Where are the '60s Hippies Now that They're Needed to Fight Keynesianism?

Keynesian economic theory is the social-science version of a perpetual motion machine. It assumes that you can increase your prosperity by taking money out of your left pocket and putting it in your right pocket. Not surprisingly, nations that adopt this approach do not succeed. Deficit spending did not work for Hoover and Roosevelt is the 1930s. It did not work for Japan in the 1990s. And it hasn't worked for Bush or Obama.

The Keynesians invariably respond by arguing that these failures simply show that politicians didn't spend enough money. I don't know whether to be amused or horrified, but some Keynesians even say that a war would be the best way of boosting economic growth. Here's a blurb from a story in National Journal.

America's economic outlook is so grim, and political solutions are so utterly absent, that only another large-scale war might be enough to lift the nation out of chronic high unemployment and slow growth, two prominent economists, a conservative and a liberal, said today. Nobelist Paul Krugman, a New York Times columnist, and Harvard's Martin Feldstein, the former chairman of President Reagan's Council of Economic Advisers, achieved an unnerving degree of consensus about the future during an economic forum in Washington. ...Krugman and Feldstein, though often on opposite sides of the political fence on fiscal and tax policy, both appeared to share the view that political paralysis in Washington has rendered the necessary fiscal and monetary stimulus out of the question. Only a high-impact "exogenous" shock like a major war -- something similar to what Krugman called the "coordinated fiscal expansion known as World War II" -- would be enough to break the cycle. ...Both reiterated their previously argued views that the Obama administration's stimulus was far too small to fill the output gap.

Two additional comments. First, if Martin Feldstein's views on this issue represent what it means to be a conservative, then I'm especially glad I'm a libertarian. Second, Alan Reynolds has a good piece eviscerating Keynesianism, including a section dealing with Krugman's World-War-II-was-good-for-the-economy assertion.

Here's How to Balance the Budget

Our fiscal policy goal should be smaller government, but here's a video for folks who think that balancing the budget should be the main objective.



The main message is that restraining the growth of government is the right way to get rid of red ink, so there is no conflict between advocates of limited government and supporters of fiscal balance.

More specifically, the video shows that it is possible to quickly balance the budget while also making all the 2001 and 2003 tax cuts permanent and protecting taxpayers from the alternative minimum tax. All these good things can happen if politicians simply limit annual spending growth to 2 percent each year. And they'll happen even faster if spending grows at an even slower rate.

This debunks the statist argument that there is no choice but to raise taxes.

There Is No Libertarian or Conservative Argument for Higher Taxes

Eli Lehrer has an article on the FrumForum entitled "Five Revenue Raisers the GOP Should Back." He argues it would be good to get rid of preferences such as the state and local tax deduction and the mortgage interest deduction, and he also asserts that there should be "user fees" for things such as transportation.

As an avid supporter of a flat tax and market pricing, I have no objection to these policies. Indeed, I would love to get rid of the state and local tax deduction so that taxpayers in Texas and Florida no longer have to subsidize the fiscal profligacy of politicians in California and New York.

But there is a giant difference between getting rid of certain tax preferences as part of revenue-neutral (or even better, tax-cutting) tax reform and getting rid of tax preferences in order to give politicians more revenue to spend.

The former is a noble goal. Who can argue, after all, with the idea of getting rid of the corrupt and punitive internal revenue code and replacing it with a simple and fair flat tax? Lots of loopholes are eliminated, so there are plenty of tax-raising provisions in tax reform. But every one of those provisions is offset by provisions that lower tax rates and get rid of double taxation of saving and investment.

The latter, by contrast, is an exercise in trying to lose with minimal damage - sort of the "French Army Theory" of taxation, surrender gracefully and hope that your new masters give you a few crumbs after their celebratory feast.

What is especially strange about this approach is that the Republicans who advocate higher taxes claim that they are political realists. Yet if we look at real-world evidence, the moment Republicans show their "realism" by putting taxes on the table, the entire debate shifts.

Instead of the debate being tax-hikes vs. no-tax-hikes, it becomes a debate over who-should-pay-more-tax. Republicans win the first debate. They get slaughtered in the second debate.

Remember when the first President Bush agreed to enter into tax-hike negotiations in 1990? He set out two conditions - that there should be a reduction in the capital gains tax and that there should be no increase in income tax rates. So what happened? As everyone with an IQ above room temperature predicted, the capital gains tax stayed the same and income tax rates increased.

Last but not least, this conversation only exists because some people have thrown in the towel, acquiescing to the idea that there is no way to balance the budget without higher taxes. Yet the Congressional Budget Office data shows that the budget can be balanced by 2020 simply by limiting annual spending growth to 2 percent.

It's Simple to Balance the Budget without Higher Taxes

John Podesta of the Center for American Progress had a column in Politico yesterday asserting that "closing the budget gap entirely on the spending side would require draconian programmatic cuts." He went on to complain that there are some people who "refuse to look at the revenue side of the ledger – while insisting that we dig the hole $830 billion deeper over the next decade by extending the Bush tax cuts."

Not surprisingly, Mr. Podesta is totally wrong. It's actually not that challenging to balance the budget. And it doesn't even require any spending cuts, though it would be a very good idea to dramatically downsize the federal government. Here's a chart showing this year's spending and revenue totals. It then shows the Congressional Budget Office's estimate of how much revenues will grow, assuming all the 2001 and 2003 tax cuts are made permanent and assuming that the alternative minimum tax is adjusted for inflation. As you can see, balancing the budget is a simple matter of limiting the annual growth of federal spending.

So how is it that Mr. Podesta can spout sky-is-falling rhetoric about "draconian" cuts when all that's needed is fiscal restraint? The answer is that politicians in Washington have concocted a self-serving budget process that automatically assumes that all previously-planned spending increases should occur. So if the politicians put us on a path to make government 8 percent bigger next year and there is a proposal to instead limit spending growth to 3 percent, that 3 percent increase gets portrayed as a 5 percent cut.

This is a great scam, at least for the political class. They get to buy more votes by boosting the burden of government spending, but they get to tell voters that they're being fiscally responsible. And they get to claim that they have no choice but to raise taxes because there's no other way to balance the budget. In the real world, though, this translates into bigger government and puts us on a path to a Greek-style fiscal nightmare.

The goal of fiscal policy should be smaller government, not fiscal balance. Deficits are just a symptom of a government that is too large, as I have explained elsewhere. But the good news is that spending discipline is the right answer, regardless of the objective. I explained this in more detail for a piece in today's Philadelphia Inquirer. Here's an excerpt.

According to the Congressional Budget Office, the federal government this year is spending almost $3.5 trillion. Tax receipts are estimated to be less than $2.2 trillion, which means a projected deficit of about $1.35 trillion. So can we balance the budget when there is that much red ink? And is it possible to eliminate deficits while also extending the 2001 and 2003 tax cuts? The answer is yes. ...It's a simple matter of mathematics. The Congressional Budget Office estimates that tax revenue will grow by an average of 7.3 percent annually over the next 10 years. Reducing the budget deficit is easy - so long as politicians increase overall spending by less than that amount. And with inflation projected to be about 2 percent over the same period, this is an ideal environment for some long-overdue fiscal discipline. If spending is simply capped at the current level with a hard freeze, the budget is balanced by 2016. If we limit spending growth to 1 percent each year, the budget is balanced in 2017. And if we allow 2 percent annual spending growth - letting the budget keep pace with inflation, the budget balances in 2020. ...Interest groups that are used to big budget increases will be upset if spending growth is limited to 1 or 2 percent each year. It means entitlements will need to be reformed. It means we might need to get rid of programs and departments that are not legitimate functions of the federal government. You better believe that these changes will cause a lot of squealing by lobbyists and other insiders. But that complaining will be a sign that fiscal policy is finally heading in the right direction. The key thing to understand is that there is no need for tax increases. Politicians might not balance the budget if we say no to all tax increases. But the experience in Europe shows that oppressive tax burdens are not a recipe for fiscal balance either. Milton Friedman was correct many years ago when he warned that, "In the long run government will spend whatever the tax system will raise, plus as much more as it can get away with."

Congressional Budget Office Says We Can Maximize Long-Run Economic Output with 100 Percent Tax Rates

I hope the title of this post is an exaggeration, but it's certainly a logical conclusion based on what is written in the Congressional Budget Office's updated Economic and Budget Outlook. The Capitol Hill bureaucracy basically has a deficit-über-alles view of fiscal policy. CBO's long-run perspective, as shown by this excerpt, is that deficits reduce output by "crowding out" private capital and that anything that results in lower deficits (or larger surpluses) will improve economic performance - even if this means big increases in tax rates.

CBO has also examined an alternative fiscal scenario reflecting several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period. That alternative scenario embodies small differences in outlays relative to those projected under current law but significant differences in revenues: Under that scenario, most of the cuts in individual income taxes enacted in 2001 and 2003 and now scheduled to expire at the end of this year (except the lower rates applying to high-income taxpayers) are extended through 2020; relief from the AMT, which expired after 2009, continues through 2020; and the 2009 estate tax rates and exemption amounts (adjusted for inflation) apply through 2020. ...Under those alternative assumptions, real GDP would be...lower in subsequent years than under CBO’s baseline forecast. ...Under that alternative fiscal scenario, real GDP would fall below the level in CBO’s baseline projections later in the coming decade because the larger budget deficits would reduce or “crowd out” investment in productive capital and result in a smaller capital stock.

There's nothing necessarily wrong with CBO's concern about deficits, but looking at fiscal policy through that prism is akin to deciding who wins a baseball game by looking at what happened during the 6th inning. Yes, government borrowing drains capital from the productive sector of the economy. And nations such as Greece are painful examples of what happens when governments go too far down this path. But taxes also undermine economic performance by reducing incentives to work, save, and invest. And nations such as France are gloomy reminders of what happens when punitive tax rates discourage productive behavior.

What's missing for CBO's analysis is any recognition or understanding that the real problem is excessive government spending. Regardless of whether spending is financed by borrowing or taxes, resources are being diverted from the private sector to government. In other words, government spending is the disease and deficits are basically a symptom of that underlying problem. Indeed, it's worth noting that there's not much evidence that deficits cause economic damage but plenty of evidence that bloated public sectors stunt growth. This video is a good antidote to CBO's myopic focus on budget deficits.

When Keynesians Attack, Part II

I'm still dealing with the statist echo chamber, having been hit with two additional attacks for the supposed sin of endorsing Reaganomics over Obamanomics (my responses to the other attacks can be found here and here). Some guy at the Atlantic Monthly named Steve Benen issued an critique focusing on the timing of the recession and recovery in Reagan's first term. He reproduces a Krugman chart (see below) and also adds his own commentary.

Reagan's first big tax cut was signed in August 1981. Over the next year or so, unemployment went from just over 7% to just under 11%. In September 1982, Reagan raised taxes, and unemployment fell soon after. We're all aware, of course, of the correlation/causation dynamic, but as Krugman noted in January, "[U]nemployment, which had been stable until Reagan cut taxes, soared during the 15 months that followed the tax cut; it didn't start falling until Reagan backtracked and raised taxes."

This argument is absurd since the recession in the early 1980s was largely the inevitable result of the Federal Reserve's misguided monetary policy. And I would be stunned if this view wasn't shared by 90 percent-plus of economists. So it is rather silly to say the recession was caused by tax cuts and the recovery was triggered by tax increases.

But even if we magically assume monetary policy was perfect, Benen's argument is wrong. I don't want to repeat myself, so I'll just call attention to my previous blog post which explained that it is critically important to look at when tax cuts (and increases) are implemented, not when they are enacted. The data is hardly exact, because I haven't seen good research on the annual impact of bracket creep, but there was not much net tax relief during Reagan's first couple of years because the tax cuts were phased in over several years and other taxes were going up. So the recession actually began when taxes were flat (or perhaps even rising) and the recovery began when the economy was receiving a net tax cut. That being said, I'm not arguing that the Reagan tax cuts ended the recession. They probably helped, to be sure, but we should do good tax policy to improve long-run growth, not because of some misguided effort to fine-tune short-run growth.


The second attack comes from some blog called Econospeak, where my newest fan wrote:

I’m scratching my head here as I thought the standard pseudo-supply-side line was that the deficit exploded in the 1980’s because government spending exploded. OK, the truth is that the ratio of Federal spending to GDP neither increased nor decreased during this period. Real tax revenues per capita fell which is why the deficit rose but this notion that the burden of government fell is not factually based.

Those are some interesting points, and I might respond to them if I wanted to open a new conversation, but they're not germane to what I said. In my original post (the one he was attacking), I commented on the "burden of government" rather than the "burden of government spending." I'm a fiscal policy economist, so I'm tempted to claim that the sun rises and sets based on what's happening to taxes and spending, but such factors are just two of the many policies that influence economic performance. And with regard to my assertion that Reagan reduced the "burden of government," I'll defer to the rankings put together for the Economic Freedom of the World Index. The score for the United States improved from 8.03 to 8.38 between 1980 and 1990 (my guess is that it peaked in 1988, but they only have data for every five years). The folks on the left may be unhappy about it, but it is completely accurate to say Reagan reduced the burden of government. And while we don't yet have data for the Obama years, there's a 99 percent likelihood that America's score will decline.

This is not a partisan argument, by the way. The Economic Freedom of the World chart shows that America's score improved during the Clinton years, particularly his second term. And the data also shows that the U.S. score dropped during the Bush years. This is why I wrote a column back in 2007 advocating Clintonomics over Bushonomics. Partisan affiliation is not what matters. If we want more prosperity, the key is shrinking the burden of government.

America's Long-Term Fiscal Crisis: Worse than Greece?

Professor Larry Kotlikoff has some very sobering analysis of America's fiscal status. Instead of just looking at current deficits, he examines the "present value" of all future expenditures and revenues. Simply stated, America is in worse shape than Greece because of the long-term burden of entitlement programs. Kotlikoff's conclusion that America is "one foot away from a deep and permanent economic grave" may be a bit too strong, but he is certainly correct that unrestrained spending is going to cause serious damage.

Greek long-term government bond yields are running 700 basis points above comparable US Treasuries. The inference is that America is in far better fiscal shape than Greece. Nothing could be further from the truth. Greek debt totals 120 per cent of gross domestic product, twice the US figure. But debt alone tells us little about a country’s fiscal condition. ...During the past half-century, the US has sold tens of trillions of unofficial IOUs, leaving it with liabilities to pay Social Security, Medicare and Medicaid benefits that total 40 times official debt. ...Fortunately, theory suggests a label-free measure of fiscal status: the fiscal gap, or the present value difference between all future expenditures and receipts. The Greek fiscal gap is staggering. Calculations developed with my colleagues at Freiberg University put it at 11.5 per cent of the value of Greece’s future GDP. And this huge figure already incorporates Greece’s recently legislated fiscal policy retrenchment. But the US figure, based on the Congressional Budget Office’s just-released projections, is even larger: 12.2 per cent. Clearly, Greece is in terrible fiscal shape. To get its books in order it would have to pull in its belt each year by another 11.5 per cent of GDP. This provides new meaning to the word draconian. But the US is in much worse shape, because the CBO’s projections that reveal the 12.2 per cent fiscal gap already assume a 7.2 per cent of GDP belt-tightening by 2020. ...Wishing won’t fix America’s fiscal mess. The US is one foot away from a deep and permanent economic grave. It is far past time to do meaningful long-term fiscal planning, level with the public, and implement radical reforms that permanently put America’s fiscal house in order.

Will America Be a Fiscal Failure?

Investor's Business Daily has an excellent editorial on fiscal policy, and not just because they quote me. They understand that America's fiscal problem is spending rather than deficits. They also realize that tax increases are completely misguided since the economy will be less vibrant and politicians will feel more leeway to spend money. The net result would be continued deficits and even bigger government.

...leaders of President Obama's deficit commission offered up the darkest of outlooks for our financial future — calling current trends in U.S. budgets a "cancer" that will "destroy the country from within" unless halted soon. ...Based on current estimates, today's total federal debt of just over $13 trillion will hit $20 trillion by 2020. Beyond that, the coming retirement tidal wave of 65 million baby boomers will push Social Security and Medicare spending to stratospheric levels. America's debts will become crippling. By some estimates, total U.S. commitments for entitlements total $107 trillion over the next 75 years or so. That's an unpaid tax bill of $912,000 per household, or $351,000 for each child born today. Besides, raising taxes will do little other than ruin the economy. As noted recently by the Cato Institute's Dan Mitchell, repeated studies over the years have shown that the optimal size of federal government spending to the economy is well below about 20% of gross domestic product. Anything above that kills off economic activity. ...By the way, when state and local spending are added in, government in a few short years will take up more than half of all U.S. GDP. In short, the U.S. is essentially on the road to becoming just another stagnant, state-run welfare economy. The only real answer: Shrink government to expand the private sector. Anything else, such as massive tax hikes, is doomed to failure.

Did the Bush Tax Cuts Cause Today's Deficits?

My former colleague at the Heritage Foundation, Brian Riedl, has a column in the Wall Street Journal today which discusses the degree to which President Bush's policies can be blamed for current deficits. I think Brian is too easy on Bush's terrible record as a big spender, but he is 100 percent correct in his big-picture analysis. Over the long run, revenues are stable. We face a future filled with red ink solely because of a rising burden of government spending.

...rapidly increasing spending will cause 100% of rising long-term deficits. Over the past 50 years, tax revenues have deviated little from their 18% of gross domestic product (GDP) average. Despite a temporary recession-induced dip, CBO projects that even if all Bush tax cuts are extended and the AMT is patched, tax revenues will rebound to 18.2% of GDP by 2020—slightly above the historical average. They will continue growing afterwards. Spending—which has averaged 20.3% of GDP over the past 50 years—won't remain as stable. Using the budget baseline deficit of $13 trillion for the next decade as described above, CBO figures show spending surging to a peacetime record 26.5% of GDP by 2020 and also rising steeply thereafter. Putting this together, the budget deficit, historically 2.3% of GDP, is projected to leap to 8.3% of GDP by 2020 under current policies. This will result from Washington taxing at 0.2% of GDP above the historical average but spending 6.2% above its historical average.

I Don't Think Merkel is the new Reagan, but I May Change My Mind if This Is True

I've been very dismissive of supposed European "austerity" initiatives, in part because the term seems to describe politicians who want tax-financed government spending rather than Keynesian-style deficit-financed government spending. What really matters is reducing the burden of government spending, regardless of how those outlays are financed. But if this Financial Times report is true and Germany reduces total government spending next year by 3.8 percent, that would be a significant achievement. Indeed, the United States has not seen a one-year-to-the-next reduction in the burden of spending since the mid-1960s. I hope this is true and my pessimism is unwarranted, but I'm still a skeptic. I may be wrong, but I wouldn't be surprised to discover that the 3.8 percent cut is based on phony US-style budget accounting (a spending increase magically becomes a spending cut if the increase is not as big as politicians want) or some sort of budget shell game (like Obama's budget freeze, which exempted the vast majority of the budget).

Germany’s cabinet is poised this week to approve a 2011 budget as part of a four-year programme of public spending cuts meant to serve as an example to other European governments without jeopardising the country’s increasingly robust economic recovery. Briefing papers for Wednesday’s cabinet meeting, released by Berlin on Sunday, argue that by curbing spending – rather than increasing taxes – the €80bn ($100.3bn, £66bn) savings programme would differ “fundamentally” from previous fiscal squeezes and offer “noticeable, better growth possibilities”. ...Germany’s economy is enjoying an industry-led growth spurt, with engineers rehiring workers and returning production almost to pre-crisis levels. The stronger-than-expected growth and falls in unemployment were making it significantly easier for Germany to reduce its public sector deficit. ...the package “would differ fundamentally from earlier consolidation efforts”, avoiding “growth-hindering tax increases”. ...Overall government spending is seen as falling 3.8 per cent next year, with smaller reductions in subsequent years before federal elections in 2013.

Illinois May Beat California to Bankruptcy

The New York Times has a story about the budget debacle in Illinois, which is a classic case of a state with too much government and too many overpaid bureaucrats. Other than being an example of what not to do, the most interesting aspect of what's happening in Illinois is trying to guess whether it is in better or worse shape than California. According to the credit default swaps market, Illinois is in slightly worse shape. Both states rank below Iraq and above Romania:

Even by the standards of this deficit-ridden state, Illinois’s comptroller, Daniel W. Hynes, faces an ugly balance sheet. Precisely how ugly becomes clear when he beckons you into his office to examine his daily briefing memo. He picks the papers off his desk and points to a figure in red: $5.01 billion. “This is what the state owes right now to schools, rehabilitation centers, child care, the state university — and it’s getting worse every single day,” he says in his downtown office. ...For the last few years, California stood more or less
unchallenged as a symbol of the fiscal collapse of states during the recession. Now Illinois has shouldered to the fore, as its dysfunctional political class refuses to pay the state’s bills and refuses to take the painful steps — cuts and tax increases — to close a deficit of at least $12 billion, equal to nearly half the state’s budget. Then there is the spectacularly mismanaged pension system, which is at least 50 percent underfunded and, analysts warn, could push Illinois into insolvency if the economy fails to pick up. ...signs of fiscal crackup are easy to see. Legislators left the capital this month without deciding how to pay 26 percent of the state budget. The governor proposes to borrow $3.5 billion to cover a year’s worth of pension payments, a step that would cost about $1 billion in interest. And every major rating agency has downgraded the state; Illinois now pays millions of dollars more to insure its debt than any other state in the nation. “Their pension is the most underfunded in the nation,” said Karen S. Krop, a senior director at Fitch Ratings. “They have not made significant cuts or raised revenues. There’s no state out there like this. They can’t grow their way out of this.”

The G-20 Fiscal Fight: A Pox on Both Their Houses

Barack Obama and Angela Merkel are the two main characters in what is being portrayed as a fight between American "stimulus" and European "austerity" at the G-20 summit meeting in Canada. My immediate instinct is to cheer for the Europeans. After all, "austerity" presumably means cutting back on wasteful government spending. Obama's definition of "stimulus," by contrast, is borrowing money from China and distributing it to various Democratic-leaning special-interest groups.

But appearances can be deceiving. Austerity, in the European context, means budget balance rather than spending reduction. As such, David Cameron's proposal to boost the U.K.'s value-added tax from 17.5 percent to 20 percent is supposedly a sign of austerity even though his Chancellor of the Exchequer said a higher tax burden would generate “13 billion pounds we don’t have to find from extra spending cuts.”

Raising taxes to finance a bloated government, to be sure, is not the same as Obama's strategy of borrowing money to finance a bloated government. But proponents of limited government and economic freedom understandably are underwhelmed by the choice of two big-government approaches.

What matters most, from a fiscal policy perspective, is shrinking the burden of government spending relative to economic output. Europe needs smaller government, not budget balance. According to OECD data, government spending in eurozone nations consumes nearly 51 percent of gross domestic product, almost 10 percentage points higher than the burden of government spending in the United States.

Unfortunately, I suspect that the "austerity" plans of Merkel, Cameron, Sarkozy, et al, will leave the overall burden of government relatively unchanged. That may be good news if the alternative is for government budgets to consume even-larger shares of economic output, but it is far from what is needed.

Unfortunately, the United States no longer offers a competing vision to the European welfare state. Under the big-government policies of Bush and Obama, the share of GDP consumed by government spending has jumped by nearly 8-percentage points in the past 10 years. And with Obama proposing and/or implementing higher income taxes, higher death taxes, higher capital gains taxes, higher payroll taxes, higher dividend taxes, and higher business taxes, it appears that American-style big-government "stimulus" will soon be matched by European-style big-government "austerity."

Here's a blurb from the Christian Science Monitor about the Potemkin Village fiscal fight in Canada:

This weekend's G-20 summit is shaping up as an economic clash of civilizations – or at least a clash of EU and US economic views. EU officials led by German chancellor Angela Merkel are on a national “austerity” budget cutting offensive as the wisest policy for economic health, ahead of the Toronto summit of 20 large-economy nations. Ms. Merkel Thursday said Germany will continue with $100 billion in cuts that will join similar giant ax strokes in the UK, Italy, France, Spain, and Greece. EU officials say budget austerity promotes the stability and market confidence that are prerequisites for their role in overall recovery. Yet EU pro-austerity statements in the past 48 hours are also defensive – a reaction to public statements from US President Barack Obama and G-20 chairman Lee Myung-bak, South Korea's president, that the overall effect of national austerity in the EU will harm recovery. They are joined by US Treasury Secretary Tim Geithner, investor George Soros, and Nobel laureate and columnist Paul Krugman, among others, arguing that austerity works against growth, and may lead to a recessionary spiral.

Will the Euro Turn into the Argentinian Peso or the Zimbabwean Dollar?

I hope the title to this blog post is completely wrong, but the news out of Europe is very grim. Politicians have been over-spending and going deeper and deeper into debt. This negatively affects the private sector in the usual ways (higher taxes, unproductive allocation of resources, etc), but also creates instability in the financial sector since many banks and other institutions have naively lent lots of money to corrupt and inefficient governments. And as this story from the Telegraph indicates, the European Central Bank has been forced to surrenders its independence and is now monetizing government debt. In theory, the ECB is taking other steps to compensate, but the problem is so large (and the political willingness to solve the problem by radically shrinking government is so small) that it is difficult to see a good ending to this saga.

Fitch Ratings has warned that it may take massive asset purchases by the European Central Bank to prevent Europe's sovereign debt crisis escalating out of control. ...The ECB agreed to start buying Greek, Portuguese, and Irish bonds in April to help buttress the EU's `shock and awe' package, known as the European Financial Stability Facility. Total purchases so far have been €47bn (£39bn). It has focused its firepower on Greece, mopping up some €25bn of government bonds. This has prevented a collapse of the Greek debt market but at the high political price of letting banks and funds dump their holdings onto the EU taxpayer. ECB council member Jose Manuel Gonzalez-Paramo said it was "not entirely correct" to assume that the ECB was the sole buyer of the debt. "We will continue buying bonds until the situation has stabilized," he said. ...Fitch said European banks must refinance nearly €2 trillion of long-term debt by the end of 2012 in an unfriendly market. "There's an awful lot of debt coming due in 2011 and 2012, and that is becoming a concern," said Bridget Gandy, the agency's banking expert.

You Don't Need to Waste More Money to Shrink Government

It's rather symbolic of what's wrong with Washington that a commission ostensibly created to promote deficit reduction is seeking a bigger budget, as noted in the Tax Notes story excerpted below. Rather than impose a bigger burden on taxpayers, though, I will generously suggest that they could easily fulfill their mandate by perusing Cato's Downsizing Government website. And if they really want to do the right thing, they can always just look at Article I, Section VIII, of the Constitution and get rid of existing programs and activities that are not enumerated powers of the federal government.

Saddled with a tight deadline and great expectations, members of President Obama's deficit reduction commission say they may not have the resources necessary to meet their task. The National Commission on Fiscal Responsibility and Reform, which the president created through an executive order in February, is charged with developing a plan by December 1 that would stabilize the budget deficit by 2015 and reduce the federal debt over the long term. The group is widely expected to consider a combination of tax reforms and spending cuts. But despite the weighty demands, the panel has only a fraction of the staff and budget of standing congressional committees. The panel's own cochairs and Senate Majority Leader Harry Reid, D-Nev., have criticized the meager resources and called for more support. ...The White House has set aside the resources to provide the equivalent of four full-time salaries and $500,000 in operating costs for the commission, fiscal commission Executive Director Bruce Reed told Tax Analysts.

Too Little and Too Late for Europe, Part II

When even the New York Times is writing articles about the collapse of the European welfare state, you know that the political establishment is finally recognizing the writing on the wall. Recognizing a problem and solving a problem, however, are two different things. They need to use an axe on their budgets, but the examples below indicate a scalpel is being wielded instead. The key thing to look for is whether government spending in the future is consuming a larger or smaller share of economic output (GDP), and I sadly expect the burden of government spending in Europe to grow:

The deficit crisis that threatens the euro has also undermined the sustainability of the European standard of social welfare, built by left-leaning governments since the end of World War II. Europeans have boasted about their social model, with its generous vacations and early retirements, its national health care systems and extensive welfare benefits, contrasting it with the comparative harshness of American capitalism. Europeans have benefited from low military spending, protected by NATO and the American nuclear umbrella. ...But all over Europe governments with big budgets, falling tax revenues and aging populations are experiencing rising deficits, with more bad news ahead. With low growth, low birthrates and longer life expectancies, Europe can no longer afford its comfortable lifestyle.... The countries are trying to reassure investors by cutting salaries, raising legal retirement ages, increasing work hours and reducing health benefits and pensions.... The reaction so far to government efforts to cut spending has been pessimism and anger, with an understanding that the current system is unsustainable. In Athens, Aris Iordanidis, 25, an economics graduate working in a bookstore, resents paying high taxes to finance Greece's bloated state sector and its employees. "They sit there for years drinking coffee and chatting on the telephone and then retire at 50 with nice fat pensions," he said. "As for us, the way things are going we'll have to work until we're 70." ...the region lacks competitiveness in world markets. According to the European Commission, by 2050 the percentage of Europeans older than 65 will nearly double. In the 1950s there were seven workers for every retiree in advanced economies. By 2050, the ratio in the European Union will drop to 1.3 to 1. ...Figures show the severity of the problem. Gross public social expenditures in the European Union increased from 16 percent of gross domestic product in 1980 to 21 percent in 2005, compared with 15.9 percent in the United States. In France, the figure now is 31 percent, the highest in Europe... The challenge is particularly daunting in France, which has done less to reduce the state's obligations than some of its neighbors. ...The legal retirement age in France is 60, while Germany recently raised it to 67 for those born after 1963. With the retirement of the baby boomers, the number of pensioners will rise 47 percent in France between now and 2050, while the number under 60 will remain stagnant. ...President Nicolas Sarkozy has vowed to pass major pension reform this year. ...the government, afraid to lower pensions, wants to increase taxes on high salaries and increase the years of work. ...while most French see a pension overhaul as necessary, up to 60 percent say working past 60 is not the answer...."This will have to be harmonized, Europeanized, or it won't work - you can't have a pension at 67 here and 55 in Greece," Mr. Fischer said.The problems are even more acute in the "new democracies" of the euro zone - Greece, Portugal and Spain - that embraced European democratic ideals and that Europe embraced for political reasons in the postwar era, perhaps before their economies were ready. They have built lavish state systems on the back of the euro, but now must change. Under threat of default, Greece has frozen pensions for three years and drafted a bill to raise the legal retirement age to 65. Greece froze public-sector pay and trimmed benefits for state employees, including a bonus two months of salary. Portugal has cut 5 percent from the salaries of senior public employees and politicians and increased taxes, while canceling big projects; Spain is cutting civil service salaries by 5 percent and freezing pay in 2011 while also chopping public projects. ...In Athens, Mr. Iordanidis, the graduate who makes 800 euros a month in a bookstore, said he saw one possible upside. "It could be a chance to overhaul the whole rancid system," he said, "and create a state that actually works."

Europe's Reforms, I Fear, Will Be Too Little and Too Late, Part I

Governments that tax work and subsidize sloth are committing a form of slow-motion suicide, and the Greek fiscal crisis is the canary in the coal mine of this phenomenon. Interestingly, some European governments are trying to halt the downward slide, though I suspect that most of them will fail to take the necessary steps. But it's nonetheless good news that this is getting coverage since it is equally important that the United States learn the right lessons so we can reverse the reckless big-government policies of the Bush-Obama years. Here's an excerpt from a thorough AP story:

...the welfare state — cherished by many Europeans as an alternative to what they see as dog-eat-dog American capitalism — is coming under its most serious threat in decades: Europe's sovereign debt crisis. Deep budget cuts are under way across Europe. Although the first round is focused mostly on government payrolls — the least politically explosive target — welfare benefits are looking increasingly vulnerable. "The current welfare state is unaffordable," said Uri Dadush, director of the Carnegie Endowment's International Economics Program. ..."We have to adjust our social security systems in a way that they motivate people to accept regular work and do not give counterproductive incentives," German Finance Minister Wolfgang Schaeuble told news weekly Frankfurter Allgemeine Sonntagszeitung on Saturday. ...Demographers and economists began warning decades ago that social welfare was doomed by the aging of Europe's baby boomers. Some governments had been trimming and reforming, but now almost all are scrambling to close deficits in order to prevent a wider collapse of confidence in the euro. The [British] government has promised to raise the age at which citizens receive a state pension — up from 60 to 65 for women, and from 65 to 66 for men. It also plans to toughen the welfare regime, requiring the unemployed to try to find jobs in order to collect benefits. ...Ministers are reviewing the long-term affordability of the country's generous public sector pensions. ...France's conservative government is focusing on raising the retirement age. Many workers can now retire at 60 with 50 percent of their average salary. ...Unions in France are organizing a national day of protest marches and strikes on Thursday to demand protection of wages and the retirement age. [Spain] has proposed hiking the retirement age for men from 65 to 67. ...After sharp cutbacks imposed as the condition of an international bailout this month, Greeks must now contribute to pension funds for 40 instead of 37 years before retiring, and the age of early retirement is set to 60 at the earliest. Civil servants with monthly salaries of above 3,000 euros ($3,750) will lose two extra months of salary — one paid at Christmas, the other split between Easter and summer vacation.

Another Deficit Hypocrite

Paul Volcker is a typical Washington insider who maintains his favorable connections by endorsing bigger government. In recent months, he's been busy supporting a value-added tax. Now he is saying that it is absolutely critical to address the deficit. Here's and excerpt from a Bloomberg report:

Former Federal Reserve Chairman Paul Volcker, a top outside adviser to President Barack Obama, said time is “growing short” for the U.S. to address problems ranging from its budget deficit to Social Security obligations. “We better get started,” the 82-year-old former central banker said in a speech yesterday in Stanford, California. “Today’s concerns may soon become tomorrow’s existential crises.”

This is the same Volcker, though, who defended Obama's $800 billion so-called stimulus. And a quick Google search does not reveal any evidence that he opposed the giant fiscal sinkhole of Obamacare (I only spent five minutes searching, so I definitely feel comfortable stating that any opposition - if it existed at all - was very muted). In other words, Volcker is a typical beltway hack. When politicians are engaged in an orgy of new spending, he either supports them or stays quiet. But when the discussion turns to taxes, then suddely the deficit is the worst thing in the world and tough steps need to be taken. It would be nice if hypocrites like Volcker just dropped out of sight and played golf all day.

Senate Unanimously Rejects Greek Bailout

In an uncharacteristic display of fiscal rectitude, Senators voted 94-0 against the Greek bailout. But don't get too excited. They only voted to instruct the White house to oppose the bailout in the absence of a plan to pay back the money. Needless to say, the Greeks, the IMF, and/or the White House will lie if the amendment becomes law. Speaking of which, approving an amendment in the Senate means nothing unless the provision is included in a final bill. Last but not least, the amendment is too weak. It should have blocked any bailout. Heck, it should have withdrawn the United States from the IMF altogether. But a baby needs to learn to crawl before it can walk, so I suppose we should be happy that the kleptocrats in Washington at least cast a symbolic vote to defend taxpayers. Here's a report from the EU Business:

The US Senate on Monday easily approved a measure aimed at blocking International Monetary Fund (IMF) aid packages like the one for Greece absent a guarantee that the money will be repaid. Lawmakers voted 94-0 to approve the measure, crafted by Republican Senator John Cornyn of Texas, attaching it to broad legislation to overhaul financial industry rules in the wake of the 2008 global economic meltdown. The amendment calls for President Barack Obama's administration to measure any IMF aid package to a country whose public debt exceeds its annual gross domestic product in order to certify that the loan will be repaid. If the administration were unable to make such a certification, it would be directed to oppose the assistance and vote against it at the IMF. "Greece is going to get 40 billion dollars in loans from the IMF, out of which seven billion dollars is attributable to the contributions of the American taxpayer. They shouldn't have to do that unless we have an assurance that it will be paid back," Cornyn said shortly before the vote. ...If the Senate passes the overhaul legislation, Cornyn's measure would still need to survive a House-Senate "conference" to reconcile their rival versions of the bill before it can go to Obama to be signed into law.

Pathetic Greek Government Tries to Blame Speculators

Making himself and the Greek government even more of a global laughingstock, Greece's President says he wants an investigation into the role of so-called speculators. Yes, I'm being serious. According to Bloomberg, he wants to blame investors who wisely (albeit belatedly) realized that reckless and wasteful spending meant the Greek government was increasingly unlikely to honor its debts. Here are key excerpts:

Greece is considering taking legal action against U.S. investment banks that might have contributed to the country’s debt crisis, Prime Minister George Panandreou said. ...Papandreou said the decision on whether to go after U.S. banks will be made after a Greek parliamentary investigation into the cause of the crisis. “Greece will look into the past and see how things went,” Papandreou said. “There are similar investigations going on in other countries and in the United States. This is where I think, yes, the financial sector, I hear the words fraud and lack of transparency. So yes, yes, there is great responsibility here.” In the days leading up to the May 10 announcement of a loan package worth almost $1 trillion to halt the spread of Greece’s fiscal woes, European Union regulators were examining whether speculators manipulated the prices of bonds and equities and contributed to the crisis. The Committee of European Securities Regulators said on May 7 it was investigating “exceptional volatility” in the markets and would work with other regulators, including the U.S. Securities and Exchange Commission, as part of a coordinated clampdown.

The 10 Most-Likely-to-Default Governments

Here's a fascinating table that was linked on Marginal Revolution. Of all the political jurisdictions in the world, the one most likely to default (according to market perception) is Venezuela. No big surprise, of course, but I was surprised to see California in 8th place. That's worse than Portugal and Spain (neither of which are in the top 10, though perhaps bottom 10 would be a better description of this list). This is a very damning indictment of the modern American welfare state. How about a new motto? Instead of "The Golden State," California's new motto can be "Better than Ukraine, Worse than Iraq."