C. Eugene Steuerle

English

Research Papers in Economics

FRBNY Economic Policy Review / April 2000 29
o tell the tale of recent fiscal policy, one must relate it to 
the recent past. The postwar period to about 1974 was an 
era of easy financing. Not only was economic growth high, it 
far exceeded the expectations conditioned partly on the 
Depression experience. But economic growth told only a small 
part of the story. Domestic policy actions were financed by an 
extraordinary shift out of defense—from about 14 percent of 
GDP in 1953 to 5.5 percent in 1974 and to about 3 percent 
today. This shift—most of which had occurred by the end 
of the Vietnam War—in today’s economy produces about 
$1 trillion that can be spent on domestic programs without any 
increase in tax rates. Inflation led to significant bracket creep in 
the income tax and, as it accelerated, it made real interest rates 
on government debt very low. Social Security tax rates were 
also rising with little notice, partly because most retirees until 
today—rich and poor alike—paid net negative tax rates when 
their increasing levels of benefits were compared with their tax 
liabilities. 
All of these factors led to extraordinary growth in the rate of 
domestic spending—so high that more than half of all this 
country’s domestic spending growth (as a percentage of GDP) 
took place during the Eisenhower and Nixon presidencies 
alone (Steuerle and Mermin 1997). Moreover, the public was 
receiving legislative tax cuts at the same time. 
Only gradually has the exceptional nature of this Era of Easy 
Finance, as I have labeled it, come to be recognized, long after 
its financing sources for domestic spending expansion began to 
wane. In the post-1974 period, defense declines as a percentage 
of GDP continued, but a moderate build-up in the early 1980s 
warned that they could not continue forever. Then the tax 
system was indexed for inflation. Meanwhile, the rate of 
inflation slowed, leading to high realized real interest rates. By 
the 1990s, we also entered the first postwar decade in which 
Social Security tax rates were not increased. Of course, 
economic growth also was slower. The easy spending/tax 
cutting days were coming to an end, and budget acts began to 
take gradual recognition of the new period. 
While before 1982, almost every major budget act was either 
an expenditure increase or a tax cut, from 1982 until 1997, 
almost all major legislation was, on net, a tax increase or an 
expenditure cut.  
The 1981 tax cuts were really old wine in a new bottle. In 
many ways, they duplicated the Kennedy tax cuts in substance 
and form. Only fiscal policy was fundamentally different. In the 
early 1960s, it did not matter whether the Keynesians were right 
or not. If right, surpluses would come in three years; if wrong, 
they would take five years or so to appear. However, in the early 
1980s, it also did not matter whether the supply-siders were 
right or not. Even with a remarkable spurt in economic growth, 
the budget was still headed toward large future deficits. 
What was different? In the earlier period—indeed, 
throughout all of the nation’s history up until then as well—
fiscal slack was scheduled for the indefinite future, and it would 
rise over time. In the later period, little fiscal slack was available, 
C. Eugene Steuerle
These comments are based in part on Steuerle et al. (1998). The views 
expressed are those of the author and do not necessarily reflect the position 
of the Federal Reserve Bank of New York or the Federal Reserve System.
Commentary
C. Eugene Steuerle is a senior fellow at the Urban Institute.
T30 Commentary
0
5
10
15
20
25
Percent
Social Security
Medicare
1940 1960 1980 2000 2020 2040 2060 2075
Source: Urban Institute. Based on the U.S. government budget, 
fiscal year 2000.
Chart 1
Social Security, Medicare, and Medicaid 
as a Share of GDP
Medicaid
and it was declining rather than rising over time.  If one looks 
closely at the Reagan cuts, especially in terms of revenues as a 
percentage of GDP, federal taxes by the mid-1980s were still as 
high as they were in the mid-1970s, right before inflation 
caused enormous bracket creep and large tax increases. Today, 
despite those cuts, average tax rates by some measures are at a 
peacetime high (primarily because a less even distribution of 
income has added to average tax rates indirectly through the 
progressive income tax). 
None of this fully explains why fiscal slack has dried up. 
Even if all sources of easy financing are eliminated and the 
economy slows, real revenues still rise about as fast as GDP over 
time. This implies that the future would portend enormous 
slack between future revenues and existing levels of 
expenditures “as far as the eye could see.” 
This type of slack used to be available when revenues were 
compared with expenditures under current law, as well as with 
existing levels of expenditures. But since the former fiscal or 
budgetary slack is gone, something must be different. And it is! 
What is fundamentally different is the composition of 
expenditures under current law. The nation moved from a 
budget that was primarily discretionary to one that was 
primarily one of entitlements. Moreover, it was not just that 
money was now put into programs that were scheduled to last 
forever. Some programs were also scheduled to grow, even at 
rates faster than GDP, forever and ever. Is it any surprise, then, 
that budget crises started to arise, and are scheduled to 
reappear once the baby-boomers start to retire?
Now, when the growth rate of entitlements is, say, 2 percent 
per year higher than GDP, there is still a lot of slack when those 
programs represent only one-tenth of the budget. When they 
start to occupy more than half of the budget, however, they 
start to matter a great deal. Chart 1, for example, shows Social 
Security, Medicare, and Medicaid as a share of GDP over the 
past few decades and according to future projections. 
Never before in our history has so much been preordained 
in the budget even before the Congress votes on it. Imagine if 
at the Constitutional Convention our founding fathers had 
decided to set the entire expenditure budget for today. We 
would find that effort almost laughable. Yet that is exactly what 
we have done for the budget more than 200 years from now. 
The reasons are not as complex as they might appear. In 
Social Security, the program is set up to grow forever faster 
than the economy because of the way it is indexed for wage 
growth and because it provides more and more years of 
benefits as we live longer. In many of the nation’s health 
programs, access to new health goods and services is provided 
at no cost to the consumer, and the producer is in a position to 
bargain with the consumer over what the rest of society can be 
charged. Some think these problems are only an issue of 
demographics. Certainly, declining fertility and mortality lead 
to an aging of the population, exacerbating the potential 
budget crisis severely once the baby-boomers begin to retire, 
but the problem exists even without these additional 
demographic pressures.  Most of the entitlements in question 
were designed around wants independently of the number of 
taxpayers who would be around to finance them. Thus, 
demographic factors simply bring to a head the difficulty of 
designing an expenditure program that has growth rates 
independent of the taxes available to pay for it. 
Just how different this era is can be seen by ranking 
presidents by the growth in domestic spending as a percentage 
of GDP when they were in office (Steuerle and Mermin 1997). 
President Roosevelt ranks near to last. It was not merely that 
spending increased under Hoover more than most historians 
recognize or that World War II led to massive increases in 
defense spending. Most importantly, the majority of the 
spending increases under Roosevelt were always meant to be 
temporary, to meet the needs of the time. Thus, they were very 
different than the modern, large entitlement programs that are 
scheduled to grow in good times and bad alike. (Social Security 
itself was established under FDR, but it was much smaller in 
scope and did not have nearly as much growth built into its 
formulas.) 
Go back further into the nation’s history, and the same 
lesson applies. Almost all prior expenditure increases—for 
example, for the Louisiana Purchase, payments to war veterans, 
fighting the Depression—were temporary, no matter how large 
or grand they were at first.FRBNY Economic Policy Review / April 2000 31
0
10
20
30
40
50
60
70
80
2030 1997 1948 2030 1997 1948 2030 1997 1948
Total Females Males
Percent
Chart 2
The Adult Nonemployment Rate
Source: Urban Institute. Based on data from the U.S. Department of  
Labor, Bureau of Labor Statistics, and the U.S. Social Security 
Administration.
Note: The chart depicts those people age twenty or older who are 
unemployed or who are not in the labor force.
Alan Auerbach suggests in his paper that assumptions used 
to project future discretionary spending are unreasonable. He 
is right. These assumptions would have such spending falling 
toward zero as a percentage of GDP over time. Today, we are 
sitting in the eye of the storm. A temporary reprieve is granted 
while the ranks of the elderly are filled with the baby-bust 
generation of the Depression and World War II and the 
baby-boomers continue to represent a large share of the labor 
force. But future deficits are scheduled because of the 
entitlement spending growth of current law. 
One final note. Fiscal policy is often considered an issue of 
how government is influencing the market for saving or 
investment. Similarly, economists love to try to demonstrate 
how they can solve almost any problem by tweaking 
(controlling) the market for saving and investment. However, 
we need to start changing our way of looking at macro or fiscal 
policy to take into account the human capital market 
as well. 
What I am suggesting is that barriers to labor were much less 
of a macro issue over the past few decades, but for reasons that 
will not continue. While federal policy was affecting the labor 
market greatly over the past twenty-five years, largely by 
subsidizing earlier and earlier retirement, there was one large 
mitigating factor. Despite the fact that men were dropping out 
of the labor market at very high rates as they sought more and 
more years in retirement, the entrance of women into the 
market in increasing numbers more than made up for the 
difference. 
In Chart 2, I present a measure that I have developed and 
call the adult nonemployment rate (Steuerle and Spiro 1999). 
Over the postwar period, the nonemployment rate has gone 
down in almost every year other than a recession year. What 
this means, interestingly, is that over the past few decades, 
leisure—at least in aggregate—was not being demanded 
increasingly as the economy got richer. But our laws now 
schedule an increase in the nonemployment rate that is on the 
order of the labor market plunge of the Great Depression. Only 
this time the decline is scheduled to be permanent. On a year-
to-year basis, the analogy would be with several small back-to-
back recessions, one following the other for a period of more 
than twenty years. Thus, I believe that these labor market 
pressures are a macro as well as a micro issue, and that they 
could have serious effects on short-term as well as long-term 
fiscal policy if and when these labor market declines start.
Mind you, the rise in the nonemployment rate does not have 
to occur at the rate currently scheduled, although the 
retirement of the baby-boomers may make some part of this 
rise inevitable. Interactions with the labor demand side of the 
market will lead to shifts in employment that I do not believe 
are being anticipated well in most economic forecasting 
models. Nonetheless, freeing up older workers to respond to 
demand requires facing up to a whole series of dams in 
institutional government policy, and in some private 
retirement policy as well (Steuerle and Spiro 1999). Getting rid 
of only one or two dams may be an inadequate way to allow the 
water to flow. Thus, the traditional focus on saving (whether 
private or public) as the core element of macro policy may be 
seriously deficient in the presence of a structure that now 
assumes such large withdrawals from the work force. References
32 Commentary 
Steuerle, C. Eugene, et al. 1998. THE GOVERNMENT WE DESERVE: 
RESPONSIVE DEMOCRACY AND CHANGING EXPECTATIONS. 
Washington, D.C.: Urban Institute.
Steuerle, C. Eugene, and Gordon Mermin. 1997. “The Big-Spending 
Presidents.” URBAN INSTITUTE BRIEF, no. 11. The Future of the 
Public Sector series. April.
Steuerle, C. Eugene, and Christopher Spiro. 1999. “Nonemployment: A 
Necessary Economic Indicator.” STRAIGHT TALK ON SOCIAL 
SECURITY, no. 2 (June 30). Washington, D.C.: Urban Institute.
_____. 1999. “The Many Reinforcements for Retiring Early.” 
STRAIGHT TALK ON SOCIAL SECURITY, no. 7 (September 15). 
Washington, D.C.: Urban Institute.
The views expressed in this paper are those of the author and do not necessarily reflect the position of the Federal Reserve Bank 
of New York or the Federal Reserve System. The Federal Reserve Bank of New York provides no warranty, express or 
implied, as to the accuracy, timeliness, completeness, merchantability, or fitness for any particular purpose of any 
information contained in documents produced and provided by the Federal Reserve Bank of New York in any form or 
manner whatsoever.

The Many Reinforcements for Retiring Early.”

Formation of fiscal policy: the experience of the past twenty-five years - commentary

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Formation of fiscal policy: the experience of the past twenty-five years - commentary

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