But here’s some surprising news: The federal government is getting smaller, at least relative to the size of the economy as a whole. This year, for the first time in more than 25 years, federal spending slipped below 20% of gross domestic product. As the chart nearby shows, this percentage has been shrinking throughout the 1990s; it is projected at 19.3% next year. That’s still too big, but it’s down from 24% just 15 years ago. True, much of this progress is a result of post-Cold War defense cutbacks, but even domestic spending is receding relative to private-sector output.
This benign fiscal state of affairs seems incomprehensible, given a Congress that has proved itself incapable of cutting nearly any federal agency budgets and a president who has stopped paying even lip service to small government. But America’s miracle economy, helped along by Ronald Reagan and Jack Kemp’s supply-side tax policies, is outgrowing the budget. The federal budget has grown by 132% in 1982, but the GDP has increased by 176%. And Americans’ financial wealth has grown to $32 trillion from $7 trillion, four times as fast as federal expenditures. The trend has been quite different for most of the 20th century. Federal spending as a share of GDP rose to 24% in 1982 from 4% in 1932.
Who gets credit for turning things around? First, Mr. Reagan, who won the Cold War, chopped punitive tax rates roughly in half and made the case that big government was the problem, not the solution. Second, Paul Volcker and his successor, Alan Greenspan, who ended double-digit inflation and returned America to price stability. Third, Bill Gates, Andy Grove, Steve Jobs, Steve Case and all the other high-tech entrepreneurs who made possible today’s booming information economy.
All this progress has happened without any serious effort to cut federal spending. If the next president adopts the right small-government policies, he could shrink federal spending to 15% or even 10% of GDP. To get there will require a combination of modest fiscal disciplinary measures to slow federal spending and a prosperity agenda aimed at coaxing economic growth up to 4% or 5% a year. The policy prescriptions necessary include: personalized accounts for Social Security, a flat 20% alternative maximum tax with unlimited IRAs, medical savings accounts for health care, unilateral free trade, the abolition of corporate welfare and an ironclad commitment to keep the Internet tax- and regulation-free.
“The natural progress of things is for government to gain ground and liberty to yield,” Thomas Jefferson observed in 1788. Today, however, liberty is growing faster than government. Perhaps this will prove to be a historical anomaly. But probably not. To an unprecedented extent, the information economy is not dependent on government and not easily subjected to wealth-redistribution schemes, welfare-state expansionism or confiscatory tax policies. Still skeptical? Consider this: Even Bill Clinton’s budget envisions federal spending dwindling to 18% of GDP within the next five years.