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Exhausting the Reserve Fund: The Big Picture of the Limits to Big Government (Part I)

By Richard Ebeling -- July 18, 2011

[Editor Note: Obama’s transformationist energy policy, enabled by taxpayer largesse, is being whipsawed by the federal deficit crisis. And the energy/environmental statists are running scared. “[Obama] has bought into and reinforced the GOP narrative that debt and spending concerns reign supreme,’ lamented Joe Romm at Climate Progress, “which will undermine short-term and long-term efforts to create jobs or promote clean energy or reduce oil dependence or cut carbon pollution.”

Today and tomorrow, economist Richard Ebeling outlines the macro crisis. On Wednesday, Lisa Linowes of Wind Action makes a case for ending all energy subsidies as a contribution toward fiscal reform.]

The economic crisis through which the United States and much of the rest of the world are now passing is not another supposed instance of the “failure” of unrestrained capitalism. It is the failure of the government’s own policies. In other words, it is a crisis of the Interventionist State.

The recession has been the inevitable outcome of the prior artificial investment boom and housing bubble, which were caused by the misguided and highly expansionary monetary policy of the Federal Reserve between 2003 and 2008. The money supply was increased by nearly 50 percent during this five-year period, and key interest rates, when adjusted for inflation, were at or below zero. Investment and housing decisions were radically out of balance with available real savings to sustain such long-term financial commitments. Consumers and homeowners were induced by low interest rates and easy mortgage policies to get in way over their heads.

The duration and slowness of the recovery, and especially the sluggish delay in anything approaching “full employment,” is also the consequence of the government’s policies. The Federal Reserve went on another massive monetary expansionist binge that has increased the money supply in the form of additional bank reserves by well over $2 trillion in just a less than three years. Interest rates have, again, been kept at or even below zero when adjusted for inflation, with the affect of continued highly distorted investment and housing sectors.

Fiscal Folly, Burdensome Government

All of this has been exacerbated by the U.S. government’s radically loose fiscal policies. But all that the massive trillion-dollar-a-year government deficits for the last three years have done is to accelerate a disastrous trend in government budget financing that had been growing worse for nearly a decade. When George W. Bush entered the White House in 2001, total accumulated government debt stood at $5 trillion. When Bush left office in January 2009, the government’s debt had more than doubled to over $10 trillion.

Now in the less than the three years of the Obama administration, Uncle Sam’s debt stands at over $14.5 trillion – and growing. This debt practically is equal to the estimated total market value of the country’s Gross Domestic Product (GDP), a level not seen since the cost of fighting the Second World War. The government, right now, is borrowing approximately 40 percent of all the money it is spending. Under current spending projections government debt will total well over $20 trillion by 2016.

For decades, the United States government has been gobbling up more and more of the wealth and resources of American society. If we take a long-term perspective, in 1902, all levels of government in the U.S. only absorbed slightly more than 7 percent of GDP. By 1998, nearly a century later, all government expenditures as a percentage of GDP had grown to 28.1 percent; ten years later, by 2008, government spending had increased to 38.3 percent of GDP. And in 2010, it has approached 43 percent of GDP. Last year, in other words, 43 cents out of every dollar was spent either by local, state or federal governments.

To at least partly fund these growing expenditures, taxation had eaten into more and more of the American taxpayers’ income and wealth. Again, looking back to over a century ago, in 1902 Federal, state and local taxes combined took only 6.7 percent of GDP. Almost a century later in 1998, tax-cost of all levels of government in the U.S. had increased to 29.2 percent of GDP. This has fallen closer to 25 percent of GDP in the last few years due to the recession, with a decline in taxable incomes and corporate profits. But as we saw, this has not stopped the government’s growth in spending by borrowing, instead, all that it has needed.

Government spending on defense, entitlements (Social Security and Medicare), and illusionary and counter-productive “stimulus” programs has been and is pushing the United States into the fiscal crisis that threatens America’s economic future.

In spite of the rhetoric from a wide variety of politicians and media outlets, the problem is not that taxes are too low or that the “the rich” are not paying their “fair share.” According to data from Organization for Economic Cooperation and Development (OECD), among twelve prominent members of the organization (Australia, Canada, France, Germany, Ireland, Italy, Japan, Mexico, Netherlands, Sweden Switzerland, and United States), the U.S. had the third lowest personal income tax rate in 1990 (with only Switzerland and Sweden’s rates being less). By 2010, the U.S. was among the higher personal income tax rate nations, along with France, Italy and the Netherlands. Even Mexico’s personal income tax rate was noticeably less than America’s

Among the same group of OECD members the U.S. corporate income tax rate was far below Germany, Sweden, Japan and Italy, and Ireland in 1990. By 2010, the U.S. corporate income tax rate was exceeded only by Japan’s, with Canadian, French, Irish, Italian, Mexican, Dutch, Swedish, and Swiss corporate income tax rates being anywhere between 10 to 50 percent less than America’s.

“Soaking the Rich”: Still Not Enough

Nor are “the rich” not paying some hypothetical “fair share.” In 1990, those in the top five percent of income earners in the United States earned about 28 percent of total gross personal income in the country. In that same year, those in this income category paid around 42 percent of all personal income taxes collected by the government.

In 2008, that top five percent of income earners earned around 32 percent of total gross personal income in America. But their personal income tax burden had increased to nearly 60 percent of all personal income taxes collected by the government.

Thus, while the “share” of personal income earned in the U.S. in the hands of this top five percent had increased by 14 percent between 1990 and 2008, their tax burden rose during this time period by nearly 43 percent.

Indeed, the top ten percent of all personal income earners paid 70 percent of all personal income taxes collected by the government in 2008, compared to 55 percent in 1990. The top 50 percent of all those earning personal income in 2008 paid 97 percent of all personal income taxes collected that year. And the latest data suggests that since 2009, at least 51 percent of all American households now pay no personal income tax. A minority of income earners now provides all the income taxes paid to partly defray the cost of government in the United States.

[to be continued ….]


Richard M. Ebeling, a leader of the modern Austrian School of economics, is professor of economics at Northwood University in Midland, Michigan, and past president of the Foundation for Economic Education. Dr. Ebeling is author of Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition (Routledge, 2010), and co-author of In Defense of Capitalism (Northwood University Press, 2010).


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  2. Marlo Lewis  

    Richard, thank you for this excellent article. I have one request, though. Please provide links to sources for the numbers you cite. Links to supporting documentation is essential if the column is to receive the respectful attention it deserves. Best, Marlo


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