Deficits Matter

In 2002, when Dick Cheney told Treasury Secretary Paul O’Neill that “deficits don’t matter,” that was politically true. No one cared about the deficit. Oh, politicians say they care—but their concern is only manifest when their party is out of power. When Republicans start cutting taxes, Democrats worry about how to pay for programs. When Democrats spend, Republicans discover fiscal religion. For a while, this pattern appeared to be changing: Clinton gave the Democrats claim to a genuine interest in fiscal responsibility. But the Obama administration has eviscerated that claim with record deficits. Republicans are outraged. Which is pretty rich, from the party that protested Medicare cuts during the recent health-care debate.

Just as Cheney’s pronouncement was true politically, at the time it may also have been true economically. Traditional theory says the problem with deficits is that they divert capital from useful investment in the private sector (we now know, of course, that capital wasn’t being usefully invested—it was building exurban McMansions that now stand empty). Still, we have no evidence that government borrowing suppressed private investment; arguably, it kept the housing bubble from being even worse.

Unfortunately, we’re now running annual deficits at a level where deficits very much do matter—as the ongoing crisis in Greece so vividly illustrates. The Congressional Budget Office says that after borrowing nearly 10 percent of GDP in 2009, we will borrow even more in 2010, and just a little less in 2011. Thereafter, we’re expected to cut our deficits—but they’ll still be 4 to 5 percent, which is bigger than anything we saw under George W. Bush and bigger than all but two of the deficits tallied under Reagan. The bills for Medicare and Social Security are finally coming due as the obligations exceed payroll-tax receipts. And this administration, like every administration before it, is unwilling to either make the necessary cuts or raise the necessary taxes. Deficits are starting to matter. A lot. Both politically and economically.

Policy makers are acting as if we have plenty of time to figure things out, but as the Greek experience illustrates, debt crises do not always unfold slowly, with plenty of warning.

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