Monday, April 30, 2012

Government as a Household

It's a popular analogy, government and household.  If a household has a drop in income it spends less.  By analogy, if government has a drop in tax revenues, it should spend less.  Makes perfect sense.  Unless you actually look at the analogy beyond the simplistic first impression.

First, let's stick with the "government is like a household analogy."  If a family loses income they don't instantly cut spending.  They can't, not unless they want to starve, freeze, and get kicked out of their homes.  Over time they can cut back, but that takes time.  Meanwhile, they look for more income.  They look for new work, second jobs, extended hours, and might argue for a raise (though if unemployment is high this isn't likely).  When they balance their budgets they don't only look at spending; they also look at revenues.

An even greater absurdity is the notion that households must balance their budgets.  Over the long-term, yes.  But over spans of weeks, months, even years, they may run debts.  They take out mortgages, which are a massive source of debt which persists for potentially decades.  They get car loans, another source of debt.  They get college loans for even more.  Households can pile on huge amounts of debt.  The last one may even be necessary, as job prospects and income are far greater with a post-secondary degree, so that not taking on debt is the truly irresponsible action.

People have credit scores and incomes and these are used to determine home much to loan them and at what rate.  Excluding the recent lying-fueled financial bubble, markets are pretty good at loaning money.  If they predict an average loss, they don't loan.

They act the same with governments.  Except in a few cases such as Greece, where the public debt was covered up by a joint public-private partnering on a corrupt government and Goldman Sachs (who has engineered it to make money off the default, still showing that the banks look for profit, rather than civic duty), investors are loaning to governments because they think they will be paid back.  They think that the spending that is being done is either stimulative enough to outgrow interest rates or is at least preventing a loss of value, making the loans as safe place to put money even if not particularly profitable.  If they didn't think so, they'd not loan the money.  If you disagree with that, then you're attacking the very notion that actors in markets seek profits or suggesting that they are all incredibly stupid.

If spending were truly "out of control" relative to expected tax incomes, then the market would stop loaning money.  The government isn't forcing banks and individuals to loan it money.  They are doing it willingly.  If the government fails to pay them back, that's part of the risk of investing.

 The analogy with a household eventually breaks down.  Households are a few people and in the US, people have safety nets.  There are charities and welfare and food stamps.  If the breadwinners can no longer afford living expenses, they can cut spending and their children won't die.  I'm not saying the safety net is perfect in terms of being too strong or weak, but it's there and it means that a family isn't a job loss away from starvation and being beset by bandits.

The magnitudes are different, as well as the responsibilities.  If government stops spending, it ripples out, fast and wide, to hit every single family in America.  Social Security stops and suddenly seniors are without income.  But Social Security isn't the fiscal problem anyway: it won't be insolvent for decades and in the meantime, it's actually a net lender to the government: it holds Treasury bills.  We could cut welfare and food stamps, which are about 13% of the budget, thereby driving millions of citizens further into poverty and possibly starvation.  Private charities aren't going to pick up that slack.  There are not enough jobs for them to all "get a job", not in a recession.  So in effect, advocates of cutting the safety net are suggesting that potentially millions of Americans end up homeless and starving, which would eventually fix unemployment by attrition.  Health care could be cut which would at least have the effect of killing them faster than starvation and exposure.

Infrastructure is about 3%, which on one hand covers bridges to nowhere.  On the other hand, it also covers infrastructure, the roads, bridges, trains, ports, and air system which make it possible to do business here.  Look up the barriers to economic development in poor nations and somewhere between lack of education and perpetual war you'll find lack of paved roads.  Speaking of education, cutting funding there is a great way to ensure that future generations are even less employable, prolonging recessions and stagnation across generations.  Science and medical research are a mere 2% of federal spending and are another necessity for long-term growth.  Cutting any of these are equivalent to selling your arms: it might give some budget relief, but it make future growth and employment even harder.

Households can cut spending without major problems.   Governments cannot.  For all the talk of waste and excessive spending, most of what is spent is spent making this a country worth doing business in, worth living in, and safe enough to work and live in.

Beyond all that, taxes interact in a backward way with the economy.  In a recession, revenues fall.  This is where much of the current "Obama deficit" has come from.  Meeting the legal obligations to citizens, the safety net, tends to get more expensive as more people are unemployed.  None of these are due to bad policies or the particular actions of any adminstrations: neither the Obama or Bush administrations caused the recessions, though the tax cuts by both have increased the budget deficit.  Merely having an economic recovery, with no changes in tax rates or spending, will improve the budget situation.

In summary:
- Governments have obligations to their citizens and their actions have dramatic ripple effects.
- Households, and governments, are under no obligations to run balanced budgets at all times.
- Spending can be stimulative and stabilizing.
- Markets are ultimately responsible for debts as they are the ones who allow them.

1 comment:

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