Understanding the Cost of Government

As I explained in my latest op-ed for InsideSources, the U.S. economy is suffering from a government-debt explosion of a magnitude that

should rightfully send shivers through the country. This is a mounting national crisis that transcends party lines and ideological affiliations. Both parties in Congress have gone AWOL on this issue, and both Donald Trump and Joe Biden carefully ignore the problem.

Plainly, this is a problem that requires urgent attention – and a comprehensive, systemic solution. The first step toward that solution is to understand the problem, namely excessive entitlement spending. Two thirds of the federal budget goes to the redistribution of income, consumption and wealth:

Figure 1: Entitlement spending as share of the federal budget

Source of raw data: Office of Management and Budget

The column for 2020 is marked red, as it only represents a prediction. When we get the final numbers the entitlement share will probably exceed 70 percent for this year.

As of today, there are no clear signs that Congress is tapering off its spending binge. President Trump has postponed any talks about more Covid-19 stimulus bills until after the election, a sign that he may have started realizing just how precarious the situation is. However, for now the most reasonable assumption is that we will continue to forge ahead, and therefore continue to define the problem and point to the absolutely necessary solutions.

The essential component of that effort is, again, to direct the spotlight squarely at the core of the problem. Entitlement spending consists of two kinds of spending: doling out cash to people, and paying for services that are then given away to citizens that government has defined as entitled. In the first spending category we find, e.g., Social Security, the Earned Income Tax Credit and Temporary Assistance to Needy Families. The latter category consists of Medicaid, Medicare, public education and other programs through which government pays for services that some citizens benefit from.

It is the sum total of these programs, as share of all federal spending, that is reported in Figure 1. This is the figure – the spending – that Congress needs to rein in and reduce. Eventually, over the long term, it needs to eliminate all entitlement spending.

As of today – and probably for the foreseeable future – it is unrealistic to imagine any Congressional constellation that would dare to go all the way to the elimination of entitlements. However, while this long-term goal is ideologically desirable and fiscally and economically necessary, the urgent goal is to bring Congress to the starting point: reining in entitlement spending.

To do that, in turn, we first need to set our own focus on entitlement spending. That is easier said than done: as demonstrated by a quick sweep through the right-of-center think tank websites, a lot of the work being produced by libertarian and fiscally conservative organizations puts its emphasis on more or less irrelevant issues.

For starters, the Yankee Institute, a think tank in Connecticut, has published a study where they report that government employees in the state on average make 28 percent more than private-sector employees. The difference, they explain, lies primarily in the more generous benefits packages paid out to government employees.

This is an important factoid to bring to the public attention. I have myself published numerous articles about this statistic, part of if under the Government Employment Ratio that I originated back in 2011. However, the focus on employment and compensation ratios between the public and private sectors is ultimately a distraction. Yes, a government workforce costs taxpayers a lot of money, but the problem with that cost is not addressed in isolation. In fact, it is not even addressed as an independent issue. The only way to tackle it is to remove the reasons for having government employees in the first place.

Figure 2 explains what this means. It reports national numbers for the total cost of government, and the compensation of government employees, as share of private-sector employee compensation:

Figure 2: Government cost ratios

Source of raw data: Bureau of Economic Analysis

The red segment shows the non-employee cost of government. Before the 1970s employment compensation dominated government outlays; once the modern, economically redistributive welfare state had been created, spending on entitlements began taking over. In 2019 the entire government sector of the U.S. economy spent 28 percent more on non-employee outlays than on compensating its workforce.

In other words, if you want to bring government spending under control, you have to reform – and eventually reform away – entitlement programs. The Yankee Institute should follow up its current study with one that addresses this aspect of government spending, even if it is focused on their home state of Connecticut.

Other states make similarly good but more or side-track style contributions. The Cato Institute just published its latest gubernatorial fiscal report card. The guy in charge of it, Chris Edwards, is a solid fiscal policy analyst whose work always stands up to scrutiny. The problem, however, is that the report only addresses part of government spending, namely the General Fund. The motivation is that governors do not have jurisdiction over Other Funds, nor do they have control over the federal money that goes into state budgets.

From a strict technical viewpoint, this is a valid argument. The problem, however, is that Other Funds are often used by state governments to “conceal” spending from the general public, sometimes even from the legislature. My home state of Wyoming is a case in point: before I started writing about the true size of government here, many legislators believed that we only had 7,500 state employees. The real number is twice as high, but half of the state workforce is paid through something called “900 series” budget items. Therefore, they do not show up under the General Fund outlays.

It deserves to be noted that the Bureau of Labor Statistics reports the actual, total number of state employees, and therefore also allows for an account of the true cost of the government workforce. However, to get to that point one must first recognize the full size of government spending, namely add up General, Federal and Other Funds in the state budget.

It is worth noting that in 2019, according to the National Association of State Budget Officers, General Fund spending only accounted for 40.8 percent of total state outlays. This share has fluctuated over the years and varies a great deal across states, but the policy implication is clear: if we ever want to bring government spending under control we must first understand and account for all of it.

The Heritage Foundation has not published anything on government spending since September 18 and Dakota Wood’s piece promoting more defense spending. Before that, Rachel Greszler published a commentary on the deferment of Social Security taxes. In short, our nation’s dire fiscal situation does not seem to be a priority for this $85-million-a-year outfit.

Over at the American Enterprise Institute, which bills itself as an organization promoting a “freer and safer world” – whatever that means – continues to move away from its originally libertarian ideological domicile. Their latest contribution to our understanding of how costly government is, comes in the form of a case for increasing that cost. Angela Rachidi and two co-authors continue to make the case for a big, new federal entitlement program known as “paid family leave”. As I explained in my white paper on paid leave, this is a fiscally outright reckless idea that Congress should stay very far away from.

One of the more important ways to fight the growth of government is for government to retreat and give room for the private sector to grow and thrive. When that happens, more jobs are created and more people start businesses. However, in order to understand whether or not that is actually happening, we first need to know what metrics to use. The Foundation for Accountable Government makes a contribution to this effect, reporting in a new brochure that 1.7 million new businesses have started since June. This, they explain, is a record number with entrepreneurs starting new businesses “60 percent faster than ever before”.

Touting this as a major success for the American economic comeback, the FAG forgets to report how many businesses were destroyed as a result of the artificial economic shutdown. The omission of this number leaves the reader with the false impression that the U.S. economy is roaring back to growth and prosperity. It is coming back, and – as I have explained elsewhere – it is doing so in a V-shaped fashion like President Trump predicted. However, if we want to understand the comeback we have to report it with analytically accurate metrics.

Without an accurate approach to economic analysis, we leave our readers and our policy makers with inadequate information and a skewed, even false picture of the economic reality in which Main Street America lives. In this particular case, we get the impression that the U.S. economy is far stronger than it really is; although the FAG brochure is not intended to say so, it is easy to draw the conclusion that our private sector is impervious to the big cost of government. The only government spending item that the brochure really criticizes is the excessive unemployment bonus, the over-indulgence of which I examined in my Inside Sources op-ed.

There is a lot more to be said about our nation’s economic reality, and the scatter-brained approach of the libertarian movement in addressing the problems out there. For now, though, let us note that we will never save our country from its approaching fiscal disaster unless we first learn to correctly define the problem. That, in turn, will require that the practitioners of libertarianism and fiscal conservatism in the public-policy sphere put their intellectual indolence aside and start doing their homework.

No Need for Covid-19 Checks

In a couple of days we will enter the last quarter of this the strange year of 2020. Hopefully, 2021 will be a more normal year, and we can look back at this year as a weird anomaly.

As part of the review, we can start taking inventory of one of the most controversial aspects of government policy this year, namely the Covid-19 stimulus spending. As I have mentioned on my podcast, the combination of irresponsible spending by Congress and irresponsible funding by the Federal Reserve has put us in a precarious economic situation as a country.

Today I can report more numbers that beg some serious questions about the alleged economic necessity – let alone soundness – of the so-called stimulus spending.

The core argument for the CARES Act, the Families First Act (which included the elements of a paid-leave program) and the bills that are now being discussed, has been that the measures would save household finances and bring the economy back from the artificial shutdown. Emerging data suggests that the entire argument for the stimulus outlays has been hyperbolic to the point of reckless.

Let us make one point clear, before we move on: when government forces businesses to close and people out of work, government has a moral obligation to remedy the fallout of its actions. In line with this, it is perfectly reasonable that Congress temporarily raised the unemployment benefits. What is not reasonable is the rest of the stimulus spending going toward household finances.

Here is why. According to the Bureau of Economic Analysis, in the second quarter of 2018 (two years ago) total personal income – in other words all the money earned by individuals in America – was $4,437.6 billion, counted on a quarterly basis. In Q2 0f 2019, a year ago, that same personal income amounted to $4,620.2 billion.

This represents an increase of a bit over 6.1 percent in current prices.

So what’s the number in Q2 of 2020? $4,365.9 billion. Again, this is an annualized number counted quarterly – the Bureau of Economic Analysis does not publish straight quarterly numbers – but this number excludes any money coming from the coronavirus stimulus and from “other” stimulus money, i.e., the checks that all households got in the spring.

Now, let’s add those numbers. Defined similarly (annualized by quarter), the unemployment money added in $278.1 billion, which took total personal income up to $4,664 billion. This number is about one percent above where personal income was a year earlier.

Adding the stimulus checks – amounting to $456.3 billion on the annualized quarterly basis – we end up with $5,100.4 billion in personal income.

We are now 10.4 percent above where personal income was a year ago.

It is important to keep in mind that these are seasonally adjusted numbers, i.e., annual rates counted without regard to normal variations in economic activity due to calendar days, the tides of seasonally dependent industries, and so on. Therefore, they do not present the whole picture of the timing of the stimulus and unemployment spending. However, they do give us one important piece of information: the stimulus checks may have been a vast over-reaction from Congress.

Again, if we subtract the stimulus spending that was not funneled through the unemployment benefits system, we still have a personal income that tracked well with where it was a year earlier.

Statistics nerds will point out that the annual-rate component in these numbers disguise a massive drop in personal income, especially in the private sector. This is a fair point, one that we cannot control directly since the BEA does not publish raw, non-adjusted quarterly numbers for personal income. They do, however, provide that very type of data on government revenue; since the federal government as well as most states and many local governments levy income taxes, we can test for the shutdown effect by looking at raw data on income-tax revenue for the second quarter.

If the personal-income data disguise a major disruption in personal income in the second quarter, then we should see it mirrored in major losses of revenue from personal income taxes.

Starting with the federal government, in Q2 of 2018 they collected $389.7 billion in personal income taxes. In Q2 of 2019 that number had increased to $412.7 billion, an increase by 5.9 percent.

In Q2 of 2020, smack in the heart of the Covid-19 shutdown, the federal government collected $387 billion in personal-income taxes. That is a mere 6.2-percent drop over 2019 and almost exactly the same as in 2018.

These numbers reinforce the impression that the stimulus checks were entirely unnecessary.

State and local government revenue data point in the same direction. In the second quarter, they collected

$113.9 billion in 2018,

$129.8 billion in 2019, and

$123.9 billion in 2020.

In other words, states and local governments collected 8.8 percent more from personal-income taxes this year than two years ago, and only 4.5 percent less than last year. Since these are raw numbers, not adjusted seasonally and not adjusted annually, they give us an accurate image of what happened to personal income – in other words household earnings – during the thick of the shutdown.

Given these numbers and given that the funding came fresh from the money printer at the Federal Reserve, those checks were simply not defensible.

Congress is currently considering more stimulus spending, with some suggesting another round of checks. That would be highly irresponsible, to the point of fiscal and macroeconomic recklessness.