Smarts: Budget Deficits

So I’ve been working on other things again – most notably, a debate rebuttal speech for my macroeconomics class.  We were assigned the topic: “Should the Government balance its budget”, which plays heavily into the cost of goods in our country and our trade with other countries.   You’re probably like, “Oh ma gawww, this is a style blog?”, and while it’s true that I feature a lot of frivolous stuff, economics is sort of interesting.  It’s a knowledge that I think everyone could benefit from.  So here you go.  Think of it as a chance for you to educate yourself and impress some cutie at a cocktail party with your intense brainpower.  You’re welcome. �

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A balanced budget?  Not necessary.

The Federal government can aim for balance during times of great economic prosperity but in recessions should invest in the economy to lessen their impact. Those who say the budget needs to be balanced will press the idea that budget deficit hurts production – however in recessions, with production already down, running a deficit to invest in the economy means the real exchange rate rises, the value of a dollar rises and we’re able to buy more or better goods; our goods are more valuable, and our Net Capital Outflow (the exports we send out minus the imports we bring in) decreases, and private saving rises because of the high return on interest. Our government has automatic stabilizers built in to reduce tax burdens on the unemployed and provide assistance to consumers who may be hard on their luck.  Those who say crowding out is a problem with government spending don’t seem to grasp the idea that a little help is better than entirely hands-off fiscal policy.

Running a deficit makes the most sense when studying recessions, though in times of economic prosperity, running a deficit isn’t detrimental as our Gross Domestic Product (what we produce in our country) continually increases.  In the late 20’s, the American people found out just how fiscally irresponsible a stringently-balanced federal budget is during downturns in the economy. A mindset of hoarding and curbed spending damaged the economy, and brought about one of the most compelling cases for government spending during recessions. The hands-off government policy of carrying a balanced budget helped turn a recession into the Great Depression.

The way to balance a budget is either to bring in more income through taxation, or to decrease spending by cutting programs like social security, education, and welfare. In recessions the worst thing the government can do is increase taxes across the board when unemployment is high and wages are low – decreasing wealth and leaving less money to purchase goods and services (thereby further damaging the economy). In an Economic Update report, the Joint Economic Committee points out, “… higher taxes mean that Americans have to send a greater portion of their incomes to the federal government. … higher taxes stifle economic growth, which in turn means that the overall economy as well as individual incomes do not grow as fast as they would otherwise.”(1) To cut spending means cutting the programs that support human capital out from under our feet (again decreasing wealth).   In the early Depression, the federal government felt that to run a deficit would be like throwing good money after bad, with the idea that putting money into the economy – investing in our country – would cheapen money and harm the economy. If the government had funneled money into the economy – that money could have been put towards policy that increases GDP (ie human capital – education programs, worker retraining) and the recession could have corrected itself.

There is no reason suffer through hardships of a recession or depression if a budget deficit reduces the impact through tax cuts and programs that benefit consumers.

Hoover did too little too late; when they realized that they may need to jump-start the economy, they put money into the business sector to try to keep it from tanking (instead of taking an evolutionary stance on business).  They increased tariffs, and bought farm surpluses.  This quickly becomes a vicious cycle.   But, the idea that the government should run a balanced budget meant that to pay for the deficit created by bailouts and “public works projects” (ie through the Reconstruction Finance Corporation), money had to be pulled from the private sector through the largest peacetime tax hike in history, up to that point. Taxes were hiked as unemployment soared to an incredible 25%. The idea of running a balanced budget in this scenario was improbable and irresponsible. As economist Milton Friedman noted, “You cannot reduce the deficit by raising taxes. Increasing taxes only results in more spending, leaving the deficit at the highest level conceivably accepted by the public.”

Economist, John Maynard Keynes published a book in 1936 that outlined “The General Theory of Employment, Interest and Money”. Keynesian ideals of correcting the economy suggested that to remedy a depression the Fed would have to create money (unless the recession was bad enough to enter a “liquidity trap” where no amount of extra money supply would correct the economy), or the government simply start spending their own money – to balance the economy instead of balancing the budget. The end of the depression came with wartime spending in 1941 – the spending did exactly what Keynesian theory said it would do.

We’re in one of the deepest recessions now, since the government started keeping records on unemployment and recessions in the 50′s.  The fact that we’ve not been reduced to bank runs and dust-bowls during our economy’s down times truly shows the effectiveness of government programs, policy, and automatic stabilizers (unemployment insurance, income tax) to alleviate the sting of recessions.

Some may think that cyclical balancing seems to be the answer to a balanced budget – aim for a balanced budget in the good years, but maintain economic responsibility in down turns. Unfortunately, the only time that the government can truly balance the budget is if our economy operates at its full potential – an economy with full employment. There’s a tradeoff between full employment and inflation – we have to sacrifice one of those things to continue to keep inflation low.

At this point, many will point out that we’re only sacrificing our children’s futures – future generations will be forced into servitude to pay off the deficit we’ve run up. This is a great scare tactic – superstitions of mortgaging the future contribute to the fear of national debt. We have to choose between the fruits of our labor that we enjoy today, and the wealth we want to enjoy in the future. The government’s taxation system is set up to redistribute income to ensure those who are holding the debt are provided for (Friedman’s quote about taxation comes into play here as well). Deficits can be economically advantageous – as is the case in each recession. Through monetary policy, the fed makes money cheaper to use so businesses and households have more of it to spend. Government has the ability to alter policy to put more people and plants to use and to decrease the amount the Government takes in through taxes – thereby putting it directly in the hands of people who will use it. These policies put the government budget in the red, but increase economic activity. It’s more important to invest in a balanced economy to avoid or lessen the impact of recessions and to make investments in education, research and infrastructure. The more responsible position is to balance the economy, rather than balance the budget.

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What do you think?  Was it convincing?  Do you feel smarter?  Was it interesting?  Boring?  Or did I just waste the 8 minutes of your life that you spent reading that?

Sources:
(1 – in text quote) http://www.house.gov/jec/growth/taxpol/taxpol.htm

http://www.capitalgainsandgames.com/blog/stan-collender/410/please-dont-promise-balance-budget

http://www.theage.com.au/news/business/winner-should-balance-the-economy-not-the-budget/2007/11/18/1195321606401.html

http://www.fsmitha.com/h2/ch15wd.html

http://www.theatlantic.com/unbound/flashbks/budget/budgint.htm

http://www.theatlantic.com/past/docs/unbound/flashbks/budget/chambf.htm

http://www.theatlantic.com/unbound/flashbks/budget/rauchf.htm

http://ezinearticles.com/?Raising-Taxes-is-Bad-Economic-Policy;-It-is-Bad-for-Our-Nation&id=315301

http://moneynews.com/StreetTalk/economy/2008/07/16/id/324574

http://www.politicalforum.com/elections-campaigns/49611-republican-created-myth-about-raising-taxes-during-recession.html

http://www.cbpp.org/cms/?fa=view&id=1032