Gillette-The National Debt as the Crazy Uncle

The National Debt as the Crazy Uncle

By Scott D. Gillette
[email protected]

1/08/2001

Ross Perot, who made reducing the deficit one of the hallmarks of his erratic 1992 campaign, described the twin problems of the deficit and the debt as a “crazy uncle that nobody in the family likes to talk about.” Well, maybe that uncle isn’t so crazy after all, and he’s gotten a bad rap.

American politics has been paralyzed by an inordinate and misplaced concern about our national debt for a long time, but no more so than now. A generation ago, it was Republican candidates who equated a balanced budget with economic happiness. Now, it is Democrats who believe that economic prosperity requires that we continue to pay off the debt at the exclusion of everyone else. Indeed, Bill Clinton said in 1998 that “saving Social Security” requires that we forsake tax cuts for the foreseeable future. As the Bush Presidency is only a couple of weeks away, there is a consensus that tax cuts are needed to ameliorate the economic slowdown; unfortunately, the imminent tax cut will be far smaller than it should be, because of misplaced concern about the debt.

Now let’s clear up a couple of things right off the bat. The idea of using the current surplus to strengthen Social Security instead of tax cuts of any kind is based on a fallacy. The surplus does not go into any kind of trust fund, but is merely used to pay down the debt, as there is no real “trust fund” for Social Security, because it is a pay-as-you-go system. Put another way, we are not shoring up the Social Security system directly, but indirectly, as we are paying down the debt now so we can increase the debt at a later date to meet those Social Security obligations.

The federal government is doing nothing more than paying a dollar now off the debt so as to add a dollar of debt at a later date. This is like emptying a bucket of water so as to fill it up again. That's fine if you want no return whatsoever on your investment. But it is not a great use of capital at all: if you put a dollar into anything, one would hope for more than $1 dollar when the return on the investment comes 15 years from now.

The second thing that must be pointed out is that we are very close to achieving the policy goal of paying off the debt in the first place. The federal budget is poised to have a surplus of US$250 billion next year, and unless a real recession ensues, we should have a US$300 billion surplus that will be dedicated to paying down the $3.7 trillion debt in Treasury securities by 2012 or 2013. At that future date, the US$300 billion and the current interest on the debt, which adds up to around $500 billion dollars, can be dedicated to Social Security at that time, or anything else that the federal government wants to tackle at that time. Moreover, any additional surpluses accumulated over the next several years can be used for spending or tax cuts, with no harm whatsoever to the plan to pay down the debt. Put simply, we are very close to paying down the debt anyway.

But what about the claim that fiscal discipline and paying off the debt will continue to keep the economy rolling? Clinton Administration officials like Dr. Laura Tyson and Gene Sperling consistently have taken credit for the recent economic conditions by attributing strong growth to reduction and eventual elimination of the debt. But this doesn’t hold up to the evidence one iota.

To begin, when Gingrich and company were advocating a balanced budget by the year 2002 way back in 1995, Democrats in Congress and the executive branch were decrying the reductions in spending being advocated as “extremist”. (Remember the “Contract with America?”) After that political debacle, there was no effort to reduce spending, as annual increases in federal expenditures between 1995 and 1999 remained in the 3.3%-3.7% range. Spending increases this year were even higher.

So the current surplus did not derive from less spending, but from increased economic growth, which propelled revenues to exceed spending increases in staggering amounts for the past two years. But how can deficit reduction cause economic growth, since economic growth came first, and only then did the deficits decline? Nobody in their right mind can say that X is the cause of Y if Y came before X. Such pronouncements may be politically appealing, but they have no bearing on the irrefutable historical and economic information that we have at our disposal.

But what about the deficit dividend that results in smaller interest rates? Well, if one measures the relationship
between debt levels and interest rates over the span of American history, there is no relationship between these
two variables. Now this does not mean that I can rule out a relationship between these two variables. But having
said that, you cannot say that such a relationship definitively exists, because there is no proof of that. Nor was the 1980s marked by higher interest rates, as they continued to decline or at least stayed even until 1989, in spite of the rising
deficits. (This trend, coupled with Ronald Reagan’s advocacy of the Star Wars missile shield, actually prompted
the Soviet Union to curtail its arms race and prompted a thawing of relations, glasnost, and the ultimate unraveling
of its empire.) Moreover, during the 1991-1992 fiscal year, when the deficit hit a record high of $290.4 billion, the
federal funds rates actually declined to 3.0% by the end of 1992; this year, with the aforementioned $250 billion
surplus, the federal funds rate stands at 6.5%, with a concomitant increase in the price of cars and houses for the
entire American population. Some dividend.

So, reducing the debt does not promote economic growth, nor does it reduce interest rates, nor does it provide a
long-term solution to the actuarial deficit in Social Security that looms fifteen years from now. Finally, we are reducing
the debt at a brisk pace anyhow. So why has a dubious policy become so popular in Washington?

The simple answer is politics. It is politically appealing to advocate policies that will somehow provide security in an unknown future, especially in prosperous times. But our future problems can be best solved by promoting social investments where they are needed and the money is put to good use, and to implementing “risky” policies like Social Security privatization and tax cuts that will ensure economic growth in the coming decade. Only by promoting such growth can our biggest social and economic problems be solved; sticking our heads in the sand and worrying about the debt will not help. Only by worrying about its crazy uncle less can the American family be free to aspire to a better future.

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