Government spending discourages work

Staff Columnist

“The French and Italians pay higher taxes and put in 30%fewer hours per person than Americans.” By Edward Lazear (Wall Street Journal, Tuesday, February 27, 2018)

“The budget deal President Trump signed earlier this month will send federal spending and the deficit skyrocketing. On top of this spending explosion, the administration now plans to add a $500 billion infrastructure bill.  Over the past century, comparatively low federal taxes and Americans’ long working hours have kept the U.S. economy growing. Politicians can always provide a rationale for increased spending.  But over time high spending necessitates high taxes, and high taxes reduce work and restrain growth.

Economic trends in developed nations consistently show that low taxes and hard work are linked to robust growth.  The U.S. is the least taxed of the Group of Seven  countries, with a tax haul amounting to 25% of gross domestic product.  Americans also work harder than their G-7 peers, with the exception of Canadians,  with whom they are roughly tied.  These factors have helped the U.S. and Canada lead the G-7 in growth since 2010.

European countries trail the U.S. in working hard and controlling taxes, and their economies have lagged  in comparison.  France has a tax-to-GDP ratio of about 44%, and in Italy it’s 43%.  Notably the French economy has flatlined  since 2010 while Italy’s has contracted.

These patterns are not a coincidence:  High taxes discourage work and capital formation.  Data from the Organization for Economic Cooperation and Development  suggest that a 1% increase in a nation’s tax rate is associated with a 1.4% decrease in hours worked per person in the working-age population.  U.S. data dating to the 1970s also shows that the higher taxes cause workers to limit their hours, reducing economic output.

With this trend in mind , it is easy to pin blame for a depressed economy on taxes and call it a day.  But taxes are ultimately dictated by spending.  Countries can borrow to finance short-run spending, but they must eventually levy taxes to repay the loans.  Whether a government raises taxes now or later to pay for expenditures is a minor consideration compared with its decision to spend in the first place.  Some spending is desirable, but even programs that we agree are useful must be financed, which requires higher taxes.

Evidence supports the rule.  Tax and spending rates correlate highly across the 35 OECD countries.  Higher spending goes hand in hand with higher taxes, higher deficits, fewer worked hours and less growth.  The international comparisons suggest that a 4% increase in spending is associated with a decrease of roughly 0.5  percentage point in the annual growth rate.

Furthermore, it is spending     rather than the deficit – that correlates with sluggish growth.  Evidence suggests that once spending is determined, it is of secondary importance whether that spending is paid for now in current taxes or later through borrowing and subsequent  taxation.”

More:  “Critics of recent U.S. Federal tax reform fretted over the amount that lost revenue would expand the deficit.  But recent OECD averages suggest that there is no correlation between deficits and growth at a given level of spending.  Deficits often coincide with low growth because deficit increases are usually caused by heightened spending, not reduced taxes.  Raising taxes, or keeping them high without lowering spending, stifles growth.  But the converse is also true:  Lowering taxes without lowering spending also has little direct effect on growth.  The recent tax legislation spurs growth by reducing  inefficient forms of taxation, such as taxes on capital that have pernicious effects on the economy.  But without commensurate spending reductions, that growth will eventually disappear as future generations raise the revenue for today’s unfunded programs.”

Concluding: “To the extent that government spending goes to programs such as welfare that directly discourage work, it has an additional growth- reducing effect.  When fewer people work, those who do must be taxed  even more to cover public expenses.   These heightened taxes on labor discourage work in turn, pushing more potential workers toward government support.  Funding welfare concentrates ever higher taxes on ever fewer workers and companies, which further reduces growth.”

Opinion:  “Without aggressive cuts, U.S. federal spending will continue to soar.  The Congressional Budget Office projects that annual spending as a percentage of GDP will be 7 points higher in 2038-47 than today.  If so, the U.S. will have to increase taxes by roughly half to close the gap between revenues and outlays. The recent history of developed countries suggests that going down that path would discourage work, depress growth and lower living standards for future generations.”

Mr. Lazear, who was chairman of the President’s Council of Economic Advisors from 2006-09, is a professor at Stanford University’s Graduate School of Business and a Hoover Institution fellow.

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1 Response for “Government spending discourages work”

  1. Doug Riemer says:

    Hmmmmm… post WWII through the 1970’s the U.S. economy bloomed, and with strong unions, the middle class led the personal income growth. Ah, the years of Father Knows Best. Marginal income tax rates as high as 90% didn’t stop investment and growth. Kennedy did drop the top marginal rate to about 80%. The middle class spending engine kept America growing. The top 1% controlled 10% of income and 20% of wealth, which didn’t skew the economy too much.

    Starting with Reagan, however, the marginal rate plummeted to less than 40%, and now with Trump’s tax cut, it’s even lower. As a result, the top 1% were able to double their income and wealth to 20% and 40% respectively. Of course, then, they moved to Longboat Key to drive out the middle class –because the 1% don’t drive economic growth; the middle class does. No more children at The Village bus stop! And they’ve driven out the middle class all over the country with their control of income and capital inflating home prices and keeping wages low. And because supply side economics really doesn’t work — H.W. Bush’s “Voodoo economics” — economic growth has slowed compared with the high tax decades 1940s through 1970s.
    So much for the argument in this article that low taxes promote growth and wealth — unless you’re in the 1%

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