This is one of the more straight forward discussions regarding supply side economics/deficit spending. It explains in very practical terms why there are limits that need to be place. Just for the record, I had no idea that the debt to equity ratio had climbed to over 60%. That's insane.
Deficit spending hits all facets of economy
By T.M. Sell
President Bush says that cutting taxes will spur the economy and make the deficit go away, which is how he can submit a budget that is $337 billion in the red and claim it's good for the economy.
Deficits, like many features of the economy, are neither all good nor all bad. They result from the federal government spending more money than it takes in.
The government doesn't just print cash to accomplish this; it borrows money by selling Treasury notes and bonds (including U.S. Savings Bonds). The money pays for wars, welfare and education.
Deficit spending echoes throughout the economy. It redistributes income and injects cash into the body economic.
This kind of spending can spur economic activity. The Depression ended when World War II began and the government was forced to borrow and spend a lot of money, which jump-started the struggling economy and spurred decades of prosperity.
(President Franklin D. Roosevelt, who usually gets credit for ending the Depression, was, in fact, obsessed with a balanced budget. Only the war changed his mind.)
Deficits also can distort the economy. When President Johnson began to borrow money to pay for the Vietnam War — at a time when the economy was already booming — that extra cash spurred demand, bidding up prices and starting the inflation that so plagued the nation in the 1970s.
It also matters what the government spends on. Spending on military goods tends to take money out of circulation, since guns and tanks usually aren't used to create further economic activity. Spending on roads, schools and ports, for example, can help make the economy more productive and help it grow.
Bush's claim that tax cuts will spur growth is nothing new. In the Reagan era, it was called supply-side economics.
The basic idea is that if taxes are too high, they will discourage economic activity. So for the president's argument to be true, you have to assume that taxes are excessive. When the top marginal income-tax rate was 70 percent, it appeared to encourage people to do silly things with their money rather than invest, so the Reagan-era tax cuts had a certain logic.
But current evidence doesn't greatly support Bush's position, and not just because the United States has among the lowest total tax burdens of any industrialized nation.
First, look at the deficit in comparison to the entire economy. Assuming normal economic growth, the new budget's projected deficit will be about 2.7 percent of gross domestic product — the best measure of the overall size of the economy. That would be down from 3.6 percent in 2004 and 3.5 percent in 2003. (That's taking Bush's figures at face value; there's a lot of debate about how accurate the budget figures are.)
Although 2004's $426.6 billion deficit was the biggest ever in dollars, when measured against the size of the economy, the biggest budget deficit on record came in 1983, and the gap between spending and taxes grew to 6 percent of GDP.
But we should look at the deficit in a couple of other ways as well.
When the nation runs a budget deficit over time, the debt piles up. A second measure of the debt is total debt to GDP, and the numbers here present a challenge to the president's tax-cut logic.
Although the budget deficit grew during the supposedly high-tax Carter years in the late 1970s, total debt as a percentage of the whole economy actually fell, to 33.3 percent by 1980. President Reagan, promising to revive the economy, got Congress to cut taxes. Although the economy grew, debt as a percentage of GDP rose to 53.1 percent by the time he left office in 1989. So the economy wasn't responding to the tax cuts with deficit-erasing growth.
That number rose throughout the presidency of George H.W. Bush, peaking under President Clinton at 67.3 percent in 1996.
But then it fell as the economy boomed in the late 1990s, so that the current president inherited both a budget surplus and a debt-to-equity percentage that had shrunk to 57.4 in 2001.
As of 2005, that number is up to 65.7, and likely to climb considering what the president is proposing.
This should be cause for concern. Too much borrowing can drive down the value of the dollar, here and abroad.
A higher supply of dollars, like anything else, lowers the price (value) of a dollar, which means a dollar buys less. That shows up as inflation, though a lot of factors can contribute to inflation.
Too much borrowing also can drive up interest rates, as the government is forced to raise rates on T-bills, etc., to encourage more investors to buy them and hence lend the government more money.
An equally important issue may be that we now regularly spend 8 to 10 percent of the federal budget paying interest on the national debt.
That's money — more than $220 billion in 2006 — that could be going to other things, including tax cuts. And projections that may be more realistic than the president's show the budget deficit continuing to grow if his tax cuts are made permanent.
Unlike a household budget, the federal budget doesn't always have to be in surplus. The budget showed a surplus throughout the Depression, and the economy suffered for a dozen years.
But it shouldn't always be in deficit. Like a household, eventually you have to pay those credit cards off, or they stop extending you credit.
seattletimes.nwsource.com |
