Hoover Daily Report

How Big Government Hurts the Average Joe

via Wall Street Journal
Friday, August 5, 2011

During the debt-ceiling debate, President Obama characterized his push for higher taxes and less aggressive budget cuts as being helpful to the middle class. The claim was that failing to raise taxes on high-income earners would place a disproportionate share of the pain on the rest. But it is our record-high government spending, not the failure to raise taxes on the rich, that is the typical American's largest long-term problem.

Workers do well only when the economy grows at a healthy and consistent pace. The biggest threat to long-term economic growth is government growth of the magnitude that characterized the past two years and that is forecast for our future.

Our current problems are not a result of acts of nature. They stem from policy choices that dramatically increased the size of the government. In the past two years, the federal budget has grown by a whopping 16%. Importantly, growth in agency budgets other than Defense exceeded that in Defense, despite the surge in Afghanistan. The budget for Health and Human Services, for example, home to Medicare and Medicaid, rose a hefty 22%, as compared with 12% for Defense.

The sum of 11 other agencies, such as the Departments of Agriculture, Education and Labor, which combined account for more annual spending than Defense, experienced an increase of more than 50% over the two-year period. Some of the budget increases, like those associated with unemployment insurance, should disappear when the economy rebounds, but much of the addition is permanent and is reflected in the president's projected future budget numbers.

What has the increase bought us? The president would have us believe that but for the stimulus, the economy would have sunk into the next Great Depression. The numbers tell a different story. Estimates of the effect of the stimulus on gross domestic product (GDP) range from zero to three percentage points of GDP. The current recession set GDP back by nine percentage points relative to where it would have been had times been normal.

If we accept the most generous estimates, with no stimulus the recession would have meant a 12 percentage point decline in GDP rather than a nine point decline. The Great Depression was about a 34 percentage point reduction in GDP relative to normal times. Even without the stimulus, our current recession would have been nothing like the Great Depression.

What about the president's claim that unemployment would be far worse without the stimulus? Despite the jobs the stimulus supposedly saved, there are two million fewer people working today than there were when the stimulus was enacted in early 2009. The unemployment rate, at 9.2%, is about one and a half percentage points higher now than then.

Furthermore, the price of the stimulus is what appears to be a permanent increase in the size of government that will continue to slow economic growth. Most economists believe that high debt and high taxes each contributes to slow economic growth, which hurts workers both in the short and long run.

In the short run, job growth is very closely linked to GDP growth. If the economy is not growing, then jobs are not being added. Data from the U.S. over the past 45 years reveal that a 1% increase in GDP generally leads to job growth of about 0.6%. As a result, to get back to pre-recession employment levels, we will need about 10% of GDP growth. At the meager growth rates we've seen during this recovery, that will require three to five years.

In the long run, wage growth suffers when GDP growth is weak. Labor productivity grows when technology advances as a result of capital investment, human or physical. But high taxes and the increased interest rates caused by high government debt reduce investment, which in turn impedes growth in labor productivity.

Over a period of four years or so, wages rise directly with labor productivity. A 1% increase in productivity translates into a 1% increase in wages. If economic growth suffers because of big government, so too will growth in labor productivity and in the typical American's wages.

The recent debt-ceiling debate was more than partisan politics. Although more could have been achieved by the compromise debt-ceiling legislation, it is encouraging that Congress took some action to limit the growth of government. If the legislation plays out as planned and is followed by even more action in the same direction, the typical American will have less to fear.

Mr. Lazear, chairman of the President's Council of Economic Advisers from 2006-2009, is a professor at Stanford University's Graduate School of Business and a Hoover Institution fellow.