One of the most common beliefs among the politicians, laypeople, and even a few economists is that govt can create jobs and wealth by using tax revenue to fund projects (usually construction projects) that otherwise would not exist due to lack of private sector incentives. Proponents of such projects say that, regardless of the value produced by the project, the project will benefit the economy by creating employment. This in turn would allow laborers to buy consumer products, creating further employment for those who produce consumer goods. It is said that the benefits keep spreading through the economy like ripples in the water when a pebble is thrown in a pond. This is false.
Know that I am not talking about temporary stimulus plans that are employed during emergency recessions or depressions. That is a similar, but different kind of scenario. Also, know that I am not talking about things like roads and bridges, as long as such things are even more necessary than the things for which the taxpayers would have spent their money if it had not been taxed away from them. It may be practically good and beneficial (but morally questionable) for the govt to fund such road projects because there is often limited avenue space that may be constrained by the construction of fixed buildings on either side and it may not be possible to fit several road options by different companies between various locations, and thus competition may not be able to exist to a sufficient level to allow the normal market self-corrective processes to take place at a sufficient level. In such circumstances, the govt funding of roads can actually be beneficial and create wealth because such roads are actually in critical demand, and the sustained supply of such roads would be relatively difficult (though possible) by private sector means. Roads and other pathways are also critical for human and commercial movement.
Instead, I’m talking about govt funded make-work projects that are done for the sake of providing employment and “stimulus” of economic activity itself during typical non-emergency economic conditions, regardless of the actual need for the products or services rendered. Examples could be the construction of roads and bridges to places that most people don’t need to travel to, or digging a ditch and then filling it back again, accomplishing nothing. Many people still think that this is good policy, but more sophisticated minds at least see the stupidity and wastefulness of these programs and instead graduate to a more subtle fallacy, that of using govt funds to produce projects and programs that actually do something useful, like mail delivery, growing food crops, housing construction, dam construction, or the construction of a sports stadium. It’s tempting to think that these are worthwhile by not only providing employment and stimulating economic activity, but also by providing a useful product or service. However, even this belief is false, as exposed by economists like Adam Smith, Frederick Bastiat, Ludwig von Mises, and F. A. Hayek, to name a few classics.
The adherents of this belief commit the fallacy of only paying attention to the effects of a policy on one group of people, while ignoring the effects on others. Adherents only pay attention to what is easily seen directly with their own eyes, but ignore the unseen precisely because it takes skill and imagination to see the unseen. More specifically, adherents of make-work projects and their supposed provision of employment ignore the fact that all such govt spending ultimately comes from taxes. All such projects are funded through taxes. Any injection of money into the economy through a project is directly cancelled by the taking of money out of the economy through taxes in the first place. There is no net increase of “economic activity”. The most optimistic view is that such projects take money from one pocket of society and places it in its other pocket. There is no net increase in economic activity or jobs in society from such an action. Such a project only increases govt employment at the expense of private sector employment. Such a project only increases govt spending and “stimulus” at the expense of private sector spending and “stimulus”.
So, let’s imagine the actual make-work project of, say, building a sports stadium (it’s actually quite common that govt uses tax dollars to help fund the construction of sports stadiums). We see the obvious: laboring men on the construction site, day after day, and such laborers are getting employment and money from govt funds which they can spend elsewhere, continuing to stimulate economic activity. And, we see the stadium itself when it’s done. But, if the stadium costs $200 million, the taxpayers will lose $200 million. Taxpayers would have that much taken away from them which they otherwise would have spent on other things they needed more, like cars, TVs, radios, food, clothing, and computers. But, we don’t see all of the private sector products and jobs lost because they have been prevented from coming into existence because money was first taken out of the economy through taxation to begin with. We don’t see that there are now less automobiles and less automobile production jobs, less TVs and radios and their associated jobs, less food and associated farm jobs, less clothes and their associated jobs, less computers and their associated jobs, etc. Indeed, it is difficult to see what the govt has prevented from existing, thus so many people are tricked into believing that a tax-funded project has created wealth and jobs on a net basis.
But, the actual story is much worse. We would be lucky if the tax-funded projects merely diverted wealth and jobs from the private sector to the public sector. The actual effect is not a zero-sum cancellation, but a net loss of total wealth for society. Before this can be understood, we must first understand a few basic economic concepts.
The meaning of wealth:
Economic wealth is NOT money. Money is merely the intermediate medium of exchange for the things that we really want. Money is useless by itself. This is why merely printing more money during inflation does not make a nation wealthier. Instead, we are happy to get more money because it allows us to buy the things we need and want, it represents a place-holder for the products and services that we need or want. Therefore, the definition of wealth is actually well-being, satisfaction of needs and desires, pleasures, comfort, happiness, and things like that.
How trade creates wealth:
A common misconception is that whenever two people trade with each other, such as $20 for a chair, that they simply traded things of equal value (assuming one chair is equal to $20) and neither person is wealthier. This is false. If the two items were of equal value to both of them, then there would be no incentive, or drive, to trade, and there would be a 50/50% chance that they choose to trade or not. Instead, the reason why they both choose to trade with each other is that they both believe that they are gaining something from the trade. If I buy a chair, I want the chair more than I want my $20, so it makes sense to make the trade. The chair-maker, who has many chairs that he has made, but only needs a few for himself, wants my $20 more than he wants his unneeded chair, so it makes sense for him to trade. This directly produces NEW wealth for both of us, since we each have increased the value of our possessions. I could stop there, but I’ll continue to make it a little clearer. The chair maker will then buy something else that he values more than the $20 that he just got, such as a microwave, and so his final net status is to have lost an unneeded chair and gained a needed microwave. The reason he made these trades is that he values the microwave more than the chair he made, and so he has increased the satisfaction of his desires, which, by definition, means he has increased his economic wealth.
Since each person generally seeks to satisfy his/her desires and happiness and gain wealth, they will do so in mutually voluntary trade settings. This is what’s happening in a large complex economy. Each person is trading in order to make net gains of wealth, as they specialize in their own tasks. Therefore, each voluntary trade almost necessarily means that those involved are gaining wealth. For, why would they voluntarily choose to trade if it did not benefit them to do so? This is one of the main reasons why free markets (voluntary trading) are so effective in creating wealth for all the people in society, as long as the govt sticks to its appropriate role in creating and enforcing the necessary conditions of a free market. But, what happens when force and coercion interrupt this process. Let’s go back to the chair example. If I go to a store and I have the option of using $20 to buy either a chair or a lamp, both of which are priced at $20, and I choose a chair, this means that I value the chair more than the lamp. Even though both are priced at $20, giving the illusion of equal value, they are actually unequal in value depending on the preferences of the buyer.
But, what if some guy named Sam comes up to me and puts a gun to my head and forces me to buy the lamp instead of the chair. My preferences and desires would be less satisfied because my first choice was prohibited, and so I had to go to a less desirable option. This means that the coercion has caused me to be less wealthy than if I was not coerced. This is what taxation does when the govt forcibly takes your money and uses it to buy a product or service for you. The govt forces you to spend your money on something that may be of some use and value to you, but not as much as you would prefer compared to other options that you would use the money for if you had the choice. The govt forces you to buy something less preferable at the expense of something more preferable. By doing this, it has necessarily, by definition, caused you to be less wealthy. This is one of the ways that taxation destroys wealth (happiness and well-being) in society. In summary, any time that coercion is introduced into a trade, it tends to decrease wealth by prohibiting people from satisfying their first and highest preferences, and instead forcing them to satisfy lesser preferences.
How Tax-Funded Projects Decrease Total Wealth:
Given the above two basic economic lessons, we can now see how tax-funded projects do not merely divert wealth and jobs from the private sector to the public sector. We would be lucky if this were the only effect. At that stage, we saw that there is no net gain of wealth or jobs for society. However, there is a net loss of wealth to society and its citizens. Tax-funded projects actually decrease total wealth because they are based on coerced trade. When money is forcibly taken from a taxpayer to pay for a govt project (even if the project has some use and value), then the taxpayer has a net loss of wealth because he can longer use that money to satisfy his first and highest preferences, and instead his money is being used to satisfy lesser preferences. He may want or need the product or service that is rendered by a govt project, but he wants or needs other things even more so. For, if he needed or wanted the govt-funded project’s products or services more than the “other things” he would spend his money on in the private sector, then he wouldn’t have to be forced to buy them through taxation. He would voluntarily choose to buy such products or services, and in the private sector. He wouldn’t voluntarily choose to buy those “other things” in the first place. The very fact that he has to be forced to buy the govt’s products and services reveals the fact that he doesn’t want those products or services as much as others that he would voluntarily buy. Therefore, tax-funded govt projects divert resources from their most efficient and beneficial use in satisfying demands and preferences and uses those resources to produce lesser benefits. Therefore, tax-funded projects, on net, decrease total wealth.
Let’s get back to our specific example of the govt paying for a sports stadium. If sports entertainment really was in high enough demand, then such activities would already be supplied on its own in the private sector free market. The very fact that the govt has to artificially support sports entertainment demonstrates that that sports entertainment is not producing something of sufficient worth to consumers because consumers are not voluntarily willing to buy that service, and instead govt is forcing them to buy that service through forced taxation. In such cases, we should let those businesses die so that their capital and labor can be used elsewhere in more productive ways that actually satisfy higher demands elsewhere. On the other hand, if the demand for sports entertainment is high enough, then it wouldn’t need govt assistance and the owners of a team or league could use their own money (or borrow) to build a stadium, which would eventually be paid for through subsequent ticket and merchandise revenue.
On a last note, we have not discussed how progressive taxation and the principle of diminishing returns of utility per dollar affect this analysis. Such things are more relevant to the question of wealth redistribution and welfare. However, that is not the main issue that I am trying to argue against here. Here, I am concerned specifically with the myth that govt-funded projects stimulate general economic activity and increase total employment.