Tag: deficit

Illinois Downgrade: More Evidence that Higher Taxes Make Fiscal Problems Worse

I don’t blame Democrats for wanting to seduce Republicans into a tax-increase trap. Indeed, I completely understand why some Democrats said their top political goal was getting the GOP to surrender the no-tax-hike position.

I’m mystified, though, why some Republicans are willing to walk into such a trap. If you were playing chess against someone, and that person kept pleading with you to make a certain move, wouldn’t you be a tad bit suspicious that your opponent really wasn’t trying to help you win?

When I talk to the Republicans who are open to tax hikes, they sometimes admit that their party will suffer at the polls for agreeing to the hikes, but they say it’s the right thing to do because of all the government red ink.

I suppose that’s a noble sentiment, though I find that most GOPers who are open to tax hikes also tend to be big spenders, so I question their sincerity (with Senator Coburn being an obvious exception).

But even if we assume that all of them are genuinely motivated by a desire to control deficits and debt, shouldn’t they be asked to provide some evidence that higher taxes are an effective way of fixing the fiscal policy mess?

I’m not trying to score debating points. This is a serious question.

European nations, for instance, have been raising taxes for decades, almost always saying the higher taxes were necessary to balance budgets and control red ink. Yet that obviously hasn’t worked. Europe’s now in the middle of a fiscal crisis.

So why do some people think we should mimic the French and the Greeks?

But we don’t need to look overseas for examples. Look at what’s happened in Illinois, where politicians recently imposed a giant tax hike.

The Wall Street Journal opined this morning on the results. Here are the key passages:

Run up spending and debt, raise taxes in the naming of balancing the budget, but then watch as deficits rise and your credit-rating falls anyway. That’s been the sad pattern in Europe, and now it’s hitting that mecca of tax-and-spend government known as Illinois.

…Moody’s downgraded Illinois state debt to A2 from A1, the lowest among the 50 states. That’s worse even than California.

…This wasn’t supposed to happen. Only a year ago, Governor Pat Quinn and his fellow Democrats raised individual income taxes by 67% and the corporate tax rate by 46%. They did it to raise $7 billion in revenue, as the Governor put it, to “get Illinois back on fiscal sound footing” and improve the state’s credit rating. So much for that.

…And—no surprise—in part because the tax increases have caused companies to leave Illinois, the state budget office confesses that as of this month the state still has $6.8 billion in unpaid bills and unaddressed obligations.

In other words, higher taxes led to fiscal deterioration in Illinois, just as tax increases in Europe have been followed by bad outcomes.

Whenever any politician argues in favor of a higher tax burden, just keep these two points in mind:

1. Higher taxes encourage more government spending.

2. Higher taxes don’t raise as much money as politicians claim.

The combination of these two factors explains why higher taxes make things worse rather than better. And they explain why Europe is in trouble and why Illinois is in trouble.

The relevant issue is whether the crowd in Washington should copy those failed examples. As this video explains, higher taxes are not the solution.

Heck, I’ve already explained that more than 100 percent of America’s long-fun fiscal challenge is government spending. So why reward politicians for overspending by letting them confiscate more of our income?

European Central Bank Research Shows that Government Spending Undermines Economic Performance

Europe is in the midst of a fiscal crisis caused by too much government spending, yet many of the continent’s politicians want the European Central Bank to purchase the dodgy debt of reckless welfare states such as Spain, Italy, Greece, and Portugal in order to prop up these big government policies.

So it’s especially noteworthy that economists at the European Central Bank have just produced a study showing that government spending is unambiguously harmful to economic performance. Here is a brief description of the key findings.

…we analyse a wide set of 108 countries composed of both developed and emerging and developing countries, using a long time span running from 1970-2008, and employing different proxies for government size… Our results show a significant negative effect of the size of government on growth. …Interestingly, government consumption is consistently detrimental to output growth irrespective of the country sample considered (OECD, emerging and developing countries).

There are two very interesting takeaways from this new research. First, the evidence shows that the problem is government spending, and that problem exists regardless of whether the budget is financed by taxes or borrowing. Unfortunately, too many supposedly conservative policy makers fail to grasp this key distinction and mistakenly focus on the symptom (deficits) rather than the underlying disease (big government).

The second key takeaway is that Europe’s corrupt political elite is engaging in a classic case of Mitchell’s Law, which is when one bad government policy is used to justify another bad government policy. In this case, they undermined prosperity by recklessly increasing the burden of government spending, and they’re now using the resulting fiscal crisis as an excuse to promote inflationary monetary policy by the European Central Bank.

The ECB study, by contrast, shows that the only good answer is to reduce the burden of the public sector. Moreover, the research also has a discussion of the growth-maximizing size of government.

… economic progress is limited when government is zero percent of the economy (absence of rule of law, property rights, etc.), but also when it is closer to 100 percent (the law of diminishing returns operates in addition to, e.g., increased taxation required to finance the government’s growing burden – which has adverse effects on human economic behaviour, namely on consumption decisions).

This may sound familiar, because it’s a description of the Rahn Curve, which is sort of the spending version of the Laffer Curve. This video explains.

The key lesson in the video is that government is far too big in the United States and other industrialized nations, which is precisely what the scholars found in the European Central Bank study.

Another interesting finding in the study is that the quality and structure of government matters.

Growth in government size has negative effects on economic growth, but the negative effects are three times as great in non-democratic systems as in democratic systems. …the negative effect of government size on GDP per capita is stronger at lower levels of institutional quality, and ii) the positive effect of institutional quality on GDP per capita is stronger at smaller levels of government size.

The simple way of thinking about these results is that government spending doesn’t do as much damage in a nation such as Sweden as it does in a failed state such as Mexico.

Last but not least, the ECB study analyzes various budget process reforms. There’s a bit of jargon in this excerpt, but it basically shows that spending limits (presumably policies similar to Senator Corker’s CAP Act or Congressman Brady’s MAP Act) are far better than balanced budget rules.

…we use three indices constructed by the European Commission (overall rule index, expenditure rule index, and budget balance and debt rule index). …The former incorporates each index individually whereas the latter includes interacted terms between fiscal rules and government size proxies. Particularly under the total government expenditure and government spending specifications…we find statistically significant positive coefficients on the overall rule index and the expenditure rule index, meaning that having these fiscal numerical rules improves GDP growth for these set of EU countries.

This research is important because it shows that rules focusing on deficits and debt (such as requirements to balance the budget) are not as effective because politicians can use them as an excuse to raise taxes.

At the risk of citing myself again, the number one message from this new ECB research is that lawmakers - at the very least - need to follow Mitchell’s Golden Rule and make sure government spending grows slower than the private sector. Fortunately, that can happen, as shown in this video.

But my Golden Rule is just a minimum requirement. If politicians really want to do the right thing, they should copy the Baltic nations and implement genuine spending cuts rather than just reductions in the rate of growth in the burden of government.

It Goes Beyond the Supercommittee

Today Politico Arena asks:

Should Obama have led the supercommittee?

My response:

Whether or not Obama had led the supercommittee in its effort to trim a pittance from our federal deficits and debt, the effort was doomed from the start for the reasons committee co-chairman Jeb Hensarling stated in this morning’s Wall Street Journal:  “Ultimately, the committee did not succeed because we could not bridge the gap between two dramatically competing visions of the role government should play in a free society, the proper purpose and design of the social safety net, and the fundamentals of job creation and economic growth.”

Obama has proven himself clueless about economics from the time he first entered public life, as evidenced by the economic disaster surrounding him and his party. Their vision was soundly rejected by the voters a year ago. If it is rejected again a year from now, we may start the slow climb out of the hole that they, as well as Republicans who share their vision, have put us in. But if the voters give us a mixed result, it’s only a matter of time before our creditors exact the price of our economic irresponsibility. These lessons, the subjects of children’s books and learned lectures, are as old as humanity itself. We have only to heed them.

American Politicians Should Copy Canada’s Leftist Government of the 1990s and Cap Spending

Since I’ve written before about Canada’s remarkable period of fiscal restraint during the 1990s, I was very pleased to see that the establishment press is finally giving some attention to what our northern neighbors did to reduce the burden of government spending.

Here are some key passages from a Reuters story.

“Everyone wants to know how we did it,” said political economist Brian Lee Crowley, head of the Ottawa-based think tank Macdonald-Laurier Institute, who has examined the lessons of the 1990s. But to win its budget wars, Canada first had to realize how dire its situation was and then dramatically shrink the size of government rather than just limit the pace of spending growth. It would eventually oversee the biggest reduction in Canadian government spending since demobilization after World War Two. …The turnaround began with Chretien’s arrival as prime minister in November 1993, when his Liberal Party - in some ways Canada’s equivalent of the Democrats in the U.S. - swept to victory with a strong majority. The new government took one look at the dreadful state of the books and decided to act. “I said to myself, I will do it. I might be prime minister for only one term, but I will do it,” said Chretien. …The Liberals thought their first, rushed budget - delivered in February 1994, three months after taking office, was tough. It reformed unemployment insurance entitlements, and cut defense and foreign aid… The upstart Reform Party, then the main national opposition party, had campaigned on “zero-in-three” - balance the budget in three years. “We were always trying to go faster,” said Reform’s leader at the time, Preston Manning. …The Liberals were stung by the criticism and, at first reluctantly but then with gusto, they got out the chain saws. …Cutting government spending programs went against the Liberal grain. Contrary to the Reform Party, the Liberals saw a more important role for government. Paul Martin now has a lasting reputation as the finance minister who slayed Canada’s deficit, but the conversion from spender to cutter was painful. His father, also called Paul, had helped create Medicare, Canada’s publicly funded health care system, and suddenly here was Paul Junior contemplating massive cuts.

This is a remarkable story. My only real quibble is that the fiscal restraint actually started the year before the Liberal Party took power, as the chart illustrates.

But the key thing to understand is that Canada enjoyed a five-year period when government spending increased by an average of only 1 percent each year.

There are more good passages in the story. Can anybody imagine Obama doing this?

At one 1994 cabinet meeting, Martin announced a spending freeze. A minister put forward a project that needed funding but Chretien cut him off, reminding him of Martin’s freeze. A second minister raised his hand to ask for funding, and a testy Chretien told the cabinet that the next minister to ask for new money would see his whole budget cut by 20 percent. …The ratio of spending cuts to tax hikes was seven-to-one. Asked why, Chretien said simply: “There was more need on one side than the other.” …Cuts ranged from five percent to 65 percent of departmental budgets.

By the way, while there were a few tax hikes implemented, they were trivial. Tax revenue as a share of GDP rose from 44.2 percent of GDP to 44.5 percent a GDP, an increase that probably was going to happen anyhow as Canada’s economy recovered.

So what were the results of Canada’s spending freeze?

The following passage has some numbers, but the second chart shows that the burden of government spending in Canada (right axis) fell from 53 percent of GDP to 44 percent of GDP in just five years. And red ink (left axis) completely disappeared.

The deficit disappeared by 1997 and the debt-to-GDP ratio began a rapid decline - it is now at about 34 percent. …After wrestling the deficit to the ground, Canada enjoyed what Crowley calls the payoff decade, outperforming the rest of the G7 on growth, job creation and inward investment. From 1997 to 2007, it averaged 3.3 percent economic growth. while U.S. growth averaged 2.9 percent.

The most important thing to understand is that Canada’s economy improved because the burden of government spending was reduced. Moreover, because the underlying disease was being treated, this meant two of the symptoms of excessive government - deficits and debt - also became less of a problem.

Last but not least, there are rewards for good policy. Just as Reagan enjoyed a landslide in 1984 after sticking to his guns, Canada’s Liberal Party also reaped the benefits of doing the right thing.

The final lesson is that you can impose painful spending cuts and still win elections. Chretien went on to win two more back-to-back to form majority governments, a rare feat. „,Drummond, who later moved to the private sector and is now an advisor helping the Ontario provincial government slash its deficit, noted that governments on the right and left in Saskatchewan, Alberta and Ontario won more voter support after their own budget cuts in the 1990s.

Here’s a video I narrated that looks at the Canadian experience, as well as similar good reforms in New Zealand, Ireland, and Slovakia.

Last but not least, let’s put all of this in context. As demonstrated here, the U.S. would enjoy a balanced budget in just eight years if politicians could be convinced to limit spending so that it increased by 1 percent each year.

Five Lessons for America from the European Fiscal Crisis

I’ve written about the fiscal implosion in Europe and warned that America faces the same fate if we don’t reform poorly designed entitlement programs such as Medicare and Medicaid.

But this new video from the Center for Freedom and Prosperity, narrated by an Italian student and former Cato Institute intern, may be the best explanation of what went wrong in Europe and what should happen in the United States to avoid a similar meltdown.

I particularly like the five lessons she identifies.

1. Higher taxes lead to higher spending, not lower deficits. Miss Morandotti looks at the evidence from Europe and shows that politicians almost always claim that higher taxes will be used to reduce red ink, but the inevitable result is bigger government. This is a lesson that gullible Republicans need to learn - especially since some of them want to acquiesce to a tax hike as part of the “Supercommitee” negotiations.

2. A value-added tax would be a disaster. This was music to my ears since I have repeatedly warned that the statists won’t be able to impose a European-style welfare state in the United States without first imposing this European-style money machine for big government.

3. A welfare state cripples the human spirit. This was the point eloquently made by Hadley Heath of the Independent Women’s Forum in a recent video.

4. Nations reach a point of no return when the number of people mooching off government exceeds the number of people producing. Indeed, Miss Morandotti drew these two cartoons showing how the welfare state inevitably leads to fiscal collapse.

5. Bailouts don’t work. This also was a powerful lesson. Imagine how much better things would be in Europe if Greece never received an initial bailout. Much less money would have been flushed down the toilet and this tough-love approach would have sent a very positive message to nations such as Portugal, Italy, and Spain about the danger of continued excessive spending.

If I was doing this video, I would have added one more message. If nations want a return to fiscal sanity, they need to follow “Mitchell’s Golden Rule,” which simply states that the private sector should grow faster than the government.

This rule is not overly demanding (spending actually should be substantially cut, including elimination of departments such as HUD, Transportation, Education, Agriculture, etc), but if maintained over a lengthy period will eliminate all red ink. More importantly, it will reduce the burden of government spending relative to the productive sector of the economy.

Unfortunately, the politicians have done precisely the wrong thing during the Bush-Obama spending binge. Government has grown faster than the private sector. This is why this new video is so timely. Europe is collapsing before our eyes, yet the political elite in Washington think it’s okay to maintain business-as-usual policies.

Please share widely…before it’s too late.

Who’s Winning the Race to Fiscal Destruction: Europe or the United States?

Even though the unwashed masses decided that I didn’t win my stimulus debate in New York City, I continue my fight for the hearts and minds of the American people.

I’m now taking part in a debate for U.S. News & World Report on “Who Is Handling Its Debt Crisis Better: United States or Europe?”

This was a tough question. I asked the organizer whether I could vote none of the above, but I was told I had to pick an option.

As you can see, I said the United States was doing a better job - but only by default.

Our long-run outlook is grim, but at least we still have time to reform the entitlement programs and save America… The only major difference is that European nations are farther down the path to fiscal collapse. The welfare state was adopted earlier in Europe and government spending among euro nations now consumes a staggering 49 percent of economic output. This heavy fiscal burden, especially when combined with onerous tax systems, helps explain why growth is anemic. …the United States still can turn things around. Greece, Italy, and other welfare states have probably passed the point of no return, but it’s still possible for American lawmakers to fix the entitlement crisis by turning Medicaid over to the states , modernizing Medicare into a premium-support system, and transitioning to a system of personal retirement accounts for younger workers. If those reforms don’t take place, the consequences won’t be pleasant. To be blunt, there won’t be an IMF to bail out the United States.

For all intents and purposes, I contend that America can be saved if something like the Ryan budget is approved.

You can vote on this page on whether you like or dislike what I said, as well as what the other participants said.

Senate Spares Rural Development Subsidies

An amendment to a Senate appropriations bill introduced by Sen. Tom Coburn (R-OK) that would have reduced funding for rural development subsidies at the Department of Agriculture by $1 billion was easily voted down today. Only 13 Republicans voted to cut the program. Thirty-two Republicans joined all Democrats in voting to spare it, including minority leader Mitch McConnell (R-KY), ranking budget committee member Jeff Sessions (R-AL), and tea party favorite Marco Rubio (R-FL).

This was a business-as-usual vote that will receive virtually no media attention. However, it is a vote that symbolizes just how unserious most policymakers are when it comes to making specific spending cuts. That’s to be expected with the Democrats. On the other hand, Republicans generally talk a good game about the need to cut spending and they rarely miss an opportunity to criticize the Obama administration for its reckless profligacy. Republicans instead fall back on their support of a Balanced Budget Amendment and other reforms like biennial budgeting.

I think most Republicans are in favor of a BBA because they believe it gets them off the hook of having to name exactly what they’d cut. There are several reasons why Republican policymakers won’t get specific: 1) they really don’t want to cut spending; 2) they’re afraid of cheesing off special interests and constituents who benefit from government programs; 3) they’re more concerned with being in power and getting reelected; 4) they’re just plain ignorant of, or disinterested in, the particulars of government programs.

As for biennial budgeting, Republicans would have us believe that appropriating money every other year will give policymakers more time to conduct oversight of government programs. I think it’s another cop-out. Coburn’s office put out plenty of information on the problems associated with USDA rural development subsidies (see here). A Cato essay on rural development subsidies provides more information, including findings from the Government Accountability Office that are readily available to policymakers.

(Note: I worked for both Jeff Sessions and Tom Coburn.)