The Fragility of Freedom at 60%

The following is a guest post from Marotta Wealth Management.  I generally like to stay out of political discussions, but the topic of over-spending by our government has been on my mind recently and I thought this piece might generate some good discussion. It's not an anti-Republican or anti-Democrat piece, but rather one that makes us think about the consequences of our on-going (and getting worse) deficit spending.

In 1977 economist Milton Friedman wrote an article "The Line We Dare Not Cross: The Fragility of Freedom at '60%.'"

He predicted that as the percentage of society that owes a portion of their livelihood to government spending increases, the ability to limit the growth of government will decrease. At some tipping point, attempts to reduce the size and scope of government become too difficult. Welfare statism sets in as a permanent malaise and drags on the growth of the economy.

Friedman said, "We still have some ruin in us, but pretty soon we are going to be forced to face up to the issue." We did a good job of keeping government spending relatively constant as a percentage of gross domestic product (GDP) for the next 30 years. Total government spending was at 33% in 1977 and had risen to only 35% by 2007. But since 2007 we've expanded the scope of government from 35% of GDP to 45%.

This overspending is certainly severe, but the cumulative deficit spending is even more critical. When Friedman warned us about the fragility of freedom, the gross public debt was at 47% of GDP. After three decades of deficits it had risen to 81%. Today it is at 120%. In just three short years we've added more to the deficit as a percentage of GDP than in the three decades before.

We don't have much ruin left. We have to face up to the issue. We are in danger of crossing a line we dare not cross.

Every time government spends money to provide security to a few, it destabilizes the rest of society. Shore up one sector and you risk impoverishing other sectors. Soon catastrophes in those sectors that are left free of government support are perceived as further evidence of the failure of the free market. Each crisis becomes an opportunity to expand the scope and power of government.

Most government spending consists of benefits given to the few while the costs are borne by the many. Thus a small minority has a large vested interest in seeing the legislation passed, and for the large majority it isn't worth the time and effort to try and defeat it.

Imagine there are 100 people in society and each earns $100 a day. Now imagine for just $5 a day from each person you could support five people so their income was secure and they could do public good. For the five people involved, it is a great deal. Everyone else is too busy to organize and fight against funding them. After all, it is only worth $5 to fight against it, but it is worth $100 each for those five to organize and agitate for it.

Perhaps there are another 10 people who benefit most from the good being done. It will only cost them $5 a day, and they might get $20 a day worth of benefit. Under the free market they could have purchased the benefit directly, but it would have cost them more. Never mind that they are middle class and could have afforded it. Why should they be obliged to pay when they can vote for the government to provide it for "free"?

The other 85 people only get $1 worth of benefit and it costs them $5 in taxes, but it isn't worth fighting, so they end up paying it. The cost to society is $500, and the benefit to society is only $285. The rest is lost opportunity costs. Most people, had they kept their $5, would have spent it on exactly what they valued at $5, and there would have been no waste. But because society pooled its money, few got what they really wanted.

And now that everyone only has $95 left to spend, everyone's businesses will collect 5% less in revenue. Society as a whole will be poorer as a result. In our example the level of missed opportunity costs was only 40% of what was collected plus an additional 5% less in GDP. In reality, the level of waste is much higher. Compliance and collection are costly. Federal monopolies are rife with enormous inefficiencies.

Ultimately the five individuals who are on public support have secure jobs, better pay, superior benefits and guaranteed pensions. In fact, we are there already. A Bureau of Labor Statistics study this month showed that federal jobs paid better than the exact same job in the private sector 83% of the time.

The difference is striking. The average salary in the private sector is $60,046, whereas the average federal worker earns $67,691. That's 12.7% more pay for the public servant. And the difference was even more pronounced in benefits. Health, pension and other benefits total $40,785 per federal worker but only $9,882 per private worker. So the total compensation package for the federal worker is $108,476--a full 55% higher than the worker in private industry whose total compensation amounts to only $69,928.

There is also the inevitable building of government fiefdoms and use it or lose it budgeting. Government bureaucrats each serve their own private interests. Many are seeking to further their careers or salaries. Others are seeking to extend their power and prestige. The legislation and regulations they put in place uses force to implement their interests.

An example from Friedman describes the problem succinctly. In a political decision, if 51% vote for red neckties and 49% vote for green, 100% of the people get red neckties. Each individual vote counts for very little in the political process. Contrast that with the free market where every vote counts and people get exactly the color they want.

The strategy for building a politically powerful coalition is to find a dozen such minorities who are willing to support you if you vote for their pet project regardless of what else you may do. This aggregate spending may be burdensome to society as a whole, but each item by itself will have a strong advocate. Although there may be popular support for cutting government spending in general, people will be reluctant to cut any specific programs because of the vehement support by an emotionally vested minority.

Friedman asked this very important question: Is there anybody in the vast American electorate who would take his or her vote away from a representative because that person voted to keep some small special-interest project? We need people like that. We need people who are against society specifying tie color even if they want red ties.

We need government employees who are willing to vote for limited government. We need middle-class families who are willing to let entitlement programs stop after funding the truly needy. And we need liberals who are willing to join with libertarians to say "Enough."

Holding the line on the growth of government is challenging, but there is a line we dare not cross. Just because something is good for most people doesn't mean it is good for everyone. Society is interconnected. We must cooperate in nearly every component of the economy.

We can either allow that cooperation to be voluntary or coerce behaviors through force. The first spreads a multitude of small benefits over many people. The second gives larger benefits to a privileged minority. One leads to freedom and prosperity. The other leads to tyranny and misery.

Comments

[wanzman]

The real issue is not a matter of being better off by working for X or better off by receiving Y for free from the governement. A very large number of people would rather live on less for free, than actually get off their butt and make a living by working hard.

As this group grows larger and larger, eventually the welfare group becomes the majority of society, and they have no reason to vote for people who be responsible with tax dollars. They will vote for people who promise more and more handouts (Obama).

These folks fail to reailize that if so much money is spent on entitlements, the US is eventually going to go bankrupt, which will mean everyone is screwed. But then again, we're not really talking about forward thinkers, this group.

The US going bankrupt used to be hard to fathom. Today, its almost hard to fathom how it won't.

[CS]

Wonderful post! We need to get more people to start waking up to this before it truly is too late. Whatever happened to: "Ask not what your government can do for you, but what you can do for your government?" We need to quit relying on the government and starting practicing personal responsibility.

[wanzman]

This is the response I am waiting for.....

"You crazy right wing nut, why don't you go and watch some more Fox News."

That is how we will know the folks described in the article have arrived at this website.

[The Biz of Life]

It's amazing how prescient Friedman was. He is still winning economic arguments from beyond the grave. Or to paraphrase Ben Franklin, as soon as the voters realize they can vote themselves money, the republic is doomed. The government job is the sweetest gig Joe Average can have today. This power shift from producers to takers bodes ill for the country's long-term financial health.

[Old Limey]

In my opinion the turning point was the 2000 election. In this election which was the closest one since 1876 and one in which the eventual winner lost the popular vote by almost 544,000 votes. Clinton had been in for 8 years so his VP, Al Gore was the candidate. Clinton left office with the largest budget surplus in US history of $237 billion and with the projection that with Al Gore staying on the same course that the National Debt would be retired by 2008.

We all know what happened. As a result of waging two long and drawn out wars, passage of a $300 billion tax cut for the wealthy and the passage of the unfunded Medicare part D program which added an estimated unfunded liability of $9.4 trillion over 75 years, the new healthcare program and the greatest recession since the Great Depression, the US budget is now on a course that can only lead to disaster. Social Security and Medicare in particular do not have the funding to be self sustaining and unemployment benefits have become a lifestyle for many.

National Debt
==========
9/30/1992 ---- $4.1 trillion
9/30/2000 ---- $5.6 trillion
9/30.2009 ---- $11.9 trillion

One of America's greatest strengths has always been higher education and innovation of fabulous new products. Now however with drastic cuts being made throughout the educational system in all states because of the great recession the quality of higher education is being threatened. Having already lost the majority of production jobs to countries with lower labor rates America's future depends upon its ability to innovate and continue to develop new products that lead the world, even though we cannot compete in their manufacture.

My hope is that we can bring all of our troops home ASAP and become the world leader in Green Energy.
We also have to get our budget under control and that is exceptionally difficult to do in an environment with such a high unemployment rate. We also no longer have a government where the two main parties are able to cooperate with each other. I don't see a path, a politician, or a party, that can lead us out of this mess.

[brooklyn money]

What drives me nutz is the pensions that government employees get. At the expense of tax payers who do not receive pensions and at the same time must finance those of public employees.

[MC]

Oh, Milton!

What cracks me up is that all "self-made men" talking like this got there by using their government-supplied childhood public education, read books while growing up that they got from the public library, did so using light from government-driven rural electrification programs, on a family farm supported by government subsidies, went to college on the GI bill, purchased a home for the mortgage tax break and has a business that relies on government-supplied transportation networks (air, train, interstates). Oh, and is looking forward to medicare and social security during retirement.

[jim]

Unfunded government spending and mounting debts are not good things. No argument there.

The main point I hear in this article seems to be : "Most government spending consists of benefits given to the few while the costs are borne by the many."

Most federal spending benefits all of us or at least the overwhelming majority of the population. Over 60% of federal government spending is on Defense, Social Security & Medicare. These are not benefits "given to the few". We all benefit from national defense and SS / Medicare benefit us all in our retirement years. Various other federal spending programs benefit all of us directly or indirectly. Dept. of Transportation helps fund building of interstate highways. Dept. of Agriculture make sure our food is safe. etc. Very little federal government spending is simply some sort of entitlement handout for a minority of non-contributing lazy people.

Second point I see in the article is an argument that government employees are over paid. I'm a bit doubtful that federal employees in general are compensated so much better on a real apples-to-apples comparison. But if it is true then it alone would not account for a large % of government spending. Federal employee salaries are not really a huge portion of federal spending. The federal government employed about 2M people in 2008. Their salaries account for around 6% of total federal spending. So even if cut their wages by $40,000 average then that would equal $80B in spending or just 2% less federal spending.

[Budgeting in the Fun Stuff]

Jim, I read it the same way. I don't think that the deficit is mainly caused by entitlement programs and overpaid federal workers.

I think it's caused by mismanaging the money they have and war.

Simply wasting less would save billions and funding the last 9 years of war drove the deficit sky high. These wars have ended up being the most expensive temper tantrum in the history of the world. Sure, entitlement programs should stop with the truly needy, that's inherent money mismanagement right there.

I wish the government was forced to live on a budget just like mine...if they want something they can't afford, they should have to save for it.

[CS]

The deficit is growing because of growing government and welfare is a big part of it. Social security is a welfare system that is putting a huge strain on our government. The tax system itself is a welfare program (you can get more money back via a refund then what you paid in). Welfare is a major problem with the deficit. The TARP and bailouts are the biggest reason the deficit has skyrocketed. Over 50 Billion given to GM and only 5 is considered a loan. Welfare has to slow down!

The wars are one of the things that GW got right, and O continues to get right.

[MasterPo]

Wanzman is 100% correct. It may not be a "good life" as we here would consider it, but for people with truly little (or nothing) the living off the government dole is a whole lot better than what they have now. Who in their right mind would actually vote for someone that wants to take them from them and make them now pay (even just a piddly $1/day) for some benefit they get for free now?!

OTOH, Old Limey is 100% incorrect. The phantom "budget surplus" was just that - a phantom. It didn't exist. There was no box at the Treasury marked BUDGET SURPLUS $$$. The "surplus" was a *PROJECTED* (that means ESTIMATED) surplus *presuming* a whole bunch of incredibly grand (and unrealistic) situations like growing tax revenues, low interest rates, steady employment figures, a good stock market, etc. It also did not account for "what-if" scenarios like disasters or - least we forget - WAR!

MasterPo would also like to take a moment to remind people that a "surplus" in the governments coffer simply means that WE the American people were taxed too much!!! Government - unlike a business - is not mandated in any way, shape or form to run a "profit". Any excess of revnue over spending does NOT belong to government. It belongs to the people government taxed to get the $$$.

[MasterPo]

Jim - Please don't lump defense in to that 60% figure.

Defense is only about 20% of the Federal budget. Social programs spending is more than 50% (and growing!).

Also, defense is MANDATED by that old document - what is it called: The constellation? The constipation? The confligration? I forget - to be provided by the government. SS, Medicare, etc. is not.

[Jeroen]

You Americans are funny when it comes to taxes. you're all yelling doom and crying about the taxes you pay. Guess what: you are among the lowest taxed people in the industrialised world. fr.ex, my income tax alone is near 50% (more for bonusses and overtime), we also have VAT on everything...

Maybe you need a new World War? To pay for the last one and the recovery, highest income earners payed 90% in taxes :o :o

Also: federal budgets, just like household ones, have an income side too. In recession years, there will be less money coming in, but the projected costs won't have changed. That's the main reason of the deficits.

And another thing: indebtness of a country is a very complex issue. When I see people not trained in macroeconomics make assumptions, they are usually completely wrong.

[Paul]

Milton Friedman was a wise man. Too many folks are selling their freedom to vote for government handouts, and too many politicians are addicted to the power it gives them.

[wanzman]

What I loved recently is how Senator Tom Coburn (from Oklahoma as am I) was talked about in the news for "holding up a Bill to extend unemployment benefits".

No much was said about how he really just wanted the darn Bill to be paid for before it was passed into law.

How long can we keep extending unemployment benefits? Maybe years and years? Maybe we can all just go on unemployment until we reach social security age. That way I would never have to work again. Ever!

[wanzman]

Old Limey:

If Clinton did such a great job at balancing the budget and even creating a budget surplus, then how come the national debt grew during his 8 years in office? Here is the data you gave:

National Debt
==========
9/30/1992 ---- $4.1 trillion
9/30/2000 ---- $5.6 trillion
9/30.2009 ---- $11.9 trillion

The national debt grew by $1.5 trillion while Clinton was in office by your data. What surplus?

Oh, that's right. There was no surplus. Only a politician spinning some data to say that IF such and such happens, and IF that happens, then we might have a surplus. But the IF's were like, if we do away with social security, and so away with Medicare, and don'y ever go to war again, and double the current tax rates, then we will have a bidget surplus.

[James]

"You Americans are funny when it comes to taxes."

If you actually knew anything about American tax policy you would have mentioned the sales taxes paid anywhere from 5% to 13% (in some cases), the numerous excise taxes paid such as those paid on all utilities and on a gallon of gas, not to mention the so called "fees" that are disguised taxes such as business license fees that you get what benefit from for registering your business with the govt? or the sneaky little extras they throw into your various insurance bills. Oh then throw in that ponzi scheme tax for FICA and the medicare care tax. Add it up sometime and you're not talking chump change for the average American. Oh, and that VAT in your country, I'm sure that is really working out well in helping to stimulate a booming economy.

[R. Killackey]

President Carter warned us in 1979 what was coming.

Our forefathers knew they could not set up a direct democracy, that is why we have a Republic (all be it broken at this point, due to lobbying).

My father always said "the masses are asses" and in a direct democracy you could elect with 51% of the vote, to kill the other 49% of the people.

What happened to the "majority rules but the rights of the minority are respected".

[Mark]

@Wanzman:

Clinton did not have budget surpluses the first few years. If you looked at the data for each year, you would see that it took his first term to get spending back into balance, and the surpluses in the last few years were real - NOT speculative.

The Bush tax cuts, combined with an economic downturn and two wars (one of which was started by choice), put the country back into deficit.

You could argue that Clinton got lucky taxing the dot-com boom. You could also argue that Bush was unlucky because he had to fund two wars. But - you cannot dispute the fact that tax receipts exceeded spending for the last few years of Clinton's presidency.

I find it extremely ironic that the big budget deficits seem to occur under Republican stewardship. Aren't they supposed to be the party of small government and fiscal responsibility? Putting aside the political necessity of war - shouldn't we pay as we go for our actions?

[wanzman]

Mark:

I am not arguing for the Republicans or Democrats.

I think that both parties are equally as stupid and foolish when it comes to spending funds. I was just pointing out that the national debt rose while Clinton was in office....a lot of people don't realize that.

I agree with this:

"Putting aside the political necessity of war - shouldn't we pay as we go for our actions?"

I agree "we" should pay as "we" go for "our" actions.

But the fact is, many American pay no income taxes at all, and receive all the same benefits (usually way more benefits). So in this case, WE pay as THEY go.

Also, the politicians really do not make decisions based upon what is best for their constituents. They make decisions based upon what will most likely get them re-elected - they make choices that please the special interest groups that pay for their campaigns. So again, in this case, WE pay as THEY go.

[Jeroen]

James,

"If you actually knew anything about American tax policy"

1. I know more about it than you do about Belgian Tax policy, I think.
2. We have all of what you said too. VAT of 7-19%, gas price are currently 1.36EUR/litre. We have a public single payer health care system, paid for by taxes, we have more levels of government than you can dream of.

Instead of getting defensive, get educated: look here: http://en.wikipedia.org/wiki/File:Income_Taxes_By_Country.svg And look at that long line there at the bottom, that's were I live.

[Rodney]

The biggest contributors to the deficit are SS, medicare, and the wars. When Social Security was first established the qualification age was close to the average life expectancy, so folks did not draw down as much in retirement. Now, with life expectancies significantly higher, the SS qualification age needs to increase accordingly. Unfortunately, with so many voting Baby Boomers nearing the current qualification age, it would be difficult to muster the political will to make changes. However, had these issues been addressed decades ago it would not have been as traumatic as folks would have had time to plan (I am 28 now and knew this was an issue since grade school just to give some perspective on fact that this was a known problem). Frankly, I was mostly against G. W. Bush, but wholeheartedly agreed with privatizing SS. In fact, I wouldn't protest getting rid of the program entirely, even if in a graduated way, since I am against wealth transfers by the government in all respects, as it introduces inefficiencies AND politics into the free market.

[Federal Lawyer]

I get very tired of people saying that federal employees are overcompensated. As an attorney who joined the federal ranks last year, I took a 60% pay cut. Although I have practiced law for more than a decade, I make less than a first-year associate at my former firm. Yes, I get a pension and better medical plan. However, I do not get maternity leave or disability insurance, which I did in the private sector. I wish the information that gets touted in the media better reflected the real economics. Perhaps in some occupations, federal workers are compensated at higher levels than their private sector counterparts. On the other hand, there are other professions for which that does not hold true.

[jim]

Rodney, SS has not contributed to national debt or deficit. SS has been running as surplus for several years and the government has turned around and spent that money elsewhere (rather than borrowing more). SS has been subsidizing the rest of the budget.