A deficit of sense
The new year has witnessed the political rhetoric become pointedly directed at the economy. Not surprisingly, the Democrats, aggressively led by Senate Majority leader, Tom Daschle, are now blaming Republicans for creating a budget deficit with the tax package that was passed in the spring. That tax package was not only appropriate but it was good (not bad) economics. Even more astonishing has been the performance of President Clinton’s one-time national economic adviser, Laura D’Andrea Tyson. On television a few days ago, she actually blamed the current recession on the tax cuts put into effect last spring. Where was she when President Clinton was cutting the capital-gains tax?President Bush has rightly responded to the new line of attacks from the left, saying a week ago that "over my dead body" would he sign any bill that raised taxes. That's a far more powerful statement than "Read my lips -- no new taxes." And it's one he won’t break.Whether the U.S. economy was in a recession before the events of September 11 is probably an arguable point. I, for one, do not believe a recession would have materialized were it not for the terrorist attacks. Admittedly, some have argued that the recession started last March, but by the traditional method of calculating a recession – two consecutive quarters of negative real GDP – no recession had started before the third quarter. Yet the magnitude of the recession has undeniably been exacerbated by those attacks.The whining by the Democrats that burdening U.S. taxpayers with deficits will result in rising interest rates is specious at best and demagoguery at its most distasteful. If rising budget deficits caused interest rates to rise, then why on earth did interest rates fall so precipitously from 1982 to 1993, a period during which the budget deficit rose dramatically?To be specific, in 1981 the 10-year bond was yielding 13.7% and the deficit was at $79 billion, or 2.6% of GDP. By 1992, the deficit had risen to $290 billion, or 4.7% of GDP, at which time the 10-year bond was yielding 6.5%. If deficits are so onerous, why didn’t bond rates soar? Because, truth be told, there is no correlation between budget deficits/surpluses and the direction of interest rates. Quite simply, long-term interest rates reflect the state of inflation -- current or anticipated. In 1981, inflation, as defined by the consumer price index (CPI), was at 10.4%, while by 1992 it had fallen to 3.1%.Budget deficits result from the government spending more than it receives in revenue. This can happen from profligate spending on the part of the government. It can also be a byproduct of recession, as tax receipts are reduced (due to lower corporate profits and personal income) while the automatic stabilizers of unemployment insurance require higher government outlays. Those increased outlays, known as unemployment insurance expenditures, are, in turn, spent, thus adding some measure of stimulus to the economy.Conversely, government budget surpluses behave as a contractionary force on the economy. They result from the over taxation of profits and personal income by the government -- profits and income that would otherwise be reinvested into the economy.The stock market, itself a leading indicator of economic and profit growth, is decidedly unperturbed by the current state of the government budget. The Dow, S&P 500 and Nasdaq are all now higher than before September 11, despite the recession. The markets read the Federal Reserve’s aggressive monetary easing as good news for the economy as 2002 progresses. They are anticipating economic recovery and a rebound in profits, and they know that those two factors can go far to eliminate any budget deficits.If the government needs to increase defense spending during wartime, so be it. The real cause of the current looming deficit is unrestrained spending by Congress. They looked at last year’s budget surplus and simply couldn’t keep their hands off it. Long before September 11, Congress had already approved a budget increase of 8% -- this in an environment of 2% inflation. Imagine what would happen to your savings if you increased your spending by 8% when the cost of things was going up by only 2%. You’ve got it right -- you’d have a lot less money, and you might even be in a deficit position.Ironically, not all Democrats appear to be united behind Senate Majority Leader Tom Daschle’s ranting about deficit spending. Senator Feinstein recently admitted that giving tax money back to taxpayers was indeed a good thing. But the message from the Democratic leadership is that they will try to nail the economic malaise on President Bush in the upcoming election. The President is on strong economic ground in defying them, and if he sticks to his guns, both the economy and the stock market should be in considerably better shape come the elections in November.And with a little bit of good luck, the Republicans will regain control of the Senate and increase their margin in the House.