Lecture Thirty
Deficits and Debts I
(Economics 100b; Spring 1996)
Professor of Economics J. Bradford DeLong
601 Evans, University of California at Berkeley
Berkeley, CA 94720
(510) 643-4027 phone (510) 642-6615 fax
delong@econ.berkeley.edu
http://www.j-bradford-delong.net
April 19, 1996
Administration
Government Deficit--This Is a "Long Run" Topic
Supply-Side Effects of a Large National Debt
National Debt in Historical Perspective
Administration
I have been reading through midterms. I have come up with the
following conclusions:
(a) this midterm was too long... (but the last one was too short;
"Goldilocks" final
(b) people did surprisingly well on this midterm--better than I had
expected. So I was happy (even though you, perhaps, were not so
happy.
View: Jeffrey Frankel and I are thinking about next fall's version of
this course. What do you think of Mankiw's book? If it is to be
replaced, replace it by a book with (a) more math, (b) less math, (c)
more examples, (d) more institutions...?
Government Deficit--This Is a "Long Run" Topic
Today I want to move into a different subject, that of chapter 16 of
Mankiw--debates about the government debt.
Important topic--seems that our federal politics talk about nothing
else than "balanced budget"
Put U.S. debt in perspective:
U.S. not unique--other countries have larger debts
Supply-Side Effects of a Large National Debt
A drag on U.S. productivity through higher tax rates... 60% of GDP x
2.5% real interest rate means that 1.5% of U.S. real GDP is taxed
just to be transferred.
What does it mean that the federal government has to collect an extra
1.5% of GDP in taxes--has to raise taxes from, say, 20% of GDP
(needed to pay for government programs) to 21.5% of GDP?
- Net of tax rate down from, say, 60%; to 58.5%--a fall of
1/40...
- Return on investment down by perhaps 1/40; return on labor
income down by perhaps 1/40; do people invest more (and consume
less) to reach their target rate of accumulation? Do people invest
less because of the lower rate of return? Do people work less
because of the lower real wage? Do people work more because more
hours of work are needed to meet their target income?
- We don't know. But the fact that we don't know means that such
effects are relatively small, in all likelihood.
- Say, an elasticity of labor and capital supply of -0.5--would
mean that we are now poorer by about 0.75% of GDP as a result of
the fact that we have a large accumulated national debt to service
than if we were, say, debt-free.
- In one sense, it is as if we had an unemployment rate 0.75%
higher forever; in another sense not--distributional impact is
very, very different
What to do about debt and deficit?
National Debt in Historical Perspective
In the old days, little debt. In fact, in the old days, little
federal government. Debt-to-GDP ratio up to perhaps 30% of National
Product in a war, but little outside of a war.
Pattern of spending. Post-Civil War return of spending to a very low
level. Run your national debt/GDP ratio down to zero after a war.
Andrew Jackson paid off the national debt in the 1830s. Post-Civil
War debt. Veterans' bonus programs. 1913 debt of 3% of GDP; 1930 debt
of 20% of GDP; 1975 debt of 25% of GDP.
With the end of World War I, however, government spending did not go
all the way back down to its pre-war share of GDP. Whether it would
eventually have done so or not in the absence of a Great Depression
is unclear--but with the Great Depression, the movement of the
federal government into infrastructure spending in a big way for the
first time, and so forth (Social Security system) civilian spending
bounced up to nearly ten percent of GDP.
And then came World War II, the Korean War, and the postwar
military-industrial buildup associated with the Cold War.
Taxes kept pace--and the underlying growth of the American economy
steadily reduced the outstanding national debt as a share of GDP.
(Expand on this: D/Y down from 112% at the end of WWII to perhaps 25%
in the mid-1970s.)
Since the end of the 1970s things have turned very strange: doubling
of debt-to-GDP; first-time emergence of large persistent peacetime
budget deficits. Steady walking away of expenditures from revenues
(which have been relatively constant as a share of GDP).
Four reasons for persistent budget deficits in the 1980s and 1990s:
- The post-1973 productivity slowdown
- The Reagan tax cuts (the Laffer Curve; too small by a factor
of three or more; not to say that there aren't lots of times and
places where Laffer Curve effects are important)
- Loss of political immunity against budget deficits as a result
of "Keynesian" expenditure policies. Cyclical deficit--good;
structural deficit--bad seems just a little bit too hard a lesson
for American politics to keep in its small collective brain.
If you look at, say, the Wall Street Journal editorial
page, you will find a fourth reason mentioned:
- Legislative changes in 1974 that established the current
congressional budgeting office, and (they claim) created a
persistent bias toward spending and excessive deficits.
I have never been able to make any sense out of this argument at
all; in the 1980s (and so far in the 1990s as well), actual budget
outturns have always shown a smaller deficit than original
presidential submissions; and congressional legislation has always
shown a smaller deficit than the presidential submission. Spending
priorities have been changed--yes (in the 1980s toward less defense
and more social programs than Reagan asked for; in the 1990s the
reverse; Dianne Feinstein: B-2 bomber carries a large payroll...).
But overall legislation tracks the presidential submission.
There are some glorious passages from the political rhetoric of the
1980s. For example, Martin Anderson, former domestic policy advisor
to President Reagan, on pages 184-186 of his book Revolution:
[W]hy are we running a triple-digit billion dollar
deficit...? Why don't we adopt responsible fiscal and monetary
policies and balance the budget?... [T]he real culprit in federal
spending is the Congress of the United States... only the Congress
makes laws. The president may propose the initial spending plan, the
federal budget, but it is the Congress that disposes, that shapes,
and that approves the final spending plans.... For a politician,
being able to spend $200 billion extra a year on popular programs...
and... do it without doing the unpopular thing of raising people's
taxes, to instead pay for this current largesse with borrowed money,
is so compellingly attractive... [T]he current institutions of our
political system are unable to withstand the power of the special
economic interest groups who benefit....
Time and time again President Reagan... sent budgets to the U.S.
Congress to limit and control federal spending. Time and time again,
the Congress has rebuffed those plans, and substituted levels of
spending they, and they alone, considered appropriate. But how does
one go about forcing our elected congressmen and senators to take
responsible positions on fiscal policy?
Note that Martin Anderson is not quite lying. He never
quite says that Congress took the (balanced) budgets submitted by
President Reagan and made them massively unbalanced--but he clearly
would not be very upset if that was the impression of the 1980s
budget struggles that you were left with after reading the book.
He never makes the point that final congressional action usually
closely mirrors initial presidential proposals in broad totals:
congressmen are extremely unwilling to raise taxes by more (or cut
taxes by less) than a president has proposed, or to spend less on
programs than a president has proposed. They will do it--but they
will only do it a small amount. They are infinitely, infinitely
happier when the president will identify his own political prospects
with the deficit reduction program...
The fear is that the president will do to them what Reagan did on
taxes--these people are denying you your tax cut.
- Or what Clinton did on Medicare in 1995...
Remedy, an informed citizenry...
Digression on Martin Anderson; the Hoover Institution; "Imposters in
the Temple"....//from my perspective, Hoover is the problem.
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