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The Debt
and the Deficit
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The
Debt and the Deficit,
Norton 1989, is the title of a small paperback book written by
economists
Robert Heilbroner and Peter Bernstein. In it they explain the
so-called
Reagan deficit that should help dispel much misunderstanding about this
politically charged issue. It is worth noting that neither of the
authors is a Reagan apologist. Following is a summary of their
views:
Effect of Reagan's
Policies on the Deficit
It is commonly
believed that
the deficit problem was caused by the Reagan administration's fatal
error
when it cut income taxes at the same time that it undertook an enormous
buildup of the defense establishment. Certainly both contributed
to the deficit, but it would be a serious oversimplification to lay
full
blame on tax cuts and increased defense expenditures.
Shortly after
the tax cuts
in 1981, the increase in payroll taxes mandated to restore solvency to
the Social Security system more than offset the reduction in income tax
revenues. In spite of the common belief, the Reagan
administration
did not cut taxes. It merely shifted them from high income
individual
and corporate payers to payroll payers. Total tax revenues during
the Reagan years averaged a little higher than during the eight years
before.
Unforeseen
Factors Behind
the Deficits
Why then did
the deficit refuse
to shrink, once the economy recovered its stride in 1982? The
answer
lies in three factors quite unforeseen by Reagan administration
economists
or, for that matter, by economists anywhere.
First was a
legacy of the inflation
that was rampant as the administration came in, namely the high level
of
entitlements like Social Security and Medicare payments. Because
of the cost of living adjustments (COLAs), the payments jumped sharply
in 1979, 1980, and 1981. They were $400 billion higher in those
three
years than they would have been using the average COLA from 1973-1980.
Second was the
drop in tax
revenues due to the severe recession that resulted from the
anti-inflationary
stance of the Fed. When Paul Volcker took over as Chairman of the
Fed in 1979, his primary challenge was to break the wage-price
inflationary
spiral that had been building for several years. The recession
that
ensued from the tight money policy of the Fed was implicitly endorsed
by
most of the Reagan economists.
Third was the
problem of interest
on the national debt. When the debt was growing most rapidly from
1981 to 1983, interest rates were still very high. As a result,
the
government's bill for interest began to rise very rapidly. As the
government borrowed to counteract the recession of the early 1980s, it
had to pay the high interest rates that were a holdover from the
inflation
era.
In summary,
even in the absence
of tax cuts or any military buildup, we would still have had exploding
deficits because of inflation-swollen entitlements, inflation boosted
interest
rates, and post-inflation effect on tax revenues.
Volcker's Contribution to
the Deficit
The authors lay
a lot of blame
on Volcker for having overdone the fight against inflation, creating a
very serious recession that contributed to the deficit. This is
of
course debatable since Volcker was fighting the inflation battle
without
much support on the fiscal side. The origin of the inflationary
spiral
goes back many years, probably to the guns and butter fiscal policy of
Lyndon Johnson, the easy money period under Fed Chairman Arthur Burns,
and to the two OPEC oil shocks. However it does appear that
Volcker
could have eased up some months before he did without danger of
reigniting
the inflation, and with less downside to the economy..
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