U.S. drifting toward European-style economic anemia

President Biden has proposed to increase the burden of federal spending substantially. According to the president’s budget, an additional $5 trillion would be diverted from the private sector over the next 10 years to fund his proposals.

Congress has divided the additional spending into a so-called Infrastructure Act and H.R.5376, a “Build Back Better” bill, to expand the welfare state, with the vast majority of Biden’s new spending crammed into the latter—$1.64 trillion according to the budget blueprint Congress approved earlier this year.

But the $1.64 trillion estimate relies on budget gimmicks, such as new entitlements scheduled to disappear after just a few years. According to independent experts at the Committee for a Responsible Federal Budget, the actual cost of the president’s policies is closer to $4.9 trillion.

Some of this new spending will be financed with red ink, but President Biden also has embraced higher tax rates on work, saving, investment and entrepreneurship. Indeed, if his plan were enacted, the United States would have both the highest corporate tax rate and the highest capital gains tax rate in the developed world.

Making government bigger is not very prudent. European welfare states such as France, Italy and Greece suffer from slower growth, higher unemployment and lower living standards, in large part because government spending consumes more of the economy’s output.

But how much would the economy be hurt? There are groups such as the Tax Foundation that do excellent work measuring the adverse effects of higher tax rates. But it’s also important to measure the harmful impact of a bigger welfare state.

And that’s what we did in a study published earlier this year by the Club for Growth Foundation.

In that study, we review many of the scholarly studies that measure the inverse relationship between government spending and economic performance. We also look at reports from institutions such as the International Monetary Fund, European Central Bank, World Bank and the Organization for Economic Cooperation and Development.

To specifically quantify the damage of President Biden’s welfare state expansion, we used a March 2021 working paper published by the Congressional Budget Office. Entitled, “The Economic Effects of Financing a Large and Permanent Increase in Government Spending,” the CBO report estimated what would happen to gross domestic product (GDP) if government expanded by either 5 percentage points of GDP or 10 percentage points of GDP, based on three different financing mechanisms (labor tax, flat tax, progressive tax).

Between 2020 and 2030, real GDP in the benchmark economy grows by 1.5 percent per year on average ... In simulations in which taxes increase to finance an increase in government spending of 5 percent of GDP, real GDP increases by 1.1 percent, 1.1 percent, and 1.0 percent per year on average for a labor tax, flat income tax, and progressive income tax, respectively. Real economic growth under an increase in government spending of 10 percent is 0.7 percent, 0.8 percent, and 0.4 percent per year on average for a labor tax, flat income tax, and progressive income tax, respectively.

Fortunately, President Biden “only” wants to increase the burden of government by about 2 percentage points of GDP to finance Build Back Better. But that expansion of the welfare state would still do considerable damage. Especially since the Biden administration is paying for much of the new spending with progressive taxation, which the CBO study found to be the most harmful financing mechanism.

Based on that CBO study, and using the CBO fiscal and economic baselines, we calculated the following unpalatable outcomes if Build Back Better bill (pushed by the president and Democrats in Congress) becomes law and growth is reduced by 2/10ths of 1 per cent per year.

• A loss of $2.7 trillion of economic output over the next 10 years
• A loss of $1.46 trillion of total worker compensation over the next 10 years
• A loss of more than $9,300, on average, in total compensation per job over the next 10 years
• A lifetime drop in living standards of almost 4 per cent for young workers

The Biden agenda will also reduce the capital stock and lower rates-of-return on investments, thus causing a $1 trillion-plus loss in financial wealth, hurting the retirement savings of American workers.

These results are not surprising. Making the U.S. more like Europe is a recipe for European-style economic performance.

To understand the consequences, consider the OECD’s data on living standards, which show that Americans (on average) enjoy 50 per cent more consumption than their counterparts on the other side of the Atlantic Ocean.

Will President Biden’s fiscal plan instantly transform the U.S. so Americans will suffer European-style economic anemia? No. That would take several decades.

But the U.S. is already drifting in that direction, thanks to an aging population and poorly designed entitlement programs. In its most recent long-run forecast, the CBO projects the burden of government spending will climb by about 10 percentage points of GDP over the next three decades.

At the risk of understatement, accelerating that process with the president’s tax-and-spend agenda would be very unwise. At least if Americans care about the prosperity of their fellow citizens.