Voters chose a different direction this election. The new administration and lawmakers nationwide must determine how to get the economy on track. The historical evidence is clear that free market capitalism best provides prosperity.
Economic growth continues to muddle along at the slowest pace since World War II. The labor force suffers from 40-year lows in major indicators. The national debt is $20 trillion and exceeds economic output. More of the same failed Keynesian policies, named after the economist John Maynard Keynes, that assume spending drives economic growth aren’t an option.
Data show better economic outcomes in places with less government and more economic freedom.
The Economic Freedom of the World (EFW) report ranks countries level of economic freedom based on government intervention in an economy. The U.S. ranking declined from second most free in 2000 to 16th today after excessive government expansion. Research finds that less economic freedom contributes to lower standards of living; no wonder many Americans are struggling seven years after the Great Recession.
Keynesian policies fail for at least four reasons.
First, individuals cannot consume without first sacrificing time and effort to produce something to exchange. Production, not spending, drives economic growth.
Second, for the government to give a dollar to Jack, it must be taken from Jill. While the federal government can issue debt, that’s just future taxation.
Third, taxing work and other so-called “economic bads,” such as carbon and alcohol, is social engineering instead of the intended purpose of taxation to efficiently fund basic government provisions.
Fourth, government spending fails from the “knowledge problem” as articulated by the Austrian economist Friedrich Hayek, noting how budget writers have insufficient information from a lack of market prices to efficiently allocate resources.
Instead of continuing these failed policies, lawmakers should look to the two largest states for solutions: Texas and California.
These states contribute 25% of U.S. economic output, have similar abundances of natural resources, and are where 20% of Americans reside. However, Texas has low taxes, no personal income tax, and less regulation, versus California’s high taxes, highest marginal personal income tax rate nationwide, and burdensome regulations.
The Economic Freedom of North America report, which is similar to the EFW, ranks Texas as the third most free state and California as second worst. The Tax Foundation ranks Texas as having the 14th best business tax climate while California ranks third worst. Meanwhile, critics of Texas claim it’s a poverty-ridden state from the model of limited government.
While more needs to be done to eliminate poverty in Texas, such as cutting excessive government spending by passing conservative budgets and eliminating the business franchise tax, standard of living measures are better for most Texans.
What about poverty? Taking the average over the 2013 to 2015 period, the Census Bureauprovides the official poverty rate of 16.1% in Texas and 15% in California, which suggests that the critics are right. However, that rate doesn’t account for regional differences in housing costs or noncash government assistance. The supplemental poverty rate includes these factors and instead finds a rate of 14.9% in Texas while California has the highest rate nationwide at 20.6%.
What about real income? Average nominal median household income from 2010 to 2014 (in 2014 dollars) in California ($61,489) is 17% higher and nationwide ($53,482) is 1.7% higher than in Texas ($52,576). But, the Bureau of Economic Analysis’ regional price parities data for 2014 show that the cost of living for California is 17% higher and the U.S. average is 3.5% higher than in Texas. Therefore, real income in Texas purchases as much as in California and even more when you consider that Texas doesn’t have a personal income tax.
What about inequality? Income inequality has been higher in California than in Texas as the average of total income held by the top 10% of income earners from 2000 to 2013 was 49.7% in California versus 46.8% in Texas.
In the last decade, Texas has been the economic and job creation engine as the real private sector expanded 29% in Texas compared with only 14% in California. Moreover, total civilian employment increased 1.2 million in California but 1.7 million in Texas, with a labor force two-thirds the size of California’s. This increase in Texas’ employment accounts for nearly one-third of all jobs created nationwide.
The more you tax and regulate something, the less you get of it. Clearly, less government contributes to higher standards of living in Texas.
Keynes recommended government intervention to stabilize an economy because “in the long run we’re all dead.” However, we may feel dead in the short run given the lower standards of living from those policies.
As the new administration and policymakers nationwide reassess which direction to take, it’s important to remember that spending is the disease and taxes are a function of that disease. Restraining spending growth while following the Texas model of free market capitalism would be an excellent way to get the economy, and personal finances, back on track.
Vance Ginn is an economist in the Center for Fiscal Policy at the Texas Public Policy Foundation, a nonprofit, free-market research institute based in Austin. Ginn may be reached at firstname.lastname@example.org.