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Growth Grade: Paul Ryan's Path to Prosperity

Article by Brian Wesbury February 13, 2013 //   7 minute read

Paul Ryan’s new budget (The Path To Prosperity) is a very positive step toward boosting economic growth. It reduces tax rates on individuals and corporations, cuts spending as a share of GDP, and reduces the burden of entitlements on future generations of taxpayers. There is a very good chance that this budget would begin a virtuous cycle for the economy similar to that of the 1980s, generating faster growth in GDP, more revenue to the federal government and less demand for government spending. The results will most likely be much better than the Ryan scoring assumes. Clearly, White House spokesman Jay Carney makes the opposite case. He said supporters of the plan “have to be aggressively and deliberately ignorant of the world economy not to understand that clean energy technologies are going to play a huge role in the 21st century.” He added that these supporters “have severely diminished capacity to understand what drives economic growth in industrialized countries in this century if [they] do not understand that education is the key that unlocks the door to prosperity.” Presumably, he is saying that Congressman Ryan’s proposed cuts in federal spending on clean energy and education will reduce the economy to rubble. But, nothing could be further from the truth. In fact, the growth grade for Carney’s economic statements is an “F.” Between the fourth quarter of 1982 and the fourth quarter of 1999, real GDP in the US expanded at a 3.8% average annual rate. During the past 10 quarters (beginning in March 2009) the economy has grown just 2.5% at an annual rate. In other words, the evidence, so far, suggests Carney is wrong. No one knows the future. Using government power to push the economy in one direction or another is an economic mistake that harms growth. See our growth grade on the Keystone pipeline. But back to the Ryan plan. The growth grade is based on the macro-picture. What we know from history and cross-country analysis is that the bigger government is as a share of GDP, the weaker overall economic growth and job creation become. As an example, with its bigger government, Europe has had much higher unemployment rates and slower growth rates in the past 30 years than has the U.S. The Ryan budget gets spending down to slightly less than 20% of GDP by 2015 and keeps it there. This will boost real growth by somewhere between 0.4% and 0.8% per year from what it would have been if spending would have remained at 23% of GDP. The top individual and corporate tax rates would be cut to 25% under the Ryan plan. This would boost growth, but with so few details of the tax cut provided, it is hard to give it credit for more than a slight boost to GDP. In the end, it is reduced spending that convinces markets that future tax rates can remain low. Under the Ryan plan, total federal spending would be cut for two years and then begin to grow again. This would initially shrink the government sharply as a share of GDP (from 23.4% to 19.4%). But then, spending would accelerate again to a 5.0% annual growth rate between 2017 and 2022, and spending would rise back to 19.8% of GDP. This is a concern. The federal budget has never been in balance with spending above 19.5% of GDP — no matter what tax rates were in place. But Congressman Ryan used static scoring models in his proposal for political purposes. These models do not give credit for positive economic feedback loops. Reduced spending will lead to higher economic growth. Higher economic growth will boost revenues and reduce the demands on governments at all levels, which will reduce the share of GDP devoted to government, which then starts the process all over again. This happened in the 1990s and the result was a boom in the economy and surpluses in budgets. As a result, we anticipate that the plan will create even more economic growth than Ryan’s current scoring anticipates. On this basis it would seem that the Budget deserves an A, or even an A+. However, while the budget would lift growth significantly, it is not a “perfect” budget from the growth perspective. Some on the right have attacked the plan because it makes little effort to immediately cut spending back to levels that would have existed if the huge spending spree of 2008/2009 had not happened. Some on the right also want to take this opportunity to “fix” entitlement programs for good. The Ryan plan pushes off Social Security fixes to a future bi-partisan commission. This attempt to make the budget palatable to a bi-partisan majority means that the budget falls short of perfect. If growth were the only measuring stick, not political expediency or social expectations, the “perfect” budget would end entitlements and redistribution as we know them, and move the US toward free-market based solutions, like Chile’s defined-contribution social security system. As a result, the Ryan plan gets a B+ because it still leaves issues unresolved. The growth grade is not made on a curve; it does not make adjustments for the current political environment. Nonetheless, the Ryan plan will lift growth and create more prosperity. Sometimes prosperity makes government more willing to spend — think about the 1960s in the US, when prosperity created an environment conducive to creating the Great Society. But, sometimes it creates momentum for more positive change … as in the 1990s, when welfare reform was signed into law. In the end, the growth grader must support proposals that lift growth, even if they are not “perfect.”