October 19, 2016

What If We Can’t Make Government Smaller?

Wagner’s Law” says that as an economy’s per capita output grows larger over time, government spending consumes a larger share of that output. There’s no reason to believe Wagner’s Law is a real social-scientific law—that it captures a real relationship of strict if-this-then-that causal necessity. Which is to say, it wouldn’t be a miracle if GDP increased for a few decades, but the government’s share of GDP didn’t. Yet that never happens in countries with political systems like ours.

As Andreas Bergh, an economist at the University of Lund, puts it, “Given how rare laws are in the social sciences, the positive correlation between the public sector’s share of GDP and real GDP per capita remains an important regularity.” Peter Lindert says that “[t]he notion that income growth will raise taxes and government spending, including social spending, is the most durable black box in the whole rise-of-the-state literature.”

Wagner’s Law names a real, observed, robust empirical pattern. But, as Lindert says, it’s a “black box.” The underlying dynamic that makes the pattern so consistent is a bit obscure. Right-leaning public choice economists often talk about the way spending ratchets up during crises and the “rent-seeking” logic of diffuse costs and concentrated benefits. Left-leaning economists, such as Lindert, emphasize that people benefit from spending on education, poverty alleviation, and social insurance. When those most likely to benefit from social spending have a political voice, they demand more of it. No doubt a mix of all this, with a dash of Baumol’s cost disease, is going on inside the black box.

Bergh and others have pointed out that the strength of the relationship between economic growth and government growth seems to have weakened among some of the wealthiest countries. That makes sense. Once government services are good enough, and further government growth becomes too expensive to sustain, spending needs to level off to maintain the economic growth required to finance those good-enough services.

Still, there’s a robust positive relationship, and it holds just about everywhere. When people get richer, they seem to want more government. In particular, they want more welfare spending. It’s mainly the positive relationship between rising demand for welfare services/transfers and rising GDP per capita that drives Wagner’s Law. The the chart below shows the long-term trends in per capita federal spending in the United States. Real spending per capita on “human resources,” which includes Social Security, Medicare, and other public assistance transfer programs, has grown at a remarkably steady rate.



The robustness of this relationship is completely maddening if you intensely favor smaller government. Wagner’s Law suggests that, as a general matter, the only really reliable method to shrink government (and not just the rate of government growth) is to shrink the economy. But most libertarians and conservatives want both things at the same time: smaller government and rising prosperity.

Indeed, free-marketeers tend to insist that the key to achieving higher rates of economic growth is slashing the size of government. After all, it’s true that the private sector is better than government at putting resources to their most productive use and that some public spending crowds out private investment.

If you’re really committed to the idea of stronger economic growth through government contraction, you’re pretty much committed to the idea that the pattern behind Wagner’s Law is a sort of fluke—a contingent correlation without any real cause-and-effect basis—and that there’s got to be some workaround or fix.

I’ve found that you can understand a lot about right-leaning policy and political strategy by seeing it as a desperate if unwitting quest to find and exploit loopholes in Wagner’s Law.

For example, you might think that the democratic public will stop wanting to plow an increasing percentage of rising economic output into welfare spending once it finally becomes aware of the TRUE THEORY OF GOVERNMENT AND ECONOMICS. In this case, you may pin your hopes on efforts to educate the public about the virtues of free markets and limited government. I’ve done my share to bring this gospel to the American people. But if you’ve been following the proposals of this year’s presidential contenders, or glanced at the unrelenting spending trendlines, it’s hard say attempts at economic and political education have had any effect at all.

There’s an abiding faith on the right that there must be policy levers that can be pulled to reduce political demand for government spending. The idea that it is possible to “starve the beast”—to reduce the size of government by starving the government of tax revenue—springs from this hope. But the actual effect of cutting taxes below the amount necessary to sustain current levels of government spending only underscores the unforgiving lawlikeness of Wagner’s Law. As our namesake Bill Niskanen showed, tax cuts that lead to budget shortfalls don’t lead to corresponding cuts in government spending. On the contrary, financing government spending through debt rather than taxes makes voters feel that government spending is cheaper than it really is, which makes them want even more of it.

Other bits of “supply-side” fiscal dogma are similarly premised on misguided hopes of hacking Wagner’s law. Consider the way some libertarians curse free-market demigod Milton Friedman for his role in inventing income tax withholding. It’s bad enough, they think, that withholding made tax collection cheaper and more reliable. But their real complaint is that paying taxes automatically and with a minimum of pain makes it less likely that you’ll be livid about them when you vote. The complaint against Friedman is the libertarian/conservative argument against a VAT or national sales tax in a nutshell. It’s the same line of reasoning that leads some libertarians and conservatives to flirt with the idea that we ought to pass a law that requires us to write a single, hugely infuriating check to the IRS each year.  The idea is that if voters are really ticked off about taxes, they’ll want lower tax rates. So taxes need to be as salient and painful—i.e., as inefficient and distortionary—as possible. But, again, the final step is very doubtful.

Supply-siders generally present two scenarios, and neither helps reduce the size of government. One: If the tax cuts pushed by ticked-off taxpayers create supply-side stimulus and increase rather than decrease revenue, there’s no downward pressure on spending. If we can really finance the current spending level with lower taxes, that’s awesome and we should do it. But it doesn’t make government smaller. Two: If tax cuts aren’t self-funding and simply leave a hole in the budget, the beast (as Niskanen showed) does not therefore get starved. Instead, spending feels cheap, the beast grows even more, and the tax bill gets shifted to the future.

There’s simply no path here to smaller government. So what’s the point of salient and painful taxes? It takes less money to collect sale taxes and VATs, tax-avoidance is less of an issue, and their lower salience minimizes the chance that they’ll hurt economic output by discouraging work effort. That’s all obviously good—unless you think that intentionally rigging taxes to do the most possible economic damage will actually minimize the economic damage of taxation by eventually generating popular demand for lower rates and lower levels of spending. I’ll admit that this is what I used to think, but it’s really a very weird idea.

Bill Niskanen said that “the longer-term challenge for those of us who favor limited constitutional government is to try to convince voters to reduce their demand for the services financed by federal spending.” However, the fact of the matter is that our well-funded and well-organized attempts “to convince voters to reduce their demand for the services financed by federal spending” so far have all failed.

It’s time to consider the possibility that there’s no convincing them. What if there’s no feasible path within the bounds of normal American democratic politics to significantly lower the level of government spending as a percentage of GDP? If we look at the world, what we see is that when people get richer, they want more welfare state. Maybe there’s nothing much we can do about that.

I’m not going to insist that that’s true. But it’s a possibility we need to think about. Folks on the right need to consider the possibility that we’ve been wrong to see demand for government as the sort of dependent variable that can be manipulated through education or propaganda or political organizing or too-clever-by-half fiscal policy gymnastics or far-fetched constitutional amendments. The only variable the level of government spending clearly and reliably responds to over the long run is GDP per capita, and the relationship goes the wrong way. When people get richer, they want more welfare state. You can want Americans to get continuously wealthier and also want the government to consume a smaller share of national economic output, but there’s very little reason to think you can have both of those things. That is what the world is telling us.

What if we listened? What if we accepted this and took it really seriously?

I think accepting that it’s probably not possible to shrink government would have a transformative effect on right-leaning politics. We would focus on figuring out the best ways to match receipts to outlays without getting distracted by half-baked ONE AMAZING TRICK strategies to downsize Leviathan. You start to think differently about cutting wasteful spending, consolidating redundant programs, and making the delivery of government services more efficient when you stop seeing it all as part of some master plan to drown the government in a bathtub. You start to accept that spending cuts are ultimately more about optimizing the composition and effectiveness of spending than about the overall level of spending or its rate of growth. This doesn’t mean not fighting like hell to slash nonsense programs, or not prioritizing reforms to make entitlement programs fiscally sustainable, or not trying to balance budgets from the spending side, or not trying to minimize the rate of spending growth. This just means that you do it all knowing that the rate of spending growth isn’t going to go negative unless you hit a recession, a debt crisis, or end a major war. You do it knowing that our government is already unusually small in comparative terms, and that it’s highly unlikely to contract and stay that way.

Giving up on the quixotic quest to find the magic words or the magic policy lever that would finally and decisively falsify Wagner’s Law would also lead us to distinguish more clearly between the welfare state and the regulatory state, and to focus our energy on removing regulatory barriers to economic participation, innovation, and growth. We’ll see more clearly that a small government and a limited government that reliably protects rights and promotes freedom aren’t really the same thing. And we’ll begin to recognize that sowing antagonism to the welfare state hasn’t accomplished anything very constructive. The war against the welfare state hasn’t slowed growth in welfare-state spending so much as it has made our system unusually loathed and unusually shoddy. Mostly, it has fostered a divisive, racially-tinged “makers vs. takers” narrative while encouraging opposition to reform measures that might have made our safety net fairer, more efficient, and better at minimizing the economic anxieties that drive populist political sentiments fundamentally at odds with an open society of free markets, free trade, liberal migration, and peace.

If you’ve ever wondered why the right-leaning “freedom movement” hasn’t had much success in actually making Americans more prosperous or free, try this on for size:

Smaller government can’t be the sine qua non of the politics of freedom in a Wagner’s Law world.

The failure to understand or accept this amounts to a fundamental misapprehension of political reality, which has led freedom-lovers to adopt a self-defeating public message and political strategy.

This is just a conjecture. But when the world’s most vocal supporters of freedom-as-small-government show that the developed countries with the biggest governments are also among the world’s freest, and show the United States—where the freedom-as-small-government philosophy is most powerfully promoted and most widely accepted—has lost ground in economic freedom year after year for nearly two decades, it’s a conjecture worth taking very seriously.