ornate offices in Miraflores Palace to launching crusades.

Not so the Social Christians. True, they students the thrill of swaggering off to battle with a submachinegun. But they do offer social revolutionary doctrine to transform Venezuelan society. The Cope Party, organized in 1946 as a conservative clerical party, is well left of center today. Its youth is particularly suspicious of private enterprise, specifically American business "imperialism." Naturally enough then not all anti-Communists here are overjoyed with the rise of the Social Christians. Parish priests imported from Spain and conservative members of the Catholic hierarchy are appalled. American businessmen (plus some staffers from the U.S. Embassy) would much prefer the emergence of a middle-class party supporting private enterprise, but that kind of party would be anathema to Venezuelan youth.

cannot match the Communists and offer

And no matter how much the radicalism of the Social Christians here may annoy Washington, they can be counted on to take a hard line against communism. That's no small assurance in Latin America today.

Mr. HUMPHREY. Mr. President, the article tells us a great deal about what is taking place in that part of the world. It is good reading for those of us who are vitally interested in the foreign aid bill.

WHAT EVERYBODY WANTS TO KNOW ABOUT DEFICIT SPENDING Mr. METCALF. Mr. President, in 1781 Alexander Hamilton, a conservative in his time, said that “a national debt, if it is not excessive, will be to us a national blessing."

Deficit spending has been, as Hamilton so wisely said it could be, a national blessing. Without deficit spending-by both Government and industry-our country could never be, nor could it have become, the mighty entity that it is today.

Why then is deficit spending by the Federal Government so widely criticized? I suggest that it is because of a lack of full understanding of the economics that lie behind such financial policy. The theory of deficit spending is difficult to explain to the layman. Anything that is difficult to explain is easy to attack without fear of retaliation. The conservative organs take advantage of this weakness and continually harp about the alleged evils of deficit spending by our Federal Government.

The summer 1963 issue of the Montana Business Quarterly, published by the School of Business Administration at Montana State University, carried an article by Dr. Robert F. Wallace, professor of economics and chairman of the Department of Economics of Montana State University, entitled "What Everybody Wants To Know About Deficit Spending." This article, which might have been more appropriately entitled "What Everyone Should Know About Deficit Spending," explains with preciseness and clarity just what Hamilton was talking about so many years ago-how deficit spending is a national blessing.

As Dr. Paul B. Blomgren, director of the Bureau of Business and Economic Research and dean of the School of Business Administration, points out in an

introductory statement to this summer issue of the Quarterly, certain criteria must be met by articles before they will be published. He writes that:

The article must treat the subject matter in a thoughtful and thought-provoking manner. Facts and figures used in the article must be documented as to source statements of conclusions must be reasonably supported by the facts presented or be a logical possible result of the reasoning presented *** the articles must be readable, with a minimum of technical terms.

These criteria further substantiate the validity, reliability and integrity of this article by Dr. Wallace, a former professor at the Universities of Kansas, Michigan State, Washington State, and Minnesota.

Here are a few excerpts from Dr. Wallace's article which should interest all of us:

From 1946 to 1962, net private debt of corporations and individuals increased by 336 percent, while net Federal debt increased by 12 percent. A 429 percent increase in State and local debt suggests that if any public debt has been out of control, it is the debt of the folks back home and not that incurred by the bureaucrats in Washington. And, in daily references to "crushing taxes," how often does the press remind us that the only tax rates that have not been raised since the war, the only tax rates that have actually been reduced are those of the Federal Government for general revenue? Yet such are the facts as contrasted with the folklore.

A nation can get rich only by spending *** spending in turn depends on deficits and growing debt *** spending, which creates income and output, cannot be maintained without continuing deficits.

If the deficit units by their spending return to the income stream less than the surplus units take out of the stream, the surplus units take out of the stream, the total level of spending and income must fall. It is this fact which explains the necessity for deficits.

If the savings of the surplus units who spend less than they receive are not borrowed and spent for investment by deficit units who spend more than they receive, the funds withheld are lost from the income stream. If this happens, total spending, income, and output must fall by an amount exactly equal to the excess of the total surpluses over the total deficits.

The concept of a Government debt skyrocketing out of control is pure folklore. The facts simply do not support it.

America's fears of deficits and debt could keep the country from carrying out production programs of which it is fully capable.

Just these few quotations lead me to recommend this article to anyone who wants to be better informed on this subject and especially to the critics of deficit

spending. A more authoritative documentary explanation of deficit spending written in the layman's language could hardly be found.

The timeliness of the article, in light of the urging of many to cut spending before cutting taxes, cannot be denied.

Mr. President, if there is no objection, I ask that the article by Dr. Wallace be printed in the RECORD.

There being no objection, the article was ordered to be printed in the RECORD, as follows:

WHAT EVERYBODY WANTS TO KNOW ABOUT

DEFICIT SPENDING

(By Robert F. Wallace, chairman, Department of Economics, Montana State University, Missoula)

When the practical man reads that the President's proposed tax cut is purposely planned to create a deliberate budgetary deficit, he is quite naturally puzzled. Such a proposal violates commonsense. Surely no individual or household can spend itself rich; nor can it continue forever to incur deficits which result in an ever larger debt which is never to be repaid. Yet for the whole Nation, strange as it may seem, exactly the opposite is true. A nation can enrich itself only by spending. Moreover, if a nation's deficits are too small and its total debts, both public and private, grow too slowly, that nation's income, output, and employment will surely decline. Actual reduction in total debt would result in major disaster. This occurred in the United States on a grand scale only from 1930 to 1933, the period known as the great depression. By contrast, from 1946 to 1962, an era of unequaled prosperity, our total debt increased from less than $400 billion to more than $1,000 billion.1

These are not opinions, but rather the elementary facts of our national accounts, the ABC's of economics. But the unfortunate situation is that most people have not had an opportunity to study the relevant relationships in a systematic fashion; nor are they familiar with the sources of statistical information which would enable them to test impressions and opinions against facts. The result is that popular concepts, at variance with readily verifiable facts, interfere with meaningful discussion of this crucial problem of public policy. For example, the popular conception of recent trends in Federal debt may perhaps be fairly described as follows: While private businesses and individuals have been conducting their financial affairs in a generally careful and circumspect manner, uncontrolled Government spending, especially at the Federal level, has caused huge deficits resulting in what Time magazine calls, "the bloating national debt." 2

1 See table 1.

2 Jan. 25, 1963, p. 12.

Some of the facts, as opposed to popular concepts, are shown in table 1. There it may be seen that from 1946 to 1962, net private debt of corporations and individuals increased by 336 percent, while net Federal debt increased by 12 percent. A 429-percent increase in State and local debt suggests that if any public debt has been out of control it is the debt of the folks back home and not that incurred by the bureaucrats in Washington. And, in daily references to "crushing taxes," how often does the press remind us that the only tax rates that have not been raised since the war, the only tax rates that have actually been reduced, are those of the Federal Government for general revenue? Yet such are the facts as contrasted with the folklore. The result is that public debate of planned deficit spending seldom involves the real issues.

The frequently absurd pronouncements of the practical man are received by professional economists with feelings ranging all the way from tolerant amusement to despair, depending on the prominence of the speaker. The practical man, drawing on the usually reliable lessons of personal experience, seeks to relate national conduct to principles which are unquestionably valid in the management of a household, or a corner grocery store. He sees in the opposing position at best, material for ridicule and, at worst, moral decay. Like Henny Penny who, according to nursery tradition, panicked the other barnyard fowls with her cry, "The sky is falling," he has been shouting in the streets for 30 years that our financial skies are falling, or at least in danger of falling. But unlike Ducky Lucky and Turkey Lurkey, his listeners have paid no attention whatever to his warning. Meanwhile disaster has appeared to recede into the distance as the Nation grows steadily in wealth and income. Evidently other more pragmatic men are willing to accept present bliss at the cost of of eventual perdition, especially since the day of reckoning seems indefinitely postponable.

The most unfortunate aspect of the situation is not merely that formal logical error invalidates the particular objections which the practical man chooses to make, though this is usually the case. The pity is that he is wrong when he might be right, that he makes little if any contribution when there is much that he could contribute. Economic analysis reveals that there may be valid grounds for his objections, or at least that there may be other solutions which could remove or minimize the economic stagnation which is the heart of the problem. But unfamiliarity with relevent principles causes him to make the wrong objections on the wrong grounds and involves him in gross logical error which his professional adversaries are not slow to point out. Thus his considerable ability is wasted on false issues while important questions of public policy are neglected or at least not related to the matter of Federal deficits to which they may be highly relevant. Our friend has brought down no birds these 30 years, for the simple reason that he has been firing blanks. But the birds are there.

In this article the reader is asked to lay aside temporarily the value judgments drawn from personal experience and, for the sake of analysis, to look at the world from what may be an unfamiliar point of view. Like the churchmen who were outraged by Galileo's denial that the sun moves around the earth, he may feel that he is being asked not to believe his own eyes. What, then, is this strange logic? How can we spend ourselves rich? How can unending deficits and their consequence, ever growing debts, be essential to the economic health of a nation?

THE ROLE OF SPENDING

We begin with a simple fact on which all can agree. Our real national income in any

1962-Continued

Thus at the very outset we see an essential relation between total output and total spending. Spending is our measure of output. Output is defined in terms of spending. But the relationship goes deeper. There is a causal connection. Spending creates or causes output since it is clear that nobody produces anything in a free market system, unless he is paid for it. And here another key relationship becomes apparent. Spending creates income as well as output. Nobody can receive money income unless someone else has spent money. The fundamental relationships can therefore be summarized by the undeniable proposition that spending creates income and output. They can be generated in no other way. Spending is just another word for what economists call demand. What businessmen call sales (their source of income) obviously depends on the spending of their customers.

Recognition of these basic facts immediately throws a different light on national spending habits. When we see the statement that the American people are on a sort of spree, spending more and more every year, this is no cause for alarm. On the contrary, we can only breathe a fervent, "Thank Heaven." For if our total spending stops growing, our production and sales stop growing. The Nation stops growing.

These are the fundamental accounting principles on the basis of which national income and output are measured by the U.S. Department of Commerce and by the governments of all nations on both sides of the Iron Curtain. If the reader picks up a copy of the Federal Reserve Bulletin, available at every national bank, or the Survey of Current Business, found in most libraries, he can himself verify the procedures described here. He will find the gross national product table labeled "Gross national product or expenditure."

TABLE 2.-National income and expenditure, 1962

[Billions of dollars]

Expenditures-Continued

Government purchases of goods and services...

117.3

62.3

55.0

Gross national product or expenditure__

553.9

Federal____-.

State and local____

NOTE. Totals may not add due to rounding.

Source: Adapted from Federal Reserve Bulletin, February 1963, pp. 260–261.

It is convenient for analytical purposes to separate the total spending into three classes: (1) spending by consumers for consumer goods and services, (2) spending by investors for additions to our real capital wealth, and (3) spending by Government for goods and services. The total spending represents payment for the gross national product and can be traced to the various recipients as income, or alternatively, as charges against the total output. As an example, the actual record for the United States in 1962 is shown in table 2, which presents a highly simplified summary of the national income and product accounts for that year.

THE ROLE OF DEFICIT SPENDING AND DEBT

Having demonstrated the point that a nation can get rich only by spending-in fact under a free market system could not produce so much as a toothpick without spending—we must now show the extent to which spending in turn depends on deficits and growing debt. We shall demonstrate the fact that spending, which creates income and output, cannot be maintained without continuing deficits. At the outset, in order to clarify general principles, we shall consider not merely Federal Government deficits, but total deficits, including Government. The Government is only one of many possible deficit spenders among the various economic units. In fact, as pointed out earlier, its deficits since World War II have represented only a tiny proportion of total deficits of all economic units. After analyzing the deficit operations of economic units-individuals, business enterprises, and Government-we may then ask what special characteristics, if any, may be attributed to those of the Federal Government.

We start with the proposition that the income of each and every economic unit is the result of spending by other units and that the aggregate income of all economic units is therefore equal to the total spending of a given period, say, a year. ·

With the exception of a negligibly few economic units whose income in a given period is exactly equal to expenditure all units can be divided into two classes, surplus units and deficit units. Since the operations of the few balanced budget units are completely neutral in their effect on total spending, tending neither to increase it nor to decrease it, their influence may be ignored in our analysis. Therefore subject to the exception noted, every individual, business enterprise, or government must fit into one of these two classes. Either the economic unit spends less than its income and is a surplus unit, or it spends more and is a deficit unit. And income is, of course, the point of reference since, obviously, the concept of a surplus or deficit has no meaning except as it relates to an income of a given size during a given accounting period.

At this point the consequences of a corollary fact must be noted. Just as the income of a particular economic unit depends on the spending of other units, so the spending of each unit creates income for others. The related role of surplus and

deficit units now becomes apparent. Surplus units receive or take out from the income stream more than they put back. Deficit units put into the income stream more than they take out. Thus we note a fundamental accounting identity: In a national income of a given size total deficits are necessarily exactly equal to total surpluses. The key importance of this identity is that it enables us to grasp the following fact: If the deficit units by their spending return to the income stream less than the surplus units take out of the stream, the total level of spending and income must fall. It is this fact which explains the necessity for deficits.

Now let us state these formal accounting relationships in more familiar language. The surpluses are more commonly known as savings and the deficits as investment spending. Money saved represents a withdrawal from the income stream. The impact of such savings, or nonspending, taken by itself is deflationary. The effect is to reduce sales and the demand for goods. Other things being equal, it is clear that these savings must cause the spending stream to drop unless there is some way to put them back.

The way in which the surplus funds of the savers usually get back into the spending

income stream is for the deficit units to borrow the savings and spend them for the production of real investment assets-new plants, new machines, larger inventory, and other actual additions to the Nation's wealth.

The necessity for continuous deficits and ever growing debt now becomes clear. If the savings of the surplus units who spend less than they receive are not borrowed and spent for investment by deficit units who spend more than they receive, the funds withheld are lost from the income stream. If this happens total spending, income, and output must fall by an amount exactly equal to the excess of the total surpluses over the total deficits. Since savers do not usually spend their own savings to produce capital goods but instead lend them to business enterprises which spend the funds for construction of such new equipment, the process necessarily involves borrowing and lending, usually with the aid of a wide variety of financial intermediary institutions such as commercial and investment banks, savings and loan associations, and insurance companies. The essential point is that except for savers who do their own investment spending, every new act of saving and lending, which results in spending for economic growth necessarily involves an addition to total debt.

A note of explanation regarding terminology is necessary here. By investment we do not mean what the average person thinks of as investment. Investment here means actual spending for the construction of a capital asset, or the acquisition of new inventory which also adds to wealth. By savings we mean funds withheld from spending for consumption and made available for production of new capital. What most people call their "investments" are really savings in the economic sense. When a saver purchases a security, a savings and loan share, or an insurance policy, or deposits his money in a bank this does not necessarily mean that these savings will actually be spent to produce new investment goods.

In fact, this is the heart of the problem. Savings decisions and investment decisions in the economic sense are not made by the same people. Every person with income must decide whether or not to save and, if so, how much. But decisions to invest are made only by the relatively few people responsible for the management of American free enterprise. If a saver buys a secondhand security the money will not be returned to the income stream and nothing will be added to the Nation's wealth if the seller uses the proceeds to increase his liquidity. No investment takes place in the economic sense un

less the security has been newly issued by an enterprise which spends the money to produce actual new capital goods. In the same way funds "invested" in a savings deposit result in no real investment if the bank simply allows its reserve ratio to increase. Deflationary, sales-destroying surpluses of savers are redeemed for the income stream only when enterprises acting as deficit units borrow these funds and spend them for construction of real additions to our wealth. This conclusion is probably consistent with the intuitive feeling of most readers that the Nation's real wealth cannot be increased merely by passing financial instruments from hand to hand.

The only exception to the necessity for borrowing relates to the savings of individuals and businesses who themselves spend for investment assets. If a man saves enough money during the year to add a room to his house he has both saved and invested. There is no effect on total spending or income. The substantial retained earnings which American corporations invest in new plant and equipment constitute a more important example. In such cases the problem considered here does not arise. The saver himself spends for investment. However, most savings get back into the income stream only when deficit units through financial intermediaries borrow and spend them.

The mystery of a healthy economy in spite of skyrocketing debt need no longer puzzle us. Growing debt is clearly essential to continued health. A nation cannot get richer without saving, any more than an individual can. We cannot grow if all of our output is consumed each year. Savers, by abstaining from spending a part of their incomes, in effect release some of the nation's resources from the production of consumer goods. The resources so released are thereby made available to enterprises for producing capital goods which add to the nation's wealth. But if enterprises as deficit units do not borrow the unspent funds and hence do not use them to produce investment goods, efforts to save become abortive. The resources released from production of consumer goods are simply unemployed. There can be no real savings without corresponding investment, that is, deficit spending. A nation's real savings, the real increases in its wealth during a given year, cannot be more than that part of its total output which it did not consume. In other words, the investment goods which it produces above and beyond the things consumed are a measure both of its savings and of its investment. Efforts to save more than enterprises are willing to borrow and invest simply result in reduced income, output, employment, and profits. Hence the amount of saving a nation can do without impoverishing itself is limited by the total amount of deficits which it finds desirable and profitable to incur. "Thus, thrift may be the handmaid and nurse of enterprise. But equally she may not. And, perhaps, even usually she is not. For enterprise is connected with thrift not directly but at one remove; and the link which should join them is frequently missing. For the engine which drives enterprise is not thrift, but profit." We conclude that if continued deficits and growing debt are "unnecessary" this is true only in the sense that unemployment, unsold goods, business losses, and decreasing rates of growth offer an alternative.

A DEFICIT SPENDING MODEL

A simple arithmetical model of an imaginary nation's economic system will help make the above points clear. Let us first consider the operations of a system where there is no government activity at all, just as in the discussion above we made no distinction between government and other

3 Keynes, John Maynard, "A Treatise on Money," vol. II, Harcourt, Brace & Co., New York, 1930, p. 140.

spending activity. Having examined the basic properties of a private enterprise system without government we can add government activity later and note whatever changes it may introduce.

Money can be spent in only two ways: For consumption, C, and for investment, I, so that C plus I equals total spending which of course equals total income, Y, and in turn measures gross national product, GNP, Hence,

C+I=Y=GNP.

This can be read, "gross national expenditure equals gross national income equals gross national product." The reader will recognize that except for the absence of Government expenditure this is in the format of table 2 taken from the Federal Reserve Bulletin. The Nation's income is generated by the two kinds of spending; but, once received, its disposition is a different matter. Since there are no taxes, the people can dispose of their income, Y, in only two ways: Either it is spent for consumption, C, or it is saved, S, so that,

Y-C S, or Y=C+S.

Note that decisions to save or consume are made by everyone who has income to dispose of while the decisions to spend for investment goods, I, are made only by a relatively small group of people. They are the owners and managers of business enterprises and the amount of the investment spending they plan to do will depend on their estimates of the prospects for realizing a profit from such investment spending.

Since these two groups do not include all of the same people it would be the merest accident if total plans to save were equal to total plans to invest. Yet we have noted that real savings cannot be different from real investment. They are in fact two words for the same thing. Also it is clear from our income creation equation

C+I=Y

and from our income disposal equation

C+S=Y

that S and I must be equal to each other. But they are equal only in the ex post, or realized sense. In an ex ante or planned sense, as noted above, plans to save may differ from plans to invest. At this point we may recall the accounting identity which states that with an income of a given size total surpluses are necessarily exactly equal to total deficits. Income has no volition or life of its own. It is the result of spending decisions by human beings exercising volition. Income is the resultant. Thus is in the ex post sense. To explain income and output we have to account for the spending decisions which cause them to be what they are. This will become apparent as we examine the operations of model I below. The Nation begins each income period, a week, a month, or a year, with a certain income which has been generated by the two types of spending. The people can then dispose of that income either by spending it for consumption or by withholding it as savings, Planned or expected magnitudes are on the left side of our model. Actual or realized magnitudes and resulting debt are shown on the right. On the left, or plans, side we find the peoples' plans to dispose of a given income, the relevant relationship being summarized by the column headings, Y-C=S. Plans to invest are shown under the column headed I. Of the four planned or expected magnitudes only C and I are solid, for they involve spending decisions which the individuals have power to make. Nobody can really say for certain and in advance what his income or savings will be in the end. But he can decide to spend. Under the actual or realized magnitudes the key relationships are again summarized by the column headings C+1=Y. In other words income depends on spending and nothing else. If it makes the analysis clearer the reader may,

3a.

Realized or actual amounts

I

C+ I = Y 400

100 500

Change Total S in debt debt 100 +100 100

500

100

400

100 500

100 +100

200

480 500

80+80 100 +100

280 200

8880

500

400

100 400

500 400 During the first two periods, everything runs smoothly since it is assumed that planned surpluses do not exceed planned deficits. Each year the $100 billion of savings are borrowed by the investors and returned to the income stream. Because income holds up, planned money savings of $100 billion result in real savings for the country, as actual capital goods are produced in the amount of $100 billion. Since this is the amount saved and lent, debt rises by $100 billion each year as a necessary result.

In year 3, things go wrong. Plans to consume and save are unchanged but, for whatever reason, estimates of profit opportunities deteriorate and investors plan to spend only $80 billion. Since only spending counts, income must drop too. But actual real savings cannot be more than $80 billion if only $80 billion is spent for construction of new capital goods. Additions to real wealth cannot exceed the difference between total production and consumption. How can this be so if the savers actually saved $100 billion and can show securities, deposit slips, and similar instruments to prove it? The answer is that a part of these savings, $20 billion to be exact, were offset by losses, mainly negative profits, of those who suffered declining income. We are concerned with the total savings of the Nation, and in computing the net change we must take into account the losses as well as the gains. Income has fallen to $480 billion and these losses have made the sum of total surpluses exactly equal to the sum of total deficits as it must be. Total demand has fallen by $20 billion compared with year 2, productive resources capable of producing $20 billion in output are wasted in unemployment and, of course, the foregone output is lost forever.

Let us now consider what would happen if the managers of business enterprises see such favorable prospects for profit that in year 3 they plan to invest $120 billion, while consumers still plan to spend $400 billion and save only $100 billion.

In order to show the effects of such a development all of the magnitudes for year 2 are duplicated in the table, the only difference being in our alternate assumptions for year 3 which is designated 3a. The results are just the opposite of those which followed when plans to invest fell short of planned savings. Since actual spending is now increased by $20 billion, total demand, in other words total spending, has risen to $520 billion. Debt has of course increased by $120 billion instead of $100 billion. If population growth and advancement

3800

120 +120 320

400 120 400 120 520 technology have provided corresponding additional productive resources, the increased spending results in real increases in output. On the other hand, if corresponding productive resources are not forthcoming, increased spending cannot cause increased output. It only raises the price tag. We get not more goods but only more expensive goods. We call it inflation. In either case the increased investment spending causes savings to be increased correspondingly as money incomes increase beyond expectations. These are real savings if increased output has been possible. If not their real value has been dissipated by higher prices.

The workings of the model have now clarified its essential properties as they relate to spending, deficits, and debt. To maintain an income of a given size, total deficits in each year must be exactly equal to total surpluses for that year and, of course, each year's deficit adds an equal amount to debt. Deficits equal to surpluses will only maintain a given level of income from year to year. Income will not fall but it will not rise either. This would be a static world. In the real world where growing population and advances in technology make possible ever-growing output, total spending must increase from year to year. To provide higher levels of spending, planned deficits must grow in size each year and must be greater than planned surpluses. The ever larger deficits in excess of planned savings are financed by the banking system which creates new money for the purpose. However, mere willingness of the banking system to lend does not assure that adequate additional money will be borrowed and spent. Deficit spenders must see advantage in such borrowing and this means that they must have reasonable expectations of profit. The appropriate rate of increase in money supply and in the level of spending depends upon how rapidly corresponding increases in real output are possible. If money supply and spending grow more rapidly than the rate at which new productive resources become available we have inflation. On the other hand, if they grow more slowly than population and other resources we have rising rates of unemployment and economic stagnation. Thus we see that spending, deficits, and debt in a free market society may grow either too rapidly or too slowly, but grow they must. It was only for the purpose of clarifying the role of deficits and surpluses in our model that we made the assumption of fixed population and static technology.

THE ROLE OF GOVERNMENT DEFICITS

We have seen that a free enterprise market economy cannot operate and grow without deficits and expanding debt. It has also become clear that since the rate of growth of deficits and debt is determined by the independent decisions of millions of free individuals subject to no central planning or control, deficits may grow either too slowly, in which case we have recession, or too rapidly, in which case we have inflation. This is simply a description of the manner in which our economy operates. It is based on accounting identities and involves no value judgments or moral principles. For good or ill, it is the way things are. We have seen that this is so even in the absence of any government at all. In contrast to model I where no government existed let us now introduce government operations into the picture.

First we must note the relationship between government deficits and surpluses and those of the private economy. Let government spending be represented by G and taxes by T. Then as we saw in table 2 which presented national income data for 1962 the spending-income equation for the real world includes government spending and must be written,

This is our fundamental deficit-surplus equation for the whole economy where Government deficits and surpluses are taken into account along with those of the private sector. Like original deficit-surplus equation, I=S, it is purely descriptive. It is also an accounting identity involving no value judgments or questions of right and wrong, desirable or undesirable. If Government spending exceeds taxes we have a Goyernment deficit. In this case (G-T) is positive and is added to I, the private deficit, thereby increasing the total flow of spending. Together the two represent the total deficit which must equal S, the total surplus. On the other hand, if tax receipts exceed Government spending we have a budgetary surplus. In the equation this surplus, which actually represents Government savings, will have a negative sign and will be subtracted from I, the private deficits. Such a surplus is, of course, an offset to private deficit spending and like any savings tends to be deflationary. Thus in a period when private deficits grow too rapidly and tend to create inflationary pressures, a Government surplus, by withholding from the income stream more than it puts back, can be used to exercise a dampening effect on total demand and is anti-inflationary.

Let us now organize our model in a more realistic format in which Government taxing and spending operations are included. As in model I, the column headings indicate rele

sumed to go wrong. Private deficit spending of $80 billion is insufficient to absorb planned private surpluses of $100 billion, and, since the Government continues to maintain a balanced budget, there is no public deficit to absorb the excess surpluses. Therefore, total spending, income, output, and the rate of growth of debt all fall by $20 billion, the amount by which planned surpluses exceed planned deficits.

Now consider the lower section of model II where we again reproduce years 2 and 3, but with a different fiscal policy. Private deficit

vant relationships. It is again assumed that spending plans are related to income earned in the previous period. An important difference in regard to plans is that planned consumption will bear an inverse relationship to taxes. The lower the taxes, the more consumers are able to spend. Since plans to invest depend on prospects for profit, which in turn have some relationship to consumer spending, it is likely that plans to invest will also be stimulated by tax reductions and repressed by tax increases. However, in order to clarify the workings of our model, let us first make the simplifying assumption that only consumption plans are affected by tax changes. We shall also assume the most favorable possible situation from the Government's viewpoint; namely, that all of any new consumer income made available by a tax cut will be spent on consumption, and that none of it will be added to savings (although there is clearly the possibility, or even likelihood, that some may be saved). 1.. It is also likely that investment plans may be directly stimulated by tax cuts, but we leave this possibility aside for the moment. For the sake of simplicity we again assume static population and technology.

Everything here operates in much the same way as in the more simple model where Government was absent. In the first model, the people used their money to buy the output of private enterprises and received in exchange finished consumer goods or titles to capital goods. Unless they could buy such things from private firms, there were no roads, no schools, no courts, no police, no fire departments, no sanitary facilities, no mail service, no military establishment, nor any other public services. In our real world model the people are able to buy such services from the Government. In addition to the goods and services purchased from the private sector of the economy by paying cash or credit, the people now buy these other things from the public sector by paying taxes. The main difference is that whereas the things people buy at the "private store" are determined by daily voting (in the form of dollars); what they buy at the public store is determined by less frequent voting. But, of course, in either case the effect is the same. The people themselves determine how much they wish to obtain from private enterprise in exchange for cash or credit and how much from Government in exchange for taxes.

But, now let us note an important difference in the two models. In model I total deficits and surpluses resulted from the independent decisions of millions of free individuals. If plans to invest were inadequate to absorb planned savings the result was that spending, income, and output inevitably fell, causing unemployment and recession. When planned deficits grew more rapidly than planned surpluses, spending increased and, if productive resources were not forthcoming at corresponding rates, inflation was the result. In the real world, since Government is also able to run deficits or surpluses, its fiscal operations afford a possible cushion against the undesirable effects of excessive private deficit or surpluses.

Turning now to developments in model II, we assume that, as in model I, everything goes smoothly during the first 2 years. Planned private deficits equal to planned private surpluses maintain maintain the level of spending and income. Since the Government budget is balanced at $100 billion, there is no Government deficit or surplus, and this, of course, is as it should be if the stability of the economy is not to be disturbed. A balanced budget in this situation is necessary. Government debt is zero and remains zero. Total debt, still made up entirely of private debt, increases by $100 billion each year, the rate necessary to absorb private surpluses. But again in the third year things are as

spending has declined, but in this case the Government does not maintain a balanced budget. In order to offset a decline of $20 billion in private deficits it cuts taxes by $20 billion, thereby incurring a public deficit of $20 billion. Thus total deficits, including Government deficit, are equal to total planned surpluses and the spending income stream is maintained. Though private debt fails to grow at the requisite rate of $100 billion per year, increasing public debt fills the gap and maintains the rate of total spending and total demand undiminished.

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According to the assumptions made earlier, all of the increased disposable income made available by the tax cut is used to increase consumption spending. In the real world, as noted earlier, some of the increase in disposable income would certainly be used to pay debts or to increase savings. To the extent that this occurs, an even greater tax cut and a larger Government deficit would be necessary in order to maintain the original level of spending. Although cutting taxes might at first seem to be a more conservative way to create a deficit than by increased Government spending, the fact is that a given change in the level of income can be achieved by a smaller deficit if it is accomplished through a change in spending. A billion dollar increase in Government spending adds a billion dollars directly to the income stream, but part of a billion dollar tax cut will be saved or used to pay debts.

The assumption that all income freed by the tax cut went into additional consumption was made only to simplify the arithmetic. In all probability some would go into increased investment spending. In the real world, the actual distribution between additional consumption and additional investment would depend on a wide variety of factors such as the distribution of the tax cut benefits, consumer optimism or pessimism, business estimates of profit prospects, and probably even the public attitude toward Government deficit spending and public debt.

The role of Government deficits can now be summarized in the same mechanical account

ing terminology employed in describing deficits in general. Provided that planned private deficits are inadequate to absorb planned private surpluses, the alternative to a Government deficit sufficient to absorb the difference is declining income output, and employment. This proposition is a in purely descriptive statement of fact which no matter of opinion or value judgment is involved. The point is that there must be total deficits of a given size somewhere in the economy if total spending and total demand are to be maintained. Hence, if sufficient deficits cannot be coaxed from the private sector, either these deficits must appear in the public sector or spending, income, and output inevitably will decline. Business sales will fall, profits will disappear and goods will remain unsold. In this situation the public must understand that either Government deficit spending or un

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80 100 600 100 employment and recession are inescapable alternatives. The only value judgment involved is in the determination of which is to be preferred. But, since it is a value judgment, the economist as economist cannot decide for the people which is the better choice. His only function is to let people know where each of the two paths leads.

GOVERNMENT DEFICITS: PLAN OR NO PLAN

Up to this point the term "planned Government deficit" has been used in a context which implied a deliberate and conscious adjustment of the Federal budget to offset excessive or inadequate private deficits. The idea was that since planned private deficits and surpluses are the product of decentralized decisionmaking it would be mainly accidental if they happened to occur regularly in just the right amounts to maintain full employment without inflation. Hence approximately "right" total amounts could be assured by central planning of Government deficits or surpluses which would provide the necessary increases or decreases in the spending stream. As an interpretation of actual Government policy in modern United States, such a concept would be naive indeed. Such has not been the case. It is true that President Roosevelt experimented with small planned deficits during parts of his first two terms. But he was not firmly convinced of the wisdom of such policies, and as a result refused to use most of the great powers given him by the Thomas rider to the farm bill in 1933. During his 8 years in office prior to 1941, most of his budget last deficit of $2.7 billion incurred by Presdeficits were not markedly larger than the ident Hoover; two were smaller, $2.6 and $1.2 billion, and two were about the same size. The largest was $4.4 billion in 1936.4 In the sion, President Eisenhower in 1954 recognized face of the threat posed by a business recesthe basic concepts in a remarkable statement:

"The fourth principle is to act promptly and vigorously if economic conditions require it. The Government will not hesitate to make greater use of monetary, debt management, and credit policy, including liberalized used of Federal insurance of private obligations, or to modify the tax structure, or to reduce taxes, or to expand on a large scale useful public works, or to take any other

Economic Report of the President, transmitted to the Congress January 1963, p. 238.