Deficits: Real Issue, Phony Debates

What's at stake on either side of the class divide.

By Rick Wolff

Deficits have now risen, yet again, to headline status. Conservatives inside and to the right of the Republican Party frame the national debates by attacking deficits. They want to reduce them by cutting government spending. Liberals respond, as usual, by insisting that overcoming the crisis requires big government spending (“stimulus”) and hence big deficits. Most Americans watch the politicians' conflicts with mixtures of confusion, disinterest, and disdain. Yet deficits pose a real issue for everyone, one that the debates among politicians and their economist advisors miss, ignore, or hide.

When the federal government raises less in taxes and other revenues than it spends, it must borrow the difference. Such annual borrowing is each year's deficit. The U.S. Treasury borrows that money by selling bonds, federal IOUs, to the lenders. The accumulation of annual deficits comprises the national debt, the total of outstanding U.S. treasury bonds. So the first and simplest questions about deficits are (1) why does the federal government choose to borrow rather than to raise taxes? and (2) why does it borrow rather than cut its expenditures? The twin answers are profoundly political. Elected officials are afraid to raise taxes on business and the rich because their profits and great personal wealth can then finance the defeat of officials who do that. Cutting government spending that benefits business and the rich is avoided for the same reason. As the tax burden shifted increasingly onto middle- and lower-income people in recent decades, elected officials have faced rising tax revolts coupled with demands for more government services and supports.

In the United States—as in most capitalist countries—business and the rich, on one side, and the middle-income and the poor on the other, have placed the same demands on the government budget. Each side has wanted more government spending on what it needs and less taxes on its incomes. Both political parties thus fear raising taxes or cutting spending on the masses because that risks electoral defeats. This has been a very real, basic, and socially disruptive contradiction built into capitalist systems.

These days, business and the rich want both massive government supports to overcome the current crisis as well as their usual government benefits. The latter include government activities abroad—including wars—that secure export markets and access to crucial imports (e.g., the needed quantities and prices of business inputs and consumer goods not domestically available). They also demand the particular subsidies typically provided to agricultural enterprises, transport companies, defense producers, and so on, as well as tax reductions offered for various kinds of investments. Businesses press government to maintain or expand roads, harbors, airports, schools, mass transportation systems, and research institutes crucial for their enterprises' profits. Wealthy individuals want government spending on the police and judicial systems that protect their wealth.

Business and the rich likewise want the government not to raise their taxes. Businesses seek to keep in place their legal opportunities to evade taxes on profits (by means of offshore operations, internal transfer invoicing, etc.). Business and the rich in the United States want donations to their own foundations, to rich universities, art institutions, and their favorite charities to remain subsidized by generous federal tax reductions granted for such donations. They also currently demand the continuation of Bush-era tax exemptions and deductions on taxes on their incomes and on the estates they leave.

Middle-income and poorer Americans demand government spending for their unemployment insurance, as well as spending to prevent or soften the blow of home foreclosures, to provide low-interest mortgage money for their home purchases or refinancing, and to guarantee low-interest educational loans for their children. They want public schools well financed to function as means of advancement for their children. They support government regulation to guarantee safe and honestly labeled consumer goods and services and likewise health and safety on their jobs. They demand Social Security retirement benefits and Medicare. They share support for Medicaid, food stamps, and welfare, despite some demonization of those programs and their recipients. And they oppose both more taxes and higher government deductions from their incomes for these programs.

In all capitalist countries, more or less, the contradiction between these conflicting financial demands on the government's budget has shaped politics. Thus, elected officials have neither raised taxes nor cut spending enough to bring them into balance. Instead they have increasingly resorted to borrowing—running budget deficits. The officials like deficits because they reap immediate political benefits—“satisfying” business, the rich, and all the rest by holding down taxes and maintaining spending—while shifting the political costs of repaying rising national debt and its rising interest costs onto office-holders coming after them (today's equivalent of Louis XV's remark, “aprés moi le deluge”).

Government borrowing also benefits businesses and the rich by offering them an attractive investment. They lend money to the government that then repays those sums with interest. Instead of losing a portion of their wealth by paying taxes, those groups keep that portion (in the form of a purchased government bond) and earn more with it. Businesses and the rich are usually major lenders to their governments; workers rarely are. The same U.S. business leaders who advise governments to “live within their means” simultaneously fill their business and personal portfolios with government bonds.

Each country's unique history, culture, and politics determine how much its government borrows. In the United States, as elsewhere, successive governments (usually of both left and right) have borrowed so much that further borrowing is becoming increasingly difficult. One obstacle looms, because the more a government pays in interest and debt repayment, the less funds it has to undertake the spending business and the public demand. Over the last five years, annual interest payments on the U.S. national debt have averaged over $400 billion. Political opposition to continuing those interest payments, and perhaps anger directed against lenders, may arise (as has already happened in Europe). Since lenders to governments are overwhelmingly businesses, rich individuals, and various government entities (foreign and domestic), such opposition may draw on deep resentments. Rising national indebtedness therefore builds its own opposition. Where and when that happens or even threatens to happen, major lenders stop risking further purchases of government bonds. Unable to borrow as before, governments return to face the original problem: which social groups are going to be taxed more and/or which will suffer government spending cuts.

Greece, Ireland, Hungary, and Spain are among countries whose people have already felt the impacts of their combinations of tax increases and spending cuts. In those countries, businesses and rich citizens have been able to impose their preferred response to the problem of deficits, what politicians call “austerity.” When government borrowing must be reduced or stopped, “austerity” means sharply cut government spending on public sector jobs and services for the mass of people. Across Europe, government after government is being pressed by its businesses and its richest citizens to impose austerity on its people. However, also across Europe, slowly but steadily—because they are less well organized and financed—labor unions, left parties, and left political formations are mobilizing against austerity and for alternative plans. These involve raising taxes on business and the rich and/or reducing the government spending benefiting them.

Because the United States is the world's richest country and can borrow more and more easily than other countries, the federal government has not yet reached the limits of its borrowing capacity. However, states and municipalities are forbidden to borrow for their operating budgets, so they have already imposed austerities across the United States (especially visible in the massive spending cuts on public services in California and New York). Yet in the United States, too, there are the beginnings of signs of an anti-austerity movement. For example, in January 2010, Oregon voters ratified their state's decision to respond to the economic crisis neither by borrowing nor by cutting state expenditures, but rather by raising over $700 million in taxes on businesses and on households earning over $250,000 per year.

Consider this example of this kind of alternative to austerity programs: Every year, two companies catering to rich investors survey their clients. Capgemini and Merrill Lynch Wealth Management's “World Wealth Report for 2010” counts as High Net Worth Individuals (HNWIs) everyone with at least $1 million of “investible assets” in addition to the values of their primary residence, art works, collectibles, etc. HNWIs in the United States numbered 2.9 million in 2009: well under 1% of the people in the United States. The HNWIs' investible assets totaled $12.09 trillion. For 2009, the total U.S. budgetary deficit was $1.7 trillion. Had the U.S. government levied an economic emergency tax of 15% on only the HNWIs' investible assets, no government borrowing would have been necessary in 2009. Obama's stimulus program would have required no deficit, no borrowing, and no additional taxes for 99% of U.S. citizens.

The real debates all along should have been—and now ought to be—about who pays how much in taxes and who benefits in what ways from government spending. Deficits are necessary neither in normal economic times nor when crises hit and government stimulus is required. That business and the rich prefer lending to finance government deficits over being taxed instead is just their understandable self-interest. The rest of us have not only the right to a very different preference, but also a clear basis in economic theory and available empirical studies not to abandon our preference for theirs. We only have deficits because of who pays and who does not pay how much in taxes and who gets how much in government spending.

We should be debating the social acceptability of a capitalist class division between employers and employees that places dangerously contradictory pressures on government budgets. Had we had such debates and a democratic process of deciding them in the United States, deficits and their consequences might have been avoided. But that never happened. Instead, the mainstream debates about deficits have simply assumed their necessity. Those debates then focus narrowly on the size of deficits—whether larger versus smaller is better—rather than on why they exist and who benefits from them. No wonder those debates have never solved the deficit problem; they functioned rather to obscure the underlying issue about who pays for and who benefits from government budgets in capitalist societies.

Rick Wolff teaches economics at the University of Massachusetts-Amherst and is author of Capitalism Hits the Fan: The Global Economic Meltdown and What to Do About It.