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Liberty: -- Analysis -- The Deficit Bugaboo

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  • Marc Brands Liberty
    Read this article and vote at: http://www.liberty-news.com/showNewsletter.php?id=200405011&src=tyg2455 The Deficit Bugaboo by Richard W. Rahn Are we better off
    Message 1 of 1 , May 1, 2004
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      Read this article and vote at:
      http://www.liberty-news.com/showNewsletter.php?id=200405011&src=tyg2455

      The Deficit Bugaboo
      by Richard W. Rahn


      Are we better off having lower taxes on interest, dividends and capital
      gains (and other taxes on capital) or having a lower deficit? Obscure as
      it may seem, this is the central economic debate being fought in the
      political arena.

      To fund any given level of government spending, our political leaders
      have to choose how much of the spending should be funded by taxing and
      how much by borrowing. Historically, Republicans tended to argue more
      than Democrats for a balanced budget or lower debt financing. Now, the
      parties have reversed themselves. Republicans have slowly accepted the
      supply-side argument that high marginal tax rates and the double tax on
      capital income is more damaging to the economy than modest increases in
      the deficit. Democrats have bought into the argument of former Treasury
      Secretary Robert Rubin and his allies that deficits are destructive and
      should be reduced through tax increases and, at the same time, they
      believe "fairness" requires the rich to pay a much larger share of the
      tax bill.

      How damaging is the deficit and at what level does it become dangerous?
      Within limits, economists are not concerned about the deficit in a
      particular year. Their concern, correctly, is with the amount of
      government debt held by the public in relation to GDP. As long as
      individuals or businesses have a yearly rise in income, they can take on
      more debt without getting into trouble, provided the cost of the
      additional debt service does not rise faster than the rise in income.
      The same is true for government. Forty years ago, in 1962, federal
      government debt as a percentage of GDP was 43.6%. It fell to a low of
      23.8% in 1974, rose to a high of 49.5% in 1993, and then dropped back to
      33.1% in 2001. Currently, it is about 35% of GDP, and the CBO projects
      it to fall back to 30.7% in 2013.

      Those who argue for lower levels of debt usually claim that higher debt
      crowds out new investment, leading to lower economic growth, more
      unemployment, higher inflation and higher interest rates, and is unfair
      to future generations, etc. At some level of debt, the arguments against
      it are undoubtedly true. But again, looking at the data for the last 40
      years, there is no evidence that federal government debt levels up to at
      least 50% of GDP have been a problem. Surprisingly, real economic growth
      averaged almost 1% higher (3.47%) in the years where debt was more than
      33% of GDP than in the years when it was less than 33% (2.59%.)
      Unemployment averaged 6.43% in the low-debt years, and only 5.65% in the
      high-debt years, and inflation averaged 7.6% in the low-debt years, and
      2.9% in the high-debt years.

      At the end of World War II, U.S. government debt was more than 100% of
      GDP. That level of debt was borne by the generations that came after the
      war, but clearly we are all better off because the war was won with debt
      financing. We are also better off because the Reagan administration
      engaged in a military buildup, financed partly through increased debt,
      to win the Cold War. Placing a debt burden on future generations is not
      wrong if it is done to help secure their liberty and prosperity.

      Those who argue for a tax increase to bring down the deficit, such as
      Mr. Rubin and his allies, have so far failed to distinguish the
      differing impact various types of tax increases would have on the
      economy. The deficit hawks argue that an additional dollar of tax
      revenue received by the government, if it is used to pay down the
      deficit, will result in one more dollar in the private sector available
      for productive investment. This is true if the dollar would otherwise be
      spent on consumption. However, if the dollar comes from individual or
      corporate saving, there would be no increase in capital available for
      private investment and, as a result, the economy would be no better off
      despite a lower deficit.

      Tax economists have long known that consumption taxes, for each dollar
      raised, are far less damaging to the economy than taxes on capital. Yet
      all of the Democratic candidates for president are proposing tax
      increases that would fall largely on capital rather than on consumption.
      When they advocate increasing "taxes on the rich" -- such as higher
      marginal tax rates on upper-income people, and higher tax rates on
      capital gains, dividends and corporations -- they are, in fact, calling
      for higher taxes on productive saving and investment. These higher taxes
      would depress investment, productivity and wage growth, making workers
      bear the ultimate cost.

      The cost of tax collection is considerable, both for the government and
      the taxpayer. Also, as tax rates rise, the increase in revenue
      diminishes as people have a greater incentive to find legal and illegal
      ways to avoid paying the tax (i.e., the Laffer curve effect). For
      instance, the repeated increases and decreases in the tax rate on
      capital gains have clearly demonstrated that the revenue-maximizing rate
      is under 20%. High tax rates, particularly on capital, misallocate
      resources, resulting in lower economic growth. This fact had become so
      obvious (both from rigorous economic analysis and from casual empirical
      observation) that during the last two decades it caused governments
      around the world to sharply lower their corporate and personal marginal
      rates, and spurred the movement toward flat taxes. The U.S. now has the
      fourth-highest corporate tax rate in the OECD (35%) -- higher than even
      Sweden, Germany and France and almost triple Ireland's 12.5% rate.

      There are costs involved whether the government obtains its funds from
      taxing or from borrowing. Yet the extraction costs of borrowing are far
      less costly than taxing. This is because the capital markets are very
      efficient. It only costs the government a few cents on the dollar to
      issue notes or bonds, and the effect of additional government borrowing
      on interest rates tends to be small (provided, of course, federal debt
      remains below 50% of GDP).

      Reducing the growth in government spending has many benefits, including
      less misallocation of resources and less need for both borrowing and
      taxes to keep the deficit within manageable range. Over the last three
      decades, federal government spending as a percentage of GDP has ranged
      from a low of 18.4% in 2000 to a high of 23.5% in 1983. This year it
      will be about 20.5% of GDP (or roughly the average of the last 30
      years). Missing from the deficit debate, however, are serious proposals
      to substantially reduce the growth in spending.

      To date, each of the Democratic candidates seems to have an economic
      plan that would repeat the mistakes of the deficit hawks. They would all
      increase rather than cut the taxes on capital, which would likely lead
      to another recession. President Ford made this mistake in 1974, as did
      President Carter in 1980 and the first President Bush in 1990.

      The Bush team has put forth a realistic program for ensuring that the
      debt-to-GDP ratio will not increase over the long run, and that the
      deficit will decline to under 2% of GDP in the latter part of the
      decade. The challenge now for the president is to show that he will hit
      his budget targets by vetoing spending bills when necessary, and
      continue to reduce taxes on productive saving and investment to keep the
      economy growing.


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      Quote:
      - You cannot bring about prosperity by discouraging thrift. You cannot
      strengthen the weak by weakening the strong. You cannot help the wage
      earner by pulling down the wage payer. You cannot further the
      brotherhood of man encouraging class hatred. You cannot help the poor by
      destroying the rich. You cannot keep out of trouble by spending more
      than you earn. You cannot build character and courage by taking away
      man’s initiative and independence. You cannot help men permanently by
      doing for them what they could and should do for themselves. --Abraham
      Lincoln
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