Myths of the Deficit

By Marty Wolfson

Nearly 15 million people are officially counted as unemployed in the United States, and more than 6 million of these have been unemployed for more than 26 weeks. Another 11 million are the “hidden” unemployed: jobless workers who have given up looking for work and part-time workers who want full-time jobs. Unemployment has especially affected minority communities; the official black teenage unemployment rate, for example, stands at 42%.

The moral case for urgently addressing the unemployment issue is clear. The costs of unemployment, especially prolonged unemployment, are devastating. Self-worth is questioned, homes are lost, families stressed, communities disrupted. Across the land, the number one issue is jobs, jobs, jobs.

The economic case for how to address the jobs issue is also clear. As Keynes argued during the Great Depression, federal government spending can directly create jobs. And the $787 billion stimulus package approved by Congress in February 2009 did help pull the economy back from disaster, when it was shedding 20,000 jobs a day in late 2008 and early 2009.

But we still have a long way to go. To get back just to where we were when the recession began in December 2007, the economy would need to create 11.1 million jobs: 8.4 million to replace the jobs lost and 2.7 million to absorb new workers who have entered the labor market since then.

Despite a pickup of economic activity recently, long-term projections are that the unemployment rate will fall only gradually over the next several years. The Congressional Budget Office forecast for the unemployment rate for 2012 is a stubbornly high 8%. So why are we not moving more aggressively to reduce unemployment?

The ideological opposition to government spending remains a major obstacle. There are those who see an increase in the role of government as something to be avoided at all costs—even if the cost is the jobs of the unemployed.

Even among those who are not subject to such ideological blinders, there is still a political argument that resonates strongly. The argument is that government spending to create jobs will create large budget deficits, which will have terrible consequences for the American people. Politicians, pundits, and other commentators—in a frenzied drumbeat of speeches, op-eds, and articles—have asserted that the most urgent priority now is to reduce the budget deficit.

It is important to note that this argument is focused on current policy, not just the long-term budgetary situation. There is room for debate about long-term budget deficits, but these are affected more by the explosive growth of health-care costs than by government discretionary spending to create jobs. Why, then, are people taken in by an argument that says it is more important to reduce the budget deficit now than for the government to spend money to create jobs? Two myths constantly repeated in the public debate have contributed to this situation:

1) Families can‘t spend more than they have; neither should the government.

It seems to be common sense that a family can‘t spend more than it has. But of course that is exactly what the family does when it takes out a car loan or a student loan, or does any other kind of borrowing. The government, just like families, should be able to borrow. The real issue is whether or not the debt is affordable. For families, and for the government, that depends on the size of the debt relative to the income available to service the debt; it also depends on the nature of the borrowing.

For the federal government, the relevant debt-income measure is the ratio of outstanding debt of the federal government to gross domestic product. (Outstanding debt is the total amount owed at a particular time, roughly the result of debt accumulated over time by annual budget deficits; GDP, the value of goods and services produced, is equal to total income.) In 2009, this ratio was 53%. Although higher than the recent low point of 33% at the end of the 1990s expansion, the ratio in 2009 was still far lower than the record peak of 109% in 1946—after which the U.S. economy in the post-World War II period experienced the strongest economic growth in its history.

The U.S. ratio of 53% actually compares favorably to those of other advanced industrial countries. For example, IMF data indicate the following debt-to-GDP ratios for 2009: France (67%), Germany (70%), Japan (105%), and Italy (113%).

The nature of the borrowing also affects affordability. If a family runs up credit-card debt to finance a lavish lifestyle, after the fancy dinners are eaten the family still needs to figure out how to pay its debt. But if a family member borrows to buy a car to get to work, presumably the job will help provide the income to service the debt.

Likewise for the federal government: If the government borrows to finance tax cuts for the rich, and the rich use their tax cuts to purchase imported luxury goods, then the government still needs to figure out how to pay its debt. On the other hand, if the government borrows to put people to work creating long-term investments that increase the productivity of the U.S. economy, like infrastructure and education, then it is in a much better situation. The income generated by the more productive economy, as well as by the newly employed workers, can help to provide the tax revenue to service the debt.

So it is a myth to say that families can‘t spend more than they have. They can, and so can the government. And both are justified in borrowing if the size of the debt is manageable and if so doing helps to provide the income necessary to service the debt.

2) Large budget deficits create a burden for our grandchildren.

This is the issue that probably resonates most forcefully with public opinion. If we in the current generation run up a big debt, it may be left to our grandchildren to repay. The only difficulty with this reasoning is that the grandchildren who may be asked to repay the debt are paying it to other grandchildren. When the government incurs a debt, it issues a bond, an obligation to repay the debt to the holder of the bond. If the holders of the bond are U.S. residents, then paying off the debt means paying money to U.S. residents. In other words, debt that is an obligation of future U.S. taxpayers is also a source of income to the U.S. holders of that debt. Thus there is not a generational burden that we today are imposing on “our grandchildren” as a collective entity.

Of course, the obvious exception to this reasoning is the debt held by non-U.S. residents. In that case, it is indeed true that future generations of Americans will need to pay interest to foreign holders of U.S. debt. But the basic reason for this situation is the trade deficit, not the budget deficit. When we pay more for imports than we receive from exports, and when U.S. multinational companies ship production abroad to take advantage of low-cost labor, foreigners are provided with dollars that they can use to invest in U.S. assets. And the real burden that this causes is the same whether foreigners invest in U.S. government debt or whether they invest in U.S. companies, real estate, the U.S. stock market, etc.

Borrowing by the federal government can in some situations create a real burden, but it has less to do with generational transfers and more to do with distributional issues and the nature of economic growth (discussed above). If the grandchildren who are taxed in the future to pay off government debt are poorer than the grandchildren who are paid, the distribution of income becomes more unequal.

Also, cutting taxes for the rich and spending money on wars in Iraq and Afghanistan do not lead to the kind of productive economic growth that generates strong tax revenue. So financing these by debt does create a real distributional burden: The rich and military contractors benefit, but the losers are those who might be taxed, or those whose government programs might be squeezed out of the budget, because of the need to pay interest on the debt.

Borrowing money to put people back to work does make sense. It helps people most in need, the unemployed. It provides them with income that they can use to pay taxes and to buy goods and services that create more jobs, more income, and more tax revenue. Indeed, our inability thus far to seriously tackle the unemployment problem is what has worsened the budget problem, as tax receipts have fallen and spending for unemployment benefits and food stamps have risen. An analysis by the Economic Policy Institute reveals that the largest source of the 2009 budget deficit (42%) was actually the recession itself.

We will leave a burden for our grandchildren if we don‘t address the urgent problem of unemployment, if we let parents and grandparents suffer the indignities and financial hardships of lost jobs. We will leave a burden for our grandchildren if we don‘t rebuild our aging infrastructure, break our reliance on fossil fuels, and provide all our children with an excellent education. It makes perfect sense to borrow money now to address these problems, and we shouldn‘t let myths about budget deficits get in the way of meeting these real needs.

Marty Wolfson is a professor of economics at the University of Notre Dame.

Sources: Congressional Budget Office, “The Budget and Economic Outlook: Fiscal Years 2010 to 2020,” January 2010; John Irons, Kathryn Edwards, and Anna Turner, “The 2009 Budget Deficit: How Did We Get Here?” Economic Policy Institute, August 20, 2009; Dean Baker, “The Budget Deficit Scare Story and the Great Recession,” Center for Economic and Policy Research, February 2010; Office of Management and Budget, “The President‘s Budget For Fiscal Year 2011, Historical Tables: Table 7.1, Federal Debt at the End of Year: 1940-2015,” February 2010.