September 8, 2020 Reading Time: 14 minutes

The Congressional Budget Office has recently issued a federal “Budget Outlook Update” for the next ten years in the context of the government’s fiscal condition in the face of the coronavirus and Washington’s spending spree. The message: the deficit for fiscal year 2020 is huge, and the national debt is getting bigger, faster than had been projected before America’s lockdowns that brought much of the economy to a halt. 

Normally, serious recessionary downturns are the result of central bank monetary mismanagement that generates unsustainable investment and housing booms and bubbles through money, credit and interest rate manipulation. Eventually, the credit expansion house of cards comes tumbling down as various sectors of the economy discover the need for a rebalancing of resource, labor, and capital uses in the face of numerous mismatches between supplies and demands. 

The Government Directly Caused the Downturn of 2020

There were many signs that ten years of nearly zero interest rates and a large expansion of bank credit were setting the stage for an eventual “correction” in the economy. However “inevitable” this might have been at some point, there was no indication at the beginning of 2020 that a serious recession was on the immediate horizon. No, what happened in the first half of 2020 had one source and cause only – the coercive commands of the federal and the state governments ordering people to stay at home, limit their shopping trips to politically-approved “essentials,” and not to go to work, as all part of a counterproductive and damaging attempt to stop the spread of the coronavirus. 

Instead, its most important outcome was to wreak havoc on not just the U.S. economy, but much of the world’s economy, as well, as most other governments imposed similar compulsory clampdowns on the citizens of their countries.

With shock and disbelief politicians, political pundits, and most of the news media seemed totally surprised and confused by the idea that telling people not to leave their homes, not to buy goods and services, and to stay away from their places of employment might actually bring the economy to a seemingly grinding halt with falling production and rising unemployment. (See my articles, “To Kill Markets is the Worst Possible Plan” and “Leaving People Alone is the Best Way to Beat the Coronavirus”.)

During the first quarter of the year, U.S. Gross Domestic Product (GDP) declined by 5 percent (at an annualized rate) and then by a whopping 30.7 percent in the second quarter of 2020 (at an annualized rate). Economywide unemployment, after being around 3.5 percent in January 2020, rose to nearly 20 percent later in the spring, and was still 8.4 percent in August, as measured by the Bureau of Labor Statistics. 

Trillions of Dollars in Government Spending and Growing Debt

Democrats with vote-getting glee and Republicans more out of fear of seeming to be flint-hearted in an election year decided to open the floodgates of government spending with trillions of dollars of borrowed money. Many in the media and among the pundits discovered the supposedly “Modern Monetary Theory” (MMT), which soothingly assured that government neither had to tax to have money to spend nor worry about building up more debt from increased deficit spending. 

As long as there is production and employment slack in the economy it’s all “positive,” – jobs and output at no meaningful cost to anything or anyone in society. If “scarcity” were to return and prices in general were to start to rise, then taxes could be used to sop up the “excess” spending causing the price inflation – and especially on “the rich” to help equalize income and wealth in the process. More employment, income, and output are just a few turns away of the handle of the monetary printing press (or its mouse click computer equivalent). 

In those “normal,” faraway days of January 2020, the Congressional Budget Office projected that the federal government would run a budget deficit of “merely” $1.1 trillion dollars in its fiscal year that ends on September 30, 2020. But in its early September update, the CBO says that Uncle Sam’s current fiscal year will end with a budget deficit of around $3.3. trillion, or three times as large as originally anticipated. 

The U.S. national debt is now over $26.7 trillion, with the CBO projecting that the federal government’s gross debt will be over $37.4 trillion by 2030. Between now and 2030, the CBO estimates that a total of more than $3.4 trillion will have been spent on the interest on that accumulated debt, which will be slightly more than all the tax revenue collected by the federal government in the fiscal year of 2018. Those interest payments will have to be funded out of taxes collected or even more borrowed money. 

Keynesian Illusion of Free Lunches with Unemployment

What needs to be understood is that there are no free lunches – even when there seems to be a significant amount of “idle resources” and unemployed labor. The old-fashioned Keynesians and their Modern Monetary Theory descendants insist that if there are out-of-work people and output capacity not operating at “full employment,” there are little or no costs if the government borrows unused money sitting in the financial markets or if the central bank just creates more units of that money for the government to spend. Where is the “opportunity cost” of something being foregone, they ask, if the production and the labor put to work has not been at the expense of something that was already being done, instead? 

In “normal” times, the response to this traditional Keynesian and MMT argument is to point out that if there is widespread unemployment, rather than looking to some imaginary deficiency of “aggregate demand,” the focus should be on any supply-side price and wage rigidities that are preventing the return to a market-based full employment through appropriate changes in the structures of money wages and prices, and accompanying reallocations of labor and capital to reflect the reality of actual market supply and demand conditions across the economy. 

Wrong prices and wages prevent successful, ongoing coordination of consumption desires with production plans. All that the Keynesian and general macroeconomic focus on “aggregate” demand and supply, and output and employment “as a whole,” succeeds in doing is diverting understanding and attention from the microeconomic relationships and patterns upon which a functioning market economy is dependent. (See my article, “The Myth of Aggregate Demand and Supply”.)

Deficit Spending Misdirects Reemployment of Resources

In the current situation the less than full employment of labor and industry has been due to the direct commands of government at the state and federal levels. If production is halted and consumers are told not to shop and buy, clearly “demand” in general will decline, income earned and earnable also will be less due to reduced sales for final consumption goods, and coerced don’t-go-to-work, stay-at-home orders curtail the ability to have the salaries to pay household bills. 

Fully free the “supply-side” of the economy from the heavy hand of government restrictions and prohibitions, and the market will soon restore the needed employments to purchase what income-earners want to buy. This “market solution” to the unemployment situation also assures that productions and jobs restored will tend to reflect the actual consumer-based patterns of demand to bring “supplies” back into proper balance with those “demands.” (See my articles, “There will be No Recovery Without Production” and “How Lockdowns Shattered the Structure of Production”.)

Hidden beneath the Keynesian macroeconomic surface of “aggregate” demand and supply is, also, the fact that when government spends taxed or borrowed or “created” money, it is not simply demanding some amorphous “output.” It is spending those taxed, borrowed or created dollars on specific goods and services, that increases the relative demands and profitability of particular industries and employments. The government spending, in other words, generates a particular and specific pattern of demands and employments, which by necessity are dependent for their continuation on the government continuing to demand and spend period-after-period additional sums in particular ways. 

And further up the supply-chains, the industries and jobs generated that feed into the sectors of the economy upon which the government has increased this greater spending are equally dependent on its continuation if their productions and employments are to be sustainable. It is, therefore, not a matter of reaching some macro-measured “full employment,” and then dialing down the government spending. Once the government does so, demands, profits and employments created by how the government has been spending deficit-funded dollars will be threatened with cutbacks or collapse. 

It is not simply a matter of how much additional employment and output is “created” by government deficit spending. It is more important for what people have been reemployed and production has been set going again. Has full employment been restored by market-based demands, supplies and prices, or by an artificial pattern of demand and spending induced by government expenditures?

At a time when “sustainability” has become a catchword in issues of public policy, it can very reasonably be applied to the issue of sustainable employments and productions reflecting actual market demands and supplies versus patterns of demand and resource use heavily dependent on artificial and politically-driven spending patterns introduced by politicians and bureaucrats serving ends and purposes very different from real consumer choices. (See my article, “Macro-Aggregates Hides the Real Market Processes at Work”.)

Taxes Plus Borrowing Equals the Total Cost of Government

Besides the misdirection of reemployed workers and industries from government deficit spending that sets the stage for some needed future correction and rebalancing of the economy, does it matter if the government funds some portion of its spending through borrowing? The Nobel economist, Milton Friedman (1912-2006), argued that at the end of the day, the answer was, “No.” What matters is the total quantity of the society’s resources the government siphons off, regardless of whether it is done through taxes or deficits. Said Friedman: 

“Keep your eye on one thing and one thing only, how much government is spending, because that’s the true tax . . . If you’re not paying for it in the form of explicit taxes, you’re paying for it indirectly in the form of inflation or in the form of borrowing. The thing you should keep your eye on is what government spends, and the real problem is to hold down government spending as a fraction of your income, and if you do that, you can stop worrying about the debt.”

If the government taxes the citizenry, the dollars collected and the real resources those dollars have buying power over in the marketplace are transferred from private sector hands to the hands of Uncle Sam, who then decides what they will be used for. 

But this is no less the case when the government borrows dollars in financial markets to cover part of its expenses in excess of collected taxes. Instead of a private borrower borrowing those dollars and using the real resources those dollars can buy in the marketplace for investment, capital formation or other purposes, the government borrows them and uses the real resources that can be bought with them for its own politically-oriented goals and ends.

Either way, the total amount of the income and resources of the society transferred out of private hands and into the hands of the government is represented by the total spending by that government, even if part has been taxed and part has been borrowed.

Friedman once asked the question: Which is preferable, a situation under which the government taxes and spends $800 billion with a balanced budget; or a situation in which it taxes $400 billion and borrows $100 billion for a total of spending of $500 billion, with a budget deficit?

In terms of the total extraction of wealth and income from the members of society by government, clearly its siphoning off $500 billion is preferable to it taking and using $800 billion of the resources and products produced through the peaceful and productive efforts of the citizen-taxpayers, Friedman reasoned.

America’s Former Balanced Budget Rule and Its Benefits

However, while it may be true that whether the government taxes or borrows the taxpayer-citizens are poorer by that total amount, it is nonetheless the case that government following a balanced budget rule versus a budget deficit expedient has a huge political difference on the institutional ease or difficulty of government growing over time. 

Nobel Prize economist James M. Buchanan (1919-2013) and Richard Wagner pointed out in Democracy in Deficit (1977) that during the first 150 years of the United States, the Federal government followed what they referred to as an “unwritten fiscal constitution.” There is nothing in the U.S. Constitution that requires the government to annually balance its budget. Such a balanced budget “rule” for managing the government’s spending and taxing was considered a way to assure transparency and greater responsibility in the financial affairs of government.

It was argued that a balanced budget made it easier and clearer for the citizen and the taxpayer to compare the “costs” and “benefits” from government spending activities. Since each dollar spent by the government required a dollar collected in taxes to pay for whatever the government was doing, the citizen and taxpayer could make a more reasonable judgment whether they considered any government spending proposal to be “worth it” in terms of what had to be given up to gain the supposed “benefit” from it.

The trade-off was explicit and clear: any additional dollar of government spending on some program or activity required an additional dollar of taxes, and therefore, the “cost” of one dollar less in the taxpayer’s pocket to spend on some desired private-sector use, instead. Or if taxes were not to be increased to pay for a new or expanded government program, the supporter of this increased spending had to explain what other existing government program or activity would have to be reduced or eliminated to transfer the funds to pay for the new proposed spending. 

There was an exception to this balanced budget rule, and that was a “national emergency” such as a war, when government might need a large amount of extra funds more quickly than they could be raised through higher taxes. But it was also argued that once the national emergency had passed, the government was expected to manage its finances to run budget surpluses, taking in more than it spent each year. The surplus was to be used to pay off the accumulated debt as quickly as possible to relieve current and future taxpayers from an unnecessary and undesirable burden. 

Amazingly, in retrospect, this actually was the fiscal rule and pattern followed by the United States government throughout the 19th century and into the 20th century until the Great Depression in the 1930s. 

Keynesian Call for Budget Deficits to “Stimulate” the Economy

However, starting with the 1930s, this unwritten fiscal constitution was permanently overturned as part of the Keynesian Revolution. It was argued that the government should not balance its budget on a yearly basis. Instead, the government should balance its budget “over the business cycle.” Government should run budget deficits in “bad” years (recession or depression) and run budget surpluses in “good” years (periods of “full employment” and rising Gross Domestic Product). 

This new “rule” of a balanced budget over the business cycle became a generally accepted idea for fiscal policy among many economists and government policy makers. However, there has been one major problem with this alternative conception of the role and method of managing government spending and taxing: During the 75 years since the end of the Second World War in 1945, the U.S. government has run budget deficits in 63 of those years and had budget surpluses in only 12 years. 

In other words, as Buchanan and Wagner called it, we live in a seemingly perpetual “democracy in deficit.”

The Fiscal Illusion of Giving Voters “Something for Nothing”

With the elimination of the balanced budget “rule” as the guide for fiscal policy, it has been possible for politicians to create the economic illusion that it is possible to give voters “something for nothing” – a “free lunch.”

Politicians have been able to offer more and more government spending to special interest groups to obtain campaign contributions and votes in the attempt to be elected and reelected to political office. They can offer benefits in the present in the form of new or additional government spending, but they no longer have to  explain where all the money will come from to pay for it. The “costs” of that deficit spending are to be paid for by some unknown future taxpayers in some amount that can be put off discussing until that “some time” in the future.

Thus, politicians can supply benefits in the present – “now” – to targeted groups whose votes are wanted on Election Day, and avoid answering how the money will be paid back (with interest) because that can be delayed until the future – a period later in time, years ahead, when someone else will hold political office and will have to deal with the problem. 

It is not as if the danger from unrestrained government borrowing was never warned about before John Maynard Keynes (1883-1946) made deficit spending a “virtue” in the name of “stimulating” the economy in his famous book, The General Theory of Employment, Interest, and Money (1936). 

Long Ago Warnings about Government Deficits and Debt 

The famous Scottish philosopher, historian and economist, David Hume (1711-1776), for instance, expressed the danger in his essay, “Of Public Credit” (1741), almost 280 years ago:

“It is very tempting to a minister [in the government] to employ such an expediency, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamors against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker’s shop in London, than to empower a statesman to draw bills [borrow money], in this manner, upon posterity.”

And almost 150 years ago, the American economist, Dudley Baxter (1827-1875), very clearly contrasted the incentives at work on those running for and holding political office when the institutional rule is a balanced budget versus deficit spending and accumulated debt in his book, National Debts (1871): 

“When money is raised by taxation within the year for which it is needed, the amount that can be raised is limited by the tax-enduring habits of the people and must be as small as possible in order not to provide discontent [among the voters]. By the same reason it must be spent economically, and made to go as far as possible. 

“But when the money is raised by loans, it is limited only by the necessity of the interest [payment] not to be too large for the taxable endurance of the people, or provoking their discontent. Hence the limits of borrowing are about twenty times larger than the limits to taxation, and an amount that is monstrous as a tax, is (apparently) a very light burden as a loan. In consequence, borrowing is freed from the most powerful check that restrains taxation…

“When a loan is obtained the reason for economical expenditure is equally wanting, and borrowed money is commonly expended with much greater profuseness, and even wastefulness, than would be the case with taxes.”

Keynesian Economics has served as an additional and powerful rationale for politicians to do what they like to do: spend other people’s money. In the process, it pushed aside the warnings of those like David Hume and Dudley Baxter, and many other economists, who understood clearly the dangers of unrestricted government authority to both tax and borrow. 

The Moral Dimension of Government Debt Financing

There is an additional moral dimension to the issue of government deficit spending and its resulting accumulation of debt. This was a theme especially addressed by the aforementioned, James M. Buchanan. 

Normally, when a private individual or enterprise undertakes debt financing of some portion of his current expenditures, the legal obligation to pay back the contracted principle and interest falls upon the borrower. If he defaults or passes away before repayment of all that had been borrowed, creditors have a lien on the borrower’s positively valued assets. 

The “benefits” of having the use of a greater sum of money in the present than his own income would enable him to spend, imposing on the borrower a “cost” of an obligation to pay back the loan out of his future income and assets. The cost and the benefit are linked together within the same person. 

It is not the same, Buchanan argued, with government deficit spending and repayment of accumulated debt:

“If I borrow $1,000 personally, I create a future obligation against myself or my estate in the present value of $1,000. Regardless of my usage of the funds, I cannot, by the act of borrowing, impose an external cost on others. Unless I leave positively valued assets against which my debts can be satisfied, my creditors cannot oblige my heirs to pay off their claims. 

“By contrast, suppose I ‘vote for’ an issue of public debt in the amount of $1,000 per person. I may recognize that this debt embodies a future tax liability on some persons, but I need not reckon on the full $1,000 liability being assigned to me. If I leave no positively valued assets, the government’s creditors can still enforce claims on my progeny as members of the future-period taxpaying group. 

“Further, the membership in the taxpaying group itself shifts over time. New entrants, and not only those who descend directly from those of us who make a borrowing-spending decision, are obligated to meet debt, interest and amortization charges.

“In sum, the institution of public debt introduces a unique problem that is usually absent with private debt; persons who are decision makers in one period are allowed to impose possible financial losses on persons in future generations. It follows that the institution [government] is liable to abuse this and overextend its borrowing practices. There are moral and ethical problems with government deficit financing that simply are not present with the private counterpart.”

Giving to Peter Today at the Expense of Paul Tomorrow

Government debt is a way to impose part of the cost of what special interest group voters and politicians want “today” on those who “tomorrow” will have to be taxed to pay back the borrowed money. 

Even if a current recipient of such governmental deficit spending largess is, himself, one of the future taxpayers, he very well may have received a greater benefit than his personal portion of the future tax burden. Suppose that he is a farmer, for instance, who receives “today” $100,000 from the government for not growing a crop. When “tomorrow” comes and taxes have to be raised to pay back that $100,000 to the creditors who lent that sum to the government, that particular farmer’s additional tax burden will be a small fraction of that total amount he earlier received from the government. 

To continue with the same example, many farmers who may have benefited from agricultural price-support programs decades ago have passed away. The burden of paying back whatever portion of that farm price support spending that was originally financed by deficit spending now falls upon others who may not even have been born at the time the recipient received this special privilege from the government. 

What is the ethics, James Buchanan asked, of a fiscal system under which incentives exist and come into play that enable the current generation of taxpayers and recipients of government programs to shift part of the burden to pay for them to future generations? Is that a culturally and economically healthy legacy to leave to our children and grandchildren?

No one in this election year even dares to raise the issue of the government’s massive deficit spending or the resulting accumulating national debt. It is not “politic” to tell voters that there are no free lunches; that if the government’s finances are to be ever gotten under control future spending will have to be reduced or even cut, or that taxes may have to be raised; or that a return to the “unwritten fiscal constitution” about which Buchanan and Wagner spoke has to be the goal for a limited and transparent government consistent with the establishment of a free society. 

If not, history is filled with many examples of financial and economic disaster that has followed government fiscal recklessness. It can happen even here, in America. 

Richard M. Ebeling

Richard M. Ebeling

Richard M. Ebeling, an AIER Senior Fellow, is the BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel, in Charleston, South Carolina.

Ebeling lived on AIER’s campus from 2008 to 2009.

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