Playing Catch-Up on Economic Freedom

Say you're making a list of the world's freest economies. Where would you place the United States? Would we be number one? In the top three? The top five?

The answer, sadly, is none of the above.

The Heritage Foundation and The Wall Street Journal recently published our 10th annual "Index of Economic Freedom," (search) and it shows that last year the U.S. dropped from being tied for sixth place worldwide to being alone in 10th.

Both the Swiss and the Brits now enjoy greater economic freedom than Americans do. We've long trailed perennial Index leader Hong Kong, but now we're looking up at the former Soviet republic of Estonia as well. That means, as far as economic freedom goes, you'd be better off starting a business in Hong Kong, London or Tallinn, Estonia, than you would be starting it in an American city.

We Americans like to think of our country as a bastion of economic freedom. And to a large extent, it still is. But while the U.S. remains one of the world's freest and most vibrant economies, the rest of the world is catching on and catching up.

What's dragging on economic freedom in America? The Index pinpoints the problem — "fiscal burden of government." It's one of 10 categories of economic freedom examined in the Index and the only one where the U.S. gets lousy grades. Were fiscal burden of government not a problem, the U.S. would easily claim a top-three ranking for economic freedom.

What do we mean by "fiscal burden of government"? It's the category that measures marginal tax rates (search) and the year-to-year increase in the level of government spending as a percent of gross domestic product.

Simply put, marginal tax rates are the price an individual must pay to supply the economic effort needed to start a business. What remains after the taxes are subtracted represents the reward of the effort.

Obviously, the higher tax rates are, the lower the reward of starting a business will be. Our income tax rates and corporate tax rates are quite high. We also suffer from extravagant government spending — 35.6 percent of GDP (search) and rising.

These days, the government is "giving" us more, far more than we can afford. Washington spent more than $20,000 per household in 2003, and plans to spend even more this year.

That spending includes last year's massive agriculture bill that boosted government subsidies to farmers (search) by $80 billion over 10 years. Uncle Sam is once again paying farmers to grow certain protected crops, or else paying them to not grow certain crops. Either way, Washington is picking winners and losers, instead of allowing the free market to decide.

Meanwhile, we impose massive import tariffs (search) on other crops, including sugar and peanuts, to keep other nations, which grow those crops less expensively, from selling them here.

Of course, when the government spends money, whether for farm programs, roads, homeland defense or thousands of other things, it is diverting resources from the productive private sector.

To pay for the increased spending, the government has two choices — either raise taxes or take on debt. Increasing taxes is a bad idea, of course. Over the past year, we've seen three rounds of tax cuts kick in and get our economy growing again. We can't afford to jeopardize those gains by raising taxes.

That's why lawmakers are using deficit spending to finance the government's growth. But there's no such thing as a free lunch. All the money we're borrowing today to pay for government programs has to be paid off eventually, meaning interest payments on the debt and, eventually, higher taxes for us —and our children and grandchildren.

Of course, it doesn't have to be this way. The United States could easily move back into the Index's top five — and enjoy the economic growth that comes with increasing economic freedom — if lawmakers trim the size and scope of government this year.

Let's do the right thing, and perhaps next year citizens in other countries will wonder how they can catch up with us again.

Ed Feulner is the president of  The Heritage Foundation, a Washington-based public policy research institute.