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Archive for the ‘Government Spending’ Category

I wrote last year about why Puerto Rico got into fiscal trouble.

Like Greece and so many other governments, it did the opposite of Mitchell’s Golden Rule. Instead of a multi-year period of spending restraint, it allowed the budget to expand faster than the private sector for almost two decades.

As the old saying goes, that’s water under the bridge. Since we can’t un-ring the bell of excessive spending in the past, what’s the best option for the future?

The House of Representatives has approved a rescue plan that is getting mixed reviews.

Desmond Lachman of the American Enterprise Institute is supportive but not enthusiastic about the proposal.

The proposed Puerto Rican Restructuring Bill is to be welcomed as a first step towards resolving the island’s chronic debt problem… However, …the bill will be little more than a stop-gap measure to get us through the U.S. election cycle without a full blown Puerto Rican economic and financial crisis before November.

The legislation creates a board with some power to force fiscal and economic reforms.

…a seven-member oversight board…is to have exclusive control to ensure that Puerto Rico’s fiscal plans are enacted and enforced as well as to ensure that necessary reforms are undertaken to help the island regain fiscal solvency. The bill also includes a stay on debt-related litigation to create an environment for consensual negotiations with creditors. It is explicit that it will not involve taxpayer money to bail out the island.

So if there’s no taxpayer money involved, why do people say the legislation is a bailout?

Because the proposal allows Puerto Rico to defer payments on existing debt and then to restructure at least some of that debt. And “restructure” is a politically correct way of saying “partial default.”

So Puerto Rico will be bailed out to the extent that it will be able to stiff bondholders to some degree.

…it would afford the island with a temporary stay on debt principal repayments to allow more time for the voluntary restructuring of its debt mountain. That stay would forestall an otherwise disorderly Puerto Rican default as early as July 1, when some $2 billion in debt repayments come due.

Lachman views that as the least worst of the possible options, so this indirect bailout is not an argument against the legislation. At least from his perspective.

He’s more worried about the fact that much more needs to be done to restore growth on the island.

…it should be obvious that if the island’s economy were to continue to contract at its present rate of around 1 percent a year and if 2 percent of its able-bodied population were to continue to migrate to the mainland each year as is presently the case, the island would become progressively less capable of servicing its $72 billion in public debt or honoring its $45 billion in pension liabilities. A lack of restoring economic growth would also mean that the island would probably need a series of debt write-downs over time.

Writing for Forbes, Ryan Ellis has a much more optimistic assessment of the overall deal.

…the bill is a big win for limited government conservatives. It has no taxpayer bailout of Puerto Rico–not a single dime of taxpayer money is sent down there. …Puerto Rico will have to work their own way out of $72 billion in debt and defaults. They will be helped by an “oversight board”…modeled after the D.C. control board from the 1990s and 2000s, and their job is to approve fiscal plans and budgets, conduct audits, etc.

But Ryan acknowledges that “work their own way out of” is just another way of saying that there is likely going to be a partial default.

The oversight board…will first try to get the 18 classes of bondholders to agree to a voluntary debt restructuring with the Puerto Rican government and government sponsored enterprises. If that fails, the control board will recommend a debt restructuring plan to be enforced by a non-bankruptcy federal judge.

That being said, he’s confident that the legislation won’t be a template for profligate states such as Illinois and California.

Congress is exercising its Constitutional authority to provide all “needful and useful” laws to govern possessions, which is a separate power from the federal bankruptcy clause. There’s no risk of “contagion” to other states.

Though he agrees with Lachman that there’s very little hope for a growth spurt.

It lacks the necessary pro-growth reforms needed for Puerto Rico to get out of its decade-long depression, reverse migration back to the island, attract capital, and create jobs.

Which is why Ryan likes the ideas being pushed by Congressman McArthur of New Jersey. He’s especially fond of territorial taxation for American companies that do business on the island.

The solution is to enact the same type of international tax reform we want to do in the rest of the world–the U.S. companies pay tax in Puerto Rico, but don’t have to pay a second tax to the IRS just to bring the money home. That’s what the rest of the world does, and it’s called “territoriality.” It’s a basic principle of conservative tax reform to move from our outdated “worldwide” tax system to a “territorial” one. There is no better place to start than Puerto Rico.

That would be a good step, and it would be a nice bookend to the very good law Puerto Rico already has for high-income taxpayers from the mainland.

Other conservatives have a less sanguine view of the legislation. Here are excerpts from a coalition statement.

People, companies, states, and territories don’t just “go” broke. Willful prior activity is required. …Puerto Rico has a long history of financial mismanagement brought about by progressive politics and crony capitalism.

Amen. Puerto Rico got in trouble because of bad policy. And the bad policy wasn’t just excessive spending. There have also been grossly misguided interventions such as price controls.

So it’s quite understandable that signatories to this statement are not overly excited that Puerto Rico will have a route for partial default.

Progressive politicians, who are already seeking an indirect bailout – in the form of upending the existing legal structure to allow bankruptcy ‐‐ in the U.S. Congress, argue that a bailout or bankruptcy will help the people of Puerto Rico.

They correctly list several procedural reforms and also point out that there are some obvious policy reforms that should be undertaken.

Sensible economic reforms include allowing Puerto Rico (1) to set its own minimum wage law, including not having a minimum wage law; (2) to be exempt from U.S. overtime rules (which have just been greatly expanded by presidential fiat); and (3) to be exempt from the Jones Act, a protectionist measure that regulates U.S. shipping practices.

Sadly, the legislation is very tepid on these non-fiscal reforms.

So what’s the bottom line? Should the law get three cheers, as Ryan Ellis argues? Two cheers as Desmond Lachman prefers? Or only one cheer (or maybe no cheer), which seems to be the position of some conservative activists?

My answer depends on my mood. When I’m going through a fire-breathing-libertarian phase, I’m with the conservatives. Puerto Rico spent itself into a ditch so they should suffer the consequences.

But when I’m in my long-time-observer-of-Washington mode, I try to imagine the best possible (or least-worst possible) outcome, then I think Paul Ryan and the Republicans did a decent job.

In other words, this is like the fiscal cliff deal back in late 2012. Disappointing in many respects, but not as bad as I would have predicted.

The key question now is whether Republicans insist on putting good people on the oversight board.

And that’s not a trivial concern. I remember thinking the 2011 debt limit fight led to a decent outcome because we got sequester-enforced caps on discretionary spending (not as good as a comprehensive spending cap, but still a good step).

And we even got a sequester in early 2013. But then later that year, and last year as well, Republicans joined with Democrats to bust the spending caps.

That doesn’t bode well for any policy that requires long-run fiscal discipline. Though maybe GOPers will be tougher this time since the spending restraint will be imposed on people who don’t vote in congressional elections.

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Much of my work on fiscal policy is focused on educating audiences about the long-run benefits of small government and modest taxation.

But what about the short-run issue of how to deal with a fiscal crisis? I have periodically weighed in on this topic, citing research from places like the European Central Bank and International Monetary Fund to show that spending restraint is the right approach.

And I’ve also highlighted the success of the Baltic nations, all of which responded to the recent crisis with genuine spending cuts (and I very much enjoyed exposing Paul Krugman’s erroneous attack on Estonia).

Today, let’s look at Cyprus. That Mediterranean nation got in trouble because of an unsustainable long-run increase in the burden of government spending. Combined with the fallout caused by an insolvent banking system, Cyprus suffered a deep crisis earlier this decade.

Unlike many other European nations, however, Cyprus decided to deal with its over-spending problem by tightening belts in the public sector rather than the private sector.

This approach has been very successful according to a report from the Associated Press.

…emerging from a three-year, multi-billion euro rescue program, Cyprus boasts one of the highest economic growth rates among the 19 eurozone countries — an annual rate of 2.7 percent in the first quarter. Finance Minister Harris Georgiades says Cyprus turned its economy around by aggressively slashing costs but also by avoiding piling on new taxes that would weigh ordinary folks down and put a serious damper on growth. “We didn’t raise taxes that would burden an already strained economy,” he told The Associated Press in an interview. “We found spending cuts that weren’t detrimental to economic activity.”

Cutting spending and avoiding tax hike? This is catnip for Dan Mitchell!

But did Cyprus actually cut spending, and by how much?

That’s not an easy question to answer because the two main English-language data sources don’t match.

According to the IMF data, outlays were sliced to €8.1 billion in 2014, down from a peak of €8.5 in 2011. Though the IMF indicates that those numbers are preliminary.

The European Commission database shows a bigger drop, with outlays of €7.0 billion in 2015 compared to €8.3 billion in 2011 (also an outlay spike in 2014, presumably because of a bank bailout).

The bottom line is that, while it’s unclear which numbers are most accurate, Cyprus has experienced a multi-year period of spending restraint.

And having the burden of government grow slower than the private sector always has been and always will be the best gauge of good fiscal policy.

By contrast, there’s no evidence that tax increases are a route to fiscal probity.

Indeed, the endless parade of tax hikes in Greece shows that such an approach greatly impedes economic recovery.

Though not everybody in Cyprus supports prudent policy.

Critics have accused the government of working its fiscal gymnastics on the backs of the poor — essentially chopping salaries for public sector workers. Pambis Kyritsis, head of the left-wing PEO trade union, said the government’s “neo-liberal” policies coupled with the creditors’ harsh terms have widened the chasm between the have and have-nots to huge proportions. …Georgiades turned Kyritsis argument around to reinforce his point that there shouldn’t be any let-up in the government’s reform program and fiscal discipline.

In the European context, “liberal” or “neo-liberal” means pro-market and small government (akin to “classical liberal” or “libertarian” in the United States).

Semantics aside, it will be interesting to see whether Finance Minister Georgiades is correct about maintaining spending discipline as the economy rebounds.

As the above table indicates, there are several examples of nations getting good results by limiting the growth of government spending. But there are very few examples of long-run success since very few nations have politicians with the fortitude to control outlays if the economy is growing and generating an uptick in tax revenue (which is why states like California periodically get in trouble).

This is why the best long-run answer is some sort of constitutional spending cap, similar to what exists in Switzerland or Hong Kong.

The bottom line if that spending restraint is good short-run policy and good long-run policy. Though I doubt Hillary Clinton will learn the right lesson.

P.S. Cyprus also is a reasonably good role model for how to deal with a banking crisis.

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Back in 2010, then-House Speaker Nancy Pelosi actually claimed that paying people not to work would be good for the economy.

Wow, that’s almost as bizarre as Paul Krugman’s assertion that war is good for growth.

Professor Dorfman of the University of Georgia remembers Pelosi’s surreal moment and cites it in his column in Forbes, which debunks the Keynesian assertion that handouts create growth by giving recipients money to spend.

It is true, of course, that the people getting goodies from the government will spend that money, which also means more money for the merchants they patronize.

People who favor redistribution for other purposes often try to convince others to support them on the grounds that their favored policies will also create economic growth. …let’s review the story as told by those in favor of redistribution. When the government provides benefits to people without much income or spending power, those people will immediately go out and spend all the money they receive. This spending creates an economic multiplier effect as those who get the dollars re-spend some of them… There is nothing particularly wrong with the above story as far as it goes. Economic spending does create more spending as each person who gains income then spends some of that income somewhere else.

But there’s always been a giant hole in Keynesian logic, as Prof. Dorfman explains.

The redistribution advocates always forget to consider one part: where did the money handed out in government benefits come from? …There are three possible answers to that question: the money was raised in taxes, the money was borrowed from an American, or the money was borrowed from abroad. The fact that the money came from someplace is the key because for the government to have money to hand out it must first take it from somebody.

I would add a fourth option, which is that the government can just print the money. But we can overlook that option for the moment since only true basket cases like Venezuela go with that option. And even though we have plenty of policy problems in America, we’re fortunately a long way from having to finance the budget with a printing press.

So let’s look at Dorfman’s options. When governments tax and borrow from domestic sources, all that happens is that spending get redistributed.

If the government raised the money in taxes, then the people paying the taxes have less money to spend in the exact amount that is going to be handed out. …somebody’s spending power was reduced by the exact amount that somebody else receives. …If the money is borrowed from an American, the same thing happens. The person lending the money now either doesn’t spend the money or cannot save the money. When money is saved, banks lend it out. That borrower intends to spend the money (otherwise, why borrow?). When the money is lent to the government instead of being put in the bank, the loan and associated spending it would have created disappear.

And the same is true even when money is borrowed from foreign sources.

…the final hope for economic growth from government transfers would be if the government borrowed the money from abroad. This could work, as long as the money otherwise would not have appeared in the U.S. economy. For example, if China sells us products, they end up with dollars. The question is: if they don’t use those dollars to buy Treasury bonds, what will they do instead? The answer is that the dollars generally have to end up back in the U.S. Even if China turns those dollars into euros and buys German bonds instead, somebody else now owns those dollars and will spend them in the U.S. in some fashion (buying products, companies, or investments).

Prof. Dorfman explains that Keynesianism is merely a version of Bastiat’s broken-window fallacy.

…the claimed economic stimulus from giving money to the poor is offset by the lost spending we do not get from the original holder of the money. …this is a classic example of a famous economic principle: the broken window fallacy. In the fallacy, townspeople rejoice at the economic boost to be received when a shopkeeper must spend money to replace a broken window. What they miss is that absent the broken window, the shopkeeper would have bought something else with her money. In reality the economy is unchanged in the aggregate.

Well said, though allow me to augment that final excerpt by pointing out that the economy actually does change when income is redistributed, albeit in the wrong direction.

This is because many redistribution programs give people money, but only if they don’t work or earn only small amounts of income. And less labor in the economy means less output.

In effect, redistribution programs create very high implicit tax rates on being productive, which is why welfare programs trap people in government dependency.

Last but not least, let’s preemptively deal with a couple of Keynesian counter-arguments.

They often argue, for instance, that redistribution is good for growth because lower-income people have a higher “marginal propensity to consume.”

That’s true, but irrelevant. Even if other people are more likely to save, the money doesn’t disappear. As Prof. Dorfman explained, money that goes into the financial system is lent out to other people.

At this point, a clever Keynesian will argue that the money won’t get lent if overall economic conditions are weak. And there is some evidence this is true.

But those weak conditions generally are associated with periods when the burden of government is climbing, so the real lesson is that there’s no substitute for a policy of free markets and small government.

P.S. Here’s the video I narrated for the Center for Freedom and Prosperity about Keynesianism.

P.P.S. Advocates of Keynesian economics make some very weird arguments to justify more government spending.

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Among Republicans and conservatives, Ronald Reagan is widely revered as a great President.

From their perspective, he was the candidate who actually made America great again.

Fans of the Gipper tell us the economy rebounded, inflation was tamed, incomes rose, unemployment fell, and the Evil Empire was defeated. What’s not to love?

That’s an impressive list of accomplishments, but is it accurate? Did Reagan and his policies produce good results, or has history created a misleading perspective (just as people for many decades credited Franklin Roosevelt for ending the Great Depression when we now know that FDR’s policies actually lengthened and deepened the downturn)?

Some libertarians are skeptics, arguing that Reagan’s rhetoric about reining in big government was much better than his actual record.

So let’s look at what actually happened in the 1980s.

The place to start, if we want neutral and unbiased data, is Economic Freedom of the World. Annual data for the 1980s isn’t available, but the every-five-year data allows us to see that economic liberty did increase between 1980 and 1990.

By the way, a couple of caveats would be helpful at this point. Reagan entered office in January 1981 and left office in January 1989, so there’s not a perfect overlap between the EFW data and the Reagan years. Also, the EFW data measures changes in a nation’s economic liberty and it silent on whether a president (or the legislative branch) deserves credit or blame.

Now let’s look at the specific components to see the potential impact of Reaganomics on important variables such as fiscal policy, rule of law and property rights, trade policy, regulatory policy, and monetary policy.

I’ve created a table from the data on page 188 of the latest Economic Freedom of the World. As you can see, there was a substantial improvement in fiscal policy, a modest improvement in monetary policy, no change in regulation, no change in rule of law and property rights, and a small drop in trade.

And if you then dig into the EFW excel file and look at the specific variables that are used to create these five scores, you’ll get more details.

On fiscal policy, for instance, there was a modest improvement in the “government consumption” score but a huge jump in the “top marginal tax rate” score. All of which makes sense because the burden of government spending (measured as a share of GDP) fell slightly during the Reagan years while the top tax rate dropped dramatically from 70 percent t0 28 percent.

Monetary policy improved for the obvious reason that the big drop in inflation meant a big increase in the “inflation” score. And the trade score dipped mostly because of an erosion in score for “tariffs.”

Now for my subjective assessment. I think Reagan was even better than shown by the EFW data. Here are three reasons.

  1. The overall burden of government spending only fell by a small amount, but that number masks the fact that domestic spending was reduced significantly as a share of GDP during the Reagan years. That decrease was somewhat offset by a buildup of defense spending, but you can argue that the subsequent collapse of the Soviet Union meant this was a rare instance of government outlays actually generating a positive rate of return.
  2. Reagan’s approach to monetary policy rarely gets the credit it deserves. By supporting a tough anti-inflation policy, he made it possible for the Federal Reserve to restore price stability. It’s very rare for a politician to allow some short-run pain (especially political pain) to achieve long-run gain for the country. And, to be fair, some of the credit goes to Jimmy Carter (though he also deserves blame for letting the inflation genie out of the bottle in the first place).
  3. On trade policy, Reagan’s legacy is much better than indicated by the EFW scores. During his tenure, the NAFTA and GATT/WTO trade liberalization negotiations began and gained considerable steam. Yes, the implementation occurred later (with both the first President Bush and President Clinton deserving credit for following through), but we never would have reached that stage without Reagan’s vision of expanded trade and rejection of the protectionist philosophy.

Last but not least, let’s look at what Reagan’s policies meant for ordinary people. Did more economic liberty lead to better lives?

The answer is yes. The poisonous hidden tax of inflation largely disappeared. The unemployment rate fell. Labor force participation increased (in marked contrast with Obama). And there was a big increase in income for average Americans (again, in sharp contrast with Obama).

No wonder, when presented with a hypothetical matchup, the American people said they would elect Reagan over Obama in a landslide.

P.S. Critics of Reaganomics, including some on the right, inevitably raise the issue of deficits and debt and assert that Reagan failed. I think red ink is the wrong measure, but even for those who fixate on that variable, it’s worth noting that deficits were relatively small by the time Reagan left office and the Congressional Budget Office predicted they would continue falling if his policies were maintained. Moreover, the 1980-1982 double-dip recession was the reason red ink expanded so much during the early Reagan years, and that was primarily the inevitable consequence of the reckless monetary policy of the 1970s.

P.P.S. For Reagan humor, click here, here, and here.

P.P.P.S. If you want to be inspired, click here and here to see two short clips of Reagan in action. And at the bottom of this post, there’s a great video of Reagan embracing libertarianism.

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We can learn a lot of economic lessons from Europe.

Today, we’re going to focus on another lesson, which is that higher taxes lead to more red ink. And let’s hope Hillary Clinton is paying attention.

I’ve already made the argument, using European fiscal data to show that big increases in the tax burden over the past several decades have resulted in much higher levels of government debt.

But let’s now augment that argument by considering what’s happened in recent years.

There’s been a big fiscal crisis in Europe, which has forced governments to engage in austerity.

But the type of austerity matters. A lot.

Here’s some of what I wrote back in 2014.

…austerity is a catch-all phrase that includes bad policy (higher taxes) and good policy (spending restraint). But with a few notable exceptions, European nations have been choosing the wrong kind of austerity (even though Paul Krugman doesn’t seem to know the difference).

And when I claim politicians in Europe have chosen the wrong kind of austerity, that’s not hyperbole.

As of 2012, there were €9 of tax hikes for every €1 of supposed spending cuts according to one estimate. That’s even worse than some of the terrible budget deals we’ve seen in Washington.

At this point, a clever statist will accuse me of sour grapes and state that I’m simply unhappy that politicians opted for policies I don’t like.

I’ll admit to being unhappy, but my real complaint is that higher tax burdens don’t work.

And you don’t have to believe me. We have some new evidence from an international bureaucracy based in Europe.

In a working paper for the European Central Bank, Maria Grazia Attinasi and Luca Metelli crunch the numbers to determine if and when “austerity” works in Europe.

…many Euro area countries have adopted fiscal consolidation measures in an attempt to reduce fiscal imbalances…in most cases, fiscal consolidation did not result, at least in the short run, in a reduction in the debt-to-GDP ratio…calls for a more temperate approach to fiscal consolidation have increased on the ground that the drag of fiscal restraint on economic growth could lead to an increase rather than a decrease in the debt-to-GDP ratio, as such fiscal consolidation may turn out to be self-defeating. …The aim of this paper is to investigate the effects of fiscal consolidation on the general government debt-to-GDP ratio in order to assess whether and under which conditions self defeating effects are likely to materialise and whether they tend to be short-lived or more persistent over time.

Now let’s look at the results of their research.

It turns out that austerity does work, but only if it’s the right kind. The authors find that spending cuts are successful and higher tax burdens backfire.

The main finding of our analysis is that…In the case of revenue-based consolidations the increase in the debt-to-GDP ratio tends to be larger and to last longer than in the case of spending-based consolidations. The composition also matters for the long term effects of fiscal consolidations. Spending-based consolidations tend to generate a durable reduction of the debt-to-GDP ratio compared to the pre-shock level, whereas revenue-based consolidations do not produce any lasting improvement in the sustainability prospects as the debt-to-GDP ratio tends to revert to the pre-shock level. …strategy is more likely to succeed when the consolidation strategy relies on a durable reduction of spending, whereas revenue-based consolidations do not appear to bring about a durable improvement in debt sustainability.

Unfortunately, European politicians generally have chosen the wrong approach.

This is an important policy lesson also in view of the fact that revenue-based consolidations tend to be the preferred form of austerity, at least in the short run, given also the political costs that a durable reduction in government spending entail.

Here are a few important observations from the study’s conclusion.

…the findings of our analysis are in line with those of the literature on successful consolidation, namely that the composition of fiscal consolidation matters and that a durable reduction in the debt-to-GDP ratio is more likely to be achieved if consolidation is implemented on the expenditure side, rather than on the revenue side. In particular, when fiscal consolidation is implemented via an increase in taxation, the debt-to-GDP ratio reverts back to its pre-shock level only in the long run, thus failing to generate an improvement in the debt ratio, and producing what we call a self-defeating fiscal consolidation. …fiscally stressed countries benefit from an immediate reduction in the level of debt when reducing spending.

In other words, restraining the growth of spending is the best way to reduce red ink. Heck, it’s the only way.

When debating my leftists friends, I frequently share this table showing nations that have obtained very good results with multi-year periods of spending restraint.

My examples are from all over the world and cover all sorts of economic conditions. And the results repetitively show that when you deal with the underlying problem of too much government, you automatically improve the symptom of red ink.

I then ask my statist pals to show me a similar table of data for countries that have achieved good results with higher taxes.

I’m still waiting for an answer.

Which is why the only good austerity is spending restraint.

P.S. Paul Krugman is remarkably sloppy and inaccurate when writing about austerity. Check out his errors when commenting on the United Kingdom, Germany, and Estonia.

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There’s a very powerful statement, variously attributed to Alexis de Toqueville, Benjamin Franklin, or Alexander Tytler, that basically warns that democracy is doomed when people figure out they can vote themselves money.

There’s no evidence that any of them actually spoke or wrote those words, though I guess it doesn’t matter that the quote didn’t originate with someone like Franklin. What does matter is that it accurately captures something very important, which is the tendency for governments to over-tax and over-spend once people decide that it’s okay to use government coercion to take other people’s money.

But it’s still nice to be able to cite something accurate. With this in mind, I came up with my Theorem of Societal Collapse. And I think it’s actually more accurate than the vote-themselves-money quote because democracy doesn’t necessarily lead to statism. What leads to bad outcomes is democracy combined with bad values.

And a pervasive belief in redistributionism is a bad value. Heck, it’s a self-destructive value. Consider Greece. When you add together the people getting welfare and disability to the people getting pension payments to the people on the government payroll, it turns out that a majority of people in the country are riding in the wagon of government dependency.

That’s bad. But what makes the Greek situation so hopeless is that those are the same people who vote. Which means there’s very little chance of getting a government that would implement good policy.

After all, why would the recipients of other people’s money vote for politicians who support limits on redistribution?

But I’m not just blaming voters. Politicians also deserve scorn and disdain because they are the ones who often seek votes by promising to take other people’s money.

Some observers would like to believe that these politicians will use their supposed superior expertise and knowledge about public policy to make appropriate tradeoffs and prevent the system from becoming over-burdened.

But that’s somewhat naive.

Indeed, there’s an entire school of thought in economics, known as “public choice,” which is based on making real-world assumptions about the self-interested behavior of politicians and interest groups. Here’s a partial description from the Library of Economics and Liberty.

As James Buchanan artfully defined it, public choice is “politics without romance.” The wishful thinking it displaced presumes that participants in the political sphere aspire to promote the common good. …public officials are portrayed as benevolent “public servants” who faithfully carry out the “will of the people.” …public choice, like the economic model of rational behavior on which it rests, assumes that people are guided chiefly by their own self-interests… As such, voters “vote their pocketbooks,” supporting candidates and ballot propositions they think will make them personally better off; bureaucrats strive to advance their own careers; and politicians seek election or reelection to office. Public choice, in other words, simply transfers the rational actor model of economic theory to the realm of politics. …collective decision-making processes allow the majority to impose its preferences on the minority.

In other words, both voters and politicians can have an incentive for ever-larger government, even if the end result is Greek-style fiscal chaos because taxes and spending reach ruinous levels.

I call this “Goldfish Government” because some think that a goldfish lacks the ability to control its appetite and therefore will eat itself to death when presented with unlimited food.

Indeed, public choice scholars explicitly recognize that unconstrained democracy can lead to bad results.

Public choice scholars have identified…deep…problems with democratic decision-making processes.

That’s the bad news.

The good news is that their research suggests ways to compensate for the natural tendency of ever-expanding government.

Like that founding father of the American constitutional republic, public choice recognizes that men are not angels and focuses on the importance of the institutional rules… If, for example, democratic governments institutionally are incapable of balancing the public budget, a constitutional rule that limits increases in spending and taxes to no more than the private sector’s rate of growth will be more effective.

Hmmm…., a rule that limits the government so it doesn’t grow faster than the private sector.

Sounds like an idea worth embracing.

But while I like anything that builds support for the Golden Rule, I’m not sure it’s a sufficient condition for good policy.

Simply stated, we have too many examples of nations that followed the Golden Rule for several years, only to then fall off the wagon with a new splurge of spending.

There are two ways to deal with this problem. First, make the spending restraint part of a jurisdiction’s constitution, as we see in Switzerland and Hong Kong.

Second, augment the internal constraint of a spending cap with the external constraint of tax competition. Bluntly stated, destructive tax policies will be less likely when politicians are afraid that taxpayers will move across borders.

I spoke about this topic at a recent conference in Slovakia.

I also discuss the critical role of demographic change toward the end of my speech.

P.S. America’s Founding Fathers had the right solution. They set up a democratic form of government, but they strictly limited the powers of the central government. This system worked remarkably well for a long period, but then the Supreme Court decided that the enumerated powers listed in the Constitution were just a suggestion.

P.P.S. While it’s bad news to combine democracy with bad value, I want to emphasize that the problem is bad values. Most non-democratic societies have policies that are so evil and destructive (think Cuba and North Korea) that they make France seem like a beacon of economic liberty.

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As a general rule, I’m not overly concerned about debt, even when looking at government red ink.

I don’t like deficit and debt, to be sure, but government borrowing should be seen as the symptom. The real problem is excessive government spending.

This is one of the reasons I’m not a fan of a balanced budget amendment, Based on the experiences of American states and European countries, I fear politicians in Washington would use any deficit-limiting requirement as an excuse to raise taxes.

I much prefer spending caps, such as those found in Hong Kong, Switzerland, and Colorado. If you cure the disease of excessive government, you automatically ameliorate the symptom of too much borrowing.

That being said, the fiscal chaos plaguing European welfare states is proof that there is a point when a spending problem can also become a debt problem. Simply stated, the people and institutions that buy government bonds at some point will decide that they no longer trust a government’s ability to repay because the public sector is too big and the economy is too weak.

And even though the European fiscal crisis no longer is dominating the headlines, I fear this is just the calm before the storm.

For instance, the data in a report from Citi about the looming Social Security-style crisis are downright scary.

…the total value of unfunded or underfunded government pension liabilities for twenty OECD countries is a staggering $78 trillion, or almost double the $44 trillion published national debt number.

And the accompanying chart is rather appropriate since it portrays this giant pile of future spending promises as an iceberg.

And when you look at projections for ever-rising spending (and therefore big increases in red ink) in America, it’s easy to see why I’m such a strong advocate of genuine entitlement reform.

But it’s also important to realize that government policies also can encourage excessive debt in the private sector.

Before digging into the issue, let’s first make clear that debt is not necessarily bad. Households often borrow to buy big-ticket items like homes, cars, and education. And businesses borrow all the time to finance expansion and job creation.

But if there’s too much borrowing, particularly when encouraged by misguided government policies, then households and businesses are very vulnerable if there’s some sort of economic disruption and they no longer have enough income to finance debt payments. This is when debt becomes excessive.

Yet this is what the crowd in Washington is encouraging.

Writing for the Wall Street Journal, George Melloan warns that misguided “stimulus” and “QE” policies have created a debt bubble.

…while Mr. Bernanke and Ms. Yellen were trying to prevent deflation, the federal government was engineering its cause, excessive debt. And the Fed abetted the process by purchasing trillions of dollars of government paper, aka quantitative easing. Near-zero interest rates also have encouraged consumers and business to releverage. Cars are now financed with low or no-interest five-year loans. With the 2008 housing debacle forgotten, easier mortgage terms have made a comeback. Corporations also couldn’t let cheap money go to waste, so they have piled up debts to buy back their own stock. Such “investment” produces no economic growth, but it has to be paid back nonetheless. Amid the Great Recession, many worried that the entire economy of the U.S., or even the world, would be “deleveraged.” Instead, we have a new world-wide debt bubble.

The numbers he shares are sobering.

Global debt of all types grew by $57 trillion from 2007 to 2014 to a total of $199 trillion, the McKinsey Global Institute reported in February last year. That’s 286% of global GDP compared with 269% in 2007. The current ratio is above 300%.

Professor Noah Smith writes in Bloomberg about research showing that debt-fueled bubbles are especially worrisome.

…since debt bubbles damage the financial system, they endanger the economy more than equity bubbles, which transmit their losses directly to households. Financial institutions lend people money, and if people can’t pay it back — because the value of their house has gone down — it could cause bank failures. …Economists Oscar Jorda, Moritz Schularick, and Alan Taylor recently did a historical study of asset price crashes, and they found that, in fact, debt seems to matter a lot. …To make a long story short, they look at what happened to the economy of each country after each large drop in asset prices. …bubbles make recessions longer, and credit worsens the effect. …the message is clear: Bubbles and debt are a dangerous combination.

To elaborate, equity and bubbles aren’t a good combination, but there’s far less damage when an equity bubble pops because the only person who is directly hurt is the person who owns the asset (such as shares of a stock). But when a debt bubble pops, the person who owes the money is hurt, along with the person (or institution) to whom the money is owed.

Desmond Lachman of the American Enterprise Institute adds his two cents to the issue.

…the world is presently drowning in debt. Indeed, as a result of the world’s major central banks for many years having encouraged markets to take on more risk by expanding their own balance sheets in an unprecedented manner, the level of overall public and private sector indebtedness in the global economy is very much higher today than it was in 2008 at the start of the Great Economic Recession. Particularly troublesome is the very high level of corporate debt in the emerging market economies and the still very high public sector debt levels in the European economic periphery. …the Federal Reserve’s past policies of aggressive quantitative easing have set up the stage for considerable global financial market turbulence. They have done so by artificially boosting asset prices and by encouraging borrowing at artificially low interest rates that do not reflect the likelihood of the borrower eventually defaulting on the loan.

In other words, artificially low interest rates are distorting economic decisions by making something (debt) seem cheaper than it really is. Sort of financial market version of the government-caused third-party payer problem in health care and higher education.

And Holman Jenkins of the Wall Street Journal makes the very important point that debt is encouraged by bailouts and subsidies.

Big banks aren’t automatically bad or badly managed because they are big, but it’s hard to believe big banks would exist without an explicit and implicit government safety net underneath them. …None of this has changed since Dodd-Frank, none of it is likely to change. …we know where the crisis will come from and how it will be transmitted to the financial system. The Richmond Fed’s “bailout barometer” shows that, since the 2008 crisis, 61% of all liabilities in the U.S. financial system are now implicitly or explicitly guaranteed by government, up from 45% in 1999. …Six years after a crisis caused by excessive borrowing, McKinsey estimates that even visible global debt has increased by $57 trillion, while in the U.S., Europe, Japan and China growth to pay back these liabilities has been slowing or absent.

The bottom line is that government spending programs directly cause debt, but we should be just as worried about the private debt that is being encouraged and subsidized by other misguided government policies.

And surely we shouldn’t forget to include the pernicious role of the tax code, which further tilts the playing field in favor or debt.

P.S. Let’s briefly divert to another issue. I wrote last Christmas that President Obama may have given the American people a present.

But the Washington Examiner reports that gift has turned into a lump of coal.

The Department of Justice announced this week that it is resuming its Equitable Sharing program…that allows state and local police to get around tough state laws that limit how much property can be taken from citizens without being charged with wrongdoing, let alone convicted of a crime. …money-hungry police departments can exploit these lax federal rules about confiscating people’s property. The feds like this because they get a cut of the loot. …there is no presumption of innocence. …civil forfeitures by the feds amounted to $4.5 billion in 2014, which is more than the $3.9 billion that all of America’s burglars stole that year. It’s hard to imagine more compelling evidence of gross wrong.

Wow, so the government steals more money than burglars. I guess I’m not surprised.

But if you really want to get upset, check out real-world examples of asset forfeiture by clicking here, here, here, here, and here.

Thankfully, some states are seeking to curtail this evil practice.

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