Jeff Madrick: How big government helps the economy take off
IN LISTENING TO this year's candidates for the White House talk about their ambitions for the economy, there's no escaping one undercurrent of contemporary American thinking: the idea that minimizing government and lowering taxes will help the economy grow.
(Globe Staff photo illustration)
In the 1970s, with inflation and slow growth plaguing the United States, a consensus began developing among certain economists that higher taxes did not merely take too big a bite out of people's incomes, but actually restrained the nation's growth and prosperity. And over the last 30 years, that view of government's relationship to the economy has emerged as a tenet of mainstream politics.
In a 1980 presidential debate with incumbent Jimmy Carter, Ronald Reagan put it effectively: "We don't have inflation because the people are living too well. We have inflation because the government is living too well." As president, he engineered a dramatic income tax cut, reducing the top rate from 70 percent in the 1960s to 50 percent - and it was about to be cut still more. Many observers argued that the economy was reinvigorated as a result.
Since then, the Democrats have slowly but surely boarded the bandwagon. By 1996, when President Bill Clinton was declaring proudly the end of "the era of big government," the transformation of the nation was complete.
The underlying economic argument is persuasively simple: Higher taxes undermine incentives to work and invest; a bigger government pushes aside private enterprise and siphons money from private investment; social programs are inefficient and make people dependent. All these cost the nation valuable gains in productivity.
Behind these arguments is the work of economists such as Martin Feldstein of Harvard University, who claimed to supply evidence to prove the point. The problem, however, is that the evidence has not held up. In fact, economic growth during the Reagan years did not increase over the beleaguered 1970s. And the economic boom of the Clinton presidency was preceded by a substantial tax in crease on the wealthy.
Since then, a series of serious, detailed investigations of the economies of rich nations across the globe, as well as reexaminations of the economic studies that helped build the antigovernment case, have found that the size of government and high tax rates do not automatically slow a nation's economic growth. Peter Lindert, a mainstream economist from the University of California at Davis, states it straightforwardly in his 2004 book, "Growing Public:" "It is well-known that higher taxes and transfers reduce productivity. Well-known - but unsupported by statistics and history."
Lindert's work surveyed a century of data across numerous countries and found that high taxes and social spending did not slow the growth of productivity or GDP. Statistically speaking, Lindert found no relationship between the level of social spending and economic growth. High tax nations like Norway grow rapidly and produce high standards of living. Even the income per hour of work in nations like France and Germany is equal to or even exceeds America's....
Contrary to the romantic claims about the nation's laissez-faire past, American history is a story of government intervening, time and again, to support growth.
Early America created a national bank to maintain its finances and currency, critical to a smooth-functioning modern economy, at the instigation of Alexander Hamilton, George Washington's treasury secretary. Under Thomas Jefferson, well-known for his laissez-faire sympathies, America bought the Louisiana territories in what amounted to a large federal spending program. He thus provided cheap land to farmers at federally controlled low prices, enabling them to feed themselves and the nation, but also soon to produce surpluses to feed Britain as well, adding to America's wealth.
State and local government were also vital contributors to growth. New York State issued bonds to finance most of the Erie Canal, opened in 1825. Other states followed suit with canals of their own, creating an efficient transportation network essential to commercial development before the Civil War.
Led by Massachusetts, the states built free and mandatory primary schools based on property and other local taxes, producing a literate and able work force. After the Civil War, the federal government donated tens of thousands of acres of land to states with the express purpose of starting new technical universities, which helped launch the University of California at Berkeley, the Massachusetts Institute of Technology, and Cornell University, among others. These research centers contributed vitally to American agriculture and manufacturing....