Reagan’s small-government vision

Last Wednesday, I gave Cato’s Chris Edwards an A for effort for his suggestions as to how to reduce government spending by almost $300 billion per year and asked you to check out the details. Some of you did and were quite hard on Mr. Edwards. After reading his “Reagan’s small-government vision” over at NRO today, I’m going to be quite hard on him for a couple of different reasons. First of all, how can one raise a small-government vision and then write: “It is true that Reagan did not control federal spending growth. By 1989, federal spending was up 69 percent from 1981”?

It is true that Reagan failed to cut government spending to pay for his tax cuts (Bush43 has the same problem) but Mr. Edwards numbers that indicate a 68.7% increase in spending are nominal figures. To suggest that an increase in government spending caused the deficit ignores that fact that nominal GDP rose by 75.3% over the same period. The increase in nominal GDP is only partly due to an increase in real income (31.9%) as prices rose by 32.9% over this period. And the increase in real income is in part attributable to the 14.4% increase in the labor force over the same period. We know that Stephen Moore understands nominal versus real when it comes to oil and gasoline prices even if his colleague Tom Nugent does not (see our discussion last Thursday) so hopefully he can teach Mr. Edwards how to do real per capita comparisons across time. Then again, Mr. Edwards seems to be following Mr. Moore’s habits of comparing total nominal Federal revenues across time when he suggests that they rose by 65.4% over this period. On Monday, we noted that when one removes increase the payroll contributions to finance the Social Security retirement benefits for the Baby Boomers, the real increase in Federal income taxes over this period is actually less than the increase in the labor force.

My second critique of Edward’s oped is over the following:

The first thing to note is that Reagan inherited a $79 billion deficit from Jimmy Carter in his last budget for 1981. Indeed, the government had run deficits every year since 1961 with the sole exception of 1969. Reagan did not invent deficit spending.

While the conventionally reported government deficit was positive during the Carter years, it is interesting that Milton Friedman wrote in a 1980 Newsweek article that Carter’s fiscal stance was showing annual reductions in the real value of debt. Even the $85.8 billion increase in gross Federal debt during 1981 (Table B.78 of the Economic Report of the President 2004) represented only a 9.4% nominal increase in Federal bond during a year when the GDP deflator also rose by 9.4%. Of course, Robert Barro’s 1979 Journal of Political Economy article “On the Determination of the Public Debt” noted that U.S. fiscal policy since 1789 had strived to retire any debt created during major wars or recessions. In fact, the ratio of gross debt to GDP fell to 32.5% by the end of 1981.

Despite Edward’s claim that “Reagan did not invent deficit spending”, Thomas Sargent and Neil Wallace warned in the fall of 1981 in “Some Unpleasant Monetarist Arithmetic” that Reagan’s fiscal stimulus of “never tax, always borrow” could imply a Federal bankruptcy path that would result in an exploding debt/GDP ratio. Table B.79 of the Economic Report of the President 2004 notes that the debt/GDP ratio rose to 67.3% by the end of 1996 before the efforts of Bush41 and Clinton managed to put Federal finances on a debt retirement path that lowered this ratio to 57.5% by the end of 2001. Alas, Bush43’s desire to be ReaganII has led to tax cuts and spending increases, which have us back on the Sargent-Wallace Federal bankruptcy path with the debt/GDP ratio expected to be 67.5% by the end of 2005.

I suspect Mr. Edwards understands that such fiscal policies are not sustainable, which is why the Cato Institute is proposing nearly $300 billion in spending cuts. Perhaps he also realizes that the Bush Administration has even less political will to follow his recommendations than Reagan displayed. Unless all of his cuts are adopted, which is not likely politically, then we will have to choose between tax increases or an ever rising debt/GDP ratio. Rather than sugar coat this issue with a misleading oped, why not just admit the fiscal irresponsibility of both ReaganI and ReaganII?