"Government - What Sort of Government Do We Want?"

Sydney M. Williams

Thought of the Day

“Government – What Sort of a Future Do We Want?”

August 30, 2011

If and when Washington gets its fiscal house in order, the ensuing debate should not be limited to tax increases and spending cuts. Tom Friedman, in his Sunday’s column in the New York Times argues for a new, hybrid politics that “mixes spending cuts, tax increases, tax reform and investments in infrastructure, education, research and production.” In my opinion, the debate must be even more fundamental. What services do we want government to provide and how much do we want to pay?

U.S. federal spending, as a percent of GDP, ranged between 18% and 22% for the forty years ending 2007 – a period that included half a dozen recessions, two of them severe. In 2010, that number reached 24.8%, the highest level since World War II. Away from the obvious spending programs of the Obama administration, there are two other explanations. First, the recession ending in May 2009 is generally considered the most severe in the post war period. Second, GDP growth during the 2000s was unusually slow, while government spending continued apace. Between 1970 and 2000, growth in government spending virtually matched growth in GDP. During the 2000s, GDP growth was 46% while government spending expanded 100%. (In fairness, GDP growth fell off sharply during the December, 2007-May, 2009 recession, while government spending increased dramatically, led by TARP and the “Stimulus.”

Among the questions investors and voters are attempting to determine is do the policies of the Obama administration represent a sharp divergence from the past, or are they only temporary? Over the past seventy-five years, voters have indicated a preference for providing increased social services in the form of Social Security, Medicare, Medicaid, unemployment insurance, etc. Because of demographic shifts, the cost of some of those services is rising faster than inflation and/or GDP growth. Those costs increases are embedded into current models and will persist. In 1960, there were 5.1 workers for every retiree. In 2009, there were 3.0. We are an aging nation. The median age in the U.S. is just over 36 years today, up about a year in the past decade. (I might note that the Williams’ family, with an average age of 26.2, is making a stab at bucking that trend.)

Reflecting this trend, the composition of the budget has changed. Discretionary spending, as a percent of the federal budget, is about 39%. Forty years ago it was around 67%. With Vietnam, defense spending in 1970 was 50%; today it is 20%.

The fact is we are a different country today than forty years ago and there is no going back to the way we were. Change is difficult; there are those who would like to slow the pace, and almost everyone realizes that the current trend leads inexorably to bankruptcy. Any solution will be painful, which explains the reluctance of politicians to be bearers of bad news. It also explains, in part, the virulent antipathies of the various political combatants – the polarization of extremists in Congress. Americans are frustrated because the stakes are so high and because of the failure in Washington to deal with intractable problems.

Americans are asking questions: what do we want our country to be and how do we get there? What will the costs be, both in dollars and in personal freedoms?

The tendency of politicians is to gloss over problems, hoping they disappear – at least beyond the next election. But action is needed now and there are things that can be done today. The age to receive Social Security and Medicare should be raised for those under fifty or fifty-five to seventy, not in fifty years, but in ten or fifteen. A means test should be imposed immediately and the level of income on which the payroll tax is applied should be increased. Tax reform should simplify the code by eliminating numerous popular deductions; it should broaden the base and lower nominal rates. I, and I suspect others, find it appalling that the sanctimonious Warren Buffett, after chastising government for not raising his tax rates (and that for others of the “rich”), concludes an agreement with Bank of America that permits him to receive $300 million in annual dividends while paying a maximum tax rate of 10.5%! Other actions could be taken. Alan Kreuger, the Princeton economist President Obama has chosen to be chairman of the Council of Economic Advisors, concluded in 2008, according to the Wall Street Journal, that “job search is inversely related to the generosity of unemployment benefits.” Those benefits have already been extended to ninety-nine weeks. Should they be extended further or curtailed?

The best way to get out of the mess is to increase GDP growth. Everybody knows that, but the philosophies are at odds. Should government take the lead or should private enterprise? If it is the latter, government must ease up on regulation and must foster free trade.

The aging problem is real, but it is a far bigger problem in Western Europe, Japan and even China. There are two ways of solving it – killing off the elderly, or increasing the number of children. Naturally, I am not in favor of the former; the latter could be solved in two ways – increasing immigration and encouraging larger families.

The change in the federal government’s budget is indicative of the change sweeping our country. Left unaltered, we are headed in a direction that leads to destruction. The debate is about how sharp a reversal is needed – a real concern for investors and voters alike, while politicians, focused on the next election, keep kicking the bucket down the road. It is little wonder that partisanship is so high. It would be nice if we could assume the civility Mr. Friedman prefers. However, we must decide, as a nation, what sort of a future we want. In the same issue of the Times, Richard Thaler asks the more pertinent question: can politicians who act like adults win elections?