Truth Deficit

Four Myths about Government Spending

It is not uncommon for a parent being pestered by a child to purchase a toy to say something like, “Mommy can’t buy it because she didn’t bring enough money.” The hope is that the words “we can’t” will end the pestering faster than the words “we don’t want to.”

The recent effort by Rep. Paul Ryan (R-Wis.) and other congressional Republicans to reduce or eliminate entitlement programs has followed the same formula. The Republicans are telling voters that the country can’t afford to help the poor, the elderly, and the sick as much as it does now. They warn that Social Security, Medicare, and Medicaid are quickly running out of money, and that without cuts to these programs the federal government will soon face a debt crisis like the one now crippling Greece. The result, fiscal hawks say, will be high interest rates, inflation, low economic growth, and possibly “widespread protests, riots and violence,” as Ryan put it in an April 29 letter [pdf] to New York Archbishop Timothy Dolan.

Because two of the most prominent deficit hawks are Catholic politicians (Ryan and House Speaker John Boehner), the debate about the national debt has occasioned a debate about the ethics of balancing the federal budget at the expense of those Christ instructed his followers to help (see Matthew 25: 31–46). The exchange of letters between Ryan and Archbishop Dolan, along with a recent letter to Boehner signed by several prominent Catholic scholars, has brought the church’s social teachings into the larger public discussion about what the government can and cannot afford. Budgets, we have been reminded, are moral documents: they express the priorities of a government and of the people it serves. It is therefore important that there be an open discussion about which values are guiding our collective decisions about taxes and spending. According to Catholic social thought, this discussion should be informed by the principles of subsidiarity, solidarity, and the preferential option for the poor. But there is another value, one fundamental to most religious traditions, that also needs to be asserted in this debate —the value of telling the truth. Politicians are haggling over which programs to cut or where to find new sources of revenue, but few have challenged the dubious premises behind the debt panic.

Voters deserve to be treated like adults, not children, and this means that politicians shouldn’t say “we can’t” when they really just mean “we don’t want to.” If some members of the House and Senate don’t think the federal government should take care of those who aren’t fully able to take care of themselves—if, say, they believe it’s up to the states or private charity to do this—then let them say so openly instead of presenting their policy preference as a matter of fiscal necessity. Small-government conservatives are now using the national debt as an excuse to cut programs they’ve long wanted to cut, even when the government was running a surplus. When the economy is in good shape, the programs are said to be unnecessary and wasteful: let the thriving private sector take care of whatever problems the public programs were designed to address. And when the economy declines, the same people tell us we can no longer afford such a generous safety net. Whatever ails us, the cure is smaller government.

The biggest economic problems the United States now faces are unemployment, income inequality, and the fact that much of the financial sector still operates like a casino. If the country could solve these problems, the gap between government outlays and government spending would immediately shrink, if not disappear. By instead focusing attention on the country’s debt, politicians are getting it backwards. Contrary to the claim of many leading Republicans on Capitol Hill, there is no reason to think that immediate cuts to government spending will help the economy—or that spending cuts can’t wait until the economy improves. Behind the confusion on these points are four myths about national debt that have somehow become conventional wisdom in Washington and in most of the media.

The first and most basic myth is the idea that the U.S. government is about to run out of money. In fact, the U.S. Treasury can’t run out of money because it pays its bills in money it creates. If the federal government owed its debt in Euros or some other currency—or if it had, say, a gold standard, which would limit the government’s ability to create new money—then Ryan and Boehner might be right to warn of bankruptcy. But U.S. debt is owed in U.S. dollars, a sovereign currency that isn’t chained to the value of any commodity. The U.S. government could of course decide not to pay its bills (for example, by refusing to raise the debt ceiling), but it can never lose its ability to pay them. When politicians and journalists say that the United States is in danger of becoming the next Greece, Ireland, or Portugal, they are ignoring the fact that these other countries no longer have a sovereign currency. They must pay their debts in Euros, the supply of which they do not control. They are thus like California, New York, and all the other states facing big budget deficits: they can solve their fiscal problems only by selling bonds or raising taxes. They cannot create more money.

The U.S. government’s situation is more like that of Japan, which faced similar dire warnings a decade ago when its debt-to-GDP ratio reached 100 percent. Now the ratio is over 200 percent (twice ours), and still the Japanese government has no problem finding people to loan it money at low interest. This is because what matters to buyers of Japan’s bonds isn’t the size of the country’s debt but the fact that it has its own currency—and so will never be forced to default.

The second big myth is that deficit spending is “crowding out” private-sector spending and investment. Only when an economy is at full capacity will an increase in government spending crowd out private-sector spending. When government spending really does compete with private-sector spending for the same goods, the result is inflation, but there has been very little inflation since the economic downturn began. Likewise, when government borrowing competes with private-sector borrowing, the result is higher interest rates, but interest rates have also remained low. This is because the U.S. economy is nowhere near full capacity now. More than 20 million Americans are out of work, and our industrial capacity is at 77 percent. We are, by some estimates, almost a trillion dollars below potential GDP. All of this indicates that the government has plenty of room to maneuver before it has to worry about crowding out the private sector.

The crowding-out argument is based on an eighteenth-century economic theory called “Say’s law of markets,” according to which supply creates its own demand and economies are always either at full employment or tending toward it. More than two centuries of experience with capitalism has shown that this is not normally the case. Periods of high (involuntary) unemployment are as characteristic of capitalism as are innovation and rising productivity. In fact, it’s these attractive features of capitalism that lead to the problem of persistent unemployment, for capitalist economies keep coming up with ways to make more goods with fewer workers. Fewer workers means fewer people who can afford to consume what the economy produces, and less consumption leads in turn to fewer jobs. Thus you get a vicious circle of high unemployment leading to lower demand leading to still higher unemployment. Capitalist economies have achieved full employment only when there is some extraordinary driver of economic activity, such as a big war (for example, World War II) or a major technological change (for example, the advent of the automobile). These generate temporarily high levels of investment. It’s worth noting that such changes are as likely to come from the public sector as from the private sector. It was, after all, the government that declared war on Japan and Germany, thus ending the Great Depression; and it was a government agency that brought us the Internet.

In a recent speech Speaker Boehner said that the increase in government spending has “hurt our economy and hampered private-sector job creation in America.” None of the available evidence supports this claim. Without the rise in government spending during the recession, the GDP would have shrunk by another 3–5 percent, causing an even bigger increase in unemployment. Insufficient as it was, the stimulus did create millions of jobs, and most of these were in the private sector.

Contrary to a common misconception, it wasn’t mainly the stimulus that caused the big increase in debt. Most of the deficit spending in the last few years has gone into what are called “automatic stabilizers.” During a recession, more people qualify for unemployment insurance, food stamps, and Medicaid, so the government’s expenses “automatically” increase. Without these stabilizers, the decline in GDP and the rise in unemployment would have been even greater than they were. And just as the demand for government services increases during a recession, job cuts and lower wages lead to a collapse in revenue, which also increases the deficit. Taxes as a percent of GDP fell from 18.5 percent in 2007 to an estimated 14.4 percent in 2011—the lowest level since 1950. Both the increased spending on entitlement programs and the fall in revenue would have occurred with or without a stimulus bill.

This brings us to the third myth about the federal government’s debt: that the problem is primarily about spending. In fact, the main problem is insufficient revenue. It is probably a bad idea to raise taxes when the official unemployment rate is still around 9 percent. But the fact is, Americans are not generally overtaxed. No matter how you measure tax rates, ours are among the lowest in the industrial world—as much as 20 percent lower than those in some comparably rich countries. Politicians tell us that U.S. corporations face the second-highest marginal tax rate among the major economies, but with all their loopholes and tax subsidies American corporations actually end up paying much less in taxes than corporations abroad. Taxes on corporate income in 2008 amounted to 1.8 percent of our GDP; the average for OECD (Organization for Economic Co-operation and Development) countries was 3.5 percent.

If the federal deficit is as big a problem as both parties say it is, then we could substantially reduce it by paying higher taxes. Instead of borrowing from rich investors (and paying them interest), the government could just tax them more. If the choice were put as simply as that—more taxes on the rich or more Treasury notes—many politicians who are currently posing as deficit hawks would prefer more debt.

Since the Reagan Revolution, it has been Republican gospel that high taxes hurt the economy and that low taxes help it. The historical record does not support this doctrine. Many countries have had both high tax rates and high growth rates, while many others have had both low tax rates and low growth. The U.S. economy grew faster and created more jobs during the 1950s and ’60s, when marginal tax rates on the rich were quite high (70–90 percent), than during the ’80s and ’90s, when marginal rates were much lower. The even-lower tax rates enacted during the presidency of George W. Bush brought little growth and no net job gains. President Reagan had famously promised that he would cut taxes and balance the budget at the same time; his critics insisted that tax cuts would cause huge increases in the deficit, and they turned out to be right. For supply-side conservatives the real goal was never to balance the budget; it was to “starve the beast,” which meant creating such high deficits that fiscally responsible Democrats would be scared into shrinking the country’s already modest welfare state. But a funny thing happened. Somehow the big federal deficits didn’t do any of the terrible things they were supposed to do to the economy. Interest rates and inflation went down, not up; the economy started to grow fast. So the starve-the-beast scare tactics became less and less effective. If those same tactics are working now, it’s because too many politicians and voters have forgotten their history. It is possible to tax people too much, but most research on the effect of tax rates on incentives to invest and work shows that upper marginal tax rates would have be about twice what they are now before they’d begin discourage work or risk taking. The argument that we need to lower our tax rates to remain internationally competitive is thus another instance of ideology winning out over the evidence.

The last big myth that distorts our discussions about the nation’s debt is the idea that only the private sector can create wealth, and that the government is essentially parasitic. This bias against public services and public employment might make sense if your only goal is to make profits for owners of capital. But the idea that the shuffling of money on Wall Street is nobler or more important than what school teachers or nurses do ought to be deeply troubling to all Christians. As Benedict XVI noted in his last encyclical, Caritas in veritate, the Catholic tradition considers wealth to be necessarily connected with well-being, and it distinguishes between creating wealth and capturing it. There are nonproductive ways to get rich. Once we acknowledge that creating wealth is not the same as making a profit, we see that governments create wealth all the time—and that without government involvement there would be very little wealth creation at all (a point Adam Smith understood much better than some of his current disciples). Governments build roads, schools, dams, and countless other things that contribute to the capital stock of the nation. Governments define and protect property rights, without which the only private wealth would be whatever you could personally defend. Most of the large accumulations of private wealth stem from government contracts, special tax treatment (subsidies), or the privatized benefits of government investments in research. Finally, some of the government’s debt is private-sector wealth (it owes that money to someone), so when the U.S. government reduces its outstanding debt, it also reduces private-sector wealth, here or abroad. We should also remember that every time the federal government has moved to sharply reduce its debt a major recession followed.

Many people express concern that China and other countries hold too much of our debt, but the problem here is not the fact that foreign countries are buying U.S. bonds; the real problem is the trade deficit. These countries have to put the money they earn from selling us their products somewhere. If they weren’t buying our government debt they would likely be buying our companies. (Some are doing both.) Politicians should worry less about where the government borrows its money from and more about creating policies that would help U.S. exports.

The church teaches us to promote the common good, to help the poor and marginalized before we help ourselves, to see in them the face of Jesus. The first Christians called this “the way of life.” The earliest manual on Christian practice, the Didache (50–150 AD), warns us against following the way of death, the way of those who “have no mercy for the poor, do not work on behalf of the oppressed…who turn away from someone in need, who oppress the afflicted, are advocates of the wealthy.”

How do we help the poor and oppressed in a twenty-first-century economy? Policies that promoted social justice in the eighteenth century might not promote it today. Before modern advances in medical knowledge, there was not much need for universal health care. Before people started to live longer lives, there was not much need for social security. Before the development of modern technology, there was little need for government-supported education. Before we allow representatives of the Tea Party to slash government spending on programs for the elderly, the sick, and the unemployed—modern programs that were designed to meet modern needs that neither Adam Smith nor our Founding Fathers could have anticipated—we should demand solid evidence that the richest country in the history of the world really cannot afford to take care of its most vulnerable citizens. We should make sure we are not reducing our commitment to the least of our brethren so that the richest 5 percent can grab an even larger share of the country’s wealth. The urgent danger facing us now is not that America is about to drown in debt, but that discredited, ahistorical economic theories will scare us into abandoning our most important values.

Related: Over the Brink, by the Editors

Published in the 2011-09-09 issue: 

Charles Michael Andres Clark is a senior fellow at the Vincentian Center for Church and Society and professor of economics at St. John’s University in New York.

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