Don't Fear Deficits
What the Government Spends Money on Is Usually More Important Than How It's Financed
DECEMBER 01, 2000 by RUSSELL ROBERTS
Filed Under : Government Spending
At current tax rates, barring a recession, the federal government will run large and growing surpluses during the next decade and beyond. Yet regardless of the identity of the new president or the character of the new Congress, we are certain to hear a great deal of talk in the coming months about deficits rather than surpluses.
Call it Ross Perot’s legacy. He seems to have created a permanent fear of government debt and deficits within the hearts and minds of the American people.
This is quite an impressive achievement. Between 1970 and 1997, the federal government ran a deficit every single year. There were some good years and bad years over that time period, so why the fear of the deficit?
Between 1982 and 1996 the federal budget deficit exceeded $100 billion dollars every year. In eight of those years the deficit exceeded $200 billion dollars. During that time the American economy added over 25 million jobs.
During those years we listened to dire predictions of what those deficits were going to do to the economy. Sure, those Cassandras warned us, the economy is doing fine, but you just wait. You just wait!
We waited. Between 1982 and 1996, the economy got 50 percent bigger after taking account of inflation. But it’s a house of cards, the worriers warned us! It’s all going to come tumbling down.
So now we’ve got surpluses. When is that house of cards going to fall apart? Are the effects of deficits so sinister that we have to wait even after the deficits have been reversed? Are deficits so insidious that their evil effects can be unleashed years and decades after the accumulated debt has been paid off?
I don’t think so.
So why did we get away with it? Shouldn’t those deficits have harmed the economy? Shouldn’t they have driven up interest rates and stifled growth?
A federal budget deficit, if large enough, could harm the economy, but a deficit of $200 billion is “small” in a certain sense. It’s hard to accept, but the budget deficits of the ‘80s and ‘90s had no appreciable effect on interest rates. In 1993, the first year of the Clinton administration, the deficit was $255 billion. In 2000 we are expecting a surplus of over $100 billion. But interest rates are higher than they were than when Clinton took office. They’ve bounced around. But there is no relationship between interest rates and federal budget deficits.
How can that be? When the federal government goes to borrow billions of dollars, shouldn’t that drive interest rates higher? Isn’t that what you learned in Economics 101 ?
Well, the poet (Alexander Pope) said a little learning is a dangerous thing. For an increase in demand to drive up prices it has to be a significant part of the market. If I decide to double my apple purchases, the price of apples will not rise. If the city of St. Louis doubles its demand for apples, there will be no significant effect on the price of apples.
When the U.S. government increases its demand for credit by $100 billion dollars, the effect is small in a world credit market that is many trillions of dollars.
There is another sense in which the U.S. budget deficit was small in the ‘80s and ‘90s. It was never so large as to alarm investors that we might not honor our debts. True, $290 billion seems like a large number. But the economy in that year (1992) was $6.2 trillion. The government collected over a trillion dollars in taxes. Were we spending more than we took in? Yes. But there was never a sense in which we were spending beyond our means.
A friend of mine asked me the other day whether the analogy of personal debt applies to the government. Isn’t it bad to go into debt, to live beyond your means? Doesn’t that burden future generations.
I asked him if he owned his house. Yes, he said. Had he paid cash or borrowed the money from the bank? He laughed and admitted he had borrowed the money.
What, I asked, in mock amazement? Wouldn’t it have been better to save up money and pay cash? How could he saddle his family with a mortgage?
The right question is how big a mortgage. Sure, a mortgage can be so big that it is irresponsible. Sure, it’s unwise to burden the family with mortgage payments that threaten its ability to pay for food, education, and health care.
But it would be just as irresponsible to plan to pay cash for such an expensive house by putting money aside every year, money that would be unavailable for food, education, and health care, just to avoid going into debt.
It’s the size of the house that determines whether the family is being responsible or not, not how the house is financed.
And the same is true for the federal government. What the government spends money on is usually going to be vastly more important than whether it finances the spending via taxes or bonds. A boondoggle ditch-digging project that achieves nothing but is fully paid for by taxes is much more harmful than a sewer project that is paid for with bonds.
So let’s ignore the forecasts of surplus or the dire predictions of doom if deficits re-appear because of a tax cut. All those predictions are wild guesses anyway. Let’s focus instead on the proper role of government and whether the money spent by government is spent wisely.