Mises Wire

Four Reasons Why Government Spending Is Even Worse Than Taxes

Money drain

Every year around tax time, we’re reminded of the pain of the income tax. We’re reminded not just of the wealth that is taken, but also of all the time and energy that must be expended helping the federal government estimate just how much they should take from us this year.

The income tax is just one part of the equation, though. Payroll taxes, corporate taxes, excise taxes, and tariffs are all federal taxes that all of us pay, whether or not one pays what is called the “income tax.”

One need not be the owner of a corporation to pay corporate taxes. When a business pays out taxes, the customers and employees also pay in terms of lower wages and more expensive goods. One need not be an importer to pay tariffs, which end up costing consumers more in terms of more expensive goods and fewer goods available to them. And one need not be a driver of automobiles in order to pay the federal excise tax on gasoline. Every good and service that relies on gasoline for transport costs us more thanks to that tax.

In spite of all of this, it’s not the taxes that are the worst part of the tax-and-spend equation. What the government does with the money — once it has it — is actually worse, and it’s more damaging both politically and economically.

Reason 1: There’s no way to rationally allocate tax money.  

Once money is extracted from an owner in the form of taxes, the money leaves the realm of the marketplace and of market prices. The funds become resources that were acquired, not through any exchange, but through a coercive transaction backed by the threat of imprisonment and fines.

At this point, the money has already been misallocated because it has been distributed (by force) in a way that was involuntary on the part of the real owners. One might claim that the rightful owners of the tax money will eventually be given goods and services in return for the tax money. But who can say the taxpayers would have been willing to pay a price equivalent to the amount taken in the form of taxes?

It’s impossible to say, since the taxpayer was never allowed to demonstrate a preference for how that money should have been spent.

In other words, it’s impossible to say how much the taxpayers actually value a road, weapons given to a terrorist organization, or a SWAT raid against raw milk producers. The taxpayers are forced to pay for all those things. How much the taxpayers value such things, however, is anybody’s guess.

Instead of value being determined by consumers in a voluntary marketplace, government resources are placed in the realm of politics and politicians who will distribute goods according to the political power of interest groups.

Reason 2: Government spending is not restrained by tax revenues.

When a central bank is present, government spending it is not constrained by tax revenues. While it’s nice to imagine that government could be reined in by simply cutting tax revenue, central banks mean there’s always a way around this.

According to Ludwig von Mises, government taxes and spending could theoretically be limited in a democratic political system by the fact that the voters would only tolerate taxes — and thus, government spending — up to a point. Once a central bank is introduced, however, this allows a government to simply create more spendable money for itself. Hunter Hastings explains how Mises viewed democracy as simply a utilitarian tool that

[makes] the organs of the state legally dependent on the will of the majority of the moment. … Mises extended this concept of utilitarian democracy to citizens’ control of the budget of the state, which they achieve by voting for the level of taxation that they deem to be appropriate. Otherwise, “if it is unnecessary to adjust the amount of expenditure to the means available, there is no limit to the spending of the great god State.” [Emphasis added.]

While the process is in reality much messier than is implied by Mises here, he is nevertheless correct that if government spending becomes independent from tax revenues, there is essentially no practical limit on the amount of government spending that can take place. Without a clear connection between tax revenues and government spending, it is politically and practically impossible for voters and taxpayers to estimate how much the state has overstepped the imposed budgetary limits. In other words, central banks — especially those that are “independent” and thus unanswerable to the voters — allow governments to do an end run around the voters by allowing governments to create more wealth for themselves beyond the prying eyes of meddlesome taxpayers.

Today we live in an age when government spending has indeed been disconnected from tax revenues. Even if the taxpayers protest against tax increases, central banks can allow governments to simply spend more money without the government having to resort to more taxes. Central banks can do this directly by simply printing money. Or, more commonly, they can do it indirectly through open market operations (such as purchasing assets, including government debt) that increase the demand for government debt, thus allowing governments to finance more deficit spending at artificially low interest rates.

Taxpayers ultimately pay for this additional spending in the form of inflation (or foregone decreases in the cost of living) due to an increase in the fiat money supply. Ordinary people also pay in terms of the ill effects of the boom-bust cycle. The central-bank workaround allows governments to hide the true costs of their spending programs, thus increasing political support for spending that is actually much more costly than it seems.

Simply limiting taxes will do nothing to solve this problem, and indeed, may even make the problem worse. If a government is committed to maintaining a certain level of spending, tax cuts cannot necessarily force any reduction in government spending. The “starve the beast” philosophy only works when there is no central bank.

Reason 3: Spending uses up scarce resources and distorts the economy.

As Rothbard pointed out in Man, Economy, and State, taxes are harmful both on the collection side and on the spending side:

There has also been a great amount of useless controversy about which activity of government imposes the burden on the private sector: taxation or government spending. It is actually futile to separate them, since they are both stages in the same process of burden and redistribution ...

[S]uppose the government taxes the betel-nut industry one million dollars in order to buy paper for government bureaus. One million dollars’ worth of resources are shifted from betel nuts to paper. This is done in two stages, a sort of one-two punch at the free market: first, the betel-nut industry is made poorer by taking away its money; then, the government uses this money to take paper out of the market for its own use, thus extracting resources in the second stage. Both sides of the process are a burden. In a sense, the betel-nut industry is compelled to pay for the extraction of paper from society; at least, it bears the immediate brunt of payment. However, even without yet considering the “partial equilibrium” problem of how or whether such taxes are “shifted” by the betel-nut industry onto other shoulders, we should also note that it is not the only one to pay; the consumers of paper certainly pay by finding paper prices raised to them.

In other words, every time the government buys something with money extracted from the taxpayers, it necessarily drives up the prices of those goods, and prevents those resources from being used by the private sector for private purposes. So, every time the government buys a gun or an airplane, it makes guns and airplanes more expensive for the private sectors, as well as all the factors that go into producing those goods. Needless to say, in addition to driving up prices, the government is also distorting the economy, as well as choosing winners (government employees, contractors, and suppliers) and losers (those not favored by the government). Whole industries — ones that were valued and profitable before the government got involved — can be destroyed in this manner; and the livelihoods of people with them. 

Reason 4: Spending creates political dependency and strengthens the state.

But one of the greatest political achievements of government spending is its success at creating vast coalitions of voters and interest groups that oppose cuts to governments spending. When the Republicans announced their latest budget deal to increase spending by a trillion dollars, it was hard to see how they could have done otherwise:

[I]n 2013, when Pew surveyed Americans as to which government programs should be cut, lopsided majorities opposed any cuts to Medicare or Social Security. When asked what programs should be cut as part of budget negotiations in DC, 87 percent of respondents opposed cuts to Social Security, while 82 percent opposed cuts to Medicare. … [T]hat puts 36 percent of the budget off limits right away.

So where to cut? Perhaps, we could cut defense? According to Pew, 73 percent of those polled are opposed to cutting defense. That puts another 23 percent off limits, so we're now up to 65 percent of the budget that few want to cut. Pew reports that 71 percent of Americans are opposed to cuts in "aid to needy" (i.e., Medicaid, TANF, etc.). … Indeed, the least popular programs, those which more than a third of those polled would like to cut, are the State Department and Foreign Aid. Unfortunately for deficit hawks, those two programs combine for a paltry sum of 38 billion dollars. In other words, only one percent of the budget is ripe for cutting. Good luck getting the government budget under control.

Immense swaths of the American population either receive government transfer payments, such as Social Security, or they work for the government, as in the case of the veritable army of military contractors — many of whom pretend to be “privately employed” — and soldiers which receive most of the 600 billion spent every year on military spending.

All of these programs mean that a single organization — the US federal government — provides for at least a portion of the livelihoods of hundreds of millions of people. That’s real power.

It’s possible that some voters may come out in favor of a tax cut, but such a move will be meaningless since few of them will also sign off on spending cuts too. Thus, even in a world full of talk about “tax cuts,” the ill effects of government spending will continue unabated, indefinitely.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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