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We Pay Millions to ‘Ghost Teachers’ Who Don’t Teach by Jason Bedrick

The Philadelphia school district is in a near-constant state of financial crisis. There are many factors contributing to this sorry state — particularly its governance structure — but it is compounded by fiscal mismanagement. One particularly egregious example is paying six-figure salaries to the tune of $1.5 million a year to “ghost teachers” that do not teach. Pennsylvania Watchdog explains:

As part of the contract with the School District of Philadelphia, the local teachers union is permitted to take up to 63 teachers out of the classroom to work full-time for the Philadelphia Federation of Teachers. The practice, known as “release time” or “official time,” allows public school teachers to leave the classroom and continue to earn a public salary, benefits, pension and seniority.

These so-called ghost teachers perform a variety of jobs for the PFT, serving as either information officers for other teachers or carrying out the union’s political agenda.

“Teachers should be paid to teach,” attorney Kara Sweigart, who is arguing ghost teacher lawsuits for the Fairness Center, a free legal service for employees who feel they’ve been wronged by their unions, told Watchdog.

“At a time when school districts are hurting financially, districts should be devoting every tax dollar to support students,” she said, “not to pay the salaries of employees of a private political organization.”

According to public salary data available through Philadelphia city agencies, the school district is paying 16 ghost teachers $1.5 million this year. All of them are making at least $81,000.

PFT Vice President Arlene Kempin, who has been on release time since 1983, is among the highest paid at $108,062. Union head Jerry Jordan, who has also been on release time for more than 30 years, is earning $81,245, according to district payroll logs. The 16 ghost teachers on the books this year are making an average salary of almost $98,000.

The “ghost teacher” phenomenon is far from unique to Philly or even the education sector. Such “release time” subsidies for ghost teachers, policemen, firefighters, and bureaucrats of all stripes are common features of public-sector union contracts nationwide. Last month, a Yankee Institute report found that Connecticut provided unions with $4.1 million to subsidize 121,000 hours union-related activities, “the equivalent of more than a year’s worth of work for 50 full-time employees.” Meanwhile, the Goldwater Institute in Arizona is in the midst of a lawsuit against the city of Phoenix for unconstitutionally providing millions of dollars in release-time subsidies.

According to the most recent report from the federal Office of Personnel Management, the federal government paid more than $157 million in 2012 for federal employees to work for their unions for a total of 3,439,449 hours. And those are just the direct costs.

In his book, Understanding the Teacher Union Contract: A Citizen’s Handbook, former teacher union negotiator Myron Lieberman explained how difficult it is to account for the full amount of subsidies that taxpayers provide to the unions:

Most school board members are not aware of the magnitude of these subsidies. In school district budgets, the subsidies are never grouped together under the heading “Subsidies to the Union.” Instead, the subsidies are included in school district budgets under a variety of headings that may or may not refer to the union…

School districts pay for these subsidies from a variety of line items in the district budget: payments to substitute teachers, teacher salaries, and pension contributions, among others.

In most situations, the union subsidy is lumped together with other expenses paid for under the same line item; for example, the costs of hiring substitutes for teachers who are on released time for union business may be included in a budget line for substitutes that also covers substitutes for other reasons, such as replacing teachers on sick leave, personal leave, maternity/paternity leave, and so on.

Taxpayer dollars allocated for education should be spent on items and activities that assist student learning, not to promote the interests of private organizations (especially when their interests often collide with the interests of students). Union work should be paid out of funds the unions collect through dues and donations, not funds expropriated from unwilling and unwitting taxpayers.

Cross-posted from Cato.org.

Jason Bedrick

Jason Bedrick

Jason Bedrick is a policy analyst with the Cato Institute’s Center for Educational Freedom.

The 50-Year Disaster of Government Trains, Buses, and Streetcars by Daniel Bier

Today, Less than 2% of Trips Use Public Mass Transit.

Ronald Reagan once quipped that “government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.”

There, in a nutshell, you have a short history of mass transit in America. CEI’s Marc Scribner explains,

Following decades of excessive local government fare regulation that led to a terminal decline in the private mass transit industry, government began taking over the responsibilities performed by now-bankrupt private mass transit companies following the Urban Mass Transportation Act of 1964.

Over the span of a decade, the mostly-private mass transit industry was replaced by government transit monopolies.

As a result, for the last several decades, government at all levels has spent trillions on mass transit, subsidizing fares, expanding lines, and building vast new rail systems. Today, transit consumes more than 25 percent of all surface transportation funds (which mostly come from non-transit users through gas taxes).

What was the result of this tidal wave of taxpayer cash?

Despite receiving more than one-fourth of the funding, mass transit still represents less than 2 percent of trips taken nationwide. Even when one looks only at commuting, where trains and buses do best, mass transit’s national mode share is less than 5 percent — down from more than 6 percent in 1980.

That’s right: after receiving a massive and disproportionate share of taxpayer funding, totaling trillions of dollars, transit’s share of commutes declined.

But government transit monopolies keep lobbying for more and more funding. They claim the real problem is that public transit systems haven’t been expanded enough to draw more people into using them. Scribner calls this theField of Dreams theory: “If you build it, they will come.

The problem with this theory is that it’s bogus. Research from Steven Polzin shows that the capacity of transit networks, including buses, streetcars, and trains, has nearly tripled since 1970, while absolute ridership has grown by just a fraction of that. Transit trips per capita have been dead flat since the 1970s.

Polzin writes, “Supply has grown far more rapidly than demand for the past several decades. This is a report card on productivity that mom and dad would hardly be proud of.”

Meaning: we built it; they didn’t come.

Scribner concludes,

The trillions spent on mass transit have given governments many more empty buses and trains, but very little in terms of additional ridership. …

Mass transit can serve a very important, albeit narrow, purpose for people in limited settings. There is a reason that 40 percent of all US mass transit trips take place in the New York City metro area.

But it is wholly irresponsible for politicians to continue mass transit’s taxpayer gravy train, which is based on less substance than Kevin Costner’s dramatized auditory hallucinations.

When the next flashy transit project comes to your town, remember to be skeptical. Proponents of light rail, streetcars, and other hugely expensive projects routinely overestimate how many people will use the line and underestimate how much it will cost to build and run. Decades of evidence shows that if you build it, people will still probably drive — and you’ll still be stuck paying for it.

Daniel BierDaniel Bier

Daniel Bier is the editor of FEE.org. He writes on issues relating to science, civil liberties, and economic freedom.

Privatize Social Security — Even if the Market Crashes by Michael D. Tanner

There have been many good, if ultimately unconvincing, arguments against allowing younger workers to privately invest a portion of their Social Security taxes through personal accounts. There have been even more silly ones.

One of the silliest is the one regurgitated Monday by ThinkProgress, that this week’s stock market decline proves that “If Social Security Had Been In Private Accounts The Stock Market Drop Could Have Been A Disaster.”

Few personal account plans would require a retiree to cash out their entire account on the day that the market crashed. But what if they did? It is important to understand that someone retiring Monday would have begun paying into their account 40 years ago when the Dow was at 835.34. After yesterday’s decline, it opened at 15,676 today. Over those 40 years, the worker would have made roughly 1,040 contributions to their account. Only 48 of them would have been at a time when the market was higher than today’s open.

Yep, even after Monday’s crash, the worker would have made a tidy profit. In fact, his return would have been substantially higher than what he could expect to receive from Social Security.

The last time that defenders of the status quo made this argument was 2009, during the market crash that led into the Great Recession. At that time the market hit a low of 6,547.  Obviously, if workers had been allowed to start investing then, they would have done pretty well. But more importantly, retirees in 2009 would have done well too, once again better than Social Security.

Cato published this comprehensive study of that downturn and its impact on personal accounts.

Social Security is running nearly $26 trillion in future unfunded liabilities. It cannot pay promised future benefits to young workers without substantial tax hikes. We should begin a discussion of how to reform this troubled program.

A start to such a discussion would be to retire the canard about market crashes and personal accounts.

Cross-posted from Cato.org and TannerOnPolicy.

Michael D. Tanner

Michael D. Tanner

Michael Tanner is a senior fellow at the Cato Institute, studying poverty and social welfare policy, health care reform, and Social Security.

Can We Afford ‘Affordable Care’? by D.W. MacKenzie

Does the Supreme Court decision upholding health insurance subsidies prove that Obamacare is here to stay?

With its legality settled, the longevity of the healthcare program is supposed to be politically inevitable. The millions of voters who receive subsidies from the Affordable Care Act will not tolerate the loss of this money. Insurance companies will no doubt also lobby to prevent any loss of ACA subsidies, as stockholders and employees are major beneficiaries of this program.

Political factors may well preserve the ACA in the short run. But the Court’s ruling came on the heels of a gloomy report from the Congressional Budget Office that may prove to be more decisive for the law than all of Chief Justice Roberts’ legal gymnastics.

The CBO forecasts anemic economic growth and rising public debt for decades to come. Projected revenues and projected spending indicate a growing imbalance in federal finances, driven by long-term unfunded liabilities in old entitlement programs — mainly Social Security and Medicare.

The Affordable Care Act was supposed to control health insurance costs — hence the name. Unfortunately, things are not working out that way, and insurance companies are pressing for significant rate increases.

Consumers might hope that government officials would resist pressure for rate increases, but such actions are unlikely: Stock prices for major health insurers rose sharply after the Supreme Court ruled in favor of the Obama administration. Clearly, investors expect the ACA to benefit health insurers. And in Oregon, state regulators actually raised premiums higher than insurers requested, just to keep companies in the market. Rising premiums will likely drive more subsidies, worsening the looming debt and entitlement crisis.

Politicians have ignored these issues for decades because they seemed like “long-term” problems, and political pressures from elections and lobbying force them to be shortsighted. The short-term financial situation is being shored up by the willingness of investors to buy federal debt at low rates.

The trouble is that the long term isn’t as far off as it used to be. The CBO indicates that the fiscal situation in the federal government worsened significantly over the past few years, even as the deficit was declining. Further deterioration in federal finances is expected over the next decade. How much longer will private investors continue to finance this soaring debt?

A large part of the problem with rising debt is that financing it requires steady economic growth, but large public debts can crush growth. Federal debt is a millstone on the economy, the burden of which could at some point lead to national bankruptcy. The ACA, with its enormous subsidies and regulatory compliance costs, will simply pile on an already unaffordable mass of federal spending programs.

The bottom line is that Supreme Court maintained the ACA subsidies legally,but the American people will not be able to maintain them financially.

The passage and continued defense of the Affordable Care Act is an example of the rank irrationality of public budgeting. The outcome of our political and legislative processes over the past few decades has been to create a myriad of wasteful and financially unsustainable federal programs. Meanwhile, the analytical office the legislative branch of government has been quietly raising the alarm about to the direction and sustainability of government finances. It would seem that delirium is winning out over reason.

There is, of course, nothing truly inevitable about the growth of federal spending. Federal spending developed into its present irrational state because many people pressed for this growth.

But spending can and will be curtailed. Citizens can push for real spending cuts through the electoral process. Otherwise, investors in financial markets will at some point put a sharp and sudden stop to government excesses.


D.W. MacKenzie

D. W. MacKenzie is an assistant professor of economics at Carroll College in Helena, Montana.

RELATED ARTICLE: Under Obamacare, Uninsured Rate Fell to Lowest Level in 50 Years. Why There’s More to That Number.

Scandinavian Myths: High Taxes and Big Spending Are Popular by Nima Sanandaji

As I have explained in previous columns for CapX, there are a number of myths surrounding the Nordic countries that don’t stand up to scrutiny. These include the notion that long life span in Nordic nations arose as the public sector expanded, the idea that generous public programs alone explain low levels of Nordic poverty and the myth that Nordic countries are bumblebees that defy gravity by not being adversely affected by high taxes.

But surely the Nordic countries do show one leftist theory to be correct: that social democrat policies can be popular with the electorate.

Although the Social Democrats have recently lost much of their previous support, they did manage to dominate Nordic policies for long. Sweden was sometimes referred to as a one-party state, since the Social Democrats ruled it almost consecutively from 1932 till 2006 (interrupted by two short spells of centre-right rule during 1976-1982 and 1991-1994).

It is sometimes puzzling to the outsider why the Nordic public repeatedly have elected tax-raising governments to power. The obvious answer is ideological support for welfare state policies.

However, there is also another reason worth examining in greater detail: the general public has not been fully aware of the price tag, in terms of higher taxes, attached to expanding public sectors. Politicians have created a fiscal illusion which has resulted in higher levels of taxation that the population would otherwise have accepted as feasible had taxes been levied in a transparent way.

Before policies radicalised in the late 1960s, the tax levels in Nordic nations were around 30 percent  of GDP – quite typical of other developed nations. At the time, the tax burdens were quite visible. Most taxation occurred through direct taxes, which showed up on employees’ payslips.

Over time, an increasing share of taxation has been raised through indirect taxes. The latter are less visible to those paying them, since they are either levied before the wage is formally given to the employee or are included in the listed price of goods.

Finland is worth considering as an example. The country’s tax level was 30 percent of GDP in 1965. Indirect taxes in the form of VAT and mandatory social security contributions amounted to a quarter of total taxation. In 2013, the total tax take had increased to 44 percent of GDP, half of which was hidden taxes.

As shown below, Finnish governments have funded the expansion of the public sector by raising the hidden, but not the visible, tax burden. Denmark has followed a route wherein both hidden and visible taxes have been hiked.

Hidden and visible taxes in Finland (percentage of GDP)

Source: OECD tax database and own calculations.

Hidden and visible taxes in Denmark (percentage of GDP)

In Norway and Sweden, visible taxes are today lower than in the 1960s, although the true taxation is considerably higher. As can be seen below, it is clear that governments in both countries have followed a strategy based on replacing visible tax income with hidden tax incomes.

Thus, whilst the average worker has paid progressively more to the government, the payslips of the same worker have misleadingly shown a reduction in taxation.

Hidden and visible taxes in Norway (percentage of GDP)

Hidden and visible taxes in Sweden (percentage of GDP)

In other words, except in Denmark, the rise in taxation has occurred fully through an increase in hidden taxation.

This is in line with the predictions of fiscal illusion made by Italian economist Amilcare Puviani in 1903. Puviani explained that politicians would have incentives to hide the cost of government by levying indirect rather than direct taxes, so that the public would under-estimate the cost of policies.

The illusion can thus be created that an expanding state benefits individuals and families and yet costs less than it actually does. Nobel laureate James Buchanan and other researchers have expanded on the idea that it is easier for politicians to raise hidden, indirect taxes rather than visible ones.

Perhaps it comes as no surprise that those who believe in a higher tax rate in other parts of the world have followed a similar strategy as the Nordic nations. The American left-liberal think tank the Roosevelt Institute openly recommends “less-visible taxes that Americans are more likely to support.”

The Obamacare system launched in the US represents a form of indirect taxation – through an overly complex system – that is even more difficult to comprehend for the average taxpayer than in the Nordic systems.

I don’t doubt that less visible taxes in the US, the UK or other parts of the world would prove an easier route to raise the tax burden than visible taxes. This is indeed a lesson that the left can learn from the Nordics.

But the question remains if this is a good route to venture on. Shouldn’t politicians strive for systems where people are aware of how much they are paying for the government?


Nima Sanandaji

Dr. Nima Sanandaji is a research fellow at CPS, and the author of Scandinavian Unexceptionalism available from the Institute of Economic Affairs.

EDITORS NOTE: This article was originally published at CapX.

Who Is Doing More for Affordable Education: Politicians or Innovators? by Bryan Jinks

With a current outstanding student loan debt of $1.3 trillion, debt-free education is poised to be a major issue leading up to the 2016 presidential election.

Presidential candidate Bernie Sanders has come forth with his plan for tuition-free higher education.

Senator Elizabeth Warren supports debt-free education, which goes even further by guaranteeing that students don’t take on debt to pay other expenses incurred while receiving an education.

Democratic Party front-runner Hillary Clinton is expected to propose a plan to reduce student loan debt at some point. And don’t forget President Obama’s proposal to provide two years of community college to all students tuition-free.

While all of these plans would certainly increase access to higher education, they would also be expensive. President Obama’s relatively modest community college plan would cost $60 billion over the next decade. What makes this an even worse idea is that all of that taxpayer money wouldn’t solve the most important problems currently facing higher education.

Shifting the costs completely to taxpayers doesn’t actually reduce the costs. It also doesn’t increase the quality of education in a system that has high drop-out rates and where a lot of graduates end up in low-paying jobs that don’t use their degree. Among first-time college students who enrolled in a community college in the fall of 2008, fewer than 40% earned a credential from either a two-year or four-year institution within six years.

Whatever the other social or spiritual benefits of attending college are, they don’t justify wasting that so much time and money without seeing much improvement in wages or job prospects.

Proponents of debt-free college argue that these programs are worth the cost because a more educated workforce will boost the economy. But these programs would push more marginal students into college without any regard for how prepared they are, how likely they are to graduate, or how interested they are in getting a degree. If even more of these students enter college, keeping the low completion rates from falling even further would be a challenge.

All of these plans would just make sure that everyone would have access to the mediocre product that higher education currently is. Just as the purpose of Obamacare was to make sure that every American had a health insurance card in their wallet, the purpose of debt-free education is to make sure that every American has a student ID card too — whether it means anything or not.

But there are changes coming in higher education that can actually solve some of these problems.

The Internet is making education much cheaper. While Open Online Courses have existed for more than a decade, there are a growing number of places to find educational materials online. Udemy is an online marketplace that allows anyone to create their own course and sell it or give it away. Saylor Academy and University of the People both have online models that offer college credit with free tuition and relatively low examination fees.

Udacity offers nanodegrees that can be completed in 6-12 months. The online curriculum is made in partnership with technology companies to give students exactly the skills that hiring managers are looking for. And there are many more businesses and non-profits offering new ways to learn that are cheaper, faster, and more able to keep up with the ever-changing economy than traditional universities.

All of these innovations are happening in response the rising costs and poor outcomes that have become typical of formal education. New educational models will keep developing that offer solutions that policy makers can’t provide.

Some of these options are free, some aren’t. Each has their own curriculum and some provide more tangible credentials than others. There isn’t one definitive answer as to how someone should go about receiving an education. But each of these innovations provides a small part of the answer to the current problems with higher education.

Change for the better is coming to higher education. Just don’t expect it to come from Washington.

Bryan Jinks

Bryan Jinks is a ?freelance writer based out of Cleveland, Ohio.

“Green Banks” Will Drown in the Red by Jonathan Bydlak

Why does federal spending matter? There are many reasons, but perhaps the most fundamental is that free markets allocate resources better than governments because markets rely on price instead of politics. Many industries show this observation to be true, but the emerging field of “green banks” offers perhaps one of the clearest recent examples.

A green bank is a “public or quasi-public financing institution that provides low-cost, long-term financing support to clean, low-carbon projects by leveraging public funds…to attract private investment.” Right now, only a handful of green banks are scattered across Connecticut, California, New York, Rhode Island, and Hawaii.

Free marketers rightly doubt whether public funds should be used to finance private startups. But regardless of where one stands in that debate, the states’ struggles serve as a valuable testing ground for future investments.

The State of Connecticut operates under a fairly significant budget deficit. California has been calculating its budgets without taking unfunded pension liabilities into account, and it’s gambling with its ability to service its debt. New York continues to live beyond its means. Rhode Island’s newest budget does little to rehabilitate its deficit spending addiction, and, despite having a balanced budget clause in its state constitution, Hawaii has a pattern of operating at a deficit.

In fact, a state solvency report released by the Mercatus Center has each of these five states ranked in the bottom third of the country, with their solvency described as either “low” or “poor.”

This all raises the question of whether these governments are able to find sound investment opportunities in the first place. Rhode Island couldn’t even identify a bad investment when baseball legend Curt Schilling wanted $75 million to make video games about something other than baseball!

Recently, though, there have been calls to extend the struggling green banking system to the federal level. Mark Muro and Reed Hundt at the Brookings Institute argued in favor of federal action in support of green banks. Somewhat paradoxically, they assert that demand for green banking institutions and the types of companies they finance is so strong that the existing state-based green banks cannot muster enough capital to meet demand.

Wherever there is potential for profit and a sound business plan, lending institutions are likely to be found, willing to relinquish a little capital for a consistent and reasonable rate of return. So where are the private lenders and other investment firms who have taken notice and are competing for the opportunity to provide loans to such highly sought-after companies and products?

Even assuming that there is demand for green banking services, recent experience shows that a federally-subsidized system would likely lead to inefficiency, favor trading, and failure. For instance, the Department of Energy Loan Program is designed to facilitate and aid clean energy startup companies. Its portfolio exceeds $30 billion, but following a series of bad investments like Solyndra, Inc., new loan guarantees have been few and far between. The program has already lost over $700 million.

Even the rosiest measurements do not show particularly exciting returns from this system. The Department of Energy itself estimates that over the lifetime of the loans it’s guaranteed, there exists the potential to see $5 billion in profit. However, those estimates also depend on the peculiar accounting methods the DoE itself employs.

This problem is apparent in other government sectors. For instance, determining how much profit the federal government makes off of student loans depends on who is asked. Some say none, while others say it’s in the billions. Gauging the economic impact or solvency of government programs is notoriously difficult, and different methods can yield what look like very different results. Add to that the consistently uncertain nature of the energy market, and profits are hardly guaranteed.

Examples abound of wasteful federal spending, and the growing green technology and renewable energy industry is no exception. The DoE Loan Program has already faced issues that go well beyond Solyndra: Abound Solar, a Colorado-based solar panel manufacturer, was given a $400 million DoE loan guarantee, only to later file for bankruptcy, potentially costing taxpayers $60 million. The Ivanpah Solar Electric Generating System, a 175,000 unit heliostat array in California, received a $1.6 billion federal loan and, because it failed to produce the amount of power estimated, was forced to later request more than$500 million in federal grants from the Treasury Department. A recent Taxpayers Protection Alliance study showed that risky investments in heavily subsidized solar energy could even lead to a bubble similar to the disastrous 2008 housing bubble.

Those who want to expand the government’s role in green banking likely want to see more clean and renewable energy reach the consumer market, and a lot of people probably applaud that goal — but the real question is whether the proposed means can reliably achieve that end. A wise manager with a solid business plan can find investors who will willingly take a chance. Considering the struggles of several states, trusting the federal government to build an even bigger system would exponentially increase that risk.

In contrast, the market offers opportunity to entrepreneurs in the green technology and renewable energy industries. For instance, GreatPoint Energy, a company specializing in clean coal, successfully went the route that other companies do: Design a product or service, find investors, and compete in the marketplace.

SolarCity, a California-based and publicly traded corporation of over 2,500 employees, entered the industry before many government loan programs were established. Thanks to a sound business model and subsequent horizontal and vertical expansion, it has become a leader in the industry. SolarCity’s success, however, cannot be touted by the Department of Energy’s Loan Program, which declined to invest in the company, leading SolarCity to try — and succeed — in finding private investment.

If GreatPoint or SolarCity had failed, only those who willingly participated in the startup would suffer the consequences. The issue with green banking — and indeed government “investments” more generally — is that taxpayers are not party to the negotiations but are the ones ultimately on the hook for failures.

In absolute terms, these billions of dollars are a lot of money. But in the grand scheme of government spending, the amount of money invested in green banks and renewable energy production is relatively small. If Social Security is the Atlantic Ocean, and wasteful defense appropriations are the Mediterranean, then green energy investments fall somewhere in the range of the Y-40 pool: easily measurable but certainly not insignificant.

Your odds of drowning may be smaller in the pool than the ocean, but that doesn’t make the drowning itself any more pleasant. The federal government is already under water; adding new liabilities on the hope that politicians can guess the future of energy is merely a step towards the deep end, not the ladder out.


Jonathan Bydlak

Jonathan Bydlak is the founder and president of the Institute to Reduce Spending and the Coalition to Reduce Spending.

What Greek “Austerity”? by Steve H. Hanke

greek president

Greek Prime Minister Alexis Tsipras

It’s hard to find anything written or spoken about Greece that doesn’t contain a great deal of hand-wringing about the alleged austerity — brutal fiscal austerity — that the Greek government has been forced to endure at the hands of the so-called troika (the European Central Bank, the European Commission, and the International Monetary Fund).

This is Alice in Wonderland economics. It supports my 95% rule: 95% of what you read about economics and finance is either wrong or irrelevant.

The following chart contains the facts courtesy of Eurostat.

Social security spending as a percentage of GDP in Greece is clearly bloated relative to the average European Union country — even more so if you only consider the 16 countries that joined the EU after the Maastricht Treaty was signed in 1993.*

To bring the government in Athens into line with Europe, a serious diet would be necessary — much more serious than anything prescribed by the troika.

* Ed. note: The treaty created the EU and the euro and also obligated EU members to keep “sound fiscal policies, with debt limited to 60% of GDP and annual deficits no greater than 3% of GDP.” Ha!

Steve H. Hanke

Steve H. Hanke is a Professor of Applied Economics and Co-Director of the Institute for Applied Economics, Global Health, and the Study of Business Enterprise at The Johns Hopkins University in Baltimore.

The Crowding-Out Tipping Point: Increasing economic growth means shrinking government by James A. Dorn

The size and scope of government in the United States today would have been beyond the imagination of the American founders. For more than a century after the Constitution’s ratification, Americans took limits on government power seriously.

At the start of the 20th century, total government spending was less than 10 percent of GDP, with the majority of spending taking place at the state and local levels. In 1900, federal spending was a mere 2.8 percent of GDP compared to 21.1 percent in 2014. Meanwhile, state and local spending stood at 5 percent of GDP in 1900, but reached 11.5 percent in 2014. Overall government spending now stands at nearly 33 percent of GDP.

That tectonic shift is largely due to the growth of entitlements and the regulatory state. Nearly half of federal spending goes toward Social Security, Medicare, and Medicaid; government imposes huge regulatory costs on the private sector; and the higher taxes needed to finance big government erode economic incentives to work, save, and invest.

How big is too big?

There is a growing body of evidence that bigger government means slower growth of real GDP. Once the level of total government spending as a percentage of GDP reaches a tipping point, estimated to be from 15 percent to 25 percent of GDP, additional expansion crowds out private productive investment and slows economic growth. An overreaching government diminishes economic freedom and limits private exchange opportunities, restricting the range of choices open to individuals.

In a pioneering study of the link between government growth and national wealth, which appeared in the fall 1998 issue of the Cato Journal, economists James Gwartney, Randall Holcombe, and Robert Lawson found that a 10 percentage point increase in government spending as a percentage of GDP decreases real GDP growth by 1 percentage point. Thus, if government spending went from 25 percent of GDP to 35 percent, real GDP growth would slow over the longer term by a full percentage point. They also found that a 10 percentage point increase in the government’s share of GDP lowered private investment by 1.6 percentage points.

Factors of growth

One of their study’s key findings was that secure property rights — which includes a legal system that protects persons and property, enforces contracts, and limits the power of government by a just rule of law — play an important role in promoting economic growth.

The late Bernhard Heitger, an economist at the Kiel Institute for World Economics, more fully developed the positive relationship between property rights and economic growth in his pathbreaking article in the winter 2004 Cato Journal. In that article, Heitger distinguished between proximate and ultimate determinants of economic growth. The former are well known: additions to physical and human capital and technological progress (also known as “total factor productivity”). But Heitger was interested in the question of what drives capital accumulation and innovation. His answer: the structure of property rights and the associated incentives.

Conventional growth theory took private property rights and incentives as givens. Heitger rigorously showed that private property rights and the rule of law are the ultimate sources of economic growth and the wealth of nations. Well-defined private property rights improve efficiency and increase per capita income. In turn, as a nation grows richer, people demand stronger protection of their property rights, advancing institutional change.

Using data from an international cross-section of countries from 1975–95, Heitger found that “a doubling of the property rights index more than doubles per capita income” and that “more secure property rights significantly raise the accumulation of physical and human capital.”

Bauer’s foresight

That outcome would not have surprised Peter Bauer, a pioneer of development economics. He was critical of the simplistic idea that physical capital accumulation is the key determinant of economic growth. As early as 1957, in his classic Economic Analysis and Policy in Underdeveloped Countries, Bauer noted:

It is misleading to think of investment as the only or the principal determinant of development. Other factors and influences, such as institutional and political forces, the qualities and attitudes of the population, and the supply of complementary resources, are often equally important or even more important.

In the same book, Bauer also anticipated modern endogenous growth theory, stating: “It is more meaningful to say that capital is created in the process of development, rather than that development is a function of capital.” What mattered to Bauer, and to other classical liberals, in the process of development was freedom — namely, the freedom to pursue one’s happiness without government interference except to protect life, liberty, and property. (See James A. Dorn, “Economic Development and Freedom: The Legacy of Peter Bauer.”)

In that sense, Bauer argued that “the principal objective and criterion of economic development” is “the extension of the range of choice, that is, an increase in the range of effective alternatives open to people.” Free markets — resting on effective private property rights — and free people are thus the ultimate determinants of economic growth. When government expands beyond its core functions, it undermines the primacy of property, diminishes the principle of freedom, and erodes the wealth of nations.

The United States falls

The loss of economic freedom in the United States is revealed in the annual Economic Freedom of the World Report, published by the Fraser Institute along with the Cato Institute and a number of global think tanks. In 2000, the United States was the second most economically free country in the world, based on data from 1998. Today it is ranked 12th, based on 2012 data.

To move up the freedom ladder, the United States needs to change the climate of ideas and recognize the importance of private property rights and the rule of law. A legal framework that safeguards persons and property means incentivizing individuals to take responsibility for their actions and allowing people to learn from their mistakes. It means cutting back the size and scope of government and not bailing out businesses.

The nature of government is coercion; the nature of the market is consent. The “great constitutional charter” that George Washington referred to in his first inaugural address (April 30, 1789) was intended to bind Congress to the powers enumerated in Article 1, Section 8 of the Constitution. Thomas Jefferson reiterated Washington’s admonition by stating in his first inaugural address (March 4, 1801): “The sum of good government” is “a wise and frugal government, which shall restrain men from injuring one another, shall leave them otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned.”

Wise and frugal

The challenge for the 114th Congress is to return to “a wise and frugal government.” A first step would be to understand the detrimental effects of expanding government power on economic liberties — especially on private property rights. If history has taught us anything, it is that the size and scope of government matter, both for freedom and prosperity.

ABOUT JAMES A. DORN

James A. Dorn is vice president for monetary studies, editor of the Cato Journal, senior fellow, and director of Cato’s annual monetary conference.