What should be done with the federal budget surplus? Does it make sense to spend the surplus on new government programs? What benefits the economy more, cutting taxes or paying down the national debt? Nobel Prize-winning economist Milton Friedman offers his advice.

Recorded on Wednesday, December 13, 2000

To view the full transcript of this episode, read below

Peter Robinson: Welcome to Uncommon Knowledge. I'm Peter Robinson. Our show today, The Federal Surplus. But, before we get to the federal budget, a few words about the family budget. Mortgage, credit card bills, the kids wanting a new computer--it goes without saying that for most of us, there's seldom enough money to go around. But, suppose for one, wonderful moment--just suppose--that instead of having too little money, you suddenly found yourself with a big windfall--an inheritance, a bonus at work--what would you do with it? Would you use it to reduce your debt, paying down your mortgage? Would you invest it, buying stocks and bonds? Or, would you blow it all on one, glorious Caribbean vacation?

Which brings us to the federal budget. You see, for several years now, for the first time in decades, the federal budget has been running surpluses--big surpluses. This year, the federal surplus is expected to exceed $280 billion. What should the federal government do with all that money? Pay down its debt? Invest it? Cut taxes?

With us today, Milton Friedman. Dr. Friedman is a Nobel Prize-winning economist and a Senior Fellow at the Hoover Institution. He was also an advisor to Presidents Richard Nixon and Ronald Reagan. Two hundred and eighty billion dollars! Milton will have a few ideas.

Title: Our Cup Runneth Over

Peter Robinson: Milton Friedman, with the sole exception of one year, 1969, in every year from 1962 all the way through 1997, the federal budget ran a deficit. In 1998, that changed; the deficit of all those decades was replaced by a surplus of $69 billion; in 1999, the surplus rises to $125 billion; in the year 2000, it rose still higher. And here we are, early in 2001, and according to the latest budget forecasts of the Congressional Budget Office, the surplus in 2001 could hit in the range of $270, 280 billion. What changed?

Milton Friedman: In the first place, you had a tremendous economic boom going on, which is raising incomes, and we have a tax system under which a ten percent rise in income yields more than a ten percent increase in taxes. People are shifting into higher brackets, they're shifting into paying higher rates of tax; so that without passing a law, the taxes go up more than proportionately to income. That's the first thing. So, receipts went up as a result of the very rapid economic expansion. But, the second...

Peter Robinson: So, even as American--as the American people have this sense that they, themselves are doing pretty well, unbeknownst to them, the feds are doing even better?

Milton Friedman: Absolutely.

Peter Robinson: All right.

Milton Friedman: Very good. But, second of all, we had gridlock. We had a Democratic President, a Republican House and Senate. Under those ci--if you had had an all-Democratic House and Senate you would not have a surplus. It would have been spent. If you had had an all-Republican House, Senate and White House, it would either have been spent, or it would have been returned in lower taxes. But, because you had divided government, you had, fortunately for the taxpayer, you had a gridlock, and the money was not spent. And that's the only reason you had a surplus.

Peter Robinson: So, this is a temporary anomaly that arises from a very good economy with money gushing in and the principal actors in Washington unable to agree on what to do with it.

Milton Friedman: Exactly.

Peter Robinson: All right.

Milton Friedman: And--and it will not last once you have, as you do now, a Republican President, a Republican House, and a Republican Senate.

Peter Robinson: Alright, let's...

Peter Robinson: The budget surplus may be temporary, but as long as we've got it, what should we do with it?

Title: Money to Burn

Peter Robinson: The surplus could be used to spend--to increase government spending programs. It could be used to pay down the public debt. Or, it could be sent back to the American people in the form of a tax cut. Or of course, some combination of the three. Could we take--go through all three of those? Here's the case as I understand it for spending that surplus. Point one, as a practical matter, that's what Congress seems to want to do anyway. Last year, with the extra money coming in, Congress which, even then, was controlled by Republicans, enacted more than 60 new spending programs. Our friend and colleague, John Kogan(?), an economist, now participating in George W. Bush's administration, said to me the other day, "You know what the definition of a surplus is? A surplus is when the money is coming in so fast that even Congress can't figure out how to spend it." Practical reality leans in that direction. As a matter of principle, the country faces an urgent need for productive capital, 2012, the first Baby Boomers, those born in 1947, begin to retire. The proportion of those in the working population to the whole population that needs to be fed, clothed and housed, shrinks. We need to increase their productivity by giving them greater capital, and higher government spending on research and infrastructure is a good way of increasing our stock of productive capital. So, why don't we just spend it?

Milton Friedman: Well, carry that logic on and you're saying government taking over the whole economy would be a good way of increasing productivity. That's an argument for socialism. We have socialism now, the economy is fifty percent socialist. If you take...

Peter Robinson: Fifty percent socialist, you mean, you don't mean the government owns the means of production?

Milton Friedman: Yes, of course. What does the ownership of the means of production means [sic]? It means you're entitled to the proceeds to the income that they receive.

Peter Robinson: So, they own fifty percent of you and me?

Milton Friedman: Well, the government, if you take spending, federal, state and local spending, it amounts to forty percent of the national income. If you--and in addition, the mandates which government imposes on private spending, the government insists that you have anti-pollution devices on your car. That might as well be in the budget. If you add those plus the regulations and restrictions on enterprises, that accounts for about another ten percent. So, about fifty percent of the output of the country is controlled by the federal government, which is the equivalent of saying that they own fifty percent of the means of production. So, we're fifty percent socialist. Well, let's go back to your analysis. I think in all of these, you have to distinguish the economics of the subject from the politics of the subject. On purely economic grounds, government spending is adverse to productivity, not favorable to productivity.

Peter Robinson: Can you--let me quote an economist, Barry Bluestone, who makes--I quote him, not because this is hugely insightful, but because it's an argument that's in the air a great deal. I quote: "It was the federal government's investment that led to the internet. The latest theoretical breakthroughs in computing miniaturization are going on in university and private labs, but almost all the funding has come from the Pentagon."

Milton Friedman: There--there's no doubt that the Pentagon funding has led to research, but you don't know what would have been done with that money if the government hadn't been spending it. In order to judge the efficacy of government spending, we have to look on a much broader range. How is it that a place like Hong Kong can have roughly--nearly the same average income per person as the great United States economy can have? Surely, it's not because of Hong Kong's plethora of resources...

Peter Robinson: It's a rocky little set of islands...

[Talking at same time]

Milton Friedman: ...it's because government spending in Hong Kong has been about ten or fifteen percent of the national income. It's now, under the new regime in Hong Kong, starting to go up and Hong Kong is going to lose its vaunted productivity. It's that comparison of that versus the nearly fifty percent in the United States that explains how little Hong Kong can match the United States. So, government, if you take it further, we saw a society in which a hundred percent of the spending was government, namely, the Soviet Union. It's hardly an advertisement for government spending as a road to productivity.

Peter Robinson: What is it that is inherently inferior or less productive about government spending when money is spent by way of the political mechanism, why is that inherently inferior?

Milton Friedman: Nobody spends somebody else's money as carefully as he spends his own.

Peter Robinson: It is as simple as that?

Milton Friedman: That's a fundamental principle, absolutely. That's why I do not think government spending is the answer, on the contrary. I think government spending is much too high now from an economic point of view.

Peter Robinson: If Milton says, "No," to government spending, what about paying off the debt?

Title: Debt Relief

Peter Robinson: Option two: Get the debt off our backs.

Milton Friedman: From the purely economic point of view, that makes a great deal of sense. If it were feasible to take the whole surplus and use it to el--reduce--pay down the debt, I might well be in favor of it. The argument against that is political, that if you do--that if you say you're going to pay down the debt, the political pressures to spend it are so strong that you will, in fact, spend it.

Peter Robinson: Hang on. I want to get you to pause for a moment on the economic arguments there. Why would you--would you rather pay down the debt than return the money in the form of tax cuts? That's a distinction between investment and consumption, is it not? Alright, could you explain that distinction?

Milton Friedman: I, personally, would rather have to go back in the form of lower taxes.

Peter Robinson: Regardless of political considerations?

Milton Friedman: Regardless of political considerations.

Peter Robinson: All right now, why is that?

Milton Friedman: But, the argument the other way, the argument that people will make, the argument that supports that is that if it's--if you pay back the debt, the money is going to people who will invest it.

Peter Robinson: Correct.

Milton Friedman: It's going to replace present assets and they will try to get other assets which will include investments.

Peter Robinson: Can I--let me quote Robert Solo.

Milton Friedman: Right.

Peter Robinson: And you see the position I'm in? He's a Nobel Prize-winning economist, you're a Nobel Prize-winning economist, how do I choose between the two? Robert Solo...

Milton Friedman: He's a very good economist.

Peter Robinson: Quote: "Reduction of the public debt will make more capital available to private business. Most of the funds previously tied up in treasuries will add to the demand for corporate securities; some potentially productive investments that had been held back will now be more valuable. So, they get made. Some businesses will finance productive investments that would not have been profitable." The business sector invests, the economy expands, that's the thing to do. But, even in principle, you're not in favor of that, as against tax cuts.

Milton Friedman: The argument is a valid argument -- it would have that effect. But, question: Is it appropriate for the government to decide how much of the public's money it should devote to investment, or how much to devote to consumption? Isn't that something for you to decide and for me to decide? Is that a proper national objective? I think not. I think that the total amount of investment ought to be the amount that individuals separately, you, me, and everybody else, that part of their income that they want to use for that purpose.

Peter Robinson: So, you're making a moral argument...

Milton Friedman: That's correct.

Peter Robinson: ...that it's simply no business of the government's, because it is no business of the government's.

Milton Friedman: Right.

Peter Robinson: Now, the political argument that you were making--you said that you'd be open to paying down the debt if it were politically feasible.

Milton Friedman: It's not politically feasible, because you--you quoted before the pressures on Congress to spend it. And those pressures mean that they--it will be spent. Look at what's been happening to the surplus so far. They've been getting rid of it as fast as they could under very difficult circumstances, because divided government up 'til now has meant that it's hard to get agreement what to do. And even so, they've been able to put through a lot of government spending.

[Talking at same time]

Peter Robinson: So, the notion...

Milton Friedman: As history shows, over a long period of time, government will spend whatever the tax system raises, plus as much more as they can get away with. That's why you have had universal deficits.

Peter Robinson: Okay. But now, let me ask you a historical question. This form of government -- the Congress, everything we live with today is set up over two hundred years ago and yet, federal government remains small, relative to the economy, relative to the powers of state governments, small, and even disciplined, one might say, right up through the middle of the last century.

Milton Friedman: That's right.

Peter Robinson: What happened then to change it? That is to say, the incentives, the fundamental institutional structures and incentives, were always there. What happened?

Milton Friedman: What happened was the Great Depression, which--which changed people's views. Before the Great Depression of '29 to '33, the general public vision was that the government was a necessary evil, and that you should rely on the private market. The Great Depression was wrongly attributed, in my opinion, it was produced by government mismanagement but, it was wrongly attributed to a failure of the capitalist system. And public attitudes changed drastically as a result of the Great Depression. From regarding the government as a necessary evil, they regarded--they came to regard the government as the cure to all problems, as the answer to all problems. And that set in motion, beginning with FDR's New Deal, that set in motion a process under which government has been incr--incrementally growing from then on.

Peter Robinson: Even under Ronald Reagan...

Peter Robinson: Next topic, one of Milton Friedman's favorites, cutting taxes.

Title: De-tax-ification

Peter Robinson: Option three: Tax cuts. You favor that above all.

[Talking at same time]

Milton Friedman: First of all, [clears throat] I favor it on economic grounds, because it enables the ultimate consumer, the ultimate individual, you and me, to decide how the money should be used. You know, it makes no sense for me to send my money to Washington to have somebody in Washington decide how to use it. I'd rather decide how to use it myself, whether to use it for charity, or for welfare, or for other purposes. So, that's the first and most important argument. But, the political argument for it is that it's the only way to keep Congress from spending it...

Peter Robinson: Is if they don't have it?

Milton Friedman: If they don't have it. I have been--for a long time, I've been in favor of any tax cut, under any circumstances, in any way, in any form, whatsoever...

Peter Robinson: On any pretext, or any excuse.

Milton Friedman: ...on any pretext, because that's the only way to keep down government spending.

Peter Robinson: Here's the argument against a tax cut. Again, Robert Solo, I quote: "Tax reduction, especially income tax reduction, fattens the disposable income of households. Most of it flows into consumption; only a small fraction is saved. The choice between debt reduction and tax reduction as ways of disposing of a budget surplus is mainly a choice between adding to investment." Investment is good -- "and adding to consumption; that is, between a provisions for the future and enjoyment today." So, you cut taxes, Milton Friedman, and all you're going to do is enable the American people to go on a brief, giddy spree.

Milton Friedman: Not a "brief, giddy spree." I'm going to enable the American people to do what the American people want to do, not what Bob Solo thinks they ought to do.

Peter Robinson: Okay. But that, again, is almost a moral argument.

Milton Friedman: Yes, that's part--that's a moral argument, absolutely. Are there any other arguments? Fundamentally, doesn't it all come down to a moral argument?

Peter Robinson: Well, now, if...

Milton Friedman: What's an a moral argument?

Peter Robinson: Well, as opposed, to say, an economic argument. I mean, you are at least open to the notion that other things being equal, it would be a better idea to pay down the debt, because that would promote investment; than to engage in tax cuts, because that would simply promote consumption.

Milton Friedman: If I believed that the government ought to decide what fraction of the national income should go to investments, and what fraction should go to consumption, and if I believed that the government ought to--that right now, investment is too low then, of course, I would be open to that argument. But, I do not believe that it's the government's business to decide what fraction of my income should be invested, and what fraction should be consumed.

Peter Robinson: Alright. You've just given me

Peter Robinson: Let's find out what Milton Friedman thinks of President Bush's plan for the budget surplus.

Title: He's Got to Have It

Peter Robinson: You've just given--we've taken this through--we'll be sending a tape of this to the White House and President George W. Bush has just heard it from Milton Friedman, "Cut taxes any way you can." Here's what he proposed during the campaign: Only to voting about twenty-five percent of the surplus to tax cuts; fifty percent goes to Social Security and Medicare; and the remaining twenty-five percent or so to new spending programs. Twenty-five percent of the surplus to tax cuts. Is that big enough for you?

Milton Friedman: No. It at least ought to be fifty percent; ought to include the twenty-five percent that's incr--in there for new programs. We don't need new programs; we need fewer programs. You know, if there were only some way in which you could insure that no law could be passed without repealing another law, we ought to have a law of conservation of laws.

Peter Robinson: You only get four hundred laws, and if you want to pass a new one, you've got to subtract an old one.

Milton Friedman: But, you can't do that...

Peter Robinson: It's not a bad idea.

Milton Friedman: ...because a law can be anything.

Peter Robinson: Right now--lately, we're taping this show in the winter, early in the year of 2001. Lately, we have been hearing and reading from Washington, D.C., that because the economy is slowing, the Bush administration may accelerate its tax cut as a way of getting the economy pumped up and rolling along again. Paul Krugman--Krugman, I think it's pronounced, had an article in which he called this suggestion. He's no friend of the Bush administration, generally. I quote him: "A crude, Keynesian view of economy policy." And he continued to say, again, I quote him, "If Milton Friedman weren't still alive, he'd be spinning in his grave." What do you make of that?

Milton Friedman: He's right!

Peter Robinson: He's right.

Milton Friedman: Absolutely.

Peter Robinson: But, you just--you just told us you'd cut taxes...

Milton Friedman: Of course.

Peter Robinson: ...at any time, under any pretext. So, let 'em cut taxes more.

Milton Friedman: I know, but--but that's not--the reason for cutting taxes is not to stimulate the economy. I was just as much in favor of cutting taxes a year or two years ago when the economy was booming. I don't believe in--that the Keynesian remedies are valid. Now, it's an interesting thing, Bob Solo is a Keynesian, but he was against reducing taxes; he would be--before--I wonder whether he would now be in favor of reducing taxes? I doubt it.

Peter Robinson: The Keynesians--there's no--no circumstance, conceivable circumstance, under which they're in favor of cutting taxes. So--but you--it is wrong for the government to stimulate the economy by cutting taxes...

Milton Friedman: Oh, no!

Peter Robinson: ...or it simply would not stimulate the economy?

Milton Friedman: It would not stimulate the economy. Look, if you want--if--if--I can give you a long, theoretical argument as to what the problem--but, just let me turn to one dominant fact. You have Japan, which has been in a kind of rolling recession for ten years; in that period, has had either four or five major fiscal stimuli programs...

Peter Robinson: That is to say increases in government spending?

Milton Friedman: Increases in government spending, and reductions in government taxes. They've been an utter failure. They haven't had any effect on the economy, whatsoever.

Peter Robinson: On account of...?

Milton Friedman: Because, if the government spends more or less, somebody else has less or more to spend. There's an offsetting element, unless the government spending is financed by printing money. What really matters is what happens to monetary policy. If monetary policy goes one way and fiscal policy goes the other way, if you look at all such examples, monetary policy has always dominated, not fiscal policy. See, if government--if you reduce taxes, then people have more to spend. But, on the other hand, government has less to spend. Why is there any net increase in total spending?

Peter Robinson: And on--on the--so, there's no net change in total spending, but on the contrary, as you've just instructed us, the people's money will be spent more wisely, more productively, and everybody's better off.

Milton Friedman: Right.

Peter Robinson: Okay.

Milton Friedman: I'm in favor of the tax cut, but not because you're in a--in a recession. I would have...

Peter Robinson: Your view is: Accelerate the tax cut, because the surplus is coming in faster than originally forecast...

Milton Friedman: That's right, exactly.

Peter Robinson: Just get that money out of Washington and back into people's pockets and bank accounts where it belongs.

Milton Friedman: Before--before Congress can spend it.

Peter Robinson: Before Congress can spend it, okay. And that's the correct reason to do it.

Milton Friedman: Absolutely.

Peter Robinson: Now that we have settled what to do with...

Peter Robinson: Last topic: Is a fiscal stimulus such as a tax cut or increased spending the best way to deal with a slowing economy?

Title: Spend and Deliver

Peter Robinson: You just s--said that the old notion of a Keynesian fiscal stimulus, cutting taxes to stimulate the economy, boosting government spending to stimulate the economy, won't work. Well, we have George W. Bush getting comfortable in the Oval Office, but he has a problem, which is that the economy is softening and everybody's turning to him. What should he do?

Milton Friedman: Sit there.

Peter Robinson: Don't just do something, sit there.

Milton Friedman: Let me give you a comparable case. In 1980-81, just prior to that, we were in a situation where inflation was running ten, twelve...

Peter Robinson: Double digits.

Milton Friedman: Double digits. And the fed--after the election, because before the election, in the five months before the election, the fed was very stimulative. It was pumping money in like mad. A more rapid increase in the quantity of money in that five month period than any other comparable five months period since the end of World War II.

Peter Robinson: Was Paul Volcker, the Chairman of the Fed at the time, culpable? Was that a direct effort to reelect Jimmy Carter?

Milton Friedman: In my opinion it was. At any rate, the month after the election, the money growth slowed down and went down very sharply. And the economy went into a recession. What did Ronald Reagan do? In my opinion, no other president in the post war period would have stood by and sat there, but Ronald Reagan sat there and supported Paul Volcker in his measures. It brought an end to the inflation, it started us on our path of lower and lower inflation, of disinflation, and the recession lasted for a year and a half, it was a fairly deep recession, but it turned around in 1982, early '83...

Peter Robinson: August of '82 is when the stock market starts to recover.

Milton Friedman: Yeah, and from then on, that's the beginning of this incredible period of good economic growth and of booming stock markets that we've had since. Now the advice that everybody was giving to Reagan at that time was that he should step in and stop that recessing from growing.

Peter Robinson: Right.

Milton Friedman: If he had done that, we would now still be having inflation in double digits.

Peter Robinson: We would never have climbed out of that whole stagflation from the 1970s. So the lesson for George W. Bush is...?

Milton Friedman: That if you stand still, if you just wait a while, it's not gonna be a major recession. It'll be a minor recession--if there is a recession. We still don't know whether we're gonna have a recession. And I might tell you that the record of economists in predicting a recession is not one you would want to stand on. It's a very poor record. So we may not have a recession, but if we do, it will be like most post-war recessions, relatively mild. It'll last less than a year or a little more than a year, and then the economy'll turn around and start going up again.

Peter Robinson: He should support Alan Greenspan in maintaining a stable growth--stable and relatively predictable, that is, winks and nods to the market; people have some notion where the growth of the money supply will come from, what it will be.

Milton Friedman: Absolutely.

Peter Robinson: He should cut taxes because is should cut taxes. He should lean against government, increases in government spending, and for the rest of it, he should just sit there, sit tight.

Milton Friedman: So far as the recession is concerned.

Peter Robinson: So far as the recession is concerned. Milton, let me close it out then by asking you to make a prediction. You've just told us economists don't predict recessions very well. I'm asking you now to make a political prediction. When George Bush the elder left office, the federal budget showed an annual deficit of $290 billion a year. As William Jefferson Clinton left office, the federal budget was showing a surplus almost a mirror image, of perhaps 280, 270, 290, maybe even $300 billion. When Bush the younger leaves office, where will the federal deficit--or federal budget--what will the federal budget be showing?

Milton Friedman: Zero or deficit.

Peter Robinson: Zero or deficit, because that is the normal course of government...

Milton Friedman: That's right. The situation right now is very abnormal. Under current governmental arrangements, the natural and normal way is to run a deficit, not to run a surplus.

Peter Robinson: Milton Friedman, thank you very much.

Milton Friedman: Glad to be here.

Peter Robinson: According to Milton Friedman, the federal surplus is an anomaly. What's normal and natural instead is for the federal government to run a deficit. I know just how that feels. I'm Peter Robinson, thanks for joining us.

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