by Henry Hazlitt of Mises.org
[Newsweek column from May 9, 1949, and reprinted in Business Tides: The Newsweek Era of Henry Hazlitt.]
We are now being told that our prosperity has been kept going in the last few years by our huge government spending, particularly on armaments and foreign aid. Any decline in this spending, we are now warned, would bring a recession. We are told, in fact, that if further signs of recession develop the Government must spend still more to keep the boom whipped up.
This doctrine is completely false. Assuming a balanced budget, an increase in government spending does not on net balance stimulate business activity at all. For every dollar that the government spends, the tax-payers have been deprived of a dollar to spend. All that a heavy government spending program can do is to divert spending from one channel into another. If we give Europeans more money to buy American goods, we have just that much less money left to buy our own goods. If we spend more for armament, we have just that much less left for television sets, refrigerators, or food. Even the Nazis knew they were choosing between guns and butter.
A huge government spending program with a balanced budget not only fails to stimulate economic activity but greatly reduces economic welfare. A $15,300,000,000 armament program, regardless of its military justification, leaves us just that much less resources to build new housing or to increase or improve our tools of production for civilian goods. Whether or not our new $5,000,000,000 ERP donation is now needed in Europe, it must obviously force us either to reduce our own consumption or to retard our own capital development by that amount. We cannot give our cake away and eat it too.
The more sophisticated advocates of a “compensated economy” recognize that huge government expenditures do not in themselves create prosperity. They put their emphasis on the amount of monetary purchasing power that government spending adds. This, they point out, is determined by the excess of government expenditures over tax collections. Put more bluntly, the prosperity would be brought about by government deficits. It is not the total size of the government expenditures but the size of the deficits that “adds to purchasing power.”
But when the compensated-economy doctrine is clearly stated in this form it has implications that its proponents have never clearly recognized. The official estimate of government receipts for the 1950 fiscal year is $41,000,000,000. Suppose it were decided that what was necessary to keep the boom whirling was a deficit of $5,000,000,000. This could, of course, be achieved by spending $46,000,000,000 (Mr. Truman has already put forward more than enough schemes to do that easily). But the inflationary deficit could be achieved just as well by holding expenditures to $41,000,000,000 and reducing taxes to $36,000,000,000. Or even by reducing expenditures to $36,000,000,000 and reducing taxes to $31,000,000,000. We could cut expenditures indefinitely, in other words, and still get our added inflation, provided only that we cut taxes still more.
Moreover, taxes could be either reduced or restored quicker than expenditures could be increased or halted. Increased expenditures create determined vested interests and tend to become permanent. Higher taxes to support higher spending destroy incentives and production. Lower taxes increase incentives and production. In short, if we wish to embark upon deficit financing again to keep our inflationary boom going, doing it through tax reductions is more flexible, more effective, and less dangerous than doing it through higher government spending.
But all this merely emphasizes the bankruptcy of the whole compensated-economy doctrine. Increased government expenditures balanced by increased taxes do not keep a boom going at all. Only deficits, financed by the creation of more money and bank credit, could do that. But this would mean merely a resumption of monetary inflation. It could prolong the boom only at the eventual cost of a bigger bust.