By Frank Shostak*
On March 11, 2021, US president Biden introduced his $1.9 trillion covid-19 stimulus plan. The president also announced a plan of more than $2 trillion to rebuild US infrastructure, which includes repairing roads and bridges, as well as expanding access to long-term care services under Medicaid, building schools, and expanding internet access across the US.
It is commonly accepted that during difficult economic times the government should run large budget deficits in order to keep the economy going. This is because when overall demand in the economy weakens, the government should step in and boost its spending in order to provide support to demand. In this situation, a widening in the budget deficit in response to increased government outlays can be great news for the economy. It is held that the increase in demand will be followed by the production of goods and services. That is, demand generates supply.
The opponents of this view hold that a widening in the budget deficit tends to be monetized and subsequently leads to higher inflation. So from this perspective, government must avoid widening the budget deficit as much as possible. In fact, the focus should always be on achieving a balanced budget.
The goal of fixing the deficit as such, however, whether it is to keep it large or to eliminate it altogether, is, in fact, an erroneous policy. Ultimately, what matters for the health of the economy is not the size of the budget deficit but the size of government outlays—the percentage of resources that government diverts to its own activities. Hence, the focus should be on government outlays and not the budget deficit as such.
Government Spending, Not Budget Deficits, Weakens Wealth Generation
A government is not a wealth-generating entity. The more it spends, the more resources it has to take from wealth generators. This in turn undermines the wealth-generating process of the economy. For instance, if the government plans to spend $3 trillion and funds these outlays by means of $2 trillion in taxes, there is going to be a deficit, or a shortfall, of $1 trillion. Since government outlays have to be funded, this means that in addition to taxes the government has to secure some other means of funding, such as borrowing or printing money.
The government is going to employ all sorts of means to obtain resources from wealth generators to support its activities. Hence, what matters here is that government outlays are $3 trillion, and not the deficit of $1 trillion.
For instance, if the government lifts taxes to $3 trillion and the deficit is erased as a result, would this alter the fact that the government still takes $3 trillion of resources from wealth generators?
This means the effective tax that the government imposes on wealth generators is determined by government outlays.
An increase in government outlays sets in motion an increase in the diversion of wealth from wealth-generating activities to non-wealth-generating activities. This results in economic impoverishment. So in this sense, an increase in government outlays to boost the overall economy’s demand should be regarded as bad news for the wealth-generating process, and hence to the economy.
Note that if government activities could generate wealth, then these activities would have been self-funded and would not have required any support from other wealth generators. If this were the case, the issue of taxes would never arise.
Increases in Government Outlays Stifle the Market Process
Whenever wealth producers exchange their products with each other, the exchange is voluntary. Every producer exchanges goods in his possession for goods that he holds will raise his living standard. The crux, therefore, is that the exchange or trade must be free and thus reflective of individuals’ priorities. Now, an increase in government outlays is an increase in various projects that are low on the priority lists of individuals at a given state of real wealth.
The increases in government outlays mean that wealth producers are in fact forced to part with their wealth in exchange for unwanted (or at least lower-priority) projects. This implies that producers are forced to exchange more for less, and obviously, this impairs their well-being.
The greater the amount of non-market-related projects the government undertakes, the more real wealth is taken away from wealth producers. Note that the real wealth is diverted from the private sector by means of taxation, borrowing, or money printing.
Again, the magnitude of the diversion is determined by the extent of government activities. Observe that it does not matter as such whether the government diverts real wealth by means of taxation, or by means of borrowings or by means of money printing. What matters is that the government diverts real wealth.
Government Can Force Us to Spend on Government Projects, but It Can’t Make Them Economically Viable
The government can force various non-market-chosen projects to be undertaken, such as those in the Biden infrastructure plan. The government, however, cannot make these projects viable. To keep these projects alive, the government will be compelled all the time to divert resources from wealth generators to these projects. As time goes by, the burden that these projects are going to impose on wealth generators is likely to undermine the well-being of individuals.
What about the lowering of taxes on businesses? Surely this will give a boost to capital investment and strengthen the process of real wealth formation? A cut in taxes for a given government expenditure will result in the widening in the budget deficit.
The widening budget deficit is going to be funded either by borrowings or by monetary pumping. This is also likely to result in the diversion of real wealth from wealth-generating activities to non-wealth-generating activities. Various capital projects that emerge on the back of such government policy are likely to be the equivalent of malinvestment.
A common justification for government spending is that the private sector cannot be trusted or is incapable of upgrading infrastructure in the US. So, the government is compelled to undertake the massive investment in the infrastructure because of the private sector’s failure to do so.
What is overlooked is that the reason the private sector of the economy did not undertake various infrastructure projects—as suggested by the Biden plan—is because the private sector found them too expensive. The private sector cannot afford these projects given the state of real wealth.
If the private sector does not consider itself “rich” enough to pursue such projects, how can the government justify embarking on such undertakings? After all, the government is not a wealth-generating entity. Since the government will be required to divert real wealth from the private sector, its actions only mean that the government is going to impoverish the private sector. This is going to result in a decline in the living standards of individuals.
Now, if the size of the pool of real savings is not large enough to afford better infrastructure, then time is required to accumulate the real savings to be able to secure better infrastructure. The buildup of the pool of real savings cannot be made faster by raising government outlays. On the contrary, that will undermine the process of real savings formation.
What is required is the curtailment of government outlays. This is going to speed up the process of real savings accumulation, i.e., it will strengthen the pool of real savings.
Does a Budget Surplus Contribute to Savings?
Popular thinking perceives a budget surplus as contributing to national savings. By generating surpluses, it would appear that the government generates real wealth, thereby strengthening the economy’s fundamentals. This argument would be valid if government activities were of a wealth-generating nature. This is, however, not the case. Government activities are confined to the redistribution of real wealth from wealth generators to wealth consumers.
What, then, is the meaning of a budget surplus? It means that the inflow of money to the government exceeds its expenditure of money. The budget surplus here is just a monetary surplus. The emergence of a surplus produces the same outcome as any tight monetary policy does. On this Ludwig von Mises wrote in Human Action,
Now, restriction of government expenditure may be certainly a good thing. But it does not provide the funds a government needs for a later expansion of its expenditure. An individual may conduct his affairs in this way. He may accumulate savings when his income is high and spend them later when his income drops. But it is different with a nation or all nations together. The treasury may hoard a part of the lavish revenue from taxes, which flows into the public exchequer as a result of the boom. As far and as long as it withholds these funds from circulation, its policy is really deflationary and contra-cyclical and may to this extent weaken the boom created by credit expansion. But when these funds are spent again, they alter the money relation and create a cash-induced tendency toward a drop in the monetary unit’s purchasing power. By no means can these funds provide the capital goods required for the execution of the shelved public works.
Many commentators are of the view that the emergence of a budget surplus makes it possible for the government to lower taxes. But a budget surplus—that is, a monetary surplus—does not automatically make room for lower taxes. Only if real government outlays are curtailed, i.e., only when the government cuts the number of economically nonviable projects will an effective lowering of taxes emerge. Lower government outlays imply that wealth generators will now have a larger portion of their pool of real wealth at their disposal.
If, however, government outlays continue to increase, no effective tax reduction is possible; on the contrary, government outlays will increase the effective tax. The share of the pool of real wealth at the disposal of wealth producers will diminish.
Source: This article was published by the MISES Institute