Curing America’s Growth Gap

Addressing Causes Instead of Symptoms

Sep 19 2013

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Excutive Summary

A more comprehensive understanding of the relationship between government spending and debt and the effect on the broader economy is imperative for all policymakers. Spending and debt can stunt economic growth, which in turn leads to a vicious cycle of further deficit spending and debt.

The fourth anniversary of the current economic recovery offers a poignant reminder: The post-2008 financial crisis recovery ranks dead last in terms of economic growth when compared with all other recoveries since World War II from recessions that have lasted longer than a year; and the “Growth Gap” going forward is bigger than ever.

The Growth Gap between what real GDP is and what it would be if America had simply experienced an average post-1960 recovery is large – $1.3 trillion. Real disposable income per capita has inched up 2.7 percent compared with an increase of 11.1 percent over the same period in an average post-1960 recovery. That is an annual difference of $2,987 per capita; which would be a difference of $11,948 for a family of four.

Even more troubling, America’s economic growth prospects going forward may have diminished. The Congressional Budget Office (CBO) recently reduced its estimate for future growth in potential real GDP from 3.2 percent to 2.2 percent per year. Over the next 50 years, a one-percentage point reduction in real annual GDP growth is the difference between an $80 trillion economy and a $50 trillion economy, a nearly 40 percent smaller economy, in 2062.

Massive stimulus spending and an expansion of entitlement programs since 2008 have failed to deliver the promised jump that our economy needs. Now, left with an even larger base of federal spending ahead of demographic changes that will place an excessive strain on existing entitlement programs, the growth of the federal government is squelching private enterprise and innovation with spending increases; crushing debt with higher interest

payments; burdensome and byzantine regulations; maligned incentives; and an ever-broadening scope of government functions.

The dual problems of fiscal unsustainability of the federal government and the Growth Gap are interrelated. So are their solutions. Without economic growth, the United States cannot achieve fiscal sustainability; without long-term government fiscal sustainability, the economic growth gap will persist.

How Government Grows despite Policymakers’ Intentions

• Government often behaves in ways that neither policymakers nor the electorate intend. Bad government is not commonly the result of bad people; dysfunctional outcomes occur in spite of rational reasons and means. For example, the Federal Reserve’s current near-zero interest-rate policy combined with the current tax system has increased the likelihood of negative real yield on investments, further reducing the incentive to invest, which is vital to economic growth. Neither policymakers nor the public wish for stunted economic growth and investment, but this has been a significant negative outcome of a plethora of rational and often “temporary” marginal tax code changes in combination with a highly interventionist Federal Reserve’s rational intent to boost lending and reduce unemployment.

• People often argue that government should run like a business; there will always be differences in the types of incentives driving the private sector and the government sector. If you want to change government, you must change the rules; the government responds to incentives that have been put in place, and these incentives remain a real challenge to those who want reform. He who writes the rules, designs the game. Much of government growth that can stand in the way of fiscal consolidation and major reforms relate to the precedents that were set by institutions in the past. What politicians are able to do is shaped by context.

• The current set of rules incentivizes government growth and further centralization and must change if the United States is to remain a sustainable economic force in the world in the long term. The composition of spending has dramatically changed over the past 50 years, moving from discretionary spending that policymakers debated and prioritized every year to an automated, centralized spending machine that doles out funds based on unsustainable obligations, fueling interest payments on debt in the process. These rules also have the unintended effect of blurring the line between revenue intake and program spending, and impeding state and local government experimentation that leads to better program outcomes and greater efficiency. For example, the transition of control f rom state and local levels to federal subsidization with strings attached has been made possible by a growing spending category in the federal budget, grants-in-aid. States receiving federal funds lack the incentive to spend those funds as carefully and efficiently as the funds they must raise from their own revenue base.

Recommendations

Following earlier papers from the Joint Economic Committee Republicans—Spend Less, Owe Less, Grow the Economy and Maximizing America’s Prosperity—this study takes a broader look at why government growth is so pervasive, and what policies can be enacted to place America on a fiscally sustainable course and prioritize core government programs. Using medical analogies, key considerations in this inquiry include:

• Balancing the budget alone is insufficient to prevent the disease of government growth. Demonstrating a path to budget balance alone does not address the underlying problems that have thrown the budget out of balance in the first place. Projections of budget balance in the future can be misconstrued as factual and mask systemic problems. The government is growing in multiple dimensions: size (i.e., relative to the economy), scale (i.e., central and federal intergovernmental roles) and scope (i.e., in new authority that can impede the effectiveness of government functions as well as the economy).

• Misdiagnosing the symptoms as causes of the disease must be avoided. Policymakers must shift focus from the symptoms of government growth to what the root cause is—overspending. Growth in scope of government can pervade agency core mission creep and drift away from the original, government-specific role. Congressional mandates and burgeoning regulations consume the resources available for government to perform its roles well, begetting more spending and borrowing to make good on ever expanding obligations. Entitlement spending has also shifted the budget landscape, placing a majority of government spending on automatic pilot and disconnecting spending from revenue. Monetary instability reduces the accuracy of budget projections and undermines the strength of the U.S. dollar.

• The body will reject the medicine if the rest of the body perceives it as harmful. Fiscal rules must not only be carefully designed, but they must receive broad bi-partisan and public support. If bi-partisan support is absent, then the fiscal rule design could undergo alterations that render it flawed and ineffective. In addition, for a fiscal rule to stick, it needs the credible commitment of both parties and wide acceptance and understanding from the public, especially since the current Congress cannot bind future Congresses.

• Ensuring that the disease of government spending is not channeled in another form is critical. Taking a multifaceted approach to prioritizing core government spending programs ensures that government growth does not overflow into another form (i.e., cutting spending and seeing an increase in regulatory action). With fiscal rules come the understanding of how to manipulate them; this is why credibility plays such an important role, and why reform of other forms of government expansion (i.e., tax reform, entitlement reform, regulatory reform, addressing intergovernmental transfers) must occur concurrently in order to reduce the opportunities and subsequent temptation to circumvent fiscal rules.

• A cure for the disease will come from an arsenal of policies designed to amplify one another, not a single silver bullet. Pro-growth reforms coupled with expenditure-based fiscal consolidation increases the chances of success for reducing debt-to-GDP ratios and boosting economic growth. According to research from Veronique de Rugy and Alberto Alesina, pro-growth reforms enhance the success of fiscal consolidation by mitigating the short-term negative effects and bolstering long-term economic growth.1

With these points in mind, this study:

(1) Identifies the multifaceted causes of expansive government growth and subsequent symptoms and consequences;

(2) Notes the common roadblocks preventing successful fiscal consolidation and real reform of government spending;

(3) Offers several broad policy recommendations that emphasize spending prioritization and promote strong and sustainable economic growth; and

(4) Demonstrates the benefits of credibly committing to pro-growth policies coupled with successful fiscal consolidation.

Government is more dependent upon strong, continued economic growth than most politicians realize. The goose that lays the golden eggs for government revenue is currently weak, and Congress needs to pursue policies that strengthen economic growth rather than provide short-sighted solutions that do nothing more than redistribute existing resources and shift economic activity from the future to the present. If business as usual persists, then both government and the economy will suffer far worse than if Congress takes bi-partisan action on difficult issues now. As the public begins to converge on the understanding that major reforms are necessary to give the bright and hopeful vision of America a chance, it is time for policymakers to do the same.

 

Read the entire study attached in pdf format below:

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