Reform Spending, Not Taxes!

In my latest op-ed for InsideSources I explain:

While the Democrat House leadership touts a very irresponsible plan for even more COVID-19 stimulus spending, the White House is signaling its equally irresponsible alternative. In an October 6 op-ed for the Wall Street Journal, Steve Moore, a member of President Trump’s economic recovery task force, proposes a 100 percent suspension of all federal personal and corporate income taxes for 2021.

Moore’s crazy idea is to simply suspend federal income-tax collections for 2021. In response, the U.S. Treasury would have to borrow $2 trillion from the Federal Reserve, on top of what the central bank is already supplying to fund the welfare state.

Moore, whom I know and who is a good and enthusiastic economist, seems to be unfettered by this increased practice of Mad Monetary Theory in Washington. To his credit, though, he has produced the same idea for abolishing the income tax in another context. Here is what Moore said back in July:

Stephen Moore, a member of President Trump’s economic recovery task force and an economist at FreedomWorks, has a bold idea for how to reinvigorate the economy: abolish the federal income tax, and replace it with a national sales tax. On the face of it, it may seem like a radical notion especially since essentially all Americans nowadays have grown up having a chunk of their income pulled out by the IRS every year. But Moore notes that the income tax is a relatively new invention in the U.S. — having only been introduced in the early 20th century.

This idea has been on the table for a long time. It has been called many things and is sometimes referred to as a “fair tax” reform.

Moore is right in that a sales tax is preferable to an income tax, and all other things equal this is a good reform to pursue. The problem is that all other things are not equal – especially not government spending. Right now, we need spending reform more than we need tax reform.

Take a look at Figure 1. It reports the shares of total government spending in the United States, federal, state and local added together. The numbers are the “rawest” you can get, with no adjustment for inflation or seasons. The message is unmistakable:

Figure 1: Shares of total government spending

Source: Bureau of Economic Analysis

Ever since the 1960s, government consumption has declined in importance. This is the kind of spending that goes to national defense, law enforcement, education, infrastructure and other outlays where a person is paid to do work for government (including on a contracting basis). In the past decade, social benefits – cash paid out under entitlement programs – has surpassed consumption as the most important function of government.

A point of order, before we move on: some consumption spending also qualifies as entitlements. For example, when government pays for health-care services through Medicare and Medicaid, it provides medical-service entitlements. We also refer to them as “in-kind entitlements”. This is a small but important note, because it helps us understand what is happening behind the numbers in Figure 1.

Before we get down into those details, let us first take a closer look at the same numbers for the federal government:

Figure 2: Shares of federal government spending

Source: Bureau of Economic Analysis

The trend from Figure 1 is even stronger here: social benefits overtake consumption already in the 1970s. Before the stimulus spending in 2020, this type of spending was already claiming more than half of the federal budget.

Which brings us back to the point about entitlements. Again, social benefits are one entitlement type – cash entitlements – but some consumption also falls in the entitlement category. Health care and education stand in the forefront, but any consumption (also known as “government services”) that is not for national defense, law enforcement and infrastructure qualifies as in-kind entitlement.

If we add up cash and in-kind entitlements, we get the welfare state. Its share of the federal budget was around two thirds before the Covid-19 stimulus craze. It remains to be seen what it will be going forward, but it is a rather safe bet that it will be higher.

Herein lies the real problem with spending: entitlements grow not because Congress keeps adding money, but because of their design. Each entitlement specifies an eligible population and how much they are entitled to. This is the entitlement value of the program, and it grows for two reasons:

  1. The eligible population grows;
  2. The product offered to them changes in character.

The second point sounds abstract, but its actual meaning is simple. In terms of services, the entitlement program promises the eligible population a portfolio of benefits with the explicit or implied promise that those benefits will be of a certain quality over time. In health care, this means that entitlement spending must grow with the rising cost of high-quality health care.

For cash entitlements, the cost driver is partly in the protection of the benefits against inflation. However, there is also the eligibility threshold: one example is the Earned Income Tax Credit, which tapers off with rising income but also expands its reach as its thresholds increase.

In short: once Congress has designed an entitlement program, it gives up control over its cost drivers. It can claim that control again, but it takes legislative action. One such action would be to bring entitlement spending out of the “permanent” section of the federal budget and into the “discretionary” fold. It is only an administrative maneuver and won’t make any difference in itself to the costs of the program, but it is the one step Congress needs to take in order to be able to reform entitlements.

Once that practical problem has been solved, Congress can move on to the next step, namely reforming the programs themselves.

How do they do that? Here is some food for thought to start with.