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Formulating
Fiscal Policy
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Fiscal policy is the domain of Congress, which has sole
authority over
government spending and taxation. This involves a far wider range
of issues than does monetary policy which is basically one-dimensional,
namely the selection and control of the short-term interest rate.
Both fiscal and monetary policy should have the same ultimate objective
-- full employment and real economic growth. But fiscal
policy
in the U.S. is often a matter of special interest politics rather than
a coherent program. While both must work together to achieve the
basic goal, unfortunately they seldom do.
Financing Government Programs
All government spending is “financed” with revenues from
taxes or borrowing.
It is not always clear which of these two sources of funds is the
better
choice for a particular program. As a general rule, government
investment
in infrastructure such as the transportation system is best financed
with
borrowed funds. This helps to spread the costs over the life of
the
benefits. On the other hand, government salaries, subsidies of
various
kinds, and transfer payments for social benefits which constitutes a
major
portion of the budget, are usually best funded with tax revenues.
The Crowding Out Hypothesis
A commonly heard criticism of deficit spending, is that
it “crowds out”
private sector investment. It is argued that government borrowing
tends to increase interest rates, or that it consumes loanable funds
that
would otherwise be available for private enterprise. There is no
significant correlation between deficit spending and real interest
rates.
And what is often overlooked is that all borrowing is promptly spent
back
into the economy.
Borrowing and taxing redistribute liquidity, but do not
reduce the total
of bank deposits or drain dollars from the private sector.
Crowding
out in the financial sense is largely non-existent. Real
crowding
out can occur when the government calls on real resources
currently
in demand by the private sector, but that usually happens only in war
time.
Taxing Guidelines
Taxes have an important effect that differs from
borrowing. Borrowing
is based on voluntary lending according to investment
preferences
of the private sector. Taxes are extracted according to
formulas
set in the tax code by Congress. The tax system should minimize
the
distortions and inefficiencies that result from high marginal rates and
inordinate exemptions, deductions, and loop holes that shrink the base
subject to taxation. Under conditions of slack employment,
increases
in taxes or cuts in desirable outlays with the intent to achieve
deficit
goals should be avoided. They are almost always
counterproductive.
Monetary Policy Coordination
In general, increased taxes on the factors of production
-- labor, land,
and natural resources -- will cause prices to rise. If the
monetary
authority then raises interest rates to counter the inflation by
curbing
aggregate demand, it will be more difficult to achieve a high level of
employment. If the goal is maximum employment and output, as it
should
be, the monetary authority should lower interest rates when increased
taxes
act to reduce supply or raise costs. That may cause higher prices
in some sectors, but result in less reduction in total output and
employment
which is what counts most.
For sustained growth, there needs to be a monetary and
fiscal policy
that promotes growth. That means keeping money and credit as easy
as possible. There is no excuse for allowing fears of inflation
in
a slack economy to keep real interest rates high and credit
tight.
Fiscal Policy and Private
Sector Wealth
Fiscal policy should enable the public to acquire
sufficient net
financial wealth, broadly distributed, to generate the spending needed
to keep the economy prosperous. A major part of that wealth
consists
of the financial liabilities of the government, mainly Treasury
securities.
That means in a healthy economy both national debt and GDP should on
average
grow together in a roughly stable debt/GDP ratio.
In the words of Walter Mead, writing in 1993 for the Los
Angeles Times:
“The national debt is no doubt a terrible thing. One day it will ruin
us
all. Everybody says it, so it must be true. But it is 300 years
old
and it hasn’t ruined us yet. On the contrary, sinking deeper into
debt, Britain and then the United States created the richest, freest,
and
most dynamic societies the world has ever known. These two
feckless
debtors beat back tyrants like Napoleon and Hitler. They settled
continents, created new technologies, and flew to the moon.”
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