And when I discuss my work on the economic impact of government spending, I often get the same reaction.

This is why it’s important that a growing number of establishment outfits are slowly but surely coming around to the same point of view.

• The European Central Bank published a study showing “…a significant negative effect of the size of government on growth.”
• A study by two Harvard economists found that “large adjustments in fiscal policy, if based on well-targeted spending cuts, have often led to expansions.”
• The Organization for Economic Cooperation and Development noted in recent research that welfare programs are economically destructive because they lure people into dependency because “net disposable income would increase despite putting in fewer hours.”
• A study from the International Monetary Fund concluded that “Cuts to pension and health entitlements had the most beneficial effect on economic growth.”

This is remarkable. It’s beginning to look like the entire world has figured out that there’s an inverse relationship between big government and economic performance.

That’s an exaggeration, of course. There are still holdouts pushing for more statism in Pyongyang, Paris, Havana, and parts of Washington, DC.

But maybe they’ll be convinced by new research from the World Bank, which just produced a major report on the outlook for Europe. In chapter 7, the authors explain some of the ways that big government can undermine prosperity.

There are good reasons to suspect that big government is bad for growth. Taxation is perhaps the most obvious (Bergh and Henrekson 2010). Governments have to tax the private sector in order to spend, but taxes distort the allocation of resources in the economy. Producers and consumers change their behavior to reduce their tax payments. Hence certain activities that would have taken place without taxes, do not. Workers may work fewer hours, moderate their career plans, or show less interest in acquiring new skills. Enterprises may scale down production, reduce investments, or turn down opportunities to innovate. …Over time, big governments can also create sclerotic bureaucracies that crowd out private sector employment and lead to a dependency on public transfers and public wages. The larger the group of people reliant on public wages or benefits, the stronger the political demand for public programs and the higher the excess burden of taxes. Slowing the economy, such a trend could increase the share of the population relying on government transfers, leading to a vicious cycle (Alesina and Wacziarg 1998). Large public administrations can also give rise to organized interest groups keener on exploiting their powers for their own benefit rather than facilitating a prosperous private sector (Olson 1982).

In other words, government spending undermines growth, and the damage is magnified by poorly designed tax policies.

The authors then put forth a theoretical hypothesis.

…economic models argue that the excess burden of tax increases disproportionately with the tax rate—in fact, roughly proportional to its tax rate squared (Auerbach 1985). Likewise, the scope for self-interested bureaucracies becomes larger as the government channels more resources. At the same time, the core functions of government, such as enforcing property rights, rule of law and economic openness, can be accomplished by small governments. All this suggests that as government gets bigger, it becomes more likely that the negative impact of government might dominate its positive impact. Ultimately, this issue has to be settled empirically. So what do the data say?

These are important insights, showing that class-warfare tax increases are especially destructive and that government spending undermines growth unless the public sector is limited to core functions.

Then the authors report their results.

Figure 7.9 groups annual observations in four categories according to the share of government spending in GDP during that year. Both samples show a negative relationship between government size and growth, though the reduction in growth as government becomes bigger is far more pronounced in Europe, particularly when government size exceeds 40 percent of GDP. …we provide new econometric evidence on the impact of government size on growth using a panel of advanced and emerging economies since 1995. As estimates can be biased due to problems of omitted variables, endogeneity, or measurement errors, it is necessary to rely on a broad range of estimators. …They suggest that a 10 percentage point increase in initial government spending as a share of GDP in Europe is associated with a reduction in annual real per capita GDP growth of around 0.6–0.9 percentage points a year (table A7.2). The estimates are roughly in line with those from panel regressions on advanced economies in the EU15 and OECD countries for periods from 1960 or 1970 to 1995 or 2005 (Bergh and Henrekson 2010 and 2011).

These results aren’t good news for Europe, but they also are a warning sign for the United States. The burden of government spending has jumped by about eight percentage points of GDP since Bill Clinton left office, so this could be the explanation for why growth in America is so sluggish.

Last but not least, they report that social welfare spending does the most damage.

Governments are big in Europe mainly due to high social transfers, and big governments are a drag on growth. The question is whether this is because of high social transfers? The answer seems to be that it is. The regression results for Europe, using the same approach as outlined earlier, show a consistently negative effect of social transfers on growth, even though the coefficients vary in size and significance (table A7.4). The result is confirmed through BACE regressions. High social transfers might well be the negative link from government size to growth in Europe.

The last point in this passage needs to be emphasized. It is redistribution spending that does the greatest damage. In other words, it’s almost as if Obama (and his counterparts in places such as France and Greece) are trying to do the greatest possible damage to the economy.

In reality, of course, these politicians are simply trying to buy votes. But they need to understand that this shallow behavior imposes very high costs in terms of foregone growth.

To elaborate, this video discusses the Rahn Curve, which augments the data in the World Bank study.

As I argue in the video, even though most of the research shows that economic growth is maximized when government spending is about 20 percent of GDP, I think the real answer is that prosperity is maximized when the public sector consumes less than 10 percent of GDP.

But since government in the United States is now consuming more than 40 percent of GDP (about as much as Spain!), the first priority is to figure out some way of moving back in the right direction by restraining government so it grows slower than the private sector.

When CBO issued new numbers early last year, I repeated the exercise and again found that the same modest level of budgetary restraint would eliminate red ink in about 10 years.

And when CBO issued their update last summer, I did the same thing and once again confirmed that deficits would disappear in a decade if politicians didn’t let the overall budget rise by faster than 2 percent each year.

Well, the new CBO 10-year forecast was released this morning. I’m going to give you three guesses about what I discovered when I looked at the numbers, and the first two don’t count.

Yes, you guessed it. As the chart illustrates (click to enlarge), balancing the budget doesn’t require any tax increases. Not does it require big spending cuts (though that would be a very good idea).

Even if we assume that the 2001 and 2003 tax cuts are made permanent, all that is needed is for politicians to put government on a modest diet so that overall spending grows by about 2 percent each year. In other words, make sure the budget doesn’t grow faster than inflation.

Tens of millions of households and businesses manage to meet this simple test every year. Surely it’s not asking too much to get the same minimum level of fiscal restraint from the crowd in Washington, right?

At this point, you may be asking yourself whether it’s really this simple. After all, you’ve probably heard politicians and journalists say that deficits are so big that we have no choice but to accept big tax increases and “draconian” spending cuts.

But that’s because politicians use dishonest Washington budget math. They begin each fiscal year by assuming that spending automatically will increase based on factors such as inflation, demographics, and previously legislated program changes.

This creates a “baseline” and if they enact a budget that increases spending be less than the baseline, that increase magically becomes a cut. This is what allowed some politicians to say that last year’s Ryan budget cut spending by trillions of dollars even though spending actually would have increased by an average of 2.8 percent each year.

Needless to say, proponents of big government deliberately use dishonest budget math because it tilts the playing field in favor of bigger government and higher taxes.

There are two important caveats about these calculations.

1. We should be dramatically downsizing the federal government, not just restraining its growth. Even if he’s not your preferred presidential candidate, Ron Paul’s proposal for an immediate $1 trillion reduction in the burden of federal spending is a very good idea. Merely limiting the growth of spending is a tiny and timid step in the right direction.

2. We should be focusing on the underlying problem of excessive government, not the symptom of too much red ink. By pointing out the amount of spending restraint that would balance the budget, some people will incorrectly conclude that getting rid of deficits is the goal.

Last but not least, here is the video I narrated in 2010 showing how red ink would quickly disappear if politicians curtailed their profligacy and restrained spending growth.

Other than updating the numbers, the video is just as accurate today as it was back in 2010. And the concluding message – that there is no good argument for tax increases – also is equally relevant today.

P.S. Some people will argue that it’s impossible to restrain spending because of entitlement programs, but this set of videos shows how to reform Social Security, Medicare, and Medicaid.

P.P.S. Some people will say that the CBO baseline is unrealistic because it assumes the sequester will take place. They may be right if they’re predicting politicians are too irresponsible and profligate to accept about $100 billion of annual reductions from a $4,000 billion-plus budget, but that underscores the core message that there needs to be a cap on total spending so that the crowd in Washington isn’t allowed to turn America into Greece.

Simply stated, people respond to incentives. When tax rates are punitive, folks earn and report less taxable income, and vice-versa.

• When tax rates increase, sometimes they engage in tax avoidance, lowering their tax liabilities legally.
• When tax rates change, sometimes they choose to alter their levels of work, saving, and investment.
• And when tax rates go up, sometimes they resort to illegal steps to protect themselves from the tax authority.

In a previous post, I quoted an article from the International Monetary Fund, which unambiguously concluded that high tax burdens are the main reason people don’t fully comply with tax regimes:

Macroeconomic and microeconomic modeling studies based on data for several countries suggest that the major driving forces behind the size and growth of the shadow economy are an increasing burden of tax and social security payments… The bigger the difference between the total cost of labor in the official economy and the after-tax earnings from work, the greater the incentive for employers and employees to avoid this difference and participate in the shadow economy. …Several studies have found strong evidence that the tax regime influences the shadow economy.

Indeed, it’s worth noting that international studies find that the jurisdictions with the highest rates of tax compliance are the ones with reasonable tax systems, such as Hong Kong, Switzerland, and Singapore.

Now there’s a new study confirming these findings. Authored by two economists, one from the University of Wisconsin and the other from Jacksonville University, the new research cites the impact of tax burdens as well as other key variables.

Here are some key findings from the study.

According to the results provided in Table 2, the coefficient on the average effective federal income tax variable (AET) is positive in all three estimates and statistically significant for the overall study periods (1960-2008) at beyond the five percent level and statistically significant at the one percent level for the two sub-periods (1970-2007 and 1980-2008). Thus, as expected, the higher the average effective federal income tax rate, the greater the expected benefits of tax evasion may be and hence the greater the extent of that income tax evasion. This finding is consistent with most previous studies of income tax evasion using official data… In all three estimates, [the audit variable] exhibits the expected negative sign; however, in all three estimates it fails to be statistically significant at the five percent level. Indeed, these three coefficients are statistically significant at barely the 10 percent level. Thus it appears the audit rate (AUDIT) variable, of an in itself, may not be viewed as a strong deterrent to federal personal income taxation [evasion].

Translating from economic jargon, the study concludes that higher tax burdens lead to more evasion. Statists usually claim that this can be addressed by giving the IRS more power, but the researchers found that audit rates have a very weak effect.

The obvious conclusion, as I’ve noted before, is that lower tax rates and tax reform are the best way to improve tax compliance – not more power for the IRS.

Incidentally, this new study also finds that evasion increases when the unemployment rate increases. Given his proposals for higher tax rates and his poor track record on jobs, it almost makes one think Obama is trying to set a record for tax evasion.

The study also finds that dissatisfaction with government is correlated with tax evasion. And since Obama’s White House has been wasting money on corrupt green energy programs and a failed stimulus, that also suggests that the Administration wants more tax evasion.

Indeed, this last finding is consistent with some research from the Bank of Italy that I cited in 2010.

…the coefficient of public spending inefficiency remains negative and highly significant. …We find that tax morale is higher when the taxpayer perceives and observes that the government is efficient; that is, it provides a fair output with respect to the revenues.

And I imagine that “tax morale” in the United States is further undermined by an internal revenue code that has metastasized into a 72,000-page monstrosity of corruption and sleaze.

On the other hand, tax evasion apparently is correlated with real per-capita gross domestic product. And since the economy has suffered from anemic performance over the past three years, that blows a hole in the conspiratorial theory that Obama wants more evasion.

All joking aside, I’m sure the President wants more tax compliance and more prosperity. And since I’m a nice guy, I’m going to help him out. Mr. President, this video outlines a plan that would achieve both of those goals.

Given his class-warfare rhetoric, I’m not holding my breath in anticipation that he will follow my sage advice.

• Using food stamps to buy luxury coffee at Starbucks.
• Buying steaks and lobster with food stamps.
• The Obama Administration rewarding states that sign up more food stamp recipients.
• Proposals to make it easier to use food stamps at fast food restaurants.
• College kids scamming the program for handouts.
• New York City giving food stamps to newly released prisoners and running foreign-language ads encouraging more people to sign up for the program.

As a taxpayer, I get upset about these examples. But as a public policy economist, I’m much more worried about the fiscal and economic impact of the program.

As a human being, though, my primary concern is the way redistribution saps the spirit of self reliance and traps people into lives of dependency. That’s the very first point I make in this debate on CNBC.

By the way, my opponent in the debate is Jared Bernstein, who is infamous for being the co-author of the Obama Administration claim that enacting the s0-called stimulus would keep the unemployment rate from rising above 8 percent.

I’ve had lots of fun mocking that claim. Every couple of months I post Jared’s predictions and compare them to the real-world results.

But it’s important to understand that I’m not blaming him for making bad predictions. After all, economists are lousy forecasters. I blame him for peddling the silly Keynesian theory that bigger government boosts economic performance.

Some of the obvious ideas include:

• Lowering tax rates to boost incentives for productive behavior.
• Reducing the burden of government spending to allow more efficient allocation of labor and capital.
• Cutting back regulation and red tape to boost market efficiency.

But those are only obvious ideas if you want a growth plan that actually leads to…(drum roll, please)…more growth.

Merkel and Sarkozy must have some other objective in mind, because they’ve proposed a plan comprised of new taxes, higher taxes, and tax harmonization.

This is beyond satire. Even if I was trying to make fun of the French and Germans (perish the thought), I wouldn’t be able to make up something this absurd.

Here’s some of what the EU Observer reported.

A six-point plan drafted by France and Germany has suggested corporate tax “co-ordination,” an EU financial transactions tax and the re-deployment of EU funds in troubled countries as ways to spur growth and jobs. …Paris and Berlin have teamed up once more and drafted a six-page paper called “Ways out of the crisis – strengthen growth now!” …The financial transactions tax – a pet project of French President Nicolas Sarkozy ahead of his re-election bid in April – features among the six proposals under “efforts to reinforce the framework of financial market.” …plans for “tax co-ordination” and another Franco-German proposal to be put forward by end of February on the “convergence of their corporate tax.” “European institutions and member states should accelerate the process of tax coordination in order to foster growth” …Apart from the Tobin tax, both leaders want to speed up EU legislation on an energy tax and a “common consolidated corporate tax base.”

Even Obama is not this blind to reality. He’s a big fan of higher taxes, of course, but at least the President realizes you don’t pass the laugh test if you tell people that higher taxes will “spur jobs and growth.”

Returning to Merkel and Sarkozy, the dynamic duo of statism also have some bizarre ideas on the spending side of the fiscal ledger. Here are a couple of additional passages from the story.

…proposal would have 25 percent of unspent EU regional funds in countries under a bail-out program or under serious economic difficulties redirected to a special “fund for growth and competitiveness.”  …As for employment-boosting measures, one of Sarkozy’s make-or-break campaign themes, the document asks governments to instruct employment agencies to make an offer to every unemployed person – be it for a job, an apprenticeship or further training.

The notion that bureaucrats and politicians can boost prosperity with some sort of “fund for growth and competitiveness” is hardly worth a rebuttal. I’ll just wish them luck as they create European versions of Solyndra.

The other idea, though, is worth a bit more analysis. If the article is correct, the Merkozy twins are going to wave a magic wand and direct employment agencies to make an offer to everybody.

Gee, isn’t that wonderful. While they’re at it, why don’t they turbo-charge the wand and insist that all the offers be for jobs making twice the national wage. With this kind of magical thinking, it’s just a matter of time before 90 percent of the population is part of the top-10 percent.

You may be thinking the previous sentence doesn’t make sense, but that’s probably because you’re one of those crazy libertarians who doesn’t understand how higher taxes boost economic performance.

In previous posts, I’ve expressed some pessimism about the future of Europe. After considerable reflection, I want to retract those statements and instead say that the outlook is hopeless. If you’re reading this from Europe, get out while you still can.

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P.S. I’ve been reminded that Merkel and Sarkozy are not alone in their crazy theory that higher taxes are good for growth. The geniuses at the Congressional Budget Office have written that higher taxes are good for long-run growth, even to the point of implying that 100 percent tax rates would maximize economic performance.

P.P.S. I’m further reminded that the Congressional Research Service also seems to think that higher taxes increase economic growth. Perhaps German and French spies have taken over Washington?

This from our first article in an ongoing investigation conducted by the MacIver News Service. Future stories will focus on any official reaction we receive from the University and an indepth look at Rogers’ Center on Wisconsin Strategy.

Joel Rogers Says College Credits May Be Available to Those Who Help Build Liberal Alternative to ALEC

[Madison, Wisc…] One of the University of Wisconsin’s most renowned liberal professors attempted to recruit his students to work on an elaborate private political project while final grades in their class were pending, the MacIver News Service has learned.

At the conclusion of his end-of-the-year email to his UW Law School students, Professor Joel Rogers wrote: “I think I mentioned a little project I’m doing now — which thus far involves professors from such crummy law schools as Yale, Harvard, Stanford, Columbia, Cornell, University of Michigan, University of Minnesota, Virgina [sic] and elsewhere, but thus far, beyond your lonesome, NOBODY from UW — to build a partial counter to ALEC. It’s going to involve a lot of law students. If you’re interested in helping out with that (no money, but possible credit), or know of somebody else who might be, please let me, or even better, “Nate Ela” <nela@cows.org>, a lawyer and now sociology grad student, know. Project description attached.“

Rogers is the Director of the Center on Wisconsin Strategy, a 501(c)(3) nonpartisan, educational, and charitable organization. COWS was founded in 1992 by Rogers, a professor of Law, Political Science, and Sociology at UW-Madison and a longtime commentator on economic development and democratic institutions. COWS is based at the University of Wisconsin-Madison, in the Social Science Building.

According to its website, COWS current and past funders include: the Alfred P. Sloan Foundation, the Annie E. Casey Foundation, the Carnegie Corporation of New York, theCarolyn Foundation, the Ford Foundation, the Garfield Foundation, Living Cities, the Joyce Foundation, the Nathan Cummings Foundation, the Open Society Institute, the Rockefeller Foundation, the Surdna Foundation, the Wallace Global Fund and the Wisconsin Department of Workforce Development.

This last semester, Rogers taught a class titled: Law & Contemporary Problems: Public Law & Private Power to approximately a dozen students at the University of Wisconsin Law School. Coursework was completed in December, but grades had not been issued at the time he sent his email to students. Rogers’ email was provided to MacIver News Service by someone who received the email from one of Rogers’ students. The MNS has confirmed the authenticity of the email, although we have not found a student who was willing to comment on the record.  Read more>>

I’m mystified, though, why some Republicans are willing to walk into such a trap. If you were playing chess against someone, and that person kept pleading with you to make a certain move, wouldn’t you be a tad bit suspicious that they weren’t trying to help you win?

When I talk to the Republicans who are open to tax hikes, they sometimes admit that their party will suffer at the polls, but they say it’s the right thing to do because of red ink.

I suppose that’s a noble sentiment, though I find that most GOPers who are open to tax hikes also tend to be big spenders, so I question their sincerity (with Senator Coburn being an obvious exception).

But even if we assume that all of them are genuinely motivated by a desire to control deficits and debt, shouldn’t they be asked to provide some evidence that higher taxes are an effective way of fixing the fiscal policy mess?

I’m not trying to score debating points. This is a serious question.

European nations, for instance, have been raising taxes for decades, almost always saying that higher taxes were necessary to balance budgets and control red ink. Yet that obviously hasn’t worked. Europe’s now in the middle of a fiscal crisis.

So why do some people think we should mimic the French and the Greeks?

But we don’t need to look overseas for examples. Look at what’s happened in Illinois, where politicians recently imposed a giant tax hike.

The Wall Street Journal opined this morning on the results. Here are the key passages.

Run up spending and debt, raise taxes in the naming of balancing the budget, but then watch as deficits rise and your credit-rating falls anyway. That’s been the sad pattern in Europe, and now it’s hitting that mecca of tax-and-spend government known as Illinois. …Moody’s downgraded Illinois state debt to A2 from A1, the lowest among the 50 states. That’s worse even than California. …This wasn’t supposed to happen. Only a year ago, Governor Pat Quinn and his fellow Democrats raised individual income taxes by 67% and the corporate tax rate by 46%. They did it to raise $7 billion in revenue, as the Governor put it, to “get Illinois back on fiscal sound footing” and improve the state’s credit rating. So much for that. …And—no surprise—in part because the tax increases have caused companies to leave Illinois, the state budget office confesses that as of this month the state still has $6.8 billion in unpaid bills and unaddressed obligations.

In other words, higher taxes led to fiscal deterioration in Illinois, just as tax increases in Europe have been followed by bad outcomes.

Whenever any politician argues in favor of a higher tax burden, just keep these two points in mind.

1. Higher taxes encourage more government spending.

2. Higher taxes don’t raise as much money as politicians claim.

The combination of these two factors explains why higher taxes make things worse rather than better. And they explain why Europe is in trouble and why Illinois is in trouble.

The relevant issue is whether the crowd in Washington should copy those failed examples. As this video explains, higher taxes are not the solution.

Heck, I’ve already explained that more than 100 percent of America’s long-fun fiscal challenge is government spending. So why reward politicians for overspending by letting them confiscate more of our income?