Tag: government spending

The Tweedle Dee and Tweedle Dum of Fiscal Policy

The fault line in American politics is often not between Republicans and Democrats, but rather between taxpayers and the Washington political elite. Here are two examples that symbolize why economic policy is such a mess:

First, we have President George W. Bush’s former top aide, Karl Rove, making the case in the Wall Street Journal that the Obama administration has been fiscally irresponsible. That’s certainly true, but as I’ve pointed out on previous occasions (here and here), Rove has zero credibility on these issues. In the excerpt below, Rove attacks Obama for earmarks, but this corrupt form of pork-barrel spending skyrocketed during the Bush years. Rove rips Obama for government-run healthcare, but Rove helped push through Congress a reckless new entitlement for prescription drugs. He attacks Obama for misusing TARP, but the Bush administration created that no-strings-attached bailout program.

Those are examples of hypocrisy, but Rove also is willing to prevaricate. He blames Obama for boosting the burden of government spending to 24 percent of GDP, but it was the Bush administration that boosted the federal government from 18.2 percent of GDP in 2001 to 24.7 percent of GDP in 2009. Obama is guilty of following similar policies and maintaining a bloated budget, but it was Bush (with Rove’s guidance) that drove the economy into a fiscal ditch.

Here’s some of Rove:

The president’s problem is largely a mess of his own making. Deficit spending did not begin when Mr. Obama took office. But he and his Democratic allies have supported, proposed, passed or signed and then spent every dime that’s gone out the door since Jan. 20, 2009. Voters know it is Mr. Obama and Democratic leaders who approved a $410 billion supplemental (complete with 8,500 earmarks) in the middle of the last fiscal year, and then passed a record-spending budget for this one. Mr. Obama and Democrats approved an $862 billion stimulus and a $1 trillion health-care overhaul, and they now are trying to add $266 billion in “temporary” stimulus spending to permanently raise the budget baseline. It is the president and Congressional allies who refuse to return the $447 billion unspent stimulus dollars and want to use repayments of TARP loans for more spending rather than reducing the deficit. It is the president who gave Fannie and Freddie carte blanche to draw hundreds of billions from the Treasury. It is the Democrats’ profligacy that raised the share of the GDP taken by the federal government to 24% this fiscal year. This is indeed the road to fiscal hell, and it’s been paved by the president and his party.

Second, we have Nancy Pelosi claiming that paying people to remain unemployed is a good way of creating jobs. She’s been appropriately mocked for this assertion, but keep in mind that she is accurately regurgitating standard Keynesian theory. It doesn’t matter that Keynesianism didn’t work for Hoover and Roosevelt in the 1930s, didn’t work for Japan in the 1990s, and didn’t work for Bush in 2008. Proponents of this approach have a childlike faith in the Keynesian model and its ability to generate very specific (albeit completely inaccurate) numbers.

Here are two videos that offer the policy-wonk version of a steel cage match. In one corner, we have the Speaker of the House arguing that subsidizing joblessness is a “stimulus” strategy. In the other corner, I explain why transferring money from the economy’s left pocket to the right pocket is not a recipe for growth.

 

“Rahn Curve” Video Shows Government Is Far Too Big

There is considerable academic research on the growth-maximizing level of government spending. Based on a good bit of research, I’m fairly confident that Cato’s Richard Rahn was the first to popularize this concept, so we are going to make him famous (sort of like Art Laffer) in this new video explaining that there is a spending version of the Laffer Curve and that it shows how government is far too large and that this means less prosperity.

The G-20 Fiscal Fight: A Pox on Both Their Houses

Barack Obama and Angela Merkel are the two main characters in what is being portrayed as a fight between American “stimulus” and European “austerity” at the G-20 summit meeting in Canada. My immediate instinct is to cheer for the Europeans. After all, “austerity” presumably means cutting back on wasteful government spending. Obama’s definition of “stimulus,” by contrast, is borrowing money from China and distributing it to various Democratic-leaning special-interest groups.
 
But appearances can be deceiving. Austerity, in the European context, means budget balance rather than spending reduction. As such, David Cameron’s proposal to boost the U.K.’s value-added tax from 17.5 percent to 20 percent is supposedly a sign of austerity even though his Chancellor of the Exchequer said a higher tax burden would generate “13 billion pounds we don’t have to find from extra spending cuts.”
 
Raising taxes to finance a bloated government, to be sure, is not the same as Obama’s strategy of borrowing money to finance a bloated government. But proponents of limited government and economic freedom understandably are underwhelmed by the choice of two big-government approaches.
 
What matters most, from a fiscal policy perspective, is shrinking the burden of government spending relative to economic output. Europe needs smaller government, not budget balance. According to OECD data, government spending in eurozone nations consumes nearly 51 percent of gross domestic product, almost 10 percentage points higher than the burden of government spending in the United States.
 
Unfortunately, I suspect that the “austerity” plans of Merkel, Cameron, Sarkozy, et al, will leave the overall burden of government relatively unchanged. That may be good news if the alternative is for government budgets to consume even-larger shares of economic output, but it is far from what is needed.
 
Unfortunately, the United States no longer offers a competing vision to the European welfare state. Under the big-government policies of Bush and Obama, the share of GDP consumed by government spending has jumped by nearly 8-percentage points in the past 10 years. And with Obama proposing and/or implementing higher income taxes, higher death taxes, higher capital gains taxes, higher payroll taxes, higher dividend taxes, and higher business taxes, it appears that American-style big-government “stimulus” will soon be matched by European-style big-government “austerity.”
 
Here’s a blurb from the Christian Science Monitor about the Potemkin Village fiscal fight in Canada:

This weekend’s G-20 summit is shaping up as an economic clash of civilizations – or at least a clash of EU and US economic views. EU officials led by German chancellor Angela Merkel are on a national “austerity” budget cutting offensive as the wisest policy for economic health, ahead of the Toronto summit of 20 large-economy nations. Ms. Merkel Thursday said Germany will continue with $100 billion in cuts that will join similar giant ax strokes in the UK, Italy, France, Spain, and Greece. EU officials say budget austerity promotes the stability and market confidence that are prerequisites for their role in overall recovery. Yet EU pro-austerity statements in the past 48 hours are also defensive – a reaction to public statements from US President Barack Obama and G-20 chairman Lee Myung-bak, South Korea’s president, that the overall effect of national austerity in the EU will harm recovery. They are joined by US Treasury Secretary Tim Geithner, investor George Soros, and Nobel laureate and columnist Paul Krugman, among others, arguing that austerity works against growth, and may lead to a recessionary spiral.

Hey, UK: Meet the New Boss, Same as the Old Boss

As the chart below indicates, the United Kingdom has a large budget deficit solely because government spending has increased to record levels (OECD data). Unfortunately, the new Tory-Liberal coalition government has decided that taxpayers should be punished for all the over-spending that occurred when the Labor government was in charge.

The Telegraph reports that the top capital gains rate will jump to 28 percent, up from 18 percent (the new government foolishly thinks this will result in more revenue). But the biggest change is that the value-added tax will increase to 20 percent. According to Business Week, the Chancellor of the Exchequer (the British equivalent of Treasury Secretary) actually bragged that the VAT increase was good since it would generate “13 billion pounds we don’t have to find from extra spending cuts.” Here are some further details from Business Week about the disappointing fiscal news from London.

British Chancellor of the Exchequer George Osborne increased the value-added tax rate to 20 percent from 17.5 percent in the first permanent change to the levy on sales of goods and services in almost two decades. “The years of debt and spending make this unavoidable,” Osborne told Parliament in London in his emergency budget today as he announced a package of spending cuts and tax increases to cut the U.K.’s record deficit. …“We understand that the budget deficit needs to be tackled but we think the focus needs to be cutting public spending over tax rises,” Krishan Rama, a spokesman for the industry lobby group, the British Retail Consortium, said in a telephone interview yesterday. …VAT has remained at 17.5 percent in every year except one since 1991, when John Major’s Conservative administration raised the rate from 15 percent to help plug a deficit.

The one tiny glimmer of good news from the budget is that the corporate tax rate is being reduced from 28 percent to 24 percent, which is probably a reflection of the strong and virtuous tax competition that is forcing greedy governments to lower tax rates in order to attract and/or retain business activity. There also is a two-year pay freeze for government bureaucrats, but this is hardly good news since a 30-percent pay cut is needed to bring compensation down to private sector levels.

Re. Ezra Klein: Did State and Local Anti-stimulus Nullify Federal Stimulus?

A recent Washington Post column by Ezra Klein dreamed up a new excuse for the conspicuous failure of Obama’s so-called stimulus plan.   Klein argues that the stimulus of federal spending has been offset by the “anti-stimulus” of fiscal austerity by state and local governments.  For proof he quotes Bruce Bartlett, who is fast becoming the favorite go-to guy for liberals seeking conservative allies in their endless quest for more spending and taxes. 

Bartlett says, “When the history of the current crisis is written, much of the blame will be placed on the sharp fiscal contraction of state and local governments.  I think economists will view this as a preventable error equivalent to the Fed’s passive shrinkage of the money supply in the early 1930s.”

A historian himself, Bartlett imagines this to be a question that will have to be pondered by historians in the distant future.   But it is easy to identify each sector’s direct contribution to the overall growth rate of real GDP from a St. Louis Fed publication, “National Economic Trends.” 

State and local government spending was rising during the first three quarters of the recession, and the drop in the fourth quarter of 2008 accounted for just 0.25% of the 5.37% annualized decline in GDP.  In the first quarter of 2009, state and local spending subtracted  just 0.19% from real GDP, but federal spending subtracted more (0.33%) due to cuts in defense spending.  Government obviously made only a minor contribution to the 6.4% drop in overall GDP.
  
In the second quarter of 2009, state and local spending was way up (by 0.48%), as was federal spending (0.85%).  But the private economy did not begin expanding until the third quarter – when government spending stopped diverting so many resources to unproductive uses.
 
The table shows that government spending on goods and services had nothing to do with the recovery (transfer payments don’t contribute to GDP).  

As a matter of simple accounting, the state and local sector has been a very minor negative force −scarcely comparable to the Fed’s inaction in 1930-32

Federal purchases, whether for heavily-subsidized ”green jobs” or shovel-ready pork, have been virtually irrelevant during the last two quarters.

Contributions to Real GDP Growth
……………………..  3rd…… 4th…… 1st qtr

Real GDP              2.2         5.6             3.0%
Private                   1.6         5.8             3.4
Federal                  0.6        0.0            0.1
State & Local     -0.1      -0.3           -0.5

Dan Mitchell Gets Results

I gave a speech in Hungary about two weeks ago and now the government has announced a big step in the direction of better fiscal policy. My role was about as meaningful as the rooster crowing, followed by the sunrise, but this is still good news. According to Reuters, “Hungary’s new government plans to introduce a flat personal income tax of 16 percent from 2011, as well as a 15 percent cut in public sector wages.” Those are the headline initiatives, but the fiscal reform package includes other good policies. Here’s a blurb from The Economist.

After a three-day emergency cabinet meeting over the weekend, Viktor Orban, the prime minister, announced the government’s new economic programme this afternoon. The battered forint quickly jumped almost 2% in response. …The introduction of a 16% flat personal income tax is a daring move, and could have important repercussions beyond balancing the state’s books. Unemployment, or at least that element of it which is declared, is nudging 12%, and one reason is Hungary’s cumbersome bureacracy and heavy tax burden. Now Mr Orban has announced that corporation tax for companies with annual profits of less than 500m forints will be reduced from 19% to 10%. Ten more small and bothersome taxes are set to be abolished altogether.

A few years ago, when several nations each year were adopting the flat tax, I arbitrarily decided that this rock classic would be the theme song of the tax reform movement. Sadly, it doesn’t look like we’ll get to play it in America anytime soon.

You Don’t Need to Waste More Money to Shrink Government

It’s rather symbolic of what’s wrong with Washington that a commission ostensibly created to promote deficit reduction is seeking a bigger budget, as noted in the Tax Notes story excerpted below. Rather than impose a bigger burden on taxpayers, though, I will generously suggest that they could easily fulfill their mandate by perusing Cato’s Downsizing Government website. And if they really want to do the right thing, they can always just look at Article I, Section VIII, of the Constitution and get rid of existing programs and activities that are not enumerated powers of the federal government.

Saddled with a tight deadline and great expectations, members of President Obama’s deficit reduction commission say they may not have the resources necessary to meet their task. The National Commission on Fiscal Responsibility and Reform, which the president created through an executive order in February, is charged with developing a plan by December 1 that would stabilize the budget deficit by 2015 and reduce the federal debt over the long term. The group is widely expected to consider a combination of tax reforms and spending cuts. But despite the weighty demands, the panel has only a fraction of the staff and budget of standing congressional committees. The panel’s own cochairs and Senate Majority Leader Harry Reid, D-Nev., have criticized the meager resources and called for more support. …The White House has set aside the resources to provide the equivalent of four full-time salaries and $500,000 in operating costs for the commission, fiscal commission Executive Director Bruce Reed told Tax Analysts.

(h/t: TaxProf)