Alan Reynolds

The government's new estimate that the budget deficit may hit $455 billion this year was quickly greeted with pompous media comments that managed to evade the main point. The Washington Post weighed in with a self-assured editorial listing four reasons "Why Deficits Matter." The first point was that deficits result in, as Alan Greenspan put it, "draining savings from the private sector," which supposedly reduces investment and growth.

That theory has been thoroughly tested over the past decade and failed spectacularly. From 1998 to 2001, while the budget was in surplus, national savings amounted to 18 percent of GDP. From 1981 to 1989, when deficits averaged 3.8 percent of GDP, national savings was 18.2 percent of GDP. Fixing the government's budget at the expense of taxpayers' budgets does not add up to a net gain for the economy as a whole.

Since national savings is about 18 percent of GDP regardless of the government's budget, the only sure way to increase savings is to increase GDP. But higher tax rates have the opposite effect, draining both the resources and incentives needed to boost economic growth. Besides, profitable investment opportunities do not really rely on the fraction of income set aside each year. Good investments can be financed from the accumulated assets of the whole world.

Savings can indeed gradually increase our collective wealth. But wealth rose far more swiftly thanks to the increased market value of stocks after the recent tax cut. Ironically, critics of the tax cut (those who now feign concern about deficits "draining" savings) argued that too much of the tax cut might be saved. The pundits' solution is always the same -- higher taxes -- only the problem changes.

The Washington Post's second complaint cites Economics 101 (as far as they got with the subject) to the effect that the alleged reduction in national savings allegedly raises interest rates. In reality, as opposed to elementary theory, there is no evidence that changes in either deficits or savings rates affect national interest rates. Interest rates reflect the real return on capital and inflation, and they are largely determined in global rather than national markets.


Alan Reynolds

Be the first to read Alan Reynolds' column. Sign up today and receive Townhall.com delivered each morning to your inbox.

©Creators Syndicate