“We can’t cut our way to prosperity” – Why not?

Even though most speeches that politicians give to large audiences are filled with general terms and are designed to be replayed in sound bites, there is one line President Obama said during his most recent state of the union address that cannot be easily taken out of context or given a reconstructed meaning. The president clearly remarked that in light of record deficits and federal debt, “we can’t cut our way to prosperity.” Though President Obama followed that comment up with what sounded like a reasonable, bi-partisan, solution of combining tax cuts with revenue increases, he didn’t explain why we cannot ‘cut our way to prosperity.’ Why cant we?

The states that have been successful in getting their fiscal houses in order have done exactly that– cut spending– and revenues so that their government’s can’t continue to spend. The Wall Street Journal reports that “Nine states—including such fast-growing places as Florida, Tennessee and Texas—currently have no income tax, and the race is on to see which will be the tenth, and perhaps the 11th and 12th.” At least 5 other states are pushing for major tax cuts; in fact, Arkansas is considering cutting their income tax by as much as half. Our states have to maintain secure fiscal environments and stable, fair, tax policies in order to attract businesses, and if they are not effective in doing so then their economies will suffer.

Despite the action that the states have chosen to take to stay competitive, the federal government, and especially the President, want to take a different path. Though the President believes, as he said many times during his campaign, that “we need to wisely invest government dollars” in things that he see’s valuable, like green energy and other research projects, it is simply not possible to have a ‘smarter’ government make ‘better’ economic decisions.

F.A Hayek, my favorite economist, put the intellectual nail in the coffin of central planning and government spending for explaining exactly that, and we was awarded the Nobel Prize in Economic Sciences for it. Hayek explained that knowledge about how resources, either capital or material, should be allocated to their highest valued use, is not something that any one person knows but rather it is something that we discover via the market process. For example, platinum is a fantastic material for train tracks, but we don’t use platinum in train tracks. Why? Because the price is too expensive. The price system is a result of the market process otherwise described as voluntary trade. Without a free market for platinum, we couldn’t know its price and thus we couldn’t possibly determine if using it for train tracks is a good idea. The government simply can’t allocate resources to their highest valued uses outside of the market. Smarter public servants and faster computers cannot substitute all of the tacit and local knowledge that each person communicates to producers when they buy and sell goods as different prices. Wisely ‘investing’ government dollars might win you more votes, but it will not lead to a just and prosperous society.

Even if government could systematically make good investment decisions, there is no reason to assume that public officials are benevolent enough to do so. In fact, government spending encourages both businessmen and public officials to collude at the public’s expense. When government has money to spend, politically influential businesses open up offices in Washington and, often successfully, collude with government officials to obtain special legal benefits that they could not obtain via voluntary action. Laws that exclude competition, regulations that favor only certain businesses, and government contracts given out to companies where public servants begin second careers, come at the expense of all taxpayers. More government spending only encourages these activities.

Instead of spending, government can create a prosperous society by maximizing our economic freedom. Economic freedom includes and impartial rule of law, the freedom to trade with others, a stable currency, and low government spending relative to the size of government. The Frazier institute’s empirical evidence is extremely strong in showing that societies with higher economic freedom enjoy higher income, lower poverty, lower unemployment, cleaner environments, and longer life expectancies. In economically free countries, people are happier, healthier and enjoy stronger civil rights.

Big government ideas might be mainstream right now, but thinking that we cannot ‘cut our way to prosperity’ is intellectually bankrupt. Bigger government spending comes at the cost of less economic freedom as government either taxes the private sector directly or via devaluing the currency.  Those who care about creating a just and prosperous society for everyone should care about maximizing economic freedom and cutting government spending.