Politicians who advertise themselves as “fiscal conservatives” sometimes campaign on crowd-pleasing pledges to cut taxes and simultaneously reduce budget deficits.  These are difficult promises to deliver on in practice, since the budget deficit equals government spending minus tax revenue.

Aspiring fiscal conservatives may be interested in learning four innovative tricks that are commonly used by American politicians who like to promise what seems impossible.   Each of these feats has been perfected over three decades or more.  Indeed they first acquired their colorful names in the early years of the Ronald Reagan presidency:

1. The “Magic Asterisk”
2. “Rosy Scenario”
3. The Laffer hypothesis
4. The “Starve the Beast” hypothesis.

As shop-worn as these four conjuring tricks are, voters and journalists continue to fall for them. Thus they remain useful equipment in the repertoire of the fiscal conservative.

The first term was coined by Reagan’s Budget Director, David Stockman.  Originally it was an act of desperation, because the numbers in the 1981 budget plan didn’t add up.  “We invented the ‘magic asterisk’:  If we couldn’t find the savings in time - and we couldn’t-we would issue an IOU. We would call it ‘Future savings to be identified.’” [p.124]   Since that time the Magic Asterisk has become a familiar device in the American policy arena.   Recent examples include the recommendation of the Simpson-Bowles commission to cut real spending growth by precise amounts, without saying where.   US Presidential candidate Mitt Romney has done the same in his spending plan.    Another current application of the Magic Asterisk is Romney’s plan to eliminate enough tax expenditures to make up the revenue lost by cutting marginal tax rates by 20% (which is $5 trillion in revenue), while steadfastly refusing to say what tax expenditures he would eliminate.

As Election Day nears, the pressure on a candidate to get more specific grows.  The conjurer is thus forced to go to Trick Two:  since he can’t find enough tax loopholes to eliminate, he must claim that what he meant by closing the revenue gap was that stronger economic growth will bring in the added revenue.   The most popular magician’s assistant of all time makes her encore on the stage.  Murray Weidenbaum, Reagan’s first Council of Economic Advisers Chairman, deserves the credit for originally dreaming up Ms. Rosy Scenario, “perhaps my most lasting legacy” [p.57].  The Reagan Administration in its early years forecast 5% income growth (twice the long-run average), in order to imply in its projections a boost to revenues big enough to make up for its many tax cut measures [p.93-97].   Since then candidates of every party have made use of Rosy’s talents.

Indeed official growth forecasts are systematically overly optimistic in almost all of a sample of 33 countries, contributing to overly optimistic budget forecasts.   European governments are particularly biased.

In the Republican primaries last year, candidate Tim Pawlenty assumed a 5 per cent growth rate to make his own plan work.   He was all but laughed out of the race.  Mitt Romney probably can’t get away with this sleight-of-hand either.   The press asks, “Why should we believe that the growth rate will magically accelerate just because you become president?   Where will this GDP come from?   It sounds like pulling a rabbit out of a hat.”  Right on cue, it is time for Trick 3.

Trick 3 is the famous Laffer Hypothesis.   This is the proposition, identified with “supply side economics,” that reductions in tax rates are like magic beans:  they stimulate economic growth a lot — so much so that total tax revenue (the tax rate times income) goes up rather than down.   One might think that the Romney campaign would never resurrect such a hoary and discredited trick.  After all, two of his main economic advisers, Glenn Hubbard and Greg Mankiw, both have textbooks in which they say that the Laffer Hypothesis is incorrect as a description of US tax rates.  Mankiw’s book, in its first edition, even called its proponents “charlatans.”  But the historical record is that each Republican presidential candidate since Reagan has had good economic advisers who disavow the Laffer Hypothesis.  Yet time and again the president (or candidate), and his vice president (or running mate) and his political aides read from a script that relies on the Laffer logic (Appendix I). They are the ones who make the policy if the candidate wins, not the academic economist.   George W. Bush had these same two top economic advisers in his first term, Hubbard and Mankiw, when he cut taxes and transmogrified a record surplus into a record deficit.

Trick 4, “Starve the Beast,” typically comes later, if and when the president is elected, has enacted his tax cuts, and discovers that smoke and mirrors don’t work against hard fiscal reality. He can’t find enough spending to cut (Magic Asterisk has disappeared up the conjurer’s sleeve); the acceleration in GDP is nowhere to be seen (Rosy Scenario has vanished in thin air); and tax revenues have not grown (no rabbit in the Laffer hat).   The audience is now told that losing tax revenue and widening the budget deficit was the plan all along.  The performer explains that the deficit is all the fault of Congress for not cutting spending and that the only way to tame the beast is raise the budget deficit because “Congress can’t spend money it doesn’t have.”  This trick never works either, of course.  Congress can in fact spend money it doesn’t have, especially if the “conservative” president has been quietly sending it budgets every year that call for that.   “Starve the Beast” as a budget strategy, like the other three, dates back to the first Reagan Administration. (Bartlett, 2007, p.6-7.)

By the time the crowd realizes it has been had, the confidence man has pulled off the greatest trick of all:  yet another audience who came to see the deficit shrunk instead leaves the theater with the deficit bigger than when it came in.

References
Bruce Bartlett, 2007, “‘Starve the Beast’ Origins and Development of a Budgetary Metaphor,”The Independent Review, XII, 1, summer, 5-26.
Jeffrey Frankel, 2008, “Snake-Oil Tax Cuts,” Economic Policy Institute, Briefing Paper 221, September.
–2011, “Over-optimism in Forecasts by Official Budget Agencies and Its Implications,” Oxford Review of Economic Policy vol.27, no. 4, 536-562. NBER WP 17239; Summary in NBER Digest.
David Stockman, 1986, The Triumph of Politics: Why the Reagan Revolution Failed (Harper & Row).
Murray Weidenbaum, 2005, Advising Reagan: Making Economic Policy, 1981-82 (Washington Univ., St.Louis).

[A version of this column appeared earlier at Project Syndicate, which has the copyright.  Comments can be posted there.]

During much of the last decade, U.S. fiscal policy has been procyclical, that is, destabilizing.   We wasted the opportunity of the 2003-07 expansion by running large budget deficits.   As a result, in 2010, Washington now feels constrained by inherited debts to withdraw fiscal stimulus at a time when unemployment is still high.   Fiscal policy in the UK and other European countries has been even more destabilizing over the last decade.  Governments decide to expand when the economy is strong and then contract when it is weak, thereby exacerbating the business cycle.    

Meanwhile, some emerging market and developing countries have learned how to run countercyclical fiscal policy - saving in the boom and easing in the recession - during the same decade that we advanced countries have forgotten how to.    

The frenetic debate at any moment for or against “fiscal conservatism” is artificial.  It is not the right answer always to shrink any more than it is the right answer always to expand.  Americans should take a perspective longer than the annual budget cycle or the bi-annual electoral cycle, let alone the daily news cycle.   When the United States was able to take advantage of the long 1992-2000 boom to eliminate its budget deficit, the key legislation had been enacted in 1990 and 1993.   Similarly, the big deficits of the last ten years were created by the legislation of 2001 and 2003.   Bringing back far-sighted fiscal policy would mean taking steps today to lock in long-term progress toward fiscal responsibility (such as enacting social security reform) but at the same time extending last year’s short-term fiscal stimulus so long as the economy is still weak.

It might help to have ways to insulate fiscal policy from some of the wilder vagaries of politics.    I came away from a conference in Chile recently, impressed anew by that country’s accomplishments.  It has achieved countercyclical fiscal policy over the last ten years by means of some innovative institutions.   Chile has a rule that targets the structural budget balance.  In other words, it can only run a deficit to the extent that GDP and the price of copper are below their long-run trends.  But a structural budget rule is not enough in itself.   Who is to say which deficits are structural and which are temporary?  Chile’s key innovation ten years ago was to vest responsibility for determining the long-run trends in GDP and copper prices in two panels of independent experts.   Why does this matter?   One reason that politicians spend too much in booms is that they convince themselves that deficits are temporary even when they are really structural.  Officials in the US and Europe made overly-optimistic forecasts of future growth rates and tax revenues during the 2001-07 expansion.  Research shows that this is a systematic pattern.  The biased forecasts contributed to unaffordable tax cuts and accelerated spending, which in turn spelled excessive deficits and debts.  Today we are living with the consequences of this procyclicality.

Perhaps we should look South, in order to re-learn how to run countercyclical budgets. 

[For comments, go to SeekingAlpha.]

Floyd Norris notes in the New York Times (Feb. 9, 2008, p.B3),“George W. Bush is in line to be the first president since World II to preside over an economy in which federal government employment rose more rapidly than employment in the private sector.”    It is another bit of confirmation of the truth behind a comment that “Joe S.” posted in response to my blog entry of February 6 (“Reagan and Stalin”): “What, pray tell, does the Republican Party have to do with conservatism?”  

The liberal and conservative labels are no longer useful.   It’s not that shorthand political labels are never useful; they are, even though individuals resist pigeonholing. 

And it’s not just that these particular words have long since lost their original meanings.   Linguistically, “liberalism” of course was supposed to refer to a philosophy of leaving individuals free from interference by government and other entrenched institutions, while “conservatism” was supposed to mean valuing continuity and stability.   But it is a commonplace that Americans use the word “liberal” to mean the opposite of what it meant in the 19^th century (which is now often called “neoliberal,” for some reason).  

Supporters and detractors alike still considered George W. Bush a conservative, despite the original meaning of the word, when he launched radical departures from longstanding American principles  in the spheres of foreign policy and domestic policy.   The White House has asserted maximal political powers for the executive, and has used these powers to enact virtually unprecedented levels of interventionist policies, ranging from Iraq to domestic citizens’ right to privacy.   

But people still seem to think that the Bush Administration also stands for conservatism in the economic sphere as well.   Or some think that President Bush may no longer stand for economic conservatism, but that other Republican politicians do.   I would contend that, not just George W. Bush, but also Richard Nixon, Ronald Reagan and (to a lesser extent) George H.W. Bush, all — in sharp distinction from their conservative rhetoric – in practice have been interventionist.  They have all wandered, far from the principles of good neoclassical economics, and far from from the principles of small government and laissez faire.  How far?   Farther than did, for example, Jimmy Carter and Bill Clinton.  

The criteria are:
(1) Growth in the size of the government, as measured by employment and spending.
(2) Lack of fiscal discipline, as measured by budget deficits.
(3) Lack of commitment to price stability, as measured by pressure on the Fed for easier monetary policy when politically advantageous.
(4) Departures from free trade.
(5) Use of government powers to protect and subsidize favored special interests (such as the oil and gas sector, among many others).   

Documentation that Republican presidents have since 1971 indulged in these five departures from “conservatism” to a greater extent than Democratic presidents can be found in some writings of mine, listed below.   The name I would give to this set of economic policies, as well as to the parallel abuses of executive power in the areas of foreign policy and domestic policy, is neither “liberal” nor “conservative” but, rather, “illiberal.”

Original:     “Republican and Democratic Presidents Have Switched Economic Policies,” in Milken Institute Review, vol. 5, no.1, 1st Quarter, 2003, pp.18-25.

Shortest:    “Trading Places” , Financial Times, Sept. 13, 2002.

Most recent: “Responding to Crises,” for 24^th Annual Monetary Conference, Cato Institute.   Cato Journal vol. 27, no. 2, Spring/Summer, 2007, pp 165-1708.