America's Fiscal Folly and Squandering of the "Reserve Fund"
The economic crisis through which the United States and much of the rest of the world are now passing is not another supposed instance of the "failure" of unrestrained capitalism. It is the failure of the government's own policies. In other words, it is a crisis of the Interventionist State.
The recession has been the inevitable outcome of the prior artificial investment boom and housing bubble, which were caused by the misguided and highly expansionary monetary policy of the Federal Reserve between 2003 and 2008. The money supply was increased by nearly 50 percent during this five-year period, and key interest rates, when adjusted for inflation, were at or below zero. Investment and housing decisions were radically out of balance with available real savings to sustain such long-term financial commitments. Consumers and homeowners were induced by low interest rates and easy mortgage policies to get in way over their heads.
The duration and slowness of the recovery, and especially the sluggish delay in anything approaching "full employment," is also the consequence of the government's policies. The Federal Reserve went on another massive monetary expansionist binge that has increased the money supply in the form of additional bank reserves by well over $2 trillion in just a less than three years. Interest rates have, again, been kept at or even below zero when adjusted for inflation, with the affect of continued highly distorted investment and housing sectors.
Fiscal Folly and Burdensome Government
All of this has been exacerbated by the U.S. government's radically loose fiscal policies. But all that the massive trillion-dollar-a-year government deficits for the last three years have done is to accelerate a disastrous trend in government budget financing that had been growing worse for nearly a decade. When George W. Bush entered the White House in 2001, total accumulated government debt stood at $5 trillion. When Bush left office in January 2009, the government's debt had more than doubled to over $10 trillion.
Now in less than the three years of the Obama administration, Uncle Sam's debt stands at over $14.5 trillion – and growing. This debt practically is equal to the estimated total market value of the country's Gross Domestic Product (GDP), a level not seen since the cost of fighting the Second World War. The government, right now, is borrowing approximately 40 percent of all the money it is spending. Under current spending projections government debt will total well over $20 trillion by 2016.
For decades, the United States government has been gobbling up more and more of the wealth and resources of American society. If we take a long-term perspective, in 1902, all levels of government in the U.S. only absorbed slightly more than 7 percent of GDP. By 1998, nearly a century later, all government expenditures as a percentage of GDP had grown to 28.1 percent; ten years later, by 2008, government spending had increased to 38.3 percent of GDP. And in 2010, it has approached 43 percent of GDP. Last year, in other words, 43 cents out of every dollar was spent either by local, state or federal governments.
To at least partly fund these growing expenditures, taxation had eaten into more and more of the American taxpayers' income and wealth. Again, looking back to over a century ago, in 1902 Federal, state and local taxes combined took only 6.7 percent of GDP. Almost a century later in 1998, tax-cost of all levels of government in the U.S. had increased to 29.2 percent of GDP. This has fallen closer to 25 percent of GDP in the last few years due to the recession, with a decline in taxable incomes and corporate profits. But as we saw, this has not stopped the government's growth in spending by borrowing, instead, all that it has needed.
Government spending on defense, entitlements (Social Security and Medicare), and illusionary and counter-productive "stimulus" programs has been and is pushing the United States into the fiscal crisis that threatens America's economic future.
In spite of the rhetoric from a wide variety of politicians and media outlets, the problem is not that taxes are too low or that "the rich" are not paying their "fair share." According to data from the Organization for Economic Cooperation and Development (OECD), among twelve prominent members of the organization (Australia, Canada, France, Germany, Ireland, Italy, Japan, Mexico, Netherlands, Sweden Switzerland, and United States), the U.S. had the third lowest personal income tax rate in 1990 (with only Switzerland and Sweden's rates being less). By 2010, the U.S. was among the higher personal income tax rate nations, along with France, Italy and the Netherlands. Even Mexico's personal income tax rate was noticeably less than America's
Among the same group of OECD members the U.S. corporate income tax rate was far below Germany, Sweden, Japan, Italy, and Ireland in 1990. By 2010, the U.S. corporate income tax rate was exceeded only by Japan's, with Canadian, French, Irish, Italian, Mexican, Dutch, Swedish, and Swiss corporate income tax rates being anywhere between 10 to 50 percent less than America's.
"Soaking the Rich" – Still Not Enough
Nor are "the rich" not paying some hypothetical "fair share." In 1990, those in the top five percent of income earners in the United States earned about 28 percent of total gross personal income in the country. In that same year, those in this income category paid around 42 percent of all personal income taxes collected by the government.
In 2008, that top five percent of income earners earned around 32 percent of total gross personal income in America. But their personal income tax burden had increased to nearly 60 percent of all personal income taxes collected by the government.
Thus, while the "share" of personal income earned in the U.S. in the hands of this top five percent had increased by 14 percent between 1990 and 2008, their tax burden rose during this time period by nearly 43 percent.
Indeed, the top ten percent of all personal income earners paid 70 percent of all personal income taxes collected by the government in 2008, compared to 55 percent in 1990. The top 50 percent of all those earning personal income in 2008 paid 97 percent of all personal income taxes collected that year. And the latest data suggests that since 2009, at least 51 percent of all American households now pay no personal income tax. A minority of income earners now provides all the income taxes paid to partly defray the cost of government in the United States.
U.S. Spending and Debt: More than the Economy Can Bear
Government spending and the accumulated debt is fast approaching more than the American economy can bear. What is collected in both personal and corporate taxes is not enough to cover all that the government spends because government's promises to an ever-expanding spider's web of special interest groups vastly exceeds what the country can afford to pay out of currently earned income. If the government attempted to raise that additional 40 cents out of every dollar it presently spends through borrowing by raising taxes it would bring the economy to a screeching halt.
It would soon be discovered that "soaking the rich" even more would barely provide a handful of drops to cover the spending in excess of taxes collected. It would have to be admitted that the only source of additional government revenue to fill the deficit gap would be significantly higher taxes on the broad middle class of income earners, as well as adding to the tax rolls many of those currently paying no taxes.
Income earners would save even less than now; incentives and resource availability for private sector investment in new or existing businesses in the U.S. would be crushed – along with any market- based job creation. The capital for research and technological development would dry up even more in America, and capital that could get away would flee to more business-friendly countries.
Nor can the borrowing binge continue for very much longer. Net interest payments on U.S. government debt presently equals about 1.3 percent of GDP. Under current borrowing projections, with no change in planned government spending, by 2020 interest payments on the government debt would nearly double to 3.2 percent of GDP. Between 2011 and 2020, this would mean that the United States government would have to pay a total of $4.8 trillion in interest payments.
And this ignores the costs of Uncle Sam's unfunded liabilities for Social Security and Medicare, which, under current law and eligibility rules, is estimated to equal more than $65 trillion over the next seven decades.
For most of the post-World War II period, the U.S. national "economic pie" was able to grow fast enough due to private sector capital investment, technological innovations, and improvements in the skills and education of the American work force that it could offer a rising standard and improved quality of living for virtually everyone in the country.
It was able to do this in spite of the fact that the government's "slice" of the national economic pie and its cost on the private sector kept growing. Growing government costs in the form of rising taxes; increased expenditures and welfare transfers; nearly annual deficit spending; growing regulations and restrictions on competitive private enterprise; along with bouts of serious price inflation and Federal Reserve-induced business cycles.
Exhausting the "Reserve Fund" of the Market Economy
We seem now to be reaching the end of what Austrian economist, Ludwig von Mises, referred to as the "reserve fund" of the market economy. The rate of growth in government taxing, spending and borrowing, and the intrusiveness of government regulations, controls, and prohibitions on the innovative competitiveness of market enterprises is resulting in a situation in which that government slice of the national economic pie is growing so much that it is seriously slowing down the ability of the economic pie to expand.
The "reserve fund" to which Mises referred is that surplus of productive output that a competitive market is able to annually generate in excess of maintaining existing capital intact and preserving present levels and standards of living. That "reserve fund" provides the resources and financial means to invest in new, more and better capital equipment; to invest in training and improving the skills of the work force, so wages over time can rise due to gains in more valuable "human capital"; it generates the greater output of desired consumer goods and services in terms of quality and variety, as well as quantity. It is the economic "fountain" from which flow the advancements in the material and cultural potentials of our civilization.
However, this "reserve fund" does not just exist "out there" to be taxed and squandered away through the fiscal spigot of government largess. It only exists through the intentional choices and deliberative decisions of members of society to save rather than consume; to invest and bear the risks of an uncertain future with the hope of profits if wise business decisions are made; to make long-run plans and develop new and innovative technologies and ways of organizing enterprises to supply those more and better consumer goods over many tomorrows.
The sluggish growth and stagnant labor market are possible indications that government taxing, spending, borrowing, and regulation are absorbing and weakening so much of the society's productive resources and wealth that the private sector is not able to expand fast enough to counteract the "drag" of that burdensome government slice of the national economic pie.
Austria's Past in America's Future?
Where can this all lead? In 1930, just as the Great Depression was beginning, Ludwig von Mises authored a study of the taxing, spending, and regulatory policies that the governments of his native Austria had been following in the 1920s. He was able to show, based on the historical evidence, that fiscal and regulatory burdens on businessmen, entrepreneurs, and investors – "the rich" – had been so great during that period that not only had capital formation and net investment stopped. The fiscal and regulatory drag had actually resulted in capital consumption. The capital stock could not be maintained because of insufficient reinvestment and the productive capacity of the Austrian economy declined; standards of living decreased for many in society as the burden of government, in fact, resulted in the Austrian economy going into "reverse." Fiscal mismanagement in interwar Austria, Mises explained, had resulted in the country's governments consuming a portion of the "seed corn," without which the existing standard and quality of life in a society cannot long be maintained.
In 1935, a summary of Mises' findings was published in English by a former student of his, Fritz Machlup, in an article on, "The Consumption of Capital in Austria" (Review of Economic Statistics, January 15, 1935). Machlup concluded by saying:
Austria was successful in pushing through policies that are popular all over the world. Austria has the most impressive records in five lines: she increased public expenditures, she increased wages, she increased social benefits, she increased bank credits [monetary expansion], she increased consumption. After all these achievements she was on the verge of ruin.
It is easy enough to say and want to believe, "It can't happen here." But like causes do tend to bring about like effects. And unless the current fiscal folly is brought to an end, America's "reserve fund" of productive potential may also be squandered away through government taxing, spending and borrowing, leaving us with poorer tomorrows than our more prosperous past and present.
Posted by oldman67 on 07/31/11 08:15 PM
The articile had a lot of truth but to say Social Security and Medicare are entitlement programs are wrong. I paid into Social Security for forty eight years. I have paid into Medicare since its inception. Food stamps and unemployment insurance are entitlement programs. Just my opinion!
Posted by WorkingClass on 07/21/11 02:04 AM
........"as well as adding to the tax rolls many of those currently paying no taxes."
A fine article but I can't let this pass. The income tax is progressive. So of course the rich pay more than the poor. But the payroll tax, excise taxes, and sales taxes (for example) are regressive. Meaning the poor pay more than the rich. "Those currently paying no taxes" do not exist. Everybody pays taxes.
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Posted by Avatar on 07/20/11 10:54 AM
Good treatise but it somewhat over looks the obscene amounts of monies the USA has spent on its military hegemony since WWII. I know he speaks of government spending in totality but if the USA only spent what is necessary for defense it could reign in its budget deficit quickly. Cutting medicare and medicaid would allow monies for rebuilding infrastructure. There are many problems and dynamics at play and simple government deregulation will not solve the issues. Deregulation in banking lead to derivatives and sub-prime mortgages that should have caused the collapse of these central banks but when you can print money out of thin air the Ponzi scheme can go on a while longer.
Posted by juajuara on 07/20/11 10:07 AM
An excellent article, thanks.
Posted by josejoe on 07/20/11 10:04 AM
when speaking of soaking the rich, why don't they differentiate between the top 1/2 percent as opposed the working rich and see what the 'obscenely' rich pay?
Posted by John Danforth on 07/20/11 09:10 AM
To really understand this, put it in the context of this translation of the Geethner's latest pronouncement:
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Posted by amanfromMars on 07/20/11 03:20 AM
With so many major problems for the dollar, it is surely a very wise move for any smart business to accept payment for their products in another currency, for to be tied to and/or to tie oneself to a rapidly depreciating instrument of convenience and exchange, is to consciously penalise oneself for the folly of others, who would/could easily be charged with, with no valid defense available to deny the charge, of taking unfair and uncompetitive advantage of a selfless supplier. And to consciously penalise oneself is certainly certifiable as undoubted madness, surely?
This then is a major global innovation which must be a most welcome development as it ensures and insures suppliers of goods and services against losses which the acceptance of monopoly monies guarantees will be heavy and unsustainable .... Click to view link