Because of the inverse relationship between tax rates and the amount of economic activity staying above the “underground economy”, tax revenue fluctuations from tax rate changes are relatively mild. Even if these proposed tax cuts do become law the amount of revenue coming into the government’s tax coffers is not likely to change much over the long term.
How about the spending side of things? Part of the enthusiasm on Wall Street and some avenues of Main Street is the proposed “stimulus” plan of more than half a trillion dollars, including construction and “infrastructure” projects spread across this fair land. (Ironically, a lesser amount of stimulus was criticized by the Right as wasteful government spending when candidate Clinton proposed a smaller, though similar spending plan.)
Sound economics, even Keynesian economics, does not equal infinite over-spending
Deficit spending, where in a given year the government spends more than its tax revenues, has long been touted by many as an anecdote to sluggish demand in the private sector. John Maynard Keynes is perhaps the most well-known proponent of such ideas, and his ideas and principles have come to be called Keynesian. In modern times these ideas have been revered in academia and government. Indeed, over the past few decades, whenever there is even a hint of weakening economic growth, an immediate response is more government spending. This was of course seen in the 2008 financial meltdown when the ultimate response to weakening demand (caused mainly by excessive debt) was a massive “stimulus” plan, that plan being more borrowing, more spending and more debt.
Whether one still believes that replacing private demand with public demand is a suitable response to misallocations and excessive debt in an economy (the conditions a recession is trying to alieve), even Keynesian principles do not advocate continual stimulus, or government overspending. The idea was that, assuming a government’s debt was non-existent or modest, then for a period of time, such as a few months or years, government “stimulus”, essentially government over-spending, deficit spending, might be appropriate to “prime the pump” of economic activity. However, the important corollary to this concept was that once the economic downturn was over the government would reduce spending and allow its debts to fall to a sustainable level where it could potentially be called upon in a future economic downturn or financial emergency.
The problem in recent times is that government has been a believer in the first part of this Keynesian idea – the overspending, “stimulus” part – but not keen to follow through on the second part. This has been clear in this current economic cycle. The outgoing president has long been touting the economic successes and recovery of the country over the last 6 or 7 years. Perhaps he believes that the 2009 government spending plan (the American Recovery and Reinvestment Act of 2009), is the main reason why the economy has improved the way it has. If that is so, sound economics, including even Keynesian economics, dictates that the proper response to a period of government overspending is a period of government underspending. That is, once the crisis has passed, the government can step aside and let the private sector take over. As we’ll see, despite the recovery, while government deficits have declined somewhat, they are nowhere near zero. In fact, despite the lauded economic expansion, yearly government deficits in American have continued to grow faster than the rate of its nominal economic growth.
We see in the graph below how well the government did in following such a plan. While the yearly accumulations of debt did decline from the years of downturn, the growth of debt has still been massive, both during and after the financial crisis. During just three years – 2008 to 2010 – the federal government added nearly $5 trillion ($4.75 trillion) of debt onto its balance sheet. Once the crisis was passed, did the government then underspend by $5 trillion over the next several years? Hardly. Two more years of trillion dollar deficits ensued, and a total of nearly $6 trillion ($5.83 trillion) additional spending over the six years after the government itself declared the recession over.
By the way, the way the government reports its yearly deficits shows lower levels than are seen here. The government’s official deficits show trillion dollar deficits for four years – 2009 to 2012 – but declining to under $500 billion for two recent years (2014 and 2015). These lower government-published deficits reflect various accounting slight-of-hand tricks to minimize the level of reported expenses. One such trick involves keeping Social Security expenses “off balance sheet”, even though the yearly losses by that agency are added onto its accumulation of government debt. (And Social Security deficits will only increase in coming years, making these yearly additions to debt wider, though still hidden on official budget deficits.) But in the end, and aside from sugar-coating with government accounting gimmicks, this marker of financial health (as with any individual or business) is defined by the yearly accumulations of debt. And the reality is that even in the midst of this economic “recovery”, the smallest accumulation of debt in a single year was $780 billion, in 2015. The total debt growth over the nine years starting 2008 is a mind-boggling $10.58 trillion.
With all the talk of the newest and greatest stimulus program it is worth remembering that the government has already been engaged in a massive stimulus program for the past nine years, and for at least six years since the time that its official stimulus program of 2009 was completed. Yet still hopes remain that this next half-billion dollars of government overspending will make the difference, and set the country on the path to prosperity. The country may find prosperity again but it won’t be because of yet more government spending. Ten trillion dollars of overspending/deficit spending/stimulus in the U.S. has not, $6 trillion in Japan has not and trillions more in Europe have not set these economies on paths to prosperity.
Perhaps in an effort to offset some of his new spending plans, in recent days, the President-Elect has talked about plans to reduce government spending. While no specifics are given, plans are to reduce spending by “as much as” 10% in some departments. Even these limited potential reductions would only apply to “discretionary” spending, not non-discretionary programs. I appreciate any sort of plan or idea to try to minimize government spending, but we can quickly see that given the enormities of government debts and deficits, as well as the spending structure in Washington, such proposed cuts, even if enacted, would lead to almost no significant fiscal improvement.
Below is a graph showing U.S. federal government spending for 2015. The two largest sectors of government spending – Social Security and Medicare are “non-discretionary” or mandatory spending. That means they are not subject to any yearly budget or Congressional negotiation. They are simply not open to any discussion of cutbacks in any way. No reductions, no cutbacks.
Those two programs alone – Medicare and Social Security – account for 60% of federal spending. Then you have the sector of Interest on Debt. That’s another 6% of federal spending that is mandatory. Once the remaining few other non-discretionary programs are added, you only have about $1.1 trillion a year of government spending that is open to cutbacks or amendments. That’s less than 30% of total government spending.
Interestingly, the yearly addition to federal debt, composed of the yearly overspending by the government has averaged about the same amount as discretionary spending, about $1.1 trillion, over the past decade. That means that essentially “all” discretionary government sectors are currently funded via government borrowing. And they have been for a decade. That includes all spending on the departments of Education, Housing and Community, Energy & Environment, International Affairs, and Science. And amazingly, it even includes the military, which you might think would be the one program that was mandatory. Nearly all current discretionary spending is already deficit spending, stimulus spending. Cutting 10% in some discretionary federal programs will hardly be a drop in the bucket to achieve a balanced budget. With the government’s current fiscal situation, balancing the budget would require the elimination of the vast majority of discretionary federal spending, includes the military.
Is there any downside to deficit, aka “stimulus” spending?
So given an already overly-indebted government and one using government borrowing to pay for nearly all discretionary spending, where does the President-Elect plan to get the money for his new, additional “stimulus” projects? Well, he wants to borrow it, selling more government bonds. Hardly a novel approach, and the same one used for decades.
The question to be asked with any new government spending plan (though hardly ever is), is whether or not the result of the spending, will more than make up for the higher debt, the increased borrowing and interest cost, and opportunity costs. The question of opportunity cost is so critical, yet so often ignored. Even if the government believes (of course it has no way of knowing) that the proposed projects will more than cover the explicit costs of borrowing, interest costs and economic costs from higher taxes, opportunity costs considers whether the proposed projects are the best use of taxpayer or debt dollars.
Is this the best use of the taxes collected today, or in the case of borrowing, from taxes collected in the future? Would taxpayers, investors and entrepreneurs make more appropriate and knowledgeable decisions about how they want to spend, invest and grow their money than the government? Or we could look at it like this: was the $10 trillion in federal government overspending over the past 9 nears the best use of that money? Might all of that spending possibly have been better used in the hands of families and individuals, small businesses and entrepreneurs? What do we have to show for that $10 trillion of overspending besides an additional $10 trillion of debt and generations of interest payments upon it?
By the way, one should be skeptical when he or she hears a politician talking about “infrastructure spending”. That phrase has a rather distinct suggested meaning, namely long-term building that will bring a return on the taxpayer’s investment, in the form of more potential economic activity or efficiency. However, in recent years, “infrastructure” has become a broader term, which may or may not bring a long-term benefit to a community, a state or the country as a whole.
Further, we can agree that roads and bridges are infrastructure, but are statues, government buildings, museums, and government “research” projects? It should also be remembered that even true infrastructure spending – let’s say on a new road or bridge – is only economically productive if it brings an increase in economic opportunity. For example, this might be the case if a new road will reduce the congestion to a work park or allow for faster commutes and business expansion opportunities. But what about building statues? The finished product might be nice to look at and employ people to create it, but what about the resulting debt from that and the opportunity cost of that spending? Was that the best use of that money? Productive infrastructure is a means to an end, not the end itself.
Economically feasible infrastructure spending is spending where increased productivity will be the result. The building of the infrastructure is not supposed to be the stimulus. That is often lost when headlines and soundbites report that a given number of jobs will be “created”. Not from the increased productivity, but the infrastructure building itself. Think of the pyramids of Egypt. Lots of jobs were created. More recently, think of some of the economic “stimulus” plan in 2009 in which many “make-work” projects were just that – making work, without a real purpose or long-term improvement in productivity. Unless they produce some productive purpose, “infrastructure spending” may be just wasted spending.
It’s only an economically viable project if it will lead to more additional future economic growth that would exist otherwise. In other words, a trillion spending on projects is economic activity, but it’s not economically viable economic activity unless future economic growth will be more than the $1 trillion in spending plus the additional interest on that debt (or if no debt, the opportunity cost). So while spending money and labor on building pyramids is economic activity, it’s not a sustainable and economically viable economic activity. It is actually a destroyer of wealth for what it takes out of the economy in wasted labor, assets and more viable economic growth. When it comes to infrastructure or “stimulus” projects, the government needs to prove that those projects will result in not just economic activity, but after accounting for explicit and opportunity costs, but an addition of real wealth, not a destroyer of it.
According to government statistics, real economic growth in the U.S. has averaged about 1.5% over the past decade. To make the case for more massive infrastructure, and the debt that will result from it, you would need to show that poor infrastructure has been holding back U.S. growth. That if not for the poor roads and bridges, and whatever else in the spending plans, the U.S. would be substantially ahead economically, and would have sustained more additional economic growth than the cost of the additional hundreds of billions of dollars of infrastructure spending itself.
On the President-Elect’s website there is a 100-day action plan to “Make America Great Again.” And there are some ideas on there that if implemented, seem like they would lead to improvement in government, society and the economy. But to me, what is notably absent is any sort of plan for, at a minimum, a balanced federal budget, or better yet, a federal-debt reduction plan. He has talked a little in recent days about cutbacks but as I’ve tried to show, even if implemented, they will not be significant to overall government spending.
There is a government website http://www.mymoney.gov/Pages/default.aspx with tips there to help individuals and families save money, manage their spending and debt. And there are many useful ideas in there that I think probably help people. However, I do find incredible irony in an organization like the U.S. government advising people on how to manage their money. This website teaches the values of making a budget to families yet most years doesn’t even pass a budget itself, and for a decade has spent more than 25% more money than its tax revenues. It talks about managing debt carefully and paying down that debt when it has averaged yearly trillion dollar accumulations of debt for a decade. It tells you to pay more than the interest on your debt yet the government actually has to borrow just to pay the interest on its existing debt. It talks about saving and investing for the future, when the only “investing” it ever does involves more spending. It talks about protecting yourself for financial emergencies down the road when the government doesn’t even shore itself up financially during times of prosperity. In other words, they preach to individuals and families to be disciplined with their spending even though they are unwilling to do it themselves.