Posts Tagged ‘government spending’

In my last two posts, I showed that the U.S. has a large social welfare state by cross-national standards, maybe even the second-largest in the OECD. However, the U.S. welfare state is much less redistributive from rich to poor than most other welfare states.

In this post, I tackle spending on infrastructure (“gross fixed capital formation”) and subsidies. According to the punditocracy, the U.S. always needs to spend more on infrastructure. Conversely, the populist mood in this country stands firmly against subsidies to business, and perhaps rightly so — very few subsidies seem rationally designed to compensate for positive externalities.

But it turns out the U.S. spends more than almost every other OECD country on public investment in fixed capital, and less than every other OECD country on subsidies. Take a look:

u.s. spends a lot on infrastructure

u.s. spends little on subsidies

The first plot shows public investment by country, divided by GDP, in 2012. It includes spending by all levels of government. The U.S. places near the top of the international standings in that year, but this is no fluke: throughout the last three decades, the U.S. has been near the top of international tables in this measure. Maybe everybody needs to spend more on infrastructure, but this certainly doesn’t seem like a uniquely American problem. And maybe you think that a less densely populated country has a higher optimal level of public infrastructure spending, but I’m not so sure: higher infrastructure spending in such a country could subsidize an inefficient distribution of population.

The second plot shows public subsidies by country, divided by GDP, in 2012, again summing up the figures for all levels of government. The U.S. stands right at the bottom, with less than half a percentage point of GDP going to subsidies. Further, state and local governments spend only about 0.1% of GDP on subsidies, so the federal government is the main sinner here. Now, these figures don’t seem to be picking up tax advantages like “tax increment financing” districts popular at the local level. Still, businesses can typically be exempted only from taxes that they otherwise would have paid; expenditure-side subsidies are potentially unlimited.

I should note that federalism doesn’t seem to be the key to U.S. spending patterns here: federal Austria and Switzerland are among the highest subsidy spenders, and are not very high on infrastructure spending.

Bottom line: it’s not clear that, at the margin, the U.S. needs a lot more infrastructure spending, and the subsidy picture certainly complicates any plausible “libertarian populist” movement aimed at big business privileges.

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The United States has long had a larger welfare state than most other Western democracies. Surprised? You may not be aware of the new research on “net social spending.”

Net social spending includes not just government expenditures on social programs, but also tax credits for social purposes and, as a debit, government taxation of social benefits. It turns out that many of the so-called “generous” European welfare states tax social benefits at a high rate. Meanwhile, the United States uses the tax code to help the poor, through the Earned Income Tax Credit. We should also include mandatory private social payments, which are not directly paid by the government.

Using the OECD data, I have plotted total net social expenditure over time for 26 rich countries (click the image to zoom in).

the united states has a bigger welfare state than most other democracies

As of 2009, the United States had the second largest welfare state in the world, at 28.8% of GDP. Only France, at 32.1%, had a bigger one. Moreover, while all advanced industrial societies show a growth in the welfare state from 2005 to 2009, due to economic conditions, the U.S. also had a big runup in welfare spending between 1999 and 2007. In 1995, U.S. net social spending stood at just 22.7% of GDP, although even that figure was higher than those for Denmark, Canada, Italy, Norway, Australia, Ireland, and South Korea. So far as we have data, the U.S. has always had a larger-than-average welfare state.

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Polisphiliac David Brooks:

Here’s a way to make money off of other people’s misery. Short house prices in Northern Virginia. Starting with sequestration and then continuing over the next several years, the Defense Department is going to be hammered. All the big defense contractors in Northern Virginia are going to be hit. It’s already happening. I don’t know if you were thinking of buying a McMansion in McLean or not, but I’d hold off for five years.

Would any of you bet your hard-earned money that the government is going to shrink enough in the DC area to significantly impact Northern Virginia housing prices?  I’m skeptical to say the least.  Betting on the long-term (budgetary) health of the state is usually – unfortunately – a winner.

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General government final consumption expenditures for the 27 member countries of the European Union, from 2002 to 2011 (fiscal years):

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In the past few months, we have had a number of lively posts by Pileus contributors and readers over the question of fiscal responsibility. Some of the posts were focused on the problem of long-term unfunded entitlements. Some revolved around the question of whether a revivified GOP would embrace fiscal responsibility. Most recently, there have been postings about the National Commission on Fiscal Responsibility and Reform.

Most students of public policy know that creating a bipartisan commission is a key indicator that no one is prepared to deal seriously with an issue (e.g., remember the Financial Crisis Commission? Its report—mandated by Congress as a means of informing the legislative debate is due December 15th).  But the rapidity with which the President and Congress threw the  National Commission on Fiscal Responsibility and Reform under the bus is somewhat stunning.

Within a week of the Commission’s report, the President and the GOP have struck a deal that would add another $900 billion to the national debt. The individual components are significant of course:

  • A two-year extension of the Bush tax cuts
  • A thirteen month extension of unemployment compensation
  • A temporary 2 percent cut in the payroll tax
  • The reintroduction of the estate tax (at 35%), albeit with an exemption for estates below $5 million.

The events of the past few days have led to a number of insights. First, it seems clear that President Obama—unlike his predecessor—does not mind negotiating with himself. Second, one may conclude there is now clear recognition that Obama has capitulated on a major point: whether tax cuts or spending are better means of stimulating a moribund economy.

The chief lesson: Regardless of partisan stripe, there is no concern whatsoever with long-term fiscal responsibility. Not only are members of both parties happy to add another $900 billion to the national debt, they are willing to do so by further endangering the financial footings of Social Security and Medicare via the payroll tax cuts.

Do we need another indicator of how seriously our legislator take the issue of fiscal responsibility? As Kenneth Vogel and Manu Raju report in Politico

Senate Majority Leader Harry Reid is trying to use the tax cut package President Barack Obama brokered with Republicans to legalize online poker…Already, the online poker proposal has exposed the Nevada Democrat to charges of flip-flopping on a controversial issue, as well as using his Senate leadership position to repay big casino interests that helped him win reelection in a hard-fought campaign against Republican Sharron Angle last month.

My prediction: the debate on fiscal responsibility and the long-term problem of unfunded entitlements—at least on Pileus—is not approaching closure.

Any thoughts on the Obama-GOP tax agreement and its fiscal implications?


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Taking up commenter Bill Bachofner’s challenge, I’m posting my personal solution to the federal deficit using that nifty tool at the NY Times. I ended all short- and long-term deficits with no tax increases (except reducing employers’ health insurance tax deduction) and without raising the Social Security retirement age. Here’s the link. Of course, much of this is politically infeasible right now.

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Peter Beinart argues that

Over the last half-century, the Republican Party has been, at times, a genuinely anti-government party and, at times, a politically successful party. But it’s never been both at the same time. Once this fall’s elections are over, I suspect the Tea Partiers will begin learning that, the hard way.

If a post-election GOP House starts trying to cut spending, will voters punish them? Of course, as documented on this blog and others, there’s very little evidence that Republicans will want to take on federal spending in any serious way. Nevertheless, it’s difficult for libertarians to berate them for this failing if it’s essential to their political preservation. However, I think there’s a much stronger case that fiscal profligacy has undermined the Republicans in the medium term. A failed, expensive war and the image of hypocritical budget-busting & earmarking in the GOP Congresses of 2001-2006 helped doom the party to voter wrath. Now, in my view, reforming entitlements isn’t going to happen without a grand, bipartisan deal, so that neither party can take the lion’s share of the blame. But at the very least, a Republican majority should end earmarking and make serious efforts to defund unpopular programs, like the government takeover of health insurance, and programs that only benefit people who vote for them anyway, like ag subsidies.

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Conor Friedersdorf says no, but at Mother Jones Kevin Drum totes up the scorecard and says, pretty much, yes:

If you can find liberals who favor charter schools, less regulation of small businesses, and an end to Fannie Mae, that’s well and good. But that’s 10% or less of my worldview. I also favor high marginal tax rates on the rich, national healthcare, full funding for Social Security, more spending on early childhood education, stiff regulations on the financial industry, robust environmental rules, a strong labor movement, a cap-and-trade regime to reduce carbon emissions, a major assault on income inequality, more and better public transit, and plenty of other lefty ambitions… If we lived in Drum World I figure combined government expenditures would be 40-45% of GDP and the funding source for all that would be strongly progressive.

The only problem with this is that Drum underestimates the expense of what he wants to accomplish. According to usgovernmentspending.com, total government spending in the U.S. in 2009 was about 42% of GDP (up from 36% the year before), and we aren’t anywhere close to Drum World. He mentions Sweden favorably – well, Sweden has government spending around 60% of GDP.

Now, I think total government spending somewhat overestimates the true fiscal impact of government on the economy, because much of that spending consists of direct transfers to individuals, who then spend their money in the market, and some of it also consists of building things like roads. Government consumption is a very conservative estimate of the fiscal burden of government, consisting of government spending on its own operations (wages and goods). (Of course, it excludes regulatory burden.) According to the OECD, in 2008 government consumption was 16.7% of US GDP, compared with 26.0% in Sweden and 26.7% in Denmark. The lowest in the OECD? Mexico (10.6%) and Switzerland (10.8%). Switzerland – that land of impoverished people starving in the streets, that dystopia of megacorporations enslaving and brutalizing their employees – has a government more than 35% smaller than that of the U.S… in 2008.

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Before I get voted off the island, let me say that I’m in favor of much smaller government, lower spending and lower taxes.  I’m also a supporter of reducing budget deficits.

That said, however, I cannot find a reason to get that worked up by the budget future of the U.S. or most developed countries.  I started thinking this way over 20 years ago when I was an undergraduate and Robert Barro came to campus to tell us that the trade deficit we were running at the time was not that big of a deal, nor was the budget deficit that the trade deficit was helping finance.  This was my first exposure to Ricardian equivalence, a concept that I still think is basically right.

Of course studying economics at Chicago didn’t really dissuade me from this view.  Our macro courses paid scant attention to government finance of any kind, and no one in Chicago (or elsewhere) was paying attention to fiscal stimulus or any other  Keynesian voodoo.  We studied real business cycle (RBC) models.  I never became a master of these models, nor did the hyper-technical, ethereal nature of these models seem to be something I would be interested in or something I would be good at.

But I did gain a sense of what was important in the macroeconomy: real things.  By this I mean machines, hours worked, human capital, technology, infrastructure, networks, relationships, and time.  Prices, deficits, interest rates, exchange rates—these are things determined in markets by the supply and demand for real things.  They are not in themselves real things.   [If you and I each sell each other one billion dollar bonds, are we both worse off or better off?]

The way to judge government spending is to determine whether we are spending money on things that have value (relative to opportunity costs), not how those expenditures are financed or how much money is being moved around and to whom.   Taking money from person A and giving it to Person B is just a transfer; it doesn’t have real consequences unless people start doing things with their real stuff to avoid those transfers, such as putting their capital in less productive uses in order to avoid taxes.

In a closed economy (which we are definitely not, but hold that thought for a moment), the idea that a society can live beyond its means is impossible.  We cannot borrow from our children’s future.  We can only borrow from the present.  People who buy those government bonds know that those bonds can only be paid back from future taxes.  This is the main idea behind Ricardian equivalence.  It doesn’t matter whether spending increases are financed by taxes or bonds.    If I want to buy a car, the important question is not whether I pay cash, or get a 4-year loan or a 6-year loan (assuming each option will leave me solvent).  The important question is whether I buy a Toyota or a Lexus.  I don’t want a Lexus government.  I want a Toyota government.  Policies that diminish productivity, reduce investments in technology and human capital, and lead individuals to divert real resources from productive uses to unproductive uses are the policies we need to be most concerned about—not how big the budget deficit is.

The humungous caveat to this analysis, however, is foreign debt.  We cannot borrow from future generations since they don’t exist, but we can borrow from the Chinese and other creditors.  This is a genuine concern, but not one that I am terribly worried about yet, at least in the short-term.   As long as people have faith in the US Government meeting its obligations (and every time there is a crisis, people flock to US Bonds), they have every incentive to keep those bonds.  A mass sell-off would only hurt the seller, since it would lower the price of bonds.

So let’s focus on what matters: what are we doing with our time, our talents, and our stuff—and how can we keep government away from it.

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Britain is barely out of recession, and the new government plans to trim the fat. We’ll check back with them in a few months and see if all hell has broken loose.

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