Debt, lies, and Reaganomics: there's nothing frivolous about the effort to debunk Reaganomics. And almost nothing true

National Review, Dec 14, 1992 by Benjamin Zycher

MOUNTAIN of debt!" "A house of cards!" "A foundation of quicksand!" "We're stealing from our children!" Such are some of the simplistic notions used widely in efforts to deny the explosion of real economic growth attendant upon Ronald Reagan's Presidency. The ongoing myth-making has as its central features the arguments that the public debt acquired during the 1980s laid the foundation for future economic weakness, and that the Reagan economic policies encouraged the accumulation of private debt for unproductive purposes.

With respect to the public debt, the narrow myths are 1) that the reduction in marginal tax rates yielded record deficits, and 2) that the deficits were used politically to constrain social spending. The larger myth is 3) that the deficits were in some (undefined) sense far too large and therefore economically destructive. Let us consider these myths one by one.

1) Tax receipts from FY 1950 through FY 1977 averaged about 18.6 per cent of GDP; for FY 1982-89 (the Reagan budget years), the comparable figure was over 18.7 per cent. The budget years of the Carter Administration (FY 1978-81) are the real aberration: tax receipts averaged almost 19.4 per cent of GDP, largely because of the effects of inflation. During FY 1950-77, tax receipts in constant dollars grew at an annual rate of 3.8 per cent; for the Carter budget years, the comparable figure was almost 4.5 per cent. For the Reagan budget years, real tax receipts grew at about 3.1 per cent annually, but that rate was affected crucially by the recession ending in the fourth quarter of 1982. For FY 1983-89, tax receipts grew annually at 5 per cent.

The Reagan tax policies, in short, yielded revenue performance that did not diverge sharply from that of most of the postwar period. The real story is on the spending side of the budget. For FY 1950-77, outlays averaged about 19.7 per cent of GDP; for FY 1982-89, the figure was about 23.2 per cent, reflecting the rise in outlays for defense and net interest. During the Carter budget years, outlays averaged "only" about 21.8 per cent of GDP.Therefore, the growth in the federal budget deficit during Reagan's tenure was the result of the growth in outlays as a proportion of GDP.

2) According to the "12 years of neglect" school of thought, all these increased outlays went to defense, while the deficit was used as an excuse to slash social spending. With respect to this argument, the table on page 42 presents data on federal spending on poverty programs before and during the Reagan Administration. The programs subsumed in the table include Aid to Families with Dependent Children (AFDC), Supplemental Security Income (SSI), Medicaid, Food Stamps, Social Services Block Grants, Head Start, various housing subsidies, the Women, Infants, and Children Nutrition program, low-income energy assistance, and others. Total transfers (cash and non-cash assistance) grew at an annual rate of about 1.6 per cent-- again, in real terms--during FY 198289. Although that growth was less rapid than in some earlier periods, depending upon the choice of starting and ending years, it hardly provides evidence supporting the assertion that the deficits were used to cut social spending. Unless we accept the notion that the Reagan deficits were close to some size limit in terms of political acceptability, the deficits may well have encouraged income-transfer programs because the spending accrued to the benefit of current voters, while the future taxes needed to pay the (interest on the) debt will be borne by future voters.

3) Answering the question whether the Reagan deficits were in some sense "too large" requires that we invoke a fundamental principle of public finance: Efficiency in government spending is furthered when the costs of government programs are borne by the beneficiaries. To the extent that this principle is incorporated into tax/expenditure policy, voters have incentives to demand neither too much nor too little government spending.

In the context of the choice between current taxation and debt for federal finance, a useful assumption is that the burden of current taxation is borne by current taxpayers/voters, while the burden of debt--or of the future taxes needed to pay the interest and principal--is borne primarily by future taxpayers/voters. In short, current taxation ought to be used to pay for government spending yielding benefits solely or primarily for current taxpayers/voters, while debt ought to be used to finance spending the main benefits of which accrue in the future. Therefore, as a first approximation, debt used to finance investment (capital formation) is crudely efficient if the investments themselves yield a social return sufficiently high to justify their cost, an issue to which I return below.

Borrow and Spend

FOR NOW, let us examine the relationship between the amount of federal borrowing and the amount of federal capital expenditures during FY 1982-89. The table on page 43 shows total federal capital investment outlays compared with the federal budget deficit. As a crude approximation, the increasing deficits in the Reagan Presidency were correlated with the increase in total federal capital investment, and in particular with the investment growth in military capital. Indeed, the increase in the debt share of GDP matched almost exactly the increase in the defense share of GDP.