Should There Be A Budget Deficit?

There is a lot of chatter about the government’s budget deficit but, politics aside, why does it matter?

Rob Muldoon famously remarked that the typical New Zealander would not know a budget deficit if he or she tripped over it in the street. Knowing a little bit about it I have puzzled as to how one would come across the deficit in the street – perhaps I lack imagination.

Even so, over the next week the deficit will be one of the centres of attention. In part it is because in last year’s election campaign the National Party promised to have the government budget in surplus this year. If it is the only promise that gets broken over the next three years, Key’s government will have performed a miracle.

In fact the deficit or surplus is the difference between two very large numbers, each subject to fluctuations and margins of error. Does the magnitude matter greatly when the difference between them is small? In some ways ‘no’, but if the deficit persists we need more caution. This is the seventh deficit in a row; cynics will not be surprised that – whatever is promised in Thursday’s budget – the eighth year will also bring a deficit.

Formally, a budget deficit requires additional borrowing (or privatising assets, but let’s not go down that path for the present). In any year the government does an enormous amount of borrowing, most of which is rolling over existing debt, preferably at low interest rates. At some time those relending the debt may get impatient with a country’s debt levels and refuse to continue lending or raise the interest rate they charge. We dont have to go through here what happens after that, because on the whole New Zealand’s public debt levels are low by international standards.

Our private international debt levels are not. There is an argument that when the private sector fails, the public sector will have to bail them out. (Sigh.) International lenders take that into consideration when they are assessing the New Zealand government’s debt position. They might well think that the government’s debt levels are currently too high from this perspective, although I do not have the impression that it is a major concern yet. But those who know what the deficit is, are aware of this danger.

Even if there is not a borrowing problem we should never forget that government debt – which is increased each year by the budget deficit – is a burden on future generations; one day they may have to pay it off. Morally I am uneasy at resolving today’s economic problems by simply passing them on to others, especially those who are yet unborn or who had no vote in the last election. Just as I worry about whether we are treating the physical environment sustainably, I am concerned whether our economic, social and financial policies are sustainable too.

That does not mean there should never be a budget deficit. Sometimes you have to ease back on the gas to drive a car around a corner, sometimes an economy taking a hard knock has to run a public deficit to ease the harshness of adjustment. But that hardly justifies seven successive years of deficit. (Those of you with a biblical turn of mind, will recall that Joseph stored grain during seven years of plenty and ran the stores down during seven of famine. We are told that these are years of abundance; yet we still seem to be running down the grain stores.)

Of course, if the deficit had the effect of reducing the burden on later generations we might be more relaxed about it. There is an argument that much of government spending – say on education and healthcare – is an investment for the future.

It is more complicated than that. Our investment in education is partly to offset the depreciation of its value in the adult population (every time someone dies the investment in their education is lost). Much of our healthcare is for improving the quality of life. I do not object to such expenditure, but it is largely for consumption purposes; children aside any investment dimension is small.

A second issue is that the investment in an individual may give zero return to the state when they migrate and take the investment with them. On the whole I am cautious about the social investment arguments.

In any case the deficit has arisen from giving ourselves income tax cuts so we could consume more – presumably at the expense of future generations’ consumption. In effect we have been stealing from our grandchildren. I would have a different view, I suppose, if the deficit had arisen from a major program to ‘invest’ in poor children rather than tax cuts.

All this suggests that analysing the budget deficit is difficult. Perhaps it is a good thing you dont trip over it in the street. But the issue is not usually the deficit per se, but what its causes are, whatever the uninformed commentators will tell you over the next week. Rather, we need to ask about the purpose, quality and extent of public spending and whether we are paying enough taxation for it. Ultimately, does it represent a sustainable strategy?

Footnote: Older readers will recall that before the Muldoon era the government regularly ran a budget deficit. While economists talked about it, they were not too concerned. In those days the deficit was measured differently. The government ran a surplus on its current account which was used to invest in public assets (such as State Owned Enterprises). The ‘deficit’ was the borrowing for the remaining investment. We can’t do that to the same extent today because most of the SOEs have been sold off.