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Suppose that year after year, you spend more than you earn. You are worried that you’ve become fiscally irresponsible. Which of the following is not a path back to fiscal sanity for your household?
- Spend less.
- Earn more.
- Stop at the ATM more often so you’ll have more cash in your pocket.
Do we all understand why the answer is C? Good. Now let’s try another one.
Suppose that year after year, your government spends more than it collects in taxes. You are worried that it’s become fiscally irresponsible. Which of the following is not a path back to fiscal sanity for the government?
- Spend less.
- Collect more taxes.
The answer is not A. Spending less—at least spending less on things you don’t need—can certainly be a path back to fiscal sanity for a government just as it is for a household.
What about B—raising taxes? There seems to be this idea floating around that raising taxes is sort of like earning more income, and can therefore also be a path back to fiscal sanity. But that’s wrong. Raising taxes is not at all like earning more income; instead it’s very like visiting the ATM.
Here’s why: The government’s chief asset—in fact, pretty much its only asset—is its ability to tax people, now and in the future. The taxpayers are the government’s ATM. Make a withdrawal today, and there’s less available tomorrow.
Now the ability to tax is a pretty huge asset and the government has not (yet!) come close to depleting it. In that sense, there’s a lot of money in the bank. But no matter how much you’ve got in the bank, a policy of ever-increasing withdrawals is nothing at all like a decision to earn more income. (Besides, a lot of us have other uses in mind for that money.) It’s important to get the analogy right. And it’s clear from the op-ed pages that not everybody gets this.
There is this notion abroad that an extra billion in federal spending can be converted from “irresponsible” to “responsible” as long as it’s accompanied by an extra billion in tax hikes. That’s like saying a $500 haircut can be converted from “irresponsible” to “responsible” as long as you withdraw the $500 from your bank account.
So when the president appoints a commission on fiscal responsibility, as he did a couple of weeks ago, I find myself hoping that its members understand this simple point—and worrying that they don’t. Fiscal responsbility means spending less. Taxes have almost nothing to do with it.
Of course the problem with spending cuts is that there’s always someone opposed to them. The solution is to package a whole lot of cuts together so almost everyone has something to gain. Here, then, is an idea to get the commission started: Currently the Department of Agriculture steals from workers and business owners to give to farmers, the Department of Labor steals from farmers and business owners to give to workers, and the Department of Commerce steals from workers and farmers to give to business owners—with a lot of wealth falling through the cracks along the way. Eliminate all three departments and every American will lose one friend and two enemies. It’s the responsible thing to do.
Ah, Stephen, when you say: “and the Department of Commerce steals from business owners to give to workers and farmers” don’t you mean, “and the Department of Commerce steals from workers and farmers to give to business owners?”
Sorry…Steven
RL: Good catch. I’ve fixed this. Thanks.
If fiscal responsibility means spending less, then all Government spending is irresponsible.
Refering back to a previous discussion, ( http://www.thebigquestions.com/2010/02/24/so-hows-that-fiscal-stimulus-working-for-you/ ) in times of recession, it is at least possible that Government spending can be the same as “earn more”. If the mysterious multiplier is above 1, then Government spending increases the economic activity (over what it would have been without the spending).
This does not change the very interesting point that irresponsible spending becomes responsible just by raising taxes to pay for it. I must admit this was my position before thinking about it. It does call into question that the spending is irresponsible.
If we assume the economy is sized at 100. There is a recession, so it will fall to 50. Further assume that a fiscal stimulus will work – the Govt. spends 10, and the final size of the economy is now 80 instead of 50. This is presumably a good thing, but the Govt. needs to get the 10 from somewhere. So it borrows, and pays it back by raising taxes by 2 over the next 5 years. Is this tax rise responsible?
I suppose it can also be said that if you do plan to indulge in irresponsible spending, it is even more irresponsible not to stop by the cashpoint to pay for it.
“The taxpayers are the government’s ATM. Make a withdrawal today, and there’s less available tomorrow.”
That’s a great way to sum it up. I believe you used another word some time ago to make the same point: inheritance.
The reality is that when government commissions a project it is the capital used for such projects that cannot be inherited by the next generation.
Harold makes a good point. Fiscal responsibility involves both (1)choosing the appropriate level of government spending, and (2) given the choice of (1) choosing the appropriate level of taxes. The choice of (1) is both influenced by the productivity of public expenditures (ex. public goods,court systems etc.) and politics/first principles (ex. welfare). The choice of (2) then becomes one of minimizing the deadweight loss caused by taxes, which typically involves setting a marginal tax rate that is uniform across the years.
So, if people are comfortable with the level of spending, then raising taxes –let’s say 5%– can be “fiscally responsible” if it avoids a future rate of 10% that would later be necessary to support the desired level of gov’t.
thedifferentphil: So, if people are comfortable with the level of spending, then raising taxes –let’s say 5%– can be “fiscally responsible” if it avoids a future rate of 10% that would later be necessary to support the desired level of gov’t. Yes, this is why I said taxes have *almost* nothing to do with it. We do want to smooth tax rates over time to minimize deadweight losses—but that’s not, what I think, what most people have in mind when they talk about fiscal responsibility. The idea one sees on the editorial pages is that raising taxes is somehow analogous to earning income and therefore can convert irresponsible spending to responsible spending. That’s the idea I want to combat.
I believe that for most government services, we should move to a system of user fees. As the Postal Service is self-funding, I argue that the the FAA, the National Parks Service, the Highway Administration should all be self funding. The FAA would fund based on airport landing fees, the NPS based on admission fees, the Highway Administration using gasoline taxes and/or registration taxes. If the NPS finds it can’t self-fund, well then, we probably have too many parks. I’m convinced that we can use the free market to fund many government services, and to set the appropriate level of those services to provide.
This also solves another problem: the implicit subsidies that some business, where their competitors do not. A great example is in freight. Trucks do not pay their share of the cost of the overall highway infrastructure, while railroads are basically 100% responsible for their infrastructure. If we require trucks to pay for their load on the highway system, railroads would become more competitive.
The problem with this system is that there are two huge components of federal spending that we have a hard time self-funding: defense and entitlements. We could certainly improve on how entitlements are funded, but I doubt we’ll ever get to a point where we can take in enough to cover the expense. The problem is that too many people get too much money from the federal government, they don’t want to give that money up, and they vote. I know the solution is to reduce what we pay in entitlements, and to increase what we take in to cover the expense, but who in Congress is going to vote for that?
Most people have no idea what fiscal responsibility means in their own lives, much less a 2.1T budget for a nation with 300M people.
How can we get the ignorance out of politics? That’s what I want to know. A high tax socialist government works, as well as a low tax free market one works. We have the worst of all types, a low tax high spending government. When are people going to learn that if you want services, you have to pay for them?
“The government’s chief asset—in fact, pretty much its only asset—is its ability to tax people”: the “pretty much” part is wrong, as a simple matter of accounting, in the case of many governments.
Many governments own a *lot* of capital, mostly in the form of land (with attendant exploitation rights, e.g. for logging, mining, grazing, …), buildings (including, esp. in Europe, many incredibly precious treasures from both historical and architectural viewpoints), works of art in government-owned museums, “intellectual property” such as patents and copyrights, etc.
E.g, for the US Federal Gov’t, cfr http://www.nationalatlas.gov/printable/fedlands.html : “The Federal Government owns nearly 650 million acres of land – almost 30 percent of the land area of the United States”; in Italy, an estimate of the value of government assets (less land, but huge lots of incredibly precious buildings and art) is that it roughly balances its liabilities (debt held by the public).
It’s quite debatable whether governments do a good job of *monetizing* all this enormous amount of capital, and even whether it’s politically feasible to monetize it well — the Italian government famously ran into political headwinds back when it proposed a plan to sell or lease art treasures and buildings to reduce the debt, the “small government except where it suits me” crowd of allegedly-rugged Westerners get up in arms at any hint that the government might start pricing-to-market their many licenses for logging, grazing and mineral exploitation, many existing laws (politically hard to change) can be held to block other monetization attempts (e.g actually enforcing patents for government owned IP and shaking down companies using that IP), etc.
But the political difficulties in monetizing capital do not mean that said capital does not exist, any more than the political difficulties in cutting expenditures mean that such cuts can’t exist;-). It could be argued that, by foregoing accurate monetization of most capital, the government is exploiting that capital strategically — much like, say, Google has many non-monetized initiatives simply to try and increase people’s use of the Internet, “grow the pie”.
Each of Google and the government may be doing a good or a bad job at such strategic exploitation of non-directly-monetized assets — that’s for the stock market, and for voters, respectively, to decide, in the end. But whether (e.g.) the govt’s giving grazing rights out super-cheaply, or Goog’s offering super-fast free DNS service, say, are or aren’t effective ways to grow the economy in general, or Internet use in particular, i.e., effective long-term monetization strategies for those assets, no accountant in their right mind would ever accept the bare statement that those assets *don’t exist at all*!-)
Alex Martelli: But the point remains: The (potentially taxable) wealth of the citizens is one of the government’s assets, and taxation depletes that asset. This is so quite independent of what other assets the government might happen to own.
I can increase my income (say by working more) without depleting any of my assets. Government cannot increase its tax revenue without depleting one of its assets. That’s the key failure of the analogy that is so often drawn between fiscal responsibility in the household and fiscal responsibility by the government.
As an individual, if I get a $500 haircut by putting it on a credit card that I never intend to repay, that’s irresponsible. If I put it on the credit card and repay it back so that it’s full price (including interest) is $1000, that’s still responsible. I am taking responsibility for the cost of my preferences.
But it’s certainly more responsible of me to pay for my $500 haircut out of savings.
As an individual, as long as I pay for my preferences, I’m being responsible. But this is different from the government, who does not pay for its preferences out of its production. Rather it taxes the production of others in order to pay for it’s preferences. I think a better analogy of government irresponsibility would be this:
Is it responsible for me to increase my spending on a $500 haircut by withdrawing $500 from my neighbor’s bank account? Answer: NO.
Dullgeek – I like it. I would just say that the perverse incentives inherent in the system might make the answer YES.
eg: Given your neighbour just withdrew $500 from your bank account to pay for his haircut, is it responsible for you to increase your spending by $500 to feed your family by withdrawing $500 from HIS bank account?
I would argue that it would be irresponsible not to do that (as much as I abhor the idea)
As per usual, I’m about a day behind Harold. Kind of lost in the discussion about $500 haircuts (wasn’t there a candidate who got one on the tarmac of LAX and tied up all air traffic for a half hour while he did? Edwards?) and farm subsidies is the leap of faith that “fiscal responsibility means spending less.” Not necessarily.
As Harold points out, at certain times such as a recession like this one where the interest rate is near the 0 bound and the multiplier is greater than one, it’s fiscally irresponsible for the government not to spend money in ways that will both stimulate demand and/or invest in the future.
http://www.princeton.edu/economics/seminar-schedule-by-prog/macro-s09/monetary-fiscal-policy-co/schedule/pdfs/multiplier-version9.pdf
If the mismatch of government spending and taxes has nothing to do with fiscal responsibility or irresponsibility, why do so many states have balanced budget requirements?
DividedLine: I agree that fiscal responsibility can, in principle, require spending either more or less. The key point, though, is that any given expenditure either is or is not responsible, and raising taxes can’t move an expenditure from one category to the other.
Instead of (or, perhaps, as well as) eliminating those departments which largely just move money around, why not just slash military spending? The US military takes over a million potentially productive people and employs them to destroy wealth (both their own and that of other countries).
Okay, I’ve thought about this, and I think the argument is wrong. Taxing power is not like money in the bank–i.e., if I don’t take it out today, it is there for me tomorrow. Taxes are on economic activity–if I fail to tax economic activity today, I miss that chance and reduce the total amount of tax I can collect overall.
The total tax that can be collected is the discounted value of the maximum possible tax rate (say the revenue maximizing rate) times the flow of economic activity in each period. If, for example, I set the current tax rate equal to zero today, I lose that tax revenue forever–the present value of future taxes doesn’t change, so the total falls.
I think that raising taxes today is somewhat more responsible than adding to the debt, because it forces people to pay for things that they want *now*, which makes them think harder about whether they really want them. (I’m hand-waving over how the tax system makes some people pay for things that benefit other people, but that’s entirely separate from the “pay now” vs. “pay later” issue.)
You said that a $500 haircut doesn’t become “responsible” just because you pay for it out of your bank account. No, but it’s slightly *more* responsible than paying for it with a credit card.
Yes, logically speaking, if you put a purchase on your credit card, you’ll have to pay for that purchase eventually, so you should weigh the costs and benefits the same as for a cash purchase. But we know that many people *do* make more irresponsible purchases with credit cards than with their checking accounts.
And that’s not even taking into account that buy-now-pay-later enables some people to get out of paying entirely, if they die before the later taxes are assessed, or if they earn all their income now and them stop earning and start living off their savings before the future tax hikes come. That’s like putting a $500 haircut on a credit card that *might* come due while you’re still working, but once you retire, has to be paid by someone else.
Of course you’re right that the important thing is to stop getting $500 haircuts in the first place.
Neil:
I lose that tax revenue forever–the present value of future taxes doesn’t change, so the total falls.
Anything you fail to tax is either saved or spent. If it’s saved, then it’s not lost because it’s still there to tax tomorrow. If it’s spent, then it’s not lost because people got something they valued for it—and the goal, here, of course, is to provide people with things they value.
In the same way, if you don’t get that $500 haircut, then the $500 either stays in the bank or is available to spend on, say, home repairs. Either way, pulling the $500 out of the bank to finance the haircut can’t make the haircut more responsible.
Isn’t part of the reason there is so much “left in the ATM” that taxes have been too low in the past? The taxes haven’t been collected in the past – which is why spending has been greater than tax revenue – so it IS there to collect now.
If a government spending more than it claims in taxes is what it means to be fiscally irresponsible, then either decreasing spending or increasing taxes will be more fiscally responsible. If the relative sizes of spending and taxes are not what makes a government fiscally responsible, then the whole basis of the analogy at the start of the blog post falls apart.