The Budget Equation

Following the previous post, there is another dubious equation

gain = money in – money out

As before, this is obviously true, but explains nothing. To increase the right hand side, we cannot simply increase our revenues, or cut our expenses. The problem is that doing one thing influences the other.

If the owner of a restaurant cuts his costs by not cleaning the toilets, using cheaper ingredients, firing staff, he is very likely to also cut the number of guests. Cutting costs is a very delicate thing, and that dependency makes the simple budget equation pointless. For a state, cutting costs usually means cutting social expenses, reducing structural investments, or cutting off subventions. All of this has direct consequences in terms of tax income with the result that the total gain can become negative. Saving can strangle a state to death.

Likewise, increasing „money in“ does not always work. In fact, it may reduce income. Every student of economy learns that there is an optimal price. Increasing beyond that point means less sales, or more costs per piece. In a state, increasing sales taxes has negative effects on the cross product, since it reduces consumption, and thus private investment. This does not imply that reducing sales taxes increases state welfare. The government needs some money for its activities, and the state needs a government to prosper.

Interestingly, when it serves their clients, some politicians do indeed ignore the budget equation, and claim that a reduction of income taxes leads to higher economical activity, which in the end increases the tax income, and reduces the costs for social measures, and so increases gain. The proof that this concept works remains to be seen.

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