA’s lack of spending cuts. In 2012 the CBO reviewed why $5.6 trillion in projected surpluses for fiscal 2001-11 instead became $6.1 trillion in deficits: Two recessions and weak recoveries triggered $3.3 trillion in economic and technical revenue losses, new entitlement and nondefense spending cost $2.8 trillion, the Bush tax cuts cost $1.8 trillion, and the war on terrorism cost $1.5 trillion.
The BBA proved that while economic growth can leverage spending restraint to generate a deficit-slashing revenue surge, it cannot subdue long-term overspending. There’s no substitute for spending cuts.
Maximizing growth nonetheless remains dominant. To do so today, a new BBA would need broad welfare work requirements and tax incentives for the working elderly. Bending the long-term spending trends would require an inflation correction like the one Mr. Clinton achieved in 1997, an investment component to Social Security, and market-based Medicare reforms.
Perhaps most challenging would be replicating the 1990s’ golden era of certainty. Global tensions are rising, trade wars loom, government debt and monetary excess have worsened, and economic growth lacks bipartisan support. Deficits are expected to average almost 50% higher as a share of GDP than those projected for 1996-2000.
Yet it’s not all bad news. America enjoys its best regulatory and tax environment in generations. Eliminating trade uncertainty could let U.S. companies employ their newly competitive tax and regulatory advantages to dominate globally. America’s overall conditions are closer to those that generated 3% growth during most of U.S. history than to those of recent decades. And they can improve further.
In four years, from 1996 to 2000, the Balanced Budget Act transformed a deficit projected to be 3.1% of the economy into a surplus of 2.3%—a swing of 5.3% of GDP. That exceeds any annual deficit currently projected by the CBO. Why are Washington policy makers not even trying to replicate this success?
Mr. Solon, a former adviser to Sen. Mitch McConnell, is a partner at US Policy Metrics.