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How We Balanced the Budget Last Time

President Obama and the Democrats argue that any debt limit deal to reduce federal deficits and debt needs to be balanced between spending reductions and tax increases. But as I show in my new book, "America’s Ticking Bankruptcy Bomb," that is not how we did it the last time we balanced the budget, in the 1990s.

The Republican congressional majorities elected in 1994 were greeted in February, 1995 with then President Clinton’s new budget projecting continued federal deficits of $200 billion or more indefinitely into the future. The ensuing government shutdown battles ended with budget policies that cut both taxes and spending.

Republican congressional majorities, led by then House Speaker Newt Gingrich, enacted the largest capital gains tax cut in U.S. history, slashing the rate by 40% from 28% to 20%. Along with some other tax cuts on capital, that helped to promote an economic boom that produced surging revenues.

The Republican Congress then cut federal discretionary spending from 1995 to 1996 by 5.4% in real dollars, after adjusting for inflation. As a percent of GDP, federal discretionary spending, including defense and non-defense, was slashed by 17.5% in just 4 years, from 1995 to 1999.

The Congress also adopted some entitlement reform. The AFDC welfare program was terminated as an entitlement, and sent back to the states with work requirements and federal financing in fixed, finite block grants. Agricultural subsidies were phased out under the Freedom to Farm reforms (later reversed under House Speaker Dennis Hastert). President Clinton deserves credit for going along with these Congressional Republican reforms.

As a result, $200 billion annual federal deficits, which had prevailed for over 15 years, were transformed into surpluses by 1998, peaking at $236 billion by 2000. The national debt was reduced by $560 billion in surpluses from 1998 to 2001.

This contrasted sharply with the budget deal reached by the first President Bush and a Democrat Congress in 1990, which followed President Obama’s “balanced” approach by raising taxes in return for supposed spending cuts. But the tax increases promoted an economic downturn that reduced revenues, while the spending cuts didn’t fully materialize. As a result, the deficit increased from $221 billion in 1990, to $269 billion in 1991, to $290 billion in 1992, when voters booted then President Bush out for violating the no new taxes pledge that got him elected.

With our current weak economy, any tax increase is more likely to lose revenue than gain it. Moreover, under current law tax rates for virtually every major federal tax are already scheduled to go up in 2013 on the nation’s small businesses, job creators and investors. That is because the tax increases of ObamaCare become effective that year, and the Bush tax cuts expire, with President Obama firmly opposed to renewing them for those disfavored taxpayers. That is only going to hurt the jobs and wages of average working people.

America’s corporate tax rate is also already virtually the highest in the industrialized world at nearly 40%, counting state corporate taxes on average. Even Communist China imposes only a 25% rate, with the socialist EU below even that on average.

In addition, even before President Obama was elected, official IRS data for 2007 showed that the top 1% of income earners paid more in federal income taxes than the bottom 95% combined. So still further tax increases are not going to promote fairness either.

Finally, both CBO and President Obama’s own 2012 budget show that with current policies federal taxes will already grow above their long run average since World War II, which allowed America to prosper as the leading economy in the world during that time. It is federal spending that is projected to grow well beyond its postwar average, resulting in unmanageable long term deficits and debt.

Consequently, history, logic, experience, and theory show that the only viable approach to reducing deficits and debt is to cut tax rates to promote a growing economy again, which will produce growing revenues, and to cut spending down towards those revenues.

Peter Ferrara is Director of Entitlement and Budget Policy for the Heartland Institute and Senior Fellow for the Carleson Center for Public Policy. He served in the White House Office of Policy Development under President Reagan, and as Associate Deputy Attorney General of the United States under the first President Bush. He is the author of "America’s Ticking Bankruptcy Bomb" just out from HarperCollins.