Why Tax Cuts and Spending Increases Are Ineffective

Liberal tax cuts combined with spending increases suck up all of our private savings and create a negative Net National Savings Balance.  A country’s Net National Savings Balance always equals a country’s Merchandise and Trade Balance[1]. This may sound like a bit of gobbledygook, but it is important. While politicians claim we have a trade deficit and export our jobs because other countries take advantage of us, the real reason for the trade deficit is more complex.

The Net National Savings Balance includes all private savings along with the difference between government receipts and expenditures. The Merchandise and Trade Balance is the difference between a country’s exports and imports. Figure 1 illustrates the size of our international borrowing and trade deficits.

Figure 1. Annual NIPA Values, 1981-2011. Sources:Bureau of Economic Analysis, Table 4.3BU.

Figure 2 identifies the biggest cause of our perpetual savings deficit, the federal government. When our government runs up huge deficits, the money has to come from somewhere to pay for the spending increases and tax cuts.  Unfortunately, U.S. citizens are typically not big savers. This means we go to foreign governments, banks and individuals to get the money.

Figure 2. NIPA Values and Government Net Lending/Borrowing, 1981-2011. Sources: Bureau of Economic Analysis Tables 3.2 and 4.3BU.

In Figure 2, the blue bars represent our trade and savings deficit. They are called our National Income and Product Accounts or NIPAs for short. There is a level of “chicken and egg” disagreement about NIPAs. Does an increase in spending on goods and services from other countries cause our savings to drop and hence increase our foreign borrowing? Or, does an increase in our borrowing cause the trade deficit to increase?  For the sake of discussion, we are going to assume NIPAs work both ways.

It is relatively easy to visualize that if oil prices go up, this decreases U.S. citizen’s  ability to save and we as a country may wind up borrowing to cover the cost increase. The increased foreign borrowing equals the new trade deficit caused by the higher oil price.

Looking at the NIPAs from the opposite way provides some understanding why tax cuts and spending increases are so ineffective when we borrow from other countries to cover their costs. In 2008, President George W. Bush ran up a $756 billion government deficit. Private U.S. savings were not able to cover the deficit and $674 billion was borrowed from other countries to balance the U.S. capital account. By definition, the $674 billion increase in borrowed dollars from other countries results in a $674 billion increase in our trade deficit. Standing back and looking at all this, Bush’s stimulative tax cuts and spending increases wound up being spent by U.S. citizens to buy goods and services from other countries. Is it any wonder that the world’s biggest saver, China, continually racks up double digit annual growth rates? They lend us money to cover our government’s spending increases and tax cuts and then sit back and produce the additional products our citizens will buy with the stimulus dollars.

Thankfully, U.S. private savings increased dramatically and we have not had to borrow internationally to cover all of President Barack Obama’s deficits. Not to be an alarmist, but the dramatic increase in private savings may have prevented the U.S. becoming another Italy, Greece, Spain or Portugal.

Summing up…

The slow economic growth and employment losses identified in Spending Increases and Tax Cuts, Employment and Economic Growth are not anomalies; they are created by successive presidents (with the exception of President Bill Clinton) abandoning true conservatism and frugality.Rather than blaming the Chinese for our economic problems, we need to recognize that if China suddenly disappeared from the face of the earth, we would still have trade deficits matching our savings rate. 

Understanding the above, the solution to our country’s economic problems are obvious. Simply balance the federal budget. Without the huge drains in private savings caused by government borrowing, we would likely have a net positive National Savings Rate and more important, possibly an occasional trade surplus. The only risk with this strategy is that the Clinton years will be repeated with record high employment rates.

 

[1] Using Bureau of Economic Analysis data, Line 46, “Net lending or net borrowing (-), Govt.” in Table 3.2. “Federal Government Receipts and Expenditures” equals the sum of Line 49 “Balance on Current Account, NIPAs” and Line 53, “Capital account transactions, (net) NIPAs” in Table 4.3U. “Relation of Foreign Transactions in the National Income and Product Accounts…”.


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