NCPA - National Center for Policy Analysis

Bush Tax Plan Would Encourage Economic Growth

April 30, 2003

Economists have developed many theories about the effects of budget deficits and public debt. The upshot is that budget deficits may affect real interest rates -- but typically by small amounts and in directions that depend on the specifics of a tax program, says Robert Barro.

To assess how real interest rates are determined within an international context, Barro relies on evidence like that from a continuing research program begun in 1990 (see "World Real Interest Rates," National Bureau of Economic Research Macroeconomics Annual, 1990). This work now considers 12 countries: the United States, Japan, Canada, Australia and several nations in Western Europe. Here are some of the findings:

  • Real interest rates depend on accumulated levels of public debt in relation to gross domestic product, not on current fiscal deficits.
  • Real interest rates in each country depend not so much on that country's debt but rather on overall debt.
  • U.S. real interest rates depend on the ratio of public debt to gross domestic product in the 12-country universe -- the U.S. debt matters here, but only to the extent that it contributes to the overall debt.

A rise in the 12-country debt-to-GDP ratio raises real interest rates in each country, but by only small amounts: specifically, if the public debt rose by 1 percent of GDP in each country, real interest rates would rise by an estimated 0.1 percent, but if debt rose only in the United States (which now accounts for 45 percent of the 12-country GDP), the rise in real interest rates would be about 0.05 percent.

The bottom line is that, in evaluating the Bush tax plan, higher real interest rates do not make the top-100 list of economic concerns, Barro says. We can get on with the business of shaping a tax-reform package that encourages economic growth. The Bush plan is a good start.

Source: Robert J. Barro, "Have No Fear: Bush's Tax Plan Won't Jack Up Interest Rates," BusinessWeek, May 5, 2003.


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