Amity Shlaes shares a little history lesson with her readers at Bloomberg today and the message is clear: The government needs to cut spending now or face the need for higher taxes in the near future. Telling the story of Andrew Mellon who is remembered as the tax-cutter’s deity, Shlaes also reminds her readers that Mellon was forced to significantly increase taxes shortly after his historic cuts, in order to save the country from the repercussions of a too deep deficit.
Here’s what the Mellon story tells us: there comes a point when even the most devoted tax cutter will raise taxes. The trick for the country is to avoid getting to that point. In our own cycle, that point of needing a dramatic tax increase is just years, possibly even months, away.
There was an era when U.S. politicians had the luxury of ample time, and their motto could be “tax cuts first, deficits second.” Another maxim was also popular: “deficits don’t matter because we outgrow them.” In many instances from the 1960s to the 1990s, tax cuts did indeed promote growth and prevent deficits.
This time yearly growth in the U.S. can’t reach 4 percent, or even 3 percent by tax changes alone. Cuts in debt and entitlement reform are also necessary. The federal debt is too big to outgrow, especially with interest rates heading up. The very structure of our entitlement programs guarantees that greater economic growth will yield larger budgetary shortfalls. The formula for Social Security is pegged to the average real wage. When the economy grows, that wage increases, driving up the government’s pension obligations commensurately.
And this time, the competition from China and Europe, in terms of their economies and currencies, will not go away. America’s next big financial crisis will be a money crisis. To survive, the dollar will have to demonstrate that it’s not based upon ever-widening debt and is worthy of investment by foreigners.