The foolishness of Keynesian stimulus

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The economics of Keynesian stimulus:

1. Spend more money on public services than tax intake
2. People earn more money and spend more money
3. More money earnt and spent means more tax intake

Result: win-win… right?

Theory vs practice

Assuming everyone is taxed at 40%, let’s see how this plays out…

Under balanced budget conditions:

1. For every £1 earned by taxpayers, 40% is taxed = 40p
2. Tax money is spent on public sector employees
3. Public sector employees earn 40p for every taxpayer’s £1
4. This 40p is in turn taxed at 40% = 16p
5. This 16p is recirculated back into the public sector

Using Keynesian stimulus:

1. For every £1 earned by taxpayers, 40% is taxed = 40p
2. Through borrowing/printing money, the amount of money available to be spent on public sector is increased by 50%
3. Public sector employees earn 60p for every £1 of taxpayer’s earning
4. This 60p is in turn taxed at 40% = 24p
5. This 24p is recirculated back into public sector

Conclusions

Observation 1: Even with very heavy overspending, the recirculated 24p tax intake is still much less than the 40p initially taxed.

Inference 1: Tax intake from recirculated from public sector spending will always be less than the public spending, which means that private sector tax is required to make up for the shortfall.

Observation 2: Heavy borrowing does not create more tax income than is initially taxed – every 20p of borrowed spending results in only 8p increase in income tax.

Inference 2: Keynesian stimulus will never increase tax intake sufficient to pay back the amount borrowed, much less cover the borrowing costs.

Bottom line

Under Keynesian economics, you borrow money to pay public sector workers more. Your workers are then taxed, and this goes back into tax. But taxation is always a proportion of income. So you will always pay the public sector more than you tax them. Which means that even under Keynesian stimulus, you need private sector economic growth in order to increase the amount of money available to spend on public services.

This post was originally published by the author on his personal blog: https://hoongwai1984.wordpress.com/2017/11/03/the-foolishness-of-keynesian-economics/