June 15, 2020 Reading Time: 5 minutes
markets, going down

Reality is not excessively simplified by dividing budget-deficit ‘doves’ into two distinct flocks. The first flock believes that deficit spending is an effective means by which government arranges for the economy to put to use idle resources, including labor. Call this flock the “Keynesians.” This flock now includes also those very bizarre birds named “Modern Monetary Theorists.”

The second flock of deficit doves – and the subject of this essay – is quite unlike the first flock. This second flock is rightly free of illusions that deficit spending is needed to stimulate the economy. Members of this second flock are not Keynesians; they don’t believe that a well-functioning economy requires active government fiscal or monetary stimulus. Instead, this second flock’s embrace of deficit financing is driven by their understanding that taxes distort economic activity and, thus, slow economic growth. Call this flock the “anti-taxers.”

Anti-taxers’ understanding of the negative consequences of taxes is correct. It leads them to support deficit financing as a means of keeping taxes to a minimum (or, for some of this flock’s most extreme members, to eliminate taxes altogether). The reasoning of anti-taxer deficit doves is built in part on the recognition that creditors lend money to governments voluntarily. This recognition, too, is correct.

And so, anti-taxers ask rhetorically, why not fund government operations with money turned over to it voluntarily rather than with money extracted coercively and, hence, distortedly? To the extent that government funds its operations with voluntarily loaned funds rather than with coercively extracted taxes, people’s tax burden is lightened and economic distortions are fewer. Also enhanced is individual liberty. It’s a win-win.

Alas, beneath this argument’s superficial attractiveness looms two fallacies. Exposure of either of these fallacies suffices to destroy anti-taxers’ case for indifference to deficit financing.

Deficit Financing Does Not Reduce Tax Burdens Over Time

The first fatal fallacy looming in the anti-taxers’ case for deficit financing is the notion that such financing lightens citizens’ tax burden. It does not. Deficit financing does lighten the tax burden on citizens today, but it does so only by increasing the tax burden on citizens tomorrow. Because debts must be repaid, to incur debt today is to raise taxes tomorrow.

An analogy with a private person is useful. To say that citizens avoid an increase in taxes whenever a government program is paid for with borrowed money rather than with taxes today makes no more sense than to say that you avoid an increased obligation to pay if you buy a car with borrowed money rather than with your income today. Clearly, when you buy a car with borrowed money you incur an increased obligation to pay. The fact that you’ve delayed the timing of your payment does not mean that you don’t pay for your car. The fact that you are not paying for your car today does not mean that your car is paid for, not by you, but by the bank from which you got a car loan. You pay for your car out of your income tomorrow.

Anti-taxer deficit doves respond by arguing that, unlike private debt that eventually must be retired with repayment, government debt never has to be retired. According to anti-taxers, government can merely borrow again to repay each debt as it comes due. And so (the argument proceeds) government programs paid for yesterday with voluntarily loaned funds are not paid for today by taxpayers; these programs are paid for today with today’s voluntarily loaned funds.

Of course government can, and often does, roll over its debt – that is, government can and often does repay debt coming due today with funds newly borrowed. But government debt can be rolled over because creditors correctly understand that government has the power to tax. Just as a bank gives you a car loan because it understands that you have the power to earn income and, thus, the ability to repay your debt, creditors buy government bonds only because they understand that government has the power to tax and, thus, the ability to repay its debts.

The need for government to repay its debts is masked in practice by the fact that governments often do roll over their debts. And because a typical government’s lifespan is much longer than that of a human being, government can roll over debt for a longer time than can a person. But to see why governments’ rolling over of debt requires an underlying power to tax, ask yourself this question: If government suddenly were to lose the power to tax (including to tax by creating money), would you lend money to government? If you’re an anti-taxer deficit dove you’re likely tempted to answer “yes,” and then explain that government can continue to borrow indefinitely.

But are you confident that, without the power to tax, other creditors will continue to lend to government? And will you lend to government if you aren’t confident that others will lend in the future? As soon as creditors come generally to realize that government has no ‘earning’ power itself – that is, that government has no power to tax – creditors become no more willing to lend to government than they are willing to lend to a penitentiary inmate serving a life sentence with no chance of parole. Assurances that the prisoner can borrow on Monday to repay debt incurred on Sunday, and then borrow again on Tuesday to repay debt incurred on Monday, and so on indefinitely, will be wholly unconvincing. This prisoner is understood to have no underlying source of income. And a government without the power to tax has no underlying source of income. (A ‘government’ with a source of income but without the power to tax would be a private organization, such as a homeowners’ association.)

As we turn to the second fatal fallacy committed by anti-taxer deficit doves, remember that a government’s ability to borrow rests ultimately on its ability to tax.

Deficit Financing Encourages Government to Grow Excessively

The second fatal fallacy is anti-taxer deficit doves’ failure to recognize that the amount of government spending is not independent of the means used to finance that spending. Specifically, because the ability to borrow allows today’s citizens-taxpayers and politicians to pass the bill for today’s government programs on to future citizens-taxpayers, the cost to today’s citizens-taxpayers and politicians of expanding government’s budget is lower than it would be if government were unable to borrow. Ability to borrow, therefore, subsidizes expansions in government’s size. Further, because the funds spent are those of future citizens-taxpayers, there’s every reason to believe that today’s expenditures are even more wasteful than they would be otherwise.

And note this irony in the position of anti-taxer deficit doves, who almost to a man and woman oppose big government: If it were true that government, as we otherwise know it, could borrow without possessing the power to tax, the rate of growth in government’s size and command over resources would increase even faster than it does now. Politicians able to obtain from creditors, for all time without taxing, all the resources they desire would be even more unconstrained in sucking up scarce resources and using these to intrude the state into ever-more arenas of life. Citizens opposed to government overreach would encounter much greater difficulty resisting this expansion of state power.

Given the existence of an organization that can legally initiate the use of physical force, we should be grateful that that organization’s access to resources isn’t as free as anti-taxer deficit doves suppose it to be. And special, extra gratitude should be expressed by those of us who are most skeptical of the motives and abilities of government. More practically, we skeptics of government power should never stop warning of the dangers of deficit financing, for such financing lowers political decision-makers’ costs of expanding government’s size and scope.

Donald J. Boudreaux

Donald J. Boudreaux

Donald J. Boudreaux is a Associate Senior Research Fellow with the American Institute for Economic Research and affiliated with the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at George Mason University; a Mercatus Center Board Member; and a professor of economics and former economics-department chair at George Mason University. He is the author of the books The Essential Hayek, Globalization, Hypocrites and Half-Wits, and his articles appear in such publications as the Wall Street Journal, New York Times, US News & World Report as well as numerous scholarly journals. He writes a blog called Cafe Hayek and a regular column on economics for the Pittsburgh Tribune-Review. Boudreaux earned a PhD in economics from Auburn University and a law degree from the University of Virginia.

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