Growing Our Way to Solvency

The solution to the fiscal problems with which we're all faced is to readjust the tax rules, accounting rules, and other regulations so that productivity increases more quickly.

In my 2008 article, I showed that we can absorb almost any one-time increase in spending if only we preserve one simple rule: the rate of spending increase in constant dollars has to be less than the rate of growth in GDP.

In the intervening years, we’ve seen the consequences of electing both a Congress and an executive who have ignored this. The result is shown in a chart that’s been all over the web; it originally came from the Heritage Foundation and is reproduced here:

The Obama administration has, with the stimulus plan, introduced a one-time massive expenditure and then followed it with rapidly growing expenditures with the health care plan. When we put those together, according to the CBO, we get a new chart, like this (linked from Greg Mankiw’s blog because the CBO chart is in an annoying slide show):

Now, squint just a little bit, so you can ignore the (rather frightening) numbers, and just look at the two colorful ribbons. The blue ribbon is tax receipts; the green ribbon is expenditures — in both cases, actual up to 2010, and estimated from then on.

You see the expenditures grow dramatically and receipts drop, between 2008 and today: that’s the effect of the recession, stimulus, Fannie and Freddie, and auto industry bailouts. Then, for a short while, receipts grow rapidly while expenditures drop, but by 2015 the expenditures are growing at least as fast as receipts. Longer-term projections show the same thing: expenditures growing much faster than receipts.

All of this really is just an extended argument to make the point the tea parties have been making for more than a year: it’s the spending, stupid!

Unhappily, simply looking at spending isn’t enough, either. Even if health care “reform” were repealed, there are existing entitlement programs that will continue to cost more, and the problems with increasing Social Security and Medicare costs won’t go away simply because we decide to not spend as much. Cut them back far enough, and people who thought their FICA “contributions” were buying them a pension will be falling back on their kids or begging on street corners. Long before that happens, the politicians who proposed the changes will themselves be out of work.

The answer is to go back to that one mathematical law: the rate of government spending growth must be less than the rate of growth in GDP. Except, let’s restate it with the inequality reversed:

The solution to the budgetary problem is that the rate of GDP growth must exceed the rate of growth of spending.

So, if spending can’t be completely contained — and it looks really difficult to do — then we have only one other solution. The economy has to grow faster.

This is assumed, but not really stated outright, in some of the Republican proposals. There’s always some lip service paid to the need to have a growing economy; the problem is we always talk about cutting taxes as a good in itself. But cutting taxes is a means, not an end. Cut taxes to zero, with the economy stagnant, and deficits simply increase radically.

So what can we do? The answer is to do the things that cause the economy to grow more rapidly, and that means increasing productivity — the amount of “stuff” you get per worker per year.

The usual way productivity increases is by investment: someone invests in building widgets more cheaply, and productivity goes up. There’s more to go around, GDP grows, and tax receipts grow.

What’s more important is that the standard of living grows. Think about the last 50 years: when I was a child, I still knew people who didn’t have indoor plumbing. Many adults today don’t remember a time when television was black and white. Kids born today will (we hope) never know a time when high-definition color television didn’t come in an square box the size of a magazine (if they remember what a “magazine” was).

Increase the rate of growth of the economy, increase gains in productivity, and everyone benefits. Sure, the rich get richer, but the poor get indoor plumbing, cell phones, and HD TV.

The solution to the fiscal problems with which we’re all faced is to readjust the tax rules, accounting rules, and other regulations so that productivity increases more quickly. An economic proposal that specifically targets faster growing productivity and thus a faster growing GDP, along with spending restraint, will let us grow our way out of the current fiscal crisis.

I’ve been saying this for years. It was the secret to the Reagan boom. I think we do need a radical reduction in the size and scope of government and a corresponding tax cut over a 2 year period (search Harding Depression 1920 to see what that will do!). But after, simple discipline of lower growth in govt. relative to GDP growth solves the problem without major jerks and starts and stops and stalls.

Cut small business regulation to the bone. Offer a new option - a Federally Chartered Small Business, that in exchange for a modest annual fee remains permanently exempt from most state and local regulations and taxes. Watch the rent-seekers scream with a cold drink in your hand and a sneer on your lips. And watch economic growth go to the moon. :)

“An economic proposal that specifically targets faster growing productivity and thus a faster growing GDP, along with spending restraint, will let us grow our way out of the current fiscal crisis.”

We will be at 100% GDP in public debt in 2015 (or sooner if the economy keeps slipping away). With that in mind, combined with the $45T in unfunded liabilities by 2025, I am nearly positive the market for government debt will fail long before we could ever grow our way out of the debt/spending problem. To quote Ben Bernanke, he said “When something is unstainable, it WILL eventually stop.” That stopping point will be a hard stop when we will no longer be able to sell our debt. At that point the spending will indeed stop, but the economy will also take a big hit, making the crisis we’ve just experienced look like some of our better days. We could tax everyone at 100% until then and still not avoid this because we simply do not have that much money, nor will we by the time the piper comes calling.

With even a basic understanding of economics you can see why government spending will never grow GDP.

GDP=C + I + X + G If you increase government spending, G, you do so by increasing taxes and/or borrowing. Higher taxes means less disposable income and reduces C (consumption) and I (investment). Borrowing reduces I (investment) because the purchase of government debt takes away money that could have been invested in businesses ...this is called the "crowding out effect". Taxing the wealthy more also reduces I (investment) because the wealthy with more disposable income save and invest more than those with lower disposable incomes.

Net exports, X, the dollar value of goods and services exported from the US less the dollar value of goods and services imported, becomes increasingly negative as the taxes and debt resulting from increased government spending drops the output of goods and services available for export and pushes US businesses to outsource to lower tax countries where the goods and services they make then get imported to the US.

Adding government jobs is also non productive in the economy as bureaucrats produce no goods or services sold in the market and the wages paid to government workers come from higher taxes and/or more government debt.

High unemployment further reduces the potential GDP. According to Okun's Law for every 1% of unemployment above the natural rate of unemployment the GDP is reduced by 2% from its full employment potential. The natural rate of unemployment in the US was about 4-6% thus with the Obama economy our GDP is as much as 15% less than what it would have been had we maintained the unemployment rate of the Bush years.

Obama's tax and spend economic policies assure a lower GDP

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