Biden Plan: More Deficits, Less Growth

As I have explained in recent articles, the new Democrat Congressional majority is gearing up for big, new spending financed with newly printed money. The combination of Modern Monetary Theory and the Green New Deal is exceptionally dangerous in terms of monetary inflation. President-Elect Biden is going into the White House in the unfortunate position of being the one who has to save America from both a fiscal crisis and the highest inflation in 40 years.

That, however, does not mean the the President-Elect is not innocent in terms of fiscal irresponsibility. He and the Democrat majority in Congress are not showing any signs of fiscal restraint. As part of his $1.9-trillion stimulus package, the incoming president has included measures that will grow the welfare state and entrench its growth-stifling, redistributive economic profile. Reports the Wall Street Journal (print ed., Jan. 15, p. A6):

In a poverty-fighting move long sought by many Democrats, the child tax credit would rise from $2,000 to $3,000 for this year under [President-Elect Biden’s] plan, with an additional $600 for children under 6 years old and new rules that would let the poorest households get the full benefit. The plan also includes money to help households with the costs of rent and child care, plus $350 billion for state and local governments.

Formally speaking, these are temporary benefits that would expire with the end of the coronavirus epidemic. However, it is very likely that once these measures are in place, Congress will make them permanent in one form or another. All these measures will noticeably increase the benefits for low-income families; while the child tax credit is not decidedly for lower-income households, on average families with children tend to be younger and therefore on average make less than households with no children.

Families who use child care are also predominantly lower-income, as are families who rent as opposed to owning a home.

The fact that these spending items are profiled as “poverty-fighting” also suggests that when they are proposed, they may come with eligibility requirements that concentrate benefits to lower-income households. This would be entirely in line with the egalitarian ideology that underpins our welfare state.

It would also reinforce the growth-depressing macroeconomic mechanisms that come with the same welfare state. These mechanisms can be seen from many different angles, one of which is the relationship between the size of government and GDP growth. Figure 1 reports numbers for these two variables from 31 European countries over the period 1996-2019, with observations sorted based on the ratio of government spending (G) to Gross Domestic Product (Y):

Figure 1

Source of raw data: Eurostat

The bigger the welfare state, the bigger is our overall government. Therefore, the farther we stretch our ambitions in terms of economic redistribution, the more we will depress economic growth.

Not only is there ample economic evidence to show this, but the negative relationship between growth and the size of government really makes common sense. The welfare state provides benefits to low-income households. Those benefits are contingent upon their income: the more they make the more they lose of their benefits. This works as a de facto tax increase on their income; in my book The Rise of Big Government I demonstrate how a family making less than $40,000 can face the same marginal-tax on a given income increase as a family making ten times as much.

When you lose benefits faster than your income increases, you are disincentivized from pursuing that increase. Therefore, workforce participation is held back, both in quantity and in quality:

  • For workers at less-than-full employment the loss of benefits discourage them from putting in more hours;
  • Workers who are offered promotions or have opportunities to improve their skills will refrain from doing so if the cost exceeds the expected benefit.

When workforce participation is held back, both quantitatively (hours) and qualitatively (skills), the economy does not grow as much as it otherwise would. In short: we get the negative correlation reported in Figure 1.

If the Democrats go ahead with their proposals as outlined in the Biden stimulus plan, they will encourage more Americans to become dependent no the welfare state and discourage more Americans from workforce participation. The inevitable consequence is rising costs of government and depressed growth in tax revenue.

A structural budget deficit. This deficit is perpetuated and exacerbated by the welfare state itself; by expanding the welfare state, the Biden administration and the Democrats in Congress will also expand our budget deficit.

Fortunately, the mechanisms that entrench and expand the structural deficit also work the other way. Once we start reducing the size of our welfare state, we will see the economy grow faster and stronger. It is definitely possible to do this: in my ebook Tax Cuts Don’t Work I explain in detail why we need to focus on spending reform, and what type of spending reform we should favor.

The Democrats need to rethink their fiscal policy, but they are not the only ones who need to do it. Republicans are just as guilty as the Democrats of creating a fiscally unsustainable government. If Republicans snap out of their fixation on tax cuts and Democrats give up their dream of endless government expansion, the two parties might actually pursue bipartisan spending reform that will stabilize the welfare state and steer us away from the rapidly approaching fiscal cliff.

Again, it is not hard to find the necessary reforms. What is hard to find is the will to get them done.