moneypolitics & government

Spending is worse for the economy than taxing

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Whenever someone proposes spending money on a new government program, critics will say that we should balance out the effect on the budget with a matching tax increase. That would be great if it worked, but it’s a mistake to think that we can make up for increased government spending by increasing taxes.

Economist Steven Landsburg tries to illustrate the problem with an analogy about personal spending, pointing out that if you spend too much on your lifestyle, you can’t make up for it by going to the ATM more often. His point is that the American taxpayer is kind of like an ATM: Keep taking more money, and eventually you’ll run out. Sooner or later, you will have to stop spending.

I’m sure he’s right, but I think there’s another way to look at the problem. When the government spends money, it spends money on stuff — roads, tanks, buildings, research, gasoline, airplanes, ammunition, computers — but when the government collects taxes, all it gets is money.

The problem is that money has no intrinsic value. It’s just ink on paper (or magnetic fields in some bank’s data center). You can’t eat it, you can’t wear it, you can’t pave a four-lane highway with it. Just having money doesn’t get you anywhere.

This is where you’d probably like to call my bluff by asking me to give you all my money. Don’t hold your breath. Although having money is intrinsically useless, there’s immense value to be had in trading money for other stuff. I can walk into a restaurant, give them some paper money (or allow them to make an entry in a credit card computer), and they will give me food. Elsewhere I can get housing, clothing, transportation, medical care, education, and entertainment.

Unlike money, these goods and services directly make our lives better, and it’s the production, distribution, consumption of these goods that constitute what economists call the real economy. The money is just a tool to help it all run smoother.

The goal of an efficient economy is using available resources to produce and distribute goods and services as efficiently as possible. It’s a complex problem, but our free markets solve it surprisingly well: Consumers buy what they need most, at the best price they can get, and producers try to earn a profit by providing those goods and services as cheaply as possible. Thus, our economy uses the least amount of resources to produce the most goods and services, in the best combination, and distribute them where they will do the most good. The free market has its problems, but it’s brought us pretty far.

Now suppose the government spends a billion dollars on a new highway. This giant construction project will use resources — building materials, construction tools, and labor — and once those resources are scarfed up for the highway, they can’t be used for anything else. Concrete that would have been used to build housing foundations gets used to build a roadbed. Trucks that would have hauled groceries to market are now hauling construction supplies. Construction workers who could have been building homes or packing groceries are now working on the government’s highway. This is the effect of government spending on the real economy: Resources that would have been used to produce other goods and services are sidelined into the government project.

That’s not to say the free market won’t provide all kinds of substitutions and adjustments. Food wholesalers probably found replacements for most of the trucks that were taken for the construction project, although the replacements are probably not as good. Or maybe the trucking companies bought additional trucks so they could continue hauling groceries during the construction project. Those trucks are now unavailable to whoever would have used them instead. Maybe someone will build new trucks to make up the difference, but then the extra materials and labor for the new trucks have to come out of something else that won’t get built.

You get the idea. The change in demand ripples through the economy in a series of trade offs that are complex, far-reaching, and sometimes hard to predict. But there’s only so much stuff we can produce, so whenever we decide to produce something, we consume scarce resources that could been used to produce something else.

Economists call this the opportunity cost because whatever that something else was, we’ve lost the opportunity to have it. When it comes to the real economy, every decision has an opportunity cost. So when the government runs a billion-dollar highway construction project, it does so at the oppornutiy cost of not producing about a billion dollars worth of something else. This is the real cost of government spending.

Of course, the government has to pay for its billion dollars worth of construction with money, and the money has a story of its own. Perhaps the government takes the money as taxes, in which case the affected taxpayers will be a billion dollars poorer, and thus have to reduce their consumption of goods and services by roughly a billion dollars. This works out okay, because the government has taken a billion dollars worth of goods and services out of the economy for its new highway construction. In a free market system, all those trade offs I described earlier will eventually end up taking goods and services away from the taxpayers who couldn’t afford them anyway.

Putting it that way makes it sound kind of magical, but what happens is that the taxpayers have less money to spend so they buy less stuff. This frees up resources which help make other stuff easier to produce, freeing up more resources for still other stuff. These ripples eventually collide with ripples of increased demand coming from the highway project and it all balances out. The process is helped along by traders who understand the system well enough to get ahead of the ripples and take steps to fill shortages and siphon off gluts before anyone feels them.

But what happens if the government doesn’t raise taxes and borrows the money instead? Well, if the government borrows the billion dollars, it has to come from people who are willing to give up spending the money now in exchange for having more to spend later. This reduces their spending by roughly a billion dollars, and has the same short-term effect as if the money had been taxed away.

The point is that however the government gets the money, the goods and services consumed by the highway project are removed from the economy. Once the government spends money, it doesn’t matter where it came from. It’s the spending that does the real damage.

One last thing: Just because the government consumes a billion dollars worth of resources doesn’t mean the economy takes a loss worth a billion dollars. The highway project used up a billion dollars worth of resources, but it created a new highway, and that’s got to be worth something to the economy. The question is whether it’s worth enough.

Highways are a notorious example of something the free market is very bad at providing, so there’s a real possibility that a billion-dollar highway project could reduce travel times and congestion to allow the economy to produce far more than a billion dollars worth of extra goods and services. It could make us all better off.

So before all the politicians and pundits debate the mechanics of paying for a government program, we need to find out if the program is going to be worth the opportunity cost of whatever the free market would have done with an equal amount of resources. In other words, before we figure out how to pay for it, we need to make sure it’s worth buying.

Mark Draughn has been blogging since 2002 at Windypundit, where he rants about legal issues, national politics, economics, and culture. Mark was born and raised in Chicago, which is also where he went to school, works, and lives with his wife and three cats.
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12 Responses to “Spending is worse for the economy than taxing”

  1. George W. (“Frat Boy”) Bush was the perfect president, then. Although he spent, he did not tax. Balances out.

  2. Okay…but did he spend wisely?

  3. Not.

  4. Good post!

    The problem with money, as I see it:

    Money is a place holder, it represents something else, namely your life.

    You go to work and give up your freedom, trade your liberty, and do as you’re told in exchange for a wage. This wage is the value that you and your employer agree is closest to the value of the time you’ve spent at work, and your overall productivity.

    The problem is: Life is beyond value. You can trade your life for money, but the reverse doesn’t work. You cannot trade money for more life.

    Thus, money is always going to be shorting the worker. It’s value goes up and down, but it never equals the value of a second’s worth of life to the worker.

  5. Mike, I see what you’re saying, but I disagree, and I think millions of American workers disagree as well. You say that money “never equals the value of a second’s worth of life to the worker,” and yet millions of workers willingly trade away their lives for money every day.

    Of course, they’re not trading their lives away for the actual money, they’re trading away their lives for the the stuff that money can buy, and they only want that stuff because they think it will improve their lives. Essentially, they’re trading away their time in order to improve the quality of the time that remains.

  6. On the most basic level, people work in order to pay for food, shelter, health care, clothing, and other necessities. Without these things, they wouldn’t live very long. So the time spent working gives them more time to keep living. And it does the same for their children. Anyone who has saved up enough to retire and then spends years not working has bought that time with the time spent working earlier in life.

  7. “Of course, they’re not trading their lives away for the actual money, they’re trading away their lives for the the stuff that money can buy, and they only want that stuff because they think it will improve their lives. Essentially, they’re trading away their time in order to improve the quality of the time that remains.”

    Very nice Mark. This is, when you get to the bottom line, that is what we are all doing. Our monotonous, repetitive lives do have meaning if you can enjoy what you are working for. Too bad our Government cannot do what is best for all of us, rather than themselves, the lobbyists, etc…

  8. @ Scott

    Not exactly the same.

    You can trade your time for more money, but you cannot trade your money for more time. Maybe you can have an easier go of it with the time you have remaining, but there is no way to purchase extra minutes. Even billionaires die.

    Does that fact that you have to work to survive make the imbalance of value between money and life any less onerous?

  9. Mike, it’s probably silly to argue about it and it isn’t the main point of Mark’s post, obviously. And anyway, our discussion might break down over semantics or an insistence on taking things literally. There is a way to buy extra minutes, and we do it all the time even if we don’t usually think of it as buying extra minutes.

    Of course even billionaries die. And no money can save you from chance, or certain diseases, or old age. Eventually you’ll die, and some will die sooner than others. All obvious.

    But even given this, in a real sense money does buy more time, more actual years, evidenced by the increase in average life span made possible by advanced medicine, made possible by wealth, made possible by productivity and the work people do in a society.

    When you take an antibiotic that cures you of something that likely would have killed you a hundred years ago, it is work — your own that paid for the pill and the work of others in society, an overall work ethic and wealth that created the advances — that made your life being longer possible. People survive illnesses and injuries and surgeries they more often died from just a few decades ago. Those extra years are many more minutes added to lives, real minutes.

    I don’t have to tell you how wealth and a productive economy and the individual working person has helped to make these advances possible. You know they didn’t happen by themselves, by magic, and you know that not every place has made these advances.

    So, yeah, many would rather not have to work at all, to just do whatever they wanted, but when you say the imbalance in value between money and life is onerous, I think, compared to when? In the old days, people worked long, hard hours and often died young. They had less life than we do. If there is an imbalance, I would say it is far less of an imbalance than it once was, based on the extra minutes our work has purchased for us in terms of leisure time, ability to travel (getting somewhere in hours instead of in weeks), and longer life spans.

    When I think about how life was for people in colonial times, in ancient times, even more recently for my grandparents, and I think of the diseases and hardships we have been spared, the medical advances and vaccinations and all the rest that have spared our children of diseases that often killed children in earlier generations, I understand that work and wealth made the improvements possible.

    Though I can certainly see work as onerous when there are frustrations or I’d rather be doing something else (and this was particularly true when I had jobs that I hated), and I know many people have more onerous jobs than I have, I also recognize that this is not a perspective that considers history and how much less onerous the exchange of time/life for money now is, and how much more life that work produces than it once did.

  10. @ Scott

    I think this fits in very well with Mr. Draughn’s post. His final thought is that we need to examine our purchases (government and private) and determine actual value.

    I have problems with trying to discuss value in terms of money, since money isn’t the most valuable part of the equation. That distinction goes to the life spent trying to earn money. Money which cannot purchase back the life spent trying to earn it.

    You argue, correctly, that money and the use of that money in R&D, has created life saving medicines and has helped to further life expectancy.

    However, Mr. Draughn also discusses opportunity costs, which is a nifty way of saying “What else happens, or doesn’t happen, when we spend that money? It’s an argument that we examine all the possibilities.

    Great! You argue that money has helped lengthen life, but you must also admit that if we’re going to discuss it in those terms, we must also conclude that money has done an awful lot to shorten lives as well. From nuclear weapons to tanks to machine guns, the products of the R&D the money funded have killed millions of people too.

    That’s where measuring value in terms of life comes in. At best, money is break even in terms of value measured by life.

  11. The principal problem (literally) regarding government spending is that the government itself doesn’t make anything or sell anything, but depends for its income on the industry of those members of society who do make or sell something. When you ask the government to pay for something, you are really asking those productive members of society to pay for it.

  12. You know, this was my first post on WFTC, and I’ve got to say that I’m really impressed by the community that showed up here in the comments. You’ve given me stuff to think about.

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