Government Spending

Please read this if you think deficits don't matter and that spending doesn't drive deficits.

Or, Fun Facts About the Fiscal Cliff!

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Columnist Ron Hart writes:

When Bill Clinton so famously "balanced the budget" with the Internet boom and all the taxes from those stock sales, the GOP and Newt Gingrich passed a budget (yes, Congress used to do that) of $1.7 trillion in expenditures. Adjusted for inflation, our federal government would be spending $2.3 trillion today and collecting $2.5 trillion in "revenues," resulting in a $200 billion surplus. But instead of increasing government spending in line with normal inflation, under Bush and Obama we are spending $3.8 trillion today. Democrats, who believe we have a "revenue" problem instead of a "spending" problem, must also think they have a bartender problem, not a drinking problem.

Hart also slags Republicans, who continue to push for more military spending despite the grim fact that we are already spending close to half the planet's dollars on that score.

Do you need another indicator that spending - and not simply tax receipts weakened by a bad economy and carve-outs for the top 2 percent of earners - is the root cause of the federal deficit? Then take a look at this chart:

It's understandable why government spending trends separate from revenue during recessions. At the same time that more people are out of work and receipts go down, demand for various welfare programs (unemployment, food stamps, etc) increases.

What was different in many ways during the thick of the Bush years was that spending continued to increase during the good times, too. In 2001, Bush took the reins of a government that was spending 18.2 percent of the economy. By 2008, government spending equaled 20.8 percent of the economy. It then spiked to 25.2 percent of GDP in 2009 (a budget year for which some expenses were Obama's but most were Bush's). That sort of massive divergence is explainable in light of the fiscal crisis and the Bush and Obama administrations' responses to it. In my my view, those responses were both hysterical, counterproductive, and at least in regard to the auto bailout, illegal. Whether you agree with me on any of that, you should be worried about whether the boost in spending as a percentage of GDP is a temporary blip or the new normal.

Certainly, it should worry all of us that President Obama's budget proposal released earlier this year envisioned a decade in which the federal government on average spends 22.5 percent of GDP (Table S-1) and that the budget plan passed by the Republican House would have government spending average 20 percent over the same time period. In terms of paying for such levels of spending, each is well above the historical average of tax receipts since 1950. In fact, the GOP plan even estimates tax revenue over the next 10 years at just 18.3 percent of GDP, ensuring more debt and deficits (Table S-1). And the GOP is supposed to be the party of budget hawks, right?

Check out Table 1.3 of the Office of Management and Budget (OMB) historical tables to get a sense of several decades' worth of spending trends. From 1950 through the mid-1970s, it was rare to see the feds spending 20 percent or more of the economy. Now - with the exception of the final Clinton years and the start of Bush's presidency, that seems to be the rule. Given that tax receipts over the same period have averaged below 18 percent of GDP, there's no surprise that the nation's debt continues to grow. At more than $16 trillion, our debt is now equal to the size of the economy. That's not a good thing (for reasons I'll get to in a second).

Here's a different chart that also helps explain the role of government spending in deficits:

That's what the feds spend per person in inflation-adjusted dollars. It's gone from just north of $6,000 at the start of the Carter years to just shy of $12,000 at the end of Obama's first term. Something similar has been happening at the state level, too, so it's not as if the feds are picking up the slack from other levels of government.

Here's some awful info from a 2009 Reason story about state spending sprees during the good years in the Aughts:

In the five years between 2002 and 2007, combined state general-fund revenue increased twice as fast as the rate of inflation, producing an excess $600 billion. If legislatures had chosen to be responsible, they could have maintained all current state services, increased spending to compensate for inflation and population growth, and still enacted a $500 billion tax cut.

Instead, lawmakers spent the windfall. From 2002 to 2007, overall spending rose 50 percent faster than inflation. Education spending increased almost 70 percent faster than inflation, even though the relative school-age population was falling. Medicaid and salaries for state workers rose almost twice as fast as inflation.

So the feds and the states increase spending during the bad times, to help people out. And they increase spending during the good times, to reward constituents and set themselves up for the next elections.

It's pretty easy to understand how massive amounts of debt screws up finances at the state level: They run out of people to tax (or taxes to hike), their ability to borrow gets downgraded, etc. Eventually, they start taxing their residents more for fewer services. Nobody's happy, people and businessess move. The feds, of course, can keep printing money or coordinating with the Federal Reserve to increase the money supply. So the string is a lot longer, especially if you're the biggest economy on the planet. Inflation may or may not happen quickly (or at all) and interest rates may or may not go up. There's a serious debate happening now as to whether inflation, predicted by virtually every conventional economic theory, is occurring or not. Interest rates, both for the government and for the diminishing number of consumers who can secure credit, are pretty damn low, in defiance of age-old fears about running large and persistent deficits. At least for the moment.

So what's the harm in the feds spending like there's no tomorrow, especially when people are still hurting in terms of jobs, wages, and the like? There are many harms - we're saddling future generations with debt squandered even before they were born, for instance. Imagine being stuck with your parents' credit card bills for vacations they took and cars they bought (and sold) back in 1970. Feh.

But for the sake of brevity, let me focus on just one serious problem with running perpetual deficits and racking up huge debts at the federal level: Countries whose governments that carry debt loads of 90 percent or more of their economies for prolonged periods squeeze down long-term economic growth, the one thing everyone agrees is central to improving living standards.

As Veronique de Rugy wrote in the October issue of Reason:

In a recent National Bureau of Economics working paper called "Debt Overhangs: Past and Present," economists Carmen Reinhart, Vincent Reinhart, and Kenneth Rogoff show that in 11 of the 26 cases in their sample, countries in which debt exceeded 90 percent of GDP for at least five years did not experience an increase in interest rates.

But stable interest rates are not a sign that these countries are in good shape. Economic growth in the 26 cases was 1.2 percentage points lower than in other periods, "the average duration of debt-overhang episodes is 23 years, and it produces a 'massive' shortfall in output that is almost one-quarter less, on average, than in low-debt periods." In other words, the fact that bond markets are blasé about high levels of debt in countries perceived as safe tells you very little about how well they are doing. It certainly should not be mistaken for a signal that the government can borrow more without risk.

How many of us will be consigned to live out our futures in that Phantom Zone of missing economic growth?

All to pay for, what, military adventures that have done precious little to reduce the world's supply of suffering? Or for expanded drug benefits for already-wealthy seniors? For a war against weed that has turned the Home of the Free into history's greatest jailer nation?

Back when he was running for president, Barack Obama used to talk about how "we have to break that cycle of debt":

We've lived through an era of easy money, in which we were allowed and even encouraged to spend without limits; to borrow instead of save….

Once we get past the present emergency, which requires immediate new investments, we have to break that cycle of debt.

That used to be part of his basic stump speech in fact. Now the president has gone from talking about cutting $2.50 in spending for every $1 of new revenue in September 2012 to pushing $4 in new taxes for every dollar of spending cuts. That's all part of his "balanced approach" to government finances.

But if the cause of growth-killing debt and deficits is increased spending - and it is - the solution is to cut spending. As the November 2010 issue of Reason detailed, we've done it before as a country (after World War II) and other advanced economies have done so are recently as the 1990s. Last year, De Rugy and I even laid out an easy way of doing it through small year-over-year cuts that amount to little more than holding spending constant in real terms.

It wouldn't even be particularly difficult. And surely it beats the alternative, which is slicing 25 percent off economic growth over the next couple of decades.

It's a standing joke that everything we do at every level is "for the children." Who among us wants to look at every fourth child walking the streets and tell them, "Sorry kid, it just wasn't your century?"