First, a quote from a famous historical figure -- don't worry if you don't understand it right away; I'll explain it."But these good effects of a public debt are only to be looked for, when, by being well funded, it has acquired an adequate and stable value. Till then, it has rather a contrary tendency. The fluctuation and insecurity incident to it in an unfunded state, render it a mere commodity, and a precarious one. As such, being only an object of occasional and particular speculation, all the money applied to it is so much diverted from the more useful channels of circulation, for which the thing itself affords no substitute: So that, in fact, one serious inconvenience of an unfunded debt is, that it contributes to the scarcity of money."Alexander Hamilton, as Secretary of the Treasury, wrote this in his first report to Congress in 1790.
What does it mean? Basically it means that, while some deficit spending can help stimulate the economy, too much actually hurts it. At any given time, a certain amount of money is available for investment in a variety of areas. The most productive area of investment is venture capital, which creates new businesses and new jobs. When the government has to borrow huge sums, however, the money that could have been used to create new jobs is soaked up instead by government borrowing.
In today's terms, it means that the reason jobs are not being created is that the federal government is running a deficit that is too large. There simply isn't enough money left over to create new businesses or expand already existing ones. And it's getting worse; current budget projections show the worst peacetime deficit ever.
As those famous commercials are fond of saying, "But wait! There's more!" In this case, however, the "more" is more bad news. The short-term news is bad enough. In the long term, continued huge deficits, and the attendant interest payments, reduce our ability, and our children's ability, to pay the debt. In other words, the longer we have high deficits, the worse things will get.
The ability to pay off the national debt can be measured most easily by one figure, known as the "Debt/GDP ratio". This ratio figures the total government debt as a percentage of "gross domestic product", or "GDP", the broadest measure of income in America.
Another way of putting it is to imagine two people, each with a family to feed and each with $100,000 in debt -- mortgage, credit cards, auto loan, etc. One person is making $200,000 a year, making his debt/income ratio 50%. That's manageable. The other person makes $40,000 a year, so his debt/income ratio is 250%, and that's not so easy to manage.
When Ronald Reagan became President, Debt/GDP ratio was at its highest level since the end of World War II. When George Bush (elder) left the Oval Office twelve years later, that ratio had more than tripled. Twelve years of Rebublican tax cuts for the rich and irresponsible spending increases (yes, the Republicans increased spending!) gave us the worst debt numbers in two centuries.
President Clinton turned that around. By the time he finished, the Debt/GDP ratio was going down -- for the first time in 30 years. Then George W. Bush and the Republicans regained power and changed all that. Now we're at new record levels, and things are getting worse.
In order to understand what President Bush and the Republicans did, we need to introduce another economic concept, known as the "Laffer curve". Arthur Laffer was an economist who pushed the idea during the 1970s that higher taxes only mean more revenue up to a certain point. Above this point, known as "T", higher taxes mean lower revenues, as people have less incentive to work.
In 1981, the top income tax rate was 70%, and that was considered too high. It was lowered as far as 28%, then raised, slowly, until in 1993 the top rate was set at 39.6%. The result? When the top rate was 28%, or even slightly higher, revenues were too low. Only when the top rate was raised to 39.6% did revenues increase to the point where the debt became more manageable.
In other words, the point on the Laffer curve called "T" is definitely not lower than 39.6%, but almost certainly lower than 70%.
Then President Bush and the Republicans lowered that top rate, and revenues fell significantly. Furthermore, even with two years of economic recovery, revenues aren't coming back up. In other words, taxes on the wealthiest income earners are too low for us to pay our bills. Moreover, because the deficit has gotten out of hand, new jobs aren't being created.
The obvious solution is to repeal the Bush/Republican tax cuts. Prior to those cuts, we had a system that worked. It created over 20 million jobs in eight years. Now, we have long-term job losses, increasing debt, and no end in sight.
Can we go higher than 39.6%? Probably. We don't have enough data to know exactly where "T" is. But if we don't have to go higher (and experience seems to show that we don't), then we shouldn't.
We must go back to that level, however, and we must do it as soon as possible. We have to act quickly to cut the deficit so that we can create new jobs. We have to act quickly to cut the deficit before the total debt becomes too large to manage.
What happened to Alexander Hamilton's recommendations? Under President Washington and the early Congress, they were followed, and America crawled out from under a crushing Revolutionary War debt. Unfortunately, Presidents Jefferson and Madison ignored his advice. As a result, America went bankrupt.
Are we headed for bankruptcy now? It depends on how long the Republicans are allowed to continue in power. That probably won't be long, however, since Republican policy is leading to higher deficits, which leads to fewer jobs. And people without jobs don't generally vote for the people who caused their unemployment.
In other words, Johnny may not be able to work, but he can certainly vote.
Copyright 2004, Dan Jacoby
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