Tag Archives: Great Recession

Economic Freedom, Growth, and What Might Have Been

Economists are obsessed with growth. And for good reason. Greater wealth doesn’t just buy us nicer vacations and fancier gadgets. It also buys longer life spans, better nutrition, and lower infant mortality. It buys more time with family, and less time at work. It buys greater self-reported happiness. And as Harvard economist Benjamin Friedman has argued, wealth even seems to make us better people:

Economic growth—meaning a rising standard of living for the clear majority of citizens—more often than not fosters greater opportunity, tolerance of diversity, social mobility, commitment to fairness, and dedication to democracy.

For much of my lifetime, brisk economic growth was the norm in the United States. From 1983 to 2000, annual growth in real (that is, inflation-adjusted) GDP averaged 3.67 percent. During this period, the U.S. experienced only one (short and mild) recession in the early ‘90s. The era was known among macroeconomists as the “great moderation.”

But starting around the turn of the millennium, things changed. Instead of averaging 3.67 percent growth, the U.S. economy grew at less than half that rate, 1.78 percent on average. To see the effect of this deceleration, consider the chart below (data are from the BEA). The blue line shows actual GDP growth (as measured in billions of chained 2009 dollars).

The red line shows what might have happened if we’d continued to grow at the 3.67 percent rate which prevailed for the two previous decades. At this rate, the economy would have been 30 percent larger in 2015 than it actually was.

This assumes that the Great Recession never happened. So to see what would have happened to GDP if the Great Recession had still occurred but if growth had resumed (as it has in every other post-WWII recession), I calculated a second hypothetical growth path. The green line shows the hypothetical path of GDP had the economy still gone through the Great Recession but then resumed its normal 3.67 percent rate of growth from 2010 onward. Under this scenario, the economy would have been fully 8 percent larger in 2015 than it actually was.


(Click to enlarge)

So what happened to growth? One answer is economic freedom—or a lack thereof. Just yesterday, the Fraser Institute released its annual Economic Freedom of the World report. Authored by Professors James Gwartney of Florida State University, Robert Lawson of Southern Methodist University, and Joshua Hall of West Virginia University, the report assesses the degree to which people are free to exchange goods and services with one another without interference. As Adam Smith might have put it, it measures the degree to which we live under “a system of natural liberty.”

As the chart below shows, economic freedom was on the steady rise before 2000. This coincided with modest deregulation of a few industries under Carter and Reagan, tax cuts under Reagan and Clinton, free trade deals, and restrained growth in the size of government. But from 2000 onward, U.S. economic freedom has been in precipitous decline. This coincides with major new financial regulations under both Bush II and Obama, significant growth in government spending, and a steady erosion in measures of the rule of law.


(Click to enlarge)

As I’ve noted before, the research on economic freedom is quite extensive (nearly 200 peer-reviewed academic studies use economic freedom as an explanatory variable). Moreover, meta-studies of that literature find “there is a solid finding of a direct positive association between economic freedom and economic growth.”

Perhaps the two charts have something to do with one another?



Teenage unemployment in cities

New research that examines New York’s Summer Youth Employment Program (SYEP) finds that participation in the program positively impacts student academic outcomes. As the authors state in the introduction, youth employment has many benefits:

“Prior research suggests that adolescent employment improves net worth and financial well-being as an adult. An emerging body of research indicates that summer employment programs also lead to decreases in violence and crime. Work experience may also benefit youth, and high school students specifically, by fostering various non-cognitive skills, such as positive work habits, time management, perseverance, and self-confidence.” (My bold)

This is hardly surprising news to anyone who had a summer job when they were young. An additional benefit from youth employment not mentioned by the authors is that the low-skill, low-paying jobs held by young people also provide them with information about what they don’t want to do when they grow up. Working in a fast food restaurant or at the counter of a store in the local mall helps a young person appreciate how hard it is to earn a dollar and provides a tangible reason to gain more skills in order to increase one’s productivity and earn a higher wage.

Unfortunately, many young people today are not obtaining these benefits. The chart below depicts the national teenage unemployment rate and labor force participation rate (LFP) from 2005 to 2015 using year-over-year August data from the BLS.

national teen unemp, LFP

During the Great Recession teenage employment fell drastically, as indicated by the simultaneous increase in the unemployment rate and decline in the LFP rate from 2007 to 2009. From its peak in 2010, the unemployment rate for 16 to 19 year olds declined slowly until 2012. This decline in the unemployment rate coincided with a decline in the LFP rate and thus the latter was partly responsible for the former’s decline. More recently, the labor force participation rate has flattened out while the unemployment rate has continued to decline, which means that more teenagers are finding jobs. But the teenagers who are employed are part of a much smaller labor pool than 10 years ago – nationally, only 33.7% of 16 to 19 year olds were in the labor force in August 2015, a sharp decline from 44% in 2005.

Full-time teenage employment is unique in that it has a relatively high opportunity cost – attending school full time. Out of the teenagers who work at least some portion of the year, most only work during the summer when school is not in session. Some teenagers also work during the school year, but this subset of teenage workers is smaller than the set who are employed during the summer months. Thus a decline in the LFP rate for teenagers may be a good thing if the teenagers who are exiting the labor force are doing so to concentrate on developing their human capital.

Unfortunately this does not seem to be the case. From 2005 to 2013 the enrollment rate of 16 and 17 year olds actually declined slightly from 95.1% to 93.7%.  The enrollment rate for 18 and 19 year olds stayed relatively constant – 67.6% in 2005 and 67.1% in 2013, with some mild fluctuations in between. These enrollment numbers coupled with the large decline in the teenage LFP rate do not support the story that a large number of working teenagers are exiting the labor force in order to attend school full time. Of course, they do not undermine the story that an increasing amount of teenagers who are both in the labor force and attending school at the same time are choosing to exit the labor force in order to focus on school. But if that is the primary reason, why is it happening now?

Examining national data is useful for identifying broad trends in teenage unemployment, but it conceals substantial intra-national differences. For this reason I examined teenage employment in 10 large U.S. cities (political cities, not MSAs) using employment status data from the 5-year American Community Survey (ACS Table S2301. 2012 was the latest data available for all ten cities).

The first figure below depicts the age 16 – 19 LFP rate for the period 2010 – 2012. As shown in the diagram there are substantial differences across cities.

City teenage LFP

For example, in New York (dark blue) only 23% of the 16 – 19 population was in the labor force in 2012 – down from 25% in 2010 – while in Denver 43.5% of the 16 – 19 population was in the labor force. Nearly every city experienced a decline over this time period, with only Atlanta (red line) experiencing a slight increase. Five cities were below the August 2012 national rate of 34% – Chicago, Philadelphia, Atlanta, San Francisco, and New York.

Also, in contrast to the improving unemployment rate at the national level from 2010 – 12 shown in figure 1, the unemployment rate in each of these cities increased during that period. Figure 3 below depicts the unemployment rate for each of the 10 cities.

City teenage unemp rate

In August 2012 the national unemployment rate for 16 – 19 year olds was 24.3%, a rate that was exceeded by all 10 cities analyzed here. Atlanta had the highest unemployment rate in 2012 at 48%. Atlanta’s high unemployment rate and relatively low LFP rate reveals how few Atlanta teens were employed during this period and how difficult it was for those who wanted a job to find one.

The unemployment rate may increase because employment declines or more unemployed people enter the labor force, which would increase the labor force participation rate. Figures 2 and 3 together indicate that the unemployment rate increased in each of these cities due to a decline in employment, not increased labor force participation.

The preceding figures are evidence that the teenage employment situation in these major cities is getting worse both over time and relative to other areas in the country. To the extent that teenage employment benefits young people, fewer and fewer of them are receiving these benefits. From the linked article:

“The substantial drop in teen employment prospects has had a devastating effect on the nation’s youngest teens (16-17), males, blacks, low income youth, and inner city, minority males,” wrote Andrew Sum in a report on teen summer employment for the Center for Labor Market Studies at Northeastern University. “Those youth who need work experience the most get it the least, another example of the upside down world of labor markets in the past decade.”

Unfortunately, in many cities the response to this situation will only exacerbate the problem. Seattle and Los Angeles have already approved local $15 minimum wages, and a similar law in the state of New York that applies only to fast food franchises was recently approved by the state’s wage board. While many people still question the effect of a minimum wage on overall employment, there is substantial empirical evidence that a relatively high minimum wage has a negative effect on employment for the least skilled workers, which includes inner-city teenagers who often attend mediocre schools. Thus it is hard to believe that any of the seemingly well-intentioned increases in the minimum wage that are occurring around the country will have a positive effect on the urban teenage employment situation presented here. A better response would be to eliminate the minimum wage so that in the short run low-skilled workers are able to offer their labor at a price that is commensurate to its value. In the long run worker productivity must be increased which involves K-12 school reform.

Municipalities in fiscal distress: state-based laws and remedies

The Great Recession of 2008 “stress tested” many policies and institutions including the effectiveness of laws meant to handle municipal fiscal crises. In new Mercatus research professor Eric Scorsone of Michigan State University assess the range and type of legal remedies offered by states to help local governments in financial trouble.

“Municipal Fiscal Emergency Laws: Background and Guide to State-Based Approaches,” begins with some brief context. Most municipal fiscal laws trace their lineage through the 1975 New York City fiscal crisis, the Great Depression and the 19th century railroad bankruptcies. Writing in 1935, attorney Edward Dimock articulated three pieces to addressing municipal insolvency:  1) oversight of the municipality’s financial management 2) stop individual creditors from undermining the distressed entity and 3) put together a plan of adjustment for meeting the creditor’s needs.

These general parameters are at work in state laws today. The details vary. Some states are passive and others much more “hands-on” in dealing with local financial troubles. Scorsone documents these approach with a focus on the “triggers” states use to identify a crisis, the remedies permitted (e.g. can a municipality amend a collective bargaining agreement?), and the exit strategies offered. Maine has the most “Spartan” of fiscal triggers. A Maine municipality that fails to redistribute state taxes, or misses a bond payment triggers the state government’s attention. Michigan also has very strong municipal distress laws which create, “almost a form of quasi-bankruptcy” allowing the state emergency manager to break existing contracts. Texas and Tennessee, by contrast, are relatively hands-off.

How well these laws work is a live issue in many places, including Pennsylvania. In 1987 the state passed Act 47 to identify distressed municipalities. While Act 47 appears to have diagnosed dozens of faltering local governments, the law has proven ineffective in helping municipalities right course. Many cities have remained on the distressed list for 20 years. Recent legislation proposes to allow a municipality that can’t “exit Act 47” the option of disincorporating. Is there a middle ground? As the PA State Association of Town Supervisors put it, “If we can’t address the labor issues, if we can’t address the mandates, if we can’t address the tax exempt properties, we go nowhere.”

Municipalities end up in distress for a complex set of reasons: self-inflicted policy and governance failures, uncontrollable social and economic shifts, and external shocks. Unwinding the effects of decades of interlocking problems isn’t a neat and easy undertaking. The purpose of the paper isn’t to evaluate the effectiveness various approaches to helping municipalities out of distress, it is instead a much-needed guide to help navigate and compare the states’ legal frameworks in which municipal leaders make decisions.




Maryland’s “severe financial management issues”

Budgetary balance continues to evade Maryland. In FY 2015 the state anticipates a deficit of $400 million. A fact that is being blaming on entitlements, mandated spending, and fiscal mismanagement in the Developmental Disabilities Administration. The agency has been cited by the HHS Inspector General as over billing the Federal government by $20.6 billion for Medicaid expenses.

For over a decade the state has struggled with structural deficits, or,  spending exceeding revenues. The state’s method of controlling spending – the Spending Affordability Commission – has overseen 30 years of spending increases, and its Debt Affordability Commission has compounded the problem by increasing the state’s debt limits in order to expand spending.

For the details, visit my blog post for the Maryland Public Policy Institute. Of related interest is the Tax Foundation’s recent ranking of government spending the states. Maryland ranks 19, and has increased spending by 30.5% since 2011  2001.

Don’t like the fiscal cliff? You’ll hate the fiscal future.

Absent an eleventh-hour deal—which may yet be possible—the Federal government will cut spending and raise taxes in the New Year. In a town that famously can’t agree on anything, nearly everyone seems terrified by the prospect of going over this fiscal cliff.

Yet for all the gloom and dread, the fiscal cliff embodies a teachable moment. At the risk of mixing metaphors, we should think of the fiscal cliff as the Ghost of the Fiscal Future. It is a bleak lesson in what awaits us if we don’t get serious about changing course.

First, some background. Over the last four decades, Federal Government spending as a share of GDP has remained relatively constant at about 21 percent. This spending was financed with taxes that consumed about 18 percent of GDP and the government borrowed to make up the difference.

After a decade of government spending increases and anemic economic growth, federal spending is now about 24 percent of GDP (a post WWII high, exceeded only by last year’s number) and revenues are about 15 percent of GDP (the revenue decline can be attributed to both the Bush tax cuts and to the recession).

But the really telling numbers are yet to come.

The non-partisan Congressional Budget Office now projects that, absent policy change, when my two-year-old daughter reaches my age (32), revenue will be just a bit above its historical average at 19 percent of GDP while spending will be nearly twice its historical average at 39 percent of GDP. This is what economists mean when they say we have a spending problem and not a revenue problem: spending increases, not revenue decreases, account for the entirety of the projected growth in deficits and debt over the coming years.

Why is this so frightful? The Ghost of the Fiscal Future gives us 3 reasons:

1) As spending outstrips revenue, each year the government will have to borrow more and more to pay its bills. We have to pay interest on what we borrow and these interest payments, in turn, add to future government spending. So before my daughter hits college, the federal government will be spending more on interest payments than on Social Security.

2) When the government borrows to finance its spending, it will be competing with my daughter when she borrows to finance her first home or to start her own business. This means that she and other private borrowers will face higher interest rates, crowding-out private sector investment and depressing economic growth. This could affect my daughter’s wages, her consumption, and her standard of living. In a vicious cycle, it could also depress government revenue and place greater demands on the government safety net, exacerbating the underlying debt problem.

This is not just theory. Economists Carmen Reinhart and Kenneth Rogoff have examined 200-years’ worth of data from over 40 countries. They found that those nations with gross debt in excess of 90 percent of GDP tend to grow about 1 percentage point slower than otherwise (the U.S. gross debt-to-GDP ratio has been in excess of 90 percent since 2010)

If, starting in 1975, the U.S. had grown 1 percentage point slower than it actually did, the nation’s economy would be about 30 percent smaller than it actually is today. By comparison, the Federal Reserve estimates that the Great Recession has only shrunk the economy by about 6 percent relative to its potential size.

3) Things get worse. The CBO no longer projects out beyond 2042, the year my daughter turns 32. In other words, the CBO recognizes that the whole economic system becomes increasingly unsustainable beyond that point and that it is ludicrous to think that it can go on.

What’s more, if Congress waits until then to make the necessary changes, it will have to enact tax increases or spending cuts larger than anything we have ever undertaken in our nation’s history. As Vero explains:

By refusing to reform Social Security, lawmakers are guaranteeing automatic benefit cuts of about 20-something percent for everyone on the program in 2035 (the Social Security trust fund will be exhausted in 2035, the combined retirement and disability trust funds will run dry in 2033, and both will continue to deteriorate).

In other words, if we fail to reform, the fiscal future will make January’s fiscal cliff look like a fiscal step. I’ve never understood why some people think they are doing future retirees a favor in pretending that entitlements do not need significant reform.

You might think that we could tax our way out of this mess. But taxes, like debt, are also bad for economic growth.

But it is not too late. Like Scrooge, we can take ownership of the time before us. We can make big adjustments now so that we don’t have to make bigger adjustments in a few years. There is still time to adopt meaningful entitlement reform, to tell people my age to adjust our expectations and to plan on working a little longer, to incorporate market incentives into our health care system so that Medicare and Medicaid don’t swallow up more and more of the budget.

Some characterize these moves as stingy. In reality, these types of reforms would actually make our commitments more sustainable. And the longer we wait to make these inevitable changes, the more dramatic and painful they will have to be.

For all the gloom and dread, the Ghost of Christmas Yet to Come was Scrooge’s savior. In revealing the consequences of his actions—and, importantly, his inactions—the Ghost inspired the old man to take ownership of the “Time before him” and to change his ways.

Let us hope that Congress is so enlightened by the Ghost of the Fiscal Cliff.

What Was Wrong with the Bush Tax Cuts?

Back in April, President Obama had this to say about the Bush tax cuts:

We tried this for eight years before I took office. We tried it. It is not like we did not try it. At the beginning of the last decade, the wealthiest Americans got two huge tax cuts, in 2001 and 2003. Meanwhile, insurance com­panies, financial institutions, there [sic] were all allowed to write their own rules, find their way around the rules. We were told the same thing we’re being told now—this is going to lead to fast­er job growth, it’s going to lead to greater prosperity for everybody. Guess what? It didn’t.

At first blush, the data would seem to be on the President’s side: even if we ignore the Great Recession,  economic growth in the 26 quarters that followed passage of the Bush tax cuts averaged just 2.5 percent while it averaged 3.7 percent in the 26 quarters that preceded the cuts.

So is this experience reason to throw out every microeconomics 101 textbook? Or at least to rip out the sections that cover the deadweight loss of taxation? No. The fact is that the Bush tax cuts were deeply flawed, even from a free-market perspective. In a new paper with Mercatus program associate, Andrea Castillo, we contend:

[T]he Bush tax cuts had a number of problems from a market-oriented perspective: they were phased in slowly, they were set to expire within a decade, they entailed a Keynesian emphasis on stimulating aggregate demand, and—above all—they were undertaken without any effort to reduce spending. In light of these problems, there is no reason to overturn decades of theoretical and empirical research supporting the link between low taxation and growth. The episode offers a cautionary lesson in how not to cut taxes.

The Ravitch Volker report: State Budget Crisis is Real

The recession of 2008 pulled the mask off of state budget pathologies that had been identified as institutional weaknesses in the decades leading to the crisis.

The “new normal” for state and local governments does not look like the booming 1980s and 1990s but in fact is riddled with many fiscal challenges.  Revenues aren’t what they were before 2008 though they are expected to reach pre-recession levels in FY 2013. The Medicaid and employee benefits bill is rising. The stimulus pushed forward budgetary reforms. These are some of the findings of the Ravitch-Volker Report, an effort of the State Budget Crisis Task Force which assembled in 2010-2012 to diagnose the major problems facing six states: California, Illinois, New Jersey, New York, Texas and Virginia.

Much of the analysis is non-controversial: Medicaid is eating up budgets, as are pensions costs and health care benefits.

Medicaid, currently at 24 percent of state spending, will continue to increase as enrollment, medical inflation and the increasing caseloads that come with higher unemployment increase costs. This is not a surprise. What is new is that the federal government is making it harder for cost-saving measure to be enacted, and “entrenched provider groups in each state resist reductions in Medicaid provider rates….”  I do not believe this is the intention of the authors of the report but the diagnosis of Medicaid’s future highlights the dysfunctional aspects of this federal-state pact which has led to the creation of special interests that benefit from inflating costs.

On the pension front the Ravitch-Volker report points to the the role discount rates have played in the pension funding problems facing the state and local governments, in particular in New Jersey. And they also note the reliance on budgetary gimmicks that may even result in a kind of budgetary “cynicism.” A point I have made in the past.

But the report also makes a few assumptions about the interplay of federal, state and local spending that I think could benefit from an expanded debate. The authors warn that cuts in federal discretionary spending will doom subsidiary governments. On the surface, that’s true. Cuts in aid mean less money in state coffers for education, transportation and other areas. But the larger question is what are the fiscal effects of grants-in-aid between governments? There is the public choice literature to consider on the role of fiscal illusion in finances. And further, does the current model of delivering these services actually work as intended?

Their recommendations are largely sound. Many of them have been made before: more transparent accounting, a tightening of rainy day fund rules (see our recent paper on Illinois), broad-based tax systems should replace narrow ones, the re-establishment of the Advisory Commission on Intergovernmental Relations (ACIR). Abolished in 1995 ACIR was concerned with evaluating the fiscal impact of federal policies in the states. Further the commission recommends the federal government work with the states to help control Medicaid costs, and the re-evaluation by states of their own local needs including municipal finances and infrastructure spending.

The report is timely, contains good information and brings many challenges to the fore. But this discussion can also benefit from a larger debate over the current federal-state-local spending model which dates largely to the middle of last century. This debate is not merely about how books are balanced but how citizens are governed in our federalist system. The Ravitch-Volker report is sober but cautious in this regard. The report sketches out the fiscal picture of the U.S. in broad strokes and offers general principles for states to follow and it is sure to create discussion among policymakers in the coming months.






An Unbalanced Budget: Fiscal Pollution

Yesterday I appeared before the House Judiciary Committee to talk about a balanced budget amendment to the U.S. Constitution. The other witnesses were Former Governor and Attorney General Richard Thornburgh, Former CBO Director and current president of the American Action Forum, Douglas Holtz-Eakin, and Professor Philip Joyce of the University of Maryland.

I began by pointing out the enormity of the problem: CBO projects that absent policy change, the nation’s debt will be 90 percent of GDP in just seven years. This is an important figure because research suggests that when national debt levels get much above this point, their growth rates tend to slow. In the median case, they slow by 1 percentage point and in the mean case, their growth rates are cut in half.

This may not sound like much, but to put it in perspective, I used the following chart.

What would current national income be if—in 1975—the U.S. had accumulated the sort of debt that we are about to accumulate and the nation’s growth rate had slowed by 1 percentage point? This is indicated by the dashed line in the middle. Today’s GDP would be about 1/3rd smaller than it actually is. And what would national income be if we had grown at half our actual pace? This is indicated in the bottom line. Today’s income would be 45 percent smaller than it actually is. To get a feel for this magnitude, notice the blip in the top right corner of the actual GDP line. That is the Great Recession that began in 2008. As I told the Judiciary Committee:

The most calamitous economic contraction in decades pales in comparison to the lost income associated with persistently anemic economic growth from too much debt.

In my view, the nation’s fiscal problems owe much to the incentives that politicians face. Around 1:27:45 I make this point:

The basic problem here is one of externalities. This is a problem that is familiar to environmental economists.  If a factory…in the process
of making a product for consumers, is allowed to bilge smoke into the air, that’s an externality. And they will make too much of the product unless it is internalized. So here, what’s happening is that this current generation is allowed to externalize the costs of government onto the next generation….The costs of reform, the costs of avoiding this kind of economic contraction that we are staring at will be borne by people like me, the median voter. But the costs of the status quo will be borne by my daughter. She cannot vote. Until we can internalize that externality, I think we are going to continue to make the wrong choice because none of you have the incentive to make the right choice. It’s not your fault; you are all good people, you are servants of the public and you are listening to what your constituents and your median voters are saying. But the incentives that they offer you are not right.

A balanced budget amendment, by internalizing this externality, would correct these misaligned incentives. Simply put, it would “make each generation that benefits from government services pay for the costs of producing them.”

The video is here (my testimony begins at 54:30). Here is my written statement.

Unfortunately, despite the ardent wishes of my 7th grade civics teacher, these sorts of hearings are not, primarily, about weighing the evidence and changing minds. Instead, they have much more to do with scoring political points and solidifying already-hardened positions. Nevertheless, I found that most of the Congress-people who disagreed with me were polite. And I hope that this leads to opportunities for more fruitful exchanges down the line.

“Where are the jobs from the Bush tax cuts?”

So asked Senator Franken (D-MN) in a press conference this week.

It is a good question.  From 1981 through 2000, real GDP grew at an average annual rate of 3.3 percent.  But from 2001 to 2008 (even before the Great Recession began), real GDP grew at only 2.1 percent per year.  Why did growth seem to slow after the Bush tax cuts?  There are a number of different plausible answers.  I’ll take a stab at two:

1.  Yes, all things being equal, some people believe that a deficit-financed tax cut should improve the economy.  But all things were not equal in the 2000s.  In just about every aspect other than taxes, economic policy in the 2000s moved in an anti-market direction.  One could cite monetary policy as John Taylor does.  One could cite regulatory policy as Mark and Nicole Crain do.  One could cite trade policy.  One could cite the increased reliance on counter-cyclical stimulus efforts (there were 4 such packages during the Bush years).  Lastly, one could cite the large increases in spending that attended two wars, the prescription-drug benefit, the farm bill, and other policies.  Indeed, according to the broadest measure of economic freedom over time, the “chain-linked” EFW score by Gwartney, Lawson and Hall, U.S. economic freedom steadily improved up until around 2000, whereupon it precipitously fell:

2.  Another reply might be: we didn’t have a tax cut.  By this I mean that a tax cut without a spending cut is not a tax cut; it is a tax deferral.  When I wrote earlier that some people believe that a deficit-financed tax cut will improve the economy, I linked to John Maynard Keynes.  This is because Keynesian models predict deficit-financed tax cuts will spur economic growth (they also predict that deficit-financed spending increases will spur growth).  But there are other schools of thought.  One theory holds that if uber-rational, forward-looking consumers know that Deficits Are Future Taxes (Professor Mike Munger uses the helpful acronym “DAFT”), then they will save for those taxes today, which means that they won’t spend, completely offsetting whatever government spending that the deficits pay for.  But as I’ve explained in a previous post, you don’t need to believe in such an extreme model of human rationality to arrive at the conclusion that deficit-financed taxes will fail to spur growth.  This is because deficits lower the nation’s capital stock, which over the medium-to-long-run also harms economic growth (see the link for more details).

The bottom line: Though he almost certainly didn’t intend it this way, Senator Franken’s observation that the Bush years were not massive growth years actually bolsters the case for both spending cuts AND tax cuts.

“Biggest _____ in History”

The on-again, off-again federal budget compromise is currently being described as “the largest one-time reduction in U.S. history.” That’s no surprise. Pundits, politicians and journalists love the superlative.

How was the Clinton tax increase described? Largest in history. The Bush tax cuts? Largest in history. Are these statements true? Well yes. But are they helpful? I think not.

The fact is—in nominal terms—the economy is almost always expanding. Inflation, population growth, and real economic growth all conspire to make this a fact of life. In the midst of the Great Recession, nominal GDP fell 2 percent in 2009 and that was the first time in 73 years that nominal GDP had ever fallen (by 2010, it was back up above pre-recession levels).

But if the economy is always growing, then things like government revenue and government expenditures are also always growing. Thus, changes in revenue and changes in expenditure are always going to appear to be THE LARGEST EVER!! (cue ominous music).

Was the Clinton tax increase the largest in U.S. history? As I noted yesterday, he raised the top rate 8.6 percentage points. But there were five other instances in history in which the top marginal income tax rate jumped more, including a whopping 52 percentage point hike in 1917 and a 38 percentage point hike by President Hoover in 1932 (!).

Was the Bush tax cut the largest in history? Well he lowered the top rate 4.6 percentage points over three years. But Reagan lowered it 42 percentage points over 7 years (and 19 points in 1981).

If enacted, would $33 billion in cuts be the largest in U.S. history? In percentage terms, this is less than 1 percent of total outlays. In 1946, spending fell by over 40 percent. The next year, it was 38 percnet. And then 14 percent. In the 50s, spending fell again by 7 percent and 4 percent.

Keep this in mind the next time you hear someone breathlessly claims that some policy will be the largest _____ ever.