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Source link: http://archive.mises.org/13318/delong-on-deficits/

DeLong on Deficits

July 19, 2010 by

From the standpoint of the actual welfare of the people, it makes a huge difference whether the government spends an additional $100 billion, or taxpayers get to retain $100 billion more of their money. FULL ARTICLE by Robert Murphy


Nick Bradley July 19, 2010 at 9:26 am

Good Read; I have a question though:

From the Austrian perspective, are deficits EVER justified? In my mind, they are as long as they’re used to get rid of a tax. For example, the tax foundation found that the compliance and opportunity cost of the corporate income tax is over 2/3rds of the revenue it generates…$100B+ in costs in 2002, with $150B in revenue; In other words, the Federal Government destroyed $100B to receive $150B. Now assuming that the Federal Government issued 30-year notes at 6% (its at 4% now), that would cost the USG $9B in interest while the economy saved $100B. That type of defecit financing would pay itself off very quickly. The personal income tax has about a 20% cost.

So, wouldn’t it be beneficial to eliminate entire tax systems and run massive deficits (as long as we can borrow it)…and perhaps service the debt with a small retail sales tax? Imagine eliminating both personal and corporate income taxes ($.15T in 2007), saving $500B in compliance/opportunity cost, and half-servicing the debt with a 10% sales tax (10% tax on $10T in goods and services).


JJ July 19, 2010 at 9:42 am

In general, it’s better to run deficits than tax because of the supply-side effect; taxes destroy incentives to produce, while the inflationary effect from deficits applies to wealth, so the incentives to produce are still largely intact.

Also, if you starve the beast, it’s easier to cut spending later to shrink the gap between taxes and spending. Alright, maybe it’s not so easy – it requires politicians to favor spending cuts, and they seemingly never do. But if you fill the gap with taxes, now you have to cut both spending and taxes to get back to square 1. Not gonna happen.

Nick Bradley July 19, 2010 at 11:15 am

Thanks JJ; If that’s the case, then wouldn’t the most efficient policy to fund government operations then be to ELIMINATE ALL Federal Taxes, borrow the entire cost of governing, and implement a broad-based sales tax to service the debt?

With the exception of government borrowing pushing rates up for the private sector, the market would be immune from tax-based interventionism.

So if the Federal Government borrowed $2 Trillion a year and raised an additional $1T from a 10% sales tax, the debt to GDP ratio would go down over time.

J. Murray July 19, 2010 at 1:37 pm

Not necessarily. A deficit today is a tax tomorrow amplified. And on a philosophical angle, deficits are indefensible as they are the ultimate in taxation without representation. A deficit is us, today, spending on the behalf of someone tomorrow without their input on the spending.

A Constitutional amendment I have supported states that no outstanding debt, either in terms of treasury or unfunded liabilities, may persist beyond the current Congressional assembly. Basically, all debt must be paid off, in full, and all future liabilities be fully funded prior to the new Congress taking office. That way, any liabilities we, today, chose to engage in are to be funded, 100%, by those of us who made the decision.

Dave Albin July 20, 2010 at 12:04 am

You have to be careful with this, however – the politicians are all too happy to tax anything that twitches, so they could simply tax their way to balanced budgets. The problems come with politicans who can’t say no to anyone who voted for them, the ability to “make” as much money as you want, and the wonderful legalized theft known as taxes.

Nick Bradley July 20, 2010 at 10:24 am

A deficit does not have to be a future tax amplified. Look at my example: if the corporate income tax destroys $100B to raise $150B, replacing that revenue with debt is a wise move indeed. And if the increased output/productivity from the tax cut exceeds the INFLATION-ADJUSTED cost of the interest and the depreciated principle, it is a net benefit.

Debt is bad when it is used to fund wars and other spending projects. The inflation-adjusted yield on the 10-year is about 0.7% annually, with the principle depreciating at the rate of inflation (let’s say 2.3% a year) — after 10 years the principle has depreciated 20%.

The future taxpayer takes on no additional burden in future years.

If you want to pass a constitutional amendment to control debt, why don’t you force the loans to be amortized? So instead of making interest-only payments like we do now, we would have to make amortized principle payments, like any other loan. So with a fully amortized loan at around 3%, the borrower would make a payment equivelant to 1% of the principle every month for 10 years.

brian July 19, 2010 at 9:33 am

bob, you’re great, but it annoys me when you refer to delong as an economist rather than an “economist”.

dogster July 19, 2010 at 10:11 am

Everybody knows that inflation is bad, but can’t seem to prove it.

If you know a bit about calculus, I have posted an equation, based on the standard quantity theory of money pQ = mV, which proves that Ponzi investment crowds out investment in the real economy. In other words, inflation causes real investment to decay as a product of inflation and time.

I have posted this at A proof that inflation destroys the real economy

If you see an error in this derivation, I would welcome your comment. No trolling, please. Thank you.

J. Murray July 19, 2010 at 1:58 pm

The problem is the “proof” is always demanded as a mathematical equation. When dealing with economics, we aren’t dealing with a predictable hard science. Man isn’t the same as a physics problem. We are unpredictable, we don’t operate on a unified set of rules, we are different. It must be approached in a different manner. If you (the philosophical you, not you you) can’t create a proof of what I’ll personally do next week on Thursday at 1645, then you can’t create a proof of what an economy will do.

Question – How does a human react when he sees prices increasing and expects prices to increase again next year?

Answer – He buys makes more of that product.

While using math can “prove” that more money = more income, it fails to consider human behavior and value judgements. The first fallacy of the mathematical approach is that money is confused as what is valuable. This is why we are living under a system that assumes printing money somehow generates additional wealth.

However, wealth is a purely subjective concept. Nothing is truly worth the monetary unit attached to it. Those who sell products value the currency more highly becuase it can be used to exchange for other products on the market. Those who buy products value the product more than the currency they gave up for it, which means they valued that product more than others on the market, including possible future products that are currently not available (saving). In essence, both buyer and seller profit from the transaction as both are better off from having engaged in the trade (or else it would not have gone through), though it’s not quantified as such under our current system.

By using money as an indirect quantifier of “value”, and again, value isn’t a physical concept that we can quantify, we run into problems.

Inflation triggers price increases above and beyond where the product would otherwise be had the new currency not entered the market. I don’t have to explain in too much detail to you as I know you understand, but for the benefit of others reading this, the “inflation” reported by our government and real inflation are two separate things. Government inflation smashes together market preferences (price increases/decreases) along with the expansion of the money supply (the real inflation/deflation) and calls it inflation. This means that if someone figured out how to produce twice as many of a particular product for the same costs and sells it for half as much, the government would call it a deflation crisis and double the money supply to counteract this.

The problem arises when those prices change in ways differing from the market preference. Money and credit creation can make a market preference for additional production of a paricular product (a small price increase due to demand) appear to be a large shortage. On the other hand, market preference for fewer of a product (a price decline to to reduced demand or increased supply) can manifest itself as a price increase due to inflation. Under both situations, the system produces false signals to producers. It creates the illusion that more production is necessary to satisfy a false increase in demand or satisfy a false decrease in supply. In reality, people have less preference than that and it leads to malinvestments.

The same happens to loan interest rates. New money entering the system keeps interest rates low, thus creating the illusion that people are saving for future use. When the loans become due, there was no savings, and business goes bust.

The problem is that none of the above can be distilled down into a mathematical proof. Math is a language used to describe the operation of our world. However, using math as a language requires a fundamental, unchangable, underlying truth before it can function. Using math to explain and prove things like the impact of inflation, value judgements, etc, are impossible as none of them have an underlying truth to start from. An economy constantly changes. What may have been true yesterday is no longer true today, and what is true today is no longer true tomorrow. If you do create a proof, that proof is only good for the immediate moment in time that you created it for, making it useless for anything but proving a fine point in the past.

Ultimately what I’m trying to say is that math has no place in economics, a purely social science. It’s simply the wrong tool for the job and it’s the attempt to use math in this system, where we can create a formula to prove anything due to the lack of an underlying natural law, that created our mess today and the wrong-headed attempts to fix it.

BioTube July 19, 2010 at 7:26 pm

You probably could shoehorn math into economics without breaking anything(there’s a “correlated to” symbol out there somewhere), but all you’d end up with is the same thing with arcane symbols which would only be useful if you’re short on space(and acronyms are probably better).

Del Lindley July 19, 2010 at 4:15 pm

One a broad level you need to realize that the equation of exchange is merely an accounting identity and as such it does not hold any time dependent information. So if you want to show that inflation destroys the real economy, you are going to have to choose a better starting point. May I suggest investigating the Austrian business cycle theory, and particularly as an application of the more general error cycle theory?

As far as your pedestrian mathematics are concerned a glaring error presents itself with your introduction of the loan interest rate “r.” By your definition of D there is no allowance for its introduction into the dL/L equation. With this correction the logic of your definitions lead to the invariance of the quantity DVP. I do not care to offer an economic interpretation of this result.

Alex July 19, 2010 at 1:50 pm

Each dollar of government spending is always matched by $1 of taxes in present value terms, regardless how the government spending is financed.

What Delong apparently believes is that it is possible to boost government spending without raising taxes, and that there is also an option of reducing taxes while holding government spending constant. These options do not exist. If the government raises spending by $100 it has raised the present value of future tax collections also by exactly $100. Similarly, if the government lowers current taxes by $100 while leaving government spending constant, the government merely substitutes future taxes for current taxes. But the present value of the future taxes is exactly equal to $100, so there is no tax reduction at all.

Even if Delong does not know this, American businesses and people do. One of the big negative impacts on business spending now is the tax bill that businesses know will be imposed in the future as the result of current deficit spending.

FatBeard July 19, 2010 at 7:31 pm

In the end, he offers little explanation of how letting politicians borrow an extra $100 billion to spend on anything at all could possibly make the whole country richer. Robert Murphy

Here is a principled approach that leads to a similar conclusion:
1) Fractional reserve lending cheats savers by suppressing interest rates.
2) Fractional reserve lending inflates asset prices for borrowers and leads to underwater homeowners during the bust.

So, right there we see the need for more money in the system, as just COMPENSATION for government backed FRL. The Keynesians resort to indirect methods to get money into the hands of borrowers which is why it seems preposterous. A more direct and just method would be to simply give every US adult an equal distribution of new legal tender fiat (United States Notes). This would:

a. enable underwater home owners to pay down their mortgages to market price levels.
b. compensate savers for years of artificially suppressed interest rates.
c. Fix the banks in nominal terms.
d. Fix state tax revenues.

Inflation risk? Maybe, but if banks were put out of the counterfeiting business via a 100% reserve requirement then the only source of new money into the system would be under government control, the Fed and US Treasury.

The long term solution is fundamental reform including liberty in money creation, usage and acceptance. But the just thing to do now is to bailout every every US adult since we are all victims of the government backed counterfeiting cartel. No dangerous deflation is needed.

André July 20, 2010 at 5:12 am

Deficits are debts – and someone has to repay them. The point is – WHO is going to settle the debt and HOW?

If I decide to finance some serious private enterprise I imagine they are going to repay their debt with their profits. Sure, in the meantime they might just be able to refinance themselves making more debts – but no purely private subject can behave like this on the long run. So, my bet is that they are good in what they are doing and they are going to return what I gave them, plus a reasonable interest. In other words, I am betting they are going to satisfy more customers. These are my expectations with private debts.

With government debt is quite different. If I buy some treasury bond, I am merely betting they are going to be able to refinance themselves to repay at least my miserable contribute – since I know they are already sinking in debts. States don’t make profits – by definition. So their resources must come from somewhere else. If it’s taxes – it’s me the one who’s going to be squeezed to repay that damn treasury bond I bought. If it’s more deficit – my kids are going to be squeezed to repay the same damn treasury bond. if it’s the printing press – me and my kids are going to be squeezed thanks to the progressive devaluation of our future savings.

Am I missing something here? Why anyone should support government spending at all?

FatBeard July 20, 2010 at 8:01 am

Deficits are debts – and someone has to repay them. The point is – WHO is going to settle the debt and HOW? André

The banks create money-from-nothing via fractional reserve lending thereby driving people into unserviceable debt and cheating savers of honest interest rates. Let the debt be paid (and savers compensated) therefore with new legal tender fiat created from nothing by the US Treasury and given equally to every US adult. Fair is fair.

Jerryhorse July 20, 2010 at 2:17 pm

We all know that the difference between borrowing and taxing is the difference between freedom and slavery. Borrowing is a voluntary matter, whereas taxing is one of compulsion and coercion. Borrowing requires an agreement between the borrower and the lender. Taxation is always a matter of force by a bully. It matters not what words one chooses to describe the act of taxation. What it means is to force one to give up that which he has earned by his own labors to one who holds power over him. Often the individual believes that the state will protect, defend and aid him in his pursuit of happiness. If one believes that the state is benevolent, then they will agree to pay taxes to the government because they believe that they are ultimately benefiting from this payment. Thus, behold the Nanny State.

The American Government’s taxing authority (IRS) describes our income tax system as a voluntary system of taxation. Unfortunately, that is simply a lie. Taxation is always a forced taking by either a threat of force or the actual use of force. If one wants to donate money to another party, then that is a gift and not a tax payment. If one wants to give something to someone with the expectation of getting something back at a future date, that giving is a loan.

Once we accept the power of the state to tax, then we are accepting that an entity in whatever form it may take, i.e. democratic, republican, totalitarian, should be allowed to hold power over us. As young childern, our parents hold this power in its natural state. But at some state of maturity, the child gains enough intellectual and physical ability to fend for him/herself and challenges this authority.

Human beings are herd animals and like all other herd animals have leaders and mostly have followers. In an evolutionary sense, human beings have the maturity of teenagers. We fight and bicker with our parents (the state) over who should be in control. How much of our freedom should be controled by the state, how much by our selves. Being human, we are not omniscient and know not the answer. We have deep intellectual discussions as to which method of governence is better, which economic theory is more accurate. We can be swayed by one argument and then another one comes along whcih describes the world better than the last one.

Unfortunately, human history does not give us many examples of human societies where there are no leaders or no government. However, Murray Rothbard’s 4 volume set “Conceived in Liberty” is a detailed examination of how the state, starting with the Crown and then the Proprietors and the Church continued to hold power over the People, using the structure and order created in the Middle Ages, feudal, then mercantile, which gave way somewhat in the days of enlightenment to allow the Quakers in PA to live a very free life for perhaps a decade or so in the later part of the 17th Century. Rothbard shows how the Quakers thrived peacefully with the native indians while living under the attempts of control by the Crown and to a lesser extent, the Proprietor, Wm. Penn. Without giving in to the attempts to tax the Quakers by the Crown and Penn and even their fellow colonists in NY, NJ and MA claiming a need to raise a militia to fight the Indians, to fight the French, the Quakers grew strong and powerful based on their own individual integrity and freedom of religious thought. Rothbard describes how they not only survived but flourished in a state of anarchy-refusing not only to obey the Crown or their proprietor when it came to rasing a militia or being taxed, but they even refused to form their own government. Now this anarchistic life was not without its difficulties, but it was free from governmental interference from above (the Crown, the proprietor) and from within, for perhaps a decade of so. Slowly, the maturing process creates mold and rot. Adult evils of corruption, selfishness, and the like helped to breakdown the noble intentions of the early Quakers along with the opening of the land to those without the same moral equivalents, so that the power of the Crown and the proprietor and other colonial oligarchs were able to impose government on the Quakers and eventually vote them out of power.

Today, we face these esoteric and somewhat heavy and complex intellectual battles between Keynesian Economics and Austrian Economic Theory with each party having their own views, neither side necessarily winning or losing the argument.
However, these academic arguments on economic theory are important because there is a very basic political difference underlying them. The former is the tool of statism and its arguments are used to sustain the concept that human beings are capable of controlling an economy by manipulation of money suppy, fiscal appropriations and the like, and the other basis its arguments that man is not omniscient and that society itself will flourish with each individual making his/her own value judgments. The former accepts taxation as a tool to sustain a certain order that has existed throughout virtually all of known history. The later, the Libertarian view proclaims the wonders of the invisible hand guiding the free market.

Rothbard most eloquently explains in the preface to each of his 4 volumes of “Concieved in Liberty” that his “…own basic perspective on the hisotry of man, and a fortori on the history of the United States, is to place central importance on the great conflict which is eternally waged between Liberty and Power, a conflict, which by the way was seen with crystal clarity by the American revolutionaries of the eighteenth century. I see the liberty of the individual not only as a great moral good in itself (or, with Lord Acton, as the highest political good), but aslo as the necessary condition for the flowering of all the other goods that mankind cheridshes…Out of Liberty, then, stem the glories of civilized life. But Liberty has always been threatened by the encroachments of power, power whcich seeks to suppress, control, cripple, tax and explit the fruits of liberty and production. Power, then, the enemy of liberty, is consequently the enemy of all the other goods and fruits of coivilization that mankind holds dear. And power is almost always centered in and focused on that central repository of power and violence: the state… I see history as centrally a race and conflict between ‘ social power’ – the productive consequences of voluntary interactions among men- and state power. In those eras of history when liberty-social power – has managed to race ahead of state power and control, the country and even mankind have flourished. In those eras when state power has managed to catch up with or surpass social power, mankind suffers and declines.”

Deficit spending and taxation are tools of the state to capture the freedom of the people. When we submit to the polish, the vaneer that the state uses to blind us, we lose our sense of liberty. We are drawn to the nanny, we remain mere children no matter how much we have progressed intellectually. We will forever squabble with the state to break free of the web of control that the state has woven around our freedom.

Greg August 18, 2010 at 11:29 am

I don’t get it. Money spent for roads, bridges, food stamps, medical care for poor people, elderly or disabled, section 8 housing, mine (or deep water well) inspectors, voting machines, police, firemen, meals on wheels, therapy for kids with autism, student loans, etc.,etc., is less wisely spent than money spent on 48oz sodas and triple cheeseburgers, iTunes, pokemon toys, car detailing, WWF tickets, cap snaffler, nutritional supplements (thanks to the free marketolators, mostly untested/unregulated), and much of whatever else the magical market(ing) induces people to buy through psychological/sociological manipulation (have you ever sat for about 1 hour watching home shopping network–that will disabuse you of some of your notions).

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