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Financial Planning > Tax Planning > Tax Reform

Bankrupting the State

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All imperial expansions in history were driven by some form of ideology. An ideology mobilizes and focuses national energies, but it can also be extremely limiting and can lead to a downfall.

Soviet Communism was an example of both an ideologically driven expansion, whereby the Russian Empire surpassed in territorial reach the 19th-century British Empire, and an ideologically driven decline. The Soviets stubbornly clung to their ideology, even though it was poorly suited to any modern economy.

It is ironic, then, that two decades after winning the Cold War — and proclaiming ideological triumph for democracy and the market economy — the United States may go bankrupt as a result of its winning ideology.

Growing Revolt

Two salient features of modern American ideology are distrust for big government and belief in the unrestrained free market. True, suspicion of the federal Leviathan permeates the Constitution. As the role of the Federal government grew over the past 200 years, various movements periodically emerged intent on curbing its advances or escaping its reach. But the extent of the current anti-government revolt, spearheaded by the Tea Party movement and enjoying broad support, is probably unprecedented in modern times.

Moreover, such distrust for Washington is a new phenomenon. In the decades after World War II, the beneficial role of enlightened government was widely recognized. Fiscal stimulus begun by the Roosevelt administration was credited with alleviating, if not ending, the Depression. Public works financed and managed by Washington had put millions of Americans to work and helped build the country’s infrastructure.
Meanwhile, the middle class began moving into private homes — thanks to government initiatives designed to promote home ownership.

Few people doubted that a variety of Federal programs, put in place in the New Deal but retained and expanded in the postwar era, were not only great achievements of an advanced society but also the foundation of the country’s prosperity. The two postwar decades are still sometimes called America’s Golden Age.

Trust in the beneficial role of government was bipartisan. During Dwight Eisenhower’s presidency, a system of interstate highways was completed, not only facilitating economic growth but cementing the American love affair with the automobile.

Those who claim that governments always fail when they try industrial policy ignore the way home ownership and highway construction programs shaped the American economy and informed the American character.

Even though Lyndon Johnson’s War on Poverty is recognized as a failure, his use of federal power to end segregation was a major achievement. Moreover, the excesses of 1960s social spending didn’t alter the attitude to government. After the Republican victory in the 1968 presidential race, Washington was still expected to direct national economic development. Richard Nixon offered federal programs to promote entrepreneurship among the poor and disadvantaged.

Reagan’s Revolution

The watershed came in 1980. Anti-government, anti-tax sentiment had been brewing locally, as evidenced by California’s Proposition 13 in 1978, which limited the state’s right to raise property taxes. But Ronald Reagan was the first to attack the federal government from a national platform, railing against Washington from the White House.

Reagan ran as an outsider and pilloried the Washington bureaucracy as overfed, intrusive and incompetent. The government was taking too much of taxpayers’ money, and squandering it. The waste, in his view, was not tied to the incompetence of a particular bureaucrat or a system in need of reform. It was a matter of principle. Businesses and consumers will always spend their money more effectively than public officials.

Reaganomics went further. No one except Karl Marx ever contested the superior economic efficiency of the market. Now, the new ideology proclaimed that the free market was even more equitable in distributing wealth. Previously, the free market had been seen as a dog-eat-dog place that had to be humanized by government intervention.

Various policy conclusions followed from this reasoning, including: that industrial policy should not be part of a government’s mandate; that regulation must be curbed; that redistributing wealth through taxation harms the economy; and indeed, that taxation is basically evil, essentially a legalized theft of private property.

Some of these notions proved highly beneficial, especially in the 1980s, as the over-regulated, highly taxed economy had clearly stagnated. Reagan’s reforms spurred rapid growth at home and abroad, a technological revolution and an unprecedented rise of entrepreneurship.

But distrust for the government and the tax revolt are a dangerous obverse of the pro-market ideology, which could negate all achievements of the past three decades.

Political Third Rail

Taxes remain taboo in U.S. politics. The elder George Bush lost his bid for a second term in 1992 largely because he broke his “read my lips” pledge not to hike taxes. While Republicans have been more consistent in anti-tax rhetoric and practice, Democrats also fear popular backlash on this issue.

Cutting taxes is still seen as a panacea to spur economic growth. There is still talk of extending George W. Bush’s tax cuts, even though they turned a federal surplus into a deep structural deficit. Even Barack Obama, while threatening to tax the wealthy, promises a “tax cut for the middle class” despite a $13 trillion government debt.

Such rhetoric ignores both economic theory and historic precedent. This is typical of ideologically driven concepts and harks back to the Communist faith in the abolition of private property. According to Marx, public ownership of all property would automatically lead to economic prosperity and social justice. The fact that it didn’t was not reason enough for Soviet leaders to shift course.

Some of Reagan’s admirers believed that rising public sector deficits during his tenure would slay the Leviathan by gorging it to excess — so even the Democrats would agree to slash government. Since then, moves toward fiscal discipline, such as they were, always entailed promises to cut government spending, never to raise revenues.

But public spending proved difficult to cut. Whether under Reagan or his successors — both Democrats and Republicans — spending rose. There is no conspiracy here. In every modern industrial democracy, governments play a massive role — and a growing one.

The only area where some rich countries have been able to curb spending has been the military. But the U.S. has had to pick up the slack instead and, in any case, this is one area where anti-tax Tea Partiers typically refuse to contemplate cuts.

Military-Industrial Complexities

The modern military is not just a standing army. It’s about technology and innovation. Silicon Valley and other high-tech hubs thrive on military orders. Since innovation does not occur in a vacuum, colleges need to graduate a wide variety of scientists, researchers, engineers. Education needs to be broad based, affordable and attractive to the best brains around the world. This is where government’s role is crucial.

Often, the complexity of modern society requires more government intervention, not less. The collapse of the financial system in 2008 and the oil spill in the Gulf of Mexico point up the perils of a devil-may-care government.

Whether we wish so or not, the Leviathan will continue to grow. But it has been expanding on an ad-hoc basis, without rhyme or reason, financing the expansion by debt. This is the least efficient way of approaching it, not to mention the costliest. It ensures that taxpayers will remain skeptical of their government, which in turn will preclude the return of fiscal discipline — and will eventually mean a default on U.S. Treasury debt.

Alexei Bayer is an economist and author based in New York City.


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