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Monday, 18 August 2014

Deficit size fetishism: Why Joe Hockey needs to learn economics

Deficit size fetishism: Why Joe Hockey needs to learn economics


(Image via georgebludger / Flickr)

Treasurer Joe Hockey – and many other treasurer's in
developed countries – have a poor grasp of economics,
wrongly conflating national fiscal policy with running a household
budget. UNSW Professor Geoff Harcourt explains (via The Conversation).

THOUGH MONEY AND FINANCIAL FACTORS are integrated in complex ways in
the workings of the economy, ultimately it is real resources – work
forces (sizes and skills), capital goods and natural resources – that
set the upper limit at any moment of time on the size of the community’s
standard of living.

And yet that hasn’t stopped successive Australian Federal treasurers
– along with their counterparts in other advanced capitalist economies
– increasingly using terms which reflect misunderstandings of the role
of fiscal policy in economic policy.

When used by treasurers, phrases such as “we cannot afford it
financially” or “where is the money to come from?” or “you are using
taxpayers’ money”, confuse affairs of the state with what should be left
to the workings of individual households.

Obsessed with the relationship of government expenditure and
taxation, many treasurers suffer from deficit size fetishism, and fall
victim to the “balancing the budget over the cycle” fallacy. Many also
get caught up with hypothecation — matching specific government
expenditures with particular tax sources.

Some confuse the significance of the national debt to income ratio
for the present and future operations of the overall economy, especially
the supposed link between them and the welfare of future generations
relative to the welfare of the present generation. The “we’ll all be
ruined” fear.

Deficit obsession

“Deficit size fetishism” reflects the view that government
expenditure and taxation are always “bad”, regardless of the absolute
sizes and compositions of the two and the overall state of the economy
— for example, the rate of unemployment, the rate of growth, the rate of
inflation (or deflation, as Japan has experienced in recent decades).
Both the sizes and compositions of government expenditure and taxation
need to be assessed by other criteria.

The composition of taxation, the contributions to the whole of
indirect, direct and other forms of taxation, and their incidence on
different groups in the community, ought to reflect equity (fairness)
— such as which groups can least or most afford to pay particular forms
of tax and taxes overall.

The total tax take should reflect the impact required on overall
levels of spending in the economy, these in turn determining the levels
of output, income and employment both prevailing and what the government
would like to see prevail.

Spending and borrowing

The composition of government expenditure is made up, first, of
current expenditures — the salaries of parliamentarians, public servants
and government employees, generally; transfer payments from taxpayers
to recipients of social services, such as unemployment benefits, old-age
pensions and so on; and interest payments to domestic holders of
government bonds.

Secondly, there is government (public) capital expenditures on social
infrastructure — the creation of new railways, roads, hospitals,
schools and so on. Ideally, the level and composition of capital
expenditure should be determined by the perceived medium to long-term
needs of the community for the services they ultimately will provide.

As these expenditures have a significant impact on the efficiency and
productivity of the nation, there is no reason why they should not be
financed at least in part by borrowing, even by borrowing from overseas.
The latter does entail a real burden because interest and principal
repayments mean higher levels than otherwise of exports to service them
would be required. Nevertheless, if the borrowings are used wisely, this
burden may be met and the economy still be better off than it otherwise
would have been.

There is no equivalent burden associated with internal debt (owed to
lenders within the country) for, as noted, this involves a transfer from
taxes to interest payments. The impact on overall demand depends upon
the differences in the consumption and saving behaviour between
taxpayers, on the one hand, and interest receivers, on the other. They
may, of course, overlap. Any fairness considerations associated with
such transfers may be tackled through the composition of the structure
of tax rates.

So government expenditure and taxation, especially taken in
isolation, are not interesting numbers. Certainly not numbers to have a
fetish about, even if you are not just an ordinary Joe, or an earthbound
Swan, or a surplus lover Costello that hands out tax cuts to friends.

The criterion of balancing the budget over the cycle – or,
preferably, creating a surplus – is based on a fallacy that the economy
is not growing, that it will remain at the same level of activity
forever. At least since the 1940s, it has been known that if economies
on average grow from cycle to cycle. Thus, it is possible always to have
deficits (within reasonable limits) without annual deficits exploding;
for specific rates of growth, the deficit approaches particular limiting
values that are livable within a wide range of values.

The real tax and spending relationship

One outcome of this discussion is that hypothecation is a fallacy —
particular forms and amounts of taxes should not be attached to
particular forms of expenditure.

Citizens should pay taxes according to their overall ability to pay
and they should receive government payments according to their
particular characteristics as citizens — unemployed, aged, disabled and
so on. The total of these government expenditures will be financed from
the total funds raised by taxation and borrowing.

“Treasurer Speak” in recent decades reflects serious conceptual
misunderstandings of how economies work and how the functions of the
state should be integrated with the workings of the private sector.

The end result has been the use of scare tactics over a wide range of
issues, tactics which have no foundation in proper economic logic.

The ConversationGeoff Harcourt is a member of the ALP. This article was originally published on The Conversation. Read the original article.

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