How do government deficits affect the economy in 2020? We need to look at how we see the entire concept of deficit spending as compared to before the Great Recession.
Before the Great Recession, I and many others believed that deficits contribute to inflation. The Fed creates excess dollars to buy government debt. It was assumed that this would crowd out private market borrowing. That along with too many dollars chasing too few goods would result in an inflationary spiral.
I remember when inflation was our biggest enemy before the Reagan/Volker taming of the beast in the 1980s. Prior during the Ford and Carter administrations my company instituted semi-annual CPI increases in our commercial leases, since to wait a year between increases caused the rent to be raised too much at any one time. In 1980 the inflation rate was 13.5%.
Of course, that inflationary spike occurred after the two oil embargos which had absolutely played havoc on the world’s economy. Politicians and the public were screaming about deficits brought on with upward pressure on prices from oil increases. The U.S. had a $79 billion deficit in 1980 ($245.5 billion in today’s dollars) and Reagan ran that year as a deficit hawk.
Volker induced a recession by tightening monetary policy to tame inflation. Reagan’s plan was to cut the tax rate and simplify the tax code to bring more economic efficiency. As an American I thought that was a great idea.
Marginal tax rates and effective tax rates became closer for the first few years of Reagan’s first term. The thinking went by eliminating tax preferences and deductions economic activity was not dependent on tax policy as it had in the past. Business decisions were to be made on whether there was a return on investment instead of how much tax savings there was in an economic activity.
The Reagan administration used the economic theory of the Laffer Curve to reduce tax rates. The curve supposedly showed that by cutting the tax rate more people would strive to increase their productivity resulting in more earnings thereby increasing tax revenue. That of course would mean that deficits would shrink. The shrinking deficit part did not occur.
In the forty years since, the Laffer Theory of proposed increase in government revenue has never materialized. By 1988, Reagan’s last year in office, the yearly deficit had climbed to $155 billion. Though Laffer’s followers have continued to proselytize this unwarranted theory, each time rates have been cut the deficit just kept on growing.
The only time the U.S. has not had a deficit in modern times, but a surplus instead, is the last three years of the Clinton administration and the first year of George W. Bush’s. Clinton raised tax rates. Once we went through the Bush tax cuts deficits began again, culminating in a $459 billion deficit in 2008 the last year of his term. In all fairness that was the beginning of the Great Recession and some of the bailout is reflected in that number.
Under Obama we had deficits in the billions each year for his first term. Obama extended the Bush tax cuts but in 2013 raised the rate on individuals earning more than $400,000 ($450,000 on a married couple filing jointly) to 39.6%. That is what rates were under Clinton.
The Trump tax cut in 2017 resulted in yearly trillion-dollar deficits. The same Republicans that railed against deficit spending during Obama’s terms thought that record deficits under Trump didn’t matter. Now that we are set to begin a Biden administration you once again hear Republican rumblings regarding the scourge of deficits.
In 1980 the U.S. government spent a little under $591 million dollars. By 1988 the figure was $1.064 trillion. By 1998 the first year that there was a budget surplus in modern times the government spent $1.650 trillion. Spending has continued to increase regardless of economic conditions or tax rates. The difference is that since 2002 both Republican and Democrat administration have had huge yearly deficits. The last three years of the Trump administration the deficits have been $665 billion in 2017, $779 billion in 2018 and $984 billion in 2019. I purposely left out 2020 because of the COVID economy.
The Trump economy until this year has had full employment, a roaring stock market and no inflation. There really has been extraordinarily little inflation since it was tamed nearly 40 years ago. That would tell any rational person that deficits in the modern era do not spark inflation or do they dampen the economy.
The runaway inflation of the 1970s was caused not by government monetary actions but by the rapid increase in oil prices. As prices increased, America and the rest of the advanced nations did not have enough money to continue spending and consuming as much oil for our cars or industry to manufacture products. That period was known for its stagnant economy and inflation. The term stagflation was coined by economists to describe that period.
We and most other industrial nations were wasteful users of oil. The U.S. was no longer an oil exporter, but we became importers. We were victims of our excesses. That era gave us the incentive to find more domestic oil and gas and discover and use technologies to be more energy efficient.
What we did not learn then and continue not to consider is the way the government spends our tax dollars. The average citizen receives no benefit from the trillions spent. Instead of spending our dollars to improve the lives of most Americans, Washington has convinced many of us that spending on large corporations and the wealthiest individuals through tax cuts and subsidies will somehow benefit all Americans. The trickle-down theory is alive. Like so much of our recent economic dogma it has been proven wrong.
Our country is literally falling apart. Yet we spend nothing on our aging infrastructure. Our educational system is basically unchanged since the late 19th century and it shows in our standing as compared to the rest of the world. The same can be said for healthcare where we have millions of Americans without basic coverage.
During a time of low taxes and rising deficits our nation except militarily has seen our standards lowered. What we cannot do is continue to be hostage to outmoded ideas and crack theories. It is time the American people demand some bang for their tax dollar and have the same level of services for all its citizens that so much of the rest of the advanced nations have for theirs.