David R. Henderson  

How Much is Government Costing Us?

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A few months ago, in the comments on one of Bryan's posts (I can't remember which one), Bob Murphy asserted that real income per capita would rise by a large double-digit percent within a year or two if the size of the government were scaled back by about 90 percent. I told Bob that I doubted it. We started to discuss it off-line and Bob convinced me that it wasn't as implausible as it sounded. So in my role as Econlib Features Editor, I suggested that he submit an article to Econlib. It appeared yesterday and in it, he makes his case. See what you think.

If he's right--and I now believe he is--think of the implications. One of the standard objections libertarians get when they advocate scaling back the government is "What about the poor?" Now, granted, the 18 percent increase in real income that he estimates is not uniform. My guess is that many high-income people would benefit by much more than 18 percent because they are now taxed so heavily. But think of the almost 100 percent implicit tax rate (marginal and average) on poor people who are in prison. Many of them would be out because the crimes they're in for would no longer be crimes. (Think peaceful dealers in illegal drugs or peaceful people who are in the prostitution business.)


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COMMENTS (24 to date)
mulp writes:

Taxes are 25% lower today than in 2000 at the Federal level, 15% of GDP today vs 20% of GDP in 2000. Cash flowing in from overseas keeps borrowing really cheap while cheap goods from overseas keeps prices down, so we don't have a case of government spending starving the private sector.

In fact, circa 2005, the mortgage originators were making loans to deadbeats because no credit worthy borrowers had anything to borrow money for that they saw as being worth the effort. Nor did they have any ideas for new firms to IPO that would slice off a fraction of the cash pouring into stocks and driving up those prices.

Why hasn't the growth in GDP, employment, wealth, incomes, been faster than in the 90% when the crushing Clinton taxes were in effect, stealing 2-5% of GDP for government waste instead of going for whatever the great ideas of the future are?

Why wasn't 2% of GDP directed into R&D by the private sector with a ten to twenty year time horizon for return on investment?

Even the Ipad represents the culmination of decades of government policy, increasingly polices set in Asian nations. The Internet underpinning it, for example, was developed with government investment and thus entered the public domain, unlike the similar networking systems developed by many other private firms that were in truth superior to the government run Internet.

The US isn't the low cost steel producer because private firms outside the US were less taxed bu government, but because governments say native steel production critical to their economic growth. And US governments had done much to help the US steel firms become dominant.

Little in the US occurred without government paving the way, or leading the way. Lincoln signed the law creating the incentives to connect the US sea to sea by rail. Jefferson signed the law to build National Road to open up the west.

"Theory is just a theory" sic if it doesn't deliver in the real world.

Paul writes:

Bottom line is the bigger governmentt is, the more WE have to pay for it. The more we have to pay for it, the less disposable income we have to spend. The less disposable income we have, means less job/economic growth provided by the private sector which pushes the economy. Without the private sector we end up with big government trying to create jobs by internal projects such as the Economic Recovery Act which have only a limited effect for a short time. You want to fix things, scale back government and reduce taxes on the private sector and watch the economy BOOM!

hp writes:

Mulp: You raise an excellent point. Convincing empirical evidence one way or the other is always going to be difficult to obtain. The "system" is very noisy. How does one disentangle the tech and housing bubbles, tax receipts, and economic growth?

Of course, everyone must agree that at some point (100%!) high levels of taxation represent a very strong disincentive to be productive. The question is at what rate of government spending do the costs outweigh the benefits? Lower growth compounded over a generation could easily be a factor of 2 in our standard of living. Truly reckless spending can lead to financial collapse.

My feeling is that 35% is way too high. It's implausible that markets are that inefficient. It's also clear, however, that economies can function for long periods of time at even higher levels.

I think that real question is this: Shouldn't it be incumbent on those who advocate very high levels of government spending to show that there are clear benefits? Why does the burden of proof lie on those who are not advocating coercion?

Randy writes:

HP,

"Shouldn't it be incumbent on those who advocate very high levels of government spending to show that there are clear benefits?"

Yes. But as long as the propoganda works (for them) they never will.

"Why does the burden of proof lie on those who are not advocating coercion?"

It doesn't really. That is, even if proved it wouldn't matter. The political class takes what it takes because it can. The rationalizations come after the facts.

Brian Moore writes:

"Many of them would be out because the crimes they're in for would no longer be crimes. (Think peaceful dealers in illegal drugs or peaceful people who are in the prostitution business.)"

I think that sadly, there is probably a significant percentage of people who would consider this a bug, not a feature.

Saying "my plan will enable lots of poor people to get jobs as drug dealers and prostitutes" strikes the average person as wrong, even though they'd be hard pressed to say exactly why.

Nick C. writes:

Good points, mulp.

I think there's more to it than a simple correlation between real income and the tax rate; political uncertainty probably plays an important role, too. For instance, if tax policy is relatively volatile and subject to political whims, then the private sector may be bearish in anticipation of a higher tax burden in the near future. If this was the case, then wouldn't real income growth be lower than we would expect if people had more confidence that lower taxes were here to stay?

The effect of the regulatory climate on real income doesn't seem to be negligible, either. Implementing stricter regulations would probably dampen the positive effects from lower tax rates, for instance. Of course this is conceptual; I don't have any specific examples in mind, so I'm not offering this as an explanation of what we observed in the 2000s. I'm just tossing it out there in the hopes that somebody smarter and better equipped than me can do something with the idea.

I'm not sure that steel production is the best example to illustrate the virtues of government intervention. As regulations (OSHA, minimum wage, etc.) and the tax rates increase, domestic prices also increase relative to foreign competitors. In order to prop up the domestic industry, the government responds by raising import tariffs on foreign steel. If everyone does this, then the global price of steel is artificially high. It's great for the U.S. steel firms if the U.S. government successfully helps them to become dominant, but it hurts any other industry that depends on steel. The price of cars, tools, equipment, buildings, etc. goes up, so as a result consumers have less purchasing power to acquire those other products. In order to prop up one industry, the government must necessarily hurt those that depend on the goods produced by that industry.

David R. Henderson writes:

@Brian Moore,
I think you missed my point, although I can see that I didn't make it as clearly as I might have. The government made these people poor by putting them in prison and cutting their pay to 11 cents an hour plus room and board. They weren't necessarily poor when they were practicing their trades.
Best,
David

Brian Moore writes:

Mulp -- some questions:

"Jefferson signed the law to build National Road to open up the west."

You mean the Braddock road opened by the Ohio Company 50 years before Jefferson? Certainly Jefferson signed into law policy to improve it, but it doesn't really work into your theory of "government paving the way."

http://en.wikipedia.org/wiki/National_Road

"Lincoln signed the law creating the incentives to connect the US sea to sea by rail. "

And nearly all of those railroads went bankrupt. Do you really want the government to take credit for the owners and labor policies of 19th century railroads? Normally pro-government people like to blame that on evil private companies.

"Why wasn't 2% of GDP directed into R&D by the private sector with a ten to twenty year time horizon for return on investment?"

You mean, into stuff like bio-fuels? Are you seriously saying that private companies don't spend billions on research as well? Have you heard of the pharmaceutical industry, perhaps? Or the microchip industry? Nah, they haven't invented anything useful in the last 50 years.

"Why hasn't the growth in GDP, employment, wealth, incomes, been faster than in the 90% when the crushing Clinton taxes were in effect, stealing 2-5% of GDP for government waste instead of going for whatever the great ideas of the future are?

Do you really want to compare those 90's rates to the 70's? It's easy to cherry pick specific examples in one nation -- look at hundreds of countries across the century. Sumner/Mankiw/Avent have been debating tax rates vs. growth/GDP for a few weeks now. Is it an airtight argument? Nope, but neither is yours.

"Even the Ipad represents the culmination of decades of government policy, increasingly polices set in Asian nations."

Did you just give the government responsibility for all of Apple? You said "culmination" not "influenced by" or even "driven by." Are you insane? All of Apple, from Steve Jobs down, is really just a division of the government, which can take credit for their consumer applications?

"The Internet underpinning it, for example, was developed with government investment and thus entered the public domain, unlike the similar networking systems developed by many other private firms that were in truth superior to the government run Internet."

Oookay, look, the government can't take credit for the internet. If you know anything about its development, you'll see how hands-off the government involvement has been. It's even overseen today by private organizations. The basic system implemented at ARPA was done by the government yes, but if you can't grasp the difference between that and what came after, and the lack of governmental involvement in it, I don't know what to tell you. It's like saying that because the person who invented the wheel worked for the government of Gilgamesh (no idea, really) that means that government can take credit for Ford.

Brian Moore writes:

David, thanks for your reply:

I completely agree. I just think there is a large number of people who think that a person being in jail is better (even for the person involved!) than not being in jail, pursuing a career in drugs or prostitution, even if they were legal. They would admit they are now more poor, but actually "better off" now that they have been freed from the terrible world of drugs and prostitution.

I know lots of drug-enforcement police feel this way -- that they are doing the people they arrest a favor. They feel that the money spent on their units and drug prohibition in general are for the benefit of the low-income people who make up the communities they police.

Brian Clendinen writes:

One, the Fortress America is a silly defense policy especially with globalization. Being able to project forces is critical to domestic security. No serious military scholar or strategist would ever think that is a good strategy. Trust me the money is well worth the security. The only real agrument is wether the wars we have fought have been worth the additional cost. Not if it was a good idea to have force to be able to fight the wars.

Secondly, studies have shown fairly conclusively that gambling leads to increased poverty. The same could be said for Prostitutes. Plus one is assuming making it legal would reduce the slavery aspect of the trade ( some estimate’s have 70% of prostitutes in the U.S. are forced to work through some sort of coercion ). I challenge anyone to prove the exploitation/slavery is less in any place that has made it legal. I would argue more people are actually exploited due to the legalization. Not sure if any studies have really looked at this closely though.
My point is legalizing some things actually lead to poverty and decreases personal freedom’s. One would need to be vary careful at what business the goverment gets out of it traditional has been in for at least a hundred years.

I agree with education. I think education done privately would be much more effective and actually increase productivity.

What we really need to focus on is limited goverment that based on experiance doing what it does better or can only due. That is I am a firm beliver that laws should only be based on experiance not ideas.

Rick Stewart writes:

What is 'the long run'? I'd say 100 years, economically, before things really settle down from a significant economic change (let's say 0.25% of GDP, more or less). The problem with any suggestion to run experiments and collect data over that time span is obvious.

Ideally we could create a new nation (perhaps a large state would suffice, if exempt from federal taxes and benefits) with a constitution strong enough to firmly resist political pressures to increase total government spending (and transfers) beyond, say, 5% of GDP.

Unfortunately, without the existence of such a space, those of us willing to try a world with less government simply have nowhere to set up camp.

Mr. K writes:

@Rick Stewart,

"Unfortunately, without the existence of such a space, those of us willing to try a world with less government simply have nowhere to set up camp."

Check out the Seasteading Institute:
http://seasteading.org/

As well as the concept of Charter Cities:
http://www.chartercities.org/concept

marxbites writes:

Brian Clendinen,

Power's wars are NEVER worth the "security" at the expense of the people's dwindling liberties.

ONLY the Revolution was a just war - all the rest were the machinations of enrichment for banksters and their merchants of death.

NEVER!

Woodrow Wilson and World War I
http://mises.org/media/4503

The Great Cooperation
http://mises.org/media/4504

The Progressive Era Triple Alliance: Government as Cartellizer
http://mises.org/media/4464

The Progressive Era Triple Alliance: Government as Cartellizer (continued)
http://mises.org/media/4465

Peace in the Middle East: Empire, Oil, and the Reshaping of the Middle East After World War I
http://mises.org/multimedia/mp3/ASC2009/ASC09_Tooley.mp3

Economist Robert Higgs talked about his life and work. Among the topics he discussed were the global financial crisis, domestic economic news, the Independent Institute, the size of government, and the Federal Register, a daily government journal of new, changed, or proposed federal regulations. He responded to telephone calls and electronic mail. Robert Higgs is a senior fellow in political economy at the Independent Institute. Previously, he had been a fellow at the Hoover Institution and the National Science Foundation. Mr. Higgs taught at the University of Washington, Lafayette College, Seattle University, and the University of Economics in Prague. He is author of: Neither Liberty Nor Safety; Depression, War, and Cold War; Resurgence of the Warfare State; Against Leviathan; The Transformation of the American Economy 1865-1914; Competition and Coercion; Crisis and Leviathan; and Politicka ekonomie strachu (The Political Economy of Fear, in Czech).

http://www.c-spanvideo.org/program/id/203876

Mr. Higgs talks about his book Against Leviathan: Government Power and a Free Society, published by The Independent Institute. The author described his views of the mismanagement of the economy in relation to foreign wars, social security and political leadership, including criticism of the Food and Drug Administration and the Patriot Act. After his presentation, Mr. Higgs answers questions from members of the audience.

http://www.c-spanvideo.org/program/175885-1

mulp writes:

Rick Stewart: why do you need a Constitution; why not a culture that strongly opposes outside control.

Like Afghanistan has for thousands of years.

The British and Russians wanted to build rail lines into Afghanistan, but those were blocked to prevent the outside influences those would bring.

Afghanistan has minimal government, with what governance that does exist being integrated into commerce and culture. In fact, if one were to objectively look at the development and rise of Islam, it is the integration of trade, culture, and governance which for a time was the biggest world empire ever. Islam in what is now Spain represented a great society with economic prosperity and uncharacteristic liberty.

Jared Diamond notes the local resources and climate limit the economic and technology development of a region, but Afghanistan is not only rich in natural resources, but was also a nexus of trade, giving it access to goods and technology.

So, why didn't Afghanistan develop into the ideal libertarian region of self rule and prosperity that would attract all libertarians? I'm sure other regions can also be identified. Yep, New Guinea didn't have the natural resources to become a great economy, surely other regions had and long had no central government to hold back all the development that would make them libertarian paradises.

The idea that the US at its founding represents some sort of libertarian ideal is rather absurd given the big government policies that transfer wealth from natives to immigrants, clearly violating every concept of property rights and liberty. And government was a big hand on the economy with the "citizens" ie voters choosing those who would use government power to boost the local economy. Roads in early American history were the key to prosperity; then rail lines, then more recently roads.

But other institutions were key as well. California today is the product, for good or ill, of big government projects to bring water to the arid southern California. Then its rise as an industrial and technology center grew from the influx of government funded investment, in part to control the Pacific, but also to develop the economy. The California University system was big government policy to make California competitive with the power of the East Coast Ivy's which were founded and gained stature as private institutions. Of course, the Midwest power houses were land grant colleges.

And why is it that NYC, nearly the most heavily taxed places in the US, the center of the US economy? What is it in NYC that draws all those to NYC where the tax burden is so high. Why not move to some low tax Southern State?

Why are the high tax States on the whole more prosperous?

Has California's economy improved as efforts of all sorts have sought to cut taxes with a thousand cuts? Are the cuts in California's education system improved California's present and future economy?

Was the big government growth policies of the 40s, 50s, 60s, and 70s bad for the US economy in producing too much growth, too much technology development, too much increase in family welfare?

Were the Clinton-Gore policies promoting some key government funded technologies like the Internet and gene sequencing bad for the US economy. The gene sequencing grew out of an effort to justify the huge investment by the DOE in supercomputers and to drive down their costs, supercomputers being a huge government funded industry. We haven't seen the emphasis on order of magnitude increases in supercomputer power since 2000 of the 90s.

We can see a century worth of different government policies in the different regions of the US, so from the standpoint of a consistent Constitutional framework, that provides the basis for long term comparison. I can think of a number of smaller government, lower tax policy states I'd consider retiring to from my career in the higher growth and income high tax big government States. They appeal to my hippie back to the earth primitivist roots.

Chris writes:

Mulp,

I see you as one of the history professors I had in HS or college teaching a long conscience full of generalizations with no data to back it up.

And .. and ... and .. then we get to had the government step in to protect factory worker rights ... and ... and... and... then they set up social security to give the people a much needed safety net... and then etc.

David C writes:

I found the original argument here. And the relevant quote is:

"I think average real wages would, within one year, be at least 5x what they are right now, and within 5 years they would probably be a good 20x what they are right now." - Bob Murphy

His current article scales back his numbers considerably.

"Such an increase would have meant an 18 percent increase in GDP in 2009. It also works out to an average of about $8,500 per man, woman, and child in America, per year, starting almost immediately after a hypothetical rollback of Big Government." - Bob Murphy

I recall the argument Tyler Cowen and Mathew Yglesias had about using growth rates or levels to compare different countries. I can't recall where, but I think one of the economics blogs commenting on the whole thing argued that eliminating government services would not continuously improve outcomes. Instead, they would create a one-time improvement in the economy.

David R. Henderson writes:

Thanks, David C.
I had forgotten that Bob's estimate was that high and I had also forgotten that my own estimate was > 30%. I talked myself down to 5 to 10 percent, which is why I found his 18% striking.
Re rates vs. levels, good point, but I can see a case for it affecting both. More profitable investment which leads to a continuously higher technology coefficient in the Solow model.
Best,
David

Foobarista writes:

There's a couple of dimensions to the cost of government: government doing too much, and the execution of government being too expensive. The latter may be as much a problem as the former, and my own feeling is the cost of government execution is a big reason why government is so unpopular these days.

I'd think "progressives" would want efficient, cost-effective government execution so more resources would be available for their ideas, but they rarely admit that cost drivers like government unions and "prevailing wage" silliness are existential enemies of the progressive project.

Brian Clendinen writes:

@marxbites

I disagree with your whole underlying argument, the problem when one gets into any justification of the additional cost of wars, one is dealing in the hypothetical of the risk it reduced. The freedoms won or lost are extremely difficult to justify cleanly and quanitify. I actually agree somewhat agree with the arguments on World War I, then again Wilson was a Bigot and Fascist (The American flavor) so what do you expect.

One has to compare what happened historical when nothing was done verse the hypothetical cost of doing something earlier. What if we had sent 80 thousand troop in 1918 to support the Whites in Russia. That would of tipped the balance and the current government would of won. How many wars and tens of millions of murders we could of avoided if communism was stopped for even two decades in Russia? Same with Hitler in the mid 30's.

I disagree on the revolutionary war being somehow more justified. Look at all the British nations which were granted freedom with-out any fighting. In retrospect the war was a good idea from what came of it. Canada was in 1867 granted freedom as a federation, the U.S. could have had it maybe in the 1840’s with little fighting. However, while the revolution going on I would understand and might of actually been a weak Tory. I mean rebelling against a what few % tax on selected goods is silly. That historical narrative is actually somewhat false. The real tipping point, was the undermining of local self rule, especially the invalidating at a whim of American courts decisions or not even allow them for domestic issues to have any authority . That was the real threat, and why the war was fought. The whole tax argument was just a minor symptom. So from that point any war protecting local rule of law and freedoms from tyrants would be justified? Is that your position?

Secondly, the main disagreement comes down to the nature of men and how one best deals with tyrants. Historical speaking show a force and using force is the only message they understand, especially Islam culture. So if you do not believe men at innately evil and believe that enlightenment can somehow prevent wars, then there is no use discussing the net return of war. Our underlying religious philosophies do not allow any common ground.

Bob Murphy writes:

David C,

Thanks for digging that up; David and I couldn't find it. But you understand why the (somewhat) documented number is a lot lower than my personal belief, right?

In other words I still believe my original estimate, but I only focused on a few things for a relatively short piece.

MernaMoose writes:

Foobarista,

I'd think "progressives" would want efficient, cost-effective government execution so more resources would be available for their ideas

Progressives don't care if the government is efficient or not. They care about the same thing that communists do -- making sure that nobody has anything, that everybody else doesn't also have.

Sure there are differences between our "progressives" (who are Euro-socialists) and outright communists. But the core ethics are identical.

I suspect far too many Americans are not quite clear on that little detail. The old school Democrats were more interested in providing a safety net for the poor, which is one thing. The modern progressive agenda is an entirely different animal.

MernaMoose writes:

Bob Murphy and David Henderson,

I agree with the gist of where you're trying to go in general terms. But can I suggest that maybe your calculations aren't quite nuanced enough.

As one who works in Big Corporate America, I've watched the cost of doing business go up over the past decade, simply due to requirements to comply with government regulations.

So we need a giant Government Sandbox somewhere (preferably deep in the Australian Outback) that they can all go off and Play Government in. With plastic dolls representing We The People. We'll pay the bill to let them have their Sandbox and play, but they aren't allowed to mess with us beyond that.

Gut-feel guess: in somewhere around five years, maybe ten at the outside, the resulting increase in economic growth would be sufficient to pay the tax burden they're laying on us.

The US economy remains an amazing creature (at least for now, though I wonder for how much longer). We can afford the dead-weight tax load. What's really killing us by far, is their interference in running our businesses.

I don't know if you were thinking along these lines or not, but I believe that's how it works.

liberty writes:

""Lincoln signed the law creating the incentives to connect the US sea to sea by rail. "

And nearly all of those railroads went bankrupt. Do you really want the government to take credit for the owners and labor policies of 19th century railroads? Normally pro-government people like to blame that on evil private companies."


See The Myth of The Robber Barons for the vast difference between fully private and heavily subsidized railroads:
http://www.amazon.com/Myth-Robber-Barons-Business-America/dp/0963020315

"Plus one is assuming making it legal would reduce the slavery aspect of the trade ( some estimate’s have 70% of prostitutes in the U.S. are forced to work through some sort of coercion ). I challenge anyone to prove the exploitation/slavery is less in any place that has made it legal. I would argue more people are actually exploited due to the legalization."

You'd be terribly wrong. Assuming that slavery is illegal in the society with legalized prostitution (as in this example), the enslaving aspect can only be effectively outlawed if the non-slavery consensual prostitution is made legal -- with things above board, those trying to force individuals to remain in prostitution when they want to leave would be stooped, and those coercing workers or to forfeit outrageous sums (uncompetitive rates) to employers (pimps), would lose out to those offering reasonable rates.

This has been shown in practice in the legalized sectors and areas, and is obvious based on standard economic theory.

David C writes:

"But you understand why the (somewhat) documented number is a lot lower than my personal belief, right?" - Bob Murphy

I do understand that you were going for a conservative estimate, but I actually thought you had changed your mind. I had assumed your article was still aiming to get into the ballpark of what eliminating government would achieve. Evidently that assumption was incorrect.

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