Back to the Future
With Bush's signing of a $330 billion tax cut, the question now is how high the federal budget deficit will rise, and what that will mean for the economy. Congress actually put a time limit on the tax package precisely because legislators fear out-of-control deficits. Conventional wisdom, reiterated by Federal Reserve Chairman Alan Greenspan last spring, holds that deficits drive up interest rates. When the government sells debt in the form of T-bills, notes, bonds, and savings bonds, it siphons money out of the private sector, raising the cost of capital for borrowers ranging from entrepreneurs to first-time home buyers.
The latest estimate from the Congressional Budget Office has the deficit hitting nearly $300 billion for fiscal 2003, even without the tax cut. Meanwhile, the U.S. Treasury is already seeking to increase its borrowing ability by $984 billion to help finance the shortfall. And a recent Brookings Institute report projected that each $100 billion of deficit will raise long-term interest rates between 0.5% and 1%.
Of course, we've been here before, and not all that long ago: The Bush plan itself recalls the Economic Tax Recovery Act of 1981. And that has Reaganites smiling. "If the government is going to borrow, this is the best time to do it," says former Reagan economist Arthur Laffer, the mastermind behind the 1981 cut and creator of the Laffer curve, a theory that supports supply-side economics.
Laffer points out that "even if we had a deficit of $300 billion a year for the next 10 years, that would still result in a deficit that is a lesser share of the gross domestic product than it was in 1993." Recent surpluses allow for this administration to spend rather liberally, he says, adding: "Clinton, bless his soul, has given us enormous room to do what's right."
"There can be little doubt that this tax cut will raise future deficits."
-- an adviser to Bush pere
That's ironic, of course, because Clinton was a deficit hawk who raised the income tax to balance the budget. So did George Bush the elder, which points to an interesting drama playing itself out in the Republican Party. Some economists from the first Bush administration now find themselves backing the very policies that made their boss retract his famous "read my lips" pledge. Take Richard Schmalensee, a Bush I economic adviser who now serves as the dean of the Sloan School of Management at the Massachusetts Institute of Technology. "I think the President is right to look to tax cuts for economic stimulus," Schmalensee says, though he thinks the ratio between each new dollar of deficit and each dollar returned to taxpayers "is not as high as it could be."
"There can be little doubt," he concedes, "that this tax cut will raise future deficits, since the public seems to have no stomach for the spending cuts necessary to avoid this." Still, a little stimulus now may be worth higher taxes later. Schmalensee only hopes that "future presidents have the courage that George Bush had to raise taxes when it is economically necessary to do so." Any confusion over which Bush he means?