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Posts Tagged ‘Fiscal Policy’

At the risk of understatement, I’m not a fan of the Organization for Economic Cooperation and Development. Perhaps reflecting the mindset of the European governments that dominate its membership, the Paris-based international bureaucracy has morphed into a cheerleader for statist policies.

All of which was just fine from the perspective of the Obama Administration, which doubtlessly appreciated the OECD’s partisan work to promote class warfare and pimp for wasteful Keynesian spending.

What is particularly irksome to me is the way the OECD often uses dishonest methodology to advance the cause of big government.

But my disdain for the leftist political appointees who run the OECD doesn’t prevent me from acknowledging that the professional economists who work for the institution occasionally generate good statistics and analysis.

For instance, I’ve cited two  examples (here and here) of OECD research showing that spending caps are only effective fiscal rule. And I praised another OECD study that admitted the beneficial impact of tax competition. I even listed several good example of OECD research on tax policy as part of a column that ripped the bureaucracy for some very shoddy work in favor of Obama’s redistribution agenda.

And now we have some more good research to add to that limited list. A new working paper by two economists at the OECD contains some remarkable findings about the negative impact of government spending on economic performance. If you’re pressed for time, here’s the key takeaway from their research.

Governments in the OECD spend on average about 40% of GDP on the provision of public goods, services and transfers. The sheer size of the public sector has prompted a large amount of research on the link between the size of government and economic growth. …This paper investigates empirically the effect of the size and the composition of public spending on long-term growth… The main findings that emerge from the analysis are…Larger governments are associated with lower long-term growth. Larger governments also slowdown the catch-up to the productivity frontier.

For those who want more information, the working paper is filled with useful information and analysis.

Here’s one of the charts from the study, showing how government spending is allocated in OECD nations.

The report also acknowledges that there’s a lot of preexisting research showing that government spending hinders economic growth.

There is a vast empirical literature investigating the relationship between the size of the government and economic growth (see Slemrod, 1995; Myles 2009; Bergh and Henrekson, 2011 for overviews). A review by Bergh and Henrekson (2011), based on papers published in peer reviewed journals after 2000, suggested a negative relationship in OECD countries. Likewise, a recent OECD study confirmed a negative relationship between the size of government and GDP growth (Fall and Fournier, 2015). …the link between the size of government and growth may vary with the income level and could be hump-shaped (Armey, 1995). A few studies have found support for the existence of a non-linear relationship between the size of government and growth (e.g. Vedder and Gallaway, 1998; Pevcin, 2004; Chen and Lee, 2005).

By the way, the reference to “hump-shaped” means that the OECD is even aware of the Rahn Curve.

The methodology in the paper is not ideal from my perspective. For all intents and purposes, the economists compare economic performance of the OECD’s big-government nations with the growth numbers from the OECD’s not-quite-as-big-government nations. But even with that limitation, the study generates some powerful results.

…the simulation assumes that in countries where the size of government is above the average level of countries in the bottom half of the sample, the government size will gradually converge to this level (36% of GDP). Similar to the spending mix reforms, this reform is phased in over 10 years. Such a reduction in the size of the government could increase long-term GDP by about 10%, with much larger effects in some countries with currently large or ineffective governments. …a reduction of the size of government has a positive, but moderate, effect on the income of the poor. The average disposable income also rises. However, the rich gain relatively more. Finally, in countries where the government is less effective (such as Italy) the growth effect dominates and a moderate reduction of the size of government would have a large growth effect, so that it would lift all boats.

And here’s a chart showing how much more growth would be possible if the countries with really-big government downsized their public sectors to the somewhat-big level.

Even with the methodology limitations I described, these results are astounding. Potential GDP gains of more than 30 percent for Greece and Italy. Gains of more than 20 percent for Slovenia, France, and Hungary. And more than 10 percent for Belgium, Czech Republic, Portugal, and Poland.

The working paper also looks at the composition of government spending. In other words, just as not all taxes are equally damaging, the same is true for spending programs.

The results from the estimation of the size of the government and the public spending mix illustrate that public spending matters for long-term growth…pension and subsidy spending [are] the two items with a significantly negative effect on growth. As each regression includes the size of government and one spending share, the estimates provide the effect of increasing this type of spending while decreasing spending on other items to keep the spending to GDP ratio unchanged… larger governments are in several specifications significantly and negatively associated with long-term growth. This is consistent with the literature… Larger governments can impede convergence (Table 8, columns 1 and 3), because they are associated with higher taxation that can discourage business investment including foreign investment and households to supply labour.

Pensions and subsidies seem to cause the most economic harm.

Reducing the share of pension spending in primary spending yields sizeable growth gains with no significant adverse effect on disposable income inequality. This reduction could be achieved by an increase in the effective retirement age or by cutting the replacement rate. …Cutting public subsidies boosts growth, as public subsidies…can distort the allocation of resources and undermine competition. …Education outcomes depend not only on education spending but also on the effectiveness of education policies, and the literature suggest the latter can be more important. Since the seminal work of Coleman (1966), a broad literature suggests that there is no clear link between education spending and education outcomes. …policies aimed at increasing education spending effectiveness can be more appropriate than an across-the-board rise of education spending. …It may be that, beyond a certain point, additional spending on investment has adverse effects, if poorly managed.

For those of you with statistical/econometric knowledge, here’s some relevant data from the study.

And you can match the numbers in Table 6 with these excerpts.

…pension spending reduces growth (Table 6, columns 2, 5, 7 and 10). Increasing the share of pension spending in primary spending by one percentage point (offset by a reduction in other spending) would decrease potential GDP by about 2%. …Public spending on subsidies also reduces growth (Table 6, columns 3, 5, 8 and 10). …increasing the share of public subsidies in primary spending by one percentage point would decrease potential GDP by about 7%.

If you’re not a stats wonk, these two charts may be more helpful and easy to understand.

What jumped out at me is how the normally sensible nation of Switzerland is very bad about subsidies. That’s a policy they obviously need to fix (along with the fact that they also have a wealth tax, which is very uncharacteristic for that country).

But I’m digressing.

Let’s return to the study. One of the interesting things about the working paper is that it notes that bad fiscal policy can be somewhat mitigated by having market-oriented policies in other areas, which is a point I always make when writing about Scandinavian nations.

…countries with a high level of public spending may also be characterised by features that partly offset the adverse growth effect of government size. …in Sweden the mix of growth-friendly structural policies…may have offset the adverse growth effect of a large government sector.

In other words, the moral of the story is that smaller government is good and free markets are good. Mix the two together and you have best of all worlds.

P.S. Even if the OECD published dozens of quality studies like this one, I would still argue that American taxpayers should no longer be forced to subsidize the Paris-based bureaucracy. And even if the OECD’s political types stopped pushing statist policies, I would still have the same view about ending handouts from American taxpayers. This has nothing to do with the fact that the bureaucrats once threatened to have me arrested and thrown in a Mexican jail. I simply don’t think taxpayers should fund international bureaucracies.

P.P.S. Other international bureaucracies, including the World Bank and European Central Bank, also have published good research about the negative effect of excessive government spending.

P.P.P.S. My general disdain for the OECD (notwithstanding my qualified praise today for their new study on spending) may be exceeded by my hostility for the International Monetary Fund. I’ve referred to the IMF as both “the Dumpster Fire of the Global Economy” and “the Dr. Kevorkian of Global Economic Policy.”

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There’s a lot of speculation in Washington about what a Trump Administration will do on government spending. Based on his rhetoric it’s hard to know whether he’ll be a big-spending populist or a hard-nosed businessman.

But what if that fight is pointless?

Back in October, Will Wilkinson of the Niskanen Center wrote a very interesting – albeit depressing – article about the potential futility of trying to reduce the size of government. He starts with the observation that government tends to get bigger as nations get richer.

“Wagner’s Law” says that as an economy’s per capita output grows larger over time, government spending consumes a larger share of that output. …Wagner’s Law names a real, observed, robust empirical pattern. …It’s mainly the positive relationship between rising demand for welfare services/transfers and rising GDP per capita that drives Wagner’s Law.

I’ve also written about Wagner’s Law, mostly to debunk the silly leftist interpretation that bigger government causes more wealth (in other words, they get the causality backwards), but also to point out that other policies matter and that some big-government nations have wisely mitigated the harmful economic impact of excessive spending and taxation by having very pro-market policies in areas such as trade and regulation.

In any event, Will includes a chart showing that there certainly has been a lot more redistribution spending in the United States over the past 70 years, so it certainly is true that the political process has produced results consistent with Wagner’s Law. As America has become richer, voters and politicians have figured out how to redistribute ever-larger amounts of money.

By the way, this data is completely consistent with my recent column that pointed out how defense spending plays only a minor role in America’s fiscal challenge.

But let’s get back to Will’s article. He asserts that Wagner’s Law is bad news for advocates of smaller government.

…free-marketeers tend to insist that the key to achieving higher rates of economic growth is slashing the size of government. After all, it’s true that the private sector is better than government at putting resources to their most productive use and that some public spending crowds out private investment. If you’re really committed to the idea of stronger economic growth through government contraction, you’re pretty much committed to the idea that the pattern behind Wagner’s Law is a sort of fluke—a contingent correlation without any real cause-and-effect basis—and that there’s got to be some workaround or fix.

I don’t particularly agree with his characterization. You can believe (as I surely do) that smaller government would lead to faster growth without having to disbelieve, deny, or debunk Wagner’s Law.

  • First, it’s quite possible to have decent growth along with expanding government so long as other policy levers are moving in the right direction. Which is exactly what one Spanish scholar found when examining data for developed nations during the post-World War II period.
  • Second, it’s overly simplistic to characterize this debate as government or growth. The real issue is the rate of growth. After all, even France has a bit of growth in an average year. The real issue is whether there could be more growth with a lower level of taxes and spending. In other words, would the rest of the developed world grow faster with Hong Kong-sized government?

All that being said, Will certainly is right in his article when he points out that libertarians and other advocates of smaller government haven’t done a good job of constraining government spending.

He then examines some of the ideas have been proposed by folks on the right who want to constrain spending. Beginning with the starve-the-beast hypothesis.

The idea that it is possible to “starve the beast”—to reduce the size of government by starving the government of tax revenue—springs from this hope. But the actual effect of cutting taxes below the amount necessary to sustain current levels of government spending only underscores the unforgiving lawlikeness of Wagner’s Law. As our namesake Bill Niskanen showed, tax cuts that lead to budget shortfalls don’t lead to corresponding cuts in government spending. On the contrary, financing government spending through debt rather than taxes makes voters feel that government spending is cheaper than it really is, which makes them want even more of it.

Here’s my first substantive disagreement with Will. I’m definitely not in the all-we-have-to-do-is-cut-taxes camp, but I certainly like lower tax rates and I definitely believe that higher taxes would worsen our long-run fiscal outlook.

And I’ve looked closely at the starve-the-beast academic research. Niskanen’s study has some methodological problems and the Romer & Romer study that most people cite when arguing against the starve-the-beast hypothesis actually shows that cutting taxes is somewhat effective so long as tax cuts are durable.

Will then looks at whether it would be effective to end withholding.

…withholding made tax collection cheaper and more reliable. …paying taxes automatically and with a minimum of pain makes it less likely that you’ll be livid about them when you vote. The complaint…is the libertarian/conservative argument against a VAT or national sales tax in a nutshell. It’s the same line of reasoning that leads some libertarians and conservatives to flirt with the idea that we ought to pass a law that requires us to write a single, hugely infuriating check to the IRS each year.  The idea is that if voters are really ticked off about taxes, they’ll want lower tax rates. So taxes need to be as salient and painful—i.e., as inefficient and distortionary—as possible.

Will is skeptical of this approach, though I would point out that the one major developed economy that doesn’t have withholding is Hong Kong. And that’s a place that has successfully constrained government spending.

To be sure, the spending restraint could exist for other reasons (such as the spending cap in Article 107 of the jurisdiction’s Basic Law), but the hypothesis that people will want less government if taxes are painful is quite reasonable.

And, by the way, requiring lump-sum payments rather than withholding wouldn’t change the degree to which taxes are distortionary.

Will then turns his attention to the ‘supply-side” argument about lower tax rates.

Supply-siders generally present two scenarios, and neither helps reduce the size of government. One: If the tax cuts pushed by ticked-off taxpayers create supply-side stimulus and increase rather than decrease revenue, there’s no downward pressure on spending. …But it doesn’t make government smaller. Two: If tax cuts aren’t self-funding and simply leave a hole in the budget, the beast (as Niskanen showed) does not therefore get starved. Instead, spending feels cheap, the beast grows even more, and the tax bill gets shifted to the future.

Since I’ve already addressed the starve-the-beast issue, I’ll simply note that self-financing tax cuts (which do exist, though only in rare cases) are only possible if there’s a big uptick in growth and/or compliance. And to the extent that the revenue feedback is due to growth, that will mean that the burden of government spending will fall relative to the size of the private sector even if actual outlays stay the same.

Maybe I’m insufficiently libertarian, but I’ll take that outcome every day of the week. Heck, I’m willing to let government get bigger so long as the private sector gets to grow at a faster pace.

Now we get to Will’s main point. He suggests that maybe libertarians shouldn’t be so fixated on the size of government.

…well-funded and well-organized attempts “to convince voters to reduce their demand for the services financed by federal spending” so far have all failed. It’s time to consider the possibility that there’s no convincing them. …If we look at the world, what we see is that when people get richer, they want more welfare state. Maybe there’s nothing much we can do about that. …When people get richer, they want more welfare state. You can want Americans to get continuously wealthier and also want the government to consume a smaller share of national economic output, but there’s very little reason to think you can have both of those things. That is what the world is telling us.

To the extent that Will is simply making a prediction about the likelihood of continued government expansion, I assume (and fear) he’s right.

But to the degree he’s arguing that we should meekly acquiesce to that outcome, then I’ll strongly disagree. I may lose the fight against big government, but I intend to go down swinging.

Interestingly, Will and I may not actually disagree. This passage points out that it’s a good idea to fight against ineffective programs and to support entitlement reform.

…accepting that it’s probably not possible to shrink government would have a transformative effect on right-leaning politics. We would focus on figuring out the best ways to match receipts to outlays… You start to accept that spending cuts are ultimately more about optimizing the composition and effectiveness of spending than about the overall level of spending or its rate of growth. This doesn’t mean not fighting like hell to slash nonsense programs, or not prioritizing reforms to make entitlement programs fiscally sustainable, or not trying to balance budgets from the spending side, or not trying to minimize the rate of spending growth. This just means that you do it all knowing that the rate of spending growth isn’t going to go negative unless you hit a recession, a debt crisis, or end a major war.

And, most important, this passage also highlights the desirability of a policy to “minimize the rate of spending growth.”

Gee, I think I know someone who relentlessly argues in favor of that approach. Indeed, this guy is so fixated on that policy that he even created a “Rule” to give the concept more attention.

I can’t remember his name right now, but I’m sure he’s a swell guy.

More seriously (and to echo the point I made above), it would be a libertarian victory to have government grow slower than the productive sector of the economy. To be sure, obeying my rule (which actually does happen every so often) doesn’t mean we’ll soon reach the libertarian Nirvana of the “night watchman” state set forth in the Constitution.

But the real fiscal fight in America is whether government is becoming a bigger burden, relative to the private economy, or whether its growth is being constrained so that it’s becoming a smaller burden.

Will closes with a very sensible point about not overlooking the other policy areas where government is hindering prosperity (though that doesn’t require us to give up on the very practical quest to limit the growth of government).

Giving up on the quixotic quest to…falsify Wagner’s Law would also lead us to…focus our energy on removing regulatory barriers to economic participation, innovation, and growth.

And his concluding passage is correct, but too pessimistic.

This is just a conjecture. But when…the United States—where the freedom-as-small-government philosophy is most powerfully promoted and most widely accepted—has lost ground in economic freedom year after year for nearly two decades, it’s a conjecture worth taking very seriously.

Yes, he’s right that overall economic freedom has declined during the Bush-Obama years.

But what about the fact that overall economic freedom increased during the ReaganClinton years? And what about the fact that we achieved a five-year nominal spending freeze even with Obama in the White House?

In other words, there’s no need to throw in the towel. I may not be overflowing with optimism about whether we ultimately succeed in sufficiently constraining the growth of government, but I feel very confident that it’s a worthwhile fight.

P.S. While I disagree with a few of Will’s points, I think his article is very worthwhile. Moreover, a consensus on restraining the growth of government would be an excellent outcome to the debate he has triggered.

But I can’t resist being a bit more critical about something Noah Smith wrote about Will’s article. In his Bloomberg column discussing the hypothesis that libertarians should focus less on (or perhaps even give up on) the battle against government spending, he has a passage that is designed to lure readers into thinking that small government is associated with economic deprivation.

…a stark fact — the richer a country is, the more its government tends to spend. …Today, the top spenders include countries such as France, Denmark and Finland, while the small-government ranks include Sudan, Nigeria and Bangladesh.

Sigh.

It’s true that the burden of government spending is much higher in France, Denmark, and Finland than in Sudan, Nigeria, and Bangladesh, but let’s take a look at the overall data from Economic Freedom of the World.

France (#57), Denmark (#21), and Finland (#20) are all much more market-oriented than Sudan (unrated, but would have an awful score), Nigeria (#113), and Bangladesh (#121). Smith’s argument is akin to me saying that government-built roads cause economic misery because that’s how they do it in the hellhole of North Korea.

More important, he either ignores or is unaware of the research showing that nations such as France, Denmark, and Finland became rich when government spending was very small. Sigh, again.

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Earlier this year, I criticized the Organization for Economic Cooperation and Development for endorsing an orgy of Keynesian spending.

Did my criticism have an effect? Well, the bureaucrats in Paris just issued a new report that bluntly suggests a reorientation of fiscal policy to achieve more growth.

…the global economy remains in a low-growth trap with weak investment, trade, productivity and wage growth and rising inequality in some countries. …a stronger fiscal policy response is needed to boost near-term growth and strengthen long-term prospects for inclusive growth.

Sounds good to me. I welcome sinners who want to repent. Is the OECD now recommending corporate tax rate reductions? A flat tax? Entitlement reform? Elimination of wasteful departments, agencies, and programs? A spending cap?

Don’t be silly. This is the OECD. Some of the professional economists are sensible and competent, but major policy initiatives almost always are determined by the high-level hacks who crank out proposals designed to give cover to politicians that want ever-more taxes and spending.

So when the bureaucrats in Paris suggest “a stronger fiscal policy response,” they’re actually advocating for more government. Which is exactly what they did back in February. And what they’ve been repetitively doing all during the Obama Administration. I’m not joking. Here are some further excerpts.

…this chapter emphasises the need for a fiscal initiative…to foster productivity in the medium to long term. Measures should be chosen depending on each country’s most pressing needs and could include not only raising soft and hard infrastructure or education spending… In many countries, such a package could be deficit-financed for a few years, before turning budget-neutral.

The OECD says that “stimulus” would be a good idea because nations now have more “fiscal space,” which is bureaucrat-speak for an estimate of how much additional red ink is supposedly feasible feasible given interest rates, existing debt levels, and other variables.

I’m more worried, for what it’s worth, about the level of spending. And on that basis, there’s less fiscal space. Here’s a comparison (based on the OECD’s own dataset) of the burden of spending before the great recession/global financial crisis and today. As you can see, government outlays are consuming almost 2-percentage points more of economic output.

Needless to say, there’s hasn’t been much “austerity” over the past decade (other than higher income taxes and higher VAT taxes, which means taxpayers have taken a hit but not bureaucrats and interest groups).

In any event, the OECD ignores all this evidence and thinks today is the perfect time for another spending binge. Here are additional details from the report.

OECD governments could finance a ½ percentage point of GDP productivity-enhancing fiscal initiative, for three to four years on average in OECD countries without raising the debt-to-GDP ratio in the medium term, provided the selected activities and projects are sound. Such an initiative could encompass high-quality spending on education, health and research and development as well as green infrastructure that all bring significant output gains in the long run. …the average output gains for the large advanced economies of such a fiscal initiative amount to 0.4-0.6% in the first year.

It’s laughable that the bureaucrats project more growth as a result of Keynesian “stimulus” even though we just suffered through the failure of Obama’s 2009 program (not to mention the repeated failure of Keynesian economics in Japan and elsewhere).

The only good news, if we grade on a curve, is that the bureaucrats apparently don’t think Keynesian “stimulus” would be that helpful for the American economy.

Though I’m worried this Table, buried four pages from the end of the report, won’t get much attention (just as other decent portions of the report, such as commentary about the damage caused by bad tax policy, also will get ignored).

If you think I’m being paranoid, check out these passages from a news report in the Wall Street Journal. The main takeaway from the OECD’s new publication, according to the reporter, is that politicians around the world have a green light for more wasteful spending.

Adding detail to earlier calls for a switch to budget stimulus from exhausted monetary policies, the Paris-based think tank said most governments have room to boost spending by half a percentage point of economic output over a period of three to four years without risking an increase in their already high debts. …The think tank calculates that an increase in spending on the scale it recommends would lift economic growth in the countries involved by between 0.4 and 0.6 of a percentage point, with an additional 0.2 percentage point boost if the effort were to be coordinated internationally. …If governments were to follow the OECD’s advice, it would mark a further turn away from the policies of austerity that were an immediate response to surging government debts in the aftermath of the 2008 financial crisis. …A slow shift toward a greater reliance on fiscal policy has been under way since last year, when Canada embarked on a fiscal stimulus, while the OECD noted that increases in spending are also under way in Germany, Italy and China. …“There is quite a bit more receptivity to the notion of using fiscal policy more actively,” said Ms. Mann.

And I’m worried that this kind of bad advice may influence President-Elect Trump, who already has made worrisome comments about spending for infrastructure and entitlements.

P.S. But I’m semi-hopeful that Trump won’t be a fan of the OECD in general, if for no other reason than the head bureaucrat in Paris called him a racist and was remarkably open about favoring Hillary Clinton’s election.

Gurria tells UpFront’s Mehdi Hasan: “I would tend to agree with those who say that this is not only misinformed, but yes, I think the word racist can be applied. “I think that because the American public is wise, it will then act in consequence,” Gurria adds.

I’ve previously argued that ending American subsidies for the OECD (and its leftist agenda) is an IQ test for Republicans. In prior years, GOPers on Capitol Hill have failed this test. Maybe Trump, if for no other reason than Secretary General Gurria’s harsh attack, will finally end the gravy train for this parasitical bureaucracy.

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When I give speeches on fiscal policy, I commonly get some variation of this question (and you can choose one of more of the options).

Isn’t our fiscal problem largely the result of the wars/intervention/Iraq/Afghanistan/Libya/Syria launched by Bush/Hillary/neocons/Blackwater/Pentagon?

I generally respond by first confessing my lack of expertise on military and foreign affairs, but then I point out that I’m not a fan of nation building (see George Will and Mark Steyn on this topic), so I tell people that I’m very sympathetic to the proposition that trillions of dollars that have been misspent on foreign adventurism this century. Not to mention the human cost of dead and wounded American soldiers.

But I then tell audiences that the Pentagon is not the reason why we’re in fiscal trouble.

Let’s look at two charts, both derived from the Office and Management and Budget’s historical data.

First, here are two pie charts based on the spreadsheet in Table 4.2, which looks at how much of the budget is consumed by different agencies and departments. For both 1962 and 2016, I added together outlays for the Department of Defense and Department of Veterans Affairs and compared that military-related spending to other major categories.

As you can see, military-related outlays used to account for more than one-half of the federal budget, but not they are less than one-fourth of total spending in Washington.

Notice, by the way, that Social Security spending now consumes a significantly larger share of the federal budget, as does spending by the Treasury Department (I assume much of that is EITC redistribution).

But the biggest change, by far, is that the Department of Health and Human Services used to account for 3 percent of federal outlays, but now eats up 28 percent of the budget. Why? Because of programs such as Medicare, Medicaid, and Obamacare.

By the way, the above numbers do not mean that the military budget has been cut.

Here’s our second chart, which is based on the spreadsheet in Table 8.2, which has the numbers for inflation-adjusted outlays for major budget categories.

As you can see, the federal government is spending more today on defense than it was back in the 1960s, even after adjusting for inflation. And outlays for “domestic discretionary” programs also have increased.

But what’s obviously driving fiscal policy is the relentless expansion of entitlements (referred to as “mandatory spending” for purposes of the Budget Enforcement Act).

And because of demographic changes and bad policy choices, outlays for entitlement are projected to become a much larger burden in the future.

So now, perhaps, you understand why I keep arguing in favor of genuine entitlement reform and why I think it’s so critical that Donald Trump reconsider his skepticism.

P.S. In addition to George Will and Mark Steyn, Barack Obama also expressed some support for a libertarian-oriented foreign policy. But only in theory, not in practice.

P.P.S. To put America’s military spending in global context, check out this pie chart.

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I’m a fiscal policy wonk, so I freely acknowledge that I sometimes look at the world through green-eyeshade-colored lenses. But I don’t think it’s an exaggeration to say that expanding entitlements,Demographic 2030 changing demographics, and increasing dependency are the main long-run threats to the American economy.

And this is why the concerns I had about a Hillary Clinton presidency aren’t that different from the concerns I have about a Donald Trump presidency.

Simply stated, he apparently doesn’t even think there’s a problem that needs to be addressed. Here’s what Trump said in an interview with the Daily Signal.

I’m not going to cut Social Security like every other Republican and I’m not going to cut Medicare or Medicaid.

Some people have told me not to get too worried about this statement because candidates make so many speeches and give so many interviews that they’re bound to make mistakes and say things they don’t really mean.

I agree that we shouldn’t get too hung up on every slip of the tongue on the campaign trail (notwithstanding this clip, for instance, Obama surely doesn’t think there are 57 states).

But the Trump people actually re-posted the Daily Signal interview on the campaign’s website, which certainly suggests (to use legal terminology) malice and forethought on the issue of entitlements.

That being said, this doesn’t mean Trump is a lost cause and that genuine entitlement reform is an impossibility.

  • First, politicians oftentimes say things they don’t mean (remember Obama’s pledge that people could keep their doctors and their health plans if Obamacare was enacted?).
  • Second, the plans to fix Social Security, Medicare, and Medicaid don’t involve any cuts. Instead, reformers are proposing changes that will slow the growth of outlays.
  • Third, if Trump is even slightly serious about pushing through his big tax cut, he’ll need to have some plan to restrain overall spending to make his agenda politically viable.

For what it’s worth, I’m particularly hopeful (or not un-hopeful, to be more accurate) that Trump will be willing to address Medicaid reform, ideally as part of an overall proposal to block-grant all means-tested programs.

One reason for my semi-optimism is that the programs is becoming even more of a mess thanks to Obamacare and plenty of governors and state legislators would gladly accept that kind of reform simply to have more control over state budget matters.

And every serious budget person in Washington understands the program must be reformed because of spiraling costs.

The Wall Street Journal has an editorial today about out-of-control Medicaid spending.

One immediate problem is ObamaCare’s expansion of Medicaid, which has seen enrollment at least twice as high as advertised. …Governors claimed not joining would leave “free money” on the table because the feds would pick up 100% of the costs of new beneficiaries. In a new report this week for the Foundation for Government Accountability, Jonathan Ingram and Nicholas Horton tracked down the original enrollment projections by actuaries in 24 states that expanded and have since disclosed at least a year of data on the results. Some 11.5 million people now belong to ObamaCare’s new class of able-bodied enrollees, or 110% higher than the projections. Analysts in California expected only 910,000 people to sign up, but instead 3.84 million have, 322% off the projections. The situation is nearly as dire in New York, where enrollment is 276% higher than expected, and Illinois, which is up 90%. This liberal state triumvirate is particularly notable because they already ran generous welfare states long before ObamaCare.

Of course, the “free money” for states is a fiscal burden for all taxpayers. It’s just that the money from taxpayers gets cycled through Washington before going to state capitals.

But it’s also worth noting that the money soon won’t be “free.”

The state spending share of new Medicaid enrollment will rise to 5% next year and then to 10% by 2020, up from 0% today. The enrollment overruns mean these states will have less to spend than they planned for every other priority, especially the least fortunate.

I suppose this is a good opportunity to recycle my video on Medicaid reform. It was filmed more than five years ago, so some of the numbers are outdated (they’re worse today!). But the policy analysis is still right on point.

Who knows, maybe Trump actually will do the right thing and (in a phrase he took from Reagan) make America great again.

Remember, none of us expected that economic freedom would expand during Bill Clinton’s presidency, so a bit of optimism isn’t totally out-of-bounds.

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I’m a big fan of the Baltic nations of Estonia, Latvia, and Lithuania.

These three countries emerged from the collapse of the Soviet Empire and they have taken advantage of their independence to become successful market-driven economies.

One key to their relative success is tax policy. All three nations have flat taxes. Estonia’s system is so good (particularly its approach to business taxation) that the Tax Foundation ranks it as the best in the OECD.

And the Baltic nations all deserve great praise for cutting the burden of government spending in response to the global financial crisis/great recession (an approach that produced much better results than the Keynesian policies and/or tax hikes that were imposed in many other countries).

But good policy in the past is no guarantee of good policy in the future, so it is with great dismay that I share some very worrisome news from two of the three Baltic countries.

First, we have a grim update from Estonia, which may be my favorite Baltic nation if for no other reason than the humiliation it caused for Paul Krugman. But now Estonia may cause sadness for me. The coalition government in Estonia has broken down and two of the political parties that want to lead a new government are hostile to the flat tax.

Estonia’s government collapsed Wednesday after Prime Minister Taavi Roivas lost a confidence vote in Parliament, following months of Cabinet squabbling mainly over economic policies. …Conflicting views over taxation and improving the state of Estonia’s economy, which the two junior coalition partners claim is stagnant, is the main cause for the breakup. …The core of those policies is a flat 20 percent tax on income. The Social Democrats say the wide income gaps separating Estonia’s different social groups would best be narrowed by introducing Nordic-style progressive taxation. The two parties said Wednesday that they will immediately start talks on forming a coalition with the Center Party, Estonia’s second-largest party, which is favored by the country’s sizable ethnic-Russian majority and supports a progressive income tax.

And Lithuanians just held an election and the outcome does not bode well for that nation’s flat tax.

After the weekend run-off vote, which followed a first round on October 9, the centrist Lithuanian Peasants and Green Union party LGPU) ended up with 54 seats in the 141-member parliament. …The conservative Homeland Union, which had been tipped to win, scored a distant second with 31 seats, while the governing Social Democrats were, as expected, relegated to the opposition, with just 17 seats. …The LPGU wants to change a controversial new labour code that makes it easier to hire and fire employees, impose a state monopoly on alcohol sales, cut bureaucracy, and above all boost economic growth to halt mass emigration. …Promises by Social Democratic Prime Minister Butkevicius of a further hike in the minimum wage and public sector salaries fell flat with voters.

The Social Democrats sound like they had some bad idea, but the new LGPU government has a more extreme agenda. It already has proposed to create a special 4-percentage point surtax on taxpayers earning more than €12,000 annually (the government also wants to expand double taxation, which also is contrary to the tax-income-only-once principle of a pure flat tax).

So the bad news is that the flat tax could soon disappear in Estonia and Lithuania.

But the good news, based on my discussions with people in these two nations, is that the battle isn’t lost. At least not yet.

In both cases, policy can’t be changed unless all parties in the coalition government agree. Fortunately, they haven’t reached that point.

And hopefully that point will never be reached if Estonia and Lithuania want long-run success.

All of the Baltic nations get reasonably good scores from Economic Freedom of the World. Ditching the flat tax will cause their scores to decline.

Given that fiscal policy is only 20 percent of a nation’s grade, adopting some bad tax policy may not seem like the end of the world.

But the flat tax isn’t just good policy. It also has symbolic value, telling both domestic entrepreneurs and global investors that a country has a commitment to a system that won’t impose extra punishment just because a person contributes more to national economic output.

By the way, the LPGU Party is very correct to worry about emigration. The Baltic nations (like most countries in Eastern Europe) face a very large demographic problem. And every time a young person leaves for better opportunities elsewhere (even if that better opportunity is a big welfare check), that makes the long-run outlook even more challenging.

But imposing a more punitive tax system is exactly the opposite of what should happen if the goal is faster growth so that people don’t leave the nation.

Let’s close with a famous quote from John Ramsay McCulloch, a Scottish economist from the 1800s.

To be sure, progressive taxation didn’t lead to total catastrophe, so McCulloch’s warning may seem overwrought by today’s standards.

But the so-called progressive income tax did lead to the modern welfare state. And the modern welfare state, when combined with demographic change, is threatening immense economic and societal damage in many nations.

So what he wrote in 1863 may turn out to be very prescient for historians in 2063 who wonder why the western world collapsed.

P.S. If Estonia and Lithuania move in the wrong direction, Latvia could be a big winner. That nation already has received some positive attention for being fiscally responsible, and it also has withstood pressure from the IMF to impose bad tax policy. So Latvia is well positioned to reap the benefits if Estonia and Lithuania shoot themselves in the foot.

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Back in 2010, I shared a cartoon video making a very important point that there’s a big downside when class-warfare politicians abuse and mistreat highly productive taxpayers.

Simply stated, the geese with the golden eggs may fly away. And this isn’t just theory. As revealed by IRS data, taxpayer will move across borders to escape punitive taxation.

It’s harder to move across national borders, of course, but it happens. Record numbers of Americans have given up their passports, including some very high-profile rich people.

Some folks on the left like to argue that taxes don’t actually lead to behavioral changes. Whenever there’s evidence of migration from high-tax jurisdictions to low-tax jurisdictions, they argue other factors are responsible. The rich won’t move just because tax rates are high, they contend.

Oh, really?

Here are some excerpts from a new Research Brief from the Cato Institute. Authored by economists from Harvard, the University of Chicago, and Italy’s Einaudi Institute, the article summarizes some scholarly research on how top-level inventors respond to differences in tax rates. Here’s what they did.

According to World Intellectual Property Organization data, inventors are highly mobile geographically with a migration rate of around 8 percent. But what determines their patterns of migration, and, in particular, how does tax policy affect migration? …Our research studies the effects of top income tax rates on the international migration of inventors, who are key drivers of technological progress. …We use a unique international data set on all inventors from the U.S. and European patent offices to track the international location of inventors since the 1970s. …We combine these inventor data with international top effective marginal tax rates data. Particularly interesting are “superstar” inventors, those with the most abundant and most valuable innovations. …We define superstar inventors as those in the top 1 percent of the quality distribution, and similarly construct the top 1–5 percent, the top 5–10 percent, and subsequent quality brackets. The evidence presented suggests that the top 1 percent superstar inventors are well into the top tax bracket.

And here’s what they ascertained about the behavioral response of the superstar inventors.

We start by documenting a negative correlation between the top tax rate and the share of top quality foreign inventors who locate in a country, as well as the share of top quality domestic inventors who remain in their home country. …We find that the superstar top 1 percent inventors are significantly affected by top tax rates when choosing where to locate. …the elasticity of the number of foreign top 1 percent superstar inventors to the net-of-tax rate is much larger, with corresponding values of 0.63, 0.85, and 1.04. The far greater elasticity for foreign relative to domestic inventors makes sense since, when a given country adjusts its top tax rate, it potentially affects inventor migration from all other countries.

And they point out a very obvious lesson.

…if the economic contribution of these key agents is important, their migratory responses to tax policy might represent a cost to tax progressivity. … An additional relevant consideration is that inventors may have strong spillover effects on their geographically close peers, making it even more important to attract and retain them domestically

And don’t forget the research I shared last year showing that superstar entrepreneurs are more likely to be found in lower-tax jurisdictions.

P.S. Seems to me, given that upper-income taxpayers shoulder most of the nation’s fiscal burden, that our leftist friends should be applauding the rich rather than demonizing them.

P.P.S. Let’s close with some more election-related humor.

Saw this very clever item on Twitter today.

And connoisseurs of media bias will have to double check to confirm this is satire rather than reality.

Regular readers know I’m skeptical about whether Trump will seek to control big government, but one thing I can safely say is that we’ll have an opportunity to enjoy some amusing political humor for the next four years.

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