Undertaxed or overspent? - national deficit analysis

National Review, June 10, 1988 by Ed Rubenstein

Undertaxed or Overspent? DURING THE 192 years before Inauguration Day, 1981, the Federal Government accumulated $914 billion in debt. The national debt is now more than $2.6 trillion, and is still rising by over $125 billion each year. Many see this as prima facie evidence of the failure of Reaganomics, which had claimed, among other things, that we could cut tax rates without increasing the deficit.

Was it all pure voodoo? A historical perspective is helpful:

Increased outlays account for the entire rise in the deficit since 1980. Despite the sharp cut in tax rates (the top marginal rate went from 70 per cent in 1980 to 38.5 per cent in 1987), total revenues as a percentage of GNP remained exactly the same in both years. Tax receipts averaged 18.2 per cent of GNP during the 1960s (when the top income tax rate was as high as 90 per cent), 18.3 per cent during the 1970s, and 18.8 per cent since 1980.

To blame tax reductions for the rise in national debt is tantamount to blaming them for increased spending relative to GNP. We might want to assign full blame for this to Congress, but that also would be wrong. Relatively uncontrollable factors such as interest rates and the business cycle play a large role and, in fact, are responsible for 80 per cent of the 1987 deficit according to a Treasury study released last October. Less than 20 per cent (only $29.4 billion) of the deficit is due to imbalances in fiscal policy.

Of course, the economic impact of persistently large deficits may be the same no matter what their source. Nobel laureate James Buchanan argues that every dollar of debt incurred to finance consumption represents a net reduction in the nation's future wealth.

But not all federal spending is for consumption: outlays for dams, highways, hospitals, weapons procurement, and other physical assets came to over $102 billion in 1987, according to the Office of Management and Budget. An additional $24 billion of federal funds was transferred to states and localities to support their capital projects, and federal loans to the private sector accounted for another $30 billion. In toto these capital investments represented 15.5 per cent of all federal outlays last year.

The benefits from these investments will redound to future generations of Americans. Debt finance insures that future generations will also bear some of the costs.

Table : Federal Taxes, Spending, and Deficits as a Percentage of GNP