Trump's Tax Cuts, Fear of Exploding Deficits and the Truth About the U.S. National Debt

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Donald Trump in the Oval Office last February. The president hasn't even signed the GOP tax bill and he’s already talking about infrastructure legislation. Getty

As Republicans prepare to pass a tax bill before Christmas, spare a thought for Congress's most endangered species: the deficit hawk, a creature of Washington who believes the ever-growing national debt actually matters. Representative Mark Meadows, a North Carolina Republican, is one of them. So are Republican Senator Bob Corker of Tennessee and Democratic Senator Ron Wyden of Oregon.

These deficit hawks are not exactly enthused about the GOP bill, though Corker and Meadows are voting for it anyway. According to Congressional Budget Office estimates, the bill will add more than $1 trillion to the national debt over the next decade. The annual deficit for fiscal 2017 was $666 billion, or 3.5 percent of the overall U.S. economy. That share, because of the tax bill, will now increase, though by how much is a matter contentious debate.

Yet gone are the days when politicians from both parties were constantly conjuring doomsday scenarios about how debt is destroying our economy. All of a sudden, no one seems to care about deficits. Why? Because for over half a century, deficit fears by both parties were alarmist and often out of touch with reality, especially when the opposing side was in control of Congress. That's not to say debt and deficits don't matter—they do—just not necessarily in the ways that deficit hawks have argued.

Related: Three big lies about Trump's tax plan

Go back to the early 1960s, when John Kennedy was president. He pushed for a big tax cut—passed just after his assassination—that angered the sound-money Republicans in Congress. They believed, as politicians of both parties profess to today, that the federal government's accounts are no different from your personal finances: You need to spend no more than you take in, and to save a bit for an unexpected expense, like a world war.

Kennedy's tax cut spurred economic growth, and the deficit actually declined as a percentage of gross domestic product. Twenty years later, this led many conservatives to cite Kennedy's move as a model of "supply-side economics" (i.e., big tax cuts) and push a similar measure as the centerpiece of Ronald Reagan's economic program.

After Reagan was elected, his tax cuts caused the left to freak out about deficits. That was novel at the time, because Keynesian economics—which held that running deficits to spur a flagging economy was the right thing to do—was central to the Democratic Party's economic program. Leading the critique of Reagan's program was Harvard economist Benjamin Friedman. His critique was standard fare: The tax cuts were a giveaway to the rich (which was arguably true), and they would inevitably "crowd out" private investment, because the federal government would compete with private debt issuance to fund things like new businesses. This would lead to higher interest rates and a steep recession.

Friedman further mocked the idea that supply-siders' peddled: that the tax cuts would "pay for themselves" by generating economic growth. (Several supply-siders from the Reagan years say they never argued that.)

The cuts didn't pay for themselves, but contrary to what Friedman thought would happen, interest rates came down steadily during the Reagan years because the Federal Reserve was ruthlessly quashing inflation. This confounded the standard view of deficit spending, which held that it either led to inflation (because the Fed had to print money to finance the government's spending) or (the Friedman view) it would inevitably drive up interest rates and prompt a recession.

Neither occurred, because the global economy was changing in ways that academic economists didn't yet understand. Globalization had arrived, and foreign investors, the Japanese in particular, started buying huge amounts of U.S. Treasury debt.

Why? Because, just as the Chinese do today, the Japanese were intentionally running huge trade surpluses —surpluses that were in dollars, the medium of international trade. They didn't want to repatriate their surpluses into yen, the local currency, because that would drive up the exchange rate of their currency against the dollar, thereby hurting their exporters. Instead, they dumped the excess into Treasuries, then—and now—the only market big enough to absorb the surpluses.

The results: There was no inflation and no immediate, dire economic effects. But deficits spiked to nearly 6 percent of gross domestic product, then tapered off, before climbing again in the late 1980s. Reagan's successor, George H.W. Bush, was spooked by those deficits, fearing the rising national debt (then just over $2 trillion). He agreed to tax increases—just as mainstream economists like Friedman had been calling for.

Bush paid a political price for his tax increase. During his campaign, he had pledged to not raise taxes, and supply-siders and others insist breaking that pledge is the reason he ended up being a one-term president. Bush's experience, in fact, was one of the reasons Dick Cheney, when working for another budget-busting president, George W. Bush, would later say, "Reagan proved deficits don't matter."

Yet deficits do matter. Every year the country runs a deficit, it adds to the national debt. That debt is now 7 percent of federal spending. That's not yet a calamitous level, but it's already more than 40 percent of what we spend on national defense—and the tax bill means that number will soon go up.

The number represents spending that lawmakers can't cut. Whether the debtholders are foreigners or Grandma's pension fund, the interest on those bonds has to be paid. Not paying it means the U.S. would default on its debt, which would roil the financial markets.

Meanwhile, the money budgeted to pay interest on the debt means it can't go elsewhere: Democrats can't spend it on free college or more health care, Republicans can't use it to ramp up defense spending. Adding to the burden of the debt: interest rates, which have been historically low for years but are now going up and may continue to rise for some time.

Those realities sound harrowing, but they're not necessarily as scary as they may seem. In the relatively recent past, debt and deficits ballooned enough that both parties got around to realizing that they had to do something. They understood that you can't keep running big deficits that add to the national debt. Which is why George H.W. Bush worked with Democrats to pass a tax increase, and restored some budgetary sanity—even if it did contribute to his defeat. His successor, Bill Clinton, worked with Republicans in Congress to actually generate surpluses during his second term.

But just because Clinton and George H.W. Bush did the responsible thing doesn't mean lawmakers will in the future. But the incentives are real. No one in either party comes to Washington merely to pass budgets that send an ever-increasing amount of money to our debtholders. They have legislative priorities that often cost money—money they'd rather have access to instead of watching it go to bondholders.

The problem is, there's no magic number that compels politicians to act. And judging by the tax bill, we're far from a tipping point. The president hasn't even signed it and he's already talking about infrastructure—a massive endeavor that will surely add to the debt, which now stands at $20 trillion and counting.