Deficit Will Continue: History Teaches That New Taxes Will Be Spent

Taxes will increase in Britain and the United States this year. Germany announced a major tax increase to begin in 1995, after the current recession ends. France did not wait for the end of recession. Almost immediately after it was elected, the new French government proposed a major tax increase.

All of this flies in the face of a durable myth. Governments are supposed to be reluctant to increase taxes because of voters’ hostility. Voters are alleged to punish governments that increase taxes. This is, at best, a half-truth. Voters don’t want their taxes to rise. Average tax rates have increased in most countries throughout this century.

Around 1900, governments in the developed countries taxed and spent no more than 10% of total income. By the beginning of the next century, governments in most of these countries will tax and spend at least 40% of total income. Many do so already, and the United States will follow, if the government manages and finances spending for health care.

The current drives to raise taxes in Britain, France, Germany and the United States have much in common. Each of these governments spends more than it receives in revenue, so each has a budget deficit. In most cases, the deficit is large relative to past performance--as much as 5% or 6% of the country’s GDP. Finance ministers rub their hands in anguish. Central bankers warn of impending disaster. Interest rates will have to rise. Presidents and prime ministers join the chorus, or lead it.

This is rubbish. If governments spent money for productive purposes, borrowing to finance their deficits would be like private borrowing. The borrowing would be repaid from the earnings of the productive enterprise. Of course, if the activity were productive, it would not require a government to do it.

Governments spend much of their money on income transfers and wasteful anti-consumer activities such as agricultural subsidies and foreign aid. Conservative governments in Britain, France and Germany that raise taxes are the tax collectors for the welfare state. Instead of balancing the budget by reducing spending, they finance the growth of government spending. Their election rhetoric notwithstanding, they contribute to growth of the government sector.

President Clinton’s campaign promised tax reduction to the middle class and higher taxes on the top 1%. Like the new French government, he claimed on taking office that the budget deficit was larger than expected. The thought of spending reductions passed through the mind of the new U.S. budget director, then vanished. There will be no reduction in total spending; government spending will increase.

The contrast with the private sector is striking. Almost every week for the last two years, there have been announcements of cutbacks and restructurings in the private sector. Businesses, faced with losses or potential losses, eliminate the least productive activities, close unprofitable operations and reduce spending to less than expected receipts so as to earn a profit. Some corporations have reduced spending by 10% or more. Indeed, some state and local governments have chosen to reduce the growth of spending or even to reduce spending. But not the federal government, and not Britain, France and Germany.

When politicians talk about reducing spending, as they often do, they do not literally mean less spending. The reductions they talk about are from a “baseline” that builds in increases in program costs. Reductions may slow the rate of increase. Few programs get less money to spend. Fewer still are eliminated. Defense spending is an exception. U.S. defense spending peaked in 1989, has declined slightly and is likely to continue to fall in the future.

The reduction will not go to the public as lower taxes or to reduce the budget deficit. Most of the money taken from the defense budget will be spent elsewhere. If the governments believed what they say about the harmful effects of deficits, they would use the saving in defense costs to reduce the deficit, but they don’t. Instead, they ask for higher taxes.

Increased taxes do not bring lower deficits. The 1990 tax agreement--the occasion for President Bush’s abandonment of his famous pledge--is only one of many examples. A study of 19 developed countries from 1972 to 1990 by the Organization for European Cooperation and Development shows that there is no relation between changes in government revenue and changes in government deficits. Countries that raised revenue most are just as likely to have large budget deficits as countries with much smaller changes in revenue. The best way to reduce the budget deficit is to keep the growth of spending on consumer entitlements below the growth of output.

Governments harangue about deficits to get more revenue so they can spend more. That is what the Clinton program will do in the United States. The deficit will fall as the economy recovers, but that would have happened without the tax increase. Increases in government spending will absorb most of the additional revenue produced by higher tax rates.