The political right in the United States today, represented by the Republican party and some Libertarian and Independent candidates, often refer to their opposition, mostly Democrats, as being Big Government, tax-and-spend Liberals.
October 19, 2008 – With the whole nation anxious about the economy, it’s certainly an interesting time to be teaching economics. As it turned out, we covered Aggregate Expenditures and Aggregate Demand and Supply in my high school Advanced Placement Macroeconomics class last week, just when our two finalists in the 2008 race for the White House were sharing details about their different plans for the economy. I showed my students a replay of selected exchanges between Senators McCain and Obama as they defended their different plans during the final Presidential debate. As my students watched with a better basis for understanding how the different plans might work, I could almost see the light bulbs going on over their heads – some tinted red, some tinted blue. Afterward, there was some vigorous discussion in class on the issue of redistributing income — “spreading the wealth around,” as Senator McCain had put it during the debate. He was referring to what he characterized as being the Big Government, tax-and-spend plans proposed by Senator Obama. Obama, according to Senator McCain, had used the spreading-the-wealth phrase as he responded to a question from the now-famous Joe the Plumber (Joe Wurzelbacher) just days before the debate.
The political right in the United States today, represented by the Republican party and some Libertarian and Independent candidates, often refer to their opposition, mostly Democrats, as being Big Government, tax-and-spend Liberals. They use these terms to describe a government that has grown excessively large, corrupt and inefficient, or a government that is inappropriately involved in certain areas of public policy where the advocates of Small Government and Laissez-faire economic policies believe government should not go. In this, I personally think the pot is calling the kettle black owing to the growth in the size of govern- ment and deficit spending during the Reagan and both Bush administrations. But I resisted sharing this opinion with my students.
According to Wikipedia, Big Government is a pejorative term that can mean any number of different bureaucratic criticisms such as: government program goals that could be accomplished by smaller, more nimble organizations; federalized programs that are tradit- ionally implemented at the state level; governments becoming involved in programs that seek to accomplish things normally done by the private sector; programs that are likely to increase significantly in cost over time; programs that are resistant to reform; large bureaucracies lacking in accountability; limited checks and balances on power; inadequate or inconsistent metrics to verify to efficacy, and; programs that return limited benefits to tax payers. Common examples of Big Government are unfunded or underfunded federal mandates (No Child Left Behind is one such mandate that immediately comes to this teacher’s mind).
Liberal commentators and some Democrats and Independents often counter the criticisms of Big Government with criticisms of “big business”, casting it and elected officials who court it with special legislative and regulatory favors in return for campaign contributions, as an alliance against the public’s interest. Other special-interest bigs include: “big labor”, “big oil”, “big tobacco”, “big pharma”, and other big Political Action Committees (PACS). Those who argue that Big Government is not the problem, that corrupt government and inefficient government programs are, believe that government governs best when it believes in itself and when it governs in the “public” interest rather than in the “special” interest. Big Government, they say, can get things done, partic- ularly in the field of large public works like: the Tennessee Valley Authority (TVA), our Interstate Highway system, the Panama Canal, the Erie Canal, the New Orleans port facilities and levee system, Hoover Dam, the Golden Gate and San Francisco Bay bridges, the Chesapeake Bay Tunnel-Bridge, and Alaska’s infamous “bridge to nowhere.”
So, which is best, Big Government or Small Government? My Libertarian son has argued that the only legitimate role for Big Government is defense, that if government at the federal level would just “butt-out”, individual states would be better off handling law enforcement, infrastructure, education, etc., by themselves. He also argues that the federal income tax is unfair, that it punishes those who are most successful by taking a larger share of their Personal Income (PI) and redistributing it to those who are less successful in Robin Hood fashion. Most Republicans, so it seems, are likewise persuaded. So, okay, let’s look at the Big vs. Small Government issue from the standpoint of taxing and spending.
First, I assume that all who are still reading this believe in utilitarianism, those who, like Star Trek’s Mr. Spock character, believe that “the good of the many outweighs the good of the few, or the one.” If you don’t believe this, then you are probably a Social Darwinist and won’t much be convinced with any argument for an economic system that, like a tide when it rises “lifts all boats.”
Second, some basic review on the Keynesian Aggregate Expenditures model…
We know from empirical data that the more societies produce, the more they consume. It is also true that the more they produce, the more they save. Saving, unlike investing, is simply the opposite of consuming, spending delayed. But it is consuming that drives our economy. Of all the factors considered in calculating Gross Domes- tic Product (GDP) using the expenditures method, consumption, gross investment, government spending, and net export (GDP = C + Ig + G + Xn), fully two-thirds is estimated to be from consump- tion. And what is true for society as a whole, is also true for households… the more “disposable” income (DI) a household has, the more it will consume or spend and the more it will save. However, the propensity or tendency to consume is higher for those with lower incomes; these households spend more and, in many cases, all of what they make. In fact, most even consume or spend more than they make, whether by borrowing, called dissaving, or by obtaining money, goods and/or services from welfare and other benevolences… TINSTAAFL (There Is No Such Thing As A Free Lunch).
Notwithstanding the source, dissaving creates a burden on households (the interest paid to service the debt plus the lost opportunity to consume). Dissaving by society as a whole creates a burden as well. Fully fourteen percent of our national budget goes to service debt currently, and ten to fifteen percent of this is paid to foreign holders of this debt, primarily Japan and China. The propensity to save, or tendency to delay consumption (the storing up of wealth) is higher for those with higher incomes – DAHHH, and much higher for the super rich. So, the more income a household has, the greater the propensity to save and the lower the propensity to consume. These are called “marginal” propensities, or the change in consumption divided by the change in income and the change in saving divided by the change in income. Added together, marginal consumption and marginal saving always equals one (1), assuming a closed economy… one without leakage such as we have as a result of our trade deficit and interest paid to foreign holders of debt obligations.
The fraction, or percentage, of total consumption divided by total income is called the Average Propensity to Consume (APC). The fraction, or percentage of total saving divided by total income is called the Average Propensity to Save (APS). For argument-sake, let’s say the APC for the United States is 0.75 and the APS is 0.25 – close enough for purposes of illustration.
Third, understanding multiplier effects…
Consumption, government spending, investment and taxation all have multiplier effects. By this it is meant that a portion of one household’s disposable income (DI), in the case of the consumption multiplier, becomes a portion of another household’s income. Likewise, government spending and investment, or the purchase of capital (although not as direct and unadulterated as consump- tion and government spending), becomes others’ incomes. In the case of consumption, 0.75 percent of DI is spent over and over again, assuming each household’s MPC is also society’s APC, until the original amount is depleted by successive reductions. An APC of 0.75 has a multiplier of four (one divided by 0.25), which means a dollar spent increases aggregate expenditures, or GDP, four dollars. All multipliers are positive, at the national level, adding to domestic output or GDP, except for the taxation multiplier, which is negative. However, since taxation reduces both consumption and savings, the effect has less weight than does government spending affecting output. Domestic government spending, like consumption, but unlike investment and foreign exchange, has a direct and unadulterated effect on aggregate expenditures.
Assume $20 billion of taxes on income where all else is equal (ceteris paribus). Applying the taxation multiplier, four (4), which is negative, to $15 billion ($5 billion of the 20 being reduced from saving, which doesn’t help the economy in the near term), output or GDP is diminished by $60 billion (15 X 4 = 60). However, assuming a balanced budget, that same $20 billion now becomes available for the government to spend, and since government never saves (hasn’t at least since the end of the Clinton administration), that $20 billion is all multiplied by four (4)… a plus four (4). Therefore, GDP grows by $80 billion, a net difference of a plus $20 billion. So taxing and spending actually helps the economy as a whole. This is what Senator Obama was trying to convey to Joe the Plumber when he used the phrase, “…spread the wealth around.”
Government spending raises the tide, a metaphor for the economy, which lifts all boats. Tax cuts too are good; they help the economy since people have more DI (personal income after taxes). But this assumes a balanced budget. When government spends more than it takes in, especially when this spending is done overseas, the tide is lowered taking all boats with it. That, at least in-part, is what has happened to our economy over the past four years.
Now, not to sound elitist or anything, but I would expect a magna cum laude Harvard law school graduate to understand this, whereas a Naval Academy officer graduating fifth from the bottom of his class, or a student who attended six colleges in five years before finally completing her baccalaureate in communications-journalism with a GPA that she has not seen fit to make public might not, much less Joe the Plumber. As Mr. Spock would say, “The logic is sound.” But, whether one follows the logic and/or accepts it, it seems to me that a true Christian would have to admit the concept is Biblical.
I invite your comment, pro or con.