Squaring the Budget Circle

Should the government borrow more, spend more, tax more?

There is an ongoing public argument about the government’s macroeconomics stance. It is largely based on the fragmentary promises of Labour when it is was in opposition, and amounts to, to simplify, whether the government should borrow more. So let us set out the logic.

Keynes advised a previous Minister of Finance, Downie Stewart, to borrow as much as New Zealand could, to offset the Great Depression. But he also said that were he a lender he would probably not prepared to advance us any more. That caveat is not as strong today. By international standards New Zealand has low public debt (although our private offshore debt is considered too high) and we have a record of prudent and transparent fiscal management. So, subject to concerns over our high private debt, the government should be able to borrow more if it wants to.

However, debt is a burden on future generations. It seems to me totally unacceptable that, except in dire emergencies and then only the short term, today’s generation should borrow for consumption and charge the interest and repayment to future generations. Any borrowing should be on behalf of those who will pay the debt servicing. (The benefits need not necessarily give a commercial return – or its equivalent of lowering costs to producers. For instance, it might make sense to borrow to spend on, say, making New Zealand pest-free.) That Keynesian borrowing should be for investment purposes was implicit in their prescription; in the early days they frequently poured money into investing in state-owned enterprises.

This approach does not meet the underlying demands of many of the government’s fiscal critics. They tend to be deeply concerned at the previous government’s starving of the public sector and think there is a need to spend more on it. (I am not unsympathetic to doing this.) But this is current spending not investment.

Of course, we could redefine some current spending as investment. Curiously, that was the logic of Bill English’s social investment approach. (I think. The notion was driven more by enthusiasm than cool analysis.) I am more cautious. If one invests in a young person’s education or health (very worthwhile activities, I hasten to add) they may migrate and leave any debt to be serviced by those left. Is that just? We should have a rigorous discussion on the issues raised here, but let’s wait for that before we borrow to fund other people’s spending.

In any case, there are urgent worthwhile demands which would be very hard to described a ‘investment’ without misusing the term. I am all for the government’s promise to spend an extra $100m a year on mental health care (providing we have the available resources to spend the money effectively).

There is another complication from spending more on investment, whether it is funded by current revenue (mainly taxation) or borrowing. The more we spend on investment the less we can spend on consumption because the economy is only capable of producing a certain amount.

What about the unemployed? Doesn’t the additional spending give them jobs? Most of the things we want to spend more on are not activities which would employ those with the unemployed’s skills. For instance we want to build more houses, but I would be very loathe to depend upon unskilled workers – as the leaky buildings saga warns. Of course, we could train them to do some of those jobs but that takes time (and resources and teaching skills, which we are not strong on, although we should do it).  And there are some key skills they will not reach easily – those of psychiatrists, for instance. (We could increase the skilled labour supply by immigrants but that raises a host of problems worthy of other columns. See here and here.)

So if we increase public current spending and investment we will have to cut back private consumption and investment. Aside from terrifying the private sector, its investment is normally cut back by higher interest rates (which flow on into higher home mortgage interest rates – ouch). To cut back private consumption one needs to raise taxation (Ouch!). In effect the additional tax would pay for the additional public spending.

At this stage the reader may be realising that the government’s fiscal stance is more complicated than the usual public comments suggest. So let me summarise.

The government could borrow more but the proceeds should, broadly, be spent only upon projects which are of benefit to those servicing the debt in the future. (Some may give a commercial return either directly – e.g. housing and state-owned enterprises – or indirectly – infrastructure – but some may improve future wellbeing without a commercial return – such as environmental enhancement.)

The government could spend more on needed public services (and social transfers) but, broadly, such spending should be funded by additional taxation.

So those who want extra current public spending are, underneath, demanding higher taxes. I do not quarrel with them, providing the additional taxes are raised fairly.

But the government has ruled out substantial extra taxes (I think; election promises are so plastic).

(It is going to substantially increase taxes on motoring. The nuances of why this did not break an election promise I leave to others to discuss. However, the additional revenue is to be spent only on transport which, like many other sectors, seems to be underfunded. That does little to help other spending deficits like housing, mental health services and social transfers already mentioned. Perhaps motorists are lucky in that they pay (almost dedicated) taxes for what they want.)

But transport aside, the public demand is to spend more, including on activities which it should not fund by borrowing. There is a bit of a quandary here. I cannot tell you how the government will square this circle. We await for the budget to give us a clearer idea.