Deficits Are Not the Only Problem

Pity the poor Federal deficit. What was once hailed as a western economic savior has been relegated to a public whipping boy. Politicians and liberal economic writers who a decade ago declared that deficits were “actually desirable because this meant the federal government was pouring funds into the economic stream” now declare with equal sincerity that these same fiscal shortfalls are a menace to economic growth.[1]

How, an astute observer of our political economy might ask, can the Federal deficit have fallen into such disrepute, especially among its onetime supporters? Did not Keynesian economists tell us in triumphant words that the so-called capitalist problems of boom and bust were to be solved by government fiscal policy of which the deficit was an integral part?[2]

Consider one economist’s claim that the 1964 Federal deficit was a “desirable” element of the nation’s economy.

The basic explanation for our achievement (a prosperous economy), I think, is that, in 1964, our politicians finally “grew up” into mid-20th century fiscal policy thinking. As a result, there was nothing less than a revolution in economic thought at the highest policy-making levels of our government.

In the past, our politicians have always considered it imperative to hail an annually balanced budget as economic purity, to condemn a budget deficit as fiscal sin, and to shrink from tax reduction in the face of budget deficits as unspeakably reckless. But in 1964, the federal budget deficit was accepted as actually desirable because this meant the federal government was pouring funds into the economic stream, and this money would help lift us to levels of full employment and full use of our great industrial capacity.[3]

One is hard pressed today to find a description of the present Federal deficit made in such hushed, reverent tones. But, then, the numbers have changed as well. In 1964, the Federal deficit to which Ms. Porter attributes such sterling results as “full employment” and “full use of our industrial capacity” was $5.9 billion, or roughly five per cent of the total budget.[4] The proposed Federal deficit for the coming year (and remember, proposals usually fall way short of real spending) is about $100. billion, nearly 15 per cent of the tentatively-approved U.S. Government budget. Even allowing for the galloping inflation since 1964, the present numbers are clearly out of hand. The “harmless” (or helpful, depending on one’s point of view) deficits of two decades ago have grown into what seems to be an uncontrollable monster.

The problems resulting from the size of the Federal deficit are not in dispute. For example, in 1965, when President Lyndon Johnson greatly expanded domestic Federal spending, the U.S. Treasury took approximately 18 per cent of available funds from the nation’s credit markets. Today that number stands at nearly 80 per cent. Funds for investment, our economy’s seed corn, are being devoured at an alarming rate which can only spell out a real decrease in standards of living for most Americans. Rates of inflation, though recently somewhat diminished, have severely depreciated the dollar, caused malinvestment and brought about economic decline.

The Real Issue: Spending

But the real issue of the Federal budget is lost in a semantic word game which, at best, diverts people’s thoughts from the main sickness—that being Federal spending—to deficits, which are only a symptom of the disease. This is not to say that budget shortfalls are not dangerous. They are. But when one simply concentrates on condemning the deficits while ignoring the dangers of government overspending, it is, to paraphrase the New Testament, straining at a gnat and swallowing a camel.

A recent editorial of a nearby major metropolitan newspaper demonstrates this kind of naivete. In the editorial, titled “Tax Hike or Recession,” the writer accurately noted that the shortfalls would have to be covered either by creation of fiat money—and thereby inflation—or by Federal borrowing from hard pressed credit markets. Both “solutions,” he pointed out, would effectively raise interest rates and limit capital expenditures.

His solution? Raise taxes, of course. Thus, he indicated, the deficit would be eliminated in this relatively painless manner, interest rates would fall and the economy would recover. The only barrier to prosperity, he reasoned, was the lack of courage by politicians to reverse the tax cuts they had given us last year.

This editorial writer has not been the only one to endorse tax increases as the way to solve the budget problems. Radio and television commentators, both liberal and conservative politicians, and economists who should know better have also jumped onto this short-sighted bandwagon declaring that tax increases are the only way to prosperity. But they ignore the fact that deficits are only a symptom. The disease is too much spending.

None of the Alternatives Is Acceptable

When the Federal budget is discussed on the news, the ultimate point of discussion is the proposed $100 billion deficit. Few commentators—and economists—ever discuss the gargantuan size of the Federal budget. This year Federal spending will most likely exceed $800 billion. The official Federal debt is more than one trillion dollars.[5]

But why, one might ask, is it not better to tax in order to curb deficits than to borrow or print money? After all, the perils of inflating are widely known even to the most economically illiterate persons, while excessive Federal borrowing not only “crowds out” capital but also diverts money from productive uses to nonproductive ones. The answer is that none of these “alternatives” is acceptable.

While past budget deficits were often run deliberately in order, as Ms. Porter writes, to pour “funds into the economic stream,” there is plenty of historical evidence to show that governments inflate even when their budgets are officially balanced. During the 1920s, as Economist Murray Rothbard has noted, the U.S. Government raised the money supply by nearly 62 per cent in the face of balanced Federal budgets.[6] From 1977 to 1980, the nation of Colombia suffered an annual increase in inflation of more than 25 per cent, despite the fact that its tax revenues exceeded government expenditures.[7] The problem here is not deficit spending, but rather government monopoly over the supply of money. Governments may use deficits as an excuse to print money, but when government con-trois the “creation” of money, any reason will do.

Nor would increased taxation eliminate government borrowing, either at local or Federal levels. As long as governments continue to involve themselves in enterprises beyond protection of citizens’ life and property, there will always be dams to build, school buildings to erect, canals to dig and individuals to support. Such multi-million (and billion) dollar ventures require vast sums of capital which can only be borrowed.[8] Thus, deficit or no deficit, governments will continue to suck capital from private markets in order to fund projects that could be handled more efficiently and with less expense by the private sector.

One is left, then, with the question of taxation. The issue is not, as many “born-again budget balancers” have declared, choosing “less-painful” taxation above borrowing or inflation. Increasing taxes to balance a budget is not a panacea for our economic ills, as many would tell us. Consider economist Alan Reynolds’ warning.

In the depths of the Great Depression, Wall Street and the financial editors agreed that restoration of confidence required a balanced budget. In 1932, the Hoover administration complied by signing the biggest percentage increase in tax rates in peacetime history. Needless to say, that did not strengthen the economy, calm financial markets or balance the budget.[9]

Unseen Consequences

People are often short-sighted on the evils of heavy taxation. They can see the credit markets being drained of capital by the government. They can see the leap in prices as inflation takes hold on the economy. But taxes go beyond their visual effects. One can see public treasuries fill up with tax revenues. What is not seen, however, is the loss of funds that might have gone into capita] markets, the loss of potential investments, the real loss of income for individuals who pay huge portions of their earned income to government. Money that might have been invested in profitable, wealth-creating projects is used, instead, for government consumption. To increase the level of taxation would not enhance investment opportunities. Indeed, to confiscate revenue through taxation is no better than to devour it straight from the markets or to print it on the printing presses at the Bureau of Printing and Engraving. The damage done to the economy will not be lessened by choosing taxation over borrowing or printing.

Heavy taxation also encourages people to take their income from productive investments—which often fall in the reach of the Internal Revenue Service—and place them in less productive tax shelters. Again, this problem is an invisible one, since people cannot see the factory that was not built, the invention that was not marketed or the entrepreneur’s dream that was unfulfilled.

No doubt, as Reynolds writes, the Federal budget, all $800 billion of it, could be balanced as “a matter of sheer bookkeeping.”[10] He points out:

. . . we could probably balance the U.S. budget by disarming, or by doubling the corporate tax, or by confiscating all income above $50,000 a year. In practice, any of these options would probably destroy the country.[11]

Intervention Brings Stagnation

Economic stagnation is not the price of “curing deficits.” Rather, it is the price the people of a nation must pay when its federal government spends far more than its citizens can afford, taking from Peter to give to both Paul and Peter—minus a hefty commission.

This is not to say that budget deficits are not a problem. They are. But the issue at hand in discussing deficits is not just bookkeeping, but also ignorance and arrogance. Since the 1930s economists have promised that budget deficits will permit politicians to circulate new money into the economy, thereby “spreading the wealth,” and politicians have eagerly obeyed. But, as a decade of runaway inflation has demonstrated beyond a doubt, dumping fiat money into an economy creates only the illusion of wealth, not wealth itself.

Since deficits became a staple of government fiscal policy, people have deceived themselves into believing that increased prosperity, the rise in real income, and a rising standard of living were due to their politicians’ spending more than was taken in taxes.

But as deficits have widened and seemingly run out of control, it has been equally deceptive for people to believe that prosperity will return as soon as the books are balanced. Prosperity will return only when citizens stop demanding their governments give them a standard of living that they cannot themselves produce, as individuals acting within the free market.

1.   Sylvia Porter, “Focus on the Economy,” The World Book Year Book, 1965, p. 27.

2.   Austrian economists, particularly von Mises and Rothbard, have conclusively demonstrated that government monetary policy is usually the cause of boom and bust cycles. It can hardly be expected, then, that erratic fiscal policies can somehow solve the very problems they create.

3.   Porter, p. 27.

4.   Source: Statistical Abstract of the United States, 1980. The federal budget in 1964 was approximately $118 billion.

5.   Economic writers such as Irwin Schiff and others have estimated that the liabilities of the Federal government are up to 10 times greater than the officially-admitted debt.

6.   Murray Rothbard, America’s Great Depression (Kansas City, 1963), p. 86.

7.   Alan Reynolds, “That Budget Deficit Is Not the Problem,” Wall Street Journal, October 5, 1981, p. 28.

8.   Contrary to what some may believe, governments usually pay for public projects with bor rowed money. The payments are paid back with tax revenues (except in the case of New York City in 1975, which paid back borrowed funds with more borrowed funds).

9.   Reynolds, p. 28.

10.   0lbid.

11.   Ibid.