Deficits have become emotive hot buttons.
A deficit arises when governments spend more than their income, which consists mainly of taxes. If the deficiency is not immediately covered, current deficits turn into long-term government debt.
No one seems to be neutral about deficits and the resulting debt.
Traditional economists argue against them, saying that spending beyond your means can ruin governments and national economies for the same reasons such practices hurt families and individuals.
Government credit ratings will fall as debt rises, increasing the cost of carrying the growing debt and leaving citizens with a higher tax burden to pay the interest on that debt. This also leaves the government with less discretionary income to provide the health care, education and other government goods and services we expect.
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A relatively new approach is Modern Monetary Theory (MMT), which sees no harm in ongoing deficit spending by sovereign nations with their own currencies. Such spending, proponents postulate, generates economic growth and, thus, increased tax revenues. And those revenues help to balance the government budget.
Too bad there has never been an example of this theory working.
Deficits are no longer just an issue for academics and policy wonks to discuss. Economies around the world have been completely blindsided by the COVID-19 pandemic. Most governments, including Canada’s, have shovelled money into the pockets of individuals and businesses to try to keep their countries functioning.
Such deficit spending is a good thing but not a new idea. Economies collapse when individuals, businesses and governments don’t spend enough. When that happens, it’s up to government to financially support the economy even if it means running a deficit.
Economist John Maynard Keynes realized this early in the last century. Business was in trouble. Many people had no jobs. Governments, clinging to balanced-budget orthodoxy, reduced their spending as well. The result was the Great Depression of the 1930s. It took the Second World War to change those circumstances.
Keynes’ position was that when the private sector isn’t spending enough to keep the economy going, government must run deficits. Balanced budgets, even if those budgets are large, won’t do it.
We should be happy about current government deficit spending. It’s what stands between us and another 1930s-type depression.
Unanimity disappears, however, when we consider what the deficit spending should be used for and what should happen next.
Government spending should create jobs, prosperity and tax revenue in the long term. We need physical and social infrastructure that generates employment and income for people in the short run, and improves Canadian productivity and output in the longer run.
Government spending has rarely accomplished this in the past. Assuming that any resulting increase in tax revenue will be sufficient to pay the bills is wishful thinking.
Keynes had a better idea about how to deal with deficits and manage the costs of needed government spending. It covered the entire business cycle and tackled the feared bogeyman of inflation as well.
In bad times, governments should run deficits, said Keynes, but good times usually both precede and follow bad times. In good times, he said, governments should run surpluses.
Surplus is a word you probably haven’t heard for a while. When times are good, governments are to spend less than they receive in revenue. This reduces inflationary pressure that can arise in boom times and allows government to put money aside to cover past or future deficits.
We can compare government deficits and debt to a family mortgage. Even though a mortgage is not desirable in itself, most of us wouldn’t own a home without one. However, we need longer term plans in place to pay it off.
A government deficit is sometimes necessary and even helpful. But it should be followed by plans to eliminate the deficit and reduce the debt. If for no other reason, that will leave us in a much better position the next time government financial intervention is needed.
Roslyn Kunin is a consulting economist and speaker.
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