NCPA - National Center for Policy Analysis


January 28, 2010

In last night's State of the Union address President Obama proposed a three-year "spending freeze" on what amounts to one-sixth of the federal budget. Our biggest entitlement programs, Social Security and Medicare, would be excluded. These changes are optical rather than substantive. Given the spending agenda that is already in place, we can expect to see large increases in the proportion of gross domestic product (GDP) that is spent by our government for years to come, says Edward P. Lazear, Chairman of the President's Council of Economic Advisers from 2006-2009 and a professor at Stanford University's Graduate School of Business and a Hoover Institution fellow.

For instance:

• Since 2008, the ratio of federal spending-to-GDP has risen by about 14 percent.
• From 2008 to 2009 we saw the greatest annual increase in spending in the last 30 years.
• In the name of stimulating job growth, the share of federal spending is now 24 percent of the economy, up from 21 percent in the last year of the Bush administration.

According to Lazear's own analysis of data from 1950 to the present:

• Periods with high tax-to-GDP ratios exhibit much slower economic growth than lower tax ratio periods.
• The GDP growth in high tax years (defined as years during which the ratio of tax-to-GDP was above 18 percent, the 60-year average) was about 1.5 percentage points lower than the growth rate in low-tax years.

High taxes are clearly bad for the U.S. economy, says Lazear:

• For example, were we to tax above the 18 percent tax-to-GDP ratio over the next 25 years, GDP per capita in 2035 would be about 50 percent less than if we were to tax below the 18 percent ratio.
• A 50 percent per capita GDP differential is about as large as the difference between the United States and Greece today.

The recent growth in spending has been camouflaged by a focus on deficits. Budgets and proposed legislation, like that on health care, are being judged not by their impact on spending and taxation, but by their projected effect on the deficit. Equal increases in spending and taxes reduce economic growth, even if they do not alter the deficit, explains Lazear.

Source: Edward P. Lazear, "The Spending 'Freeze' That Isn't," Wall Street Journal, January 28, 2010.

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