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Bush's Fancy Finance

Tags Taxes and SpendingFiscal Theory

10/27/2004Robert P. Murphy

A recent NRO article by Larry Kudlow illustrates the absurdities to which analysts can be driven in order to defend a political party.1  The piece opens with the line, "Is there more sanity in the federal budget than people think?"  Such a question should prepare the reader for some fancy footwork, and Kudlow doesn't disappoint.

First Kudlow informs us that the "latest budget numbers closing out fiscal year 2004 show slower spending growth."  In and of itself this isn't that impressive, since it just means that the Bush Administration raised spending by a smaller percentage this fiscal year than it did last year.  Kudlow says that this reduction in the rate of increase of spending, coupled with "stronger tax receipts," will yield "a $413 billion deficit that came in about $100 billion less than the Office of Management and Budget predicted at the start of the year and $64 billion lower than the Congressional Budget Office estimate."  True, a $413 billion deficit is better than a $513 billion or even a $477 billion deficit, but it is hardly evidence of fiscal sanity.  

Yet the most impressive maneuver comes a few paragraphs later:

Overall budget outlays increased 6.2 percent in the recent fiscal year, which is less than last year's 7.3 percent. Excluding spending for defense and homeland security, as well as entitlements for healthcare and Social Security, domestic discretionary federal spending increased by a very moderate 3.4 percent in fiscal year 2004. If you remove net interest, then the budget increase was only 3 percent—just a bit higher than the inflation rate.

Now this is quite amazing!  In just 71 words, Kudlow has explained away a $132 billion increase2 in spending.  (That's $1.9 billion per word.)  For future articles—perhaps if Bush is reelected and shows us more of his conservatism—I suggest Kudlow multiply the deficit by a negative number.  Then we'd have a surplus.

Deficits Don't Affect Interest Rates?

After excusing the record-breaking Bush deficits by converting them to shares of GDP, Kudlow takes on the "crowding out" argument.  According to this view, a government deficit is harmful because it sucks savings out of the private sector (where they would be used for investment) and channels them into wasteful government projects.  Yet Kudlow rejects this concern as silly:

Believe it or not, there are still people out there who cling to the view that deficits drive up interest rates. How can they justify that when the current interest rate structure is at a 45-year low with the Treasury-bond yield around 4 percent? In fact, the 10-year note was yielding around 6 percent in 2000 when the budget was throwing off unwise and unusually high surpluses that drained the economy of private sector resources.

The problem here is Kudlow's reliance on statistics to (apparently) trump economic logic. But this is pure confusion; if an economic law is correctly deduced, then no amount of data can possibly refute it.  For example, an economist can argue that increasing government regulations hamper productivity and thus lower real wages. It would be no answer to this claim to cite the fact that real wages generally rose throughout the 20thcentury, despite the growth of big government. This is because real wages would have been even higher still had the government refrained from interference.

The case is the same when it comes to interest rates. Other things equal (and that is an important caveat), if the government increases the demand for loanable funds by borrowing billions of dollars, that will necessarily drive up interest rates.  Now if other things are not equal, and the rising deficit occurs at the same time that the supply of loanable funds increases, then the actual rate of interest may remain stable, or even fall.  But even if the rate of interest falls, we still know that it would have fallen even more had the government refrained from entering the loan market.  (Imagine a man caught embezzling funds from his employer.  Would it be an adequate defense if he could truthfully point to the firm's increased profits during the period in question?)

Lower Spending the Key

As the above Kudlow quote illustrates, there is a belief among supply-side economists that tax revenues are truly sucked out of the private sector, but that voluntary loans to the government (such as purchases of Treasury bonds) are not. Now it is certainly true that, from a moral point of view, it is better to finance government spending through voluntary arrangements than through outright theft (i.e. taxation). From this limited perspective, it seems that the supply-siders have a legitimate point.

But when we realize that the only reason people voluntarily lend money to the government is that they expect repayment, and that this repayment will come about through future taxation, then it is no longer clear that a "tax cut" with no corresponding reduction in spending is such a blessing after all.  I put the phrase "tax cut" in quotation marks because—absent future defaults on government securities, or perhaps sales of national forest land—it is really only a tax deferment.  The best illustration of this point comes from Jeff Tucker:

Metaphors never really work when it comes to government finance, but let's try this one out. Let's say you loan a friend some money and he finally gets around to paying you (this is Bush's tax cut). You say, thanks, but where did you get the money? He says, well, he took out a loan from the bank (here's the debt increase).

Now, that makes you vaguely uncomfortable but you might still be glad to have the cash in hand. But what if it turns out that he forged your signature on a co-signed note? In other words, what if you are actually responsible for paying the debt? Far from being glad that he paid you back, you now want to wring his neck! You realize that his apparent act of honesty is actually a hoax masking a great act of dishonesty.


The supply-siders are right to draw attention away from Keynesian "demand management," and they're right that tax cuts are the best way to promote economic growth.  However, their refusal to hold Reagan and the Bushes accountable for their massive deficits is wrong both economically and politically.  After all, Bill Clinton really did balance the budget (after raising taxes), whereas Reagan and now Bush really did have the largest deficits in US history after cutting taxes.  No wonder the American public takes John Kerry seriously!

  • 1. I should mention that I used to really enjoy Larry Kudlow's analyses.  In fact, it was Larry Kudlow (on a cable news show many years ago) who taught me that federal relief to disaster victims is self-defeating because it encourages people to live in disaster-prone areas.
  • 2. This number may not match up with other estimates.  I calculated the figure by multiplying Kudlow's reported rate of increase of 6.2 percent by the official fiscal 2003 budget of $2.128 trillion.

Contact Robert P. Murphy

Robert P. Murphy is a Senior Fellow with the Mises Institute. He is the author of many books. His latest is Contra Krugman: Smashing the Errors of America's Most Famous KeynesianHis other works include Chaos Theory, Lessons for the Young Economist, and Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) which is a modern distillation of the essentials of Mises's thought for the layperson. Murphy is cohost, with Tom Woods, of the popular podcast Contra Krugman, which is a weekly refutation of Paul Krugman's New York Times column. He is also host of The Bob Murphy Show.

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