Federal spending has been out of control for so long, it's hard to imagine how big cuts in taxes and spending — actual cuts, not baseline cuts — could ever be achieved. True, John F. Kennedy and Ronald Reagan achieved epic personal income tax cuts, but neither controlled spending, and both incurred budget deficits every year of their administrations. The federal government has incurred budget deficits more than 80% of the time since 1930, a period when the number of governmental functions increased dramatically.
It's instructive to look at two of history's greatest successes cutting taxes and spending. They occurred back when there were relatively few governmental functions — and that is where we need to return.
The first success occurred in England. Considerable credit goes to William Ewart Gladstone (1809-1898), who dominated British politics in the heyday of market liberalism (the opposite of contemporary American liberalism). Gladstone entered Parliament at age 23, first held a cabinet post at 34 and delivered his last speech as an MP when he was 84. He served as Prime Minister four times. He was Chancellor of the Exchequer (equivalent to our Treasury Secretary) in four ministries. He was an inspiration for Margaret Thatcher. Historian Paul Johnson declared, "there is no parallel to his record of achievement in English history."
Gladstone knew the national government budget better than anyone else, and in 1861 he began his great tax-cutting campaign. He had Britain unilaterally lower tariffs (import taxes), because he recognized that the main beneficiaries of lower tariffs are the people who lower them, which makes things less expensive — therefore, people can buy more with their hard-earned money. Gladstone announced treaties that further reduced tariffs affecting trade with Austria, Belgium and the German states. Gladstone helped abolish more than 1,000 — about 95% — of Britain's tariffs. Then in 1865, Gladstone brought the income tax down to an astonishing 1.66%. The British income tax had been 10% during the Napoleonic Wars and 6.6% during the Crimean War.
What was the secret of Gladstone's extraordinary tax cuts? As the Austrian economist Joseph Schumpeter explained, in Gladstone's view "the most important thing was to remove fiscal obstructions to private activity. It was necessary to keep public expenditure low…this means the reduction of the functions of the state to a minimum."
The more Gladstone cut the cost of government, the more people prospered. In 1859, British imports were £179 million, and exports were £155 million. A decade later, British imports soared to £279 million, while exports hit £237 million. Historian Asa Briggs hailed this as an "age of improvement" and noted how Gladstone "took pains to emphasize the effect of taxation not only on enjoyment but on employment." Economic historian Charles More added, "The improved living standards of manual workers were paralleled by improved living standards for the middle class and the very rich."
A second great success cutting both taxes and spending involved an American president who inherited one of the worst depressions in American history. It happened in 1921, after World War I as the government cancelled orders for war materials. Unemployment doubled, and wholesale prices plunged about one third.
The president was Warren Harding (1865-1923), who shrewdly believed that if tough adjustments must be made — such as from a wartime economy to a peacetime economy — the most humane policy is to get through the inevitable adjustments as fast as possible. Although the intention of bailouts and relief programs is to relieve misery, Harding recognized that such policies undermine incentives to make adjustments rapidly and can end up prolonging misery.
Harding cut spending about 50%, he cut taxes about 40%, and he started paying down the debt. There were no bailouts, no "stimulus" programs, no entitlements, no government employee unions, none of the things that made it extremely difficult for later presidents to cut spending.
Although FDR's New Deal was plagued by unemployment that averaged 17% throughout the 1930s, and now Obama is plagued by chronic 9% unemployment, Harding's policies helped turn around the American economy within 18 months. The Roaring Twenties were underway in 1922. Harding died in August 1923, but his successor Calvin Coolidge (1872-1933) continued his policies. Consequently, during the 1920s, taxes and spending were cut 50%, and about 30% of the national debt was paid off. There were budget surpluses every year during the 1920s. Unemployment dropped to 1.8%, the lowest in more than a century. There were plenty of jobs.
Economic historians have acknowledged Harding's remarkable success. John M. Peterson and Ralph Gray, for instance, reported that "The postwar depression set records both for the rapidity of the 1921 contraction and for 1922's rapid climb back to prosperity." Gary M. Walton and Hugh Rockoff wrote that the policies launched by Harding "added to an environment that produced unparalleled business prosperity. Spectacular advances in the production of consumer durables, electric power, new appliances, suburban housing, and city skyscrapers highlighted the decade." According to economist Stanley Lebergott, "The gain in the standard of living during the 1920s was without precedent in U.S. experience."
If Harding's policies were so good, then how does one explain the stock market crash and the Great Depression that followed? The short answer is that government policies changed. There were a series of Federal Reserve blunders that began in 1928 and continued through the late 1930s. Herbert Hoover signed the Smoot-Hawley tariff (1930) that throttled trade, and he signed big tax hikes (1932) that meant employers had less money for hiring, and consumers had less money for spending. Taxes tripled under FDR who also signed a number of laws that made it more expensive for employers to hire people, so there was less hiring.
Although Gladstone and Harding affirmed that dramatic tax and spending cuts could be achieved, they're not likely to happen again unless the number of functions performed by the federal government is reduced. If government continues to do everything it's doing now, efforts to cut taxes and spending are probably doomed. A bureaucracy might have its budget cut for a while, but as long as that bureaucracy exists, it can be counted on to lobby aggressively for bigger appropriations, and they are bound to come.
The number of government functions will have to be reduced one at a time, starting with those that cost too much, are inefficient, counter-productive or obsolete. Obama's spending blowout and the resulting debt crisis has made clear that the government is grossly over-extended. Financial pressures to cut back are intensifying. Reducing the number of government functions seems likely to emerge as a leading strategy for cutting taxes and spending — the sooner, the better.