In fact, lower taxes, especially lower tax rates that encourage more investment and work effort, are far more stimulative and less inflationary than higher government spending. Lower tax rates increase the supply of goods and services available at any price level, an upward shift in aggregate supply. Demand may also increase as faster growth and less taxation per dollar of (higher) income drive up after-tax incomes, but the increase in aggregate supply will hold inflation in check. In contrast, higher government spending increases demand for goods and services with no impact on the economy’s capacity to produce them and therefore is unambiguously inflationary. Consequently, it is fiscal stimulus in the form of higher government spending, not lower tax rates, that may require an offset from tighter monetary policy to avoid inflation.

Historically, large deficits and attendant increases in national debt have been tied to the conduct of wars. Presumably, feelings of vulnerability with respect to the inability to finance another war prompt urgent drives to reduce debt in the aftermath of war. America’s Revolutionary War gave rise to a large debt, nearly $75 million, which was 42 percent of estimated national product at the time, not very high by current standards. More problematically, the interest burden consumed more than half of the meager federal revenues whereas today interest on the national debt consumes about 11 percent of federal revenue. Still, Alexander Hamilton took the view that consolidating the debt and servicing it in a reliable and timely manner would enhance America’s standing as a worthy creditor, turning debt from a liability into an asset. Hamilton also, no doubt, recognized at the time the value of a benchmark asset, an interest-bearing liability guaranteed by the government’s ability to levy taxes in order to ensure payment of interest on the debt.

The current notion that the $4.2 trillion in prospective surpluses over the next decade ought to be devoted in large part to eliminating the national debt of about $3.5 trillion is a preposterous idea. Paying off the national debt would leave global financial markets with no benchmark risk-free asset in the form of U.S. government securities. High-quality liabilities of the U.S. government confer benefits on both the private sector and the government, enabling the government to borrow when necessary at low cost. If the U.S. government were to absent itself from the credit markets, it would hamper its ability to smoothly resume borrowing, should the need arise.

The biggest downside to simply paying down the debt over the next decade arises from the need for taxes and tax rates to be higher than they would otherwise be if we aimed just to stabilize the debt-to-GDP ratio between 30 and 35 percent—about one half of the average for industrial countries. Critics respond by asserting that the remarkable prosperity of the 1990s—a period of deficit and debt reduction—outstripped the economic performance of the 1980s, when tax cuts and spending growth initially led to higher deficits. This claim is factually untrue and represents a major confusion of cause and effect. It is higher growth that has led to lower debt and deficit levels, not lower debt and deficit levels that have led to higher growth.

First, consider the record. When President Reagan took office in 1981 and cut taxes on investment while the Federal Reserve pursued policies that cut inflation rapidly, the deficit rose from 2.6 percent of GDP in 1981 to a peak of 6 percent in 1983, then eased to around 5 percent through 1986. The fact is that much of the rise in the deficit was due to a rapid slowdown in inflation rather than to tax cuts or higher spending growth. But still, despite the much bemoaned higher deficits of the Reagan years, the economy grew at an average annual rate of 4.5 percent during the five years following 1982, while the stimulative fiscal policies of the Reagan administration were producing an increase in deficits. The 4.5 percent growth rate for 1982 through 1987 was a full percentage point above the average growth rate of 3.5 percent over the four decades since 1959.

President Clinton took office in 1993 and that year effected deficit reduction measures, largely through higher taxes. The deficit as a share of GDP went from 3.9 percent to a surplus of about 1 percent over the five years following the enactment of the reduction measures. The surplus has continued to rise and probably will reach close to 2 percent of GDP this year.

During the five years following the 1993 measures, which followed on deficit reduction measures enacted in 1990 under President Bush, U.S. economic growth averaged 3.8 percent, still above the average of 3.5 percent for the period since 1959, but below the 4.5 percent enjoyed during the period of fiscal stimulus and higher deficits in the Reagan years.

A full assessment of the determinants of growth is, of course, a complex process. Some of the faster growth during the 1980s was undoubtedly due to the elimination of the dangerously high and unstable inflation rates of 1973 through 1981. The higher growth rate of the 1990s, which did not appear until after 1995, was due largely to a surge in capital spending on new technology and an associated increase in productivity growth from a 1 percent average during the twenty years before 1995 to about 2.75 percent in the years after 1995. That extra rise in productivity has helped to extend America’s noninflationary expansion to a record of nine and a half years (and counting). No one links the post-1995 surge in productivity growth to the higher tax rates enacted in 1993.

The truth is that, in the 1980s, stimulative fiscal policy, especially lower tax rates coupled with monetary policy acting to reduce and stabilize inflation, pushed up growth. The higher growth generated the revenue to bring budget deficits down sharply and stabilize the ratio of debt to GDP. The productivity boom that began in 1996 produced the deficit reduction and surpluses of the 1990s. Just for the record, the ratio of federal debt held by the public to GDP rose from 25 percent in 1981 to 41 percent in 1988. Thereafter, it rose to just over 49 percent during the mid-1990s and then started to fall, reaching 43 percent by 1998. The debt-to-GDP ratio was higher in the 1990s than it was in the 1980s. Only after the technology-driven surge of growth that began in 1996 did the debt-to-GDP ratio start to drop rapidly as a result of higher growth and the controls on government spending growth enacted in 1990 under the Bush administration. In terms of historical and cross-country comparisons, a debt-to-GDP ratio that has moved from 26 percent to close to 50 percent and back down to around 35 percent is hardly a major fiscal or economic event for the United States economy, notwithstanding comments of politicians to the contrary.

The important question to ask now is, what is the best way to invest a modest part of the possible $4.2 trillion in prospective surpluses over the next decade to sustain growth without inflation? Spending a trillion dollars on lowering tax rates, especially while tax revenues at nearly 21 percent of GDP are at their highest levels since World War II, is far more likely to benefit the economy than leaving tax rates at current levels in order to cut the federal debt by another trillion dollars. In the 1982˙1987 period associated with lower tax rates and higher deficits and debt, the economy grew at a 4.5 percent rate—a full percentage point above the long-run average growth rate of 3.5 percent. If we conservatively estimate that spending $1 trillion on tax rate reduction could add only 0.5 percent to growth, taking the underlying average growth rate from 3.5 to 4 percent over the coming decade, what would be the effect on the economy? Given that the gross national product is now about $10 trillion, adding an extra half-point to growth would add $3.44 trillion to the cumulative total of GDP over that period. That is, a reduction in federal tax revenues by a gross amount of $1 trillion would add $3.44 trillion to total GDP available to the economy over the next decade. That is a return of 13.1 percent a year.

But the actual result is even better. The $3.44 trillion in extra GDP over the next decade would generate $689 billion in federal tax revenues, given that revenues average about 20 percent of GDP. The net revenue reduction for the federal government would be $311 billion, enough to leave surpluses intact while creating a $3.44 trillion increase in GDP. That represents a fabulous rate of return of 27 percent per year. If enacting $1 trillion of tax rate cuts over the next decade boosted average annual growth by 0.7 percent instead of the more conservative estimate of 0.5 percent, the tax rate cuts would result in no loss of federal revenue.

The lessons of history and basic economic theory suggest that the promises of the benefits of further federal debt reduction will not materialize, especially if tax rates are held at current high levels to achieve that goal. Beyond that, if surpluses persist, the risk is that they will be spent, adding to demand in an overheating economy, thereby requiring an offset of tighter money from the Federal Reserve. Or worse, in the highly unlikely event that the debt did disappear, the federal government would have to start using its extra revenue to invest the public’s tax payments. Those favoring debt paydown are advocating a move toward paying taxes to the federal government so it can decide how to invest our money, a perverse turnaround given the widespread desire for more control over retirement funds.

But signs are already emerging that debt paydown is going to slow rapidly. Government spending has begun to accelerate, with the growth of discretionary federal outlays over the next fiscal year now set at 6.4 percent, more than triple the average growth rate of the past decade. Former Congressional Budget Office director Robert Reischauer has warned that if the Congress just lets discretionary spending keep up with inflation over the next decade, then over $1 trillion of the prospective $4 trillion surplus disappears.

Fiscal policy supports the economy best when government revenues are collected in a way least harmful to the economy and are allocated efficiently among essential government programs. The surge in economic growth and government revenues over the past five years provides an opportunity for the federal government to invest in sustained growth, both of the economy and government revenues, by reducing tax rates. That strategy will leave intact far more of the $4 trillion in federal surpluses projected over the next decade than would offering up the siren call of the benefits of debt reduction and then spending more of the taxpayers’ money when those benefits fail to materialize.

John H. Makin is resident scholar at the American Enterprise Institute.