Today’s Economist: Bruce Bartlett: The True Burden of Government

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

Famously, Milton Friedman always said that the true burden of government is what it spends, not what it taxes. While correct up to a point, his statement has unfortunately led many conservatives to believe that the budget deficit is of no economic importance. That is to say, they believe there is nothing to be gained by reducing the deficit unless it results from lower spending, because that and that alone reduces the burden of government, and reducing the burden of government is the only thing that will raise growth.

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However, as I explained last week, there is a cost from deficits in the form of interest on the debt. If government revenues are too low to finance the level of spending that voters insist upon, spending automatically rises. Eventually, interest on the debt can only be paid with higher taxes, even if all spending except for interest is abolished.

Put another way, the amount of future spending cuts or tax increases necessary to stabilize government finances will always have to be larger when spending increases or tax cuts are deficit-financed. That is because interest increases the size of the future fiscal adjustment. Compounding means that the longer an adjustment is put off, the larger it must eventually be. And of course, debt default is simply a form of tax that falls disproportionately on bondholders; inflation is a tax paid by everyone.

Additionally, government borrowing has effects on the economy independent of spending in general. The economic impact of spending depends on what it is for and that impact may be positive or negative. Conservatives often imply that all spending reduces growth by pre-empting resources that the private sector could use better. But unless one believes that anarchy maximizes growth, that is nonsense.

Government borrowing necessarily takes money out of capital markets, crowding out private investors who would otherwise use those funds for business expansion, new plants and equipment or other business purposes. Such crowding out may be modest today, mainly because a slowdown in growth has sharply reduced the demand for capital. Should growth strengthen, federal borrowing could become a major constraint on investment.

Obviously, many forms of spending greatly increase growth. Military spending protects us from threats from abroad, the police and courts protect our lives and property, schools raise the quality of the labor force, and public works like roads are vital to commerce, to name just a few examples.

Moreover, conservatives tend to believe that to the extent that taxation imposes a burden on the economy, it is largely in its aggregate form. That is, the total amount of revenue collected constitutes the burden of taxation; therefore, all tax cuts are per se stimulative to growth.

To the extent that the tax structure imposes a burden, it is only in the form of its effects at the margin, on the last dollar earned, conservatives believe. They deny that tax expenditures, special provisions of the tax code that cause individuals and businesses to spend or invest in particular ways, diminish growth.

Conservatives may acknowledge that tax expenditures are inferior to rate reductions in stimulating growth, but in practice conservative groups like Americans for Tax Reform, the misnamed organization run by the Republican tax guru Grover Norquist, support every single new tax expenditure because they think all tax cuts are per se good and always better than an equivalent government spending program for the same purpose.

Such groups also oppose any elimination of tax expenditures as a tax increase that will impose an unconscionable burden on the economy and diminish political pressure to cut spending. But in the real world there is no meaningful economic difference between direct spending and spending through the tax code.

If spending diminishes growth it has to be because resources are misallocated. But tax expenditures also misallocate resources. The idea that there is a significant difference between a misallocation resulting from the receipt of a government check and one resulting from a special tax deal is nonsense.

Conservatives cannot acknowledge this because it would lead them to accept the fact that eliminating tax expenditures, even if not accompanied by offsetting tax cuts, might raise growth for the same reason that cutting spending raises growth in their economic model.

Senator Tom Coburn, Republican of Oklahoma, has been asserting for years that many tax expenditures are identical to spending in all but name and are nothing but giveaways with no economic benefit except to the recipients. On Dec. 13, he released a new list of egregious tax loopholes that should be abolished and raise $130 billion of additional revenue over the next decade.

His view has led to a war of words with Mr. Norquist for several years. Writing in The New York Times, Senator Coburn explained that the Norquist tax pledge, which opposes any tax increase for any reason, is ultimately counterproductive on Mr. Norquist’s own terms. The deficit, Senator Coburn says, is a type of tax increase on future generations. And by increasing the likelihood of a future debt crisis, the pledge virtually assures future explicit tax increases in the form of higher interest rates and debasement of the currency.

Conservatives believe that slashing entitlement programs like Medicare is the key to avoiding a future tax increase. But for those who will have to work longer before qualifying for Medicare or spend more out of pocket to compensate for cuts in medical benefits, these effects are little different to them than the equivalent tax increase. What really is the difference to them of paying $1,000 more a year because of Medicare cuts or $1,000 more in taxes?

In short, the black-or-white distinction between taxes and spending, which conservatives believe to their core, is much more complex when looking at specific policies. Tax expenditures can be de facto spending and benefit cuts may be de facto tax increases.

The goal of public policy should be to use the policy instrument best suited to the nature of a problem. A tax incentive may simply work better than the equivalent spending program or vice versa. There is no reason to think, as conservatives do, that a tax cut is always superior to direct spending or that spending constitutes an economic burden while tax expenditures are costless.

Article source: http://economix.blogs.nytimes.com/2012/12/18/the-true-burden-of-government/?partner=rss&emc=rss