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Decimal Digest
29 Oct 2012

Fiscal Imprudence in Well Functioning Democracies

Recently in the western world, there has been a lot of discussion on “everybody in it together”, and the need of rich to contribute to the society their “fair share”, as defined by the marginal tax rate. (Aka OWS)

In this whole discussion, the emphasis is more on resource generation; and less on the process of decision making involved in the expenditure side of government.

People born in free, democratic societies generally believe in the principle of equality of all citizens of a nation state, and hence subscribe to universal suffrage as the best form of democratic participation.

As stated in the opening paragraph, some of us believe that the rich amongst us should do more on a per capita basis “ex-gratis” for the government. However, the irony and imbalance it creates on the first principle of democracy – all humans are equal - is lost on those of us who subscribe to this view.

Before we go further in this exposition, let us pause and think how a person can become rich – there are only three ways – inheritance, crime and hard work1. Inheritance goes against the principle of equality of all humans, however could also be argued to be a key motivator for hard work. The current solution to partly tax wealth bequeathed presents a good compromise, in our opinion.

Of these, crime as a cause of wealth is straightforward to handle in any well functioning society. However, some democracies notably in southern Europe and in the developing world have still to get this sorted with rampant corruption, crony capitalism and massive tax evasion. Such massive failure of delivery of justice, a key element for any well functioning democracy/society, would inevitably lead to fiscal problems as an initial symptom and possibly revolutions eventually.

The final cause of wealth creation - hard work should be celebrated by all the societies and not punished or taxed higher on a per capita basis.

We notice that by and large, nearly all democracies are experiencing a rapidly rising share of government in their economies and also rising government debt – basically resources borrowed by the current generation from future generations.

The notion of borrowing from future generations is an anathema for the Darwinian Mother Nature; and is a relatively new phenomenon in human history as well. Before the advent of republics, the kings used to borrow on the basis of their might (to tax own subject and to plunder other King’s subjects/colonies), leading to a major agency problem. The kings borrowed for whatever grandiose purpose, while knowing clearly that they would not pay for it from their own pocket, instead use their might to wrestle the money from someone if the need be. The democracy, on the other hand, is borrowing from its own future generation. So, theoretically, it will borrow only for projects where the expected societal benefits over the life of borrowing significantly outweigh the cost of borrowing.2

However, we notice an important trend in the change of composition of expenditure of democratic governments. The expenditures are moving away from either projects (e.g. road / dam building) or programs (e.g. health care / education) towards entitlements to individuals (e.g. unemployment doles). While projects or programs have some hope of producing some benefits for societies; large & prolonged individual entitlements, by definition, cannot produce positive societal good for the next generation as a whole.

In other words, most democracies are behaving like irresponsible parents – instead of requiring citizens/societies to live within means are splurging money on dubious items and leaving the debt for the next generation to sort out.

It would be very important to ask this question - why this unnatural behavior (of irresponsible parenting) is becoming more and more prevalent in otherwise well functioning democracies. Universal suffrage is the basic tenet of any democracy. Could it be the problem? Or is a monetary system that allows for such reckless borrowing and spending the true culprit. We think it is time for democracies to put their thinking caps on and come up with a system that has proper check and balances to prevent such imprudence.

1Ignoring “luck” and intersection of luck and hardwork. Pure luck – by definition – is transient and can be ignored as source of wealth.

2This cost of borrowing should be nominal cost, if the democracy is borrowing from its own citizens, and real cost if it is borrowing from foreign citizens.


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