By Frank Shostak*

Keynesian economists say that during an economic slump, the government must run large budget deficits in order to keep the economy going. In contrast, Austrian economists maintain that increased budget deficits are usually monetized, leading to general price increases. Therefore, from this perspective, the government should avoid increasing budget deficits and instead balance the budget.

Government Spending Takes Resources from Wealth Generators

Governments do not generate wealth, as government spending uses resources that must be taken from people who generate wealth. This, in turn, undermines the wealth-generating process of the economy. This means that the effective level of tax is the size of the government.

For instance, if the government plans to spend $3 trillion and collects $2 trillion in taxes, there will be a shortfall, or deficit, of $1 trillion. The government will attempt to obtain resources from wealth generators to support its activities. Hence, what matters here is that government outlays are $3 trillion and not that the deficit is $1 trillion.

For instance, if the government lifts taxes to $3 trillion, resulting in a balanced budget, would this alter the fact that it still takes $3 trillion of resources from wealth generators? We hold that government outlays set into motion a diversion of wealth from wealth-generating activities to non-wealth-generating activities, leading to economic impoverishment. Therefore, government outlays ostensibly to boost economic activity actually should be regarded as bad news for the economy.

Government Taxes Stifle Market Processes

Wealth producers exchange their products with each other, a voluntary activity. The key point is that trade must be free and reflect the individual’s priorities. Government taxes, however, are coercive, forcing producers to part with their wealth in exchange for unwanted services. This implies that producers are forced to exchange more for less, reducing their well-being.

The more non-market-related projects the government undertakes, the more real wealth is transferred from wealth producers. We can conclude that the amount of taxes taken from the wealth-generating private sector is directly determined by the expanse of government activities.

As a wealth consumer, the government cannot contribute to the pool of real savings. Moreover, if government activities could produce wealth, then they would have been self-funded and would not have required any support from other wealth generators. Therefore, the issue of taxes would never arise.

None of this is altered by introducing money into the economy. In the money economy, the government will tax wealth generators and pay out the take to people employed directly or indirectly by the government. This money gives government employees and contractors access to the pool of real savings. Government-employed individuals are now able to exchange the tax money for consumer goods.

The Meaning of a Budget Surplus in a Money Economy

What then is the meaning of a budget surplus in a money economy? It means that the inflow of money to the government exceeds its expenditure of money. The budget surplus here is just a monetary surplus. The emergence of a surplus produces the same effect as any tight monetary policy. On this Ludwig von Mises wrote:

Now, restriction of government expenditure may certainly be 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 considerable 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 contracyclical 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.

Lower government outlays imply that wealth generators will now have a larger portion of the pool of real savings at their disposal. If, however, government outlays continue to increase, no effective tax reduction is possible; on the contrary, the share of the pool of real savings at the disposal of wealth producers will diminish.

Critics of smaller governments hold that the private sector cannot be trusted to build up and enhance the nation’s infrastructure. However, can individuals afford the improvement of the infrastructure?

The referee should be the free market where individuals, by buying or abstaining from buying, decide what infrastructure will emerge. If the pool of savings cannot afford better infrastructure, then time is needed to accumulate savings to build a better infrastructure. Increased government outlays cannot raise the pool of savings, and increased government spending will only reduce it.

Government Can Force Non-market-chosen Projects but Cannot Make Them Viable

The government can force the creation of non-market-chosen projects, but it cannot make them viable. Over time, these projects will impose burdens on the economy that undermine individual well-being and will make these projects even more costly.

Will lowering taxes on businesses boost capital investment and strengthen the process of wealth formation? If lowering taxes is not matched by a reduction in government spending, this will encourage a misallocation of savings. The emerging budget deficit will be funded either by borrowing money or by creating new money. Obviously, this diverts real wealth from wealth-generating activities to non-wealth-generating activities. Various capital projects that emerge on the backs of such government policies are likely to be the equivalent of useless pyramids.

Why Government Cannot Be a Genuine Borrower

One way the government secures necessary funds for nonmarket infrastructure is through borrowing. However, a borrower must be a wealth generator to be able to repay the principal loan plus interest.

That is not the case as far as the government is concerned. It is not a wealth generator. So, how then can the government as a borrower ever repay its debt? The way it can do this is by borrowing again from the same lender—the wealth-generating private sector. It amounts to a process whereby the government borrows from you to repay you.

Conclusion

The government does not generate wealth, and the more it spends, the more resources it must take from wealth generators. This, in turn, undermines the wealth-generating process of the economy, meaning that the effective level of tax is the size of the government.

Government outlays divert wealth from wealth-generating activities to non-wealth-generating activities, leading to economic impoverishment. Thus, an increase in government outlays to boost economic activity should be regarded as bad news for wealth generation and to the economy.

About the author: Frank Shostak‘s consulting firm, Applied Austrian School Economics, provides in-depth assessments of financial markets and global economies. Contact: email.

Source: This article was published by the MISES Institute