Saturday, December 03, 2011

Cause and Effect

Krugman, Baker and others are claiming that the current deficit and debt are not caused by a combination of excessive spending and inadequate taxes, but rather by the recession, which caused tax revenues to collapse and at the same time drove upward the costs of the “social safety net.” I'm calling nonsense on that, and here’s why.

Keynesian theory, even if you subscribe to it and for the moment let’s suppose that we do, says that the government should spend during lean times to support and “restart” the economy, and that it should pay off that debt and build a surplus during prosperous times, sort on the "save for a rainy day” concept. The current debt and deficit is caused by our failure to do the latter in the 90's and the first decade of this century.

The Great Depression and World War 2 caused us to build up a huge debt. Contrary to common Keynesian thought, the latter did not cause us to recover from the former, it added further to our economic woe, because we spent heavily to win that war, expenses which were not countered by tax revenue. An economic boom in the 50’s and 60’s brought our debt under control, but the growth of the Cold War exacerbated it once again.

The Clinton Administration raised taxes and balanced the budget, and then the Bush tax cuts were passed because we were developing excess revenue in a booming economy. Rather than pay down the debt, we reduced taxes for the specific purpose of not paying down the debt. I do not recall any Keynesian economists howling with outrage when we did that. Keynesians are only outraged by spending cuts, not by tax cuts.

Had we left the tax rates where they were and used the excess revenue to pay down the debt, then the economic downturn of 2008 would have caused far less governmental revenue problems. Instead of turning a small deficit into a huge one, it would have turned a surplus into a small deficit, and the debt would be far smaller and growing at a much slower rate.

So how do we respond to the deficit and debt in the midst of the economic disaster? Of course, the way we deal with everything, tax cuts. Payroll tax cuts, business tax cuts…

Reminds me of the carpenter with the saw and the baffled look. “I don’t understand,” he moans, “I’ve sawed it off three times and it’s still too short.”

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