The Efficient Government Theory

While the success of the stimulus bill can hardly be applauded, I believe that it is worth taking another look at the thinking that concludes that the government is best suited to direct economic spending.

Let us assume that the public dollar spent by the government is done so more efficiently than a private dollar spent by any other entity.

Let us define efficient as that which has the greatest effect on aggregate demand.

Therefore, we can assume the Efficient Government Theory, which states that government spending is most efficient, is true.

Now, let us consider the source of the dollar the government spends.

A dollar spent by the government may originate from one of three sources: by selling bonds, collecting taxes, or printing money. It is important to recognize that bonds sold by the government are considered to be riskless, insofar as the government never “defaults” on its bonds per se, but rather has the ability to simply collect more taxes or to print more money to service or retire debt.

­Let us differentiate these three sources of spending further.

All money spent by the government represents a tax on the economy at-large; the only difference is when the tax is levied.

Simple taxation collects the money in the immediate present.

The printing press constitutes a tax deferred until the money is spent – presumably in the near-term, thus diluting the purchasing power of the original dollars.

Debt, however, is a tax deferred into the distant future.

Let us assume then, that among the sources of income available to the government to fuel spending, debt is the most attractive. It is attractive because politicians are able to bestow all the benefits of the efficient government dollar, i.e. maximizing increases in aggregate demand, without having to confiscate wealth from the present, and because aggregate demand increases debt capacity, thus perpetuating economic growth.

Furthermore, since cash given to the government in exchange for riskless bonds creates the most aggregate demand, such an investment would rationally be the most attractive among all potential investment dollar destinations.

Therefore, if the Efficient Government Theory were true then there would be a sufficient market for government bonds such that no government spending would come from taxation. In other words, in the presence of taxes, we can assume that the Efficient Government Theory is false.

If the Efficient Government Theory is false, then the dollar spent by the government is not the most efficient, and thus the spending of the government should be minimized to allow for more efficient spending.

Without considering how government spending should be minimized (that is to say, to what extend government spending should be constrained), it is possible to conclude that government spending should be limited only to taxation as a source of funding.

Indeed, by limiting the source of government spending to taxation, those who must bear the cost of funding the government are given input into how much the government spends and upon what.

It is the premise upon which the American experiment began, and today it stands to be the reason why the American experiment fails.