A graphic representation (from the Bloomington, Ill. Pantagraph and via the American Family Business Institute’s Twitter account).
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Tax and Budget Policy
“Good Federal Spending” versus Bad Federal Spending
Washington, DC is a company town, and the company is the federal government. Between the executive branch, the Congress, the Supreme Court and all the rent-seekers and hangers-on that come to court power, the city is a veritable petri dish that breeds and nurtures the worst human impulses. Some Cato people live here, too.
Local politics in DC is so dominated by Democrats that the Republican Party in DC is a perennial butt of jokes. Between its role as the seat of the federal government and the Democratic Party’s Turkmenbashi-level control of local government, it is a city that conservatives love to hate.
Across the river in Virginia, by contrast, there are lots of Republicans, and they are still able to compete against the Democrats statewide. Lots of Republican politicians in Virginia sing sweet songs about the dangers of big government and hold themselves out as the true holders of the limited government faith. But it sure would be nice if they could spit the teat out of their own mouths while they warble:
Ten cents of every federal procurement dollar spent anywhere on Earth is spent in Virginia. More than 15,000 Virginia companies hold federal contracts, a number that has almost tripled since 2001. Total federal spending — from salaries to outsourced contracts — has more than doubled, to $118 billion, since 2000, as homeland security and defense spending skyrocketed in response to the 2001 terrorist attacks and the wars in Iraq and Afghanistan. By 2008, it accounted for about 30 percent of Virginia’s entire economy.
Federal dollars have filtered through the rest of the economy, too, helping to build the high-tech Dulles corridor and funding new homes and cars for federal workers and contractors and meals at local restaurants. The billions have helped fuel the economic boom cycles of the past decade and have cushioned the blow of the recent recession, particularly in Northern Virginia, where the unemployment rate has stayed stubbornly below 6 percent, less than the state and national rates.
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Good Spending[/caption]
In an interview, [Governor Bob] McDonnell acknowledged last week that federal per-capital spending is high in Virginia. And it is true, he said, that most of Northrop Grumman’s business comes from the government. But he said the company’s business is largely defense-related, including shipbuilding in the Newport News area.
“I call that good investment and good federal spending,” he said.
He said the government must restrain spending in other areas — entitlements, earmarks and “other kinds of pork projects.”
Note that McDonnell’s definition of “good” versus “bad” spending seems either to be determined by potential lethality or by location in his state. As the article points out, “defense spending accounts for 900,000 Virginia jobs, close to one in five in the state.” Moreover, McDonnell makes no argument about why we need to prepare to fight China, which makes up the bulk of the justification for the Northrop project in Newport News. (Which, by the way, is an awesome sight, in a literal sense, but also terribly wasteful.)
Moreover, you could zero out “pork” and earmarks tomorrow and while morally satisfying, it would not come even close to filling in the giant hole our rulers in Washington have dug. And as for entitlements? By all means, let’s take a scythe to them. Except a recent Economist/YouGov poll asked the question “If government spending is reduced in order to cut the budget, which of the following government programs should receive lower federal funding than they currently do?” Seven percent ticked the “Medicare” box, seven percent ticked “Social Security” and 11 percent ticked “Medicaid.” In fairness to McDonnell, only 22 percent selected “national defense” and there was only one item, foreign aid, that won a majority.
If getting the deficit fixed means relying entirely on cutting pork, earmarks, and entitlements, the picture is grim. Defense spending needs to be on the table. Even the parts in Virginia.
The Liberty Bus Tour
A new organization called Liberty in America is launching a nation-wide “Liberty Bus” tour in Buffalo next week. The goal is to educate Americans across the country on the need to reduce the federal government’s role in our lives. Downsizing the Federal Government materials will be among the educational resources the Liberty Bus will be making available to concerned citizens.
The following map shows the Liberty Bus’s schedule (click map for bigger version):
Each circle represents an area that is 300 miles in diameter. The idea is for the bus to settle in the center of the area for the designated week and lead or participate in programs in any direction during that week. Folks interested in having the Liberty Bus participate in a program or event should contact Liberty in America here.
For those unable to physically meet up with the Liberty Bus, material from the tour can be requested here.
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How the Debt Crisis Will Stop
The economist Herb Stein famously said, “If something cannot go on forever, it will stop.” That’s a good riposte when people wring their hands over something unsustainable. Of course, that fact doesn’t tell you how unsustainable situations will stop, and some ways are less pleasant than others.
I thought of “Stein’s Law” when I read former California Assembly speaker Willie Brown’s response to a question about whether California’s lavish public-employee pensions would bankrupt the state:
No, it’s not going to bankrupt the state. My guess is that the State of California, like most places involved with pensions, is going to cease to pay them.
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What’s the Future for Supply-Side Economics?
Kevin Williamson has a long-overdue piece in National Review making two essential points about supply-side economics and the Laffer Curve. First, he explains that tax cuts are not the fiscal equivalent of a perpetual motion machine. Simply stated, too many Republicans have fallen into very sloppy habits. They oftentimes fail to understand the difference between “supply-side” tax rate reductions that actually improve incentives to engage in productive behavior and social-engineering tax cuts that simply allow people to keep more money, regardless of whether they create more wealth. This does not necessarily mean the latter form of tax cuts are bad, but they definitely do not boost economic performance and generate revenue feedback. Moreover, even when GOPers are talking about supply-side tax cuts, they frequently exaggerate the positive effects by claiming that lower tax rates “pay for themselves.” I certainly think that can happen, and I give real-world examples in this video on the Laffer Curve (including Reagan’s lower tax rates on those evil rich people), but self-financing tax cuts are not common.
Williamson’s second point is that the true fiscal burden is best measured by looking at how much government is spending. I might quibble with his description of deficits as a form of deferred taxation since technically debt can be rolled over in perpetuity, but his main point is right on the mark. There is no doubt that most forms of government spending — regardless of the means of financing — harm growth by diverting money from the productive sector of the economy (technically, the economic damage occurs because capital and labor are misallocated and incentives are diminished, but let’s not get too wonky). Here are some excerpts from Williamson’s article:
Properly understood, there were no Reagan tax cuts. In 1980 federal spending was $590 billion and in 1989 it was $1.14 trillion; you don’t get Reagan tax cuts without Tip O’Neill spending cuts. Looked at from the proper perspective, we haven’t really had any tax cuts to speak of — we’ve had tax deferrals. …even during periods of strong economic growth, there has been nothing to indicate that our economy is going to grow so fast that it will surmount our deficits and debt without serious spending restraint. This should be a shrieking klaxon of alarm for conservatives still falling for happy talk about pro-growth tax cuts and strategic Laffer Curve optimizing. …The exaggeration of supply-side effects — the belief that tax-rate cuts pay for themselves or more than pay for themselves over some measurable period — is more an article of faith than an economic fact. But it’s a widespread faith: George W. Bush argued that tax cuts would serve to increase tax revenues. So did John McCain. …It is true that tax cuts can promote growth, and that the growth they promote can help generate tax revenue that offsets some of the losses from the cuts. …The problem with magical supply-siderism is that it gives Republicans a rhetorical and intellectual framework in which to ignore spending — just keep cutting taxes, the argument goes, and somebody else will eventually have to cut spending. The results speak for themselves: Tom DeLay and Dennis Hastert and Trent Lott and Bill Frist all know how to count, but, under their leadership, Republicans spent all the money the country had and then some.
Now that we’ve chastised Republicans, it’s time to turn our attention to the Democrats. We know they are bad on spending (I often joke that Republicans expand government out of stupidity, while Democrats do it for reasons of malice), so let’s focus on their approach to Laffer Curve issues. If the GOP is guilty of being too exuberant, the Democrats and their allies at the Joint Committee on Taxation (the bureaucracy on Capitol Hill that estimates the revenue impact of tax policy changes) are guilty of deliberate blindness. The current methodology used by the JCT (with the full support of the Democrats) is to assume that changes in tax policy — regardless of magnitude — have zero impact on economic performance. If you double tax rates, the JCT assumes the economy is unaffected and people earn just as much taxable income. If you replace the IRS with a flat tax, the JCT assumes there is no effect on macroeconomic performance. Sounds unbelievable, but this video has the gory details, including when my former boss, Senator Bob Packwood was told by JCT that revenues would rise year after year even if the government imposed a 100 percent tax rate.
Interestingly, the European Central Bank just released a new study showing that there are substantial Laffer Curve affects and that lower tax rates generate large amounts of revenue feedback. In a few cases (Sweden and Denmark), the researchers even conclude that some lower tax rates would be in that rare category of self-financing tax cuts. But the key point from this ultra-establishment institution is that changes in tax rates do lead to changes in taxable income. This means it is an empirical question to determine the revenue impact. Here’s a key excerpt from the study’s conclusion:
We show that there exist robust steady state Laffer curves for labor taxes as well as capital taxes. …EU-14 countries are much closer to the slippery slopes than the US. More precisely, we find that the US can increase tax revenues by 30% by raising labor taxes but only 6% by raising capital income taxes, while the same numbers for EU-14 are 8% and 1% respectively. …We find that for the US model 32% of a labor tax cut and 51% of a capital tax cut are self-financing in the steady state. In the EU-14 economy 54% of a labor tax cut and 79% of a capital tax cut are self-financing. We therefore conclude that there rarely is a free lunch due to tax cuts. However, a substantial fraction of the lunch will be paid for by the efficiency gains in the economy due to tax cuts.
Contrary to over-enthusiastic Republicans and deliberately-dour Democrats, the Laffer Curve/supply-side economics debate is not a binary choice between self-financing tax cuts and zero-impact tax cuts. Yes, there are examples of each, but the real debate should focus on which types of tax reforms generate the most bang for the buck. In the 1980s, the GOP seems to have the right grasp of this issue, focusing on lowering tax rates and reducing the discriminatory tax bias against saving and investment. This approach generated meaningful results. As Nobel laureate Robert Lucas wrote, “The supply side economists, if that is the right term for those whose research we have been discussing, have delivered the largest genuinely free lunch that I have seen in 25 years of this business, and I believe we would be a better society if we followed their advice.”
But identifying and advocating pro-growth tax reforms, as Williamson notes, is just part of the battle. The real test of fiscal responsibility if controlling the size of government. Republicans miserably failed at this essential task during the Bush year. If they want to do the right thing for the nation, and if they want to avert a Greek-style fiscal collapse, they should devote most of their energies to reducing the burden of government spending.
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Earmarkers vs. Bureaucrats: Taxpayers Lose Either Way
One of the justifications members of Congress offer for earmarking is that the Constitution gives the legislative branch the “power of the purse.” Congressional earmarkers often denigrate the executive branch’s inability to effectively allocate funds. But just because the federal bureaucracy does an abysmal job of spending taxpayer money, it doesn’t mean lawmakers would do any better.
The following example out of Florida illustrates why lawmakers are just as likely as bureaucrats to misspend taxpayer money. According to the St. Petersburg Times, a developer who has never had a successful project was able to convince four members of Florida’s congressional delegation into supporting a $500,000 earmark for a Tampa affordable housing project. The developer had already wasted $563,000 in federal and state taxpayer funds on housing projects that now “sit vacant and rotting.”
According to the article, suckering more money out of Congress was apparently pretty easy:
But the federal earmark process involves little vetting of recipients. So the four members of Congress didn’t know that Foster had never successfully completed a housing project. They didn’t know he exaggerated the involvement of his partners in the proposal he presented to them. They didn’t know he has a record of mishandling grants for much less ambitious projects. And they didn’t know his nonprofit has faced legal troubles, including IRS liens for unpaid payroll taxes.
The lawmakers, who represent Florida and the Tampa Bay area, say they made their decision based largely on information provided by Foster. Others say he never should have gotten a cent.
“I am flabbergasted that this guy’s getting another $500,000. That’s just insane,” said Craig Rothburd, an attorney working pro bono for the Hillsborough County Homeless Coalition. The coalition directed a $400,000 state grant to Foster to develop housing for homeless people. It is now suing Foster for fraud and breach of contract.
Might these lawmakers have put a wee bit more effort into scrutinizing the developer had the money been their own?
Regardless of whether federal funds are allocated by the bureaucracy or earmarked by politicians, both are spending other people’s money. Neither has the incentive to conduct the due diligence necessary to ensure that the money is properly spent. This is one reason why the federal government’s “affordable housing” efforts have been a failure.
Therefore, the question of whether the executive or legislative branch should have more control over spending is a secondary concern. The primary focus should be on efforts to restrict the government’s activities to the small number defined in the Constitution.
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Tax Collection Ain’t Pattycake
And in case you’re wondering, your privacy don’t matter one whit.