Three Myths: Federal Budget Edition

America, noted famed US diplomat George Kennan, is notoriously slow to respond to problems, but when it does, it comes down on them with a vengeance. While Kennan was speaking of American geopolitical policy, the same could be said of its reaction to domestic crises as well.

In a 2007 Gallup poll, only three percent of Americans claimed the federal deficit was their greatest concern. A similar poll from earlier this month puts that number at 13 percent. And an astounding 87 percent of Americans now worry a “great deal” or “fair amount” about the deficit. It should not be surprising, thus, that the national political dialogue has shifted dramatically towards the subject. This epitomizes the “better late than never” nature of our republic that Kennan described: it may have taken us a while to realize our debt is a problem, but we came to eventually and seem ready to confront it head on. By my estimation, this recognition is a positive showing for America.

We now confront another issue: major media outlets and politicians are trying to sell economic snake oil, and the public seems willing to buy much of it.

Each citizen has to discover their own ideological path and economic views; sites like RealClearPolitics aggregate leading voices from both sides and can thus be a great place to start. As such, my goal is not to turn the reader into a disciple of Hayek. I will, however, attempt to clarify three objective economic myths that seem to have gained traction in the past months.

Increased tax rates lead to increased tax revenues: Logically, such thinking makes sense on some level. If 100 people each making $100,000 a year pay federal income tax of 20%, the federal government collects $2 million. If the rate is increased to 30%, the government collects $3 million. Right?

Wrong. In reality, tax rates and tax revenue are entirely independent. Historically, regardless of tax rates, the fed on average has only collected 20% of GDP. It doesn’t matter what the top marginal rate is; 20% is the best you can realistically hope to get for any extended period.

It seems obvious enough, but people respond to incentives. And as any business owner knows, hiking the price of a good or service often leads to less of that good or service being bought. Companies often increase their total revenue by lowering their prices (or rates). If Apple were to increase the price of the iPad by 20%, many consumers would either buy an alternative tablet or opt out of the market altogether. Similarly, when the federal government jacks up tax rates, those who are able to avoid the “tax” marketplace as much as possible. Perhaps a small business owner invests less money in taxable assets (i.e. employees). A business professional may not work as hard for a promotion, knowing that most of the additional money will be taken by the government.

The most ironic (and tragic) part of this is that the policy harms the group that its advocates purport to represent: the middle class. A truly wealthy individual can hire attorneys and financial professionals to devise complex schemes with which to hide his income (tax shelters, loopholes, deductions, etc.). Most middle class individuals cannot afford such resources, and are thus hit disproportionately hard by tax hikes.

Serious cuts cannot be made without throwing America’s vulnerable citizens to the curb: Wrong. In 2002 the federal government accrued a $150 billion debt; in 2011 it will be $1.6 trillion. Conflicts in Iraq and Afghanistan do not account for the tenfold increase. And yet in 2002, the streets were not full of displaced elderly and impoverished citizens. What gives?

Spending has grown rapidly across the board (entitlements, defense, and discretionary). All categories of growth can be explained by the same phenomenon: it is much easier to add a program (and thus spending/debt) than it is to cut a program. The larger the federal government grows, the easier it becomes for a politician to tack on a few million dollars here and a few billion there. Additionally, each government outlay carries with it a group of intensely concerned citizens who will lobby for their cause (read: dollars) extensively. These programs individually may only cost each taxpayer a few cents. Collectively, they add up. But Joe Voter tends not to notice until it’s too late.

Thus, the government has myriad programs that voters have grown used to. The notion of slashing these projects and services appalls those who have become dependent on them, even when they concern less than life-or-death matters (state parks, etc.). It’s not surprising that beneficiaries of this new spending don’t want to see it go away. However, it is complete fiction to associate cuts of programs that are only a few years old with wholesale abandonment of the poor and elderly.

As for entitlements: they use formulas that were designed 76 and 46 years ago to calculate costs for Social Security and Medicaid/Medicare, respectively. Spending for all three programs has grown exponentially without providing concurrent increased benefits. The formulas need to be tweaked to account for both individual income (aka means testing) and the increase in lifespans since the advent of, well, modern medicine. These cuts (particularly means testing) will hurt the rich; the truly poor will always be eligible for emergency care.

Cuts to defense spending should be off of the table: Republicans are urging the federal government to live within its means, advice I couldn’t agree more with. What is perplexing is when they insist that this rule apply to everything but the Department of Defense.

America currently spends around $700 billion a year on defense. This is almost as much as the rest of the world combined. To portion off this segment of federal spending entirely is foolhardy. For a party so skeptical of bureaucratic largesse, it is mind boggling as to why the GOP thinks the Pentagon can’t reduce spending. It is easy for politicians to pander to the public using phrases such as “keeping our troops safe”. The reality is that most military personnel wage war using PowerPoint, not M-4 assault rifles.

Furthermore, cuts can be made easier by politicians who exhibit more judiciousness when deciding whether or not to place young men and women in harm’s way. Just like corporations often have to identify their strategic lines of business and cut funding for the peripheral ones, so too should America with its military operations. (In this sense, the emerging military might of China can be used as a deficit reduction tool: as their economy grows, so too does their list of regional interests. Let them foot the bill for conflict mediation in their own backyard, ala Korea.) If policymakers insist upon a more focused and realistic foreign policy, we can both lessen the intense burdens on the military and their families and also reduce the deficit.

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