“Government spending should be significantly reduced. It has grown far too quickly in recent years, and most of the new spending is for purposes other than homeland security and national defense. Combined with rising entitlement costs associated with the looming retirement of the baby-boom generation, America is heading in the wrong direction. To avoid becoming an uncompetitive European-style welfare state like France or Germany, the United States must adopt a responsible fiscal policy based on smaller government.” So says Daniel J. Mitchell writing for the Heritage Foundation in March 2005. There is mounting research and real-world evidence supporting his position.
For decades economists and monetary experts worked to determine a “best-amount scenario” for government spending. Everyone agrees governments can spend too little. Without any government spending, the economically vital functions of national defense, enforcing the rule of law, maintaining domestic tranquility, etc. would be unfulfilled, leading to anarchy, reduced economic activity and near zero economic growth. Our government is therefore rightly charged with the responsibility to “establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the Blessings of Liberty to ourselves and our posterity.” Even libertarians acknowledge the necessity and benefit of rightly constituted government.
Conversely, almost everyone agrees governments can spend too much. The Soviet Union was less than a decade old when Lenin, and later Stalin, encouraged a measure of free-market reforms to avert mass starvation. Every dollar a government spends represents a “cost” to the nation’s economy. Governments cannot spend unless they first take money from the private sector, thereby reducing economic vitality. Nevertheless, because of the benefits of government spending discussed in the previous paragraph, government spending can and does have a positive economic impact, up to a point. For instance, each dollar taken and spent by a government may lead to $1.20 of economic activity, because the government dollar provided the peace and security required for economic transactions to flourish. The $1.00 to $1.20 ratio is arbitrary. The point is, up to a point, government spending produces benefits that outweigh the costs of government.
As government spends a higher and higher percentage of a nation’s Gross National Product (GNP), at some level the expenditures outweigh any derived benefit. In rough terms and just for illustration, government spending up to the optimum point produces the favorable cost/benefit ratio above; every $1.00 of government spending leads to more than a dollar of economic activity. However, once the optimum point is surpassed, the opposite is true. Then, every government dollar spent produces a return of less than one dollar. If a government spends heavily enough, economic growth will be entirely stifled. The $64,000 question remains; where is that optimum point? What percentage of GNP should a government spend to achieve the best possible economic results?
A growing body of research and empirical evidence suggests 20% of GNP is the optimum amount of government spending. Of course, “economic theory does not generate strong conclusions about the impact of government outlays on economic performance,” meaning this is not an exact science, interpretations can vary, and differing conditions — high inflation or economic depression — would call for adjusting the formula. Nevertheless, we have the advantage of observing a wide variety of government expenditures around the world, and these observations confirm 1) that there is an optimum amount of government spending relative to GNP, above which economic activity is depressed and 2) the best-case amount of government spending is approximately 20% of GNP.
Comparing economic data of the United States with that of the European Union countries is instructive. Government spending in the USA stands at 35.7% of GNP; in the EU-15 the figure is 47.6%. Tax revenues in the United States amount to 28.9% of GNP; EU-15 governments take 41.0% of GNP. America’s government debt totals 29.6% of GNP; EU-15 government debt equals 50.1% of GNP. If our theory is correct, America should be outperforming the European Union nations. There is no surprise coming.
“Per capita economic output in the U.S. in 2003 was $37,600 — more than 40% higher than the $26,000 average for EU-15 nations.”
“Real economic growth in the U.S. over the past ten years [through 2004] (3.2 percent average annual growth) has been more than 50 percent faster than EU-15 growth during the same period (2.1 percent).”
“The U.S. unemployment rate is significantly lower than the EU-15 unemployment rate, and there is a stunning gap in the percentage of unemployed who have been without a job for more than 12 months — 11.8 percent in the U.S. versus 41.9 percent in EU-15 nations.”
“Living standards in the EU are equivalent to living standards in the poorest American states — roughly equal to Arkansas and Montana and only slightly ahead of West Virginia and Mississippi, the two poorest states.”
The sad truth is that runaway government spending, especially when funding cradle to grave social security, crushes more than economic enterprise. Repressed economic opportunity often quenches the human spirit, a tragedy manifested in this nation’s underclass. Limited government has the responsibility to secure and protect a nation’s economic soil, but individual citizens must assume the responsibility of tilling the ground. Or, as Ben Franklin put it, “The Constitution only gives people the right to pursue happiness. You have to catch it yourself.” The combination of excessive government and lethargic citizens, evident in many EU nations, provides Americans with an example to avoid at all costs.
There remains reason for great hope. Tomorrow we’ll examine three countries — Ireland, New Zealand, and Slovakia (of all places) — as examples of what can be done when a nation sets its economic house in order. More in depth study of these issues can be found at www.limittaxes.org.
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Posted by Jerry Pomeroy in Budgets, Economics, Limiting Government, Politics, Video