Arnold Kling  

Why U.S. Budget History is Not Encouraging

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My essay claims,


there is no precedent for reducing the ratio of debt to GDP by simply growing our way out of it.

My general worry is that the essay is incomprehensible to people who have never walked through the algebra of the ratio of the debt to GDP. See the end of this post.


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CATEGORIES: Fiscal Policy



COMMENTS (6 to date)

Not encouraging? To me, signs that the U.S. government's ability to spend money has reached a limit is encouraging (though I acknowledge it will be hard on people on a fixed income).

What is even more encouraging is Arnold's observation that the U.S. government cannot tax as efficiently as most Western democratic governments because in the U.S., much more tax money is collected by state and local governments.

In fact, it seems to me that one of the most effective ways to preserve liberty (and particularly, freedom from high taxes) is to help the big-government states like New York and California protect (bet yet, to expand but that is unlikely) their ability to collect taxes -- in other words, to help New York and California resist the natural tendency of the federal government to try to replace state and local taxation with federal taxation -- because that will cause the tax payers in those state to pressure the federal government to tax less, which will in turn make the states and localities with low tax burden an attractive target for immigration by liberty-loving U.S. citizens. (I believe that there is no significant benefit under current conditions to try to protect the liberty of U.S. citizens who do not care enough about their liberty to consider and plan to move eventually from a high-tax U.S. state to a low-tax U.S. state.)

In other words, because U.S. states enjoy significant taxing power -- and in particular, because one U.S. state has to power to collect taxes at a much higher rate than other U.S. states choose to do -- the fact that there are no significant legal barriers for a U.S. citizen to change states is one of the world's most important opportunities for competitive government even though U.S. states enjoy limited sovereignty.

So for example, those of us wishing to preserve liberty might donate money or acquire expertise in helping the public-employee unions of New York and California resist more effective regulation of their pension systems because that will tend to increase the tax burden of residents of those states, which will again cause them to pressure the feds to keep federal taxes low (by voting, lobbying, refusing to work or working under the table when taxation reaches a certain threshhold). Resisting the creation of new federal mandates and new federal agencies (such as the creation by the Carter administration of the U.S. Department of Education) in areas traditionally handled by state and local governments would seem to be another effective way to protect liberty.

Yes, I know this sounds wasteful, but in a democracy not in a state of civil war, expanding and entrenching government power is so much easier than going in the opposite direction and there are so few other promising way to protect liberty that such strategies seem worthy of serious consideration.

mulp writes:

Here's the title I would use:

"We can't tax cut our way to a balanced budget"

The argument has been that tax cuts will increase growth and that will balance the budget. That has clearly been proven false.

Obama started off massively cutting taxes, a larger tax cut to stimulate the economy than Bush in 2001 or Reagan in 1981.

I do take issue with your claim that Federal revenues generally run 20% of GDP; that has been true only for a short time since 1980 for the last few years of the Clinton budgets which started off with tax hikes that were forecast to cause a major recession, coming as they did on the heels of the Bush tax hikes in the middle of the 1990 recession.

One important point is that tax revenue are highly tied since the 80s especially to earned income. If employment falls, not only do the costs of government increase significantly, the tax revenue falls significantly as well. The deficit isn't so high because of spending, but because Federal tax revenues are so low at less than 15% of GDP. That is down from more than 20% of GDP in the last years of Clinton budgets, but they were well over historic post war levels.

And we have the Bond Market Vigilantes at work today, borrowing from the Fed at near zero and then charging 3% to government in the best case and 5+% to the private sector. Even as real assets are still falling in price, and wages and consumer goods are struggling to stay flat, interest rates are higher than in the 50s and 60s when inflation was very real. And the rising stock market prices indicates lots of cash is sloshing around looking for a return even as many firms are still cutting their real capital assets to spike profits.

I find it interesting to read Bill Clinton's address to the nation February 17, 1993. In many respects it was relevant to February 2009, but instead of the tax hikes Clinton proposed, Obama called for massive tax cuts, like Bush in 2001 and Reagan in 1981, to spur growth and reduce the deficit. Clinton proposed tax hikes on those who had done very well even as the working and lower income classes lost ground.

But Obama said he learned from Reagan. Tax cuts are politically popular and the way to the voter's heart. And Reagan proved deficits don't matter, or so Cheney claimed.

Bob Murphy writes:

Krugman claims the opposite--namely, that the US *did* grow out of its WW2 debt--and it seems he offers pretty convincing evidence: The absolute size of the national debt didn't shrink after WW2, but GDP grew a lot faster.

Assuming those facts are true, I don't see how Kling can possibly be right. I read the article, but I still don't see how he gets around the basic facts about what happened to the numerator and denominator in the debt/GDP ratio.

Arnold Kling writes:

Bob,
Suppose that every month the payments you make to your credit card company exceed your new expenses. Call those your primary surpluses.

Your loan balance could nonetheless keep going up, because of interest charges. Your debt/income ratio could still decline, because your income grows faster than your debt.

You want to say that this is growing your way out of debt. I want to say that, without those primary surpluses, you never would have been able to do it. That is, if you had kept spending more than you paid the credit card company each month, you would not have outgrown your debt.

The historical numbers in the U.S. are that we did not just sit back and grow our way out of debt. We shrank our debt to GDP ratio when we ran primary surpluses.

The latest CBO forecast has the U.S. running primary deficits all the way to 2020, when they only start to get bigger. Thus, the ratio of debt to GDP is going to explode, even with growth of GDP.

Ritwik writes:

Arnold, the data you present in your article is as compelling a data-based macroeconomic case as I have ever seen - AGAINST your argument.

Take the period in which the US reduced its debt/GDP the most - 1950 to 1969. You present four periods. The average 'growth factor' (taking a quick and dirty arithmetic mean) for those 4 periods is 22.2% Of GDP. Similarly, the average primary surplus is 7.1%. Of net outstanding debt. Which itself went from 79% to 29% in those years (let's take 54%). This translates to 3.9% of GDP.

Of course, 3.9% of GDP and 22.2% of GDP does not translate to debt reduction of 26.1% per period (nearly half of that, due to obvious reasons). However, it gives an idea of the proportion that was contributed by each. 22.2/26.1 is nearly 85%. So cut all the primary surplus that the US ran, and my estimate it would have still reduced its debt/GDP from 79% about 33%. 33% vs. 29% is not a huge deal at all!

Of course, one could argue that if the US was not running primary surpluses, its growth factor would have reduced too (bond vigilantes et al). But then again, if the US was not growing so fast, it may not have been running primary surpluses either.

If I was PK, I'd wear a placard with your data and a 'I told you so' printed on it.

Ritwik writes:

"That is, if you had kept spending more than you paid the credit card company each month, you would not have outgrown your debt."

Why not, if my income is rising much faster than the interest rate the credit card company is charging me? That is precisely your growth factor isn't it?

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