Only death and taxes are inevitable. Fiscal deficits of governments are a matter of choice by politicians to spend beyond the means of current taxpayers.
As such, deficits cannot be blamed upon economic slowdowns or tax cuts, since these can be offset by reduced government spending. Either way, deficits can and should be avoided, since they have no merit as a counter-cyclical tool and they inhibit long-term economic growth.
Governments should not run budget deficits to offset sluggish economic growth because deficit spending cannot restore economic growth. This is because deficits have no net effect on aggregate spending. Larger deficits created by lower taxes or higher spending can alter the composition of aggregate spending, but the overall magnitude cannot be increased.
It does not matter how public-sector spending is financed, either consumption or investment or saving in the private sector must decline. While it does not matter how resources are lured away from the private sector to finance to government consumption spending, any increase in investment costs will cause economic growth to be lower than otherwise.
It is useful to think of budget deficits as a stealth tax increase that allows governments to capture resources without raising current taxes. Deficits allow governments to defer tax increases to the future or when their debts become unmanageable, they will turn to inflationary financing to reduce the real value of their obligations.
All methods of financing government spending will involve some form of taxation. If a government wishes to spend more today by raising tax rates, current taxpayers will bear the burden. But raising taxes tends to be a vote-loser, so politicians may support increased spending by running a deficit that adds to public-sector debts.
Debt-financed deficits simply shift the burden of paying off the debt on future taxpayers who must repay both the interest obligations plus the interest. An additional burden will be imposed if public-sector spending is directed toward current consumption rather than investment. When savings are diverted from investment to consumption, future purchasing power will be lower.
As such, future tax obligations will be higher but there will no basis for improving productive capacity. In the end, this is likely to lead to the worst of both worlds where there is slower economic growth but a heavier tax burden.
Deficits might also be funded through an inflationary monetary policy that puts more pieces of paper money or credit into the financial system. But this approach not only distorts the pattern of production, it also tends to cause current account deficits in the international payment accounts. Central bank policies that allow for excessive credit expansion will induce many misguided production decisions to occur in response to the false signals of cheap credit. Once rising consumer and producer prices lead to an end of the credit expansion, these ventures will prove to unsustainable when confronted by higher interest rates.
In all evens, it turns out that the way that deficits affect the economy is often misrepresented. For example, it is often argued that deficits are more harmful to the economy than high taxes because of the direct effect that deficits have upon savings and interest rates. But this would be closer to the truth only if government spending was a small proportion of GDP that sets in an upward cycle of spending and taxes.
As it is, when governments directly compete with the private sector for funds there will be a need to raise taxes to pay interest on their borrowing at some point. In this case, raising current taxes can leader to higher rates of interest since taking tax revenues diverts funds from private spending so that savings may be lower than otherwise. While deficits can influence interest rates, there is no mechanical relationship.
Deficits caused by increased government spending generate a mistaken belief that it is an act of fiscal prudence to raise taxes to eliminate the deficits created by their own acts. Eventually, combined government spending at all levels will be so high that it becomes reckless since the tax burden will be too high. And so it is that the basic issue is not whether there are deficits, per se, but how to control government spending that causes them.
However, it is true that when governments increase the demand for savings to fund a deficit, deficits there will be an inevitable influence over interest rates. But it is not certain that a deficit will always push up interest rates.
It is possible that rising deficits may not actually crowd out private investments since demand is only one determinant of interest rates. Reducing taxes on capital gains and ending the double taxation of dividends could cause savings to rise and interest rates to tend to decline.
In this instance, deficits may cause a rise in the demand for public funds that might simply offset the pressures for interest rates to decline. And so interest rates should not be expected to move in lock-step with deficits.
Consider the case of Japan. Despite running massive public-sector deficits for more than a decade, the Bank of Japan ran an ultra-low interest rate policy. In no way did these large and growing deficits push up interest rates.
It is interesting that there is general agreement that raising taxes during an economic downturn is a recipe for stagnation. However, the logic follows that fiscal deficits will simply shift the stagnation effect to a later time period.
Christopher Lingle is a visiting professor of economics at Universidad Francisco Marroquon in Guatemala.
Could Asia be on the verge of a new wave of nuclear proliferation? A look back at the early history of the North Atlantic Treaty Organization (NATO), which recently celebrated its 75th anniversary, illuminates some reasons for concern in the Indo-Pacific today. US Secretary of Defense Lloyd Austin recently described NATO as “the most powerful and successful alliance in history,” but the organization’s early years were not without challenges. At its inception, the signing of the North Atlantic Treaty marked a sea change in American strategic thinking. The United States had been intent on withdrawing from Europe in the years following
My wife and I spent the week in the interior of Taiwan where Shuyuan spent her childhood. In that town there is a street that functions as an open farmer’s market. Walk along that street, as Shuyuan did yesterday, and it is next to impossible to come home empty-handed. Some mangoes that looked vaguely like others we had seen around here ended up on our table. Shuyuan told how she had bought them from a little old farmer woman from the countryside who said the mangoes were from a very old tree she had on her property. The big surprise
The issue of China’s overcapacity has drawn greater global attention recently, with US Secretary of the Treasury Janet Yellen urging Beijing to address its excess production in key industries during her visit to China last week. Meanwhile in Brussels, European Commission President Ursula von der Leyen last week said that Europe must have a tough talk with China on its perceived overcapacity and unfair trade practices. The remarks by Yellen and Von der Leyen come as China’s economy is undergoing a painful transition. Beijing is trying to steer the world’s second-largest economy out of a COVID-19 slump, the property crisis and
The past few months have seen tremendous strides in India’s journey to develop a vibrant semiconductor and electronics ecosystem. The nation’s established prowess in information technology (IT) has earned it much-needed revenue and prestige across the globe. Now, through the convergence of engineering talent, supportive government policies, an expanding market and technologically adaptive entrepreneurship, India is striving to become part of global electronics and semiconductor supply chains. Indian Prime Minister Narendra Modi’s Vision of “Make in India” and “Design in India” has been the guiding force behind the government’s incentive schemes that span skilling, design, fabrication, assembly, testing and packaging, and