Deficit Reduction Will Not Work Until People Do

The awful truth is that last week’s highly publicized budget vote in the House--if sustained by the Senate--will probably make the deficit larger and the economy slower for some time to come.

That’s not only because of the energy tax--or gasoline tax, as it may become--on which a nervous Congress is battling a politically weak President.

The major reason deficit reduction will slow the economy is that it will pull money out of it. The deficit, which will run an estimated $260 billion in this fiscal year, is both a tonic and a drug.

The tonic part is not often acknowledged these days, but it’s very real. The deficit replenishes lost deposits in failed savings and loans, pays more in Medicare than the government insurance program takes in, funds welfare rolls swollen by high unemployment, keeps defense projects working a bit longer. Thanks to the deficit, we live better than we otherwise might. It’s a prop.

The aim of President Clinton’s budget package, which still must pass the Senate, is to wean the economy off that prop by stemming the deficit’s growth. If successful, the program would hold the deficit down to $200 billion in 1997 by raising taxes and cutting federal spending by $500 billion between now and then. The logic is that a $200 billion deficit in 1997 will be only 2.6% of the gross national product, where today’s deficit is 4.3% of the total economy.

But unless there is an accompanying rise in job-creating investment, cutting away so much support will “almost certainly hurt the economy and widen the deficit,” says S. Jay Levy, chairman of the Jerome Levy Economics Institute.

However, creating jobs would reduce the deficit dramatically. “If national unemployment now were back at 5.3%--the average of the late 1980s--the deficit would be $100 billion less today,” writes Northwestern University economist Robert Eisner in a notable article in the Harvard Business Review.

Jobs are key, as President Clinton recognized when he sent Congress an economic stimulus package before deficit reduction. But the stimulus bill was defeated, thanks in large part to his own political weakness, for which we all pay a price.

Make no mistake, the deficit does need to come down. It is a drug, distorting the economy and society. For one thing, it tends to transfer resources from younger people to older. Interest on the federal debt runs $210 billion a year. So taxes are levied on the entire work force to pay interest on Treasury securities held generally by older members of society and institutions investing retirement funds.

The deficit distorts our politics. In the last decade the federal government, going more deeply in the hole itself, mandated many tasks for state governments--which as a result are having a hard time balancing their own budgets. Among other irritants, the states cannot tax the interest on all those Treasury bonds Washington has been selling.

Clinton and members of Congress are aware of those realities. One significant step in the deficit package now emerging is an attempt to cap the rise in entitlements, such as Medicare and Social Security.

But that is a digression from the heart of the problem, which is how to restart economic growth in America. That’s the real reason everybody wants to cut the deficit--we believe that once we balance our checkbook, we can move forward again.

There’s logic in that belief. The hope is that reducing the deficit will lower interest rates and spur investment.

But interest rates are low now and likely to go lower--many economist see long-term bonds at 6% and Treasury bills paying 2% in the next year. Yet there is little investment; banks have more money than borrowers. The reason is that here in the United States, and in Europe and Japan, economies are working off a surplus of office buildings and factories built in the last few decades. That’s why we see businesses downsizing; they have realized that computerization reduces the need for old structures--and for vast numbers of employees. In this time of transition to an information economy, private investment is not supplying great job creation.

That’s why economists such as Eisner call for public investment, even at the risk of larger deficits. Eisner notes that throughout U.S. history, deficits and the public debt have gone up with depressions and wars, and down with prosperity--which often was spurred by government spending. The GI Bill for education, housing and business loans after World War II is a good example.

But government spending has become a dirty word in our politics. Posturing politicians claim that “government spending cannot create jobs.” But that’s nonsense--and particularly ironic at this time. For it was government spending in the last 50 years that created the enormous, technologically fruitful defense industry, which underwrote the prosperity we knew for decades.

Now, looking to a more peaceful time, we are reducing that defense industry. But without something in its place, jobs are a problem. We can bring soldiers home, but where will they work?

That’s why Clinton earlier proposed public spending to repair America’s old roads and bridges and to build new ones, including “information highways”--as a way of creating jobs. But he was defeated in that effort.

Which is too bad, because without job creation, reducing the deficit drug habit is likely to stall an economy that is already shaky.