By Dr Frank Shostak
Projects that the government undertakes are likely to be of a questionable nature. The fact that the private sector did not undertake these projects raises the likelihood that these projects cannot be afforded by individuals.
Let us say that the government decides to build a pyramid and that most people regard this as a low priority. The people employed on this project must be given access to various goods and services to sustain their existence.
Now, the government is not a wealth producer, it has to impose taxes on wealth generators in order to fund the building of a pyramid. The more pyramid-building that the government undertakes, the more wealth is taken away from wealth generators. It follows that the level of tax is directly determined by the size of government activities. If government activities could generate wealth, they would be self-funded and the issue of taxes would never arise.
In the money economy, the government will tax and transfer the received money to various individuals who are employed directly or indirectly by the government. The government employees can now exchange this taxed money for various goods and services and engage in the consumption of wealth without making any contribution to the wealth formation.
Government uses various methods to divert wealth from wealth producers toward its activities. These methods include direct and indirect taxes and levies, monetary printing as a result of government borrowings from the central bank and borrowings from the private sector.
The method of diverting wealth is of secondary importance. What matters here is that wealth is taken from wealth producers. The more that is taken, the higher the effective tax imposed on the wealth-generating private sector is going to be.
Now, when government borrows from the private sector, it cannot repay the borrowed wealth. Only wealth producers who are borrowing from each other are in a position to repay from their future production of wealth. All that government can do is to pay back the borrowed wealth by means of newly created money, or through new taxes, or through new borrowings, thereby further impoverishing wealth producers. It amounts to a process whereby government borrows from you in order to repay you.
Similarly, when government borrows from the central bank, it effectively causes the central bank to hand the government newly generated money, which is employed to divert wealth from the private sector.
With respect to the government borrowing from overseas, the burden of servicing the foreign debt is going to fall on the private sector given that the government is not a wealth producer.
What then is a budget surplus? It means that the government intake of money exceeds its spending of money. The emergence of a surplus produces the same effect as any tight monetary policy would. 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.
Contrary to the widely held view, the budget surplus does not automatically make room for lower taxes. Taxes cannot effectively be lowered until government outlays are curtailed. Only a cut in government outlays is going to result in an effective tax cut. All else remaining equal, a cut in the tax rate while government outlays continue to increase will lead the government to impose greater burdens on wealth producers through higher borrowings, higher levies, and higher indirect taxes, and through monetary pumping. The way to make tax cuts effective is to back them with government spending cuts.
Lower government outlays imply that wealth generators will now have a larger portion of the pool of wealth at their disposal. If, however, government outlays continue to increase, notwithstanding budget surpluses, no effective tax reduction is possible; on the contrary, the share of the pool of wealth at the disposal of wealth producers is going to diminish all other things being equal.
For example, if government outlays are $3 trillion and government revenue is $2 trillion, then the government will have a deficit of $1 trillion. Since government outlays have to be funded this means that the government would have to secure some other sources of funding such as borrowing, printing money or new forms of taxes. The government is going to employ all sorts of means to obtain resources from wealth generators to support its activities.
What matters here is that government outlays are $3 trillion, not that the deficit is $1 trillion. For instance, if government revenue were $3 trillion then we would have a balanced budget. But would this alter the fact that the government still takes the $3 trillion of resources from wealth generators?
Some commentators are likely to react that the private sector cannot be trusted to build up and enhance the nation’s infrastructure. For instance, the US urgently requires the building and upgrading of bridges and roads.
Even if this is the case can Americans afford the improvement of the infrastructure? The arbiter here should be the free market where individuals, by buying or abstaining from buying, decide on the type of infrastructure that is going to emerge.
If the size of the pool of wealth is not adequate to afford a better infrastructure, then time is needed to accumulate wealth to be able to secure better infrastructure. The build-up of the pool of wealth cannot be made faster by raising government outlays. On the contrary, an increase in government spending is going to weaken the pool of wealth.
Note, that whilst the government can force various non-market chosen projects, the government however, cannot make these projects viable. As time goes by the burden that these projects are likely to impose on the economy through the higher ongoing levels of taxes is going to undermine the well-being of individuals and will make these projects even more of a burden.
What about the lowering of taxes on businesses – surely this is going to give a boost to capital investment and strengthen the process of wealth formation? As long as the lowering of taxes is not matched by a reduction in government spending this is going to encourage a misallocation of capital.
Various capital projects that emerge on the back of such government policy are likely to be the equivalent of useless pyramids.
Conclusion
The only meaningful contribution the government can make to the pool of wealth, and hence people’s living standards, is by focusing on a reduction in its outlays – not whether there is a budget surplus or a deficit. This in turn means the government must remove itself from business activities and permit wealth generators to get on with the business of wealth generation.
