Firstly, nowhere in my original response to Daniel Klein’s essay did I argue that the trend in the United States over the past thirty years has been towards a smaller state. Unfortunately, both Republicans and Democrats find it quasi impossible in a mature democracy as this one to cut spending and public services to their constituents.
Klein, like most libertarians, casually overlooks the fact that it is his own dogmatic libertarian thinking — centered on lower taxes, deregulation, absolute private property rights, and smaller government — that has led to the biggest economic disaster since the Great Depression.
If the dogmatic thinking of libertarians, centered on smaller government, didn’t result in smaller government, it’s a bit hard to see why Matthias blames it for recent economic difficulties. Ditto for the rest of his list.
I think the more important point is not about the size of the state — something which nobody disputes — but about the distribution of income. Since the coming to power of Ronald Reagan in the United States and Margaret Thatcher in the United Kingdom, both countries have become almost as unequal as many developing countries today. The distribution of income as a consequence of their regressive measures of cutting income tax and raising all kinds of indirect taxes — all in the name of supply side stimulus — became much more unequal since 1980.
The CBO has published estimates of the distribution of the federal tax burden as of 2007. I don’t know if Matthias has looked at them. The top 1% of the income distribution pays almost 40% of all federal income taxes; the bottom 60% pays just over 1%. The burden of other federal taxes is somewhat less uneven; the CBO’s estimate is that the top 1% in 2007 paid 29.5% of all federal taxes, and the bottom 60% paid 14.4%. It is also more ambiguous; it isn’t clear, for instance, how much of the payroll tax goes to lower after tax wages and how much to raise the cost of labor to employers, or who really end up paying corporate income taxes.
It is hard to see how a system where most of the taxes are paid by people in the upper part of the income distribution can be the explanation of increases in income inequality.
Since 1979, there has been a relentless movement towards less government intervention in the economy — probably all over the world. So, to now blame the biggest economic disaster since the Great Depression on two quasi-governmental firms with perverse incentives in the mortgage market strikes me as too easy an explanation.
There has certainly been such a movement in much of the world — accompanied, in poor countries such as India and China, by a striking increase in standards of living. It doesn’t follow that there has been a similar movement in the United States. Rhetoric has become more favorable to free markets, but practice need not follow rhetoric, as George W. Bush quite strikingly demonstrated. I believe that under Reagan the rate at which new regulations were issued declined somewhat, but that’s a reduction in the rate of growth of government power, not the level.
As far as the cause of the recession and the financial crisis, that is a subject on which there is widespread agreement: virtually every commentator attributes it to some set of policies he is against. The only disagreement is on the details — whether it was due to too much government intervention in the housing market or too little, regulation or deregulation, increase or decrease in the size of government. Matthias concedes that part of the cause was government intervention in the housing market, but nonetheless asserts with complete confidence that the real cause was “dogmatic libertarian thinking” in his first essay and “the distribution of income” and “the overarching neoliberal economic framework” in this one.