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Peter Crabb: Deficit spending leads to a larger question — who gets to invest?

Gov. Arnold Schwarzenegger of California came to office in 2003 claiming he would "end the crazy deficit spending." The effort received a large setback Tuesday as voters in the Golden State rejected numerous proposals.

These voter referendums included a number of tax increases and proposals to cap spending. The voters didn’t like the proposals, or simply don’t like the policymakers, but the need to end the deficits appears well supported.

In contrast, U.S. voters and policymakers have done little to end “crazy” deficit spending at the national level. The April 2009 Monthly Treasury Statement of Receipts and Outlays of the United States Government shows the fiscal year deficit increased 640 percent over the same period last year.

From October 2008 through April 2009, federal tax receipts declined 29 percent while spending rose 31 percent. To finance this massive increase, the total federal securities outstanding rose more than 20 percent.

Total federal borrowings from the public now stand at $11.2 trillion. This is to say nothing of the unfunded liabilities for health care and retirement benefits, under Medicare and Social Security, respectively.

So the debate continues: Should governments balance their budgets?

Proponents of a balanced federal budget generally argue two points. First, that budget deficits impose a burden on future generations by raising taxes higher than they would be otherwise, thereby lowering their incomes or standard of living. Second, budget deficits can cause crowding out. This is a process whereby the total national saving declines and interest rates rise. The higher interest rates crowd out private investment. With less investment there is less capital and productivity falls. The net effect is smaller economic growth than would have occurred otherwise.

Opponents of a balanced budget requirement argue that a government deficit does not preclude investment and that the problems caused by the government debt are overstated.

Yes, private investment may fall, opponents argue, but fiscal policy includes many important public investments. If the federal government reduces, for example, education spending, this could also lower economic growth in the future. Government investments can make future generations better off.

In their second argument, opponents of balanced-budget requirements are saying we are not taking on too much debt. Based on the gross domestic product report for the first quarter of 2009, the deficit is a little less than 7 percent of our current income. Many households spend more than that percentage above their current income each year.

So far, the market has judged in favor of the opponents. There are no current indications that U.S. federal deficit spending is harmful or unsustainable.

Interest rates on U.S. Treasury bills, notes and bonds remain well below their levels of just a few years past. The yield spread, or difference between rates on short-term and long-term debt, is rising, suggesting higher inflation in the future. But the cost of financing government spending is historically low.

Thus, the U.S. government budget deficit remains a focus of debate, and both sides have reasonable arguments. However, a better question is: How big a government do we want?

The answer better determines who will win the deficit debate because it determines the need to raise taxes on future generations. If we choose a larger government — through continued investments in education, health care, or a myriad of other policy proposals — a limit on borrowing from the public will eventually arise.

If we choose a smaller role for the government, the current debt will be paid in the same way households eventually pay all their debts: with higher future incomes. The U.S. economy will have more private investment rather than more public investment.

It is not a question of investment. It is a question of who you want making the investments.

Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.