Both taxes and spending must be cut
By W. James Antle III
Milton Friedman recently observed that government spending and government-mandated private expenditures exceed 50 percent of national income, making the United States economy "more than half socialist." While Friedman, the leading voice of the Chicago school of free-market economics, views this fact with disdain, it didn't deter President Bush from submitting a budget that increases federal spending in most categories and includes some $1.96 trillion in outlays for the new fiscal year.
With federal spending now approaching $2 trillion annually under a Republican administration, compared to $1 trillion in 1987 and only $2 billion when Franklin D. Roosevelt took office in 1933, perhaps there would be criticism from conservatives of Bush's spending increases. Instead, there is criticism of Bush's effort to limit annual spending increases to 4 percent annually. It should be noted that this projected rate of increase will almost certainly be greater than inflation and possibly greater than the economic growth rate, yet even some Republicans are calling this modest effort at spending restraint too parsimonious.
Both Senate Finance Committee Chairman Charles Grassley (R-Iowa) and Senate Budget Committee Chairman Pete Domenici (R-N.M.) have called for the bloated federal budget to grow at a 6 percent rate annual rate, 50 percent faster than the White House deems prudent. Many Republican members of Congress are calling on President Bush to lavish new spending on Republican constituents such as farmers, small business owners and pensioners. That politicians would eschew fiscal responsibility in order to buy votes with the confiscated wealth of their fellow Americans isn't particularly surprising. What is disappointing is that even some conservative opinion leaders, people who are engaged in persuasion and marketing ideas rather than winning votes, are opposing Bush's plan to limit federal spending growth.
Lawrence Kudlow recently came out against efforts to cut spending in an article for National Review On-Line, in which he restated the basic supply-side case against spending restraint. Kudlow is correct in his fervent advocacy of tax reduction and is a persuasive defender of tax cuts, but his economic analysis often flounders when he leaves the realm of marginal tax rates. When he is not urging the Federal Reserve to inflate the money supply, he is discouraging conservatives from seriously trying to limit government.
Kudlow seems to be among the conservatives, including Jack Kemp, who regard supply-side economics as a deal with the welfare state. In exchange for lower tax rates and a more rational tax policy, a growing economy will provide the welfare state with even more revenues. Thus the right gets lower taxes and preserves a relatively free economy, while the left can continue to expand government without fear of budget cuts. Aside from the inherent moral and philosophical contradictions of such a policy (why leave unjust federal redistributive powers intact?), you can't indefinitely maintain what journalist David Frum has called "post-Great Society government at pre-Great Society prices."
In his NRO piece, Kudlow also repeats the argument that a growing economy induced by lower tax rates will produce more favorable conditions for limiting government later. It is true that people demand fewer services and subsidies from government when the economy is producing jobs and wealth. Conversely, an economic contraction increases the demand for subsidies and services from the government. Kudlow is also correct in his observation that a growing economy creates more favorable political conditions for the passage of certain government-limiting measures, such as welfare reform in 1996 and private investment-account Social Security reform in the future. But cutting taxes without cutting the government spending that drives those taxes forever upward is not a sound long-term strategy for either keeping taxes low or limiting government.
The evidence from the Reagan years shows quite clearly that this strategy is doomed to failure. President Reagan won passage of the largest tax cut in history, an across-the-board 25 percent reduction in marginal income tax rates. The tax cut was successful in igniting an almost decade-long economic recovery and increasing federal revenues. Yet the Reagan administration failed to adequately confront federal spending, and the end result was that the government continued to grow larger and taxes eventually went up again.
Federal spending increases outstripped the gains in federal revenues, causing three-digit budget deficits and the doubling of the national debt. With both parties basically opposed to significantly shrinking the federal budget and only the Republicans opposed to higher taxes, it soon became clear that it was tax limitation that would have to give when it came time for Congress to confront the deficit. Surreptitious tax increases began as early as 1982, before the Reagan tax cuts were even fully implemented, yet Congress still continued to spend every dollar that came in and then some. Additionally, the Reagan administration's unwillingness to challenge federal spending on health care and deposit insurance helped foster medical price inflation and the S&L debacle, respectively. Massive deficit spending undermined public confidence in the Reagan tax cuts and supply-side economics generally, obscuring the accuracy of supply-side predictions about marginal rate cuts and the overall success of the Reagan economic program.
The end result? The effects of escalating health care costs, flagging real estate markets and the S&L disaster contributed to the 1990-91 recession about as much as the hated 1990 tax-rate increase. Taxes, regulation and spending all ended up increasing. The top marginal income tax rate was raised from 28 percent to 31 percent in 1990, and then to 39.6 percent after Bill Clinton won the 1992 presidential election. Even Reagan signed tax increases into law that ended up eroding about half his landmark 1981 tax cut.
Had federal spending grown no faster than the rate of inflation from 1979 to1989, government would be smaller, tax rates would be lower and the economy would be more prosperous. Social Security reform even more ambitious than envisioned by President Bush would have been possible, because we could have afforded a one-third cut in payroll taxes. The corporate income tax could have been completely repealed. Rather than tax increases, deeper tax cuts could have been contemplated. This would not have been a Herbert Hoover austerity program; it would have been a more sustainable Reagan growth program.
Today's conditions are even less favorable to Kudlow's proposal than they were during the Reagan years. A 39.6 percent top marginal rate may be immoral and economically self-defeating, but cutting it will yield less Laffer Curve effect than cutting the 70 percent rate of 1981. Cutting the lower rates and dropping 4.5 million low-income taxpayers from the rolls entirely will probably have no significant revenue-reflow effect, as even the most committed supply-sider must concede a 15 percent tax rate isn't very far out on the Laffer Curve.
Even if a budget-busting Congress does not bring back deficits, surpluses have certainly not brought about spending restraint. Kudlow argues that during the sustained growth of the 1980s and 1990s, "continued prosperity shrunk government as never before." It is true that various categories of government spending declined relative to GDP. But some of these percentages represent the speed of economic growth, not the retrenchment of government. Moreover, some of the discretionary spending restraint was the result of pay-as-you-go budget rules that were adopted in exchange for increasing the top income tax rate in 1990. Under those rules, new discretionary spending had to be paid for with corresponding budget cuts - or tax increases.
Far from limiting government, more robust growth has increased tax burdens by pushing Americans into higher tax brackets. Federal spending has increased in recent years at rates last seen during the Carter administration. In fiscal 1998, federal discretionary spending increased by 2.9 percent after inflation, double the rate of the previous year. The rate of increase doubled again to 5.95 percent the following year and reached 7.1 percent the following year - twice the rate of inflation. The Republican Congress authorized spending $225 billion more than the Clinton administration requested through 2010 and exceeded the budget caps set in 1997 by $83 billion. Discretionary spending was set to rise at perhaps an 8 percent rate. In the era of surpluses, the pay-as-you-go budget rules are gone.
If you are not persuaded by the example of this profligacy and don't see anything inherently wrong with government forcibly confiscating people's wealth for pork-barrel projects and corporate subsidies, perhaps you might still think the Constitution is binding on the US government. Kudlow, like most people in America, ignores the fact that the Constitution enumerates federal powers and sets limits on what federal spending may be considered legally permissible. Yet Kudlow isn't just concerned about budget-cutters trimming popular but unconstitutional programs. He is even willing to accept corporate welfare if it improves the odds of passing a tax cut. He describes pork as "part of the congressional job description."
Lowering tax rates on income and capital is an important objective, especially in the current economic climate. Kudlow is right to think that this will encourage investment and promote economic growth. But ultimately, the only way to reduce the amount of private wealth the government will confiscate is to reduce the size and reach of the government. The modern welfare state and a vibrant, low-tax, free-market economy cannot indefinitely co-exist. This is not a root-canal approach to austerity. It is a basic arithmetic reality.
W. James Antle III is a former researcher for the Rhema Group, an Ohio-based political consulting firm. You can e-mail comments to email@example.com.
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