Exhausting the Reserve Fund: The Big Picture of the Limits to Big Government (Part II)

By Richard Ebeling -- July 19, 2011

Editor Note: Dr. Ebeling’s two-part post (Part I yesterday) provides the necessary background to understand how debt reduction is driving energy policy. Regarding the budget fight, E&E News (see Appendix) reported yesterday: “As the proverbial eleventh hour looms for the nation’s maxed-out debt limit, this week brings energy-policy battles of all sizes — from how to divide offshore-drilling revenue to the lessons gleaned from recent oil spills — that will play out amid the larger fiscal showdown.”

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“Austria was successful in pushing through policies that are popular all over the world. Austria has the most impressive records in five lines: she increased public expenditures, she increased wages, she increased social benefits, she increased bank credits [monetary expansion], she increased consumption. After all these achievements she was on the verge of ruin.”

– Fritz Machlup, “The Consumption of Capital in Austria,” Review of Economic Statistics (January 15, 1935), pp. 13-19 at 19.

U.S. spending and the accumulated deft load is more than the economy can bear. What is collected in both personal and corporate taxes is not enough to cover all that the government spends because government’s promises to an ever-expanding spider’s web of special interest groups vastly exceeds what the country can afford to pay out of currently earned income. If the government attempted to raise that additional 40 cents out of every dollar it presently spends through borrowing by raising taxes, it would bring the economy to a screeching halt.

It would soon be discovered that “soaking the rich” even more would barely provide a handful of drops to cover the spending in excess of taxes collected. It would have to be admitted that the only source of additional government revenue to fill the deficit gap would be significantly higher taxes on the broad middle class of income earners, as well as adding to the tax rolls many of those currently paying no taxes.

Income earners would save even less than now; incentives and resource ability for private sector investment in new or existing businesses in the U.S. would be crushed – along with any market- based job creation. The capital for research and technological development would dry up even more in America, and capital that could get away would flee to more business-friendly countries.

Nor can the borrowing binge continue for very much longer. Net interest payments on U.S. government debt presently equals about 1.3 percent of GDP. Under current borrowing projections, with no change in planned government spending, by 2020 interest payments on the government debt would nearly double to 3.2 percent of GDP. Between 2011 and 2020, this would mean that the United States government would have to pay a total of $4.8 trillion in interest payments.

And this ignores the costs of Uncle Sam’s unfunded liabilities for Social Security and Medicare, which, under current law and eligibility rules, is estimated to equal more than $65 trillion over the next seven decades.

For most of the post-World War II period, the U.S. national “economic pie” was able to grow fast enough due to private sector capital investment, technological innovations, and improvements in the skills and education of the American work force that it could offer a rising standard and improved quality of living for virtually everyone in the country.

It was able to do this in spite of the fact that the government’s “slice” of the national economic pie and its cost on the private sector kept growing. Growing government costs in the form of rising taxes; increased expenditures and welfare transfers; nearly annual deficit spending; growing regulations and restrictions on competitive private enterprise; along with bouts of serious price inflation and Federal Reserve-induced business cycles.

Exhausting the “Reserve Fund”: Is the End Near?

We seem now to be reaching the end of what Austrian economist, Ludwig von Mises, referred to as the “reserve fund” of the market economy. The rate of growth in government taxing, spending and borrowing, and the intrusiveness of government regulations, controls, and prohibitions on the innovative competitiveness of market enterprises is resulting in a situation in which that government slice of the national economic pie is growing so much that it is seriously slowing down the ability of the economic pie to expand.

The “reserve fund” to which Mises referred is that surplus of productive output that a competitive market is able to annually generate in excess of maintaining existing capital intact and preserving present levels and standards of living. That “reserve fund” provides the resources and financial means to invest in new, more and better capital equipment; to invest in training and improving the skills of the work force, so wages over time can rise due to gains in more valuable “human capital”; it generates the greater output of desired consumer goods and services in terms of quality and variety, as well as quantity. It is the economic “fountain” from which flow the advancements in the material and cultural potentials of our civilization.

However, this “reserve fund” does not just exist “out there” to be taxed and squandered away through the fiscal spigot of government largess. It only exists through the intentional choices and deliberative decisions of members of society to save rather than consume; to invest and bear the risks of an uncertain future with the hope of profits if wise business decisions are made; to make long-run plans and develop new and innovative technologies and ways of organizing enterprises to supply those more and better consumer goods over many tomorrows.

The sluggish growth and stagnant labor market are possible indications that government taxing, spending, borrowing, and regulation are absorbing and weakening so much of the society’s productive resources and wealth that the private sector is not able to expand fast enough to counteract the “drag” of that burdensome government slice of the national economic pie.

Remember Austria

Where can this all lead? In 1930, just as the Great Depression was beginning, Ludwig von Mises authored a study of the taxing, spending, and regulatory policies that the governments of his native Austria had been followed in the 1920s. He was able to show, based on the historical evidence, that fiscal and regulatory burdens on businessmen, entrepreneurs, and investors – “the rich” – had been so great during that period that not only had capital formation and net investment stopped.

The fiscal and regulatory drag had actually resulted in capital consumption. The capital stock could not be maintained because of insufficient reinvestment and the productive capacity of the Austrian economy declined; standards of living decreased for many in society as the burden of government, in fact, resulted in the Austrian economy going into “reverse.”

In 1935, a summary of Mises’ findings was published in English by a student of his, Fritz Machlup, in an article on, “The Consumption of Capital in Austria.” Machlup concluded by saying:

Austria was successful in pushing through policies that are popular all over the world. Austria has the most impressive records in five lines: she increased public expenditures, she increased wages, she increased social benefits, she increased bank credits [monetary expansion], she increased consumption. After all these achievements she was on the verge of ruin.

It is easy enough to say and want to believe, “It can’t happen here.” But like causes do tend to bring about like effects. And unless the current fiscal folly is brought to an end, America’s “reserve fund” of productive potential may also be squandered away through government taxing, spending and borrowing, leaving us with poorer tomorrows than our more prosperous past and present.

Appendix: This Week’s Energy Battles (Elana Schor, E&E reporter, subs. required)

As the proverbial eleventh hour looms for the nation’s maxed-out debt limit, this week brings energy-policy battles of all sizes — from how to divide offshore-drilling revenue to the lessons gleaned from recent oil spills — that will play out amid the larger fiscal showdown….

“The truth is, you can’t solve our deficit without cutting spending, but you also can’t solve it without asking the wealthiest Americans to pay their fair share,” President Obama said in his Saturday radio address, returning to a favorite argument of his party by urging the revocation of oil-industry tax breaks as part of any final deal.

To a great extent, the energy and environmental elements of the debt drama have changed little over the past few weeks. Republicans still resist Democratic leaders’ calls to scale back oil and gas tax benefits, while two major ethanol supports remain endangered after a Senate repeal vote but are mired in a partisan clash over raising revenue in a debt pact. And discretionary agencies such as U.S. EPA and the Energy Department continue to face a rocky-at-best budgetary future.

In that vein, this week’s votes on the GOP’s new “cut, cap and balance” legislation could provide green groups a forum for messaging on the punishing impact that a balanced-budget amendment and spending caps would have on their public-health and environmental priorities (E&E Daily, June 30)….

Amid the flurry of rhetorical punches, time is running short for accord on the debt, in an echo of April’s fight over funding federal agencies for the remainder of fiscal 2011 to avoid a government shutdown. The White House says that if lawmakers do not produce a legislative framework for raising the $14.3 trillion borrowing ceiling by week’s end, a devastating default come Aug. 2 becomes far more likely….

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Dr. Richard M. Ebeling regularly blogs at http://defenseofcapitalism.blogspot.com/. His previous post at MasterResource was on  The True Meaning of Thanksgiving: Private Enterprise in America.