Why Do We Want to Cut Government Spending?

My Sunday article on the Liberty Bullhorn where I criticized Veronique de Rugy’s conclusions regarding European government spending inspired a few rather intense conversations. The conversations have been revealing and – hopefully – clarified my points further. I have also gained valuable insights into the views held by other libertarians and fiscal conservatives who side with de Rugy.

I maintain, though, that my libertarian and fiscally conservative friends, primarily on the East Coast, do indeed belong to an unhealthy consensus circuit on what to do with government spending. Their view can be summarized - perhaps a bit harshly – as “just cut spending, damn it”. In this article I would like to elaborate on why I believe that this view would have bad consequences if it was ever translated into fiscal policy.

My disagreement with the consensus circuit centers in on one critical question: why do we want to cut government spending in the first place? There are two answers to this question, a principled and an economic answer. The principled answer places a goal post on the horizon, showing us where we want to take our country. The economic answer tells us how we want to get there.

As for the principled answer, my goal post is Robert Nozick’s minimal state. As is well known, this state is strictly limited to the protection of life, liberty and property; there is absolutely no government-forced redistribution of resources between citizens. Almost every kind of government spending we know of is banned, from public education to the Earned Income Tax Credit. Even Social Security must go, of course, though its redistributive properties are a bit different from those of, say, Medicaid or unemployment benefits.

I have no doubt that I share this goal post with every other libertarian. (Conservatives tend to disagree, wanting a limited government-provided “social protection” system.) The disagreement between me and the consensus circuit is instead in the answer to the economic question - How do we get to the goal post? - and the disagreement lies first and foremost in how the circuit thinks about government spending.

While the prevailing view among fiscal conservatives is that all government spending is the same, and while I agree that all government spending – except what fits inside the minimal state – must eventually be cut to zero, it is a grave mistake to treat all government spending the same way in the process of cutting spending.

In other words: not all government spending is the same. This is a statement of fact, not a value statement. In order to understand why it is not a good idea to “just cut spending, damn it”, we need to separate government spending into the following categories:

• Service production;
• Permanent financial entitlements;
• Temporary financial entitlements.

Financial entitlements (explained in detail in a moment) are always redistributive in nature: they take money from one citizen and give to another. Service production, on the other hand, is only partly redistributive. Services that protect life, liberty and property are not redistributive in nature, while services such as public education, health care and and child care are.

[The astute student of Nozick would qualify this distinction by adding that even services that protect life, liberty and property can be redistributive according to the definition of the ultra-minimal state. I disagree with this statement, but I will give you a chance to convince me that I am wrong!]

The overwhelming majority of government spending is redistributive in nature, i.e., must eventually go away. The question is: what happens if we decide to cut all redistributive government spending overnight? (This is the pointed meaning of “just cut spending, damn it.”)

To answer this, we need to get back to the financial entitlements. In short, they are cash handouts: any kind of check you get from government that does not pay you for work or for a product you sell to government, is a cash handout. People qualify for financial entitlements because they belong to a distinct group that government has identified as deserving of redistribution. Some cash handouts are permanent, or open-ended, in the sense that there is no distinct cut-off date when you disqualify. America does not have a whole lot of these programs, though there is a long-term, disturbing trend where some of the temporary programs are taking on the role of permanent financial entitlements. Programs like TANF, WIC, unemployment benefits and food stamps belong in this category (though food stamps have a limited cash value as they can only be used to buy food).

Because a financial entitlement does not pay for a job, but “simply” puts cash in a person’s pockets, the consequences of spending cuts are different than if we cut services production. If a person loses parts or all of a cash handout, the theory is that he or she is incentivized to go out and find a way to support him- or herself.  Therefore, if we cut financial entitlements we will create more labor supply, which in turn will fill a lot of vacant jobs and inspire people to start new businesses.

I generally view this reasoning as over-simplifying a complex issue, but the underlying incentives structure is correct. If there are a lot of jobs waiting to be filled and we can motivate people to take them by cutting or eliminating financial entitlements, then by all means, let’s do it. Most of the research on the 1990s welfare reform seems to agree that with the proper implementation, cash-handout cuts is a way to self sufficiency.

The problem comes when we already have a recession with high unemployment. The ’90s reform took place during a time when unemployment was trending down below four percent. It is an entirely different matter to cut welfare to encourage self sufficiency at a time when unemployment is persistently in the 8.5-9.5 percent bracket. If we “just cut spending, damn it” today in our cash handout programs we will leave a lot of people without any means to put food on the table.

[If anyone wants to make the case that an elimination of the minimum wage could help here, I am all ears. The minimum wage law is economically stupid and morally objectionable. But please don't just suggest that it will solve our welfare cost problems here and now. Provide some analytical backup. We need solutions, not rhetoric.]

Generally, therefore, it is unwise to cut temporary financial entitlements in times of a deep recession. But what about permanent entitlements? Well, we don’t have a whole lot of those in America. Social Security is one, and its eligibility structure is different than that of other entitlements. Furthermore, in order to have any effect on the budget, cuts in Social Security would have to come with structural changes to the funding of the program, and be pretty darn significant. I strongly encourage Social Security reform, but it should be done separately from any attempts to cut government spending here and now.

So what about services production? The simple answer to this question is: government is selling us services for tax money – making us offers we can’t refuse – and by doing so is effectively monopolizing markets that otherwise would be in the hands of the private sector. “Just cutting spending, damn it” on services has two consequences that we need to recognize:

1. It lays off people who get a paycheck that they spend – no matter how inefficient they are at what they do at work;
2. People still pay for those services, which means that they have no more money to spend on a replacement for what government cut away; government takes as much but gives less back.

So long as government keeps taxes unchanged when it cuts services, the cuts will have a business-cycle style negative effect on the economy. One consequence is a drop in consumer spending, and it comes from two sources: laid off workers getting welfare and unemployment, and families redirecting spending to buy compensate for what government no longer provides. This leads to an increase in financial entitlement spending that counters the cut in spending on services.

In short: if you close a school to reduce government spending, the teachers and janitors are going to get cash handouts from government, and some parents will reduce their work hours and try to homeschool their kids instead. Less earnings means less spending in the local community. More job losses, more cash handout spending.

So, says the consensus circuit member, are you against cutting government spending entirely?

Of course not. Let’s remember what I said about the principled answer to the question why we cut government spending. The point here is to once again consider the question: Why do we want to cut government spending?

The economic answer to this question – or at least the policy we design based on our economic answer – is conditioned by what the intermediate, economic goal is with the spending cuts. If our goal is to reach that principled goal post, then “just cut spending, damn it” is a counter-productive strategy. However we go about it, we will create more problems than we solve. The reason is that spending cuts lopsidedly drain the economy for resources. No matter how inefficient government is at what it does, it still provides services and entitlements that feed back into the economy. In the areas of redistribution the output from government is always inefficient compared to what the private sector would produce, but the output nevertheless exists, and people adjust their lives to it. (They have no choice.)

A far more productive approach to reaching the goal post is to structurally reform away government, program by program, with a package of supply and demand side reforms. On the supply side:

• Deregulations that allow      private entrepreneurs to replace government on private-market terms; and
• Tax cuts that make it cheaper      to set up and operate a business.

On the demand side, we cut taxes and make other reforms that put more money in consumers’ pockets.  That way entrepreneurs will have reason to believe that there is a market for the products they are going to sell. In terms of public education reform, the demand-side measures would, e.g., include property tax cuts, a voucher system and the creation of private, charitable scholarship programs for private schools.

I don’t think the libertarians and fiscal conservtives on the consensus circuit disagree with this model for long-term, structural reforms to eliminate the welfare state. I believe instead that their mistake lies in that they confuse two answers to the question why we want to cut government spending.

While aiming for the minimal-state goal post, they adopt an attitude toward spending cuts that is embraced by people who have a different goal post in mind. The “just cut spending, damn it” approach is common among those whose goal post is a balanced budget. If your goal is to eliminate a budget deficit with spending cuts, then your primary concern will be spending cuts – not to reform away the spending programs themselves. Politicians who want to close the budget deficit use the across-the-board approach to reduced spending, not realizing that they are re-creating the very same problem they are trying to solve.

To sum up, then: I do believe that libertarians on the consensus circuit share the principled goal of eliminating the welfare state, but I also believe that they have confused the method for getting there with the method for balancing the budget. The two are incompatible: you cannot “just cut spending” to eliminate the welfare state. Across the board cuts are not designed, and not macroeconomically suitable, for such reforms. Only a structural elimination of the welfare state can reach that goal post.