How Big Are the Losses Created by Government?
by Michael S. Rozeff
by Michael S. Rozeff
Surprisingly large. How large? No one knows, and no one can know. But it won't hurt to do some rough back-of-the-envelope calculations of a portion of the losses. The amounts are shocking.
Government costs us, but we can't measure how much it costs us. Government taxes, regulation, borrowing, and inflation all create economic inefficiencies because they interfere with and nullify individual decisions. We can't measure how big these losses are. We can't measure how individuals value what they are losing. When the state takes $1,000 of income from Joe Doaks, we do not know what this is worth to Joe Doaks. When he freely exchanges $1,000 for goods that he values, they are worth more to him than $1,000. We can't know what those personal valuations are or what Joe might have bought or invested in. Therefore, we can't know how he values the loss of $1,000. It's reasonable to say that the loss is at least $1,000. In some cases, this may be false if Joe doesn't care about money. Most of the time, it will be a sensible assumption.
When the state imprisons a drug offender, we can estimate the out-of-pocket costs of imprisonment, the costs of housing, feeding, guarding, etc. These will be impounded into the state's taxes and borrowing costs. The losses are far greater than these amounts, however. The drug offender's life is interrupted. He can't make a living while imprisoned. He may be harmed in prison. His ability to earn money after release is impaired. He may become a hardened criminal. His family is affected. The costs mount up, and we can't measure them.
If the state starts a war, lives will be lost. Bodies will be injured, minds undone. Families will suffer. Property will be destroyed. Again, we will have a very hard time estimating the total costs. Wealth is diverted from productive uses, and we don't know what might have been produced that people value. The out-of-pocket costs will be more visible and measurable, not that we can even know those very accurately.
Regulations, volumes and volumes of regulations, cost society very great amounts. They prevent people from competing, from developing and marketing new products, and from building dwellings where and how they might like to. They affect speech, communications, transportation, financial transactions, and money. What is left out of this list exceeds what is in the list. To estimate the total costs is a Herculean task. In principle, as in the other cases, it can't be done.
How much do big programs like Social Security and Medicare cost? What losses do they cause the American people? We can't say. The state takes one person's wealth and gives it to another. This is not a wash. We can't measure how much the gainers and losers value the funds, not that this provides a just criterion. There are large "frictional" or "transactions cost" losses when the state acts as the intermediary. These include the costs of collection and dispersal and the costs of tax avoidance. Beyond these, the state's interventions alter the incentives to work, save, marry, have children, and care for families. It alters the incentives for employers to hire. It alters family structure. No one knows the ultimate costs of these programs.
I can't tote up all the possible costs of the American state (shorthand for all its governments combined). What I can do is some rough calculations simply to get some idea of a portion of the costs.
To do that, we need the concept of present value. That's because taxes go on year after year after year, and I want to compare their sum total (present value) to other present value totals that we are reasonably sure of, like the values of stocks. Stock values are in terms of present values already. I want to compare oranges with oranges.
Getting present value is like reversing compound interest. Place a dollar in the bank at 4 percent interest. After one year, it's worth $1.04; in two years it's worth $1.0816. That's compound interest. Present value finds the present worth of cash flows occurring in the future. That $1.04 in the future is worth $1 now; so is $1.0816 received or paid two years from now. They are equivalent at a 4 percent interest rate. We divide the 1.04 by 1 + the rate of interest, or 1.04, to get $1, the present value.
When there is a stream of future cash flows, like $1 to be received (or paid) for the next 50 years or 100 years, the computations are more complicated. But for a perpetual stream of cash flows that goes on forever, the computation simplifies. If $1 is to be paid out annually forever, then at 4 percent interest, the present value is $1/0.04 = $25. This is one formula I will use. Although forever sounds like a long time, the value of this annuity is almost the same as an annuity that lasts 40 years. I use it because of its simplicity.
Stocks, bonds, and other assets are valued at the present value of their future cash flows. Stock market values are present values. They impound all the potential future cash flows, brought back to present value using (unknown) interest rates. They vary depending on the riskiness of the cash flows. For cash flow streams that are virtually sure things, like some bonds, the interest rates are around 4—5 percent or a little higher.
A perpetual bond that pays $1 a year interest is worth $20 at 5 percent interest. That is, $20 = $1/0.05. If you pay $20 for the bond, you receive a cash income each year of 0.05 x $20 = $1. That is why $20 is a fair price for this bond when the interest rate is 5 percent.
Total market values
The value of all the domestic stocks in the United States is about $17 trillion, according to the New York Stock Exchange. This is a reasonably hard figure. We know the prices on the exchange and we know the numbers of shares outstanding. Multiplication and addition provide the answer. This $17 trillion is part of our collective wealth or that of overseas owners. I use this number as a reference point because it's a great deal more specific, accurate, and meaningful than a number like the gross domestic product (GDP).
The U.S. market value of private credit market instruments (debts and loans) runs between $5—$7 trillion. Public debt doesn't count as net wealth because its value is offset by future tax liabilities. Real estate wealth, net of debt issued against it, is hard to estimate. Judging from high net worth investors, real estate values (excluding homes) might approximate those of stocks, maybe around $20 trillion. So far, we are up to $17 + $7 + $20 = $44 trillion.
Wealth is held in other forms, such as minerals, oil, and timber that I ignore. We hold wealth in human form too. We have the capacity to produce income by working and using our knowledge and social relations. Many economists refer to this wealth as human capital. It adds up to a large amount.
Human capital that produces wages and salaries is very hard to estimate. The gross domestic product (GDP) is a complex statistical construct that gives us a rough idea of magnitudes. The 2005 GDP is $12.5 trillion. That includes $2.4 trillion from governments and $10.1 trillion private. If the $10 trillion is an income stream from our collective wealth, then perhaps its present value is 20 times as great, or $200 trillion (using a 5 percent interest rate). Subtract the $44 trillion to get $156 trillion, which measures the value of human capital in the U.S.
The government's take
The national income accounts say that governments at all levels made up $2.4 trillion of spending in 2005. How much of this cost is loss to American citizens? We don't know. This number underestimates losses because of the factors mentioned earlier that are not included such as unmeasured value losses. It overestimates losses because some of these costs are not total losses. There is a partial recovery when payments are made from one group of citizens to another. For the sake of argument, let us say that these two issues offset one another. Then we count the loss as $2.4 trillion. The reader can adjust the loss to his liking. Personally, I count the losses as much greater than $2.4 trillion because I believe the opportunity losses in wealth and welfare from not having a free economy are very large. I believe that the extent of unhappiness, frustration, and disruption of people's lives as a consequence of government are immense.
From other viewpoints, counting all of government spending as a loss seems sensible. Rothbard pointed out that "the government's productive contribution to the economy is precisely zero." About 20 percent of the total goes to defense spending. It's hard to see the benefits, but it's easy to see the uncounted losses. Wherever the private sector is spending large amounts of money to obtain the services that the state is supposed to be providing, it is evidence that the state spending is simply waste. Education and policing come to mind. I happen to hear Minister Farrakhan on C-Span saying: "The educational system isn't worth a damn!" Many other like instances can be cited in which the total government spending is sheer waste.
Now we come to the heart of the matter. How big are the losses? A loss of $2.4 trillion a year is not the whole loss. It will go on year after year. This means we must find its present value. Since taxes are as certain as death, a sure rate of interest like 5 percent a year is a reasonable rate to use in the calculation. The present value of a perpetual $2.4 trillion payment is 20 x $2.4 trillion = $48 trillion!
If our economy were completely tax-free and the government came along and imposed a tax of $2.4 trillion a year as it now is doing, our wealth would drop by $48 trillion. If government is eliminated, then our wealth rises by $48 trillion.
We know quite surely that our entire stock market wealth is worth $17 trillion. Imagine. Our wealth is being depressed by the equivalent of nearly 3 entire U.S. stock markets! That is our back-of-the-envelope estimate of how big the losses are that are being created by all levels of government. Even if this calculation is off by a factor of 2, the loss is still immense, almost unimaginable. Quite possibly, I have left out factors. By using GDP figures, I may be underestimating losses. They may be even higher.
If the private sector had an additional $48 trillion of wealth, it might be able to earn a rate of return of at least 5 percent on it, which is the state's take of $2.4 trillion. The income available to the private sector would go up from $10 trillion to $12.4 trillion, an increase of 24 percent. Suppose that this occurred over a period of 10 years. Each year the growth rate of income would be about 2.4 percent higher than the norm we are used to. Instead of 3.5 percent growth, we'd see 5.9 percent growth, not that we should use growth as a criterion of welfare. A magnificent boom would occur. This again illustrates how large the losses from government are.
As the state grew over the decades, the opposite happened. As it wasted taxpayer income, the rates of growth of the economy slowed down. The effects of differences in interest rates are hard for the human mind to comprehend. If we invest $100 a year for 40 years at 3 percent, it grows to $7,500. The same $100 a year invested for 40 years at 4 percent grows to $9,500. If in this way the state slows the economy down by 1 percent a year over a 40-year period, we end up being 21 percent poorer than we might have been (2,000/9,500.)
This is a lot when we consider the whole of society. In the aggregate, if our total capital is $200 trillion, it might have been $248 trillion. We are about 19 percent below where we could be if we eliminated the losses from governments at all levels. And I believe that this estimate is conservative.
How big is $48 trillion? If there are 100,000,000 households in the U.S., this is $480,000 per household.
It gets worse
Analysts bandy about a variety of estimates of the present value of the cash flows that Social Security and Medicare are slated to pay out in the future. Together they are between $65 and $75 trillion. These are unfunded liabilities. That means that if the government decides to pay them, it has to raise taxes to pay for them. The present worth of those taxes is the $65—$75 trillion figure. This will depress the wealth creation of the private sector, much as the growth of the state has in the past 40 and more years. American standards of living will be crimped by another 1—2 percent a year growth. Real growth will be reduced to near zero.
There exist other insurance and disaster guarantees that the state has enunciated. These are unfunded. They add to the future potential taxes. These include guarantees to eliminate terror and install democracy everywhere.
We know that government taxes incomes and everything else that moves and doesn't move. I've emphasized here that we should think about the effects of this in terms of present values, and we should compare the results to numbers we are sure of, like stock market valuations. It's not hard to see that the depressing effects of government spending are very large. At today's levels, they are the equivalent of about $48 trillion, as compared with a total value of all U.S. stocks of $17 trillion. Such huge expenditures depress the well-being of the private sector. This shows up in slower and slower increases and even decreases in living standards. The state has already made huge promises for the future which, if kept, imply an end to improvements in American living standards.
Will Americans quietly keep mum while they run and run merely to stay in the same place? The American state cannot keep its current programs intact or carry out its grand foreign agenda without slowing down the U.S. economy to a crawl. Will Americans see what is happening to them and cut back the spending and taxing mammoth? Will they slay the overbloated Leviathan? The prognosis is guarded. If there are clear signs that this politically divided people is ready to act in this direction, I am unaware of them.
February 27, 2006
Michael S. Rozeff [send him mail] is the Louis M. Jacobs Professor of Finance at University at Buffalo.
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