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Warping the Economy with Welfare and Warfare

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Let’s assume a society in which there is no income tax, no welfare state, no overseas military empire, and no military-industrial complex. Assume that the tax burden amounts to an average of 2 percent per person, with it being collected with a sales tax on imported goods People are keeping 98 percent of their income.

In such a society, people would be free to do whatever they want with their money. Production and consumption of goods and services would be driven by that 98 percent that people are keeping. Businesses would almost be entirely oriented toward satisfying consumer preferences or saver/investor preferences. The citizenry, through their buying and selling, would be directing most of the economic activity in society.

The probability is that overall people would be saving a large portion of their incomes, which is the key to economic prosperity. The savings are placed into banks, which then lend the money to businesses that are purchasing machinery and equipment which make workers more productive. More productivity means higher wage rates and increasing standards of living throughout society.

Now, imagine that the state decides to impose an 80 percent income tax on the citizenry. Everyone is now required to send in 80 percent of his income to the government, keeping 20 percent for himself. The government uses the money to build an enormous welfare bureaucracy, distribute a welfare dole to large segments of society, and build a vast overseas military empire and domestic military-industrial complex.

Obviously, this new state of affairs dramatically changes the orientation of economic activity in the society. Thousands of businesses and industries that previously catered to the consumer/savings/investment preferences of the private sector go out of business because people are no longer disposing of the 80 percent that they previously spent or saved.

The government hires tens of thousands of people to serve as tax and welfare bureaucrats and to serve in its vast foreign and domestic military empire. Those people come out of the private sector, where they use to be productive. Now working for the government, they are living off of the 80 percent of taxes that are now being taken from those who remain in the private sector.

Vast new businesses and industries come into existence to cater to the wants of the government — to the new non-productive class, i.e., the soldiers, the welfare bureaucrats, and the welfare dole recipients.

The thing to note is that we are dealing with two completely different groups here: a productive group and a non-productive group. The private sector is the productive group. The government sector is the non-productive group. The private sector produces the wealth in society. The government sector — consisting of soldiers and bureaucrats — produces no wealth; instead it thrives off the money that is taken through taxation from the private sector.

For a time, everything works out, in large part because the private sector is able to sustain the burden of paying for the welfare-warfare sector. Standards of living continue to rise, albeit not as enormously as before, but most people don’t seem to notice that. Anyway, people are told that it’s all because of national security and to fight poverty, and so people are willing to accept the lower standard of living than they otherwise would have had.

Over time, however, the private sector cannot handle the financial burden of supporting the non-productive sector. For example, let’s say that it’s costing $1 million to pay for the soldiers, the bureaucrats, and the welfare recipients but the taxes being collected through the 80 percent income tax amount to $800,000.

Obviously, the government could raise the income tax to 90 percent to cover the difference, but the problem is that that tax increase will drive more businesses into bankruptcy, thereby shrinking the tax take from the private sector.

So, the government simply goes into the investor marketplace and borrows the money to make up the difference. The next year, it’s faced with the same problem. It goes out and borrows more money. Year after year, it continues borrowing and borrowing and borrowing, until the total amount of its debt becomes so large that the government cannot pay all the soldiers, the bureaucrats, the welfare recipients, and the interest on its debt, much less any of the principal, with its tax revenues.

That hypothetical essentially describes the economic situation of such countries as Greece, Italy, Cuba, and the United States. Obviously, the numbers are different in each country, and the situation is different in each country, but the principle is the same in all of them.

The government sector — the non-productive sector — has grown so large that tax revenues are not enough to cover the expenses. The government sector knows that a critical point has been reached. If taxes are raised on the productive sector, it will shrink, thereby exacerbating the problem. The government has borrowed so much money that it is unable to pay interest except by borrowing more money. But for countries like Italy and Greece, that game is just about over, given that investors are now refusing to lend their governments any more money by buying their bonds.

What’s the solution? The solution is obvious: dismantle the welfare-warfare sectors and and the taxes needed to sustain them. End the welfare, dismantle vast the military empire, and abolish the income tax. Leave people free to keep everything they earn.

That’s where the statists go ballistic. They say that that would be the worst thing that could happen because of the vast unemployment that would accrue from discharging all those soldiers and welfare bureaucrats and terminating the dole for all the welfare recipients. They also point to all the businesses that cater to the public sector that would go out of business.

What they miss is the tremendous economic boon that dismantling the welfare-warfare sector would produce. All those discharged people would soon find jobs in the productive sector. Thus, there would be a doubly positive economic effect: People currently in the private sector would now be free to keep their own money — money that was previously used to sustain people in the non-productive sector — and people previously in the public sector would now be in the productive sector too.

The same holds true for the businesses that cater to the public sector. They would go out of business but be replaced by all the new businesses that would come into existence to serve the productive sector.

Today, 80 percent of the workforce in Cuba is employed by the public, non-productive sector. The Cuban government is proposing discharging 100,000 workers. American statists are undoubtedly exclaiming what a bad idea that would be because, they would say, it would bring about unemployment. They miss the point. By relieving the private sector of the burden of paying the taxes that sustain those unproductive 100,000 workers, the private sector is strengthened. Moreover, those 100,000 workers are no longer living parasitically off of the taxes imposed on the private sector but instead are now part of the private sector and producing wealth.

The welfare-warfare state has warped the orientation of goods and services in society and impoverished the productive sector. The best thing people could do is dismantle the welfare-warfare state, thereby restoring a vibrant, productive, prosperous private sector to society.

This post was written by:

Jacob G. Hornberger is founder and president of The Future of Freedom Foundation. He was born and raised in Laredo, Texas, and received his B.A. in economics from Virginia Military Institute and his law degree from the University of Texas. He was a trial attorney for twelve years in Texas. He also was an adjunct professor at the University of Dallas, where he taught law and economics. In 1987, Mr. Hornberger left the practice of law to become director of programs at the Foundation for Economic Education. He has advanced freedom and free markets on talk-radio stations all across the country as well as on Fox News’ Neil Cavuto and Greta van Susteren shows and he appeared as a regular commentator on Judge Andrew Napolitano’s show Freedom Watch. View these interviews at LewRockwell.com and from Full Context. Send him email.