The national ascension of Bernie Sanders and Alexandria Ocasio-Cortez as firebrands of democratic socialism has rocked the D.C. political establishment. Furthermore, recent electoral victories by self-avowed democratic socialists during the midterms seem to validate polls showing Americans have grown increasingly accepting of socialism. The rising popularity of socialism is often attributed to multiple socio-economic factors. Pundits are quick to recite talking points on a range of issues such as income inequality and stagnant wage growth to a new generation of youthful voters ignorant of a failed track record of big-government central planning.
Although the aforementioned variables certainly play a role in the current rise of socialism, a little-known public choice concept – the fiscal illusion – may also be quietly unfolding at the national level. First theorised by Italian economist Amilcare Puviani in 1903, the fiscal illusion is a phenomenon that manifests when the cost of public programmes is distorted or hidden from voters. This creates an illusion among the public that the cost of government programmes is substantially lower than it actually is, hence, sprouting a proclivity for a socialist system.
Fiscal illusion is most frequently cited when accounting for the fiscal effects of monetary grants from federal to local governments, also known as the flypaper effect. As federal and state governments grant money to municipalities, the fiscal illusion may cause the public to demand unsustainable increases in public spending. This occurs because local taxpayers might be unaware of the grant as a source of the local government’s revenue, which generates a faulty perception of low-cost programmes. This is a fairly common occurrence in property tax relief schemes that are designed to benefit taxpayers but generally end up ratcheting up cost in the long run.
In the 1960s, economists James M. Buchanan and Richard E. Wagner expanded on the work of Puviani, stating that the complexity of the American tax system increased public expenditures by making it impossible for individual taxpayers to determine the cost they pay for particular government programmes. In a 2004 paper, economist William Niskanen applied these ideas to the national deficit. He questioned the validity of the ‘starve the beast’ strategy to limit government. Conservative and libertarian intellectuals argued that the government can be reduced by starving it of funds, or by, in other words, instituting tax cuts.
Niskanen argued that, “It is most implausible that reducing the current tax burden of federal spending would reduce the amount of federal services that voters demand” and that, “the level of current federal receipts as a percent of GDP has a significant negative effect on the change in current federal spending as a percent of GDP”. Niskanen’s core arguments is that tax cuts lead to more spending, not less, and that price theory suggests a lower price for public services will increase demand. He did not directly cite the fiscal illusion in his research but heavily eluded to such phenomena.
Niskanen’s original observations remain applicable today. The Reagan-era tax reform, and subsequent reductions, reduced the federal income tax burden to zero for millions of poor and middle-class Americans. However, these working-class tax cuts may have had an unintended effect. After decades of paying little to no taxes, Americans are becoming increasingly oblivious to the cost of government. The most recent round of tax cuts may have had some stimulatory effects at the expense of perpetuating a dangerous cycle in American public finance that will continue to increase federal debt. The public seeks more for less as the government obliges. A recent Fox News poll found that 63% of Democrats, 50% of independents, and 39% of Republicans want the nation to spend more on infrastructure, national defence, education and healthcare. The predictable result has been more spending and more tax cuts.
The aforementioned would be less concerning if the federal deficit was not nearing $1 trillion a year with the total federal debt above $22 trillion. According to Pew Research, the disregard of the national debt has become increasingly common with only 48% of Americans viewing deficit reduction as a top priority – this is down from a high of 72% in 2013. The seemingly inverse relationship between concern about the national debt, its growth and calls for new massive government programmes may be evidence of the fiscal illusion as a disconnect between the actual cost of government and the perceived cost.
For those of us who still subscribe to fiscal conservatism, these trends are troubling. The nation cannot sustain unlimited military spending, the massive expansions of social programmes, trillions of dollars in new environmental mandates and unfunded tax cuts. A lack of financial buy-in may be exacerbating this problem as the voting public seems increasingly willing to ignore fiscal limitations and demand more government. The fiscal illusion is arguably present on both sides of the political spectrum. Those on the right are willing to ignore the deficit to increase the military budget, which is already the world’s largest. Those on the left are willing to dramatically expand healthcare and environmental spending. The only uniting aspect of both right and left is their willingness to pass the cost onto the rich.
There is ample reason to believe that this passive attitude towards the national debt will only grow more prevalent as proponents of the pro-deficit economics of modern monetary theory (MMT) are elevated in public discourse. MMT advocates that a government can self-finance by printing money to service or pay off public debt. MMT proponents argue that because American debt is denominated in the American dollar, the government has a lot of latitude to accrue debt. This is true to some extent, but it is not without substantial risk.
America currently occupies a unique position in global finance. The US dollar is positioned as the international reserve currency. The strength, size and relative stability of the US economy attract both domestic and international investors as a safe place to store wealth. This means that the country can temporarily, but not indefinitely, avoid horrid economic outcomes such as those seen in Venezuela, Zimbabwe and Greece. When given enough time, the American dominance of the international financial system may erode and be surpassed by another global superpower or an alliance of regional powers. However, the country is not immune to hyperinflation or insolvency. Since the conclusion of World War II and the fall of the Soviet Union, international stability has become more of the norm. As peace and trade take hold globally, America faces more competition from other relatively large, stable and safe economies (i.e., the EU, China and India). In short, although there is no immediate threat to the ability of the US government to borrow funds, long-term risks are present.
Economists Thomas Firey and Stephen Slivinski expanded upon Niskanen’s observations by arguing that, in the long run, servicing government debt will force tax hikes. Proponents of MMT also concede the need for some taxation to avoid rampant inflation, thus confirming an inability to avoid future tax hikes to service debt payments. Firey and Slivinski further argue that future tax hikes will result in some sort of constraining effect on the size of government.
This may be compounded by the fact that the United States seems to be following in the path of Japan. Low birth rates, both domestically and globally, and more restrictive attitudes towards immigration could leave the country with more and more debt and fewer people to pay it. This alone should be a sufficient reason for credit rating agencies to reconsider their role in underwriting America’s soaring debt.
However, the long term is ill-defined in the macroeconomic literature. At some point, there will be a painful reckoning. When this day will come is currently outside the predictive capabilities of modern economics. If fiscal responsibility is wholly abandoned, citizens will have to make very painful trade-offs between tax hikes and reduced government benefits or likely a combination of the two. Addressing the fiscal illusion requires the public to recognise the actual cost of running massive government programmes. There can be no illusion about the fundamentals of debt. All debt is a promise of future repayment. The ability of the United States to make such payments should be a concern to all, especially creditors. Promises of free stuff (socialism) maybe become a successful electoral strategy, but no promises can invalidate the long-term dangers of the exponential growth of government debt.