PrintFebruary 10, 2010
Multiplier Effect Defect
Liberals are fond of referring to government spending as "investment." From Barack Obama on down, Democrats speak of investing in job creation, education, alternative fuels, high-speed rail, and every other pet project for which they can expect to receive lobbyist donations. As recently as February 3, the president announced yet another "investment" guaranteed to enhance "American energy independence" while creating "millions of jobs." No, this is not the initiative from April 22, May 5, or October 27 promising more or less the same thing. This is another initiative, with another enormous price tag.
Defending this dubious form of investment, liberal economists such as Alan Blinder fall back on the Keynesian theory of the "multiplier effect," according to which each dollar of government spending generates additional wealth as the increased monetary supply circulates throughout the economy. It is a lot like planting a handful of magic seeds and hoping to see a beanstalk shoot up to the sky.
The problem is that it costs the government a lot to plant those magic seeds, and too often government plants them in the wrong places. It costs a lot to collect taxes and even more for businesses and individuals to comply with federal tax laws. As David R. Burton and Dan R. Mastromarco write in a Cato Institute policy analysis report, a major advantage of eliminating the IRS "would likely be a windfall produced by liberating capital unproductively spent on the cost of complying with the current complex tax system." The Cato Institute elsewhere estimates a cost of 25% attributable to the collection of revenues. A study published by the Tax Foundation estimates that in 2005, the cost of compliance with federal income taxes was $265.1 billion, or 22% of tax collected. That figure of 20% to 25% has remained constant for decades, but the amount in absolute terms has skyrocketed along with rising federal tax receipts.
In addition, there is the cost of administering government programs and the cost of fraud and abuse. Washington is loath to report the cost of program administration, and when it does, the reported cost is nearly always accompanied by a windy disquisition on the effectiveness of the program at hand. This is the case with Job Corps, which was defended in a series of questionable Labor Department reports in the 1990s and 2000s, just as it continues to be defended today. In fact, the actual cost of Job Corps approaches $200,000 per graduate, and this for a program that has not "consistently raised incomes" of its young participants.
Even "mainstream" programs involve large administrative costs, especially considering the economies of scale that ought to operate. The most recent data show that the cost of administrating Social Security benefits averages 1.425%. How is it that Vanguard can administer its Total Stock and Bond exchange traded funds -- conservative investments that in contrast with the nearly empty Social Security Trust Fund have yielded a significant return to investors -- at an average cost of 0.115%, or less than one-twelfth the administrative cost of Social Security?
Now comes another decrement: government's sheer inefficiency and lack of competitiveness (along with a sizeable sum for outright graft and corruption, estimated by the CBO, for example, at 5% on the $787-billion stimulus package). While difficult to quantify, inefficiency and lack of competitiveness reduce the already negative return on government spending a great deal more. So now, for every dollar collected in taxes, one can expect a return of perhaps sixty cents in "services," which in most cases are services that one does not want enough to be willing to pay for them voluntarily.
The Obama administration's enormous "investment" in alternative energy is precisely this sort of sixty-cent return. It is no accident that T. Boone Pickens, an investor who has risked his own wealth and not merely that of the taxpayer, has apparently changed his mind about wind power generation. In mid-January, it was reported that Pickens had dramatically cut his $2-billion order of wind turbines. Private-sector investment in biofuels has declined even more, and it would decline further were it not for continuing government grants and subsidies. For the foreseeable future, natural gas appears a more efficient choice -- a fact that has not yet sunk in on the president, who continues to announce more spending on wind, solar, and biofuels while raising taxes on those fuels that are known to be more efficient. If Spain's experience with large-scale solar installations is any guide, the cost of alternative over conventional fuels will be as much as 75% higher. As the example of Spain's current economic situation also illustrates, the cost to the overall economy in lost private-sector productivity can be very great. Spain today stands in danger of default as a result of excessive government spending.
Waste, graft, and inefficiency are bad enough, but as Milton Friedman suggested long ago, the greatest loss of wealth resulting from faith in the multiplier effect comes from the reduction of the private-sector capital base, and from the "rational expectations" of the public, who eventually are led to curtail spending and savings in the face of rising government deficits. Lost investment in the private sector, where the multiplier effect actually does operate, will necessarily reduce future GDP growth. Unlike government, which scatters its seeds in fields controlled by lobbyists and contributors, the private sector tends to plant in fertile fields, where it can expect to earn a return on investment.
Christina Romer, chair of the Council of Economic Advisers, seems at least half-sensible on the issue of multipiers. She recognizes that job-creation depends on growth of investment in the private sector. No amount of stimulus spending or hiring credits will take the place of growth in the private sector, and the best way to spur such growth is through permanent tax cuts and with stable, predictable tax and regulation policies. Unfortunately, Romer is the odd woman out in this administration.
Liberals like Barack Obama never seem to consider the effect of their colossal spending on the real economy. They believe that they can plant magic seeds that will sprout a beanstalk leading up to the sky, and that in the sky there exists a golden goose which will fund one grand welfare initiative after another. In reality, all we will possess after running up a $14-trillion debt is a hill of beans.
Dr. Jeffrey Folks taught for thirty years in universities in Europe, America, and Japan. He has published many books and articles on American culture and politics.
