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140 IRET Congressional Advisory 1 (2002)

handle is hein.taxfoundation/iretcgadv0137 and id is 1 raw text is: INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION IRET is a non-profit 501 (c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote growth and efficient operation of the market economy. November 8, 2002 Advisory No. 140 DEFICITS, TAX CUTS, INTEREST RATES AND INVESTMENT (PART H): WOULD FINANCIAL MARKET CONSEQUENCES OF TAX REDUCTION NEGATE POSITIVE EFFECTS ON GROWTH? For years, students of economics were taught that deficits drive up interest rates. In recent decades, some Democrats and old-guard Republicans have argued against tax cuts, even those designed to promote investment, on the grounds that cutting taxes would raise interest rates and retard investment and growth, and thus be self defeating. In a recent budget resolution, Republicans claimed that policies to increase the budget surplus would reduce interest rates and further improve the budget outlook. For years, stu The trouble is, the data don't were taug t. bear out the claims. were.taught. t Part become deficit is deficit ma real defic the amo outstandii of the reason people frightened by the that the nominal ay be higher than the it. Inflation reduces unt of real debt ng. For example, if the obligations will be dealt with either through benefit formula changes or tax changes. Also, several trillion dollars worth of federal assets, such as land, buildings, and weaponry, are not counted as offsets to the debt either. But let's get back to the traditional measure of the deficit and th and interest rates dents of economics iat deficits drive up inteest ates...I lhe trouble is, the data don 't bear out the claims... Numerous studies have found only limited relationships between deficits and interest ates. federal debt held But this assumes ie traditional discussion of deficits A rise in the deficit is assumed to absorb more of the nation's saving, and leave less for the private sector. According to flow of funds analysis, the deficit increase means more demand for saving out of a relatively fixed 'supply, so the price (the interest rate) must rise. This is also expressed as the notion that a higher deficit means a lower rate of national saving. that the supply of domestic saving by the public (that is, not in federal government accounts) is $4 trillion and inflation is 2 percent, then the real debt is falling by $80 billion a year. There is a real deficit only when the nominal deficit exceeds $80 billion. Even that overstates the economic and budget impact of the debt, because the Federal Reserve buys some of the debt each year as it increases the money supply, and returns the interest payments on its holdings to the Treasury (after meeting its own minimal expenses). Of course, some obligations of the federal government, such as rising future Social Security obligations, are not recorded as part of the debt, but these is fixed, and that we have no access to world credit markets. In fact, changes in the government deficit are significantly offset by opposing changes in private sector saving. Lower taxes, especially those that raise after-tax retained earnings (part of business saving) or that encourage saving by individuals and raise the returns to investment, primarily boost saving, not consumption. When tax cuts boost saving to match, they leave national saving unchanged. When tax cuts encourage larger increases in saving, they may boost national saving. 6~,I S I 66 6 ~. ~66 S.

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