PrintJuly 2, 2009
We Could Cut Spending
In the June 30th WSJ Editorial entitled, "We'll Need to Raise Taxes Soon," Roger Altman, former deputy secretary of the Treasury in the first Clinton administration acknowledges the grim reality of the current fiscal situation. He argues that the current level of spending can't be maintained without pushing the deficit to an intolerable level and therefore the administration must raise taxes. Unfortunately, this solution would have far-reaching economic consequences. The other solution to address the current fiscal crisis, which Mr. Altman fails to acknowledge, that would have a positive economic effect, is to decrease government spending.
Mr. Altman explains that the deficit outlook has worsened because of "the burst of spending in recent years and the growing likelihood of a weak economic recovery. The latter would mean considerably lower federal revenues, the compiling of more interest on our growing debt, and thus higher deficits."
Cogan et al. and the CBO have already predicted that the stimulus bill and the President's budget will have negative economic consequences. Mr. Altman cites new data from Goldman Sachs and International Monetary Fund, which forecasts an annual growth rate of 2% for 2010-2011 and contrasts this with the President's Council of Economic Advisors who is still forecasting a traditional recovery of 3.2% for 2010 and 4% for 2011.
Mr. Altman suggests that "Mr. Obama and his economic advisers understand this deficit outlook and undoubtedly view it as unsustainable." He further states, "The problem is the deficit's sheer size, which goes way beyond potential savings from cuts in discretionary spending or defense." This leaves two solutions; one, which Mr. Altman acknowledges - to raise taxes; the second, which he ignores - to cut spending. Mr. Altman concludes that the U.S. has room for a broad-based tax increase, such as a value-added tax (VAT), because compared to other OECD member countries we have one of the lowest tax revenues as a percent of GDP. He fails to mention that it is because we have a relatively low tax rate that we have a relatively high economic output. In making the case for a tax increase, Mr. Altman evades the empirical evidence, which suggests that increased levels of government spending and taxation slow economic growth and erode prosperity. Not only would increased taxation negatively affect our long-term economic prospects but during a recession it would damage any recovery efforts.
Research from The Institute for Market Economics is among the latest in a long line to demonstrate that government spending at a level greater than 25% of GDP causes a decrease in economic growth and prosperity. The reason: Beyond a certain level government spending and the taxation required to support it smother the productivity of the private sector. Government spending requires a transfer of wealth (through taxation) from the private sector to the public sector, which isn't driven by the same incentives as the private market and therefore is less efficient and less productive. You can think of it as the government literally stealing production capacity away from the private market and then squandering it. To put this in perspective, 2008 U.S. government spending was equivalent to 36% of GDP, for 2009 it is projected to be equivalent to 45%. The Administration is clearly making a bad situation they inherited much worse.
To demonstrate the relationship between economic productivity and the level of government spending and taxation we have graphed GDP per capita (blue) versus government spending (red) and total tax revenue (green) as a percent of GDP for the world's five largest economies in 2008.
The graph displays an inverse relationship between productivity as measured by GDP per capita and government size (measured by government spending and total tax revenue) -- in short, as government spending and tax revenue increase, economic production goes down. In light of the Administration's actions this data suggests our long-term economic prospects are poor even if increased tax revenue can close the growing budget deficit. It is important to keep in mind that even a country with a balanced budget will not grow their economy if government spending and taxation are oppressive.
The graph displays an inverse relationship between productivity as measured by GDP per capita and government size (measured by government spending and total tax revenue) -- in short, as government spending and tax revenue increase, economic production goes down. In light of the Administration's actions this data suggests our long-term economic prospects are poor even if increased tax revenue can close the growing budget deficit. It is important to keep in mind that even a country with a balanced budget will not grow their economy if government spending and taxation are oppressive.
During a recession, the negative impact (from increased taxation on economic growth) is magnified from what it would be if the economy were in a period of normal growth before taking on the tax increase. This impact will frustrate recovery efforts further and this is where we find ourselves at the current time. It would seem then that there is only one thing to do - cut spending to close the growing budget deficit.
The Administration claims to have identified $500 billion in savings over the next 10 years from Medicare and Medicaid. This would appear to be a good place to start saving as government healthcare spending represents the biggest driver of long-term debt. Unfortunately, the Administration is looking to squander these savings through the creation of the new public healthcare plan, which will require an additional $500 billion to $1 trillion in government spending over the next 10 years on top of the savings from Medicare and Medicaid cuts.
Significant spending cuts can be made at the federal, state, and local levels - the Cato Handbook for Policymakers is an excellent resource for identifying potential targets however, getting lawmakers from both ends of the political spectrum to agree to these cuts is another story. The alternative, if we're not willing to decrease government spending, will have to be increased taxation. While this seems like the easy bet, the consequences of choosing it will be severe: a prolonged recession and a permanently decreased rate of economic growth upon which the future improvement of society and the future degree of opportunity for its citizens depends.
Andrew Foy, M.D. and Brent Stransky are co-authors of the forthcoming book, "The Young Conservative's Field Guide." They can be contacted through their website aHardRight.com.
