Posts Tagged ‘Growth of Government’

Looking through the freedom index data over time, it can look like a depressing series of new laws and restrictions on people’s lives. Now, freedom has increased at the state level on certain issues (local gun bans overturned, sodomy laws overturned, medical marijuana laws passed, eminent domain reforms enacted, same-sex partnerships spreading). But there are ever more areas in which state governments find new ways to intervene: E-Verify mandates (which are likely coming to the entire country soon), smoking bans, online gambling bans, salvia bans, DNA databases for arrestees (recently upheld by the U.S. Supreme Court), trans-fat bans, and ever-more occupations coming under the license Raj.

Libertarians often look at this endless march of new regulations and dourly quote Thomas Jefferson, “The natural progress of things is for liberty to yield and government to gain ground.” Yet what this ignores is the explosion in the unregulated areas of human life. Ever-lengthening statute books do not necessarily mean more restrictions on what people are actually doing.

Advocates of positive freedom have always celebrated technological change as liberating. More options mean more choices mean more freedom. Traditional libertarians don’t often seem to want to think this way, probably because they think of negative freedom as more important: i.e., the absence of restrictions on peaceful choices. I agree with them there: positive freedom is desirable but not at the expense of negative freedom.

I am arguing here that technological change enhances negative freedom, even if the number of laws and formal restrictions remains constant. How is this possible? Most importantly, technological change opens up new domains of human endeavor that have yet to be regulated. Secondarily, certain technological changes can disrupt government regulation. Finally, crowded agendas mean that governments stop enforcing certain laws, which leads to new social expectations about what laws will be enforced.

To understand the first point, it is important to recognize that human life is finite. Therefore, (more…)

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Stephen Moore has a depressing piece in today’s WSJ. Money quote:

Today in America there are nearly twice as many people working for the government (22.5 million) than in all of manufacturing (11.5 million). This is an almost exact reversal of the situation in 1960, when there were 15 million workers in manufacturing and 8.7 million collecting a paycheck from the government.

It gets worse. More Americans work for the government than work in construction, farming, fishing, forestry, manufacturing, mining and utilities combined. We have moved decisively from a nation of makers to a nation of takers. Nearly half of the $2.2 trillion cost of state and local governments is the $1 trillion-a-year tab for pay and benefits of state and local employees. Is it any wonder that so many states and cities cannot pay their bills?

One only wishes that Moore would have concluded his piece with two words: “April Fools.” Alas, he did not.

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Harry Truman (if I recall correctly), frustrated with the economic advice he was receiving from the Council of Economic Advisors, asked for a one-armed economist who could not say “one the one hand…on the other.”

Ten former CEA heads have issued a joint letter on the long-term budget crisis: Martin N. Baily (Clinton), Martin S. Feldstein (Reagan), R. Glenn Hubbard (Bush I), Edward P. Lazear (Bush II), N. Gregory Mankiw (Bush II), Christina D. Romer (Obama)Harvey S. Rosen (Bush II), Charles L. Schultze (Carter), Laura D. Tyson (Clinton), and Murray L. Weidenbaum (Reagan).

While they disagree on some of the details, “we find ourselves in remarkable unanimity about the long-run federal budget deficit: It is a severe threat that calls for serious and prompt attention.”

While the actual deficit is likely to shrink over the next few years as the economy continues to recover, the aging of the baby-boom generation and rapidly rising health care costs are likely to create a large and growing gap between spending and revenues. These deficits will take a toll on private investment and economic growth. At some point, bond markets are likely to turn on the United States — leading to a crisis that could dwarf 2008.

Bottom line: they “urge that the Bowles-Simpson report, ‘The Moment of Truth,’ be the starting point of an active legislative process that involves intense negotiations between both parties.” Reducing waste, fraud and abuse and cutting domestic discretionary spending are simply insufficient. Entitlements, defense, and significant tax reform (elimination of expenditures) must be central to any solution.

Of course, the fact that the Bowles-Simpson Commission, former GAO head David Walker, the Congressional Budget Office’s Long Run Budget Projections, and now ten former CEA chairs agree on the fundamental problem may not be sufficient to outweigh the short-term incentives of our elected officials who remain—with a few exceptions–addicted to rent extraction, mud-farming, and kicking the can down the road.

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As Congress turns attention to regaining rediscovering discovering fiscal responsibility, one would assume that a good place would be eliminating unnecessary duplication of government effort.

Last week, the GAO released a study—the first in what will be a statutorily mandated annual exercise—on waste and duplication. In the first part of the report, the GAO has identified 34 areas where agencies have similar or overlapping objectives. “Reducing or eliminating duplication, overlap, or fragmentation could potentially save billions of tax dollars annually and help agencies provide more efficient and effective services.” You can read a summary of the report or download it here.

Take the example of education. The GAO reports on 82 distinct programs in 10 agencies designed to improve teacher quality. When addressing the 60 programs administered by the Department of Education, the GAO notes: “Education officials believe that federal programs have failed to make significant progress in helping states close achievement gaps between schools serving students from different socioeconomic backgrounds, because, in part, federal programs that focus on teaching and learning of specific subjects are too fragmented to help state and district officials strengthen instruction and increase student achievement in a comprehensive manner.”

In the second part, it expands its scope to explore “47 additional areas—beyond those directly related to duplication, overlap, or fragmentation—describing other opportunities for agencies or Congress to consider taking action that could either reduce the cost of government operations or enhance revenue collections for the Treasury.” The reforms that GAO identifies could yield “ financial benefits ranging from tens of millions to tens of billions of dollars annually.”

Of course, although reasonable people might disagree on what precisely government should do, one would assume that all would agree that it should do it efficiently (to the extent possible). Unfortunately, every effort to reduce waste and redundancy is easily portrayed as “an assault on _____________” (you can fill in the blank or wait of the NYT editorial page to do it for you).

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I am assuming that most readers of this blog have a commitment to freedom of association and, as a result, are quite willing to accept voluntary self-organization of labor via trade unions in the private sector. Management and labor can negotiate over the terms of the labor contract and, if it appears that higher levels of compensation are compatible with corporate profitability, mutually beneficial exchange may occur. If the two bargaining partners miscalculate, they bear the costs (e.g., through declining market share reducing profitability and the demand for labor). They are free to renegotiate the terms of their agreement in subsequent rounds.

But what of unions in the public sector? There seems to be a clear public choice problem: public unions and elected officials engage in mutually beneficial exchanges—generous compensation packages for political support and campaign finance—while shifting the costs on to the unorganized taxpayers. On the face of things, this seems no different than the dynamics intrinsic to Stigler’s economic theory of regulation.

In the case of Wisconsin, it is clear (at least to me) that the effort to eliminate collective bargaining for public sector unions is as much about politics as it is about long-term budget imbalances. The Wisconsin Education Association Council (WEAC), which represents some 98,000 workers, charges membership dues that run some $1,000 per year. Some of these funds, in turn, are spent to support candidates and incumbents (largely Democratic) who will prove overly sympathetic to union demands for higher rates of compensation.
As an AP story by Ryan Foley explains:

WEAC is typically among the largest-spending special interests in Wisconsin politics, helping former Democratic Gov. Jim Doyle win two terms in office and often trying to sway key legislative races with television ads and mailers. It also contributes to other groups that run political ads in favor of Democrats and against Republicans.

WEAC’s political arm has spent more than $11 million in donations to campaigns and spending to support and oppose other candidates since 1998, nearly all of it helping Democrats, according to McCabe [Mike McCabe, director of the Wisconsin Democracy Campaign]. The group endorsed Milwaukee Mayor Tom Barrett, a Democrat, in his race against Walker for governor last year.

McCabe said WEAC’s campaign spending dwarfs that by other unions — including American Federation of State, County and Municipal Employees, which represents tens of thousands of state and local workers in Wisconsin. But he said they were all a key part of the Democratic party’s coalition in a state that has generally leaned to the left.

By eliminating collective bargaining, forcing annual union certification, and ending the automatic deduction of union dues, Walker would eliminate a potent source of Democratic campaign finance while changing the dynamic that is driving the long-term growth of health care liabilities. Whether Walker’s campaign is driven primarily by budgetary concerns or the desire to solidify Republican control in the state government is anyone’s guess. Both will result if the bill is passed.

There could be institutional changes that would alter the dynamics and allow for the continuation of collective bargaining for public sector unions (e.g., public financing of political campaigns, bans on union contributions to political campaigns). But they seem unlikely. Absent such changes, the public choice problem remains.

It seems difficult to escape the conclusion that public sector unions are different.

Update (h/t Naben)
This morning’s Milwaukee Journal-Sentinel reports:

The 14 Wisconsin Democratic senators who fled to Illinois share more than just political sympathy with the public employees and unions targeted by Gov. Scott Walker’s budget-repair bill.

The Senate Democrats count on those in the public sector as a key funding source for their campaigns.

In fact, nearly one out of every five dollars raised by those Democratic senators in the past two election cycles came from public employees, such as teachers and firefighters, and their unions, a Journal Sentinel analysis of campaign records shows.

The 14 senators raised $1.9 million since the start of 2007, with $344,000 from public employee unions and government workers. As the story notes, this does not count donations of under $100 and independent spending (e.g., “the Wisconsin Education Association Council, the state teachers union, dropped nearly $1.6 million in independent spending in four Senate races last fall”). No surprises here, of course. Transfer-seeking is ubiquitous and is not reserved for businesses, even if they tend to be the most adept at the game.

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“Over the past decades we’ve talked of curtailing government spending so that we can then lower the tax burden. Sometimes we’ve even taken a run at doing that. But there were always those who told us that taxes couldn’t be cut until spending was reduced. Well, you know, we can lecture our children about extravagance until we run out of voice and breath. Or we can cure their extravagance by simply reducing their allowance.” Ronald Reagan, February 5, 1981

One of the claims often made was that the Reagan administration broke the back of stagflation—the combination of high inflation and stagnant growth—by departing from the crumbling Keynesian orthodoxy and embracing supply side doctrines. Of course, the credit for price stability can be assigned to the tight monetary policy enacted by Paul Volcker and the Federal Reserve. Let us turn to the question of growth.

Most certainly, the Laffer Curve received a good deal of play in those days with its promise that a reduction in marginal rates could not only stimulate growth but raise greater revenues. The promise of higher revenues at lower marginal rates was unfulfilled, as subsequent analyses confirmed. But what of growth? In the last posting, I noted the failure of the Reagan administration to reduce the size of government. In fact, despite the President’s analogy in the above quote to reducing the allowance of a spoiled child, the de facto policy was to hand the fat boy a credit card with no spending limit.

As we all know, the Reagan administration and Congress ran significant deficits each year, creating a high level of stimulus that looks quite Keynesian (recall that taxation is a policy instrument that can be used for Keynesian ends). The average annual deficit during the Reagan administration was 4.2 percent of GDP (the peak deficit, in 1983, was 6 percent of GDP, the largest since 1946 and greater than anything experienced in the pre-war days of FDR and the New Deal).

To place these figures in context, consider the following (calculated from OMB Historical Table 1.2):

1950s: average deficit 0.4 percent of GDP
1960s: average deficit 0.8 percent of GDP
1970s: average deficit 2.2 percent of GDP
1981-1988: average deficit 4.2 percent of GDP
1989-1992: average deficit 4 percent of GDP
1993-2000: average deficit 0.8 percent of GDP
2001-2008: average deficit of 2 percent of GDP

In terms of deficits, the Clinton presidency looked a lot like the Kennedy-Johnson years; the Bush II presidency looked a lot like the 1970s. The Reagan administration…well, it stands alone as having provided the highest level of stimulus since World War II.

And while the administration’s policy mix did result in recovery, the rate of growth (average of 4.3 percent, 1983-88) is not all that impressive when we recall that the 1960s experienced an average growth rate of 4.4 percent with annual average deficits that were remarkably lower (0.8 percent of GDP compared with 4.2 percent of GDP). See Table B-4, Economic Report of the President for percent change in real GDP.

The large deficits incurred in the 1980s reversed a long-term trend in the national debt (the following data is drawn from OMB Historical Table 7.1). In 1946, gross federal debt was 121.7 percent of GDP, a product largely of World War II. Over the course of the next several decades, the national debt declined steadily relative to the economy, reaching a low of 32.5 percent of GDP the year of Reagan’s inauguration. With the passage of the Economic Recovery Tax Act, revenues fell from 19.2 percent of GDP to 17.5 percent of GDP; when combined with unrestrained spending, the inevitable result was a ratcheting up of the debt. Indeed, by the time the Gipper left office, the debt was 51.5 percent of GDP (effectively erasing 25 years of progress).

Things would get much worse in subsequent years (indeed, gross debt as a percentage of GDP is projected to exceed 100 percent of GDP in 2012) so the mix of policies embraced by the Reagan administration and its successors is only part of a larger story that must include the uncontrolled growth in entitlement spending (a product of program design and demographic trends).
Was there a supply side miracle? Certainly marginal rates were slashed and the administration introduced a cost-benefit analysis-based system of regulatory review (executive order 12291) and continued the process of deregulation initiated by Ford and Carter. But the economic recovery looks more like a closeted return to Keynesian stimulus than a sharp turn to supply side revolution.

So much for Reaganomics.

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Reagan at 100

February 6 was the 100th anniversary of Ronald Reagan’s birth. Several commentators have reflected on the Reagan legacy and, as one might suspect, these assessments have been quite divergent. Some thirty years after Reagan’s first inaugural, there remain many on the right and the left who claim that there was something amounting to a Reagan revolution.

The basic narrative runs something like this: after years of stagflation and mounting evidence that the welfare-regulatory state inherited from the New Deal and Great Society was failing to achieve its objectives and undermining the incentives for growth and entrepreneurship, Ronald Reagan assumed the presidency with a clear message: government is the problem, not the solution. Over the course of the next eight years, he worked diligently to reverse the changes of previous decades.

High marginal tax rates were slashed via the Economic Recovery Tax Act and the Tax Reform Act.

The size of the government was reduced through significant cuts in domestic spending and a series of welfare reforms that set the stage for the elimination of AFDC a decade later.

The regulatory state was disciplined through the application of cost-benefit analysis –based regulatory review (executive order 12291), reductions in regulatory budgets, and further deregulation.

Inflation was eliminated via tight monetary policy and, when combined with tax cuts, the foundations were created for an era of steady non-inflationary growth.

The selective protectionism of the past was eliminated by fidelity to free trade. The administration’s efforts led, ultimately, to NAFTA and the creation of the World Trade Organization.

Carter-era détente was cast aside for a policy of “rollback” that led, ultimately, to the collapse of the Soviet Union.

While Reagan may not have achieved all that he hoped to achieve, subsequent presidents (George H.W. Bush and Bill Clinton—with the prodding of Republican majorities in Congress) consolidated and extended his accomplishments. In subsequent decades, the key features of the US political economy would be largely in accordance with the broad vision articulated by Reagan in 1981.
Analysts may well diverge on their evaluation of this new order and whether the changes rise to the level of a “revolution.” But there is little question that Reagan was the key architect. At least this is the argument…

In a few postings this week, I would like to provide my interpretations of the Reagan revolution and his long-term legacy. Lets start with the low hanging fruit.

Reagan and the Size of Government
In 1981, Ronald Reagan famously noted: “government is not the solution to our problem; government is the problem. From time to time we’ve been tempted to believe that society has become too complex to be managed by self-rule…Well, if no one among us is capable of governing himself, then who among us has the capacity to govern someone else?”
It is commonly claimed that Reagan implemented his broad vision by waging a war on the sprawling state that had been constructed during the New Deal and expanded dramatically during the Great Society and the 1970s. To evaluate this claim, it is useful to turn to some empirical indicators.

To simplify a bit, let us just consider federal outlays as a percentage of GDP. All figures are from OMB Historical Table 1.2

In 1940, on the eve of US entry into World War II, the federal government was spending 9.8 percent of GDP. Spending had actually peaked at 10.3 percent in 1939.

In 1950, federal outlays were 15.6 percent of GDP

In 1960, federal outlays were 17.8 percent of GDP

In 1970, with a hot war in Vietnam and the welfare state expansions of the Great Society and War on Poverty, federal outlays were 19.3 percent of GDP

In 1980, the last year of the Carter presidency, federal outlays had reached 21.7 percent of GDP, more than twice the level relative to the economy as had been reached during the peak year of pre-war New Deal spending.

During Reagan’s first term in office, federal outlays averaged 22.8 percent of GDP. During his second term in office, federal outlays were an average of 22.1 percent of GDP. The average for the Reagan presidency as a whole was 22.4 percent of GDP.

Did the Reagan administration shrink government (the problem, not the solution)? The simple answer is: No! If fact, government expanded during this period such that relative to the economy, the Reagan administration spent 20 percent more than the Johnson presidency that was so reviled by the critics of the Great Society.

Now, one might argue that there were good reasons for this pattern of spending (e.g., a deep recession, the growth in defense spending designed to bring an end to the Cold War). Regardless, there is no evidence to support the contention that Reagan ushered in an era of small government.

Domestic per capita spending
In a post last year, I provided a different indicator of government growth: per capita, inflation adjusted domestic spending. I argued at the time that this is a useful measure because if GDP grows faster than the population, the government’s claim on GDP could overstate levels of spending. I focus on domestic spending not because I think that military spending is unimportant—in fact it is quite important. But a focus on domestic spending allows us to see the trend more clearly. Figures are derived from data in OMB Historical Tables 3.1 and 15.3, and expressed in 2005 dollars.

In 1940, the federal government spent $715 per person.

By 1960, federal non-defense spending was $1,332 per capita, and by the end of the Johnson presidency, it has reached $2,286 per capita.

By 1980, non-defense spending rose to $2,633 per capita.

By the last year of the Reagan presidency, nondefense spending had risen to $4,827 per person—more than twice the level of the Great Society.

In sum, when we look at per capita domestic spending in constant dollars, the data reveals significant expansion under Reagan.

Once again, there are explanations to consider, some of which I may touch on later in the week. For now, let us be content with a simple but important take home message: for all the claims that Reagan ushered in a period of small government, the government actually expanded during the Reagan presidency and, depending on your indicator, the expansion may be characterized as significant.

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Fred Korematsu

The NY Times has a rather nicely written editorial today honoring Fred Korematsu.

As you may recall, Mr. Korematsu was one of citizens interred under FDR’s Executive Order 9066. Initially, he went on the lamb but was ultimately arrested and convicted of violating the internment order. He received 5 years probation and spent the next few years in de facto forced labor at the Central Utah Relocation Center. Mr. Korematsu appealed his conviction all the way to the Supreme Court (Korematsu v. United States). Alas, the Court refused to overturn the conviction (6-3), viewing the internment as justified by the security risk posed by Japanese Americans.

Although the decision deserves a reading, let me simply quote Justice Robert Jackson’s dissent:

A military order, however unconstitutional, is not apt to last longer than the military emergency. Even during that period, a succeeding commander may revoke it all. But once a judicial opinion rationalizes such an order to show that it conforms to the Constitution, or rather rationalizes the Constitution to show that the Constitution sanctions such an order, the Court for all time has validated the principle of racial discrimination in criminal procedure and of transplanting American citizens. The principle then lies about like a loaded weapon, ready for the hand of any authority that can bring forward a plausible claim of an urgent need. Every repetition imbeds that principle more deeply in our law and thinking and expands it to new purposes.

In the early 1980s, Professor Peter Irons (you may have read his fine 1982 book, The New Deal Lawyers) discovered documents revealing that Solicitor General Fahy, who had argued the government’s case in Kormatsu v United States had suppressed the military’s intelligence that concluded that there was, in fact, no security risk. In response, the US District Court vacated the earlier conviction in 1984. Although he would be honored in subsequent years (e.g., he was awarded the Presidential Medal of Freedom), the Supreme Court decision was never overturned.

The New York Times editorial concludes with a few brief paragraphs on Mr. Korematsu’s response to the War on Terror:

In 2004, he submitted a brief to the Supreme Court in support of the right of enemy combatants to challenge their detention in court. The brief used his old case to stress the “extreme nature” of the government’s position. He and his lawyers argued that in the name of national security the government was limiting civil liberties “much more than necessary” and fending off “any judicial scrutiny.”

The court ruled that enemy combatants could challenge their detention in federal court. Still, the president retains power to identify people as enemy combatants and treat them like enemies without much due process. Mr. Korematsu hoped no one would be locked away again for looking like an enemy. But after Sept. 11, 2001, he was not certain that would never happen. He stayed vigilant. All of us should.

I am not a big fan of holidays named after distinguished American citizens. But California’s decision to celebrate Fred Korematsu Day (this past Sunday) seems well justified. Perhaps we should all remember Mr. Korematsu’s struggle and spend a few minutes reading the NYT editorial, the Supreme Court decision (Korematsu v. the United States)and Jackson’s stirring dissent.

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As Congress prepares to raise the debt ceiling and the recommendations of the U.S. National Commission on Fiscal Responsibility and Reform fade from our memories, the credit rating agencies are getting a bit anxious. From today’s WSJ:

Moody’s Investors Service said in a report that the U.S. will need to reverse an upward trajectory in the debt ratios to support its triple-A rating.

“We have become increasingly clear about the fact that if there are not offsetting measures to reverse the deterioration in negative fundamentals in the U.S., the likelihood of a negative outlook over the next two years will increase,” said Sarah Carlson, senior analyst at Moody’s.

Standard & Poor’s Corp. also didn’t rule out changing the outlook for its U.S. sovereign-debt rating because of the recent deterioration of the country’s fiscal situation. The U.S. has a triple-A rating with a stable outlook at both raters.

“The view of markets is that the U.S. will continue to benefit from the exorbitant privilege linked to the U.S. dollar” to fund its deficits, Carol Sirou, head of S&P France, said at a conference in Paris on Thursday. “But that may change. We can’t rule out changing the outlook” on the U.S. sovereign debt rating in the future, she warned. She added the jobless nature of the U.S. recovery was one of the biggest threats to the U.S. economy. “No triple-A rating is forever,” she said.

The problem is not the slow recovery, of course, but the long-term projections:

The most recent official figures show the ratio of federal debt to revenue averaging 397% of gross domestic product in the period to 2020, while the ratio of interest to revenue will rise to 17.6% by 2020, from 8.6% in the last fiscal year. “These figures are “quite high for an Aaa-rated country,” Moody’s said.

This past summer, I had posting on the long-term budgetary imbalances in which I quoted the Congressional Budget Office, which projected:

higher debt could raise the probability of a fiscal crisis in which investors would lose confidence in the government’s willingness to fully honor its obligations, and thus, the government would be forced to pay much more for debt financing. Interest rates might rise only gradually to reflect growing uncertainty about whether government debt would be fully honored, but other countries’ experiences suggest that a loss of investor confidence could occur abruptly instead. If interest rates on government debt spiked, the value of outstanding government debt would fall sharply. That decline in value could precipitate a broader financial crisis by causing large losses for mutual funds, pension funds, insurance companies, banks, and other holders of federal debt.

Katie Martin (WSJ) provides a comparable assessment of what would happed if the US lost its triple-A rating:

Still, what would happen if the ratings agencies took the plunge? No one really knows, but we’d probably see the dollar drop like a stone, as some types of super-conservative investors would be barred by their own rules from investing in U.S. government debt, and many would have to sell their existing holdings. Other currencies around the world would be likely to shoot through the roof.
Long term, the dollar’s role as a safe-haven currency that draws in flows in times of stress would be seriously compromised, overturning the way the market has worked for decades.
What’s more, as pretty much every debt instrument in the world is priced in comparison to U.S. Treasurys and their rating, the debt markets would be sent into a tailspin.

With the credit rating agencies getting jittery and a continued deterioration of our long-term fiscal position, one wonders: How much longer the US will be able to ride on its past reputation? Assuming that elected officials will fail to take the issue of long-term financial sustainability seriously, will the bond markets ultimately force the United States to engage in significant reform?

Will the day of reckoning finally arrive?

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Professor Krugman has an opinion piece in the NYT today chastising the “Hijacked Commission.” No one who has read Dr. Krugman’s columns before will be at all surprised with his take on the National Commission on Fiscal Responsibility and Reform. It may be “bipartisan,” he notes, but this simply means that the commission will be a compromise between “the center-right an the hard-right.”

Krugman opens his indictment with the following observation:

Start with the declaration of “Our Guiding Principles and Values.” Among them is, “Cap revenue at or below 21% of G.D.P.” This is a guiding principle? And why is a commission charged with finding every possible route to a balanced budget setting an upper (but not lower) limit on revenue?

This is a rather selective reading. The earlier pages discuss the need to reduce the debt (or soon face $1 trillion a year in interest payments) and move toward a balanced budget, lest we push the costs of our decisions on to future generations. Before discussing revenues, the report then proposes: “Bring spending down to 22% and eventually 21% of GDP.”  It is within this context that the co-chairs propose that revenues be capped at or below 21% GDP.

Professor Krugman’s question, to repeat, is: “why is a commission charged with finding every possible route to a balanced budget setting an upper (but not lower) limit on revenue?” The answer: because the limit it sets on revenue matches the limit it sets on expenditures (hence the goal of balancing a buget).

Any exercise of this type must begin with an assumption of how large the government should be relative to GDP and then explore means of reaching this goal. This would be true even if the commission had assumed 30, 40 or 50 percent of GDP. Of course, one can only speculate that there would be fewer complaints from Professor Krugman had the commission assumed that government should spend 50 percent of GDP and then proposed to cap revenues at this level.

On the issue of revenues, as noted in an earlier post, the co-chairs’ report presents three broad options for revenue reform. Within one of the options, it provides four different combinations of  marginal rates and eliminated tax expenditures/exemptions. One of these three involves eliminating all expenditures (another, for  example, maintains most of the major expenditures).  Dr. Krugman’s take:

They suggest eliminating tax breaks that, whatever you think of them, matter a lot to middle-class Americans — the deductibility of health benefits and mortgage interest — and using much of the revenue gained thereby, not to reduce the deficit, but to allow sharp reductions in both the top marginal tax rate and in the corporate tax rate.

Once again, of the three broad options discussed, one variant of one option does what Krugman suggests. By the way, this is also combined with a chart that shows who enjoys these expenditures and, contra Professor Krugman’s assertion, most of the current benefits are claimed by the top quintile not the middle class. This is nothing new, by the way. There is ample empirical support for this claim that our system of tax expenditures and exemptions strips much of the progressivity out of the tax system.

On the Social Security proposals, Dr. Krugman like others who likely wrote their critiques before reading the report (or wrote their critiques assuming, quite rationally, that no one else would read the report) focuses on the gradual increases in the retirement age without saying a word on what would be the greatest change: progressive indexing. Once again, this would retain the benefits for lower wage workers while significantly reducing benefits for upper income workers.

Why does this feature of the reform proposal go unaddressed? The simple answer: the closer you come to transforming Social Security into a means-tested policy, the more you subject it to the political dynamics that have limited the expansion of other welfare programs (or, in the case of AFDC, led to its elimination). Retain its universal benefits, and you retain the broad base of support that will lead to its ongoing expansion (until it collapses under its own weight, of course).

I strongly suggest that readers of Pileus go and examine the report (available here). It is 50 pages of PowerPoint slides. Don’t rely on editorial writers or bloggers of any ideological stripe to do the work for you.

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Alan Simpson and Erskine Bowles foreshadowed some of the ideas currently being circulated within President Obama’s National Commission on Fiscal Responsibility and Reform with their co-chairs’ proposal (download here).

The work of the Commission is critical. The deficit is heading toward the 10.6 percent of GDP (the highest in the postwar period) and the debt is currently 94 percent of GDP, projected to break the 100% mark in the next few years. The major unfunded entitlement obligations are going to lead to collapse unless reforms are initiated soon.

To provide a quite and simplified overview of the co-chairs’ proposal (it is only 50 pages long, worth a read) let me say a few words about the spending and revenue sides.

On the spending side:

The goal is to reduce spending to 22 percent of GDP (and ultimately reduce it to 21 percent of GDP). This is to be achieved in a number of ways, including caps on discretionary spending (including $200 billion in cuts by 2015, split evenly between defense and domestic). There are also recommended reforms in medical entitlements (basically the list of incremental reforms that have been discussed widely in recent decades). For Social Security, the recommendations include progressive indexing (i.e., maintaining the current formula for low income workers but switching to the chained CPI for those above the 50 percent breakpoint) and increases in the earning cap combined with gradual increases in the retirement age (to 68 by 2050 and 69 by 2050).

On the revenue side:

The goal is to raise revenues to 21 percent of GDP. This is to be achieved by reducing marginal rates and, most importantly, eliminating some tax expenditures and exemptions (at the extreme, this could be worth $1.1 trillion).  The report provides a series of options. At the extreme, marginal rates drop dramatically (8%, 14%, 23%, and 26%) when combined with the elimination of all tax expenditures and exemptions. If one wanted to retain child tax credits, the EITC, and current mortgage interest, health and retirement benefits, the marginal rates would have to be higher. This is combined with a modest increase in the gasoline tax.

On the expenditure side, the Democrats have already declared the proposal DOA.

Speaker Nancy Pelosi  characterized the proposals as “simply unacceptable.” “Any final proposal from the commission should do what is right for our children and grandchildren’s economic security as well as for our nation’s fiscal security, and it must do what is right for our seniors, who are counting on the bedrock promises of Social Security and Medicare.”

Not to be outdone, AFL-CIO President Richard Trumka clained that the proposal told “working Americans to ‘Drop Dead.’”

Unsurprisingly, the GOP is displeased with the tax reforms.

A few initial comments are in order:

First, the goal of reducing government to 22 percent of GDP seems overly modest.  This was largely the level of spending exhibited during the 1980s and the end of the George W. Bush presidency. Reductions to 2000 level (18 percent of GDP) would seem to be within reach.

Second, the howling from Pelosi and Trumka is painful. The proposed changes in Social Security would have positive impacts on low-income elderly (they would retain the same COLA formula and the program would be there for them in the long run). The greatest negative effects would be felt by high-income earners (via progressive indexing and increases in the cap). The tax reforms—particularly if we eliminate all exemptions and expenditures—would shift a greater burden to upper income earners (the primary beneficiaries of the “hidden welfare state”).

If I could simply impose changes in Social Security, I would likely means test the entire program (and do the same with Medicare). I would eliminate the exemptions and expenditures from the tax code but retain slightly higher marginal rates to accelerate the movement toward a balanced budget. But given that we have to work within the world of the politically possible, this seems like a credible—if modest—first step.

Prediction: The political capital to be gained from opposing reform will prove far too attractive for anyone to pass up and the final report of the National Commission on Fiscal Responsibility will be stored safely in the Library of Congress only to be discovered by future historians hoping to document the decline of the Republic.


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Myths of the Fall

I often disagree with Robert Reich, but nonetheless find his arguments quite interesting. From what I gather, his forthcoming book (After Shock) is going to situate the financial collapse and the troubled recovery in a longer record of declining wages (a product of the decline of manufacturing) and growing inequality (a product of these declines and changes in tax policy). I have not read the book, but I have heard Mr. Reich speculate that the decline in the savings rate and the growing levels of indebtedness resulted from the disjunction between expectations of improving levels of consumption and the stagnation of real wages for much of the population. There is likely much to this argument, although the fully developed argument would have to take a host of additional factors into account.

Having heard Mr. Reich on NPR the other evening, I dropped by his blog to see if I could find a written version of his argument. No such luck. However, I came upon his critique of the Republican Pledge in an posting entitled “Republican Economics as Social Darwinism.” Let me quote:

John Boehner, the Republican House leader who will become Speaker if Democrats lose control of the House in the upcoming midterms, recently offered his solution to the current economic crisis: “Liquidate labor, liquidate stocks, liquidate the farmer, liquidate real estate. It will purge the rottenness out of the system. People will work harder, lead a more moral life.”

Actually, those weren’t Boehner’s words. They were uttered by Herbert Hoover’s treasury secretary, millionaire industrialist Andrew Mellon, after the Great Crash of 1929.

But they might as well have been Boehner’s because Hoover’s and Mellon’s means of purging the rottenness was by doing exactly what Boehner and his colleagues are now calling for: shrink government, cut the federal deficit, reduce the national debt, and balance the budget.

And we all know what happened after 1929, at least until FDR reversed course.

I remain somewhat stunned that the standard issue story of the Great Depression and the Hoover administration continue to find an audience.  It is not as if the data is hard to find. One can go to the OMB’s Historical Tables (Table 1.1 ) and discover the following:

  • 1929: the federal government ran a surplus of $732 million
  • 1930: the federal government ran a surplus of $738 million
  • 1931: the federal government ran a deficit of $462 million
  • 1932: the federal government ran a deficit of $2.7 billion. In dollar terms, this was larger than the deficit in FDR’s first year in office ($2.6 billion)


Reich’s claim: The Hoover administration’s response to depression was “shrink government, cut the federal deficit, reduce the national debt, and balance the budget.”


The OMB’s data: As a percentage of GDP (Table 1.2), the deficit incurred during Hoover’s last year in office was 4 percent of GDP. During the decade of the 1930s,  the federal government would run higher deficits in 1933 (4.5 percent of GDP), 1934 (5.9 percent of GDP), and 1936 (5.5 percent of GDP). But its deficits would be the same as Hoover’s last year in 1935, and smaller in 1937 (2.5 percent GDP), 1938 (.1 percent GDP) and 1939 (3.2 percent GDP).

To compare Hoover’s 1932 spending record to more recent years, a deficit of 4 percent of GDP was greater than the US government incurrent from any time from 1993 through 2008. It ballooned to 9.9 percent of GDP (2009) and is estimated to hit 10.6 percent this year (2010).

The Republican Pledge suggests that we can move to a balanced budget via reductions in discretionary spending and an extension of tax cuts, with no serious discussion of entitlements (another myth worth rejecting).

I wonder if we can have serious discussions of large economic policy questions when we work with inaccurate caricatures of the past. The Left tells a story of Hoover and Mellon, champions of laissez faire, heartlessly shrinking the government in the wake of the depression and Roosevelt riding in on a white horse to save the nation’s economy.  The Right tells a story—equally inaccurate—of Great Society social engineers inflating the size of government until Ronald Reagan rode into town, explained that government was the problem, not the solution, and reduced the size and role of government, unleashing the marvels of the market and the private sector.

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Sara Murray (Wall Street Journal) has an interesting piece, “Obstacle to Deficit Cutting: A Nation on Entitlements.” The lead paragraphs lay out the problem:

Efforts to tame America’s ballooning budget deficit could soon confront a daunting reality: Nearly half of all Americans live in a household in which someone receives government benefits, more than at any time in history.

At the same time, the fraction of American households not paying federal income taxes has also grown—to an estimated 45% in 2010, from 39% five years ago, according to the Tax Policy Center, a nonpartisan research organization.

This should come as no surprise. We are in a deep and prolonged recession and one would expect a greater reliance on unemployment, Medicaid, TANF, and food stamps. But there is also a long-term trend in entitlements that is being driven by demographics and changes in policy (e.g., the recently passed healthcare reforms that will extend subsidies to another 19 million Americans by 2019).  As Murray correctly notes: “despite occasional bouts of belt-tightening in Washington and bursts of discussion about restraining big government, the trend toward more Americans receiving government benefits of one sort or another has continued for more than 70 years—and shows no sign of abating.”

Payments to individuals—a budget category that includes all federal benefit programs plus retirement benefits for federal workers—will cost $2.4 trillion this year, up 79%, adjusted for inflation, from a decade earlier when the economy was stronger. That represents 64.3% of all federal outlays, the highest percentage in the 70 years the government has been measuring it. The figure was 46.7% in 1990 and 26.2% in 1960.

Data presented in the article reveals that US households claim a far smaller share of their after-tax income from government (9.4 percent) than do other nations (e.g., the OECD average appears to be around 20 percent). Obviously, demand for government services varies widely across nations and nations with different levels of social provision do just fine. The real problem seems to be that the US has developed a greater demand for entitlements while retaining its historical aversion to taxation.

There were times in the recent past when elected officials could paper over this demand for high levels of spending and low levels of taxation by simply claiming, in the words of Dick Cheney, that “deficits don’t matter.” But after almost two years of the Obama administration, the GOP is stepping into the 2010 midterms and the 2012 presidential election with a different message: deficits and debt do, in fact, matter.

After the polls close, one wonders whether elected officials will have the will to follow through in reducing spending and/or increasing revenues to prove that fiscal responsibility is more than a convenient campaign theme. Regardless of the technical justification, the political electoral costs could be significant. I could issue my own predictions (and who would be surprised).

Regardless, the Murray piece is worth your time.

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The World Economic Forum’s  Global Competitiveness Report has been released. You can read a summary in the Washington Post or go directly to download the report and the fascinating data tables here. As one might expect, the US has slipped from first to fourth (of 139 nations) over the past several years. Some of the data on how the US is doing relative to its competitors is disturbing. For example,

  • Government budget balance relative to GDP (117th), placing the US between the UK and Romania
  • Size of the government debt relative to GDP (122nd ), placing the US between Côte d’Ivoire and Hungary.
  • National savings rate (130th ), placing the US between Burundi and Serbia

These are based on official data sources. What I find far most interesting  are some of the data tables that speak to corporate perceptions of the government. The data is collected as part of the World Economic Forum’s Executive Opinion Survey.

  • Protection of property rights (40th), placing the US between Gambia and Malaysia
  • Diversion of public funds to companies, individuals, or groups due to corruption (34th), placing the US between Botswana and Chile
  • Public trust of politicians (54th), placing the US between Estonia and the UK
  • Favoritism in decisions of public officials (55th), placing the US between Lithuania and Tajikistan.
  • Irregular Payments and bribes to public officials (40th), placing the US between Spain and Poland
  • Wastefulness of government spending (68th), placing the US between Ghana and El Salvador
  • Burden of regulation (49th), placing the US between Guyana and Jordan
  • Efficiency of  legal framework in settling business disputes (33rd), placing the US between Botswana and Ireland
  • Efficiency of legal framework in challenging regulations (35th), between Uruguay and Gambia
  • Transparency of government policymaking (41st), placing the US between Saudi Arabia and India
  • Taxation: Data table 6.04 presents the rank ordering of nations based on the question: “What impact does the level of taxes in your country have on incentives to work or invest?” The US falls 71st out of 139 nations (the better the ranking, the less the perceived impact of taxation).  Data table 6.05 rank orders nations based on the total tax rate on businesses. The US, with a total tax rate of 46.3 percent has a higher rate than 88 of the 139 nations.

The US has long had an anti-statist culture and there has long been an adversarial relationship between business and the state. But I must admit, I find these figures striking. If we assume that economic recovery depends on corporate investment decisions, and these decisions are influenced by perceptions of the larger political-institutional environment, none of this can be good news.

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Freddie and Fannie are in the news again.

Freddie is currently seeking an additional $1.8 billion in funding (to be added to the $160 billion that has already been spent on the two government sponsored enterprises or GSEs). This recent news has led me to pose an account of how a standard political choice story of political exchange evolved into one of state vampirism. Let us review some of the facts.

The financial collapse revealed the weakness of many institutions, much to the surprise of regulators. No one in government fully appreciated the fragility of AIG or Lehman, for example.  But the same cannot be said of the GSEs. A partial accounting of the warning signs:

  • When accounting scandals led to the collapse of Enron in 2001 and WorldCom a year later, attention turned to the misapplication of accounting standards in other large firms. In January of 2003, Freddie Mac admitted that it had engaged in creative accounting to “smooth out” its earnings growth and mask underlying volatility.
  • That same year, the IMF  identified a host of problems at the GSEs including the “systemic risks inherent in the agencies’ large mortgage portfolios and their hedging operations” and the “lack of transparency.”
  • In 2004, the OMB warned: “The GSEs are highly leveraged, holding much less capital in relation to their assets than similarly sized financial institutions….a misjudgment or unexpected economic event could quickly deplete this capital, potentially making it difficult for a GSE to meet its debt obligations. Given the very large size of each enterprise, even a small mistake by a GSE could have consequences throughout the economy.”
  • Congress held hearings over the course of the next several years to consider strengthening the oversight of the GSEs  and limiting the size of their portfolios. Greenspan—usually skeptical of regulation—testified that the GSEs should be forced to reduce their trillion dollar portfolios to $100 or $200 billion, a position echoed by Treasury officials. Although proposals to create a new agency to oversee the GSEs were introduced in both chambers, Republicans and Democrats blocked reforms—refusing to place restrictions on the size of their portfolios, preventing the regulator from considering systemic risk, or tying passage to the creation of an affordable housing fund to make grants to advocacy groups.

The GSEs avoided the kinds of regulations that, if introduced early enough, might have limited the extent of the crisis.

Making Sense of Nonsense

The above pattern might not seem to make sense until once considers it through the lens of public choice.   The GSEs, although private in the pre-crash days, benefitted dramatically from the implied backing of the US government. They were able to attract capital more cheaply because investors believed that their debt was as good as T-bills.

The GSEs preserved their status by funneling large amounts of money into politics. As Open Secrets noted in a brief 2008 piece on Freddie, Fannie, and political giving:

Fifteen of the 25 lawmakers who have received the most from the two companies combined since the 1990 election sit on either the House Financial Services Committee; the Senate Banking, Housing & Urban Affairs Committee; or the Senate Finance Committee. The others have seats on the powerful Appropriations or Ways & Means committees, are members of the congressional leadership or have run for president.

During the 1989-2008 period, Open Secrets reported that “Current members of Congress have received [as of 2008] a total of $4.8 million from Fannie Mae and Freddie Mac, with Democrats collecting 57 percent of that.” Top recipients of GSE largess for the period 1989-2008:

  1. Christopher Dodd (D-CT)
  2. John Kerry (D-MA)
  3. Barack Obama (D-IL)
  4. Hilary Clinton (D-NY)
  5. Paul Kanjorski (D-PA)

Obama’s performance is pretty amazing given his short tenure in the Senate. In case your are wondering, the top 25 also included Barney Frank (D-MA), Rahm Emaunuel (D-IL), Nancy Pelosi (D-CA), and Steny Hoyer (D-MD) were also in the top 25. And even if the top of this list was full of Democrats, Republicans were recipients of GSE funds as well, claiming a majority in 2006.

So, we have profit-maximizing firms (in this case the GSEs) investing in vote-maximizing politicians (see above) and receiving special regulatory treatment. The costs were borne by consumers and taxpayers. Many members of Congress undoubtedly thought they were doing good while doing well. By requiring via statute that the GSEs make 55 percent of their mortgage purchases from low and moderate income borrowers, they were furthering pressing social goals and contributing to the creation of an ownership society.

From Political Exchange to Political Vampirism

As we know, in 2007-2008, many of the misguided policies interacted to produce a daunting financial crisis and the largest issuance of debt relative to GDP since World War II.  Freddie and Fannie, carrying large portfolios that had been politically insulated by Congress, all but collapsed, forcing a government bailout that has cost, to date, $160 billion.

In 2010, Congress passed the financial reform legislation (formally, the Dodd-Frank Wall Street Reform and Consumer Protection Act).  As noted in a previous posting, Dodd-Frank was expansive enough to cover everything from conflict metals to the racial composition of financial institutions. What was left out? The provisions of the act did NOT cover the GSEs.

One reason for leaving the GSEs alone may have been their continued utility as instruments of social policy.  As Zachary Goldfarb notes in today’s WaPo:

Since then [the collapse], they have been run by government overseers who have told the companies to help carry out the Obama administration’s housing policy. They have focused on continuing to guarantee mortgages to keep interest rates low and on reworking unaffordable home loans so borrowers can avoid foreclosure. The federal government has pledged to keep the companies solvent.

One might be surprised that the administration is using the GSEs to promote the same kind of credit policies that contributed to the housing bubble—on second thought, who would be surprised, since the clownish and melodramatic explanations of the collapse are the ones that have prevailed politically.

Some things did change with the collapse of the GSEs. When the government stepped in with a bailout, new bans were placed on campaign donations. Amazingly enough, Congress believed that once it owned an entity, it might be somewhat unseemly for it to extract donations from it.  Some predicted that after decades of Freddie and Fannie dominance of housing policy, this would have some profound implications. As the WaPo noted on August 7: “now Fannie Mae and Freddie Mac, titans of the mortgage finance industry, are wards of the state, bailed out by Washington to the tune of $160 billion and banned from political activity.”

But even if political donations are temporarily off the table, there are other ways to extract blood from Freddie and Fannie.  From today’s WaPo:

The firms are also paying steep dividends to the government in return for the aid. The dividend rate, 10 percent, is far more than the companies would pay to raise money in the capital markets. After the latest round of assistance, Freddie will be required to pay $6.4 billion in annual dividends to the government. “This dividend amount exceeds the company’s annual historical earnings in most periods,” Freddie said in a statement. “Freddie Mac expects to request additional draws under the Purchase Agreement in future periods.”

So let us review the key facts: Initially, Congress provides the GSEs with an implicit guarantee in exchange for a steady flow of donations and lax oversight. That equilibrium proved quite stable for decades and delivered the goods for legislators regardless of their political stripe. However, exogenous and endogenous shocks punctuated this equilibrium and gave rise to the political vampirism witnessed today. The GSEs are given a lease on life, but a life that might feel more like a slow death as its resources are being drained away.

How are things working out? In Goldfarb’s words: “Now, it is government decisions that are driving a good bit of the companies’ losses.”  How great are these losses? Since the collapse, Freddie has received over $60 billion from the public coffers, and now it is approaching Congress for an additional  $1.8 billion in government aid.  The combined GSE bailout has cost a mere $160 billion, as if anyone other than bondholders are counting.

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As commentators begin to read the Dodd-Frank Wall Street Reform and Consumer Protection Act, they are discovering some hidden gems. The most recent discoveries:

Diversifying the Portfolio (via Carrie Budoff Brown at Politico):

Congress gives the federal government authority to terminate contracts with any financial firm that fails to ensure the “fair inclusion” of women and minorities, forcing every kind of company from a Wall Street giant to a mom-and-pop law office to account for the composition of its work force.

Maintaining Transparency (via Ed Morrissey at HotAir):

Under a little-noticed provision of the recently passed financial-reform legislation, the Securities and Exchange Commission no longer has to comply with virtually all requests for information releases from the public, including those filed under the Freedom of Information Act.

Controlling the Market in “Conflict metals” (via Michael Tennant at NewAmerican):

it includes language compelling American-listed “companies to certify whether their products contain minerals from rebel-controlled mines in Congo and surrounding countries.”

Since gold is on this list of “conflict metals,” conspiracy theories are beginning to blossom.

What readers will NOT find: reforms of Freddie Mac and Fannie Mae, the two government sponsored enterprises that were embroiled in the financial meltdown (see Colin Barr, Fortune). Not to worry…hearings are scheduled.


Congress, in its infinite wisdom, is prepared to provide  the Financial Crisis Inquiry Commission an additional $1.8 million to continue its work. Daniel Indiviglio (the Atlantic) wonders why, given that Congress leapfrogged the commission:

At a time when both sides of the aisle are worried about excessive government spending on waste, it’s hard to justify providing more funding to a commission whose purpose has become questionable, at best.

Michael Smallberg and Rick D’Amato (the Project on Government Oversight) are concerned about the burdens that the new rules and mandated studies will place on regulators:

we’re concerned that Congress may be burdening regulators and watchdogs with unnecessary studies, rather than putting hard-and-fast rules in place. Many of these studies will simply provide another avenue for the financial services industry to exert its influence on the process, and in the meantime, the studies could impose a significant burden on regulators and watchdogs that are already short on funding, staff, and resources.

Of course, one man’s burden is another’s opportunity. The new regulations this should provide a great source of employment opportunities, thereby contributing to the ongoing success of Recovery Summer. As Julie Steinberg notes:

With the passing of the financial reform bill, the SEC, CFTC and FDIC are all on the hiring warpath. The new CFPB and the beefed-up OCC are also expected to join hiring fray once they figure out staffing needs. The creation of at least 1,343 jobs across two of the agencies has already been announced (SEC and CFTC), and more hiring announcements are expected to follow.

Undoubtedly, there will be thousands of more jobs to come. Ms. Steinberg provides useful information on how to snag a job as a regulator.  What is unclear is whether currently unemployed Census workers will have a suitable skill set. If they do, the last month of Recovery Summer may fulfill the administration’s promises.

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Democrats heaped praise on the Congressional Budget Office during the health care debates (remember SpeakerPelosi’s  breathless excitement over the “scoring” from the “bipartisan” Congressional Budget Office?).  The CBO’s newest “Long-term Budget Projections” have not engendered the same level of attention…but it should. The report was released about a month ago and my guess is that it fell under the radar screens of loyal Pileus readers. So here are a few highlights for your consideration (the entire document is available here, and CBO Director Elmendorf’s brief presentation to the National Commission on Fiscal Responsibility and Reform is available here).

The CBO begins with a cheery review of recent events:

Recently, the federal government has been recording the largest budget deficits, as a share of the economy, since the end of World War II. As a result of those deficits, the amount of federal debt held by the public has surged. At the end of 2008, that debt equaled 40 percent of the nation’s annual economic output (as measured by gross domestic product, or GDP), a little above the 40-year average of 36 percent. Since then, large budget deficits have caused debt held by the public to shoot upward; the Congressional Budget Office (CBO) projects that federal debt will reach 62 percent of GDP by the end of this year—the highest percentage since shortly after World War II.

Yes, I know, we are in the greatest recession since the Depression. The CBO recognizes that budget deficits will likely decline markedly in the next few years. Nonetheless, the CBO notes: “over the long term, the budget outlook is daunting.” The retirement of the baby boomers (assuming any of us can retire) will drive entitlement spending. “Without significant changes in government policy, those factors will boost federal outlays sharply relative to GDP in coming decades under any plausible assumptions about future trends in the economy, demographics, and health care costs.

The CBO develops its projections under two scenarios: an extended-baseline scenario and an alternative fiscal scenario.

The extended base-line scenario, is based on current law and the assumptions that (1) the health care legislation will have the anticipated effects on revenues and spending, the Bush tax cuts will expire as scheduled, and the alternative minimum tax (ATM) will cover a growing percentage of tax payers. Under this scenario, total revenues will increase to 23 percent of GDP by 2035 and grow substantially thereafter. On the spending side, “government spending on everything other than the major mandatory health care programs, Social Security, and interest on federal debt—activities such as national defense and a wide variety of domestic programs—would decline to the lowest percentage of GDP since before World War II.” In other words, the US would be primarily involved in the provision of insurance and the payment of interest on the debt. Debt held by the public would increase from 62 percent this year to 80 percent in 2035 while interest payments would increase from a current level of 1 percent of GDP to 4 percent of GDP by 2035 (essentially one-sixth of federal revenues).  (page x)

The alternative fiscal scenario—in my mind, the more reasonable one—assumes that some of the Bush tax cuts will be extended, the ATM will cover about the same percentage of taxpayer as today, Medicare reimbursements for physicians would increase gradually, and spending under the alternative scenario, and “spending on activities other than the major mandatory health care programs, Social Security, and interest would fall below the average level of the past 40 years relative to GDP, though not as low as under the extended-baseline scenario.” Under this more realistic scenario, debt would hit 87 percent of GDP by 2020. “After that, the growing imbalance between revenues and noninterest spending,  combined with spiraling interest payments, would swiftly push debt to unsustainable levels. Debt as a share of GDP would exceed its historical peak of 109 percent by 2025 and would reach 185 percent in 2035.” (page x-xi)

Indeed, under this scenario, in 75 years, revenues would reach 19.5 percent of GDP, expenditures would constitute 28.2 percent of GDP, leaving a fiscal gap of 8.7 percent of GDP (Table 1-3, p. 15).

In a sobering qualification (p. xi), the CBO states:

In fact, CBO’s projections understate the severity of the long-term budget problem because they do not incorporate the significant negative effects that accumulating substantial amounts of additional federal debt would have on the economy:

  • Large budget deficits would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment—which in turn would lower income growth in the United States.
  • Growing debt would also reduce lawmakers’ ability to respond to economic downturns and other challenges.
  • Over time, higher debt would increase the probability of a fiscal crisis in which investors would lose confidence in the government’s ability to manage its budget, and the government would be forced to pay much more to borrow money.

The CBO elaborates on the fiscal crisis scenario (pp. 20-21):

higher debt could raise the probability of a fiscal crisis in which investors would lose confidence in the government’s willingness to fully honor its obligations, and thus, the government would be forced to pay much more for debt financing.  Interest rates might rise only gradually to reflect growing uncertainty about whether government debt would be fully honored, but other countries’ experiences suggest that a loss of investor confidence could occur abruptly instead. If interest rates on government debt spiked, the value of outstanding government debt would fall sharply. That decline in value could precipitate a broader financial crisis by causing large losses for mutual funds, pension funds, insurance companies, banks, and other holders of federal debt. Experience in other countries suggests that resolving such a crisis would require fiscal policy changes that would be far more drastic and painful than if policies had been adjusted sooner to avoid a crisis.

One might suppose that such dire predictions would force a response from the White House or Congress.  Peter R. Orszag, OMB Director, used the occasion of the release to celebrate the role of the Affordable Care Act in helping to enact “substantial, long-term deficit reduction.” To be fair, he devoted a line at the end of his comments to the long-term scenario. In Congress, the majority broke from the practice of presenting a five year budget plan and presented a one-year budget resolution, which Speaker Pelosi described as “another key step . . . in restoring fiscal responsibility.” This decision was justified by the existence of the National Commission on Fiscal Responsibility and Reform.

When in doubt, create a commission. And as the legislative history of the current financial reform legislation reveals, be certain that you do everything humanly possible to avoid its findings.

And so, we return to a central question: On the assumption that we want to avoid the bleak scenarios painted by the CBO (one that has been presented on numerous occasions in earlier years) and that whatever the benefits of growth, we simply cannot “grow our way” out of the problem,  what are the options?

  1. Dramatic reductions in the core entitlement programs
  2. Dramatic increases in taxation
  3. Some combination of 1 and 2

Will elected officials–who dance to the 24 hour news cycle and whimper in fear of voters who have been assured that they can have endless entitlements and low taxes– be able to soberly face the long-term crisis and select from the limited set of options?

Is any of this politically viable absent a significant change in the popular expectations of government’s role in society and the economy?

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A three part series in the Washington Post (“Top Secret America”) should prove quite interesting.  Dana Priest andWilliam Arkin are exploring the security state that has emerged in the wake of 9/11. The lead quote:

The top-secret world the government created in response to the terrorist attacks of Sept. 11, 2001, has become so large, so unwieldy and so secretive that no one knows how much money it costs, how many people it employs, how many programs exist within it or exactly how many agencies do the same work.

This security state is comprised of some 1,271 government organizations and 1,931 private companies.  Around the Beltway, “33 building complexes for top-secret intelligence work are under construction or have been built since September 2001. Together they occupy…about 17 million square feet of space.” Priest and Arkin go on to present a tale of redundancy, waste, and a dearth of oversight (including little information on how much of our resources the new security state is consuming).

None of this should come as a surprise. As scholars as ideologically diverse as Charles Tilly (Coercion, Capital and European States) and Robert Higgs (Crisis and Leviathan) have long noted, security and economic crises are the mothers of state expansion (those who are interested, might also consult  my book, From Warfare State to Welfare State).

Depression, war and the preparation for war have driven state-building. As Higgs documented in his fine book, Crisis and Leviathan, there is a ratchet effect in state expansion. That is, expansion is justified by a crisis but, post crisis, things never return to their pre-crisis levels.  In part, this is a story of the ideological changes that accompany a crisis. Invariably, ideology shifts to support a more expansive role for the state and once these changes occur, they take on a certain permanence. In part, this is a public choice story.  Interests that secure transfers as a result of state expansion form close and enduring relationships with vote-maximizing politicians and budget-maximizing bureaucrats. In part, this is a story of bureaucratic permanence (as Reagan once quipped, there is nothing more permanent than a temporary program).

One can only imagine the aggregate long-term impact of 9/11 and the global financial crisis. If history is any guide–and it usually is–the changes forged under conditions of crisis may well become permanent.

The next few installments of the Washington Post story should prove interesting.

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Jonah Goldberg is absolutely right today (I don’t get to say that too often!).

I’m not a binary partisan, but if I were advising the Republican Party, I would  tell them it would be foolish to divert any political attention right now from economic issues (such as spending and debt), the growth of government (size and scope), and government failure/corruption.  Of course, as a political scientist, I am prone to think the bigger macro variables have the most sway – so a lot of this strategizing and messaging isn’t as important as you might think.  But if they are working on the margins, then don’t push pocketbook voters away with social issues from either a conservative or libertarian perspective (unless you can tie them into the larger narrative of government run amok).  And I say this as someone who has very strong preferences on social issues and personal freedom issues*

I would guess that Republican party operatives get this.  And for what it is worth (n=1, so perhaps not much), I made the case for this position recently to a very well-connected Republican insider, and he agreed. 

*(For example, I favor drug legalization even though I think it is immoral to use or abuse most currently illegal drugs).

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In the 2005 case Gonzales v Raich, the Supreme Court pulled back on its federalism jurisprudence and ruled that the federal government may prosecute someone for growing marijuana at home for personal use under the authority of the Commerce Clause of the U.S. Constitution, which grants Congress the right to regulate commerce among the several states. This year, Congress passed a bill essentially federalizing Massachusetts’ health insurance regulations, mandating pure community rating, guaranteed issue, and individual purchase of health insurance, fairly extreme left-wing policies previously unknown to much of the country.

Oddly, these blows to the remnants of American fiscal federalism are coming just as scholars have recognized the virtues of the system. In the 1990s, Barry Weingast’s market-preserving federalism research agenda showed how mobility of people, goods, and capital across borders of a fiscal federation defined by decentralized policy-setting under hard budget constraints could restrain the growth of government and promote economic development. In the 2000s, scholars such as Jonathan Rodden, Erik Wibbels, and Sebastian Saiegh have investigated the economic consequences of federal institutions. What they found was that when subnational governments are responsible for “paying their own way” with own-source revenues, debt is lower and government is smaller. The reason why fiscal federalism constrains Leviathan is that it allows taxpayers to seek low-tax jurisdictions, which in turn encourages these jurisdictions to compete with each other.

Among the true fiscal federations in the developed world – Canada, Switzerland, and the U.S. (that’s it!) – the U.S. is the most centralized. The chart below shows tax decentralization (subnational own-source revenues divided by total government revenues) in 1999, the latest year for which data are available, for a number of OECD countries.

Tax Decentralization, 1999In Switzerland and Canada, over half of all government revenues are raised by provincial/cantonal and local governments through taxes over which they control either the rate or the base. In the U.S., that figure has generally been around 35-40%. Sweden and Japan actually score higher on tax decentralization than the U.S., although subnational units in those countries don’t enjoy nearly the policy and political autonomy that American states do.

Will Americans eventually realize that fiscal federalism actually works and reverse the decades-long trend toward greater centralization? For that to happen, voters and federal politicians would have to realize that the things they want to have done, from gun control to health care policy, are best handled at the state and local level. They would have to take a stand on principle to reject one-size-fits-all federal solutions. Either that, or the Court is going to have to acquire the nerve and intellectual honesty to realize that it’s their job to safeguard important institutions from marauding politicians, regardless of what their personal views might be on the issue before them.


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For those who followed the neo-Marxist debates on state theory in the 1970s (or were forced to learn about them by one’s professors), one of the more interesting contributions came from James O’Connor’s book, The Fiscal Crisis of the State. In essence, O’Connor argued that the state must simultaneously execute two conflicting functions: an accumulation function (creating the conditions for capital accumulation or corporate profitability) and a legitimation function (responding to the demands of voters and mobilized groups).  As elected officials meet the demands for social provision, they embrace higher levels of taxation, ultimately reaching a point where capital accumulation collapses. They can try to put off the day of reckoning (e.g., through incurring debt) but ultimately, the crisis would occur, perhaps as a result of an exogenous shock. Of course, some of what O’Connor argued could also be extracted from public choice arguments that were emerging at the same time (see Buchanan) and the work of Mancur Olson (see The Rise and Decline of Nations).

With this in mind, the press is increasingly full of pieces detailing the fiscal crisis of in Europe, which has come to a head as a result of the sovereign debt crisis.  I find these pieces interesting, in part, because they may foreshadow what will be occurring in the US in the next few decades.

As Michael Weissenstein reports, “the welfare state—cherished by many Europeans as an alternative to what they see as dog-eat-dog American capitalism—is coming under its most serious threat in decades.”

Peggy Hollinger (Financial Times) reports that France is seriously contemplating an increase in the retirement age, “as it embarks on a contentious reform of its debt-laden pension system and brings public finances back into line.”  The unions are (insert shocked expression here) strongly opposed to any cuts and are planning a national strike on Thursday.

There was an interesting “debate” at the New York Times on whether we are witnessing the twilight of the welfare state and whether the sovereign debt crisis holds any important lessons for the United States.

It is my take (corrections are welcome) that the extent of the crisis in Europe is a bit overstated. First, the coverage of the crisis seems to suffer at times from what logicians call the fallacy of false dilemma (dismantle the welfare state or suffer collapse). There is often a failure to acknowledge that there is much room for reform and viable models within Europe (e.g., , flexicurity in Denmark).  Second, the European welfare states have been far more generous than the US welfare state. In France, for example, the debate focuses on whether to increase the retirement age from 60. And as one 92 year old Spanish pensioner said (in the Weissenstein piece above) “he was unlikely to live long enough to see the worst of the pension freeze, but had no doubts he would have to start relying on savings to maintain his lifestyle.” My guess is very few 92 year old retired civil servants in the US are starting to contemplate dipping into savings.

Yet, one must ask: to what extent is the current crisis in Europe a harbinger of what will occur in the United States (2030, or 2040)?  We are incurring ever-greater debt (and I know this may not strike a chord with Sven, but it certainly does with me) and this is only the beginning given the problem of long-term unfunded liabilities. Our demographic profile, while not nearly as bad as Europe’s, is nonetheless going to place ever-greater stress on a smaller proportion of the population, mandating levels of taxation that will have negative implications for growth and social cohesion.

The end result may not take the form of crisis, but a painful state of sclerosis and a moribund economy.  O’Connor may have gotten the basic story right, but in the end, Mancur Olson may have been far better in teasing out the implications.

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I remember a few decades ago when figuring out how a given regulatory agency functioned (or failed to function) required endless hours in the library stacks, paging through poorly bound government documents. Life has become far simpler thanks to the combined efforts of regulators and youtube.

To celebrate Earth Day, the EPA stepped into the youtube age by inviting people to submit “a video clip up to 10 seconds long of someone doing something for the environment, then reading and passing along a sign that says ‘It’s My Environment.’” To assist in this contest, the EPA has provided pdf files of their sign in English, Spanish, French, Chinese (traditional and simplified), Portuguese, Quechua, Urdu, Russian, Albanian, Croatian, Slovenian, German, Vietnamese, Hindi, Japanese, Irish, and American Sign Language. Ultimately, selected clips will be combined to create a “human chain.” So if you’ve got something to say about the EPA and you can keep it to under 10 seconds, submit. The deadline has been extended until the end of December.

(NB. the EPA notes that videos cannot contain “direct attacks on individuals or organizations.”)

If ten seconds seems like too great a constraint, or you really feel like a challenge, the EPA has also introduced a video contest to “explain rulemaking.” According to the EPA, “the video contest is your opportunity to explain federal rulemaking and motivate others to participate in the rulemaking process.” Not only do you get 90 seconds—nine times longer than you would receive to explain why its “your” environment—you could win a cash prize ($2,500). The video must use the phrase “Let your voice be heard.”

(NB. The EPA once again notes that videos cannot include “attacks on individuals or organizations.”)

Having taught regulation to college students for over a decade, I can testify that anyone capable of explaining the rulemaking process in 90 seconds deserves a Nobel, not a mere $2,500.

The EPA is a little late in entering the world of video. USA.gov—“the official web portal of the U.S. federal government”—has already concluded its video contest sponsored by the General Services Administration, awarding a $2,500 prize. Contestants were asked to explain how USA.gov had made their lives easier. There were 30 entries between February 22 and April 2, when the contest formally closed. Let me repeat: 30 entries.

Promoting government through short videos is a compelling concept. I would love to propose new contests, each of which would require contestants to address the theme in question (NB. videos cannot contain “direct attacks on individuals or organizations”) expending no more than 90 seconds. Here are some ideas:

Explain the Social Security Trust Fund’s role in covering future liabilities.

Explain how specific features of the stimulus package made your life easier.

Explain how Freddie and Fannie helped us build an “ownership society.”

The Question: Does anyone have any ideas for additional contests? Undoubtedly, there are endless opportunities for explaining how [fill in government agency of your choice] has improved your life.

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The blog begins! There are many things that I find particularly infuriating but one of the greatest is the complete disregard for the long-term fiscal impacts of our policy decisions.  Assuming that there are only two kinds of taxes—those we pay now and those we impose on future generations—I find the growing deficit and debt to be a particular source of frustration. True, my grandchildren (as of yet, unborn and hopefully yet to be conceived) never did a single thing for me. But I still find the decision to shackle them with the costs of our spending decisions to be morally indefensible.

There will be time to explore these issues in greater detail.  I would like to kick things off with a few reflections on a related topic: the growth of government (or “fatboy,” my shorthand for what has become our government). There are different ways of documenting this growth and some are more revealing than others.  Most commonly, the size of the government is represented as a percentage of GDP.

Along this dimension, the size of the US government has expanded dramatically over the course of the past eight decades, The 1930s witnessed an expansion from 3.4 percent GDP to 10.3 percent. By 1950, federal outlays equaled 15.6 percent of GDP, a figure that would reach 17.8 percent in 1970 and  21.7 percent by 1980. Under the stewardship of Ronald Reagan and George H.W. Bush, this number peaked at 23.5 percent of GDP (1983) before beginning a long decline such that by 2000, federal outlays had fallen to 18.2 percent, the lowest levels since LBJ declared a war on poverty and escalated the war in Vietnam. The record of the past decade needs little description as the government’s share of GDP increased significantly and is slated to exceed 25 percent of GDP in 2010—a level second only to World War II mobilization.

Things are even more striking when we consider what I believe to be a far more revealing metric—inflation adjusted government spending per capita.  Consider the following: government outlays measured as a percentage of GDP may not be the best indicator of government growth. If the economy grows faster than the population, for example, the government’s take of GDP could remain stable while its actual spending per capita expands. Alternatively, if the GDP lags population growth, the government could spend less per person in real terms while consuming a stable percentage of GDP. The first scenario describes what has occurred in the US over the course of the postwar period.

To illustrate this point, consider the following: in 1960, federal outlays consumed 17.8 percent of the GDP. Expressed in 2005 dollars, this was a total of $2789 per capita. Since the government’s non-defense spending only accounted for 8.5 percent of GDP, the figure we are most interested in is a far more modest $1332 per person. By 1970, this figure would increase to $2332 per person and by 1980, it would reach $4208 per person (once again, these are 2005 dollars and we are only talking nondefense spending). Ronald Reagan was elected in 1980 explaining that government was the problem, not the solution.  Reflecting this change in orientation, by 1990 per capita nondefense spending had increased to $5364. This sum would expand again to $7235 by 2000 and today it stands at more than $10,800.  This figure would increase significantly if we included state and local spending.

To summarize things, in inflation adjusted dollars, federal nondefense outlays per person are more than 8 times greater today than they were in the last year of the Eisenhower presidency. Since the election of Reagan in 1980—the beginning of the so-called conservative revolution—spending has more than quadrupled.

Many libertarians are fixated on FDR (or “that man,” as one of my fellow bloggers, Grover Cleveland, often refers to him) and with good reason.  But compared to contemporary presidencies of both political stripes, FDR was a skinflint. In 2005 dollars, federal nondefense spending at the height of the domestic New Deal was less than $900—less than a tenth of what fatboy spends today.

In recent days, the Fed Chairman and the director of the Congressional Budget Office issued distressing warnings that our current levels of deficit spending are simply unsustainable. Those who are interested, should explore the presentations by David Walker, former Comptroller General and currently head of the Peter G. Peterson Foundation. The core message: we must make dramatic changes to our entitlement programs and/or equally dramatic increases in taxation if we don’t want to face a fiscal Armageddon that will in all likelihood mark the end of the American Republic as we have known it.

A significant part of reform will be reconsidering our expectations of public provision. As odd as it sounds, a return to New Deal or Great Society levels of spending might be necessary to secure long-term fiscal stability and protect those who have yet to be born from bearing the costs of our irresponsible demands for unlimited spending and low taxes.

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