Government Spending is the Real Tax

Government Spending is the Real Tax


By Veronique de Rugy


As a libertarian economist who has worked in the nonprofit world almost 20 years, I often despair about our failures to rein in government spending. It seems that we have made no progress on that front—quite the opposite actually—since Milton Friedman made the observation that the true size of government is measured not by how much it rakes in currently in taxes by how much it spends.


He writes as follows:


“Keep your eye on one thing and one thing only: how much government is spending, because that’s the true tax … If you’re not paying for it in the form of explicit taxes, you’re paying for it indirectly in the form of inflation or in the form of borrowing. The thing you should keep your eye on is what government spends, and the real problem is to hold down government spending as a fraction of our income, and if you do that, you can stop worrying about the debt.”


What follows is a reflection—rather than a solution—about what new approach we may want to adopt to fight for smaller government and what new research is still needed.


Let us start with mandatory spending. For decades, scholars have fought healthcare battles by tinkering along the margins of existing government programs (e.g., ACA, Medicare, and Medicaid). What’s more, scholars of all persuasions have mostly focused on ways to have third parties pay for health care consumed by Americans rather than exploring what health care would look like if provided by competitive and consumer-based markets. The last is what my colleagues at the Mercatus Center are doing, but there are too few scholars joining their efforts.


Now I should say that this novel approach for looking at health-care spending has been common practice in the study of non-health government spending. Sites like the Cato Institute’s Downsizing Government are packed with examples of the works of scholars studying many possible ways to significantly reduce government spending – to reduce it for the sake of economic growth and prosperity.


What about other mandatory programs like Social Security?  Like Medicare, the program is discriminatory and bankrupt. One solution—that applies to Medicare as well— would be to move away from age-based programs and toward need-based programs. This simple/not-so-simple reform would help return these programs to the original intent of their designers. It would also save money and end the redistribution that takes place from young to old, from minorities to white, and from the relatively poor to the relatively rich.


However, even such a significant reform would not get to the heart of the true problem. (It’d be more like advocating for Obamacare-lite as a fix for Obamacare.) A better and more inspiring challenge is for libertarians to offer a vision of what a world with much lower government spending would allow in terms of human flourishing, and all the steps needed to get there. Restoring civil society is an important part of that vision, yet, it feels—it could be that I am not seeing it—that it is an often overlooked question.


It’s not that there is no innovation in the battle for less government spending. Back in 2007, the country was entering a terrible financial crisis. Americans became acutely aware of our fiscal peril as government deficits and debt levels skyrocketed. This international economic breakup explains why many of the research effort from scholars across think tanks and universities was aimed at understanding the effects on economic growth of federal debt and taxes.


Many contributions were made by scholars on issues such as “whether Congress should demand built-in reductions to future spending on programs that are the main drivers of our debt before raising the debt ceiling,” or “what should austerity measures look like to truly reduce the debt,”,” and “what is the impact of debt on economic growth.” Research on this last topic is ongoing.


Economists had understood the impact on economic growth of government spending (crowding out, eviction effects, and so on) but very little was understood about the impact on the economy of government debt. Groundbreaking research by Carmen Reinhart and Ken Rogoff started an important conversation when their data showed that countries with debt-to-GDP levels exceeding 90 percent suffered from debt overhang and experienced reductions in economic growth. This finding also triggered a large amount of new research, all trying to figure out whether or not the Reinhart-Rogoff finding is correct.


As is often the case, some models confirm Reinhart and Rogoff’s finding while others claim to debunk it. (A data error in Reinhart and Rogoff’s original publication muddied the debate.) To this day, for better or for worse, the battle of models continues. Meanwhile, government spending grows unabated, with little consideration for the effects on growth. (Indeed, Republicans who were so concerned about budget deficits during the Obama administration have suddenly rediscovered their comfort with Keynesian profligacy.)


From his very first published academic paper in 1949, 1986 Nobel laureate James Buchanan set the tone for a more realistic and less naïve approach to all things government-related, and that includes spending. Following this tradition, over the years scholars have studied the impact of defense and infrastructure spending on economic growth, and many other issues relevant at the time to show that the claims about the power of government spending made by those who want more of it are at best naïve, and often misleading.


What we could do more of, however, is systematically outline the multi-dimensional costs of the spending itself, not just their failure to deliver stimulus or revitalization. A good example of that type of research is the paper from the Harvard Business School that federal spending in states causes local businesses to cut back rather than grow. In other words, more government spending causes the private sector to shrink, an effect exactly the opposite of the intended result. We must continue to bring concrete examples of this phenomenon to the public’s attention.


Then there is the issue of what rules we should implement to shrink/control the size of government. For instance, Friedrich Hayek noted that, “[Adam] Smith’s chief concern was not so much with what man might occasionally achieve when he was at his best but that he should have as little opportunity as possible to do harm when he was at his worst. It is a social system which does not depend for its functioning on our finding good men for running it, or on all men becoming better than they are now, but which makes use of men in all their given variety and complexity, sometimes good and sometimes bad, sometimes intelligent and more often stupid.”


However, it was Buchanan who really pioneered the notion that the key to both controlling government spending and restraining government borrowing is a set of sound fiscal rules. His extensive body of work shows that, in theory, fiscal rules enforce budgetary restraints by tying politicians’ hands. In turn, as the underlying structural roots of chronic budget deficits have become more widely understood, a growing number of countries have adopted fiscal rules to restrict policymakers and reshape democratic governance.


There is a lot more that scholars can do to enhance this area of research. The most interesting question, which remains unanswered, is this: if budgetary rules themselves are the products of the same political pressures and election dynamics that lead to growing debt and deficits, how can we get politicians to adopt strict and binding rules in the first place?


This is just a sample of what more we could do to continue fighting against the growth of government spending. I have no clue if it will make a difference. All I know is that I can’t stop fighting.


Veronique de Rugy

AIER Senior Fellow Veronique de Rugy is also a Senior Research Fellow at the Mercatus Center at George Mason University and a nationally syndicated columnist. Her primary research interests include the US economy, the federal budget, homeland security, taxation, tax competition, and financial privacy.