ABSTRACT
Before the mid-twentieth century the US government ran deficits in war and paid the debt down in peace except when recessions depleted tax receipts. The budget was in surplus every fiscal year from 1866 to 1893, 1920 to 1930, and overall, 51 of 60 peacetime years between 1866 and 1930. By comparison, there were five surpluses between 1950 and 1997, none of them after 1969. What were the reasons for the change? The standard explanation or assumption in the economics literature is the diminished aversion to deficits arising from Keynesianism and the trauma of the Great Depression. This chapter suggests a different explanation that rests on traditional practices instead of new ideas: the principle of tax smoothing continued and deficits were due to war. The Cold War was small, but a war nevertheless. It ‘was a real war, as real as the two world wars’, with a major campaign – Korea – and several minor ones, a Soviet buildup in the 1970s that, like the German offensive in 1918, turned out to be the last burst of energy by the losing side, Reagan’s military buildup, and again similar to World War I, a sudden and unexpected collapse (Friedman 2000: xi-xii). A simple model of choice between long-term budget balance and tax smoothing is developed. The estimates presented here are tentative – further research is needed – but they suggest continuity in government budget principles, particularly that spending shocks should be paid for over time. What was new after 1950 was significant military spending of unprecedented length, not its finance.
