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.
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:
- If median income is $50,000 and the poverty limit is 55 percent of that, then you are poor if you make $27,500;
- 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):
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:
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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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:
- The rules are “Pippi rules”, i.e., they are self enforced with impunity for non-compliance;
- 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:
- 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;
- 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;
- when government spending grows faster than tax revenue, we get a structural budget deficit.
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:
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:
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:
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:
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:
We have now learned three important things about the government budget:
- As spending grows, GDP growth declines;
- As GDP growth declines, spending growth accelerates; and
- 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:
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:
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.
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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 For a more detailed discussion of the ideological character of the American welfare state, see Larson (2018) and Larson (2020f).
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:
- More and more people get benefits from government in the form of health care, education (including college), income security, retirement and plain cash handouts;
- 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.
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:
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
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.
 Moore and Laffer: Trumponomics. All Points Books (2018).
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
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
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.
There are some very good organizations out there fighting to keep taxes down. Americans for Tax Reform is at the forefront, with others not far behind. They all fight the good fight: it is always preferable to have lower taxes than higher taxes.
Many economists propose tax cuts as a way to reduce the budget deficit. The idea, known as supply-side economics, is based on the premise that lower taxes generate stronger economic growth, which in turn generates more tax revenue.
Supply side economics is a valid theory and the Laffer Curve – almost the hallmark of supply-side theory – has strong empirical support. I recently published an article where I reported data for the European economy, showing a solid Laffer effect on tax revenue. However, I also cautioned:
There is another side to the Laffer Curve, of course. If government does not cut spending in tandem with the tax cuts, but if entitlement programs are allowed to continue to grow, then the rise in revenue collections will be inadequate and fail to fully fund the welfare state. Therefore, the Laffer Curve must not be used as a simple go-to solution when deficits get out of hand; it is an instrument that should only be applied as part of a structural transition from a big welfare state to a small government focused on its core functions.
Once the welfare state grows past a certain point, the Laffer effect, while still visible, will be far too weak to close deficit gaps. Plain and simple, the supply-side mechanism ceases to function insofar as the government budget goes. Tax cuts still generate more economic growth and thereby an increase in tax revenue, but without adequately affecting the government budget.
The reason is as simple as it is brutal: too much spending. Having grown increasingly frustrated with the lack of focused attention to the spending side among libertarians and conservatives, in the next few days I will be rolling out a series of articles on the dynamics between tax cuts and spending cuts.
While fiscal conservatives do pay attention to spending, it is almost always in an ad-hoc manner. A common idea for reform is a penny-plan style reform that slows the growth of government spending. This is not a bad idea in and of itself, but as we will see in a coming article it does not solve the underlying structural problems that drive government spending. A penny-plan style spending reform buys us time, slowing the growth of government enough to let Congress piece together a major entitlement reform agenda.
What we need is a master plan for the structural overhaul of our welfare state. We need to reform it away until government is out of the business of economic redistribution.
This is no easy task. It is in fact more daunting than it was back in the 1960s putting the first man on the moon. That, however, is no excuse not to do it. Leaving an unaffordable welfare state for our children to pay for, and asking them to do so while also funding our consumption of the welfare state in the form of a big government debt, is nothing short of collective egoism.
It is also a safe way to ruin the country and the future of generations of Americans.
To see why the master plan is the way to go, and supply-side economics no longer works, we will work our way through a stack of data. We start today with a review of state and local government finances. Specifically, the review will show that the absence of an income tax does not help in terms of containing government spending. Bluntly: states with no income tax have just as big governments as states where income taxes provide a large share of government revenue.
As a first step, Figure 1 reports the combined fiscal balance for general revenue and expenditure for 2018 in all the 50 states. The vertical axis represents the difference between general revenue and general spending as percent of general revenue. This metric varies from year to year, with the majority of states swinging between surplus and deficit. However, the picture is almost always mixed, as reported here:
Figure 1: State and local government fiscal balances
Over the long term, states and local governments have had about the same problem with balancing their books as the federal government has. The deficit problem is not as pervasive, but there are years when almost all of them run deficits.
It is important to remember that these numbers include both states and local governments; the local-government share of spending varies significantly across state lines. In other words, to ignore local governments would be to give an unfair, even skewed representation of the role of government in our states’ economies.
Most of our government spending is allocated to the welfare state, i.e., programs that provide government benefits to people for the purposes of economic redistribution.* Two thirds of federal spending is for the welfare state; in 2018 the average for states and local governments was 56 percent. This share has increased over time, slowly increasing the stress on government finances. A spending program for economic redistribution is driven not by what taxpayers can afford, but by the definition of the entitlement embedded in the program. Medicaid, e.g., provides health care to its enrollees, giving them access to a portfolio of medical services the quality of which is defined by medical technology, and the quantity by patient health conditions.
I have discussed the discrepancy between health-care costs and tax revenue in a previous article. The same principle of independent cost hikes applies to education, income-security programs, housing and everything else provided under the welfare state.
This point is almost universally overlooked in the fiscal-conservative movement. Too much focus is no tax reform, specifically to keep taxes as low as possible. While, again, a respectable ambition in itself, it does not help with containing the growth of government. For example, if a state eliminates its income tax, it will most certainly not reduce the size of its government. Again based on 2018 Census Bureau data on state and local government finances,
-In the nine states where the personal income tax contributes 0-1 percent of total revenue, government spending amounted to 21.9 percent of total private-sector economic activity, a.k.a., private-sector GDP;
-In the 12 states where the personal income tax provided more than 15 percent of total revenue, government spending was equal to 21.2 percent of private-sector GDP.
The 29 states in between had roughly similar-sized governments. In other words, it does not help fiscal conservatism to abolish the personal income tax.
But does it harm fiscal conservatism to do so? That question is not primarily a matter of economic analysis, but there is one point that can contribute to the answer. Table 1 reports the revenue share of the personal income tax (Typ) and the revenue share from non-tax sources:
Table 1: Government revenue sources
In short: when governments cannot rely on the income tax they seek out other revenue sources instead. To take one of the favorite examples among opponents to the income tax, in 2018 government in Wyoming got 75 percent of its revenue from non-tax sources. This is the highest share in the country. Contrast this to Connecticut, where the personal income tax provided 22.3 percent of total government revenue and non-tax sources added one third of total revenue.
Government spending as share of private-sector GDP was 16.6 percent in Connecticut – and 29.9 percent in Wyoming. In other words, the supposedly low-taxed Cowboy State has the fourth largest government in the country. And this is a reasonably generous measure: if we use private personal income instead – the most proper tax base measure available – Wyoming has consistently ranked in the top two in the country.
However, more important than these factoids is the problem with political effort. It takes a lot of work to advance policy reform – spending of political influence capital – which means that every such effort must be designed to yield the best possible outcome. If we use proper metrics for that outcome (rolling back the welfare state) then it is unquestionably better to focus on spending reform instead of tax reform.
In Part 2 of this series we take a detailed look at why supply-side tax cuts are no longer effective, and why spending reform is the only way forward.
*) This category of spending includes social programs, income maintenance, health care, unemployment benefits, housing and community development and education. The last item is often overlooked, but regardless of whether or not one defines education as an essential government service, it does belong in the redistribution category. Government provides the service based on criteria defined by government, not decisions made by individuals; funding is also independent of the use of the service.
In my latest op-ed for InsideSources I explain:
While the Democrat House leadership touts a very irresponsible plan for even more COVID-19 stimulus spending, the White House is signaling its equally irresponsible alternative. In an October 6 op-ed for the Wall Street Journal, Steve Moore, a member of President Trump’s economic recovery task force, proposes a 100 percent suspension of all federal personal and corporate income taxes for 2021.
Moore’s crazy idea is to simply suspend federal income-tax collections for 2021. In response, the U.S. Treasury would have to borrow $2 trillion from the Federal Reserve, on top of what the central bank is already supplying to fund the welfare state.
Moore, whom I know and who is a good and enthusiastic economist, seems to be unfettered by this increased practice of Mad Monetary Theory in Washington. To his credit, though, he has produced the same idea for abolishing the income tax in another context. Here is what Moore said back in July:
Stephen Moore, a member of President Trump’s economic recovery task force and an economist at FreedomWorks, has a bold idea for how to reinvigorate the economy: abolish the federal income tax, and replace it with a national sales tax. On the face of it, it may seem like a radical notion especially since essentially all Americans nowadays have grown up having a chunk of their income pulled out by the IRS every year. But Moore notes that the income tax is a relatively new invention in the U.S. — having only been introduced in the early 20th century.
This idea has been on the table for a long time. It has been called many things and is sometimes referred to as a “fair tax” reform.
Moore is right in that a sales tax is preferable to an income tax, and all other things equal this is a good reform to pursue. The problem is that all other things are not equal – especially not government spending. Right now, we need spending reform more than we need tax reform.
Take a look at Figure 1. It reports the shares of total government spending in the United States, federal, state and local added together. The numbers are the “rawest” you can get, with no adjustment for inflation or seasons. The message is unmistakable:
Figure 1: Shares of total government spending
Ever since the 1960s, government consumption has declined in importance. This is the kind of spending that goes to national defense, law enforcement, education, infrastructure and other outlays where a person is paid to do work for government (including on a contracting basis). In the past decade, social benefits – cash paid out under entitlement programs – has surpassed consumption as the most important function of government.
A point of order, before we move on: some consumption spending also qualifies as entitlements. For example, when government pays for health-care services through Medicare and Medicaid, it provides medical-service entitlements. We also refer to them as “in-kind entitlements”. This is a small but important note, because it helps us understand what is happening behind the numbers in Figure 1.
Before we get down into those details, let us first take a closer look at the same numbers for the federal government:
Figure 2: Shares of federal government spending
The trend from Figure 1 is even stronger here: social benefits overtake consumption already in the 1970s. Before the stimulus spending in 2020, this type of spending was already claiming more than half of the federal budget.
Which brings us back to the point about entitlements. Again, social benefits are one entitlement type – cash entitlements – but some consumption also falls in the entitlement category. Health care and education stand in the forefront, but any consumption (also known as “government services”) that is not for national defense, law enforcement and infrastructure qualifies as in-kind entitlement.
If we add up cash and in-kind entitlements, we get the welfare state. Its share of the federal budget was around two thirds before the Covid-19 stimulus craze. It remains to be seen what it will be going forward, but it is a rather safe bet that it will be higher.
Herein lies the real problem with spending: entitlements grow not because Congress keeps adding money, but because of their design. Each entitlement specifies an eligible population and how much they are entitled to. This is the entitlement value of the program, and it grows for two reasons:
- The eligible population grows;
- The product offered to them changes in character.
The second point sounds abstract, but its actual meaning is simple. In terms of services, the entitlement program promises the eligible population a portfolio of benefits with the explicit or implied promise that those benefits will be of a certain quality over time. In health care, this means that entitlement spending must grow with the rising cost of high-quality health care.
For cash entitlements, the cost driver is partly in the protection of the benefits against inflation. However, there is also the eligibility threshold: one example is the Earned Income Tax Credit, which tapers off with rising income but also expands its reach as its thresholds increase.
In short: once Congress has designed an entitlement program, it gives up control over its cost drivers. It can claim that control again, but it takes legislative action. One such action would be to bring entitlement spending out of the “permanent” section of the federal budget and into the “discretionary” fold. It is only an administrative maneuver and won’t make any difference in itself to the costs of the program, but it is the one step Congress needs to take in order to be able to reform entitlements.
Once that practical problem has been solved, Congress can move on to the next step, namely reforming the programs themselves.
How do they do that? Here is some food for thought to start with.
Over the past 20 years our economy has been growing more slowly than it did during the 20th century. We went through two presidential terms under Obama without a single calendar year with three percent growth. In his first term, Trump has presided over a modestly better economy, thanks in no small part to his tax cuts and his deregulation policy, but we still have barely touched three percent.
The source of our slow growth is to be found in the welfare state. This big conglomerate of economic redistribution puts mechanisms to work in the economy that slowly grind it to a halt. I explained those mechanisms in my book Industrial Poverty and I discussed them further in my book The Rise of Big Government.
Slow economic growth claims many casualties. One of them is, of course, the welfare state itself, the entitlement systems of which are slowly starved to the brink of implosion as tax revenue dries up. Europe is painfully aware of what this means; here in America we have seen the first glimpses of this phenomenon in the massive money printing that the Federal Reserve has engaged in from time to time over the past two decades.
Another casualty is our children’s prosperity. As I explain in Industrial Poverty, a country that is brought into economic stagnation by its welfare state will suffer from high, permanent youth unemployment. It will be so high that the young generation is effectively barred from ever obtaining a higher standard of living than the generation of its parents. More than likely, every generation will grow up to be slightly poorer than its parents were.
This economic regress takes many forms. One of the less explored is the slow demise of retirement security. It is well known that Social Security is one of the big casualties of our emerging economic stagnation. As I explained in Ending the Welfare State, we can still save retirement security from the Social Security collapse, and the solution – an algorithm-driven transition into private accounts – could serve as a platform for saving another stagnation casualty.
Private retirement saving.
Americans continue to rely to a large degree on private savings accounts. This is good, because it gives people a certain level of independence from government fiscal excesses, but those savings are not immune to economic stagnation. All other things equal, private retirement savings depend on the long-term growth in personal income. That growth, in turn, is closely tied to the growth rate of Gross Domestic Product.
Pension systems – government or private – are never better than the balance between contributions and benefits. The original pension-system form where retirees relied on defined benefits are the most vulnerable to the long-term slowdown in economic growth, but the alternative, also known as defined-contribution plans, is also vulnerable. The reason is in the difference between the plans:
- Under a defined-benefit plan the implicit assumption is that discrepancies between benefits and contributions are solved by means of changes to contributions (higher fees, simply);
- A defined-contribution plan is supposed lower benefits to weather cash-flow crunches.
In reality, the maneuverability of either plan is limited. The defined-benefit plan can only raise its fees within the realm of what people can spare out of their current paychecks. The defined-contribution plan cannot lower its benefits more than what people will tolerate without pulling their money out. Nevertheless, the prospect of fixed fees and some variation in benefits has slowly increased the attractiveness of defined-contribution plans. As Figure 1 reports, over the past decades this plan type has slowly gained ground on the defined-benefit alternative:
Figure 1: Source of retirement benefits by plan type
Despite the shift toward defined-contribution plans, our retirement systems are slowly sinking into a cash-flow squeeze. The rise of the defined-contribution alternative has slowed this trend, but it has not stopped it. As Figure 2 reports, those plans are also fighting a losing battle against economic stagnation. The cash flow reported in this figure is simply the margin between, on the one hand, actual employer and household contributions plus the plan’s earnings on assets, and on the other hand benefit payments, withdrawals and administrative expenses. The net, which is the cash flow surplus, is reported as a percentage of total plan revenue:
Figure 2: Pension-plan cash flow
In addition to the slow cash-flow decline, the urgent message in Figure 2 is the plunge of defined-benefit plans into negative territory. They pay out more than they take in, simply. This means, plainly and brutally, that we are already in a situation where our retirement system is degrading.
We hear a lot about how our pension-plan problems are allocated to government. This is correct, and as Figure 3 demonstrates, state and local governments are seeing their defined-contribution plans bleed cash. However, what is often overlooked is the precarious situation for the defined-benefit plans in the private sector:
Figure 3: Cash flow balance in defined-benefit plans
To some degree the deterioration of defined-benefit plans in the private sector could be the result of withdrawals to invest in defined-contribution plans. As we saw earlier, those have grown in prominence and are now responsible for almost half of all benefits paid out. However, as Figure 2 told us, even that type of plan is in financial decline.
To get another perspective on the problems with the private plans, consider Figure 4 which reports the cash-flow deficit in defined-benefit plans as share of total employee compensation for the private sector. The red columns represent the rise in fees needed each year to avoid the negative cash flow:
Figure 4: Cash Flow and Employee Compensation
Over the past ten years, owners of private defined-benefit plans would have had to surrender almost one extra percent of their employee compensation – or about 1.2 percent out of their wages and salaries – to avoid the negative cash flow. This does not sound like much, but it is only to keep the defined-pension plans afloat. We have not even taken into account what we would have to do to stop the deterioration of defined-contribution plans.
Then, of course, we have the state and local government plans, plus Social Security. Adding up all these plans, we as a nation face a retirement-funding crisis that is being exacerbated by our inability to get the economy back to higher rates of growth.
That, in turn, is a problem caused by our ideological commitment to a fiscally unsustainable welfare state.
We as a nation have a lot of work to do.
The Covid-19 epidemic has given the world a good opportunity to study the quality of health care systems. We often hear from proponents of single-payer systems that we would get so much better health care if we just handed it all over to government.
Experience from this epidemic says otherwise. On the contrary, Europe, which is saturated with government-run health care systems, has struggled quite a bit with the epidemic. At the forefront of their problems has been a shortage of hospital beds.
Before we get there, though, we first need to take a quick look at the U.S. system. Thankfully, we don’t have a Medicaid-for-All system, but politically we are closer to it than most people realize. We are in fact hanging on the precipice of it, which makes the recent European experiences so much more important. There are few people remaining on the right side of the political aisle who are willing to fight back against the Medicaid-for-All movement. Outside of the Republican Study Committee, whose report last year presented a great plan for strengthening free-market health care, there is not too much happening among conservatives and libertarians.
This is strange and tragic. A Medicaid-for-All system is the crown jewel of the socialist welfare state, and since the libertarian movement has essentially surrendered on the welfare state in general, it lacks the ideological prowess to fight back on the Medicaid-for-All issue.
The lack of interest in fighting socialism in practice – the welfare state – is clearly noticeable across the libertarian movement. Their own party and presidential candidate barely even pay token interest to the welfare state. Worse still, America’s leading libertarian think tanks only use about ten percent of their resources to the fight against socialism in practice:
- The Cato Institute reports 67 experts on their website; six of those can be said to be working with issues even tangentially related to the welfare state and its systemic impact on the U.S. economy;
- American Institute for Economic Research, with its 63 experts, has four or five that touch the welfare state in their work (depending on how thin you want to stretch the definition);
- The Reason Foundation, proudly libertarian since 1968, boasts no more than three welfare-state interested individuals among its 32-strong expert crew;
- The Mercatus Center, the think tank at George Mason University, has practically enrolled the entire economics-department faculty among its 60 scholars, yet they still cannot find more than five whose research interests even affiliate with the welfare state.
The Heritage Foundation is the strongest institution in this respect. They have the Grover Hermann Center, which is dedicated to the study of the federal budget. In total, spread across all their departments, the Heritage Foundation has 12 welfare-state oriented experts, out of 96. Still spending only a small minority of their resources on the most critical problem of our time, Heritage nevertheless leads the libertarian movement in that regard.
With this scant attention to the practice of socialism in general, there is very little in the libertarian movement that can stop a Medicaid-for-All program. This leaves the field essentially open to the neoconservatives within the Republican party (who want a single-payer system because Irving Kristol said so) and the socialist left. Our hope lies with the aforementioned RSC report and its appeal to more conservatively minded Republicans.
Hopefully, they can find some strength in the numbers presented below. It looks increasingly as if private health-care funding is instrumental in protecting public health. This is not surprising, given that government-run health care systems suffer from two deficiencies, the first of which is its reliance on taxes for funding. By virtue of advancements in medical skills and health-care technology, the cost of providing health care goes up over time. In other words, just to keep health care quality intact, medical professionals need to raise prices over time.
This tendency, in turn, is countered by market forces. He who does more with less will always win over less productive competitors. Only a market-based health care system can strike a proper balance between the rise in costs due to quality advancements and the competition-driven decline in prices.
As an example of what this means, the health-care share of our economy (our GDP) has increased over time: looking at medical technology alone – disregarding for now all other components of health care expenditures – it was 1.3 percent of our GDP in 1980. In 2017, the latest year for which the Department of Health and Human Services publishes comprehensive data, that share is more than twice as high at 2.9 percent.
How would a single-payer system handle this? Since it lacks a countervailing force to the cost drive from quality advancements, and since health-care costs evolve independently of what taxpayers can afford, the only choices for a single-payer government are to raise taxes constantly, or ration health care access.
If we had operated a Medicaid-for-All single payer system, and if Congress had been wise enough not to raise taxes, we would have been forced to keep the med-tech share of our health care costs constant. We would therefore have had to forfeit advances in medical technology – or raise taxes.
But what is a tiny share of our economy like this one to quarrel about? As a general point, this is a valid question, of course. As share of GDP, spending on medical technology looks like chump change. However, looking at it as a market within the economy, medical technology actually translates into significant numbers. In 2017 we spent a total of $569 billion on medical technology. This includes durable technical instruments, non-durable instruments, prescription drugs, health-care facilities and the medical equipment needed for them to be operational.
If we had kept the med-tech share of GDP constant, from 1980 to 2017 we as a nation would have been limited to spending only $267.4 billion on medical technology. This would have meant a loss of more than $301 billion worth of instruments, equipment, clinics, hospitals and pharmaceutical products.
Such rationing would have had serious consequences for health care access. For every $1 million we reduce spending on medical technology, we have to make proportionate reductions in staffing. Over time, this kind of rationing has serious cumulative effects: as a thought experiment, consider what the effects would be if we removed 53 percent of all health-care spending in our country.
Another key question is, of course, what incentives entrepreneurs would have had to develop new technology for our health care system. To stick with the time horizon from 1980 and on, where would our health care have been today in terms of quality and ability to cure and heal?
Proponents of health care socialism often bring up administration as the holy grail of cost reductions. What they forget is that the decisions being made by administrators in today’s systems also must be made under a single-payer system. Hospitals and clinics still need to file claims for every procedure; someone needs to evaluate every claim; someone needs to process every claim; someone needs to cut the checks and send them out to the health care provider.
Someone still needs to keep track of supplies, order supplies, pay for them, make sure deliveries were according to specifications, distribute the supplies within the hospital… Human resources staff still need to make sure there are enough doctors, nurses, midwives, cleaning staff, procurement staff, computer experts and other employees throughout the health care system.
And someone still needs to evaluate the health care procedures to make sure that resources are not being wasted. For a glimpse of what this means under a government-run system, see the chapter on fiscal eugenics in my book The Rise of Big Government.
Table 1 explains the components of health-care costs (billions of dollars) in 2017, for the nation’s entire health care system.
|Health Care Cost Breakdown||US$ billion|
|National Health Care Expenditures||3,492.1|
|Physician and clinical expenditures||694.3|
|Other health-care professionals||96.6|
|Home health care||97.0|
|Non-durable medical products||64.1|
|Durable medical products||54.4|
|Nursing, continuing care||166.3|
|Other health care||183.1|
|Administration, net insurance costs||274.5|
|Public health activity||88.9|
|Structures and equipment||116.9|
Administration costs amount to less than eight percent of total health-care expenditures. Of this, 83.6 percent is the net cost for insurance. In other words, even if the entire insurance administration cost was eliminated it would only save the health care system 6.6 percent of its total costs.
This would, again, be possible if and only if there would be no need for any administration in a single-payer system. As mentioned earlier, that kind of administration is always going to be needed. Government doesn’t just funnel money out to hospitals, clinics and other health-care providers without any kind of information on what is being done, when, how, why and for how much money.
On the contrary, a single-payer system would come under intense cost scrutiny, given the very high taxes it would require. If anything, administration would increase to minimize waste, fraud and abuse. It is simply a pipe dream to think that elimination of administrative overhead would have paid for the $301 billion in med-tech advancements that we would have had to give up in order to not raise health care taxes from 1980 for our hypothetical Medicaid-for-All system.
But that’s not all. A single-payer system requires another layer of administration: central planning of all resources. It would require National Medicaid-for-All Agency that would micro manage the appropriations for every hospital bed, every medical procedure, every drug prescription and every other transaction within the entire American health care system.
That takes a lot of people, and a lot of people cost a lot of money.
Once the single-payer system is in place, government will freeze its costs in parity with the tax base. This means making health-care rationing a standard operating procedure for the allocation of health care resources, meaning in practice that access and quality are made scarce.