But how will you pay for it?

"How will you pay for it?"  That's a tough question for anyone on the receiving end.  It's a good bet we'll hear it from one side or the other on any given talk show featuring any politician talking about fiscal matters, especially within 18 months of a national election.  Democrats use it on Republicans when the subject is a tax cut (such as eliminating the Alternative Minimum Tax, or AMT), and Republicans use it on Democrats when the subject is a social spending increase. 

The person on the receiving end of that snappy question typically stutters like Porky Pig for a while, until the talk show host runs out of time and has to cut to a commercial.  It's a great "gotcha" question.  But there's a subtle fallacy embedded in it: the false premise that everything the government buys must be paid for right now with tax receipts or spending cuts, or else we shouldn't do it. 

It's a bad idea, but one that's easy to accept—because so many others of us are accepting the idea without objection ("social proof").  It's like the big crowd in New York City that was staring up at the sky—because they'd come upon other people standing there, staring up at the sky.  (The small original core of sky-gawkers had been recruited by a psychologist to do just that: stare at the sky for no reason.  The subsequent contagion of sky-gawking caused a traffic jam.  For more detail, see this Washington Post article, "Bad Ideas Can Be Contagious.")

If I were asked the snappy how-will-you-pay-for-it question on a program I supported, I'd respond as follows:

Well, how did we pay for the GI Bill?  We did it by educating and housing our returning GIs, who paid us back, and then some—starting a half-generation later.  It wasn't a pay-go program; we borrowed money from willing lenders to help fund it—but it subsequently paid for itself (and still is) via economic-growth-driven tax receipts.  You see, back then, some politicians were capable of thinking past the current budget year—a skill most of today's politicians seem to have forgotten. 

Let's illustrate further.  Here's the question in more specific terms using several situations from the past:

1. How did we "pay for" the Louisiana Purchase in 1803, without which we wouldn't be the United States of America today?

2. How did we "pay for" winning WW2, then rebuilding Europe?

3. How did we "pay for" the GI Bill, the last and arguably most successful New Deal program, still educating our GIs?

4. How did we "pay for" winning the Cold War, a victory that arguably prevented WW3? 

5. How did we "pay for" beefing up security at all of our overseas embassies, to prevent their destruction from terrorist attacks?

6. How did we "pay for" the necessary intelligence, diplomacy, and military capabilities to prevent the 9-11 attacks (and thereby the subsequent wars)? 

Here's the way I would answer those six how'd-we-pay-for-it questions:

1. We borrowed money from foreigners for the Louisiana Territory, and subsequently serviced that debt via generations of economic-growth-driven tax receipts.

2. We borrowed money from ourselves to win WW2 and rebuild Europe, and subsequently serviced the debt via generations of economic-growth-driven tax receipts.

3. We borrowed money from ourselves to send returning GIs to college, and subsequently serviced the debt via generations of economic-growth-driven tax receipts.

4. We borrowed money from ourselves and foreigners to prevent WW3, and subsequently serviced the debt via generations of economic-growth-driven tax receipts.

5. Uh, we didn't beef up all of them.  It's too bad that our embassies in Kenya and Tanzania were subsequently blown up by terrorist bombs, but at least we didn't have to borrow any money, or dent the surplus that so pleased both political parties. 

6. Uh, we didn't invest in the necessary intelligence, diplomacy, or military capabilities in the '90s; instead, we trimmed those costs down to a much smaller portion of the budget.  It's too bad 9-11 wasn't prevented, but at least we didn't have to borrow any money, or dent the surplus that so pleased both political parties. 

The point: Not everything needs to be "pay-go" because some things are good investments in the future—one of the best of those being war prevention (according to John Stuart Mill).  Good investments eventually (by definition) pay for themselves, and then some.  Borrowing money for good investments is sound financial practice; ask any banker.  Statesmen of the past who stuck by their convictions against the odds (Jefferson, FDR, Reagan) knew that in their hearts. 

Wouldn't it be a startling change to start hearing substantive debate about the future merits of tax or spend proposals, instead of the usual "How will you pay for it" zinger?  Wouldn't it be nice if fewer of us were just staring at the sky, accepting the pay-go malarkey without questioning it?

=============
End note about this blog's future:

In a few weeks, I'll be undertaking a sizable business-related project that will reduce the amount of non-business time I've had for the last three years for composing material here, answering all the emails, etc.  The new project will take a minimum of five months, and could stretch to two years. 

I will post as frequently as time permits, but I can guarantee the time available for this blog will be squeezed significantly.  Business was taking 1/3 of my time; it will soon become 2/3.  I'm targeting to post at least once a week here, but we'll see.  I'll do my best, so bear with me. 

Comments

[Bob]

Instant gratification world, Steve.
EPS must be accretive, NOW. New employees must hit the ground running, NOW. Quarterly guidance and results, YESTERDAY.

Best on the project. If it is related to this blog in some way, perhaps you can let us know how it's going.

Will miss your more frequent entries.

[Steve]

Bob:
The project in question is an investment in the future.

[Bret]

I think it's quite misleading to claim that asking how things will be paid for relies on fallacious thinking. In an economy with low unemployment that is operating near capacity, every new program is paid for NOW by foregoing other potential consumption and/or investment. Either it's paid for by foregoing other specific government programs, or it is paid for by consuming or investing less in unforseeable ways in the private sector. Just because you can't identify exactly what consumption and/or exactly which investments don't happen doesn't mean you're not redirecting current resources. It also doesn't much matter if taxes or borrowing are used to suck resources from the private sector into the government.

[ASAGUYTHINKETH]

Good luck with your new business project.

Many thanks for what you have posted here to date. I visit a number of blogs daily and yours is one of the top five, hands-down. I have learned much here.

[Steve]

Bret:
Some things, such as national security, are the federal government's job, and only the federal government's. The idea that a surplus (or smaller deficit) is more desirable than preventing war is fallacious, because it perversely places more importance on the money than on what we get for the money. Moreover, borrowing as necessary to achieve that goal does not suck private resources from the bond market; the crowding out theory (that deficits cause interest rates to rise) doesn't square with the data -- probably due largely to the massive size of the global, dollar-denominated bond market. A few hundred billion dollars of deficit is a drop in that bucket.

[Kevin]

Hey if I can make the time to read your blog when I'M at work than you can post to it when YOU'RE working...

[Boghie]

Steve,

The problem is not the big and valuable projects that require credit.

The problem is that we are using credit every minute of every year. In other words, we use credit for groceries.

I have no problem with funding WWII with credit - but funding peacetime expenditures in the 1990s...

[Bret]

Steve,

I agree with all of your statements above.

What I'm trying to point out is the distinction between the financing of spending and the spending itself. I absolutely agree that financing by borrowing is perfectly okay, especially when in the range of just a few percent of GDP.

However, the cost is immediate at the point of spending. Resources (labor, tangible capital assets, etc.) are now deployed. When the government spends money, those resources are no longer available for other productive purposes.

Take your example of guarding embassies. A fine thing to do for sure. However, those additional contractors or military personnel guarding the embassies are no longer available for other productive work (starting companies, making bon-bons, etc.). Assuming unemployment is low, we have, therefore, less available to consume and invest in other areas because of the decision to deploy the labor to guard the embassies.

Again, the financing method chosen in order to deploy the resources is immaterial. But when scarce resources like labor are deployed somewhere, they cannot also be deployed somewhere else. That is an immediate and unavoidable cost which we have no choice but to "pay" as we "go".

[Bob]

Bret,

Look at it another way. Clinton cut defense spending and budgets at the CIA. Would we have been attacked if the cuts did not happen? I don't know, but look at what we have spent in the aftermath.

It's penny wide, dollar foolish as my grandma would say.

Granted no entity, public or private should spend in a freewheeling manner but they also should not be so short term focussed that they wind up spending it later down the road....usually when someone else is running the ship. I've experienced the latter time and again in my career.

There are costs of action AND inaction.

[Gil]

Hmmm. This could go some way to explain declining birthrates in various parts of the world.

[Aaron]

Is there some way to categorize spending promises to see which ones need to be looked at more closely for "how do we pay for it" while others are "investments?"

Or can we put ROI numbers on these things and then see what really happens (not always possible, but some programs may have net zero or negative effects and thus are not good investments and yet they keep going and going and going"

MITT ROMNEY QUOTE BELOW:

"We have in the federal government 342 different economic development programs, often administered by different departments. We don't need 342. We probably don't need 100 of those. We probably need a lot fewer than that.

We have 40 different programs for workforce training. There are probably five or six that are really working, and a lot that are not working terribly well. We can get rid of some of those.

We have 13 different programs to prevent teenage pregnancy. Well, they're obviously not working real well and we can probably cut it down to one or two that are making a difference.

[Grodge]

Steve,
You had me until the lugubrious swipe at the deficit hawks of the 1990's:

"It's too bad that our embassies in Kenya and Tanzania were subsequently blown up..."

and especially your strained causality for the 9-11 attacks,

"It's too bad 9-11 wasn't prevented, but at least we didn't have to borrow any money..."

Your casual surmise is that more money would have prevented said atrocities, and nothing is available to prove this theory, or even support it.

Deficits are okay, maybe even preferable as you have opined these many months, but only so long as the revenue borrowed is put to good use. I doubt my wife would approve of my assuming a home equity loan to buy an Abrams tank for our front yard... unless of course I could justify it with some dire reason for such materiel. An Abrams tank alone would not protect our home from an asymmetric home invasion by a stealthy burglar and those funds would be better spent on, say, our retirement or health care. To provide safety against attackers, there is no substitute for the house's residents paying close attention to the expensive alarm system already in place, and unfortunately our Resident-in-Chief was asleep during the summer of 2001.

I would maintain that our military and intelligence budget cuts did not produce any structural anomaly that led to any attacks... as also concluded in the 9-11 Commission Report.

{Best wishes on your new venture; your frequent posts will be missed.}

[mark]

I am with Bret on this one. The government maintains a balance with the private sector when it comes to the money. Money collected by taxes and bond sales is immediately returned to the private sector in the form of spending. It is the real resources consumed by government spending that can have an effect on the private sector. If the government consumes a large amount of jet fuel for fighting a war, what will happen to jet fuel cost (and plane tickets)? Of course if we don't fight the war and terror takes over the middle east, what will happen to jet fuel cost?
The only question I have for Bret is what do you consider low unemployment? Is the current 4.7% (almost 1 out of every 20 people actively seeking work) low?

[Bret]

mark wrote: "The only question I have for Bret is what do you consider low unemployment? Is the current 4.7% (almost 1 out of every 20 people actively seeking work) low?"

I believe that 4.7% is low enough such that incremental government spending on labor will transfer resource from the private sector to the government. The lower the unemployment, the closer to unity this effect would be.

[Bret]

Bob wrote: "Clinton cut defense spending and budgets at the CIA. ... It's penny wide, dollar foolish as my grandma would say."

I'm not arguing that the government should not spend money. I'm simply stating that the cost of spending money is real and immediate if those resources would've been deployed elsewhere in the private sector, even if the spending is financed by borrowing.

I have no problem with the government spending money. But let's not pretend that there's no cost. There is, and it's incurred at the point of spending (deploying the resources), unless those resource would not have been otherwise deployed (for example, when unemployment is high).

[Bret]

Bob wrote: "It's penny wide, dollar foolish as my grandma would say."

I'm not arguing that the government should not spend money. I'm simply stating that the cost of spending money is real and immediate if those resources would've been deployed elsewhere in the private sector.

I have no problem with the government spending money. But let's not pretend that there's no cost. There is, and it's incurred at the point of spending (deploying the resources), unless those resource would not have been otherwise deployed (for example, when unemployment is high).

[Bret]

Bob,

I'm not arguing that the government should not spend money. I'm simply stating that the cost of spending money is real and immediate if those resources would've been deployed elsewhere in the private sector.

I have no problem with the government spending money. But let's not pretend that there's no cost. There is, and it's incurred at the point of spending (deploying the resources), unless those resource would not have been otherwise deployed (for example, when unemployment is high).

[Steve]

Two key points have been made here, and I agree with both of them:
(1) Programs that waste money are a bad idea, and
(2) Government purchases use resources that might cause inflationary pressure in a near-capacity economy.

Reasons I agree:

(1) Bad ideas should not be funded, period; not by taxes, not by borrowing. That begs the question, how do we identify the bad ideas in time to prevent funding them? Good question; some we can't, and they'll slip through the process. Others can, if only we would shift the debate to merits and away from how we'd fund it if it passed. Again, unworthy programs should not be funded, period. Worthy programs should be funded even if every penny must be borrowed, regardless of the size of the deficit or debt at the time of funding.

(2) I have no argument with the theory that a fully-utilized economy is a special case: we risk inflation when we start competing for resources. In practice, how do we know when we've reached the point of full utilization? Especially in a growing economy with continually shifting resource allocations? Labor productivity, capital productivity, innovation, and creative destruction make it impossible (in my judgment) to nail down "full utilization" regardless of how hard the green eyeshades try.

But that doesn't answer the important question, How might we judge whether we're at or near "full capacity"? I think inflation is the key number, even though we are far from perfect at measuring it. (Just look at all the measures, and all the arguments about which one is the meaningful one. Some are backward looking, some are forward looking, none is sufficiently accurate. As a result, today you can find respected economists who insist inflation is too high and on the rise, as well as respected economists who insist we now have deflation and the threat of a deep recession or depression. Which side should we believe? Well, when the economics are no more accurate than flipping a coin, we tend to listen to what our favorite politicians have to say -- and they are experts at gaming the system, I've noticed.)

Solution: I think spending a few tens of billions of dollars to find a better way to measure current inflation, and to predict inflation six months into the future, would be a very good investment. (In the long run, it might be worth a hundred billion or so.) But if we succeeded in getting a better measure of inflation, that new indicator would give us a less ambiguous signal as to whether we are at or near "full utilization." If we had that, we'd have the basis for a substantive debate about fiscal priorities and monetary policy. We'd have a much better foundation for debating programs on their merits, instead of getting diverted to the unimportant question of whether we'd have to borrow money to do it.

There are only two answers to the question "How will we pay for it?":
(1) "Its benefits will exceed its costs in the long run, so we should borrow whatever is necessary now to fund it"; or
(2) "Its costs will exceed its benefits in the long run, so let's not do it -- period."

[Steve]

NOTE: The new spam filter implemented by TypePad seems to be too restrictive for some reason. I had trouble all day posting the comment above. If you've had similar trouble, send me an email and I'll try to fix it.

Steve

[Louis]

I always enjoy reading this column, and the comments as well. I will continue to check, but less frequently now.

One aspect of this subject has not yet been addressed clearly, although a few here have alluded to it.

When you make any "investment" there is an opportunity cost. It you decide for example to build a 'bridge to nowhere' in Alaska, then you are really allocating resources out of the pockets of taxpayers who will ultimately 'pay' via taxes used to pay the interest (and maybe even principal) on the debt.

Yes, you can point out that economic growth will pay for it and not the taxpayers, but in a way that too is a fallacious argument, because the owners of production own the economic output, not the Government.

Back to opportunity cost -- for most Government spending, a better investment would more likely have been made by the private sector, which would have provided three or four times more economic impact than did the Government spending.

So, any question of "but how will we pay for it?" should instead be answered with: "the economic growth taken by the Government from the owners of production."

Certainly not all Government spending is bad, and yes economic growth is the result of investment, but, let's be clear on who is doing the investing.

[Steve]

SPAM FILTER NOTE: TypePad says the new "spam" folder they created for me will "learn" what's okay as I approve the suspect comments that got diverted to that purgatory. Not sure what criteria trigger it; I sent them a copy of my long comment above asking why it got diverted. Maybe we'll all learn something from their answer.

Anyway, I just cleared it, so all the comments that hung up in the last two days should be posted now.

[Bret]

Steve wrote: "How might we judge whether we're at or near "full capacity"? I think inflation is the key number, ..."

I don't think so. As Milton Friedman said, "inflation is always and everywhere a monetary phenomenon." The Fed could keep inflation in check while the government deploys ever more resources to its own ends (financed by taxes and borrowing).

Steve also wrote: "Its benefits will exceed its costs in the long run, so we should borrow whatever is necessary now to fund it."

I don't think that's the correct metric. I think the correct metric is that the benefits will exceed the benefits of what would otherwise been gained from those resources.

I think you're looking at the world through the glasses of a corporation where your statement is undoubtedly true. I believe that differs significantly from the entity that controls the fiat currency. In other words, being able to justify the benefits versus the costs when using someone else's currency (like corporations do) is a more restrictive justification than justifying benefits versus costs when you control the amount of money available.

P.S. My multiple responses to Bob above were at first blocked by the spam filter. I kept cutting my response back until it got through. I didn't mean to deluge Bob with responses.

[Aaron]

Let's take a specific program: Head Start

Now, there may be new evidence that its working or whatever, but let's assume that its a marginal failure costing more than it provides in benefits.

The political economy in the United States is such that I predict it would be very, very difficult to actually cancel this program. Which is I why I suggest always erring on the side of caution in government "investment"

Ethanol programs and farm subsidies are other examples where this happens.

So, I think you can see where some of the skepticism comes from.

[markg]

Another problem with inflation Steve is knowing the cause. Should monetary policy be used to fix a global supply problem (such as energy)? Should fiscal policy be used to fix a monetary policy error?
And best wishes on your business related project. Sounds like it would be a good investment since you are involved, or would that be inside information if you told us about it? Of course Martha only had to do 6 months; you would do that for us - wouldn't you?

[The Practical Skeptic]

In my Libertarian opinion the argument put forth by the Skeptical Optimist is illogical in several ways.

It presupposes federal government spending is (a) necessary (b) good (c) is better than what the private market would do on its own accord (d) makes our nation stronger, better, more secure, and/or more prosperous.

It fails to acknowledge that the way the federal government has “paid” for things since 1913 the year the Federal Reserve Act and the Federal Income Tax were passed is to print more money, to inflate, to use fiat currency backed by nothing more than the “full faith and credit of the U.S.”

Borrowing and spending continue to subject taxpayers to ever increasing financial burdens to support a gargantuan federal bureaucracy

Now on to the problems with the examples of borrowing…

We borrowed money from foreigners for the Louisiana Territory, and subsequently serviced that debt via generations of economic-growth-driven tax receipts.

The American government used $3 million in gold as a down payment, and bonds for the balance to pay France for the purchase. Also, part of the 80 million Francs (approximately $15 million) sale price was used to forgive debts owed by France to the United States. In the end, France received $8,831,250 in cash for the sale.

Point: We borrowed but a lot less than what we borrow now.

We borrowed money from ourselves to win WW2 and rebuild Europe, and subsequently serviced the debt via generations of economic-growth-driven tax receipts.

The U.S settled for appropriating German patents as well as all German company assets in the U.S. The "intellectual reparations", such as patents and blueprints, taken by the U.S. and the UK amounted to close to $10 billion, equivalent of around $100 billion in 2006 terms. The program of also acquiring German scientists and technicians for the U.S. was also used to deny the expertise of German scientists to the Soviet Union.

United States Secretary of State George Marshall, the "European Recovery Program", better known as the Marshall Plan, which called for the U.S. Congress to allocate billions of dollars for the reconstruction of Europe. Also as part of the effort to rebuild global capitalism and spur post-war reconstruction, the Bretton Woods system was put into effect after the war.

The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value—plus or minus one percent—in terms of gold and the ability of the IMF to bridge temporary imbalances of payments. In the face of increasing strain, the system collapsed in 1971, following the United States' suspension of convertibility from dollars to gold.

Point: Bretton Woods allowed the U.S. to share the financial pain of partially financing the rebuilding of Europe.

We borrowed money from ourselves to send returning GIs to college, and subsequently serviced the debt via generations of economic-growth-driven tax receipts.

The G.I. Bill (officially titled the Servicemen's Readjustment Act of 1944, PL345) provided for college or vocational education for returning World War II veterans (commonly referred to as GIs or G.I.s) as well as one year of unemployment compensation. It also provided loans for returning veterans to buy homes and start businesses.

Point: Veterans who graduated from college ultimately “paid” for their college education in the form of taxes charged by the federal government to finance the program. There is no such thing as a free lunch.

We borrowed money from ourselves and foreigners to prevent WW3, and subsequently serviced the debt via generations of economic-growth-driven tax receipts.

Uh, we didn't beef up all of them. It's too bad that our embassies in Kenya and Tanzania were subsequently blown up by terrorist bombs, but at least we didn't have to borrow any money, or dent the surplus that so pleased both political parties.

Uh, we didn't invest in the necessary intelligence, diplomacy, or military capabilities in the '90s; instead, we trimmed those costs down to a much smaller portion of the budget. It's too bad 9-11 wasn't prevented, but at least we didn't have to borrow any money, or dent the surplus that so pleased both political parties.

Too much military spending to beef up overt and covert military operations to prop up "Pro-Western" corrupt foreign dictatorial regimes that suppress democracy, jail, murder, or deport citizens who back democracy and other democratic reforms, and threaten violence on the world stage results in blowback, the unintended consequences of foreign policy decisions. Prime example, the U.S. trained Bin Laden to fight the Soviets in Afghanistan only to have this anti-communist weapon ultimately turn against its “handlers.” Not a very wise foreign policy expenditure in my estimation.

The Practical Skeptic

[Bob]

Let's see if I can persuade some of you to look at this in a different light.

There are some similaritis between a very large business (like a Fortune 50 firm that Steve was in) and the government. Both can be filled with bureaucrats and politics (the government defintely is) and both have to allocate resources and obtain capital to fund objectives. Where the similarities end is that a well run business uses any number of tests to determine how capital is allocated and invested.

In business we can imagine various departments or people kneeling at the altar of cap-ex (capital expenditures). Armed with spreadsheets, research (sometimes very questionable) and lavish powerpoint presentations, those folks go before senior management to make their case. They'll passionately present why their project is good for the company.

People in government do the same dance only more often and with, IMO, more passion and emotion and quite possibly inaccurate and biased research. Too much emotion is not a good thing, IMO. Furthermore, I think most people would agree that the government has so many projects and conflicting priorities that an attempt to make a presentation that is in sync with a strategic objective is almost impossible. Now add in that the Executive branch may only be around for four years and the CEO (POTUS), is very tempted to focus on the short term (to soldify his/her legacy.... while they are still alive)and it's not hard to see what an unwieldly and unmanageable mess develops. If we're lucky someone comes along to try and clean up the mess (like a Reagan) but generally only after there has been preventable hardship. BTW, the messes and clean-up happen in business all the time and short term thinking is a far too often contributor.

Our Skeptical Optimist has a background in capital budgetting. From what I've read here, if I were going before his team to get my share of cap-ex, I know it would be me meeting with a well informed and tough businessman. A smile and a shoe shine wouldn't get me very far. Nor would any attempt to ensure my year-end bonus. That's the way it should be in a well run organization.

Now, imagine that our government decides to get real serious about setting objectives, ranking priorities and allocating capital subject to real world tests. Would that make a difference? I think it would, especially if the leader is more interested in the long term prosperity of the country rather than his/her ideology or self interest.

Now, if only we can find a way for Steve to become director of the OMB or head the Senate finance committee.