April 15 is here and we are required to do the following: tell the government our income and send much of it to Washington.
Austrian-school economists are likely to tell you this is a bad thing and that taxes and government spending lower our living standards. In other words, the more government we are required to finance, the poorer we will be. According to the Austrians, economies grow through capital investments reflecting time preferences of individuals. Furthermore, Austrians actually claim that individual savings lead to economic growth. The more we pay in taxes, the less money we have for capital investment and saving. In other words, the more taxes we pay, the less we have for the building blocks of economic growth.
However, disciples of John Maynard Keynes, like Paul Krugman and others, take a rather different view. For them, wealth is achieved by spending, which creates economic growth. When consumers don't spend enough, government rescues the economy by upping its spending. Because of this, should government raise taxes, it actually stimulates the economy more than individuals can do through their own spending. We could allow people to spend their money as they see fit. But, it's better to be on the safe side and tax as much of it as possible, instead.
The Keynesian “Balanced Budget Multiplier” makes it all possible. It is a version of 2 + 2 = 5. The tax-fueled magic is explained as follows:
- All spending has a “multiplier” effect. Spending increases the incomes of others, who then spend their increased income, and the pattern continues indefinitely.
- Individual savings, according to Keynesians, are “leakages” from the system, and if not offset by equal “injections” via government spending or increased exports, the “multiplier” then works in reverse, pulling the economy into recession.
- Government tax increases, however, have two-fold positive net effects. First, government spends new tax revenues, which quickly multiplies and creates new jobs. Second, by reducing individual incomes, people must spend larger percentages of their incomes to uphold their present standard of living. (The famed Keynesian “multiplier” equals 1 over the savings rate, so the less we save, the greater the multiplier.)
The “logic” of the balanced-budget multiplier differs from the logic of taxation and spending in Denmark. There, individuals pay most of their income in taxes, but supposedly receive marvelous government services that are more valuable to them than what they would have purchased on their own had high tax rates not existed.
Instead, the “Balanced-Budget” multiplier creates wealth by destroying savings. Austrians obviously disagree, and the “reality gap” between Austrians and Keynesians is widened. Austrians emphasize savings, capital accumulation, market prices and market interest rates, profits, losses, with entrepreneurs making decisions in an uncertain climate under the umbrella of economic calculation.
Keynesians promise an easy way out. Just give money to the government, which will spend and spend, and the spending multiplies prosperity. Interestingly, modern intellectuals will tell you that Keynesianism is “real world,” while Austrian economics is “pie in the sky.”
On April 15, Keynesians will contribute to growing prosperity by sending more money to Washington. However, Austrians likely will have a different take.