I'm working on revisinig my suggestion for an income-tax plan for Democrats. Several of the responses to my first version, however, were really proposals of the responder's own. One of these involved what the poster claimed was a year-to-year balanced federal budget.
This is not possible, but -- more importantly -- it is not desirable.
Lord Keynes poiinted out that:
1) In any economic situation, savings (as economists mean the term) equals investment (as economists mean the term).
2) The decisions to save and invest are generally made by different persons, and even when made by the same person are not made in synch.
3) When the toal intent to save at a given level of economic activity is greater than the total intent to invest at that level of activity, the level drops until the two intents coincide.
4) Government can raise the level of economic activity by l
Keynes wrote a massive tome demonstrating this, but I can make a more persuasive abbreviated case than the short list above. I do below below the fold.
The first point is that the terms have to be used as Keynes used them. In particular, "savings" is income not spent on consumption. For any period, it doesn't iniclude money that you had at the beginning of the period; it does include money you have in your wallet that you fully intend to spend after the end of the period.
Investment is money spent on productive matter and net change in inventory, investment in plant and equipment and investment in inventory.
The equation is only strictly true of a closed system, one which neither imports nor exports and which meither pays foreign investors nor collects from foreign investments. The entire Earth is certainly such a closed system. The USA is technically not, but the consequences of the analysis are very, very good approximations. We'll discuss this later.
In such a world, there is only so many results of the physical production of goods. They can be consumed, they can be invested in plant and equipment. If they are not, then they go into inventory. Anything taken out of inventory can only be for consumption or for new plant and equipment.
Production + reduction in inventory = Consumption + Investment in plant and equipment + addition to inventory,
OR
Production = Consumption + Investment in plant and equipment + net Investment in inventory.
Now, whenever something is produced, someone gets the reward for production. That has noting to do with deserving those rewards. Maybe Smith grows radishes in his garden and Jones steals a radish; Jones gets the reward from production, but somebody does. In industrial society like the USA, more often production (and distribution) are done by many hands. If you assign a value to the product at any stage, though, the value equals the total of the rewards for production and distrigution. This includee the taxes paid to government.
And any rewards can either be consumed, saved, invested in plant and equipment, or invested in inventory. (In the case -- rare in modern society -- where the reward for production is the product itself, then it either consumed or added to inventory.)
So, adding up value of the products.
Production = Consumption + Saving
Comparing the two:
Savings = Production - Consumption = Investment in plant and equipment + Investment in inventory.
Now, this has been presented as a macro-economic phenomenon over a large area and a significant period of time. It, however, applies to single transactions.
Smith comes into Brown's store and buys a pair of gloves for $10 that Brown values in his inventory at $7.
Brown's profit, $10 - $7 = $3 Brown's savings + $3
Smith's savings, - $10
Total savings -$10 + $3 = - $7
Total Investment, - $7 (Brown's investment in inventory.)
Savings = Investment.
Conversely, if Brown expects to sell 1000 pairs of gloves in a month, and consumers in his town decide to save more -- which is identical to consuming less -- and buy only 800 pairs, then his investment in inventory is $1,400 greater than he intended. Thus he orders fewer gloves than he did the preceding month. If it's just Brown's customers, this gets lost in the fog of the variation of orders.
If, however, there is significantly more saving than expected, the glove orders from many retailers are lower than expected. Glove manufacturers lower production.
If the increase in savings is general -- e.g. if people consume not only fewer gloves but less of products in general, then manufacturing is lower. Manufacturers lay off workers. The workers, in turn, buy less -- not because they are saving more but because they have less money to divide between saving and consumption.
The lower consumption means yet lower employment. (And, for that matter, if the employers eat the lost revenue and maintain their work force, then those employers have less money to spend.)
As the economy gets worse, both the investment in new plant and equipment is lower and people spend a greater fraction of their income on consumption -- therefore a lesser fraction on savings; many of them either borrow or withdraw from their accumulated savings. When the second reduction overcomes the first, the pressure for lower levels of economic activity ceases, and the economy begins to recover.
Clearly, if the government is spending more money than it is taxing, it is absorbing private savings. That exerts an upward pressure on the economy. You might call the federal government the borrower of last recourse.
Of course, there is nothing special about the federal government in this regard. If another factor borrows and spends more, that accelerates the economy. What is special about the federal government is:
1) It is huge. My splurge spending of half a thousand will have the same effect as the Treasury's spending of half a thousand. The Treasury, on the other hand, can afford to spend half a trillion.
2) The federal credit is almost unlimited.
3) The federal government has responsibility for the economic well-being of the country.
=+=+=+=+=+=
So, how does foreign trade enter into this?
We can picture two extremes.
1) If the foreign involvements are constant, that is to say that the same amounts of goods and money cross the border after the federal intervention as before, then the effect of the federal intervention on the economy would be the same as if there were no foreign involvement. (The state of the two equations might be different, but the change would be the same.)
2) If you consider the world economy as a whole, then the intervention would mitigate a global recession.
The actual results will be somewhere between these extremes, probably closer to the first. (Although it might be argued that the US deficit is a necessary correction to the Chinese government savings. Otherwise, the world would spin into a deeper recession than the Bush period.)
=+=+=+=+=+=
Why is a balanced federal budget not only a bad idea, but impossible with present income and expenditure methods?
Federal expenditures may be divided into three types:
1) Fixed amount appropriations. (i.e. We will spend $X for new fighter planes and $Y for new roads next fiscal year.)
2) Condition of need appropriations. (i.e. We will pay social security to any who meet the criteria and apply.) These tend to increase when the economy is bad.
3) Emergencies. (Harvey, Irene, Pearl Harbor.)
Federal income is almost all taxes on activity, and proportional to the activity. These decrease when the economy is bad.
So, the predictions of the federal surplus or deficit depend upon the prediction of the economic situation. Those predictions are chancy at best. Even the Reagan administration whose economic-growth estimates were notoriously rosy, guessed low one year.
Localities which tax buildings based on evaluations which do not change from year to year have a much easier time with their budget predictions.