Monday, July 25, 2011

The Missing Piece in the Private Finance Analogy

By Mike Dorf

In their dueling speeches on the debt ceiling impasse, both President Obama and Speaker Boehner reached for a very familiar analogy between the government and private actors.  President Obama analogized our situation to that of a family that is maxing out on its credit card.  Speaker Boehner contrasted the responsible behavior of companies that balance their books with the behavior of governments that do not.

As any competent macro-economist will tell you, the analogies are deeply flawed.  Individual families and businesses do not have the capacity to manipulate interest rates and the money supply, but the government does.  Individual families and businesses acting in ways that don't correlate with the behavior of others do not cause contractionary cycles through the paradox of thrift when they save money.  But drastic government reductions in spending in a recession can trigger that effect.  Etc.

Nonetheless, with polls showing that most Americans don't really understand the debt ceiling debate, it's understandable that politicians would try to frame the issue in simple terms.  I tend to think that the framing favors the Republican position right off the bat, because it cuts out the unique role that the government can play, but that fight is probably lost already, with very little appetite in DC for more stimulus.

Even accepting the framing, though, there's an obvious piece missing.  Consider the following line from Boehner's remarks: "if you're spending more money than you're taking in, you need to spend less of it."  Well, yes, sometimes, but doesn't it depend what you're spending the money on?  Suppose you're spending more money than you're taking in because you're unemployed, and you need to spend some of your savings now to eat, pay rent, and look for a job.  Wouldn't you be better off continuing to spend on these necessities, even if to do so you need to borrow some money?

More fundamentally, the private finance analogy trades on a misdirection play about sources of revenue.  Again, let's accept the basic framing and suppose that mom and dad collectively earn $50,000/year after taxes, but that their expenses have gone up because one of their kids needs services that health insurance doesn't fully cover, so that for a few years, anyway, their annual expenses will be $60,000/year.  Under Boehner's formulation, "the solution to this crisis is not complicated: if you're spending more money than you're taking in, you need to spend less of it."  The family should simply spend less.  But if they're already spending only on necessities, how do they do that?  If they can, isn't the better option to "take in" more?  Perhaps mom or dad can work an extra shift or a second job, or the family can take on a border, or whatever.

The insidiousness of the private finance framing is that it doesn't readily produce the analogous option for government--which is also to "take in more," i.e., to raise taxes.  The reason this option doesn't appear salient is that taxing people doesn't "feel" like working a job to earn money.  But of course, collecting taxes is the main way that our government "earns" money.  So if politicians were to be honest about the analogy, they would recognize that raising taxes is like working a second job.

To be sure, taxes aren't the only way that government can take in more money without borrowing.    In some resource-rich countries, the government owns the natural resources and sells them directly.  The problem with this approach is it tends to lead to autocracy.  See, e.g., Libya.  In other countries, the government derives a substantial portion of its revenues from government-run businesses, but this tends to lead to corruption and economic stagnation.  See, e.g., Egypt.  So long as no one is advocating nationalization of much of American business (and no one is), the only fair comparison to the second job is raising taxes.

There may be sound reasons not to raise particular taxes at particular times, but the mere assertion that we need to "live within our means" is not among them.  For the government, raising taxes is a form of living within our means.