"Ronald Reagan proved that deficits don’t matter," snapped Vice President Richard Cheney to about-to-be-fired Treasury Secretary Paul O’Neill a little over a year ago. He’s wrong – as wrong about deficits as he was about Ahmad Chalabi’s popular support in Iraq or Saddam Hussein’s capability to threaten America. Deficits do matter.
How much do they matter? How much they matter is what’s missing from the mainstream press. In fact, you’ll have a hard time finding deficit forecasts by reading the mainstream press.
You’ll have an easy time finding the Bush administration’s official deficit forecast for 2009: $237 billion. But reading through the news section of the Washington Post will tell you almost nothing more. You will read uncontradicted quotes from OMB head Josh Bolten about how "with Congress’ help in enacting the budget�???? we will be well on the path to cutting the deficit in half within five years." You’ll come away with the (false) impression that the Bush budget manages to do this and provide $1.24 billion in tax cuts too. You’ll find news reporters writing with a straight face about Bush’s "confidence" that the deficit can be halved by 2009 alongside big boosts in Defense and Homeland Security spending and the extension of all the Bush tax cuts.
You’ll do somewhat better with the news pages of the New York Times: Edmund Andrews will tell you that "tough surgery on… spending… produce[s] only a tiny reduction in the… deficit," and that there are enormous unreported deficits after 2009. But you’ll have to read down to and beyond the twelfth paragraphs of articles to learn that neither Democrats nor Republicans in Congress find the Bush forecast credible. Only the Wall Street Journal dares tell its readers in any article’s first paragraph that the Bush budget is "fiscal sleight of hand."
You’ll do much better with the editorial pages (except the Journal, of course). The Post writes of "Bogus Budgeting," and says "the likely deficit in 2009… more than $150 billion higher… the administration’s fuzzy math." The Times writes of the "Pinocchio Budget" with its "central fiction… that it constitutes the first step in halving the… deficit." (And the Journal calls it the "best budget of [Bush’s] tenure.")
But even the closest reading of the mainstream daily media to the very last paragraphs of articles won’t give you more than a vague picture of what the deficit is likely to be. And we need to have a sharper picture. Make no mistake: the Bush administration’s current tune in public is very different from what Cheney says in private. In public it says that reducing the deficit is one of its highest priorities. But don’t be fooled. Cheney has carried the day.
So let me fill in what’s missing, and give an honest forecast of what the policies the Bush administration espouses are likely to do. The honest forecast is for a deficit of $400 billion in 2009, rising to $600 billion in 2014, and then rising still further thereafter.
What effects will these deficits have on the American economy? The media tell you that deficits are bad. They may even tell you that deficits slow growth, and raise the chances of a financial crisis that will turn into not a recession but a depression. But we need to have a sharper picture. So let me once again fill in part of what’s missing. I cannot put a number on the chance that Bush deficits will trigger a financial crisis and a depression. But I can put a number on how the growth slowdown: big enough to cut an average American family’s income by $4,000 by the end of the standard 10-year budget forecast period.
Think of it that way: George W. Bush wants to give your family a $4,000 annual pay cut in a decade.
How will this happen? A deficit means that the government is spending more than it takes in through taxes. A government that spends more than it takes in borrows. Savers – households, banks, and businesses – buy Treasury bonds. Each dollar of savings used to buy these Treasury bonds and thus snarfed up by the Treasury is a dollar that cannot be used to finance the building of a house, the purchase of a machine tool to boost a factory’s productivity, or the replacement of an outdated inventory-control system with a cheaper high-tech one. A bigger deficit means less investment in America. And less investment in America means slower economic growth.
Now this year’s deficit isn’t a mistake, or at least isn’t a big mistake: we shouldn’t worry about this year’s, or next year’s deficit. As long as unemployment is high and capacity utilization low, a deficit is a good thing, but over the long term, as N. Gregory Mankiw, current chair of Bush’s Council of Economic Advisers (CEA), put it: the fact that budget deficits slow economic growth is "the most basic lesson about budget deficits." This lesson "follows directly from their effects on… supply and demand…. When the government… [runs] a budget deficit, the interest rate rises, and investment falls. Because investment is important for long-run economic growth, government budget deficits reduce the economy’s growth rate."
By how much? Mankiw and Federal Reserve economist Doug Elmendorf – a Clinton administration official at the Treasury Department – have some crude rules of thumb. Each dollar of deficit reduces economic growth enough to reduce America’s real GDP by seven cents. The $400 billion deficit of 2009 will lower GDP that year by $28 billion – and GDP will stay $28 billion lower than otherwise in all subsequent years: that lost economic growth will not be made up.
Apply this rule of thumb to honest forecasts of what Bush administration policies will do, and find that by 2014 deficit-induced lower investment and slower economic growth will leave America’s GDP some $300 billion a year lower than it would have been otherwise. A lot of the benefits from what would otherwise have been higher investment – a lot of the buildings and machines that would have helped America’s workers do their stuff – will simply not be there. Productivity will be lower. And wages will be lower. That’s $4,000 per family in lost income every year. That’s a lot of clothes dryers not bought, a lot of vacations not taken, a lot of doctor’s visits not made, a lot of old cars driven into the ground for an extra two years. That’s a poorer America with less money to fund education or environmental cleanup. That’s what will be missing.
And what will we have in exchange? Big cuts in taxes for the $300,000-plus-a-year crowd, profits for politically well-connected companies, and very little else. It looks to me at least like a very bad bargain.
This is not a partisan view. From the left my friends will point out that faster economic growth is not the only thing, and that budget surpluses plus faster capital accumulation are not worth the price they cost if they are funded by cuts in education or public investment or the safety net. And they are right. But they will also admit that budget surpluses and higher investment are better than tax cuts for the $300,000-plus-a-year crowd.
From the right my friends and non-friends will say that well-designed tax cuts that improve incentives could boost production by enough to outweigh the drag of deficits for a decade or so, but they will also admit that the Bush tax cuts are not the well-designed incentive-compatible ones they have in mind.
Everyone else will have few problems with what I have written. After all, it is what the chairs of Bush’s CEA teach their classes when they are at their academic jobs. It is what O’Neill begged Cheney to help him get Bush to understand. It is what Bolten and NEC Chair Stephen Friedman and current Treasury Secretary John Snow said before they joined the Bush administration. Why aren’t they effective on the inside in getting policies like those they used to advocate when they were on the outside? That’s really what’s missing.
Brad DeLong is a professor of economics at the University of California at Berkeley, and former deputy assistant secretary for economic policy. You can read his blog here.