Threading the Needle of History

By my lights, historian Heather Cox Richardson engages in some questionable interpretations of history in her newsletter. She says that "leaders of both parties believed that deficits should reflect emergencies and that debt should be held at a low percentage of the nation’s Gross Domestic Product....It was to pay down the national debt that the Republican Party created national taxation, including the income tax, during the Civil War, and that Republican Dwight Eisenhower kept the top income tax bracket at 91% during his administration. Eisenhower was the last Republican president to balance a budget."

Orthodox economics has  been trying to prove large national debts are a problem for some time now. The most high-profile recent attempt to do this was Reinhart and Rogoff's paper that concluded debts above 90% of GDP tend to inhibit the economy. This kind of thinking intimates that if the debt gets too big, the bond markets will charge interest premiums to nations trying to sell their bonds. Meanwhile, Japan has a debt-to-GDP ratio of roughly 240% and their bonds sell for no such interest premium (roughly 0% interest is their yield!).

Other economists examined this paper and found Rienhart and Rogoff cherry-picked their historical examples. A graduate student even discovered the spreadsheet they used to calculate their results had an erroneous formula. One might think R & R's credibility as economic advisors after such sloppy research would be in shreds. One might also be wrong: they remain respected by both the political right and left, and the anxiety about national 'debt' remains unabated. Both major parties declare they are dedicated to reducing the 'debt,' and their advisors (e.g. Larry Summers) continue to try to revive that bankrupt argument (here, for one example)

Treating currency creators like households is at the root of this problem. "Tax and spend" is the phrase that describes how households work--they get their income not from printing money but from revenue gained elsewhere. However, such a sequence is an impossibility for a currency creator. Where would tax payers get the dollars to pay taxes if the government didn't spend them into the economy first? 

Taxes create the demand for dollars, they do not, and cannot, provision government programs since spending must precede taxation. So it must be "spend first, and retrieve some dollars in taxes later." The operational nature of reality demands it. 

And what do we call the money left out in the economy, not retrieved in taxes? Answer #1: the dollar financial assets of the population (i.e. their savings). Answer #2: national 'debt.' Both answers describe exactly the same thing. It's analogous to your bank account. To you, that account is an asset, but to the bank it's a liability. Marching down to the bank to demand it reduce its debt (i.e. make your account smaller) is clinically insane, but reducing national debt remains a popular public policy demand.

Meanwhile, did Republicans really initiate national taxation? Aren't tariffs a form of national taxation? Tariffs surely predated Republican efforts to nationalize tax charges just before the Civil War, or even the existence of the Republican party.

The Republicans did pass a 3% tax on incomes over $800 in 1861, but Congress repealed that  income tax in 1872. The 16th amendment enabled a modern income tax and that passed when (Democrat) Woodrow Wilson was in office.

As for Eisenhower balancing a budget: "[Eisenhower's] final 1960 budget was  balanced. Admittedly, it was aided by a bit of luck and one big gimmick. The good fortune: The recovery from the 1958 recession turned out to be more vigorous than expected. The  gimmick: A large contribution to the International Monetary Fund was artificially moved forward into 1959 so it would not count against the 1960 budget." (from Rudoph G. Penner [CBO director from 1983 to 1987])

So, without such "gimmicks," the last Republican to balance a budget was actually Herbert Hoover. Either way, a "balanced" budget from a creator of money has not boosted the economy, historically. Every time public policy makers have treated the currency creator government as though it was a currency-using household, and "balanced" the budget with significant deficit reductions, a Great Depression-sized hole in the economy appears shortly. (See here for the footnotes) 

Remember: Great Depressions occur every time significant deficit reductions occur!

And did "leaders of both parties" really want to cut debt and deficits? Maybe both parties give "Fiscal Responsibility™" lip service, but they sometimes actually say otherwise. Republican vice president Dick Cheney famously said "Reagan proved deficits don't matter," and Republican strategist Jude Wanniski advised his party to run up as big a deficit as possible when in power and complain as bitterly as possible about national 'debt' when out of power. So...hypocrisy, not truth, guided policy.

Reagan took Wanniski's advice, cutting the top marginal tax brackets roughly in half, claiming the economic revival it sparked would actually increase tax collections--something that didn't happen, although that didn't keep Reaganites from blaming Democratic "spending like a drunken sailor" for the increase in deficits. 

Less well publicized was that, between Reagan and his successor, payroll taxes increased eightfold. For lagniappe, the Reagan administration also cut the federal affordable housing budget 75%. Isn't it a puzzle why income inequality and homelessness haunt us today?

The supposedly exceptional Reagan recovery dubbed "Morning in America," by the Wall Street Journal turned out to be an average business cycle recovery, with lower-than-average capital investment. 

Here's a graph from the Bureau of Economic Analysis:

 

Notice the large spikes at the beginning of this graph for the New Deal and that large public works project known as World War II (when the government took over roughly 50% of the U.S. economy). That's when government spending was large relative to GDP, too. The Reagan "miracle" of the early '80s is roughly in line with the remaining ups and downs of subsequent business cycles, although subsequent recoveries were more muted than when taxes were higher.

Ms. Richardson even attempts to correlate government 'debt' to stagflation, ignoring the real cause of the '70s economic distress: oil shocks. U.S. oil production (pre-fracking) peaked in 1971. Price per-barrel then: $1.75. Distressed by the Yom Kippur war in 1973, the Arab nations in OPEC decided to curtail oil exports. 

This was the first time the U.S. couldn't produce its way out of a shortfall in the supply of oil, and petroleum prices soared four-fold almost immediately, peaking at $42/bbl in 1982. Reagan was lucky enough to get the benefit of Alaskan oil coming online after that, and the price subsided to around $10/bbl. 

A critical commodity like oil is an enormous influence in our economy. The U.S. doesn't even have solar agriculture. Michael Pollan reports U.S. agriculture burns 10 calories of petroleum for every one calorie of food produced. So oil shortages had knock-on impacts in many more sectors of the economy than just energy. Trying to relate these impacts to government spending amounts to a distraction, in my humble opinion. It's straining at a gnat while swallowing a camel.

Ms. Richardson correctly surmises the Republicans want to continue to cut taxes (and regulation!), and want to blame Democrats for the deficit if they try to pass social spending or infrastructure programs. Unfortunately this public policy direction opens a Pandora's box of troubles. Republicans are cavalier about handing tax breaks to the wealthy, but continue to believe that crushing the bottom 90% of incomes under the burden of increased payroll taxes and diminished social services will not spark the kind of backlash that led voters to reject the Republican establishment's candidates and "vote with their middle finger" for the likes of Trump. 

Unfortunately, the Democrats have not promised the kind of social spending required to revive the working class's incomes. Their leadership remains loyal "Pay-Go" fans--promising to raise taxes for any new programs.

I actually heard a local Republican leader say he regrets his party has not done more to curtail national 'debt.' If he is an orthodox Republican, he still would balk at raising taxes to reduce people's savings...I mean the deficit. And if he subscribes to current Republican orthodoxy, he would not cut the defense spending that remains six times higher than China's, or more than the next 14 nations' defense spending combined. 

But since 85% of federal spending goes to the military, Social Security and Medicare, what he's really regretful about is that we're not cutting Social Security and Medicare. That's the agenda.

And why attack social safety net programs? Claims that there is no alternative to austerity have been a bipartisan exercise for generations now. Besides the hypocritical Republican allegiance to balanced budgets, Democrat Bill Clinton signed the "end of welfare as we know it" passed by Newt Gingrich's Republican congress. That immediately threw a half million adults off of food stamps. Before that "end" 76% of those needing public assistance got it; after: 26%. Federal welfare expenses amounted to a rounding error on the trillion-dollar budgets, but Democrats can't even claim to be the party of the poor any more.

Why attack safety nets? Two words: Labor discipline. It sends the message that "You had better take whatever crappy job is on offer, or you will suffer the indignities of poverty, perhaps even homelessness and starvation. And if you're extra ornery, we'll put you in a cage." One is reminded of the old French maxim that "The law in its magnificent equality forbids rich and poor alike from sleeping under bridges, begging in the street and stealing bread."

We're coming to the end of the effectiveness of labor discipline. People are attacking the police because their circumstances are so desperate, and defunding the police is actually being considered. You may even see outraged citizens climbing on the furniture at local City Council and County Supervisors' meetings. 

The current Republican motto remains firmly in place, though: "The beatings will continue until morale improves."