Voodoo Deficits

...Germany is the other way around: it has a budget deficit and a hefty trade surplus...

...Britain, perhaps, was a better laboratory for supply-side economics than was the United States...

...It's arrant nonsense," says Milton Friedman...

...People who aren't thinking clearly try to link the two...

...The British household savings rate fell from 14.2 percent in 1980 to 5.6 percent in 1987...

...Taxes were much higher, indisputably beyond the point of maximum revenue on the Laffer Curve...

...1 Savings are taxed while mortgage interest is tax-deductible...

...Foreign capital has filled the breach but has distorted the trade balance in the process...

...That is 2.3 percent of GNP, the equivalent of the United States running a budget surplus of about $115 billion...

...At the same time, the states and cities have been running a pension fund surplus of about 1.2 percent of GNP...

...There are well-known political reasons why tax increases do not close the deficit...

...Britain is an extreme case, but not unique...

...I'm very sorry Alan said that," says Milton Friedman...

...But there is also an economic snag...

...The British national debt, four times as high as that of some European countries only a decade ago, is coming down so fast that there is now talk of wiping it out entirely and putting the surpluses into an investment fund to be tapped when the baby boomers reach retirement...

...George Bush can now exploit the same arguments to make hefty cuts for which Ronald Reagan would have been flayed alive by the grand press...

...The British economy is booming in spite of fiscal restraint and enjoys the lowest unemployment rate (8 percent) of any major country in Europe...

...The closest it has come is to discuss consumption taxes, but even here, there is a catch...

...THE AMERICAN SPECTATOR FEBRUARY 1989 15...

...He portrays the 1980s as an import binge on a credit card...

...Margaret Thatcher has rescued the Laffer Curve...

...At first the budget deficit was said to be causing the strong dollar, then all of a sudden it was causing the weak dollar...

...Nigel Lawson, the Chancellor of the Exchequer, is predicting a budget surplus of about $18 billion for this fiscal year...

...It's the central bank disease...

...Thatcher's supply-side successes prove a point of immediate relevance to the Bush Administration: that the Keynesian orthodoxies about budget deficits are bunk...

...It assumes that other things are equal, which they cannot possibly be...

...It also compares with estimated deficits of 10.2 percent in Italy, 3.6 percent in Canada, 2.5 percent in France, and 2.2 percent in Germany...

...Their savings are drawn from the discretionary income that is left over...

...It is a beautiful curve, but it needs a decade to work its magic...

...You don't get the deficit falling by the amount of the tax increase," says Stephen Entin...

...If the central task of President Bush is to calm the markets by restoring equilibrium to America's international accounts, then he must enlarge the capital pool by increasing savings...

...The budgetary process is inexorably spendthrift, and Congress simply spends the extra revenue to accommodate pent-up demands by lobbies, leading to further deficits, then further demands for taxes, and on and on in an endless spiral of statism...

...They allowed their partisans to excite unrealistic expectations instead of inoculating the theory by warning in advance, and repeating forcefully, that President Reagan's tax cuts would lead to several years of budget deficits before real revenues caught up again...

...Frankly, however, I don't see why the deficit needs to be reduced any faster than it is already falling...

...Keynesians predicted that the Reagan deficits would lead to inflation because they fueled 'demand" in the economy...

...A number of economists are instead tackling the problem circuitously, calling for a balanced budget in order to stop the Treasury from plundering the savings pool...

...But it can be just as useful to collectivists as an argument for higher taxes...

...However, Mrs...

...Every Fed chairman always blames fiscal policy for when things go wrong...

...An increase in the Social Security tax is scheduled automatically for 1990...

...Peter Peterson's apocalyptic article "The Morning After" in the Atlantic (October 1987) is typical of the genre...

...This is half the 4.1 percent deficit of 1975 (as it happens, the year of America's biggest trade surplus ever—nota bene "twin deficit" theorists...

...Washington has completely lost sight of that purpose in its bizarre conversion to fiscal fundamentalism...

...It was 3.3 percent of GNP in 1988...

...The supply-side economists failed as propagandists...

...It's enabled us to have a higher level of investment...

...Soon there could be a real (inflation-adjusted) surplus as baby boomers build up the Social Security trust fund...

...Neither country can finance its own investment boom...

...which means cutting federal spending on transfer payments...

...Foreign capital also poured in...

...This is a very peculiar statement...

...The basic rate of income tax has come down from 33 percent to 25 percent with further cuts planned...

...Thatcher took power in 1979 that there was the potential for leaps in productivity...

...Yet the concept of the "twin deficits" is so embedded in American opinion that even reporters for the Wall Street Journal, like Alan Murray, write as if it were self-evident that the U.S...

...Americans stopped sending about $100 billion a year overseas and invested it at home instead...

...Green-span's comment overlooks a wealth of data collected by the Treasury showing that it is of critical importance how the deficit is cut...

...The way to reduce the deficit with the best overall effect on savings is to restrain consumption by the state...

...She has cut top marginal rates from 98 percent on dividends and 83 percent on earned income to 40 percent for both...

...Five years ago the deficit was indeed high, at 5.2 percent of GNP, but it has since come down precipitously...

...But if the budget compromise after Black Monday is any guide, Washington will be too paralyzed to do much more than tinker at the edges...

...It is also the only angle of attack left to them after six years of rolling expansion with low inflation...

...You may as well flip a coin, at least you'll be right half the time," says Michael Darby, the assistant secretary of the Treasury for economic policy...

...If I've left out your favorite special interest, I'll be happy to include it," he told an audience at the Cato Institute...

...They're taking it straight out of undergraduate textbooks," says Stephen Entin, a former Treasury official now at the Institute for Research on the Economics of Taxation...

...If George Bush can navigate through the reef over the next few months, he could find himself sailing out onto a beautiful calm sea...

...He's building an advance alibi for the next recession...

...As everybody now knows, inflation plummeted as the Federal Reserve tightened monetary policy, more than offsetting the fiscal stimulation of the deficits...

...The trade deficit is an economic blessing...

...A study last year by the Joint Economic Committee found that since 1947, "a one-dollar increase in taxes leads to a 58 percent increase in the deficit, meaning a $1.58 increase in spending...

...At the moment, the inflation component is about $90 billion and virtually eliminates the combined deficit...

...It is a formidable tool for disciplining Congress, helping to reduce federal spending from 24.3 percent of GNP in 1983 to 22.3 percent in 1988...

...Britain is at an earlier phase of exactly the same process...

...The parliamentary system made it possible for the prime minister to control spending and lower taxes step by step, avoiding sudden deficits and a loss of nerve...

...It takes a long time to forget such lessons...

...Paul Volcker testified to the same Trojan Horse Commission that a 10-centsa-gallon increase in the gas tax would cut the deficit by $10 billion, and a 50-cents increase would cut it by $50 billion...

...Remember the Laffer Curve...

...Murray Weidenbaum has assembled a package of about $100 billion in cuts, ranging from diet COLAS and caps on Medicare to military bases and aid to the Middle East...

...This has a great deal to recommend it, so long as it is clear that the purpose is not to cut the deficit as an end in itself, but rather to raise the national savings rate...

...The question is how...

...A Treasury study by Michael Darby came to the same conclusion: "This inflation component has no economic effect, and should be removed when thinking about the appropriate level of the deficit...

...Friedman joins classical economists in arguing that changes in capital flows have been driving the dollar up and down, determining the trade balance...

...If the central task of President Bush is to calm the markets by restoring equilibrium to America's international accounts, then he must enlarge the capital pool by increasing savings...

...Let us call these the "twin opposites...

...Something interesting happened when the British budget went into surplus: the trade balance went into massive deficit...

...The consumption of gas will fall...

...Those who put their savings in a bank received an after-tax return below the rate of inflation, while those who bought a house with a big mortgage quickly became rich as the debt was devalued...

...Some improvement is going to happen for demographic reasons: the young borrow, the old save...

...No American President could hold the Congress to such a strategy as long as incumbency and profligacy go hand in hand on Capitol Hill...

...It could have the self-defeating consequence of sharp recession and much bigger deficits...

...2 / FEBRUARY 1989 Ambrose Evans-Pritchard VOODOO DEFICITS For the edification of George Bush: Ronald Reagan's and Margaret Thatcher's supply-side successes have already proved that the Keynesian orthodoxies on budget deficits are bunk...

...The question is how...

...The dismal expectations for his presidency are essentially founded on the doomsday dogma that the country is crippled by debt...

...The delicious irony of the doomsday rhetoric about the deficit is that liberals have ensnared themselves...

...The combined "publicsector borrowing requirement," as it is known in Europe, is therefore 2.1 percent of GNP...

...However, it is not easy to raise taxes sharply once they have been cut, and the one clear mandate that George Bush secured in the election was "no new taxes...

...At the end of the Carter malaise there was a flight from American assets...

...In Britain we see the corollary of this...

...rr he myth of the budget deficit has 1 its uses...

...Over the decade Americans have saved, in a sense, through the appreciation of their homes, but that does not feed into the capital markets in the way that bank deposits and pension funds do...

...When the "Great Depression of the 1990s" fails to arrive, President Bush will look like a magician...

...The American household rate has fallen from 7.1 percent in 1980 to about 4 percent now, although it is partially compensated by higher corporate savings...

...When Reagan restored confidence and improved the (real, after tax) yield on investment, the dollar became fashionable again...

...Gary Hufbauer, a trade specialist at Georgetown University, says that low savings have been the root cause of the trade deficits in both economies...

...Australia is in the same predicament...

...The government sector as a whole is already in surplus on a structural basis, and this surplus is projected to become quite large in the near future," concluded Darby...

...They laid themselves open to accusations of voodooism by Keynesian economists, and to caricature by Washington liberals who saw it as a ploy to starve the government of funds...

...Now that the investment expansion has run its typical course of five or six years, the capital inflow has slowed, bringing down the 14 THE AMERICAN SPECTATOR FEBRUARY 1989 dollar and, with a time-lag, the trade deficit...

...Looking at the industrial economies over the last forty years, it is hard to see any connection between fiscal policy and the trade balance...

...Yet the Treasury is awash with tax revenue...

...Some of the Keynesian arguments do not even make sense...

...Britain and the United States have something else in common: low savings...

...The British economy had fallen Ambrose Evans-Pritchard is the Washington correspondent for the London Spectator...

...The increased cost of gas will have collateral effects on the rest of the economy, putting marginal companies out of business and therefore cutting tax revenue from other sources...

...Robert Eisner, president of the American Economic Association, says that this combined deficit of 2.1 percent is an illusion...

...The savings ethic of the Eisenhower Era will never be restored entirely as long as the government undermines individual responsibility, but the wounds of the Great Inflation will slowly heal...

...It was the graph that Arthur Laffer drew on a napkin to show that lower taxes donot necessarily cut tax revenue...

...The evidence has been piling up through the 1980s...

...When I was growing up in the 1970s, I soon learned that only idiots save money...

...After all, it used to be conservatives who were denouncing Democratic deficits...

...Edward Yardeni of Prudential Bache Securities predicts that household savings will go up from 4 percent to 10 percent within five years as baby boomers enter their forties...

...Indeed, deficits have historically been the ratchet mechanism of statism...

...so far behind when Mrs...

...Unfortunately, there is no political will to go to the root of the problem and invert the tax structure...

...budget deficit is the cause of the trade deficit...

...The dollar soared, and so did the trade deficit...

...There is a budget surplus, which should stifle "demand" in Keynesian theory, yet inflation is picking up...

...About 80 percent of a tax increase comes out of savings, at least in the short run," says Michael Darby...

...Most of the money goes to higher interest-payments that compensate lenders for the effects of inflation, which is currently devaluing the national debt by about 4 percent a year...

...But there is a danger that the international markets will be spooked by the phantom deficits, precipitating a crisis and an overwhelming momentum for a tax increase...

...Who can blame Lloyd Bentsen for saying that anybody can buy the illusion of prosperity with "$200 billion in hot checks every year...

...This has become an article of faith for a whole generation of financial journalists and investment analysts who learned their economic theory in the 1960s, before capital flows came to eclipse the effects of fiscal policy...

...Alan Greenspan, the chairman of the Federal Reserve, made an astonishingremark shortly after the election when he testified to the National Economic Commission, the Trojan Horse of higher taxes, that the deficit "courts a dangerous corrosion of our economy," and that how it is reduced "is far less relevant than that it be done...

...T he government does not help...

...The Trojan Horse Commission has not wrestled with the relationship between taxes and savings, and it seems to be overlooking the other half of its mandate, which is to recommend policies that promote growth...

...The Germans and the Japanese weren't able to compete for their own capital," says Paul Craig Roberts, former deputy secretary of the Treasury...

...It is hardly surprising that opponents of the Reagan Administration have seized on the argument with relish...

...Most Americans are locked into expenses like rent and car payments...