Democrats and many Republicans in Congress are calling for the rejection of the latest spending “cuts” arguing that they cannot be absorbed without undue pain. These cuts are in most cases reductions in growth and do not go far enough, in my estimation, and even if enacted will still result in a budget deficit above 4% of GDP.
The size and scope of government under a Republican President, Republican House and Republican Senate have seriously undermined the ability of the economy to grow at its full potential. To sustain the current level of growth in federal government spending, either long-term interest rates will rise or tax rates will increase at an unacceptably high rate. Both outcomes subdue economic growth.
The outrageous growth in federal spending is unrelated to political party affiliation, or to professed fiscal doctrines. Federal spending grew at a compound annual growth of 6.6 percent under George W. Bush, 6.5 percent under Clinton, and 7.1 percent under George H.W. Bush; so much for party discipline.
The real difference between Republican and Democrats is in how they would fund raucous spending growth. Both Bush senior, with a Democratic House and Senate, and Clinton raised tax rates in order to grow government receipts by 4.7 percent and 7.3 percent, respectively. George W. Bush has instead funded his federal spending growth by expanding the magnitude of the deficit while reducing tax rates (AMT aside).
Now the Congress is wrestling with extending the 15 percent capital gains tax rate on dividends. The five year “cost” of this extension to 2010 is estimated to be $21 billion. The House has passed the extension while the senate has not. Data indicate that failure to pass the extension will only allow federal spending to grow at an even higher rate and will punish the over 50 percent of Americans who hold stocks either directly, in mutual funds, or in their retirement accounts.