The Road to Freedom

by Arthur C. Brooks

  Average Americans viscerally dislike big government. Most of their ordinary contacts with the government are pretty unpleasant. Remember how much fun it was the last time you had to go to the DMV? Have you ever tried calling the IRS’s helpline for assistance filling out your tax returns?

  So Americans profess a love for free enterprise and dislike “big government.” But here’s the paradox: They are more than willing to accept policies that do violence to the system they say they love. For example, a February 2011 NBC News/Wall Street Journal poll asked a thousand Americans whether it was acceptable to cut Social Security as a way to reduce the deficit. To this question, 77 percent of respondents said that it was either mostly unacceptable or totally unacceptable.4 About half of Americans tell pollsters they are pretty comfortable with the idea that the U.S. should “redistribute wealth by heavy taxes on the rich.”5

  One explanation for this paradox is that Americans don’t really love free enterprise as they say they do. They talk about it sentimentally. After all, everything was better in the old days. But in practice, Americans prefer a modern welfare state. This is the explanation I often hear from my progressive friends.

  I don’t think that’s the real reason. I believe that most Americans still love and want the kind of freedom that the Founders envisioned. But a drift toward statism has happened so gradually that most haven’t noticed it. It has happened because most people aren’t really paying attention to the net growth of government. Americans are busy people, living private lives full of everyday jobs, church socials, and soccer practices. As the leader of a think tank dedicated to public policy, I would love it if Americans were as obsessed with policy as I am. But let’s be realistic: most people don’t have time to contemplate the potential damage each government bill—each tiny encroachment on their freedom—could cause.

  Politicians have offered one policy compromise after another, from a government subsidy here to a hidden tax there. Slowly, people have become anaesthetized to the cumulative result. Over the years and decades, these gradual encroachments have reoriented the U.S. toward European-style social democracy. Americans know something is wrong—which is why 81 percent say they are dissatisfied with the way the nation is being governed.6 But they rarely make the connection between their free enterprise values and the statism they are getting instead.

  WHEN AND HOW did this slide begin? The answer to this question depends upon whom you ask. Some say it started in 1912, with the election of Woodrow Wilson. Others say it began with Franklin D. Roosevelt’s New Deal in the 1930s. Others say it started with Lyndon B. Johnson’s Great Society programs of the 1960s.

  Woodrow Wilson had a statist philosophy that today sounds quite academic; indeed, he held a PhD in political science and taught at Princeton years before his tenure in the White House. In 1887 he published the essay “Socialism and Democracy,” in which he stated, “Men as communities are supreme over men as individuals. Limits of wisdom and convenience to the public control there may be: limits of principle there are, upon strict analysis, none.”7 Clearing away the rhetorical clutter in the last sentence, Wilson was asserting that there was no moral claim for limited government. This is why he believed there was no inherent moral difference between democracy and socialism—and what led to his belief in bureaucracy as a science.8

  After he was elected president, Wilson sought to change the relationship of Americans to their government. His expansion of the state was massive. He created the Federal Reserve and agencies such as the Federal Trade Commission, increasing the size of government by almost 171 percent from 1913 to 1921, even after the buildup for World War I had ended and the war expenses had ceased.9

  Wilson’s efforts to increase the size and scope of government were carried forward a few decades later by Franklin D. Roosevelt. FDR met the Great Depression with government growth—“stimulus,” in today’s parlance. He created dozens of government agencies, from the Federal Housing Administration to the National Labor Relations Board, increasing the size of the federal government by 90 percent in the first eight years of his presidency (prior to America’s entry into World War II).10

  You probably learned in school that New Deal government programs were terrific for the American economy: They ended the worst period of unemployment in American history. But, what you learned is not true. Roosevelt’s policies were not good for the economy. A 1935 study by the Brookings Institution, for example, examined the accomplishments of Roosevelt’s National Recovery Administration (NRA), which regulated working conditions. According to the Brookings study, the NRA “on the whole retarded recovery.”11 In her bestselling book The Forgotten Man, economic historian Amity Shlaes shows that Roosevelt’s spending heaped massive burdens on the country that more than offset the benefits of New Deal programs.12 Shlaes argues that federal intervention helped prolong the Great Depression and made it deeper than it would otherwise have been. But government works like a ratchet, and government activity levels effectively never fell from their New Deal highs.

  Lyndon B. Johnson picked up where FDR had left off in making the government central in the lives of millions of Americans. In his five years in office, Johnson increased the size of the federal government by 30 percent, but much more importantly, started a tidal wave of entitlements that inflated the size of government for many years after he left office. Johnson’s legacy accomplishment was a set of programs collectively known as the Great Society, which dealt with education, medical care, urban problems, and transportation. The most ambitious part of it was known as the War on Poverty, which started programs from Head Start to food stamps.

  Critics say generations of Americans were alienated from the workforce as a result of Johnson’s programs, whole classes defined themselves as claimants on the U.S. government, and millions were consigned to squalid government housing and dignity-stripping welfare programs. As Ronald Reagan later quipped, “My friends, some years ago, the Federal Government declared war on poverty, and poverty won.”13 But at the time, the benefits of the programs seemed plausible to millions of Americans. Some of the most damaging welfare programs (such as Aid to Families with Dependent Children, or AFDC) have been reformed or replaced, but other Great Society entitlements such as Medicare and Medicaid have yet to be reformed, and today threaten the viability of the U.S. economy.

  These eras of Wilson, Roosevelt, and Johnson were profligate indeed, as the data in the next section will show. But there is a broader point to absorb: No particular president (except perhaps Calvin Coolidge) since the beginning of the twentieth century is really blameless when it comes to the explosion in government activity. Some like Wilson, Roosevelt, and Johnson were especially enthusiastic proponents of government growth, and some like Ronald Reagan held the line a little more than others. But none reversed the trends. In general, the twentieth century was the bipartisan century of big government.

  SOCIAL DEMOCRACIES have been the norm in Western Europe since World War II. These systems are mildly utopian—based on a philosophy that the government can improve its citizens. But fundamentally, these systems are practical. They are motivated by a popular will to achieve higher levels of comfort, and lower levels of personal risk. Social democracies dominate in low-fertility, aging societies that are less comfortable with risk than they once might have been.

  While professing some reliance on market forces, social democracies always build a large welfare state. Citizens enjoy early retirement ages, short working hours, generous unemployment benefits, and various types of socialized medicine. In social democracies, taxes tend to be high to pay for the large state and are extremely progressive to lower economic inequality. Regulation is generally complex and onerous, to achieve social goals and curb excess profitmaking.

  With some exceptions like Germany, social democracies spend more money than their tax revenues can generate, so a large and increasing national debt is the norm. Economic growth is relatively low as the tax and regulatory systems leave entrepreneurs little incentiv
e to innovate and work hard. In the long run, social democracies can produce dysfunctional governments and unstable economic and social situations like those in Spain, Greece, Portugal, and Italy—all of which are now being crushed under a burden of debt after years of profligate government spending but modest national output.

  But America is different, right? Actually, no. Despite all the claims that America is organized on free market principles, over the decades it has become arguably just as socially democratic as Europe. Consider the following five facts.

  FACT #1. U.S. GOVERNMENT SPENDING HAS MASSIVELY EXPANDED AS A PERCENTAGE OF GDP.

  In 1913, after passage of the Sixteenth Amendment that created the federal income tax, total government spending at all levels was about 8 percent of GDP. By 2010 it had risen to 36 percent, and by 2038 it will be 50 percent.14

  Figure 5.1 is a graphic story of America’s economic transformation. Ignore the World War I and World War II spending surges, and note only the broader trends. Big spending run-ups during the century never reverse, except for a brief period in the 1990s when the United States was disinvesting in its military. The increases are largely explained by massive entitlements, which politicians on both sides of the aisle have never meaningfully reined in.

  The political right can crow all it wants about how America is a “conservative country,” unlike, say, Spain—a country governed by the Spanish Socialist Workers Party for most of the past thirty years. But, according to OECD data, U.S. government spending relative to its GDP is approximately equal to Spain’s.15

  Figure 5.1. Government spending has risen massively as a percentage of American GDP. (Source: Author’s calculations.16)

  FACT #2. AMERICA’S TAX SYSTEM IS HIGHLY PROGRESSIVE, WITH MORE AND MORE PEOPLE PAYING NO INCOME TAX AT ALL.

  Progressive taxation means that the more you earn, the higher percentage you pay in taxes. For example, if you earn $34,500 today, your federal income tax rate on the last dollar you earn is 15 percent. If you earn $380,000, your rate is 35 percent. Most Americans do not object very much to this basic system. According to a November 2011 NBC News/Wall Street Journal poll, 56 percent of Americans prefer a graduated income tax system, while 40 percent of people prefer a system in which everyone pays the same rate.17 Even conservative “flat tax” proposals almost always stipulate that low earners pay less—or even zero taxes.

  Cutting the bottom out of the tax distribution has been a pronounced trend since the early 1990s, and it has silently exploded the progressivity of the American income tax system. While progressives have screamed that upper tax rates have not gotten more progressive year after year—they have gone up and down over the decades for top earners—the percentage of Americans who don’t pay income taxes has steadily risen.

  In 1990, 21 percent of Americans paid no federal income taxes.18 In 2009, it was 46 percent.19 For nearly half of all households in America, federal government services, from the US Army to the space program, are free. In fact, more than half of nonpayers pay less than zero: 30 percent get a “refundable credit,” meaning they get a check from the government for more than they paid in.20

  Progressive tax rates at the top may not bother you, within reason. But having a lot of people with no skin in the game bothers most Americans a great deal. According to the Tax Foundation, 66 percent of Americans believe that everyone should be required to pay some amount of federal taxes.21

  This leads to an even more troubling social democratic fact: Most Americans are on a form of welfare. The majority of Americans today consume more in government services than they pay for in taxes. When George W. Bush left office, this percentage was 60 percent. Today, it is headed toward 70 percent as various parts of President Obama’s social agenda are enacted.22

  Progressive leaders often complain that America’s income distribution is lopsided—for example, that the top 5 percent of earners in America earn 35 percent of total national income. Yes, but they pay 59 percent of all the federal income taxes.23 That is to say, their tax share is 69 percent larger than their income share.

  Of course, income tax is only one part of the full tax burden Americans bear. But even if the taxes that the poor do pay, like payroll and excise taxes, are added in, the story is essentially unchanged. According to the CBO, adding together all federal taxes, the bottom quintile of Americans paid 4 percent of their income in taxes in 2007. Meanwhile the top 5 percent paid 28 percent of their income in federal taxes.24 These large differences are explained by the high percentage of nonpayers.

  Figure 5.2. The government is loading a higher and higher percentage of the tax bill on fewer and fewer people. (Source: Gerand Prante and Mark Robyn, “Summary of Latest Federal Individual Income Tax Data,” Tax Foundation Fiscal Facts, October 6, 2010, http://www.taxfoundation.org/news/show/250.html.)

  Social democrats believe this is right and just because progressive taxation redistributes money and services in a way that lowers income inequality. The rest of Americans should see this as a huge problem. America simply cannot expect to maintain a responsible citizenry when half of its citizens don’t pay for key public services such as the national defense.25

  FACT #3. THE TAX AND REGULATORY BURDENS ON AMERICAN BUSINESS ARE HEAVY BY WORLD STANDARDS, AND GROWING

  In social democracies, the government tends to penalize productive activity to raise revenues and achieve social goals. It does so by taking a relatively large share of private sector business revenues in taxes, and raising the cost of production through regulation. Both of these phenomena have cropped up in the United States—especially in the past few decades.

  Here are two false “facts” that we often hear: (1) compared to other countries, America does not tax corporations heavily, and (2) America has a lightly regulated economy. Both are false.

  Let’s start with corporate taxes. The U.S. top combined statutory corporate tax rate—which includes both federal and (average) state taxes—was 39.2 percent in 2011, the second highest in the industrialized world, next only to Japan.26

  Until the late 1980s, corporate tax rates in the social democracies exceeded America’s. At that point, virtually all of the U.S. competitor nations—even the most socialist democracies such as Sweden—began to find that in order to prosper in a global marketplace, penalizing entrepreneurship in this way was unwise. To attract business, their business income tax rates began to fall. The United States lowered its top rate one time (in 1986), but never again. The U.S. even raised its top rate by 1 percentage point in 1993. Around 1990, the industrialized world average dropped below that of the U.S., and the gap has gotten wider ever since. Today, Sweden’s effective corporate rate is 13 percent lower than America’s.27

  The story about regulation has followed the same pattern. Regulation has gradually increased the cost of entrepreneurial activity since about 1960. Two Lafayette University professors have calculated the current total burden of regulation on the U.S. economy, in terms of the cost of compliance.28 They found that in 2008, the regulatory burden was $1.75 trillion. That was 12 percent of GDP—18 percent larger even than 2012’s record-busting government budget deficit.29

  The burden of regulation is especially high on small businesses, traditionally the job creators, and America’s means of recovery from a national recession. In 2008, just adhering to federal rules cost businesses with nineteen workers or fewer $10,585 per worker. That’s how much value workers need to create before employers break even and can afford to pay the first dollar in wages. Looking at the regulatory burden per employee is especially useful because it gives an idea of the drag government puts on job creation. According to one study, the burden increased by 21 percent in inflation-adjusted dollars from 2000 to 2008.30 No wonder economists are finding that the U.S. economic recovery is so slow. Small businesses aren’t hiring because it simply costs too much.

  To get an idea of how much more regulated Americans’ lives and the economy are today compared with the past, consider the growth in the workforce of federal r
egulatory agencies. In 1960, there were about 57,000 employees in this sector. Today, there are about 292,000. In 2000, the number of regulators per billion dollars of GDP was sixteen. Today, it is twenty-one.31

  So the regulatory environment is increasingly onerous, and the U.S. taxes business more than the European countries do. This is not encouraging, if we seriously think we can avoid Europe’s economic fate.

  FACT #4. U.S. NATIONAL DEBT HAS GROWN STEADILY SINCE 1980, IN INFLATION-ADJUSTED TERMS.

  What do Mark Twain, P.T. Barnum, and Oscar Wilde have in common? They were all wealthy people who went bankrupt. There are many similar stories: A rich celebrity lives more extravagantly than he can afford, and goes bust. Reading about his situation, you are filled with a little bit of schadenfreude, and a big dose of contempt. All that money, you think, and still he racked up ruinous debt. He’s irresponsible.

  Look in the mirror—he is you, my fellow American. As of December 2, 2011, America—the richest nation in the history of the world—owes its creditors $15,101,125,095,514.72.32 To put that into perspective, that’s $48,290 for every American, which the U.S. will either have to pay back or default on if it goes bankrupt like so many other countries throughout history.

  When faced with this problem in Great Britain in the 1980s, Prime Minister Margaret Thatcher is reported to have said that the problem with socialism is that eventually you run out of other people’s money. That’s the road America is headed down now.

  When did the binge begin? Back through history, there have been many periods of high debt, often correlated with periods of war. Eliminating those, the modern peacetime debt increases started around 1982 in America, when Ronald Reagan’s defense buildups were not paid for by reducing domestic spending. Debt leveled off and decreased somewhat through the late 1990s and early 2000s, but then exploded back up to their highest levels ever, starting in 2009.