Paying Off The National Debt, A Bad Idea Jude Wanniski September 28, 2000

Memo To: Website Fans, browsers, clients
From: Jude Wanniski
Re: Paying Off the National Debt

This is a memo I wrote to then Speaker Newt Gingrich that originally ran on June 24, 1997. At the time, momentum was building to use the forthcoming budget surpluses to pay off the national debt -- instead of to reform the tax code to spur more growth and more revenue. It is a useful exercise to read through it again, as the arguments today are as timely as they were more than three years ago. We now observe both major political parties in essential agreement that the best thing we could do with multi-trillion dollar budget surpluses as far as the eye can see is to extinguish the national debt, as it is central to the campaign planks of both Governor George W. Bush and Vice President Al Gore. The reason for this “agreement” is because both camps’ economic advisors are operating in a Keynesian demand model -- one conservative, one liberal. As such, both campaigns are quibbling over narrow aggregate demand issues instead of pursuing Lafferian economic principles. The confusion can be ironed out, I think, by a refreshing glance at this memo, which discusses the history of public finance, deficits, and taxation through the lens of classical, supply-side economics.

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As a man interested in history, you should be aware that your support of Rep. Mark Neumann’s National Debt Repayment Act puts you on the wrong side of history. The idea of keeping wartime tax rates high in order to pay down government debt accumulated in wartime seems prudent, but it is most imprudent. It is essentially why the Pax Brittanica ended after WWI and why England remained weakened after WWII, until Maggie Thatcher came along.

If you remember reading The Way the World Works, you may recall that I reviewed the history of taxation in Great Britain following the 22 years of the Napoleonic Wars. Britain’s debt in 1815 was astronomical, notwithstanding the fact that practically everything imaginable was taxed. At the time, the major political parties in the UK were of a mind to keep the tax rates at wartime levels, but a parliamentarian named Henry Brougham led a tax revolt. After Proposition 13 passed in California in 1978, I had lunch with Howard Jarvis in Manhattan, and I told him I considered what he had done the equivalent of Brougham’s initiative, which ushered in the golden age of the Pax Brittanica.

After WWI, there was no Brougham in England, and the wartime income-tax rates were left in place as Tories and Whigs agreed to pay down debt. In the United States, remember, the Wilson Democrats urged the same here, where a top rate of 76% had been legislated. The GOP, advised by the financier Andrew Mellon, made the argument that we now identify with supply-side Reagonomics. Not only should revenues be dedicated to reducing wartime tax rates. It should also be assumed that the process could be started by anticipating the higher revenues that would flow from lower rates.

After World War II, conservative Republicans argued for lower rates and Harry Truman became unpopular for wanting to keep them high. In 1948, however, the GOP candidate, Thomas E. Dewey, said nothing about lower tax rates, instead urging fiscal responsibility. He lost. In 1952, Dwight Eisenhower promised an income-tax cut and the voters gave him the White House and Republicans control of Congress. As soon as he was inaugurated, Ike announced at his first press conference that before taxes could be cut as promised, the budget had to be balanced. You more or less are familiar with the Kennedy years onward, so I will not go into the parallels of the last 40 years.

The reason it is incorrect to pay down national debt is not that it is never a good idea. It is not a good idea while the federal government can invest revenues in better ways. The situation is similar to a major corporation in the private sector, which, with expanding revenues, must decide whether to plough them back into the business, or use them to acquire other businesses, or use them to pay down corporate debt, or use them to buy back corporate equity. It is always a good idea to pay down debt or buy back equity if management can’t think of an investment that might yield a better return. They have to make this decision carefully, for if they invest expanding revenues into acquisitions that the market judges to be inappropriate, the value of their debt and equity would decline.

In the 1970s, as the price of gold shot up as a sure signal of the monetary inflation that would follow, the price of oil -- black gold -- was the first commodity that ran up in tandem. Suddenly oil companies were engulfed with unanticipated revenues. They could either declare them and pay steep taxes; or, they could acquire companies -- like Montgomery Ward -- which were running big tax losses. The age of conglomeration was a direct result of Nixon going off gold. If we had not gone off gold, the deficits would not have emerged, Newt. I’ll say that again: If we had not gone off gold, the deficits would not have emerged. The fact that since 1983 -- first with Paul Volcker, then with Alan Greenspan -- we have been gradually getting the gold price to behave -- is the reason the deficits are evaporating. President Clinton gets credit only for having given Greenspan his support, moreso than George Bush and Nick Brady. The 1993 tax increase was a dead loss, which Greenspan had to accommodate by allowing gold to rise to $383 from $350. The economy swallowed the Clinton tax increase, as bad as it was, but it has been overcome by Greenspan’s steadiness in fending off debilitating rate increases. The bottom of the economy, the low-wage economy, remains fragile, though, and can only really strengthen with a cut/indexing of capital gains taxation.

The legislation Mark Neumann proposes would never be appropriate, because it ties the hands of Congress in making investment decisions. This is why Gramm-Rudman-Hollings was a terrible idea and why it has worked so poorly. It is also why a Balanced Budget Amendment is a terrible idea. As revenues appear on the horizon, there must always be a serious debate in Congress between the two political parties on how they should be invested. It may be that in the year 2007, with a streamlined flat tax system in place and thus no need to dedicate new tax revenues to lower tax rates, that Congress would decide to spend at the 2006 baseline, and use the revenues to redeem debt. It is a decision that should be made then, not now. It would of course be appropriate for this Congress to put into this year’s legislation a commitment to invest fresh revenues in tax cuts next year -- because you are expected to make decisions of this kind in a two-year framework. You could negotiate this with the President and congressional Democrats, to accelerate the timetable for their college credits next year if they would agree to the commitment of tax cuts being financed with future growth revenues.

As a historian, you know that generals always plan to fight the last war. This is what Mark Neumann is doing. His arguments in The Washington Times of June 20 reveal a complete and total misunderstanding of where the deficits of the past 30 years have come from. They can be entirely explained by the monetary inflation, which began in 1967 when LBJohnson closed the London gold pool. With the price of gold up by a factor of 10 in this period, the national debt of $5.9 trillion is really only $590 billion, when related to gold, the most appropriate measure of government debt. My guess is that Mark Neumann knows nothing about any of this. He somehow believes with evangelistic fervor that he is sent as an avenging angel to smite irresponsible “bureaucrats,” who he blames for the national debt. It is not a bad thing for him to put a stress on eventually paying down the national debt to some level. Because we use our national debt as our national money, we can’t pay it all down anyway. A significant amount is used as global money, on which we do not have to pay interest. Does Mark Neumann understand this? Obviously not, if he believes being a “debt-free nation” would be a good thing. The idea is preposterous.

His idea of replacing government paper in the Social Security System with “real assets” is also nonsensical. Government paper is as real as any other and is the most secure. Ross Perot did a great disservice in spreading the idea that there is nothing of value backing the Trust Funds. The government’s promise to pay seniors by getting the resources from juniors is the same as IBM’s promise to pay its shareholders and bondholders with revenues it gets from sales of its products. But we do know the U.S. Government will be around in 40 years and we can’t be sure about IBM.

It continues to amaze me, Newt, that you have available old friends and supporters who know a hundred times more about public and private finance than you will ever know -- and you instead search out “experts” who studied from the textbooks of the people who made it necessary to have a Reagan Revolution. There is a gang of us here who would be happy to help you as Speaker, with economics and finance, as we did before you got there. Whenever you’re ready.