The problem with deficits (you have to pay for them)

Congress has approved a budget blueprint that could allow Republicans to add $1.5 trillion to annual deficits over the next 10 years. The resolution sets the stage for tax cuts, strictly along party lines, which Republicans do not intend to pay for. That means our government would borrow money that we will all pay back for years to come, a wasteful burden on tomorrow’s taxpayers. Republicans could use a quick review of basic economics: Deficits in a strong economy crowd out private investment and increase the debt burden while producing inflation rather than real growth. When the federal government runs a deficit, the Treasury borrows money by auctioning off U.S. government bonds. Investors buy these bonds, thereby funding the government. What economists insist that we acknowledge in this transaction is that the money spent by investors on U.S. government bonds comes directly out of the economy. If the U.S. government adds $1.5 trillion to the deficit and that deficit is funded by U.S. investors buying bonds, there is no gain to the economy at all. Investors have simply put their money in government bonds rather than investing it elsewhere in the economy.

Economists dub this “crowding out,” because the government borrowing leads to a corresponding decrease (“crowds out”) in private investment.

Now, if the government has a justifiable use for the money (such as a major war), such crowding out is clearly justified. But if the government just wants to cut taxes, then the deficit results in investors lending money to taxpayers.

People may feel good about having more cash in the short term, but inevitably they will pay back the investors long term. In other words, when politicians say they are cutting your tax bill, don’t think of it as cash in your pocket. Think of it as a loan that you or your kids will have to pay back.

Won’t the tax cuts stimulate the economy? Probably not today.

The idea of stimulus is simple: The government can borrow and spend (or provide tax cuts) now, increasing current gross domestic product at the cost of future deficits.

When economists argue for fiscal stimulus, we usually point to economies that experience high unemployment. A large number of workers without jobs is a huge waste of resources; the government can borrow money in the short term that helps put people back to work, enlarging the tax base, thus making it easier for the government to pay that money back later while also helping workers immensely.

However, this type of stimulus works only when the economy is weak. If unemployment is low, as it is today, then extra money in the economy cannot simply put people to work. Instead, it leads to extra competition for scarce resources as people with more money run out of products to buy. Businesses then raise prices; inflation results.

Many economists thus are very skeptical that running deficits when the economy is strong will have any beneficial effects. Inflation will likely increase, and the Federal Reserve will respond by raising interest rates, which will slow the economy back down. Any economic benefit of the extra money through tax cuts flowing through the economy will likely be dissipated as inflation and/or higher interest rates.

There is an economic case for tax reform; that is, changes to the tax code that would close inefficient loopholes and simplify taxes. Such reform, however, should not add a dime to the deficit.

If Republicans advance tax legislation that adds to the deficit, don’t think of it as a bill that will put extra cash in your wallet. Think of it as Congress giving you a loan — which you’ll need because everything is going to get more expensive.

When 2018 elections come around, maybe Americans will vote for actual fiscal conservatives.

Don’t think of a tax cut as cash in your pocket. Think of it as a loan that you or your kids will have to pay back.