21 February 2014

The 3 Big Lies About The Deficit

The deficit has  rapidly fallen from its peak of $1.4 trillion in 2009. This year the CBO is projecting the deficit to be $514 billion, and I think it could easily come in at $400 billion. Essentially, the deficit is down nearly a trillion dollars in 5 years and to about where it has been as a percentage of GDP for half a century.*

There are three big lies about the deficit that are rarely exposed. The first is that Republicans shrink and  Democrats explode deficits. Data from 1975 through 2014 easily refutes that. The second big lie is that the deficit is something conservatives dislike. And the third big lie is that our deficit is more important than half a dozen other economic questions.

Lie Number 1: Republicans Shrink the Deficit and Democrats Explode It

The blue lines in the following graph show the change in deficit as a percentage of GDP. For instance, in 1975, the first year in this graph, the deficit rose by nearly 3% of GDP. In 2014, the last year in this series, the deficit fell by 1.3% of GDP.

I've used the red state / blue state distinction to indicate whether the Oval Office is held by Republicans or Democrats. When the colored overlay is red (as in the 1975-76 period) the president is a Republican; when it is blue, (as in the 1977-80 period) the president is a Democrat.

As you can see, for this period of 40+ years, most of the blue lines above zero (that is, years when the deficit grew) coincide with Republican presidents, and most of the blue lines below zero (that is, years when the deficit shrunk) coincide with Democratic presidents.

In fact, on average the deficit grew by 0.8% of GDP when Republicans were in office and shrunk by 0.9% of GDP when Democrats were.  (As a percentage of this year's GDP, that's between $100 and $150 billion.)

You may have good reasons to vote for a Republican president but fiscal discipline should not be on that list. 

Lie Number 2: Conservatives Dislike the Deficit

The first regular use of government debt in the West after the fall of the Roman Empire was probably in Venice. The wealthy who could afford to support the government were given two choices: pay enough in taxes to fund Venetian government (specifically, a costly war was the big catalyst for this choice), or loan the government money. If they loaned the money, they'd get paid interest AND get their money back. If they paid taxes, they would simply lose the money. By buying bonds, worst case the government would be unable to pay back the loan and the rich would end up paying the sum in taxes anyway, but at least at a later time and after collecting some interest. Unsurprisingly, wealthy Venetians said yes to buying bonds instead of paying taxes. And soon a secondary market emerged that let Venetians sell those bonds to each other. This was a huge boon to the evolution of financial markets and government bonds were instrumental to first the Venetians and then the Dutch and then British becoming leaders in finance and the wealthiest people of their day.

Wealthy people like debt, like bonds, because they - quite rationally - would rather get their money back than lose it completely.

Government bonds - the debt - of modern democracies make for pretty safe investments. The US government has never defaulted on its debt. The Dutch have been regularly paying on bonds first issued centuries ago.  As long as inflation remains low, government bonds make an ideal investment if you're already rich and simply don't want to lose your wealth. Stocks and real estate are great investments but they're risky; if you are already wealthy, there is no sense in going for a double or nothing investment when the doubling would not change your quality of life but the nothing would. At a certain point it is rational to invest less for change, progress, and high returns than for a continuation of the status quo.

Lie number two is that conservatives don't really like government debt. They do. It's worth remembering that just before Clinton left office, projections suggested that the federal debt was going to disappear in about a decade. Alan Greenspan - the former Federal Reserve Chairman who dislikes social security and welfare and likes Ayn Rand - testified at the time about the dangers of not having any debt. Government bonds are, he said, a key part of investment choices. And he's right. Modern financial markets - that is, markets since before 1700 - have always offered investment choices that included government debt. That stability is a nice anchor to other, riskier investments.

Lie Number 3: The Deficit Is One of the Top 5 Economic Issues We Face
Still, politicians and reporters all talk about the deficit as if it something new and dangerous and more important than questions about how to stimulate economic growth, lower healthcare costs, protect the environment or create jobs and more engagement for workers. When the deficit was 10% of GDP it rightfully deserved some attention; now that it's back within historic norms, it only deserves some attention. The deficit has been fairly constant for centuries and whether economies have thrived or stagnated during that time rarely had anything to do with the deficit but instead had to do with things like innovation, problem-solving, and finding new ways to make people more productive. The deficit is not that important and real discussion about it is occluded by lies anyway (specifically these three lies). Focusing on the deficit allows everyone - reporters, politicians, and citizens - to avoid the real and creative thought that would be required to address significant economic issues.

*The 2014 deficit is projected to be 3.0% of GDP. The average from 1974 to 2013 was 3.7%. The average from 1974 to 2008 - the year just before the Great Recession - was 3.1%.


gabby57 said...

One of the things that keeps the "deficit" conversation going in circles is the lack of convention to either use the amount of deficit for this year vs. the amount of accumulated total debt.

This allows conservatives to cry about the total debt while the progressives can crow about how fast the debt is shrinking.

Ron Davison said...

Gabby - good point, thanks.
And actually, the debt is not shrinking - just the deficit.
I do think that the debt is a real issue but it simply - at current levels - doesn't rank very high as issues that will determine whether our future is prosperous or a slog.