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JOHN MASON: New Thinking About Fiscal Stimulus Policies Is Needed

Friend of the Peak John Mason rethinks the cycle of tax cuts and budget deficits

BY: JOHN MASON

One of the problems economists have is that most of their theory is based on the assumption that “all else is held constant.”

In effect, economists develop their models within the reductionist framework so commonly used by physicists. That is, reduce the problem you are working on to its simplest and narrowest frame and then deduce your conclusion from the resulting model.

Currently, there is a debate going on about the effectiveness of a government’s fiscal policy and what deficit spending does to the economy.

In light of the tax plan and subsequent budget produced by the Trump administration, many people are expressing concerns over the increasing deficits that these policies will produce.

And, there is increasing angst that these deficits are being produced by a government that is under the control of the Republican party, a party that has fostered the idea in the past that it is the only watchdog of fiscal discipline in the United States against a “tax-and-spend” opponent, the Democratic party.

Now, however, a discussion has arisen that challenges this perception. David Leonhardt, in the New York Times, has written an op-ed piece titled “Democrats, the Real Fiscal Conservatives.”

In this piece, supported by a chart, Mr. Leonhardt argues “Over the past few decades, Democrats have repeatedly reduced the deficit. They have raised taxes. They have cut military spending and corporate welfare. Some of them have even tried to hold down the cost of cherished social programs, Obamacare, for example, including enough cost controls and tax increases that it’s cut the deficit on net”

And, Mr. Leonhardt closes that “it would certainly be false to claim that Democrats are perfect fiscal stewards and that Republicans are all profligates. Yet it’s just as false to claim that the parties aren’t fundamentally different. One party has now spent almost 40 years cutting taxes and expanding government programs without paying for them. The other party has raised taxes and usually been careful to pay for its new programs.”

How and when did fiscal deficit spending become a tool of the national government?

Well, the story goes back to the 1930s and the efforts of the English economist John Maynard Keynes to develop a theory that would support government spending as a way to stimulate economic growth, put people back to work, and end the Great Depression.

In general, liberals supported this idea…and, conservatives despised it.

Keynesian thinking finally came into the mainstream with the election of the Democrat John F. Kennedy to the United States presidency in 1960. Mr. Kennedy came into office based on the promise to “get America growing again.” His tax cut, deficit-creating policies became a reality under the Democratic President Lyndon Johnson, after Mr. Kennedy’s assassination.

Deficit spending became the “thing to do” as the Republican President Richard Nixon, in the late 1960s claimed that “We are all Keynesians now” as he proposed Keynesian-type policies to spur on the US economy to get himself re-elected.

So, after Mr. Nixon, it became alright for either side of the political spectrum to stimulate the US economy by fiscal deficits. It became even more so as President Ronald Reagan came into office promising supply-side tax cuts to get the economy growing again after the stagnant years of the presidency of Jimmy Carter.

But, a new idea appeared in the political environment during this time.

If deficit spending created economic expansion and higher levels of employment, and if faster economic growth and lower unemployment helped politicians to get elected or re-elected, why not make tax cuts a major platform for the party.

And, if fiscal deficits were bad, because financial markets reacted badly to more and more government debt, why not push this off so that the party out-of-power would have to deal with them. That is, the party out-of-power would not be able to get what they wanted because of the budget deficits and the mounting debt and would have to respond to the financial markets and cut deficits…and maybe reduce the debt outstanding.

This is exactly what happened in the 1980s. Thinking changed. And even with the tax increases passed by President George H. W. Bush, the federal deficits, as a percent of GDP remained higher during his tenure than was recorded during the presidency of Jimmy Carter.

This was what was left for President Bill Clinton after his election. And, Bill Clinton, ably assisted by his Treasury Secretary Robert Rubin, cleaned up the mess left him and even got the budget into a surplus position before leaving office.

Then George W. Bush got elected as president and, basically, had a clean slate to produce tax cuts that resulted in a rapidly climbing deficit. And, President Bush not only left his successor, President Obama a healthy deficit to deal with, he also left him the Great Recession which worsened the deficit.

President Obama had to fight the deficit all during his tenure in office and fiscal policy became basically a absentee during the recovery that followed the Great Recession.

Now there is President Trump, who has opened up the spigots and created a future of rising government debt. And, the economy is at or nearly at full employment.

The point is that the assumptions underlying the Keynesian policy of using tax cuts and budget deficits has changed. At the beginning, it was supposed that Keynesian deficit spending would combat a cyclical business cycle and when the economy returned to full employment, the deficits would end and the fiscal discipline of budget surpluses would be re-instated to balance the budget over the business cycle.

Now, one party can produce budget deficits and more budget deficits and then leave the other party to clean up for it.

Mr. Reagan and Mr. George H. W. Bush left Mr. Clinton a recession to deal with early and Mr. George W. Bush left Mr. Obama a Great Recession to deal with. Mr. Clinton left Mr. George W. Bush a budget surplus and a long recovery to deal with and Mr. Obama left Mr. Trump with a falling deficit and an economic recovery of almost nine years.

It seems that beginning with Mr. Reagan, the Republicans have played the election cycle pretty well, allowing them to be very free to enact the programs that support their constituents. The Democrats, however, have had to clean up the fiscal mess left them which has constrained them from really fully developing their agenda.

How this will play out in the future is unknown. As mentioned above, Mr. Trump has produced his tax cuts and budget plans at a time the economy is at or near full employment and in its ninth year of expansion. If the Republicans are unable to escape a major recession before they turn the government back over to the Democrats, then the cycle may be broken. Regardless, the thinking about Keynesian deficit stimulus programs needs to be re-addressed.

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