By Dr Frank Shostak
On March 11, 2021, the US President Biden introduced his $1.9 trillion COVID-19 stimulus plan. The President also announced a more than $2 trillion plan to rebuild US infrastructure, which includes repairing roads, 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 if overall demand in the economy weakens then 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 because of the increase in demand, the production of goods and services will follow suit – demand generates supply.
The opponents to 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 as much as possible widening the budget deficit. In fact, the focus should always be on achieving a balanced budget.
We suggest that the goal of fixing the deficit as such, whether to keep it large or trying to eliminate it altogether, could be 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 amount 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 outlays not budget deficit weakens wealth generation
Observe that 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, it 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, the government lifts taxes to $3 trillion and as a result, deficit is erased. 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.
We hold that 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 have generated 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.
Increase in government outlays stifles 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 individual’s priorities. Now, an increase in government outlays is an increase in various projects that are on the low priority list of individuals at a given state of real wealth.
The increases in government outlays means that wealth producers are in fact forced to part with their wealth in exchange for unwanted projects (or at least lower on their priorities). 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, borrowings 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 non-market chosen projects it cannot make these projects viable
The government can force various non-market chosen projects, such as those suggested by the Biden’s 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 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 towards government spending is that the private sector cannot be trusted or capable to upgrade the infrastructure in the US. On this way of thinking, the government is compelled to undertake the massive investment in the infrastructure because the private sector has failed to do so.
We suggest that 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 the real wealth.
If the private sector does not consider itself ‘rich’ enough to pursue such projects how can the government justify to embark on such undertakings? After all the government is not a wealth generating entity. Since the government will require to divert real wealth from the private sector it only means that the government is going to impoverish this 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 real savings to be able to secure better infrastructure. The build-up of the pool of real savings cannot be made faster by raising government outlays. On the contrary, it will undermine the process of real savings formation.
What is required is the curtailment of the size 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 national savings?
Popular thinking perceives a budget surplus as contributing to national savings. By generating surpluses, so it would appear, the government generates real wealth, thereby strengthening the economy’s fundamentals. This argument would have been valid if government activities were of a wealth-generating nature. Again, 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,
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. A budget surplus – i.e. 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 non-viable projects will an effective lowering of taxes emerge. Lower government outlays imply that wealth generators will now have a larger portion of the pool of real wealth at their disposal.
If, however, government outlays were to continue to increase, no effective tax reduction is possible; on the contrary, the effective tax is going to increase because of the rising government outlays. The share of the pool of real wealth at the disposal of wealth producers will diminish.
The US President Biden formally announced his $1.9 trillion COVID-19 stimulus plan on January 14, 2021. On March 11, 2021, he made it a reality. Following the signing of the American Rescue Plan into law, President Biden also introduced a separate infrastructure investment plan to the tune of $2 trillion.
According to commentators, rising government outlays can be great news for the economy. We hold that the larger the government outlays are the greater the economic impoverishment is going to be.
Following our analysis, we can suggest that the proposed Biden’s economic plan is going to inflict severe damage on the foundations of US economy – the wealth generators. The plan – once implemented – is likely to obliterate whatever is still left out of a free market economy. This we suggest is likely to push the US economy towards the path of economic impoverishment.