Spending, Not Taxes, is the True Measure of the Burden of Government

Filed Under (U.S. Fiscal Policy) by Jeffrey Brown on May 25, 2010

USA Today released an article last week that made a big deal of the fact that average individual tax rates in the U.S. are now at their lowest level since 1950.  The spin of the article was essentially that Tea Party activists, tax cut advocates, and other proponents of small-government are misguided in their concerns about our current fiscal state.

This spin, however, ignores one of the most basic, essential important lessons of public economics (the sub-field of economics that studies the public sector).  This lesson is that spending, not taxes, are the true measure of the burden of government.  (I will ignore other problems with the analysis, such as the fact that from an efficiency perspective we care more about marginal than average tax rates.)

The reason that spending is key is really quite simple.  All government spending must be financed by taxes.  So it is somewhat meaningless to argue that small-government conservatives are misguided simply because average tax rates are low if that argument is coming at a time when spending is above recent historical trends.  High spending and low tax rates are a nasty combination, of course, because the result is a large government budget deficit that crowds out private investment, hinders economic growth, and passes the tax burden on to future generations.

In short, once we have chosen to allow the government to spend a dollar, that dollar must be financed through higher taxes, either on the current generation of taxpayers or on a future generation of taxpayers.

As I have written before, our federal budget is on a fiscal death march.  We face a fundamental choice between reining in spending or raising taxes (or both).  These are not pleasant options, but they are choices that ordinary American households and businesses have to make every single day.  If only our elected officials in both parties would provide some honest leadership on this issue.

On that note, if you would like to see the mix of changes that are required and figure out what you think would be the optimal mix of tax and spending changes required to balance the budget, take a look at the new federal budget calculator put out last week by the Committee for a Responsible Federal Budget. You will quickly see why the required changes are so politically difficult.

The Laws of Arithmetic and Illinois Pensions

Filed Under (Retirement Policy) by Jeffrey Brown on May 17, 2010

An article on Saturday in the Tribune pointed out the obvious – that there are no easy solutions to Illinois state budget woes.  Lawmakers are not even thinking about how to backfill the enormous pension funding gap that already exists.  Rather, they are spending all their energy trying to figure out how to deal with one piece of it – namely, the $4 billion or so that is due this year.

It reminds me, once again, of former Fed Chairman Greenspan’s remark about Social Security options, and how we only have three options – raise taxes, reduce benefits, or repeal the laws of arithmetic.

The same three options are the only ones on the table for Illinois.  Our ability to reduce benefits is limited.  And as many have pointed out in comments on my prior posts, one can hardly lay the blame for this problem at the feet of the pension participants who paid their share along the way.  That leaves tax increase or borrowing.  But I would hasten to add that borrowing is just a tax increase on future generations of taxpayers.  This being gubernatorial election year in Illinois, I suspect that lawmakers will once again kick this fiscal can down the road …

The Future of Fiscal Responsibility

Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Feb 23, 2010

On February 18, the President Obama signed an Executive Order establishing the “National Commission on Fiscal Responsibility and Reform.”  The Commission will consist of 18 members.  Of these, 6 will be appointed by President Obama (with no more than 4 of the 6 being Democrats).  The remaining 18 will be divided up “3 each” among Democratic and Republican House members and Democratic and Republican Senators. 

The stated mission of this Commission is to identify “policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run.”

The mission is a critical one.  As I have noted in other posts (see, for example, my post from 2/2/10 on the 2011 budget or my post on 1/14/10 about why deficits matter), the long-term fiscal outlook is dire.   While the short-term deficits are being driven by a combination of recession-induced revenue declines, aggressive spending policies targeted at averting an even worse credit crunch and/or recession (e.g., TARP, stimulus, etc), as well as high levels of spending on Iraq and Afghanistan, the most serious long-term fiscal problems arise as a result of the runaway growth of entitlement programs.  Social Security, Medicare, and Medicaid are growing faster than the economy as a result of an aging population, rising health care costs, and the important interaction of these two factors. 

Commissions have a long history in the U.S., some of them successful in terms of leading to real changes (e.g., the Greenspan Commission in 1983) and some of them not (e.g., the President’s Commission to Strengthen Social Security in 2001 on whose staff I served.)  One of the features of this new commission is that it will be dominated by sitting members of Congress.  IF (1) these members are ones with real power (e.g., chairs and ranking minority members of the key committees like Senate Finance and House Ways and Means) and IF (2) these members can somehow move beyond ideological bickering and election-year politics and come to some meaningful compromises, THEN such a Commission could have an extraordinarily meaningful and positive impact on our fiscal future.  If, however, they simply resort to their political safe zones – with Republicans calling for balancing budgets solely through spending cuts and Democrats calling for balancing budgets solely through tax increases – then I would not expect much to come out of it.   

The political outlook is not promising, however.  Recall that only a month or so ago – in January 2010 – the Senate failed to garner the 60 votes needed to pass the “Bipartisan Task Force for Responsible Fiscal Action Act of 2010.”  In a blog on this same subject (click here to see it), Stephen Huth notes that “even before members have been appointed, both liberals and conservatives are dooming the work …”

The economic consequences are real.  As the Financial Times reported in January, the credit rating agency Moody’s announced that the U.S. could be at risk of losing its tripple A credit rating in the future unless it took steps to reduce its long-term deficits.  While Treasury Secretary Geithner says the U.S. will “never lose” its top rating, the very fact that the Treasury Secretary has to engage in such a conversation is an indication of just how serious are the risks posed by long-term deficits.  As noted by CNBC, “even if a downgrade in US credit is not imminent, the underlying conditions that raised such fears are worrying investors about what the future holds.” And even if our credit rating is not at risk, the long-run tax burden required to finance projected levels of spending are so enormous that I am afraid we will risk something far more important – our potential for sustained economic growth.

In short, I am in the “glass half empty” camp when it comes to my political assessment of the Commission’s likely impact.  I hope they prove me wrong …