After two decades of back and forth, with partisans on both sides hurling invective at one another, the best that can be said is that the two philosophies seem to have fought each other to a draw. Measured by growth and jobs, both have worked much better than their opponents predicted -- but not the way their supporters expected.
Consider, for example, the public debate over the short-run effects of Reagan's first set of tax cuts. Supply-siders predicted that tax cuts would generate enough additional growth that they would quickly pay for themselves with new tax revenues -- the so-called Laffer curve. Conversely, opponents -- a group that included most mainstream economists -- argued that big tax cuts would create an inflationary surge, boost interest rates, and squeeze out private investment, leading to sluggish growth.
Neither the Pollyanna nor the Doomsday short-run scenarios turned out to be true. Soon after taking office, economists in the Reagan Administration abandoned the idea that the immediate growth dividend from tax cuts would be big enough to hold down the budget deficit. Indeed, as the economy went into a deep recession from July, 1981, through the end of 1982, the deficit skyrocketed, hitting 6% of gross domestic product in 1983.
Still, Reagan's growth record looks pretty good in retrospect, averaging 3.4% annually from the time he took office to the time he left. That's just below the 3.6% average growth rate during Clinton's term, and right around the post-war average. And while unemployment stayed high, private-sector jobs grew at a 2.3% annual rate, again just below Clinton's 2.6% rate.
What's more, many of the negative consequences predicted from big deficits didn't happen. Inflation, rather than soaring, fell sharply. The interest rate on 10-year government bonds plummeted, from over 12% in 1984 to less than 8% in 1986, despite deficits that still exceeded 5% of GDP. And business investment during the Reagan years averaged 12% of GDP, higher than during Clinton's term, as foreign money flowed in to help fund the deficit. "Most of us were surprised at how open the U.S. economy turned out to be," said Benjamin M. Friedman, a Harvard University economist who wrote a skeptical book in 1988 about Reaganomics called Day of Reckoning.
Similarly, when the debate over taxes vs. the budget deficit was replayed in the early 1990s, all the short-term forecasts, both positive and negative, were once again off the mark. When Clinton raised taxes in 1993 to stem the yawning deficit, Newt Gingrich, then a leading Republican member of the House of Representatives, famously argued: "The tax increase will kill jobs and lead to a recession, and the recession will force people off of work and onto unemployment and will actually increase the deficit."
That didn't happen, of course. The economy went on to experience the longest expansion on record, unemployment eventually fell below 4%, and the deficit not only fell, by 1998 it had turned into a surplus. The stock market, adjusted for inflation, went up at an 11.2% average yearly rate during the Clinton years, compared with an average gain of 6% for Reagan.
The economy did not follow the course predicted by the deficit-cutters, however. Although the deficit did fall sharply, long-term interest rates rose, going from under 6% in 1993 to almost 8% by the end of 1994. It wasn't until 1998 that rates fell conclusively below their 1993 levels. And even during the so-called investment boom from 1995 to 2000, business capital spending averaged only 11.8% of GDP, below the Reagan average. Rubin acknowledges the problem in his 2003 book, In an Uncertain World: "In retrospect, the effect of the Clinton economic plan on business and consumer confidence may have been even more important than the effect on interest rates."
In fact, the real story of the Clinton years is something the supporters of Rubinomics never expected -- the technology boom of the late 1990s. Although average business investment during the boom years was not exceptional, the Information Revolution helped trigger big gains in productivity and growth as early as 1996. That's not something Clinton's economists saw coming or even expected to continue: the 1997 Economic Report of the President, released in February of that year, predicted that growth would average a meager 2.2% over the next four years. The actual growth rate turned out to be 3.9%.
Given today's intensely partisan political atmosphere, it's ironic that the economic record of the past two decades favors neither Reaganomics nor Rubinomics. History shows that it's possible to have a sustainable boom with high deficits, as Reagan did, just as it's possible to have a sustainable boom with higher taxes, as Clinton did. Taxes and deficits do matter -- they just don't matter as much as the ideologues would have us believe. By Michael J. Mandel in New York