Everybody’s deploring partisan polarization these days, especially this presidential term, especially this week. Including the Cato Institute’s president, Peter Goettler: “two years in Washington has taught me that tribalism is a huge factor in driving the political process and discourse.” On the other hand, as I’ve written before, bipartisanship is typically a conspiracy against the taxpayers. Here’s the latest example, from the Wall Street Journal:
‘We Don’t All Hate Each Other’: Senate’s Bipartisanship Obscured by Kavanaugh Fight
The intense partisanship engulfing Supreme Court nominee Brett Kavanaugh has diverted attention from a raft of recent bipartisanship in the Senate during the past few weeks, drowning out issues that could appeal to voters in the midterms.
The chamber on Wednesday passed legislation to reauthorize the Federal Aviation Administration for five years by a 93–6 vote. That legislation included a measure to double funding for big infrastructure projects around the world, combining several little‐known government agencies into a new body with authority to do $60 billion in development financing.
Also on Wednesday, the Senate advanced an opioid bill to President Trump’s desk by a vote of 98–1. That bill includes several changes to Medicare and state Medicaid programs, such as requiring Medicare to cover services provided by certified opioid treatment programs.
And last week, Mr. Trump signed into law a spending bill that increases military spending for the next fiscal year.
It was reported last week that a Republican working group is considering a proposal to link spending caps to the growth of actual or potential GDP. This is encouraging, and much more economically sensible than rigid balanced budget legislation.
I’ll write about other countries’ experiences with backward-looking rules in the future. But one country which uses forward-looking estimates of potential GDP to determine overall government spending is Chile. Indeed, economists such as Jeffrey Frankel have previously written glowingly about Chile’s fiscal rule, which Frankel concluded had constrained government debt whilst being flexible enough to allow automatic stabilizers to operate.
First, some background: in 2000 the Chilean government voluntarily adopted a structural budget surplus rule of one percent of GDP each year. This was lowered to half a percent of GDP in 2007, and then to a simple balanced structural budget rule in 2009 once government debt had essentially been paid off.
What does this mean in practice? A committee of independent experts meets once a year to provide the government with estimates of potential GDP. A separate committee assesses whether copper prices (a key driver of revenues) are higher or lower than trend. These two opinions are put together to determine an estimate of government revenues for the year if the economy was operating at its potential with copper prices at their long-term level. This determines the total maximum spending level allowed in the budget plan for the year. In other words, spending is capped based upon an estimate of tax revenues if the economy was at potential.
Former Treasury Secretary Larry Summers claimed at a Wednesday lunch that the “Republican vow to significantly reduce the size of government is a foolish pipe dream” due to “structural economic realities.”
What are these realities, according to Summers?
- An aging population will mean upward pressure on entitlement spending on unchanged policy.
- The rise in inequality requires government spending to “ameliorate” the consequences.
- Prices tend to rise relatively quickly in service sectors such as education and healthcare, necessitating more government spending.
- Rising national security threats and increased military spending by geopolitical foes will necessitate more U.S. military spending too.
Where to start?
Summers is right that, on unchanged policies, government spending would balloon due to aging.
The Congressional Budget Office projects spending on Social Security would rise from 4.9 to 6.3 percent over the next 30 years, whilst Medicare spending would nearly double from 3.1 percent of GDP to 6.1 percent. The impact of all that extra spending, even as non-Social Security and healthcare spending is projected to fall from 8.9 percent of GDP to 7.6 percent, is a growing budget deficit and accumulated debt. This would raise net debt interest payments further, such that by 2047 the U.S. budget deficit stood at (a completely unsustainable) 9.8 percent of GDP.
These long-term projections come with all the usual caveats. They use assumptions about the likely path of productivity growth in the economy, population growth, and the extent of labor force participation. Nevertheless, this analysis does highlight the scale of the contingent liabilities embedded in current policy.
To be blunt, Republicans are heading in the wrong direction on fiscal policy. They have full control of the executive and legislative branches, but instead of using their power to promote Reaganomics, it looks like we're getting a reincarnation of the big-government Bush years.
As Yogi Berra might have said, "it's déjà vu all over again."
Let's look at the evidence. According to The Hill, the Keynesian virus has infected GOP thinking on tax cuts.
Republicans are debating whether parts of their tax-reform package should be retroactive in order to boost the economy by quickly putting more money in people’s wallets.
That is nonsense. Just as giving people a check and calling it "stimulus" didn't help the economy under Obama, giving people a check and calling it a tax cut won't help the economy under Trump.
Tax cuts boost growth when they reduce the marginal tax rate on productive behavior such as work, saving, investment, or entrepreneurship. When that happens, people have an incentive to generate more income. And that leads to more national income, a.k.a., economic growth.
Borrowing money from the economy's left pocket and then stuffing checks (oops, I mean retroactive tax cuts) in the economy's right pocket, by contrast, simply reallocates national income.
Back in April, I shared a new video from the Center for Freedom and Prosperity that explained how poor nations can become rich nations by following the recipe of small government and free markets.
Now CF&P has released another video. Narrated by Yamila Feccia from Argentina, it succinctly explains — using both theory and evidence — why spending caps are the most prudent and effective way of achieving good fiscal results.
Ms. Feccia covers all the important issues, but here are five points that are worth emphasizing.
- Demographics — Almost all developed nations have major long‐run fiscal problems because welfare states will implode because of aging populations and falling birthrates (Ponzi schemes need an ever‐growing number of new people to stay afloat).
- Golden Rule — If government spending grows slower than the private sector, that reduces the relative burden of government spending (the underlying disease) and also reduces red ink (the symptom of the underlying disease).
Success Stories — Simply stated, spending caps work. She lists the nations that have achieved very good results with multi‐year periods of spending restraint. She points out that the U.S. made a lot of fiscal progress when GOPers aggressively fought Obama. And she shares the details about the very successful constitutional spending caps in Hong Kong and Switzerland.
- Better than Balanced Budget Amendments or Anti‐Deficit Rules — The video explains why policies that try to target red ink are not very effective, mostly because tax revenues are very volatile.
- Even International Bureaucracies Agree — Remarkably, the International Monetary Fund (twice!), the European Central Bank, and the Organization for Economic Cooperation and Development (twice!) have acknowledged that spending caps are the most, if not only, effective fiscal rule.
I touch on some of these issues in one of my chapters in the Cato Handbook for Policymakers. The entire chapter is worth reading, in my humble opinion, but I want to share an excerpt echoing Point #4 that I just shared from Ms. Feccia’s video.
There’s a very practical reason to focus on capping long‐run spending rather than trying to balance the budget every year. Simply stated, the “business cycle” makes the latter very difficult. …when a recession occurs and revenues drop, a balanced‐budget mandate requires politicians to make dramatic changes at a time when they are especially reluctant to either raise taxes or impose spending restraint. Then, when the economy is enjoying strong growth and producing lots of tax revenue, a balanced‐budget requirement doesn’t impose much restraint on spending. All of which creates an unfortunate cycle. Politicians spend a lot of money during the good years, creating expectations of more and more money for various interest groups. When a recession occurs, the politicians suddenly have to slam on the brakes. But even if they actually cut spending, it is rarely reduced to the level it was when the economy began its upswing. Moreover, politicians often raise taxes as part of these efforts to comply with anti‐deficit rules. When the recession ends and revenues begin to rise again, the process starts over—this time from a higher base of spending and with a bigger tax burden. Over the long run, these cycles create a ratchet effect, with the burden of government spending always reaching new plateaus.
It’s not that I want to belabor this point, but the bottom line is that it is very difficult to amend a country’s constitution (at least in the United States, but presumably in other nations as well).
So if there’s going to be a major campaign to put a fiscal rule in a constitution, then I think it should be one that actually achieves the goal. And whether people want to address the economically important goal of spending restraint or the symbolically important goal of fiscal balance, what should matter is that a spending cap is the effective way of getting there.
It's both amusing and frustrating to observe the reaction to President Trump's budget.
I'm amused that it is generating wild-eyed hysterics from interest groups who want us to believe the world is about to end.
But I'm frustrated because I'm reminded of the terribly dishonest way that budgets are debated and discussed in Washington. Simply stated, almost everyone starts with a "baseline" of big, pre-determined annual spending increases and they whine and wail about "cuts" if spending doesn't climb as fast as previously assumed.
Here are the three most important things to understand about what the President has proposed.
First, the budget isn't being cut. Indeed, Trump is proposing that federal spending increase from $4.06 trillion this year to $5.71 trillion in 2027.
For folks who prefer a more quantitative approach, Economic Freedom of the World uses dozens of variables to rank nations based on key indices such as rule of law, size of government, regulatory burden, trade openness, and stable money.
One of the heartening lessons from this research is that countries don't need perfect policy. So long as there is simply "breathing room" for the private sector, growth is possible. Just look at China, for instance, where hundreds of millions of people have been lifted from destitution thanks to a modest bit of economic liberalization.
Indeed, it's remarkable how good policy (if sustained over several decades) can generate very positive results.
That's the main message in this new video from the Center for Freedom and Prosperity.
The first part of the video, narrated by Abir Doumit, reviews success stories from around the world, including Hong Kong, Singapore, Chile, Estonia, Taiwan, Ireland, South Korea, and Botswana.
Pay particular attention to the charts showing how per-capita economic output has grown over time in these jurisdictions compared to other nations. That's the real test of what works.
The second part of the video exposes the scandalous actions of international bureaucracies, which are urging higher fiscal burdens in developing nations
even though no poor nation has ever become a rich nation with bigger government. Never.
Yet bureaucracies such as the United Nations, the International Monetary Fund, and the Organization for Economic Cooperation and Development are explicitly pushing for higher taxes in poor nations based on the anti-empirical notion that bigger government is a strategy for growth.
I'm not joking.
As Ms. Doumit remarks in the video, these bureaucracies never offer a shred of evidence for this bizarre hypothesis.
And what's especially frustrating is that the big nations of the western world (i.e., the ones that control the international bureaucracies) all became rich when government was very small.