Deficit Spending and Future Generations: Not What You Might Think
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Tags: deficit spending • government borrowing • national debt • taxes
Conventional wisdom on both the right and the left says that because the “stimulus” package is being financed by deficit spending—that is, borrowing now, taxing later—Congress and the President are forcing future generations to pay for our problems. As the story goes, we are shifting the costs of this massive spending scheme to our children. While this sounds accurate, it is in fact impossible to shift costs this way.
Neither the government nor anyone else can spend future dollars. In reality all current spending must come from current revenues and can use only existing resources. Every dollar the government spends, even if borrowed, has to come out of some existing person’s pocket and therefore preempts the use of that dollar somewhere else in the economy—not in the future, but here and now.
The government can obtain its borrowed money by selling Treasury bonds to either American citizens or foreigners. If it borrows from domestic sources, it is getting money that Americans would have either invested somewhere in the economy or spent on goods and services. Government borrowing simply diverts the cash from other uses, just as if its spending were financed by taxation. Economists call this the “crowding out effect.”
A typical response is that most of the government borrowing will be from foreigners and that the Obama deficit won’t crowd out economic activity in the United States. Thus we are said to be mortgaging our children’s future to people in other countries. The first thing to notice is that we can’t know who the bondholders will be in the future when the loans come due. Treasuries are sold and resold many times over. This is also true of debt originally issued to Americans.
The real problem has nothing to do with who holds the note at the time of repayment. A good economist asks what else these foreigners would be doing with their dollars. Because they are lending dollars, as opposed to euros or yen, this money would ultimately be either spent on American goods, thereby increasing exports, or invested in the U.S. economy. We reach the same conclusion regardless of who lends the government the money. The real costs of government spending, no matter how it is financed, are experienced here and now.
Government Spending Always Competes with Private Spending
Also, regardless of where the money comes from—taxation, borrowing, or printing press—government spending always preempts other spending in the economy. Those who get the borrowed money have purchasing power transferred to them that will increase the demand for the resources they use. That will increase the cost of those resources to other buyers. Government spending thus always competes with private-sector spending for scarce resources and preempts growth.
This is not to argue that deficit spending is the same as tax-financed spending. It is not. Deficit spending creates the occasion for coercive wealth transfers from future taxpayers to future government bondholders. When the bills come due, most of our children and grandchildren will have part of their incomes coercively transferred through higher taxes to those who hold the Treasury notes. Government debt makes our children less free.
Furthermore, deficit spending obfuscates the true cost of government, not only in lost liberty but also in lost productivity and wealth. Deficit spending is dishonest because it leads people to believe they are getting something for nothing while in reality their wealth is diminished just as if the spending were covered by taxation. But that cost is not seen in the tax bill. This is why politicians find deficit spending so appealing. It is a tool for pulling the wool over citizens’ eyes while rewarding special-interest groups and expanding the state’s control over the private sector.
Ultimately, the real choice is not between deficit-financed and tax-financed spending. The moral question is whether we should have more spending and bigger government with less liberty or less spending with a smaller government and more liberty. The hand-wringing on the left and right about passing the cost of “stimulating” our economy onto future generations is misplaced. No matter how it’s financed, Obama’s new spending has the potential to stimulate only one thing: the size, scope, and power of government.
Comment by Lexi on 26 May 2009:
This article outlined perfectly what I’ve been trying to understand. I think most of us know that deficit spending is harmful, fewer understand why. This is the perfect explination, in simple terms, to explain. Even a high schooler like me can understand it!
Comment by John on 5 June 2009:
Unless I’m missing something, this article doesn’t address an additional potential consequence. That additional possibility could be paying back the “bondholders” in the future with inflated dollars (seems like we went through this in the past to a certain degree during the 1970s). I do understand that inflation is another form of “wool over the eyes” taxation on future generations, but also the “bondholders” are cheated as well. (Perhaps that is what was being alluded to in 2nd to the last paragraph). The people who benefit most from higher inflation are borrowers – and the biggest borrower in an era of deficit spending is the government. Only those assets that are somewhat immune to inflation (such as real estate and rents – once this “busted bubble” has stabilized) and those who borrow long term (as an example – 30 year mortgages) will be the least damaged from this deficit spending and in some cases are helped.
That being said, the best thing our federal government should do would be to cut spending by at least 50% across the board for each existing federal program. None should be exempt from cuts and all should be equal (initially) and their annual budgetary increase should be a % that is half of the inflation rate.. That increase should also be on a sliding scale – the higher the rate of inflation, the lower the percentage should be. (as an example, if inflation is 5%, the spending would increase by only 2.5% – however if the inflation rate is 10%, the spending should increase only 4% etc.) If government spending were cut by 50% and decreased as inflation rises, it would be a good start. Then tackle the issue of taxes. Any surplus in taxes would have to be returned proportionally to those who paid the taxes. Tax cuts without corresponding spending cuts are not very beneficial. 1st deal with spending, then deal with taxes.
Comment by Paul on 28 September 2009:
Hmm . . Paragraph 1 says we aren’t shifting real costs to our children. Paragraph 4 says we aren’t mortgaging our children’s future to people in other countries by selling debt to foreigners. Paragraph 7 says that deficit spending will cause our children to pay higher taxes to pay those who hold the notes. So if we are paying the true costs now–and our children are also paying for something in the future, in money and in freedom–what is it that our children actually will be paying for that is being precipitated by today’s government borrowing? A coercive wealth transfer that doesn’t pay for anything–any real debt obligation–sounds like pure theft to me. If someone has a note or bond that says that future taxpayers owe them principle and interest–those are borrowing costs–direct consequences of deficit spending. So how can it be both things–that all of the costs of deficit spending are incurred through “opportunity cost” now, and there is a cost consequence as a result of today’s deficit spending for future generations?
Whatever the answer to that dilemma, the principle remains that it is unjust for younger generations to pay for their elders government programs. I would propose that no one be liable to pay taxes to support any government program that was instituted before that taxpayer reached voting age. Of course, as soon as you apply for a government benefit, you would become liable for the corresponding tax. Each 2-year Congress could vote to extend the application of programs to the newest voters, subject to the wrath of their constituents. This, however, sets up a new tyranny-of-the-majority problem where 18-20 year olds could always be outvoted by their elders. But there should be a direct accounting and correspondence between taxes and benefits so people know what they are paying for. But one thing for sure–that age group would be the most vocal and politically active of any.