Confronting the prospect of a serious
recession, Members of Congress are split over whether the economic
stimulus package should mostly include tax cuts or spending
increases, or some combination of both. The direction Congress
chooses will have profound implications for the well-being of all
Americans because, as past efforts in the United States and other
countries demonstrate, strategies that rely on increased spending
will fail. Indeed, lessons from past experience and economic
studies suggest that spending strategies could very well make
things worse by diverting scarce resources away from productive use
in the private sector toward wasteful uses that pander to the
interests of influential constituencies.
Instead of increasing spending, a much
sounder economic strategy--based on proven experiences both here
and abroad--would be to restrain or shrink government and utilize
broad-based tax rate cuts that encourage work, savings, and
September 11 terrorist attacks caused many to fear that an economy
already showing signs of weakness would slide into a full-fledged
recession. With hundreds of thousands of workers laid off within
the first few weeks following the terrorist assault, both the
President and many in Congress acknowledged a need for some sort of
government-sponsored stimulus to deter the decline and spur
was often the case during the past 70 years when government
embarked upon an exercise to promote economic revitalization, the
effort to find a solution often divides public officials into
opposing camps with competing visions: increasing spending or
cutting taxes. Some in Congress and many lobbyists want to do the
former, while President George W. Bush and others in Congress
advocate cutting taxes.
President, building on the success that followed President John F.
Kennedy's broad-based income tax rate cuts in the early 1960s and
President Ronald Reagan's in 1981 (which led to the then-longest
peacetime expansion in history), has proposed a package of tax cuts
and worker relief that totals as much as $75 billion. Many in
Congress have endorsed the effort in principle, and the House Ways
and Means Committee has responded by reporting out a tax reduction
bill containing $99.5 billion in tax cuts and relief.
Opposing this approach are a variety of
budget-busting spending proposals--from Congress, governors, and
business lobbyists--to stimulate select sectors of the U.S. economy
by substantially increasing and targeting federal spending that
benefits them. Senator Harry Reid (D-NV), for example, has proposed
a $40 billion stimulus package that includes $22 billion in
transportation spending. More than half of that
spending, about $12 billion, is to go to Amtrak, which carries
one-half of 1 percent of inter-city passengers. Moreover, $1
billion of this would be dedicated to help fund three magnetic
levitation trains, including a new train
connecting Los Angeles and Las Vegas.
Representative James Oberstar (D-MN),
ranking member of the House Committee on Transportation and
Infrastructure, wants $50 billion in new infrastructure spending,
including $23 billion for Amtrak and other rail purposes. His
colleague, committee Chairman Don Young (R-AK), wants a $70 billion
loan and grant package for railroads. A substantial increase in
infrastructure spending is also sought by a bipartisan group of
Senators on the Environment and Public Works Committee. And New
York Governor George Pataki is pressing Congress for a $54 billion
spending package for his state. Reflecting the rail vogue that has
smitten elected officials this year, the package includes a
proposal for a high-speed rail line connecting Schenectady, above
Albany, with New York City.
Before Congress commits itself to a
budget-busting porkfest in the belief that it would help the
economy and put people to work, it is instructive to review the
experience of the United States and other countries with such
A WEALTH OF EXPERIENCE
the findings of comprehensive government-sponsored studies show, efforts to achieve prosperity
through more government spending invariably yield greater poverty
The U.S. Experience with Spending v. Tax
1930s. Perhaps the classic failures in government spending to boost
the U.S. economy were the pump-priming efforts conducted during the
1930s to ameliorate the effects of the Great Depression after the
stock market crash of October 1929. From 1930 to 1940, federal
spending tripled in volume as new programs were created and old
ones expanded in a costly effort to revive the collapsing economy.
As a share of the gross domestic product (GDP), federal spending
rose from 3.4 percent in 1930 to 9.8 percent in 1940. Yet, despite this
unprecedented surge in spending, America's GDP fell by 27 percent
part way through the decade and by 1938 was less than two percent
above its 1929 level.
American workers, the failure of this spending spree to do anything
more than expand the deficit and bureaucracy was devastating. The
number of unemployed more than doubled from 2.8 million at the
beginning of the decade to 6.9 million in 1940.
1960s. Inheriting a sluggish economy when he took office in 1961,
President Kennedy learned from these lessons and instead relied on
a massive tax cut to get the economy going again. It worked;
inflation-adjusted GDP grew by 50.5 percent during the 1960s, a
postwar record for decade-over-decade growth rates.
1980s and 1990s. The 1981 tax cuts of President Reagan led to what
then became the longest peacetime economic expansion in U.S.
history--a record that was broken during the 1990s when economic
expansion was accompanied by a shrinkage in government spending
relative to the size of the economy.
federal government's share of GDP fell from 22.3 percent in 1991
during the brief recession that marked the beginning of the decade
to 18.2 percent by 2000. Because of the restraint on
federal spending, which allowed resources to shift to the more
productive private sector, the economy boomed and a new American
record was set for the duration of an expansion that only an
outrageous act of terrorism could end.
Japan's Sad Experience in the 1990s
United States was not the only country to experience an economic
downturn in 1991 as the Gulf War and its impact on energy prices
and business confidence depressed commerce worldwide. Although the
negative impact on the U.S. economy was brief and shallow, the
effect in Japan was much more severe, exacerbated by that country's
highly leveraged and overextended financial system and inefficient
service, agriculture, and distribution sectors.
Increased Infrastructure Spending. Whereas
the United States responded to this downturn with a sustained
program of fiscal discipline, which eliminated budget deficits and
reduced government's share of GDP by more than 18 percent over the
decade, the Japanese government pursued a contrary tack to economic
Beginning in 1991-1992, Japan adopted the
spending approach now advocated by many in the U.S. Congress when
it embarked on a massive nationwide program of infrastructure
investment. Between 1992 and 2000, Japan implemented 10 separate
spending stimulus packages in which public infrastructure
investment was a major component.
Excluding the 2000 program, for which final costs are not yet
available, additional spending on the infrastructure component
alone amounted to 30.4 trillion yen, or $254 billion at the current
Rising Government Share of GDP.
Combined with increases in other government spending programs,
Japan's efforts to spend its way to prosperity led to substantial
increases in government spending as a share of GDP. Chart 1
illustrates this trend in comparison to fiscal trends in the United
States over the same period.
Historically, the Japanese government
maintained a share of GDP that was smaller than that of the United
States; at the same time, both the Japanese and U.S. governments
had significantly smaller shares of GDP than was typical of most
other industrialized countries. Whereas the U.S. governments' GDP
share was 29.3 percent in 2000, Sweden's share of 53.9 percent was
the highest among the world's advanced countries, followed by
France at 51.2 percent.
Beginning in 1991 and in response to a
weak economy, government spending in Japan rapidly increased. The
relative positions of GDP share between the U.S. and Japan reversed
in 1993 as Japan's program of fiscal stimulus crossed paths with
America's program of fiscal restraint. In the years following, the
gap widened as the countries pursued strikingly different fiscal
result, Japan's growth of government during the past decade may
very well have been the fastest of any country in the postwar
period, in marked contrast not only to the U.S. experience, but to
that of virtually every industrialized country during the decade.
Indeed, between 1995 and 2000, Japan was only one of two in the top
16 nations in the Organisation for Economic Co-operation and
Development (OECD) to experience an increase in government spending
as a share of GDP.
Growth. Japan's failed policies had severe negative consequences
for its economy and citizens. As Chart 2 illustrates, measured in
inflation-adjusted GDP growth, Japan went from being a high-growth
country in the 1980s to a slow-growth country during the 1990s.
Industrial Production. At the same time, Japan's much-vaunted
industrial powers began to wane, as Chart 3 reveals. Between 1992
and 1999, industrial production in Japan increased by just 0.7
percent, while in the United States it increased by 39.6 percent.
France, which each year surrenders half of its GDP to government,
saw an increase in industrial production of only 15 percent, which
closely matched the average performance of most other countries in
Europe where big government is the norm, not the exception.
Decline in the Standard of Living. For the
average Japanese citizen, the chief consequence of this economic
underperformance has been both a relative and an absolute decline
in the nation's standard of living, defined by per capita GDP as
measured by the World Bank and adjusted for differences in
purchasing power parity (PPP). Chart 4
illustrates trends in the Japanese standard of living, as so
measured, compared with that of the United States, which to serve
as a benchmark is set at 100 (as defined by U.S. per capita GDP,
adjusted for PPP).
Japan began gradually to close the gap
beginning in the late 1970s, when its standard of living was about
72 percent of that of the United States. By 1991, its standard of
living had risen to nearly 90 percent of that of the United
States. During this period, Japan's
level of government spending in proportion to its economy, while
rising, was still the lowest of the major industrial countries.
Japan continued with this policy of fiscal restraint and low taxes,
its per capita income (adjusted for PPP) would likely have
overtaken America's by the mid-1990s. But 1991 was also the
beginning of the Japanese government's spending spree and the
country's relative, and then absolute, decline.
After coming within 12 percentage points
of matching U.S. per capita GDP, Japan's relative performance began
its inexorable decline and fell to a 78 percent share by 1999, a
milestone it had surpassed--on the way up--only 12 years earlier.
More important, the standard of living also fell in absolute terms.
After reaching a per capita, PPP-adjusted GDP of $25,373 in 1997,
that measure fell to $24,314 in 1998 and remained below $25,000 in
1999. Significantly, this was the first decline experienced by the
Japanese since this data series began in 1975.
Other Nations' Experience
should be noted that while the Japanese-U.S. contrast is one of the
most striking because of the dramatic policy differences that
occurred during the period under review, U.S. performance
vis-à-vis most other leading countries follows similar
France, for example, which experienced
steady growth in government's share for most of this period, also
saw steady but slow deterioration in its GDP compared with that of
America. Registering a 78 percent share in 1975 (when Japan's was
72 percent), it never got higher than 82 percent and now stands at
just 71.8 percent, reflecting the bloated government (which, again,
spends more than 50 percent of national income) that burdens the
Sweden, whose government is the largest at
53.9 percent (down from its lofty perch of 62 percent in 1995), has
seen its standard of living decline as well compared with that of
the United States. From 79 percent of the U.S. standard of living
in 1985, Sweden's level fell to 71 percent in 1999. Reflecting a
relatively bigger government than any other advanced country's,
over the same period Sweden also fell from being slightly more
prosperous than the French and Japanese to being poorer than
Ireland's experience shows, the United States is not alone in
reaping the economic benefits of less government. Ireland reduced
the government share of national spending in a dramatic fashion
over the 1990s and now has the distinction of being the only
Western European member of the OECD that has a government smaller
than America's, as measured by spending share of GDP. In 2000,
government spending in Ireland was at 27.7 percent of GDP, compared
with 29.3 percent for the United States.
Significantly, this government spending share reflects a marked
decline for Ireland from 36.4 percent in 1995 and over 50 percent
in the early 1980s.
Ireland's government has shrunk proportionately, its standard of
living has soared. Once one of the poorest countries in Europe,
Ireland is now one of the richest. In 1975, per capita income in
Ireland was half as much as it was in France and 42 percent as much
as it was in the United States. By 1999, Ireland's per capita
income had reached 81 percent of America's and exceeded that of
every other leading European country except Norway (whose GDP is
boosted by high oil production compared to its small population)
and Switzerland, whose government's share is also small.
These relationships between government
spending and economic performance have been confirmed in a December
1998 study produced by the Joint Economic Committee of the United
States Congress. Using sophisticated econometric models to examine
data from the U.S. and other countries, the study concluded:
suggests that large transfer payments in particular have negative
consequences for growth. The results for the federal government are
confirmed for state and local governments and several other
countries. The findings suggest that a federal budget strategy of
constraining spending below output growth, with particular
attention paid to constraining transfer payments, would have
positive effects on economic growth.
Although Congress is split over whether
the stimulus package should be comprised of tax cuts or spending
increases or some combination of both, lessons derived from such
past efforts at home and abroad demonstrate that strategies relying
on increased spending will fail. Indeed, such lessons also suggest
that such strategies make things worse by diverting scarce
resources away from productive use in the private sector.
Instead, a sounder strategy to advance
economic activity and prosperity, based on proven performance in
countries around the world, is to restrain or shrink government and
to utilize broad-based tax rate cuts to encourage work, savings,
D. Utt, is Senior Research Fellow in the Thomas A. Roe
Institute for Economic Policy Studies at The Heritage