How Big Government Makes America Poorer

HOW DO WE MEASURE whether a society is getting richer or poorer? What is the tape measure that we use to put around the belly of the economy to determine whether its girth is growing and by how much? The conventional modern measure of the economic well-being of a nation is the gross domestic product (or GDP)—a statistical attempt to gauge the value of all the goods and services produced by a nation over a discreet period of time. GDP is the standard measuring rod we use to determine how much economic progress we are making over time. But it is a flawed statistic for taking the temperature of the American economy because it takes into account the growth of government, and includes public sector expansion as a good not a bad. Real wealth creation is driven by private businesses, entrepreneurs, and investors, not by putting to work more government employees.

This convention creates the illusion that bigger government means more prosperity. The dramatic expansion of government that we have seen in the United States over the past century has no doubt had some positive benefits—the government builds roads and schools and spends money on our national defense and police and fire service. The problem is that many of the goods produced in the public sector add little value to the wealth of the citizenry. These are goods and services demanded by politicians, not by willing consumers in the free marketplace.

The conventional definition of GDP is total consumption by individuals plus the amount of money invested in the economy plus government spending and net exports. What is needed is a new measuring rod I call Private Sector GDP—equal to GDP with the government sector subtracted. Other economists, including Lawrence Kudlow, the economics editor of National Review magazine, have also suggested this new way to measure GDP.

Improving the way we measure GDP is not just an academic exercise. Including government expansion in GDP reinforces the flawed notion, accepted by many politicians, news reporters, and leading economists that a nation’s well-being can be advanced by expanding the size of government programs. Since politicians are fond of spending money in any case, the fact that expenditures by politicians are counted as contributions to GDP gives the political class an intellectual and economic justification for growing the government.

In 1900, government in America was still, by today’s standards, comparatively lean and efficient. At that time, total federal, state, and local expenditures were $26 billion. Americans now support a $3 trillion government, more than a 100-fold increase in real outlays! Much of this growth was encouraged to aid the growth rate of the American economy.

Keynesian Myth

The superstition that government spending can stimulate economic expansion became accepted during the Great Depression when economist John Maynard Keynes was the most influential economist in the world. Keynes believed that when the private sector was underperforming, the government could spur economic activity by spending money itself. We have years of empirical evidence that disproves the supposition that increasing government expenditures over a certain minimum level necessary for basic services does not promote economic growth. In most cases, government spending over minimal amounts impairs economic growth. If government sector expansion were correlated with high economic growth, then the communist countries in the post-World War II era would have grown rich, and the capitalist nations would have fallen behind.

Economist Milton Friedman long ago exposed the flaw in the notion that government growth causes modern economies to grow. Government can only spend money that it takes from others. He showed that there are only three ways government can find the money to spend on public programs: it can raise taxes, it can borrow, or it can print money. High taxes inhibit growth by reducing the private sector’s capacity and willingness to expand. Government borrowing simply crowds out borrowing that would be made by private businesses to expand, by raising interest rates. And when the government prints money, it reduces the value of the currency, thus making every citizen who holds the currency poorer by the amount that was printed.

Governments cannot create wealth. At best, they can redistribute it. At worst, through high taxes and high deficits and reckless monetary policy, governments can reduce the wealth and well-being of a nation.

Government Growing Pains

The growth of government has led to more centralized, more bureaucratic, and less citizen-responsive government. Second, bigger government has meant less efficient government. Costs of government services are rising and quality is eroding. Third, larger government, higher taxes, and more regulation are a restraint on economic growth in America. Fourth, government growth necessarily requires citizens to surrender economic freedom and individual liberties.

Much of this expansion of government documented above occurred as a result of well-intentioned legislation to aid the American economy in times of trouble. As recently as the 1920s, the federal government was still quite inexpensive and insignificant, accounting for just about 5 percent of national income versus more than 20 percent today.

James Madison once wrote that crisis is the rallying cry of the tyrant. In his 1989 classic Crisis and Leviathan, the renowned economic historian Robert Higgs documented the tendency of government to ratchet upward in cost and influence during periods of crisis. Higgs’ insight into public finance was that governments rarely contract to their previous size after a war or economic depression.

During the Great Depression, the New Deal was launched in an effort to put America and Americans back to work again. From 1930 to 1940 federal spending as a share of GDP doubled from 4 to 8 percent of total national output, as FDR launched major new initiatives in areas including farm subsidies, public works, jobs programs, unemployment benefits, home mortgage insurance programs, and bank regulations. The sad irony, of course, of the New Deal is that after this massive infusion of spending and debt, by 1940 the nation remained mired in Depression. It was only when the nation went to war with Germany and Japan, and several million American men were conscripted into the armed forces, that the nation was finally able to regain its industrial might and return to full employment.

The New Deal and then the Great Society, launched in the 1960s by Lyndon Johnson, sanctioned government to spend tax dollars on activities that had never before in American history been permitted. Until about the 1930s, the federal government spent almost nothing on agriculture, health care, and education.

Substantial federal spending on agriculture began during Franklin Roosevelt’s New Deal era of the 1930s; substantial federal spending on health care began during Lyndon Johnson’s Great Society of the 1960s when Medicare and Medicaid were created; substantial federal spending on housing subsidies began in the immediate post-World War II period; substantial federal spending on education began under President Jimmy Carter.

Regulating Wealth Away

Politicians lay claim to the resources of our economy in other ways besides direct spending of tax dollars. Over the last several decades, there has been a proliferation of federal regulations requiring private businesses to spend money on health, worker training, safety, consumer protection, aid to the disabled, and environmental protection. These are backdoor forms of taxation.

It is very difficult to tally the total cost and total number of federal regulations, but an indirect way of measuring the government regulatory burden is by counting the number of pages of regulations that appear in the Federal Register each year. The number of new regulations has grown fifteen-fold since 1935.

In 1935 there were 4,000 pages in the Federal Register. In 1950 there were 12,000 pages in the Federal Register. In 1980, pages in the Register peaked at 73,528 under President Carter. Ronald Reagan’s anti-regulation policies reduced the number of pages of regulations to 44,812 in 1986. Under George Bush, regulations climbed back up to 49,795 pages in 1990.

Regulations add as much as 33 percent to the cost of building an airplane engine and as much as 95 percent to the price of a new vaccine. Environmental laws are the largest and fastest growing areas of economic regulation. Economists Dale Jorgenson of Harvard and Peter Wilcoxen of the University of Texas calculate that the cost of environmental regulation alone is a long-run reduction of 2.59 percent in the level of the U.S. GNP.

Smart regulations can compensate victims from misbehavior in the marketplace. Draconian regulations promulgated without any regard to costs and benefits have become far too commonplace in the U.S. economy over the past quarter century and work to slow down the engine of economic progress in America.

No Free Lunch: How We Pay

One flaw in the theory that government spending adds value to the economy is that government is clearly not free. Public sector expenditures must eventually be paid for out of taxes. But high taxes can stifle the very kinds of economic activity that the government spending was intended to stimulate. As President John F. Kennedy once put it: “It is a paradoxical truth that tax rates are too high today and tax revenues are too low—and the soundest way to raise revenues in the long run is to cut rates now … The purpose of cutting taxes now is not to incur a budgetary deficit, but to achieve the more prosperous expanding economy which will bring a budgetary surplus.”

Let us quantify the tax burden in America today. When combining federal, state, and local taxes, many middle-income Americans work a larger share of the day to pay the government’s bills than their own.

  • In 1930, workers paid one of every eight dollars of their income in taxes.
  • In 1950, workers paid one of every four dollars of their income in taxes.
  • In 1999, workers paid just over 40 percent of their income in taxes.

This rising tax burden has meant that workers have less take-home pay for consumption and savings. It also means that workers’ incentive to work and employers’ incentive to hire is impeded by the excessive cost of taxation. Taxes create a wedge between what the worker receives in pay and what the employer pays. These figures do not even include the cost to American individuals and firms of complying with complicated and time-consuming tax laws. By one estimate, Americans spend 5.4 billion hours at an annual cost of $600 billion to the economy just completing the paperwork requirements of federal taxes.

Reliable federal tax data are available back to 1800. For the first 100 years of the nation, taxes were very low. Government revenues predominantly came from two sources: revenue tariffs and land sales. The limited sources of revenues for the federal government were a natural restraint on its expenditures.

Three events changed that. First, the imposition of the income tax in 1913, second was the two World Wars, which made the American people accustomed to very high tax rates, and the third was the creation of the Social Security program with gradually rising payroll taxes. As a consequence of all these factors, the federal tax burden has undergone a meteoric rise since the founding of the nation.

  • In 1800, per capita federal taxes were $25.
  • In 1900, per capita federal taxes were $140.
  • In 1950, per capita federal taxes were $1,860.
  • In 1999, per capita federal taxes were $6,661.

Is Government Dragging Down Our Economy?

A recent study by economists Richard Vedder and Lowell Gallaway of Ohio University finds that periods of government expansion (both in spending and regulating) tend to be periods of slow or negative economic growth. They concluded: “Put simply, small government seems to be growth enhancing; big government is growth reducing.” Again, no one knows for certain when government begins to be a deterrent to income growth and output expansion. One study by Thomas Dye of Florida State University has suggested that the output-maximizing level of government is 15 percent of GDP. If he is right then our government today is at least twice as large as we would want it to be if our goal was to maximize the prosperity of the people.

Government spending could be cut without impairing vital and needed government services because most of the addition in spending over the past 50 years has been in discretionary spending, rather than essential programs. For example, if we go back to 1902, we find that almost all government expenditures then were for the vital services we must have from government: the military, transportation, the courts, police, veterans, parks, public health, and education. In 1902, about $3 out of every $4 spent by government went for these essential public services. Today, only about $1 out of every $3 goes to these core activities of government. The rest of the expenditures go toward lower priority social programs and income redistribution activities—the biggest, of course, being social security, Medicare, and welfare payments.

Redefining Progress

Our society needs a barometer of economic progress that is accurate, easy to measure, and unbiased. By including government as a contributor to growth, we are foolishly following in the Keynesian footsteps of Argentina and Japan—two of the nations with the biggest bloat in government in recent years. Government didn’t stimulate those economies ; it further capsized them, plunging them from recession to depression. The real resources in the economy captured by government for additional public sector spending can only come from three sources: taxes, debt, or inflation. In the 1970s all three accelerated at once, and the U.S. industrial economy collapsed until rescued by Ronald Reagan’s supply-side and limited government ideas.

Government growth does not drive productivity; it does not rally the stock market; it does not put more Americans to work (unless they work for the government itself); and it does not raise incomes of workers (in fact, because it necessitates higher taxes, it reduces take-home pay).

The conventional GDP numbers should be replaced with Private Sector GDP. Governments do not create wealth. If they are properly functioning, they provide a strong national defense, a court system, police and fire services, good schools, and so on. The role of government is primarily to protect and preserve the wealth that our private free- enterprise system creates. It is statistical malpractice to report increases in government spending as an increase in economic well-being. That is particularly true now that our government spends well over $3 trillion a year—more than the government spent in real terms from 1787–1930 combined.

The fact that our government sector is now larger than our entire manufacturing sector is evidence that government growth is now parasitic. Government growth doesn’t enhance our private sector markets—it displaces them. When we put that tape measure around the waist of our economy, we ought to exclude government, or we will mistake fat for muscle. Governments can only grow at someone else’s expense, and increasingly that someone is all of America’s hardworking taxpayers.

Mr. Moore is President of the Club for Growth and a Senior Fellow at the Cato Institute. This article is excerpted from a study originally published by The Taxpayers Network and is reprinted here with permission.