As the national debt balloons, the deficit hawks have swooped in again, crying for “fiscal responsibility.” According to C. Fred Bergsten of the Peterson Institute for International Economics, that means restricting or cutting spending on “entitlements”– Medicare, Medicaid and Social Security–and imposing a national consumption tax. And now President Obama has heard their cries–and proposes to freeze discretionary spending–except for the military!
The hawks’ concern is justified. But their policy conclusions don’t follow.
When a government runs a “deficit”–spends more than it collects in taxes, –it borrows by selling securities, mostly short and long-term bonds known as treasuries. When a government runs a “surplus”, it pays off treasuries. People often muddle deficits–one year’s borrowing, with national debt–accumulated borrowing, which equals the quantity of treasuries outstanding.
Chart I shows national debt held by the public as a percent of US Gross Domestic Product (GDP), the total annual value of goods and services. From a high during World War II, it falls to an all time low in the mid 1970’s, rises under Reagan-Bush I, falls under Clinton, and begins to rise again under Bush II Debt as projected by the Congressional Budget Office (CBO) really takes off under Obama, as bailouts and stimulus take their toll.
High levels of national debt weaken the economy. That’s because buyers of the debt, domestic and foreign, substitute passive holding of US treasuries for productive investment. They avoid riskier but productive private investment in small to medium business–precisely the investments that create the most jobs and products and services per dollar invested. In economic language, the passive investments “crowd out” the productive ones.
The more unequal the economy the worse the effect. In fact, growing debt itself can worsen inequality. Consider who holds most of the debt: banks, mutual funds, large corporations, wealthy individuals and–in recent years–foreign governments, notably China. So a buildup of debt both cuts productive investment and tips distribution of wealth towards large passive entities.
The recent history of US debt supports the inequality connection. Chart II, from the US Census, shows the ratio of the 90th to 10th percentile of income, from 1967 to 2008–a rough measure of inequality. (By other measures, inequality fell steadily after WW II before the Census time series begins.) As the Census series shows, inequality loosely parallels debt as a percentage of GDP, at its lowest in the mid 1970’s, rising steeply during the Reagan-Bush I era, leveling off during the Clinton era, and rising again during the Bush II era. (Of course many other factors, including the business cycle, also affect year-to-year debt and inequality numbers.)
I don’t consider the debt-inequality parallel a coincidence. The same policies that drove up the debt after the 70s–tax cuts and other favors for wealthy interests, Star Wars and Iraq spending–also raised the level of inequality in the US. It’s also no coincidence that when President Clinton paid down the debt, we enjoyed a brief economic boom that increased jobs and wages, especially at the lower end of the scale.
Consequently the “stimulus”–funded by growing the debt–may do more harm than good. Money spent on “shovel-ready” construction, much of it in rural areas, may briefly create a few jobs–or divert a few jobs from elsewhere–but it’s not productive investment. Only where stimulus spending helps maintain vital high-value services, notably in health and education, can the benefits outweigh the economic drain of deficits–at least as a short-term measure. The “pop Keynesian” argument for the stimulus simply disregards both the quality of spending, and the damage from running up the debt.
So the deficit hawks are right about national debt. But the answer isn’t to cut social spending and raise regressive taxes. In brief, the answer is to go back where we were after World War II–to high social spending, high progressive taxes, and (sometimes) low military spending.
In Part II, I will address specific policy responses to rising debt.