The assumption that government borrowing can increase indefinitely is no longer valid. The remaining question is whether the needed cuts will occur catastrophically as a result of sovereign default, or whether the process will be orderly and occur within a framework of public support and relative confidence.

Large budget cuts done under the threat of default will inevitably entail major economic and social hardship. Beyond that looms the danger that the cuts made will not be the ones that are needed and possible, while spending both unnecessary and actually harmful will be preserved through politically motivated choices. It is therefore essential to understand beforehand which categories of spending are superfluous or harmful, and which ones are needed and should be preserved.

There are four main types of discretionary government spending, outside of the monies needed simply to maintain government operations. We will rank them in order of decreasing usefulness.

The first and most useful type of state spending is support for scientific research and the development of new technology. This is particularly true of basic research, which, if properly managed, will eventually lead to the greatest advances in applied science and technology. The government’s contribution here is particularly valuable as practical applications cannot be predicted and usually fall beyond the planning horizon of private enterprise. Therefore long-term type of research is unlikely to be financed by the private sector and is best done with government support.

The second category in terms of positive economic impact covers very large investments which due to their size, cost, and duration are beyond the means of the private sector. National defense essentially falls into this category, although it is usually treated separately due to its special requirements. Another example is provided by such complex undertakings as the Tennessee Valley Authority, or the potential development in the future of a synthetic fuel production base. Government funding here not only demonstrates feasibility and viability of a new industrial sector, but leaves behind a working enterprise of significant economic value.

In both above cases government spending and investment, if adequately managed and controlled, is both needed and economically beneficial. The “multiplier”, or the amount of economic activity per tax dollar spent, will be higher, and sometimes much higher, than one.

The opposite is true for the next two categories on the list. It is also not coincidental these are where most government spending is directed today, resulting in uncontrollable cost, lack of accountability, economic inefficiency and political corruption.

First in this class come all forms of subsidy. Under this heading comes spending to fund activities which are not justified on grounds of economic efficiency, but are supported mainly for political or ideological reasons. Subsidies breed technical and scientific stagnation as they favor existing and “safe” technology over potential progress with its attendant risks. They also breed political corruption by creating interest groups and lobbies the goal of which is to maintain and increase their share of tax revenue regardless of the usefulness of the subsidized activity. Since subsidized activities are by definition less efficient, the value obtained per tax dollar is less than what that dollar would produce if left in the private sector.

The last and most wasteful form of government outlay are cash transfers, generally known as entitlements. These are subsidies not for specified activities, but for entire groups or populations. They are politically attractive as they offer a legal way to favor specific voting groups, in other words to purchase their votes. This is most often “justified” by turning a temporary need into a ground for permanent outlays, thereby creating a client group dependent on the state. This confusion between a need that is temporary but real and the fostering of a lasting state of dependence is at the core of the entitlement issue. It also offers, as we shall see in one of the coming planks, an exit path from the entitlement trap.

The multiplier of cash transfers is always negative, since the cost of managing the program must be deducted before the recipients get their “due”.

The above categorization roughly outlines the priorities in reducing government spending. This must be done before the sovereign debt structure collapses, bringing with it economic disaster and potentially immense human suffering and distress. Here it must be said that the reduction of spending and of the activities it supports will not have entirely negative consequences. On the contrary, if properly managed, such a transition will be beneficial from both the social and the economic standpoint, as the money saved can and will be invested in more productive ways.

The above lays the foundation for the shift in our perception of government’s role and functions that the current situation requires. The coming planks will deal in more details with how such a shift can be accomplished.

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