Opinion: Carolina Beat

The Myth of Deficit Spending

Conventional wisdom on both the right and left has it that because the president’s stimulus package is being financed by deficit spending, i.e., borrowing now and taxing later, Congress and the president are forcing future generations to pay for our problems. As the story goes, we are shifting the costs of this massive spending scheme to our children. While this sounds like it makes sense, it is in fact a myth. More than that, it would be impossible to shift costs in this way.

Neither the government, nor anyone else, can spend future dollars. In reality, all current spending must come from current revenues and can utilize only current resources. Every dollar that the government spends, even if borrowed, has to come out of some existing person’s pocket and therefore preempts the use of that dollar somewhere else in the economy — not in the future, but in the here and now.

The government can obtain its borrowed funds by selling treasury bonds to either American citizens or foreigners. If the government borrows the funds that are needed domestically, it is getting money that these citizens either would have invested elsewhere in the economy or would have spent on goods and services. This is what economists call “the crowding-out effect.” In other words, as would be the case if the spending were financed by taxes, the government borrowing simply diverts revenues from other uses.

A typical response is that most of the government borrowing will be from foreigners. In other words, the Obama deficit won’t be crowding out economic activity in the United States because the bonds are going to be sold to investors from other countries. The typical complaint is that we are mortgaging our children’s future to foreigners. First, there is no way of knowing who the bondholders will be in the future when the loans ultimately come due. Treasury notes are sold and resold many times over. This is also true of debt that is originally issued to American citizens.

The real problem has nothing to do with who holds the note at the time of repayment. A good economist asks: what else would these foreigners be doing with those dollars they are lending to the United States Treasury? Because they are lending dollars, as opposed to euros or yen, this money would be spent ultimately on American goods — thereby increasing exports — or otherwise invested in the U.S. economy. In other words, the conclusion is the same regardless of whom the money is barrowed from. The real costs of government spending, no matter how it is financed, are experienced in the here and now.

Also, regardless of where the money comes from, i.e., taxes, borrowing, or printing, government spending always preempts other spending in the economy, not only on the borrowing side, as just noted, but also on the spending side. Those who get the borrowed funds will have purchasing power transferred to them. Because of this, they will increase the demand for the resources that they use, which will increase the cost of those resources to other businesses and consumers. In other words, government spending financed by borrowing, like all other government spending, preempts growth in the private sector. Government spending always competes with private-sector spending for scarce resources.

What deficit financing does is transfer wealth from future taxpayers to future government bondholders. When the bills come due, some of our children and grandchildren, through higher taxes, will have their income coercively transferred to those of our children who hold the debt. This is the real problem with deficit spending; the government is extending and expanding its coercive powers to transfer private wealth in future generations. In this sense, all of Obama’s debt is making our children less free.

Cordato is an economist and vice president for research at the John Locke Foundation..