Why treasurers should go back to economics school – Extracts of Geoff Harcourt article

In a perceptive article appearing in the web journal The Conversation (19 Aug 2014) Geoff Harcourt took the federal treasurer to task over his misunderstandings about the role of fiscal policy in the economy. The current federal treasurer falls firmly within the category of deficit hawks because he appears obsessed with the objective of achiev- ing a regime of budget surpluses.

It would be wrong to conclude from the deficit hawkishness of this treasurer that his opposition counterpart is a deficit dove. The reality is that the previous federal treasurer (in the Labor government) was similarly obsessed with achieving a surplus.

The following extracts are from Prof Harcourt’s article.

“Though money and financial factors are integrated in complex ways in the workings of the economy, ultimately it is real resources – work forces (sizes and skills), capital goods and natural resources – that set the upper limit at any moment of time on the size of the community’s standard of living.

“And yet that hasn’t stopped successive Australian federal treasurers, and their counterparts in other advanced capitalist economies, increasingly using terms which reflect misunderstandings of the role of fiscal policy in economic policy.

“When used by treasurers, phrases such as ‘we cannot afford it financially’ or ‘where is the money to come from?’ or ‘you are using taxpayers money’, confuse affairs of the state with what should be left to the workings of individual households.

“Obsessed with the relationship of government expenditure and taxation, many treasurers suffer from deficit size fetishism, and fall victim to the ‘balancing the budget over the cycle’ fallacy. Many also get caught up with hypothecation – matching specific government expenditures with particular tax sources.

“Some confuse the significance of the national debt to income ratio for the present and future operations of the overall economy, especially a supposed link between them and the welfare of future generations relative to the welfare of the present generation. The ‘we’ll all be ruined’ fear. ”

Deficit obsession

Prof Harcourt now addresses the commonly held notion that government spending and taxing are bad.

“The term ‘deficit size fetishism’ reflects the view that government expenditure and taxation are always ‘bad’, regard- less of the absolute sizes and compos- itions of the two and the overall state of the economy, for example, the rate of unemployment, the rate of growth, the rate of inflation (or deflation, as Japan has experienced in recent decades).

Both the sizes and compositions of government expenditure and taxation need to be assessed by other criteria.

“The composition of taxation, the contributions to the whole of indirect, direct and other forms of taxation and their incidence on different groups in the community, ought to reflect equity (fairness), for example which groups can least or most afford to pay partic- ular forms of tax and taxes overall.

“The total tax take should reflect the impact required on overall levels of spending in the economy, these in turn determining levels of output, income and employment both prevailing and what the government would like to see prevail.”

Spending and borrowing

Next, Prof Harcourt addresses the issue of why the modus operandi of the affairs of the state should not be confused with issues that properly apply to household budgeting, and why government borrowing – if it is done correctly – can be good for the economy.

“Government expenditure composition is made up, firstly, of current expenditures, the salaries of parliamentarians, government employees generally; transfer payments from taxpayers to recipients of social services including unemployment benefits, pensions and so on; and interest payments to the domestic holders of government bonds.

“Secondly, there is government (public) capital expenditures on social infra- structure, the creation of new railways, roads, hospitals, schools and so on.

Ideally, the level and composition of capital expenditure should be determined by the perceived medium- to long- term needs of the community for the services they ultimately will provide.

“These expenditures have a significant impact on the efficiency and productivity of the nation, so there is no reason why they should not be financed at least in part by borrowing. The latter does entail a real burden because interest and principal repayments mean higher levels than otherwise of exports to service them would be required.

Nevertheless, if the borrowings are used wisely, this burden may be met and the economy will still be better off than it otherwise would have been.

“So government expenditure and taxation, especially taken in isolation, are not interesting numbers. Certainly not numbers to have a fetish about, even if you are not just an ordinary Joe, or an earthbound Swan, or a surplus lover Costello that hands out tax cuts to friends.

“The criterion of balancing the budget over the cycle (or, preferably, creating a surplus) is based on a fallacy that the economy is not growing, that it will remain at the same level of activity forever. At least since the 1940s it has

been known that if economies on average grow from cycle to cycle, it is possible always to have a series of working deficits (within reasonable limits) without having those deficits explode.”

The real tax and spending relationship

In conclusion, Prof Harcourt discusses tax hypothecation (the dedication of a specific tax revenue for a particular expenditure) to government budgeting.

“One outcome of this discussion is that hypothecation is a fallacy – particular forms and amounts of taxes should not be attached to any particular forms of expenditure.

“Citizens should pay taxes according to their overall ability to pay and they should receive government payments according to their particular characteristics as citizens – unemployed, aged, disabled and so on. The total of these government expenditures will be financed from the total funds raised by taxation and borrowing.

“ ‘Treasurer Speak’ in recent decades reflects serious conceptual misunderstandings of how economies work and how the functions of the state should be integrated with the workings of the private sector. The end result has been the use of scare tactics over a wide range of issues, tactics which have no foundation in proper economic logic.”

Source: https://theconversation.com/search?q=geoff+harcourt (The Conversation, 19 Aug)

Dr Geoff Harcourt is a leading post Keynesian economist and visiting Professorial Fellow at the Univ of New South Wales – Australia Business School