Government expands on the taxpayer's dime, while 99.99% of taxpayers contract.

The following is an article by Alan Reynolds, a senior fellow at the Cato Institute, on government stimulus:

A Second Stimulus Package? Yikes!

by Alan Reynolds

Alan Reynolds is a senior fellow at the Cato Institute, and the author of Income and Wealth (Greenwood Press, 2006).

This article appeared in Forbes on July 10, 2009.

India, Japan and the U.S. repeatedly deliver unaffordable and ineffective spending proposals.

“Calls Grow to Increase Stimulus Spending,” says a recent front-page Wall Street Journal headline. Author Deborah Solomon claims, “Some economists are pressuring the White House to enact a second round of stimulus spending.” The article mentions only two economists, however, one of whom heads “a left-leaning Washington think tank” (the Economic Policy Institute) that always tries to pressure the government to spend more. The other, a former Bush official, dreams of “something that is relatively fast and thoughtful” like “personal tax cuts.” But asking Congress to do something fast and thoughtful is like asking fish to fly.

Ironically, another headline in the same paper on the same day said, “Spending Spooks India’s Sensex.” The article read: “Indian stocks fell 5.8% Monday amid concern the proposed government budget will add to the country’s fiscal deficit.”

Investors understand that increased government spending diverts valuable resources away from the private sector and ends up imposing even more demoralizing taxes on labor and capital.

A major study of 18 large economies by Alberto Alesina of Harvard and three colleagues appeared in the 2002 American Economic Review. This paper, “Fiscal Policy, Profits and Investment” found that the surest way to make economies boom can be through deep cuts in government spending–the exact opposite of the “fiscal stimulus” snake oil.

Ireland, for example, slashed government spending by more than 7% of GDP from 1986 to 1989–nearly as much as the 8.4% of GDP the U.S. spends on Social Security and Medicare combined. The Irish economy suddenly switched from a 0.2% pace of economic growth in the early 1980s to annual real GDP growth of 7.2% from 1989 to 2001. With GDP doubling every decade, government debt dropped from 125% of GDP to less than 40%.

By contrast, Japan spent trillions on Keynesian “stimulus” schemes after 1991, doubling the ratio of national debt to GDP. Amazingly, they are doing it still. Japan’s “lost decade” of economic stagnation is now approaching two decades with no end in sight.

Spending cuts ensured much lower tax rates in Ireland, including substantial cuts in personal income and payroll tax rates and the VAT, as well as the famed 12.5% corporate tax. Similar fiscal restraint in India, while it lasted, facilitated cutting the top income tax rate to 30% from 60% at the start of yet another “economic miracle.”

By contrast, because of the huge debts piled up by “fiscal stimulus” schemes, Japan felt compelled to add new taxes on consumer spending, land, securities trading and capital gains.

The Alesina study acknowledges that spending cuts were conducive to pro-growth tax policies, but that same study also found that big government spending is inherently bad for economic growth. The authors noted that government hiring lures skilled workers away from private businesses, and so private employers are forced to raise wages even if that means reduced hiring. Artificially boosting labor costs per employee, in turn, depresses profits and investment. They also found that a reduction of 1 percentage point in the ratio of government spending to GDP leads to an immediate increase in the ratio of private investment to GDP, which adds up to 0.8 percentage points after five years. In other words, government spending (regardless of whether it is financed by borrowing, taxing or printing money) will eventually “crowd out” private investment on nearly a dollar-for-dollar basis.

The authors (Alesina, Ardagana, Perotti and Schiantarelli) concluded that fiscal policies that “have led to an increase in growth consist mainly of spending cuts, particularly in government wages and transfers, while those associated with a downturn in the economy are characterized by tax increases.”

In reality, the so-called stimulus package was actually just a deferred tax increase of $787 billion plus interest. As in the case of India’s recent spending spree, and the endless “fiscal stimulus” fiascoes in Japan, the U.S. stock market reacted very badly to the last huge increase in government spending as it passed through the House and Senate.

The bond market too has suffered periodic setbacks from the incredible magnitude of Treasury borrowing. Peter Orszag, President Obama’s budget director, co-authored a 2003 study with Bill Gale, claiming “a sustained 1% of GDP rise in projected deficits would raise current yields by between 20 and 60 basis points.” [Editor's note: 100 basis points equal one percentage point.]

Orszag and Gale were probably wrong about that. But the current budget deficit is five times larger than the deficit in 2003 when Orszag, Robert Rubin and others were warning that deficits threatened “financial and fiscal disarray.” We’re swimming in uncharted waters. With Treasury now borrowing at levels that provoke credit rating agencies to warn of a downgrade, it is plainly foolhardy to contemplate further increasing the Treasury borrowing under the oxymoronic guise of “stimulus spending.”

Whether we are talking about India, Japan or the U.S., all such unaffordable spending packages have repeatedly been shown to be effective only in severely depressing the value of stocks and bonds (private wealth). To call that result a “stimulus” is semantic double talk, and would be merely silly were it not so dangerous.

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Can anyone site one credible example where Keynesian economics and budget deficit spending effectively created economic growth? Mr. Reynolds points out “the lost decade” example in Japan, as well as Ireland cutting government spending to bring about a boom. Particularly insightful, this article discusses the distortions in the labor marketplace brought about by government hiring; and just in time for the Federal government to expand. In fact, the feds are by far the largest employer in the country with almost 3 million employees. This figure doesn’t include contractors and military personnel. A recent study by the Heritage Foundation estimates that around 250,000 new federal government workers will be needed just to spend the Obama administration’s new budget. Opined White House Budget Director Peter Orszag:

“…investing in skilled professionals will not only pay off over time but also immediately deliver better service to taxpayers.”

And drive up wages in the private market during a recession, right Mr. Orszag. Not to mention the impending increase in the minimum wage from $6.55 to $7.25 on July 24th, pressuring employers to cut jobs or hours. Now, fewer people will make a non-livable wage as a result of the legislation. It may be that not everybody deserves six-figure government pensions like they do it in California.

The Bureau of Labor Statistics (BLS) reports that over 150,000 jobs were added in government at all levels in 2008, while the private sector lost close to 4 million. Everyone contracts except for the feds, who the taxpayers subsidize, while contracting. That sounds about right.

The government cannot “create” anything; all they can do is redirect wealth or economic activity, and diminish the value of money through the printing press. Their funds come from taxing the public and printing new money. Their spending projects are transfer payments from one person to another. When they stimulate job growth or price appreciation (real estate, for example) in one sector of the economy, it is simply taking money and resources away from another sector. Directing money and resources to select industries, or offering incentives like subsidies, causes a misallocation of resources.

People like Buffet, and the pro-deficit spending representatives in Washington, can always rebuke that previous stimuli were not large enough, and more stimulus is needed. Or, in Buffet’s case, use a Viagra metaphor. Stimulus, though, by definition, is not economic growth or prosperity. It is, at best, misguided attempts to prop up employment. At worst, it is a huge, revolving political slush fund for cronies.

Keeping people employed is a noble aim. But keeping people employed in failing companies, if not industries, doesn’t do anybody any good in the long run. And using other people’s money to protect failing institutions, without asking, is pretty much the opposite of a representative government. Punishing success to reward failure is an exercise in futility, if your goal is to spark economic growth. Debt and worthless assets must be liquidated, and the capital and resources tied up in these endeavors must be moved to productive areas of the economy. You know, like auto manufacturing and housing.

The government can encourage economic growth through rule of law, upholding contracts and the Constitution. For the government to create economic growth, though, it would have to bring something of value to the table, not derived from tax revenue or printing presses. More specifically, an income-producing asset (yes, in the black) funded by capital raised from the free market. Until then, understand that government stimulus is moving resources around, not creating growth. When the money being shuffled around comes off the printing press, the value of money itself has been diminished.

“U.S. companies axed 532,000 jobs last month, though this was fewer than the revised 545,000 jobs lost in April, according to the ADP National Employment Report.”

Oh good deal, that’s a 2.4% improvement. So if we can keep that rate steady of improvement month by month, the U.S. will only lose some 11 million jobs before we begin to gain jobs again sometime around August 2012. Not too shabby. It would certainly be better than the 500 million jobs Nancy Pelosi said we would lose every month if the stimulus package didn’t pass. That would put unemployment at around, oh 167% next month. A rate that even an economy as dynamic as ours, might not be able to recover from.

Gold is also up from around $870/ounce in early April to close at $982.30 today, a rise of almost 13% in just about two months! Gold prices are a good sign of inflationary pressures. It looks like we’re going to be in for some pretty vicious price increases in the near future. I guess that’s what happens when you print money like we’re going to run out of paper.

In other news, perhaps Karl Marx had a bit of a point when he said capitalism would turn everything into a commodity. Sure, the system he envisioned got 100 million people killed when a bunch of vicious statists actually implemented it, but hey, at least he got one thing right. According to the New York Post, Natalie Dylan (not her real name) auctioned off her virginity online. The winning bid: a cool $3.8 million dollars! Unfortunately (I guess that’s the right word), the deal fell through. The “winner,” a 38 year old Australian businessman, had to back out. Shockingly, his wife wasn’t particularly pleased with his recent purchase and put some modest pressure on him to renege on his “contract” (and thus keep true to some oath he presumably took). Luckily for all you millionaires with ridiculously, creepy fetishes out there, Natalie is back on the market. Let the bidding begin!