Government spending and taxes during recession.
Government spending and taxes during recession.
During a recession, the private sector spending drops for a variety of reasons.
Demand for goods and services drop. Private investors tend to restrict their investments. Factories tend to drop production and lay off workers.
Eventually more and more businesses will continue to lay off more because less and less people have the money to spend.
Revenues of government, state and local communities will also fall. These revenues usually come from taxes, which is a portion of individual and corporate incomes.
Local communities will be forced to cut back on many essential services like law enforcement, emergency services, education, and the maintenance of infrastructure.
All this will lead to higher unemployment, bankruptcies, hunger, homelessness, desperation, and crime. In addition, there will be social issues such as loss of personal dignity and in extreme situations we have seen political revolutions. If this downward spiral continues we can expect serious consequences for everyone including corporations, the rich, the middle class, and the poor. In extreme situations, faith in capitalism can erode and there can be considerable social pressure to move away from capitalism.
We all know that in every business transaction for goods and services there must be a buyer who will spend. Without a buyer or a spender there will not be any economic activity.
To prevent the downward spiral there has to be spending. If the ailing private sector cannot provide enough spending, we will need someone else to resuscitate the economy during a recession.
Economists recommend injecting government funds into the economy without increasing taxes. Recession may be one of the few exceptions in which economists can justify deficit financing.
In order to do this right the spending should be big enough to make an impact. Ideally, spending should be in labor-intensive projects that would benefit the community and businesses.
It can include spending in construction, education, communication networks, massive power-generation, and other major infrastructure projects. For example during the Great depression of the 1930s, the TVA was created. This not only created jobs, but it also helped us come out of the economic depression. It also improved the quality of life by providing cheap and clean electricity for millions. Industries who were heavily dependant on large amounts of energy thrived. TVA also helped the US during the Second World War by providing a huge amount of electricity needed to build the atomic bomb that stopped the war with Japan.
With an effective stimulus package, such job creation will start very quickly. With workers now having money, they will be able to create a demand for goods and services. Businesses with capital will now begin to invest in goods and services. This in turn creates more jobs and more demand for good and services. More small business such as retail shops and restaurants will sprout within many communities. There will be ample opportunities for the masses to rise above subsistence. Self-esteem and consumer confidence of the masses will improve. Human hardships, homelessness, crime and other social issues will decrease.
Eventually, as the positive ripple effect continues, the tax revenues naturally will go up and government’s deficit financing will not be needed at some point. Eventually tax revenues will automatically rise due to higher economic activity. This rise in revenues should now be used to reduce the budget deficit. The justification for a budget deficit will not be there anymore after the recession. Then taxes, fiscal policies, and interest-rates should be adjusted to maintain the health of the economy and keep government budgets balanced.
It has been argued that lowering taxes can help the economy. It does up to some point.
The poor usually don’t pay much in taxes. Even though the poor are likely to spend all they have, the relative small tax breaks will not be significant enough to improve demand in goods and services. However, tax breaks for them can still be justified due to human hardship.
During this time, with low consumer confidence, the middle class may tend to hold back spending received from tax breaks. Some of them may decide to spend more. Therefore, it is difficult to see if these tax breaks alone to the middle class can be a significant factor in pulling the whole economy out of recession.
During a recession tax breaks for huge corporations many not be very helpful either.
A CEO once reported that even with corporate tax breaks there is no incentive for his corporation to invest on adding jobs or increasing production. This is because there is very little demand for his goods from the masses during a recession.
For rich individuals, who make millions of dollars a year, a tax break of $20,000 will not significantly change their spending habits either. It is unlikely that Bill Gates or Warren Buffett would change his personal spending habits just because of a $50,000 tax break. And since millionaires are not as common as the rank and file these tax breaks will not have the desired impact on the economy. To make things worse such tax breaks would take a bigger toll on the federal budget. So the tax breaks for the rich during recession puts the government in a deeper deficit with less positive impact to the economy. Therefore, tax breaks for the rich are not likely to get us out of recession.
Should the government spend more in areas such as unemployment benefits by raising them or extending them during a recession, the impact of every dollar would be quite significant. This segment of the population is living near or below subsistence.
They are likely to spend all their benefits to make ends meet. Even then, a good portion of them will not have enough to pay for all basic needs such as rent, mortgage, auto repairs, and insurance premiums. Since they are likely to spend all they get, every dollar spent on these entitlements has a good impact on the economy. These entitlements also have a big impact in reducing human hardships and stabilizing the community while the unemployed are seeking employment opportunities that can provide a better income to maintain a more desirable lifestyle.
In conclusion, it should be understood that deficit financing by the government is appropriate when it comes when the economy is in recession or depression. This is also considered to be a textbook solution by many economists. It has been practiced in many countries including China, Japan and parts of Europe and Asia. Deficit financing should not be abused just for just tax reductions during normal times. Japan was one of the first nations to successfully use deficit financing to reduce the impact of the economic depression during the 1930s. It was so effective that they were out of that depression as early as 1933.
Deficit spending by the government is advocated here in the context of recession or depression. It is not applicable for individuals and corporations. They should exercise caution when getting into debts.
Most of us are aware that there are good debts and bad debts. There are two important conditions for a good debt. The first is that it is needed for something critical and necessary or is a good investment. For individuals it could be a primary residence, an automobile for basic transportation to go to work, or a life- sustaining medical procedure. A good investment can be funds for college or capital for a business. The second critical condition for a good debt is that the borrower has the capacity or has a reliable plan to repay the debt.
Deficit government spending during recession is a good debt. It meets all conditions of a good debt. There is a vital need to get out of recession. The resulting debt can be repaid by successful individuals and corporations through taxes with relatively less pain because income and profits and risen considerably. Increases in tax rates may not be necessary.
However, the government should not give in to pressures to reduce taxes to cause deficits when there is no recession. This is a bad and an unnecessary debt and would make the government less capable of reacting to an impending recession.