On January 5, Hillary and I announced that we would enroll Chelsea in a private school, Sidwell Friends. Until that time, she had always been in public schools, and there were some good ones in the District of Columbia. After discussing it with Chelsea, we decided on Sidwell primarily because it guaranteed her privacy. She was about to turn thirteen, and Hillary and I wanted to give her the chance to live out her teenage years as normally as possible. She wanted that, too. On January 6, with only two weeks to go before the inauguration, and the day before my first meeting with my economic team, the Bush administration’s OMB director, Richard Darman, announced that the coming year’s budget deficit would be even higher than previously estimated. (My staff was convinced Darman had known about the larger deficit earlier and had delayed his bad-news announcement until after the election.) Regardless, now it was going to be much more difficult to juggle the competing priorities: to cut the deficit in half without weakening the fragile economic recovery in the short run; to find the right combination of spending cuts and tax increases necessary to reduce the deficit and increase spending in areas vital to our long-term economic prosperity; and to ensure more tax fairness for middle-and lower-income working people. The next day, the economic team gathered around the dining-room table in the Governor’s Mansion to discuss our dilemma and explore which policy choices would produce the most growth. According to traditional Keynesian economic theory, governments should run deficits in bad economic times and balanced budgets or surpluses in good times. Therefore, the combination of tough spending cuts and tax increases necessary to halve the deficit seemed to be the wrong medicine for the present moment. That’s why FDR, after being elected on a promise to balance the budget, abandoned deficit reduction in favor of big spending to put people back to work and stimulate the private economy. The problem with applying the traditional analysis to current conditions was that under Reagan and Bush, we had built in a large structural deficit that persisted in good times and bad. When President Reagan took office, the national debt was $1 trillion. It tripled during his eight years, thanks to the big tax cuts in 1981 and increases in spending. Under President Bush, the debt continued to increase again, by one-third, in just four years. Now it totaled $4 trillion. Annual interest payments on the debt were the third-largest item in the federal budget after defense and Social Security. The deficit was the inevitable result of so-called supply-side economics, the theory that the more you cut taxes, the more the economy will grow, with the growth producing more tax revenue at lower rates than previously had been collected at higher ones. Of course it didn’t work, and the deficits exploded throughout the recovery of the 1980s. Though supply-side theory was bad arithmetic and lousy economics, the Republicans stayed with it because of their ideological aversion to taxes, and because, in the short run, supply-side was good politics. “Spend more, tax less” sounded good and felt good, but it had put our country in a deep hole and left a cloud over our children’s future. Coupled with our large trade deficit, the budget deficit required us to import tremendous amounts of capital every year to finance our overspending. To attract that kind of money and avoid a precipitous drop in the value of the dollar, we had to keep interest rates far higher than they should have been during the economic downturn that preceded my election. Those high interest rates inhibited economic growth and amounted to a huge indirect tax on middle-class Americans who paid more for home mortgages, car payments, and all other purchases financed through borrowing.
After we sat down to work, Bob Rubin, who was running the meeting, called on Leon Panetta first. Leon said the deficit had gotten worse because tax revenues were down in the sluggish economy, while spending was up, as more people qualified for government assistance and health-care costs soared. Laura Tyson said that if current conditions continued, the economy would probably grow at a rate of 2.5
