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Debt, Deficit and Policy

The national debt has been a punching bag for almost a century, even mentioned in a song written in 1951 ("If You're So Smart, How Come You Ain't Rich?") The debt now stands at over $30 trillion and the alarms are sounding just as they did when it hit $5 Trillion, $10 trillion, $15 trillion... you get the idea. Everyone's hair goes on fire with each high water mark, and yet, nothing catastrophic has happened. It's nice to be the world's reserve currency.


There is occasional talk about a "Balanced Budget Amendment" to cure this, but it's hardly necessary and would needlessly hamstring the government. But I think people are looking at this the wrong way, and in very simplistic terms.


The last time we ran a surplus was in 1998 to 2001. A confluence of a strong economy and higher tax rates, among other factors, propelled revenues over the level of expenditures. We stopped issuing 30 year Treasuries during this period as there was no need to run auctions to fund the government. People were wondering aloud at that time how mortgages would be priced if the same thing happened with shorter maturities that base their yields off 10 and 15 year paper.


A series of unfortunate events ended this state of affairs in short order. First the "dot-com" market crash, then, the September 11th catastrophe, and lastly, two ill considered and reckless tax cuts executed by the Bush Administration. The rationale presented by the Administration was that "it was your money" so it should be returned, as if the recession we went through at that time wasn't enough to eliminate the surplus all by itself. You will note in the chart above that nothing shrivels revenues and grows the debt stack like a recession, shown by the vertical grey bars.


Worse is the political discourse on this subject. The comparisons offered by Congress people referring to the debt as if it were a credit card balance, or likening it to household debt are just plain infantile. But there is a mature way to look at this and a rather obvious one.


Note that no matter what, spending and revenue always go up over time. They can vary at different rates depending on what is going on at any given moment, but generally speaking, the economy will continue to expand and so will the funding and the spending needed to maintain it.


The first thing to acknowledge is that strong economies deliver stronger revenues. If a solid pace can be maintained, the gap between spending and revenue narrows. Again, nothing kills revenue like an economic downturn. To my mind, the definition of a recession is best determined by a reversal in revenue flows from positive to negative.


The second thing to acknowledge is that tax policy has deliberately sabotaged revenue growth below what could be considered a more "natural," for lack of a better term, rate than what has been needed. That's what grew the debt, and although we've had moments where the deficit shrank dramatically, it was never enough to pole vault over the debt threshold. But with judicious steps taken, that can be done. And to remind, you don't reduce the debt without completely eliminating the deficit first.


You'll hear a lot of nonsense regarding tax hikes, and it's no surprise no one likes them, depending on who's targeted. The Bush tax cut plan was actually promoted with these "benefits."


  • Reduce the federal surplus by $1.4 trillion from FY 2002 to FY 2011. Even with higher spending, the total surplus would be $4.2 trillion from FY 2002 to FY 2011. Moreover, because employment and payroll tax revenue will rise, the Social Security surplus would increase by $85 billion and the Medicare Part A surplus would increase by $39 billion, making more resources available over the next 10 years to reform those programs.


  • Effectively pay off the federal debt. The Bush plan would decrease federal debt to the lowest possible level at which it could be redeemed--$818 billion in FY 2011 (see Chart 4).25 From FY 2001 to FY 2011, federal debt as a percentage of GDP would decline from 30.5 percent to just 4.7 percent under the plan.

These assertions are, of course, nonsense. Would that these were the only ones that were predicted. Imagine my surprise discovering one of the authors is the current head of the Bureau of Labor Statistics. In any case, this is a common theme with the tax cutters: if you do enough of it, the economy will grow and the debt will take care of itself.


There is only one flaw in this theory: It is a complete fantasy, and tax policy over the years has not been a major factor in overall economic performance. This chart I constructed nearly a decade ago tells the tale.

No matter what the tax rate, there are dozens of levers working on the economy at any given time, and to underscore the obvious again, a solid economy will generate solid revenue growth, and tax policy doesn't help or hinder to any outsized degree unless it's some targeted sector like real estate, for example. So recessions come and go no matter where marginal rates sit, or how capital gains are taxed.


Moreover, consider how ludicrous the proposition is: for every dollar of tax cuts, not only do we have to make that dollar back in whole terms, the stimulus it supposedly provides will get you the whole dollar back and more. That is patently absurd.


Moreover, the tax cutting policy sows the seeds of ever larger debt. As mentioned, spending and revenues always go up, save for the occasional disruptions that history serves up. So if you never give revenues a boost in order to catch up to expenditure after a debilitating episode like the 2008 crisis, it's like dropping the baton in a foot race several times over. You'll just keep falling behind, and there is no way to catch up. Ever.


So hopefully, this explains why we needlessly torture ourselves over the national debt, and why a few sober, simple acts of policy should end the farce once and for all. That's where the conversation should start. Not with an artificially imposed debt limit.



January 30, 2023

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