Topic: Tax and Budget Policy

Trump and Federal Workers

The incoming Trump administration has indicated that it will make reforms to the federal workforce. Here are a few places where the administration may focus its efforts:

  • Freezing Hiring: Trump’s Contract with the American Voter promised “a hiring freeze on all federal employees to reduce federal workforce through attrition (exempting military, public safety, and public health).” As a goodwill gesture, Trump should also shrink the army of almost 4,000 political appointees in his administration in order to speed agency decisionmaking.
  • Increasing Firing: Trump is famous for firing people on his TV show, and he will likely support reforms to increase federal firing. On the campaign trail, Trump talked about firing VA executives, and his advisors Chris Christie and Newt Gingrich talked about the importance of civil service reforms to increase firing. Reforms are needed: federal civilian workers are fired at just one-sixth the rate that private-sector workers are. Members of the federal senior executive service are fired at just one-twentieth the rate that corporate CEOs are.
  • Reducing Retirement Benefits. Federal wages and benefits are higher, on average, than in the private sector, but it is on benefits that federal compensation really stands out. The WaPo has discussed various GOP proposals to reduce federal benefits. My favored reform is to repeal the old-fashioned defined-benefit pension plan. That would leave federal workers with a generous defined-contribution plan, which is the standard in the private sector.  
  • Reforming Federal Unions. One reform was mentioned in the Republican platform: “union representatives should not be allowed to engage in union-related activities while on the public’s time.” Republicans on the Hill have been investigating the use and abuse of such “official time” in federal agencies.

My essays “Bureaucratic Failure in the Federal Government” and “Reducing the Costs of Federal Worker Pay and Benefits” should provide useful information to the Trump team in assembling its workforce reform agenda.

Trump Spending Cut Ideas

President-elect Donald Trump said on the campaign trail that he will balance the federal budget and cut wasteful spending. Here are some of Trump’s views on budget reforms:

  • “We are going to ask every department head in government to provide a list of wasteful spending projects that we can eliminate in my first 100 days.” Source.
  • “We can also stop funding programs that are not authorized in law. Congress spent $320 billion last year on 256 expired laws … Removing just 5 percent of that will reduce spending by almost $200 billion over a ten-year period.” Source.
  • “I may cut Department of Education. I believe Common Core is a very bad thing,” Trump said. “I believe that we should be — you know, educating our children from Iowa, from New Hampshire, from South Carolina, from California, from New York. I think that it should be local education.” Source.
  • “If we save just one penny of each federal dollar spent on non-defense, and non-entitlement programs, we can save almost $1 trillion over the next decade.” Source.
  • “We’re going local. Have to go local. Environmental protection—we waste all of this money. We’re going to bring that back to the states … We are going to cut many of the agencies, we will balance our budget, and we will be dynamic again.” Source.
  • “Waste, fraud and abuse all over the place. Waste, fraud and abuse. You look at what’s happening with Social Security, you look—look at what’s happening with every agency—waste, fraud and abuse. We will cut so much, your head will spin.” Source.

I hope my head does spin from cuts, although most of Trump’s proposals are vague and quite timid. Still, I’m hoping that the more the incoming president finds out about the federal budget, the more he will appreciate the need for major terminations.

The Rise and Fall (and Rise) of Sweden

I’m in Sweden today, where I just spoke before Timbro (a prominent classical liberal think tank) about the US elections and the implications for public policy.

My main message was pessimism since neither Donald Trump nor Hillary Clinton support genuine entitlement reform.

But I’ve addressed that topic many times before. Today, motivated by my trip, I want to augment my analysis about Sweden from 10 days ago.

In that column, I highlighted some research from Professor Olle Kranz showing that Sweden became a rich nation during a free-market era when government was relatively small. And as you can see from his chart (I added the parts in red), this is also when per-capita economic output in Sweden caught up with - and eventually surpassed - per-capita GDP in other advanced countries.

Then Sweden began to lose ground. Some of this was understandable and inevitable. Sweden didn’t participate in World War II, so its comparative prosperity during the war and immediately afterwards was a one-time blip.

But the main focus of my column from last week was to show that Swedish prosperity began a sustained drop during the 1960s, and I argued that the nation lost ground precisely because statist policies were adopted.

In other words, Sweden enjoyed above-average growth when it relied on policies I like and then suffered below-average growth when it imposed the policies (high tax rates, massive redistribution, etc) that get Bernie Sanders excited.

Hillary Clinton’s Debt Promise (That She’d Definitely Break)

In the third and final debate last week, Hillary Clinton tried to flex her fiscal responsibility bona fides by vowing  that she “will not add a penny to the debt” on three separate occasions. That must mean she has comprehensive reforms to address entitlements, rein in other spending, and reduce our commitments abroad, if she is not going to add a penny to the current gross debt of $19.7 trillion, right? No, not really.

She is only promising not to make things worse relative to the current baseline, which projects the debt increase to $28.2 trillion over the next decade. To be fair, her plans would add less to the debt than Donald Trump’s, although that’s almost entirely due to an array of new taxes. Even with those hikes, the debt would increase a lot more than a penny were she to win, and neither major party candidate has put forward a substantive plan to address the problems with the country’s fiscal health.

And that’s just the projection over the next decade. The long-term fiscal picture is even bleaker. In the baseline scenario from the most recent Long-Term Budget Outlook from the Congressional Budget Office, federal debt held by the public will almost double by midcentury, from around 77 percent of GDP to more than 140 percent by 2046. Kicking the can down the road, which is effectively the plan by for both candidates in the debate due to their lack of an actual plan, would only increases the magnitude of the changes that will eventually be needed.

Clinton may have meant that her specific proposals are paid for, but even that is not accurate, as the Committee for a Responsible Federal Budget (CRFB) estimated that her proposals would add $200 billion to it, even with the assumption that she would be able to help shepherd immigration reform through Congress and attributing that positive fiscal impact to her. If she were to stabilize the debt to GDP ratio and restrict herself to her preferred method of hiking taxes on high earners (eschewing spending cuts or entitlement reform), she’d have to raise the top tax rate all the way to 61 percent, which would impose significant new disincentives and economic distortions. 

She is not promising that she would not “add a penny to the debt” or at least that can’t be what she means, unless she wants to set herself up to break that promise shortly after taking officer were she to win. She’s promising not to further accelerate our movement down the unsustainable fiscal path we’re on now, which is hardly comforting. Neither of the candidates at the debate last week has put forward any substantive plan to do anything to address the debt or our fiscal trajectory, despite what promises they may have made. 

In One Chart, Everything You Need to Know about Big Government, the Welfare State, and Sweden’s Economy

Sweden punches way above its weight in debates about economic policy. Leftists all over the world (most recently, Bernie Sanders) say the Nordic nation is an example that proves a big welfare state can exist in a rich nation. And since various data sources (such as the IMF’s huge database) show that Sweden is relatively prosperous and also that there’s an onerous fiscal burden of government, this argument is somewhat plausible.

A few folks on the left sometimes even imply that Sweden is a relatively prosperous nation because it has a large public sector. Though the people who make this assertion never bother to provide any data or evidence.

I have five responses when confronted with the why-can’t-we-be-more-like-Sweden argument.

  1. Sweden became rich when government was small. Indeed, until about 1960, the burden of the public sector in Sweden was smaller than it was in the United States. And as late as 1970, Sweden still had less redistribution spending that America had in 1980.
  2. Sweden compensates for bad fiscal policy by having a very pro-market approach to other areas, such as trade policy, regulatory policy, monetary policy, and rule of law and property rights. Indeed, it has more economic freedom than the United States when looking an non-fiscal policies. The same is true for Denmark.
  3. Sweden has suffered from slower growth ever since the welfare state led to large increases in the burden of government spending. This has resulted in Sweden losing ground relative to other nations and dropping in the rankings of per-capita GDP.
  4. Sweden is trying to undo the damage of big government with pro-market reforms. Starting in the 1990s, there have been tax-rate reductions, periods of spending restraint, adoption of personal retirement accounts, and implementation of nationwide school choice.
  5. Sweden doesn’t look quite so good when you learn that Americans of Swedish descent produce 39 percent more economic output, on a per-capita basis, than the Swedes that stayed in Sweden. There’s even a lower poverty rate for Americans of Swedish ancestry compared to the rate for native Swedes.

I think the above information is very powerful. But I’ll also admit that these five points sometimes aren’t very effective in changing minds and educating people because there’s simply too much information to digest.

As such, I’ve always thought it would be helpful to have one compelling visual that clearly shows why Sweden’s experience is actually an argument against big government.

And, thanks to the Professor Deepak Lal of UCLA, who wrote a chapter for a superb book on fiscal policy published by a British think tank, my wish may have been granted. In his chapter, he noted that Sweden’s economic performance stuttered once big government was imposed on the economy.

Though the Swedish model is offered to prove that high levels of social security can be paid for from the cradle to the grave without damaging economic performance, the claim is false (see Figure 1). The Swedish economy, between 1870 and 1950, grew faster on average than any other industrialised economy, and the country became technologically one of the most advanced and richest in the world. From the 1950s Swedish economic growth slowed relative to other industrialised countries. This was due to the expansion of the welfare state and the growth of public – at the expense of private – employment.57 After the Second World War the working population increased by about 1 million: public employment accounted for c. 770,000, private accounted for only 155,000. The crowding out by an inefficient public sector of the efficient private sector has characterised Sweden for nearly half a century.58 From being the fourth richest county in the OECD in 1970 it has fallen to 14th place. Only in France and New Zealand has there been a larger fall in relative wealth.

And here is Figure 1, which should make clear that what’s good in Sweden (rising relative prosperity) was made possible by the era of free markets and small government, and that what’s bad in Sweden (falling relative prosperity) is associated with the adoption and expansion of the welfare state.

But just to make things obvious for any government officials who may be reading this column, I augment the graph by pointing out (in red) the “free-market era” and the “welfare-state era.”

As you can see, credit for the chart actually belongs to Professor Olle Krantz. The version I found in Professor Lal’s chapter is a reproduction, so unfortunately the two axes are not very clear. But all you need to know is that Sweden’s relative economic position fell significantly between the time the welfare state was adopted and the mid 1990s (which presumably reflects the comparative cross-country data that was available when Krantz did his calculations).

You can also see, for what it’s worth, that Sweden’s economy spiked during World War II. There’s no policy lesson in this observation, other than to perhaps note that it’s never a good idea to have your factories bombed.

But the main lesson, which hopefully is abundantly clear, is that big government is a recipe for comparative decline.

Which perhaps explains why Swedish policymakers have spent the past 25 years or so trying to undo some of those mistakes.

Infrastructure Investment: A Look at the Data

Hillary Clinton says that “we are dramatically underinvesting” in infrastructure and she promises a large increase in federal spending. Donald Trump is promising to spend twice as much as Clinton. Prominent wonks such as Larry Summers are promoting higher spending as well. But more federal spending is the wrong way to go.

To shed light on the issue, let’s look at some data. There is no hard definition of “infrastructure,” but one broad measure is gross fixed investment in the BEA national accounts. 

The figure below shows data from BEA tables 1.5.5 and 5.9.5 on gross investment in 2015. The first thing to note is that private investment at about $3 trillion was six times larger than combined federal, state, and local government nondefense investment of $472 billion. Private investment in pipelines, broadband, refineries, factories, cell towers, and other items greatly exceeds government investment in schools, highways, prisons, and the like.

One implication is that if policymakers want to boost infrastructure spending, they should reduce barriers to private investment. Cutting the corporate income tax rate, for example, would increase net returns to private infrastructure and spur greater investment across many industries.

Proposed Spending Cap in Brazil Could Be a Key for Economic Recovery and Renaissance

One of the most remarkable developments in the world of fiscal policy is that even left-leaning international bureaucracies are beginning to embrace spending caps as the only effective and successful rule for fiscal policy.

The International Monetary Fund is infamous because senior officials relentlessly advocate for tax hikes, but the professional economists at the organization have concluded in two separate studies (see here and here) that expenditure limits produce good results.

Likewise, the political appointees at the Organization for Economic Cooperation and Development generally push a pro-tax increase agenda, but professional economists at the Paris-based bureaucracy also have produced studies (see here and here) showing that spending caps are the only approach that leads to good results.

Heck, even the European Central Bank has jumped into the issue with a study that reaches the same conclusion.

This doesn’t mean balanced budget requirements are bad, by the way, but the evidence shows that they aren’t very effective since they allow lots of spending when the economy is expanding (and thus generating tax revenue). But when the economy goes into recession (causing a drop in tax revenue), politicians impose tax hikes in hopes of propping up their previous spending commitments.

With a spending cap, by contrast, fiscal policy is very stable. Politicians know from one year to the next that they can increase spending by some modest amount. They don’t like the fact that they can’t approve big spending increases in the years when the economy is expanding, but that’s offset by the fact that they don’t have to cut spending when there’s a recession and revenues are falling.

From the perspective of taxpayers and the economy, the benefit of a spending cap (assuming it is well designed so that it satisfies Mitchell’s Golden Rule) is that annual budgetary increases are lower than the long-run average growth of the private sector.

And nations that have followed such a policy have achieved very good results. The burden of government spending shrinks as a share of economic output, which naturally also leads to less red ink relative to the size of the private economy.

But it’s difficult to maintain spending discipline for multi-year periods. In most cases, governments that adopt good policy eventually capitulate to pressure from interest groups and start allowing the budget to expand too quickly.

That’s why the ideal policy is to make a spending cap part of a nation’s constitution.

That’s what happened in Switzerland early last decade thanks to a voter referendum. And that’s what has been part of Hong Kong’s Basic Law since it was approved back in 1990.