The United States is No Longer the Champion of Economic Freedom

We Americans love to be champions: champions of the Olympics, champions of democracy, champions of the world. For the most part, we are pretty good at it. However, for the last 10 years, America has been losing the championship of economic freedom. According to the 2004 Index of Economic Freedom,1 published by The Heritage Foundation and The Wall Street Journal, nine other countries--Hong Kong,2 Singapore, New Zealand, Luxembourg, Ireland, Estonia, the United Kingdom, Denmark, and Switzerland--are now ranked above the United States.

The United States is losing ground on economic freedom for two reasons: First, other countries are freeing their markets at a faster pace than the U.S. Second, the United States is simultaneously burdening its own economy with increasingly higher government expenditures and barriers to trade and investment. This is not something to take lightly. Economic freedom is the foundation of U.S. economic strength, and economic strength is the foundation of America's high living standards, military power, and status as a world leader.

The U.S. government should take steps to reverse this slide in economic freedom. To that end, the Bush Administration and Congress should cut expenditures to balance the federal budget; eliminate agricultural subsidies, anti-dumping provisions, and other protectionist policies; and continue to support the expansion of free trade. More economic freedom at home will assure that a healthy U.S. economy remains the solid basis of U.S. prosperity and strength.

Why America Is Falling Behind

The United States is losing the economic freedom race for two reasons. First, the U.S. government's continued expansion of expensive entitlement programs has increased the fiscal burden. Second, other important areas of economic openness--capital flows and foreign investment, trade policy, wages and prices, and regulations--have simply failed to maintain pace with the changing world.

Increasing Government Expenditures
The Index measures the fiscal burden of government by the year-to-year change in government expenditures plus top marginal corporate and personal income tax rates. This is an area in which the United States is in a free fall. While the overall economic freedom position of the United States is 10th among 161 countries, when ranked solely in terms of fiscal burden, the U.S. plummets to 103rd place--23 places behind Germany, one place behind Denmark, one place ahead of Sweden, and two places ahead of Norway. By contrast--again in terms of the fiscal burden--Hong Kong is 6th, Ireland is 12th, and Chile is in 22nd place.6

Specifically, high U.S. corporate tax rates7 are negatively affecting investment. The U.S. ranks a dismal 107th out of the 161 countries surveyed in the 2004 Index, meaning that 106 countries have a lower corporate tax rate. To make matters worse, rising government spending has already caused the United States to fall behind other countries, and this situation promises to worsen as the massive commitments of entitlement programs (e.g., Social Security and Medicaid) come due, including the new drug prescription benefit passed by Congress and signed by President George W. Bush in 2003.

Why has the fiscal burden of government in the United States gotten out of hand? Brian Riedl, a budget expert at The Heritage Foundation, has identified several reasons. First, despite $110 billion saved due to a drop in net interest payments on the national debt, the federal budget for fiscal year (FY) 2003 was $353 billion above the 1998 level.8 This means that federal spending represented $20,300 per household in FY 2003, while taxpayers paid an average of $16,780 per household in taxes. The difference ($3,520) is the per-household portion of the federal deficit for FY 2003, which will be paid with higher taxes in the future.9

For many, the events of 9/11 and the need for a stronger national defense justify an extraordinary and unexpected increase in the government's budget. Ironically, however, the majority of the government's spending spree since 2001 is unrelated to 9/11 and national defense.10 (See Chart 2.)

Spending has increased in almost all federal budget categories since 1998, but the fastest growing categories (outside of 9/11 response and defense) include:

• Unemployment compensation , which increased by 132 percent to $56 billion because of rising unemployment and the several extensions of unemployment benefits passed by Congress;
• Education spending , which increased by 78 percent to $58 billion, mostly due to the No Child Left Behind Act;
• Health programs outside Medicare and Medicaid, which increased by 81 percent to $60 billion; and
• Agricultural subsidies , which increased by 76 percent to $23 billion.11

Trade Barriers
U.S. citizens currently pay higher prices for SUVs, textiles, lumber, sugar, peanuts, orange juice, and many other products than they would if there were no trade barriers in place12 As if that were not enough, U.S. consumers and some producers suffered two blows to their pockets subsequent to the start of the Bush Administration: First, in March 2002, President Bush raised steel tariffs to protect a few steel producers at the expense of all American consumers of steel and producers of steel-made products. Second, in May 2002, President Bush signed an agriculture bill that dramatically expanded farm subsidies, which essentially subsidize wealthy U.S. farms at the expense of millions of consumers.13 In addition, the U.S. government continues to use China as the scapegoat for job losses in manufacturing and threatens to meddle with tariffs on Chinese products. The most recent proposal would impose nine different tariff rates on Chinese furniture.14

To its credit, the Bush Administration has engaged in an aggressive expansion of free trade with more than 10 nations, and President Bush lifted the steel tariffs in late 2003. These are steps in the right direction, but the Administration needs to express its support for freer markets more forcefully and credibly by pushing for elimination of subsidies and tariff barriers at once so that America can increase its economic freedom and preserve the image of a pro-freedom government.

Resting on Its Laurels
Much in the same way that the hare lost the race to the turtle, the United States is not taking economic competition with other countries seriously. America is relying too much on its self-image as the free market "champion," but already nine foreign economies have friendlier business environments. It is past time for the United States to start taking this race seriously.

Better policy choices have made these nine economies more attractive than the U.S. economy. For example:

• Trade Policy. Hong Kong, Singapore, and Estonia are virtually duty free. Each country's weighted average tariff rate is lower than 0.5 percent, and there are almost no non-tariff barriers. In contrast, the United States has an average weighted tariff rate of 1.8 percent and numerous non-tariff barriers, including import quotas, antidumping provisions, countervailing duties, and licensing requirements on a number of goods.15
• Fiscal Burden. Hong Kong, Singapore, Ireland, Estonia, and Switzerland have better tax regimes. (See Table 2.)

• Capital Flows and Foreign Investment. Hong Kong, Singapore, New Zealand, Luxembourg, and Ireland have fewer restrictions on foreign investment and on the free movement of capital.
• Regulations. Hong Kong, Singapore, and Denmark have fewer regulations on establishing a new business--including labor laws, environmental and zoning regulations, and bureaucratic steps required to start a business.
• Informal Market. Singapore, New Zealand, Luxembourg, the United Kingdom, Denmark, and Switzerland have a smaller informal market.

The world does not stand still. The perception of the United States as the most attractive place to do business has changed now that other countries have surpassed the U.S. in economic freedom. That same perception will become more dated as the U.S. federal deficit swells; as Congress threatens more trade tariffs and passes legislation to support underfunded transfer programs like Medicare and Social Security; and as the President supports corporate welfare programs such as agricultural subsidies and the American Jobs Creation Bill (H.R. 4520)--a bill that would substitute new export subsidies for the old ones that the World Trade Organization (WTO) has found illegal.

America needs economic growth to maintain its high living standards, support its military power, and continue its influence around the world. To increase economic growth, America needs to "get serious" about the race by immediately sprinting toward economic freedom.

What the Bush Administration and Congress Should Do

The U.S. government should support economic freedom by all means at its disposal. Keeping America free of protectionism and special favors while reducing the fiscal burden of government will foster economic growth. To that end, both Congress and the Bush Administration should work together to:

• Cut expenditures to balance the federal budget. The federal government can balance its budget in two ways: cutting expenditures or raising taxes. Raising taxes means people keep less of what they earn, reducing incentives to produce more, thus thwarting economic growth. Therefore, the U.S. government should reduce government expenditures to ease the fiscal burden of government. Riedl recommends a strategy to keep federal spending under control, which includes the following actions:

• Eliminate agricultural subsidies, antidumping measures, and other protectionist policies. Subsidies and special protections benefit small economic interests or sectors at the expense of millions of American consumers and producers. They translate into higher prices, which disproportionally affect poor Americans. The Bush Administration should advance an agenda to eliminate agricultural subsidies at the WTO. It should take advantage of Europe's recent proposal to put the Doha round back on track by ending agricultural export subsidies, and it should encourage Japan to eliminate agricultural export subsidies as well.
• Continue to support the expansion of free trade. So far, the Bush Administration has advanced free trade agreements with Chile and Singapore and has completed negotiations with Central America, Australia, and Morocco. It should continue to negotiate free trade agreements with other countries around the world and Congress should approve these trade agreements.