Data in New World Bank Report Shows that Large Public Sectors Reduce Economic Growth
When Ronald Reagan said that big government undermined the economy, some people dismissed his comments because of his philosophical belief in liberty.
And when I discuss my work on the economic impact of government spending, I often get the same reaction.
This is why it’s important that a growing number of establishment outfits are slowly but surely coming around to the same point of view.
- The European Central Bank published a study showing “…a significant negative effect of the size of government on growth.”
- A study by two Harvard economists found that “large adjustments in fiscal policy, if based on well-targeted spending cuts, have often led to expansions.”
- The Organization for Economic Cooperation and Development noted in recent research that welfare programs are economically destructive because they lure people into dependency because “net disposable income would increase despite putting in fewer hours.”
- A study from the International Monetary Fund concluded that “Cuts to pension and health entitlements had the most beneficial effect on economic growth.”
This is remarkable. It’s beginning to look like the entire world has figured out that there’s an inverse relationship between big government and economic performance.
That’s an exaggeration, of course. There are still holdouts pushing for more statism in Pyongyang, Paris, Havana, and parts of Washington, DC.
But maybe they’ll be convinced by new research from the World Bank, which just produced a major report on the outlook for Europe. In chapter 7, the authors explain some of the ways that big government can undermine prosperity.
There are good reasons to suspect that big government is bad for growth. Taxation is perhaps the most obvious (Bergh and Henrekson 2010). Governments have to tax the private sector in order to spend, but taxes distort the allocation of resources in the economy. Producers and consumers change their behavior to reduce their tax payments. Hence certain activities that would have taken place without taxes, do not. Workers may work fewer hours, moderate their career plans, or show less interest in acquiring new skills. Enterprises may scale down production, reduce investments, or turn down opportunities to innovate. …Over time, big governments can also create sclerotic bureaucracies that crowd out private sector employment and lead to a dependency on public transfers and public wages. The larger the group of people reliant on public wages or benefits, the stronger the political demand for public programs and the higher the excess burden of taxes. Slowing the economy, such a trend could increase the share of the population relying on government transfers, leading to a vicious cycle (Alesina and Wacziarg 1998). Large public administrations can also give rise to organized interest groups keener on exploiting their powers for their own benefit rather than facilitating a prosperous private sector (Olson 1982).
The Real Tragedy of the Komen/Planned Parenthood Flapdoodle
…is that it overshadowed news that the U.S. House of Representatives overwhelmingly voted to repeal one of two new entitlement programs created by Obamacare—the ironically named CLASS Act—with a bipartisan three-fifths majority. (With numbers like that, Congress could even repeal Obamacare’s death panel!)
But really, one private organization pulling funding for another private organization is way more important than Congress voting to repeal an entitlement program … isn’t it?
New Congressional Budget Office Numbers Once Again Show that Modest Spending Restraint Would Eliminate Red Ink
Back in 2010, I crunched the numbers from the Congressional Budget Office and reported that the budget could be balanced in just 10 years if politicians exercised a modicum of fiscal discipline and limited annual spending increases to about two percent yearly.
When CBO issued new numbers early last year, I repeated the exercise and again found that the same modest level of budgetary restraint would eliminate red ink in about 10 years.
And when CBO issued their update last summer, I did the same thing and once again confirmed that deficits would disappear in a decade if politicians didn’t let the overall budget rise by faster than two percent each year.
Well, the new CBO 10-year forecast was released this morning. I’m going to give you three guesses about what I discovered when I looked at the numbers, and the first two don’t count.
Yes, you guessed it. As the chart illustrates (click to enlarge), balancing the budget doesn’t require any tax increases. Nor does it require big spending cuts (though that would be a very good idea).
Even if we assume that the 2001 and 2003 tax cuts are made permanent, all that is needed is for politicians to put government on a modest diet so that overall spending grows by about two percent each year. In other words, make sure the budget doesn’t grow faster than inflation.
Tens of millions of households and businesses manage to meet this simple test every year. Surely it’s not asking too much to get the same minimum level of fiscal restraint from the crowd in Washington, right?
At this point, you may be asking yourself whether it’s really this simple. After all, you’ve probably heard politicians and journalists say that deficits are so big that we have no choice but to accept big tax increases and “draconian” spending cuts.
But that’s because politicians use dishonest Washington budget math. They begin each fiscal year by assuming that spending automatically will increase based on factors such as inflation, demographics, and previously legislated program changes.
This creates a “baseline,” and if they enact a budget that increases spending by less than the baseline, that increase magically becomes a cut. This is what allowed some politicians to say that last year’s Ryan budget cut spending by trillions of dollars even though spending actually would have increased by an average of 2.8 percent each year.
Needless to say, proponents of big government deliberately use dishonest budget math because it tilts the playing field in favor of bigger government and higher taxes.
There are two important caveats about these calculations.
1. We should be dramatically downsizing the federal government, not just restraining its growth. Even if he’s not your preferred presidential candidate, Ron Paul’s proposal for an immediate $1 trillion reduction in the burden of federal spending is a very good idea. Merely limiting the growth of spending is a tiny and timid step in the right direction.
2. We should be focusing on the underlying problem of excessive government, not the symptom of too much red ink. By pointing out the amount of spending restraint that would balance the budget, some people will incorrectly conclude that getting rid of deficits is the goal.
Last but not least, here is the video I narrated in 2010 showing how red ink would quickly disappear if politicians curtailed their profligacy and restrained spending growth.
Other than updating the numbers, the video is just as accurate today as it was back in 2010. And the concluding message—that there is no good argument for tax increases—also is equally relevant today.
P.S. Some people will argue that it’s impossible to restrain spending because of entitlement programs, but this set of videos shows how to reform Social Security, Medicare, and Medicaid.
P.P.S. Some people will say that the CBO baseline is unrealistic because it assumes the sequester will take place. They may be right if they’re predicting politicians are too irresponsible and profligate to accept about $100 billion of annual reductions from a $4,000 billion-plus budget, but that underscores the core message that there needs to be a cap on total spending so that the crowd in Washington isn’t allowed to turn America into Greece.
The Laffer Curve Works, Even in France
One year ago, I wrote about how the French government was getting unexpected additional revenues following the implementation of lower tax rates.
This is the Laffer Curve in action, and it’s happening again in France, only this time because the government reduced the wealth tax.
Here’s part of the story at Tax-news.com.
France’s solidarity tax on wealth (l’impôt de solidarité sur la fortune – ISF), which was radically reformed by the government in June last year, has served to yield much greater fiscal revenues for the state than initially predicted.
…[T]he government agreed that the solidarity tax on wealth would in future comprise of only two tax brackets: a 0.25% tax rate imposed on individuals with net taxable wealth in excess of EUR1.3m (USD1.7m), and a 0.5% tax rate levied on individuals with net taxable assets above EUR3m. Previously, the entry threshold at which wealth tax was applied was EUR800,000, with the rates varying between 0.55% and 1.8%. To alleviate any threshold effects, a discount mechanism was also instated applicable to wealth of between EUR1.3m and EUR1.4m, as well as to wealth of between EUR3m and EUR3.2m. Although the new provisions provide for lower tax rates and for the abolition of the first tax bracket, effectively exempting around 300,000 taxpayers from the tax, according to latest government figures, the tax yielded around EUR4.3bn in 2011, almost EUR60m more than originally forecast in the collective budget.
This is not to say that France is an example to follow. There shouldn’t be any wealth tax, and income tax rates are still far too high.
And it’s also worth remembering that tax policy is just one of many factors that determine economic performance.
That being said, nations that shift from terrible tax policy to bad tax policy will enjoy better economic performance, just as nations that go from good policy to great policy also will reap benefits.
In other words, incremental changes make a difference. That’s even the case when the politicians impose a “Snooki tax” on indoor tanning services.
The most dramatic Laffer Curve effects, though, occur when there are big changes in policy. The video after the jump looks at some of the evidence.
Illinois Downgrade: More Evidence that Higher Taxes Make Fiscal Problems Worse
I don’t blame Democrats for wanting to seduce Republicans into a tax-increase trap. Indeed, I completely understand why some Democrats said their top political goal was getting the GOP to surrender the no-tax-hike position.
I’m mystified, though, why some Republicans are willing to walk into such a trap. If you were playing chess against someone, and that person kept pleading with you to make a certain move, wouldn’t you be a tad bit suspicious that your opponent really wasn’t trying to help you win?
When I talk to the Republicans who are open to tax hikes, they sometimes admit that their party will suffer at the polls for agreeing to the hikes, but they say it’s the right thing to do because of all the government red ink.
I suppose that’s a noble sentiment, though I find that most GOPers who are open to tax hikes also tend to be big spenders, so I question their sincerity (with Senator Coburn being an obvious exception).
But even if we assume that all of them are genuinely motivated by a desire to control deficits and debt, shouldn’t they be asked to provide some evidence that higher taxes are an effective way of fixing the fiscal policy mess?
I’m not trying to score debating points. This is a serious question.
European nations, for instance, have been raising taxes for decades, almost always saying the higher taxes were necessary to balance budgets and control red ink. Yet that obviously hasn’t worked. Europe’s now in the middle of a fiscal crisis.
So why do some people think we should mimic the French and the Greeks?
Austan Goolsbee’s Budget Math Is Wrong – More than 100 Percent of Long-Term Fiscal Challenge Is Government Spending
Austan Goolsbee, the former Chairman of President Obama’s Council of Economic Advisers, had a column in the Wall Street Journal that argues government spending isn’t too high.
That’s obviously a silly assertion, as I explain here, here, and here, but I want to focus on what he wrote about tax revenues.
Here’s the relevant passage from his column.
The true fiscal challenge is 10, 20 and 30 years down the road. An aging population and rising health-care costs mean that spending will rise again and imply a larger size of government than we have ever had but with all the growth coming from entitlements—while projected federal revenues as a percentage of GDP after the rate cuts of the 2000s will likely remain below even historic levels of 18%.
He’s right that the main problem is in the future. As I’ve noted before, America is doomed to become Greece because of rising entitlement spending.
But he’s completely wrong when he implies that the problem is because taxes will stay below the long-run average of 18 percent of economic output. Here’s a chart I posted last year showing that tax receipts will soon rise above the long-tun average – even if the 2001 and 2003 tax cuts are made permanent. And these numbers are from the left-of-center Congressional Budget Office.
It’s rather shocking that a former Chairman of the Council of Economic Advisers isn’t aware of this CBO data. Or, if he is aware of the data, it’s unseemly that he would deliberately mislead readers.
But let’s set aside any discussion of why Goolsbee made such a fatuous claim about revenue. What really matters is that this is a debate about fiscal policy and the size of government.
The folks on the left want to convince us that inadequate revenue is causing deficits, both in the short run and long run.
We can see that they’re wrong in the short run.
But what’s especially remarkable is that they are wildly wrong about the future. The long-run data from the Congressional Budget Office shows that the federal tax burden over the next 70-plus years will jump to more than 30 percent of GDP.
This CBO baseline data assumes the 2001 and 2003 tax cuts expire, so it exaggerates the increase in the future tax burden compared to current policy. But even if you correct for this assumption and reduce tax receipts by about 2-percentage points of GDP (and presumably even more than that in the long run), it’s clear that the tax burden will be far above the historical average of 18 percent of GDP.
It’s easy to understand why Goolsbee ignores this data. After all, why report on information that completely debunks the left-wing argument about the supposed need to increase the tax burden.
But this isn’t the first time Goolsbee’s been wrong about tax policy. Let’s dig into the 2010 archives and share this video, which takes apart his arguments for class-warfare tax policy.
So what’s the bottom line? Well, we know Goolsbee and other leftists are being deceptive about taxation.
But my main takeaway is that I wish the left would be honest and admit that taxes already are projected to increase. And I’d like them to level with the American people and admit that they want the tax burden to climb even faster because they want government to get even bigger.
Will the Last Job Creator to Leave California Please Turn Off the Lights?
I’ve written before about whether California is the Greece of America, in part because of crazy policies such as overpaid bureaucrats and expensive forms of political correctness,
And we all know that California has one of the nation’s greediest governments, imposing confiscatory tax rates on a shrinking pool of productive citizens.
So it is hardly surprising that the Golden State is falling behind, losing jobs and investment to more sensible states such as Texas.
But not everybody is learning the right lessons from California’s fiscal and economic mess.
There’s a group of crazies who want to increase the top tax rate by five percentage points, an increase of about 50 percent. And they have made Kim Kardashian the poster child for their proposed ballot initiative.
I’m relatively clueless about popular culture, but even I’m aware that there is a group of people know as the Kardashian sisters. I don’t know who they are or what they do, but I gather they are famous in sort of the same way Paris Hilton was briefly famous.
And they have cashed in on their popularity, which may not reflect well on the tastes of the American people, but it’s not my job to tell other people how to spend their money.
But not everybody share this live-and-let-live attitude, which is why the pro-tax crowd in California produced this video.
I suppose I could criticize the petty dishonesty of the proponents, since they deliberately blurred of the difference between “tax rates” and “taxes paid.”
Or I could expose their economic illiteracy by pointing out that higher tax rates would accelerate the emigration of investors, entrepreneurs, small business owners, and other rich taxpayers to zero-tax states such as Nevada.
But I won’t do those things. Instead, like the Nevada Realtors Association and Arizona Business Relocation Department, I’m going to support this ballot initiative.
Not because I overdid the rum and eggnog at Christmas, but because it’s good to have negative role models, whether they are countries like Greece, cities such as Detroit, or states like California.
So here’s my challenge to the looters and moochers of the Golden State. Don’t just boost the top tax rate by five-percentage points. That’s not nearly enough. Go for a 20 percent top tax rate. Or 25 percent. After all, think of all the special interests that could use the money more than Ms. Kardashian.
And if somebody tells you that she will move to South Beach or Las Vegas, or that the other rich people will move to Texas, Wyoming, or Tennessee, just ignore them. Remember, it’s good intentions that count.
In closing, I apologize to the dwindling crowd of productive people in California. It’s rather unfortunate that you’re part of this statist experiment. But you know what they say about eggs and omelets.
By the way, here’s some humor about the Golden State, including a joke about the bloated bureaucracy and a comparison with Texas.
Senator Schumer’s Feeble Grasp of Fiscal History
I’m not a big fan of Senator Schumer of New York. As I’ve noted before, he’s a doctrinaire statist who wants the government to have control over just about every aspect of our lives.
But that describes a lot of people in Washington. I guess what also bothers me is his willingness to say anything, regardless of how divorced it is from reality, to advance his short-run political agenda (sort of a Democrat version of Karl Rove).
For example, here’s part of what the Empire State Senator recently had to say about fiscal policy, as reported by a Washington Post columnist.
Schumer said, “…Republicans came in and said, `We can solve your problem by shrinking government’…We tried their theory…The American people resent government paralysis, but most of them would say that government is doing too little to help them, not too much.”
What’s remarkable about this statement is that it’s so inaccurate that we can’t even decipher what he means. I’ve come up with three possible interpretations of what he might have been trying to say, and they’re all wrong.
1. He’s referring to GOP actions this year. This interpretation might make partial sense because the House Republicans have made a few semi-serious efforts to shrink government, but how can Schumer say “we tried their theory” when every Republican initiative was blocked by the Senate and Obama?
The Ryan budget died of malign neglect since the Senate didn’t even bother to produce a budget, and Republican efforts on the 2011 spending levels and the debt limit also were stymied, resulting at best in kiss-your-sister deals.
2. He’s referring to GOP actions during the Bush Administration. This interpretation might make some sense because the GOP did control the House, the Senate, and the Presidency, but does Schumer understand that “shrinking government” was not part of the Republican agenda during those years?
But don’t believe me. The numbers from the Historical Tables of the Budget unambiguously show that the federal budget almost doubled during the Bush years because of huge increases in domestic spending.
3. He’s referring to GOP actions during the 1990s. This interpretation actually does make sense because the burden of the public sector did shrink as a share of GDP during the Clinton years when Republicans controlled Congress, so it would be accurate to say “we tried their theory.”
But what was so bad about the era of spending restraint during the 1990s? The economy expanded and people were better off, in large part because, to quote Schumer, government was “doing too little to help them.”
Heck, the Clinton-GOP Congress years were so good that I even offered, during a debate on national TV, to go back to Clinton’s higher tax rates if it meant we also could undo all the reckless spending of the Bush-Obama years.
This doesn’t mean I’ve stopped caring about low marginal tax rates. It just means that I understand that the ultimate tax is the burden of the public sector. This video explains more, in case you’re wondering why I’d like to go back to the 1990s.
It goes without saying (but I’ll say it anyhow) that it would be even better to combine Clinton’s spending levels with Reagan’s tax rates.
European Central Bank Research Shows that Government Spending Undermines Economic Performance
Europe is in the midst of a fiscal crisis caused by too much government spending, yet many of the continent’s politicians want the European Central Bank to purchase the dodgy debt of reckless welfare states such as Spain, Italy, Greece, and Portugal in order to prop up these big government policies.
So it’s especially noteworthy that economists at the European Central Bank have just produced a study showing that government spending is unambiguously harmful to economic performance. Here is a brief description of the key findings.
…we analyse a wide set of 108 countries composed of both developed and emerging and developing countries, using a long time span running from 1970-2008, and employing different proxies for government size… Our results show a significant negative effect of the size of government on growth. …Interestingly, government consumption is consistently detrimental to output growth irrespective of the country sample considered (OECD, emerging and developing countries).
There are two very interesting takeaways from this new research. First, the evidence shows that the problem is government spending, and that problem exists regardless of whether the budget is financed by taxes or borrowing. Unfortunately, too many supposedly conservative policy makers fail to grasp this key distinction and mistakenly focus on the symptom (deficits) rather than the underlying disease (big government).
The second key takeaway is that Europe’s corrupt political elite is engaging in a classic case of Mitchell’s Law, which is when one bad government policy is used to justify another bad government policy. In this case, they undermined prosperity by recklessly increasing the burden of government spending, and they’re now using the resulting fiscal crisis as an excuse to promote inflationary monetary policy by the European Central Bank.
The ECB study, by contrast, shows that the only good answer is to reduce the burden of the public sector. Moreover, the research also has a discussion of the growth-maximizing size of government.
… economic progress is limited when government is zero percent of the economy (absence of rule of law, property rights, etc.), but also when it is closer to 100 percent (the law of diminishing returns operates in addition to, e.g., increased taxation required to finance the government’s growing burden – which has adverse effects on human economic behaviour, namely on consumption decisions).
This may sound familiar, because it’s a description of the Rahn Curve, which is sort of the spending version of the Laffer Curve. This video explains.
The key lesson in the video is that government is far too big in the United States and other industrialized nations, which is precisely what the scholars found in the European Central Bank study.
Another interesting finding in the study is that the quality and structure of government matters.
Growth in government size has negative effects on economic growth, but the negative effects are three times as great in non-democratic systems as in democratic systems. …the negative effect of government size on GDP per capita is stronger at lower levels of institutional quality, and ii) the positive effect of institutional quality on GDP per capita is stronger at smaller levels of government size.
The simple way of thinking about these results is that government spending doesn’t do as much damage in a nation such as Sweden as it does in a failed state such as Mexico.
Last but not least, the ECB study analyzes various budget process reforms. There’s a bit of jargon in this excerpt, but it basically shows that spending limits (presumably policies similar to Senator Corker’s CAP Act or Congressman Brady’s MAP Act) are far better than balanced budget rules.
…we use three indices constructed by the European Commission (overall rule index, expenditure rule index, and budget balance and debt rule index). …The former incorporates each index individually whereas the latter includes interacted terms between fiscal rules and government size proxies. Particularly under the total government expenditure and government spending specifications…we find statistically significant positive coefficients on the overall rule index and the expenditure rule index, meaning that having these fiscal numerical rules improves GDP growth for these set of EU countries.
This research is important because it shows that rules focusing on deficits and debt (such as requirements to balance the budget) are not as effective because politicians can use them as an excuse to raise taxes.
At the risk of citing myself again, the number one message from this new ECB research is that lawmakers – at the very least – need to follow Mitchell’s Golden Rule and make sure government spending grows slower than the private sector. Fortunately, that can happen, as shown in this video.
But my Golden Rule is just a minimum requirement. If politicians really want to do the right thing, they should copy the Baltic nations and implement genuine spending cuts rather than just reductions in the rate of growth in the burden of government.
The Less-than-Thrilled Case for Extending the Payroll Tax Holiday
When I think about taxes, my first instinct is to rip up the corrupt internal revenue code and implement a simple and fair flat tax.
When I think about Social Security, my first instinct is to copy dozens of other nations and implement personal retirement accounts.
Unfortunately, the political system rarely generates opportunities to enact big reforms that actually solve problems and increase freedom. Instead, we’re stuck with proposals that make things modestly better or modestly worse.
So you can imagine my sense of dissatisfaction that I’m getting peppered with questions about whether the one-year, two-percentage point payroll tax holiday should be extended.
But it’s more complicated than that. The Democrats in the Senate want to make the temporary tax cut even bigger and “offset” that tax cut with some soak-the-rich tax increases. Republicans, meanwhile, are frozen like deer in the headlights. They understandably don’t like the Democrat plan, but they seem reluctant to support anything else, not even a “clean” extension of the current policy.
Here are a handful of observations.
- The Democrat’s proposal for a one-year payroll tax cut financed by a permanent income tax hike on investors, entrepreneurs, and small business owners would be a big net negative for U.S. job creation and competitiveness.
- A “clean” extension of the payroll tax holiday would modestly improve incentives for work, but the temporary nature of the tax cut substantially weakens pro-growth effects.
- Ideally, the extension of the tax holiday should be financed by reducing the growth of federal spending.
- There are other tax cuts, such as permanent reductions in marginal income tax rates and/or permanent reductions in the double taxation of saving and investment, that would have a better impact on the economy.
- There are other tax cuts, such as expanded credits, deductions, preferences, exemptions, and shelters, that have no positive impact on the economy.
- A payroll tax holiday does not undermine Social Security since the Trust Fund is nothing but a big pile of IOUs.
- The best incremental reform would be a permanent reduction in the payroll tax, with the money channeled to personal retirement accounts. This would lower the tax burden of work while reducing the long-run burden of entitlement spending.
- This discussion of payroll taxes and incremental reform should not distract us from the enormously important issue of genuinely fixing entitlement programs, something that is needed to save America from Greek-style fiscal collapse at some point in the future.
So what does all this mean? Simply stated, there are many other fiscal reforms that are preferable, but a temporary extension of the payroll tax holiday is better than nothing—assuming, of course, it is not poisoned by accompanying class-warfare tax hikes.
American Politicians Should Copy Canada’s Leftist Government of the 1990s and Cap Spending
Since I’ve written before about Canada’s remarkable period of fiscal restraint during the 1990s, I was very pleased to see that the establishment press is finally giving some attention to what our northern neighbors did to reduce the burden of government spending.
Here are some key passages from a Reuters story.
“Everyone wants to know how we did it,” said political economist Brian Lee Crowley, head of the Ottawa-based think tank Macdonald-Laurier Institute, who has examined the lessons of the 1990s. But to win its budget wars, Canada first had to realize how dire its situation was and then dramatically shrink the size of government rather than just limit the pace of spending growth. It would eventually oversee the biggest reduction in Canadian government spending since demobilization after World War Two. …The turnaround began with Chretien’s arrival as prime minister in November 1993, when his Liberal Party – in some ways Canada’s equivalent of the Democrats in the U.S. – swept to victory with a strong majority. The new government took one look at the dreadful state of the books and decided to act. “I said to myself, I will do it. I might be prime minister for only one term, but I will do it,” said Chretien. …The Liberals thought their first, rushed budget – delivered in February 1994, three months after taking office, was tough. It reformed unemployment insurance entitlements, and cut defense and foreign aid… The upstart Reform Party, then the main national opposition party, had campaigned on “zero-in-three” – balance the budget in three years. “We were always trying to go faster,” said Reform’s leader at the time, Preston Manning. …The Liberals were stung by the criticism and, at first reluctantly but then with gusto, they got out the chain saws. …Cutting government spending programs went against the Liberal grain. Contrary to the Reform Party, the Liberals saw a more important role for government. Paul Martin now has a lasting reputation as the finance minister who slayed Canada’s deficit, but the conversion from spender to cutter was painful. His father, also called Paul, had helped create Medicare, Canada’s publicly funded health care system, and suddenly here was Paul Junior contemplating massive cuts.
This is a remarkable story. My only real quibble is that the fiscal restraint actually started the year before the Liberal Party took power, as the chart illustrates.
But the key thing to understand is that Canada enjoyed a five-year period when government spending increased by an average of only 1 percent each year.
There are more good passages in the story. Can anybody imagine Obama doing this?
At one 1994 cabinet meeting, Martin announced a spending freeze. A minister put forward a project that needed funding but Chretien cut him off, reminding him of Martin’s freeze. A second minister raised his hand to ask for funding, and a testy Chretien told the cabinet that the next minister to ask for new money would see his whole budget cut by 20 percent. …The ratio of spending cuts to tax hikes was seven-to-one. Asked why, Chretien said simply: “There was more need on one side than the other.” …Cuts ranged from five percent to 65 percent of departmental budgets.
By the way, while there were a few tax hikes implemented, they were trivial. Tax revenue as a share of GDP rose from 44.2 percent of GDP to 44.5 percent a GDP, an increase that probably was going to happen anyhow as Canada’s economy recovered.
So what were the results of Canada’s spending freeze?
The following passage has some numbers, but the second chart shows that the burden of government spending in Canada (right axis) fell from 53 percent of GDP to 44 percent of GDP in just five years. And red ink (left axis) completely disappeared.
The deficit disappeared by 1997 and the debt-to-GDP ratio began a rapid decline – it is now at about 34 percent. …After wrestling the deficit to the ground, Canada enjoyed what Crowley calls the payoff decade, outperforming the rest of the G7 on growth, job creation and inward investment. From 1997 to 2007, it averaged 3.3 percent economic growth. while U.S. growth averaged 2.9 percent.
The most important thing to understand is that Canada’s economy improved because the burden of government spending was reduced. Moreover, because the underlying disease was being treated, this meant two of the symptoms of excessive government – deficits and debt – also became less of a problem.
Last but not least, there are rewards for good policy. Just as Reagan enjoyed a landslide in 1984 after sticking to his guns, Canada’s Liberal Party also reaped the benefits of doing the right thing.
The final lesson is that you can impose painful spending cuts and still win elections. Chretien went on to win two more back-to-back to form majority governments, a rare feat. ,,,Drummond, who later moved to the private sector and is now an advisor helping the Ontario provincial government slash its deficit, noted that governments on the right and left in Saskatchewan, Alberta and Ontario won more voter support after their own budget cuts in the 1990s.
Here’s a video I narrated that looks at the Canadian experience, as well as similar good reforms in New Zealand, Ireland, and Slovakia.
Last but not least, let’s put all of this in context. As demonstrated here, the U.S. would enjoy a balanced budget in just eight years if politicians could be convinced to limit spending so that it increased by 1 percent each year.
Supercommittee Tax Fight Is About Increasing Spending, not Reducing Deficits
Some people have asked why I’m so agitated about the possibility that Republicans may acquiesce to tax increases as part of the Supercommittee negotiations.
Rather than get into a lengthy discourse about the proper role of the federal government or an analysis of how the Bush-Obama spending binge worsened America’s fiscal situation, I think this chart from a previous post says it all.
Republicans are considering a surrender on taxes because they are afraid that a deadlock will lead to a sequester, which would mean automatic budget savings. And the sequester, according to these politicians, would “cut” the budget too severely.
But as the chart illustrates, that is utter nonsense.
There are only budget cuts if you use dishonest Washington budget math, which magically turns spending increases into spending cuts simply because the burden of government isn’t expanding even faster.
If we use honest math, we can see what this debate is really about. Should we raise taxes so that government spending can grow by more than $2 trillion over the next 10 years?
Or should we have a sequester so that the burden of federal spending climbs by “only” $2 trillion?
The fact that this is even an issue tells us a lot about whether the GOP has purged itself of the big-government virus of the Bush years.
A few Republicans say that a sellout on tax hikes is necessary to protect the defense budget from being gutted, but this post shows that defense spending will climb by about $100 billion over the next 10 years under a sequester. And that doesn’t even count all the supplemental funding bills that doubtlessly will be enacted.
In other words, anyone who says we need to raise taxes instead of taking a sequester is really saying that we need to expand the burden of government spending.
So even though Ronald Reagan and Calvin Coolidge are two of my heroes, now you know why I don’t consider myself a Republican.
Cato on Facebook
Cato on Twitter
Cato on Google+
Cato on YouTube
