Thursday, February 25, 2010

The Federal Budget Deficit & the National Debt

In tough economic times, it is not un precedented to cut taxes. Even if it means short-term deficit spending. However, when the economy is doing well there's nothing wrong with raising taxes and cutting federal spending in order to balance the federal budget and keep the national debt at a manageable level.

What makes our current situation so screwed up is that during the last period of economic "growth" (i.e. the housing bubble), we didn't cut spending, we increased it without raising taxes to pay for it (again, justifiable when the economy is growing). Pile onto that two major wars--of questionable legality--without a clear exit strategy (wartime also being a justifiable reason for increasing taxes) and we compromised our ability to handle future crises.

Look at the mismanagement of the federabl budget under George W. Bush: He fulfilled his promise to cut taxes (favoring the wealthy); he saw an opportunity to go to war with Iraq after establishing a token presence in Afghanistan following 9/11; He sought MORE tax cuts during these wars (which is unprecedented) to buy more votes during a relative time of "plenty" (the housing bubble); Bush and the GOP bought the senior vote for 2004 with Medicare Part D funded solely by deficit deficit spending. By the time the current recession had hit, there would have been fewer headaches and much less anxiety over a stimulus package and tax cuts even while running a deficit over a period of years had the previous administration been true to conservative values like fiscal responsibility--the GOP claims to have seen the light as they take on the role of deficit hawks and point fingers at the Obama administration's spending but can we really trust them to balance the budget and pay down the debt were we to put them back into power in Washington? I seriously doubt it. Especially considering their opposition to PayGo and a bipartisan panel aimed at reducing the deficit. All the GOP is interested is returning to power for power's sake.

As for the national debt*, as long as it's maintained at manageable levels as a percentage of GDP (for the sake of argument, let's say around 30%) the Federal government can afford to run deficits in times of financial crisis and times of war and still be able to rebalance the budget within a decade of the end of the crisis.

At the end of World War Two the national debt was 125% of GDP. After the war the economy exploded (having blasted most foreign competition to smithereens helped) and the highest income tax bracket was over 90%. We paid off the debt within a decade--and fought an entirely new war in Korea to boot.

The current national debt has yet to hit 100% of GDP. Theoretically, we can afford borrow another trillion dollars just to pay off everyone's credit card balance and keep responsible people from losing their homes. However, this scenario presents a moral dilemma. We're supposed to be a country of do-it-your-selfers, where each individual is responsible for their own success or failure. The government stepping in to bail out individuals should be just as bitter as bailing out the banks, if not more so. The numbers make sense, sure. But one old quote I keep hearing is that the country that can give you everything you want can also take everything away. Paying off individual debts would be the ultimate form of government influence over the economy because the results would almost be instant (look how fast they got the money to the banks). I'm willing to bet that if a lot of people had their credit card balances paid, they'd waste no time racking up that debt again. It would sure get the economy moving but we would wind up exactly where we are now. Our culture has to change first.

The thing we have to be prepared to do however is that once the economy is back on its feet and people have switched from public jobs--financed by the stimulus--to private sector jobs is to have the courage and commitment to cut spending AND raise taxes in order to get back to budget surpluses so we can pay the debt back down to manageable levels and keep the economy from burning itself out in another bubble. Spending cuts alone aren't going to do it (and are unlikely to happen because they are politically unpopular, no matter what the GOP says) and raising taxes on the super rich (say $10,000,000+ yearly incomes) won't hurt the spending ability of the lower classes (I'm starting to wonder if the middle class even exists anymore).

Once we're back on even keel with a manageable debt load, we can ease the tax burden without running a deficit--helping the economy by demanding less from those who spend the most--and be in a better position to handle the fiscal demands of the next crisis.

The only problem with all of this: It's a long term, historically precedented solution but impatient Americans want it fixed NOW! ;-)

*Remember, not all debt is owned by the Chinese, Japanese and other foreign interests. It also includes savings bonds, treasury bills and other debt instruments. The social security trust (which basically means that the government owes money to itself). Not all federal debt is bad. As long as it's properly managed, foreign governments would love to keep investing in treasury bills even if we didn't ask them too because they earn interest on it. When economic times are good and the government manages our money responsibly it can benefit people around the world.

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