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Archive for the ‘Government Spending’ Category

The Congressional Budget Office just released a Monthly Budget Review showing a $782 billion deficit for the 2018 fiscal year.

My recommendation is to mostly ignore data on red ink. Yes, it is possible that a country can get in trouble because of deficits and debt, but it’s far more important to look at what’s happening with government spending.

This is for two reasons.

  • First, spending is the most accurate way of measuring the fiscal burden of government. Regardless of whether it is financed by taxes or borrowing, spending is what requires resources to be diverted from the economy’s productive sector.
  • Second, the best way of predicting red ink is to look at what’s happening to spending. If the burden of government spending is growing faster than the private sector, that’s a very worrisome trend. In the long run, it leads to fiscal crisis.

With this in mind, I dug into the CBO numbers to see what’s really happening.

Lo and behold, we find that the deficit was falling rapidly when there was a de facto spending freeze between 2009 and 2014. But ever since 2014, spending has been growing more than twice the rate of inflation and the deficit is climbing.

Does tax revenue also play a role? Of course.

I’ve already explained that the Trump plan has a front-loaded tax cut, so that has an effect on short-run deficits. But I also noted that the tax cut gradually disappears because the revenue-raising provisions from last year’s legislation become more important in the long run.

In other words, America’s long-run fiscal challenge is entirely the result of a rising burden of government spending. And that’s very clear in the Congressional Budget Office numbers.

The bottom line is that America has a spending problem, not a red ink problem. Deficits and debt are symptoms, but the underlying disease is that the federal government is too big and that spending is growing too fast.

The solution is to follow my Golden Rule with a spending cap.

P.S. To help them understand this point, Republicans need shock therapy.

P.P.S. Maybe it’s difficult to educate Republicans because they’re part of the problem?

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I’ve been in Lebanon for the past few days, but not because I’m seeking a replacement for the Princess of the Levant.

Instead, I’m here because the Lebanese Institute for Market Studies arranged a briefing in the Parliament on the perilous state of the nation’s finances.

Lebanon is in trouble because policy makers have violated my Golden Rule by allowing spending to grow too fast. As such, even though the overall fiscal burden of government is relatively modest, red ink has climbed to about 150 percent of economic output. That’s higher than Italy today, and higher than Greek debt when that nation’s fiscal crisis occurred.

I’ve pointed out before that there’s not an automatic tipping point when a debt crisis occurs. It happens whenever investors decide that they no longer trust that a government will pay its debt.

I’m not going to predict exactly when Lebanon reaches that point, but I suspect sooner rather than later. Unless, of course, Lebanon changes direction.

And that’s exactly what I’m recommending. I made three points.

First, higher taxes are not a solution. Given the IMF’s awful track record of pushing tax hikes in the region, I repeated my standard joke about arresting any of those bureaucrats who enter the country.

Second, a rule requiring a balanced budget is not the ideal solution. Not because balanced budgets are a bad idea, but because such rules put fiscal policy at the mercy of the business cycle.

This chart showing Lebanon’s revenue makes my point. When there’s strong growth and revenues are increasing rapidly (between 2001-2004 and 2006-2009), big spending increases are possible. But when the economy is weak and revenues are flat (between 2004-2006 and 2009-2016), politicians are very resistant to fiscal discipline during a downturn.

Even the IMF and OECD agree with me that this is a big reason why anti-deficit rules don’t work.

Which leads me to my third point, which is that Lebanon should copy Hong Kong and Switzerland by adopting an annual limit on spending growth.

I didn’t specify a specific number for a spending cap. Instead, I emphasized that the key goal is to make sure spending – over time – grows slower than the private sector.

But I did show what would have happened if lawmakers had limited nominal annual spending increases to 6 percent starting in 1992 (that sounds far too high, but keep in mind that inflation averaged about 4 percent over the past 25 years).

I told the audience that they would have a budget surplus today, and also very little debt, if a spending cap had been in effect (same results would hold for America).

And I also pointed out that lawmakers could avoid boom-bust budgeting with a long-run spending cap. With a fixed limit on annual spending increases, they would not have to cut outlays during a recession, but they also would not be able to have a spending orgy during a boom.

That’s a good recipe for Lebanon. It’s also the right recipe for the United States.

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I explained last year that there is an inverse relationship between government efficiency and the size of government.

And Mark Steyn made the same point, using humor, back in 2012.

Interestingly, we have some unexpected allies.

In a recently released study, two economists for the World Bank decided to investigate the effectiveness of government spending.

Governments of developing countries typically spend resources equivalent to between 15 and 30 percent of GDP. Hence, small changes in the efficiency of public spending could have a significant impact on GDP and on the attainment of the government’s objectives. The first challenge faced by stakeholders is measuring efficiency. This paper attempts such quantification and verifies empirical regularities in the cross country-variation in the efficiency scores.

So they calculated how much different governments were spending and the results that were being achieved.

Using two different methodologies, here’s what they found for health spending and life expectancy.

The goal, of course, is to get good results (to be higher on the vertical axis) without having to spend a lot of money (in other words, try to be farther left on the horizontal axis).

And here are the numbers for education quality and education spending.

The economist then crunched all the numbers to determine the relationship between spending and outcomes.

The results may surprise some people.

Government expenditure (GOVEXP) is negatively associated with efficiency scores in education (Tables 14 a and b). This result is robust to changes in the output indicator selected. In the output efficiency case, the impact is ambiguous specially when the PISA Math and Science scores are the output indicators (Table 14 b). In health (Tables 15 a and b), the negative association is present in both input and output efficiency. In infrastructure, the expenditure variables (GOVEXP and PUBGFC10PC) are negative in the six output indicators that are used (Table 16a).23 There is a robust trade-off between size of expenditure and efficiency. …The share of public financing within the total (sum of public and private) is robustly associated with lower efficiency scores.

But here’s another surprise.

These World Bank results are not an outlier.

The European Central Bank has two separate studies (here and here) that conclude smaller government is more effective.

And the International Monetary Fund found that decentralized government is more efficient.

P.S. Don’t forget that this competency argument for small government is augmented by the economic argument for small government.

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Way back in early 2011, I wrote about the likelihood of various nations suffering a Greek-style meltdown. After speculating on the importance of debt burdens and interest payments, I concluded that

…which nation will be the next domino to fall? …Some people think total government debt is the key variable…that’s not necessarily a good rule of thumb. …Japan’s debt is nearly 200 percent of GDP, yet Japanese debt is considered very safe… The moral of the story is that there is no magic point where deficit spending leads to a fiscal crisis, but we do know that it is a bad idea for governments to engage in reckless spending over a long period of time. That’s a recipe for stifling taxes and large deficits. And when investors see the resulting combination of sluggish growth and rising debt, eventually they will run out of patience.

As I noted earlier this year, it’s not easy to predict the point at which “investors no longer trust that they will receive payments on government bonds.”

Though that would be useful information, which is why a new study from the International Monetary Fund could be very helpful. The researchers look at how to measure fiscal crisis.

The literature on fiscal crises and on early warning indicators is limited, although it has expanded in recent years. Most of the past literature focused on sovereign external debt defaults alone …the canonical fiscal crisis is a debt crisis, when the government is unable to service the interest and or principle as scheduled. … It is important to note, however, that fiscal crises may not necessarily be associated with external debt defaults. They can be associated with other forms of expropriation, including domestic arrears and high inflation that erodes the value of some types of debt. …a fiscal crisis is identified when one or more of the following distinct criteria are satisfied: …Credit events associated with sovereign debt (e.g., outright defaults and restructuring). …Recourse to large-scale IMF financial support. …Implicit domestic public default (e.g., via high inflation rates). …Loss of market confidence in the sovereign.

The goal is to figure out the conditions that precipitate problems.

…The objective of this paper is to better understand the structural weaknesses that make countries prone to entering a fiscal crisis. …We use two of the more common approaches to build early warning systems (EWS) for fiscal crises: the signal approach and logit model. …event studies indicate that a fiscal crisis tends to be preceded by loose fiscal policy (Figure 3.1). In the run-up to a crisis, there is robust real expenditure growth.

Some of the obvious variables, as noted above and also in Figure 3.1 (the dashed vertical line is the year a crisis occurs), are whether there’s a rising burden of government spending and whether the economy is growing.

For readers who like wonky material, the authors explain the two approaches they use.

In order to construct early warning systems for fiscal crises, we adopt two alternative approaches that have been used in the literature. We first use the signal approach, followed by multivariate logit models. …The signals approach involves monitoring the developments of economic variables that tend to behave differently prior to a crisis. Once they cross a specific threshold this gives a warning signal for a possible fiscal crisis in the next 1-2 years. …Logit model…early warning systems…draw on standard panel regression…with a binary dependent variable equal to one when a crisis begins (or when there is a crisis). …The main advantage of this approach is that it allows testing for the statistical significance of the different leading indicators and takes into account their correlation.

Then they crunch a bunch of numbers.

Here’s what they find using the signal approach.

…current account deficit, degree of openness, use of central bank credit to finance the deficit, size of the fiscal (overall or primary) deficit and pace of expansion in public expenditures—all these increase the probability of a future crisis.

And here’s what they conclude using the logit approach.

The results, by and large, highlight similar leading indicators as the signals approach… The probability of entering a crisis increases with growing macroeconomic imbalances due to large output gaps and deteriorating external imbalances. The results also indicate a role for fiscal policy, via public expenditures growth. … high expenditure growth could contribute to a deterioration in the current account and a large output gap, making the fiscal position vulnerable to changes in the economic cycle.

The bottom line is that both approaches yield very similar conclusions.

Our results show that there is a small set of robust leading indicators (both fiscal and non-fiscal) that help assess the probability of a fiscal crisis. This is especially the case for advanced and emerging markets. For these countries, we find that domestic imbalances (large output or credit gaps), external imbalances (current account deficit), and rising public expenditures increase the probability of a crisis. …Our results suggest that indeed fiscal variables matter. Strong expenditure growth and financing pressures (e.g., need for central bank financing) can help predict crises.

Some of this data is reflected in Figure 5.2.

And here’s the bottom line, starting with the claim that governments are being semi-responsible because we don’t actually see many fiscal crises.

…we find that some types of vulnerabilities are consistently relevant to explain fiscal crises. This raises the question why governments do not act as they see signals. In large measure they do, as crises among advanced economies are rare. Still, the occurrence of crises may reflect overly optimistic projections about the future… Our results show that a relatively small set of robust leading indicators can help assess the probability of a fiscal crisis in advanced and emerging markets with high accuracy. …countries can reduce the frequency of fiscal crises by adopting prudent policies and strengthening risk management. Fiscal crises are more likely when economies build domestic and external imbalances. This calls for avoiding excessively loose polices when domestic growth is above average. For fiscal policy, this means avoiding procyclical increases in expenditures.

The key takeaway is that spending restraint is a very important tool for avoiding a fiscal crisis.

Yes, a few other factors also are important (central bankers should avoid irresponsible monetary policy, for instance), but some of these are outside the direct control of politicians.

Which is why this new research underscores the importance of some sort of spending cap, preferably enshrined in a jurisdiction’s constitution like in Hong Kong and Switzerland.

P.S. While there haven’t been many fiscal crises in developed nations, that may change thanks to very unfavorable demographics and poorly designed entitlement programs.

P.P.S. I hope the political decision makers at the IMF read this study (as well as prior IMF studies on the efficacy of spending caps) and no longer will agitate for tax increases on nations that get into fiscal trouble.

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President Trump has proposed a one-year pay freeze for federal bureaucrats, which has reinvigorated the debate over whether compensation levels for the civil service are too lavish.

The Washington Post opines this is nothing but “government bashing,” but this chart from my former colleague Chris Edwards should be more than enough evidence to show that federal bureaucrats have a big advantage over workers in the economy’s productive sector.

And there is plenty of additional evidence that federal employment is very attractive. For instance, it’s just about impossible to get fired from a bureaucracy.

Though defenders of the civil service sometimes make the preposterous claim that nobody gets fired because bureaucrats are such good employees.

The low rate at which federal employees are fired for poor performance doesn’t prove the government accepts it but instead “could actually be a positive sign,”… A report from the Merit Systems Protection Board in effect responds to members of Congress and others who contend that federal managers don’t care, or don’t dare, to take disciplinary action because of civil service protections. “…If the agency is successful in preventing poor performance…, a small number of performance-based removals could actually be a positive sign,” MSPB said. …Of the 2.1 million federal employees in a government database…, about 10,000 are fired for either poor performance or misconduct each year. …That low rate of firing has been cited in proposals to force agencies to take action… Individual employees, too, commonly express dissatisfaction with how agencies handle poor performers among their co-workers.

I have to confess that my jaw dropped when I read this article. Maybe we should ask veterans whether they think all federal bureaucrats do a good job?

Or we can ask non-profit groups whether they think IRS bureaucrats are top-quality workers? Or ask anyone who has ever tried to navigate the federal government?

We also know that the counties where most federal bureaucrats reside are now the richest region of the entire nation.

The three richest counties in the United States with populations of 65,000 or more, when measured by their 2016 median household incomes, were all suburbs of Washington, D.C., according to data released today by the Census Bureau. Eight of the 20 wealthiest counties with populations of 65,000 or more were also suburbs of Washington, D.C.–as were 10 of the top 25. …With Falls Church City included in the 2015 data, the nation’s four wealthiest counties were D.C. suburbs.

To be fair, this data is also driven by all the high-paid lobbyists. contracts, consultants, and others who have their snouts buried in the federal trough. So the incredible wealth of the DC region is really an argument for shrinking the size and scope of the federal government.

But the bureaucracy is part of the problem.

Interestingly, even the Congressional Budget Office concluded that bureaucrats are overpaid. And CBO almost certainly understated the gap, as noted in congressional testimony.

The CBO report’s headline figure is that, on average, federal salaries and benefits are 17 percent above private-sector levels. … I would consider the CBO’s reported federal compensation premium to be on the low end… when I analyze federal employee wages using the methodology that the progressive-leaning Economic Policy Institute has used in numerous studies of state and local government salaries, I find an average federal salary premium of not 2 percent but of about 14 percent. … The CBO chose to value federal employees’ pension benefits using a 5 percent discount rate. Using that discount rate, the federal employee retirement package was found to be substantially more generous than is received by comparable private-sector employees. But…corporate pensions are not nearly as safe as federal pensions, as witnessed by pending benefit reductions for “multiemployer” defined benefit plans. Valuing federal pension benefits using a lower discount rate to better reflect their safety would find a higher overall federal compensation premium.

Notwithstanding all this evidence, the unions representing bureaucrats nonetheless try to crank out numbers showing federal employees are underpaid.

To be sure, overall compensation levels don’t tell us everything. It is important to adjust for education, skills, and other factors.

Which is why the most useful, powerful, and revealing data in this debate is produced by the Bureau of Labor Statistics, which measures voluntary quit rates by industry. If there is a lot of turnover in a sector of the economy, that suggests workers are underpaid. But if there are very few voluntary departures, that suggests workers in that part of the economy are overpaid.

And the numbers from BLS clearly show that federal bureaucrats are far less likely to leave their positions when compared to employees in the private sector.

This five-fold gap is staggering. I have lots of friends who work for the federal government. Most privately confess that they know that are making out like bandits. I think I’ll send this chart to the few holdouts.

By the way, I shared the numbers about quit rates for state and local bureaucrats back in 2011. Same story, though the compensation gap isn’t quite as large and may be driven mostly by unfunded fringe benefits.

P.S. I’m much more interested in shrinking government rather than shrinking pay levels. The correct pay for bureaucrats at the Departments of TransportationHousing and Urban DevelopmentEducationEnergy, and Agriculture is zero. Why? Because they bureaucracies shouldn’t exist.

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Shortly after the fiscal crisis began in Greece, I explained that the country got in trouble because of too much government spending.

More specifically, I pointed out that the country was violating my Golden Rule, which meant that the burden of spending was rising relative to the private economy.

That’s a recipe for trouble.

Unfortunately, thanks in large part to bad advice from the International Monetary Fund, Greek politicians decided to deal with an overspending problem by raising taxes.

Then doing it again.

And raising taxes some more.

And raising them again.

Then adding further tax hikes.

The tax burden is now so stifling that even the IMF admits the country may be on the wrong side of the Laffer Curve.

And establishment media sources are noticing. Here are some excerpts from a report in the Wall Street Journal.

Greece is…raising taxes so high that they are strangling the small businesses that form the backbone of its economy. …The tax increases have left Greece with some of Europe’s highest tax rates across several categories, including 29% on corporate income, 15% on dividends, and 24% on value-added tax (a rough equivalent of U.S. sales tax). Individuals pay as much as 45% income tax, plus an extra “solidarity levy” of up to 10%. Furthermore, workers and employers pay social-security levies of up to 27% of their salaries. …small and midsize businesses and self-employed people…are fighting the government in court over having to pay what they say is up to 80% of their average monthly takings in taxes and levies. Some also have to pay retroactive social-security contributions, to the point where professional associations say some of their members are having to pay more to the state than they make.

Paying more than they make? Francois Hollande will applaud when he learns that another nation has an Obama-style flat tax.

…economists and Greek entrepreneurs say heavy taxation doesn’t help. The tax burden is considered the most problematic factor for doing business in Greece, according to the World Economic Forum. “The tax burden creates a serious disincentive for economic activity. It mainly hits the most productive part of the Greek society… Aris Kefalogiannis, the CEO of olive-oil and food company Gaea, said the fiscal straitjacket is keeping highly qualified executives he would like to hire from coming to Greece. It has also made him more sparing with investments. …“But this abusive taxation is not backed by any actual reforms that would make the state efficient.”

Of course the state hasn’t been made more efficient. Why would politicians shrink government if higher taxes are an option?

It’s not as if Greek voters are poised to elect a Ronald Reagan or Margaret Thatcher, after all.

In any event, all of the tax increases are having predictably bad effects.

Tax evasion has led to higher tax rates on those Greeks who can’t or won’t evade taxes. The so-called gray economy is estimated at 26.5% of GDP… “Overtaxation is a vicious circle, which is not fixing the problem,” said 40-year-old electrician Antonis Alevizakis. “Only a third of customers want a receipt. The incentive to avoid a 24% value-added tax surcharge is big for them.” …More than 100,000 self-employed professionals have closed their businesses since mid-2016, to avoid rising taxation and social-security contributions, according to Finance Ministry data. Some of these people stopped self-employment, while others turned to the gray economy. …tax consultant Chrysoula Galiatsatou said. “A financially active part of the population sees no reason to try to do more.”

Why “try to do more” when the government gets the lion’s share of any additional income?

And why even stay in the country when there are better (less worse) tax systems in neighboring nations? Indeed, Greece is one of the few nations to raise corporate tax rates as the rest of the world is taking the opposite approach.

Here are some of the details. It appears that Bulgaria is a preferred destination for tax exiles.

Greece’s direct competitors for investment in its poorer, southeastern region of Europe have much lower taxes. For that reason, many Greek businesses and professionals are migrating to neighboring countries such as Bulgaria and Cyprus. …Around 15,000 Greek companies are registered in Bulgaria. Greece’s Finance Ministry estimates that 80% of them have a registration number but no activity in Bulgaria, and are only there to avoid Greek taxes. “If I stayed in Greece I would most certainly be in jail by now,” said John Douvis, who used his remaining savings in 2015 to move his family’s furniture factory from Athens to Blagoevgrad in Bulgaria. In Greece, he said, “it’s almost impossible for a company to survive unless it evades tax.”

In other words, the problem is tax rates, not tax evasion.

Lower the rates and evasion falls.

Let’s wrap up today’s column with a final observation. The WSJ story states that there have been spending cuts in addition to tax increases.

That’s basically true, but net effect of the Greek fiscal crisis is that government has become a bigger burden, relative to private economic output. Here’s a chart, based on data from the IMF.

The bottom line is that Greek politicians did way too much spending last decade and now they’re augmenting that mistake with way too much taxing this decade.

P.S. To reward everyone who read to the end, here’s some Greek-related humor.

This cartoon is quite  good, but this this one is my favorite. And the final cartoon in this post also has a Greek theme.

We also have a couple of videos. The first one features a video about…well, I’m not sure, but we’ll call it a European romantic comedy and the second one features a Greek comic pontificating about Germany.

Last but not least, here are some very un-PC maps of how various peoples – including the Greeks – view different European nations. Speaking of stereotypes, the Greeks are in a tight race with the Italians and Germans for being considered untrustworthy.

P.P.S. If you want some unintentional humor, did you know that Greece subsidizes pedophiles and requires stool samples to set up online companies?

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Last week, I shared a graph showing that there are more guns than people in the United States, and I wrote that it was the “most enjoyable” chart of the year, mostly because it gets my leftist friends so agitated.

But I’m more likely to share gloomy visuals.

  • The “most depressing” chart about Denmark, which shows a majority of the population lives off government.
  • A “very depressing” chart about the United States, which shows how big business profits from cronyism.
  • The “most depressing” chart about Japan, which shows that the tax burden has nearly doubled since 1965.

Now it’s time to add to that list. There’s a website called “Our World in Data,” which is a great resource if you’re a policy wonk who likes numbers. But some numbers are quite depressing.

For instance,if you peruse the “public spending” page, you’ll find a chart showing the dramatic expansion of redistribution spending as a share of economic output.

These numbers are very similar to the table I shared from Vito Tanzi back in 2013, which isn’t surprising since Professor Peter Lindert is the underlying source for both sets of data.

While the above chart is depressing to a libertarian, it’s nonetheless instructive because it confirms my argument that the western world became rich when government was very small and redistribution was tiny or even nonexistent.

For instance, nations in North America and Western Europe largely made the transition from agricultural poverty to middle-class prosperity during the “golden century” between the Napoleanic wars and World War I. And that was a period when redistribution spending basically didn’t exist and most nations didn’t even have income taxes (the U.S. didn’t make that mistake until 1913).

And even as recently as 1960, welfare states were very small compared to their current size. Indeed, redistribution spending in western nations averaged only about 10 percent of economic output, about half the size of today’s supposedly miserly American welfare state.

These points are important because some folks on the left misinterpret Wagner’s Law and actually try to argue that bigger government is good for growth.

P.S. South Korea has been a great success story for the past five decades, but that redistribution trendline is very worrisome.

P.P.S. The trendline for Greece helps to explain why that nation is bankrupt.

P.P.P.S. The chart shows that Canada is better than the United States, though that may not last since Canada’s current Prime Minister is seeking to undermine his nation’s competitive advantage.

P.P.P.P.S. While fiscal trends in the western world have been unfavorable, that bad news has been offset by positive trends for trade liberalization. Whether we see a big step backwards because of Trump remains to be seen.

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