Deficit spending -- when more is spent by the government than is collected in taxes -- has frequently been a policy of the U.S. government. Alexander Hamilton, Secretary of Treasury under President Washington, promoted the policy of incurring debts as a method of establishing sound credit. Many succeeding administrations followed suit. However, debts were incurred mainly as a result of wars, and periods of postwar prosperity made them easy to erase. Government debts had not been used to attempt to improve peacetime economic conditions. As a result of the Great Depression, however, a new era was ushered in -- an era in which fiscal policy included government borrowing aimed specifically at lessening the effects of the depression.
In campaigning for the presidency in 1932, Franklin D. Roosevelt promised the American public that a balanced budget would be maintained. In fact, during all his years in the White House, prior to our buildup for World War II, a balanced budget was uppermost in his mind. Philosophically, he was against the government's going further into debt -- but, in order to support his many relief programs, his advisors felt that it was necessary to spend more. As program after program was passed -- programs that would cost taxpayers billions of dollars -- the choices were increased taxes or government borrowing. So, to give the American people a "New Deal," a budget deficit was needed.
When he first took over the presidency, Roosevelt had the backing of many segments of society -- not only the general public but bankers and businessmen. The depression affected everyone. Business was hurt badly; government borrowing was far more acceptable to the business community than higher taxes. Such was the attitude until 1936, when bankers and businessmen began to change their views. As recovery began to take effect, the deficit was not considered necessary. Even though he did not favor greater debt, Roosevelt had his priorities. Convinced that deficits were temporary and not a permanent fact of fiscal life, he was exultant about the pump-priming consequences of spending. In his budget message of 1936 he stated:
Our policy is succeeding. The figures prove it Secure in the knowledge that steadily decreasing deficits will turn in time into steadily increasing surpluses, and that it is the deficit of today which is making possible the surplus of tomorrow, let us pursue the course we have mapped.
As unemployment decreased during those early years of pump-priming, there seemed to be some grounds for President Roosevelt's optimism. Then, one year after his second inauguration, unemployment began to rise. Why, in spite of this pump priming, was there a recession within a depression? The pump was not running; prosperity generated by deficits had not survived the withdrawal of the stimulus. Were deficits to become a permanent part of government policy?
Looking back upon those deficit days of the New Deal, it is well to note that the average yearly federal budget deficit was about three billion dollars, out of an entire federal budget of six to nine billion dollars. The federal government was borrowing a larger portion of its operating expenses in the 30s than it is today.
However, after the Second World War, the United States had far rosier economic prospects than it does today. This country was the world leader in technology, and emerged from WWII as the world's pre-eminent military power. Our major industrial competitors in Europe and Japan were rebuilding from a devastatingly destructive war. Today, however, the U.S. faces stiff competition on all fronts.
In the early 1980s the Reagan administration pursued a "supply-side" economic policy. A number of economic theorists, most notably Arthur Laffer, advocated deep cuts in taxes, particularly on businesses and those with higher incomes. The rationale was that the savings would be invested in job-creating productive capital. Theory predicted that government revenues would increase, even though tax rates were lower, because the overall production pie would be bigger. However, at the same time, the U.S. engaged in a large military buildup, aiming to spend the Soviet Union into insolvency. The result of lowered tax rates and increased military spending was a large federal budget deficit.
Unfortunately, the "supply-side" tax cuts didn't work out the way President Reagan's economic advisers expected. For the most part, the savings were not invested in productive capital but in speculation in real estate and the stock market. Tax revenues did not increase anywhere near as much as was hoped, and the nation is now faced with an ever-growing debt.
In the 1930s, the U.S. government tried an innovative program of using deficit spending to help get the economy out of a depression. Business cycles have come and one since then, and deficit spending has become established as a tool that can blunt the edge of recessions. However, government deficits today threaten to grow uncontrollably, recession is still an ever-looming possibility, and economists still search for root causes and solutions.
Background Questions:
- How did the deficits during the New Deal differ from past deficits?
- Why did President Roosevelt feel it was necessary to incur a deficit?
- Explain why bankers and businessmen changed their views toward a deficit in 1936.
- What is the difference between "deficit" and debt?
- Compare personal debt with national debt. Who borrows the national debt, and who pays it back?
- How did supply-side economic policy increase the deficit?