There is a particular point that I have been hammering home in the last few months. It is that total government spending is what ultimately matters the most, whereas tax rates or total taxes are not nearly as significant. This is especially important to know right now, with all of the talk about the so-called fiscal cliff.
The fiscal cliff is a combination of increasing tax rates and “forced” spending cuts. While the cuts are almost insignificant, I think any cuts in government spending are a positive thing. But most of the focus on the fiscal cliff right now is on the tax rates.
The federal government is spending over 3 and a half trillion dollars per year right now. Regardless of where this money is coming from, it is being spent. While it is not all a complete waste of resources, it is a big misallocation of resources. The government is spending your money on things that you probably wouldn’t have chosen if you had been able to keep the money you earned.
There are three main ways that the government can get money. It can get it through taxes, borrowing, or inflation. I do not count “revenues” from things like the Post Office, because the revenues aren’t even enough to cover the expenses. And even if they were, it is only because the government is using the threat of force to keep away competition. There is also the possibility of the government selling land or buildings or other assets, but this is not common and will be disregarded for this discussion.
If the government is getting most or all of its money from taxes, borrowing, and inflation, then that capital is being drawn away from someone else. It means that some individual or business cannot use that money. It doesn’t really matter how it is obtained. In one way or another, it is money (which represents resources) that is being drawn in to the government and spent. We pay for it in some way or another.
We frequently hear that running up the national debt will burden our grandchildren and future generations. But it is really burdening us now. We are paying for it now. Future generations are only paying for it in the sense that there is less savings, less capital investment, and less advances in technology than would have otherwise occurred.
Even if a private investor is buying a government bond, he is still handing resources over to the government. I suppose the only case where the total spending scenario does not hold completely true is when a foreign central government (like China) buys government debt. The Chinese government is subsidizing the U.S. in a sense.
I know everyone wants to focus on the taxes, because that is what you see on your paycheck. While it might matter in the very short term, it really doesn’t matter much ultimately. Perhaps it will matter a little in how wealth is distributed, but it means very little to the overall health of the U.S. economy.
The government could cut all taxes to zero and keep spending what it spends now. Do you not think that you would pay for this? If it had to resort to inflation to spend over 3 and a half trillion dollars per year, you would see massive price increases in a short period of time, with most wages lagging far behind. So your bigger paycheck wouldn’t really get you any more.
This is why the focus must be on total government spending. If you are going to waste time writing to your congressman, at least focus on the right thing. Don’t tell him to keep taxes low. Tell him to dramatically cut spending. That is really what ultimately matters. If spending is cut enough, then taxes can eventually follow. Just cutting spending enough to stop the Fed from monetizing any government debt would be a big accomplishment at this point. At least we wouldn’t be paying the hidden tax of inflation.
This whole issue of total government spending vs. total taxes is what has allowed the Republican politicians to get away with having a label as the party of smaller government. It is easy for them to advocate lower taxes. But lower taxes don’t matter if they keep increasing spending. We are paying for it one way or another.
We are not burdening future generations like we think. We are burdening ourselves now. We are not going to see a really strong economy again until government loosens its grip. That means that government spending must be cut drastically. Until that happens, it doesn’t matter much in the long term what the tax rates are.