09 September 2010

The Myth of Government Growth

One of the core messages of the Republican party, American conservatives, and the Tea Party movement within the Republican party, is that government is too big, and is on track to grow out of control. This rhetoric particularly vilifies the growth of the federal government, which is portrayed as distant from the American people, relative to state and local government.

The trouble is that there is really no factual support for this kind of alarmism.

Federal government employment has been declining, and government employment at all levels of government combined has remained remarkably steady. Neither federal taxes, nor combined taxes at all levels of government combined, are out of control. And, it is the policies that Republicans favor and are continuing to campaign on in this election that have been the main drivers of the growing federal deficit.

The solution that some Republicans have proposed in this election cycle, which is to gut Social Security, Medicare and Medicaid, without offering many specifics regarding how they would go about doing this, moreover, would inflict untold pain on tens of millions of vulnerable Americans.

The only cold comfort we can have in the face of Republican rhetoric urging major rollbacks in Social Security, Medicare and Medicaid is that if it every came close to being translated into law by a Republican controlled Congress, that the Republican party would have written itself a death warrant and the United States would become a dominant party system in which the Democrats were predominant in every single state until a new center-right party emerged from its ashes. Someone on the right seems to have forgotten that American senior citizens are one of the most powerful political forces in the nation, but if their candidates are elected and do what they claim that they will do to reduce the deficit, they will surely discover that this is the case.

The fear of big and growing government that Tea Party advocates are channeling in their political movement is one that they have manufactured in their heads. The facts tell a different story.

Government Employment Is Not Growing

Government employment at all levels combined, as a percentage of the nation's population, has remained essentially constant, at just under 10%, since at least 1976.

Federal government employment has decreased over the last 35 years (mostly in the 1990s), state government employment has been flat, and local government employment has increased.

Federal government employment is approximately 1% of the United States population, and about a tenth of all government employment in the United States.

Local government employment apart from education, has remained roughly constant as a percentage of the U.S. population since 1976, so total government employment apart from education has fallen from about 6% of the United States population in the late 1970s to about 5% now, mostly as a result of declining federal government employment.

Education related employment, which accounts for roughly 45% of all government employees, almost all of whom work for state and local government, has risen as a percentage of the U.S. population since 1976 (when education related government employment accounted for roughly 35% of all government employment) in an amount roughly equal to the decline in federal government employment.

The growth in education related government employment, however, conceals the facts that (1) many of these employees work at nominally public institutions of higher education that are highly autonomous and derive a declining percentage of revenues from legislative appropriations of tax revenues, and (2) an increasing share of K-12 educators who are counted as government employees work at charter schools that have substantial autonomy from the employment structure that applies in ordinary public schools and are subject to market-like competition.

The fear that we have a rapidly growing federal government, or of a growing government sector relative to the private sector, as measured by employees anyway, simply isn't true.

Tax Trends Are Not Alarming

The fear that government is swallowing up the economy, or that federal taxes have grown, are similarly unfounded.

Federal tax revenues as a percentage of GDP have been lower during the Obama administration than at any time in the last three decades, at least (averaging 16.1%), and there is no longer term trend towards increases in taxes as a percentage of GDP in the last generation. Federal government spending growth has closely tracked GDP growth for the entire post-World War II period. There were temporary surges in the amount of federal government spending during the American Civil War, World War I and World War II. There was also a surge in federal government spending during the New Deal, although not nearly as striking a surge relative to GDP as one might expect.

Taxes at all levels of government combined also aren't particularly high in the United States:

U.S. taxes are low relative to those in other developed countries. In 2005 U.S. taxes at all levels of government claimed nearly 27 percent of GDP, compared with an average of 36 percent of GDP for the 30 member countries of the Organization for Economic Co-operation and Development (OECD).

Federal tax revenues, as a percentage of GDP, are lower now than they were in 2005. The complete repeal of the Bush tax cuts of 2001, which no one in Washington is proposing (but which could come about if no deal is reached), would still return the U.S. to a set of tax rates that are still moderate by comparison to other countries and historical U.S. tax rates relative to GDP. If some of those tax cuts are extended, or if new tax cuts are passed, the overall increase in federal tax revenues from their current record lows will be even more modest.

State and local governments have dealt with the financial crisis by both raising taxes and reducing spending, in different proportions. There has not been dramatic growth in state and local government spending in most states and localities, although obviously, trends in government employment, tax rates and spending vary from state to state and locality to locality.

The National Debt

There are basically three ways to measure the size of government: employment, taxation, and government borrowing to facilitate spending in excess of the amount of taxes levied. Government employment levels and taxes are overall low, and haven't been growing. Federal government employment has actually shrunk significantly relative to the U.S. population, and federal taxes have stayed steady and low relative to GDP.

These benign indicators could be deceptive, however, to the extent that government borrowing is concealing growing levels of government spending.

There is relatively little room for this to happen at the state and local government level, because state constitutions, and state laws, greatly limit the amount of money that states raise through debt. While a large share of state and local governments do borrow money to fund capital projects, and federal tax subsidies encourage this practice, state and local governments do not generally borrow large sums of money to fund their general operations. So, the kind of concerns about government borrowing as a way to evade fiscal constraints imposed by tax revenues doesn't really apply at those levels of government, something reflected by the fact that state and local government deficits are largely absent as an issue in the political debate (although there will be a ballot issue on the subject this year before state voters in Colorado as part of the three "Dr. Evil" initiatives).

The debate over government borrowing therefore is the mainly a debate about federal government budget deficits and the national debt that results from them.

Recent Trends In National Debt Levels and Their Causes

The federal debt has risen relative to GDP under ever Republican presidential administration since President Ford, and has fallen relative to GDP under every Democratic presidential administration prior to the current one, in the post-World War II era.

The Bush tax cuts, the wars in Afghanistan and Iraq, and the financial crisis have so far prevented President Obama from living up to this tradition of his Democratic Presidential predecessors, although his term isn't over yet.

The national debt of the United States government reached its modern peak relative to GDP at 109% at the end of World War II. It steadily declined relative to GDP in all Presidential administration from Truman to Nixon. The national debt as a percentage of GDP grew a little during the Ford administration, fell during the Carter administration, grew dramatically during the Presidential administrations of Reagan and George H.W. Bush, fell in the Clinton Administration, and rose again during the George W. Bush administration, and has continued to rise during the Obama administration. The national debt as a share of GDP has now reached a little more than 90% of GDP.

During the Reagan and George H.W. Bush administration tax cuts and increased cold war defense spending were two of the main causes of the growth in the national debt.

The growth in the national debt during the administrations of Presidents George W. Bush and Obama has been mostly due to the Bush tax cuts, increased defense spending, and stimulus related spending (and GDP contraction) in connection with the financial crisis.

To Whom Is The National Debt Owed?

A little under 30% of the publicly held United States national debt (i.e. ignoring intra-governmental debts owed by the federal government to federal government trust funds), is held by foreign governments, mostly through their central banks. The biggest sovereign owners of U.S. national debt obligations (in order) are China, Japan, the United Kingdom, Brazil, the regional government of Hong Kong, Russia and Taiwan.

About 15% of the publicly held United States national debt is held by private foreign nationals and companies owned by them.

The American owned part of the publicly held United States national debt is owned about a quarter by individuals, and about three-quarters by a diverse mix of public and private sector institutional investors like banks, insurance companies, public and private pension funds, state and local government treasurers, and mutual funds.

Does Foreign Investment In Treasury Bonds Put America At Risk?

Treasury bond holders, of course, have no direct say in the policy decisions made by the United States governments. They are debt, not equity. The equity holders in the federal government in the United States are voters.

The fact that a large share of the national debt is owed to international rivals is also not necessarily bad for our national security. While the United States has a storied tradition of never defaulting in the national debt for more than two centuries under the current constitution, if China or Russia were to go to war with the U.S., no one would consider it improper for the U.S. government to declare all Treasury bonds held by their governments forfeit as a penalty for their acts of war, and to deprive them of tens of billions of dollars a year in interest payments on those bonds.

The problem is that if other countries stop buying Treasury bonds to finance the deficits of the United States government, then the interest rates on new debt to replace Treasury bonds that have matured and raised new funds with debt, will rise. Foreign investment in Treasury bonds at low interest rates gives Americans the luxury of paying less in taxes.

And, these foreign governments can inflict this modest amount of pain on the United States federal budget, and in turn, on our economy, by buying fewer Treasury bonds, simply by changing their sovereign wealth fund investment strategies, something infinitely more subtle than an act of war.

The ability of these governments to inflict that modest amount of economic pain gives them some slight leverage in foreign affairs and in matters of U.S. policy, to the extent that American elected officials and their political appointees care.

Still, the depth of the top rated corporate bonds and municipal bonds makes it fairly easy to predict that the increase in the interest rates on Treasury bonds that would flow from a decline in foreign sovereign investment in Treasury bonds would be pretty modest. Treasury bonds are an important part of the overall market for bonds, but not a dominant part of that market, and other market actors would be happy to buy them at only a modestly higher interest rate.

Future Drivers Of The National Debt

The two government programs to do threaten to dramatically increase as a share of federal spending are Medicare and Medicaid, and the interest on the national debt.

There is also a wild card that influences the size of the national debt in the future. It is impossible to predict future defense spending in that kind of time frame which is heavily influenced by the course of our current and future wars, yet war spending has historically almost always been one of the key factors determining the size of the national debt.

Health Care Spending Drives The Future Size Of The National Debt

It is common to describe the Medicare and Medicaid spending growth problem as a problem with "entitlement spending" in general. But, the problem is really a health care spending problem, not a problem with "entitlements" and "mandatory spending programs" per se.

Contrary to rhetoric from some Republicans and a lot of financial advisors and cynical individuals, Social Security is not in fiscal trouble. It is fiscally sound for as far out as it is possible to make meaningful economic projections (about three decades). Projections of future payroll taxes, benefit amounts, and interest rates in that time frame are far too inaccurate to make meaningful estimates any further out, or for that matter, even that far out. Social security's share of federal spending will increase, mostly due to the rising proportion of Americans old enough to be eligible for the program, but that spending is largely funded already with payroll taxes, and slight tweaks to the program could make it even more fiscally secure.

Entitlements without a health care component other than Social Security are also not in trouble. There is no impending collapse of the unemployment trust fund, for example.

Projected Medicare and Medicaid spending increases reflect the assumption that there will be continued growth in health care spending at rates much greater than the rate of inflation, with no corresponding increases in tax revenues.

The health care reform bill passed this year by the Obama administration made a serious dent in these projections by increasing the Medicare payroll tax in both the rate that applies to high income taxpayers and by expanding the breadth of its tax base. It also reduced these projections by reducing growth in health care spending under this programs.

Long term projects of Medicare and Medicaid spending, and the deficits that would accompanying this growth several decades from now, are absurd. The fact that the real cost of health care has increased by double digit percentages for a decade does not imply that it will continue to grow at this rate indefinitely. And the assumption that government spending will increase indefinitely without tax increases or cuts to ballooning health care programs, is highly implausible. At some point, Congress would limit increases in provider compensation, the scope of benefits, eligibility for the programs, or the way that they were funded, before those programs got wildly out of hand.

Also, one of the truism of economic history is that short term exponential growth in any economic variable rarely continues forever. GDP, population and inflation have defied that general rule, but very little else has managed to do so. Prices of a commodity don't increase at inflation adjusted exponential rates forever. Sooner or later people decided that they are no longer willing or able to pay the higher price, or a price bubble unrelated to economic fundamentals collapses.

As an aside, it is also worth mentioning that even if Medicare and Medicaid spending explode, that this doesn't put the United States on the path to socialism. Health care is provided under this programs by private health care providers. These are health care funding programs, not health care provision programs. Massive increases in health care spending in these programs might slightly increase the number of government employees needed to process claims from providers by something far less than 1% of total federal government employment (and wouldn't impact the number of employees needed to collect taxes or raise money by selling Treasury bonds in any meaningful way). Explosions in spending on these programs without further legislative action would increase the amount of the national debt or tax revenues, or both, but that is all they would do.

Increased costs for these programs would only modestly increase the total government share of health care spending in the nation, and would not change the extent to which providers in the program are entangled in government regulation from the status quo. It would simply transfer more money from taxpayers to doctors, nurses, drug companies, and hospitals, who would provide medical care to the same people that they do today.

Interest Rates and the National Debt

Record low interest rates on Treasury bonds cause the current national debt have a much more modest effect on the annual federal budget than it would at historically normal levels. Sustained large deficits and higher interest rates would make interest on the national debt much more burdensome for taxpayers than it is now. But, big unknowns, like the size of future deficits, future interest rates, future inflation rates, and the rate of change in the gross national product over the next few decades, make long term projections regarding the national debt highly suspect.

In the short to medium term time frame where it is possible to make meaningful predictions about the size of the national debt, the primary factors are:

(1) the rate of growth in Medicare and Medicaid spending,
(2) the extent to which the Bush tax cuts are extended (reduced by any new tax cuts),
(3) the size of the defense budget,
(4) interest rates on the treasury bonds,
(5) the size of the losses sustained on financial crisis bailout loans, and
(6) the speed with which the U.S. economy recovers from the financial crisis recession.

Factors (4), (5) and (6) are largely impossible for U.S. elected officials to control.

Republicans are largely committed politically to fully extending the Bush tax cuts and to not reducing the defense budget, so they have left themselves with dramatic cuts to Medicare and Medicaid spending as the only possible solution to the rising deficits they claim to be concerned about. A significant minority of Republican political leaders even openly admit this reality, but they seem oblivious to what this means to beneficiaries of these programs and health care providers. Medicare is the primary means by which almost all Americans over the age of sixty-five pay for their very expensive health care (at a cost of something on the order of $14,000 per person per year, on average). Medicaid funding is a life and death issue for millions of poor, non-elderly beneficiaries, and funds a very large share of all nursing home care in the United States for working class and middle class senior citizens.

Medicare already pays significantly less than the private sector rates to providers, and Medicaid pays about 30% less than that, with the result that private sector health care providers are increasingly refusing to participate in either program, something that will render those programs unworkable in practice if this trend continues.

Democrats, in contrast, have already made a major down payment towards controlling Medicare and Medicaid spending with the health care reform bill, plan not to extend most of the Bush tax cuts for high income taxpayers, and are looking for ways to cut defense spending that will not harm the ongoing war in Afghanistan.

Neither past experience, nor current Republican rhetoric, however, provides any reason to think that the Republican party would be more effective at controlling the national debt than the Democratic party will be this time around.

1 comment:

Norma said...

"The solution that some Republicans have proposed in this election cycle, which is to gut Social Security, Medicare and Medicaid." Do you have names of the Republicans and dates of the proposals?