The public choice economics of spending cuts

by on April 18, 2010 at 6:48 am in Economics, History, Political Science | Permalink

This issue deserves more attention and I cover it in my latest NYT column:

Most relevant, perhaps, is Canada, which cut federal government spending by about 20 percent from 1992 to 1997. The Liberal Party, headed by Jean Chrétien as prime minister and Paul Martin as finance minister, led most of this shift. Prompted by the financial debacle in Mexico, Canadian leaders had the courage and the foresight to make those spending cuts before a fiscal crisis was upon them. In his book “In the Long Run We’re All Dead: The Canadian Turn to Fiscal Restraint,” Timothy Lewis describes Canada’s move from fiscal irresponsibility to a balanced budget – a history that helps explain why the country has managed the current global recession relatively well.

To be sure, the spending cuts meant fewer government services, most of all for health care, and big cuts in agricultural subsidies. But Canada remained a highly humane society, and American liberals continue to cite it as a beacon of progressive values.

Counterintuitively, the relatively strong Canadian trust in government may have paved the way for government spending cuts, a pattern that also appears in Scandinavia. Citizens were told by their government leadership that such cuts were necessary and, to some extent, they trusted the messenger.

It’s less obvious that the United States can head down the same path, partly because many Americans are so cynical about policy makers. In many ways, this cynicism may be justified, but it is not always helpful, as it lowers trust and impedes useful social bargains.

Forces like the Tea Party movement argue for fiscal conservatism, though it isn’t obvious that they are creating the conditions for success. Over the last year, we have been treated to the spectacle of conservatives defending Medicare against proposed cuts, in large part to curry favor with voters and mobilize sentiment against the Democratic health care plan.

The column also offers up some general reasons for considering spending cuts and not just tax increases.  Maybe Arnold Kling won't like this column, but when I look around the globe for episodes of successful spending restraint I see Canada, Finland, Sweden, and now possibly (probably) Ireland, which is in the midst of fiscal restructuring.  I see change coming from elites and I see relatively left-wing governments (Ireland, admittedly, is harder to classify) which are trusted by their citizens.  The Greek government, in contrast, doesn't operate with the same level of social cohesion and thus it is likely to fail.

I believe the "social trust" scenario for spending cuts is overlooked because it raises the relative status of groups which people who favor spending cuts do not wish to raise.

I wouldn't want to force the view that the United States will or can follow the path of these other nations.  But when there is no other evidence, look to the path of what has been shown to be possible.  This is a neglected point in the debate on fiscal restructuring and it suggests we are not currently on a propitious path.  Right now many fiscal conservatives are looking to voter outrage to drive change and I'm just not sure there is a "there there."  Here's one good post on how much conservatives like government spending.

The Timothy Lewis book, by the way, deserves far more attention than it has received.  Note that the earlier sections of the book are somewhat boring but it picks up in the later parts.

Addendum: Arnold Kling comments.

Manny C April 18, 2010 at 7:34 am

You forget Australia. The Liberal (read, Conservative) and National Party Coalition which governed AUstralia from 1996 to 2007 smashed the net budget from approx -2% of GDP in 1996-97 (i.e. deficit) to +1% (i.e. surplus) in 2005-06. They also wiped out government debt in that period.

Australians tend to be pretty cynical about politicians and distrust them.

All of that is now reversing very quickly under the Rudd Labor (centre-left) government. Big budget deficits, lots of government stimulus measures that are grossly inefficient (Building Economic Recovery Act) and government debt expected to balloon for hundreds of billions by 2015. Interestingly, Rudd campaigned in the 2007 election as an “economic conservative”.

Bill April 18, 2010 at 7:43 am

You also forget the United States.

Bill Clinton created a surplus by the end of his term.

Misplaced trust in those who call themselves fiscal conservatives, who, at the first chance, cut taxes for themselves and increased the deficit.

Oz Ozzie April 18, 2010 at 7:57 am

ok, well, I’m Australian too. We are pretty cynical about politicians, but we trust them a whole lot more than USA (I’m a frequent visitor there). Our governance standard here in Australia is *much* higher. The tea partiers are missing the problem, I think. They are against tax and federal government spending – though they don’t actually know what they want to change. I think the real problem – from talking to tea partiers – is that they no longer feel as if the federal government is accountable for how it spends their money – i.e. it’s actually a governance problem.

Consider: We had a political storm because a local car salesman lent the Prime Minister an old pickup truck for personal use. That’s nothing compared to USA

Last year I laughed when that Russki guy predicted the end of USA next year – but I starting to wonder whether he’s that stupid after all.

JonF April 18, 2010 at 8:05 am

Re: The Democrats’ refusal to craft health-care legislation that is centrist enough to capture even a single Republican vote….

What are you talking about? The ACA isn’t just centrist: it’s decidedly right of center, following, on the main, conservative proposals from the early 90s, as well as the MA plan put into effect by Mitt Romney there. Republicans refused to vote for it for reasons that are purely political and have nothing to do with the merits, or lack thereof, of the plan. We are at a point where mindless partisanship rules the GOP. Recall that the GOP was demanding a budget-balancing commisson too, but when Obama got behind the idea and Democratic leadership in Congress sought to create that commission suddenly the GOP reversed course and rejected their own idea!

April Harding April 18, 2010 at 8:33 am

This piece in today’s Wall Street Journal pointed out another link between the level of trust in government and deficits – noting that a big part of the Greek deficit problem comes from low tax collections. People feel that gov’t is so corrupt that they feel fully justified in avoiding paying taxes.
http://online.wsj.com/article/SB10001424052702303828304575179921909783864.html?mg=com-wsj

JoddeHaa April 18, 2010 at 8:48 am

I am reminded of Olivier Blanchard’s suggestion that interest inflation rate targets should be raised in order to avoid liquidity traps. A bigger state can function in the same way. For the social democracies that you mention (Sweden, especially) They have more state spending to cut because of their bigger welfare states. When you already have a minimal state, like in the US, every cut is far more painful and therefore cuts are a less effective way to balance the budget. (the question is if they are a less effective way to balance the budget THAN tax increases)

Jeff April 18, 2010 at 9:59 am

zbicyclist, I would’ve said it exactly the other way around. America has one of the lowest tax rates in the developed world, and, as a result, we get things like long waits in line at the DMV, which erodes trust in the competence of the government. It seems more likely to me that governments with high enough taxes to develop a reputation for competence would engender more trust.

Ted Craig April 18, 2010 at 10:02 am

If 2/3 of the U.S. population lived in Pennsylvania and New York state, which is the situation in Canada, we may have more trust in our government. Stockholm and Sydney each have about 20 percent of their respective country’s population in their metro areas. Our largest city has less than 10 percent, by contrast. Distance does not make the heart grow fonder. It doesn’t help that we capped the size of Congress, either.
And you’re leaving out a major factor – China and other nations aren’t paying a high admission cost to get into Canada, Sweden, etc. You always spend more money when somebody else is paying the bill.
A big question that nobody’s asked is if the U.S. becomes a more socialized, austere nation, what happens to those other countries? Will we buy as many Legos and as much Canadian oil? Will the Chinese really pick up the slack? And in the same way?

GermainB April 18, 2010 at 10:13 am

It is indeed possible to reduce government spending, when voters finally realize they have no ther choice. The Chrétien government did it when polls showed it was a political winner. Here is my modest contribution to this debate: http://www.iedm.org/main/show_publications_en.php?publications_id=250

Bill April 18, 2010 at 11:42 am

Noah, “…and Congress was too gridlocked to spend any of it.”

Too bad we lost the gridlock in the next election cycle, and they spent it with an unstainable tax cut, returning us to permanent deficits.

You make my point about Trust.

John Thacker April 18, 2010 at 11:44 am

Too bad we lost the gridlock in the next election cycle, and they spent it with an unstainable tax cut, returning us to permanent deficits.

Luckily we may be getting the gridlock back this election cycle.

Daniel Klein April 18, 2010 at 11:55 am

Unless one believes that national bankruptcy would be a good thing, Tyler’s post/NYT piece contains much wisdom.

He ends by the NYT piece by saying: “How deeply will we dig ourselves in before we create a more mature and more forward-looking political culture?”

Clearly some mechanisms are needed to make politicos more trustworthy and more trusted. They need signals from people other than the political class, the academic class, and leftists, signals telling them that spending, especially entitlements, must be cut very substantially.

Also we need mechanisms for citizens to enlighten and pressure OTHER CITIZENS to favor serious spending cuts.

I have a great idea for advancing such mechanisms.

Let’s create a spontaneous, bottom-up network of people who still believe in limited government and free enterprise to organize peaceful rallies around the country, rallies that stand up for just those messages which the political chiefs and other citizens need to hear, and need to see that many of us are so serious about that we are willing to sacrifice our time and energy in organizing and communicating the message.

If we can get many spontaneous gatherings going, politicos will perhaps begin to get the message, will be pressured to get the message. They may, thereby, become more trustworthy and more trusted.

billd April 18, 2010 at 11:58 am

the most intriguing sentence to me in the post is the point suggestiong that

the “social trust” scenario for spending cuts is overlooked because it raises the relative status of groups which people who favor spending cuts do not wish to raise.

would like to see you expand on that thought.

Bill April 18, 2010 at 12:21 pm

@John Thacker, please note that the Bush tax cuts had to expire in ten years because they projected continued unsustainable deficits with them, and the only way they could get this enacted was through reconciliation. Not hyperbole at all. Reality.

E. Barandiaran April 18, 2010 at 12:40 pm

Daniel Klein,
You should know that the network that you suggest has already been created. Read
http://www.washingtonpost.com/wp-dyn/content/article/2010/04/17/AR2010041702652.html

Andrew April 18, 2010 at 1:36 pm

The problem is that the US government is devoid of elites. It is a mediocracy.

The Tea Party isn’t about fixing the problem, it is about beating the mediocracy over the head to let them know there is a problem. They still aren’t getting it.

Careless April 18, 2010 at 1:54 pm

America has one of the lowest tax rates in the developed world, and, as a result, we get things like long waits in line at the DMV, which erodes trust in the competence of the government.

Want to try to correlate state tax levels and customer satisfaction levels with the DMV in the state and get back to us? Want to go out on a limb and bet that California has a better DMV experience than Texas? Want to bet that Vermont, with its famously high state taxes, has far better DMV service than New Hampshire?

Bill April 18, 2010 at 2:00 pm

@Daniel Klein, good point, but are you sure you are not confusing overall debt with yearly deficit. I said deficit, and the document you point to shows total debt and without reference to debt as a percent of GDP. I can go to the Statistical Abstract, but I am sure there were surpluses and projected surpluses at the end of the 90′s. I even remember Greenspan saying that the surpluses were going to make it more difficult for him to “manage” the economy with interest rates. Funny, isn’t it.

Slocum April 18, 2010 at 2:11 pm

Let’s grant that what Tyler claims about Canada, Sweden, et al is true. The problem is I don’t see any reason to believe there’s much of a chance of transforming the relationship between government elites and voters in the U.S. into something resembling Canada or Sweden. It appears to me that the ‘Tea Party’ approach has a much higher probability of succeeding here (even if it’s still more likely to fail than not).

Cog April 18, 2010 at 2:22 pm

Mike: The CBO says there was a surplus from FY 1998-2001

http://lmgtfy.com/?q=cbo+historical+budget&l=1
(Table F-1)

so either you’re better at accounting than the CBO or you’re missing some crucial fact.

Oh, here it is: the table you cite is the “gross debt” which includes intragovernmental “debt”. Social Security has been running surpluses for ages, and Congress has been spending this money in the general fund. Officially this means that the SSA is “loaning” money to the rest of the government. But this is not a real debt obligation that the Federal government has to pay back to somebody else; it’s just an accounting maneuver. As a thought experiment, it would be trivial, for example, to change the ratio of payroll vs. income tax paid by the public and make money flow in the other direction, without changing net Federal outlays or receipts.

The debt that you care about is “Debt Held by the Public”, which includes all debt that the Federal government owes to entities which are not part of the Federal government. As you can see in Table F-1, this debt decreased every single year there was a budget surplus.

All this is readily available in the Wikipedia article:
http://en.wikipedia.org/wiki/United_States_public_debt

BKarn April 18, 2010 at 2:28 pm

Good god. This is supposed to be one of the most intellectually respectable blogs on the planet, and it’s still filled with “this is really all the fault of Republicans.” Good job, Tyler (and no, when you have no contextually relevant examples, citing other examples isn’t of much value unless your goal is to demonstrate that those examples are not contextually relevant and thus should not be used), and good job to the hyperpartisan posters who are so deep in the Kool Aid they can barely read their screens through the wash of it.

Cog April 18, 2010 at 3:15 pm

Andrew, when I said “somebody else” I meant somebody outside the Federal government. Of course the loan has to be “paid back”, but the mechanism of paying back does not involve net transfer of funds into or out of the Federal budget.

Do you seriously think that intra-Federal government loans are in the same category of debt as loans to external entities? If so, I propose the following thought experiment: I can make the total Debt Outstanding arbitrarily large by increasing the number of Federal agencies on paper. For every federal agency A0, create (on paper) shadow agencies A1, A2, …, AN. Now, for all i in 0 to N-1, have agency i lend its budget at 0% interest to i+1. Then have agency AN do all the work. Ta-da, instant debt N times the size of the Federal budget. Holy shit, explain *that* to grandma’s kids! What a catastrophe! The sky is falling! How will they ever pay it back?

The transfer from the SSA to the general fund is an accounting maneuver, nothing more. You can make the flow stop by cutting payroll taxes and raising income taxes in a revenue-neutral way. You can reverse the flow by cutting payroll taxes and raising income taxes even further in a revenue-neutral way.

There’s a good reason that the CBO excludes intragovernmental debt from “Debt Held by the Public”. In short, it is because they are not morons; a quality that Tea Partiers and their apologists do not share.

AyeCarumba April 18, 2010 at 3:59 pm

It’s also easier to trust governments that you believe *will eventually bring those services back*; that is, you believe the cuts are truly temporary. This is possible when you have a party that actually believes in having government services in the first place.

Mike April 18, 2010 at 5:10 pm

Cog,

If the SS surplus were not being spent, total outstanding debt would still drop. If there really were a budget surplus during the Clinton admin., the SS administration would have been buying up already issued T-bills, bonds and notes on the open market, not buying new issues directly from the Treasury with their cash flow surplus.

So yeah, I do think I am a better and more honest accountant than the CBO. Goes back to the whole trustworthiness thing, eh?

This isn’t any sort of idealogical test either. If debt rose there was no surplus. It’s not a value judgement its an accounting identity.

And yes, the debt rose faster under W.

R. Richard Schweitzer April 18, 2010 at 5:15 pm

The essential function of taxation is to provide revenues for the functions of governments.

We are all well aware that essential function of taxation has been, and continues to be, perverted by applications to achieve social and political goals through impacts on economic activities and human interactions.

As destructive as that perversion has become as a tool of politicians and social engineers, it can be dealt with once we resolve the greater issues.

Governmental spending is determined by the accepted (and to some extent, expected) functions of governments (at all levels). Thus, the revenues extracted from private intercourse as taxations of all kinds increase and expand as governmental functions are allowed, or expected, to expand.

The fiscal “diseases” and disorders lie in the cancerous growth of functions of governments, spending and taxation are only symptoms. We will master none of the symptoms unless we attack the disease itself.

Some sense of this is beginning to be reflected in the nostalgiac “Constitutionalism” references indicated in current popular movements, vaguely recalling that there once was a standard for the limitations of federal governmental functions; from which extensive and damaging departures have occurred and are accelerating.

Unless and until there is at least a decline, if not a reversal, in the willingness of the electorate to allow, and in many cases to expect, governmental functions to be the vehicles for deaing with what are essentailly civic and personal matters, there will be no progress toward amelioration (let alone cure) of the underlying disease.

Bill April 18, 2010 at 6:50 pm

What this post and the comments indicate are the following:
1. Consensus will be much harder to achieve, particularly when some items are off the table.
2. Fiscal history gets rewritten in the US, other countries fiscal corrections are only seen through the eyes of budget cuts when in fact there were both budget cuts and tax increases.
3. Starve the beast gets rewritten as give it heart disease, even though we are all in this together.
4. Some people are silent only when they are in power to both the growth of government and the growth of deficits, and try to convince others that it was not this bum but the other bum that got you into this mess.
5. History repeats itself. Go back to number 1.

Ralph April 18, 2010 at 9:23 pm

The reason to expect the right to not cut spending in the US, is because they worry about getting re-elected. Two things make you lose elections, raising taxes and cutting services. The right has won many elections by promising to cut taxes and reduce spending. All they have done is the politically popular part of cutting taxes. They have been unwilling to face voter backlash from actually cutting services. The Dems have been willing to add services AND raise taxes, hence the appellation, tax and spend. Their doing the unpopular part of raising taxes loses elections for them.

It may be difficult to cut spending, but I wonder if it would be anymore difficult than getting rid of the child care tax credit?

Michael G Heller April 18, 2010 at 10:08 pm

I’m a day late, but plenty of space left at the end of the comments…

Tyler, I agree with your article wholeheartedly except for the framing of change in terms of ‘trust’ and ‘political culture’. It may be nitpicking, but I think important. The two concepts are alright as long as defined in relation to what I see as the greater-priority concepts of leadership and ideology, and potential role of formal institutions in shaping informal norms.

I was reminded of this just now when reading an article by John Gray (who I don’t agree with) in London Review of Books (22 April 2010) posted today at The Browser. He says —

“Speaking to the Sunday Times in 1981, Thatcher defined the aim of her policies: ‘Economics are the method; the object is to change the soul.’†

Could I suggest that Thatcher was pretty skilled in shaping politics for the task of cutting spending, but that a better sentence might be —

“Economics is the knowledge, ideology is the inspiration, leadership is the catalyst, policy is the method; the object is to change the soul. Political culture is the outcome†.

That’s just a first highly imperfect stab at conceptualizing causality in the limited task of cutting government spending.

The ordinary person perfectly understands the household economics of cutting spending when your debt is unsustainable and your income is reduced. Change could come from below via enough-is-enough Filipino-style people power (tea parties, citizen networks, etc.), the ever-awaited politics of *basta*.

Or change could more quickly from above when intelligent political elites level honestly with the people, explain to them why the shortest path back to growth is the hair shirt route of austerity (viz. research of Alesina and Ardagna). If I’m not mistaken this is the post-crisis method of change occurring in Ireland, i.e. leveling with the people. Ireland may in that sense be adaptively efficient.

The Conservative Party in UK seems to have left it too late in preparing the ground for hair shirt ideologies, so instead ham-fisted neoliberal communitarianism will the risky manifesto they take to the election. Still, at least its a manifesto that points in the same longer direction — end of the welfare state binge.

Of course on the ideology route bloggers, journalists, academics, et al. have a powerful role and give courage to politicians. I hope your NYT column contributes in this way.

Michael G Heller April 19, 2010 at 5:34 am

Ok, I was wrong. There was still mulp to come. Actually Clive Crook also adds to the discussion here –

http://www.ft.com/cms/s/0/2ff4a9dc-4b1f-11df-a7ff-00144feab49a.html

“The US parties have clashing ideologies and the middle ground has been vacated. US politics is more polarised than anybody can recall. Luckily, the constitution provides checks and balances†¦. But cross American turbulence with polarised politics and “European† ambitions, and watch out.”

Ted Craig April 19, 2010 at 8:33 am

Mulp, why don’t you get your own blog instead of taking this saturation bombing approach to comments? Seriously.

Bill April 19, 2010 at 10:12 am

Ted, if you oppose mythology, perhaps you can respond to Mulp’s comments with facts. For example, even if the North Tower falls, that doesn’t mean you don’t raise taxes to pay for increased defense spending or perhaps you moderate tax cuts or tax earmarks. Personal, ad hominems, should not be part of the debate.

anonymous April 19, 2010 at 3:30 pm

Lest Canadians allow themselves a self-congratulatory sense of virtuous thrift and smug exceptionalism…

There was a very fortuitous set of political circumstances that enabled Canadian fiscal rectitude in the 1990s, and they are NOT likely to be repeated any time soon, if ever:

1) The previous Progressive Conservative government under Brian Mulroney introduced a GST (goods and services tax, a sort of VAT tax)

2) This was so massively unpopular that not only was the party all but wiped out in the next election (its very survival was in doubt for many years), but there was a decade-long split into two separate conservative parties: the Progressive Conservatives and the Reform (later renamed to Canadian Alliance) parties

3) This enabled the Liberal party under Jean Chretien to win three strong majority governments in a row in a cakewalk, because vote-splitting between PC and Reform/CA ensured the Liberals won nearly every single seat in the demographically lopsided province of Ontario: 98/99 seats in 1993, 101/103 in 1997 and 100/103 in 2000. With that kind of utter dominance in Ontario, election results in the rest of the country hardly mattered, the Liberals simply couldn’t be voted out of power.

The Liberals, incidentally, had originally promised to abolish the GST if elected. They promptly broke that promise, of course.

4) The GST, as designed, produced large amounts of tax revenue. As an unintended indirect consequence, it also produced an “unremovable” government which therefore had a free hand in implementing spending cuts. Combined, these two circumstances resulted in an unbroken period of large budget surpluses.

PS) The two conservative parties finally did manage to push through a very belated merger to become the modern Conservative party, which eventually came to power under Stephen Harper. Ironically, its precarious position as a minority government, especially combined with the global economic crisis, means Canada is back to large deficits.

Needless to say, this set of circumstances is unlikely to repeat anytime soon, if ever. We are not likely to see anything comparable to Brian Mulroney’s suicidally reckless courage/folly in spending every last ounce of his political capital by ramming through first the free trade agreement with the US and then the GST, both in the face of vehement opposition.

In other words, if Canada ever needs to repeat this budget-cutting feat in the future, it is by no means certain that it would be it any more politically feasible than in any other Western country.

anonymous April 19, 2010 at 6:04 pm

And by the way, Canada does not exactly have an unbroken record of social cohesion in times of severe crisis. The democratically-elected mayor of Montreal was sent to an internment camp during World War II for his outspoken opposition to the draft (“conscription”), a sentiment that was widely shared in the rest of Quebec. Upon his release, by the way, he was promptly re-elected.

chev April 20, 2010 at 3:05 am

Hayekian:

Well there is no New York or London anywhere else. But when you adjust for size of city/country, Toronto is somewhat comparable New York or London. According to wikipedia, 49% of the population of Toronto is born outside Canada. I doubt there is a “far” greater cultural divide between rural Alabama and Boston than Toronto, except that maybe Canada is more of a middle class society than the USA. Boston isn’t just the Harvard Yard, it also includes West Roxbury, Southie, etc. Canada is not relatively homogeneous unless you are referring to a much smaller black population.

I agree with your statement that there is more agreement about the role of government than the US. But the US political system doesn’t work too well since there is no accountability. You can’t throw the government out due to your political system (aside from the the importance of money/lobbyists, gerrymandering etc.) In a parliamentary system, when the government gets voted out, cabinet ministers with many years of experience find themselves unemployed. In the US, despite the great dissatisfaction with government, there is so little turnover of federal Senators and Representatives.

JonF April 20, 2010 at 8:45 pm

Re: We are all well aware that essential function of taxation has been, and continues to be, perverted by applications to achieve social and political goals through impacts on economic activities and human interactions.

Yes, Heaven forbid political goals should mix in with the business of govermment. That’s as awful as water being wet and fire being hot.

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