Jamie Whyte: Deficit and surplus mean little - problems are always in spending

Prime Minister John Key. Photo / United Nations

Opinion

The government accounts have returned to surplus after seven years of deficits. On Wednesday, the Prime Minister celebrated the news, saying "it's a very positive thing that the country is now earning more than it is spending".

Rarely can so much error have been packed into so few words.

First, the government isn't the country. Those who have been in power for a long time can easily forget the difference.

When the government and the country are not the same thing, nor are their finances. A government can run a deficit while the country altogether is earning more than it spends.

As 19th century economist David Ricardo argued (and Nobel prize winner Robert Barro confirmed in the late 20th century), government borrowing can cause the population to save, because they know they (or their children) are ultimately liable for repaying the debt.

Suppose the government spends $100 per New Zealander. It can fund this by taxing each of us $100 (on average) or by borrowing the money. If it takes the first option, the cost to each of us is $100 today. For option two the cost is also $100 today.

To see why, suppose the government borrows $100 (per person) for one year paying 2.5 per cent interest. To repay this loan, the government will need to tax each of us $102.50 in a year's time.

If you want to cover this future obligation today, you could deposit $100 in an account paying 2.5 per cent interest. Or, more simply, you could directly lend the government the $100. When the government taxes you $102.50 in a year, it will simultaneously repay its debt to you with interest: $102.50.

When the going rate of interest is 2.5 per cent, getting a bill for $100 payable today and getting a bill for $102.50 payable in a year are exactly equal costs.

This is why Andrew Little, the Labour Party leader, embarrasses himself by complaining about the interest payments on accumulated government debt.

If the government had not borrowed over the last seven years, then, to maintain its spending (which Mr Little has never suggested cutting), it would have needed to increase taxes. But the cost of those taxes to the population is exactly the same as the cost of the government's borrowing, including the interest payments.

In short, the burden of government spending is the same whether it is funded from taxation or from borrowing.

Of course, the populations of some countries with heavily indebted governments, such as Greece, have suffered economic calamity. But the problem is the spending, not the way it was funded. If the Greek government had lifted tax rates to the levels required to fund its spending, the Greek economy would also have ground to a halt.

For the same reason that deficits don't matter, surpluses don't either.

If the government collects more tax than it spends, you can expect tax cuts in the future. And you can enjoy the benefit today by borrowing money that you will repay from the expected tax cuts. When the government saves the population borrows.

Why then does Mr Key celebrate the surplus? The clue lies, I think, in his idea that the government "earns" money. He seems to think of the government as a kind of business. When it earns more than it spends, it is making a profit. And business profits are good, right?

To make a profit, you must sell what you supply for more than it cost to produce: your output must be worth more than its inputs. For example, Apple makes a profit because people value iPhones higher than what goes into their production. Making profit is a sign that you have improved the world. But nothing of the sort occurs when the government is in surplus, because its earnings are not derived from its spending.

Suppose the government spends $100 and has a surplus of $10. This does not show that what the government supplied by spending that $100 was worth $110. It shows that the government collected $110 in tax.

Because government services are funded from taxation rather than prices paid by willing buyers, we have no way of knowing if they are worth what they cost to supply. In fact, we have every reason to expect them to be wasteful. If Apple were granted the power to tax the public on condition that they supply iPhones free to consumers, they would lose any incentive to limit their costs or improve their product.

Government spending is the problem, not the borrowing that may or may not fund it over the short term. Achieving a surplus is a trivial achievement for an agency with the power to tax.

Ending the crazy practice of supplying tax-funded education and healthcare free to consumers: that would be an achievement worthy of an economically competent government.