America Depends on Government

In the latest issue of our Liberty Bullhorn Economic Newsletter we explained what an American fiscal crisis would look like. (Sign up today and also get our Special Report on MMT and the Green New Deal – only $2.99/month!) We also explained why Congress, with its obsessive deficit spending and money printing, is hurling our economy into one of two disasters: hyperinflation or a Greek-style debt crisis.

Time is running short for Congress to avoid both disasters; the longer they wait, the more their choice is going to be between the two; the “none of the above” scenario is withering away. Regardless of which of the two disasters will hit us, the consequences are going to be formidable. To illustrate this point, we are going to take a look at just how dependent Americans are on government for their daily lives.

Before the Covid-19 epidemic happened, entitlements – tax-paid benefits – accounted for an average of 17 percent of the personal income earned by American households. This is a smaller share than in the standard European welfare state, but it is a historic high for our country. It tells us that once we are hit by either hyperinflation or a fiscal crisis, the impact on personal income is going to be serious:

  • Under hyperinflation, benefits are rapidly eroded as prices skyrocket. The purchasing power of entitlements vanished with sharply rising prices. It becomes tempting for government to compensate by increasing benefits, funding the compensatory increases with more money printing. This creates a vicious spiral where inflation accelerates out of control and people’s dependency on entitlements becomes a trap where daily life is reduced to a matter of survival. (We will discuss this scenario in more detail in a coming subscriber-exclusive Special Report.)
  • Under a fiscal crisis, or debt crisis, government makes drastic reductions in benefits. During the thick of the Greek fiscal crisis in 2009-2014, government cut entitlement programs by up to 50 percent, with at least one program being reduced by 90 percent. Those are the same types of programs that account for 17 percent of U.S. personal income.

A fiscal crisis where government reduces entitlements by 50 percent would cut almost $1.6 trillion away from family and household budgets. This would equal an 8.5-percent reduction in total personal income; for reference, the artificial economic shutdown in 2020 caused a six-percent decline in personal income (after deduction of entitlements). In other words, if a fiscal crisis in America leads to austerity measures anywhere close to what the Greeks had to resort to, the macroeconomic repercussions would be disastrous.

America did not become dependent on the welfare state overnight. Figure 1 explains how this dependency has evolved over time; in Figure 2 we examine what entitlement programs have driven the expansion.

Figure 1

Source of raw data: Bureau of Economic Analysis

The episodes marked in Figure 1 can be correlated with Figure 2 below; first, an overview of the seven episodes. We start with those marked by arrows, which highlight the systemic nature of the welfare state:

  1. The 1950s. This is when Social Security becomes a relevant source of income for retired Americans. It marks the first significant rise in the country’s dependency on government.
  2. The mid-1960s through the 1970s. The modern, socialist, economically redistributive welfare state replaces the socially conservative welfare state from the Franklin Roosevelt era. This new welfare state adds many new entitlement programs, most notably Medicare and Medicaid. Subsequently, Medicaid expands in several steps, contributing to the long-term rise in entitlement dependency.
  3. The 2010s. This is the slow recovery after the Great Recession of 2008-2010. During this the 2010s income growth is comparatively modest, but unemployment falls consistently. Under a socially conservative welfare state, entitlement dependency would have declined during this period of time. However, since America has a socialist, economically redistributive welfare state, entitlement dependency remains flat.

After episode 2, the new welfare state (which was designed based on the same ideological architecture as the Swedish welfare state) settles in, so to speak. Its programs slowly become more important to American households, just as they are intended to do. This is clearly visible at four different points in time, marking four different recessions. The remarkable effect of those recessions is that our dependency on entitlements ratchets up with each one of them. This happens by design, as we will see in a moment. First, the four recessions, marked by A-D in Figure 1:

  • A. The stagflation episode from the late 1970s increased unemployment and made more people eligible for poverty-related benefits. In the strong economy of the 1980s, the “recession peak” in entitlement dependency went away and the ratio stabilized around 12 percent of personal income. This was higher than the pre-stagflation point at just over 11 percent.
  • B. A more protracted peak in dependency occurred after the recession of the early 1990s. Part of the reason for this prolonged peak was actually a cumulative effect of the expansions in Medicaid that President Reagan signed into law in the 1980s. Thanks only to the combined effect of strong economic growth and President Clinton’s fiscal conservatism, government dependency eventually declined, but it is worth noting that its trough before the next recession was higher than the low point of the 1980s.
  • C. With the Millennium Recession – a brief and mild one by historic comparison – entitlement dependency returned to its peak from a decade earlier. This time, though, when the economy recovered dependency did not decline. It parked itself at the 14-percent level for the duration of the growth period just prior to the Great Recession. The reason is that by this point in time, with the socialist welfare state having been up and running for three decades, GDP growth declined permanently. Income growth was held back by slow economic growth and more people became eligible for entitlements.
  • D. As the recession started in 2008 and gained full force in ’09, entitlement dependency shot up drastically. After a peak above 18 percent it declined to approximately 17 percent, where it remained for the coming decade.

Figure 2 explains the same growth in entitlement dependency, broken down by program type. Reporting the shares of entitlements that different program types account for, it puts two types on prominence:

  • Retirement benefits: Social Security (blue) becomes significant in the 1950s and gradually settles in as the second-largest type of entitlement;
  • Health insurance: Medicare and Medicaid combined (green) emerge from the ideological redesign of the welfare state with the War on Poverty in the 1960s; in 2019, these two programs accounted for 45.4 percent of all entitlements paid out to American households.

Figure 2

Source of raw data: Bureau of Economic Analysis

Again, the consequences for America’s families will be significant, even crippling in many ways, under either hyperinflation or a fiscal crisis. Both concepts are largely unknown to Congress, and the same ignorance seems to plague the Biden administration. The Trump administration was not much better in this regard, though a conservative majority in Congress would probably be less inclined to spend more money under Modern Monetary Theory.

The one thing that the Biden administration has going for it is its Treasury Secretary Janet Yellen. She has signaled that she is unhappy with the current levels of monetized deficit spending. Hopefully, she can encourage President Biden to counter the bipartisan spending binge on Capitol Hill with at least a modicum of fiscal sanity. That would buy us more time to avoid the Devil and the Deep Blue Sea, a.k.a. a fiscal crisis and hyperinflation.