Budget deficits can increase social inequality
Vincent GelosoEconomy General Government Manufacturing debt deficits Economy manufacturing taxes
Burden falls on the whole population, and low-income Canadians can least afford to contribute.
There’s been much talk about the federal government’s attempts to enact redistributive policies to reduce income inequality in Canada. But the way these measures are funded could increase inequality.
One think-tank in Quebec surveyed a panel of 70 policy experts who noted that the 2019 federal budget would, on the whole, reduce inequality.
I contributed as a dissenter from the majority opinion because it’s rarely considered that deficit financing can increase inequality in the long run.
Any government that decides to run a deficit by increasing spending must sell government bonds to borrow the funds.
Those who buy the bonds are among society’s richest. However, the burden of the debt financing falls on the whole population, since virtually everyone pays taxes. So the debt redistributes resources from the entire population to the wealthy holders of government debt.
When (or if) the government decides to buy back those bonds to reduce the debt, it must use tax revenues. As a result, a transfer occurs towards the richest in society. It’s a regressive policy bound to increase inequality as long as those who buy the bonds are the richest in a society.
We have a strong historical example of this. From the early 18th century until 1815, England was intermittently at war with the rest of Europe and wars are costly. England financed these wars mostly by borrowing on financial markets. By 1815, when the English defeated Napoleon at Waterloo, the public debt was 2.5 times larger than the whole British economy. That proportion is larger than that during the two World Wars.
This massive debt was largely funded by wealthier British households. But simultaneously, taxes increased rapidly and were applied to a wide variety of goods and services consumed by the poorest in England. These households paid the taxes necessary to service the debt. Even when the wars were over, they had to keep paying.
So it’s unsurprising that economic historians note rising income inequality over this period.
Modern evidence corroborates this. Large and persistent deficits increase the public debt and impact the distribution of income. This is why some scholars find that reducing the deficit by reducing public spending that’s most detrimental to economic growth leads to less income inequality.
Government securities have increasingly been held by the richest in society. In the United States, the richest one per cent of taxpayers held close to 15% of government securities in 1970. Today, that proportion stands closer to 45%.
To be sure, this outcome depends on how progressive taxation is (how much government revenues come from the richest) and who benefits from the additional government spending. Governments could reduce inequality by taxing the rich more heavily.
There is, however, a downside. Taxes on the wealthy often translate as taxes against investment and innovation, which slow economic growth. While this reduces inequality, it also makes the poorest worse off by slowing the improvement of their conditions.
And income from securities investment gives the richest the ability to alter public policy in ways that benefit them. They’re better equipped to push for loopholes in the tax code. So a bondholder has greater political leverage to reinforce inequality.
The net effect on inequality is uncertain, but it’s entirely possible that deficits increase inequality.
So it’s reasonable that governments – including Canada’s federal government – consider that they do more harm than good with recurrent deficits.
Vincent Geloso is a senior fellow at the Fraser Institute and visiting professor of economics at Bates College who earned his PhD from the London School of Economics.
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