This graph is gorgeous. US deficits have, historically, been driven overwhelmingly by the state of the business cycle, and have very little to do with tax policies and spending decisions that dominate press coverage. In booms, income rises, so tax rate times income rises. In busts, the opposite, plus “automatic stabilizer” spending kicks in. Until now. There is a good reason past deficits did not really spook markets. They understood the deficit was a temporary phenomenon, due to temporary poor demand-side economic performance. We do not have that excuse now.
I’m wondering if Cochrane’s goal of late is to make his readers more stupid. First of all – looking at the nominal debt today compared to a decade ago is highly misleading. James Tobin once noted that the tripling of the Federal debt during the 1980’s was misleading as the real debt only doubled. He usually said that with his usual smile. OK – inflation today is a bit lower than it was during the 1980’s but the debt/GDP ratio only doubled over the last decade. Now we should admit that the fiscal stimulus since Trump took office is an alarming trend but it is very much like Reagan’s fiscal stimulus in 1981 in that both cut taxes for the rich and increased defense spending. Oh wait – Cochrane was all supportive of these fiscal moves last year but now he is sounding the alarm bells as Team Republican really does want to cut “entitlements”. To be fair – Cochrane did say:
I do think that roughly speaking we could pay for American social programs with European taxes. That is, 40% payroll taxes rather than our less than 20%; 50% income taxes, starting at very low levels; 20% VAT; various additional taxes like 100% vehicle taxes and gas that costs 3 times ours.
He said a whole lot more that one can take a look at. My only response is that he is echoing another Team Republican line – tax everyone except the rich. But let me directly challenge this nonsense that our deficits have been “overwhelmingly by the state of the business cycle, and have very little to do with tax policies and spending decisions”.