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Steve Forbes is 100 percent correct, as was Milton Friedman. Bloated and wasteful government spending is the problem, not inadequate revenue. Deficits are merely a symptom of over-spending:

The late Nobel Prize-winning economist Milton Friedman once famously observed that he would prefer a federal government budget of $1 trillion (this was when a trillion bucks was real money) with a big deficit to a federal budget of $2 trillion that was balanced. His obvious point was that the bigger Washington is, the more of a burden it puts on the economy, whether it finances its spending via taxation, borrowing or printing money. So it’s not President Obama’s mind-numbing, from-here-to-eternity deficits that we should be worrying about but the increasing deadweight put on the rest of us by Washington’s burgeoning budget bloat. Senate Republicans were right to put the kibosh on the formation of a formal bipartisan deficit-fighting commission. Those things always end up increasing taxes while doing little to reduce spending. …One of the biggest economic myths since the Great Depression is that governments can ameliorate or counteract the ebbs and flows of free markets. Government spending has never worked as a trigger for sustained and vibrant economic growth. Ever. Scholarship has demonstrated that the New Deal perpetuated the Depression rather than cured it. On the eve of the Depression the U.S. had the lowest unemployment rate among developed nations. But a decade later, despite six years of FDR’s New Deal, our unemployment rate was one of the highest among developed economies. Japan’s serial stimulus programs over the past two decades have repeatedly underscored this truth. The more the government takes as a proportion of the economy, the worse equity markets do and the higher the unemployment rate.

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I like that the video pointed out how tax-the-rich schemeswouldn’t work, though it would have been nice if they added some information on how genuine entitlement reform could solve the problem  (as you can see here and here, I’ve also nit-picked other debt-themed videos).

Which is why I humbly think this is the best video ever produced on the topic.

As you can see, I’m not an anti-debt fanatic. It was perfectly okay, for instance, to incur debt to win World War II.

But I’m very skeptical of running up the nation’s credit card for routine pork and fake stimulus.

But my main message, which I’ve shared over and over again, is that deficits and debt are merely a symptom. The underlying disease is excessive government spending.

And that spending hurts our economy whether it is financed by taxing or borrowing (or, heaven forbid, by printing money).

Now let’s look at some recent articles on the topic.

We’ll start with Eric Boehm’s column for Reason, which explains how red ink has exploded in recent years.

America’s national debt exceeded $10 trillion for the first time ever in October 2008. By mid-September 2017 the national debt had doubled to $20 trillion. …data released by the U.S. Treasury confirmed that the national debt reached a new milestone: $30 trillion.…Entitlements like Social Security and Medicare are in dire fiscal straits and will become even more costly as the average American gets older. Even without another unexpected crisis, deficits will exceed $1 trillion annually, which means the debt will continue growing, both in real terms and as a percentage of the economy. The Congressional Budget Office estimates that the federal government will add another $12.2 trillion to the debt by 2031.

As already stated, I think the real problem is the spending and the debt is the symptom.

But it is possible, of course, that debt rises so high that investors (the people who buy government bonds) begin to lose faith that they will get repaid.

At that point, governments have to pay higher interest rates to compensate for perceived risk of default, which exacerbates the fiscal burden.

And if there’s not a credible plan to fix the problem, a country can go into a downward spiral. In other words, a debt crisis.

This is what happened to Greece. And I think it’s just a matter of time before it happens to Italy.

Heck, many European nations are vulnerable to a debt crisis. As are many developing countries. And don’t forget Japan.

Could the United States also be hit by a debt crisis? Will we reach a “tipping point” that leads to the aforementioned loss of faith?

That’s one of the possibilities mentioned in the New York Timescolumn by Peter Coy.

It’s hard to know how much to worry about the federal debt of the United States. …Either the United States can continue to run big deficits and skate along with no harm done or it’s at risk of losing investors’ confidence and having to pay higher interest rates on its debt, which would suppress economic growth. …the huge increase in federal debt incurred during and after the past two recessions — those of 2007-09 and 2020 — has used upa lot of the “fiscal space” the United States once had. In other words, the federal government is closer to the tipping point where big increases in debt finally start to become a real problem. …any given amount of debt becomes easier to sustain as long as the growth rate of the economy (and thus the growth rate of tax revenue) is higher than the interest rate on the debt. In that scenario, interest payments gradually shrink relative to tax revenue. …but it doesn’t explain how much more the debt can grow. …Past a certain point, there’s a double whammy of more dollars of debt plus higher interest costs on each dollar. …sovereign debt crises tend to be self-fulfilling prophecies: Investors get nervous about a government’s ability to pay, so they demand higher interest rates, which raise borrowing costs and produce the bad outcome they feared. It’s a dynamic that Argentines are familiar with — and that Americans had better hope they never experience.

For what it’s worth, I think other major nations will suffer fiscal crisis before the problem becomes acute in the United States.

I really this will make me sound uncharacteristically optimistic, but I’m keeping my fingers crossed that this will finally lead politicians to adopt a spending cap so we don’t become Argentina.

P.S. The Wall Street Journal recently editorialized on the issue of government debt and made a very important point about the difference between the $30 trillion “gross debt” and the “debt held by the public,” which is about $6 trillion lower.

…the debt really isn’t $30 trillion. About $6 trillion of that is debt the government owes to itself in Social Security and other IOUs. …The debt held by the public is some $24 trillion, which is bad enough.

As I’ve noted when writing about Social Security, the IOUs in government trust funds are not real.

They’re just bookkeeping entries, as even Bill Clinton’s budget freely admitted.

Indeed, if you want to know whether some is both honest and knowledgeable about budget matters, ask them which measure of the national debt really matters.

As you can see from this exchange of tweets, competent and careful budget people (regardless of whether they favor big government or small government) focus on “debt held by the public,” which is the term for the money government actually borrows from credit markets.

If you want to know the difference between the various types of government debt – including “unfunded liabilities” – watch this video.

P.P.S. This column explains how and when debt matters. If you’re interested in how to reduce the debt, there’s very good evidence that spending restraint is the only effective approach. Even in cases where debt is enormous.

P.P.P.S. By contrast, the evidence is very clear that higher taxesactually make debt problems worse.

The premise of Starve the Beast is very simple.

Politicians like to spend money and they don’t particularly care whether that spending is financed by taxes or financed by borrowing (both bad options).

As Milton Friedman sagely observed, that means they will spend every penny they collect in taxes plus as much additional spending financed by borrowing that the political system will allow.

The IMF published a study on this issue about 10 years ago. The authors (Michael Kumhof, Douglas Laxton, and Daniel Leigh) assert that there’s no way of knowing whether Starve the Beast will lead to good or bad results.

…there is no consensus regarding the macroeconomic and welfare consequences of implementing a starve-the-beast approach, henceforth referred to as STB. …it could be beneficial in the ideal case in which it results in cuts in entirely wasteful government spending. In particular, lower spending frees up resources for private consumption, and the associated lower tax rates reduce distortions in the economy. On the other hand, …lower government spending may itself entail welfare losses…if it augments the productivity of private factors of production. …the paper examines whether the principal macroeconomic variables such as GDP and consumption, both in the United States and in the rest of the world, respond positively to this policy. …In addition, the paper assesses how the welfare effects depend on the degree to which government spending directly contributes to household welfare or to productivity.

The authors don’t really push any particular conclusion. Instead, they show various economic outcomes depending on with assumptions one adopts.

Since plenty of research shows that government spending is not a net plus for the economy (even IMF economists agree on that point), and because I think a less-punitive tax system is possible (and desirable) if there’s a smaller burden of government spending, I think the findings shown in Figure 4 make the most sense.

Now let’s shift from academic analysis to policy analysis.

In a piece for National Review back in July 2020, Jim Geraghty notes that Starve the Beast has an impact on government finances at the state level.

…we’re probably not going to see a massive expansion of government at the state level in the coming year or two. …Thanks to the pandemic lockdown bringing vast swaths of the economy to a halt, state tax revenues are plummeting.…So states will have much less tax revenue, constitutional balanced-budget requirements that are not easily repealed, and a limited amount of budgetary tricks to work around it. State governments could attempt to raise taxes, but that’s going to be unpopular and hurt state economies when they’re already struggling. Add it all up and it’s a tough set of circumstances for a dramatic expansion of government, no matter how ardently progressive the governor and state legislatures are.

For what it’s worth, Geraghty warned in the article that fiscal restraint by state governments wouldn’t happen if the federal government turned on the spending spigot.

And that, of course, is exactly what happened.

Now let’s look at the most unintentional endorsement of Stave the Beast.

A couple of years ago, Paul Krugman sort of admitted that cutting taxes was a potentially effective strategy for spending restraint.

…the same Republicans now wringing their hands over budget deficits…blew up that same deficit by enacting a huge tax cut for corporations and the wealthy. …this has been the G.O.P.’s budget strategy for decades. First, cut taxes. Then, bemoan the deficit created by those tax cuts and demand cuts in social spending.Lather, rinse, repeat. This strategy, known as “starve the beast,” has been around since the 1970s, when Republican economists like Alan Greenspan and Milton Friedman began declaring that the role of tax cuts in worsening budget deficits was a feature, not a bug. As Greenspan openly put it in 1978, the goal was to rein in spending with tax cuts that reduce revenue, then “trust that there is a political limit to deficit spending.” …voters should realize that the threat to programs… Social Security and Medicare as we know them will be very much in danger.

In other words, Krugman doesn’t like Starve the Beast because he fears it is effective (just like he also acknowledges the Laffer Curve, even though he’s opposed to tax cuts).

Let’s close by looking at some very powerful real-world evidence. Over the past 50 years, there’s been a massive increase in the tax burden in Western Europe.

Did all that additional tax revenue lead to lower deficits and less debt?

Nope, the opposite happened. European politicians spent every penny of the new tax revenue (much of it from value-added taxes). And then they added even more spending financed by additional borrowing.

To be fair, one could argue that this was an argument for the view of “Don’t Feed the Beast” rather than “Starve the Beast,” but it nonetheless shows that more money in the hands of politicians simply means more spending. And more red ink.

P.S. I had a discussion last year with Gene Tunny about the issue of “state capacity libertarianism.”

Friedman & Sowell: Should Our School System Be Privatized?

Related posts:

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MILTON FRIEDMAN ON SPENDING

Posted on October 3, 2020 by Dan Mitchell

I identified four heroes from the “Battle of Ideas” video I shared in late August – Friedrich Hayek, Milton Friedman, Ronald Reagan, and Margaret Thatcher. Here’s one of those heroes, Milton Friedman, explaining what’s needed to control big government.

Friedman Fundamentals: How To Control Big Government

Switzerland actually has a spending cap in its constitution, and similar fiscal rules also exist in Hong Kong and the state of Colorado.

These policies have produced very good results.

There are many reasons to support a spending cap, including the obvious observation that an expenditure limit (as it is sometimes called) directly addresses the actual problem of excessive government.

And addressing the underlying disease works better than rules that focus on symptoms, such as balanced budget requirements or anti-deficit mandates.

You’ll notice toward the end of the video that the narrator cites pro-spending cap research from international bureaucracies, which is remarkable since those institutions normally have a biasfor bigger government.

I’ve also written about that research, citing studies by the International Monetary Fund (here and here), the Organization for Economic Cooperation and Development (here and here) and the European Central Bank (here).

Today, let’s look at more evidence from these bureaucracies.

We’ll start with a new study from the European Central Bank. Here’s some of what the authors (Nicholai Benalal, Maximilian Freier, Wim Melyn, Stefan Van Parys, and Lukas Reiss) found when comparing spending limits and anti-deficit rules.

…this paper provides an in-depth assessment of two alternative measures of fiscal consolidation and expansion: the change in the structural balance (dSB) and the expenditure benchmark (EB). Both the dSB and the EB are currently used to assess compliance with the fiscal rules under the Stability and Growth Pact (SGP).…The EB was introduced as an indicator in 2011, and has gained in importance relative to the dSB since the European Commission began to put more emphasis on it in 2016. …A comparison of the fiscal performance of euro area countries reveals significant differences depending on whether the assessment is based on the dSB or the EB. …this paper finds that the EB has advantages over the dSB as a fiscal performance indicator. …expenditure rules…provide more predictability in fiscal requirements. …Even more importantly, the EB can be shown to be less procyclical as a fiscal rule than the dSB. 

Let’s also review some 2019 research from the International Monetary Fund.

This study (authored by Kodjovi Eklou and Marcelin Joanis) looks at whether fiscal rules can constrain vote-buying politicians.

In order to increase their chances of reelection, politicians are known to undertake fiscal manipulations, especially in election years. These fiscal manipulations typically take the form of increased public expenditure… Many countries, both developed and developing, have adopted fiscal rules in recent decades as an attempt to enforce fiscal discipline. …In this paper, we employ a cross-country panel dataset in order to test whether fiscal rules adopted in developing countries have been effective in constraining political budget cycles. The dataset covers 67 developing countries over the period 1985-2007. …Our dependent variable is the general government’s final consumption expenditure as a share of GDP.

Here’s what the authors concluded about the effectiveness of spending caps.

Our empirical evidence in a sample of 67 developing countries over the period 1985-2007, shows that fiscal rules cause fiscal discipline over the electoral cycle. More specifically, in election years with fiscal rules in place, public consumption is reduced by 1.65% point of GDP as compared to election years without these rules. Furthermore, the effectiveness of these rules depends on their type… In particular, expenditure rules, rules covering the general government and rules characterized by a monitoring body outside the government dampen political budget cycles in government consumption.

Indeed, footnote 12 of the paper specifically notes the superiority of expenditure limits.

…the results show that public consumption is reduced by 2.44% points during election years with expenditure rules in place. The findings on expenditure rules are consistent with Cordes et al. (2015) who show that the compliance rate for these rules are high.

Last but not least, the fiscal experts at the Office of Management and Budget included in Trump’s final budget some very encouraging language at the end of Chapter 10 of the Analytical Perspectives.

…additional efforts to control spending are needed. Several budget process reforms should be considered, including setting spending caps… Outlay caps that are consistent with the historical average as a share of gross domestic product (GDP),post-World War II levels could be enforced with sequestration across programs similar to other budget enforcement regimes. An outlay cap on mandatory spending would complement discretionary caps, which have been in place since 2013. The Budget proposes to continue discretionary caps through 2025 at declining levels and declining levels through 2030.

Trump was a big spender, of course, but at least there were people in his administration who realized there was a problem.

And they recognized the right solution.

P.S. It’s also interesting that the authors of the IMF study found that fiscal rules work better in democracies.

…estimates focusing on the subsample of democratic elections. The effect of fiscal rules on the political budget cycle is larger… More specifically, public consumption is reduced by 2.46% point of GDP (while it is 1.65% point in the baseline).

This may not bode well for the durability of Hong Kong’s spending cap.

The authors also found that foreign aid makes it less likely that a government will follow sensible policy.

Foreign aid, which relaxes the budget constraint of the government, is negatively correlated with the probability of having fiscal rules.

Needless to say, nobody should be surprised to learn that foreign aid undermines good policy.

The premise of Starve the Beast is very simple.

Politicians like to spend money and they don’t particularly care whether that spending is financed by taxes or financed by borrowing (both bad options).

As Milton Friedman sagely observed, that means they will spend every penny they collect in taxes plus as much additional spending financed by borrowing that the political system will allow.

The IMF published a study on this issue about 10 years ago. The authors (Michael Kumhof, Douglas Laxton, and Daniel Leigh) assert that there’s no way of knowing whether Starve the Beast will lead to good or bad results.

…there is no consensus regarding the macroeconomic and welfare consequences of implementing a starve-the-beast approach, henceforth referred to as STB. …it could be beneficial in the ideal case in which it results in cuts in entirely wasteful government spending. In particular, lower spending frees up resources for private consumption, and the associated lower tax rates reduce distortions in the economy. On the other hand, …lower government spending may itself entail welfare losses…if it augments the productivity of private factors of production. …the paper examines whether the principal macroeconomic variables such as GDP and consumption, both in the United States and in the rest of the world, respond positively to this policy. …In addition, the paper assesses how the welfare effects depend on the degree to which government spending directly contributes to household welfare or to productivity.

The authors don’t really push any particular conclusion. Instead, they show various economic outcomes depending on with assumptions one adopts.

Since plenty of research shows that government spending is not a net plus for the economy (even IMF economists agree on that point), and because I think a less-punitive tax system is possible (and desirable) if there’s a smaller burden of government spending, I think the findings shown in Figure 4 make the most sense.

Now let’s shift from academic analysis to policy analysis.

In a piece for National Review back in July 2020, Jim Geraghty notes that Starve the Beast has an impact on government finances at the state level.

…we’re probably not going to see a massive expansion of government at the state level in the coming year or two. …Thanks to the pandemic lockdown bringing vast swaths of the economy to a halt, state tax revenues are plummeting.…So states will have much less tax revenue, constitutional balanced-budget requirements that are not easily repealed, and a limited amount of budgetary tricks to work around it. State governments could attempt to raise taxes, but that’s going to be unpopular and hurt state economies when they’re already struggling. Add it all up and it’s a tough set of circumstances for a dramatic expansion of government, no matter how ardently progressive the governor and state legislatures are.

For what it’s worth, Geraghty warned in the article that fiscal restraint by state governments wouldn’t happen if the federal government turned on the spending spigot.

And that, of course, is exactly what happened.

Now let’s look at the most unintentional endorsement of Stave the Beast.

A couple of years ago, Paul Krugman sort of admitted that cutting taxes was a potentially effective strategy for spending restraint.

…the same Republicans now wringing their hands over budget deficits…blew up that same deficit by enacting a huge tax cut for corporations and the wealthy. …this has been the G.O.P.’s budget strategy for decades. First, cut taxes. Then, bemoan the deficit created by those tax cuts and demand cuts in social spending.Lather, rinse, repeat. This strategy, known as “starve the beast,” has been around since the 1970s, when Republican economists like Alan Greenspan and Milton Friedman began declaring that the role of tax cuts in worsening budget deficits was a feature, not a bug. As Greenspan openly put it in 1978, the goal was to rein in spending with tax cuts that reduce revenue, then “trust that there is a political limit to deficit spending.” …voters should realize that the threat to programs… Social Security and Medicare as we know them will be very much in danger.

In other words, Krugman doesn’t like Starve the Beast because he fears it is effective (just like he also acknowledges the Laffer Curve, even though he’s opposed to tax cuts).

Let’s close by looking at some very powerful real-world evidence. Over the past 50 years, there’s been a massive increase in the tax burden in Western Europe.

Did all that additional tax revenue lead to lower deficits and less debt?

Nope, the opposite happened. European politicians spent every penny of the new tax revenue (much of it from value-added taxes). And then they added even more spending financed by additional borrowing.

To be fair, one could argue that this was an argument for the view of “Don’t Feed the Beast” rather than “Starve the Beast,” but it nonetheless shows that more money in the hands of politicians simply means more spending. And more red ink.

P.S. I had a discussion last year with Gene Tunny about the issue of “state capacity libertarianism.”

Friedman & Sowell: Should Our School System Be Privatized?

Related posts:

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