Thursday, January 28, 2010

Let's not miss the fiscal forest for the deficit trees

Ed Lazear, an excellent economist who also has Washington experience, has a great article in today's WSJ that puts taxes, spending and deficits into sharp focus. Like me, he agrees with Milton Friedman that it's not the deficit that really matters, it's the level of spending. Obama & Co. have been working very hard to camouflage the huge increase in government spending they are promoting by insisting that they won't grow the deficit. But that of course means that they plan to grow taxes—by a lot. The chart above highlights the stakes involved, and is a useful companion to Lazear's article.

Today both spending and tax revenues are in uncharted post-war territory. Tax revenue as a % of GDP hasn't been this low on a sustained basis since the early 1940s. Spending relative to the economy hasn't been this high since the wartime expenditures of the early 1940s.

Here are some highlights from his article:

My analysis of data from 1950 to the present shows that periods with high tax-to-GDP ratios exhibit much slower economic growth than lower tax ratio periods. The GDP growth in high tax years (defined as years during which the ratio of tax-to-GDP was above 18%, the 60-year average) was about 1.5 percentage points lower than the growth rate in low-tax years.

High taxes are clearly bad for the U.S. economy. For example, were we to tax above the 18% tax-to-GDP ratio over the next 25 years, GDP per capita in 2035 would be about 50% less than if we were to tax below the 18% ratio. A 50% per capita GDP differential is about as large as the difference between the U.S. and Greece today.

The recent growth in spending has been camouflaged by a focus on deficits. Budgets and proposed legislation, like that on health care, are being judged not by their impact on spending and taxation, but by their projected effect on the deficit. Equal increases in spending and taxes reduce economic growth, even if they do not alter the deficit.

So the rhetoric surrounding the health-care bills misses this point. Were they to pass, it would mean more spending, more taxes and less growth.

It will be virtually impossible for Mr. Obama to keep his promise not to raise taxes on the middle class while paying for an enormous increase in spending. Given the planned spending levels, taxes will have to rise substantially to get to the target 4% deficit figure that the White House wants.


Bill said...

Are you counting on Republican wins in November and in 2012 to change this ugly course? It certainly looks pretty grim for the economy based on this analysis.

Benjamin Cole said...

Well, I sure hope it is not the "Red-Ink Republicans" who win in 2012 or later this year. Maybe Newt G. can ride to the rescue, although his personal life makes Bill Clinton look like a Boy Scout.

Look at the chart during the Clinton years. Pure beauty.

The Bush years. A train-wreck into a sewage treatment plant.

Obama? I am not impressed so far. He did inherit a train wreck into serious brown effluent, but he has not responded all that well. His health plan is a dud.

I don't mind federal revenues down where they are. I think with some reductions in outlays across all departments--including defense and agriculture--we could thrive with revenues at about 15 percent of GDP, and outlays roughly the same (perhaps minor deficits for capital outlays).

15 percent of GDP is a huge honking amount of money, and our federal agencies should be able to execute their duties on that amount. Some agencies might profitably be eliminated, such as Education and Agriculture.

Sadly, do not look for Deficit Democrats or Red Ink Republicans for salvation.

Scott Grannis said...

Bill: one of my enduring themes for the past year or so has been that the direction Obama wants to go is almost certainly not where the electorate wants to go. I've been expecting for a long time that he would be getting more and more pushback on his agenda and that in the end he would be forced to give it up and/or change course. Cap and trade went under the bus last year, card check is history, and now healthcare is a non-starter. The one thing left to do is to cancel what remains unspent of the stimulus funds.

I have been excited about the Tea Party movement from the very beginning, and I think this will carry quite a few Republicans into office in November and further change the political dynamic. The success of the Republicans will be directly proportional to how well they get the message, which is libertarian in nature: smaller government, and lower taxes.

So things look bad, but they have changed immensely for the better already, and there is more good news to come.

Scott Grannis said...

Benjamin: I'm with you 100%. If we could keep revenues at 15% and cut spending to match it this economy would take off like a rocket.

Paul said...

Those "red ink Republicans" look mighty good in hind sight. Remember when we used to gasp at billion dollar spending packages? Obama and the Pelosi\Reid Democrats spends that much before breakfast.

Jay Norman Davis said...


A bit off track:I have been told that past Goldman Sachs employees are now in charge of regulating important financial parts of the economy, Treasury, CFTC, etc. etc etc. They have been appointed by the current admin. Ihave heard that GS is more entrenche3d than ever. especially IF these people have loyalty to GS. Any thoughts how this may play out in the future. Jay

Anonymous said...

If USA runs on Obamas healthcare plan, it will be much worse. Watch Europa - healthcare insurances are totally out of control there. Germany, Switzerland, Czech...all fu--ed up with increasing healthcare budgets.

Benjamin Cole said...

I caution anyone to look to the Red Ink Republicans for a federally balanced budget. If the record of 2000-2008 didn't convince you--in a generally growing economy--what would?

Like Grannis, I hope the "Tea Party" movement yields results--but I am much less optimistic on this one point than Grannis.

I suspect the Tea Partiers will concentrate only on tax breaks, as other issues would create fissures. Right now you have libertarians and anti-abortionists showing up at rallies. Hmmm. What till they get to know each other.

Okay, tax cuts are easy, everyone is happy. Problem is, without spending cuts, they can lead to chronic deficits. Again, see 2000-2008.

The Red Ink Republicans, as constituted, are deeply enamored of federal outlays, especially to rural areas.

When was the last time you heard a Red Ink Republican deliver impassioned speech for free enterprise, in which the Department of Agriculture was singled out for a real searing?

Yet the most regulated, subsidized, molly-coddled sector of our economy is agriculture. The Detroit bailout? Every year is a bail out for farmers.

There is an extensive panoply of federal subsidies for rural areas, extending to highways, power systems, postal service, telephones, water systems, airports--almost everything in rural America is subsidized, directly or cross-subsidized.

It is the nature of rural Congressman to seek federal subsidies for their districts.

I won't mention the Department of Defense, as people get too angry and my comments will be deleted. But therein lies another story--these topics are simply verboten in Red Ink Republican circles.

More than 70 percent of federal income taxes (not payroll taxes) are consumed by the Department of Agriculture, DOD, VA, Homeland Security and Civilian Defense, Commerce and Interior, and debt.

Like Grannis, I am optimistic about the economy. The only negative I see is that there is not a party I can vote for that will balance the federal budget.

Clinton balanced the budget, even ran surpluses, but I am beginning to think that is a fluke.

Paul said...

"I caution anyone to look to the Red Ink Republicans for a federally balanced budget. If the record of 2000-2008 didn't convince you--in a generally growing economy--what would?"

Yeah, the Republicans spent too much, Benny. But there's just no comparison to what we have now.

You keep obscuring the very real differences because you were one of those fools who jumped on the Hopeandchange Train, didn't you?

Scott Grannis said...

Jay: I can only speculate that former GS people have no more loyalty to GS than they do to their belief that smart, hard-working people can be enormously successful. That is not necessarily a good thing when one controls the reins of power however; the temptation to control too much is the problem.