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Can a budget surplus lower taxes?
Dr Frank Shostak
It is widely held that a government budget surplus makes room for lower taxes. Furthermore it is held that a budget surplus raises the level of savings in an economy. By generating surpluses, so it would appear, the government creates real funding thereby strengthening economy’s fundamentals. This way of thinking would have been correct if government activities were of a wealth generating nature.
This is however, not the case. Government activities are confined to the redistribution of real funding from wealth generators to wealth consumers. In short, government activities result in taking funds from Joe and channelling those funds to Bob. Various impressive projects that government undertakes also fall into the category of wealth redistribution.
The fact that the private sector didn’t undertake these projects indicates that they are on the low priority list of consumers. In other words, given the state of the real pool of funding the implementation of these projects will undermine the well being of individuals since they will be introduced at the expense of projects that are on a higher priority list of consumers. Most writers and commentators overstate the importance of the government budget deficit or surplus.
This way of thinking is misleading for it confuses monetary with real factors. To clarify this issue let us consider an individual who produces bread. The stock of bread in the possession of this individual constitutes his wealth or his pool of funding. A portion of this pool is employed in the exchange for consumer goods and services. The other part of the pool is invested in the production of tools and machinery. The investment of bread means that the portion of the stock of bread is exchanged for services of various workers who are employed in the production of tools and machinery. With better tools our individual will be able to raise the production of bread.
Let us assume that the government decides to build a pyramid that most people regard as low priority. The people that will be employed on this project must be given access to various goods and services to sustain their life and well beings. Since the government is not a wealth producer it would have to impose taxes on wealth producers (those individuals who produce goods and services in accordance with consumers most important priorities) in order to fund the building of a pyramid.
Now, whenever wealth producers exchange their products with each other the exchange is voluntary. Every producer exchanges goods in his possession for goods that he believes will raise his living standard. The crux therefore is that the exchange or the trade must be free. Government taxes are of a coercive nature, they force producers to part with their wealth in exchange for an unwanted pyramid. This implies that producers are forced to exchange more for less, obviously this impairs their well being.
The more pyramid building undertaken by the government the more real wealth will be taken away from wealth producers. We can thus infer that the level of tax i.e., real wealth taken from the private sector is directly determined by the size of government activities. Observe that by being a wealth consumer the government cannot make any contribution to savings and to the real pool of funding. Moreover, if government activities could have generated wealth then they would have been self funded and would not require any support from other wealth generators. In short if this were to be the case, the issue of taxes would never arise. What is the role of a budget surplus or deficit in all this? How important are they? The surplus or deficit is the outcome of the monetary economy. The essence of our previous analysis will not be altered by the introduction of money.
In the money economy the government will tax (take money from wealth generators) and disburse the received money to various individuals that are employed directly or indirectly by the government. The money will give all these individuals access to the real pool of funding that is goods and services. Government employed individuals could now exchange the taxed money for various goods and services that are required to promote their lives and well beings. What does it then mean a budget surplus in the money economy? It is basically means that the government intake of money exceeds spending of money. This budget surplus is just a monetary surplus. The emergence of a surplus produces the same effect as any tight monetary policy would. On this Ludwig von Mises wrote”
Now, restriction of government expenditure may be certainly a good thing. But it does not provide the funds a government needs for a later expansion of its expenditure. An individual may conduct his affairs in this way. He may accumulate savings when his income is high and spend them later when his income drops. But it is different with a nation or all nations together. The treasury may hoard a part of the lavish revenue from taxes, which flows into the public exchequer as a result of the boom. As far and as long as it withholds these funds from circulation, its policy is really deflationary and contra-cyclical and may to this extent weaken the boom created by credit expansion. But when these funds are spent again, they alter the money relation and create a cash-induced tendency toward a drop in the monetary unit's purchasing power. By no means can these funds provide the capital goods required for the execution of the shelved public works. (Ludwig von Mises, Human Action, Scholars Edition, chapter 31, p. 79).
Contrary to the widely spread view, the budget surplus i.e. monetary surplus, doesn’t automatically make room for lower taxes. Only if real government outlays are curtailed, i.e. only when the government cuts the number of pyramids it plans to build, will effective tax be lowered. Lower government outlays imply that wealth generators will now have a larger portion of the real pool of funding at their disposal. If however, government outlays continue to increase, notwithstanding budget surpluses, no effective tax reduction is possible, on the contrary the share of pool of funding at the disposal of wealth producers will further diminish.
We can does conclude that the only meaningful contribution the government can make to the real pool of funding and hence peoples living standard is not by having a budget surplus as such, but through the reduction in government real outlays.
Dr Frank Shostak is a former professor of economics who now works in the private sector
BrookesNews.Com
Monday 23 October 2006