Lost lessons during the surplus years

President Barack Obama regularly reminds us that he "inherited" an economy that was sinking fast, with a dysfunctional banking sector and with job losses running at a rate of three quarters of a million per month. Just as regularly, he is criticized for not solving the nation's economic problems fast enough and for blaming his predecessor.

While Bush-bashing is a time-wasting distraction, the period 2001-09 simply must be examined thoroughly for lessons to be learned. There are at least six reasons to examine this period, and assigning blame is not among them.

First, in 2001, the national debt was $6 trillion and projected to fall to zero by the end of the decade. Had this occurred, the nation would be in much better shape now to fight this Great Recession. Instead, by the end of 2008, the national debt had risen to $12 trillion.

So, one key lesson is demonstrated by our current situation: When the country is running a surplus, use it to reduce the debt. The surplus is the excess of tax revenue over government spending, and so it is tempting to claim that the excess must be returned. But the large national debt belongs to the taxpayers, too. We should follow a basic rule: The time to build up the debt is while fighting recessions, and the time to "build-down" the debt is while enjoying expansion.

Second, we need to take a closer look at the budgets for those years to discern the spending categories that have contributed to the current deficits. Those deficits resulted from tax cuts, Medicare Part D, two wars financed by borrowing, recession-fighting policies, and a debt-financed stimulus package for both infrastructure improvements and a banking system rescue.

Rather than focus on these contributors to the deficits, the measures being proposed to bring the debt under control include cutting Medicare benefits, block grants to limit Medicaid payments, and reduced spending on efforts ranging from the arts to food stamps to Pell grants to pothole repair. The proposed cuts have little to do with the costs that caused the deficits in the first place.

Third, the 2001 and 2003 tax cuts put the federal budget in "structural deficit." That is, even when the economy returns to full employment, the budget will remain in deficit. With the tax rate structure as it is, the economy can be earning full-employment national income, paying taxes on that income, and still not cover the costs in the budget, and deficits would continue at full employment.

The fourth reason to examine the years 2001-09 is to question "Why the delay in balancing the budget?" Banks were in financial trouble, the auto industry was facing bankruptcy, and the unemployment rate was reaching double-digit levels. All econometric models indicated that a balanced budget in 2009 or 2010 would have required subtracting over a trillion dollars of spending from the economy, resulting in much higher unemployment.

Fifth is to respond to the criticism that these enormous deficits are planned to continue until 2021. Econometric models show that these deficits can be brought down only on a slow path ending in 2021. Until then, deficits will be required to avoid sudden shortfalls in total spending as consumer spending and business investment slowly builds to full-employment spending levels.

To attempt to balance the budget before a full-employment rate of spending is achieved would simply invite a new recession which would bring with it larger deficits. The length of this path underscores the importance of taking advantage of surpluses when they are available to reduce the national debt. Since the paths to balance after a disastrous recession are so long, it pays to build fiscal strength by reducing debt when the opportunity is available.

A final reason to review 2001-09 is to learn whether the tax cuts paid for themselves. That is, did the cuts in tax rates unleash such an increase in economic activity that tax revenue actually increased? Life would certainly be grand if we could have greater revenue from lower tax rates. The idea that tax cuts pay for themselves prompted Vice President Dick Cheney to declare that "Ronald Reagan proved that deficits don't matter." Reagan himself knew that deficits do matter, and he raised taxes 11 times as he tried to bring his deficits under control. The data from 2001-09 reinforce what Reagan knew: Reductions in tax rates do not pay for themselves; actually they decreased revenues and made deficits worse, not better. Deficits matter a great deal. Moreover, huge deficits cannot be brought down quickly; the best path requires us to wrestle with them for years to come.

Charles O. Kroncke, left, is associate dean in the University of South Florida College of Business. William L. Holahan is emeritus professor of economics at the University of Wisconsin-Milwaukee.

Lost lessons during the surplus years 07/17/12 [Last modified: Tuesday, July 17, 2012 5:31pm]

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