Category Archives: Big Government

Regulation, Crowding Out, and Malformed Capital

19 Saturday Oct 2019

Posted by in Big Government, Regulation

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Expanding regulation of the private sector is perhaps the most pernicious manifestation of “crowding out”, a euphemism for the displacement of private activity by government activity. The idea that government “crowds out” private action, or that government budget deficits “crowd out” private investment, has been debated for many years: government borrowing competes with private demand to fund investment projects, bidding interest rates and the cost of capital upward, thus reducing business investment, capital intensity, and the economy’s productive capacity. Taxes certainly discourage capital investment as well. That is the traditional fiscal analysis of the problem.

The more fundamental point is that as government competes for resources and absorbs more resources, whether financed by borrowing or taxation, fewer resources remain available for private activity, particularly if government is less price-sensitive than private-sector buyers.

Is It In the Data?

Is crowding out really an issue? Private net fixed investment spending, which represents the dollar value of additions to the physical stock of private capital (and excludes investments that merely replace worn out capital), has declined relative to GDP over many decades, as the first chart below shows. The second chart shows that meanwhile, the share of GDP dedicated to government spending (at all levels) has grown, but with less consistency: it backtracked in the 1990s, rebounded during the early years of the Bush Administration, and jumped significantly during the Great Recession before settling at roughly the highs of the 1980s and early 1990s. The short term fluctuations in both of these series can be described as cyclical, but there is certainly an inverse association in both the short-term fluctuations and the long-term trends in the two charts. That is suggestive but far from dispositive.

Timothy Taylor noted several years ago that the magnitude of crowding out from budget deficits could be substantial, based on a report from the Congressional Budget Office. That is consistent with many of the short-term and long-term co-movements in the charts above, but the explanation may be incomplete.

Regulatory Crowding Out

Regulatory dislocation is not the mechanism traditionally discussed in the context of crowding out, but it probably exacerbates the phenomenon and changes its complexion. To the extent that growth in government is associated with increased regulation, this form of crowding out discourages private capital formation for wholly different reasons than in the traditional analysis. It also encourages malformation — either non-productive or misallocated capital deployment.

I acknowledge that regulation may be necessary in some areas, and it is reasonable to assert that voters demand regulation of certain activities. However, the regulatory state has assumed such huge proportions that it often seems beyond the reach of higher authorities within the executive branch, not to mention other branches of government. Regulations typically grow well beyond their original legislative mandates, and challenges by parties to regulatory actions are handled in a separate judicial system by administrative law judges employed by the very regulatory agencies under challenge!

Measures of regulation and the regulatory burden have generally increased over the years with few interruptions. As a budgetary matter, regulation itself is costly. Robert Higgs says that not only has regulation been expanding for many years, the growth of government spending and regulation have frequently had common drivers, such as major wars, the Great Depression of the 1930s, and the financial crisis and Great Recession of the 2000s. In all of these cases, the size of government ratcheted upward in tandem with major new regulatory programs, but the regulatory programs never seem to ratchet downward.

While government competes with the private sector for financial capital, its regulatory actions reduce the expected rewards associated with private investment projects. In other words, intrusive regulation may reduce the private demand for financial capital. Assuming there is no change in the taxation of suppliers of financing, we have a “coincidence” between an increase in the demand for capital by government and a decrease in the demand for capital by business owing to regulatory intrusions. The impact on interest rates is ambiguous, but the long-run impact on the economy’s growth is negative, as in the traditional case. In addition, there may be a reallocation of the capital remaining available from more regulated to less regulated firms.

The Costs of Regulation

Regulation imposes all sorts of compliance costs on consumers and businesses, infringing on many erstwhile private areas of decision-making. The Mercatus Center, a think tank on regulatory matters based at George Mason University, issued a 2016 report on “The Cumulative Cost of Regulations“, by Bentley Coffey, Patrick A. McLaughlin, and Pietro Peretto. It concluded in part:

“… the effect of government intervention on economic growth is not simply the sum of static costs associated with individual interventions. Instead, the deterrent effect that intervention can have on knowledge growth and accumulation can induce considerable deceleration to an economy’s growth rate. Our results suggest that regulation has been a considerable drag on economic growth in the United States, on the order of 0.8 percentage points per year. Our counterfactual simulation predicts that the economy would have been about 25 percent larger than it was in 2012 if regulations had been frozen at levels observed in 1980. The difference between observed and counterfactually simulated GDP in 2012 is about $4 trillion, or $13,000 per capita.”

In another Mercatus Center post, Tyler Richards discusses the link between declining “business dynamism” and growth in regulation and lobbying activity. Richards measures dynamism by the rate of entry into industries with relatively high profit potential. This is consistent with the notion that regulation diminishes the rewards and demand for private capital, thus crowding out productive investment.

Regulation, Rent Seeking, and Misallocation

Some forms of regulation entail mandates or incentives for more private investment in specific forms of physical capital. Of course, that’s no consolation if those investments happen to be less productive than projects that would have been chosen freely in the pursuit of profit. This often characterizes mandates for alternative energy sources, for example, and mandated investments in worker safety that deliver negligible reductions in workplace injuries. Some forms of regulation attempt to assure a particular rate of return to the regulated firm, but this may encourage non-productive investment by incenting managers to “gold plate” facilities to capture additional cash flows.

Regulations may, of course, benefit the regulated in certain ways, such as burdening weaker competitors. If this makes the economy less competitive by driving weak firms out of existence, surviving firms may have less incentive to invest in their physical capital. But far worse is the incentive created by the regulatory state to invest in political and administrative influence. That’s the thrust of an essay by Wayne Brough in Real Clear Markets: “Political Entrepreneurs Are Crowding Out the Entrepreneurs“. The possibility of garnering regulations favorable to a firm reinforces  the destructive focus on zero-sum outcomes, as I’ve gone to pains to point out on this blog.

Crowding out takes still other forms: the growth of the welfare state and regulatory burdens tend to displace private institutions traditionally seeking to improve the lives of the poor and disenfranchised. It also disrupts incentives to work and to seek help through those private aid organizations. That is a subject addressed by James Whitford in “Crowding Out Compassion“.

Just Stop It!

President Trump has made some progress in slowing the regulatory trend. One example of the Administration’s efforts is the two-year-old Trump executive order demanding that two regulatory rules be eliminated for each new rule. Thus far, many of the discarded regulations had become obsolete for one reason or another, so this is a clean-up long overdue. Other inventive efforts at reform include moving certain agency offices out of the Washington DC area to locales more central to their “constituencies”, which inevitably would mean attrition from the ranks of agency employees and with any luck, less rule-making. The judicial branch may also play a role in defanging the bureaucracy, like this case involving the Consumer Financial Protection Bureau now before the Supreme Court. Unfortunately, tariffs represent taxation of consumers and firms who use foreign goods as inputs, so Trump’s actions on the regulatory front aren’t all positive.

Conclusion

The traditional macroeconomic view of crowding out involves competition for funds between government and private borrowers, higher borrowing costs, and reduced private investment in productive capital. The phenomenon can be couched more broadly in terms of competition for a wide variety of goods and services, including labor, leaving less available for private production and consumption. The growth of the regulatory state provides another piece of the crowding-out puzzle. Regulation imposes significant costs on private parties, including small businesses that can ill-afford compliance. The web of rules and reporting requirements can destroy the return on private capital investment. To the extent that regulation reduces the demand for financing, interest rates might not come under much upward pressure, as the traditional view would hold. But either way, it’s bad news, especially when the regulatory state seems increasingly unaccountable to the normal checks and balances enshrined in our Constitution.

Who Are the Zero-Sum Winners?

09 Monday Sep 2019

Posted by in Big Government, rent seeking

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Productive effort seldom goes unrewarded, but all too often rewards are directed to nonproductive activities and secured in ways that are outright takings of resources and rights from others. These are zero-sum propositions at best, as the rewards come only at equivalent or greater costs to others. Gains from zero-sum activities are often purely consumptive in nature and tend to foster more destructive behavior. A clear-cut example is outright thievery, but there are many cases in which, by matters of degree, the perpetrators are not even dimly aware that their gains bring harm to others.

Sadly, our society has undergone a transition to a state in which everyone collects ongoing streams of zero-sum rewards, which are, by definition, at someone else’s (and often our own) expense. The turbulence caused by this unnecessary and avoidable mix of costs and rewards is all too real for consumers and businesses, but again, they don’t always fully grasp its dysfunctional nature.

The Way To Positive Sums

Of course, there are winners and losers in almost any area of economic life. Even when two individuals engage in mutually beneficial exchange, an otherwise win-win situation, other traders might regret missing out on the deal. Pleasing buyers more effectively than one’s competitors might force those rivals to turn to other pursuits. That’s all for the best from a social point of view, unless they can come up with an even better idea to win back customers. In this way, things can keep getting better and better for everyone, even for the one-time losers who are free to compete in trades to which they are better suited. Winners, then, are defined by their success in creating value for others. These are the productive winners. But again, material success doesn’t always come so honorably.

Bobbing For Booty?

Purely “consumptive” or zero-sum winners might be simple crooks who are able to avoid apprehension, or perhaps they are dishonest business-people who sell goods with hidden defects or inferior workmanship. There are many degrees here: a talented salesperson with shoddy merchandise might compromise on price. A clever product manager might reduce the size of a package slightly without reducing price.

A simple gamble is zero-sum in a purely monetary sense, but both gamblers do it for enjoyment, so there are psychic gains involved. A successful gambler might be a zero-sum winner in a monetary sense, but luck usually runs out on honest players. A cheater qualifies as a zero-sum winner. Conversely, it’s not correct to say that casinos are strictly zero-sum winners, though the odds are always stacked in favor of the house and everyone knows it. Casino patrons enjoy the experience, including other amusements available in casinos, so they are often happy customers despite their losses. They are engaging in mutually beneficial exchange.

Private Affairs Made Public

A short-hand description encompassing much of our zero-sum havoc is “the public trough”. Many zero-sum rewards have arisen out of legislative battles, court cases, and regulatory actions restricting private decision-making and encroaching on private property rights. The unremitting tendency is for expansion of these kinds of actions. Where there are zero-sum winners at the public trough, or an opportunity to expand the trough itself, there are always more covetous seekers of zero-sum winnings, otherwise known as rent seekers. They are reliable promoters of “do-something-ism” relative to the outrage du jour through more legislation, lawsuits, and regulatory filings. The tragic thing about rent seeking is that the process itself consumes resources and undermines private incentives, thereby transforming zero-sum outcomes into wasteful, negative-sum outcomes.

Winners At the Trough

There are many kinds of zero-sum winners at the public trough. The winning and losing often occur separately and asynchronously, connected only by an enabling authority who sets rules and funds winners from proceeds taken from losers. For this reason, it is easy for citizens to lose track of the “zero-sumness” of the many benefits they receive. After all, the government can deliver things for “free”, right? And the connection between one’s obligations, losses, and the gains reaped by others is not always obvious.

All of the following involve some degree of zero-sum activity, and all attract rent seekers:

  • Public aid in exchange for no contribution to output, funded by zero-sum losing taxpayers.
  • Subsidies for politically-favored technologies that are otherwise uneconomic, funded by zero-sum losing taxpayers.
  • Farm subsidies when too much is produced and the output is not highly valued, leading to an overallocation of resources to agricultural activity and rents for farmers funded by zero-sum losing taxpayers.
  • Complex regulatory and tax rules generate income for compliance advisors such as attorneys, accountants, and consultants. Those are rents, pure and simple, paid for by parties who must comply under penalty of law.
  • Regulatory advantage conferred upon firms sufficiently large or dominant to afford compliance. That penalizes smaller competitors and undermines their market position. The additional profit large firms may earn as a consequence is a rent, funded by zero-sum losing consumers and weaker competitors.
  • The award of government contracts is often as much political as it is economic. Such a process is not subject to the market discipline imposed on private contracts, so there is ample opportunity for rents via cost-padding and graft, again funded by zero-sum losing taxpayers.
  • More generally, government purchases of any kind are subject to weak market discipline, like any buyer spending someone else’s money. Thus, government has a tendency to pay prices not supported by economic value, offering rents to suppliers, funded by zero-sum losing taxpayers.
  • The tax deduction afforded to employer-provided health care is a targeted subsidy that leads employees to over-insure. More fundamentally, these employees and their employers are zero-sum winners. It also creates profits for health insurers and drives up health care costs. The zero-sum spoils are to the detriment of other taxpayers and participants in the individual insurance market.
  • Drug prohibition drives up black market profits, creating zero-sum winnings at the expense and safety of users.
  • Social Security creates zero-sum winnings for those who will not or cannot save. But this is a mixed bag to the extent that some people are unable to save privately: their ability to do so is largely usurped via payroll taxes, both on them and on their employer. The many zero-sum losers would otherwise have no difficulty earning better returns on private investments.

There are many other examples. And almost everyone ends up on one side or the other of many different zero-sum outcomes. Show me a government action and I’ll show you zero-sum winners and losers. This is not to say there are no welfare gains associated with government action. Public aid, for example, is intended as social insurance and surely has some value in mitigating the risks of personal economic calamity. Nonetheless, the overextension and poor incentives of aid programs create a significant zero-sum component. Likewise, government spending on public goods creates social benefits, but government is insufficiently incented to economize, creating a zero-sum win for contractors and losses for taxpayers.

Not Zero Sum

While zero-sum winners collect economic rents, the existence of economic rents does not imply a zero-sum winning. For example, members of the so-called rentier class collect passive investment income. Those investments represent a supply of current resources to other parties hoping to transform them into a greater supply of future resources. That’s productive, and so the gains enjoyed by rentiers are not zero-sum winnings, but payments for the use of transformational capital.

Economic profits are those exceeding the owner’s opportunity cost, and they too are called rents. They should not necessarily be classified as zero-sum gains, however. Only sometimes. Successful innovators and first movers often earn economic profits as a reward for their efforts, as do alert entrepreneurs deploying their resources where they are most demanded. This “positive-sumness” applies to monopolists with a hot product just as surely as it applies to a firm facing nascent competition. But economic profits gained through political connections, outright graft, and government-enabled monopoly are zero-sum, enabled by non-market, authoritarian forces. Members of the political class tend to share in these zero-sum gains, and there are many losers.

Zero-Sum Psyche

Unfortunately, zero-sum thinking is deeply ingrained in the human psyche, despite our transition to a higher plane of social cooperation via markets. Even in those markets, certain outcomes might seem zero-sum in the moment. Witness the widespread denigration of the profit motive, which produces efficient outcomes in the long-run. As noted above, over time, the biggest winners tend to be those capable of creating the most value.

If you ask school children today how to get rich, many will say “win the lottery” without hesitation. I know, I know, government-sponsored lotteries are a relatively new phenomenon, and some of the lottery proceeds may benefit schools or other public programs, but the idea that a game of chance is so indelibly ingrained in the minds of children is a manifestation of the psychology of zero-sum success.

The Tangled Mess

So we have the zero-sum winners: successful gamblers, thieves, and rent seekers. The latter root deeply for gains made possible by government intervention in private affairs, actions that always leave room for enduring rents. They always lobby fiercely for new public interventions that might confer private advantages. And then we have the hapless public, stumbling through a series of zero-sum gains and losses made possible by the Leviathan they know and obey. They should look in the mirror, because every law and every program they have allowed their political leaders to hatch, reliably sold as good and just, creates more zero-sum activity to the detriment of long-term economic welfare. Roll it back!

The Special Olympics and Tax-Funded Philanthropy

30 Saturday Mar 2019

Posted by in Big Government, Education, Federal Budget

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The federal government’s contribution to funding the Special Olympics (SO) illustrates the widespread view of government as a limitless font of subsidies for appealing causes. People were up in arms over the elimination of $17.6 million dollars in federal grants for the SO in President Trump’s budget proposal. Granted, that’s a pittance as budget items go. Later, Trump promised to restore the funding. That is, of course, in addition to the millions in federal tax subsidies already granted on private gifts to the SO.  As Nick Gillespie explains, SO funding is like so many other things people want from government that government has no business doing. Why, exactly, should the federal government, or any level of government, fund the SO? It is a wonderful program, but it simply does not have the character of a public good, nor is it a safety net issue.

The SO certainly benefits the athletes and families that take part, but those benefits are strictly private. Perhaps the larger population of disabled individuals takes inspiration from watching the SO, along with good-hearted people everywhere. Most everyone is happy to know that the SO happen, but those are no more public benefits than the good vibes you get from viewing an inspirational film or theatrical production. For that matter, sports fans and patriots are inspired by great efforts on the part of the U.S. Olympic team, but the federal government does not fund the U.S. Olympic Committee. It’s therefore absurd to assert that the public bears an obligation to pay for the most athletic of disabled individuals to have opportunities to compete and win medals just like Olympic athletes.

Gillespie explains a little about the history and funding of the SO:

“Founded in 1968 by Eunice Kennedy Shriver, the Special Olympics is a 501(c)3 nonprofit, meaning that deductions to it are tax deductible. According to its 2017 financials (the most-recent available on the web), the organization had total revenues of about $149 million, including $15.5 million in federal grants. It’s not a stretch to assume that if federal funding disappears, the resulting outcry would lead to record donations.”

And again, let’s not forget that corporate gifts to the SO are tax deductible up to certain limits. Gillespie also quotes Secretary of Education Betsy DeVos:

“There are dozens of worthy nonprofits that support students and adults with disabilities that don’t get a dime of federal grant money. But given our current budget realities, the federal government cannot fund every worthy program, particularly ones that enjoy robust support from private donations.”

Families with disabled children have extraordinary needs. It’s probably better to think of federal support for those needs as a safety net issue, a form of social insurance. There are several federal programs that provide funds to support low-income families with disabled kids. And while the cut to SO funding was in the budget originally submitted by Secretary DeVos, Gillespie notes that the DOE’s budget “allocates over $32 billion for ‘high-need students,’ which includes intellectually disabled students.” 

DeVos was widely criticized for her budget, but as Gillespie says, she sets a fine example for anyone in a position to help rein in the growth of federal spending and ultimately the federal budget deficit. Given the DOE’s track record of poor programmatic guidance (Common Core), counter-productive school disciplinary mandates, and it’s complete lack of impact on educational outcomes after 40 years of existence and many billions of dollars spent, the continued existence of the DOE is difficult to rationalize.

Once a program appears in the federal budget, no matter how inappropriate as a public priority, and no matter how ineffective, its constituency will always defend its funding with rabid enthusiasm. That defense is multiplied by a chorus of statists in the media and elsewhere who, in their benevolent intentions for the taxes paid by others, can be counted upon to call out the “cruelty” of any proposed cuts, or even mere cuts in a program’s projected growth. The Special Olympics episode, and the DOE, are cases in point.

Closing “Nonessential” Government

19 Saturday Jan 2019

Posted by in Big Government, Regulation, Uncategorized

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Contrary to the cartoon above, it’s not back up and running, though tax withholding and the impacts of regulatory rules continue unabated, and almost assuredly surveillance as well. After all (!), the federal government shutdown affects only “nonessential” activities of the federal government. Federal workers who are furloughed will receive back pay when the partial shutdown ends, but for now, federal spending is down roughly 25%.

The very real inconveniences for furloughed workers are regrettable. TSA employees continue to work while their paychecks are deferred indefinitely, though rates of absenteeism are high. So, we have slowdowns in security lines at airports, a lack of services at national parks (at least those not managed by private firms collecting revenue from visitors on-site), and a variety of other disruptions. For the time being, however, the lives of most Americans are largely unaffected. Except for the news coverage, my life hasn’t changed in any way, though I haven’t traveled during the shutdown.

Unfounded rumors about the shutdown have been rampant. For instance, I’ve heard that Social Security checks and weather forecasts would be suspended. Nancy Pelosi said the Secret Service would be unable to protect the President at the State of the Union address in the House chamber, a statement which the Department of Homeland Security promptly refuted. Many of the federal agencies with the highest shares of furloughed employees are regulators whose services are arguably counter-productive.

The White House Council of Economic Advisors (CEA) estimates that each additional week of the shutdown will reduce first quarter GDP growth by 0.13%. That means the interruption would take about 0.5% off first quarter growth if it lasts through January (say, from an annual rate of 2.5% to 2.0%). To the extent that people view the shutdown as temporary, and most do, the so-called “multiplier effects” of the shutdown should be relatively minor.

GDP is intended to measure of the value of the economy’s physical output. It is calculated in two independent ways based on 1) all income earned, and 2) the total of all spending on final (not intermediate) goods and services. Most components of final spending are well defined by the values assigned to goods and services traded in markets. Likewise, most incomes are based on the value assigned by labor markets to a given productive effort. Government “output”, however, is rather suspect as a component of spending because it is generally not subject to a market test of value. On the income side of the ledger, do government workers produce actual outputs? Some do, of course, but those outputs cannot be measured except by assigning a value based on what the workers are paid, and the payer is spending other peoples’ money! It’s not too speculative to suggest that the government’s output is a fraction of its spending. If that’s the case, the actual reduction in output caused by the shutdown is much smaller than the measured reduction in GDP. Therefore, the CEA’s estimates are a fiction.

To put an even finer point on it, many nonessential functions absorb resources while contributing very little to the nation’s wealth. Adam Brandon and John Tamny assert that private economic growth gives us the luxury of a large government sector, not the other way around. Government absorbs resources when it spends, but only by virtue of the taxes it imposes on private activity that is otherwise more highly productive. In the long run, as Brandon and Tamny argue, a smaller government (given a permanent shutdown of certain functions) might well yield greater economic output, not less.

Read this interesting essay for a discussion of the wasted, even counterproductive, utilization of human resources in government:

“They do nothing that warrants punishment and nothing of external value. That is their workday: errands for the sake of errands — administering, refining, following and collaborating on process. ‘Process is your friend’ is what delusional civil servants tell themselves. Even senior officials must gain approval from every rank across their department, other agencies and work units for basic administrative chores.

Process is what we serve, process keeps us safe, process is our core value. It takes a lot of people to maintain the process. Process provides jobs. In fact, there are process experts and certified process managers who protect the process. Then there are the 5 percent with moxie (career managers).

Again, many and perhaps most Americans view the shutdown itself with a certain degree of cynicism. In “America’s shutdown indifference“, Matthew Walther recalls this entertaining aspect of the last shutdown under President Obama:

“…of barriers being erected around various D.C.-area landmarks, including open-air war memorials. To this day I cannot think of any good reason for this save sheer caprice. If the idea was that 550-foot obelisks made of granite simply could not be meaningfully serviced during those lean two weeks in 2013, then who was responsible for putting up the rent-a-fence barricades around them? Civic-minded volunteers? The U.S. Marine Corps? Barack Obama himself? It was beautifully cynical, and I congratulate whoever came up with it.”

Both sides of the aisle play politics at the expense of the federal workforce. I certainly don’t wish to denigrate all federal workers. They perform varied functions and many are hard-working individuals. But still, it’s hard to feel very sorry for them given that they out-earn their private sector counterparts at almost every education level. Again, here’s Walther:

“Government employees, at both the state and federal level, are among the only workers in the United States who continue to be represented by powerful unions, despite the fact that by definition they’re not bargaining against capital but against their fellow citizens.”

I haven’t even mentioned the debate over open borders and the proposed wall, but that’s not my purpose here. All parties to that debate seem to think the shutdown is unlikely to harm their side politically. That’s either because the shutdown isn’t perceived as very impactful, or the “other” side can be blamed. One theory making the rounds is that the shutdown is part of a larger plan to institute permanent Reductions in Force (RIFs) at federal agencies, which are permissible after a furlough of 30 days or more (by January 19th). The argument plausibly suggests that some federal agencies might operate more effectively once the bureaucracy is pruned back via furloughs and/or RIFs. That’s especially true if “deep-state” sabotage of efforts to roll-back regulations are as common as the author asserts. Is the shutdown therefore a trap for unsuspecting congressional Democrats? Who knows, but to my way of thinking, government RIFs might even be worth the trouble of building a wall!

Government Output: Illusions and Handicaps

09 Sunday Sep 2018

Posted by in Big Government

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Building a big government is thought to be a luxury that prosperous nations can afford, but such efforts have a systematically negative effect on their ability to generate income, much as eating the seed corn delivers a farmer to poverty. Daniel J. Mitchell puts it bluntly in a piece entitled “Rich Nations That Enact Big Government Don’t Remain Rich“. This is nowhere more obvious than in Argentina and Venezuela, two nations that were prosperous 50 years ago and are now economically feeble, or in Venezuela’s case, imploding. Government, in the final analysis, extracts resources from the private economy, often contributing negatively to productivity. Yet the idea that government is a tonic for economic growth persists, and it persists even in the face of weakness induced by excessive government.

Government statistics on Gross Domestic Product (GDP) exaggerate the contribution of government to income in at least a couple of ways. To understand why, it’s necessary to distinguish between spending aggregates and income aggregates, which add up to the same total GDP. The former  include consumption, investment, and government spending. Income aggregates are the other side of the GDP “coin”: payments made to factors of production, which represent GDP as a measure of output value.

A dissociation between these alternative views of GDP with respect to government’s contribution is that government payments count as spending and income regardless of the recipient’s contribution to output. Even if nothing is accomplished, nothing is produced, it is measured as income and spending and it is an increment to GDP. Payments to dig holes and refill them contribute to GDP as long as the government does the “job”. By contrast, if a worker in the private sector is paid but produces nothing of value, the firm’s owners suffer a loss of income corresponding to the worker’s pay, and GDP is unchanged! So increased factor payments by government cause an implicit bias in the measurement of output.

A second government bias implicit in GDP statistics is that public spending and government labor payments are often not subjected to a “market test” of value. The activity is “mandated”, so there is no correspondence to a willingness to pay or real value. Public employee unions exaggerate these distortions. There are generally no competitors for government provision of services, few incentives for efficiency, and often little discipline in government procurement processes. So the pricing of government transactions tends to be inflated. And yet when the government gets ripped off by overcharges or cronyist kickbacks, the excess payments contribute positively to GDP. In contrast, when a private firm gets ripped off, its income is correspondingly reduced and the transaction generally will not contribute to GDP.

It takes taxes to fund government, either immediate or deferred, and the taxes are either explicit or implicit in the form of eroded purchasing power. This creates negative incentives that retard private investment incentives, work incentives, and thereby private economic growth. Redistributional efforts retard work incentives as well because welfare–state beneficiaries often face high marginal tax rates on earned income.

Does big government represent a good investment for the wealth of a prosperous nation? In view of the above, one can hardly trust official statistics in rendering a judgement on that question. But despite these distortions, big government and measured economic growth are still negatively correlated. Mitchell provides more detailed analysis of government and economic growth at Heritage, including a set of references to academic papers on the topic.

One important way that government may contribute to economic growth is through the provision of physical infrastructure, which theoretically improves efficiency in private production. However, public infrastructure spending is subject to the same upward cost pressures discussed above, it is often tied to bumbling industrial policy efforts, its utilization by the public is usually mis-priced, and governments are congenitally inept at operating facilities efficiently. It is not clear that private developers could be counted upon to fill the void without some form of partnership with government, however, which has its own pitfalls. There are certainly reforms that could make private and public infrastructure investment and operation more viable, such as eliminating regulatory roadblocks to the installation of new facilities.

Another area in which government may generate a positive economic return is public investment in education, but that return is far from guaranteed. The success of public education investment depends on a wide range of cultural, political, and economic factors. For example, Cuba has the third largest proportion of government education spending to GDP, but the country’s ability to profit from that investment is severely crimped by its totalitarian economic and political system. I have been a frequent critic of public education in general, and I am not persuaded that education is truly a public good, despite some degree of spillover benefit. And while education may be a worthwhile national priority in many circumstances, it is not clear that government should necessarily fund education, let alone “run” education. Public education spending certainly doesn’t automatically translate to effective education outcomes, and it does not guarantee economic growth.

There is great exaggeration regarding the success of certain nations that have allowed government to absorb a large share of resources. That includes many of the European states, for which average incomes are roughly comparable to the Mississippi Delta. Only Luxembourg, Norway and Switzerland have income levels that are respectable relative to the U.S., and Norway relies heavily on oil extraction. Attributing economic power to government in the Nordic countries is especially misleading because the strength of those economies has always stemmed from their fundamentally capitalist underpinnings. Sweden built its wealth on capitalism, but it has cannibalized that strength over several decades with a burgeoning welfare state and high taxes. It only recently has begun attempting to reverse course.

Economic progress is unlikely to be achieved by “investing” in a larger public sector. Instead, encouraging private activity via positive incentives and minimal regulatory interference is a better route to success. The measured economic benefits of government spending are illusory to a significant degree. Even those activities thought to be the most productive avenues for government involvement, like investment in infrastructure and education, are plagued by cost inflation and incompetent execution. Finally, cross-country empirical evidence confirms that a more dominant public sector is associated with lower income growth. And yet there will always be a faction subscribing to the infantile, “free-lunch” belief that big government can deliver growth, and deliver it in excess of the predictable damage it inflicts on the private economy.

New Socialists Fail Socialism 101

02 Sunday Sep 2018

Posted by in Big Government, Socialism

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Not many self-styled socialists can actually provide a proper definition of socialism these days. That includes the celebrated Alexandria Ocasio-Cortez, the New York congressional candidate who has proven herself to be an incredible stumble-bum in numerous media appearances since her primary victory over incumbent democrat Joe Crowley. Maine Wire‘s Matthew Gagnon calls her “belligerently ignorant” as she tweets what she believes to be examples of democratic socialism. Gagnon dissects some of her flakey assertions. The sad truth is that Ocasio-Cortez is fairly typical of her generation, despite her dual college majors in economics and political science.

Gagnon notes that socialism is public ownership of the means of production. But socialism is somehow regarded as a “soft” version of communism: less authoritarian, perhaps. That premise deserves closer examination. There is only one way that the public sector can take possession of private property: by force. A new, authoritarian regime might simply commandeer property, nationalize it, and revoke prior ownership claims at the point of a gun or a club. The government would ultimately impose new rules under which management of formerly private enterprises must operate, and it would engage in centralized decision-making and planning to a large extent. This is essentially communism. Some personal freedoms might be preserved, but they are likely to be severely curtailed; dissidence is not likely to be tolerated.

There is another mechanism by which society can declare public ownership of productive resources that is nominally less authoritarian: democracy. Citizens or their elected representatives simply vote for the state to acquire particular resources and enterprises, in whole or in part. Enabling legislation might authorize administrative agencies to determine how the former private owners of these enterprises are to be compensated. To one extent or another, this involves takings of private property and rights, and it boils down to a very real tyranny of the majority: we will vote to take possession of your business; we will vote to create a bureau that will determine its worth and your compensation; we will vote that henceforth you may not operate this business on your own behalf, but only in the service of the people; and we will vote on what rights you possess. This is the ugly tyranny of democratic socialism, and it still requires force.

Self-proclaimed socialists are fond of proclaiming that we already have socialism in many sectors of the economy. They cite public parks, roads, bridges, K-12 education, and other goods and services sometimes provided by the public sector. There is a key distinction, however, that separates many of these examples from actual socialism: whether a good is actually a “public good”, meaning that its benefits are non-exclusive, as opposed to a private good that yields exclusive benefits. A more precise definition of socialism, in my view, is public ownership of the means of producing private goods.

The typical example of a public good is national defense: the benefits I receive do not reduce the benefits you receive, so those benefits are non-exclusive. I have little personal incentive to pay for national defense if anyone else is willing to pay for it, as I’ll receive the benefits anyway. But who will pay if everyone tries to free-ride on others? That’s why the provision of public goods is an appropriate function of government, and it is not generally what is meant by socialism. Gagnon is correct that government involvement in an activity is not the same as socialism, and he correctly ridicules some examples of governmental activities (and non-governmental activities like cooperatives) that Ocasio-Cortez believes to be socialism.

In contrast to public goods, private goods are exclusive in their benefits. The development of a private market can be counted upon to fulfill demands for such goods because private individuals are willing to pay. However, when government grants itself an advantaged position as a provider in such a market, such as a monopoly franchise, we can safely describe it as socialism. Many goods are not purely private, having some degree of non-exclusivity in their benefits. This is commonly asserted to be the case for K-12 education, but the matter is not as clear-cut as the public education establishment would have you believe. The bulk of the benefits to education accrue privately. Therefore, it is fair to describe public K-12 education in the U.S. as socialism. And it is largely a disaster.

Is a social safety net rightly described as socialism? Gagnon thinks not and, strictly speaking, the welfare state does not require public ownership of the means of production, only a means of redistribution. It requires funding, so private resources will be extracted via taxes, and the same is true of public goods. Taxes do not make it “socialism”. Let’s stipulate for the moment that there is a true safety net supporting only those unable to support themselves, either on a temporary or a permanent basis. This may yield non-exclusive benefits to the extent that such a “lifeline” reduces crime, begging, and our personal discomfort with the possibility that other individuals might starve. However, on an ex ante basis, some of these benefits represent a form of risk reduction that, in principle, could be arranged privately. To the extent that we vote to provide these potentially private benefits, those parts of the safety net can be construed as democratic socialism. In practice, our “safety net” covers a large number of able-bodied individuals. Unfortunately, it does a poor job of encouraging self-sufficiency. Like most public benefit programs, it is expansive, poorly designed, and has pernicious effects on the private economy that act to the long-term detriment of its intended beneficiaries.

Leftists fancy that socialism is “compassionate” and righteous, despite its predictably harsh outcomes. The misleading conceit that universal alms-giving by the state is always empowering to individual recipients, and potential voters, is an extremely corrosive element of democratic socialism. William Voegeli, Senior Editor of The Claremont Review of Books, writing in Imprimis makes “The Case Against Liberal Compassion“. (I dislike his misuse of the word “liberal” — too many conservatives are willing to cede that label to the Left.) Voegeli notes the “never enough” mentality of welfare statists, who refuse to acknowledge that the expansive growth of the welfare state over the past five decades has failed to reduce rates of poverty. The programs are rife with fraud, waste and bad incentives. If leftists are truly compassionate, Voegeli insists, they ought to take more interest in fixing problems that leave less for the truly needy and create dependencies rather than simply increasing the flow of funding.

Many well-meaning individuals are careless about affiliating with socialist causes because they do not understand what it actually means, and they often lack any historical and theoretical perspective on the implications of socialism. The flirtation is dangerous, and we can only attempt to educate and reason with them. Some will grow into greater wisdom. Some, like Bernie Sanders, will never come around. While we educate, let’s keep their hands away from the reins of power.

Multipliers Are For Politicians

02 Wednesday May 2018

Posted by in Big Government, Fiscal policy, Stimulus

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Here’s a major macroeconomic sacred cow among professional economists and the politicians whose fiscal profligacy they enable: the presumed salutary effect of an increase in government spending on economic activity, including its so-called “multiplier effect”. Government fiscal stimulus is prescribed by the Keynesian school of economics to remedy any decline in the total demand for goods. A classic case is “underconsumption”, or excess saving, such that labor and capital resources are in excess supply. The idea is that government will mop-up some of this excess saving by borrowing and spending the proceeds on goods and services, putting resources back to work. In the standard telling, digging holes and refilling them is as effective as anything else. The increased income earned by those resources will be re-spent, creating income for the recipients and leading to repeated rounds of re-spending, each successively smaller due to “leakage” into saving. Adding up all these rounds of extra spending yields a multiple of the original government stimulus, hence the Keynesian multiplier effect. The stimulation of the demand for goods and services pushes the economy back in the direction of full employment, thus correcting the original problem of underconsumption. Nice story.

Keynesian economics is a short-run, demand-based framework that delineates behavior by the constructs of national income accounting, segmenting demand into consumer spending, investment in productive capital, government spending, and net foreign spending (net exports). Except for the limit imposed by full employment, the supply side of the economy and the processes giving rise to growth in productive capacity are ignored.

Within the Keynesian framework, can offer many qualifications to the story of a shortfall in demand to which even a dyed-in-the-wool Keynesian would agree. First, government stimulus cannot have an effect on the real economy at a time when the economy is operating at full capacity, or full employment. The increased government spending will only lead to bidding against other uses of the same resources, increasing the level of wages and prices.

Another qualification within the Keynesian framework is that the leakage from spending at each round of re-spending is made greater by taxes on marginal income, thus reducing the magnitude of the multiplier. In addition, some of the extra income will be spent on foreign goods — another leakage that reduces the multiplier effect on the domestic economy. In fact, this is why multipliers for spending at local levels are thought to be relatively small. The more local the analysis, the more income will be re-spent outside the locality at each round. More fundamentally, private parties should know that increased government borrowing must be repaid eventually. At some level, they know that additional taxes (or an inflation tax) will be necessary to do so. Therefore, their reaction to the additional income derived from government demand will be muted by the need to save for those future liabilities. Put differently, consumers do not view the gain as an increase in their permanent income. That’s essentially the mechanism underlying the “Ricardian equivalence” between methods of funding government spending (government debt or taxes).

In the “real world” there are many other practical problems that lead to ineffectual and even counter-productive government stimulus. One is the problem of cost control endemic to the public sector. Related to this are seemingly unavoidable timing issues. These factors have a strong tendency to make counter-cyclical fiscal programs too costly and too late. There is also the tendency toward graft and cronyism wherever the government spreads its largess. The “perfectibility of man” is certainly not evident in the execution of government stimulus programs. Their economic impacts often become pro-cyclical, or even worse, they become permanent increases in spending authority. More on the latter below.

Deeper objections to the Keynesian framework have to do with its demand-side orientation and the conceit that government, solely by borrowing and spending, can contribute to “real demand” and add to a nation’s output. And even if government spending takes up slack at a time of unemployed resources or excess supplies, it is unlikely to resolve the conditions that led to the decline in private demand. Therefore, even if government stimulus is successful in spurring a temporary increase in actual production and utilization of resources, it is likely to delay or prevent the downward wage and price adjustments necessary to permanently do so.

Recessions are typically characterized by an effort to work off over-investment in various sectors: housing, commercial structures, oil and gas extraction and processing, technology assets, inventories, or factories. Over-inflation of asset values is usually at the root of malinvestment, often accompanied by overinflation of wages and prices. These dislocations do not occur evenly, but the market process acts to correct misallocations and mispricing precisely where they occur. It might take time, but if government steps in to prop-up weak sectors, forgive the economic consequences of mistakes, and place more upward pressure on wages and prices, the dislocations will persist. So again, even if stimulus and the multiplier effect offer a short-term palliative, the benefits are illusory in a real sense. The long-run consequences of failing to allow markets to repair the damage will be negative.

One of the greatest skills that economists should possess is the ability to discern the most plausible counterfactual in a given situation: the world as it would have played out in the absence of a particular event, often a policy initiative. This is a great shortcoming among those who subscribe to the efficacy of government stimulus programs. In the scenario just described, there will be a decline in capital investment, consumption, and saving, but that saving, whatever its level, will still be channeled into capital investments unless the funds sit idle in bank vaults. If the saving is instead absorbed by the government’s effort to fund a stimulus program, even that reduced level of investment will not take place. The net effect is zero! Thus, the Keynesian stimulus and multiplier effect represent a failure of the economics profession to “see the unseen”, as Frederic Bastiat would have put it. Unless government can produce something of value to generate income, perhaps something that improves private returns, it will not contribute to income growth.

Permanent displacement of private capital investment is the most fundamental detriment of government fiscal activism. That it might well supplant private production should come as no surprise. Matthew D. Mitchell and Jakina R. Debnam describe the phenomenon this way:

“The tendency for ostensibly temporary spending to become permanent spending helps explain why policy makers fail to take the Keynesians’ advice when it comes to surpluses. Though governments invariable go into deficit during recessionary periods, they rarely run surpluses during expansionary periods.”

Mitchell and Debnam provide an interesting quote:

“… Richard Wagner and Nobel Laureate James Buchanan concluded: ‘Keynesian economics has turned the politicians loose; it has destroyed the effective constraint on politicians’ ordinary appetites. Armed with the Keynesian message, politicians can spend and spend without the apparent necessity to tax.'”

In a footnote, Mitchell and Debnam note that Milton Friedman once said, “Nothing is so permanent as a temporary government program.” The Keynesian prescription for stimulus allows politicians to assert that they are empowered to rescue the unemployed or those suffering a loss of income. They want you to believe that they can do something. The multiplier gives license to still greater mischief on the part of politicians, because it can help politicians sell almost any pork-barrel project. But continuing government expansion requires that it extract resources from the private economy. That’s true whether the government spends directly on goods or redistributes, and the mechanics of these processes involve additional resource costs. As long as government can borrow private savings, politicians will disguise the true cost of their munificence to constituents. Economists should not be their enablers.

The Bad News Industrial Complex

20 Friday Apr 2018

Posted by in Big Government, Corruption, Risk Management

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Matt Ridley had an interesting piece on his blog last month entitled “Bad News Is Sudden, Good News Is Gradual“. It’s about the timing of news, as stated, and it’s about our bias toward bad news more generally. There is no question that bad news tends to be more dramatic than good news. But with steadily increasingly lifespans, growing prosperity, and world poverty at an all-time low, surely good news must come as much or more frequently than bad. But good news can be inconvenient to certain narratives. It is therefore often ignored, and some other purported disaster is found as a substitute:

“Poverty and hunger are the business Oxfam is in, but has it shouted the global poverty statistics from the rooftops? Hardly. It has switched its focus to inequality. When The Lancet published a study in 2010 showing global maternal mortality falling, advocates for women’s health tried to pressure it into delaying publication ‘fearing that good news would detract from the urgency of their cause’, The New York Times reported. The announcement by Nasa in 2016 that plant life is covering more and more of the planet as a result of carbon dioxide emissions was handled like radioactivity by most environmental reporters.“

Tales of bad outcomes can be alluring, especially if they haven’t happened yet. In fact, bad things might even happen gradually, but dark visions of a world beyond the horizon impart a spooky sense of immediacy, and indeed, urgency. Ridley notes the tendency of people to regard pessimists as “wise”, while optimists are viewed as Pollyannas. And he recognizes that risk aversion plays an important role in this psychology. That brings me to the point I found most interesting in Ridley’s piece: the many vested interests in disasters, and disasters foretold.

Risk management is big business in an affluent society. There is a lot to lose, and a squeamish populace is easily cowed by good scare stories. The risk management and disaster-prevention narrative can be wrapped around any number of unlikely or exaggerated threats, serving the interests of the administrative state and private rent-seekers. One particular tool that has been most useful to this alliance is the precautionary principle. It is invoked to discourage or regulate activities presumed to pose risks to the public or to the environment. But there are three dimensions to the application of the precautionary principle: it provides a rationale for public funding of research into the risk-du-jour, for funding projects designed to mitigate its consequences, and for subsidizing development of alternative technologies that might help avoid or reduce the severity of the risk, often at great expense. The exaggeration of risk serves to legitimize these high costs. Of course, the entire enterprise would be impossible without the machinery of the state, in all its venality. Where money flows, graft is sure to follow.

Well-publicized disaster scenarios are helpful to statists in other ways. Risk, its causes, and its consequences are not distributed evenly across regions and populations. A risk thought to be anthropomorphic in nature implies that wealthier and more productive communities and nations must shoulder the bulk of the global costs of mitigation. Thus, the risk-management ethic requires redistribution. Furthermore, wealthier regions are better situated to insulate themselves locally against many risks. Impoverished areas, on the other hand, must be assisted. Finally, an incredible irony of our preoccupation with disaster scenarios is the simultaneous effort to subsidize those deemed most vulnerable even while executing other policies that harm them.

Media organizations and their newspeople obviously benefit greatly from the subtle sensationalism of creeping disaster. As Ridley noted, the gradualism of progress is no match for a scare story on the nightly news. There is real money at stake here, but the media is driven not only by economic incentives. In fact, the dominant leftist ideology in media organizations means that they are more than happy to spread alarm as part of a crusade for state solutions to presumed risks. There are even well-meaning users of social media who jump at the chance to signal their virtue by reposting memes and reports that are couched not merely in terms of risks, but as dire future realities.

Mitigating social risks is a legitimate function of government. Unfortunately, identifying and exaggerating risks, and suppressing contradictory evidence, is in the personal interest of politicians, bureaucrats, crony capitalists, and many members of the media. Everything seems to demand government intervention. Carbon concentration, global warming and sea level changes are glaring examples of exaggerated risks. As Ridley says,

“The supreme case of unfalsifiable pessimism is climate change. It has the advantage of decades of doom until the jury returns. People who think the science suggests it will not be as bad as all that, or that humanity is likely to mitigate or adapt to it in time, get less airtime and a lot more criticism than people who go beyond the science to exaggerate the potential risks. That lukewarmers have been proved right so far cuts no ice.”

Other examples include the “beepocalypse“, genetic modification, drug use, school shootings, and certain risks to national security. Ridley offers the consequences of Brexit as well. There, I’ve listed enough sacred cows to irritate just about everyone.

In many cases, the real crises have more to do with government activism than the original issue with which they were meant to reckon. Which brings me to a discomfiting vision of my own: having allowed the administrative state to metastasize across almost every social organ and every aspect of our lives, a huge risk to our future well-being is continuing erosion of personal and economic liberties and our ability to prosper as a society. Here’s Ridley’s close:

“Activists sometimes justify the focus on the worst-case scenario as a means of raising consciousness. But while the public may be susceptible to bad news they are not stupid, and boys who cry ‘wolf!’ are eventually ignored. As the journalist John Horgan recently argued in Scientific American: ‘These days, despair is a bigger problem than optimism.'”

Federal Unaccountability Beyond My Wildest Dreams

06 Friday Apr 2018

Posted by in Big Government, Federal Budget

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In December, Laurence Kotlikoff wrote in Forbes about large chunks of federal spending over many years that have not been reconciled with known accounting transactions. (The link is to a cached version of Kotlikoff’s article because Forbes blocks its site to those using adblockers). I first learned of these massive discrepancies at The Solari Report, which covered the issue in February. At first, I was so dumbfounded by the numbers that I thought it might have been a joke, or worse: fake news on Solari? But the story is real and it is shocking: $21 TRILLION of spending that cannot be explained, spanning the years 1998-2015! That’s more than five times the level of federal spending in 2017. It’s also shocking that the gap has gone almost unnoticed by the news media, though a few specifics have garnered attention at different stages of the disgorgement, as demonstrated by the various links provided in the Solari article.

The discrepancies are concentrated mainly in two departments of the federal government: Defense (DOD) and Housing and Urban Development (HUD). Kotlikoff quotes a description of the “accounting adjustments” from the Comptroller General of the General Accounting Office (GAO). These adjustments are akin to the entries people make in their checkbook registers when the balance can’t be reconciled to their bank statement:

“‘Journal vouchers are summary-level accounting adjustments made when balances between systems cannot be reconciled. Often these journal vouchers are unsupported, meaning they lack supporting documentation to justify the adjustment or are not tied to specific accounting transactions…. For an auditor, journal vouchers are a red flag for transactions not being captured, reported, or summarized correctly.'”

The article at Solari makes the following observations:

“There appear to be at least five possibilities: 1-The missing money was spent appropriately, but existing accounting infrastructure is incapable of tracking it. 2-The money was “wasted,” i.e. spent unwisely. 3-The money was directed into black projects and Special Access Programs in massive amounts outside the Constitutional appropriations process, and therefore without the knowledge of Congress and the citizenry, for purposes unknown. 4-The money was used to manipulate markets to maintain the reserve status of the dollar. 5-The money is being stolen by fraud and collusion between government and private interests. Or perhaps a combination of all of these.“

All five explanations represent a form of failure of governance or government administration. Some are more nefarious than others. While #1 might seem fairly innocuous, it nevertheless would demonstrate a slovenly approach to record-keeping and accountability as well as a ripe temptation to anyone seeking opportunities for graft. Furthermore, one cannot trust that #1 is the full explanation. The amounts are so massive that they far exceed the waste in government that even I thought possible. And no one in the federal agencies seems to have an explanation. Mark Skidmore, a Michigan State University economist who has studied the issue and made inquiries with these agencies, describes what sounds like a runaround. In December, however, the DOD announced a positive step: it’s first-ever department-wide independent audit. The Office of the Inspector General (OIG), the Congressional Budget Office, and the General Accounting Office are certainly aware of the discrepancies. Links to supporting documentation at the OIG and DOD web sites appear in both the Solari and Kotlikoff articles.

If these funds have been wasted or misused, taxpayers are the victims, of course. There are a few well-known examples of private and even public companies that have victimized investors to perhaps a similar (proportionate) extent over the years. Bernie Madoff and Exxon come to mind. But in general, public companies cannot escape demands that their books be in order and that they produce value over time. The federal government, however, has received a pass for this fecklessness over many years. Perhaps it’s because the public has such low expectations for the government’s effective use of tax dollars. Federal agencies such as HUD and DOD seem almost as budgetary “black holes” into which tax dollars are sucked, with an apparent lack of scrutiny.

Kotlikoff closes by urging a thorough investigation into the government’s cockeyed accounts:

“Taken together these reports point to a failure to comply with basic Constitutional and legislative requirements for spending and disclosure. We urge the House and Senate Budget Committee to initiate immediate investigations of unaccounted federal expenditures as well as the source of their payment.”

The Solari piece is no less emphatic in demanding a full probe of the causes of the budgetary discrepancies:

“We must recognize the possibility that massive fraud is being perpetrated against the American people. If that is not the case, it would take relatively little effort and expense to put that concern to rest. On the other hand, what malfeasance might investigation reveal, and who might be responsible?

At the very least, we should be asking the secretaries of DOD, HUD, and the Treasury, the chairman of the Federal Reserve, and the President of the NY Fed what they know, and we need independent audits of all those entities plus the Exchange Stabilization Fund. Anything less will be to acquiesce in an ongoing financial coup d’état.“

Deficits Are a Symptom of Statist Excess

12 Monday Feb 2018

Posted by in Big Government, Taxes

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One thing’s clear with respect to President Trump’s budget proposal and the ongoing debate over appropriations: federal spending will increase and add to future budget deficits. This follows the Tax Cuts and Jobs Act (TCJA) enacted late last year, which many expect to add upwards of $1 trillion to deficits over the next 10 years. I have offered mixed praise of some of the reforms and rate cuts in the TCJA, though it does not accomplish much in the way of tax simplification and it will almost certainly require a large increase in federal borrowing. Ultimately, however, dollar for dollar, a tax cut giving rise to a deficit inflicts lower (or even negative) costs on the private sector than an unfunded spending binge, which is costly in the most basic terms: resources devoured by government.

Cost of Spending

The cost of an extra dollar of government spending at the most basic level is the value of lost opportunities to which the resources absorbed by government otherwise could have been put. When the government spends an extra dollar, and if the government pays a competitive market price, the goods and services exchanged for that dollar by private party “A” would be valued at more than one dollar by other private parties who lost the opportunity to trade with “A” for those same goods and services.

There might be a strong case for incremental spending in any particular instance, of course. Can we benefit from more national defense? Infrastructure? Grants of foreign aid? Subsidies for this industry or that? This technology or that? This cultural program or that? Public aid? Primary research? Regulatory budgets? I’d favor very few of those as general spending priorities. However, there are many subcategories and so many special interests that it is difficult to control spending as long as compromise is needed to accomplish anything.

The Trump budget is a mix of cuts in non-defense spending and large increases in defense, infrastructure outlays, and border security. On balance, it would lead to substantially higher budget deficits over the next ten years. He won’t get all of what he wants, but it would be astonishing if larger deficits are not an outcome.

Unfortunately, government is typically inefficient in the execution of its tasks and it is less responsive to price incentives than private buyers, who are fully vested in “ownership” of the dollars they spend. Government agents, no matter how honorable, simply do not have the same kind of stake in the outcome as a private owner. Obviously, spending by federal agencies is influenced by the political process, which creates opportunities for side rewards for those who direct or influence spending and those who receive the payments. These side rewards are pure private rents arising from public largess. For a private party, the profitability of transacting with government may well exceed the normal return to capital or entrepreneurship. The efficiency of government spending is compromised by its political nature and the uneconomic behavior of government agents. I therefore have strong doubts about the cost-benefit comparison of almost any public initiative.

Un-Taxing

The government ultimately acquires its funds from taxes enforced via coercive power. After all, tax collection requires a considerable enforcement effort. A tax payment of one dollar requires the sacrifice of things that would have been acquired, now or in the future, in voluntary, private transactions valued more highly than one dollar by the taxpayer. That is the nature of gains from voluntary trade foregone. The result is that one dollar of taxation extracts more than one dollar of value from the private sector. Conversely, a reduced tax liability of one dollar means that private parties can engage in an extra dollar of voluntary trade and benefit from the surplus.

There are few forms of taxes that don’t distort incentives in the private market. Taxes may blunt incentives for work, saving, and deployment of capital in productive uses. To the extent that these private decisions are twisted by taxes in ways that differ from fully voluntary decisions, there is a further loss of value and resource waste. Eliminating these distortions is always a worthy goal.

Funding Deficits

Government has ways other than immediate taxation of paying for excess spending. One is to borrow from the public, domestic or foreign. Those who purchase the government’s debt, loaning their money to the government, do so voluntarily. That debt carries an interest obligation by the government, and it must repay the principle some day. That will require new taxes and their attendant distortions, even more borrowing, and/or some other method of extracting value from the private sector. A principle known as Ricardian equivalence holds that the effects of government outlays are the same whether financed by taxes or borrowing, because taxpayers know that future taxes will be owed to pay off government debt, and so they discount that liability into their behavioral calculus.

Additional borrowing can create an unstable financial environment if borrowing occurs at interest rates higher than the economy’s rate of growth. Borrowing might also “crowd out” private borrowers, absorbing saving that would otherwise be used to finance investment in the economy’s productive capacity. In other words, the resources acquired with that extra dollar of government spending will lead to less private investment and a sacrifice of future production.

Sneaky Inflation Tax

Another way that government can pay for spending is by imposing an inflation tax. This amounts to a devaluation of privately-held assets accomplished by inducing unexpected inflation. It allows government debt to be extinguished in the future with dollars having reduced purchasing power. Essentially, more currency (or its electronic equivalent) is placed into circulation: money printing, if you like. That sets up the “too-much-money-chasing-too-few-goods” inflation cycle. But like any other tax, the inflation tax is involuntary and creates waste by inducing the public to respond to distorted incentives.

Summary

An additional dollar of government spending absorbs a dollar of resources, and destroys more value than that given lost surplus to those who would otherwise have benefited from those resources. Moreover, the spending often fails to return a full dollar in benefits, often lining the pockets of elite grifters in the process. Ultimately, the funding for incremental spending must be commandeered from private parties via taxes or an inflationary taking of assets. Public borrowing might conceal the reality of taxes for a time, but it may crowd out productive investment that would otherwise enhance economic growth. So a case against incrementally larger government can be made in terms of resource costs as well as the distortionary effects of taxes and dissipation of future private growth.

By the same token, an ostensible reduction in taxes might be illusory, to the extent that future taxes or an inflationary taking will be necessary to cover the debt one day. On the other hand, there is no direct resource cost involved, and a tax reduction unbinds constraints and distortions on private incentives, which is unambiguously beneficial. And that’s true as long as the tax reductions aren’t targeted to benefit particular sectors, parties or technologies in any new misadventures in government central planning.

Deficits, in and of themselves, are either irrelevant or possibly damaging to long-term economic growth. You’ll get them with either tax cuts or spending hikes. But spending hikes absorb real resources, whereas tax cuts release resources by transforming a dead weight loss in private markets into proper gains from trade. If deficits are a problem, and if eliminating them requires costly tax distortions, then the real problem is the expanse of the state.