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Thursday, February 05, 2004

Thought-Provoking Article by Rahn

Howie, I enjoyed the article you included by Richard Rahn. Before I go too far in praising it, however, I'd like to make note of a couple of points I found a bit troubling:

(1) Rahn presents statistics about growth, unemployment, and inflation in high-debt and low-debt years as if this year's total debt is highly correlated to these stats. I find this dubious. There are major lags between federal debt-financing and the potential negative repercussions of it. It should not be surprising at all that when debt is created, there is a fairly quick stimulus. This is easy to perceive on a personal level -- if I go borrow and spend $100,000 from the bank this year, I could buy a lot of nice things from my local merchants. A serious statistical analysis would look at lags and lots of other variables. I'm guessing that the overall direction or acceleration of the debt (i.e., the first or second derivative) might provide some additional insight.

(2) I'm also skeptical about the CBO projection. I'm guessing that he's quoting the projection widely cited in the news lately which does not include "extraordinary" spending on Iraq or Afghanistan. Ignoring these special costs might be tempting (since, theoretically, they should not be structural), but they are pretty darn big right now and may be for a few more years, adding a percent or two each year to the total debt. Further, I believe the CBO projection is based on the budget submitted by the administration. But, Bush has shown no inclination to curb spending (Rahn's own Cato Institute blasts him for increasing the NEA budget), and his enthusiasm for everything (trips to Mars!) seems endless. Are we to expect the Democrats to restrain spending?

All that said, Rahn's basic premise that our current federal debt levels are manageable is reasonable. However, other factors should not be ignored. Lack of leadership that actually wants to shrink government is a big problem. Highly leveraged U.S. citizens -- uncomfortably dependent on low interest rates -- are another concern. Finally, I haven't seen a good analysis of the impact of the upcoming demographic shift wherein a lot of baby boomers will go from savings mode to consumption mode. What will happen then?

As we've discussed previously, I do agree that more aggressive consumption taxes would be preferable to high income taxes. I do, however, believe that rich people should pay a higher percent of their incomes in taxes than poor people -- primarily achieved by having a very high exemption -- e.g., $50,000 for a married couple.

Maybe I'm too simplistic when it comes to debt, but running a 5% of GDP deficit in an economy that really is not all that bad seems unwise. What if we do experience another recession -- whether because of a Democratic president raising income taxes or some other reason? Will 8 or 10% deficits be OK?

The one point you, I, and the Cato Institute do agree upon is that federal spending is too high, and the federal government is too intrusive. I have little confidence that either Bush or Kerry will move in the right direction on these issues.

Thanks for the article. I'll look forward to your more extensive thoughts on this issue.

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