Saturday, May 14, 2011

Debtors Prism

Funny thing about debt. Everybody has a definitive opinion on it, but few, if any seem to know much about it. Of course, if you belong to the Tea Party, you know everything there is to know about debt. It’s very bad, and, like some virus infecting our bodies, it must be rooted out. Of course, debt is a lot more complicated than that, and, while I don’t profess to have a degree in economics, I thought a slightly more sober and balanced reading on the subject might be in order.

Now let me start off by stating categorically that I acknowledge that the United States has a long-term debt problem that poses a serious threat to its future, and at some point we are going to have to come to grips with it before it ends up destroying us. There, I said it. Let no one say from this moment on that I’m a deficit hound. But, having said that, I also wish to make clear that I am not given to bouts of hysteria and hyperbole. Yes the debt needs to be dealt with, but not this very minute. Real problems like persistent high unemployment and a sluggish recovery continue to affect millions of people in a profound way, but to listen to the pundits you’d think the only problem besetting us is that mounting debt. It hangs over us like the sword of Damocles.

So let’s talk about debt shall we? In an earlier blog post I wrote back in 2009, titled Pay As You Go: The Great American Myth Exposed, I began to peel back some of the misconceptions about debt and deficits. For instance, did you know that less than a decade after defeating the British, America’s debt stood at a robust $75 million? While that may not seem like a lot when compared to the $14 trillion debt we currently have, it constituted 40% of the country’s gross national product. Quite a feat for a fledgling nation. And did you also know that once, and only once, has the nation had no public debt at all? The date was January 8, 1835 and the president was Andrew Jackson. Since then the national debt has risen steadily over time.

Here are the pertinent periods, their timelines and the corresponding debt increases:

The Civil War (1861 – 65): From $65 million to $2.7 billion
World War II (1940 – 45): From $51 billion to $260 billion
The Reagan years (1981 – 89): From $930 billion to $3.2 trillion
George W. Bush (2001 – 09): From $5.7 trillion to $10.4 trillion

What I find amazing in these statistics is how much the debt rose in such a short time. Equally impressive was the fact that since 1835 the nation has always had debt and somehow managed to not only get by, but, in some instances, thrive. In deed, far from being the albatross it has been portrayed as, debt has played a major role in helping the United States become the nation it is today.  For instance, in 1945, the debt was 123% of GDP, and yet, with the exception of a brief economic downturn – understandable after the end of such a massive undertaking as a world war – America went on to enjoy the greatest period of economic prosperity, quite possibly, in its entire existence.

Of course the top marginal tax rate during that period was 91% on incomes over $400,000, helping to drive down the tremendous debt that had piled up during the War. You think perhaps that had something to do with it? But then that has always been the dirty little secret of debt hasn’t it. It’s easy to look at expenditures, but it’s so much harder to analyze revenues.

But statistics don’t lie. They can be manipulated, but eventually they reveal clear and undeniable patterns. Like, for instance, this little tidbit: Since the end of World War II, without exception, the periods that witnessed the greatest decrease in the national debt owed that decrease almost exclusively to an increase in the top marginal tax rates. Conversely, the biggest increases in the debt occurred when those top marginal tax rates were reduced. If you subtract wars from the equation, the single biggest contributor to America’s debt is lower revenue stream. Period. For example, the difference between Bill Clinton’s top marginal tax rate and George Bush’s top marginal rate equated to about a $400 billion per year net loss to the treasury, thus turning a budget surplus of $200 billion in 2001 into a trillion dollar deficit by 2009. To say that the only contributor to the national debt is spending is to just flat out ignore the facts.

Now supply-side proponents defiantly maintain that lowering tax rates encourage investment, thus resulting in revenue gains. Unfortunately for these proponents, while lower taxes do increase base line revenues, the gains do not offset the losses generated by the tax reductions. Even Arthur Laffer – who came up with his “legendary” Laffer curve, upon which most supply-side economics is based – has admitted that not all the tax cuts would pay for themselves. In fact for every dollar the treasury sent out, it got back about eighty cents.

How profound was the turnaround from the surplus of the Clinton years to the massive deficits of the Bush years? In 2001, the CBO had forecast that within ten years the entire debt of the United States would’ve been paid off. For the first time since 1835, America would be debt free. Instead, the national debt stands at over $14 trillion. Now, to be fair, not all the debt can be laid at the feet of the Bush tax cuts. Two massive wars, Medicare Part D – all unpaid for – and the worst recession since the Great Depression certainly contributed to the massive debt problem. And then there was the $787 billion stimulus that helped keep the economy from going off the cliff. But the lion’s share of the blame must go to the decision to lower the top marginal tax rate from 39.6% to 35%. The resultant $4 trillion in lost revenue over the last ten years is now the number one long-term threat facing the nation.  Until the powers that be accept the painful reality that balancing the budget means increasing revenues as well as cutting expenditures we will continue this silly dance and an awful lot of misinformed people will continue to delight in their ignorance.

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