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Big deficit, tax cuts can serve as investments

Updated: May 3, 2013 12:14PM

Originally published: July 17, 2003

For years I’ve been preaching about the dangers of debt, advising people to pay off their credit cards and avoid tapping home equity. So how can I--or anyone--defend the $455 billion fedceral budget deficit that is predicted for this year?

Viewed in any perspective, the numbers are massive. Not only will the government spend $455 billion more than it collects in tax revenues this fiscal year, but that number will be even greater next year, with a projected $475 billion deficit.

Those figures tower over the $290 billion deficit in 1992--and far exceed the levels that encouraged Ross Perot to pique the national attention with his homemade charts a decade ago.

But leaving politics aside, can these deficits possibly be good economics? History gives us some hope.

Higher interest rates? Many people worry that higher deficits, which lead to more government borrowing to fund those deficits, will crowd out private business borrowers, and thus lead to higher interest rates.

But that fear flies in the face of the experience of the 1980s, when budget deficits soared under President Reagan, and yet interest rates made a dramatic decline from a prime rate of 21 percent to single digits.

Just two years ago, when we had a $294 billion budget surplus, interest rates on 10-year U.S. Treasuries were 5.8 percent. Today, even as the budget deficit projections have grown, rates on the same Treasuries have dropped to 3.9 percent! So history shows that big budget deficits don’t necessarily cause higher interest rates.

Inflation? Others worry that big budget deficits are a cause of inflation. But again, we had budget deficits in many of the last 20 years without significant inflation. And our biggest inflationary period in the late 1970s occurred when budget deficits were relatively meager by today’s standards. The federal budget deficit in 1978 was just $24 billion. Inflation is caused by excessive creation of new money, not just by the existence of deficits.

So why worry about deficits?

Headlines about big budget deficits do make us squirm. It’s almost as if there’s something inherently wrong or immoral in running up those huge debts. We know that if we did that in our own family budgets, we would someday cross a line, unable to make our payments or borrow more. We would have to declare bankruptcy.

But sometimes going into debt doesn’t lead to dire consequences. It depends on what you do with that money you borrow.

For example, if you borrowed the money to build a business that becomes successful and increases your income, you’ll be able to pay down that debt in the future. And you’ll have future income. This debt creates a profitable investment.

So it’s important to look at just how the government’s borrowed money is being spent. It’s quite a mix. Some spending on national defense can’t really be classified as a financial investment in the future. But if we don’t protect our country, it won’t matter how large the deficit grows.

Other spending can be easily criticized as wasteful. But when we spend on education or other programs that help Americans become more productive, it clearly is a good investment in the future.

The tax cut investment

Then, there are tax cuts. They truly seem irresponsible at first glance. After all, the deficit would be far smaller if we hadn’t had the tax cuts.

But if those tax cuts--more than $100 billion in lost revenues this year--can encourage future growth in the economy, then new tax revenues will dwarf the current budget deficits. Then tax cuts become an investment in the growth of future revenues.

If it all worked so logically, there would be no grounds for debate about the size of the deficit and the likely outcome of the tax cuts. Just as there’s risk in taking on debt to start your business in the hopes of future income, there’s risk in the plan to cut taxes to bring economic growth. But without economic growth, all hope is lost.

So now we have a huge government deficit. We’ll see how it works out. But let me once again warn against following the government’s lead in your own personal finances. After all, if things go wrong, the government has one weapon in its arsenal that you and I don’t have: The government can always print the money to bail itself out of debt. And that’s The Savage Truth.

Terry Savage is a registered investment adviser and is on the board of directors of the Chicago Mercantile Exchange and McDonald’s Corp.

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