February 25, 2004

Now that I have reviewed the economic assumptions and the spending priorities of the U.S. budget, I probably should address some of the questions that an economist should ask about our government. 

First, how big should government be?  Actually, most people have some sense of the correct answer.  Government should be no bigger than we can afford.

However, this does not mean that spending should be restrained by how government is financed.  Most people assume that government should be no larger than what the current tax codes can support.  If they want to shrink government, they assume that cutting taxes will do the trick. 

In fact, the answer should be that government should not extract any resources from its citizens that will be used to provide more value privately than by the government. 

Sure, we should care about our children, the elderly, the poor, those workers who need training to be re-employed, and many other issues.  However, if that last dollar spent on education in the public sector is not effective in teaching our children, then it should remain in the private sector.  A worthy objective is not sufficient to create a government program. 

Now answering how effective that dollar in the hands of government will be is not easy.  Sometimes government is constrained by issues that distort the effective use of resources.  Sometimes, government is needed to provide infrastructure, both legal and operational, to facilitate the ability of the private sector to perform better. 

Sometimes there are public issues, such as how the waters of a river that flows through several states should be used, that require some government intervention.  None of these issues are easy. 

Second, how should government be financed?  Sometimes, taxing the private sector is appropriate.  At other times, borrowing to obtain the resources may be more efficient.  How the private sector is using its purchasing power will determine what the best method is for obtaining resources.

In a recession, borrowing is preferred.  At full employment taxing may be more appropriate. 

Third, cutting taxes by borrowing money is not returning the people’s money to them.  Rather, it is providing tax relief for current earners by delaying obligations, with interest, until a future time.  If the interest rates appropriately reflect the future cost of funds, the net effect upon the economy could be negligible. 

Fourth, most economists would prefer direct subsidies or spending to tax initiatives to change private economic behavior.  One reason for this is that the same reasoning in determining whether a government program deserves to divert resources from the private sector can be used to evaluate the returns from subsidies. 

Another reason is that tax initiatives usually reward people for doing what they would have done anyway in order to get a few more people to do the desired thing.  In other words, it is an inefficient way to alter private behavior. 

Frankly, most people do not accept most of these principles.  They believe what we can afford depends upon the prevailing tax code.  Our history shows many times when the tax codes failed and needed to be changed.

Many also believe that cutting taxes is good regardless of whether it is because of a more efficient government (certainly a good thing)or the result of deferring the tax payments with interest into the future. 

Because many people do not agree with most of the principles indicated above, they do not know when their government is the right size with the right programs being financed the right way.  That criticism can be leveled against both major political parties. 

And that is a shame. 



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