The Deficit Scare: Myth vs. Reality

If right-wing deficit hawks get their way, they will eliminate an essential tool for fighting economic recessions and cripple our ability to make the crucial public investments in education, technology, and infrastructure that would lay the groundwork for future economic expansion.


In recent years, a new and dangerous front has opened up in the conservative war on government: the battle over deficits and debt. The anti-government forces have tried to portray their position as merely one of fiscal common sense. They say that it is simply a matter of not spending more money than one earns. But make no mistake: this anti-debt crusade is a highly politicized effort to fundamentally undermine liberal programs and progressive government in this country.

If the deficit hawks are successful, they will do major damage to society and the economy. They are promoting a deficit hysteria in an effort to force the government to enact deep cuts in vital social programs like Social Security, Medicare, and Medicaid. This fiscal austerity movement would also prevent the government from using deficit spending to speed the recovery of the economy when it is in recession. And it would inhibit us from making the crucial public investments in education, technology, energy, and transportation that are necessary to improve society and lay the foundations for future economic growth.

The Anti-Deficit Campaign

 First, let’s be clear on the terminology. The “deficit” is the yearly difference between the money the government takes in and what it spends, while the “national debt” is the accumulation of the yearly deficits. The debt is funded by the federal government selling Treasury securities like T-bills, notes, Treasury Inflation-Protected securities, and savings bonds to the public.

Since the election of President Obama, the Republicans have been working diligently to whip up public panic about growing deficits and the debt. Conservative commentators like Glenn Beck have been pushing this issue hard in their daily tirades against overspending “socialist” government. These ideologues maintain that deficits hurt economic growth and that the national debt is putting an unfair burden on the future generations. The only answer, they argue, is to reduce government, rein in public spending, and to move toward balanced budgets.

Also leading the charge to alarm the public has been private-equity billionaire Peter G. Peterson. For 25 years he has been warning that the growing national debt would lead the economy into a disastrous collapse – even during the Clinton administration when many economists predicted many coming years of budget surpluses. In recent years he has pledged to spend a billion dollars to convince lawmakers that we must drastically curtail spending and reduce Social Security and Medicare benefits. He has funded a foundation dedicated to this cause, produced a documentary shown on PBS, and created an on-line newspaper, Fiscal Times, to spread his alarmist point of view.

Despite the fact that Peterson’s anti-deficit arguments rely on highly questionable predictions and fuzzy math (more on that later), he has been effective in his efforts to woo lawmakers to his cause, even some Democrats. And all these conservative propaganda efforts are having an effect on public opinion, with more Americans saying that deficits are one of the most serious problems facing our country.

Clearly this anti-deficit campaign is part of the larger “starving the beast” strategy that was discussed in another article. But deficits and debt are complicated topics that merit some analysis on their own.  This article takes on the “deficit hawks” and critically examines their arguments. It will show that (1) Republicans only care about deficits when the money is being spent on liberal programs; (2) our current large deficits have not been caused by overspending by the Obama administration; (3) deficit spending is an essential tool for combating economic recessions and depressions; (4) public debt can fuel vital public investments in education, technology, and infrastructure that lay the groundwork for future economic expansion; (5) the inflated and misleading right-wing rhetoric about deficits and debt is distracting from a more rational and helpful discussion of the financial problems that we do face as a nation.

Deficit Hypocrites

Before considering what exactly is wrong with the conservative critique of deficits, it is first useful to see just how hypocritical many of them are about this topic. In reality, most conservative politicians don’t care nearly as much about deficits as they claim. Consider the evidence: most Republicans in Congress did not become deficit hawks until after President Obama was elected. During the previous administration they were busy helping President Bush turn the budget surpluses of the Clinton era into large deficits. Most conservatives did not see this rapid increase in the national debt as a problem at all. Vice-President Cheney blithely dismissed those issues at the time by saying, “Reagan proved deficits don’t matter.”

So clearly many Republicans think deficits are just fine when they are spending the public’s money on their own political priorities. It didn’t bother them to fund the wars in Iraq and Afghanistan by massive deficit spending. And they were all too glad to add hundreds of billions to the national debt by passing several enormous tax cuts – money that went largely to the wealthy. The Center for Budget and Policy Priorities has estimated that those wars and tax cuts will eventually contribute a whopping $7 trillion to federal deficits by 2019.1  

Many Republicans know – or should know – that almost all the projected deficits in the coming years have nothing to do with “out of control and irresponsible spending” by the Obama administration. Consider, for example, the projected deficit for 2013 of $962 billion. A study has shown that 42% ($402 billion) of that deficit will be due to the Bush-era tax cuts. Costs of the Bush initiated wars in Iraq and Afghanistan will account for 16% ($153 billion). Another 41% ($395 billion) of the deficit will be caused by the economic downturn that began in 2008.2 This last figure includes lost tax revenues, money for the bailout that was necessary to prevent a complete economic meltdown, and money for an economic stimulus package to speed economic recovery. All these factors together will amount to 99% of the deficit in 2013!  But this reality is being ignored by Republican politicians who continue to erroneously claim that Democrats and their policies are the main cause of our deficit problems.

Further evidence of Republican hypocrisy about deficits can be found in the way they ignore obvious ways of addressing this problem. If they really cared about reducing deficits, they would be enthusiastic about letting the Bush tax cuts expire. This would be the single most immediate and effective way to help rein in deficit spending. But instead, in 2010 they refused to extend unemployment benefits to millions of Americans until the Democrats agreed to extend all of these tax cuts – thus adding hundreds of billions to the national debt. Apparently, preserving low taxes, especially for the rich, is the real number one priority for Republicans, not cutting the deficits.

As their behavior indicates, many Republicans are not in principle against deficits, only deficit spending they don’t agree with. It is only when the Democrats want to spend money on things like making health care more accessible, improving education, or extending unemployment benefits that suddenly deficits matter and we are “broke” and “can’t afford” these “irresponsible” expenditures.

 

  

  

The Real Reasons the Republicans are Pushing Deficit Reduction

If deficit reduction isn’t a matter of principle for many Republicans, what are the real reasons they are pushing this issue so hard? There are two. First, conservatives believe that deficits make a good campaign issue. They need something to rile up people – something to fan their anger and resentment against government – and deficits fit the bill. Unfortunately, it seems to be working. Polls find increasing numbers of Americans are mentioning deficits and the national debt as one the most important problems facing our nation.

However, the main reason the Republicans have seized on this issue is that it is a good way to reduce government or at the very least prevent its expansion. Efforts to rein in the budget have long been a part of their “starving the beast” strategy that was described in another article. That is why Republicans have no interest in one of the obvious ways to approach this problem: raising taxes so government does not have to borrow so much money to pay for necessary programs. In their view, there is only one way to addresses deficits: cut spending. Of course this could eventually necessitate cutting back on many of the established liberal programs – like Medicare and Medicaid – that Republicans have never liked. In fact, the Republican budget proposal in 2011 actually called for ending Medicare and Medicaid as we know them.  In the end, this renewed conservative concern about deficits is simply a new way to pursue their real goal – reducing big bad government.

Deficits Are Good During Recessions

But irrespective of their motivations, aren’t Republicans right that deficit spending is a terrible idea and we must stop doing it? Aren’t balanced budgets just a matter of common sense? The answer is “No.” In fact, a good case can be made that deficit spending is an indispensable government tool in addressing serious economic problems.

For example, most economists agree that deficit spending during a recession, especially a severe one, is a very good thing to do. Even though tax revenues are decreasing, the best thing for the economy is for the government to keep spending money, and even increase spending. When consumer and corporate spending are swooning, only the government is in the position to spend money and stimulate economic activity. The market will not take care of this problem, so the government must step in.

Government spending has a multiplier effect that provides a large economic boost during recessions. If it spends money on building schools and roads, for example, that money first helps constructions companies. These companies in turn will hire more workers who will then spend more money on goods and services, thus helping other businesses. The construction companies will also purchase more tools and materials from other businesses, who will then hire more workers, and so on. In this way, deficit spending spreads through the economy, lessening the impact of recessions and helping to speed economic recovery. And as the economy rebounds, this produces higher tax revenues, which eventually lessens the need for deficit spending.

Contrary to the wildly erroneous claims of the political right, most economists agree that the deficit spending and economic stimulus programs of the Obama administration provided enormous benefits. A 2010 study by Alan Blinder of Princeton and Mark Zandy of Moody’s Analytics found that the combined effect of the fiscal stimulus package, TARP, and the actions of the Federal Reserve Board raised real GDP 11% over where it would have been, saved an estimated 8 million jobs, and probably averted deflation and a depression. They concluded: “It is clear that laissez faire was not an option; policymakers had to act. Not responding would have left both the economy and the government’s fiscal situ­ation in far graver condition. We conclude that Ben Bernanke was probably right when he said that ‘We came very close in October [2008] to Depression 2.0.’”3

The worst thing the federal government could have done was to listen to the deficit hawks and curtailed spending in the face of a severe recession. To see why, you simply need to look at state governments that did this in recent years. As their economies were tanking, many state governments – which are constitutionally required to balance their budgets – had to lay off workers, cut benefits to individuals, and curtail purchases of goods from the private sector. This simply made a bad economic situation worse. It created a kind of reverse multiplier effect, taking money and jobs out of the economy and lowering demand for goods and services in an already weak economy. Instead of speeding an economic recovery, this kind of frugal spending policy actually slows it down. It hardly makes sense to kick the economy when it is down, but this is what happens if governments are forced to balance their budgets every year.

 

If the Republicans continue to be successful in blocking further stimulus spending, this will only hurt the economy. At best, it will delay recovery from the recession, and at worst, it might actually precipitate a dip back into more severe recession. Either way, this will only add up to more suffering for millions of American workers. Chronic long term unemployment has reached heights not seen since the Great Depression of the 1930s. This is the real crisis facing many Americans. They are out of a job, out of savings, and losing their house. Their American dream is fading fast. Only the government is in the position to help – to stimulate the economy to produce more jobs. And yet the Republicans keep insisting that budget balancing must be our first priority – thus leaving millions of jobless working class and middle class Americans hung out to dry.

Bogus Math and Questionable Estimates

Peterson and many other fiscal austerity zealots rely primarily on highly questionable predictions that budget deficits and the debt will soar to unimaginable heights several decades from now. They predict economic doom as interest rates soar and investment grinds to a halt. But as numerous critics have pointed out, predictions that extend out several decades are extremely unreliable and depend entirely on the assumptions one uses. For example, slight changes in his assumptions about the rate of economic growth or key tax rates would mean that none of his dire predictions about soaring debt would actually come about.

 Robert Kuttner is particularly critical of the misleading calculations in Peterson’s analysis:

The Peterson Foundation’s central claim of over $50 trillion in unfunded liabilities is arrived at by miscounting apples and oranges. The only true figure for debt—that is, debt on which actual interest is paid by taxpayers—is the public debt held by the public, estimated as of January 12, 2009, according to the Treasury, is $7,781,352,915,790.80.

The Treasury Department’s figure for public debt is about 54 percent of GDP, a far smaller portion of GDP than at any time during the quarter-century after World War II, a period of record economic boom. The rest of the Peterson Foundation’s fanciful arithmetic is derived by adding debt that one government agency owes to another (another roughly $4.5 trillion) as well as the projected seventy-five-year deficits for Social Security, Medicare, and Medicaid, using worst-case scenarios.4

Social Security is a good example of just how questionable Peterson’s alarmist analysis really is. There is clearly no immediate crisis and not a likely long-term problem either. The Social Security payroll tax was hiked in the 1980s to handle the increasing number of baby-boomers retiring now. As a result, the program's trust fund is projected to grow steadily, with a surplus lasting until at least 2027. After that, some very small modifications in income or payouts could return the system to surplus. Even if that wasn’t done, the program will still be able to pay 100 percent of benefits until 2041.5

The only way that Peterson can make Social Security look like a problem is if he projects the program out 75 years, and assumes very low rates of economic growth and wage increases. Slightly more optimistic economic assumptions would mean that Social Security would be quite viable for the foreseeable future. So to whip up public panic about the Social Security system, as Peterson and his allies have done, is simply irresponsible.

 

 

Deficits and Debt can Encourage Economic Growth

Conservatives are also wrong when they argue that deficit spending and a large national debt will inevitably undermine economic growth. To see why, we need to simply look back at times when we have run up large deficits and increased the national debt. The best example is World War II when the national debt soared to 120% of GDP – nearly twice the size of today’s debt. This spending not only got us out of the Great Depression but set the stage for a prolonged period of sustained economic growth in the 50s and 60s. Massive investments were made in science and technology, American workers were re-trained and re-employed, private investment was encouraged, and consumer purchasing power was increased. That 25-year post-war economic boom, with the most rapid increase in living standards in our history, would not have happened without the stimulus of all this deficit spending.

History also shows that balancing the budget does not necessarily ensure a spurt of economic growth. In fact, in most periods when we have not had deficits, such as the 1990s, this was followed by an economic recession.6 So there is clearly little historical evidence to show that deficits and debt inevitably hurt economic growth.

But what about the conservative argument that public spending “crowds out” private investment, to the detriment of economic growth? They maintain that if the government is borrowing a lot money, that is money that the private sector cannot invest to increase its production and productivity. This has to undermine economic growth, right? The answer is “No, not necessarily.”

As most economists point out, government spending also has a “crowding in” effect that actually encourages more private investment. That is because much of the money that the government borrows and spends goes to the private sector. Private industry must then prepare to provide the various goods and services demanded by the government – such as weapons systems, green energy systems, new roads and schools, etc. In order to do this, these businesses must invest in new production facilities and greater productivity. This “crowding in” effect thus helps to mitigate any negative effects that public borrowing has on the private sector by indirectly encouraging more private investment and business growth.

Investing in America’s Future

But there is even a more important issue here – one often brought up by Joseph Stiglitz, a Nobel Prize winning economist. He argues that deficit spending, when it is done right, can be a major stimulus to economic growth and actually lower long term government debt.7 When economic growth is back on healthy terms, this leads to increased tax revenues, which eventually lessen the need for government to borrow money. For Stiglitz, the key is to spend that deficit money on things like education, technology, and infrastructure that lay the groundwork for future economic expansion. We will not remain competitive with other countries for long if we don’t have decent roads, efficient airports, adequate clean water supplies, and sufficient school facilities. Recently the American Society of Civil Engineers estimated that over the next five years it would take at least $1.6 trillion to bring our national infrastructure into an acceptable state. These are huge investments that the private sector is unwilling to make. Going into debt to pay for these things is a good investment in our collective futures.

We also need government to invest in emerging technologies that are vital to our economic prospects. We are falling behind many other countries in our public investments in high-speed rail, modern telecommunications technology, and an advanced electricity grid. Another area that will drive economic expansion in the future is green technology and alternative energy. Left to itself, the market has not been leading us in that direction. Several other countries, including China and Germany, have been spending billions in public funds to encourage consumers and industry to jump on the green technology bandwagon, and they are already beginning to reap the economic rewards of this strategy. We are trailing badly in this vital economic area and we are unlikely to catch up without substantial investments by our government.

Who Really Cares about Our Children?

One of the most common Republican complaints about deficits is that they will ruin our children’s future. We are saddling them with this enormous debt that they will have to repay – presumably to their great detriment. So if we care about future generations, we must severely cut spending to rein in this increasing debt. “Do if for the kids,” say the deficit hawks.

The main problem with this argument is that it focuses only on the costs of deficit spending for future generations, and completely ignores how that spending would actually benefit them. Would you be a good parent if you considered only the costs of buying braces for your child and not the benefits they would enjoy for the rest of their lives? Similarly, we must not just think about the national debt that we are handing down to our children, but consider also all of the valuable assets, projects, and programs that could be financed by that debt. Those benefits could make future generations much better off.

It all depends on what the deficits are spent on. If we are simply going into debt, as we did in the Bush era, to pay for tax cuts for the rich and wars like those in Iraq and Afghanistan, this will do little to help our descendants. But what if some of that deficit spending goes to make higher education more affordable? A study by the National Center for Public Policy and Higher Education gave the public college and university systems in 43 states a grade of “F” for affordability. This means that many kids who do go to college end up saddled with enormous student loans that will detract from their standard of living for years. More importantly, many low and middle-income students simply cannot afford college anymore – hundreds of thousands of kids are being turned away every year for lack of money. In contrast, public investment by many countries in Europe has made higher education there low cost or free. Whose kids are better off?

In addition, we are not doing our offspring any favors if they inherent a country whose infrastructure is in disastrous condition. They will not enjoy balanced budgets if that means living in a world of bad roads, dangerous bridges, failing sewer systems, questionable drinking water, and congested airports. Future generations might also be thankful if we spend some money now on lessening the potentially disastrous impacts of climate change. Global warming is already beginning to do enormous harm with unusually intense droughts and floods. If we do nothing now, the impacts on our children and grandchildren will be much more severe.

Finally, as noted earlier, government spending can be crucial for ensuring a prosperous and growing economy. A large part of the economic growth in the last twenty years has been fueled by various kinds of private sector economic bubbles. This is hardly desirable or sustainable. In the 1990s, there was a large technology bubble that created billions in apparent investment profits. Later, it was the housing bubble which encouraged consumers to borrow and spend much more money because of the rapidly increasing value of their homes. When these bubbles burst, they took the economy down with them. Today, we need a more stable and reliable way of encouraging economic growth. Public investments in emerging technologies, like alternative energy, could prove to be a valuable part of that economic strategy. If we can leave our children a sustainable growing economy, this could be their greatest inheritance.

 

 

Our Real Financial Concerns

All of this is not to say that there are not some serious financial concerns looming on the horizon. But they are all solvable. The challenge is to do so in a way that does not shred our social safety net or prevent us from engaging in the kind of public investment that we so crucially need.

The main problems we face are with Medicare and Medicaid. Without any reforms, Medicare will go into deficit by 2020, and benefits will have to be reduced. This is due to the fact that that health care costs in this country are already high and rising even further. Why are costs so high? Because we have one of the most inefficient health care systems in the world. We pay almost twice as much per person for health care compared to many other advanced countries, and we often provide worse care (and a lower life expectancy). The main culprit is the commercial domination of our health care system. We rely primarily on private, for profit, insurance companies and healthcare companies. Many other countries have more streamlined, government-run, single-payer systems that provide high quality care at much lower costs.

In the long run, then, solving the financial problems of Medicare and Medicaid require some basic reforms in our health care system. As Dean Baker, one of the most thoughtful economists analyzing government debt has explained it, the best way to address our debt is to “fix health care, fix health care, fix health care.” The health care reforms passed in 2010 have some promise to slow down growing costs. But the health care system remains the hostage of the private, profit-making, health care industry. Many analysts believe that additional major reforms must take place if we are truly to rein in rising medical costs. The crucial importance of doing so was made clear in a report by Our Fiscal Security, which concluded: “The rapidly rising cost of private health care—doctor’s visits, prescription drugs, procedures—is the only truly unsustainable part of the long-term budget. If U.S. health care costs were growing at the rate of other wealthy countries, we would have no long-term debt problem.”8

A Crucial Part of the Solution: Raising Government Revenue

Baker and other progressive economists have also been promoting another approach to long-term debt reduction: raising more revenue. For example, Robert Kuttner has proposed a series of tax changes that could bring in an addition $800 billion a year into the federal coffers.9 These include:

  • A tax on Wall Street financial transactions. This would have the added benefit of discouraging short term speculative trading and encouraging more stable longer term investments.
  • Crack down on off-shore tax havens. Estimated to bring in at least $100 billion a year.
  • End the deferral on foreign source dividend income. Obama promised to close this loophole, which also would discourage shifting jobs overseas.
  • Eliminate deductibility of interest payments on corporate mergers. Should bring in at least $50 billion a year and discourage abusive takeover attempts.
  • Raise taxes on short term capital gains. These gains should be treated as ordinary income, as they were before the Reagan era.

None of these additional revenue sources would have much of an effect on 90% of Americans. More importantly, they would enable us to stabilize and perhaps even expand our crucial safety net programs and also to pay for vital public investment projects, such as alternative energy and infrastructure improvements.

Other analysts have argued that much of the needed money for social programs and public investments could easily come out of the defense budget. If one considers how much countries spend on defense, the U.S. heads that list by a very wide margin. In fact, we spend more money on defense than the next nineteen countries on that list combined. Our navy alone has the capability of the next eight countries navies combined – many of which are our allies. So there is a lot of room to downsize without undermining our security. A bipartisan group, the Project on Defense Alternatives, has done an analysis that found we could cut a trillion dollars out the defense budget in the next ten years without compromising our military superiority.10 That kind of money would go a long ways toward solving our fiscal problems.

The Real Battle

In the end, the political battle over deficits and the national debt is really just a proxy for the more basic ideological struggle over the proper role of government in a modern society. The Republicans want to use fear-mongering over these alleged financial problems to advance their political vision of the minimal state. They promise Americans a future of balanced budgets, reduced spending, and lower taxes. But what they don’t tell us is that this would also be a future in which most people would be on their own to try to deal with serious economic, social, medical, and environmental problems that face our country. The jobless would be left to fend for themselves during serious recessions. Basic safety net programs like Social Security and Medicare would be cut back and/or privatized, and scores of other unmet human needs would be neglected due to lack of sufficient taxes and public funds. It would be a world where infrastructure would continue to crumble and we could not afford to make the necessary investments in education and growth-producing technologies.

Of course there is another possible scenario: a much more positive one in which we all worked together through government to address our common problems. It would be a future in which active government used all of the tools at its disposal – including taxation and deficit spending – to improve the lives and security of average Americans. Where the government would step in vigorously to reduce the impact of recessions and to promote job creation. Where the government would make the necessary investments to shore up vital safety net programs, and to update and improve our educational and infrastructure systems. In this scenario, we would also have a society that was made more sustainable and livable by public spending to encourage alternative energy and other green technologies.

But it is exactly this future that will be denied us if we fall prey to the deficit hysteria being manufactured by the anti-government forces in this country.

 


1. Kathy Ruffing and James Horney, “Critics Still Wrong on What’s Driving Deficits in Coming Years,” June 28, 2010, Center for Budget and Policy Priorities. http://www.cbpp.org/cms/index.cfm?fa=view&id=3036

2. Kathy Ruffing and James Horney, “Economic Downturn and Bush Policies Continue to Drive Projected Deficits,” May 10, 2011, Center for Budget and Policy Priorities. http://www.cbpp.org/cms/index.cfm?fa=view&id=3490

3. Alan Blinder and Mark Zandy, “How the Great Recession was Brought to an End,” July 27, 2010. http://www.economy.com/mark-zandi/documents/End-of-Great-Recession.pdf

4. Robert Kuttner, “Progressive Revenue as the Alternative to Caps, Commissions, and Cuts,” February 25, 2010. http://www.scholarsstrategynetwork.org/pdfs/Progressive_Revenue_as_the_Alternative-Robert_Kuttner.pdf

5. David Knox, “Social Security More Solvent that Most American Realize,” August 24, 2008

http://www.ohio.com/news/american_dream/27325314.html

6. Ezra Klein, “Galbraith: The Danger Posed by the Deficit is Zero,” May 12, 2010, “http://voices.washingtonpost.com/ezra-klein/2010/05/galbraith_the_danger_posed_by.html

7. Joseph Stiglitz, “The Dangers of Deficit Reductions.” March 5, 2010. http://www.sfbg.com/bruce/2010/03/05/stiglitz-dangers-deficit-reduction

8.Our Fiscal Security, “The Budget Deficit and Debt: What You Need to Know,” September 2010, http://www.ourfiscalsecurity.org/deficit-101

9. Robert Kuttner, “Progressive Revenue as the Alternative to Caps, Commissions, and Cuts,” February 25, 2010. http://www.scholarsstrategynetwork.org/pdfs/Progressive_Revenue_as_the_Alternative-Robert_Kuttner.pdf

10. Project on Defense Alternatives, “Debt, Deficits, and Defense: A Way Forward,” June 11, 2010, http://www.comw.org/pda/