08/24/2011 07:37 pm ET | Updated Oct 24, 2011

Don't Confuse the Federal Deficits

Financial FAQs

Why the confusion over the federal budget deficit numbers? We should ask ourselves why there is such confusion over what in fact are two budget deficits -- two -- not one that budget deficit hawks say will run forever if we don't get our spending under control!

It's confusing because every politico and some economists are using the deficit debate -- how much spending to cut, vs. stimulus spending to create jobs -- to really disguise the fact that there are two deficits. One is the current deficit created by all the tax breaks, the wars, and lost tax revenues from the recession -- the lowest revenues as a percentage of GDP growth since World War II. (That tells us how severe was the Great Recession, the worst since the Great Depression.)

The second is a much longer term deficit that will happen if we don't get entitlement spending under control. But here's the thing. Unless we first take care of short term deficit #1, then long term deficit #2 will be harder to fix. That's because lost revenues -- whether from wars, tax breaks, or recessions -- are permanently lost. So to make up for those losses, we must create policies that expand economic growth as quickly as possible, period.

We can't reduce the actual deficit without stimulating growth, in other words. That is the misconception touted by Tea Partiers in particular. Newly elected Republican Senator Pat Toomey, one of the 12 debt ceiling 'Super Committee', is a very good example of the misconception.

He maintained in a recent Bloomberg Marketwatch interview that his twin goals were "deficit reduction and pro-growth policy". Yet he would only talk about deficit reduction without offering a single idea how to achieve it. Instead, he repeated the Tea Party mantra when asked this by Marketwatch: "Why not inject some stimulus like more spending, or tax cuts?"

"A: There's a huge difference between lower taxes and increased spending. Lower taxes generate growth through the supply side. It makes it less expensive to launch a venture, to expand a venture, to hire workers and so it's an incentive to increase production and ultimately it's production that's the source of wealth of a society. So my focus has always been on the supply side."

Toomey and fiscal conservatives in general have never offered one shred of evidence that supply-side policies reduce deficits. In fact, all the evidence disproves supply-side theories. The largest deficits were created by supply-side Presidents Reagan and GW Bush. That's because, as Warren Buffet said recently:

"Back in the 1980s and 1990s, tax rates for the rich were far higher, and my percentage rate was in the middle of the pack. According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends."

"I didn't refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone -- not even when capital gains rates were 39.9 percent in 1976-77 -- shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000."

This from one of the richest men in the world. Also, Nobelist Paul Krugman said in a recent blog:

"If there was an alien invasion, or another war, we would spend what it took to win. And that spending could cure deficit #1 in 18 months."

"What the market was saying -- almost shouting -- was, "We're not worried about the deficit! We're worried about the weak economy!" For a weak economy means both low interest rates and a lack of business opportunities, which, in turn, means that government bonds become an attractive investment even at very low yields. If the downgrade of U.S. debt had any effect at all, it was to reinforce fears of austerity policies that will make the economy even weaker. "

That's the sad truth. We know to spend to simulate production during wartime, but then forget that it boosts growth during peacetime as well. And the short term deficit is just that. Defense spending will fall as our wars wind down, tax revenues will increase as the economy continues to recover, and the Bush tax cuts will probably expire in 2012 -- if politicos are serious about deficit reduction.

Hence the confusion with long term debt problems. They are mainly due to rising medical costs, as the social security fund is in surplus and should pay for itself until about 2040. So Medicate entitlements are where the real political deadlock sits -- private healthcare vs. universal health care for all. Which is more likely to bring down those medical costs? Is it really a surprise that the private, for profit health care system hasn't done the job? When an untruth is repeated enough, though, and there is little written about the truth, then the untruth will prevail.