Cayman is rich, and Belize is poor. Why? Both are small Caribbean countries with the same climate and roughly the same mixed racial heritage, and both were English-speaking British colonies. Belize (the former British Honduras) received its independence in 1981, while Cayman is still not fully independent but is self-governing at the local level, with its own currency, laws and regulations.

Belize should be richer: It has a larger population than Cayman (345,000 as contrasted with Cayman’s 54,000). Belize has a much larger and more varied land area with many more natural resources, including gas and oil, and some rich agricultural land that Cayman lacks. Both have nice beaches, but Belizehas the second-largest barrier reef in the world after Australia and also has Mayan ruins. Yet Cayman, with fewer points of interests, has done more to attract tourists.

Back in the early 1970s, Cayman was as poor on a per capita basis as isBelize today. Both countries had ambitions to be tourist and financial centers. Cayman succeeded and has about six times the real per capita income of Belize. What did Cayman do right and Belize do wrong?

Perhaps most important is that Cayman had and maintained a competent and honest judicial system, which gave foreign investors confidence that their property would be protected. Cayman also has a very low crime rate. Tourists and other visitors walk around freely day or night in Cayman without fear. Unfortunately, the same cannot be said for many parts of Belize, where crime is often a problem. In addition, many judges in Belize are poorly trained, incompetent and, in some cases, corrupt. These issues cause foreign investors to consider higher-risk factors for projects in Belize as contrasted with Cayman.

Belize has a more investor-friendly tax system than the United States, but Cayman has no corporate or individual income taxes on noncitizens and citizens alike – advantage Cayman. The problem for Belize is that it is competing with the likes of Cayman, Bermuda, the Bahamas and the British Virgin Islands, but not the United States. Also, the regulatory environment in Cayman is largely free of corruption, which is not true inBelize.

The latest Index of Economic Freedom ranks Belize as the 77th most economically free country in the world (out of 179). If Cayman were large enough to be ranked, it almost certainly would be in the top 10. There is a very high correlation between economic freedom and per capita income. Any country can decide to become more free. Belize ranks a miserable 93 out of 183 countries ranked by the World Bank’s DoingBusiness project.

It is obvious why Cayman is rich and Belize is poor, and it comes down to one word: governance. If Belize would clean up its courts, fully protect property rights and adopt the best economic practices of its competitors, it could quickly become rich. For instance, it takes an average of 44 days to get all of the required permits to open a new business. In some countries, such as Estonia, Singapore and even the Commonwealth of Virginia in the U.S., the required paperwork to open a business can be done online. Thus, days have been reduced to just a few hours.

There is no reason any country has to remain poor. Countries are not poor because of climate, lack of natural resources or race. Countries as locationally varied as Singapore, Mauritius, Korea, Chile, Estonia and Cayman have become relatively rich over the past few decades. Those countries that are still relatively poor are poor because they have not put in place the necessary institutions, political structures and policies.

The United States and a number of other wealthy nations are becoming less free and thus, not surprisingly, are growing more slowly.

Belize could become rich and the U.S. and Cayman could become poor. It all depends on whether the political entities elect wise and courageous leaders.

Even though some are predicting the end of the world in 2012, there is a possibility it could turn out better than 2011 (a low bar). Many people who are not part of the political class continue to advance civilization and make things better for us – like the late Steve Jobs.

Dr. Ito Briones, who is a biochemist research scientist, a medical doctor and something of a Renaissance man, recently wrote to me that he thinks the greatest discovery in medical science was the creation of iPS (induced pluripotent stem cells, or stem cells from reprogrammed skin cells) by Drs. Shinya Yamanaka and Kazutoshi Takahashi. According to Dr. Briones, “Even though the clinical application of iPS cells remains untested, the theories about aging and stem cells and the fountain of youth principles are groundbreaking and extremely fascinating. IPS science continues to move very fast. … The promise for cures to cancer and other diseases appears plausible now with iPS science. What this discovery has also done is to open scientists’ minds to the concept that nothing is indeed impossible in biology.”

Other potential good news is that not all members of the political class are unprincipled, self-serving, ignorant and shortsighted. We are seeing a growing band of smart, responsible and knowledgeable people being elected to Congress and other political bodies. One example is Rep. Paul Ryan, Wisconsin Republican, who is chairman of the House Budget Committee. Mr. Ryan, a fine economist, put together an economically sound and politically realistic budget that passed the House of Representatives but, not unexpectedly, died in the Democrat-controlled Senate. There is a real possibility that a sufficient number of the American people will be rational enough to elect new members to the House and Senate (and the presidency) to pass a Ryan-type budget before the United States goes off the fiscal cliff, like Greece.

In democratic countries, many politicians get themselves elected by making promises for spending programs that the citizens cannot or are unwilling to pay for. The result is persistent deficit spending that ultimately spirals out of control. The good news is that some democratic countries have learned how to avoid the spending/deficit trap, and those countries can serve as examples for the less prudent majority. (See accompanying chart.)

The best example is Switzerland. The Swiss have managed to be fiscally responsible for many decades, in part because they have a highly decentralized, direct democracy. Most governmental functions take place at the local level rather than the federal level in Switzerland, and as a result, the local governments must compete with each other on taxes, regulations, etc., which tends to hold down the growth in government and promotes liberty. Where government is close to the people, and where the democratic process is direct, the people can more directly hold elected officials responsible for misspending and mismanagement.

The United States was designed by its founders to have a small and relatively weak central government, in which most of the government functions and power were supposed to be at the state and local level. The 10th Amendment to the U.S. Constitution is very explicit: “The powers not delegated to the United States by the Constitution nor prohibited by it to the States, are reserved to the States respectively or to the people.” The potential good news is that as a result of the presidential debates, more people are becoming aware of the 10th Amendment and are beginning to understand that if Congress and the courts stopped ignoring this amendment, the U.S. likely would have a smaller, more effective and more fiscally sound government.

Sweden and Canada provide role models for how highly developed democracies that have created unsustainable welfare states can find peaceful and constructive ways out of the dilemma. In the mid-1990s, both countries were stagnating and headed toward a Greek-style credit default because of the drag of bloated government spending, taxing and regulation. In both countries, the parties of the left and right came together to reverse course by reducing tax rates, spending and destructive regulation and privatizing much of what had been nationalized. Real growth has been revived in both Canada and Sweden, and they both have very manageable debt-to-gross-domestic-product ratios. Because Sweden is a small, homogenous country, it is able to maintain a larger government as a percentage of GDP and still obtain normal rates of economic growth than can more heterogeneous countries like the U.S. and Switzerland.

Source: The Economist Magazine

The good news is that it is well-known what economic reforms are necessary to revive growth and fiscal sanity in the major European countries and America. But it also takes leaders who can explain what needs to be done and persuade the people to endure the pain of the necessary transitional hardship in the way British Prime Minister Margaret Thatcher and President Reagan did.

As a reality check on the potential good news, my friend Jim Stewart, a neurologist, asked: “While the medical community is indeed making great strides in extending our lives, who … wants to live longer if the politicians keep making things worse?”

Richard W. Rahn is a senior fellow at the Cato Institute and chairman of the Institute for Global Economic Growth.

Artykuł po raz pierwszy ukazał się w Washington Times.

Do increases in government spending increase or decrease the number of jobs? Conventional wisdom is they will increase jobs, and a few left-wing economists, such as Paul Krugman of the New York Times, frequently are trotted out by reckless politicians and some in the news media to argue that we need more government spending in order to create jobs. If this were true, we should be able to see it in the historical evidence, so let’s look at the numbers.

Government spending grows each year, but what is relevant is whether it is increasing or decreasing as a percentage of gross domestic product (GDP) and how it relates to the percentage of the adult labor force at work. As can be seen in the accompanying chart, there is an inverse relationship between increasing the size of government and job creation. This empirical evidence, along with much other evidence, is contrary to the argument made by those calling for more government spending to create jobs. Some who argue for more government spending, such as economistMark Zandi of Merrill Lynch, use neo-Keynesian models to justify their conclusions – conveniently ignoring the fact that such models almost always have been wrong.

What also typically is ignored by the neo-Keynesians is that there is an enormous tax extraction cost for the government to obtain each additional dollar. Estimates of this extraction cost typically run from $1.40 to well over $2.50 of lost output for each dollar the government obtains. In addition, there is vast literature showing how specific government spending programs have little or even negative benefit and, as a result, are actually wealth and job destroyers. Thus, the real deadweight loss of additional government taxing and spending is estimated to be in the $3 to $4 range.

If additional government spending could create more jobs, it would be expected that over the long run, the socialist or semisocialist economies would have full employment and the smaller-government, developed economies would have higher unemployment. Again, the empirical evidence shows just the opposite. Sweden and Canada are examples of countries that reduced government spending as a percentage of GDP 15 years ago, and as a result, both countries saw increased economic growth and employment.

The length of the periods in the chart was determined by the number of years in which the government trended relatively larger or smaller. The World War II and Korean War years were left out because of the necessary jumps in government spending as a percentage of GDP. Even during those wartime periods, there was almost no change in civilian employment as a percentage of GDP. The Vietnam War had little impact on the size of government. A big increase in government spending started during the Nixon administration after the end of the war, as many of his predecessor’s Great Society programs started to have an impact, along with Nixon’s big increase in government programs. As he famously said, “We are all Keynesians now.”

Government spending as a percentage of GDP almost tripled between 1929 and 1939 under Presidents Hoover and Roosevelt, yet the number of Americans at work fell through this period despite a growing population. The percentage of growth in government spending was less than GDP growth during the period from 1983 to 2000 (Ronald Reagan through Bill Clinton), and job growth soared.

I expect no amount of evidence will persuade Mr. Krugman and President Obama that they have it totally backward. Over the years, I have had the good fortune to know a number of the Nobel laureates in economics and have found them to be careful scholars, not allowing their political leanings to overcome what they believe to be good economics.

Mr. Krugman is the exception. He frequently misstates the good work of others. His attack on the Austrian School economists last week is a prime example. The Austrians, such as F.A. Hayek, argued that governments tend to debase currencies (when they are not tied to gold or other commodities) by creating too much money to cover excessive spending, resulting in inflation. Mr. Krugman acknowledges that there has been a very large increase in the money supply, so he asks, “Where is the inflation?” First, he greatly understates the current rate of inflation (3.4 percent over the past year), and then he ignores the fact that changes in the velocity of money (the number of times a dollar changes hands in a year) also determine the rate of inflation. Businesses and individuals are now hoarding cash because of tax and regulatory uncertainty; hence, velocity is down, even though the supply of money is up.

The Federal Reserve and the European Central Bank are creating money to bail out the indebted countries. They are either going to have to stop and destroy much of the new money they have created, or there will be a great inflation when velocity returns to normal. My bet is that at some point, inflation will come roaring back, and I also bet Mr. Krugman and others in his camp will no more admit they are wrong about that than they have about the destructive effects of increases in government spending. Some are forever blind to evidence.

The financial crisis in Europe has resulted in the appointment of new prime ministers in both Greece and Italy, in reality, by the Germans and French, rather than through the ballot box in Greece and Italy. This raises the question, “Is it possible to have both a bureaucratic welfare state and a democracy that protects individual liberties?”

In the United States, as well as most other countries, the people are increasingly governed and regulated by unelected bureaucrats who create “administrative law.” The rise of the bureaucratic state, at least in the U.S., is only about 80 years old. The number of federal employees grew slowly over the first hundred years of the American Republic so by the time of the first Grover Cleveland administration in the 1880s, there were still fewer than 100,000 federal civilian employees.

By 1925, the number had grown to about a half a million, and now there are almost 3 million civilian federal government employees, plus another 17 million state and local government employees. Many government services are now contracted out, such as printing and maintenance, so the proportion of government employees engaged in some sort of regulation, rather than providing a service, has risen.

The war on terrorism and the ongoing global financial crisis have resulted in a great increase in the power of unelected officials. It is true that elected officials are the ones who have created the bureaucracies that reign over the people, but that fact does not mean that either the will of the people or their liberties are being protected. There are two fundamental reasons for this trend: The first is as government takes on more and more functions, its complexity and size grows, making it increasingly unmanageable. The second reason is that politicians promise the people more than can be delivered, and when the time ultimately comes to pay the bill, the politicians have a great incentive to duck and try to delegate the decisions to others (e.g., the supercommittee), so they do not have to take direct responsibility.

When the elected (now deposed) Greek Prime Minister Georgios A. Papandreou, said that he wanted to submit the austerity program being imposed by the other eurozone countries to a vote of the Greek people, he was quickly forced by the German and French leaders to rescind the proposal. He was then required to step aside for an unelected “technocrat” to carry out the austerity program, which the Greek people would probably have rejected. In a similar vein, anyone who has seriously looked at the numbers knows that the U.S. Medicare program must be cut back. Only a few politicians, such as House Budget Committee Chairman Paul Ryan, are willing to stand up and state the obvious and propose real solutions.

The others do their best to hide, with the aid of a compliant press, as they have done with Obamacare. One provision of the new health care law empowers unelected panels of technocrats to make reductions in Medicare benefits each year in order to hit budget targets. This enables the politicians to claim they are not responsible for the cuts, but someone behind the tree is.

All of these nondemocratic procedures are designed to thwart the will of the people and ultimately, individual liberty. None of these observations is new. F.A. Hayek, in his best-selling book, “The Road to Serfdom” (1944), argued that socialism and the welfare state would ultimately lead to a totalitarian society. Other wise economists and political scientists, including James Buchanan, Gordon Tullock, Richard Wagner, William Niskanen and James Q. Wilson, have written influential books and papers in the past half-century, warning about the rise of the bureaucratic state.

What is new is that due to the global financial crisis, the rate at which democratic control and individual liberty are being destroyed has greatly accelerated. Most of the world’s developed democracies, including the United States, are running unsustainable budget deficits with ratios of gross domestic product to debt spiraling out of control. The electorate in most countries is in denial and votes against politicians who act to cut back the unfundable “entitlements.” Hence, power to make the necessary changes is delegated to authoritarian bureaucrats and central bankers who understand their job is to destroy the value of the government debt by inflating the currency through the printing press.

Despite the depressing global situation, there are glimmers of hope. There are a couple of examples of developed democratic countries that were headed toward a Greek fiscal meltdown but were able to summon the political will to make necessary changes in spending, taxing and regulations. Sweden and Canada are perhaps the two best examples of countries where the politicians across the political spectrum were able to come together in the mid-1990s to make necessary changes. Canada sharply cut back government spending and greatly reduced its GDP-to-debt ratio. Sweden now has the least progressive tax structure (other than the flat-tax countries) of the developed economies, so most Swedes realize if they demand more government services they are going to have to pay for them, rather than some invisible “rich” person.

Control by the electorate in the United States will continue to diminish as long as the people demand more from government than they (not someone else) are willing to pay for and the economy can support. The loss of democracy might be tolerable if judges would start demonstrating some courage in protecting the liberties of the people against the unelected bureaucrats as the Constitution requires them to do. Short of these changes, it is hard to be optimistic about the future.

President Obama and many in his administration, as well as the Democrats left in Congress, keep expressing bewilderment as to why the economy is not producing the jobs they had promised with their “stimulus program.” The problem is that their model of what is supposed to happen is wrong, and it has been known to be wrong for decades.

In essence, they are fixated on the old Keynesian idea that government spending can create jobs. Milton Friedman, F.A. Hayek, and many other Nobel Laureates and other fine economists, such as Harvard’s Robert Barro, have demonstrated that the concept is dead wrong and neither works in theory or practice. Yet, because it gave politicians a rationale to spend more of other people’s money, it is a bad idea that has never died.

Mr. Obama still seems to actually believe that government spending is the solution, not the problem, forgetting what President Reagan correctly said: “Government is the problem and not the solution.” The Keynesian argument is that if government increases spending, there will be a “multiplier effect,” where each dollar of additional spending increases output by more than the dollar.

In an International Monetary Fund (IMF) paper published in March titled “How Big (Small?) are Fiscal Multipliers?” the authors Ethan Ilzetzki, Enrique G. Mendoza and Carlos A. Vegh conclude that “in economies open to trade or operating under flexible exchange rates, a fiscal expansion leads to no significant output gains. Further, fiscal stimulus may be counterproductive in highly-indebted countries; in countries with debt levels as low as 60 percent of GDP [gross domestic product], government consumption shocks may have strong negative effects on output.” Note the U.S. has a 68 percent debt-GDP ratio and it is rising.

In the graph above, it can be easily seen that increases in government spending are associated with lower levels of employment and vice versa. Proponents of more government spending argue there is a lag between increases in government spending and increases in employment, but this lag is stated to be in months, not years, and the average recession lasts less than a year. The chart also clearly shows that even with a lag of a year or so, job creation, correctly measured as a percentage of the adult population employed, is again negatively associated with bigger government.

President of Encima Global and former U.S. Treasury economist David Malpass said Friday that wages are “up only 1.8 percent over the last year and well below the 3.2 percent inflation rate.” He also noted, “The more government spends, whether on so-called investment, entitlements or just plain waste, the less the private sector wants to hire new workers. Businesses realize that government debt puts them at risk.”

In addition to government spending, the other big reasons businesses are not hiring are the fears of new tax increases, particularly on labor and capital that the president has promised, the explosion in regulatory costs, and uncertainty.

One of the major impediments to job growth is the cost of regulation, which has been growing far faster than GDP. In September, economists Nicole V. Crain and W. Mark Crain did a comprehensive study of the cost of regulation for the Small Business Administration. They estimated regulatory costs were $1.75 trillion in 2008, or about 14 percent of GDP. The Crains’ report also showed that regulatory costs are about 36 percent greater for small firms (the big job creators) than for large firms ($10,585 per year versus $7,755). Regulation is a hidden tax on both employment and productivity growth. Much regulation does not even come close to meeting reasonable cost-benefit tests. Government agencies, such as the Environmental Protection Agency, the Securities and Exchange Commission, the Internal Revenue Service, etc., do not have truly independent economists evaluating the cost-effectiveness of their regulations. The IRS and Treasury are now developing regulations to try to stem tax evasion but which may have the unintended consequence of driving as much as a trillion dollars of foreign investment out of the United States, which could cost millions of jobs. Those at the IRS claim the proposed regulations will have only minimal impact, but since they have not done an independent cost-benefit analysis, such assertions are meaningless and dangerous.

The distinguished professor of law and economics, Richard A. Epstein, wrote last week, “American businesspeople complain most about the uncertainty associated with the current regulatory (and tax) environment. … Clear rules are a necessary condition for good government, but they are not a sufficient one. What is needed are rules that make sense in their ends and their means. What we have now is neither, whether we are looking at old regulations like those of the EPA or new ones like Dodd-Frank [financial reform law].”

If Mr. Obama really wants many new jobs now to bring the unemployment rate down substantially before the next election, he has no choice but to reverse his current policies:

• He immediately needs to cut spending by at least 20 percent. There is virtually no federal department that is not loaded with fat – federal spending has grown by 30 percent just since 2008.
• He needs to pledge not to further increase tax rates on labor and capital – the inputs for a growing economy.
• He needs to impose a freeze on all new regulations until each proposed regulation has undergone a full, competent and independent cost-benefit study subject to outside legal challenge.

These three measures would remove much of the uncertainty job creators face and give them the confidence they need to hire their fellow Americans.

The only constructive way out of America’s current economic crisis is to go for growth in the way that Reagan did, by cutting tax and regulatory impediments and also greatly cutting the size of government. There is no other path to liberty and prosperity.

So you have just finished preparing your income taxes, but did you understand the tax code? If you said yes, you do not know what you do not know. The U.S. tax code has become so long, complex, contradictory and devoid of common sense that no one can fully understand it – and this includes tax professionals and Internal Revenue Service (IRS) personnel. Can honorable persons of good conscience harass, fine and even imprison their fellow citizens for an alleged violation of laws and regulations they themselves do not completely know? But that is a topic for another column.

Tax economists have long argued that the U.S. income tax causes an enormous – and largely unnecessary – dead-weight loss to the economic system. The sheer cost and time burden of businesses and individuals trying to comply with the tax system – let alone the cost of the more than 100,000 bureaucrats at the IRS who claim to be administrating it – waste hundreds of billions of dollars. This waste of resources unnecessarily reduces economic growth and job creation. A major reason this obscenity persists is that few lawmakers and IRS rule makers think seriously about the consequences of what they have done and are doing, or just don’t care.

One person who does think seriously about tax and other financial issues, including the morality of the tax code, is California venture capitalist and financial scholar Kip Hagopian. Mr. Hagopian has a most timely and provocative article in the April-May issue of Policy Review (a publication of the Hoover Institution at Stanford University) titled “The Inequity of the Progressive Income Tax.” The U.S. has had a progressive income tax (in which rates rise at higher income levels) since the beginning of the income tax in 1913. The progressive income tax is considered fair by many people. But is it? Mr. Hagopian argues that if people really think through the issue, they are likely to come to a very different conclusion.

Tax scholars have been debating the pros and cons of tax systems for centuries. Taxes on consumption – what people take out of an economy – are generally considered less destructive than taxes on labor and capital, which are inputs into an economy. As Mr. Hagopian notes, there are basically four (broadly defined) income tax systems debated in the literature:

• A per-capita, or “head” tax, which would require each person to pay his per-capita share of the costs of government.
• A proportionate or “flat” tax, which would tax each dollar of income at a single rate, usually with few if any exemptions or credits.
• A degressive tax, which is a proportionate tax only on income above a certain threshold or exemption. The exemption makes the system progressive but typically much less so than a system of graduated rates.
• A progressive tax, which taxes incremental income at higher marginal rates as income rises, resulting in an increase in taxes as a percentage of income as income increases.

The United States has one of the most progressive tax systems in the world. The top 1 percent of taxpayers pay 38 percent of all the income taxes despite having just 20 percent of the income. The top 10 percent of taxpayers pay 70 percent of the income tax while having just 46 percent of the income. At the other end, the bottom 50 percent of taxpayers pay just 2.7 percent of the income tax while having 13 percent of the income.

The income tax has become much more progressive in the past 30 years, resulting in a situation in which a relatively small minority of taxpayers pay the bulk of the taxes, while most American pay little or any income tax. This is causing an increasing disconnect between benefits from government and what most citizens pay for. One result is a greater polarization in the political realm where a majority of citizens increasingly demand more government benefits for which they want others to pay.

The Swedes were on this same destructive path, but they reversed course over the last couple of decades and made their tax system far less progressive even though their tax rates at all levels are above most of those in the United States. The result has been a tempering of demand for new government services as people at all income levels realize they will be the ones paying for those services and not some mythical “rich” person. The side benefit is that Sweden, as a result of tax and other reforms, now has one of the highest economic growth rates in the world.

Mr. Hagopian has carefully looked at the pros and cons of each system in a most dispassionate way, and concludes, “Since there is no perfectly equitable tax system, the goal must be to design the least inequitable system.” He concludes that the degressive system is the least inequitable. It is not possible to summarize Mr. Hagopian’s arguments for and against each tax system in a newspaper column; hence, I will not attempt the impossible. But for those who think a progressive system is equitable, please explain the equity in taxing one person at a higher rate on each extra hour he or she works to make life better for his family while taxing the less responsible and less industrious person at a lower rate.

If your accountant told your family that you are spending 40 percent more than you are earning and that your borrowing limits have been reached, how would you cut your expenditures? Would you stop buying food and not pay your mortgage and utilities, or would you first cut out entertainment, such as movies, sports events, cultural performances, nice restaurants and vacation trips? Rational people would do the latter, but government bureaucrats often do the equivalent of the former. This is known as the Washington Monument Ploy, which got its name when a national parks director shut down the Washington Monument and Grand Canyon for two weeks in 1969 to protest budget cuts, rather than cutting administrative costs, deferring maintenance and curtailing new projects.

When faced with a need to cut budgets, the Washington Monument Ploy – or stunt – is the political tactic of shutting down the most visible, popular and/or valuable government service while leaving less important and less appreciated government activities untouched. This is designed to pressure legislators to appropriate more funds for the more popular government service.

Many businesses find that over the years they have allowed some fat to grow in their operations. During recessions or periods of increased competitive pressure, businesses realize they must cut costs drastically in order to remain profitable and survive. Firms like IBM and Ford have done this in recent years, and now both are in fine shape. The process of getting rid of non-essential activities is painful but the alternative is far worse.

All bureaucracies have a tendency to grow fat and lazy over time, whether they are in businesses, nonprofit hospitals, associations, charitable foundations or governments. Other than in government, all other entities normally go through periods of cost-cutting and renewal. Government should not be exempt. Some state and local governments are now suffering through painful, but necessary, cost reductions because they must comply with balanced-budget requirements and they have reached their limits on increasing taxes or borrowing.

Only the federal government can go on without facing normal economic constraints because it prints its own money. However, Congress could require every government agency to rank its programs from the most to the least cost-effective, and present a detailed plan as to how each agency would deal with a required 10, 20 or even 40 percent budget reduction, just as businesses often have to do.

To bring the federal budget into balance this year would require spending cuts of approximately 40 percent. No one has proposed cuts of that magnitude at the moment – Republicans are proposing cuts of about 1.8 percent of this year’s budget and Democrats are only proposing cuts of 0.28 percent. If Congress and the administration fail to agree on a budget or debt-limit increase, government tax revenues would only cover about 40 percent of spending, so a ranking of spending priorities would be necessary.

The Republicans are now being criticized in the media for some of their proposed budget cuts. We have all been exposed to the heart-tugging stories of how small children will go without adequate food if the budget is cut. Everyone who has ever worked for or interacted with government knows there is tremendous waste and inefficiencies and that there are programs that just don’t need to be funded, such as National Public Radio, the Organization for Economic Co-operation and Development, and ethanol subsidies. I often speak before groups of government executives, and when I ask them, “If you were forced to substantially reduce your budgets without impairing the effectiveness of your operation and mission, could you do so – if you were freed from unnecessary paperwork and other absurd requirements?” The answer is almost always “yes,” including those in the military.

Rather than taking all of the heat, the members of Congress should do what boards of directors in companies and other organizations do and that is to require management to come up with specific – and very substantial – budget cuts that would not impair the core functions of the organization. Specifically, they should require each government department to state specifically how it would reduce its budget (by some specified amount) in the most cost-effective way, and be prepared to defend it before the appropriate congressional committees. In addition, the government departments should be required to rank the importance of their activities on the Internet and state how they would reduce the budget (if required to) so members of the media and the public could comment on their rankings. Even the managers of Social Security, Medicare and Medicaid should be forced to come up with proposed reforms to their programs to meet the budget constraints.

Congress could enforce compliance with this requirement by denying the right of any department to spend monies, after a specified date, until each department has submitted an acceptable budget-cutting plan to Congress. The bureaucrats would hate it, but the American people would relish it.

Imagine that you have a serious drinking problem, which has caused your job performance to decline. If your doctor said to you, “Don’t stop drinking now, because going sober may cause you discomfort and may not immediately improve your job performance” – while failing to tell you that if you keep drinking, you will become totally dysfunctional and may die – what would you think of your doctor?

The U.S. government has a serious overspending problem. If the spending and the resulting deficits are not soon stopped, the U.S. economy will become dysfunctional, and our prosperity and freedoms will disappear. Despite the overwhelming evidence that the government is headed for a debt crisis, there are still a few economists who are saying: “Spend more.” Last week, one of the “spend more” crowd, Mark Zandi of Moody’s, made the absurd claim that the attempt by the Republicans to cut the budget by approximately $60 billion (or less than 2 percent of total federal spending) would result in 700,000 lost jobs. The Democrats and their media allies, of course, jumped on the opportunity Mr. Zandi gave them as their latest excuse not to reduce spending. Instead, they have proposed cutting the budget by one quarter of 1 percent.

Economists like Mr. Zandi, and the notoriously irresponsible Paul Krugman of the New York Times, who demand massive new government spending, are unreconstructed Keynesians who cling to totally discredited ideas, which, time and time again, have been shown not to work. When I was a doctoral student at Columbia University, I, too, was taught the Keynesian orthodoxy of the time. But when the great stagflation of the 1970s set in, it was obvious that what was in the textbooks did not fit the real world in which I was living. Up to that time, I had little knowledge of the Austrian (led by F.A. Hayek) and Chicago (led by Milton Friedman) schools of economics. But I soon realized that Hayek, Friedman and their colleagues had a much better understanding and explanation of the real world. The Keynesian ideas work in theory, but not in practice; but the Austrians and Chicagoans have ideas that both work in theory and practice – as demonstrated by Ronald Reagan, Margaret Thatcher and many others around the globe.

The Keynesians’ basic argument is that if the government increases spending during a downturn, it can employ people who are not working and the additional spending will have a “multiplier” effect throughout the economy. This can be true only if the new spending does not replace more productive private-sector spending and even more productive government spending, and uses the personal and business savings more productively than private parties would. But in the real world, most government spending is far less productive than private spending. For example, the Government Accountability Office (GAO) has just released a report showing hundreds of redundant and duplicative government spending programs – hence, the forecasted multiplier effects never occur. Because the multipliers are not there, the Keynesians never reach their promised land of full employment so they are reduced to crying for more and more government spending without end.

The Keynesians have a consistent track record of failure. During the 1930s, government spending was greatly increased, yet the economy stayed in depression and the private economy revived only after the end of World War II when government spending was radically reduced. The Keynesians said this would renew the Depression – but they were wrong. They were wrong again in the 1970s when they said stagflation could not occur and the early 1980s when they said the Reagan supply-side program could not work. Mr. Zandi, Mr. Krugman and the rest were wrong when they said the Obama stimulus program would keep the unemployment rate below 8 percent. The only reason they are now trotted out is they give the big-government people an excuse to spend other people’s money. How sad.

John B. Taylor of Stanford University, a most-respected and responsible economist and former undersecretary of the Treasury and member of the President’s Council of Economic Advisers, correctly noted that “[n]othing could be more contrary to basic economics and experience and facts” than the claim by Mr. Zandi and the others that reducing federal spending will reduce economic growth.

In the real world, any increase in government spending is going to further worsen the debt/gross domestic product ratio, meaning debt service will become more and more costly, eventually reaching a point when it is unsustainable – which is what happened to Greece. Government bondholders are going to demand higher and higher interest rates at some point because of the increased risk of default and/or inflation. Governments normally default on their debts (i.e., cheat the bondholders) by inflating the currency by printing money or not paying all the interest due and extending the date of payback. The United States is fast reaching the point of unsustainability – hence there is no real choice but to greatly reduce government spending.

Although he got many things wrong, John Maynard Keynes understood the problem of too much debt, which is why he advocated balancing the budget over the business cycle. If Keynes were alive today, would he associate himself with the modern day Keynesians? Not likely.

Wildly inaccurate statements from news commentators, financial analysts, politicians and even administration officials have most people believing that if Congress does not increase the debt limit in March, the U.S. government will default on its debt obligations, thus ending the government‘s ability to borrow. Nonsense.

If you make $5,000 per month, have a mortgage payment of $1,500 per month and then spend another $4,500 per month on food, utilities, gasoline, insurance and other expenses, including $2,000 per month traveling to sporting events and going to expensive restaurants, you will find yourself running a deficit of $1,000 per month. Your choice is to default on your mortgage and ruin your credit rating or cut back on sporting events and expensive restaurants.

The U.S. government is in exactly the same position. If the debt ceiling is not raised, government officials will have a choice to default on the interest payments (less than 10 percent of the government‘s total income) or cut spending. Sen. Pat Toomey, Pennsylvania Republican, has introduced the Full Faith and Credit Act (S.163), which would require the Treasury to make interest payments on U.S. government debt its first priority if the debt ceiling is not raised. This legislation would require the federal government to reduce spending on other activities and/or sell assets, as any business or family would need to do when faced with a similar problem.

The big-government crowd claims huge hardships would result from the mandatory spending reductions. Again, nonsense. Spending would only have to be reduced to roughly the 2006 level to avoid an ongoing deficit. The government receives a little more than $70 billion a day, or more than $2.5 trillion a year. Much of what the government spends is downright destructive and should be stopped. For instance, ethanol subsidies increase the price of food, decrease automobile mileage efficiency and increase – not decrease – the amount of carbon dioxide, which even Al Gore admits now. The U.S. government has roughly a trillion dollars in financial assets that are marketable and could be sold. It could lease for hundreds of billions of dollars oil, gas and mineral assets that it has locked up to keep the environmental fringe happy. The U.S. government owns about one-third of the country’s land – 654 million acres – worth several trillion dollars. Much of this land is poorly managed and, if sold, would bring in revenue, be better managed and be put on the tax rolls of state and local governments. A win, win, win.

Another widespread myth is that if the government reduces its spending, that will cost jobs. This myth is being promulgated by many Democrats and their allies in the media. The fact is that the percentage of adults in the labor force has fallen to its lowest level in three decades even as the government has grown by a quarter in relative size in the past three years. If government spending could bring about full employment, the socialist countries would have been great successes rather than basket cases. Remember, the money government spends on “creating” jobs comes from either taxing or borrowing – both of which take money and jobs out of the more productive private sector – thus reducing the total number of jobs.

The myth that the deficit problem can be solved only by some combination of tax increases and spending cuts is accepted as revealed wisdom by much of the political class, including some conservative commentators and economists. This myth is only true if you believe that the so-called entitlements – primarily Social Security, Medicare and Medicaid – must grow as a share of gross domestic product (GDP). The Cato Institute and other policy organizations have developed realistic and financially sound plans that both protect those who need to be protected and keep these programs from swallowing everything else. When you hear this myth, keep a simple fact in mind: If the government is growing faster than the economy (as it is now) no increase in taxes can reduce the deficit. If the government grows slower or at least no faster than the economy, as it did in the last Clinton and Reagan administrations, the deficit and federal debt will come down as a percentage of GDP without tax-rate increases.

Finally, the destructive myth persists that if only we could get the rich to cease engaging in tax avoidance, which is legal, and stop tax evasion, which is illegal, government would have adequate revenue. The fact is that rich people already pay most of the taxes. The top 5 percent pay almost 60 percent of the income tax, and trying to get more money out of them will just chase them away. One advantage rich people have is that if they feel too much tax oppression, they can leave for greener pastures – from New York to Texas, for instance. This past year, Congress passed measures to catch a few tax cheats that are having the unintended effect of making it almost impossible for many foreign financial institutions to invest in the United States, costing the U.S. tens of thousands of jobs and hundreds of billions of dollars in tax revenue.

The lack of jobs and economic growth in the United States easily can be traced back to policymakers who believe in destructive myths. Fortunately, on the centennial of his birth, more people understand a piece of wisdom from Ronald Reagan: “Government is the problem, not the solution.”

Last Friday, it was reported that economic growth was only 2.4 percent in the second quarter of this year – far below what the Obama administration had forecast. Yet the administration and its supporters continue to be in denial about the fact that their policies are not working. Psychologists refer to the refusal to change one’s mind when confronted with contrary evidence as cognitive dissonance.

As almost everyone now knows, there are two competing theories about how to revive the American economy. One theory is to promote the supply-side of the economy by cutting tax rates or at least to maintain the Bush-era tax rates and reduce spending and government regulation; the other theory is to follow the Keynesians’ advice by allowing some or all of the Bush-era tax rates to increase while also increasing government spending and government regulations (which proponents call “more stimulus”). The new data, as captured in the accompanying chart, provides even more evidence as to which of these competing theories is correct.

The first theory was tried during the Reagan administration, and the second theory is now being tried during the Obama administration. Both administrations inherited an economy in trouble. President Reagan inherited an economy with stagnant growth (two years without real growth), rising unemployment and double-digit inflation. President Obama inherited an economy with falling growth and rising unemployment, but little inflation. President Obama likes to say that he inherited the “worst” economy since the Great Depression, but the fact is that the economic “Misery Index” (inflation plus unemployment) – which the Democrats used as a weapon against Republicans – was twice as high when President Reagan took office. (By the time President Reagan left the presidency, the Misery Index had dropped to less than half of what it had been when he assumed office.)

The economy bottomed out in the fourth quarter of 1982 under Reagan, and the economy bottomed out in the second quarter of 2009 under President Obama. As can be seen in the accompanying chart, the economy grew more than twice as fast in the first four quarters after the 1982 bottom as it has in the four quarters since the 2009 bottom. During the 1983 recovery, the unemployment rate fell two full points, while during the present recovery unemployment has barely changed. Why the difference?

Reagan’s policy was to sharply cut individual and corporate tax rates, and to restrain the growth in government spending and regulation. The Democrats, who were in control of the House of Representatives, resisted and delayed the Reagan tax cuts, so they were not fully implemented until 1983. Mr. Obama had the luxury of having his party in control of both houses of Congress, so he was able to get his proposed, massive government spending increases enacted almost immediately.

When Reagan left office in January 1989, he had presided over “seven fat years,” as Bob Bartley, the now-deceased editor of the Wall Street Journal, called the Reagan era. Unemployment was half of its recession high, economic growth averaged more than 4 percent after the recession bottom in 1982, the deficit was falling and was under a very manageable 3 percent of gross domestic product, the GDP-debt ratio was falling, inflation had dropped by about two-thirds, and every American individual and company had seen very sharp reductions in their marginal tax rates – the maximum rate fell from 70 percent to only 28 percent by the time Reagan left office.

Keynesian economics, practiced during the late 1960s and 1970s, became thoroughly discredited with the stagflation of the 1970s – which, in theory, was impossible under the old model – and the subsequent Reagan supply-side boom. The Clinton administration, after its so-so economic performance in the first term with small increases in tax rates and government spending, partially reverted to Reaganomics in its second term; with a capital-gains rate cut and reductions in spending as a percentage of GDP. The result was very strong economic growth and budget surpluses.

Given the above facts – which have the benefit of being true (unlike many “facts” delivered by our elected officials) – would you follow the Reagan/Clinton II economic policies or the Obama ones? Where is the evidence – empirical evidence, as contrasted with theoretical models – that Obamanomics will work, particularly, since it is not now working as advertised? Will the Misery Index be cut by more than half during the Obama administration, as it was during Reagan’s terms, or will it rise? Obama economic advisers Paul Volcker, Larry Summers and Christina Romer have, at times, all advocated polices totally contrary to the ones that Mr. Obama is now practicing. Are they, like many of those in the Democratic Party, all suffering from cognitive dissonance by continuing to push a failed model?

The economy performed better under Reagan’s supply-side policies than President Carter’s economic team had forecast it would if their man had been re-elected and continued his high-tax, Keynesian policies. The economy is now performing worse than Mr. Obama’s economic team forecast with its Keynesian policies. Looking at the evidence, it strains credulity to believe that the economy will actually perform better next year when all the tax increases are slated to go into effect. When will Congress wake up?