The Fallacy of Government Spending

There has been a pretty heated argument over the past few years on the effect of government spending having a stimulative effect in the economy. Keynesians say it’s positive. Others say it’s zero or perhaps even negative. Certainly it’s not 1:1.

Mark Perry has an excellent blog you should read on food stamps. But his food stamp analogy carries over to all government transfer payments. Every program. Not just your favorite ones. Every one. That includes Social Security and Medicare.

In an economy, the economic effects from a transfer program always sum to zero. Simply put, there can be no economic stimulus from increased food stamp usage.

Given the massive inefficiencies the government creates in transferring resources from one group to another, along with the disincentive effects for those Americans who are de-stimulated through higher taxes, there might actually be an overall negative net effect on economic activity.

If we look at the facts on the ground, Obama’s economic plan has destroyed economic growth. The Geithner plan to re-capitalize banks and make them healthy has not made banks any better. As a matter of fact, since the passage of Dodd-Frank, the velocity of money through the economy has slowed to a trickle and we have had little GDP growth.

Combine the knowledge that government programs do nothing to stimulate economic activity with the welfare cliff and one can understand that the economic incentives for growth as presently constructed in the US are totally screwed up in favor of no growth.

Government programs are creating incentives to stay home and not work. We are seeing that reflected in the labor participation statistics as the rate has gone down consistently since Obama has been elected.

If we are going to change the outcome, we need to change the incentives. The path that Obama and the Democratic Congress put us on in 2008 was horrific when it comes to growing an economy.

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Tip of the hat to The Daily Crux.

28 thoughts on “The Fallacy of Government Spending

  1. Has anyone ever figured out why…when they began Social Security that the first participants paid for the generation before them. Wouldn’t it have made more sense to pay for their own Social Security? It has always irked me when the “professionals” write about Social Security and call it an “entitlement” program – I have paid into that program for over 50 years – so yes, I do feel like I am entitled to it. I had no choices – it HAD to be paid. I do realize that ALL of these programs have to be revamped and I am ok with that. I just wish we had a Congress with a large enough set to get ‘er done! Oh, and it would be nice to have a President to lead them.

    1. LostAmerican, I feel for you. BUT, imagine what benefits would be available for you if all the money you paid in, plus all the money your employers had paid in, over all your years of service would have been invested in a simple 50% S&P Index fund; 50% US Treasury bond fund strategy. You would be in control of your retirement with 10X the resources as the current “ponzi scheme” offers. SS is currently a system that, by definition, implodes the moment that the number of workers working cannot support the number of retirees retired. FYI, the Congress, the post office, and most other government workers who are excluded from having to utilize SS, are enrolled in what amounts to the “privatized” market based retirement system I describe above (403(b). “We the people” are screwed as they bad talk the same “privatization” for “us” that they enjoy! It’s time that retirees like yourself mobilize and are “up in arms” to at least prevent this travesty from continuing – for the sake of your grandchildren!

      1. Much too theoretical. If the retirement system were orivatized as you note it is likely that events over the past 15 years would now have it underwater. State plans prove that point alone and when you add in cronyism and poor management it is assured.

        1. I challenge you to prove that quantitatively. The point would not be government management (we know how well that works) but private management. For the statists among us, the government could specify basic allocation parameters but not specify managers. For instance “no more than 35% in Morningstar 4 and 5 star funds.”

          1. In addition, if we were smart enough not to have entitlements structured the way they are, or have them at all, we probably would have been smart enough not to allow the government to lay the foundation for the crisis!

    2. Social Security, as originally conceived, was a “tontine,” i.e., everyone pays in but not everyone collects. At implementation, the cost of paying benefits plus administering the program meant that the age to collect could be set at 65, and the dead would pay the living, based on life expectancies as they were then; it was expected that maybe half, if that, of the population would reach 65, and of those, the majority would die by 70 and almost everyone, in a macro-statistical sense, would die by 75, and realistically so few above 80 as to be negligible. Social Security may, and I stress MAY, have been actuarially sound like insurance when it started, but it morphed into the Townsend Plan, essentially a bribe to get older workers out of the workforce to accommodate younger workers with families to support. Even in the depths of the Depression that Plan was seen as unsustainable, and wasn’t even supported by Democrats, less a matter of that they wouldn’t like something like this (of course, they would!) as that the public would eventually catch on when times got better and would realize the speciousness of the Plan and would take out their wrath on the Dems. But it really makes me laugh to hear “I paid in, so I deserve something!” Errr, no…you don’t. That’s not how it was set up. And that’s not how your car, or homeowner’s, or health insurance works, either. Social Security, unless it is run as actuarially-sound insurance, is a Ponzi scheme by definition.

  2. you fail to take into account the ability of children to learn when hungry versus not hungry and safety when living in a good neighborhood versus an unsafe neighborhood and having access and usage of good medical treatment versus none at all.

    I will grant you that the current way that the programs are implemented cause the above perversion. That is why I advocate an effective change to how this welfare is performed. We already have statistics on what is poverty and not poverty. So we should change the programs and provide everyone with a flat poverty level on a family basis amount of money no questions asked and a graduated increasing tax rate for every dollar earned above that amount. I am sure that I could craft a graduated rate that would accomodate incomes upto $1 billion without difficulty, though it could take a few days to tweak.

    1. Children are innocent. They don’t choose where they are born. But their parents are making choices for them. As they grow, they make bad choices. They do drugs. They drop out of school.

    2. If you can figure out how to give money away without creating moral hazard (which is the whole point of the subject article) you should do so and do it soon.

    3. The Fed Gov is already $15+ Trillion in debt. Where will you get the money to “provide everyone with a flat poverty level on a family basis amount of money no questions asked”?

      1. Well put, Mr. Carter.

        Unfortunately, morons (such as “yowsir”) still have the right to vote. Which may explain a lot about how some politicians arrive in elected office.

        1. “arrive”? anybody can make a mistake. Please explain how they stay in office. e.g., Nancy Pelosi.

  3. What do we expect when the White House is getting such sterling advice as this direct quote from Valerie Jarrett:
    “Even though we had a terrible economic crisis three years ago, throughout our country many people were suffering before the last three years, particularly in the black community. And so we need to make sure that we continue to support that important safety net.
    “It not only is good for the family, but it’s good for the economy,” Jarrett argued during a speaking engagement at North Carolina Central University in Durham, North Carolina.
    “People who receive that unemployment check go out and spend it and help stimulate the economy, so that’s healthy as well,”

    …and with enough velocity, pigs fly just fine. If you don’t believe me, you have many, many other perfect examples of the total duplicitousness of this administration.

  4. from the chart … is it true that NO income generates government benefits equivalent to a gross income of %55K … or do I misunderstand the chart?

  5. The one good thing that Chile did do was to privatize their social security in a conservative way that required great diversification and limited the amount of
    equities versus bonds that could be hoarded. In spite of the fact that Chile
    is more a donkey, pick and shovel politically captive domain of Western free
    trade agreements, they are still a low tech tiger, in the sense of having a
    very high personal savings rate for growth that has allowed strong infrastructure
    development by the government while maintaining one of the the lowest debt to GNP
    in the world, Chile does have a safe currency, as a result of their fiscal conservative

  6. This is the “Broken Window Fallacy” all over again. We lose over 10% of our jobs, products and services (wealth) annually due to transfer programs.

    Assume that everyone got paid every 2 weeks, just to keep to simple. Then we work for 2 weeks in our “pay forward” system helping each other achieve our pursuit of happiness. When we get paid, we use that money to pay others to produce. We don’t pay them to do nothing for us.

    Then the government comes along and says they do a service for us, so they need approximately 2 pay periods of our money each year. Defense, schools, park services and so on are provided.

    But then the government says they need to provide a “safety net” and want 3 pay periods of our money. This is transferred to others for doing nothing. 3 transfers out of 26 each year, over 10%, are removed from a system that provides jobs, products and services and given to provide none. Now the recipients of those transfers spend it, but those 3 transfers a year are already lost when they would have provided jobs and wealth, they did not.

    Investing in Social Security, Medicaid, Medicare, welfare, and unemployment programs, 3/5th of Federal spending, are investments in big government. IRA’s, 401K’s, medical savings programs and just remembering that we all need to save for the rainy day, are investments in our economy. There is a huge difference in outcomes. Who do we want happy? Who do we want in control? The government or ourselves?

  7. The effect is definitely negative. Does everyone remember the term “hot” connected to theft? When something is taken without the consent of the owner there is a sharp break in energy flow, which some people have felt or experienced – a hot sensation. Positive flow of energy is required for a prosperous economy. This also goes back to that expression, “What goes around comes around.” Socialism in any shape or form stops the flow of positive energy; the economy becomes stagnant, and there is less useful productivity. Socialism produces a low-energy economy that in turn creates low average per capita income.

  8. When housing prices were going up and it was assumed they would continue to go up, everyone was exuberantly optimistic and the consumer spent like there was no tomorrow sometimes going deep into debt. Given today’s conditions you can probably assume the consumer is worried about his next paycheck and how to pay his current bills and not so much his mortgage. Consequently, the multiplier effect ( a Keynesian term most College graduate baby boomers are familiar with) is close to zero. That means there are no jobs for those that want them because business see’s no end to current economic conditions. Either we have to turn into a Nation of Entrepreneurs or get us a government who will spend money on the consumer to jump start them in the short run. Trouble is, consumers, given any gift these days will more likely be inclined to “save it” for even worse times. FDR had the right idea starting WPA projects, not wars or other calamities that mess with the world’s population and cause those “consumers” to be dead consumers. I saw an article in the news today calling for a reduction in military spending, but I thin it’s the wrong thing to do! I know our tax situation is not great. Excluding bad past practices our legislators can’t seem to find the bottom of the box we are in and can only think of ridiculous ways to try to increase “their” revenue side so that they alone can control what we as a people do! I say it’s time to vote out all these miserable creatures, mess with their retirement before they get to re-do mine. Let me remind you that I paid FICA for over 40 years and my employer was required to match that. Because he matched my contribution he was in no position to increase my wages without heart-stomping attention to increasing productivity and the growth rate of his company. That in effect means I PAID ALL OF THE FICA WITHHOLDINGS to the government that wasted much of what I contributed due in part to Exuberance also, but I really had no say in how it was used. Now our politicians want to punish us again and reduce social security checks while they vote themselves raises. Seems like a one sided approach don’t you think? Purchase a $300,000 annuity these days on the open market and if your lucky enough to get it to pay out now, you might get 16 or so thousand out of it annually. That’s all my retirement is good for ….. so the addition of social security, which has always been in the planning phases of my retirement, helps to supplement my living into an older age. Compare that to what a legislator gets for only one term in office ….. It’s just wrong!

    1. The policies of FDR actually didn’t do much of anything. Milton Friedman did a lot of research on the Depression, and found that there was indeed a bump, that died in 1937. That’s why people mistakenly think WW2 got us out of the Depression. It didn’t. You are correct, entrepreneurs will get us to grow. But, the things the Republicans and Democrats have put in place over the past several years step on the backs of entrepreneurs. Best thing to do is reform military spending and make it more efficient. Reform all entitlements and change government pensions from defined benefit to defined contribution. Then slash the size and scope of government.

  9. Looking at the curve, it would seem that there is a powerful incentive for employees to offer in-kind (not counted as income) benefits/compensation rather than cash for certain employees. For example I have seen an increase in the use of payroll deduction for mass transit fares (basically you have the cost of a monthly pass dedected from your paycheck on a pre-tax basis). It would be interesting to look at how much income is shifted off the income rolls this way.
    Another thought that always comes to mind – when you compare current US income distributions to the 50s, it is important to remember that changes in welfare and tax policy have exaggerated the underlying trend by significantly reducing incentives to shift compensation out of taxable income (AGI) at the high end of the scale AND increasing them at the lower end as show in the chart.

  10. So every EmployER who offers salaries under $56,000 knows his EmployEE can go get more benefits from Uncle Sam – thus the Employer does not need to up salaries. Or am I missing something.

    No wonder real take home pay has stagnated for 30 years.

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