Many assume that budget deficits reduce national savings, while a budget surplus contributes to national savings. National savings are defined as the sum of private savings (the after-tax income that households save) and public savings. By generating budget surpluses—not spending all that it receives in taxes—it would appear that the government generates wealth, thereby strengthening the economy’s fundamentals. This argument would be correct if government activities were of a wealth-generating nature. This is, however, not the case.
Government activities, by definition, are confined to the channeling of wealth from wealth-generators to wealth-consumers. Government literally depends on its taxation (i.e., direct taxes, debt, and/or inflation) of the private, productive sector of society for its existence. Government can transfer and rearrange resources, but it does not produce them. This results in taking wealth from one person and shifting it to another. Various impressive public “projects” that the government undertakes also fall into the category of wealth redistribution.
The fact that the private sector didn’t voluntarily undertake these projects indicates that these projects are low on the priority list of individuals. Private sector projects are determined by projected profit and loss and use economic calculation to arrange resources in ways that serve consumers. In order to realize sustainable and stable economic growth, production, saving, and capital investment are necessary, which establish a basis for present and future growth. The amount of voluntary savings in an economy sets a limit on how much can be devoted to expansion. Therefore, when governments tax, spend at a deficit, and/or inflate, then redirect those resources to projects chosen by political elites, all the resources devoted to those projects come at the expense of the private economy and crowd out other opportunities.
Let us say that the government decides to build a pyramid and the private economy has not sought to build a pyramid voluntarily already, signalling that other wants are more urgent and demonstrating their preferences. The individuals to be employed, the money and the resources employed to build the pyramid, the time and energy committed, all must be paid for by revenue extracted from the private sector in taxation (either in the present and/or the future) and all of those factors must be bid away from the private economy, therefore, resources are used for the pyramid that now cannot be used elsewhere in the economy. Even if somehow built efficiently or at or under budget, the tax and resource costs still fall on the private sector. This means that other production, consumption, and/or saving cannot take place.
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 increase his well-being. This is a value-maximizing transaction that creates wealth. However, the crux is that the exchange must be free and thus reflective of an individual’s preferences. By contrast, government taxes are coercive by 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, and obviously this impairs their well-being.
Therefore, the more pyramid-building undertaken by the government, the more wealth is taken away from wealth producers, both in the initial tax but also in the act of spending. We can thus infer that the level of tax taken from the private sector is directly determined by the size of government outlays. Moreover, if government outlays could have generated wealth, then these outlays would have been self-funded and would not have required any support from wealth-generators.
Introduction of Money
The essence of what was said is not altered by the introduction of money. In the money economy, the government taxes and pays the money received to individuals that are employed directly or indirectly by the government and also purchases resources out of the private economy. The money received by these individuals increases access to goods, altering the structure of production by bidding up prices and stimulating sectors to an extent they would not have otherwise been. Government employees are now able to exchange the taxed money they receive as their paychecks for various goods. This distorts the structure of production and adds further costs paid by net-taxpayers.
What then is the meaning of a “budget surplus” in a money economy? It basically means that the inflow of money to the government from taxation exceeds its current expenditure of money. The budget surplus here is just a monetary surplus. The emergence of a surplus produces a similar effect to tighter monetary policy since the taxed revenue is not being spent into the economy and changing the structure of prices and production as much. 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.
Contrary to the popular way of thinking, a government budget surplus does not automatically make room for lower taxes. Only if government outlays are curtailed (i.e., only when the government reduces its spending on the number of pyramids it plans to build) is tax effectively lowered. While the money is still taxed, which also distorts the voluntary and productive sector, lower government spending means more labor and resources are not being bid away from the private sector.
For example, if government outlays are $3 trillion, and the government revenue is $2 trillion, then the government will have a budget deficit of $1 trillion. Since government outlays have to be funded, this means that the government would have to secure some other sources of funding such as borrowing, printing money, or a new form of taxes. We should also note that the spending of government itself effectively is the tax since it pulls resources away from the private sector. The government will employ all sorts of means to obtain resources from wealth-generators to support its activities. What matters here is that government outlays are $3 trillion, not that the deficit is $1 trillion. For instance, if government revenue because of higher taxes were $3 trillion, then we would have a balanced budget. But would this alter the fact that the government still takes $3 trillion of resources from wealth-generators? The effective tax is $3 trillion of government spending.
Some commentators are of the view that the private sector cannot be trusted to build up and enhance the nation’s infrastructure. For example, the US urgently requires the building and upgrading of bridges and roads. There is no doubt that this is the case. However, can Americans afford the improvement of the infrastructure? The arbiter here should be the free market, where individuals—by buying or abstaining from buying—decide on the type of infrastructure that is going to emerge. If the amount of savings is not adequate to afford better infrastructure, then time is required to accumulate savings to be able to secure a better infrastructure. That said, without touching the bureaucratic nature of government projects that lack economic calculation and profit and loss, government taxing and spending on infrastructure must come from expropriating resources from the private sector. Governments cannot magically “afford” something that the private economy cannot, though inflation and spending give this illusion.
The increase of production, saving, and capital investment cannot happen faster by raising government spending. On the contrary, an increase of government spending weakens production, saving, and investment and replaces it with government consumption (i.e., government spending). Also, while the government can force various non-market chosen projects, the government cannot make these projects economically viable.
What about the lowering of taxes on businesses—surely this will give a boost to capital investment and strengthen the process of wealth formation? As long as the lowering of taxes is not matched by a reduction in government spending, this will encourage a misallocation of savings. (This will divert savings from wealth-generating projects towards activities that emerged on the back of the tax reduction, all other things being equal). Various capital projects that emerge on the back of such government policy are likely to be the equivalent of useless pyramids.
Now, one of the ways of securing the necessary funds by the government is by means of borrowing. But how can this be? A borrower must be a wealth-generator in order to be able to repay the principal loan plus interest. This is, however, not the case as far as the government is concerned, for the government is not a wealth-generator—it only consumes wealth. So, how then can the government, as a borrower that does not produce wealth, ever repay its debt? The only way it can do this is by taxing, inflating, and/or borrowing again from the same lender—the wealth-generating private sector. It amounts to a process whereby the government borrows from you in order to tax you to repay you.
Conclusion
We can conclude that the only meaningful contribution the government can make to the process of wealth generation, and hence individual living standards, is by focusing on a reduction in its spending—not whether there is a budget surplus or a deficit. This, in turn, means the government must remove itself from business activities and permit wealth-generators to get on with the business of wealth generation.
