GOP's Myopia on Debt Retirement

June 2, 1999

by Lawrence Kudlow and Stephen Moore

Lawrence Kudlow is chief economist at American Skandia. Stephen Moore is director of fiscal policy studies at Cato Institute.

In the Reagan era, Republicans found political pay dirt by defining themselves as the party of tax relief. But now the Republicans, at least in Washington, have converted themselves into the party of debt retirement.

Many congressional Republicans have lost interest in tax cutting and instead want to devote two-thirds of the surplus tax payments over the next 10 years to paying down the national debt. Some of the militant debt hawks have announced their goal is to retire the entire $5 trillion national debt over the next 20 or so years.

Has this Congress forgotten all of the economic and political lessons of the past 20 years? Using surpluses to cut marginal tax rates, as Mr. Reagan did, is the most economically productive use of tax surpluses. Moreover, financing Social Security privatization, as much of the rest of the world is now doing, would enhance the long-term growth potential of the U.S. economy substantially more than retiring treasury notes. We worry that this Congress is squandering a once-in-a-lifetime opportunity to fix our federal tax and retirement programs that nearly all Americans recognize as economically dysfunctional.

By our calculations, the budget surpluses are going to be much larger than is currently projected by the government estimators. If the economy continues its current growth path - and it should - the federal government will collect nearly $1.5 trillion more in tax receipts than it will spend through 2004. One-and-a-half trillion dollars. Two-thirds of the nations in the world today have a gross domestic product of less than that amount. If Congress were to simply place surpluses into worker IRA accounts, the average worker would receive some $15,000 in contributions over the next 10 years - not counting the interest build-up.

There are two problems with diverting $1.5 trillion of surplus tax collections to debt reduction. First, it will never, ever happen. Leaving Congress with $1 trillion of extra cash and not expecting members to spend it is like serving whipped cream and chocolate cream puffs at a dieters' convention. Congress will spend the money, because it is in their nature.

Just observe what has happened in just the past 18 months. Congress has spent Social Security surpluses on pork barrel highway bills, a $500 billion omnibus budget, and two multibillion-dollar "emergency" spending bills. The debt hawks say: stash the surplus money away so it's available for a rainy day. The truth is, for Congress, every day is a rainy day.

But even if we suspend our disbelief and assume that every surplus penny were used to buy down debt, the economic benefit would be trivial. The primary argument in favor of debt reduction is that it will relieve the burden from our children of having to pay off the debt in the future. But as long as we don't add to the debt over the next decade through a return to deficit spending, the debt burden on the next generation will fall automatically. It already is happening. Even without a penny of actual debt retirement, the debt as a share of GDP will nose-dive from 50 percent of GDP in the early 1990s to about 25 percent of GDP 10 years from now.

How is this possible? As the economy grows and the debt doesn't, the ratio of debt to GDP shrinks every year. In fact, over the next 10 years, the debt burden will fall to its lowest level of GDP since before World War II. The debt burden on our children will be lower, not higher than today. Moreover, buying down debt doesn't much accelerate this process. If we retire $1 trillion of debt over the next 10 years, the debt burden falls from just 25 percent to 20 percent of GDP.

The smarter strategy for reducing the debt burden is to grow the GDP faster. A dollar devoted to reducing marginal tax rates or to reducing the tax penalty against saving and investment will yield a higher return to the American economy, and thus to future generations, than a dollar used for retiring debt. That is particularly true when interest rates are low, as they are today, and thus the carrying cost of the debt is not excessive. Another high priority pro-growth policy would be to divert payroll taxes to genuine forms of IRA savings.

Importantly, there is no evidence federal debt has blocked growth, zero inflation or declining interest rates. It should be remembered that debt finance during the Reagan years was used to fund tax cuts and disinflation necessary to restore growth, and the build-up of military resources necessary to defeat the Soviet Union. Ronald Reagan's legacy of peace and prosperity is a moral and economic bequeathal to future generations.

Infatuation with the debt is contributing to the GOP's political meltdown. Paying down the government's credit card only allows the big spenders in Washington to run it up again in the future. Saving Social Security means transforming it into a true individual investment system, not pouring more funds into it to delay the system's financial collapse by a few more years.

The GOP will only regain the confidence and support of the middle class and the 70 million-strong investor class by beginning to lift the albatross of an unfair, anti-growth tax system and a dreadfully low rate of return Social Security system off the backs of these workers. Republicans lost ground with these voters in 1998 because they failed to offer a pro-growth tax-cutting agenda. The biggest demographic group that switched to the Democrats in 1998 was Americans earning more than $75,000.

Here's our warning: If Republicans' only remaining economic program is to retire debt, overtaxed voters may respond in 2000 by retiring Republicans.

This article appeared in The Washington Times on May 25, 1999.

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