Undertaxed or Overspent? E.C. Pasour, Jr.

166 THEFREEMAN IDEASON LIBERTY Undertaxed or Overspent? by E. C. Pasouf, Jr. A mericans and many other members of the world economic community are worried about the U.S. government's budget deficits. The deficit in any year is the amount by which Federal expenditures exceed receipts. Recent turmoil in U.S. and other fi nancial markets has been attributed to uncer tainties about whether and how U. S. budget deficits willne reduced.! There is widespread agreement that the def icit should be reduced but little agreement about how to do it. Much of the disagreement has been over whether the Federal deficit should be reduced by increasing taxes or by re ducing spending. The factual question of whether budget deficits during the Reagan era have risen because of lower taxes or increased expenditures is important in the public policy debate. Historical spending and rev~nue data cannot be used to justify current levels of expenditures or taxation. However, it is important that thoughtful citizens as well as those directly in volved in deficit-cutting legislation be informed about the origins of the deficits. Have recent deficits been the result of taxes falling more than spending or of spending increasing more rapidly than taxes?

Public support for tax increases appears to be rooted in the widely held belief that the former explanation is correct. That is, rising budget deficits during the 1980s are considered to be the fruits of one aspect of "Reaganomics" reductions in tax rates. The following analysis, Dr. Pasour is a professor of economics at North Carolina State University at Raleigh. contrary to the conventional wisdom and typ ical news story, demonstrates that Federal budget deficits have increased since 1980 be cause of increases in government expendi tures-not because of reductions in tax rev enues. Federal Expenditures and Receipts Since 1960 A historical perspective is helpful in studying the relationship between Federal taxes, expen ditures, and budget deficits. The budget of the federal government was essentially balanced in 1960. Except for one year (1969), there has been a Federal budget deficit each year during the past quarter century. Indeed, budget deficits during the Reagan Administration have been considerably higher than during any other pres idency since 1960. The annual budget deficit as a per cent of Gross National Product (GNP) averaged 4.8 per cent during the first 6 years of the Reagan Administration. In contrast, the deficit reached 4 per cent in only one year (1976) from 1960 to 1981.

Tax receipts as a percentage of GNP aver aged 18.2 per cent during the 1960s, 18.3 per cent during the 1970s, and 18.8 per cent since 1980. 2 Thus, despite tax law changes, in cluding significant reductions in tax rates in 1981, Federal tax receipts have increased, and have increased as a share of GNP as well, during the Reagan era. Rising tax receipts mean that increased deficits during this period were rooted. in government spending policies. There was a gradual and sustained increase in Federal expenditures during the 1960s and 1970s. Federal outlays as a per cent of GNP averaged 19.0 per cent during the 1960s and 20.7 per cent during the 1970s. Since 1980, however, Federal expenditures have increased dramatically - averaging 23.6 per cent of GNP. 3 Budget deficits have increased since 1980 because Federal spending has been out stripping tax receipts even though tax receipts are higher, absolutely and as a share of GNP, than they averaged from 1960 to 1980.

Interest Payments and Social Security Expenditures Some analysts contend that rising budget deficits since 1980 are a result of too little taxa tion rather than of too much spending. A 1987 study by Citizens for Tax Justice, for example, claims that spending on Federal programs (ex cluding Social Security and interest payments on the national debt) has declined since 1980 as a share of GNP. In support of this argument, it is shown that total spending excluding interest expense and Social Security declined from 14.9 per cent in 1980 to 14.3 per cent in 1987.4 Citizens for Tax Justice attributes increased budget deficits of the 1980s to tax cuts for cor porations and high income individuals that began in the late 1970s and accelerated in the early years of the Reagan presidency.5 The pre scription of the Citizens for Tax Justice group is higher taxes on corporations and wealthy in dividuals, instead of reduced spending for so cial programs to reduce the budget deficit.

The Citizens for Tax Justice analysis of Fed eral spending has two major shortcomings. First, even omitting interest expense and Social Security payments from Federal spending data, Federal spending as a share of GNP may not have decreased during the 1980s. For example, total spending as a proportion of GNP averaged 14.5 per cent from 1970 to 1980. Since 1981, however, it has averaged about 15 per cent. Thus, the contention that outlays on Federal programs adjusted in this way have uniformly decreased during the Reagan years is not cor rect, although this comparison is quite sensitive to the years selected. During the decade of the 1960s, for example, Federal spending, ex cluding interest expense and Social Security, 167 was slightly higher (15.2 per cent versus 15.0 per cent), on average, than during the Reagan era. The Citizens for Tax Justice approach to the analysis of government spending trends, how ever, ignores a more fundamental problem.

Why should interest expense on the national debt and Social Security payments be omitted in analyzing trends in government spending? Net interest costs were three times as high in fiscal 1986 as in 1980-the last year of the Carter Administration. It is true that interest costs are determined by interest rates and the amount of debt and, in this sense, are beyond the control of Congress or the President. In a more fundamental sense, however, past gov ernment policies are responsible for the current level of debt, and present government policies influence both future levels of debt and current interest rates. Inflationary monetary and fiscal policies, for example, tend to raise interest outlays for any given level of debt. Moreover, the distortions of economic ac tivity associated with taxation are similar whether the tax receipts are used for interest payments on the debt or for any other program.

Thus, we should include interest on govern ment debt when analyzing trends in govern ment spending. The situation is similar for Social Security, even if the program is treated as a self-funding entity. From the standpoint of the individual participant, Social Security is a transfer pro gram rather than an insurance program. Pay ments made to recipients are not actuarially de termined by contributions, as they are in a bona fide insurance program. Thus, there is no reason to exclude Social Security taxes and payments in analyzing trends in Federal spending and taxation. Conclusions and Implications There is a great deal of concern but no con sensus about the economic effects of increasing Federal deficits. The effects of higher deficits on economic activity, including interest rates, international trade, and private investment, are debated within the economics profession, and a summary of these issues is beyond the purview of this paper. However, Nobel Laureate James 168 THE FREEMAN. MAY 1988 Buchanan makes a compelling argument that national debt (like private debt) incurred to fi nance consumption in some past period is tan tamount to a reduction in net wealth. He con cludes: "The issue of public debt to finance the great and continuing fiscal spree of the 1960s, 1970s and 1980s has been equivalent, in all rel evant respects, to the destruction of capital value. "6 Regardless of the economic effects of higher budget deficits, an analysis of the record of the past quarter century clearly reveals the source of the deficits. When compared with the 1960s and 1970s, Federal taxes as a per cent of GNP have not decreased during the 1980s, whereas Federal expenditures as a share of GNP have increased substantially during this period.

What Is Seen and What Is Not Seen Thus, the evidence strongly supports the con clusion of a recent Tax Foundation analysis of the increased budget deficits of the Reagan era: "We are not undertaxed but overspent."7 D 1. Jeffrey H. Birnbaum and Ellen Hume, "Budget Negotiators May Try to Delay Gramm-Rudman Cuts if Accord Is Near," The Wall Street Journal, November 18, 1987, p. 3. 2. Office of Management and Budget, Historical Tables: Budget of the United States Government, Fiscal Year 1988 (Washington D.C.: U.S. Government Printing Office, 1987). 3. Ibid. 4. Jeffrey H. Birnbaum and Alan Murray, "Reagan's Assump tions in Budget Cutting Talks Called Dubious by Some Involved in His Decisions," The Wall Street Journal, October 29, 1987, p. 68. 5. Ibid. 6. James M. Buchanan, "Public Debt and Capital Formation," Ch. 18 in Liberty, Market and State: Political Economy in the 1980s (New York: New York University Press, 1986), p. 201.

7. Tax Foundation, "Social Welfare Outlays Dominate Federal Government Expenditures," Tax Features 31 (September 1987): pp.I-4. IDEAS ON LIBERTY H ave you ever heard anyone say: "Taxes are the best investment; they are a life-giving dew. See how many families they keep alive, and follow in imagination their indirect effects on industry; they are infinite, as extensive as life itself." The advantages that government officials enjoy in drawing their salaries are what is seen. The benefits that result for their suppliers are also what is seen. They are right under your nose. But the disadvantage that the taxpayers try to free themselves from is what is not seen, and the distress that results from it for the merchants who supply them is something further that is not seen, although it should stand out plainly enough to be seen intellectually. When a government official spends on his own behalf one hundred sous more, this implies that a taxpayer spends on his own behalf one hundred sous the less. But the spending of the government official is seen, because it is done; while that of the taxpayer is not seen, because-alas!-he is prevented from doing it.

-FREDERIC BASTIAT 169 The Brady Report: Threat to Stock Market Stability by Christopher L. Culp T he President's Task Force on Market Mechanisms, created in the wake of the October 19 stock market crash, has rec ommended actions designed to make the stock and derivative markets more stable. But the Commission, headed by Nicholas F. Brady, has made proposals which would actually in crease the likelihood that another crash will occur. Part of the problem with the Brady Commis sion's recommendations lies in its interpreta tion of the role that futures markets play in maintaining the financial integrity of the market system. In particular, the Commission neglects the role of the Chicago Mercantile Exchange (CME) as an instrument of risk management for the New York Stock Exchange (NYSE). The most popular of all the futures markets is CME's Standard & Poor's 500 stock index fu tures market. On this market, contracts are traded anticipating price changes in stocks on the NYSE.