Deficit Reduction vs. Tax Cuts
There are times when the American political cycle and the global economic cycle overlap to create a potentially dangerous situation. This could be one of them. Global growth is in a major upswing at a time when U.S. Presidential candidates are making big promises to cut taxes and boost spending. Oil is pushing $30 a barrel, commodity prices are rising sharply, and core inflation rates for the U.S., Europe, and most of Asia (except Japan) are beginning to creep up from their lows. With estimates for the budget surpluses growing ever larger, the debate over how to return a portion of it to tax payers grows ever louder.
In economics as in life, timing is everything. At this particular time, we think that using the surplus to pay down the federal debt and gradually lower interest rates is the best way to provide the greatest benefit for the largest number of people. Clearly, the risks of the moment are of an overheated economy. In this environment, a government budget in surplus makes the most sense. It cools demand and keeps interest rates lower than they would otherwise be, stimulating investment in capacity and raising productivity
Since the business cycle, though changed, is still with us, there will certainly come a moment when the economy turns down. When this happens, tax cuts on marginal rates and increased government spending will serve to boost demand and return the economy to solid growth. Right now, there is enormous demand in the U.S. economy--and fast-growing demand overseas as well. Slack in the global economy can no longer be counted upon to keep inflationary pressures under control.
Cutting taxes to increase take-home pay, boosting spending to improve the nation's infrastructure and the people's skills, and paying down the debt to lower rates can all play a role in nurturing economic growth. But timing is all important. With the U.S. economy running red hot, and Europe and Asia moving into high gear, the best use of the surplus right now is to pay down the debt.