The Debt-Limit Mess

You would think that any institution with that capacity for damage would be an object of concern, not just to Americans but to everyone else on the planet. But will any fundamental change to the government come from the experience? Not likely. The U.S. corporate welfare-warfare state will go on pretty much as before the crisis (if that’s indeed what it was) — only bigger.

To recap, on August 2 the U.S. Treasury was to hit the point at which, unless it could borrow more money, it would be unable to make its interest payments on the national debt and cover all its other bills, from paying contractors and military personnel, to mailing checks to Social Security, Medicare, and Medicaid beneficiaries. By one estimate, on August 3 the government would have had enough cash to pay the interest due and only half the remaining obligations.

The previous debt ceiling set by Congress — which started setting borrowing limits in 1917 — was $14.294 trillion. The actual debt was higher, but some debt does not count against the limit. This year the government is borrowing 40 cents of every dollar it spends. But apparently that’s not enough for Washington’s politicians, which is why they needed a new, higher debt limit. Both major parties tried to make political hay out of the matter. Republicans generally supported a higher limit if it was combined with spending “cuts” (the quotation marks will be explained below), while the Democrats were willing to accept “cuts” (some even in entitlement programs), but only if the deal included increased tax revenues. That disagreement is what had things at an impasse for so long.

A few matters failed to get the emphasis they deserved. First, most Republicans — those self-styled small-government fiscal hawks — favored lifting the debt limit. They were willing to vote to let the federal government borrow more money, even with the total debt roughly equaling GDP. That is astounding.

Second, the “cuts” in spending being touted were not true, absolute cuts off current spending levels, but rather cuts in the rate of growth in future spending. This is the trick of baseline budgeting. Government budget agencies assume spending will rise indefinitely into the future at least by the rate of price inflation under unchanged laws. Any proposal that would reduce the steepness of the spending line is treated as a cut because under the new scenario, the government would spend less than it was scheduled to spend. In government terms, that’s a budget cut. Ezra Klein of the Washington Post, for example, noted that the government could effortlessly “cut” the budget by a trillion dollars simply by acknowledging that someday the troops in Afghanistan will come home rather than being left there permanently. I could treat my personal finances similarly by, for example, deciding not to buy a Rolls-Royce, cutting my household budget and future borrowing by $350,000.

The fact is, 10 years from now — unless something unforeseen happens — government will be spending more money even after adjusting for inflation and population growth. Will the deficit be smaller? Maybe, maybe not. Will the budget be balanced? I suspect not. But who wants it balanced at a higher level anyway?

Third, long-term budget deals, which many of the negotiations focused on, are inherently unreliable and therefore worthless. No Congress can bind a future Congress, so even the cuts in the rate of growth could be reversed. Moreover, long-term projections of a shrinking deficit crucially depend on soft assumptions about future tax revenues, which in turn depend on soft assumptions about rates of future economic growth. If economic growth is less than predicted, revenues will be less — and there goes the deficit projection. On the other hand, if taxpayers come up with new ways to avoid taxes, the projections could be out the window. The upshot is that all the numbers coming out of Washington amount to game playing. Apparently, the credit-rating agencies (even S&P) and stock markets are willing to go along. It’s the only game in town.

Fourth, the Republicans ruled the trillion-dollar-plus military budget off-limits. The party remains tied to its imperialist paradigm and is afraid to budge lest it lose an imagined political advantage over the Democrats. That’s the theory, at least. In fact the Democrats show no eagerness to cut the military budget either, certainly not while Obama is in office. His aggressions in Libya and Somalia, not to mention his open-ended occupations of Iraq and Afghanistan and wars in Pakistan and Yemen, don’t lend themselves to budget cutting.

The total “national security” (better to be known as the “war”) budget and the “entitlement” programs — Social Security, Medicare, and Medicaid — are the biggest spending items, along with interest on the debt, which was more than $400 billion last year. If those are to remain essentially intact, how can the budget actually be cut? There’s not enough in the “domestic discretionary” category to yield much in the way of savings.

Reducing revenue

At least the Republican rhetoric was on target. Too bad the party didn’t back it up with action. As many Republicans said, the deficit problem is a spending problem, not a revenue problem. Spending has skyrocketed since 2001, with Obama outdoing the profligate George W. Bush. Total federal spending approaches 25 percent of GDP, which rivals the level reached during World War II. In the postwar period, the level typically has been about 22 percent. Obama and his party said a “balanced” approach to deficit reduction would include new revenues as well as spending “cuts,” if not from higher tax rates on the wealthy, then from abolishing deductions, credits, and other exemptions for corporations.

To prove their claim that the deficit is as attributable to under-taxing as to overspending, Progressives point to the historically low share of GDP that revenues represent today: 16 percent. They neglect to mention that the economy has been in recession and unemployment is over 9 percent. Of course revenues are down. In the postwar period, revenues have been just under 20 percent regardless of tax rates, indicating that people adjust their behavior to the changing tax code. That means that even if, in a misguided attempt to shrink the deficit, taxes were raised, there’s no reason to believe the amount of money anticipated will actually be received. If for no other reason, raising taxes is a bad way to try to diminish a deficit.

The main reason taxation is a bad approach to attacking the deficit is that it relies on the threat of violence. Therefore a humane society should not tolerate it. As a great libertarian writer put it, “Taxation is robbery.”

When Obama calls for “shared sacrifice” — in the form of spending “cuts” and tax increases — he hopes you will overlook the difference between reducing a government benefit and raising taxes. Reducing a government benefit means that beneficiaries will receive less of other people’s stolen property. Raising a tax means the taxpayers will see more of their own money taken from them by force. There is no comparison between the two. Obama engaged in sheer demagoguery with that appeal.

Tax deductions, credits, and exemptions should be of concern to advocates of freedom, but not because the qualifying taxpayers aren’t paying their “fair share.” These so-called tax preferences represent the politicians’ attempts to micromanage the economy by encouraging some activities and discouraging others. If taxation is robbery, then no tax system passes moral muster. But we can distinguish better and worse among second-best arrangements. A tax system designed simply to raise a little money is preferable to one designed to reward and punish activities according to the politicians’ preferences. That system not only steals property from its owners; it also sets politically chosen objectives for the economy. For example, the tax credit for ethanol (plus the mandate that ethanol be used) represents a plan for the energy industry. (It is by no means the first.)

But as objectionable as a preference-laden tax system is, we should keep our language straight. A tax credit is not a form of government spending like a subsidy. A subsidy is the transfer of tax revenues from the government to a special interest. A tax preference is the government’s abstaining from taxing a portion of someone’s income. While both are methods of manipulating economic activity and may be indistinguishable in effect, they are not the same means. One requires that money be taken from its owners; the other does not. (Of course, if there were no taxation, there could be no tax preferences.)

Every so often the mood in Washington turns toward tax “reform” that would eliminate deductions and credits (“broadening the base”) in return for lowering tax rates. These plans typically seek to keep revenues at least equal to what they are under the present system. (Some hope to raise more money.) But what is sacred about the current level of taxation? When was the last time you heard a politician (other than Ron Paul) propose that less revenue be raised? On the contrary, most Republicans think it’s a virtue that the tax reform they favor will raise more revenue through supply-side feedback. Real advocates of liberty will embrace Milton Friedman’s admonition: If cutting tax rates brings in more revenue, the rates weren’t cut enough.

Finally, raising taxes in the name of economic recovery (which deficit reduction is supposed to facilitate) is ridiculous. Where did people ever get the idea that transferring scarce resources from the voluntary productive sector to the coercive political sector could revitalize an economy?

In a nominally free society, there is something outrageous about government’s owing an amount of money equal to the economy’s annual output and running annual deficits exceeding a trillion dollars. The only way to reverse this horrendous condition is for the government to scrap missions wholesale. That means liquidating the global empire and scrapping the corporate and individual welfare state. Anything short of that will be meaningless.

This article originally appeared in the October 2011 edition of Freedom Daily. Subscribe to the print or email version of Freedom Daily.