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Saturday, November 22, 2003

Is the Deficit too Small?

No. Really. I'm not joking (well, maybe a little). From an article in the Washington Times:
The conventional wisdom is our federal government deficit is too large. However, the empirical evidence suggests the deficit might be too small. [...]

The total federal government debt held by the public (which is the relevant number to be concerned about) dropped from 42 percent of gross domestic product (GDP) in 1962 to a low of 25 percent in 1975, then rose to a high of 50 percent in 1993, and then dropped back to 33 percent in 2001. Currently, debt as a percent of GDP stands at about 35 percent.

Since 1963, we have had 14 years when debt has been below 33 percent of GDP and 26 years when it has been higher. Conventional wisdom is that economic performance should have been better in the years when we had less relative debt, but the facts are the opposite. Real economic growth averaged 3.47 percent in the high debt years, which was almost 1 percent higher than the 2.59 percent average growth of the low debt years.

Unemployment was also lower in the high debt years averaging 5.65 percent as opposed to 6.43 percent in the low debt years. Inflation averaged a whopping 7.6 percent in the low debt years, almost 3 times as high as the average 2.95 percent of the high debt years.

The Congressional Budget Office (CBO) estimates federal debt could grow to as much as 40 percent of GDP by 2005 and then begin declining again. From 1986 to 1999, it was above 40 percent, and we did quite well during most of those years. Recent data showing both much higher economic growth and higher inflation (meaning much higher nominal GDP) than the CBO forecasted means the debt GDP ratio in fact is likely to remain almost constant. [...]

Finally, the analysis of the historical data clearly indicates that if we had properly structured tax cuts (like the first Reagan and the most recent Bush tax cuts) in 1969, 1973, 1979, 1989 and 2000 we may have avoided the recessions, with all their human misery and unemployment, that occurred the year following each of the above dates. Unfortunately, policymakers in all of those years were more preoccupied with reducing the deficits rather than keeping the economy growing.

The lesson is clear, economic prosperity can continue, even if the federal government never balances its budget, provided it keeps government spending from growing as a percentage of GDP, and has an ongoing program of removing tax and regulatory impediments to growth.
Obviously, the debt itself isn't what causes superior economic performance. It's probably reduced inflows to the government (i.e., reduced taxation) which then causes both the increased economic performance and also the debt. Nonetheless, DOD (debt obsession disorder) is at this point,more of a problem than the debt itself (in my opinion).

This article also reminds us that as more and more worldwide economic data becomes available, it is critically important to learn from, and rely on that data, as opposed to relying on economic theory or "common sense". There will continue to be situations where there is no comparable historical data, but these situations are becoming fewer and farther between. In every case where taxes above 20% of GDP are cut, growth accelerates (with a slight lag). In every case growth eventually benefits the poor (though never as much as the rich). Therefore, if you want to help the poor, cut taxes.

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