The decline of reasonably free markets in America can be traced to government expenditure growth over a long history. From 1880 until 1917, the percent of GDP spent by governments of all types was generally below 2%; essentially government providing personal and property protection. WWI raised that number to 20% at the peak, but it fell back to 5% or so afterwards in the 1920s. The Depression saw a big jump in expenditures after FDR took over. Why? The argument was that the Depression was caused by market failure. FDR convinced America that government was the answer.
Government expenditures in the 1930s were around 10% of GDP. A major pop from the 1920s. This was an attempt by government to spend its way out of the Depression. However, it did not work amid uncertainty, massive government regulation and market intervention. Essentially, FDR and associates did not know how to get out of the Depression. They flailed around with chaotic, ineffective policies. The country finally moved out of the Depression with massive WWII production starting in about 1939. At the height of the war, government spending was 45.7% of GDP.
The Depression was an unnecessary national tragedy based on the market failure myth as shown by Milton Friedman (see Milton Friedman and Anna Schwartz, A Monetary History of the United States,1867-1960, 1975). The Federal Reserve (Fed) caused the Depression by allowing hundreds of banks to go bankrupt. It was no secret about how to offset a panic run on a bank. The New York Federal Reserve Bank explained this to the Fed. To stop a run on a bank the Fed simply injects money into the bank. When depositors see that they can get their money out of the bank the panic is over. They would re-deposit their funds, the injected funds would return to the Fed, and life would go on with perhaps a standard recession followed by a standard recovery. But the Fed refused to act. It was government failure, not market failure that created the Depression. The Fed allowed the money supply to crater, which killed thousands of businesses and millions of jobs. Ask the general population what caused the Depression and 99 out of 100 respondents will say the market failed and, therefore, it was necessary for the government to step in and alter the free market in large with alphabet agencies and regulations galore. The result of this myth has been the unchecked growth of government expenditures since the Depression.
After WWII government expenditures to GDP fell from the mid-forties percent level into the teens and continued at that level thru the 1950s. Still, if compared with the market oriented economy before WWI, this was an enormous leap.
In the 1960s another major increase took place moving the number into the 30% range. From the 1980s it moved into the 40% range. Amazingly, we have arrived at a level of government spending to GDP on a regular basis that matches the peak of WWII. In 2020 the number rocketed to about 60%. Is there no limit?
Of course, government spending is fueled by taxes. Taxes allow borrowing against the future to supplement spending. High spending and high taxes go together. So let's review a few facts.
Federal, state and local income taxes are progressive. As income rises the rates rise. Most of the overall tax burden comes from income taxes and Social Security (SS) taxes. Everyone who works pays Social Security taxes or an equivalent at about 15%, even if their income tax is zero. This is what keeps the monthly payments to retirees flowing. There is no vault containing stored funds capable of paying the bill. Sales taxes, property taxes and so forth further increase the tax burden.
No matter how appealing progressive taxes are to some, they violate the 5th Amendment of the Constitution. Taxing one person at a higher rate than another is unfair confiscation of property - a taking (see Richard Epstein, Takings, 1985). Unfortunately, the Supreme Court has never fully dealt with this issue. Nevertheless, only a flat tax satisfies the 5th Amendment, since it treats everyone equally.
Businesses should not pay any tax, since the owners ultimately pay tax on their earnings from the business. A business tax is a double tax. Furthermore, such a tax increases the price of goods and services for no good reason. Maybe we should call a business tax a triple tax.
The two hidden taxes of inflation and regulation increase the tax burden still more. Inflation is a form of a tax since under a progressive system it moves individuals into a higher bracket, which generates more tax revenue. The Fed is on record to target 2% inflation per year. Over time this would compound to a much higher level. If inflation rises above 2% the damage is even greater. Regulation is like a tax since it raises the price of goods and services.
Government spending writ large is founded in the myth of market failure. Market failure can exist, but it is a rarity. Therefore, the vast majority of government spending from the Depression to the present cannot be justified by market failure.
Can anything be done to rectify the situation? Start by revealing the myth of market failure to everyone via Milton And Rose Friedman's Free To Choose video (PBS, 10 episodes, 1980). This video should be a part of the curriculum from junior high to graduate school. A monumental tax cut is in the offing if enough people are able to process and act on this information. Such a cut would mean the market, performing more efficiently, more fairly and with freedom of choice, would fill the void.
Christopher Garbacz is a former economics professor who lives in Madison County.
