Category: government investment

The Role of Government

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March 3, 2024

by Stephen Stofka

This week’s letter is about the federal government, its expenses and the role it plays in our lives. As originally designed in 1787, the federal government was to act as an arbiter between the states and provide for the common defense against both Indians and the colonial powers of England, France and Spain. James Madison and others considered a Bill of Rights unnecessary since the powers of Congress were clearly set forth in Article 1, Section 8 of the Constitution. However, they agreed to attach those first ten amendments to the ratification of the Constitution to soften objections to a more powerful central government (Klarman, 2016, p. 594). After the Civil War, the federal government was given a more expanded role to protect citizens from the authoritarianism of the states. The authority to do so came from the amendments, particularly the recently ratified 13th, 14th and 15th additions to the Constitution (Epstein, 2014, p. 15).

After the Civil War, the Congress awarded pensions to Union soldiers, their widows, children and dependent parents. In 2008, there were still three Civil War dependents receiving pensions! (link below). This program indebted future generations for the sacrifices of a past generation. Aging soldiers sometimes married young women who would help take care of them in return for a lifetime pension until they remarried. The provision of revenues for these pensions provoked debate in Congress. In the decades after the Civil War, the federal government’s primary source of revenue was customs duties on manufactured goods and excise taxes on products like whiskey. Farmers and advocates for working families complained that this tax burden fell heaviest on them, according to an account at the National Archives. There were several attempts to enact an income tax, but these efforts ran afoul of the taxing provision in the Constitution and courts ruled them invalid. Fed up with progressive efforts to attach an income tax to legislation, conservatives in Congress proposed a 16th amendment to the Constitution, betting that the amendment would not win ratification by three-quarters of the states. Surprisingly, the amendment passed the ratification hurdle in 1913. In its initial implementation, the burden of the tax fell to the top 1% so many disregarded the danger of extending federal power. Filling out our income tax forms is a reminder that our daily lives are impacted by events 150 years in the past.

In the decade after the stock market crash of 1929, the government extended its reach across the generations. Under the Franklin D. Roosevelt (FDR) administration, the newly enacted Social Security program bound successive generations into a “pay-go” compact where those of working age paid taxes to support the pensions of older Americans. The government assumed a larger role in the economy to correct the imbalance of a free-market system which could not find a satisfying equilibrium. This expanded role of government and the writing of John Maynard Keynes (1936) helped spawn a new branch of economics called macroeconomics. This new discipline studied the economy as a whole and a new bureaucracy was born to measure national output and income.

Students in macroeconomics learn that the four components of output, or GDP, are Consumption, Investment, Government Spending and Net Exports. In its simplest definitional form, GDP = C+I+G+NX. In the American economy each of these four components has a fixed portion of output. Net exports (FRED Series NETEXP) are a small share of the economy and are negative, meaning that America imports more goods and services than it exports. The largest share is consumption (PCE), averaging 67% over the past thirty years. Government spending and investment (GCE) and private investment (GPDI) have averaged an 18% share during that time. Because these two components have an equal share of the economy, more government spending and taxes will come at the expense of private investment. This helps explain the intense debates in Congress over federal spending and taxes. Federal investment includes the building of government facilities, military hardware, and scientific R&D. I have included a link to these series in the notes.

The Social Security program is as controversial as the pensions to Civil War veterans and their survivors. The long-term obligations of the Social Security program are underfunded so that the program cannot fully meet the promises made to future generations of seniors. The payments under this program are not counted as government spending because they are counted elsewhere, either in Consumption or Investment. They are treated as transfers because the federal government takes taxes from one taxpayer and gives them to another taxpayer. The taxpayer who pays the tax has less to spend on consumption or saving and the person who receives the tax has more to spend on consumption or saving. However, those transfer payments represent already committed tax revenues.

The chart below shows total transfer payments as a percent of GDP. Even though they are not counted in GDP, it gives a common divisor to measure the impact of those payments. The first boomers born in 1946 were entitled to full retirement benefits in 2012 at age 66. In the graph below those extra payments have raised the total amount of transfers to a new level. After the pandemic related relief transfers, total transfers are returning to this higher level of about 15% of GDP. I have again included government spending and investment on the chart to illustrate the impact that the federal government alone has on our daily lives. In one form or another, government policy at the federal level steers one-third of the money flows into the economy.

For decades, the large Boomer generation contributed more Social Security taxes than were paid out and the excess was put in a trust fund, allowing Congress to borrow from the fund and minimize the bond market distortions of government deficits. Outgoing payments first exceeded incoming taxes in 2021 and Congress has had to “pay back” the money it has borrowed these many years. To some it seems like a silly accounting exercise of the right pants pocket borrowing from the left pocket, but the accounting is true to the spirit of the Social Security program as an insurance program. Paul Fisher, undersecretary of the Treasury, quipped in 2002 that the US government had become “an insurance company with an army” but the quip underscores public expectations. Workers who have been paying Social Security taxes their entire working life expect the government to make good on its promises.

We are mortal beings who create long-lived governments that act as a compact between generations. We argue the terms and scope of that compact. What is the role of government? The founding generation debated the words to include in the Constitution and even after the words were on the page, they could not agree on what those words meant. The current generations are partners in that compact, still debating the meaning of the text of our laws and the role of government in our lives.

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Photo by Samuel Schroth on Unsplash

Civil War pensions – a National Archives six page PDF https://www.archives.gov/files/calendar/genealogy-fair/2010/handouts/anatomy-pension-file.pdf

Data: a link to the four data series at FRED https://fred.stlouisfed.org/graph/?g=1hxIK. There is a small statistical discrepancy, and that series is SB0000081Q027SBEA.

Social Security: Notes on the adoption of a 75-year actuarial window used by the trustees of the Social Security funds to assess the ability of the program to meet its obligations. https://www.ssa.gov/history/reports/65council/65report.html. In 2021, the Congressional Research Service published a three-page PDF explainer for the choice of a 75-year term.

Epstein, Richard Allen. (2014). The classical liberal constitution: The uncertain quest for limited government. Harvard University Press.

Keynes, J. M. (1936). The general theory of employment interest and money. Harcourt, Brace & World.

Klarman, M. J. (2016). The Framers’ Coup: The Making of the United States Constitution. Oxford University Press.

Sugar Daddy

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June 7, 2015

Older readers may remember Bizarro Superman, the mirror image of Superman, who did things backwards, or in reverse.  That’s the world we live in today; good news is bad, and vice versa.  The employment news was doubly good.  Job gains were stronger than expected at 280,000 but more importantly the unemployment rate went up a smidge, and for the right reasons.  As people become more confident in the job market, they re-enter the labor force, actively looking for work.  Discouraged job applicants have fallen 20% in the past twelve months.  The civilian labor force, the sum of employed and the unemployed, has grown.

Is good news good or bad?  If only the news would wear a hat, white or black, so we could tell. In Friday’s trading, investors bet on the timing of the Fed’s first interest rate increase.  September of this year or the beginning of 2016? When will Sugar Daddy, the Fed, take away the punch bowl of easy money?

The core work force, those aged 25 – 54 who drive the economy, continues to show growth greater than 1%.

Although hourly wage growth for all private employees has been modest at 2.3% annual growth, weekly earnings for production and non-supervisory employees have risen 30%, or 2.7% per year in the past decade, a period which has included the worst downturn since the 1930s depression.  This more positive outlook on wage growth does not fit well with some political narratives.

The decade from 1995 – 2005 had 36% gains, or 3.1% annual growth, only slightly above the gains of the past decade and yet this period included the go-go years of the dot-com bubble and the housing boom. Inflation was higher in that decade, and in inflation adjusted dollars, the earlier period was only slightly stronger than this past decade.  In short, we are doing suprisingly well considering the negative impacts of the financial crisis.

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CWPI

Every month I update the Constant Weighted Purchasing Index, a composite of the Purchasing Manager’s monthly index published by the Institute for Supply Management.  This month’s reading was similar to last month’s, continuing a trough in the strong growth region of this index.

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Heaven On Earth

Last week I asked the question: Why can’t a government with a fiat money system simply give everyone a lot of money and create a heaven on earth?  The standard answer is that it would cause inflation.  For several millennia, when a government injects money into an economy, inflation soon follows as the supply of purchasing power increases without a concurrent increase in the supply of goods and services.  In the 18th century philosophers David Hume (On Money) and Adam Smith (Wealth of Nations) noted the phenomenon.  Peter Bernstein’s Power of Gold recounts ancient examples of kings and governments debasing metal monies and the inflation that ensued.

In the seven years since the recession began in late 2007, the government has borrowed and spent $27,000 per person and there has not been the slightest hint of inflation. Why? There are several reasons.  If a government borrows money from the private sector, there is no net injection of money into the system, no printing of money. A Federal Reserve FAQ on printing money is careful to note that “printing money” is the permanent financing of a government’s debt by a central bank.  Whatever people want to call it, when the Federal Reserve buys government debt, new money is injected into the system.  Since 2007, the Fed has injected almost $4 trillion (Balance Sheet), or about $12,000 per person, of new money without an uptick in inflation.  How is this possible?

There are two types of spending – today and tomorrow.  Spending for today is consumption.  Spending for tomorrow is investment.  Both types of spending drive demand for goods and services.  The paucity of private investment since 2007 is at levels not seen since the years immediately following World War 2.

Although government investment is a relatively small percentage of GDP, that has also fallen to historically low levels.

The sum of private and government investment as a percentage of GDP is shockingly low.

If we use 2007 investment levels as a base, the accumulated lack of investment is far more than the $4 trillion that the Fed has pumped into the economy.

The Fed’s injection of money into the system is primarily spent on government consumption, or today spending, which is helping to offset the lack of investment spending.  As investment spending rises, the Fed has been able to stop adding to its portfolio, although this “tomorrow” spending is still so low that the Fed can not begin to lighten its portfolio of government debt.

Advocates – economist Paul Krugman for one – of greater government investment spending, even if it borrowed money, hope to offset the lack of private confidence in the future.  Previous government stimulus spending did have little effect on overall economic growth simply because it did little more than offset the lack of long term confidence by those in the private sector.