Sunday, April 11, 2004

How much should government spend?

Steven Weinberg's reply to my correction of his article contained an interesting comment: "I'm not in favor of very possible tax. But I deplore the automatic assumption that lower taxes are always better than higher taxes."

I had to think about that. I realized that I'm guilty of that automatic assumption. I do, in fact, tend to assume that lower taxes are always better than higher taxes. There's a necessary caveat, which is that it's the spending that really matters. Taxes are the symptom; spending is the disease. And every time an issue comes up that might allow us to cut spending and lower taxes, I'm for it.

Why? Because I think we spend too much. If we are spending too much, the right thing to do is spend less. "When you're in a hole, the first thing to do is stop digging."

If you disagree, consider this: Based on your own values, would you be willing to grant the possibility that there is some optimal level of government spending as a percentage of GDP?

For instance, if I grant that 0% government spending is too low, will you grant that 100% is too high? How about 99%? 98%? What level of spending do you think is too high, too low, or just right? How could you know?

I believe there is some optimum amount of government spending, above which spending more does more harm than good. That is to say: there are "diminishing returns" on investment in government just like investment in anything else. You might get a lot of benefit from the first dollar spent, but as more and more dollars are spent, the amount of benefit declines until eventually spending more on government is less valuable than spending on something else. At which point, increasing government spending decreases human welfare. It makes us worse off.

If you answered that, yes, 0% is too low and 100% is too high, then presumably there's a peak somewhere in the middle, an Optimum Maximum Spending Level. If you were to graph the benefit we get from various levels of government spending, let's call the position of the highest point on the graph (or the rightmost highest point, if it's non-unique) "OM", for Optimum Maximum, and call our current spending level (again, as a percentage of GDP) "CS" for Current Spending.

Then the question is: is OM < CS ?

How would you answer that?

Because if, in fact, OM < CS, then it is simply true that lower taxes (accompanied by lower spending) are "always" better than higher taxes (with higher spending).

But only if the word "always" is suitably qualified. Like so:

AS LONG AS (OM < CS), every time the issue comes up whether we should raise or lower taxes and spending, the true answer will be that we should lower them. But if we actually follow that advice and reduce taxes and spending, eventually it will no longer be the case that (OM < CS), and the advice will no longer hold.

So, if OM < CS it is "always" right to cut taxes/spending, until current spending drops to OM. Then (assuming OM is a unique point), once current spending is BELOW OM, then it is "always" right to RAISE taxes/spending until it returns to that point.

Does OM exist? Do you believe OM > CS? If so, how much greater? When would you say "enough!"

(My personal suspicion is that OM is in the ballpark of 10% of GDP.)