Wednesday, August 03, 2011

Debt Deal Was Setback For Big Government

Was the debt deal a win for Republicans or Democrats, or more specifically for small- or big government advocates? Left-wing opponents and right-wing advocates say that Republicans won while right-wing opponents and left-wing advocates say that Democrats won-or at least got a fair deal.

The answer to that question depends on what gauge of spending you rely on. Cato Institute's Chris Edwards points to the fact that discretionary spending will continue to rise in nominal terms. But apart from using a very misleading graph (that starts at $900 billion and goes up to $1,300 billion, which makes an annual average increase of 1.9% look like big boom), Edwards' use of nominal numbers are misleading for the same reason that it would be misleading to say that countries with hyperinflation are experiencing unprecedented booms. It is the amount of real goods and services that matters, not the nominal numbers.

It is also misleading not to take economic growth into account. The level of economic freedom is essentially a function of (average) tax rates, and tax rates in turn are a function of high government spending is relative to the size of the economy.

Thus, assuming that average annual nominal growth stays at the 4% level America had during the latest decade, a 1.9% average annual increase in nominal spending will mean a big reduction in the cost for the private sector of government spending , meaning that taxes can be reduced without an increase in the deficit-or more likely in this case that the deficit can be reduced without an increase in taxes.

For this reason, the debt deal did in fact mean progress for the cause of limited government and a setback for the cause of big government.

2 Comments:

OpenID savecapitalism said...

The main question in my mind is, are we more likely to see 4% or sub-1.9% growth? I'll bet the latter, thus big government won again. Going for broke, though, so it really doesnt matter for much longer.

5:17 PM  
Blogger stefankarlsson said...

Savecapitalism, you're right that slower growth would mean that the decline in the burden of spending would be lower.

But it should be noted first of all that the 4% nominal increase (2.5% inflation, 1.5% real growth) number I used was based on the last decade which has been the weakest ever in American history except for the 1930s.

And secondly, lower nominal growth will also mean that spending will increase less as lower inflation means that the cost of purchasing goods and services increases less. And even lower real economic growth reduces spending growth because this means lower increases in real wages for government workers.

8:11 AM  

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