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General thinking about government deficits is mostly wrong – Darian Hiles

The following is an abbreviated version of an article in the context of the current US federal government budget deficit by Stephanie Kelton, former chief economist for the US Senate Budget Committee Democratic staff and professor of public policy and economics at Stony Brook University, and published in the New York Times on 5 October 2017. [1]

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Donald Trump has promised to deliver “the biggest tax cut in the history of our country” and both the Republicans and Democrats worry about the plan’s potential to increase the deficit. Senator Bob Corker, Republican of Tennessee, said, “If I think it adds one penny to the deficit, I’m not going to vote for it”.

But it would be unwise to oppose tax cuts or any other federal legislation simply because they add to the deficit. Bigger deficits won’t wreck the nation’s finances. This fear is almost Pavlovian and it’s also holding us back. Politicians of both parties should stop using the deficit as a guide to public policy.

Instead, they should be advancing legislation aimed at raising living standards and delivering the public investments in education, technology and infrastructure that are critical for long-term prosperity.

Right now, anything ambitious requires a score from the Congressional Budget Office. A “bad” score – one that adds to projected budget deficits – can easily doom good legislation because law- makers are told that their math doesn’t add up.

But actually it always adds up because Government spending adds new money to the economy and taxes take some of that money out again. It’s a constant churning of pluses and minuses; the Government’s minuses become the real economy’s pluses.

When the government spends more than it gets in taxes, a “deficit” is recorded on the government’s books. But suppose the government spends $100 into the economy and collects just $90 in taxes, leaving behind an extra $10 for someone to hold. That extra $10 gets recorded as a surplus on someone else’s books. That means that the government’s –$10 is always matched by +$10 in some other part of the economy. There is no mismatch and no problem with things adding up.

The problem is that policy makers are looking at this picture with one eye shut. They see the budget deficit, but they’re missing the matching surplus on the other side. And since many citizens are missing it, too, they end up applauding efforts to balance the budget, even though it would mean removing the surplus in the private sector.

When there’s a Government deficit, some of that new money can be traded in for a government bond. What’s often missed in the public debate is the fact that the money to buy the bond comes from the deficit spending itself.

What isn’t missed is the fact that the government pays interest on those bonds. Lawmakers are obsessed with this line item in the budget, as if it’s akin to a cable bill that keeps taking a bigger and bigger bite out of your household budget. It isn’t. Unlike a household, the government doesn’t have to trim parts of its budget to make ends meet. The Congress can always create more room in the budget by adding rows or widen- ing the columns to put more resources into education, infrastructure, defence and so on. It is a political decision.

Of course, there are real limits to what can be done. No country can commit to large-scale infrastructure investment unless it has available labour, machinery, concrete and steel.

Trying to spend too much will cause an inflation probem. The trick is to adjust the budget to make efficient use of the people, factories and raw materials we have.

In a rational world, lawmakers would abandon the crude Congressional Budget Office scoring model and recognize that the risk of overspending is inflation, not bankruptcy. They would avoid fruitless battles over the debt ceiling, and they would acknowledge that the deficit itself could be deployed as a potent weapon in the fights against inequality, poverty and economic stagnation

1. Stephanie Kelton, “How we think about the deficit is mostly wrong”

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