Never Never Land

It often seems that one should look over one’s shoulder in Washington, DC and search for Tinkerbell. Politicians seem to exist in Never Never Land, where little boys always play games and never grow up. At this moment, the economy is limping along at low growth levels while Democrats and Republicans argue about how to keep federal surpluses at historic highs. The total debt is rapidly decreasing, deflating the economy so much that successive cuts in the Federal Reserve rate have not yet restored robust economic growth.What few people realize is that even if the annual federal deficit is nominally zero and the total federal debt does not increase in a particular year, inflation and growth conspire to reduce real debt load. A zero deficit is deflationary and a modest deficit can be neutral.

During the late 1970s, inflation was so high that real debt was rapidly decreasing the debt load even while the country ran a nominally high yearly deficit. That explains how during the Carter-years we experienced a large nominal deficit with a sluggish economy suffering high unemployment. The lowest federal debt load in the post World War II era occurred in 1979, at a time when inflation was over 11 percent. Presently, total federal debt load is rapidly decreasing and we should take care in imposing substantially more deflationary pressure on the economy. Even we if had no growth, inflation would convert a surplus into a two to three percent decrease in the real debt load.

A Conservative wit once remarked that America has two parties the “stupid” party (Republicans) and the “evil’ party (Democrats). Apparently when both Republicans and Democrats agree on something, the policy is likely to be both stupid and evil. Thus in February of this year, Congress passed the Social Security and Medicare Lock-Box Act of 2001 by a bi-partisan vote of 407-2.

Of course the lock box is a fiction. Excess funds received from Social Security can do three possible things. They can fund more current spending, allow for tax reductions, or reduce the total federal debt. Republicans, for their part, hope that the budget discipline imposed by keeping the federal total surplus greater than or equal to the Social Security and Medicare surplus will prevent Democrats from increasing spending. Democrats, by contrast, expect to use the tool of the lock box to restrain Republicans from their congenital urges to return money back to taxpayers.

Unfortunately, the argument between Republicans and Democrats about the size of the surplus will mask the real issue: How do we restore the economy to economic growth? We should return from our trip to Never Never Land. Democrats should make their best case for more spending increases even if the lock box idea is jettisoned. Republicans should urge even larger tax reductions, perhaps even reductions in the Social Security and Medicare taxes, despite decreasing nominal surpluses.

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