The shortsightedness of excessive government spending

When a government’s spending exceeds its revenues, a budget deficit results. Governments generally issue interest-earning bonds to finance their budget deficits. These bonds comprise the national debt. A budget deficit increases the size of the national debt by the amount of the deficit. In contrast, a budget surplus allows the government to pay off bondholders and thereby reduce the size of the national debt. Basically, the national debt represents the cumulative effect of all the prior budget deficits and surpluses.

Prior to 1960, almost everyone thought that the government should balance its budget. The Keynesian revolution changed all of this. Keynesians—those accepting the views of English economist John Maynard Keynes—believed that changes in government spending and budget deficits could help promote a more stable economy. They argued that, rather than balancing the budget, the government should run budget deficits during periods of recession and shift toward a budget surplus when there was concern about inflation. In short, the Keynesian revolution released political decision-makers from the discipline imposed by a balanced budget. Freed from this constraint, politicians consistently spent more than they were willing to tax.

The Philippines recorded a budget deficit equal to 2.2 percent of the country’s Gross Domestic Product (GDP) in 2017. The deficit averaged 2.1 percent of GDP from 1988 until 2017, reaching an all-time surplus high of 1 percent of GDP in 1994 and a record low deficit of 5.3 percent of GDP in 2002. As of May 2018, the deficit widened to P148.8 billion from P63.6 billion in the same period of 2017. The government has programmed deficits of P523.6 billion in 2018 and P624.4 billion in 2019, both about 3 percent of GDP, and up from the P350.6-billion deficit recorded in 2017.

Deficits push the national debt upward. Government debt to GDP averaged 56.3 percent from 1990 until 2017, reaching an all-time high of 74.9 percent in 1993 and a record low of 42.1 percent in 2016. As of April 2018, the debt stood at P6.88 trillion, or 42.6 percent of GDP, and up from 42.1 percent in 2017.

The political attractiveness of spending compared to taxation is not surprising. It reflects what economists call the shortsightedness effect: the tendency of elected political officials to favor projects that generate immediate, highly visible benefits at the expense of costs that can be cast into the future and are difficult to identify. Legislators have a strong incentive to spend money on programs that benefit voters and special interest groups that will help them win reelection. They do not like to tax, since taxes impose a visible cost on voters. Debt is an alternative to current taxes; it pushes the visible cost of government into the future. Budget deficits and borrowing allow politicians to supply voters with immediate benefits without having to impose a parallel visible cost in the form of higher taxes. Thus, deficits are a natural outgrowth of democratic politics unrestrained by a commitment to a balanced budget.

The unconstrained political process plays into the hands of well-organized interest groups and encourages government spending to gain rich patronage benefits for a few at the expense of the many. Each representative has a strong incentive to fight hard for expenditures beneficial to his or her constituents and has little incentive to oppose spending by others. In contrast, there is little incentive for a legislator to be a spending “watchdog.” The watchdog will incur the wrath of colleagues who will find it more difficult to deliver special programs for their districts and retaliate by providing little or no support for spending in the watchdog’s district. More importantly, the benefits of spending cuts and deficit reductions that the watchdog is trying to attain (for example, lower taxes and lower interest rates) will be spread so thinly among all voters that the legislator’s constituents will reap only a small part of these benefits.

The following illustration will help explain why it is so difficult for 297 congressmen and 24 senators to bring spending and the budget deficit under control. Suppose these 321 individuals go out to dinner knowing that after the meal each will receive a bill for 1/321 of the cost. No one feels compelled to order less because his or her restraint will exert little impact on the total bill. Why not order shrimp for an appetizer, entrees of steak and lobster, and a large piece of cheesecake for dessert? After all, the extra spending will add only a few pesos to each person’s share of the total bill. For example, if one member of the dinner party orders expensive items that push up the total bill by P1000, his share of the cost will be P3. What a bargain! Of course, he will have to pay extra for the extravagant orders of the other 320 diners. But that’s true no matter what he orders. The result is everyone ends up ordering extravagantly and paying more for extras that provide little value relative to cost.

What will happen if the government does not bring its finances under control? As a nation’s debt gets larger and larger relative to the size of the economy, there will be repercussions in the credit markets. Extensions of loans to the government of a country with a large debt to GDP ratio is risky. As a result, the highly indebted government will have to pay higher interest rates. In turn, the higher interest costs will make it even more difficult to control spending and keep taxes at reasonable levels.

If the debt continues to rise relative to income, investors will become more and more reluctant to buy the bonds issued by the Philippine Treasury. Eventually, it will lead to a financial crisis—either outright default by the government or finance of the debt by money creation and inflation. In either case, there will be a destructive impact on the economy. This has occurred in other countries that have failed to control government finances.

It is vitally important for the government to control its spending and borrowing in the years ahead. This is unlikely to happen without a change in the constitutional rules to make it more difficult for politicians to spend more than they are willing to tax. Such rule changes would strengthen the government’s budget constraint and force legislators to consider more carefully the costs of government programs. An improvement in government’s cost-effectiveness would result.

Topics: budget deficit , John Maynard Keynes , Gross Domestic Product , watchdog
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