Democracy in Deficit - 2. The Old-Time Fiscal Religion

Classical fiscal principle

• The history of both principle and fiscal practice may reasonably be divided into pre- and post-Keynesian periods
• The classical principles can be coinceived in the same image as that by the family
  • Frugality was accepted as the cardinal virtue
  • Deficits were to be tolerated only in extraordinary circumstances
• Classical or pre-Keynesian fiscal principles, in other words, supported a budget surplus during normal times so as to provide a cushion for more troublesome periods.

Fiscal practice in Pre-Keynesian Times

• Pre-Keynesian fiscal practice was clearly informed by the classical notions of fiscal responsibility
  • There were considerable year-to-year fluctuations in receipts, in expenditures, and in the resulting surplus or deficit.
  • Deficits emerged primarily during periods of war; budgets normally produced surpluses during peacetime, and these surpluses were used to retire the debt created during war emergencies.
• Book proceeds to talk about surpluses and deficits during 1700s to 1900s.
  • Until 1946, then, the story of our fiscal practice was largely a consistent one, with budget surpluses being the normal rule, and with deficits emerging primarily during periods of war and severe depression.
  • The history of fiscal practice coincided with a theory of debt finance that held that resort to debt issue provided a means of reducing present burdens in exchange for the obligation to take on greater burdens in the future.
  • It was only during some such extraordinary event as a war or a major depression that debt finance seemed to be justified.
• Fiscal theory began to change during the 1930s.
  • The Keynesian theory of public debt emerged.
  • This theory explicitly denies that debt finance places any burden on future taxpayers.
  • It suggests instead that citizens who live during the period when public expenditures are made always and necessarily bear the cost of public services.

Balanced budgets, debt burdens, and fiscal responsibility

• To fund government there are three possibilities:
  • Taxation
  • Public borrowing or debt issue
  • Money creation
• When a government borrows, what happens that does not happen when it finances the same outlay through current taxation?
  • With borrowing, the command over real resources is surrendered to government by those who purchase the bonds sold by the government.
• Who pays for these benefits?
  • With taxation, the cost is placed on the current beneficiaries.
  • With borrowing, the cost is postponed until later periods, when interest payments come due.
• There exist norms for financial responsibility.
  • Resorting to borrowing should be limited to those extraordinary circumstances in which spending needs are bunched in time.
  • Borrowing should be accompanied by a scheduled program of amortization.

Fiscal principles and keynesian economic theory

• Through the Keynesian revolution, there was a shift in the paradigm for the operation of the whole economy.
  • The nonclassical theory of public debt was superimposed on the nonclassical theory of economic process, which elevated deficit financing to a central role.

The fiscal constitution

• We can describe the prevailing rules guiding fiscal choice as a "fiscal constitution".
  • Pre-Keynes, the fiscal constitution was based on the central principle that public finance and private finance are analogous, and that the norms for prudent conduct are similar.
  • Public expenditures were supposed to be financed by taxation, just as private spending was supposed to be financed from income.
• Keynesianism offered the promise of replacing the old fiscal religion with a better, more efficient fiscal constitution.
  • But the Keynesian promise has not been kept. The economy has not performed satisfactorily, despite the Keynesian-inspired direction of policy.