Back when Ronald Reagan was president, he once said, “I never worry about the deficit. The deficit is big enough to take care of itself.”
According to some, there is support for that view in the Bush White House, too.
“Reagan proved deficits don’t matter,” Vice President Dick Cheney told former Treasury Secretary Paul O’Neill, according to a new book.
The context: The former secretary was trying to discourage another George W. Bush tax cut. He failed.
Both Reagan’s and Cheney’s views are questionable and go against the evidence that deficits, especially when they reach stratospheric levels, do matter.
They matter in particular to young people who will have to pay the debts of previous generations. They matter to businesses and individuals who might have to pay higher borrowing costs than they otherwise would as the economy rebounds. Deficits matter to future retirees, who might see their benefits cut before they can finish their working careers. And, oh yes, they matter from a moral standpoint.
They even mattered to Reagan.
First of all, Reagan’s famous deficit remark was in jest. In fact, Reagan twice raised taxes to lower the deficit after he had slashed taxes deeply upon his election. His chief domestic adviser, Martin Anderson, said in an interview last week that Reagan believed in a balanced budget but could never get Congress to cut spending.
Also, President Bush’s father raised taxes to lower the large deficit that arose during the 1980s and perhaps lost his presidency as a result. President Bill Clinton raised taxes, too, in 1993, and Congress followed spending limits throughout the 1990s to control the budget’s red ink. The Republican “Contract With America” of 1994 strongly favored budget austerity.
Those efforts combined with booming economy to produce four straight years of surplus, beginning in 1997. That was before the red ink turned into a gusher during the Bush presidency as the Sept. 11 attacks, recession, war with Iraq and the president’s own large tax cuts created the largest deficit in U.S. history this year: $521 billion.
Politicians who ran the government in the 1980s and the 1990s, including Reagan, thought deficits mattered. And now, after virtually ignoring the deficit in his first three years in office, Bush is coming around to that same point of view–Cheney’s reported quote to the contrary–although he won’t likely scale back his tax cuts.
Not all deficits matter. Relatively small ones can be managed when the economy is perking along, with little or no economic damage.
Big ones can be tolerated when the economy is in the tank or if the country is at war, as at the height of World War II, when the deficit was 30 percent of gross domestic product instead of the 4.5 percent today. During the Reagan years, deficits rose to 6 percent of the gross domestic product, and that alarmed many economists.
The economic effects of deficits aren’t always obvious. In fact, the country is running a record deficit now (in current dollar terms), yet interest rates are the lowest in 40 years, and the economy is recovering. Deficits can increase interest rates, but interest rates are also influenced by many other factors, such as economic conditions and Federal Reserve monetary policy.
But deficits truly matter in some circumstances, and one of those circumstances is rapidly approaching.
Not this instant, mind you, because the real problem won’t occur until early in the next decade, when the Baby Boom’s retirement will bring explosive costs to Social Security and Medicare that the U.S. government will not be able to cover without very large tax increases or spending cuts.
The Congressional Budget Office said that what the government spends on Social Security, Medicare and Medicaid will rise from 8 percent of the GDP this year (now at $11.4 trillion) to 14 percent of the GDP in 2030.
Gloomy outlook
“Such increasing demands on spending will exert pressure on the budget that economic growth alone is not unlikely to alleviate,” the agency said in a recent report. In other words, changes will have to be made, such as cuts in benefits or huge tax increases.
“The coming retirement of the Baby Boom represents a massive transfer of wealth from workers to retirees,” said Brian Riedl, budget expert for the Heritage Foundation. Running a large deficit in advance of this event isn’t wise, he said, “because deficits represent future taxes.”
In a study of budget trends, the Brookings Institution said the national debt will increase by $5.3 trillion over the next decade, so that by 2014 the increase in government borrowing will cost the average household in America an extra $3,000 just to pay interest on the debt.
Many concerned about the deficit believe that this is the time to get the budget under control.
Chris Edwards of the Cato Institute is concerned that, if today’s big deficits aren’t contained in a few years, America could be stuck with deficits as far as the eye can see.
But how to solve the problem is the problem. Gene Sperling, former economic adviser to Clinton, blames Bush’s tax cuts for the huge deficits he sees looming in the next 10 years. If the tax cuts are made permanent as Bush wants, the Congressional Budget Office says that could increase the deficit by another $1.4 trillion over the next decade.
Proving that a deficit is economically harmful is not as easy as it might seem. Most economists say that large, persistent deficits tend to make interest rates higher than they would be otherwise. That’s because the government finances the deficit by borrowing from the pool of private savings in America, reducing the capital that companies and individuals need, say, for buying a piece of machinery or a house.
Globalization has made this pool of capital much larger so that big U.S. deficits can be more easily financed overseas. But at the same time, America is increasingly relying on foreign sources of money.
In one sense, this is akin to being dependent on foreign oil because “we aren’t the masters of our destiny,” said Robert Reischauer, former director of the Congressional Budget Office and now president of the Urban Institute. “We could be creating financial instability in the world.”
As long as foreign countries continue to finance our annual deficits, some analysts said, the budget’s red ink isn’t such a big deal. Globalization of finance is here to stay, and the U.S. is a huge economic locomotive with a respected “safe harbor” currency.
But the value of the dollar has plunged recently, and there is more foreign concern about the U.S. deficit. The International Monetary Fund recently criticized America’s large budget deficits and urged more austerity.
National debt cited
To many economists, it isn’t the deficit that matters as much as national public debt, because that determines how much annual interest is paid by the government. It is now 37 percent of the GDP and rapidly on the rise. Some economists calculate that interest rates tend to rise as the percentage of debt to GDP creeps up.
Federal Reserve Chairman Alan Greenspan warned Congress in November that the deficit could have “notable, destabilizing effects” on the economy’s growth when the Baby Boomers retire as the result of rising interest payments on the national debt.
Bruce Bartlett, an economist who worked in the Reagan and first Bush administrations, said there is not much evidence at the moment that the deficit is causing higher interest rates, but he added that it could happen as the economy grows stronger. He said he favors more fiscal discipline.
But Bartlett isn’t as worried as some analysts about the deficit’s effect on the retirement of the Baby Boom. All the gloomy statements aren’t likely to come true, he said. Many Americans will postpone retirement and contribute to the Social Security system longer.
“I don’t think we are going to fall off a cliff,” he said.
Anderson, another Reagan adviser, also took a sunnier view about the long-term deficit problem.
“We pay far too much attention to what is going to happen five to 10 years from now,” he said. “Nobody knows the slightest bit what is going to happen.”
But the Heritage Foundation’s Riedl, only 28 years old, believes such an attitude is cavalier and calls the deficit a profound moral issue for his generation. He said Baby Boomers will get their benefits while the younger Generation X and Generation Y will face the big burden.
“Basically, I am going to be paying for it,” he said.
