The Silliness of Spending Caps

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.

23 responses to “The Silliness of Spending Caps

  1. “Prediction? Pain.”
    - James “Clubber” Lang

  2. If I’ve got this right, Modern Monetary Theory (MMT) would have the U.S. Treasury credit the accounts of the States rather than go to the bond markets and incur more debt.

    As a “thought experiment” what might go wrong with this approach? What might go right?

  3. I’m with you to a certain degree, but… Good God… we are $14T in debt! It does seem to be out control. When service on the debt accounts for a third of spending it doesn’t seem hard to imagine that a default is becoming a more and more real possibility, especially if we have more big shocks to the system (you site a lot of good potential ones here).

    Legislators KNOW that they can’t trust themselves with money. That’s a part of the problem with Social Security. We didn’t bank that money. The legislators spent it and replaced it with Treasuries. Sure Treasuries are safe but…
    good heavens,
    that’s a lot of treasuries.

    So what do you propose as a realistic measure to reign things in? I mean, obviously get out of all our wars and get back to the peace dividend. That would be a nice start. But, it does seem fair to say that the US Government is a bit profligate.

  4. Ask the question:

    Why would a potential French president and IMF head attempt to rape a hotel maid?
    Then, all of a sudden, someone from 2002 also wants to tell a story.

    This is beyond stupid. Talk about building a history that’ll stick.

    These types of men walk in circles where they can hire the most exquisite women with the utmost discretion. We are being led to believe that he’d throw away everything that he has ever worked for to forcibly has s3x with a hotel maid? Are you kidding me?

    The real question here should be : Why is Strauss-Kahn being ripped from his IMF post and basically thrown to the lions? Something stinks here.

  5. Rien Huizer

    The problem with government spending is that it is very hard to do well. Democracies in particlular are very bad at spending in a way that does not distort the functioning of superior allocative mechanisms (already under pressure from ideological, “fairness” oriented politics, or the politics that aim at dismantling the artifacts of the fairness crowd). So measures that aim at constraining spending are by themselves laudable (take into account that Singapore provides a superior government “service offering” at less than a third of the cost of the US equivalent. Why shouild US citizens pay so much for so little?) but unlikely to be sincerely aimed at the interests of broad sections of the US public.

    Just let the financial problems cure themselves and see hoe it works out. No politician or economist can solve them anymore. This is the stage where only scavenger politics attract rational operators…

  6. @Eat the Babies: I think that debt is largely imaginary, just like our money. We are a monetarily sovreign nation, as explained here: http://rodgermmitchell.wordpress.com/2010/08/13/monetarily-sovereign-the-key-to-understanding-economics/

  7. @TippyGoldenPress – I think it is an excellent idea and will probably be implemented in due time. Though after catastrophic pain (we seem to prefer that as a policy approach.)

    @James “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 — …”

    The point raised here is based on an incomplete setup. There is no reason to increase the taxes for the federal government to spend and with that aside, in recent political fiscal compromises, the tax incentives approach typically doesn’t include tax increases.

    So if we add the -no tax increase- condition, the answer is very different. In one case the federal government spends thereby creating income in the private sector and in the other case the private sector receives no additional income but is able to retain what is already there.

    The difference provides additional tools for policy makers. By spending, the federal government can pay for a new service. When properly targeted, the new service will require a new job. When allowing financial interests to retain what they have, they have the option of providing the service with the same resources. If the labor resources are underutilized then it is a good thing, or it would just increase profit if the financial interest has no pressure to increase wages or hire more labor. If policy makers target spending so that new resources are required to provide the service, more labor is hired.

    We have policy choices to make at every turn. So far, we have chosen to increase financial interests’ profit at the expense of the laborers (tax credits benefit the supply side much more than the demand side, if ever.) We’ll see if that is a good plan.

  8. @Eat the Babies:
    As stated in the article, “the federal government lumps together all sorts of different kinds of animals that should not be thought about in the same way”. What this means is that we are NOT 14 trillion in debt, because a lot of that debt is “Intragovernmental transfer”; it is money that one internal government entity owes another internal government entity.

    You mention Social Security, but Social Security is solvent and will remain solvent. According to current projections, with absolutely NO CHANGES to current assumptions, the Fund will have to reduce payout to 75% of projected payout sometime between 2037 and 2041. If the current income cap (and all income was taxed) then the fund would remain solvent with very minor tweaks (like lifting the income cap) on it. If current wages of the working population of the U.S. were to rise, then Social Security is a non-issue. The Social Security Trust funds are held in interest bearing instruments, so the United States Government does pay interest to the Social Security funds.

    So, where do you propose that the excess Social Security revenue be accumulated? Or should the Social Security tax be adjusted on a yearly basis to guarantee that it never runs a surplus or deficit (Now THAT would be an accounting nightmare)?

    You mention interest, and currently the Federal Government is paying about 6% of its total expenditures to interest on the debt, not a third as you stated (2011 budget).

  9. “The Silliness of Spending Caps”

    Hmm, not so fast, James! Unless you take literally whatever show these clowns put up. These caps could be need for a few reasons:
    1) project an image of responsibility to foreign capital;
    2) allow for all kinds of cuts that enable the insider games to go on;
    3) project an image of responsibility to the Tea Party crowd;
    4) ’cause everything ought to look heroic, lest we get heroic ourselves.

    @The Light:
    It could be that this man is sick and his known dependency was exploited by the professional handlers of the victim(?).

    Indeed, growing popularity in France was construed as a risk not only for L’américain, our ever obliging friend at Élysée Palace, but also to US capitalism itself–see DSK’s murmurs about state regulations. Surely I take your question to be rhetorical, but could not resist.

  10. Of course the same people screaming for spending caps are also claim that tax revenues shouldn’t be higher than 18% of GDP, meaning there’s a 3% gap each and every year – exaclty how we pay down the debt under than scenario is anybody’s guess.

  11. Gee, you have massive tax cuts(2001,03, 09) meanwhile spending trillions upon trillions, and you get deficits. Shocking.

  12. Excellent post Mr. James Kwak!

    I’m hoping to get my hands on a used copy for half price at Amazon. Currently reading three books simultaneously (themes are juxtaposed and subtly intrinsic), cross-referencing dictum per usual, somewhat (normal critique) obfuscated by biased ideology, and philosophies to the best of my knowledge (but aren’t we all[?]).
    Your immediate correlation with your prior post paints a proselyte vision for solidarity, Bravo!

    Thankyou

  13. Bayard Waterbury

    James, this post identifies the very problem which must be resolved. Sadly, as we both know, in the current political environment, both level headed talk and even handed, rational solutions are nearly impossible. It seems to me that both parties need to focus not on differences, ideological or otherwise, but on rational, meaningful solution. It’s almost as if we can be sold the idea that government taxing and spending don’t really need to be resolved, but that somehow, just taking money from one pocket and putting it in the other is a solution, rather than a continuation of the abrogation of leadership responsibilities.

    I am very close to losing hope that democracy will be completely discarded over favoring a plutocracy where governance is to be done strictly to preserve and increase the wealth and power of our oligarchs.

    I refuse to put my faith in either of the current major parties, their membership or ideas. I feel like everything in the media is misdirecting our attention to inconsquential sound and fury which signifies nothing. America is closer to the verge of collapse than most understand, and that failure will be largely unrelated to the $14 trillion dollars. It will be related to wasted opportunities for the population to demand more right thinking and right action from its elected officials at every level of government.

  14. CBS from the West

    @The Light

    Perhaps. Given the ruthlessness of politicians, it is entirely plausible that DSK was framed or set up. But consider it from a different angle. Rape, the attempt of which is alleged here, is not about sexual gratification. It’s about power, dominance. People with a pathological need to dominate gravitate to positions that facilitate their doing so. And they can easily begin to believe that everything in sight is theirs for the taking. Think French aristocracy pre-revolution. I believe this type of behavior among the politically and financially powerful is probably rather common, and only seldom revealed.

    Well, DSK and the aggrieved maid will both get their day in court. We’ll find out soon enough what the physical and DNA evidence has to say about both sides of this story.

    Given the way our legal system works, and given DSK’s enormous wealth giving him access to the “best” (read, in this case, most vicious and sociopathic) lawyers we may guess at the outcome. If this woman truly was assaulted as she describes, I only hope that she does not come away from the trial wishing she had kept her mouth shut and just taken it wherever he was planning to put it. See, for example, the cases of Kobe Bryant, William Kennedy-Smith, and the like.

    The rich _are_ different from the rest of us: they are accountable to nobody.

  15. winstongator

    Deficit targets are also a terrible idea. Think about a very reasonable federal government – one that spends money on social security, medicare, medicaid, unemployment insurance and wars. Then think about regular business cycles. Not messing with tax rates or spending patterns, our government’s net, whether we’re running surpluses or deficits, will be highly cyclical. In recessions, spending actually goes up because of programs that are means-tested (UI included) having more participants, and the fact that a large part of our tax base is pro-cyclical (no capital-gains, no capital-gains tax income).

    We’d be better off with hard Keynsian limits. If GDP is growing, then you raise tax rates. If GDP is falling, lower them. I’ll bet we had a few quarters of GDP contraction before we got Bush’s tax cut stimulus. This gets back to Bush’s original logic on his original tax cuts. Returning the surplus to taxpayers. Anyone remember that?

  16. So what insurance can we buy against plutocracy and kleptocracy, (with a big dose of goth fashion), becoming the new-age permanent “normal” in USA…?

    Get out the calculator to figure out the monthly premium…

  17. CBS from the West

    @ Annie: “So what insurance can we buy against plutocracy and kleptocracy, (with a big dose of goth fashion), becoming the new-age permanent “normal” in USA…?”

    You can’t buy insurance for your house after it’s already burned down.

  18. @Bayard: “America is closer to the verge of collapse than most understand, and that failure will be largely unrelated to the $14 trillion dollars. It will be related to wasted opportunities for the population to demand more right thinking and right action from its elected officials at every level of government.”

    Bayard, I agree with most of your statement…but then what is right thinking and right action? Are we a monetarily sovereign nation? What is money? What is OUR money?

    Politicians and the person on the street constantly talk about the national debt, as if it were analogous to a personal debt. Is it?

    There are constant threats. And as far as I can tell, everyone is speaking in code.

    About democracy: wonder and worry no more. It is gone. The people will have to take it back, recreate it, but even if we want to, we are ill prepared to do so.

    It’s a grim time. Some of us are going to have start sticking together.

  19. “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”

    Why not? Certainly, sane and rational people wouldn’t want that – but the Tea Party has demonstrated again and again that they aren’t composed of sane *or* rational people. When one chamber of government has been taken over by religiously-delusional anarchists, all bets are off…

  20. @anonymous, you’re quite right, as anyone who lived through the rationing and domestic shortages during WWII can attest. But that was a real war, with real threats, perceived by all, fought by an army composed of a greater cross-section of the country (because of the draft), formally declared by Congress, and the decision taken in a more cohesive time albeit strained from the Depression.
    Kwak reveals a common misconception of today that war activities are just another line item in a huge budget that the electorate experiences only through the bill every April 15th. In a real war, all is sacrificed or suspended to support the war effort, and yes, everything else is cut. But we haven’t declared a real war in generations.

  21. @CBS from the West

    Looks like you haven’t been paying attention in class…

    If you spread the *risk* around through *derivatives* then you don’t care if the house burns down – heck, depending on where you are in the *swap*, you want the house to burn down…

  22. Moses Herzog

    Isn’t this spending cap a little late???? Was Paul Ryan in Congress during the “W” Bush years??? Why did this brilliant idea of a spending cap just hit him now??? ANY discussion of deficits and spending caps should require the accompaniment of this graph, courtesy Jesse’s Cafe’ Americain
    http://2.bp.blogspot.com/-8LVw3-YXt_A/TdWj8nQyUkI/AAAAAAAAQ1w/wGI39TSyujc/s1600/DeficitChart.png

  23. @ The Light — this is not about getting “exquisite women,” it’s about impulse and narcissism.