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Federal Prodigality

Mises Daily: Thursday, October 24, 2002 by

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Many Americans are questioning not only President Bush's foreign policy but also his economic decisions.  They cannot forget that the U.S. Supreme Court, by a 5 to 4 vote, effectively made him the winner in the closest presidential election in modern history and that he is governing with the weakest mandate in more than a century. 

The U.S. Congress, divided almost evenly between the two political parties, is deadlocked on many issues, but the President and Congress surprisingly are in friendly accord in matters of government expenditures.  The boosts surpass even President Lyndon Johnson's Great Society spending initiatives some 30 years ago. 

According to a Heritage Foundation estimate, the federal government will spend nearly $800 billion more in 2000-2003 than it did in the previous four-year period, or some $5,000 more per household, now totaling some $73,000.  Just 21 percent of the boost is allocated to national defense and one-fourth thereof to the war on terrorism.

The love of spending has changed the financial condition of the federal government dramatically in recent months.  When President Bush came to power he easily could persuade Congress to lower federal taxes, pointing to prospective surpluses of several trillion dollars.  This talk about budget surpluses has long since given way to the more familiar discussion of deficits. 

The fiscal year closed on September 30 with a deficit of some $160 billion which, at 1.5 percent of gross domestic product (GDP), is rather moderate, yet also alarming because of the speed at which the surpluses gave way to deficits.  Just last year, Federal Reserve Chairman Alan Greenspan still reflected anxiously on the eventual consequences of a federal government without debt, a capital market without U.S. Treasury securities.  No one in Washington is giving thought to such strange notions now.  Congress recently raised the legal debt limit by $450 billion, which hopefully will keep the government solvent for a year or two.


The sagging economy undoubtedly is contributing to the growing budget deficits.  Business profits are declining or even turning into losses, which inevitably are reducing tax revenues.  Similarly, falling stock prices do not produce capital gains taxes.  Surely, all such losses in revenue may some day be offset by soaring revenues when the economy heats up again and suffers new boom fevers a few years hence. 

It is more alarming to watch the great joy of spending which is tearing big holes in the federal budget.  While the Pentagon received an increase of $46 billion in the new fiscal year for purposes of security and defense, American farmers will pocket another $73 billion. Numerous other programs will increase the hole.

The spenders give little thought to matters of revenue. After all, there is the other financial arm of the U.S. Government, the Federal Reserve System, which can provide any amount at any time.  It is the deus ex machina which can create one million dollars as easily as one-million million dollars.  Unfortunately,  most members of Congress are unaware that every act of money creation bears a lengthy chain of consequences working their way throughout the economy. 

A million-dollar purchase of U.S. Treasury obligations by the Fed with newly printed money or merely new credits on its books obviously enriches the Fed at the expense of all present holders of money.  It does not create a single economic resource but merely gives rise to new purchasing power claims against all given resources.  As more people bid for economic goods their prices tend to rise, which favors some people and harms others.  Prices rise unevenly beginning with the Fed purchase and gradually spreading throughout the economy.

Fed money creation also falsifies interest rates, which gives rise to the boom and bust cycle.  Unhampered market rates indicate the demand and supply of capital, reflecting the value judgments of all participants.  The rates are relatively high in poor countries where capital is very scarce, and lower in countries with a more plentiful supply.  The Federal Reserve generally ignores the market rate and keeps its discount rate, which it charges member banks, far below market rates and thereby falsifies all rates.  It signals a larger supply of liquid capital than actually exists and thus misleads and entices many businessmen to embark upon uneconomic expansion projects. 

Just as consumers may first rejoice about government edicts lowering some goods' prices but later deplore the inevitable shortages, so do many businessmen exuberantly welcome low interest rates and the business boom they engender but later lament the inevitable recession which forces them to correct their mistakes.  The falsification of interest rates is an unending cause of economic irritation and maladjustment which inflicts immeasurable harm on a market economy.  As the U.S. dollar serves as the world money standard, the Fed policy subjects the whole world to recurring maladjustments and painful readjustments.

Most members of Congress may disagree on questions of taxation but usually cooperate amicably in the allocation of public funds. They work together because they are guided by the same ideology of the cares and functions of government.  They are kindred souls although they may belong to different parties and come from different parts of the country.  Their votes reveal their devoted attachment to one or more of the party factions, such as the "social-need faction," "parochial-imperative faction," "anticyclical full-employment faction," and "affordability faction."  A few lonely voices may plead for individual freedom, but they hardly qualify to be called a party faction.

The "social-need factions" usually point the way, engaging in noisy debates about urgent economic and social needs, especially the dire needs of the sick and elderly, and pointing to labor, agriculture, transportation, and housing.  Their representatives thoroughly distrust the individual enterprise system which, in their belief, fails to meet important social needs but serves the interests of greedy, profit-seeking businessmen. They, therefore, readily allocate funds for every conceivable federal benefit program.   But they also are ever mindful that such policies afford advantages to themselves as they assure reelection and many personal benefits of the office.

Many members of Congress live by the "parochial imperative" which calls for economic favors to voters in their respective districts.  Hoping to promote local commerce and industry, they bring government spending into their districts, secure subsidies to district interests, and gain many other district favors.  Of course, this imperative also tends to redound to the legislator's benefits.

In times of economic stagnation and looming recession, such as the present, both factions can count on the fervent support by the contracyclical full-employment group.  Its agents value government spending as an important key to economic prosperity.  They are quick to cite John Maynard Keynes and a host of academic successors who favor budgetary deficits whenever the economy threatens to sink into recession.  Economic decline and mass unemployment, they contend, are the result of inadequate effective demand. Therefore, government must apply monetary and fiscal stimuli that increase aggregate demand.  The stock of money must be increased, which hopefully causes interest rates to fall, investments to increase, and income to rise.  Should monetary policy prove to be ineffective, direct government spending must stimulate activity and restore full employment.

The fourth faction, visibly the smallest in Congress, consists of politicians who may favor individual freedom and self-reliance but readily surrender their basic principles in order to get and stay elected.  Most conservatives who belong to this party may wax eloquent about the free enterprise system but do not dare to cast their votes against any popular entitlement such as Social Security, Medicare, or school lunches.  They may muster the courage to question the "affordability" of new benefits but not their very justification, which would jeopardize their reelection.  Nevertheless, the timid question of affordability has created the public perception that many conservatives do not care about the weak and poor but heartlessly favor the survival of the fittest.

The four factions form a united front that passes "guns-and-butter" legislation with emphasis on the butter.  They justify the spending on grounds of the old, self-serving fallacy that government spending stimulates the economy.  They refuse to see that every penny spent by government comes from the pockets of taxpayers and inflation victims and that the spending, since it ignores the laws and values of the market, is wasteful, ineffective, and discriminatory.

There presently are some 100 major federal programs some of which have become sacrosanct institutions.  Some are unfunded and contribute to growing budget deficits.  All divide American society into two hostile social classes, the provider class and the dependent class.  The multitudes of dependents happily surrender their "natural rights" for the "social rights" of benefits, some of which, thanks to the progressive tax code, are rendered without charge to them.  They elect the politicians who promise and deliver the benefits. 

On the other hand, the provider class consists of a minority of productive individuals who are forced to pay an array of personal as well as business taxes.  They may be tempted to avoid and evade the tax levies or even escape to tax havens.  All the while, the benefit legislators labor anxiously to devise new penalties and erect new barriers to their escape.  They ignore the old proverb that "prisons are built with bricks of shame; tax prisons are surrounded by bricks of shame of the builders."

Many members of Congress are attorneys at law, officers of a court of law and experts in legal proceedings.  They think in terms of man-made law and directive; they have difficulties conceiving of inexorable principles of the market, of the old American ideals of natural rights to life, liberty, and property, and of the need for constitutional limitations of government.

With their minds disposed in the ways of government programs and benefits, they approve of common dependency in such matters as healthcare either through Medicare, Medicaid, or mandated employer health insurance.  They endorse dependency on Social Security when people retire, and parent dependency on government to educate their children.  In fact, many Americans now prefer government care over the freedom to live independent lives; many already have lost the ability to be free and independent.

Stone walls do not prisons make; they are houses of care and dependency.  Many members of Congress are busily building legal walls that are as real as the walls surrounding a prison.  They are erecting fiscal walls which are to confine the income and wealth of productive Americans, and formidable walls of dependency in which any thought of freedom soon wastes and withers away.


Hans F. Sennholz, emeritus professor of economics at Grove City College, is an adjunct scholar of the Mises Institute. Send him MAIL. See also his Mises.org Articles Archive and his Personal Website.