What’s Wrong With Large Government Spending?


The Covid-19 pandemic expanded the national debt of advanced countries. In Japan, the total amount of debt of national and local government exceeded 1.2 quadrillion yen. Supply-side economics places an emphasis on reining in government spending. The Liberty Magazine asked Dr. Laffer for an ideal fiscal policy.

Interviewer: Hanako Cho


Cho: The federal budget was balanced during the Clinton administration. It is also said that this was not due to the 1993 tax increase, but to the Republican Party’s fierce budget negotiations with President Clinton. Could you elaborate on what happened?

Dr. Laffer: Let me go through it with you from the time Reagan left office.

As you know, Reagan left office on Jan. 20, 1989. Everyone thought that George Herbert Walker Bush would be the third term of Reagan, so George H.W. Bush won in a landslide against Michael Dukakis, who had been the Democratic governor of Massachusetts. When Bush got into office, it became very clear that he was very much not a Reagan. He declared war in Kuwait and his popularity went up, and he raised taxes.

That’s when I came out against him. At that time, I said that he wouldn’t stand a chance of winning the election. Sure enough, his polling fell dramatically. The economy did badly, and Bush was defeated by Bill Clinton, the Governor of Arkansas, in 1992.


Flat Tax Gains Popularity in the Election

Dr. Laffer: I’ve talked about it before, but in the 1992 presidential race, Governor Jerry Brown of California ran on flat rate taxes in the Democratic primary.

I knew Jerry Brown from when California’s Proposition 13 was passed, and I was extremely involved in the 1992 presidential race on the Democratic side. Jerry Brown’s proposal was to get rid of all federal taxes except sin taxes, such as cigarette taxes, which are very small. He proposed to get rid of these federal taxes, from the income tax, Social Security taxes, the corporate tax, the capital gains tax, the inheritance tax and the gift tax, and to replace them with two flat tax rates of 13%: one on corporate income and another on individual income. My numbers came out to 12%, which was-static revenue-neutral. Jerry Brown made the rate 13% because he wanted to have a reduction in the debt. We proposed getting rid of all tax credits, exclusions, exemptions and deductions.

That took Jerry Brown from eighth in the race to second in the race. We were just about to defeat Bill Clinton, and Jerry Brown was just about to become the Democratic nominee, when Jerry announced Jesse Jackson as his running mate. But even though Bill Clinton won the primary, Jerry Brown still got the second largest number of delegates.

The first thing Bill Clinton did, now that he had control of the House and the Senate, was put through his tax bill that raised the top income tax rate from 31% to 39.6%. The tax increase also raised other taxes such as the new energy tax, Social Security taxes and the gasoline tax. The bill was voted on in 1993. Not a single Republican voted for it. Even some Democrats in the House voted against it.

The bill passed in the Senate by one vote, and that was Al Gore. 50 Democrats and Republicans voted against it. 50 Democrats voted for it. The tie was broken by Al Gore, and it was passed and signed into law by the president. That’s the backdrop of 1993.

When the midterm election of 1994 came, in the House, every single Republican running for re-election in 1994 won. Not one seat flipped from Republican to Democrat. Also in the Senate, every single Republican running for re-election in the Senate won. Let me add that every single U.S. Republican governor running for re-election won. This is a joke, but that includes two governors running for re-election while they were under federal indictment for crimes. Even the ones who were accused of crimes and indicted for those crimes won their elections. The Republicans took both the House and the Senate by a big amount.

Newt Gingrich became the Speaker of the House. It was a new period of Republican domination in Congress. It is basically the first time in 40 years that the Republicans had dominated the Congress of the United States. In my view, it was a tax revolt. Not everyone will agree with this, but it was a tax revolt in response to Bill Clinton’s silly insistence on raising tax rates. The tax increase had this much impact.

Bill Clinton raised tax rates on the top two income brackets. That’s all he did. He didn’t raise the rest of the brackets. It was very Biden-esque. I see a very good parallel between what Biden is doing today with the left-wing of his party and what Bill Clinton did in 1993, also with the left-wing of his party.

Obviously, the time is different. The ethnicity of the voters is different. There are lots and lots of differences. But I do see a lot of similarities today. There is a very hard-left vision of the world playing out on every sympathy of an American, whether it be racial, social or economic differences. All of these things are very similar to what was happening with Clinton between 1992 and 1994.

What I am seeing right now, in the U.S., is that the vision of Joe Biden and the Democrats is becoming clearer by the electorate.

They’re now disliking Joe Biden and what’s going on. The poll numbers show a huge drop in his popularity, and we’re coming into the midterm election period. This will be the last time the Democrats have a chance of getting a bill through.


Clinton Switched to Pro-Growth

Dr. Laffer: Let me go back to the topic of Clinton.

Bill Clinton, with his wife Hillary Clinton, tackled the reform of the health care system as one of his highest priorities. Under the U.S. health care system, except for Medicare for the elderly and Medicaid for low-income earners, insurance oftentimes does not cover medical expenses if you’re unemployed or work for a company that does not pay insurance premiums. So Hillary Clinton had proposed The Health Security Act healthcare reform in 1993 to achieve universal health insurance, which requires all businesses to have voluntary insurance.

The proposal was defeated due to criticism that it would increase government involvement, lead to a bigger government and expand the budget deficit. In the November 1994 midterm election, the Democratic Party was defeated. Bill Clinton switched from being a left-wing president to being a right-wing president. Once we got to 1995, the world was completely different.

Bill Clinton became a very pro-growth president of the United States. He did welfare reform. The welfare reform was that no one could get welfare without actively looking for a job. Can you imagine that? He cut government spending as a share of GDP by more than the next best three peacetime presidents in U.S. history. Bill Clinton also had all of these tax changes. He lowered the capital gains tax from 28% to 20% which led to greater investments and economic growth.

1995 to 2000 was one of the most wonderful periods that has occurred in U.S. history, where Bill Clinton switched and became a pro-growth Democratic president of the United States. That’s what happened after the election in 1994.


The Logic of People Who Support Tax Increases

Cho: Japan’s government debt is over 1.2 quadrillion yen (over $11 trillion at current rates), and the government debt-to-GDP ratio is said to surpass 250%. The pandemic is also expanding our government budget, and our government started to spend over 100 trillion yen (over $9 billion at current rates) every year. Of that government spending, 30 to 40 trillion yen are financed through the issuance of government bonds. What is your outlook on this situation in Japan?

Dr. Laffer: Like you ask, it’s important to look at the amount of government spending compared to GDP. But you should not look at your government debt-to-GDP ratio.

Debt is a stock, and GDP is a flow. Debt is a balance sheet item, and GDP is an income statement item. You should never compare balance sheet items with income statement items. Instead, you should always compare balance sheet items with balance sheet items and income statement items with income statement items.

What you should look at is government debt to national wealth, or government debt service costs to GDP.

When you look at Japan’s government debt to wealth, you will find that debt-to-wealth ratio to be high, but not nearly as scary as the 250% debt-to-GDP number that you use. I think the debt-to-GDP number exaggerates the problem.

The next thing politicians think about are how to increase taxes, not how to reduce government spending. That’s all they think about in both Japan and the U.S.

What is scary is government spending. It’s inclusive of federal government spending, as well as state spending and government restrictions such as Covid-19 mandates. What you want to do is look at the total impact of the Japanese government’s spending on the private sector.

The transfer payment problem, or the redistribution problem, is the massive spending and intrusion into private lives that is brought about by your federal, state and local governments.

In Japan and the U.S. today, governments are redistributing income from one group of people who produce the income to another group of people based upon some characteristic other than production. It can be from rich people to poor people.

The key feature of redistribution is that people who get the money don’t get the money because they produced income. They get the money because they’re old. They get the money because they’re black. They get the money because their business’s loans are guaranteed and forgiven, whatever the silly reasons are.

The key here is that disassociation between work and receipt of benefits. It’s what we call the wedge. We’ll pick up from here next time.

What’s Wrong With Large Government Spending?
Copyright © IRH Press Co.Ltd. All Right Reserved.