Tagged: The Welfare State

Student Loans: Another Entitlement

Why should a kid who went to work straight out of high school, who learned a trade and worked his way up there, pay for another kid’s college degree?

One of the arguments for socialized higher education is that society benefits from kids putting their academic learning to work. However, this is true only insofar as the college graduate can actually get a job based on his college-learned skills. If he can’t, it means that his degree does not let him add enough value to the economy to make it worth the while getting the degree in the first place.

If, on the other hand, the college degree leads to a job with a career, then the student will add enough value to pay for his tuition based on his own income.

At this point, countless college graduates around the country will protest loudly. They are staggering under the burden of student loans, struggling to make ends meet even on a decent salary. However, that does not mean someone else should be responsible for paying for their degree: if you choose to go to a college that charges $70,000 per year instead of a much-cheaper school, then you have made the calculation that the extra tuition you will be paying will give you a much better career start after graduation.

In short: your calculation says that with a $35,000/year degree, you will (all other things equal) make half as much as you would if you graduate from the more expensive school. If the earnings potential does not reflect the difference in cost of the degree, then you have made a poor choice of school to go to.

Your parents should have taught you better.

Recently, it seems as though parents and prospective college students have started making better choices. With annual tuitions increasingly outpacing the earnings of even older college grads trying to save up for their kids’ education, it has become more accepted to shop around and find less-astronomical alternatives to the supposedly top schools. The coronavirus craze has added its fair share to stimulate market-based choices; why would anyone pay more than a quarter of a million dollars to go to a first-tier school when all the education takes place online anyway? How big of a difference is that – really – from getting a degree from the University of Phoenix or your local state college?

As someone who has been a college professor in three different countries, I can only encourage parents and high-school kids to stay away from the most expensive schools. Even under normal circumstances, with campus life at normal pulse and all the traditional college atmosphere in place, it is absolutely not worth it to pay the equivalent of three Mercedes S450s for a college degree, that you can get for a fraction of the price at Ashland University in Ohio. Sure, there is some cachet to the degree, and there are minor academic differences that could translate into better earnings potential, but they are nowhere close to motivating the often-exorbitant differences in tuition.

It is also important to remember that big research schools, like all the Ivy Leagues or the Big Ten in the Midwest, not to mention the ones in the Democratic People’s Republic of California, almost invariably assign grad students to teach undergraduates. This is especially true for the bigger classes that most students take in order to learn the basics in what they will later major in. If you end up with a grad student teaching you Macroeconomics 101, I can guarantee that you will not learn nearly as much as you would if your class was taught by a Ph.D. with an active, relevant research agenda.

In other words, by paying more for a big, fancy school you run the risk of getting a lower-level academic education than you would at a smaller, cheaper school where all the professors have doctorates.

There is also a tendency among bigger schools to hire people as adjuncts. This means, simply, that they don’t have to make a salary commitment and they certainly don’t have to dole out benefits for them. (These are schools where most faculty normally vote for Congressional candidates who rail against the unfairness that we don’t have single-payer health care in America.) Adjuncts are usually less anchored in their subject matter, or have other priorities that draw their intellectual attention away from what they are teaching. There are exceptions, but in my experience the adjuncts usually do not rise to the same academic standards as full-time faculty.

In short, the choice of college is complicated, especially when taking the cost of it all into account. It doesn’t get better, though, from the fact that our college campuses have become rampant socialist breeding grounds. Faculty with political leanings, who see it as their mission to preach socialism to the students (and yes – that’s exactly how they see it), hire younger faculty with the same political leanings. For each generation of new hirings the political preferences slowly gnaw away at academic proficiency; the more important the political preference becomes, the less important are academic standards.

As the political pressure on students is dialed up, the academic challenge is dialed down. You get more politics and less learning for your hard-earned tuition dollars; the more tuition dollars you spend, the more politics you get for them.

With all this in mind, it is – again – absurd to ask a 19-year-old welder who did not go to college, to pay the tuitions for Jennie and Johnnie to get a degree in oh-my-god-i-hate-donald-trump studies. Nor is it fair to ask the plumber who learned a trade and built a successful business to fund the tuitions of someone who got a business degree and became an accountant. The accountant, just like the plumbing entrepreneur, is adding value to the economy, enough so that he can pay for his own student loans.

This common-sense reasoning, however, is falling on deaf ears among many Americans. So pervasive is this political hard-of-hearing disability that we the taxpayers are now on hook for well over a trillion dollars worth of student loans. Reports the Wall Street Journal (p. A1, print ed., Nov. 23):

The U.S. government stands to lose more than $400 billion from the federal student loan program, an internal analysis shows, approaching the size of losses incurred by banks during the subprime-mortgage crisis. The Education Department, with the help of two private consultants, looked at $1.37 trillion in student loans held by the government at the start of the year. Their conclusion: Borrowers will pay back $935 billion in principal and interest. That would leave taxpayers on the hook for $435 billion, according to documents reviewed by The Wall Street Journal.

On top of that, the Journal reports, government is the co-signer for $150 billion in private student loans.

In short, our beloved federal government is now sitting here with a pile of unfunded liabilities that our beloved Congress did not see fit to take into account when they got us – the taxpayers – involved in the student loan business.

This was, of course, not by accident. It was entirely intentional. This is the way the socialist American welfare state expands: not by big, revolutionary sweeps, but by mission creep. There have been two exceptions:

  • The Social Security Act of 1934, which created a socially conservative welfare state; and
  • The War on Poverty, which created a lot of new programs and redefined the purpose of the federal government in the image of the socialist Swedish welfare state.

Other than that, the expansion of our system for economic redistribution has been a gentle canter through time. In this tradition, we can safely expect tax-backed student loans to turn into refundable student loans – also known as loan forgiveness – which will then turn into student grants, which will then turn into student entitlements.

All in due course of time. And we can all sit back and watch as another generation sink their common-core shaped minds into grievance studies, the Millennial generation’s up-the-ante to art history, the most useless college degree of the last century.

Structural Spending Reform, Part 3

In Part 2 we discussed reactive spending cuts, which include the Penny Plan and traditional European austerity. We concluded that this type of spending reform defeats its own purpose: it does not solve the underlying problems causing a structural budget deficit. The reform type does not incentivize economic growth, but instead contradicts it by keeping government expensive over time, while eroding its benefits.

Today we will dive into the alternative reform type: proactive spending cuts. This type is almost unheard of in reality, and there is scant literature – if any – explaining either its theory or its practice. The closest real-world example is the Dutch health-insurance reform: in 2005, the year before the reform went into effect, government paid for two thirds of all health care in the Netherlands; in 2007, the year after the reform went into effect, the proportions were reversed.

As of 2017, the latest year with available data, the private share was three quarters. This is higher than in America.

A coming article will examine the Dutch reform in detail; for now, let us lay out the principles for proactive spending reform. Before we do, though, let us notice that this reform type is associated with some significant political and policy challenges. We can overcome those – in fact, we must. Proactive reform is the only way to secure the fiscal sustainability of our government. However, the challenges are not be under-estimated, and will be discussed in articles on specific reform proposals: health insurance, Social Security and income security.

In Part 2 we noted that entitlement spending, which accounts for two thirds of all federal government spending and more than half of state and local government spending, is defined in principle by a simple equation. Spending, GE, is determined by the share of the population, e, that is eligible for the entitlement program, and the amount they get in benefits, B:

Benefits, in turn, are determined by the value of those benefits, b, as share of household income, Y:

The problem with these two equations is that they define a trajectory of perpetual increase in government spending. The key element of proactive spending reform is to break this trajectory and point government spending in a new, fiscally sustainable direction.

There is a technical and a theoretical component to this reform. First, the technical component, which consists of severing the tie between b and Y in the equation above. We replace the bY variable with a fixed B:

Each eligible individual now gets a fixed amount of benefits. That amount is independent of household income; as a ratio of household income, it declines over time.

From a theoretical viewpoint, this reform requires a more substantial change than its technical representation may suggest. The key is to redefine the formula by which we estimate poverty: today our definition of what it means to be poor is relative, with the poverty limit largely tracking median household income. This has absurd consequences, primarily that a thriving economy cannot reduce poverty. On the contrary, the population defined as poor can actually increase, even though employment is high and household income is rising.

The reason is, again, that poverty is defined as a percentage of median household income:

  1. If median income is $50,000 and the poverty limit is 55 percent of that, then you are poor if you make $27,500;
  2. If median income rises to $55,000, then the poverty limit rises to $28,250.

You are now better off being poor than you were before. As a result, the amount of entitlement spending has to rise, as per the definition of B above.

To decouple B from Y, we need to replace the relative definition of poverty with an absolute definition. This is represented by the third equation above, where entitlement benefits are capped and kept constant.

Before the War on Poverty, the federal government used an absolute definition of poverty. It constituted the foundation for the welfare-program reforms under the Social Security Act of 1934. Figure 1a sketches the idea behind a return to this reform. The present trajectory in government spending (1) will continue unchanged (2) if no reform is made. If the definition of poverty is changed from relative to absolute (A) the trajectory of entitlement spending will change radically (3):

Figure 1a

But wait: doesn’t this look a lot like a Penny Plan in practice?

Superficially, yes, it does. However, Figure 1a only tells half the story of a proactive spending reform. There is another side to the equation, namely the funding of the welfare state. However, before we get to the taxes, let us also note that this is just the fiscal schematics of a proactive reform; its execution within each entitlement program will bring far more difference than is laid out here. Those details will come in subsequent articles.

One more point before we get to the tax side: let us not forget the purpose behind proactive spending reform. The reactive type aims to make the welfare state more affordable – it does not seek to eliminate the welfare state. Therefore, government promises remain on the shoulders of the taxpayers, whose duty it is to work harder and harder over time to foot the bill.

A proactive reform seeks to permanently alleviate the burden on taxpayers.

Speaking of which, if the proactive reform is going to work as intended – in other words to roll back the welfare state – it must include reforms that alleviate the burden on taxpayers. In other words, tax cuts, but not just any tax cuts.

Today, the welfare state is paid for with tax revenue that rise and fall with GDP and, more specifically, personal income. Let TE be total tax revenue paying for the welfare state. Let t be the aggregate tax rate – how large a share we all pay in taxes combined – and let Y, again, be household income:

If we leave taxes alone, the burden will rise not only with income, but also relative welfare-state spending after the reform in Figure 1a. In other words, we have to combine the reform that changes the spending trajectory with a reform that caps taxes on par with spending:

Let us now plot the tax-revenue trajectory together with spending from Figure 1a. We assume that we have a structural budget deficit, represented by the vertical difference between the red (spending) and blue (tax revenue) functions.

With points 1, 2, 3 and A being the same as before, we now have tax revenue originally growing parallel to, but numerically below spending (4). If no reform takes place, it continues upward (5). However, suppose we combine spending reform (A) with tax reform (B). Revenue now veers off (6) to eventually catch up with the news spending trajectory:

Figure 1b

What type of tax reform would produce this result? It would take a reform that shifts from a tax that is proportionate to economic activity – be it income or consumption – to a tax that is proportionate to expected spending. Denoting this spending variable with *, we set the tax rate to:

Expected spending, in turn, is determined by spending in the past – say one year – and a forecast for spending in the coming year:

Since economists are notoriously bad at forecasting, it is reasonable to balance the forecast against past experience.

An important consequence of defining the welfare-state funding tax in this way, is that the tax rate will change with spending. Increases in spending will immediately translate into higher taxes, and vice versa. This has one important effect: as incomes grow and entitlement spending remains constant, the tax burden will gradually decrease.

As the tax burden declines, the private sector gradually gets more room to spend, invest, create jobs and build wealth. Over time, this keeps the economy on a path where demand for government entitlements will not only be a lighter burden at a constant rate of eligibility, e, but where the population needing government assistance will gradually decline.

Now: how do we put this proactive type of spending reform to work? The answer begins with Part 4!

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Structural Spending Reform, Part 1

I have drawn some ire from fellow libertarians for my criticism of their fiscal policy priorities. My review of the book Trumponomics by Steve Moore and Art Laffer, which concluded that tax cuts have become ineffective, rendered a couple of surprising comments from fellow libertarian economists. Nevertheless, as I explained in my series Tax Cuts or Spending Cuts, facts are facts; cutting taxes to close the budget gap in a big welfare state is about as futile as ignoring gravity.

The only way to close the budget gap is by means of structural spending reductions. Since such reforms are no longer being discussed in the public discourse, nor being given attention by leading libertarian thinkers, pundits and scholars, starting today I am rolling out a series of articles on how to structurally reform away the welfare state.

In this the first installment we will condense the case for structural spending reform. I find it necessary to do so, partly – again – in response to the conventional wisdom that tax cuts can save us, but partly also in response to another idea being floated around among conservatives and libertarians: fiscal rule making.

Many people with influence have suggested that all Congress needs in order to end our deficits and prevent a debt crisis, is to follow a set of fiscal rules. A new book from the Cato Institute offers a collection of 20 essays centered around this notion; as I explained in my review of the book, for two reasons fiscal rule-making does not work:

  1. The rules are “Pippi rules”, i.e., they are self enforced with impunity for non-compliance;
  2. Without exception, the rules rely on healthy levels of GDP growth in order to work.

The last point applies not only to fiscal rule-making but also to the unending pursuit of tax cuts. In the case of rule-making, the prevailing wisdom is that GDP growth is exogenous to fiscal policy, in other words that it is not affected by the enforcement of a fiscal rule. However, as we will see in a coming article, fiscal rules can actually undermine the very basis for their own enforcement.

In other words, GDP growth is not exogenous, but endogenous to fiscal policy.

Proponents of tax cuts recognize this: in fact, the endogenity of GDP is the very life blood of the tax-cut argument. The problem here, though, is that tax cutters limit the endogenity to taxes; there is no explicit consideration of the effects of government spending on GDP growth. Right there we have the mistake that prevents the tax cutters from seeing how their budget-balancing strategy has run its course and no longer works.

It is essential for any attempt to save us from a debt crisis, that we understand why GDP growth is affected by the size of government spending. Before we get to the analytical explanation, let us start with empirical evidence. Figure 1 summarizes what this evidence says, namely:

  1. When government spending as share of GDP increases, i.e., when G/Y goes up (horizontal axis), initially the growth rates of taxes (t) and government spending (g) are largely similar;
  2. As the size of government passes a certain point, the growth rates of t and g divert, with the former declining and the latter increasing;
  3. when government spending grows faster than tax revenue, we get a structural budget deficit.

Figure 1

Let us review some data that confirm the image in Figure 1. First, Figure 2 reports data from Europe on the relationship between government spending as share of GDP, G/Y, and real GDP. Covering 31 countries, almost all of them over a 25-year period (1995-2019), it paints a stark image of the negative relationship between economic growth and the size of the welfare state:

Figure 2

Source of raw data: Eurostat

Next up: numbers from the U.S. economy, which gives us an opportunity to link the size of government to the root cause of the budget deficit: the welfare state.

Government growth in America can be divided into five distinct phases. The first era runs from 1950 to 1963. This is the first phase of stability (Stability 1 in Figure 3 below). During this phase the welfare state was still ideologically conservative and did not engage in economic redistribution. It was, simply, confined to the provision of a safety net for the poor and needy. This was the welfare state that Congress and the Franklin Roosevelt administration created in response to the Great Depression.

The second phase of government growth begins with President Lyndon Johnson’s State of the Union speech in 1964. There, he declares his War on Poverty and marks the beginning of a fundamental overhaul and expansion of the welfare state. New entitlement programs like Medicare and Medicaid are created, others revamped for much more comprehensive purposes.

At the heart of the War on Poverty is a new, relative definition of poverty. A person is no longer poor because he lives below a certain, fixed standard of living. A person is now poor because he earns below a certain percentage of median income. When median income rises – as it does when the economy is doing well – the poverty limit rises as well. More people qualify for government handouts.

As I explained in my book The Rise of Big Government, the significance of this welfare-state metamorphosis cannot be understated.

After this roll-out phase for the new, socialist welfare state, it was time for the implementation phase: government needed to consolidate its new spending programs. Fiscally, this meant that government grew to the new, larger proportions that all the War-on-Poverty legislation prescribed. During this phase, which essentially coincided with the 1970s, government spending increased significantly.

This is also the phase during which government spending outpaced tax revenue on a permanent basis. The structural budget deficit was born.

Once the new welfare state was consolidated, government went into a new phase of relative stability. It lasted from 1980 to 2007, the year before the Great Recession started. During this Stability 2 phase (again, see Figure 3 below), government spending remained largely constant as share of GDP, but that stability was attainable thanks only to two tax reforms. Government spending was still small enough to let tax cuts work – there was a Laffer effect to be counted on.

If it had not been for the Reagan tax cuts fundamentally overhauling the tax code, there would not have been a long, stable growth period through the 1990s; the Bush tax cuts generated a more limited, yet visible growth spurt that helped carry the economy through most of his presidency.

With their growth record, these two tax reforms generated enough growth to essentially keep steady the ratio of government spending to GDP.

It is easy to get the impression from this long phase of stability that America had struck a golden balance between the welfare state and free-market capitalism. That was not the case, as evidenced by the perpetuated deficit. The Reagan and Bush tax reforms were not enough to close the budget gap, and the difference in effect of the two, with the first having stronger effects than the second, remains unrecognized in the literature.

The reason why the two reforms failed to fully fund the welfare state is simply that this structure of government spending grows by its own volition. Government spending is exogenous to economic growth, a fact that originates in the very ideological design of the welfare state.

Phase five, the Stagnation phase in Figure 3, is when the welfare state has grown big enough to permanently depress economic growth. This phase provides ample evidence of how the welfare state overpowers its host economy. During this phase, which begins in 2008 with the Great Recession, total government outlays average more than 37 percent of GDP. Economic growth is so poor that its annual average for the entire period is only 1.7 percent:

Figure 3

Source of raw data: Bureau of Economic Analysis

Predictably, the decline in growth has taken a toll on government revenue. When taxes have not delivered sufficient money to fund the growing welfare state, government – especially states and municipalities – have resorted to non-tax revenue. As Figure 4 explains, the rise of fees, charges and other revenue sources has coincided in time with the transformation, implementation and growth of the socialist welfare state. However, not even the rise of non-tax revenue has been enough: the deficit reported in Figure 4 (red) is mostly federal but also includes overspending by state governments.

De facto, deficits have become a permanent source of government funding:

Figure 4

Source of raw data: Bureau of Economic Analysis

It is worth noting that as taxes become less important as a revenue source for government, the effectiveness of tax cuts also declines.

With declining GDP growth under an increasingly burdensome welfare state, government debt keeps rising. Figure 5 compares the debt-to-GDP ratio to real GDP growth. To highlight trends, the numbers are reported as five-year moving averages:

Figure 5

Sources: Office of Management and Budget (Debt); Bureau of Economic Analysis (GDP)

Let us now add together everything we have learned so far about the interaction between government spending, GDP growth and tax revenue, and add one more twist to the tax-or-spending-cuts debate. Figure 6 reports a total of 262 quarterly observations of annual growth rates in all three variables, from 1954 to Q2 of 2019. The observations are not reported chronologically, but are instead organized by GDP growth, from high to low (blue).

Tax revenue correlates positively with GDP growth (black dashed), which is not surprising. What does stand out, however, is the turn upward of government spending growth (red dashed) when GDP growth falls below three percent per year. As GDP growth gets weaker, government spending accelerates:

Figure 6

Sources of raw data: Bureau of Economic Analysis

We have now learned three important things about the government budget:

  1. As spending grows, GDP growth declines;
  2. As GDP growth declines, spending growth accelerates; and
  3. With declining GDP growth, tax revenue slacks off as well.

There is more to be said about the first two points; for now, let us note the conspicuous divergence between GDP and government spending toward the right end of Figure 6. That gap alone explains our structural budget deficit.

However, first, we need to add one last point about taxes. As Figure 6 tells us, tax revenue fluctuates with GDP growth, but the fluctuation is higher in tax revenue. This means, plainly, that tax revenue is a volatile source of revenue. Figure 7 extracts the equations defining the trend lines in Figure 6 and plots them strictly as analytical representations of how these two variables correlate:

Figure 7

The problem with Figure 7 is that the volatility in tax revenue has increased with each supply-side tax reform. This means, in turn, that tax revenue plunges more violently in recessions, but since the long-term growth trajectory for GDP – and therefore the tax base – is lower than it used to be, this volatility is not symmetrical. We don’t get enough of a compensating “Keynesian” surge in tax revenue at the peak of the business cycle.

In other words, we are left with a structural deficit.

But why, then, do we actually have this structural deficit? This question is of course essential to our discussion of structural spending reform. Figure 8 has the answer. It reports the share of the federal budget that is dedicated to entitlement spending, i.e., the welfare state. The blue function represents the welfare state’s share of the budget in 1964, when the War on Poverty began. Today, two thirds of all federal spending goes toward entitlements, from education to Social Security, from the Earned Income Tax Credit to Medicaid and Medicare:

Figure 8

Source of raw data: Office of Management and Budget

To highlight, Figure 9 divides the 2019 federal budget by major program category. Notice the share that goes to national defense: in 1960 that share was 50 percent.

Figure 9

Source of raw data: Office of Management and Budget

Spending on entitlement programs grows for reasons that are inherent to the programs themselves. This growth causes a depression in GDP growth, which in turn causes a structural budget deficit. The only way we can close the budget deficit is by reforming away the welfare state.

How? Please proceed to Part 2.

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[1] For a more detailed discussion of the ideological character of the American welfare state, see Larson (2018) and Larson (2020f).

Why Can’t Republicans Beat Socialism?

As we await the outcome of the vote recounts around the country and the inevitable court battle over the artificial boost in Biden votes in Michigan, it is time to ask some pertinent questions about why Americans keep voting for socialist politicians.

Even more important is the question why the Republican party, which has declared itself anti-socialist, continues to fail in decisively beating back this nasty ideology.

In my new book Socialism or Democracy: The Fateful Question for 2024 (Palgrave), I take an in-depth look at the structure, function and consequences of socialism. My analysis traces the roots of socialism all the way back to Marx. I explain how his economic analysis has defined socialism in both theory and practice throughout the past 150 years.

I also explain that there are two strains of socialism. The first strain is well known as the version practiced in Cuba and North Korea. This is the Stalinist form where government owns all property and plans the entire economy.

Republican politicians, and conservatives in general, are very good at lambasting this communist version of socialism. We can hear prominent Republicans such as Liz Cheney make speeches to this effect. Cheney, specifically, has been forceful in her criticism of Stalinist socialism, as exemplified by her excellent speech at the International Democratic Forum in the fall of 2019.

The problem is that most Americans do not believe that the Democrat party stands for this abhorrent version of socialism. Rightly so: there is not a trace of Stalinism in mainstream Democrat policies. Bernie Sanders, the long-standing radical socialist Senator from Vermont, has openly and repeatedly declared that his socialism is not of the Soviet kind.

Plain and simple: Soviet socialism is not on the agenda of the American left.

What is on their agenda is the other strain of socialism, the one that is typically “democratically” prefixed. To be a democratic socialist is perfectly normal in American leftist circles.

This is the strain of socialism that America’s conservatives in general are having a very hard time fighting. The same is definitely true for the Republican party and for Liz Cheney. Despite her sincere commitment to fight socialism, she keeps missing the target. The reason is not that they lack dedication to fight socialism per se – the reason is that they deny that democratic socialism is socialism, period.

As I explain in my book, this is dead wrong. Democratic socialism is just another format under which socialism is practiced. The reason why Republicans fail to understand this is that they have fundamentally misunderstood socialism as an ideology: they still believe that it is all about confiscating private property.

Not once do they stop to ask themselves: why would socialists want to confiscate private property?

When practiced in its “democratic” form, socialism does not confiscate property. It leaves intact property rights in their traditional sense. Instead, the “democratic” socialist uses taxation and government spending to achieve his ideological end goal.

What is that goal? It is the very same that motivates the Stalinist socialist – the communist – to confiscate private property and put the whole economy under teleological central planning. My book explains this goal in detail, as well as its practice in the two strains of socialism.

Economic redistribution. That is what socialism is all about. It is about reducing and eventually eliminating economic differences between individuals. Under communism, this is done quickly by means of private-property confiscation. When ownership of property – including wealth – is outlawed, so are the proceeds of said property. If you cannot earn good money by owning and running a business, you cannot make more than anyone else.

But it does not stop there. Communism dictates that people be paid based on the labor value of their work. This value is crude and entirely alien to human nature, but it is what communists practice. It destroys the free market, which is entirely intentional: according to communist doctrine, a surgeon should get paid less than a factory worker because his production of labor value is lower.

In short: communism outlaws all means by which one person can earn more than another. The only exception is the cumulative addition of labor value, which favors labor-intensive manufacturing and un-mechanized agriculture over medical services.

By contrast, “democratic” socialists use democratic methods for the advancement of their ideology. They pass laws that raise taxes on “the rich”, redefine the definition of “rich” as they run out of them, and spend more and more money on handing out entitlements. The goal is to erode economic differences by means of economic attrition:

  1. More and more people get benefits from government in the form of health care, education (including college), income security, retirement and plain cash handouts;
  2. More and more higher-income households lose more and more of their money to taxes.

Working both ends of the stick, the “democratic” socialist gradually uses the welfare state to reduce and eventually do away with economic differences.

We already have a welfare state. We have one of the most progressive, most redistributive, most socialist tax codes in the world. We already have a wide roster of entitlement spending for the very purpose of redistributing income, consumption and wealth. From Social Security all the way down to the Earned Income Tax Credit; from Medicare and Medicaid to public education; we already have a major apparatus in place in America for the practice of “democratic” socialism.

It is this very strain of socialism that the Democrat party wants to expand and practice more intensely. When Republicans define socialism as communism and then put that label on the Democrat party, they appear to be just as incoherent as they are.

If Republicans ever want to win the battle against socialism, they must first learn what socialism is. Every Republican, every conservative and every libertarian in America needs to read my new book Socialism or Democracy: The Fateful Question for 2024. It goes into production at the end of this month. Stay tuned for preorder information.

Laffer and Moore Get It Wrong

Art Laffer and Steve Moore are widely considered to be the foremost economists of the libertarian movement. They are praised and raised to the skies, lauded and quoted widely. In Laffer’s case, it is in many ways merited. He did a fantastic job getting the Reagan administration to agree to a sweeping tax reform.

Since then, though, as I have shown in my four-part series on tax and spending reform, his theory has lost its steam.

Tax cuts don’t work anymore. I wish they did, but they don’t. The evidence is irrefutable.

But it gets worse than that. Not only do tax cuts don’t work, but these two fine gentlemen are selling this ineffective medicine as a means to pay for the welfare state. In short: cut taxes, and we can afford socialism.

Yes, that’s right. Art Laffer and Steve Moore make this case. In their book Trumponomics they explain that higher growth will pay for our socialist welfare state:[1]

One underappreciated dividend from this higher permanent pedestal of economic growth is that, if Trump succeeds, it will help largely solve the long-term funding crisis of Social Security and Medicare. With 3 percent economic growth, up from the 1.8 percent predicted by the Social Security and Medicare actuaries, the compounding effect over 50 years means more than $50 trillion of revenues into Medicare and Social Security trust funds, largely dissolving the funding shortfalls of these programs – and perhaps leaving them in long-term surplus, not deficit.

That’s it. Cut taxes, get more growth, and we can continue to use two thirds of the federal budget to take from Pete and give to Paul.

This paragraph is also the closest that Laffer and Moore get to even discussing government spending. They have a non-committal passage on pages 99-100 about how nice it would be if people didn’t get more in welfare than they get working a minimum-wage job, but they have absolutely no ideas on how to approach that problem with tangible reform ideas.

I have actually proposed a welfare reform that would do what Laffer and Moore are dreaming about. If Steve Moore had shot me an email, I could have shared my plan with him (again). If the original version is not palatable, I have an updated model from 2012, published on SSRN in 2013, that I originally developed for a presidential campaign.

The problem, of course, is that spending reform is hard work. It is quite a bit harder than to propose and lobby for tax cuts. Spending reform quickly runs into a fire storm of criticism from the left: do you really want to take away Medicare from this grandma and Medicaid from that poor family? Are you cruel and cold-hearted?

My reform circumvents that problem. In other words, the big obstacle to spending reform is not the design of workable solutions – it is the lack of courage among the layers of libertarians. Courage to propose workable reforms. Courage to convince Congressional Republicans to think anew.

Courage to go against the mainstream.

Laffer and Moore lack that courage. The closest they get to discussing actual, actionable spending reform is a quick, positive mention of the Penny Plan. As I recently demonstrated, this plan is entirely unworkable. Why? Because it keeps all the welfare-state promises intact. It rests on the premise that government can provide everything it has said it will provide, only do so more efficiently.

As my numbers show, that is wholeheartedly impossible. The only option is to reform away the promises – to return them to the private sector and get government out of economic redistribution altogether.

Laffer and Moore steer clear of that one. Their solution is a dreamy comment about how higher growth would eliminate the budget deficit and perhaps even let the welfare state run a surplus.

This is the neoconservative approach to the welfare state. It is close to what Irving Kristol, William F Buckley Jr. and others talked about when they discussed the American welfare state. Like Laffer and Moore, the neocons of the 20th century firmly believed that the welfare state should be preserved, but that it should be run a bit more efficiently than it would be under socialist management.

In the 21st century model, this neoconservative dream relies on yet more tax cuts to generate yet more economic growth. I hate to be the Grinch that stole Christmas, but the facts on the ground speak a different language. First, consider Figure 1, which reports 715 pairs of observations of government revenue as share of GDP, and GDP growth. The numbers are from 29 European countries from the period 1996-2019 (with limited availability from some countries). These observations are then organized in deciles based on the tax-to-GDP ratio, with average tax ratios and growth rates for each decile:

Figure 1: Growth and government in Europe

Source of raw data: Eurostat

The bigger government gets, the more sluggish the economy grows. The same economic mechanisms that work in Europe, work here as well.

But wait – didn’t I just say that this is tax revenue as share of GDP? Exactly. But what if we cut taxes? Doesn’t that move us up the blue function?

No, it doesn’t. Laffer and Moore want to keep spending as usual (assuming that they realize what will happen in Congress when the Penny Plan starts pinching away big chunks of our entitlement programs) which means that the welfare state will not get smaller. It will continue to grow. Therefore, government spending will continue in the bracket of 37-40 percent of GDP. If we are going to balance the budget, we need to collect the same share of GDP in taxes, fees and charges.

Since the size of the welfare state remains unchanged, all that the Laffer-Moore growth strategy will accomplish is a redistribution of the tax burden.

But wait: if GDP grows, then the denominator grows. That means the welfare state may not shrink in terms of dollars, but it certainly declines are share of GDP, right?

No, it doesn’t. As I explained in my book The Rise of Big Government, our welfare state has a built-in mechanism that automatically grows its size as GDP grows. It is called the “relative definition of poverty” and states that people are entitled to government benefits, cash and in-kind, when their income is at a certain percentage of median household income. Since GDP growth means that median household income grows, so does the eligibility threshold for welfare-state benefits.

In short: the more the economy grows, the bigger the welfare state gets. Therefore, if Laffer and Moore got what they wanted, their sought-after surge in tax revenue would be chasing welfare-state spending like the rabbit that tried to race the turtle and never caught up with him.

To solve this problem, you need to redefine the ideological nature of the welfare state.

Then, of course, there is the problem with economic planning. Government does not operate under the free-market price mechanism. It uses a different value unit, one that is directly derived from Marxist labor-value theory. Therefore, the allocation of resources under government is neutral, even hostile, to economic growth.

I elaborate on this problem in my forthcoming book Socialism or Democracy: The Fateful Question for 2024. Until it is out this winter, we will simply note that the bigger government gets, the larger a share of the economy is put under growth-hostile administration. There is simply less economic activity out there that can produce the growth that Laffer and Moore depend on.

Simple arithmetic, in other words. I am surprised that two guys as smart as Steve Moore and Art Laffer did not figure this out.

Structural spending reform, folks. Nothing else works.

[1] Moore and Laffer: Trumponomics. All Points Books (2018).

Tax Cuts or Spending Cuts: Part 2

In Part 1 I explained that fiscal conservatives no longer can rely on tax cuts to save us from big government. I noted specifically that libertarians who want to eliminate the income tax as part of such tax cuts, are missing the point entirely. Using state-level data I pointed out that states without an income tax show no sign of having smaller governments than states with an income tax.

In short: tax cuts no longer work as a means to contain government growth. They also do not help with balancing government finances. Government is simply too big.

Supply-side economics doesn’t work anymore. Only an ideologically principled, theoretically consistent and morally sound welfare-state reform effort can make the difference. There is compelling data to make this point, but first, let us take a look at the theory behind the demise of supply-side economics.

The blue, solid line in Figure 1 represents government spending, growing at a steady pace (hence the modest upward slope). Tax revenue is represented by the solid red line. A supply-side oriented tax cut initially depresses tax revenue, but as the economy starts growing faster under lower tax rates, revenue picks up at a faster pace. Eventually, revenue collection surpasses government spending and government runs a surplus:

Figure 1: The theory behind supply-side tax cuts

There is nothing wrong with the theory behind the red, solid function, quite the contrary. It has good empirical support from previous tax-cut reforms. The problem lies instead on the spending side: consider a slightly higher growth rate in government spending, as per the dashed blue line. When government grows faster, its depressing effect on government spending kicks in earlier than it otherwise would.

Specifically, there is the 40-percent threshold where four out of ten dollars in the economy runs through government. I discussed this point in my book Industrial Poverty, where I presented evidence by me as well as others on how this threshold works. Once government occupies more than 40 percent of GDP, there is a permanent slowdown in economic growth.

Once this happens, it becomes harder for the private sector to put a tax cut to good use. Bluntly, there will be less growth from every dollar’s worth of tax reductions. Hence the dashed red line.

Once the solid lines in Figure 1 become dashed, tax cuts no longer work. It is futile to spend political energy and efforts on those; we should still oppose tax hikes, but the reform efforts must be allocated to the spending side.

As a reinforcement of this point, consider Figure 2. It reports the growth in $100 worth of, respectively, total government spending and current-price GDP for the U.S. economy. For every $100 we spent through government in 1954, we spent more than $7,500 in 2019; over the same period of time, $100 worth of GDP grew into $5,000.

Government outpaced its own tax base by $1.50 to $1:

Figure 2: Growth in government spending relative GDP

Source of raw data: Bureau of Economic Analysis

The growth of government is stunning in itself, as are its causes. Consider Figure 3, where we also pinpoint how the size of government (relative GDP) has become increasingly immune to supply-side tax cuts. To highlight the relationship between federal tax cuts and the size of government, we now disregard states and local governments and focus solely on the spending that Congress has jurisdiction over:

Figure 3: Cycles in federal government spending

Source of raw data: Bureau of Economic Analysis

President Kennedy worked with Congress on the lowering of federal income taxes (1). It is hard to identify any clear downward trend, the reason being in part that defense spending at this time constituted almost 50 percent of the federal budget. That spending tends to be entirely immune to the ups and downs of the economy; at this time it was slowly being ramped up for the purposes of the Vietnam War.

Nevertheless, it is worth noting that the Kennedy tax cuts were indeed followed by a strong growth episode in the U.S. economy, one we would not see the like of until the 1990s. Unfortunately, the relatively modest size of the federal budget under JFK was replaced by a steady climb under President Johnson (2). Launching his War on Poverty, LBJ led the transformation of the American welfare state from socially conservative to redistributive socialist. New entitlement programs, built around a new, relative definition of poverty, permanently expanded the federal government. What had been a budget equal to 17-18 percent of GDP became a fiscal conglomerate equal to 22 percent and more.

It was not just the federal government that expanded. State spending grew even faster, as they became responsible for running a good part of the new programs that Congress put in place under the auspices of fighting poverty. With the rapidly expanding weight of government on the economy, growth slowed down and taxes depressed both entrepreneurship and career development.

In response, President Reagan spearheaded major tax reforms that rejuvenated the U.S. economy. Growth picked up and the private sector gained back some ground lost to government (3). The architect behind the supply-side strategy, Art Laffer, was proven correct on all points except one: the federal budget deficit did not vanish.

This was a sticking point that supply siders never quite addressed. It was not their theory in itself that was wrong; it was its omission of the spending side. Notably, it took a fiscally conservative Democrat in the White House to shed light on the importance of the spending side: working with fiscally conservative Republicans, President Clinton significantly tightened the belt on the federal budget, not to a point where he shrunk it, but by significantly reining in its growth (4).

With an economy growing in excess of four percent, Clinton was able to sign four budgets with a surplus. However, despite a reasonably good welfare-reform bill, known by its PRWORA acronym, he did not do much to turn the long-term tide of the welfare state. On the contrary, when he signed SCHIP into law he added a big spending program that later became a driver in Medicaid costs.

Once again, a Republican took the leadership on the tax side of the budget. With two tax cuts, one in 2001 and one in 2003, President Bush Jr. tried to counter the Millennium recession by repeating the Reagan supply-side success. It worked to some degree: while the economy revved back up again and tax revenue with it, non-military spending increased at about 6.5 percent per year. The welfare state almost outpaced tax revenue.

Not quite, though. If the economy had not gone into the Great Recession in late 2008, the federal budget would have been in balance by 2009. For sure, that was six years after the second Bush tax cut, but it was en route to happen.

Does this mean that supply-side economics worked under Bush? Modestly. It showed that it could still deliver good government finances under the best possible economic conditions. The problem is that last part: best possible conditions. A recession was all it took to throw the federal budget back in the hole again (5). For sure, President Obama and the Democrats recklessly increased government spending in the first couple of years of his presidency, but once the Republicans took back the House a fiscal standoff between Congress and the White House actually led to a de-facto practice of fiscal responsibility.

With Trump in the White House, Republicans tried for a third time to put supply-side theory to good use. Its positive effects, which were visible in the economy all the way up to the artificial economic shutdown in 2020, were too modest to bring about three percent annual economic growth. They also failed to make a dent in the budget deficit.

The reason is painfully obvious: government spending has weakened the transmission mechanisms that generate economic growth. The welfare state has eroded the incentives that drive employment, innovation, investments and entrepreneurship. It has not destroyed them, but it has worn them down to a point where we get much less growth out of every $100 worth of tax cuts than we did under Kennedy, or even Reagan.

Figures 2 and 3 tell us that the size of government is immune to tax cuts. What it does not tell us is how that size has remained comparatively stable since the 1970s thanks only to growing budget deficits.

A coming article will discuss tax hikes – and why they are a thoroughly bad idea. First, though, in Part 3 we look at what would have happened if we had tried to end the deficits by means of a Penny Plan.