Why Government Stimulus Isn’t a Free Lunch

Your editor spent most of yesterday polishing off the August issue of Australian Small-Cap Investigator. Today we’ve just a few small bells and whistles to add to it, before we should have it delivered to subscribers after 4.10pm this afternoon.

If you’re not a subscriber yet, then why not take a few moments to read how you too can become what I like to call a Disaster Profiteer…

Anyway, on with today’s Money Morning. While the scumbags in Canberra squabble like spoilt brats over who gets to tax and spend your income, we’ve been cruising the streets of the interweb to see what humbug and nonsense we can uncover.

And boy, have we come across plenty of it.

Take for example a paper by Phil Hagen and Nicholas Gruen titled, “Repaying the fiscal stimulus”.

You can read the full paper by clicking here.

We knew we weren’t going to like what was in the paper when we saw the quote on the front page by Keynesian fan, Joseph Stiglitz:

“If you hadn’t spent the money [Australian stimulus], there would have been waste… You would have had high unemployment, you would have had capital assets not fully utilised – that’s waste. So your choice was one form of waste verses another form of waste…”

And so the quote goes on for another mind numbing eight lines or so.

But it’s once you get into the guts of the nine page report that the real nonsense begins. It’s crammed full of everything the Keynesians and other interventionists would have you believe is true.

However, it only takes a small tap for their argument to collapse.

Before I go through the details, in a nutshell the paper argues that the Australian stimulus programme is self-funding. Simply because whatever money was handed out by the government eventually comes back to the government as tax receipts.

Here’s how Hagen and Gruen put their case:

“Thus for each dollar Australians received from the cash payments of late 2008 and early 2009, they only increased the Australian governments’ debt that must ultimately be serviced and/or paid back by around 77.5 cents with the other 22.5 cents being the tax windfall from additional employment. Australians received nearly $30 billion in one off transfers but will need to service and/or [pay back] only around $23.2 billion in state and federal taxes.”

So, is what Hagen and Gruen claim true?

I mean, it sounds reasonable enough doesn’t it? If we accept the argument that the stimulus payments kept people in jobs then it must be true that those people paid taxes on the income they otherwise wouldn’t have received.

Therefore the tax paid has gone straight back to the government helping to reduce the debt incurred as a result of saving the jobs.

At first glance you could be forgiven for thinking they’ve got a valid case. Let’s put their case in simple terms for them…

The government hands out $1. The people who receive it then spend it. That money helps to keep people employed. They pay 22.5 cents of every dollar they earn in tax back to the government.

Hey presto, the stimulus programme is partially self-funding. And isn’t the Australian government fabulous for having come up with such a great idea.

But as is usually the case, it doesn’t take much effort to cast the self-funding argument aside.

For instance, why didn’t Hagen and Gruen extend this scenario for future years?

If the debt was funded by taxpayers who didn’t lose their jobs this year, then surely those same taxpayers won’t lose their jobs next year and they’ll repay more of the debt. So that in just over three years from now those grateful taxpayers would have fully paid everything back.

It’s the logical extension isn’t it?

Perhaps they didn’t extend the argument that far out because they know it doesn’t stack up.

You see, the main problem with claiming that the stimulus is self funding is that it treats the stimulus programme in isolation from everything else. But you can’t do that.

Whichever way you look at it, it has to be remembered that governments don’t have their own money. Whatever money it has it has taken from individuals. It has either taken it from them now through taxation, or it has taken it from them in the future via debt which must ultimately be repaid through taxation.

So the idea that the government has paid out $1 and then received straight back 22.5 cents without any negative impact on the economy is nonsense.

For a start, it needs to be remembered that the government would already have allocated that 22.5 cents of tax revenue to other projects. Hagen and Gruen themselves argue that these are people who otherwise would be out of work.

Therefore if they were in work they would have been taxed and the government would have already anticipated receiving those tax dollars when it formed its budget.

Let me put it this way, the $30 billion in taxpayer handouts was additional government spending over what it had budgeted. As we recall – without looking to check – the Australian federal government spends around $330 billion per year and raises taxes of roughly the same amount.

Hagen and Gruen argue that the tax receipts from the stimulus programme equalled around $6.8 billion. But for the argument to hold that these were jobs that would have been lost then surely the $6.8 billion of tax revenue is revenue that was expected as part of the $330 billion budget.

So if the $6.8 billion from the stimulus job saving has gone to pay back some of the stimulus debt then it must surely mean that the budget ex-stimulus is now short by $6.8 billion.

In other words, there is still a $30 billion shortfall that the government needs to cover.

Whichever way you cut and dice it, it’s not possible for a stimulus programme to be the self-funding scheme that the Keynesians and interventionists would have you believe.

Take the argument further. Using their theory, why doesn’t the government spend $100 billion today to save/create even more jobs knowing that $22.5 billion will head back to the government’s coffers next year, with the whole thing being paid for three-and-a-bit years after that?

Or why not $1 trillion? That would be even better wouldn’t it? Imagine all the jobs that could be saved and created that way.

It doesn’t take a PhD from Harvard to figure out that whether it’s $30 billion, $100 billion or $1 trillion, that money has to come from somewhere. And if it comes from somewhere it has to be repaid.

And that either means increasing taxes or keeping them higher than they otherwise would have been.

But not if you’re a mainstream economist. In the media release for the paper, Gruen claims that the tax receipts from the stimulus are a “free lunch”:

“So for every dollar the government spent, tax revenue to Australia’s governments rose by around 22.5 cents, leaving just 77.5 cents to be repaid. The total windfall to the budget – and to the community – of the additional tax revenue from the cash transfers is around $6.7 billion. This money and the production of all those people and all that capital kept in employment are the riches of good economic management – the only kind of free lunch we know of.”

Sorry, wrong. There’s no “free lunch” and it’s crazy to believe there is. There’s no free lunch because there’s no such thing as a self-funding government stimulus programme.

The Australian government’s stimulus is no exception to that. The fact is, the stimulus programmes have increased the tax and debt burden on Australian citizens to a greater extent than if the stimulus wasn’t there.

That’s inarguable. No amount of flimflammery can turn a tax and debt increase into an economic windfall for the economy. Taxes and debt are a detriment to an economy, regardless of what the tax and spend brigade would have you believe.

Cheers.
Kris Sayce
For Money Morning Australia

Tagged as: budget, debt, employment, government, job, stimulus, tax