The Causes and Cure of Government Bloat


Rick Scott, a Republican senator from Florida, recently caused controversy with a sentence buried in a policy manifesto that declared, “All Americans should pay some income tax to have skin in the game”—which he suggested might help shrink the federal government. President Biden pounced on the line, which Scott acknowledged had been poorly worded, to accuse Republicans of having a secret plan “to raise taxes on 75 million American families.”

Biden’s accusation may be farfetched, but Scott is also mistaken. Government spending has not grown because voters lack skin in the game, but because funds have become more readily available for politicians to spend.

Voters everywhere, political scientist Sven Steinmo observes, “like public spending and hate taxes.” To these “conflicting incentives, political elites in all democracies have responded similarly,” Steinmo continues. “They have ratcheted up both tax rates and tax bases during times of crisis, relied on economic growth and inflation to push up revenues, and attempted to hide tax hikes via indirect, or hidden, taxes.” When “political elites are able to override initial public resistance to taxes,” he says, “they will have much greater scope for expanding welfare state programs.”

World War II transformed the role of the state by legitimizing mass income taxation for the first time. From 1939 to 1945, the proportion of American households paying income taxes soared from 6 percent to 72 percent† A Nov 1942 New York Times editorial warned: “Taxes of the magnitude now provided for call for violent readjustment in living standards.” Over the course of the war, federal tax revenue surged from 7 percent to 20 percent of GDP.

There was no rollback of taxes following the Second World War as there had been after the First. The era’s Republicans, led by President Eisenhower, opposed broad-based tax cuts in order to maintain revenues for the Cold War and to minimize budget deficits. Yet, as defense spending plummeted from 37 percent of GDP in 1945 to 7 percent in 1965 and postwar economic growth fueled a surge in revenues, Democrats eagerly repurposed funds for domestic spending, powering the party to unbroken control of Congress from 1955 to 1981.

From 1945 to 1980, federal spending on social-welfare programs rose steadily, from 1 percent to 11 percent of GDP, but only 1.6 percent of GDP went to programs reserved for the poor, such as Medicaid, food stamps, or Supplemental Security Income. For all the fuss over Lyndon Johnson’s War on Poverty, the Office of Economic Opportunity (which encompassed Head Start and community-action, urban-development, and job-training programs) spent only 0.2 percent of GDP at its height, and shrunk thereafter. As eligibility for welfare expanded, states often reacted to rising costs by cutting benefit levels.

President Johnson’s chief economic advisor, Walter Heller, justified the lack of concern for distributive impact and cost-effectiveness by arguing that, when the “social pie grows bigger, there is less reason to quarrel over who gets the biggest slices.”

However, while the bulk of postwar domestic spending increases went to middle-class Medicare and Social Security beneficiaries, the associated tax increases weighed heaviest on the poor. From 1950 to 1980, payroll taxes had grown from 0.4 percent to 2.3 percent of the incomes of the highest-earning 5 percent of Americans, but for Americans with below-median incomes they had surged from 2.9 percent to 8.8 percent. Legislators also quietly welcomed additional revenue as rising inflation pushed Americans with modest incomes into higher tax brackets.

Taxes consumed 34 percent of the incomes of the richest 10 percent of Americans in 1980, just as they had in 1944 (when the top marginal tax rate was 94 percent). But over that same period, Americans with below-median incomes saw their taxes rise from 16 percent to 25 percent of their pay. As voters caught on, a tax revolt, driven in part by blue-collar workers, swept Ronald Reagan into the White House.

Reagan pledged to turn Republican strategy on its head. Denouncing legislators “who told us that taxes couldn’t be cut until spending was reduced,” he proposed to “cure their extravagance by simply reducing their allowance.” The crux of Reagan’s agenda was the 1981 Economic Recovery Tax Act, which deprived the federal government of stealth tax increases to which it had become accustomed by indexing tax brackets for inflation. As political scientist Paul Pierson noted, “If the government wished to spend more, it would now have to vote openly for higher taxes.”

The tightening of fiscal constraints forced legislators to prioritize. They reined in eligibility for entitlements so that benefits became better targeted at those in need. Expansions of benefits for the poor, such as Medicaid and the Children’s Health Insurance Program, were subsequently funded with cuts to the scheduled growth of existing programs, such as Medicare—which cost only 3.1 percent of GDP in 2021, rather than the 4.1 percent predicted 20 years earlier. Though federal spending on entitlements reserved for the poor increased from 1.6 percent of GDP in 1981 to 3.5 percent in 2019, overall federal expenditure declined slightly from 21.6 percent of GDP to 21 percent.

Senator Scott is right to be wary of welfare dependency, but rising entitlement costs are far more the result of health and retirement benefits for the middle class than of aid for the poor. Indeed, Medicare and Social Security are the main reason that federal spending is projected to surge from 20 percent to 30 percent of GDP over the next 25 years. These programs have grown on autopilot because they enjoy guaranteed access to dedicated payroll tax revenues, which have insulated their expenditures from pertinent questions about needs and priorities. Voters certainly have no shortage of skin in the game: 85 percent of Americans pay more in payroll taxes than in income taxes. But it is only because these revenues will soon fall short of the programs’ expected costs that policymakers will possess any ability to advance reform.

Photo: Luciano_Queiroz/iStock

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