Part 2: How Washington Learned to Embrace the Deficit

 

Takeaway

  • Both political parties have added to the deficit, and both will need to work together in a non-partisan way to solve the problem

What a difference a decade makes.

Eleven years ago, the budget of the U.S. government was $236 billion in the black. Today, it’s $1.6 trillion in the red, and the national debt has nearly tripled. How did it climb so far, so fast?

Call it Deficit Attention Disorder: an irresistible urge to cut taxes and increase spending, whether or not the nation can afford it. It afflicts both major political parties, say faculty at the McCombs School of Business. Over the past 80 years, each party has relaxed standards and upped antes, making the national debt perhaps the most bipartisan program ever to come out of Washington.

“The parties keep fighting over it, but nothing’s getting done,” says Jim Nolen, senior lecturer in finance at McCombs. “Republicans were supposed to be fiscally conservative, but when they have no checks and balances, they like to spend as much as the Democrats.”

It wasn’t always so. During most of America’s first 150 years, its government ran deficits only during wartime, says McCombs finance professor Lewis Spellman. “Typically, following each war, there was an active effort to raise taxes and retire debt.”

Peacetime deficits first became popular after World War II, he says. During downturns, the government would overspend to prime the economic pump. As the economy bounced back, the nation would run surpluses and pay down its debts. It happened in 1947-49 and again in 1951, 1956-57, and 1969.

Tom Gilligan

We’re not going to solve this in a partisan fashion.”

Dean of the McCombs School of Business

America’s fiscal belt loosened another notch during the 1980s. Reaganomics, which reduced taxes while expanding the military, ballooned the deficit from $79 billion to $208 billion in two years. Not to worry, said supply-side economists. Tax cuts would spur enough economic growth to wipe out the deficits.

They didn’t. Deficits stayed stubbornly high, despite a seven-year economic recovery. Some economists changed their thinking, and the notion of sustainable deficits was born. A deficit, they theorized, might be sustainable if it remained under 2 percent of Gross Domestic Product.

Spellman has another word for it. “It’s spin control,” he says. “The notion is that if you add to your debt at the same rate the economy is growing, your cost of indebtedness relative to your income stays constant. It’s not putting us under. It’s a sustainable overhead. But it would be much better not to have that overhead.”

America’s overhead finally inched downward in the 1990s, as tax increases and a high-tech boom produced its first surpluses in three decades. It helped, says Nolen, that conflict between a Democratic President and a Republican Congress kept spending in check.

But the respite was brief. After 2000, the fiscal ripples of a high-tech recession were amplified by terror attacks and tax cuts. Federal revenue sank $243 billion, while spending jumped $371 billion, much of it to pay for  new Department of Homeland Security and two wars. 

Revenues rebounded after 2003, thanks largely to a real estate boom. Deficits shrank to 1.2 percent of the GDP, and Uncle Sam felt flush enough to launch a Medicare prescription drug plan, with an annual tab of at least $40 billion. Economists, says Spellman, came up with another new notion: the structural deficit. It would shrink but never disappear, not even in the best of times.

The trouble was that small deficits in boom times might explode during the next bust. As the real estate bubble burst, starting in 2007, the deficit soared to 10 percent of the GDP.

Republicans blamed high spending, while Democrats blamed low taxes, says McCombs Dean Tom Gilligan. Both sides, he adds, are partly right. The years 2007 to 2009 saw a $463 billion drop in revenues, while business bailouts, unemployment benefits and economic stimulus brought a $789 billion surge in outlays.

Both trends must be reversed, he adds, to bring the deficit back to earth. He points to the president’s National Commission on Fiscal Responsibility and Reform, which has recommended both spending cuts and tax increases. If Deficit Attention Disorder is a bipartisan ailment, it needs a bipartisan cure.

“I don’t think proposals made by any one party are politically viable,” says Gilligan. “They’re only trying to gore the interests of the other party. It would be great for the commission’s recommendations to be taken up by the leadership in the Senate and the House. We’re not going to solve this in a partisan fashion.”

 

Faculty in this Article

Jim Nolen

Distinguished Senior Lecturer (retired), Department of Finance McCombs School of Business, The University of Texas at Austin

Jim Nolen received his BBA and MBA from The University of Texas at Austin. Until his retirement in May 2012, he taught both undergraduate and...

Jim Nolen teaches in the Texas Executive Education program, featuring open enrollment, custom and certificate classes for executives and organization teams.

Lew Spellman

Professor, Department of Finance McCombs School of Business, The University of Texas at Austin

Lewis Spellman received his BBA and MBA from the University of Michigan and his MA and Ph.D. from Stanford University. His research interests include...

Thomas Gilligan

Dean McCombs School of Business

Thomas Gilligan is the tenth dean of the McCombs School of Business. His main areas of expertise are economics and fiscal policy, with special...

About The Author

Steve Brooks

In a quarter-century as a journalist, Steve Brooks has won two Neal awards for excellence in trade reporting and a Press Club of New Orleans award...

Comments

#1 To me, when you look at

To me, when you look at things since 2001, things have gotten so unsustainable that it seems like the only options are 1)hyperinflation by monetizing the debt, leading the U.S. to become Zimbabwe or 2) defaulting on it, which could probably lead to option 1 anyway. What is everyone's thoughts on this?

#2 Your comment is a failure of

Your comment is a failure of imagination, and a lack of belief in the abilities of at least some in America to lead when called upon. 1) If we systematically apply the savings that the CBO has alrady published to remove fraud and waste from the government, and task them to go through the governmet department-by-department over the next 2 years, we can cut out all of the 'easy' waste. 2) Meanwhile, we set in place rules to reduce government spending across the board at a detail level by 5% each year until we reach a balanced budget. 3) Next, we set in place rules to determine spending priorities in even years, and use the odd year for oversight, efficiency reviews, spending reduction, and ELIMINATION of ineffective, duplicitative, or obsolete programs and tax incentives, which currently live for eternity in the government. 4) Finally, we index the retirement age for those 55 and younger (which includes me) by one every two years (66 two years from now, 67 four years from now, etc) until it matches the current US Longevity Index, as was the case when Social Security was initially established. This would give those currently 55 and younger time to alter their spending and saving patterns to match the new environment, such that personal responsibility reigns supreme for retirement income, but the social safety net still exists for those who fall on hard times. We would also set maximum income levels to receive Social Security such that those who've planned ahead would not be depending on the Social Security system to support them, and the system would only be paying out to those who've fallen through the cracks, as the system was originally designed.

#3 I agree with your comments,

I agree with your comments, but here's the kicker - WHO in Washington is willing to execute what you're recommending? The best laid plans in the world are utterly meaningless unless the follow-through and execution is there. Right now, the federal government is so addicted to spending that I don't see how it can reverse the course to what you're recommending. And if the U.S. attempted to print more money, this would result in nothing more than us becoming Zimbabwe of a few years ago.

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