By James Kwak
One of the new old ideas floating around Washington these days is an aggregate spending cap for the federal government. For example, both the House Republicans’ budget and one of those “moderate bipartisan” Senate proposals calls for limiting total government spending at around 21 percent of GDP. This is silly for at least two reasons.
First, and less controversially, the number of dollars that flow from the federal government to entities that are not the federal government is not an economically significant number*. The most obvious example of this is tax expenditures: subsidies that are implemented through the tax code, usually as deductions or credits. For example, let’s say the government wants to promote renewable energy. It can increase taxes and write checks to companies that produce solar panels; or it can keep taxes the same and enact tax breaks for companies that produce solar panels. Same difference — except that the former “counts” as government spending and the latter doesn’t. So a spending cap simply motivates Congress to spend money through tax credits rather than by writing checks, which is bad for all sorts of reasons. (It is harder to target, it reduces the tax base, etc.).
There are plenty of other ways to game the system, too. The federal government could impose unfunded mandates on the states — and then provide federal tax credits that make it easier for states to raise money. Think this is unlikely? This is what we have already with the federal tax deduction for state and local taxes and the federal tax exemption for state and local government bonds.
Second, even without the tax expenditure issue, the federal government lumps together all sorts of different kinds of animals that should not be thought about in the same way. I’ve discussed this a bit in a previous post, but let’s try again. Take Social Security, for example. Let’s say the government offered an optional add-on to Social Security where you could elect to increase your payroll taxes by 2 percentage points. That additional tax levy would go into an individual account that you could control. The plan would be administered by the Social Security Administration, but you could select from a range of funds managed by private sector fund management companies. It would have the same tax preferences as a typical IRA. Such a plan would count as an increase in “taxes” and “spending,” even though it’s voluntary (and therefore, for you free marketers out there, unambiguously welfare-increasing). Yet a spending cap says that you can’t even have incremental self-funding government programs that increase individual choice, which by definition do not contribute to the deficit.
The implication is that we need private-sector solutions, which doesn’t sound all bad. But what about areas where the private sector has failed to come up with a viable solution, like long-term care insurance? There, a spending cap means we’ll either get nothing — or we’ll get heavy regulation of private sector actors to try to get them to do what the government is no longer allowed to do, which will be both costly and inefficient.
(For an example, imagine the following: Eliminate the U.S. Postal Service. Say that licensed private companies can provide mail service. But, they have to deliver first-class mail to every address in the country for the same price — and a price that is regulated by the government. If no one is willing to do that in a competitive market, then you have to create a licensed monopoly with cost-plus pricing. Now you’re worse off than where you started — except that the whole operation is off the government’s books, so you have “smaller government.”)
In addition to those two problems, there’s the more obvious problem with setting a hard cap on government spending: What if we go to war? (Wait, we’re at war already.) What if we have a massive epidemic? What if an earthquake devastates California? For that matter, what if we have a recession and spending increases because of automatic stabilizers? I have to imagine that the people proposing these spending caps have considered this, but the answer can’t be that if we have to increase military spending because of a war, we automatically cut everything else; by that logic, in World War II the government would have completely disappeared.
Taken on its face, the idea of having rules that enforce deficit targets is not a terrible one. But having targets just for spending is both misguided and dangerous. Deficit targets are better, but they still have to be set and enforced over a cycle, with a buffer for catastrophic events. (And when it comes to catastrophic events for the national balance sheet, there is almost nothing worse than a financial crisis, as the past few years have proven.)
* For more on this topic, see Daniel Shaviro, Taxes, Spending, and the U.S. Government’s March Towards Bankruptcy.