The Negative Consequences of Government Expenditure

The U.S. national debt currently stands at 62 per cent of gross domestic product (GDP) – its highest level since WWII. Under plausible assumptions, this ratio will rise to at least 80 per cent and possibly 185 per cent of GDP by 2035 and continue increasing thereafter. As the debt ratio increases, the country's creditors will demand higher and higher interest rates to continue financing this debt. This means even larger deficits and ultimately a U.S. default, says Jeffrey Miron, senior lecturer and director of undergraduate studies in the department of economics at Harvard University and a senior fellow at the Cato Institute.

Both macroeconomic and microeconomic perspectives suggest that tax increases cannot address the debt problem because higher taxes mean slower economic growth, reducing the scope for increased tax revenue. If tax increases cannot restore fiscal balance, the United States must slow the path of expenditure, starting with reforming entitlement spending, to avoid fiscal Armageddon. Expenditure cuts can simultaneously improve fiscal balance while enhancing economic growth.

Large chunks of current expenditure are counterproductive and fail to accomplish reasonable policy goals. Determining the ideal level of government expenditure is difficult, but just a few decades ago the United States was a productive economy with far lower expenditure.

In the 1960s, for example, federal government expenditure was below 20 per cent of GDP, and state and local expenditure was below 12 per cent.

This contrasts with roughly 25 per cent and 15 per cent now.

The good news is that, from a fiscal perspective, the United States can have its cake and eat it too. By slashing expenditure, the country can simultaneously improve economic efficiency and get the debt under control.

Source: Jeffrey Miron, The Negative Consequences of Government Expenditure, Mercatus Center, November 2010.

For text: http://mercatus.org/sites/default/files/publication/Negative%20Consequences%20Government%20Expenditure.MoP_.Miron_.11.9.10.pdf

For more on Federal Spending & Budget Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=25

First published by the National Center for Policy Analysis, United States

FMF Policy Bulletin/ 30 November 2010