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27.10.2004, 16:11

Bush's Fancy Finance

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<h3>Bush's Fancy Finance</h3>
<h4 class="MsoBodyText" align="left">by Robert P. Murphy</h4>
[Posted
October 27, 2004]

<img alt src="http://www.mises.org/images3/bush.jpg" align="right" border="0" width="197" height="242">A
recent NRO
article by Larry Kudlow illustrates
the absurdities to which analysts can be driven in order to defend a political
party.<a id="_ednref1" title href="http://www.mises.org/fullstory.aspx?Id=1659#_edn1" name="_ednref1">[1]</a> 
The piece opens with the line,"Is there more sanity in the federal budget
than people think?"  Such a question should prepare the reader for
some fancy footwork, and Kudlow doesn't disappoint.

First Kudlow informs us
that the"latest budget numbers closing out fiscal year 2004 show slower
spending growth."  In and of itself this isn't that impressive, since
it just means that the Bush Administration raised spending by a smaller
percentage this fiscal year than it did last year.  Kudlow says that
this reduction in the rate of increase of spending, coupled with"stronger
tax receipts," will yield"a $413 billion deficit that came in about
$100 billion less than the Office of Management and Budget predicted at the
start of the year and $64 billion lower than the Congressional Budget Office
estimate."  True, a $413 billion deficit is better than a $513 billion
or even a $477 billion deficit, but it is hardly evidence of fiscal sanity.  

Yet the most impressive
maneuver comes a few paragraphs later:

 

Overall
budget outlays increased 6.2 percent in the recent fiscal year, which is less
than last year's 7.3 percent. Excluding spending for defense and homeland
security, as well as entitlements for healthcare and Social Security, domestic
discretionary federal spending increased by a very moderate 3.4 percent in
fiscal year 2004. If you remove net interest, then the budget increase was
only 3 percent—just a bit higher than the inflation rate.

Now this is quite amazing! 
In just 71 words, Kudlow has explained away a $132
billion increase<a id="_ednref2" title href="http://www.mises.org/fullstory.aspx?Id=1659#_edn2" name="_ednref2">[2]</a>
in spending.  (That's $1.9 billion per word.) 
For future articles—perhaps if Bush is reelected and shows us more of his
conservatism—I suggest Kudlow multiply the deficit by a negative number. 
Then we'd have a surplus.

Deficits
Don't Affect Interest Rates?

After excusing the
record-breaking Bush deficits by converting them to shares of GDP, Kudlow takes
on the"crowding out" argument.  According to this view, a
government deficit is harmful because it sucks savings out of the private sector
(where they would be used for investment) and channels them into wasteful
government projects.  Yet Kudlow rejects this concern as silly:

Believe it
or not, there are still people out there who cling to the view that deficits
drive up interest rates. How can they justify that when the current interest
rate structure is at a 45-year low with the Treasury-bond yield around 4
percent? In fact, the 10-year note was yielding around 6 percent in 2000 when
the budget was throwing off unwise and unusually high surpluses that drained
the economy of private sector resources.

The problem here is
Kudlow's reliance on statistics to (apparently) trump economic logic. But
this is pure confusion; if an economic law is correctly deduced, then no amount
of data can possibly refute it.  For example, an economist can argue that
increasing government regulations hamper productivity and thus lower real wages. It
would be no answer to this claim to cite the fact that real wages generally rose
throughout the 20thcentury, despite the growth of big government. This
is because real wages would have been even higher still had the
government refrained from interference.

The case is the same when
it comes to interest rates. Other things equal (and that is an important caveat),
if the government increases the demand for loanable funds by borrowing billions
of dollars, that will necessarily drive up interest rates.  Now if other
things are not equal, and the rising deficit occurs at the same time that
the supply of loanable funds increases, then the actual rate of interest
may remain stable, or even fall.  But even if the rate of interest falls,
we still know that it would have fallen even more had the government
refrained from entering the loan market.  (Imagine a man caught embezzling
funds from his employer.  Would it be an adequate defense if he could
truthfully point to the firm's increased profits during the period in question?)

Lower
Spending the Key

As the above Kudlow quote
illustrates, there is a belief among supply-side economists that tax revenues
are truly sucked out of the private sector, but that voluntary loans to
the government (such as purchases of Treasury bonds) are not. Now it is
certainly true that, from a moral point of view, it is better to finance
government spending through voluntary arrangements than through outright theft
(i.e. taxation). From this limited perspective, it seems that the supply-siders
have a legitimate point.

But when we realize that
the only reason people voluntarily lend money to the government is that
they expect repayment, and that this repayment will come about through future
taxation, then it is no longer clear that a"tax cut" with no
corresponding reduction in spending is such a blessing after all.  I put
the phrase"tax cut" in quotation marks because—absent future
defaults on government securities, or perhaps sales of national forest land—it
is really only a tax deferment.  The best
illustration of this point comes from
Jeff Tucker:

Metaphors
never really work when it comes to government finance, but let's try this one
out. Let's say you loan a friend some money and he finally gets around to
paying you (this is Bush's tax cut). You say, thanks, but where did you get
the money? He says, well, he took out a loan from the bank (here's the debt
increase).

Now, that
makes you vaguely uncomfortable but you might still be glad to have the cash
in hand. But what if it turns out that he forged your signature on a co-signed
note? In other words, what if you are actually responsible for paying the debt?
Far from being glad that he paid you back, you now want to wring his neck! You
realize that his apparent act of honesty is actually a hoax masking a great
act of dishonesty.

Conclusion

The supply-siders are
right to draw attention away from Keynesian"demand management," and
they're right that tax cuts are the best way to promote economic growth. 
However, their refusal to hold Reagan and the Bushes accountable for their
massive deficits is wrong both economically and politically.  After
all, Bill Clinton really did balance the budget (after raising taxes),
whereas Reagan and now Bush really did have the largest deficits in US
history after cutting taxes.  No wonder the American public takes John
Kerry seriously!

 

 

<hr align="left" width="33%" SIZE="1">
Robert Murphy (mail)
is an adjunct scholar of the Mises Institute. He teaches economics at Hillsdale
College. See the Murphy Archive.
Discuss this article on the blog

<hr align="left" width="33%" SIZE="1">
<a id="_edn1" title href="http://www.mises.org/fullstory.aspx?Id=1659#_ednref1" name="_edn1">[1]</a>
I should mention that I used to really enjoy
Larry Kudlow's analyses.  In fact, it was Larry Kudlow (on a cable news
show many years ago) who taught me that federal relief to disaster victims is
self-defeating because it encourages people to live in disaster-prone areas. 

<a id="_edn2" title href="http://www.mises.org/fullstory.aspx?Id=1659#_ednref2" name="_edn2">[2]</a>
This number may not match up with other
estimates.  I calculated the figure by multiplying Kudlow's reported rate
of increase of 6.2 percent by the official
fiscal 2003 budget of $2.128 trillion.