Cut Taxes, Even Without Spending Cuts

While the issue of tax reform has taken center stage lately, there is a minority out there who bring up the problem of federal government spending.  This minority does not include those on the left who are simply opposing Trump and the Republicans and complaining about tax cuts for the rich.

The issue of government spending is a major one that does not receive enough attention.  Politicians and the media can get away with ignoring the spending issue to a large degree simply because many American voters don’t care.  They may say that they care in a poll, but they still believe in a free lunch.  They say they don’t want deficits, but then they are not prepared to identify where the major cuts should be made.

In the debate over taxes, there are some (including libertarians) who say that taxes and spending are two separate issues.  When taxes are on the table, we should support tax cuts and/ or tax reform.  When spending is on the table, then we can support decreased spending.

The problem with this theory is that spending is pretty much never on the table.  Do you really think we are going to have as big of a debate about spending as what just happened with tax reform?  And even if there is a debate, we can be sure that it won’t entail major cuts to major programs.  If anything, the debate will be whether to increase the total budget by 2% or by 5%.

Taxes and spending do go together.  They are linked.  It isn’t quite the same thing as a family separating their expense budget from their income.  With the federal government, it has become common to change the tax code without changing spending (or the pace of accelerating spending).  Taxes can be cut, and if there is a reduction in tax collections to the government, the difference is made up with an increased deficit.  In other words, it just gets tacked onto the national debt.

There are some who will make a Laffer Curve argument.  They will say that we can cut taxes without it resulting in decreased tax collections.  This can be true in some cases if the tax rates are confiscatory enough, but most people have not been arguing that with the current tax reform.  If the latest tax cuts end up being “revenue neutral”, part of that will be because of a reduction in the deductions.

When taxes are cut without commensurate spending cuts, and the deficit increases as a result, then we are not really getting tax reduction.  Specific individuals may get a reduction at the expense of someone else, but as a whole, we are not getting tax reduction.

If the federal government is spending $4 trillion per year, and then it continues to spend $4 trillion per year after tax cuts, then the government is still consuming (misallocating) $4 trillion worth of capital.  These resources are coming from somewhere.  Therefore, we are not going to see a significant improvement in living standards due to tax cuts if the government is still spending a huge amount every year.

With that said, I think we should still support tax cuts.  As individuals, for those of us who understand some economics, at least we have a slightly better chance of protecting ourselves.  If you are allowed to keep additional money (nominally speaking) from a tax cut, then hopefully you will use it wisely and not spend it frivolously.

But even on a national level, I believe we would be better off to have the tax cuts.  To illustrate why, let me use an extreme example.

Let’s say we could just get rid of all federal taxes while keeping spending the same.  The government would have to use debt and inflation in order to fund its $4 trillion plus annual budget.  Of course, it would never do this, even in the short run, because it would illustrate the absurdity of the system.

However, if this did actually happen, and the government had to issue $4 trillion of new debt every year to fund its budget, then it would not last long.  There would not likely be enough private investors to buy the debt, and the Federal Reserve would have to buy massive quantities of U.S. Treasury bills.  In other words, the Fed would have to engage in massive monetary inflation.

Consumer price inflation would likely spike higher, and interest rates on the debt would go up quickly.  This would quickly put a limit on the Fed’s monetary inflation, unless it wanted to risk hyperinflation.

While the current deficit/ debt is unsustainable in the long run, it has not been great enough yet to bring down the system.  The central bankers and the politicians have been able to kick the can down the road.

If the government were adding $4 trillion per year to the national debt, while much of this was also being added to the Fed’s balance sheet, then the game would end quickly.  They would have to start taxing again, or they would have to drastically cut spending.  Likely, it would be a combination of both.

The reason the middle class is struggling so much right now is because of the burden of government.  It is both regulatory and spending.  The U.S. federal government alone is consuming $4 trillion in resources.  Sure, some of this goes directly back to people in the form of welfare, but it is still a misallocation.  If we want to significantly improve our living standards, government spending has to be cut dramatically.

Since most people don’t care that much, and since politicians definitely don’t care, the only thing that is going to bring about lower spending is an increase in interest rates, likely coupled with higher consumer price inflation.  This seems to be the only thing at this point that can put a hard limit on the government’s ability to issue new debt.

If popular opinion can’t bring down federal spending, then the laws of economics will have to do it eventually.

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