Suddenly people were calling for significant cuts in government spending in the face of a rapidly growing national debt.

As often happens, calls for cuts in government spending were met by competing calls for higher taxes, especially on higher-income earners and businesses. They can afford to pay the extra taxes, we were told. And what’s more, higher taxes could actually help the economy.

In making this case, proponents of raising taxes pointed to the tax increases that came out of Washington under President Clinton in 1993. The U.S. economy, as measured by GDP growth, was strong in the years after those tax hikes while unemployment and inflation were relatively low. The argument now is that the 1993 tax increases did not inhibit the economic boom the country enjoyed in the last six or seven years of the twentieth century.

In April New York Times columnist Nicholas Kristof made this very argument. He wrote that while it’s true higher taxes in general “tend to reduce incentives,” this apparently “weak effect” is often overwhelmed by other factors. “Were Americans really lazier in the 1950s, when marginal tax rates peaked at more than 90 percent?” Kristof asked. “Are people in high-tax states like Massachusetts more lackadaisical than folks in a state like Florida that has no personal income tax at all?”

Like other observers, Kristof also contrasted the “golden period of high growth” after the Clinton tax hike with the “anemic economy” that followed George W. Bush’s tax cuts.

But do higher taxes really spur (or at least not inhibit) prosperity? Looking at the data from the 1990s, one might believe so. After all, the 1993 tax hikes were followed by years of strong economic performance. Post hoc ergo propter hoc (after this, therefore because of this), many might believe.

But not everyone agrees the data are quite so clear. The Heritage Foundation’s J. D. Foster, for example, believes the data show that the U.S. economy was already expanding when the Clinton tax increases took effect. If anything, he believes, those tax hikes slowed overall growth for several years until 1997, when the Republican-led Congress passed a series of tax cuts, including a reduction in the capital gains tax rate from 28 to 20 percent.

The “real acceleration in the economy began in 1997, when economic growth should have cooled,” Foster wrote. “This acceleration in growth coincided with a powerful pro-growth tax cut.”

Foster also authored a 2008 Heritage Foundation summary of several scholarly studies showing tax hikes corresponding with slower or negative economic growth. In theory higher taxes could encourage greater levels of private investment through lower borrowing costs—if government used the money to retire debt and reduced its competition for lendable funds. But this potential “silver lining” is overshadowed by the negative effects of higher taxes, he stated. However plausible theoretically, in practice the argument runs into trouble, not least from the fact that governments seldom save any of their revenue, Foster notes.

Still, the idea that the 1993 tax increases spurred economic growth will not die easily. For instance, some people argue that those tax hikes provided much needed confidence in the U.S. economy. As Kristof put it: “Tax increases can also send a message of prudence that stimulates economic growth.”

With this much disagreement it’s hard to know what is really the truth. And this is always the case when looking at the effects of any single economic policy in a vast and complex system. Indeed, so much is happening at any given time in a modern economy—central-bank policy, trade policy, military spending, technological innovation, war or peace, and more—it’s impossible to draw hard and fast conclusions from macroeconomic data alone.

The Austrian economist Ludwig von Mises made this point in his classic treatise, Human Action, in 1949. In discussing the role of historical data in economics, he wrote: “The champions of logically incompatible theories claim the same events as the proof that their point of view has been tested by experience. The truth is that the experience of a complex phenomenon—and there is no other experience in the realm of human action—can always be interpreted on the ground of various antithetic theories. . . . History cannot teach us any general rule, principle, or law.”

Stepping back, therefore, it may be worthwhile to consider fairly uncontroversial economic propositions, such as the law of demand or the law of marginal utility, when trying to determine the likely effects of a tax increase.

Basically, taxes alter relative prices. A tax on gasoline makes gasoline more expensive. A tax on whiskey makes whiskey more expensive. By the same token, a tax on income affects the “price” of leisure; that is, an income tax reduces the reward or “price” one receives for forgoing leisure in order to work. If you are willing to work for $10 an hour, you’re essentially “selling” your leisure time for that price. You might not be willing to sell that leisure time for a lower price. Thus an income tax can be expected, on the margin, to reduce the willingness of some people to work.

While all this is important, it’s probably more important to consider what happens to taxes after the government collects them. How government officials spend tax revenue can damage the economy as much as the tax itself can. That’s because taxes are used for any number of things that distort markets and waste resources, such as providing subsidies to favored industries or strengthening bureaucracies.

As a newspaper reporter I have frequent opportunities to witness government decisions to spend taxpayer dollars. Often an argument in favor of a particular spending program is that it will only add a few dollars to any single individual’s tax burden. Once a government program is in place, however, it’s extremely difficult to reverse it because government spending benefits particular individuals and they are quite motivated to maintain it. When budget cuts are proposed, government officials have effective ways of fighting back. For example, a proposed cut in education spending is nearly always said to be taking teachers out of classrooms, and a proposed cut in police spending is nearly always said to be taking neighborhood cops off the streets. The “fat” in education and law-enforcement spending may be elsewhere. But those are the items placed on the public chopping block by clever bureaucrats and politicians.

So the real problem with taxes and tax increases may be that they simply feed the beast—the political and less-efficient government sector—while shrinking the voluntary, more-efficient private sector. For anyone concerned about liberty this is reason enough to oppose higher taxes.

Imagine how upset the ruling elite will be when it can spend money on nothing but so-called entitlements and interest? That would leave nothing for the military-industrial complex, nothing for business and farm subsidies, nothing for all the ways that politicians buy off constituents so they can be reelected over and over. If they try to keep spending on everything, total government expenditures would have to rise to half or even three-quarters of GDP.

Thus the ruling elite’s concern and the various reform fantasies. But the elite has few good options. Default on the debt would mean no more borrowing. Inflation won’t work. Raising taxes won’t do it either. Revenues as a percentage of GDP have been virtually constant since World War II regardless of tax rates, indicating that people adjust to the tax environment. (Revenues are historically low now because of the recession.)

Why couldn’t the politicians dramatically cut spending? The political system doesn’t typically reward spending cutters. People say they want government to spend less—on the things they don’t depend on. Among the biggest-ticket items are Social Security and Medicare (with tens of trillions in unfunded promises). Elderly people, made dependent on the State, vote in high numbers, and they will vote defensively. The special interests that live off a trillion dollars in annual “defense/security” spending—another big item—won’t let go easily either.

Let us then acknowledge the debt of gratitude due every politician who put us in this predicament. Each spending vote dug the hole deeper and made it harder to get out.

But aren’t the voters ultimately to blame? In a way, yes, but there’s more to the story. People are left no choice but to pay taxes, so when virtually every politician promises “benefits” in return for those coerced payments, what will most people do? The political establishment has implicitly sold the system as a big mutual-aid society. Most people don’t realize that government’s forced transfers are as much acts of robbery as those that occur in dark alleys. Nor do they understand the harm done or the opportunities forgone when government distributes the money. The well-heeled, well-organized, and well-connected have no trouble securing their subsidies and tax preferences, while sundry “benefits” are bestowed on others in return for their acquiescence in the corrupt process.

Some now call for spending cuts—modest in the scheme of things—while others would rather see higher taxes on the rich coupled with even more modest spending reductions. In its own way, each side seeks to preserve the welfare-warfare state. Several objections leap forth regarding the case for higher taxes: It’s not the politicians’ money, so taking it is immoral; hiking tax rates won’t raise as much money as they think (people adjust); the politicians can’t be trusted with the money anyway; and leaving it in the private economy would yield general benefits.

It’s hard to be optimistic. Until there is a deep rethinking of government, the public will not accept the drastic near-term budget cutting required to head off a fiscal crisis, much less the longer-term structural steps needed to prevent a repetition of what we’ve been through. People will need to learn that while the wish for “social security” in an uncertain world is entirely reasonable, the route to it is not Medicare, Medicaid, and Social Security—which tether people to the political class—but freed markets and voluntary mutual aid.

The fiscal problems have more than a fiscal solution. People would be less attracted to government succor if the barriers that raise the cost of initiative and independence were removed and individuals were freed to live without having to kowtow to power and privilege.

* * *

Commodity prices are rising worldwide but the Federal Reserve chief claims he’s not responsible. Gerald O’Driscoll says Ben Bernanke shouldn’t be let off the hook.

Economic hardship engenders xenophobia, and the most popular target right now is China. Robert Murphy examines the charge that Americans are harmed by Chinese currency manipulation.

Patents and copyrights are often defended in terms of liberty, but they began as State privileges and have never been anything else. Stephan Kinsella explains.

Women have played key roles throughout the history of the struggle for liberty. Sarah and Angelina Grimké are prime examples. John Blundell tells their story.

A good deal of what the U.S. government does abroad these days comes under the rubric of “nation-building.” Is that something we should expect government to be good at? Steven Horwitz says no.

Whenever the government wants to do you a favor, watch out. The more it meddled with beef cattle and meatpacking, for instance, the more consolidated those industries became. Paul Schwennesen speaks from personal experience.

Jury nullification—the principle that lets jurors acquit defendants when they find the law unjust—has been a popular cause with libertarians. Wendy McElroy sees the appeal but she also sees some risks.

Here’s what our columnists have come up with: Lawrence Reed celebrates the power of ideas. Donald Boudreaux critiques the interventionists of all parties. Robert Higgs dissects the political economy of the Great Society. John Stossel says gun owners have a right to privacy, too. Charles Baird skewers crony unionism. And George Leef, seeing Paul Krugman’s call for “shared prosperity,” retorts, “It Just Ain’t So!”

Books coming under scrutiny focus on European social democracy, the drug war abroad, political illusions, and happiness research.

Capital Letters asks the question: Must formal law precede prosperity?

On the other hand, some don’t care. The end is near, and there is no way to change the direction of things. So let’s have a toga party. Washington has too many interest groups wanting too many things, so we are supposed to pretend we are prosperous even if we are not.

The first view is more often heard, but the second seems to reflect how the political classes really act.

However, there is also a third viewpoint: There is no crisis at all. The U.S. government can borrow money indefinitely and by so doing, those debts magically will morph into “savings.”

I’m not joking. In a recent column, Paul Krugman (who wrote in his bestseller The Return of Depression Economics that when the government prints money, it can create a “free lunch”) said that in the short term the government is doing just fine and in the long term Obamacare will lower federal deficits

[Y]ou have to realize two things about the fiscal state of America. First, the nation is not, in fact, “broke.” The federal government is having no trouble raising money, and the price of that money — the interest rate on federal borrowing — is very low by historical standards. So there’s no need to scramble to slash spending now; we can and should be willing to spend now if it will produce savings in the long run. [Emphasis added.]

Second, while the government does have a long-run fiscal problem, that problem is overwhelmingly driven by rising health care costs….

So if you’re serious about deficits, you shouldn’t be pinching pennies now; you should be looking for ways to rein in health spending over the long term.

For Krugman, newly created or government-borrowed money seems to have a magic all its own. Just stir in new money and the economy magically blooms. However, as the Austrians and many in the neoclassical mainstream note, that is not an economy; it is a creation of some academic economists. A real economy involves heterogeneous assets and capital, with resources being moved via entrepreneurship from lower valued to higher valued uses.

The Scenario

The Krugman scenario seems to go as follows: 1) the government borrows and spends at its current record levels; 2) at some point the economy gains “traction” and then moves forward on its own; and 3) the budget deficits morph into surpluses and the savings Krugman refers. That might be true in Krugman’s highly stylized world in which academic economists create “models” that can be manipulated into affirming whatever their creators desire, but in the real world of heterogeneous assets and factors, that claim is nonsense.

What about Obamacare? Won’t it lower medical costs and thus drive down the costs of Medicare and Medicaid? One has to remember that Krugman is not referring to opportunity costs, as economists understand costs, but rather administrative numbers. In his view, just lower the numbers by fiat (which is done mostly by delaying or denying care), and the deficits take care of themselves.

Free marketers might lament that Krugman’s views receive top billing in Washington, but we should not be surprised when the words of a hardcore statist are welcomed by those who wield political power and benefit from it. In the end, the economic crisis is the ugly child of politics as usual, and now it is time to pay the piper.

Tracy begins by noting that government debt is “a subject on which the general good sense has greatly preceded the science of the pretended adepts. Simple men have always known, that they impoverished themselves by spending more than their income, and that in no case is it good to be in debt. . . .” On the other hand, “men of genius believed and even wrote, not long since that the loans of government are a cause of prosperity, and that a public debt is new wealth created in the bosom of society.” (All emphasis has been added.)

In his sarcasm about “men of genius,” Tracy was clearly rejecting the idea that government borrowing creates wealth. He had already disposed of the claim that government spending could stimulate productive economic activity. Rather than adding to “the general mass of circulation,” he said, government expenditures “only change its course and in a manner most often disadvantageous.” Here is Bastiat’s “broken window” a few decades early.

Still, he takes up this question: “When expenses are very considerable, ought we to felicitate ourselves on being able to meet them by loans, rather than taxes?”

Politicians and pundits say yes, believing that borrowing brings good economic times, provides money in emergencies, and “thus . . . is the true palladium of society.”

“Yet,” Tracy responds, “I think I have good reasons for combating their opinion.”

Here Tracy pauses, cagily, to state he “will say nothing of the grievous effects of loans on the social organization, of the enormous power they give to the governors[,] of the facility they afford them of doing whatsoever they please, of drawing everything to themselves, of enriching their creatures, of dispensing with the assembling and consulting the citizens; which operates rapidly the overthrow of every constitution.”

Economic Effects

“The first thing said in favour of loans,” he wrote, “is, that the funds procured by these means are not taken involuntarily, from any one.” Tracy didn’t buy the argument: “I think this an illusion. In effect it is very true, that when government borrows it forces no one to lend; . . . When, therefore, the lenders carry their money to the public treasury it is freely and voluntarily; but the operation does not end there. These capitalists have lent, not given: and they certainly intend to lose neither principal nor interest. Consequently, they force the government to raise, one day or other, a sum equal to that which they furnish and to the interest which they demand for it. Thus, by their obligingness, they burthen without their consent not only the citizens actually existing, but also future generations. . . .”

Borrowing doesn’t dispense with taxes; it merely shifts them to the future, except that they must be raised high enough to pay the interest as well as the principal. “Thus, sooner or later, it [borrowing] affects industry as much and in the same manner as if it had been levied at first.”

But this raises a question “which I am astonished to have seen no where discussed”: Does government have “a right thus to burden men not yet in existence, and to compel them to pay in future times [its] present expenses?”

No, Tracy answered. “One generation does not receive from another, as an inheritance, the right of living in society; and of living therein under such laws as it pleases. The first has no right to say to the second, if you wish to succeed me, it is thus you must live and thus you must conduct yourself. For from such a right it would follow that a law once made could never be changed.”

Here he offered a proposal:

[W]hatsoever is decreed by any legislature whatsoever, their successors can always modify, change, annul; and that it should be solemnly declared, that in future this salutary principle shall be applied, as it ought to be, to the engagements which a government may make with money lenders. By this the evil would be destroyed in its root: for capitalists, having no longer any guarantee, would no longer lend; many misfortunes would be prevented, and this would be a new proof that the evils of humanity proceed always from some error, and that truth cures them.

Repudiation

He was calling for future generations to repudiate the government debt of past generations and predicting, sensibly, that no one would lend money to the government if that principle is in effect! Laissez-fare advocates were true radicals in those days.

Tracy also debunked the claim that money lent to the government has no opportunity cost:

“The second advantage which is found in loans, is that the sums which they furnish are not taken from productive consumption: since it is not undertakers of industry who place their funds in the hands of the state; but idle capitalists only living on their revenue, who choose this kind of annuity rather than another. . . .[E]ven admitting that all were equally idle if the state had not borrowed, it is certain that if they had not lent it their money they would have lent it to industrious men. From that time these industrious men would have had greater capitals to work on, and, by the effect of the concurrence of lenders, they would have procured them at a lower interest.”

Well, then, how about this justification for borrowing: Loans “furnish in a moment enormous sums, which could only have been very slowly procured by means of taxes, even the most overwhelming.”

Tracy rejects this too. “Now I do not hesitate to declare that I regard this pretended advantage as the greatest of all evils.”

Use Is Abuse

Some might contend this is an abuse rather than a use of credit, but not Tracy. “I answer, first, that the abuse is inseparable from the use, and experience proves it.

“But I go farther. I maintain that the evil is not in the abuse; but in the use itself of loans, that is to say that the abuse and the use are one and the same thing; and that every time a government borrows it takes a step towards its ruin. The reason of this is simple: A loan may be a good operation for an industrious man, whose consumption reproduces with profit. By means of the sums which he borrows, he augments this productive consumption; and with it his profits. But a government which is a consumer of the class of those whose consumption is sterile and destructive, dissipates what it borrows, it is so much lost for ever [sic]; and it remains burdened with a debt, which is so much taken from its future means. This cannot be otherwise.”

I think you’ll agree that they’re not making many economists like that anymore.

That’s how George Mason University economist Russell Roberts describes the logic—rather, illogic—of the economic “stimulus” proposals that everyone and his uncle have been proposing.

If we needed further demonstration of the folly that is the American political-economic system, there it is. The leaders of the interventionist state and the candidates who aspire to command it will continue to produce this inanity until people see it for the balderdash it is and resoundingly reject it.

The problem is that most people don’t see it for what it is. When told economic activity is slowing down, they demand that their “leaders” and candidates assure them there is a Plan to keep them safe. The politicians are more than happy to oblige. Details don’t matter much.

The economic-stimulus theory is plainly incoherent. Besides the swimming-pool analogy already quoted, Russell Roberts showed the futility of what’s being proposed in another vivid way. Noting that politicians love to talk about “injecting” money into the economy, like a doctor giving a patient a transfusion, Roberts writes, “But where does the economic injection come from? It has to come from inside the system. It’s not an outside stimulus like . . . the transfusion. It means taking money from someone or somewhere inside the system and giving it to someone else.”

If the government uses fiscal means to goose the economy, the money has to come from somewhere. The politicians do not propose to cut spending—quite the contrary. So, since the budget is already in deficit, any tax “rebates” and new government spending will have to come from borrowing. But government debt doesn’t create wealth; it only transfers it. The lenders won’t be able to spend or invest the money. And the new debt will have to be repaid with interest through taxation in the future, suppressing economic activity then. Likewise, if taxes are raised to provide the stimulus—well, you can finish the thought.

If the government increases some people’s ability to spend by decreasing other people’s ability to spend, where’s the stimulus? Maybe these measures aren’t really intended to stimulate anything but a candidate’s popularity with appropriate constituencies. The underlying rationale for stimulus is that consumption is insufficient. While the purpose of production is indeed consumption, it doesn’t follow that the government can create economic growth by stimulating consumption. You can’t consume what hasn’t been produced.

Thus giving people money and urging them to spend it won’t improve their economic prospects. As usual, what looks like a political favor to low-income people is just a cruel hoax. Their well-being depends on genuine and sustained economic growth, which would maximize job opportunities and lower prices. But that requires a radical freeing of the economy—which politicians are not wont to favor.

The most objectionable side of the stimulus frenzy is the assumption that government can and should run the economy. The reports of the death of Keynesianism were apparently exaggerated. Most people still believe the economy is a vehicle and the government the driver, precisely adjusting the gas pedal and brake as needed. But really there is no “economy.” There are only people pursuing ends and the property they use and exchange in the process. If the government tries to “run the economy” it has to run us. It is a dangerous mistake to think the would-be driver can know what he’s doing. He can’t possibly know. The system is too complex, the necessary information—much of which is never articulated—scattered too far and wide. In contrast, the market process solves the problem of how to coordinate the productive activities of countless people in order to satisfy consumers.

Those who are biased against freedom will proclaim that our economic problems show that the free market has failed. What free market? Do they mean the “free” market that for ages and in myriad ways the government has straitjacketed and skewed on behalf of favored interests?

We are in our present position because government has burdened us with taxes, spending, debt, regulations, subsidies, guarantees (to banks, for example), trade restrictions, fiat money, and other impositions. Between the endless domestic schemes and war, we are being crushed by the weight of the state. We don’t need a stimulus. We need the weight lifted. We need freedom.

* * *

We’ve all seen those signs in stores bragging that only “fair trade” coffee is sold or served on the premises. Is this a worthy cause for advocates of freedom? Gene Callahan has the scoop.

It’s now uncomfortably common to see reports about abuse of innocent people by police forces resembling military units. Steven Greenhut examines this ominous development.

Condemnation of the profit motive is routine. But as Steven Horwitz explains, the profit motive is ubiquitous. What makes it beneficial or harmful is the institutional setting.

When a government official harms someone and the victim wins a lawsuit, it’s usually the taxpayers, not the offender, who pay the price. Is that justice? Ridgway Foley says no.

Some environmentalists think outer space should be preserved in its pristine state, free from human pollution. Are they kidding? J. H. Huebert and Walter Block ask.

The word “efficiency” is thrown around far too casually in discussions of government policy. It might be good to know what the word means. Gary Galles takes a look.

Here’s what our columnists are serving up this issue: Richard Ebeling dissects the “new happiness economics.” Lawrence Reed tells why a Continental was worth so little. Thomas Szasz points out that being drugged against one’s will is not treatment. Robert Higgs assays the effect of the New Deal on local government. John Stossel is glad that Third World nations are getting richer. Charles Baird documents how the government helps union leaders to plunder. And David Henderson, stunned by the assertion that medical care in the United States is worse than in other places, responds, “It Just Ain’t So!”

Books on democracy, market-based management, pharmaceutical regulation, and wealth-creation come under review.

—Sheldon Richman
srichman@fee.org

Editor’s Note: With the federal deficit expected to reach $500 billion or more this fiscal year, Congress on a spending binge unequalled in recent times, and the President without a veto pen, it’s a good time to revisit this FEE Timely Classic on budget deficits.

Politicians and officials in high places are telling us that government debt does not matter; after all, we owe it to ourselves. As long as government borrows funds internally and expenditures are financed from internal sources, so the notion goes, no real cost is incurred. Interest payment on debt merely represents transfers from taxpayers to bondholders. Debt to foreigners, by contrast, is seen as a wholly different matter because it necessitates interest payments to outsiders. It is analogous to private debt.

The recurrent notion that “we owe it to ourselves” springs from the doctrines of mercantilism. It was very popular with European monarchs during the sixteenth, seventeenth, and eighteenth centuries because it placed them in the center of economic life and made them the promoters and guardians of national prosperity. Kings and princes who looked upon the economic lives of their subjects as mere extensions of their own economic activities viewed their debts as both accounts payable and accounts receivable. After all, if the subjects belong to his lordship, also their property is his. The debt he may owe them he owes to himself.

The so-called Keynesian revolution during the 1930s revived the doctrine and promoted it to a great principle of economic knowledge. Economists throughout the Western world accepted it almost universally. And yet, it is as fallacious today as it was when the kings and their ministers proclaimed it. It is the rationale of spendthrift governments ever eager to run into debt.

The federal government debt now exceeds $2 trillion and is expected to reach the $3 trillion mark by the end of the decade. We do not owe these sums to ourselves, the U.S. government owes them to individual savers and investors. Surely, in a command system such as communism or fascism, government owns and controls everything and everyone and, therefore, may be said to owe it and simultaneously own it all. But in our free order, individuals do have rights and may own property. They may own treasury bills, notes, and bonds and expect to be paid; the fact that they, too, may be taxpayers is irrelevant for the claim. They expect to be reimbursed by the debtor, the government, which in turn depends on taxpayers for payment. It does matter to every individual whether he owns such obligations or merely owes taxes that service the debt.

The core of the fallacy lies in the holistic way of equating individual action with community action as a whole. If individuals were part and parcel of the collective whole and personal property an integral part of government property, it would not matter how the credits and debits are listed; they all would balance out. But in our free order, private property is not government property and government property is not private property. This is true no matter whether the individual owner is a native or foreigner. The law protects both from government infringement and transgression.

Deficits Curtail Investments and Are Tax Liens

Government debt usually signals the consumption of individual savings and economic resources. It is a rare exception for government to invest its funds productively, applying property for future income or benefits. Politics tends to favor present use and enjoyment at the expense of the future. A huge debt signals huge consumption of economic resources for political ends, incurred in the past at the expense of the future. It speaks of factories not built, stores not opened, businesses not started, and jobs not created.

Deficits consume funds that otherwise would be available for private investment; they represent a direct transfer from investment to consumption. The deficits of the U.S. government curtail the rate of economic expansion, keep productivity and labor income lower than they otherwise would be, impede international competitiveness, and cause American levels of living to fall relative to those in other countries where people save and invest more.

It may be argued that other governments throughout the world incur similar deficits and, therefore, exert similarly restrictive effects on their countries. But such an argument is badly misleading because the savings rate is much higher in many other countries. Where the investment rate exceeds 20 to 30 percent of income, the impact of a 5 percent deficit is less adverse on investment than in the U.S. where the savings rate barely reaches 5 percent. Americans cannot afford any further reduction in investment through government deficits.

Deficits and debts also signal future tax exactions. Having incurred the debt in the past, government, in order to repay the funds or just pay the interest, must levy taxes in the future. In essence, therefore, a government debt is a government claim against private property—an unpaid tax bill so to speak—that will fall due in the future. Like all other business taxes, it is bound to depress labor productivity and the value of productive property.

To most people government spending is a panacea for all economic evils and difficulties, a cure-all for human woes. Where economic stagnation impedes progress and prosperity, government is expected to stimulate through deficit spending. Where there is unemployment, government is expected to supplement private demand and thus create jobs. Where there is poverty it is expected to provide affluence through more spending and debt. But nature forgives no debt and grants no benefit without cost.

There can be no beneficiary of government largess without a victim of exaction. Government cannot pile up debt without ever paying it off; all government expenditures must ultimately be paid out of tax revenues or be repudiated through inflation, which is merely another form of taxation. Either immediately or ultimately every dollar of government spending is taken out of the pockets of taxpayers. When seen in this light, the supposed benefits of government spending are rather questionable. To build a pyramid of Federal debt is to delay the inevitable and pay interest thereon.

Inflation Reduces Debt

Politicians point out that over the decades the Federal debt has actually declined in terms of purchasing power as well as relative value. If growing budgetary deficits are accompanied by shrinking real debt and rising ability to pay the debt, the happy spenders may indeed be right that Federal debt no longer matters.

True, the Federal debt has actually declined both in purchasing power and relative value. But this decline in itself is a great evil that is spawning many other evils. Most of it is the handiwork of inflation, the willful policy of currency debauchery, which enriches one class of people at the expense of another. It deprives creditors of their rightful claims and enriches the debtors, primarily politicians and government officials who incur the debt and place it on the people. It breeds economic and political conflict as it pits the economic interest of one social class against another, jeopardizing peaceful social cooperation and endangering the democratic process. Surely, debt and depreciation do matter.

Depreciation of debt by inflation is repudiation pure and simple. It is deceit, wicked and desperate; its consequences can never be foreseen. When deceit has been practiced in matters where all should be fair, confidence cannot be easily restored. In financial terms, interest rates signal the dangers of repudiation; they cannot be expected to return to normal as long as deceit can be expected. In this sense, the deceiver is bound to pay a price for his evil ways.

The rising burden of interest on the Federal debt illustrates the point. In fiscal year 1986 the U.S. government is estimated to pay $196.095 billion in interest on its debt; in 1987 it is scheduled to pay $206.855 billion. In terms of Federal revenue the interest is expected to consume some 25 percent of estimated receipts, in terms of gross national product some 4.5 percent, which is the highest in U.S. history. Even in 1945 when the Federal debt amounted to 133 percent of GNP, the burden of interest consumed less than 10 percent of net receipts and barely 2 percent of GNP. If government expenditures on goods and services were deleted from GNP figures because government revenue merely consists of exactions from private production, the interest burden on every American would be seen to be even greater. Surely, debt and interest do matter.

Deficits Disrupt Foreign Trade

Federal budget deficits cause interest rates to be higher than they otherwise would be, which may induce the American people to save more and foreigners to move funds into the United States. The foreign investments alleviate the savings shortage, permitting the federal government to continue the deficit spending and the American people to maintain their levels of living. But the foreign investments also serve to drive up the value of the dollar, which causes American goods prices to rise in international markets and American firms to become noncompetitive. In other words, the inflow of foreign capital leads to an overvalued dollar, which leads to more imports of foreign goods and to what is commonly called balance-of-trade deficits. The imports, in turn, keep the price inflation low but also hamper American competitiveness, depressing competing industries and causing the loss of jobs in those industries.

If the budget deficits continue, American competitiveness may be damaged permanently. The consumption of capital in the United States and the formation of capital abroad may necessitate permanent adjustments in patterns of production and international trade. Capital-intensive industries may contract in the United States but expand wherever capital continues to be formed. American wage rates may fall while some foreign rates continue to rise.

As budget deficits continue, the U.S. dollar must ultimately fall not only in purchasing power but also in the money markets of the world. When foreign investors finally conclude that they have enough dollar liquidity and enough investments in the United States, the dollar must fall. In fact, it may plummet when foreigners lose confidence in U.S. economic and monetary policy, when willful dollar depreciation inflicts painful losses on their dollar investments, and causes them to liquidate rather than invest. When foreigners become dollar sellers rather than dollar buyers the international situation is bound to change. The American dollar will fall, American competitiveness will improve, the flood of imports will cease, competing American industries may relax, but goods prices will soar. After all, if the rising dollar stimulates foreign imports and investments, a falling dollar tends to bring forth the opposite. Smaller supplies signal higher prices. Moreover, as foreign imports decline the American firms that compete with imports can now, in turn, raise their prices. In the end, large Federal deficits are bound to generate serious inflationary pressures.

Even Keynesians Object

Large budget deficits usually induce monetary authorities to engage in massive credit expansion in order to finance the deficits. They conduct what Keynesian economists call “an infusion of aggregate demand” which in time is said to add to inflationary pressures. The inflation effects are said to be rather slow, though, given idle plant and equipment and a high unemployment rate. Nevertheless, Keynesian economists recommend that budget deficits should be avoided as the economy approaches full employment. Federal deficits, Keynesians reassure us, are the appropriate remedy for recessions; they are inflationary at other times. If they are already very large at the beginning of a recession, public policymakers may be reluctant to pursue yet larger deficits during the recession. They may be reluctant to prescribe Keynesian remedies so that, according to Keynesians, recessions will be deeper and larger than they otherwise would be.

One may disagree completely with the Keynesian rationale, and yet agree with the conclusion that government budgets should be balanced. In fact, they should be balanced all the time, not just during periods of “full employment,” which may be slow in coming. Government deficits consume economic substance and wealth; by their very nature they depress economic activity. The stimulation that may be observed in the wake of deficit spending is the result of willful currency and credit creation; it is the effect of the injection of monetary funds that lower interest rates and misguide businessmen in their investment decisions. When interest rates are lower than market rates and goods prices are made to rise faster than wage rates and fringe costs, the demand for labor tends to rise and unemployment may fall. This morsel of economic knowledge constitutes the secret ingredient of the Keynesian recipe.

Keynesian deficit spending during recessions is destined to fail whenever goods prices don’t rise faster than labor costs. Workers and their trade unions may see through the inflation machination and readjust their demands to the willful depreciation, demanding cost-of-living clauses and other compensation adjustments to offset the inflation losses. When the workers no longer can be made to suffer reductions in real income the Keynesian recipe loses its power. Moreover, when deficit spending is given in large doses in recessions after large deficits were suffered in a boom period, deficits may turn into a prescription for deep depression and mass unemployment. A 20 percent inflation rate may cause a 20 percent unemployment rate because productive capital may no longer function; it may join other assets in the flight into inflation hedges.

Deficit spending is the mother of debt, which is the prolific mother of folly and despair. A small debt may be cleared off in a little time, whereas a large debt may never be repaid. A debtor who owes a great deal may despair of ever being able to pay and, therefore, may be tempted to default. As the U.S. government debt soars past the $2 trillion mark, the possibility of default looms ever larger.

Call it Ross Perot’s legacy. He seems to have created a permanent fear of government debt and deficits within the hearts and minds of the American people.

This is quite an impressive achievement. Between 1970 and 1997, the federal government ran a deficit every single year. There were some good years and bad years over that time period, so why the fear of the deficit?

Between 1982 and 1996 the federal budget deficit exceeded $100 billion dollars every year. In eight of those years the deficit exceeded $200 billion dollars. During that time the American economy added over 25 million jobs.

During those years we listened to dire predictions of what those deficits were going to do to the economy. Sure, those Cassandras warned us, the economy is doing fine, but you just wait. You just wait!

We waited. Between 1982 and 1996, the economy got 50 percent bigger after taking account of inflation. But it’s a house of cards, the worriers warned us! It’s all going to come tumbling down.

So now we’ve got surpluses. When is that house of cards going to fall apart? Are the effects of deficits so sinister that we have to wait even after the deficits have been reversed? Are deficits so insidious that their evil effects can be unleashed years and decades after the accumulated debt has been paid off?

I don’t think so.

So why did we get away with it? Shouldn’t those deficits have harmed the economy? Shouldn’t they have driven up interest rates and stifled growth?

A federal budget deficit, if large enough, could harm the economy, but a deficit of $200 billion is “small” in a certain sense. It’s hard to accept, but the budget deficits of the ‘80s and ‘90s had no appreciable effect on interest rates. In 1993, the first year of the Clinton administration, the deficit was $255 billion. In 2000 we are expecting a surplus of over $100 billion. But interest rates are higher than they were than when Clinton took office. They’ve bounced around. But there is no relationship between interest rates and federal budget deficits.

How can that be? When the federal government goes to borrow billions of dollars, shouldn’t that drive interest rates higher? Isn’t that what you learned in Economics 101 ?

Well, the poet (Alexander Pope) said a little learning is a dangerous thing. For an increase in demand to drive up prices it has to be a significant part of the market. If I decide to double my apple purchases, the price of apples will not rise. If the city of St. Louis doubles its demand for apples, there will be no significant effect on the price of apples.

When the U.S. government increases its demand for credit by $100 billion dollars, the effect is small in a world credit market that is many trillions of dollars.

There is another sense in which the U.S. budget deficit was small in the ‘80s and ‘90s. It was never so large as to alarm investors that we might not honor our debts. True, $290 billion seems like a large number. But the economy in that year (1992) was $6.2 trillion. The government collected over a trillion dollars in taxes. Were we spending more than we took in? Yes. But there was never a sense in which we were spending beyond our means.

A friend of mine asked me the other day whether the analogy of personal debt applies to the government. Isn’t it bad to go into debt, to live beyond your means? Doesn’t that burden future generations.

I asked him if he owned his house. Yes, he said. Had he paid cash or borrowed the money from the bank? He laughed and admitted he had borrowed the money.

What, I asked, in mock amazement? Wouldn’t it have been better to save up money and pay cash? How could he saddle his family with a mortgage?

The right question is how big a mortgage. Sure, a mortgage can be so big that it is irresponsible. Sure, it’s unwise to burden the family with mortgage payments that threaten its ability to pay for food, education, and health care.

But it would be just as irresponsible to plan to pay cash for such an expensive house by putting money aside every year, money that would be unavailable for food, education, and health care, just to avoid going into debt.

It’s the size of the house that determines whether the family is being responsible or not, not how the house is financed.

And the same is true for the federal government. What the government spends money on is usually going to be vastly more important than whether it finances the spending via taxes or bonds. A boondoggle ditch-digging project that achieves nothing but is fully paid for by taxes is much more harmful than a sewer project that is paid for with bonds.

So let’s ignore the forecasts of surplus or the dire predictions of doom if deficits re-appear because of a tax cut. All those predictions are wild guesses anyway. Let’s focus instead on the proper role of government and whether the money spent by government is spent wisely.