Ah, the Joys of Deficit Reduction!

Sanjay Paul
September 1995

(A version of this article appeared as Cutting Nation's Budget Deficit Has Drawbacks in Business Forum, Green Bay Press-Gazette, September 9, 1995.)

Ever since Ross Perot displayed his charts on television during the 1992 Presidential campaign, it has become an article of faith that one of the most serious problems facing the country is the size of its budget deficit. Indeed, after Bill Clinton took office, one of the first things he did was to address the issue of deficit reduction.

After a fairly quiet two years during which deficit reduction was relegated to the back burner, the subject is back with a vengeance. The Republicans, aglow in the triumph of their showing in the Congressional elections last year, have made cutting the d eficit a primary goal.

The Republicans attempted early on to engineer a balanced-budget amendment to the United States Constitution. The attempt failed - the Senate nixed the plan by the narrowest of margins. (Ironically, it was a dissenting Republican who thwarted his party's efforts.)

The GOP, led by Newt Gingrich and Bob Dole, are at it again. This time they have come up with a plan that, they say, will eliminate the deficit within 7 years. The Republicans hope to accomplish their objective by making drastic cuts in various governmen t programs - welfare, agricultural subsidies, Medicare, etc. Some of the more gung ho Republicans are in favor of axing entire government departments, including Commerce and Energy; but the political will for such draconian measures is weak.

While the Republicans argued over the nature of spending cuts, the Clinton administration watched from a distance. Hoping that the Republicans would self-destruct as they squabbled over the details of their deficit reduction plan, Clinton stayed on the s idelines for as long as he could.

Eventually, however, when it became clear that the Republicans, for all their dissensions, were remarkably united in their intent to reduce the deficit, and attacks of a "redundant President" began to sting, Clinton came up with a plan of his own.

Clinton's proposal also called for the complete elimination of the budget deficit; however, instead of the 7 years under the GOP plan, his would take 10 years. Furthermore, Clinton took pains to point out that, under the Republican plan, the rich would b enefit handsomely (thanks to tax cuts) while low-income families would bear the brunt of reductions in social services.

Amidst all the brouhaha, one detail seems to have escaped public attention: What exactly does the country stand to gain, and lose, by reducing the budget deficit?

When they talk about deficit reduction, the Republicans and President Clinton alike are likely to wax eloquent about its presumed benefits. They will say how cutting the deficit is good for our grandchildren, how our descendants will have a smaller debt to contend with, how we will no longer be at the mercy of those foreign, especially Japanese, investors whom we borrow from, etc. etc. While there may be some merit to these arguments, one should note that most of the government debt is held by Americans; thus, interest payments on debt are largely a transfer of income from one group of Americans (the taxpayers) to another (holders of government debt).

What, then, are the true benefits? The most significant benefit of deficit reduction is likely to be a decline in interest rates. With smaller deficits, the government's borrowing needs are reduced. Less government borrowing implies diminished demand for "loans"; consequently, interest rates will fall which, in turn, will lead to higher spending and output in the economy.

Sounds good, doesn't it? Unfortunately, these benefits of deficit reduction are likely to be outweighed by economic losses in the short run: As the government and government-related industries lay off workers, the economy will experience higher unemploym ent, reduced incomes and lower economic growth. Most unpleasant - and our political leaders are careful not to draw attention to this.

Today the deficit reduction debate rages on in Washington. The Republicans, having virtually ignored Clinton's proposal, are forging ahead with theirs. President Clinton, unable to do much else, threatens to veto the GOP's proposal unless they make certa in changes. In the meantime, as a result of sustained economic growth over the past three years, buoyant tax receipts have brought down the budget deficit to around $150 billion (from over $260 billion in 1992).

Incidentally, at about 2.5% of GDP, the current U.S. budget deficit is lower than the corresponding percentages for many industrial countries. Such facts, alas, are not the fodder for television charts: Presidential candidates are only too aware that not hing captures the public imagination like a rollickingly good doom-and-gloom picture!

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