Moving Closer to Europe: Americans Should Instead Pursue Policies for a Better Economic Future

Americans need less “have a nice day” and more “try hard.” Tolerance for mediocrity and openness to daily idleness is not the path to increased productivity. It is the path to economic stagnation, Western European style.

The United States is the world leader in high technology and has the most productive economy in the world. But the U.S. economy is built on the shifting sands of federal debt. Federal debt, publicly owned, is now about 100 percent of gross domestic product, or $100,000 per person. That’s a dangerous path.

France’s political and economic systems are being tested in part because of its excessive government debt. French stock and debt markets are in turmoil because of the upcoming general election and because France’s national debt is unsustainable. France is therefore a loud siren for the U.S. Every 1% increase in the cost of borrowing for the federal government raises the cost of servicing the debt by 1% of GDP, or almost $300 billion. Like France, the U.S. borrows money to service existing debt.

That’s not sustainable. And it’s getting worse. The nonpartisan Congressional Budget Office just revised its forecast for federal deficits. The CBO put it plainly: “The deficit is projected to be about 7.0% of GDP in fiscal year 2024 and 6.5% in fiscal year 2025. Moreover, deficits will average more than 5% over the next decade, significantly higher than the 3.7% that deficits have averaged over the past 50 years.”

President Joe Biden bears considerable blame here. He has embraced Modern Monetary Theory. He believes that deficits do not matter. Biden is using the federal debt to dramatically increase the size of the federal government and create a European-style welfare state. Biden has expanded the government by 10% or more in less than four years.

The correlation is obvious. As government grows, economic growth slows. Over the past 15 years, the US share of global output has increased slightly. The share of global output generated by the European Union and the UK has decreased slightly. Europe lags behind the US and other major economies. Today, US GDP is almost 45% greater than the GDP of the free countries of Europe.

What explains this discrepancy?

For starters, Europe is opting for etatist economic policies, including a comprehensive regulatory regime. Biden and many Democrats are trying to emulate Europe. But to achieve the goals of a strong economy, unburdened by excessive debt, unchoked by regulation, and free from unnecessary government interference in the daily lives of responsible citizens, the country must return to first principles.

The basic principle is to restore economic freedom. Allow Americans to decide what to produce, what to consume, what to buy and what to sell. Choose capitalism over etatism and industrial policy run by government. America was founded on freedom, and capitalism provides the invisible structures so that people have the freedom to choose how they live.

Government policy should be directed towards strengthening the market economy, rather than state-led mandates as is common in Western Europe. This can be achieved through deficit reduction, comprehensive tax reform, root canal treatment of the administrative state, and a renewed focus on government-funded research and development.

The deficit here is huge. The U.S. economy is operating at full employment. But the federal deficit is 7% of GDP. Outside of the coronavirus pandemic, the deficit has never been this high at a time of near or full employment. Deficits have exploded under Biden, but the primary driver of the deficit is entitlements: Social Security, Medicare, other mandatory spending, and interest on the debt. People love entitlements. And there’s no political will to reduce them.

But the federal government has to pay for the debt it has accumulated. And rising deficits are pushing up interest rates, raising the cost of capital for businesses, reducing investment, lowering long-term productivity growth and making the American dream of homeownership a mirage for many.

Ultimately, entitlement reform will be necessary. Most people receive more from Social Security and Medicare than they pay into the trust fund systems. A 1% increase in the employee contribution to Social Security and Medicare would close the deficit gap by about 1% of GDP. But increasing the employer contribution would be a tax on employment. It is better to tax entitlements than employment. We should not imitate Europe, where mandatory employment taxes can be as high as 40%.

Yet the American welfare system has largely eliminated real poverty. Research by Bruce D. Meyer and James Sullivan suggests that at most 1 percent or 2 percent of the U.S. population lives in real poverty, as measured by consumption. As markets force reform, Congress should consider cutting benefits for the wealthiest, reforming bloated Social Security disability spending, and raising the age of eligibility at all levels. Restrictions on discretionary spending and civil service reform would also make government more accountable and efficient.

But comprehensive tax reform is also important. That means tough choices. First, the United States should introduce a 5% value-added tax on all goods and services. That would raise about 1% of GDP each year. Fixing the deficit won’t be painless. Politicians with courage and common sense could convince the public that a VAT is necessary to restore fiscal sanity. Sell the new tax as a tariff on overconsumption. But a small VAT won’t be enough to close the structural deficit, which is about 5% of GDP. More revenue is needed to reduce the budget deficit to 2% of GDP.

On the sidelines, tax loopholes could be closed. A consumption tax could be imposed on the extremely wealthy so that they cannot avoid income and estate taxes by borrowing against assets with market value.

A combination of sensible tax reform, spending, and entitlements would reduce the deficit from its current 7% of GDP toward revenue parity. Restoring fiscal sanity would lower the cost of borrowing for the federal government and for all households. Americans could dream again.

But tax reform will not be enough to prevent the United States from becoming a European welfare state or a welfare state like Denmark or Sweden, where top tax rates are 56 percent or higher. Very high tax rates reduce incentives and encourage legal tax avoidance. The administrative state must be rolled back. Excessive regulation imposes a clear tax on businesses. Regulatory costs account for 1.34 percent of the nation’s total wage bill, or almost $150 billion a year. Regulatory reform could help employers raise wages and reverse some of the effects of higher Social Security contributions.

Profit and investment are the basis of economic growth. Western Europe has turned away from capitalism. The consequences are clear: people in Europe are getting poorer. But profit is not a dirty word. Profit is to be praised. Profit drives investment, and investment drives productivity growth.

The US attracts strong foreign direct investment because of low corporate taxes. Western Europe is deindustrializing. European manufacturers are turning to the US because the US has not fully embraced green zealotry. Corporate taxes should not be raised when the renewal of the Tax Cuts and Jobs Act of 2017 is debated in 2025. Investment has increased because of the TCJA. Capital has been repatriated. Wages have increased. The deficit effects of the corporate tax reform have been de minimis.

The battle for dominance over the technologies, goods, and services of the future will also be crucial. U.S. policy should especially support investment in research and development. Fifty years ago, the federal government funded two-thirds of the country’s R&D spending. Today, the private sector funds more than 70 percent of R&D. Entitlement spending has crowded out government-funded R&D. The private sector won’t invest in moonshot technologies, but the government can. Look at what the Trump administration has accomplished with Operation Warp Speed, the rush to secure COVID-19 vaccines.

Shifting federal spending from welfare to R&D would be a big win. Congress should also eliminate Biden’s green energy subsidies and redirect the money to basic R&D. Leading economists recently concluded that government-funded R&D is key to productivity growth, stating bluntly:

“The declining role of the public sector in R&D has coincided with a slowdown in productivity growth and a stagnant standard of living for most Americans. … Studies show that after about 8 years, increases in government funding for basic productivity R&D programs begin to increase substantially and steadily.”

Put simply, government funding for R&D contributes to increased productivity and the long-term well-being of all.

People are important too. Uncontrolled immigration is bad for America. Biden has waited too long to make any effort to secure the border. But the evidence is overwhelming: controlled immigration is great for America. We should secure the border while keeping the door open for those who self-select out of determination and hard work. Policies should encourage the best and brightest from abroad to immigrate to the US. Immigrants account for 36% of the innovation in America. Immigrants self-select out of intelligence, determination, determination, and hard work.

Winning the race for AI supremacy is equally critical. The EU is stifling AI with regulation. The US must reject this approach. AI could increase long-term US productivity growth by 0.5% to 1%. If it succeeded, such gains would have profound effects on national well-being and the long-term trajectory of the budget deficit. The CBO noted that without any tax increases or spending cuts, “if nonfarm labor and capital productivity rose 0.5 percentage points per year faster than CBO projects, federal debt held by the public in 2054 would be 124% of GDP, up from the 211% currently projected.”

The bottom line: Future deficits could be nearly halved by fully implementing AI. But the data centers that power AI require vast amounts of energy. Scientists predict that AI energy demand will grow from 3% of national energy consumption to 8% by 2030. That matters because green energy is too expensive and not yet a 24/7 fuel. The United States has a strong comparative advantage in fossil fuels. Europe has turned its back on fossil fuels. That move is sterilizing Western European economies. But absurdly, Biden has said he wants to eliminate fossil fuels.

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This is nihilistic. Instead, we must rush to develop AI and power this transformative technology with America’s cheap and abundant fossil fuels.

The United States has enormous potential to continue to dominate the global economy and provide its citizens with a higher standard of living. But unless bold leadership emerges, we risk repeating the economic disintegration of Europe.

James Rogan is a former U.S. Foreign Service officer who later worked in finance and for almost 30 years. He writes daily note in markets, politics and society.