Good Effects of the Deficit Suggest That Maintaining Status Quo Is the Best Plan

Today’s “unanimous” agreement that the U.S. budget deficit poses such a threat that almost any deficit-reduction package should be accepted by a new President is neither unanimous nor based on fact.

In contrast to the “awful” things that might happen if we don’t do “anything necessary” to cut the budget deficit, there are five good points about the deficit that are solidly in the realm of the actual instead of the possible.

First of all is the solid reason that no disaster has yet befallen us. The deficit is coming down at the right pace. A close look at the budget numbers shows that the rapid spending growth and lower taxes attributed to the Reagan revolution ended three years ago.

The average growth rate of federal spending for the past 20 years (measured in current dollars) has been 9% a year. Since 1985 the annual growth rate of federal spending has dropped to 4%. If the annual growth of federal spending during the next Administration could be cut to 4% from the 5% currently planned, the 1993 deficit would be 0.9% of gross national product--well below the 1973-80 average of 2.4%.

Part of the reason that the virtual elimination of deficit spending is well within the grasp of the next President stems from the fact that, taken as a whole, the Reagan years have not been low tax years. The steady rise in the Social Security payroll tax and the post-1986 increase in corporate taxes have combined to increase federal revenues to about 19.25% of GNP in 1988--well above the 18.5% average revenue share of GNP during the two Administrations preceding President Reagan’s. Taxes do not need to be increased, because they already have been increased.

The second good point about the federal deficit is the defense that it provides against the many special-interest groups wanting to undo the Tax Reform Act of 1986. That landmark legislation provided for a revenue-neutral cut in marginal tax rates by broadening the tax base. Tax breaks cost revenue. Lost revenue or more spending means a higher deficit, and nobody wants to be in a position of pushing up the deficit at a time when everybody thinks that it needs to go down.

The third good point about the deficit is that it is forcing economists to rethink their theories on debt accumulation and its effect on the economy. If the actual fiscal events of the last seven years had been described to most economists in 1981, they would have predicted calamitous recession, soaring inflation or some disastrous combination of the two. Neither has occurred.

The American experience has caused many of us to look at other industrial countries with regard to the accumulation of government debt. Such an investigation discloses that a debt-to-GNP ratio in the range of 40% to 50%, the range currently prevailing in the United States, is typical of advanced industrial countries like Japan and the United Kingdom.

A fourth good point is that the deficit has discredited the old shibboleth that deficit finance always leads to faster inflation. It is ironic that at a time when most analysts are claiming that “monetarist” propositions no longer hold, the price level during the 1980s obeyed the most fundamental monetarist proposition of all: Inflation is ultimately a monetary phenomenon. Provided that abnormally large deficits are not accompanied by abnormally high money-growth rates, inflation need not be an inevitable result of deficit finance.

We did learn that large deficits accompanied by a monetary policy aimed at avoiding inflation produce a strong currency and large dislocations in the manufacturing sector. The degree of those dislocations, and the fact that we’re still working our way out from under some formidable problems created by an overly strong dollar, suggests that more attention should be paid to the international effects of the fiscal-monetary policy mix. It was an expensive lesson, but, having learned it, we need not repeat the same mistake.

The fifth good effect is that the deficit has initiated a fundamental rethinking of America’s role in the world. I refer to the strains that large deficits create concerning the allocation of federal spending, coupled with their effect on exchange rates and the trade balance. Taken all together, these realities have led to an increasing awareness that America is evolving from a position of leadership to a first-among-equals relationship with its allies.

Obviously even the silver linings cannot allow us to forget about the deficit. We still have a debt about $750 billion larger than it would have been had pre-Reagan budgetary trends been followed. And we are in no position to undertake new government programs or to cut taxes further.

Remember, a cut of only one percentage point in the growth of federal spending over the next four years would get us close to a balanced budget. That fact should put our budget problem’s size into perspective. And from that view maybe the best thing that America’s newest National Economic Commission could do is--gasp!--nothing.