A More Realistic View of Government Spending

My last post used a method for predicting government action that isn't very realistic.  The approach was to look at government spending as if it were spending by an individual and try to discern what the government would likely do if it had access to additional revenue.  That is to try and figure out what government would spend money on at the margins.

Actual government spending decisions are the product of negotiation between the parties.  There is no individual who compares the benefits of an additional dollar of social spending to the competing benefits of military spending.

The three main components of the budget are taxes, social spending and defense spending. It seems most realistic to consider these three components separately.  Other approaches have made the unrealistic assumption of a balanced budget.  Using these three we can think of social spending and military spending as taking money away from investments.  Some of the social spending will add it back in, since the recipients will save and invest a proportion of their benefits, or their benefits might provide services that they would otherwise have to pay for enabling them to save and invest funds taken from elsewhere.  Taxation can be thought of as taking money away from some people and investing it.  It is likely that money that investors use to purchase bonds would likely go to other investments if the bonds were not issued.  Of course some of this money that was taken away in taxes would have been invested, but not quite all of it.

This approach will take the point of view that taxation encourages investment.  Many will no doubt object, but we should note that this is only the case because we are considering taxation as being separate from government spending.  Spending will have the effect of reducing investment.  Taxation will have the effect of increasing it.

Generally it will not be worthwhile to consider the benefits of collecting taxes and using the money for social spending.  In order for this to be an important consideration we would have to have one party that wanted higher taxes and less spending and another party that wanted the exact opposite.  What we have is allegedly that the Democrats want more social spending and higher taxes and the Republicans want the exact opposite.  Given that this is an accurate picture we would expect that the parties would trade lower taxes for higher social spending, which is indeed what we see.

I think that if you were to ask people what each of the two parties want, I think that what you would likely get is that Democrats want higher social spending, higher taxes and less money spent on "national defense" and the Republicans want the exact opposite.  What we actually see is lower taxes under the Republicans.  Mitt Romney has spoken in favor of increased military spending.  That is spending over and above what the government is already planning on spending.  The government is planning on reducing spending in this area as the conflicts in Iraq and Afghanistan wind down.  Social spending seems to rise regardless of which party is in the White House.

Hence a victory for the Republicans in the next election likely means more money spent on national defense, lower taxes and the same amount spent on social programs.  This will mean a decrease in investment.

Using this kind of analysis I would regard military spending as being a pure loss of investment money.  With taxation and social spending it would be more mixed.  The effect of taxation would depend on the spending habits of those paying the taxes.  That of social spending would depend on the spending habits of the recipients.  Taxation would increase investment, but not quite as much as social spending would decrease it.  This is because both are generally designed to be progressive.  Those who pay the taxes would generally be richer than those receiving the benefits.  Hence taxpayers would save a greater proportion of their money at the margin.