Dean Baker
The International Economy, Spring 2017

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The country is paying an enormous price in the form of an “austerity tax” due to completely unrealistic fears about government deficits. Following the collapse of the housing bubble in 2008, output and employment fell off much further and longer than was necessary because of unfounded concerns about the deficit getting out of control. These concerns both limited the size of the initial stimulus and then forced a turn to austerity in 2011 when the economy was still very far from having recovered.

The immediate result was that millions of workers were needlessly kept from having jobs in these years. In addition, the weakness of the labor market led to an unprecedented shift from wages to profits that depressed wage income by at least 6 percent. Furthermore, the economic weakness of this period had a lasting impact on growth by curtailing investment, causing some people who were unemployed long-term to become unemployable.

As a result, GDP in 2017 is more than 10 percent below the level that had been projected by the Congressional Budget Office in 2008. We can think of this gap of almost $2 trillion ($6,000 per person annually) as an “austerity tax” that the deficit hawks have imposed on the country.

The austerity demanded by the deficit hawks was completely unnecessary, as any careful examination of the economy shows. The problem of deficits is supposed to be that excessive government spending is pulling resources away from the private sector. This is supposed to lead to high interest rates and/or high inflation. In fact, interest rates were at historic lows in this period and inflation was running far below the Federal Reserve’s targets.

The argument that the debt will impose some huge burden on our children suffers from both bad arithmetic and bad logic. The burden of the debt is the interest payments we must make each year. Currently the interest on the debt, net of money refunded by the Federal Reserve Board, is around 0.8 percent of GDP. This is near a post-war low and far below the more than 3 percent of GDP we paid in the early and mid-1990s.

The obsession with debt payments also shows profound ignorance about the way the government obligates payments for the future. In addition to the money it takes in taxes, the government also pulls money away from the country by imposing patent and copyright monopolies. These monopolies are important mechanisms through which the government finances innovation and creative work.

The amount of money raised through these monopolies, which are effectively privately collected taxes, is very large relative to the economy. In the case of prescription drugs alone, the gap between protected prices and free market prices is likely in the neighborhood of $400 billion a year. This is more than 2 percent of GDP or 10 percent of total government revenue. Any budget analyst who ignores such massive commitments is simply not being honest.

Unfortunately, the well-funded Washington deficit lobby will be using its power to continue to sow confusion and prevent the public from thinking clearly about how government debt and deficits affect the economy. As a result we will pay a large price because policymakers listen to their recommendations.