Tuesday, February 6, 2018

Fiscal Panic: It's Already Here

This week is dedicated entirely to articles about austerity and what will happen if we continue to spend as usual and just raise taxes as we go along. Yesterday I gave an example of what can happen to a person who entrusted her life to the welfare state, and was then thrown to the wolves when big government, no longer able to pay for all its promises, goes into fiscal panic. When that happens, people who depend on government are discarded as irritating cost items.

This is the ugly, dark side of big government that our statists refuse to see. It is the underbelly of the welfare state that brings people to their knees, for no other reason than believing in the spending promises that their politicians made.

I have seen, first hand, how people's lives get crushed when an over-promising government goes all-out austerity. I have seen great schools crumble under panic-driven budget cuts. I have seen patients die while waiting for health care that government promised, but never could afford to deliver. I have seen good neighborhoods be turned into criminal war zones because government chose to defend its vote-winning entitlements and could no longer afford police.

Can't happen here? That is what they said in Sweden, Britain, Denmark, Spain, Portugal, Greece, Puerto Rico... Who thought Illinois would be brought to the brink of bankruptcy?

So far, Illinois, New York, New Jersey and California have not resorted to the kind of fiscal massacres that European welfare states have been through. They are still in the process of taxing their citizens to the max. Once they are done with that, though, things will turn bad rather quickly.

Unless they give up the welfare state now. Before disaster strikes.

If we go down the path of raising taxes, the fiscal-panic clock will start ticking here, too. It is very important that we understand exactly what this means; what will happen on the ground, in our schools and hospitals; what will happen to our highways, to law enforcement - and to the overall reliability of government.

Later this week I will use a government-budget scenario to explain exactly what we can look forward to if we raise taxes today and get on the path to austerity and fiscal panic. Today, though, we are going to take a quick look at the mechanics that open the path to fiscal panic. (A shorter version of the same explanation is available here.)

Figure 1 explains how a government budget is supposed to work. Suppose government spending follows path (a) over time. Revenue rises and falls with the business cycle: in growth periods, when times are good (1), revenue exceeds spending; in recessions, when times are bad (2), revenue falls short of spending. The surplus (blue) can then pay for the deficit (red):

Figure 1

This is, again, how the government budget is supposed to work according to theory. In practice, there is never a perfect balance between surpluses and deficits. That said, government can balance its finances relatively well if it dedicates a budget surplus to coming deficits - and refrains from growing spending in good times.

That last point is usually where things go wrong. We will get back to that point in a moment; for now, let us look at what happens in a situation with declining tax revenue, like the one we have experienced in the past couple of years here in Wyoming.

Figure 2 adds the drop-in-revenue scenario to Figure 1. A non-cyclical event (3) - we tend to think of it as a decline in minerals activity - permanently reduces government spending. Assuming that this happens at the bottom of a recession*, the expected increase in tax revenue that would have followed with a regular recover, is now replaced with a major decline (b):

Figure 2

Instead of shrinking, the deficit is now expanding. The state is burning through savings at a rapid pace, in order to fund the deficit. However, since funding a deficit is different from solving it, the state will burn through its savings at an increasing rate. 

This is the scenario that opens for austerity. Even though our state government has quite a bit of cash in the bank, you can only spend a saved dollar once. As savings deplete, the legislature and the governor will resort to faster, increasingly desperate measures to reduce the deficit. 

One of those measures is panic-driven tax increases. We have already seen the first example of that here in Wyoming, in the form of the Taxmageddon package. It died in the Revenue Committee, but since the panic behind the Taxmageddon package has not gone away, we can safely expect other measures of at least the same drastic nature. 

In fact, if the legislative leaders, their statist cohorts and Governor Mead double down on their panic-driven solution to the current budget crisis, their measures will become increasingly desperate over time. Those measures will include both destructive tax increases and disorganized reductions in government spending.

That is the scenario we are going to explore this week. 

Before we sign off for today, let us quickly take a look at the mechanics of a solution to a budget crisis. Instead of waiting for the jaws of fiscal panic to start chewing away at taxpayers and people dependent on government, the legislative response must be a proactive package of thoughtful, substantial and permanent reductions in government spending. 

At the very least, as Figure 4 demonstrates, the goal is to bring the cost of government down to a point where, initially, we can fund it even at the bottom of a recession (4). Then, as that new, slimmer and less costly government settles in, we can cut taxes permanently (5). This lowers the long-term trajectory of both spending and taxation, eases the burden of government and allows the private sector to grow:

Figure 3

When government is smaller relative the economy, the risk for panic-causing episodes of austerity is considerably lower. A smaller government imposes a lighter burden on the private sector, thus making it easier for businesses and households to thrive. Recessions become lighter and easier to deal with. 

That is all for today. See you right back here tomorrow.
*) In theory, a structural decline can happen at any time. The problem is that it usually masks itself as a regular recession; often, it is not until we are somewhere in the middle of the recession that the true nature of the economic downturn unmasks itself. This makes it all the more difficult to identify the structural declines, reinforcing the point that we to put as much distance between regular government spending and fiscal panic.

No comments:

Post a Comment