Do Deficits Matter? (June 2008)

Dominick Paoloni

In his book with Ron Suskind, The Price of Loyalty, former Treasury Secretary Paul O'Neill gives readers valuable insight into the Bush administration's spending philosophies. When O'Neill raised concerns about a carte-blanche tax break that continued as we launched two wars, Vice President Dick Cheney informed O'Neill, "Reagan proved deficits don't matter." O'Neill relayed his astonishment at hearing this—it took over a decade to recover from the excesses of the Reagan era. Given that lengthy recovery time, is Cheney's statement accurate? Just how did Regan's exorbitant spending hurt the economy? Do deficits really matter?

When Mr. Reagan began his term we were spending only $112 billion a year to finance our national debt. Over its eight year run, the Reagan administration the debt figure doubled, leaving Mr. Clinton with a $225 billion price tag to finance our outstanding budget balance. Sadly, that seems like a walk in the park compared to this year's budget deficit of more than $500 billion. That means we are spending $500 billion more in one year than we are earning as a country. To make matters worse, this daunting figure added to the national debt will cost our country $429.9 billion dollars in interest every year—even if we stop overspending right now. According to the 2007 budget, by 2050 debt held by the public is projected to be 231% of GDP—a debt and deficit level that no economy could possibly sustain.

So do deficits matter? Let's simplify this discussion. Let's assume you own a furniture store and decide to expand. You move into a bigger building, pass around raises for all the employees, provide pension benefits, redecorate, and more. As you expand and spend all this money your friend, the local banker, agrees to give you loans. As time goes on, unfortunately, your sales aren't covering your current costs. Your only choice is to keep going to the banker for more loans. Year after year this situation persists, and as your furniture store goes deeper and deeper into debt, the interest on your loan becomes bigger and bigger.

Then the clouds break and you post several banner years in sales. Relieved, it seems like you might be finally in the clear. You tell your banker friend you don't have to borrow money from him for several years. However, your banker tells you that the interest alone on what you have borrowed is almost as much as you are currently making. The business cycle starts to slow and you borrow money from your banker friend again, but this time your borrowing explodes, and the interest on your loans is greater than the money you make. You just entered the abyss.

The banker starts to worry and thinks about stopping the lending, but he can't because the non-performing loan on the books would shut down the bank and the store, which would make the stock in the furniture store, which he owns, worthless. So what choice does he have? He starts dumping shares in the company (Which is what China, Japan & Europe, our lenders, are doing to the U.S. dollar). The banker completes a financial projection and tells you that if you continue borrowing at this rate, by the year 2050 your outstanding loan amount will be 229.4% of your company's gross income (similar to the projections for the U.S.).

Your health starts to deteriorate and on your deathbed, you tell your daughter she is inheriting a store that has 231.4% more debt than what it's worth—she'll be paying back the loan for the rest of her life.

So deficits do matter, if you love your children. Simply put, gaping deficits are nothing more than future taxes that will saddle the next generation with massive obligations. And what's worse, today's debt will plague the next two generations with debt and will result in radically high taxes that will buy them no services! Without some miraculous change, their tax dollars will be completely absorbed by the requirements of repaying our national debt—there won't even be enough to use them to fund things like Social Security, Medicare, and more.

The question is, why would a reasonably responsible government continue to cut taxes on the present generation while simultaneously stealthily riddling the next with a gigantic tax increase?