How did we get to the point where it is automatically assumed that any increase in taxes will slow the economy, but that there is no limit to the amount of spending cuts you can make without harm to the economy? There is there is absolutely not justification for that in macroeconomic theory.
Both spending cuts and tax increases are a form of fiscal contraction and should serve to slow the economy. As a general rule, a spending cut of $X should end up slowing the economy by more than an increase in taxes of $X. That is because all spending is, well, spent. At least some of a tax cut will be saved.
That any tax increase will kill jobs is simply asserted over and over again, often without any logical justification. Please explain to me how ending the carried-interest exclusion — which allows hedge-fund managers to pay just 15% of their income in taxes — is going to kill jobs? What jobs? Please identify them. How many more maids and lawn service people can they possibly lay off on the margin?
That is not to say that all tax increases, and all spending have equal impacts on the economy. There are lots of tax increases that could be more damaging than some spending cuts. Yes, there are areas of “waste fraud and abuse” in government, as there are in any large organization. If you have ever worked in a large private sector company, you can probably attest to a fair amount of waste and inefficiency there as well.
There are programs that don’t work, and there are cases where several programs overlap and try to do essentially the same thing, and which could be better run if they were combined. Often the reason for this is nothing more than bureaucratic turf battles. Such battles need to be resolved and redundant programs need to be consolidated.
There are cases where government spending is actually counter productive to economic activity; paying farmers not to grow crops is a classic example. However, those are rare.
Breaking Down Government Spending
Some Government spending goes for direct purchases of goods. The Federal Government is the largest spender on Information Technology in the world. When it buys a PC it is revenue for Hewlett Packard (HPQ) or Dell (DELL) just as if that PC were bought by a private firm or an individual. It is revenue to Intel (INTC) and Microsoft (MSFT) just as if it was a private sector sale.
If the government builds a bridge or a water system, those materials are made by and generally installed by private sector enterprises. Entire industries, most notably Aerospace, would not exist (or would be vastly smaller) if it were not for government spending. Does General Dynamics (GD) add nothing to the economy? Don’t their employees have homes? Don’t they go shop at Wal-Mart (WMT) just like everyone else?
Granted, military spending is the least effective sort of direct government spending in boosting the economy. We have greatly stimulated the economy of Afghanistan with our military spending, but not our own. Build a bomb and blow it up is the equivalent of dig a hole and then fill it up. Economic stimulus is not the prime reason for buying Aircraft Carriers and the Aircraft that go on them, or at least shouldn’t be.
Entitlements
Another big part of the Government is transfer payments or entitlements. Social Security is the biggest of these. It is mostly just a forced savings plan to make sure that everyone has at least something to fall back on in retirement.
What is the difference between cutting the benefits of a Social Security recipient by $1000 a year and raising their taxes by $1000 per year? The answer: nothing. They still have $1000 less to spend, and the government would have $1000 more. Yet one is called “spending” and the other is called “taxes.”
Medicare is the next biggest of the entitlement programs. It was enacted because private insurers don’t want to insure old people, who have a nasty habit of getting sick. The administrative cost of Medicare is far lower than that of private insurance, and while the cost of Medicare has risen over time, it has done so at a far slower pace than have private insurance premiums.
The problem is not with Medicare per se, it is with the absurdly expensive and inefficient U.S. Health Care system. Unless we want to drop the idea that old people should have access to Health Care, we need to keep Medicare.
Instead of raising the age for Medicare eligibility to 67 as President Obama offered to do, if we really wanted to control health care costs and help the economy, we should lower the eligibility age to birth. Yes, taxes would be higher, but you wouldn’t have to pay any health insurance premiums.
Which would you rather pay: $1,500 in taxes, or $1000 in taxes and $1,000 in Health Insurance premiums? The Ryan Plan, passed by the House, would simply shift the cost of health insurance onto the individual and off the government. The total cost of getting health insurance for seniors would go up significantly, and in the process seniors would once again be far more likely to die in poverty, just as they were before Medicare was passed.
Health Care Reform, Such As It Is
While the ACA (aka "Obamacare") was sort of a Rube Goldberg approach, but it does have provisions that will expand coverage and lower costs over time. The CBO scores the savings in the trillions over the next 20 years.
If we cut spending by getting rid of the ACA, then there will be 34 million more Americans who don’t have health insurance. Every year over 40,000 people die in this country because they don’t have access to health insurance. How high do people want that number to go? Spending cuts have real consequences, some of them literally life and death.
State & Local Governments
The Federal Government also spends a lot of money supporting the States and Local governments. There is a good argument that the States should just raise their own taxes to support the spending they need to do rather than wait for checks from the Federal Government.
When the economy turns south, tax revenues tend to fall by more than the amount that GDP falls. Some expenses also go up. For example, more unemployed, the more that has to be spent on unemployment benefits. So States are left in a bind and would have to slash spending, laying off people like teachers and police and prison guards.
That, in turn, makes the downturn worse. How did we get to the situation where any revenue increase, even if just eliminating a subsidy that distorts the overall economy, is instantly labeled a "job killer," but spending cuts are never referred to that way, despite literally 522,000 reasons (522,000 is the total jobs reduction in S&L Government employment since September ’08) to see them as "job killers."
A big part of the ARRA (the Stimulus) was increased payments to States to help prevent that from happening. Those funds have largely dried up, and over the last year the job cuts have been accelerating. 305,000 of those 522,000 cuts have happened over the last year alone.
Who Says?
The idea that you always have to cut taxes to spur economic growth is as best unproven. We had massive tax cuts in 2001 and in 2003. Yet the expansion following the 2001 recession was extremely anemic, with very little job creation, and lackluster growth in real GDP, Industrial Production and employment.
We had a significant tax increase in 1993, and it was followed by very strong growth in real GDP, OK growth in Industrial Production and very strong job creation. U.S. economic growth was much higher in the 1950’s and 1960’s, when marginal tax rates were well above 50%, than it was in either the 1980’s when President Reagan cut taxes (at least at first; he later reversed course and raised them) or than we have has so far this century with extremely low marginal tax rates.
The chart below shows the year-over-year growth rates for each of those data since 1950. How could anyone make the case that the Bush tax cuts caused better economic growth? Even the Reagan 1980’s don’t look all that impressive.
The pathetic expansion that was the ’00’s is even worse when you consider that what growth we did have was due to the housing bubble that led people to act as if they had an ATM installed in the kitchen. That housing ATM — or mortgage equity withdrawal — was regularly over 5% of disposable personal income during the housing boom. It was the collapse of the housing bubble and the subsequent economic collapse that was the direct cause of the big deficits we are facing today.
Mostly Reagan shifted taxes from the rich to the middle class and the working poor. He did this through the Greenspan Commission, which substantially raised the Social Security tax. That tax was used to build up the Social Security Trust fund, which now stands at $2.7 Trillion. That money was invested in special non-marketable T-notes, the safest investment in the world at the time.
Lots of people now complain that those are just “worthless IOU’s,” but only when they are saying we have to cut Social Security benefits. However, that $2.7 Trillion is a big part of the $14.3 Trillion debt. That’s right — a big chunk of the debt the government owes is actually held by the government itself. The Federal Reserve, which while nominally an independent body, is effectively an arm of the Government which owns another big part of the debt.
Still the debt ceiling is based on the total debt, not the debt owed to the public (i.e. not to itself or the Federal Reserve). Here is a graph of GDP, Total Debt and the Debt held by the public. Unfortunately, the St. Louis Fed measures GDP in billions and the debt in millions, so the GDP had to be on the right hand scale. Total Debt is approaching the level of GDP, but the debt held by the public is still well below that level.
Choose to Do Nothing?
Yes, we need a long-term plan to bring the deficit under control. One plan that would do a lot to control the deficit is actually to do nothing. In that case, all of the Bush tax cuts would be repealed, and the AMT would not be fixed each year, and doctors would get a lot less for each Medicare patient they see. It’s not a perfect plan by any stretch of the imagination, and personally I don’t think that the source of our economic problems is that the after-tax incomes of the poor and lower middle class are too high.
That is, however, effectively what is being argued when you hear people complain about the large number of taxpayers that don’t pay any income taxes. The reason they don’t is that they don’t make enough to do so. They are not the ones taking obscure deductions on their returns; for the most part they take the standard deduction and don’t even benefit from the mortgage interest deduction.
Letting all the cuts expire would force many of those people to pay taxes. Taking money out of the pockets of the working poor and the families just desperately trying to make it from paycheck to paycheck will do much more damage to the economy than raising taxes on people earning over a million a year. Still, doing nothing would do more to close the long-run deficit than most of the plans that are under discussion.
I’m not thrilled with the Reid plan under discussion in the Senate. Proposals that only cut spending are not any better if they come from someone with a "D" after their name than if they come from someone with an "R." Relative to the Boehner plan, it at least has the advantage of avoiding a replay of this debt ceiling fiasco in six months.
Yes, a lot of the savings are things that would have happened anyway, such as drawing down from Iraq and Afghanistan, but those “savings” were also counted by the GOP in their plans like the Ryan Budget, so it is more than a little disingenuous to object to them now on those grounds.
Both of these plans avoid the heart attack to the economy that would occur if the debt ceiling is not raised. However, both would slowly bleed the economy of life, and the House plan would explicitly leave open the possibility of a heart attack early next year. That doesn’t do the economy any good at all, and just leads to more uncertainty and thus lower business confidence.
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