Urgent need for deficit financing No excuse for more tax abuse
– The fiscal and monetary measures needed to tackle the economic downturn, in large part due to policy responses to COVID-19, require more government accountability and discipline to minimize abuse. Such measures should provide relief to vulnerable people, prevent recessions from turning into depressions and restore progress.
They should help the most disadvantaged, especially in the informal sector and casual jobs. Efforts should also be aimed at accelerating structural transformation towards the Sustainable Development Goals (SDGs). Progress was already fall behind before the pandemic, for example, on the mitigation of global warming.
The pandemic and the political responses have created a most unusual situation, requiring extraordinary political responses to mitigate threats to livelihoods and incomes. Bold initiatives are needed to overcome obstacles to sustainable development.
Unconventional solutions must be considered because conventional wisdom is part of the problem, especially since the neoliberal counterrevolution against Keynesian and development economics four decades ago.
In recent decades, counter-cyclical fiscal policies during business cycles have been replaced by annual “balanced budgets” and “fiscal consolidation”. This has involved cuts in public spending, including social services, and social protection more broadly.
Taxation has become more regressive, with lower direct tax rates on wealth as well as corporate and personal income, while indirect taxation, mainly on consumption, has increased. Such tax reforms and regressive public spending have worsened inequalities.
Financing the inflationary deficit?
Citizens often assume that governments tax first to spend. In practice, they usually spend first and then tax. Public spending generally requires more borrowing and debt, traditionally by selling bonds and other securities, including to the central bank.
Selling government bonds to the central bank increases the money supply, unless the monetary authority reduces its other liabilities accordingly. Neoliberal critics insist that the increase in the money supply, commonly referred to by the media as “printing money”, must inevitably make inflation worse.
However, there is overwhelming empirical evidence to the contrary, as the US Federal Reserve, European Central Bank, Bank of England, and Bank of Japan have dramatically increased money supply over the past decade. They did this mainly by buying private securities and by inducing commercial banks to lend more at lower interest rates.
Since such unconventional monetary policies, including “quantitative easing” (QE), over the past decade have not raised prices, there is no reason to assume that central banks buying treasury bills – to pay for aid, recovery and building a better future – to be inflationary.
Inefficient deficit spending?
Governments can also borrow from the public, for example by selling them bonds. But according to neoliberal beliefs, borrowing from the public will raise the interest rate, “crowding out” private borrowers who cannot afford the higher “borrowing costs”. As a result, they argue, investment will fall, slowing growth.
But for Keynesians, government spending is not inflationary when economic resources are not fully utilized or utilized, that is, as long as there is excess spare capacity, such as unemployment.
Keynesians also reject the neoliberal claim that public investment “crowds out” such private spending. Keynesians point out that economic stagnation discourages private investment. By stimulating demand and sales, public spending increases profits and private investment.
Declining private spending or demand therefore requires public spending to stimulate aggregate demand. Public spending on infrastructure, health and education also improves productivity, and hence profitability, offsetting rising borrowing costs. Thus, public spending serves to “attract” and not to “crowd out” private investment.
Inconsistent and unfounded objections
The ‘The Ricardian equivalence objection is very different, claiming that when governments borrow, people spend less, in anticipation of higher taxes. This supposedly undermines the intention to increase government spending to increase aggregate demand. But again, there is no strong evidence to support this effect.
This argument is not only quite different from earlier objections to “crowding out” and inflation, but also implies that the three neoliberal arguments against deficit financing are mutually contradictory and cannot be consistently supported.
In contrast, the International Monetary Fund (IMF) find that “debt-financed projects could have significant effects on production without increasing the debt-to-GDP ratio, if clearly identified infrastructure needs are met through efficient investments”, accelerating the recovery from the global financial crisis ( CFM).
Likewise, in response to recessions induced by the pandemic, the IMF argues that “increased public investment… could help revive economic activity after the most brutal and deepest global economic collapse in contemporary history”.
“Healthy finance”, fiscal rules
Unfortunately, expansionary fiscal policies are often mistreated by the “short-term” governments of the day, little concerned with the long- and even medium-term consequences of increased spending, borrowing and debt.
In response, the neoliberals ostensibly invoke ‘healthy finances‘ principles. Sound finance seems desirable when spending abuse, waste and leakage are prevalent. However, he became a pretext to dogmatically oppose bold tax measureseven if necessary. Neoliberals want fiscal rules from governments in a straitjacket, forcing authorities to balance budgets every year or keep budget deficits to a minimum. Many advocate independent tax advice, akin to politically irresponsible “independent” central banks, ostensibly to minimize political influence over government budget decisions.
Even where fiscal rules or boards allow flexibility in times of crisis or in response to severe shocks, the biases in favor of “fiscal consolidation” and procyclicality run deep, undermining development efforts. Therefore, the fiscal rules hinder, rather than help development.
Counter-cyclical and developmental “functional finance”
In place, ‘functional financeProposed by Abba Lerner to lessen prejudices against activism in fiscal policy, is necessary. Rather, public spending and fiscal policy should be consistent with countercyclical and development fiscal needs.
This has been recognized by the Development Committee of the World Bank and the IMF in Fiscal policy for growth and development: an interim report who observed:
“The problem with the design of fiscal policy reflects the choice of the budget deficit as the policy objective. The budget deficit is a useful indicator…, but it offers little indication of the longer-term effects on public assets or on economic growth… There is a clear need for fiscal policy to incorporate… the likely impact of the level and the composition of spending and taxation on long-term growth while maintaining the emphasis on indicators essential to economic stabilization ”.
Oppose abuse, no more spending
Unresponsive governments often take advantage of real, exaggerated or imagined crises to pursue macroeconomic policies aimed at ensuring the survival of the regime and for the benefit of politically well-connected cronies and supporters.
Undoubtedly, much better governance, transparency and accountability are needed to minimize the likely immediate and long-term damage from the “leaks” and abuse associated with increased borrowing and spending.
There needs to be much greater discipline and tighter control over government borrowing, spending and debt, as well as government guaranteed commitments. Systematically countercyclical fiscal policy throughout business cycles provides useful guidance.
Citizens and their political representatives, especially in developing countries, must develop more effective ways of disciplining the conduct of fiscal policy to ensure space for responsible counter-cyclical and development spending. However, this task should not hamper the urgent efforts needed to finance relief, rehabilitation and sustainable development.
Central banks must support governments’ fiscal stimulus plans for lean, recovery and building a better future. This requires complementary fiscal and monetary policies working in tandem for sustainable development.