Author: Andreas Kapounek (Treasurer and Sponsorships officer)
There are different ways to increase government revenue (a non-complete list):
- Tax more
- Grow the economy so the same percentage of tax leads to more revenue
- Borrow more
Nevertheless, it often seems like politicians neglect the economic realities that trade-offs between these three streams pose.
Tax more? You run the threat of depressing economic growth (as you reduce the incentives to start or expand a business). This means you may end up with less revenue than with the previous, lower, tax burden. This becomes clear in the limit: in the extreme, a 100% income tax would remove any economic (!) incentive to pursue a job, likely leading to the loss of most jobs.
Borrow more? If the markets are led to believe that the government may not be as likely to pay back all of this larger amount of debt than they owed previously, they will ask the government to pay larger risk premiums to lend money to the government. In practice this means that the government will have to pay higher yields on government bonds, as perfectly illustrated by the recent hike in German “Bund” borrowing costs in response to the announcement to moderate the German debt brake to increase defense spending.
Paradoxically, the interplay between taxation and borrowing is what stumped some recent British governments: If you promise to cut taxes and keep expenditure the same, people will assume that you must borrow the difference, driving up borrowing costs. At the same time, if you promise to keep taxes the same but spend more, people will equally assume that you will have to borrow the difference.
So having explored the interplay between taxation and growth, we are left with one more way to fund expenditure: government debt. As the famous (well, in Austria at least) Austrian chancellor Bruno Kreisky said: “And when someone asks me what I think about debt, I tell them what I always say: that a few billion more in debt gives me fewer sleepless nights than a few hundred thousand unemployed people!” I believe most people agree with that statement in principle!
So why can more borrowing be bad? Borrowing can have adverse consequences, because it affects anyone in the country with debt. For example, it drives up the cost of mortgage repayments. Furthermore, it increases the cost of future government debt, making it harder (for example) to raise capital for urgent infrastructure repairs when needed. Or as John F. Kennedy (who might be more familiar to many readers of this blog than Bruno Kreisky) said, when advertising for more spending in economically robust times: “the time to repair the roof is when the sun is shining.”
All sides of the political landscape seem to appreciate these concepts when convenient but forget about them and selectively moralize these principles when not. At face value, it can be hard to see a necessary connection between economic policy and political philosophy. Believing that more borrowing without the matching growth expectations or unfunded tax cuts drive up the cost of debt (bond yields) is neither right-wing, left-wing, libertarian, capitalist, communist, or centrist: it is the best model of reality we currently have.
Least understandable about these moralist views on economics is that it seems as if we broadly agree on the goals we pursue in our economies: There is broad agreement that (other things being equal) more wealth is better than less wealth, better living standards are better than worse living standards, and a more equal income distribution is better than a less equal income distribution. I would broadly call these shared goals “good stuff”. Now, of course, there can be fervent arguments about the relative importance of these goals and this may be a legitimate driver of ideological differences. But surely, we should be opposed to any policy reducing all three and support policies improving all three goals.
There is strikingly much less political agreement on the goals pursued through social policy (people legitimately debate whether a more progressive or more conservative set of values is “better”). On contentious social issues such as reproductive rights, gun control, or school uniforms, people who differ in their political views often do not share a common set of policy goals.
But back to fiscal policy. What I would argue for, is a more honest approach to fiscal policy. It is perfectly legitimate to want to increase public services and equally legitimate to want to cut taxes if one has evidence that either measure may contribute to a more prosperous economy – but on this issue we really cannot have our cake and eat it.
The discussion above has largely focused on taxing and borrowing, but has broadly neglected the size of the economy. To stay with our ill-fitting cake metaphor – perhaps, if we just grow the cake, there will be some to have and some to eat? There is! But growing the economy is hard and getting harder.
As our advanced economies have matured over the second half of the 20th century into the 21st, the technological advances required to support high growth have increased. While it may have been really fruitful to build the Channel Tunnel it would add almost no utility to the European economy to now dig another one. Inventing the iPhone added great value to the economy but “inventing” the iPhone 367 might only marginally grow GDP and living standards. This is also why China is outgrowing the West but is not projected to catch up in per capita terms anytime soon – as they approach the Western level, their growth rates are expected to flatline too. AI might change this logic – but for now, the iron logic of marginal returns is tightening its screws on economic progress.
We should and can be honest about this – in some way, we can even be proud of this. Never in the history of humankind has there been a better time to be alive than today and it is objectively hard to improve the current situation quickly.
There is hope: We are not in the dark about our progress. Economists have spent decades putting the concepts so amateurishly (and in an oversimplified way) articulated by me in this blog into formulas. These formulas do not quite have the predictive power of Newtonian physics (Einstein did away with that anyways!), and acting as if they were a perfect description of the world can be dangerous. While the mathematical modelling underlying classical economics is fantastically rigorous, many concepts have not been experimentally validated (but this topic may need to wait for another blog post). Furthermore, in no way should this blog post diminish alternatives to current economic theories when these alternative descriptions of the economy are model based, yield testable predictions, and these predictions turn out to be true when tested: in fact, I would argue one should be agnostic to dogma and ideology, and focused solely on accurately describing reality, making sure to update beliefs when new evidence arises. Progress should be guided by the scientific method and controlled experiments where possible – if someone serves a piece of cake to 1000 participants, which all proceed to have it and eat it, I might have to find new metaphors. Nevertheless, most current models are performing much better than random guessing at forecasting developments in our economy and are our best available tool to shape policy.
Therefore, we do have means to make educated guesses about which policies may increase “good stuff” and which policies may decrease “good stuff”. Maximizing “good stuff” should guide our fiscal, monetary and economic policy – and nothing else.
Therefore, we should:
- Improve and verify our methods to forecast “good stuff” and create policies accordingly
- Apply these policies
- Measure the effects and adjust policies accordingly
Students Against Pseudoscience 