Government Spending vs. Government Taxation

The state of the American economy is deteriorating at a rapid pace. This is large because of the indiscriminate spending being undertaken by the American government. In order to understand the true scale of this spending, let’s have a look at some numbers.

In 1987, the entire budget controlled by the United States government amounted to about $1 trillion. Within 15 years, this budget doubled and reached $2 trillion in 2002. The next rise was even sharper. In 2009, the budget was estimated to be $3 trillion. In 2016, the budget grew to $4 trillion. The bottom line is that the federal budget is growing at a rapid speed. However, no one seems to be paying attention to this number.

People are more obsessed with the fact that the federal debt has risen to $21 trillion. There are debates about whether attempts should be made to ensure that the federal budget is balanced or not. However, it seems like critics are missing the point. The real problem here is the size of government spending. How the government finances this spending is beside the point. Once the government decides it is going to spend a large amount of money, the private economy suffers.

Let’s understand how that happens with the help of an example.

Why is Government Spending a Problem?

It needs to be understood that the government has no money of its own. If it spends any money, it has to obtain this money from the people in one form or another. There are three common ways that governments use to obtain money from people. For instance, if a government spends $4 trillion and has only $3 trillion it can obtain the balance in the following ways.

  • The first and the most obvious way is that the government introduces more tax on its subjects. This can be directly attributed to the government and hence is highly unpopular.
  • Some governments resort to borrowing money from the bond markets. Now, it needs to be understood that there is only a finite amount of money in the debt markets as well. If the government borrows more and more, less is left for the private sector. Also, excessive government borrowing tends to raise the interest rates making it unviable for the private sector to raise money via this route. Hence, the economic effect is exactly the same as taxation. Money leaves private hands and goes into the government kitty.
  • Lastly, some governments resort to total dishonesty. They simply start printing more currency. As the amount of currency in circulation increases, the currency becomes less valuable. The effect of this is borne by people who are left holding the currency.

It needs to be understood that almost all governments in the world are using a combination of these three measures intermittently. Sometimes, they cut taxes to increases borrowing. Other times they raise taxes to reduce debt. Hence, in effect governments are going around in circles in order to avoid facing the root issue, i.e. government spending.

Why Government Spending can’t be Reined in?

The problem with government spending is that it is popular with the masses. The lower income voters of any country are very happy when the government gives them freebies. However, they are not aware about how these freebies cost them a lot more in the long run.

For instance, consider the fact that most Americans are very happy with the latest tax reforms announced by Donald Trump. They can see a visible difference in the salary that they receive every month. However, what they cannot see is that if the state doesn’t take money in the form of taxes, it will have to borrow the same money. Also, if the state tries to borrow large amounts of money, it will end up increasing the interest rates.

It is, therefore, no surprise that the Federal Reserve has to raise interest rates. On the one hand, Donald Trump is expressing his displeasure at the fact that the interest rates are being raised. However, on the other hand, he is the person who has set into motion the forces which cause interest rates to hike.

The Conclusion

Governments all over the world are trying to create some form of economic magic. They want to give money to the poor so that their votes can be obtained. However, they want to pretend that this money has not been taken from anybody. The bottom line is that once the government has spent money, it will have to take it from the private sector. Hence, to solve the problem governments have to be prevented from spending excess money.

The fact of the matter is that the economy can only grow if government spending is reined in vis-a-vis tax revenues. For instance, if a government is able to collect 20% of the GDP in the form of taxes, it should spend less than 20% of its GDP. Economists such as Milton Freidman are of the opinion that governments should be forced to restrict their spending to less than 10% of the GDP. In such a situation, the taxes would also be restricted to about 10%. Hence, people will be free to choose how they want to spend their money instead of letting the government decide it for them.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to and the content page url.