Here’s How to Balance the Budget
Our fiscal policy goal should be smaller government, but here’s a video for folks who think that balancing the budget should be the main objective.
The main message is that restraining the growth of government is the right way to get rid of red ink, so there is no conflict between advocates of limited government and serious supporters of fiscal balance.
More specifically, the video shows that it is possible to quickly balance the budget while also making all the 2001 and 2003 tax cuts permanent and protecting taxpayers from the alternative minimum tax. All these good things can happen if politicians simply limit annual spending growth to 2 percent each year. And they’ll happen even faster if spending grows at an even slower rate.
This debunks the statist argument that there is no choice but to raise taxes.
Overhauling CBO and JCT Is a Real Test of GOP Resolve, not the ‘Pledge to America’
While I’m glad Republicans are finally talking about smaller government, I’ve expressed some disappointment with the GOP Pledge to America. Why “reform” Fannie and Freddie, I asked, when the right approach is to get the government completely out of the housing sector. Jacob Sullum of Reason is similarly underwhelmed. He writes:
In the “Pledge to America” they unveiled last week, House Republicans promise they will “launch a sustained effort to stem the relentless growth in government that has occurred over the past decade.” Who better for the job than the folks who ran the government for most of that time? …Republicans, you may recall, had a spending spree of their own during George W. Bush’s recently concluded administration, when both discretionary and total spending doubled — nearly 10 times the growth seen during Bill Clinton’s two terms. In fact, says Veronique de Rugy, a senior research fellow at George Mason University’s Mercatus Center, “President Bush increased government spending more than any of the six presidents preceding him, including LBJ.” Republicans controlled the House of Representatives for six of Bush’s eight years.
Redemption is a good thing, however, so maybe the GOP actually intends to do the right thing this time around. One key test is whether Republicans do a top-to-bottom housecleaning at both the Congressional Budget Office and the Joint Committee on Taxation.
These Capitol Hill bureaucracies are not well known, but they have enormous authority and influence. As the official scorekeepers of spending (CBO) and tax (JCT) bills, these two bureaucracies can mortally wound legislation or grease the skids for quick passage.
Unfortunately, that clout gets used to dramatically tilt the playing field in favor of bigger government. It was CBO that claimed that Obama’s stimulus created jobs, even though the head of CBO was forced to admit that the jobs-created number was the result of a Keynesian model that was rigged to show exactly that result . You would think that would shame the bureaucrats into producing honest numbers, but CBO continues to produce absurd job creation estimates regardless of the actual rate of unemployment.
CBO favors deficits and debt when it is asked to analyze proposals for more spending, but it rather conveniently changes its tune when the discussion shifts to tax increases. Since we’re on the topic of twisted economic analysis, CBO actually relies on a model which, for all intents and purposes, predicts that economic performance is maximized with 100 percent tax rates.
The Joint Committee on Taxation, meanwhile, is infamous for its assumption that taxes have no impact – at all – on economic output. In other words, instead of showing a Laffer Curve, JCT would show a straight line, with tax revenues continuing to rapidly climb even as tax rates approach 100 percent. This creates a huge bias against good tax policy, yet JCT is impervious to evidence that its approach is wildly flawed.
And don’t forget that CBO and JCT both bear responsibility for Obamacare since they cranked out preposterous estimates that a giant new entitlement would lead to lower budget deficits.
Not that we need additional evidence, but the head of the CBO just repeated his higher-taxes-equal-more-growth nonsense in testimony to the Senate Budget Committee. With this type of mindset, is it any surprise that fiscal policy is such a mess?
Douglas Elmendorf said extending breaks due to expire at year’s end would increase demand in the next few years by putting more money in consumers’ pockets. Over the long term, he said, the tax cuts would hurt the economy because the government would have to borrow so much money to finance them that it would begin competing with private companies seeking loans. That, in turn, would drive up interest rates, Elmendorf said.
I’ve already written once about how the GOP sabotaged itself when it didn’t fix the problems with these scorekeeping bureaucracies after 1994. If Republicans take power and don’t raze CBO and JCT, they will deserve to become a permanent minority party.
It’s Simple to Balance the Budget without Higher Taxes
John Podesta of the Center for American Progress had a column in Politico yesterday asserting that “closing the budget gap entirely on the spending side would require draconian programmatic cuts.” He went on to complain that there are some people who “refuse to look at the revenue side of the ledger – while insisting that we dig the hole $830 billion deeper over the next decade by extending the Bush tax cuts.”
Not surprisingly, Mr. Podesta is totally wrong. It’s actually not that challenging to balance the budget. And it doesn’t even require any spending cuts, though it would be a very good idea to dramatically downsize the federal government. Here’s a chart showing this year’s spending and revenue totals. It then shows the Congressional Budget Office’s estimate of how much revenues will grow, assuming all the 2001 and 2003 tax cuts are made permanent and assuming that the alternative minimum tax is adjusted for inflation. As you can see, balancing the budget is a simple matter of limiting the annual growth of federal spending.
So how is it that Mr. Podesta can spout sky-is-falling rhetoric about “draconian” cuts when all that’s needed is fiscal restraint? The answer is that politicians in Washington have concocted a self-serving budget process that automatically assumes that all previously-planned spending increases should occur. So if the politicians put us on a path to make government 8 percent bigger next year and there is a proposal to instead limit spending growth to 3 percent, that 3 percent increase gets portrayed as a 5 percent cut.
This is a great scam, at least for the political class. They get to buy more votes by boosting the burden of government spending, but they get to tell voters that they’re being fiscally responsible. And they get to claim that they have no choice but to raise taxes because there’s no other way to balance the budget. In the real world, though, this translates into bigger government and puts us on a path to a Greek-style fiscal nightmare.
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Spending and Deficits
E. J. Dionne writes in the Washington Post today that many Republicans think the George W. Bush administration was “too ready to run up the deficit.” But, he says,
That the deficit increased primarily because of two tax cuts and two wars was not part of most conservatives’ calculation because acknowledging this was ideologically inconvenient.
That’s one explanation. Of course, spending did rise by more than a trillion dollars during Bush’s eight years, and it wasn’t all military spending.
And as Michael Tanner writes today, “The Deficit Is a Symptom, Spending Is the Disease.”
Traditionally, federal spending has run around 21 percent of GDP. But George W. Bush and (even more dramatically) Barack Obama have now driven federal spending to more than 25 percent of GDP. And as the old joke goes, that’s the good news. As the full force of entitlement programs kicks in, the federal government will consume more than 40 percent of GDP by the middle of the century.
The real objection of libertarians and many conservatives to Bush is the massive increase in federal spending. As Tanner says, the deficit is just the symptom of an out-of-control, overspending federal government.
Congressional Budget Office Says We Can Maximize Long-Run Economic Output with 100 Percent Tax Rates
I hope the title of this post is an exaggeration, but it’s certainly a logical conclusion based on what is written in the Congressional Budget Office’s updated Economic and Budget Outlook. The Capitol Hill bureaucracy basically has a deficit-über-alles view of fiscal policy. CBO’s long-run perspective, as shown by this excerpt, is that deficits reduce output by “crowding out” private capital and that anything that results in lower deficits (or larger surpluses) will improve economic performance — even if this means big increases in tax rates.
CBO has also examined an alternative fiscal scenario reflecting several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period. That alternative scenario embodies small differences in outlays relative to those projected under current law but significant differences in revenues: Under that scenario, most of the cuts in individual income taxes enacted in 2001 and 2003 and now scheduled to expire at the end of this year (except the lower rates applying to high-income taxpayers) are extended through 2020; relief from the AMT, which expired after 2009, continues through 2020; and the 2009 estate tax rates and exemption amounts (adjusted for inflation) apply through 2020. …Under those alternative assumptions, real GDP would be…lower in subsequent years than under CBO’s baseline forecast. …Under that alternative fiscal scenario, real GDP would fall below the level in CBO’s baseline projections later in the coming decade because the larger budget deficits would reduce or “crowd out” investment in productive capital and result in a smaller capital stock.
There’s nothing necessarily wrong with CBO’s concern about deficits, but looking at fiscal policy through that prism is akin to deciding who wins a baseball game by looking at what happened during the 6th inning. Yes, government borrowing drains capital from the productive sector of the economy. And nations such as Greece are painful examples of what happens when governments go too far down this path. But taxes also undermine economic performance by reducing incentives to work, save, and invest. And nations such as France are gloomy reminders of what happens when punitive tax rates discourage productive behavior.
What’s missing for CBO’s analysis is any recognition or understanding that the real problem is excessive government spending. Regardless of whether spending is financed by borrowing or taxes, resources are being diverted from the private sector to government. In other words, government spending is the disease and deficits are basically a symptom of that underlying problem. Indeed, it’s worth noting that there’s not much evidence that deficits cause economic damage but plenty of evidence that bloated public sectors stunt growth. This video is a good antidote to CBO’s myopic focus on budget deficits.
Maybe the French Aren’t So Bad After All
I like poking fun at French politicians for being hopeless statists, and I always assumed that French voters shared their collectivist sympathies. But according to new polling data reported by the Financial Times, there may be a Tea Party revolt brewing in France. Among major European nations, the French are most in favor of smaller government. Sacre Bleu!
European governments have solid public support, at least for now, for the spending cuts they are making in an effort to boost economic recovery, according to the latest Financial Times/Harris opinion poll. …The poll’s results point to a fiscal conservatism among the European public that contrasts with the eagerness with which most governments ran up high deficits to protect jobs and living standards as the crisis unfolded. …Asked if public spending cuts were necessary to help long-term economic recovery, 84 per cent of French people, 71 per cent of Spaniards, 69 per cent of Britons, 67 per cent of Germans and 61 per cent of Italians answered Yes. …Asked if they preferred public spending cuts or tax rises as a way to reduce budget deficits and national debts, strong majorities in the five EU countries as well as the US were in favour of spending cuts. Similarly conservative views on public expenditure emerged when people were asked if EU governments were right to engage in large-scale deficit-spending after the 2008 crisis. In all five EU countries, a majority – ranging from 68 per cent in France and Italy to 54 per cent in the UK – said the governments were wrong to have done so.
“Rahn Curve” Video Shows Government Is Far Too Big
There is considerable academic research on the growth-maximizing level of government spending. Based on a good bit of research, I’m fairly confident that Cato’s Richard Rahn was the first to popularize this concept, so we are going to make him famous (sort of like Art Laffer) in this new video explaining that there is a spending version of the Laffer Curve and that it shows how government is far too large and that this means less prosperity.
The G-20 Fiscal Fight: A Pox on Both Their Houses
Barack Obama and Angela Merkel are the two main characters in what is being portrayed as a fight between American “stimulus” and European “austerity” at the G-20 summit meeting in Canada. My immediate instinct is to cheer for the Europeans. After all, “austerity” presumably means cutting back on wasteful government spending. Obama’s definition of “stimulus,” by contrast, is borrowing money from China and distributing it to various Democratic-leaning special-interest groups.
But appearances can be deceiving. Austerity, in the European context, means budget balance rather than spending reduction. As such, David Cameron’s proposal to boost the U.K.’s value-added tax from 17.5 percent to 20 percent is supposedly a sign of austerity even though his Chancellor of the Exchequer said a higher tax burden would generate “13 billion pounds we don’t have to find from extra spending cuts.”
Raising taxes to finance a bloated government, to be sure, is not the same as Obama’s strategy of borrowing money to finance a bloated government. But proponents of limited government and economic freedom understandably are underwhelmed by the choice of two big-government approaches.
What matters most, from a fiscal policy perspective, is shrinking the burden of government spending relative to economic output. Europe needs smaller government, not budget balance. According to OECD data, government spending in eurozone nations consumes nearly 51 percent of gross domestic product, almost 10 percentage points higher than the burden of government spending in the United States.
Unfortunately, I suspect that the “austerity” plans of Merkel, Cameron, Sarkozy, et al, will leave the overall burden of government relatively unchanged. That may be good news if the alternative is for government budgets to consume even-larger shares of economic output, but it is far from what is needed.
Unfortunately, the United States no longer offers a competing vision to the European welfare state. Under the big-government policies of Bush and Obama, the share of GDP consumed by government spending has jumped by nearly 8-percentage points in the past 10 years. And with Obama proposing and/or implementing higher income taxes, higher death taxes, higher capital gains taxes, higher payroll taxes, higher dividend taxes, and higher business taxes, it appears that American-style big-government “stimulus” will soon be matched by European-style big-government “austerity.”
Here’s a blurb from the Christian Science Monitor about the Potemkin Village fiscal fight in Canada:
This weekend’s G-20 summit is shaping up as an economic clash of civilizations – or at least a clash of EU and US economic views. EU officials led by German chancellor Angela Merkel are on a national “austerity” budget cutting offensive as the wisest policy for economic health, ahead of the Toronto summit of 20 large-economy nations. Ms. Merkel Thursday said Germany will continue with $100 billion in cuts that will join similar giant ax strokes in the UK, Italy, France, Spain, and Greece. EU officials say budget austerity promotes the stability and market confidence that are prerequisites for their role in overall recovery. Yet EU pro-austerity statements in the past 48 hours are also defensive – a reaction to public statements from US President Barack Obama and G-20 chairman Lee Myung-bak, South Korea’s president, that the overall effect of national austerity in the EU will harm recovery. They are joined by US Treasury Secretary Tim Geithner, investor George Soros, and Nobel laureate and columnist Paul Krugman, among others, arguing that austerity works against growth, and may lead to a recessionary spiral.
Public Pensions as Property Rights
On Thursday I noted that former California House Speaker Willie Brown said we shouldn’t worry about the cost of government workers’ pensions because “My guess is that the State of California, like most places involved with pensions, is going to cease to pay them.”
My former colleague Andrew Biggs, writing at The American, says Speaker Brown and I are, believe it or not, too optimistic:
In most states, accrued public-sector pension benefits carry an effective property right, either through legal rulings or outright constitutional provisions. As Donald Kohn, the vice chairman of the Federal Reserve Board, put it, “For all intents and purposes, accrued benefits have turned out to be riskless obligations.”
Some states interpret these rights as prospective, meaning that not only does a public-sector employee have a right to the benefits he’s already earned, but he has a right to continue earning benefits at the same rate no matter how financially unsustainable the pension formula may be. These provisions make state pension benefits far more assured than even Social Security, which the federal government can legally cut at anytime.
Plus, he says, the pension shortfalls are even larger than most analysts think.
Resume worrying.
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.
Thursday Links
- Greece, here we come…. Congressional Budget Office estimates budget deficits will average nearly $1 trillion per year for the next decade.
- Matt Drudge re-titles a Cato op-ed: “Mob Tactics Used to Push Healthcare Through.”
- Daniel Griswold: “On trade, as on so much else, the populists have it wrong again. Free trade and globalization are great blessings to families across America.“
- Could Dennis Kucinich bring both sides of the aisle together to end the war in Afghanistan?
- Podcast: “Seventies Redux?” featuring John Samples, author of the forthcoming book The Struggle to Limit Government.
There Is Some Budget Good News, but It Is Actually Really Bad News
The Office of Management and Budget has released the President’s FY2011 budget and the Congressional Budget Office has released its semi-annual Budget and Economic Outlook. Much of the coverage of these documents has focused on deficit numbers. This is not a trivial concern, particularly since the Bush-Obama policies of bigger government have dramatically boosted red ink.
But the most important numbers in the budget documents are the estimates of what is happening to government spending. The good news is that burden of government spending is projected to decline over the next few years from about 25 percent of GDP to less than 23 percent of GDP.
That’s the good news. The bad news is that federal government outlays only consumed 18.2 percent of economic output when Bush took office. In other words, notwithstanding the good news cited above, the size and scope of government has increased dramatically since 2001. The worse news is that the long-run spending forecasts show a cataclysmic expansion in the burden of government. The “optimistic” estimate is that the federal government will consume more than 30 percent of GDP by 2050 and 40 percent of GDP by 2080.
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