Over the last couple of decades, the world has watched the Middle East as country after country has tried to establish a democratic regime and country after country has failed. The United States and its allies toppled Saddam Hussein and announced that they wanted to see a democratic regime take root in Iraq. The western powers helped to topple Colonel Gaddafi in Libya, and welcomed moves towards democracy in Tunisia, Egypt and the Yemen. Today, democracy looks like a very frail flower or has completely disappeared in all those countries. Perhaps that can be blamed on the very long history of autocratic rule which preceded the tentative steps towards democracy. Or perhaps it can be blamed on Islam, some strains of which are deeply and explicitly antagonistic to rule by the people.
Plato warned that democratic leaders would ‘rob the rich, keep as much of the proceeds as they can for themselves and distribute the rest to the people’. James Madison, one of America’s founding fathers, feared that democracy would lead to ‘a rage for paper money, for an abolition of debts, for an equal division of property and for many other improper or wicked projects.’ Similarly John Adams, the country’s second president, worried that rule by the masses would lead to heavy taxes on the rich in the name of equality. As a consequence, ‘the idle, the vicious, the intemperate would rush to the utmost extravagance of debauchery, sell and spend all their share, and then demand a new division of those who purchased from them.’
So where are we now, more than two centuries after John Adams was US president, and more than two millennia after Plato issued his warning?
All democracies have steeply progressive income tax systems, designed (if not always successfully) to take a lot more in tax from those on high incomes than from those on low incomes. To be sure, the very highest income tax rates are lower today than they were, say, 30 years ago, largely because most countries discovered that tax rates well above 50% produced vigorous efforts to avoid and evade tax. But even today many countries have top tax rates approaching 50%. And such tax rates are accompanied by strongly redistributive systems designed to provide income support to those on lower incomes.
And we’ve certainly seen a “rage for paper money”, with consequentially enormous erosion in the value of all the currencies of the major democracies over the last century. Yes, we’ve had several decades of relatively low inflation in New Zealand – indeed, in most developed countries – but my adult children find it hard to believe that when I returned to New Zealand to become the chief executive of a small investment bank in 1971 my very substantial salary was just $14,700, while my secretary was paid an annual salary of just $2,500. Our five bedroom home in Castor Bay, on a quarter acre section and with a sea view, cost $43,000. People who put their money into “safe” government bonds at the time were ripped off, seeing their savings effectively confiscated by inflation.
With very few exceptions – New Zealand and Australia being two of them – the democracies of the developed world are now deeply in debt. The gross outstanding government debt of most democracies exceeds 80% of their respective GDPs, and in Japan that debt well exceeds 200% of GDP.
Even more serious, these debt figures tell only a small part of the real problem. When Lawrence Kotlikoff, Professor of Economics at Boston University, visited New Zealand more than a decade ago he noted that while US federal debt at that time was about US$16 trillion, or about the same size as US GDP at the time, the real problem was not that US$16 trillion but rather the difference between the present value of what the US government had promised to pay out in the future and the present value of what the US government could expect to take in in tax revenue in the future on the basis of current tax rates. That difference was not US$16 trillion but in excess of US$200 trillion – an amount many times the size of the US economy. He concluded that the US government would not be bankrupt in 50 years’ time, or in ten years’ time – it’s bankrupt now!
The same general picture is true in other democracies – a huge increase in government commitments which, it is planned, will be met by generations not yet born.
Much of the problem relates to the enormous demographic change which is taking place in all major economies. In a speech to a conference hosted by the Centre for Independent Studies in Australia a few years ago, Oliver Hartwich (now the executive director of the New Zealand Initiative) noted that, according to the World Bank, the age dependency ratio – that is the ratio of those typically not in the labour force to those typically in the labour force – which currently stands at around 50% in most western democracies, would rise to 68% in the UK, to 78% in Germany and to 89% in Japan by 2050. But he warned that, with pensioners in time forming the majority of the voting public, getting the serious fiscal implications of this demographic change under control “looks like an impossible task”.
In the first of his four BBC Reith Lectures in 2012, Niall Ferguson quoted from Edmund Burke’s Reflections on the Revolution in France, published in 1790. The real social contract, Burke wrote, is not Jean-Jacques Rousseau’s contract between the sovereign and the people, but the “partnership” between the generations. “The state… is… a partnership not only between those who are living, but between those who are living, those who are dead, and those who are to be born.” Ferguson went on to note that “in the enormous intergenerational transfers implied by current fiscal policies we see a shocking and perhaps unparalleled breach of precisely that partnership so brilliantly described by Burke.”
And there can be no serious doubt that this crisis, because that is surely what it is, is a direct result of our democratic form of government. It is easy to blame politicians for this crisis, and that’s what many people do. The reality is that in a state where every person has a vote, politicians feel obliged to buy enough votes to stay in office, and they can always justify their behaviour by reasoning that if they didn’t buy the votes some other party would do so.
I well recall being in a briefing for National Party candidates contesting the 1981 general election. Rob Muldoon, Prime Minister at the time, explained to the candidates that the Labour Party could not promise to fund additional spending programmes – “the cupboard is bare!” he bellowed, almost proudly; he had spent the lot.
And the simplest way to stay in power is to take money off the most affluent minority – subject only to the constraint that taking too much off them may prompt them to leave the country, or work harder to find ways to avoid tax – and redistribute that to the rest of the voting public. For a right-of-centre government that is relatively easy to do in that such a government can be reasonably confident that the affluent minority are unlikely to vote for a left-of-centre government. Even if the votes of the most affluent minority are lost, these are more than compensated for by the votes of the grateful recipients of the bribes. And of course for a left-of-centre government, taking money off the most affluent minority poses no direct risk at all, because that group of voters is unlikely to vote for a left-of-centre government in any event. As has been said, or at least thought, by many a politician, take $100 off one person and hand out goods, services and cash worth $20 to each of five others, and gain a net four votes. And that’s a deal which no other political party dare promise to reverse.
Prior to the advent of universal suffrage in New Zealand, the income tax was levied at the same rate irrespective of income, but subject to a large exemption at the bottom. In other words, income tax was proportional above the exemption threshold. After the advent of universal suffrage, governments quickly realised that they could win more votes than they would lose by making the system steadily more progressive, and so it has been ever since. Once freed from the concept of proportionality, there is, of course, no logical basis for determining what share of tax should be paid by each income cohort. At the moment, roughly half of all New Zealanders receive as much or more in transfers from the state as they pay in all forms of taxation; net tax revenue is all paid by the other half. Is that fair? There is no objective way of answering that question.
So the need to win votes in a democracy inevitably drives towards a progressive tax system and towards constant pressures to increase government spending. When the practical limits of revenue-gathering from those with high incomes are reached – perhaps as higher income groups work harder to avoid taxation, or simply emigrate – governments are under pressure to maintain increases in spending by borrowing from the future, or committing to spending in the future, which is the same thing. In all democracies we have seen government spending rise from 10 to 15% of GDP early last century to triple that level currently. Core Crown spending in New Zealand – that is, spending on current activities, as distinct from investment, by central government – is now some 32-33% of GDP.
Where has all the increased government spending gone? Most of it has gone in an enormous expansion in the role of the state in funding welfare benefits, including New Zealand Superannuation; education, including a very large increase in the funding of students attending tertiary institutions; and healthcare. Today, spending on benefits, on education, and on healthcare absorbs some 70% of total central government spending in New Zealand, and as every politician would be happy to attest, reducing that spending tends to be politically suicidal (just ask Ruth Richardson).
Unfortunately, welfare spending is addictive. And addictive in two ways. First, once government has committed to a particular level of benefit, it is exceedingly difficult to reduce that level.
And second, the benefit itself changes behaviour: many people who might otherwise have tried harder to find employment choose to go on, or stay on, a benefit, something strongly encouraged by the very high effective marginal tax rate faced by those trying to get off a benefit. The Domestic Purposes Benefit, introduced in 1974, provided financial support for just 17,231 people in 1975. By 1985, that number had increased to 56,548, and by 1995, little more than 20 years after the benefit was introduced, the number was 104,027. Until around 2013 the number of sole parents on welfare was consistently above 100,000. The number dropped post GFC during the second half of National's term of government (2008-17) but the downward trend has since reversed. At the beginning of 2021, there were 99,000 sole parents receiving a benefit - 10 percent up on the previous year. Many have never been in a stable relationship and anecdotal evidence suggests that some women become pregnant, or continue with a pregnancy, confident that taxpayers will provide on-going support.
Certainly there can’t be much doubt that the existence of taxpayer-funded support has eroded a sense of personal responsibility, eroded the tradition of family support, and undermined the organisations which flourished to provide support before the advent of large-scale taxpayer support, such as friendly societies. I have heard plenty of people upset at being expected to pay some modest contribution to the cost of their child’s education, while seeing nothing odd about expecting other people to pay for that education. I have seen plenty of media sympathy expressed for women (and on rare occasions men) who have three, four and sometimes more children and who are on a waiting list for taxpayer-funded accommodation. There is just a very strong presumption that taxpayers should be willing to fund the support of a substantial number of children brought into the world by parents who have neither the financial capacity nor, in many cases, the emotional capacity to support them.
Not only has the state’s willingness to provide income, housing, education, and healthcare to an increasing fraction of the total population become hugely expensive, it has almost certainly contributed to the gradual demise of the traditional family structure. I may be the last person who should be preaching about the virtues of marriage, having separated from not one but two eminently attractive wives. The only thing I can say in self-defence is that my children were well into their teens before either marriage broke up; and neither wife ever had to depend on income support from the state. I was able to maintain contact with all of my children after my separations. But there is no longer any serious doubt that children are better off in every way – emotionally, economically, educationally – when they are brought up in a stable environment, preferably with both their natural parents. Of course, in some cases that is not possible, but that is clearly the ideal, and the extensive provision of taxpayer welfare has clearly made it too easy to walk away from that norm. We do nobody any favours by pretending that children can prosper whatever the family structure within which they are brought up.
In the US, it seems very likely that this year will see some of these issues come to a head.
American democracy is already at considerable risk from the millions of Trump supporters who have been willing to buy into the lie that Trump won the 2020 presidential election, despite every court case taken to overturn the election being rejected by the courts (including the Supreme Court, despite the conservative majority on that court) and despite the unambiguous assertion of the Attorney General appointed by Trump that there was absolutely no basis for believing that Trump had won.
But now the conflict between a government’s desire to bribe the electorate with spending and reluctance to get the electorate to pay for those bribes seems likely to precipitate a different kind of crisis. Until recently, both major parties have been willing to authorise government spending while reducing tax rates, borrowing any shortfall between spending and revenue. That has required Congress to periodically authorise an increase in the so-called debt ceiling, currently US$31.4 trillion. Now, a sufficiently vocal number of Republican members of the House of Representatives have made it clear that they will not vote to increase the debt ceiling unless the Democrat government of President Biden agrees to substantially cut government spending (no suggestion that any of the tax cuts implemented by the Trump Administration should be reversed).
Earlier this month, the Treasury Secretary announced that the US government had reached the debt ceiling – in other words, the government had borrowed as much as was legally possible to meet the deficit between current government spending and government tax revenue. Unless Congress votes to raise the debt ceiling by mid-year, the US government will, she warned, be faced with defaulting on its debt. A US government default on its debt – for the first time in history – would, by common consent, be an economic and political shock which would shake the world economy because to date the debt obligations of the US government have been regarded as absolutely without risk.
Forcing the US to default on its government debt would be an act of extraordinary irresponsibility. But it is also true that for the US government to keep adding to its debt year after year, even when, as now, the US economy is growing strongly and unemployment is very low, is also grossly irresponsible. That the US has been able to continue running a government deficit of the present scale, and of growing government debt faster than the US economy itself grows, is only because savers in the US and around the world have been willing to believe that eventually the US will get its fiscal house in order. But as Professor Kotlikoff noted, on the basis of present policies the US government is on a clearly unsustainable track. The Democrats are very reluctant to cut government spending, and Republicans want to cut government spending and don’t want to countenance any increase in taxes. The prospect of reaching agreement on the kind of deficit-reducing measures which the US situation clearly demands seems about as likely as making a manned trip to Mars and getting back alive. It might happen, but it won’t happen any time soon.
A somewhat similar situation prevails in several of the countries in Western Europe: reducing government spending, or increasing tax revenue, to the extent required to reduce the enormous gap between future spending commitments and future revenue projections appears to be quite beyond the ability of current political systems to achieve. Witness the protests which President Macron of France is facing because of his very modest proposal to increase the age of eligibility for the taxpayer-funded pension from 62 to 64. Already several of the countries in the Eurozone are seeing the rise of “non-mainstream” political parties of the right and the left, and the adjustment of government spending levels has scarcely begun. To quote Oliver Hartwich again, the adjustments required “are unlikely to be achieved in a democracy without risking civil war”.
What can be done? I find it very hard to be optimistic. Niall Ferguson suggested, in the Reith Lecture I mentioned earlier, that having governments adopt Generally Accepted Accounting Principles and publish proper balance sheets would be a good start – that would at least enable the public to see the true situation. New Zealand already does that, and perhaps that is one reason why our government debt position is somewhat better than that in many other developed countries. Ferguson also suggests that “generational accounts” should also be prepared on a regular basis “to make absolutely clear the intergenerational implications of current policy.” New Zealand doesn’t do that, although the long-term projections, of the kind published by the Treasury at four-yearly intervals, go some way to addressing that issue in this country. The latest such projection shows that the ratio of government debt to GDP will reach almost 200% of GDP here by 2061 unless some changes in current policies are made, primarily as a result of the increasing fiscal cost of both New Zealand Superannuation and healthcare as the population ages.
Ferguson says that unless the situation changes “western democracies are going to carry on in their current feckless fashion until, one after another, they follow Greece and other Mediterranean economies into the fiscal death spiral that begins with a loss of credibility, continues with a rise in borrowing costs, and ends as governments are forced to impose spending cuts and higher taxes at the worst possible moment.” And in my view, there has to be a serious risk that democracy will not survive that kind of shock.
The great 19th century French historian Alexis de Tocqueville once remarked that “the American Republic will endure until the day Congress discovers it can bribe the public with the public’s money.”
Even earlier, in the late 18th century, Alexander Tytler, a Scottish history professor at the University of Edinburgh, is alleged to have said, in commenting on the fall of the Athenian Republic some 2000 years earlier:
A democracy is always temporary in nature; it simply cannot exist as a permanent form of government. A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy, which is always followed by a dictatorship.
Others are more optimistic. David Roche and Bob McKee wrote a book entitled Democrisis: Democracy caused the debt crisis. Will it survive it? Though acutely aware of the serious debt issues facing all democracies, they are more optimistic, and conclude that “the flexibility and responsiveness of democracy are the key reasons why we believe it will continue to be the global winner – the preferred operating system of the global system – with other systems converging towards it. The unpredictable nature of future outcomes of the debt crisis makes democracy much more likely to be able to cope than any other political model.”
I profoundly hope they are right, and recall Winston Churchill’s famous assertion that “democracy is the worst form of government except all the others that have been tried.”
If I had a choice, which of course I don’t, I would go for some form of “guided democracy” but alas the world has only seen one Lee Kwan Yew in my lifetime.
Dr Don Brash, Former Governor of the Reserve Bank and Leader of the New Zealand National Party from 2003 to 2006 and ACT in 2011.