Adding up America’s Fiscal Follies through the Years

America's fiscal policies over the last 100 years show a deep ignorance of, or at least antipathy toward, basic economics.

Recently, a passage from an economics textbook, Modern Principles of Economics, came to my attention. It was written by Tyler Cowen and Alex Tabarrok, professors at George Mason University and fellows at the Mercatus Center. (I use some of their videos in classes I teach.) The topic was fiscal policy over the course of the business cycle.

In it, they point out that economists believe “government should spend more” during a recession and less during good times. This is basically the Keynesian school of thought. Having always been curious about this, I checked out the history of how this doctrine has influenced policy.

The Great Recession

For example, at the onset of the Great Recession, Presidents Bush (W) and Obama signed off on $1.5 trillion to bail out financial institutions and automakers and to aid the economy in general. The federal government also quadrupled the duration of unemployment benefits.

From 2008–2011, the federal budget deficit measured almost 8 percent of gross domestic product (GDP), according to Office of Management and Budget data. In that time, unemployment hovered just under 9 percent while labor force participation (LFP) fell to a historical low of 62-63 percent.

Then, in 2011, spending cuts of almost $1 trillion over ten years were set in motion. Unemployment benefits also returned to the standard 26 weeks. Deficit/GDP subsequently dropped to nearly 3 percent over the next few years. Unemployment followed suit.

Regrettably, the LFP continued to drop as well, though not as solely due to the retirement of baby boomers as one might suspect. Around two million people had dropped out of the labor force and filed for disability, a program that has ballooned since eligibility was expanded in 1984.

Over the course of the last ten years, we’ve been told that such spending measures were necessary to avoid another Great Depression.

The Great Depression

During the Great Depression, despite having approved of $500 million in 1929 to help farmers, President Hoover tried to cajole industry leaders to resist market forces before committing any more taxpayer resources. Alas, eventually he relented and agreed to $5 billion in aid to businesses and state and local governments in 1932. Average annual spending hikes of 13-14 percent ensued for the balance of the 1930s, and the deficit/GDP averaged almost 4 percent.

Then Hoover approved raising a variety of taxes in 1932, the top rate on income more than doubling from 25 percent to 63 percent. President Roosevelt (FDR) took that baton and raised them even further in 1935 and 1936.

The economy subsequently struggled for a decade to return to where it was in terms of nominal GDP, with unemployment fluctuating between 15-20 percent.

While the spending during the Great Depression fit the new Keynesian theory, raising taxes did not. Concern for “paying off the bill” should have been postponed until “good times.” Even so, whether or not the bills get paid depends upon how they are viewed.

Good Times

For example, after both taxes and spending were cut in the mid-1990s, GDP ticked up a point and a half, the deficit/GDP sank below 1 percent, and the Halley’s Comet of government figures appeared; budget surpluses.

Rumblings could be heard about “shoring up Social Security,” paying down the $5+ trillion national debt, etc. This might have made sense if people accepted things the way they were.

Instead, W campaigned on, and a bipartisan Congress delivered, $1.35 trillion in tax cuts in 2001. Paying down some of the aforementioned bills would have been construed by some as treating a symptom of the real problem; government spending.

After World War II, much of the “New Deal” was gone, Congress largely rejected President Truman’s “Fair Deal,” and President Eisenhower continued to hold the line on spending so that the “reduction of taxes … a very necessary objective of government” could be addressed.

As a result, the budget remained mostly in balance through the 1950s, the debt/GDP ratio kicked off a four-decade decline, and the unemployment rate averaged 4-5 percent.

Government Spending, a Recent History

The costs of government spending are varied. It tends to erode individuals’ motivation to work as well as the incentive for companies to produce high-quality, low-cost goods. The private sector also has to compete with the public sector for resources, consequently driving up the price of final consumer goods. Americans get hit twice when their taxes essentially travel a “bridge to nowhere.”

Moreover, income must be diverted from productive activities and/or consumer expenditures to pay taxes to support this spending. And that’s to say nothing of the billions of dollars and hours spent to do so.

By the time W signed off on reducing taxes, the “bills to be paid” had accumulated to push the national debt to 55 percent of GDP.

When that still doesn’t bring in sufficient revenue, government borrows.

The budget surpluses that resulted from Eisenhower’s spending restraint paved the way for President Kennedy’s income tax cuts, the top rate dropping from 90 percent to 70 percent. Then came President Johnson’s (LBJ) “Great Society”: the “War on Poverty,” Medicaid and Medicare, and increased federal spending on education. Although revenue surged by an annual average of 8 percent, spending grew by 10-11 percent. The deficit subsequently climbed back over 2 percent of GDP during the inflationary grind of the 1970s.

Since 1980, according to U.S. Debt Clock.org, after dropping from almost 2/3 of the federal budget to just over 1/3 in 1990, health and income security entitlements have crept back to almost 60 percent.

By the time W signed off on reducing taxes, the “bills to be paid” had accumulated to push the national debt to 55 percent of GDP.

Incurring debt is not absolutely a bad thing. It’s advisable if the return-on-investment is greater than the interest expense. Additionally, there’s a reason Uncle Sam is able to borrow so prolifically; investors regard him as one of the safest investments in the world, though that might change if he continues to borrow to fund consumption.

Rather than “paying the bills,” proper reform is needed.

In the areas of education and health care, price inflation has soared to ten times that of goods and services where the government footprint is smaller.

Since Social Security’s introduction, life expectancy has grown by roughly a decade, while the qualifying age for benefits has inched forward only two years. Surely even current beneficiaries, who contributed to the decades-long declining birthrate that has chipped away at the worker/retiree ratio, can see the need for reform.

When you look up the definition of insanity, you might see our approach to education. Uncle Sam has increasingly subsidized higher education, while we’ve spent more and more money on education at all levels since LBJ, and getting mediocre results at best.

In the absence of serious change to free up the areas of education and health care, price inflation has soared to ten times that of goods and services where the government footprint is smaller, according to the Bureau of Labor Statistics’ Consumer Price Index.

Unfortunately, we’ve made things worse by adding prescription drug coverage to Medicare in 2003 and increasing student loan forgiveness and expanding Medicaid eligibility in 2010.

The federal budget has more than doubled this century.

Learning the Basics

The passage of Messer’s Cowen and Tabarrok’s textbook later mentions the “folk wisdom” of voters, that government should spend more “only in good times,” and less in bad times.

I’ve personally never heard of the former. Why, when unemployment would be low, wages presumably solid, returns on investment healthy, etc., would government need to get involved? The latter, however, is a matter of principle to many.

The key is merely having a rudimentary understanding. Whether or not people choose to educate themselves is another story.

Common sense dictates that we cut back when the economy heads south. Obviously, that wouldn’t be enough for those of us hit directly. In such a case, those who “saved for a rainy day” are quite possibly miffed when government jumps in to bail out those who lived more profligately.

Ultimately, I believe history and the discipline of economics speak for themselves. To the former, I can point to the increased revenue that has resulted from every substantive tax reduction/simplification over the last century to show that the constitutional functions of government can still be adequately funded. And to the latter, all I have to do in class is stick to the basics and “keep it simple, stupid.”

A recent article in The Economist stated, good economics should involve using theory and data to quell prejudices.” The key is merely having a rudimentary understanding. Whether or not people choose to educate themselves is another story.

Further Reading

{{article.Title}}

{{article.BodyText}}