As some may know, I argue for a much greater focus on borrowing as a way to fund governmental functions. Taxation and borrowing are the ways in which a government lacking resources pays for its functions, but taxation is the most destructive and iniquitous instrument in any economy. An article recently appeared titled ‘r<g’ whose author, John Cochrane, an economist more on the right, raises the possibility that a government could borrow indefinitely as long as the cost of interest for government, r, was inferior to the rate of growth, g, in the economy. After a limited examination of the idea, Cochrane rejects it on the basis that government could never invest so wisely and prudently such that r generally would be less than g.
Though Mr. Cochrane and others are clearly right when speaking of a system of exclusively taxation, or taxation used in conjunction with borrowing, the view here is that they haven't fully considered the advantages that come with a system of full public borrowing. The condition r<g would be perpetually true because of heavy constraints placed upon the whims of politicians to spend, and the elimination of taxation’s deterrent effect.
In taxation, there are great costs that may be separated into two general categories: government waste and deterrence. There is no dispute that deterrence, the more detrimental cost, would disappear with full borrowing, a system in which lenders are enticed with rewards. With a tax rate of nil one should expect a flood of foreign investment, a return of investment chased elsewhere, the abolition of complicated tax regulations or use of tax avoidance schemes, and a surge in consumption, labor, and savings as people freely enjoy the full extent of their earnings. An economy producing 100 units with 40 to government could grow to 135 units with termination of deterrence. The initial and singular explosion having occurred, the economy should experience elevated rates of growth thereafter. On the point of deterrence alone the condition r<g is satisfied.
Of the second cost, government waste and corruption, the diminution and elimination of reckless of resources in public expenditures is a certainty. If government must borrow only from resident citizens on a voluntary basis and in the currency of the land, the people, former taxpayers by law transformed into scrutinizing, petulant public bankers, become the perpetual arbiters of what public expenditures are worthy and deserving of funding. Compelled daily to plead for funds in financial markets, honest practice and profitable endeavor shall diminish and obliterate the fiery aspirations of political and bureaucratic parasites.
The nature of government shall change drastically. People like to see the valued or profitable investments their money funds, within or in proximity to their community, not transferred and spent in distant lands by strangers. Thus, local government would become the great beneficiary and national government, far reduced in scope and size, the loser.
As many still doubt the leverage local citizens would exercise over their local government an illustration from the financial sector may help.
Suppose there exists a lone bank in operation for many years in a district which offers the depositor a secure building in which to store their money, but pays no interest on deposited funds. The management of the bank has long grown accustomed to confiscating large fractions of deposits from account holders through unscrupulous and heavy service charges.
As ruthless in the extraction of fees, bank management has become as reckless in the use of deposited funds, funding projects no matter how marginal or dubious their value. Bank principals have assigned allies, associates, familial relations, and friends to leading positions without regard to character or skills. When misadventures arise in bank operations that threaten profits and returns, management quickly and eagerly introduces new or raises existing fees upon depositors’ accounts, even to extortionate levels.
In response, oppressed and resistant depositors slowed and terminated dealings with the nearly situated and offending institution, burying funds at home or seeking relief in foreign banks imposing less onerous charges. The profligate local banker, viewing a diminishing reservoir of funds, seized ever-greater fractions of account funds, further inflaming clients and aggravating the erosion of deposits and flight of funds.
Suppose one day the bank erased all fees and offered an interest rate on deposited capital. Would the flight of funds continue, abate or reverse?
It is certain the residents of the community, seeing the returns offered in place of fees imposed, would cease concealing funds in mattresses and deposit them at the local bank for the pledged reward. A great number should recall funds placed in distant and inconvenient foreign vaults still demanding scant charges, but charges nonetheless. And a large slice of the deluge would come from foreigners seeking similar relief from bank fees charged elsewhere.
To offer such returns bank managers must implement cautious and profitable lending practices, heed obligations to depositors and shareholders. Risks are reflected in rates demanded. If doubts arise regarding the borrower’s ability to repay funds, the risks are reflected in market rates for the bond issued or loan’s value. A few bad loans could jeopardize the bank’s stability and cause account holders to withdraw funds and seek refuge in better managed banks elsewhere.
I have been comparing bankers, but the same argument applies to government. By substituting government for banker and tax for service fee, nothing is altered. If a city, state or nation were to end taxation in favor of borrowing, an interest rate or capital charge would be applied to all public expenditures, giving the public the novelty of a solid financial measure of government’s performance. Government managers would be forced to re-evaluate everything done, to operate under sound financial imperatives, to act as prudently as people and corporations do.
Violate the public trust or offend the majority, the public shall cease lending, and perhaps start selling large amounts of bonds, lessening their value and causing great losses to all bondholders among whom one may count public servants, labourers, professionals.
If economists were to recognize the consequences of imposing a capital charge on all public expenditures, they would welcome rather than ridicule such a profoundly benign and enriching measure. The condition r<g is always satisfied with taxation abolished.
