The money that government is spending comes from you

Government budgets tell citizens a great deal about the kind of government they have. Does the wording of the budget speech reflect a recognition that it is taxpayers and not government that must take the credit for the building of infrastructure, provision of services, and anything else listed on the expenditure side of the document? Or are the taxpayers treated as though they are captives engaged in involuntary servitude, guilty of having made inadequate contributions to the government coffers?

Too often we hear politicians and government officials declaring how much government has paid towards a particular project, followed by the question: “And now I would like to know what percentage of the total cost the private sector is going to contribute?” The response should be: “The private sector has already contributed 100% and going beyond that percentage of the total is mathematically impossible.” If everyone inside and outside of government were to recognise that in the final analysis all funds spent by government are taken in taxes from private citizens there would perhaps be pressure for taxes to be reduced. Government has no source of funds other than taxes on its citizens.

Taxes paid by politicians and civil servants represent a circular transaction. It is similar to an individual taking money out of one pocket and putting it in the other. Purely for psychological reasons, income tax is deducted from people on the government payroll. If they were paid amounts equal to their existing after-tax income and no tax was deducted, private citizens would know with too much certainty where the taxes are coming from.

Is it really that simple? Fundamentally it is, but there are a few confusing wrinkles. Governments have got into the bad habit of spending more than the total taxes they receive. They call this figure a deficit and the projected amount for the 2002/03 fiscal year is R22,1 billion. To put this figure in perspective, it is one-third of the total VAT takings of R66 billion, or slightly more than the total taken for excise and customs duties. Government then borrows to cover the deficit. These borrowings generally keep growing because the loans get “rolled over” and never really get paid back. Taxpayers get stuck with the interest on the borrowings, which for 2002/03 amounted to R47,5 billion or more than half the total R90 billion in income tax on individuals. Another way to look at it is that taxpayers have to annually cover interest that exceeds R1,000 for every man, woman and child in the country. Yet another angle is that if there was no interest to pay on the accumulated debt load, the budget could be balanced and income tax on individuals could be reduced by 25%.

Yes, and there is another factor that affects every citizen, no matter how poor. When government needs cash and it is shy about increasing visible taxes even more, it resorts to “invisible taxation”. In this it is assisted by the Reserve Bank, which simply prints money and uses the proceeds to buy government securities. The government spends the money, the Reserve Bank reflects the government securities amongst the assets on its Balance Sheet, and the securities become part of the accumulating government debt upon which taxpayers pay interest. However, that is not the end of the tale. Increasing the quantity of Rands at a faster rate than South Africa produces goods and services, causes all existing money to decline in value. Looking at the matter another way, we find that more money chasing fewer goods causes general price increases, commonly known as inflation.

The invisible inflation tax is hardest on pensioners and other people on fixed incomes, which generally includes the poor. The little old lady who hides her life’s savings under the mattress may have some of it stolen, not by robbers, but by the government institution that has the constitutional duty to “protect the value of the currency”. The money’s purchasing power is reduced and the old lady gets less and less for her money when she goes to the shops. She will blame the shops, not realising that the real culprits are the issuers of the depreciating notes she guards with such care.

According to Nobel prize-winning economist, Milton Friedman, reducing government spending is more important than balancing the budget. However, he would expect government to cover the deficit by borrowing and not by resorting to the printing press. His view is that, for example, a South African government expenditure budget of R150 billion with a deficit of R75 billion is preferable to a balanced budget with expenditure of R300 billion. Although the prescription appears extreme, taxpayers will be better off by R150 billion. Naturally, Friedman is aware that such levels of deficit spending are unsustainable over the longer term and government would be forced to prune expenditure.

Studies have shown that countries with lower government spending, as long as the rule of law applies and governments are performing their basic law and order functions properly, will have higher growth. The reason is that entrepreneurs utilise funds for investment and growth while governments consume resources. Consequently, resources taken away in taxes from highly productive citizens have a retarding effect on the economy.

Trevor Manuel has been an above-average Minister of Finance, with a sound understanding of all these issues. However, heavy pressure is doubtless being exerted on him to tax and spend in view of the forthcoming elections. If he remembers the little old ladies with their savings under their mattresses and the millions of unemployed people in desperate need of jobs he will resist these pressures and remain as fiscally responsible as he has always been.

Author: Eustace Davie is a Director of the Free Market Foundation. This article may be reproduced without prior consent but with acknowledgement to the author. The patrons, council and members of the Foundation do not necessarily agree with the views expressed by the author.

FMF Article of the Week / 25 February 2003 - Policy Bulletin / 29 September 2009