From UPSC perspective, the following things are important :
Prelims level : Not much
Mains level : Paper 3- How fiscal deficit financed government spending leads to wealth inequality
The article highlights the issues with government expenditure driven by the selling of public sector assets.
How public asset selling could affects private investment decisions
- Public sector assets are not bought by reducing consumption or investment.
- Current investment expenditure depends on decisions taken in the past and is more or less pre-determined.
- Investment decisions that are taken today for fructification tomorrow that may be scaled down by such a purchase.
- However, if investment decisions taken today are scaled-down, then it results in crowding out and such a strategy should be avoided anyway.
- This implies that selling public sector assets therefore does not release any resources from private use for government spending.
How selling public asset has same macroeconomic effect as fiscal deficit
- In case of fiscal deficit, the government puts its bonds in private hands; in sale of a public asset, the government puts its equity held in public sector assets in private hands.
- The macroeconomic consequences of a fiscal deficit on the economy are no different from those of selling public assets.
- However, finance capital, and institutions like the IMF treat the sale of public assets on a different footing from a fiscal deficit, for ideological — not economic — reasons, because they ideologically favour a dismantling of the public sector.
How fiscal deficit leads to wealth inequality
- In a situation of demand-constraints, where unutilised capacity and unemployed workers exist aplenty, if an appropriate monetary policy is pursued, it can have no adverse effects whatsoever, except one: It increases wealth inequality.
- The government expenditure financed by the fiscal deficit creates additional aggregate demand that increases output and incomes until the additional savings generated out of such incomes exactly match the fiscal deficit.
- These additional savings accrue to the savers without their having to reduce their consumption, compared to the initial situation (that is, prior to government expenditure increase).
- Since savings represent additions to wealth, this amounts to putting extra wealth into the hands of the rich.
- Selling public assets puts into private hands public assets, and that too at prices well below the capitalised value of earnings.
- This increases wealth inequality for two reasons:
- First, it does so exactly as a fiscal deficit does.
- Second, the public asset it puts in private hands is under-priced.
Why tax financed government spending should be preferred
- If the same government expenditure is financed by taxation, no matter who was taxed, then there would be no addition to private wealth and hence no increase in wealth inequality.
- Which is why tax-financed government expenditure should always be preferred to fiscal-deficit-financed government expenditure.
What alternative government have
- The obvious one is wealth taxation.
- Taxing away the private wealth created by a fiscal deficit leaves private wealth inequality unchanged at its initial level; it does not exacerbate it.
- If the government is unwilling to impose higher wealth or profit taxes, it can raise GST rates on several luxury goods.
Consider the question “How fiscal deficit financed government spending differs in its impact on weath inequality from the tax-financed government spending?”
Thus, selling public assets to finance government spending is both undesirable and unnecessary.