Thursday, August 23, 2018

The Distortionary Growth in Government

Government in America is too big. We are not (yet) at European levels, but unless we turn around the reform trend in the welfare state - which currently points to even bigger government in the near future - we are going to end up with the same macroeconomic problems as the Europeans have

Our government has sprawled in many directions, first and foremost through the expansion of entitlement programs. This, in turn, has led to a distortion in the operation of our government sector that adds to the difficulty of reforming away our welfare state. It consists of the combination between, on the one hand, a shift in government employment toward states and local government and, on the other hand, an increase in federal funding of the entire government sector. 

To approach this distortion, let us begin with some government employment numbers. First and foremost, a look at the Government Employment Ratio, which measures the number of federal, state and local government employees per 1,000 private-sector employees. It is interesting to note that this ratio has not changed dramatically over the long term - in fact, it was higher in the early 1960s than it is now: 

Table 1

Government Employment Ratio for the U.S. Economy
1955 161 1975 238 1995 198
1956 164 1976 233 1996 195
1957 171 1977 227 1997 190
1958 183 1978 223 1998 187
1959 181 1979 218 1999 186
1960 185 1980 221 2000 187
1961 192 1981 215 2001 190
1962 193 1982 217 2002 197
1963 197 1983 216 2003 198
1964 199 1984 206 2004 196
1965 201 1985 204 2005 194
1966 205 1986 204 2006 192
1967 212 1987 202 2007 192
1968 214 1988 200 2008 196
1969 212 1989 199 2009 207
1970 218 1990 202 2010 208
1971 223 1991 206 2011 201
1972 223 1992 209 2012 195
1973 220 1993 207 2013 191
1974 223 1994 203 2014 187
2015 184
2016 182
2017 180

Source of raw data: Bureau of Labor Statistics

The problematic part is that the character in government employment has changed over time. Starting at the federal level, more and more employees work with other things than the constitutional government duties. As Figure 1 reports, the share of federal employees that work for the Department of Defense or the U.S. Postal Service has gone down over time, to a point where these two functions do not even employ half the federal workforce:

Figure 1
Source: Bureau of Labor Statistics

The majority of the federal government's 2.8 million employees do other things than defend our country and provide for a critical part of our infrastructure. Not all of the rest of the workforce is idling in the welfare state - the federal government must also provide law enforcement and run its part of our judiciary - but the fact that the two constitutionally mandated functions represent less than half the total workforce is a wake-up call as to what we are asking, and what we should be asking, our government to do for us.

While the federal workforce has gradually shifted priorities away from its constitutional duties, states and local governments have grown their employment over time. They have increased their combined share of the total government workforce from 67 percent in 1955 to more than 87 percent today. 

This increase reflects a growth in the responsibility of our states to produce the entitlements that our welfare state hands out. Instead of running programs such as Medicaid, SNAP, WIC, TANF etc., at the federal level, Congress has structured these programs in such a way that the operational responsibility falls on the states. To honor their responsibilities, the states obviously needs to hire more people. 

At the same time as employment has grown in state and local governments, the funding responsibility for the welfare state has largely remained with the federal government. Over time, as the welfare state has grown with the War on Poverty, the funding provided by the federal government has increases as well. Federal funds as share of state and local government revenue has increased substantially, from eight percent in 1957 to 22.5 percent in 2017. Figure 2 compares these two trends (the employment share is displayed on the right-hand vertical axis):

Figure 2
Sources: Bureau of Labor Statistics (employment), Bureau of Economic Analysis (funding)

These two trends tell us that we, simultaneously, have localized government employment and centralized government funding. Since the first trend means increased local responsibility for government functions, these two trends together create a mounting obstacle to reforms that could turn the growth of the welfare state around. 

With more of the operational responsibility at the state and local level, and more of the funding at the federal level, where do we start if we want to reform welfare, Medicaid and other parts of the federally sponsored conglomerate of entitlements? Theoretically, the answer is Congress, because they provide the funds and define the programs they help paying for. In practice, though, there is a great risk that Congress draws down funding without rolling back the entitlement mandates in the programs. This would leave the states with a greater funding responsibility, one that they have to pass on to taxpayers. 

Another option is to start at the state level and ask state legislatures to change these programs. However, Congress could retaliate to any reforms it did not like, by drawing down funding of the reformed program as well as others. Again, states would be forced to raise taxes. 

There is a way out of this, called block grant reform for the states. I developed a model for it six years ago. It remains to be seen if it can get some traction in Congress.  

No comments:

Post a Comment