The Federal Debt


FDR Changes the Rules

What happened? One answer, of course, was the Great Depression. World trade collapsed, corporate profits vanished, the incomes of the rich—the only people to feel the personal income tax in those days—steeply declined, and government revenues plunged. More than $4 billion in 1930, they were less than $2 billion in both 1932 and 1933. Meanwhile, government outlays rose sharply as cries for federal relief funds became undeniable: $3.3 billion in 1930 and $4.7 billion in 1932, when the deficit amounted to 142 percent of revenues, by far the worst peace-time deficit in the nation’s history.

Herbert Hoover, true to the old wisdom, tried desperately to do something about the mounting deficits. In 1932, in the teeth of both a re-election campaign and a still-collapsing economy, he pushed a large tax increase through Congress to help balance the books, an act that not only deepened the depression further but ensured his overwhelming defeat in November.

Franklin Roosevelt largely based his presidential campaign that year on lambasting Hoover’s fiscal mismanagement. “Let us have the courage to stop borrowing to meet continuing deficits….” Roosevelt said in a radio address in July. “Revenues must cover expenditures by one means or another. Any government, like any family, can, for a year, spend a little more than it earns. But you know and I know that a continuation of that habit means the poorhouse.”

No sooner was he in office himself, however, than Roosevelt made an unbalanced budget a matter of deliberate policy for the first time in the history of the Republic. His advisers quickly convinced him that “passive deficits,” not profligate spending, were, under the circumstances, good policy. They should be tolerated, the advisers thought, because any attempt to balance the budget would only make matters worse, as Hoover’s taxes had, and might even threaten domestic stability.

In any event, despite his campaign rhetoric, Roosevelt—who possessed in spades the gut political instincts that Hoover completely lacked—was not about to continue the policies that had destroyed Hoover’s Presidency. He had no trouble discerning that new spending programs were politically popular while new taxes most emphatically were not. Thus the extraordinary conditions of the 1930s allowed Roosevelt to institute an array of new federal programs, doubling federal spending between 1933 and 1940, while raising taxes only on what was left of the very rich, who saw their income tax rates increase sharply.

These spending programs proved enduringly popular even as better times began to return. So the increased tax revenues the improved economy brought were applied largely to extending the new social safety net, not to balancing the budget, still less to reducing the debt. Furthermore, the percentage of the gross national product that passed through Washington began to climb sharply. Federal outlays amounted to 3.7 percent of GNP in 1930. By 1940 they were 9.1 percent. It is perhaps not going too far to say that Roosevelt changed the country’s perception of the proper scope of the federal government’s responsibilities as much as the Civil War had changed the country’s perception of itself.

It was World War II, however, not New Deal programs, that finally ended the Depression. And needless to say, the war only increased the deficits. By 1946 the United States had run sixteen straight deficits. The national debt now stood at $271 billion, a hundred times what it had been at the end of the Civil War and almost seventeen times what it had been in 1930.

But now, for the first time after a great war, debt reduction was not the first object of federal budgetary policy. The most influential economist since Adam Smith, Britain’s John Maynard Keynes (Lord Keynes after 1942), had appeared on the scene. American government fiscal policy would never be the same again.

In the Long Run We Are All Dead

Before Keynes, economists had been largely concerned with what is now called microeconomics, the myriad individual allocations of resources that determine prices and affect markets. In effect, economics had been concerned with the trees. Keynes, however, looked at the forest, the macroeconomic phenomena of aggregate demand and supply.

Keynes argued, in one of his most famous aphorisms, that while these must balance out in the long run, it was equally true that in the long run we are all dead. In the short run, aggregate supply and demand often do not balance, with pernicious results. If demand outstrips supply, inflation occurs. If total demand is insufficient, depression results.

Keynes further argued that government could and should take an active role in affecting both aggregate demand and supply. When inflation threatens, Keynes thought, government can dampen demand by reducing the money supply, raising taxes, reducing government spending, or some combination of the three. Opposite government action could deal with an economic slowdown. The result, thought Keynes, would be a smoothly functioning economic system, permanently high employment, and low inflation.