Basic Economics

by Sowell, Thomas

  How serious such dangers are depends on the size of the national debt—not absolutely but relative to the nation’s income. Professional financiers and investors know this, and so are unlikely to panic even when there is a record-breaking national debt, if that is not a large debt relative to the size of the economy. That is why, despite much political rhetoric about the American government’s budget deficit and the growing national debt it created in the early twenty-first century, distinguished economist Michael Boskin could say in 2004: “Wall Street yawned when the deficit projections soared.”{678} The financiers were vindicated when the size of the deficit in 2005 declined below what it had been in 2004. The New York Times reported:

  The big surprise has been in tax revenue, which is running nearly 15 percent higher than in 2004. Corporate tax revenue has soared about 40 percent, after languishing for four years, and individual tax revenue is up as well.{679}

  Surprise is in the eye of the beholder. There was nothing unprecedented about rising tax revenues without an increase in tax rates. Indeed, there have been at various times and places increases in tax revenues following a cut in tax rates.

  While the absolute size of the national debt may overstate the economic risks to the economy under some conditions, it may also understate the risks under other circumstances. Where the government has large financial liabilities looming on the horizon, but not yet part of the official budget, then the official national debt may be considerably less than what the government owes.

  After the financial crises in the housing industry in early twenty-first century America, for example, the Federal Housing Administration had far less money on hand than they were supposed to have, in proportion to the mortgages that they had guaranteed. As more mortgages defaulted, it was only a matter of time before the Federal Housing Administration would have to turn to the Treasury Department for more money. But any such transfer of money from the Treasury would add to the official annual deficit and thus to the national debt, which could be a political embarrassment before an election.

  Thus, although the Wall Street Journal reported in 2009 that the Federal Housing Administration’s “capital reserves have fallen to razor-thin levels, increasing the likelihood the agency will eventually require a taxpayer bailout,”{680} that bailout did not come until 2013—the year after the 2012 elections.

  When the Treasury Department supplied the FHA with $1.7 billion, {681}only then did the government’s financial liability enter the official annual federal deficit and become part of the national debt. Yet it would be politically impossible for any administration to let the FHA default on its mortgage guarantees, so this financial liability was always just as real as anything that was included in the official national debt, even before the Treasury bailout actually occurred.

  As the national debt of the United States rose in 2013 to nearly $17 trillion—just over 100 percent of Gross Domestic Product{682}—Wall Street was no longer yawning, as Professor Boskin put it nine years earlier.

  It is one thing to have a national debt as large as the Gross Domestic Product, or larger, at the end of a major war, for the return of peace means drastic reductions in military spending, which presents an opportunity to begin paying down that national debt over the ensuing years. But to have a comparable national debt in peacetime presents more grim options, because there is no indication of the kind of reduction of government spending which occurs at the end of a war.

  Charges for Goods and Services

  As already noted, both local and national governments charge for providing various goods and services. These charges are often quite different from what they would be in a free market because the incentives facing officials who set these charges are different. Therefore the allocation of scarce resources which have alternative uses is also different.

  Mass transportation in cities was once provided by private businesses which charged fares that covered both current expenses—fuel, the pay of bus drivers, etc.—and the longer run costs of buying new buses, trolleys, or subway trains to replace those that wore out, as well as paying a rate of return on the capital provided by investors sufficient to keep investors supplying this capital. Over the years, however, many privately owned municipal transit systems became government-owned. Often this was because the fares were regulated by municipal authorities and were not allowed to rise enough to continue to maintain the transit system, especially during periods of inflation. In New York City, for example, the five-cent subway fare remained politically sacred for years, even during periods of high inflation when all other prices were rising, including the prices paid for the equipment, supplies, and labor used to keep the subways running.

  Clearly, privately owned subway systems were no longer viable under these money-losing conditions, so the ownership of these systems passed to the city government. While municipal transit was still losing money, the losses were now being made up out of tax revenues.

  Incentives to stop the losses, which would have been imperative in a privately owned business faced with financial extinction, were now much weaker, if not non-existent, in a municipally owned transit system whose losses were automatically covered by tax revenues. Thus a service could continue to be provided at costs exceeding the benefits for which passengers were willing to pay. Put differently, resources whose value to people elsewhere in the economy was greater were nevertheless being allocated to municipal transit because of subsidies extracted from taxpayers.

  Incentives to price government-provided goods and services at lower levels than in a private business are by no means confined to municipal transit. Since lower prices mean more demanded than at higher prices, those who set prices for government-provided goods and services have incentives to assure a sufficient continuing demand for the goods and services they sell and therefore continuing jobs for themselves. Moreover, since lower prices are less likely to provoke political protests and pressures than are higher prices, the jobs of those controlling the sales of government-provided goods and services are easier, as well as more secure and less stressful when prices are kept below the level that would prevail in a free market, where costs must be covered by sales revenues.

  In situations where the money paid by those people who are using the goods and services goes into the general treasury, rather than into the coffers of the particular government agency which is providing these goods and services, there is even less incentive to make the charges cover the costs of providing the goods and services. For example, the fees collected for entering Yosemite, Yellowstone, or other national parks go into the U.S. government’s treasury and the costs of maintaining these parks are paid from the treasury, which is to say, from general tax revenues. There is therefore no incentive for officials who run national parks to charge fees that will cover the costs of running those parks.

  Even where a national park is considered to be overcrowded and its facilities deteriorating from heavy use, there is still no incentive to raise the entry fees, when what matters is how much money Congress will authorize to be paid out of general tax revenues. In short, the normal function provided by prices of causing consumers to ration themselves and producers to keep costs below what consumers are willing to pay is non-existent in these situations.

  The independence of prices from costs offers political opportunities for elected or appointed officials to cater to particular special interests by offering lower prices to the elderly, for example. Thus senior citizens are charged a one-time $10 fee for a pass that entitles the holders to enter any national park free for the rest of their lives, while others may be charged $25 each time they enter any national park. The fact that the elderly usually have greater net worth than the general population may carry less weight politically than the fact that the elderly are more likely to vote.

  Although there are many contexts in which government-provided goods and services are priced below cost, there are other contexts in which these services are priced well above their costs. Bridges, for example, are ofte
n built with the idea that the tolls collected from bridge users over the years will eventually cover the cost of building it. However, it is not uncommon for the tolls to continue to be collected long after the original cost has been covered several times over, and when the tolls necessary to cover maintenance and repairs are a fraction of the money that continues to be charged to cross the bridge.

  Where the particular government agency in charge of a bridge is allowed to keep the tolls it collects, there is every incentive to use that money to undertake other projects—that is, to expand the bureaucratic empire controlled by those in charge of the agency. The bridge authority may decide, for example, to initiate or subsidize ferry service across the same waterway spanned by the bridge, in order to meet an “unmet need” of commuters. As already noted in the first chapter, there are always “unmet needs” in any economy and, at a sufficiently low fare on the ferries, there will be people using those ferries—politically demonstrating that “need”—even if what they pay does not come close to covering the cost of the ferry service.

  In short, resources will be allocated to the ferry that would never be allocated there if both the bridge and the ferry were independent operations in a free market, and therefore each had to cover its costs from the prices charged. More important, ferries can be allocated resources whose value is greater in alternative uses.

  In California, for example, the two million ferry rides annually from San Francisco to Sausalito and to Larkspur are subsidized by about $15 per ride, or about $30 million total. On the ferry service from South San Francisco to Oakland and Alameda that began in 2012, the average fare charged per round trip was set at $14, with the subsidy from taxpayers and toll payers combined being $94 per round trip.{683} No doubt this new ferry provides a service that benefits the riders. But the relevant question economically is whether these benefits cover the costs—$108 per round trip in this case, of which only $14 is paid by the riders. The only way to determine whether the benefits are really worth the cost of $108 per round trip is to charge $108 per round trip. But there are no incentives for the officials who run the service to do that, when subsidies are readily available from taxpayers and bridge users.

  Sometimes taxpayer-provided subsidies for some government-provided goods and services are said to be justified because otherwise “the poor” would be unable to obtain these goods and services. Putting aside for the moment the question whether most of “the poor” are a permanent class or simply people transiently in low income brackets (including young people living with middle-class or affluent parents), and even accepting for the sake of argument that it is somehow imperative that “the poor” use the particular goods and services in question, subsidizing everybody who uses those goods and services in order to help a fraction of the population seems less efficient than directly helping “the poor” with money or vouchers and letting the others pay their own way.

  The same principle applies when considering cross-subsidies provided, not by the taxpayers, but by excessive charges on some people (such as toll bridge users) to subsidize others (such as ferry boat riders). The weakness of the rationale based on subsidizing “the poor” is shown also by how often taxpayer subsidies are used to finance things seldom used by “the poor,” such as municipal golf courses or symphony orchestras.

  In general, government charges for goods and services are not simply a matter of transferring money but of redirecting resources in the economy, usually without much concern for the allocation of those resources in ways that maximize net benefits to the population at large.

  GOVERNMENT EXPENDITURES

  The government spends both voluntarily and involuntarily. Officials may voluntarily decide to create a new program or department, or to increase or decrease their appropriations. Alternatively, the government may be forced by pre-existing laws to pay unemployment insurance when a downturn in the economy causes more people to lose their jobs. Government spending may also go up automatically when farmers produce such a bumper crop that it cannot all be sold at the prices guaranteed under agricultural subsidy laws, and so the government is legally obligated to buy the surplus. Unemployment compensation and agricultural subsidies are just two of a whole spectrum of “entitlement” programs whose spending is beyond the control of any given administration, once these programs have been enacted into law. Only repeal of existing entitlement legislation can stop the spending—and that means offending all the existing beneficiaries of such legislation, who may be more numerous than those whose support made that legislation possible in the first place.

  In short, although government spending and the annual deficits and accumulated national debts which often result from that spending are often blamed on those officials who happen to be in charge of the government at a given time, much of the spending is not at their discretion but is mandated by pre-existing laws. In the U.S. budget for fiscal year 2008, for example, even the military budget for a country currently at war was exceeded by non-discretionary spending on Medicare, Medicaid and Social Security.{684}

  Government spending has repercussions on the economy, just as taxation does—and both the spending going out and the tax revenues coming in are to some extent beyond the existing administration’s control. When production and employment go down in the economy, the tax revenues collected from businesses and workers tend to go down as well. Meanwhile, unemployment compensation, farm subsidies and other outlays tend to go up. This means that the government is spending more money while receiving less. Therefore, on net balance, government is adding purchasing power to the economy during a downturn, which tends to cushion the decline in output and employment.

  Conversely, when production and employment are booming, more tax revenues come in and there are fewer individuals or enterprises receiving government financial help, so the government tends to be removing purchasing power from the economy at a time when there might otherwise be inflation. These institutional arrangements are sometimes called “automatic stabilizers,” since they counter upward or downward movements in the economy without requiring any given administration to make any decisions.

  Sometimes more is claimed for government spending than the reality will support. Many government programs, whether at local or national levels, are often promoted by saying that, in addition to whatever other benefits are claimed, the money will be spent and respent, creating some multiple of the wealth represented by the initial expenditure. In reality, any money—government or private—that is spent will be respent again and again. In so far as the government takes money from one place—from taxpayers or from those who buy government bonds—and transfers it somewhere else, the loss of purchasing power in one place offsets the gain in purchasing power elsewhere. Only if, for some reason, the government is more likely to spend the money than those from whom it was taken, is there a net increase in spending for the country as a whole. John Maynard Keynes’ historic contribution to economics was to spell out the conditions under which this was considered likely, but Keynesian economics has been controversial on this and other grounds.

  The Keynesian policy prescription for getting an economy out of a recession or depression is for the government to spend more money than it receives in tax revenue. This deficit spending adds to the aggregate monetary demand in the economy, according to Keynesian economists, leading to more purchases of goods and services, thereby requiring more hiring of workers, and thus reducing unemployment. Dissenters and critics of Keynesian policies have argued that markets can restore employment better through the normal adjustment processes than government intervention can. But neither Keynesian economists nor economists of the rival Chicago School represented by Milton Friedman have advocated the kind of ad hoc government interventions in markets actually followed by both the Republican administration of Herbert Hoover and the Democratic administration of Franklin D. Roosevelt during the Great Depression of the 1930s.

  Costs vs. Expenditures

  When discussing government policies or program
s, the “cost” of those policies or programs is often spoken of without specifying whether that means the cost to the government or the cost to the economy. For example, the cost to the government of forbidding homes or businesses to be built in certain areas is only the cost of running the agencies in charge of controlling such things, which can be a very modest cost, especially after knowledge of the law or policy becomes widespread and few people would consider incurring legal penalties for trying to build in the forbidden areas. But, although such a ban on building may cost the government very little, it can cost the economy many billions of dollars by forbidding the creation of valuable assets.

  Conversely, it may cost the government large sums of money to build and maintain levees along the banks of a river but, if the government did not spend this money, the people could suffer even bigger losses from floods. When the cost of any given policy is considered, it is important to be very clear as to whose costs are being discussed or considered—the cost to the government or the cost to the economy.

  One of the objections to building more prisons to lock up more criminals for longer periods of time is that it costs the government a large amount of money per criminal per year to keep them behind bars. Sometimes a comparison is made between the cost of keeping a criminal in prison versus the cost of sending someone to college for the same period of time. However, the relevant alternative to the costs of incarceration is the costs sustained by the public when career criminals are outside of prison. In early twenty-first century Britain, for example, the financial costs of crime have been estimated at £60 billion, while the total costs of prisons were less than £3 billion.{685} Government officials are of course preoccupied with the prison costs that they have to cover rather than the £60 billion that others must pay. In the United States, it has been estimated that the cost of keeping a career criminal behind bars is at least $10,000 a year less than the cost of having him at large.{686}