President Joe Biden insists that his $3.5 trillion ($5 trillion if the budget gimmicks are removed) “human infrastructure” bill “costs zero dollars.”
While every president makes mistakes, this has to be the most economically illiterate presidential utterance since Jimmy Carter’s demand that the Federal Reserve lower interest rates in the face of double-digit inflation.
In Carter’s case, the outcome was a currency crisis. What will the Biden administration’s foray into nonsense lead to?
Biden, like other Democratic leaders such as House Speaker Nancy Pelosi, claims that the plan will be “fully paid for” with tax increases. The administration appears to believe that only budget deficits impose costs. Despite the tax increases, it has long been clear that the bill would leave a $1.5-$3 trillion hole that would have to be filled with debt.
In any case, the American people aren’t buying it. Polls show that roughly half of Americans want less government and lower taxes, and three-quarters are skeptical that the $3.5 trillion bill will make them “better off.” Not surprisingly, a majority now opposes the Biden administration.
In introductory economics classes, students learn that the social cost of something is the value of the goods and services that could have been produced with the same resources. Typically, this “opportunity cost” can be measured using market prices – though these must sometimes be adjusted to account for other factors such as pollution or monopolies.
There are three fundamental errors in Biden’s “zero-cost” argument from the standpoint of basic economics. The first suggestion is that the proper cost measure is the impact on the federal fiscal position. Adam Smith demolished the notion that a country’s wealth is determined by the value of the sovereign’s Treasury 245 years ago. He demonstrated that wealth is derived from a country’s ability to produce goods and services that people require and desire. For any country, the cost of government spending is the value of foregone opportunities as a result of shifting resources from the private to the public sectors. Less private consumption and investment result in fewer houses and factories.
Second, taxes are far from free because they, too, divert resources away from the private sector, resulting in an opportunity cost. Similarly to how sales taxes primarily affect consumption, corporate income taxes primarily affect investment. The value of displaced private consumption and/or investment is the cost.
The third fundamental flaw in Biden’s approach is the belief that the cost can be measured solely in terms of dollar amounts. In reality, these figures are much higher than stated. There are administrative and compliance costs, but there is also the economic damage caused by taxation by distorting incentives. Income taxes, for example, reduce incentives to work and save (though this is partially offset by tax-deferred savings accounts); corporate taxes, on the other hand, reduce incentives to invest; and progressive tax rates, on the other hand, reduce incentives to invest in one’s skills.
Every introductory economics course teaches that the harm caused by these distortions grows in direct proportion to the square of the tax rate and the responsiveness of the taxed activities. Doubling the rate quadruples the tax’s inefficiency (what economists call deadweight loss). The effective tax rate includes all taxes on the activity, such as state, local, and federal income taxes.
This isn’t a doctrinal issue; it’s just a description of what’s going on in the areas between the supply and demand curves on a graph. Because the marginal cost of federal dollars is estimated to be in the $1.30 range, spending $5 trillion will cost the economy approximately $6.5 trillion. To be considered reasonable, a government spending program must provide benefits worth at least $1.30 per dollar spent.
The proposed tax increases on capital income would be especially damaging to the economy, as they would introduce a tax distortion that would compound over time as horizons lengthened. That would harm economic growth while also increasing the barriers to more people getting ahead financially – building their own wealth, reducing their reliance on government, and, yes, becoming wealthy.