Should the Public Budget be Cut or Expanded?

Dr. Caner Gerek

During periods of poor economic performance, the state of the public budget becomes a subject of debate. In these debates, proponents of public intervention support the public budget deficit by advocating an increase in budget expenditures. They demand that the public sector should create demand and stimulate the economy. On the other hand, social expenditures emphasize unemployment and social assistance. Free market supporters, on the other hand, have a negative view of public expenditures and argue for a balanced budget. This debate between the parties has been back on the agenda recently. The debate was reignited in the previous weeks when the Minister of Treasury and Finance Mehmet Şimşek stated that savings in the public sector would be emphasized. This week, Minister Şimşek emphasized that new tax increases will be coming, and some tax increases are slowly being implemented. This week's economic agenda is austerity and taxes.

Economic views that advocate for increased public spending during economic downturns also argue for reducing public spending when the economy recovers. In this way, the public sector plays a stabilizing role. However, it is often observed that once public expenditures start to increase, it becomes easier to cut them even if the economy recovers. Once public expenditures rise, there is rarely any turning back. One of the biggest misconceptions of governments is the belief that when the economy is performing well, the confidence gained from managing the economy correctly will ensure continued success in the future, and therefore, cutting expenditures is deemed unnecessary. As Carmen Reinhart puts it, the situation is different for governments, so they do not cut spending when things are going well. One of the best examples of this was the Venezuelan economy under Chavez. When oil prices were high, Chavez increased spending instead of balancing the budget by cutting public expenditures. When the situation deteriorated, he could not reduce spending, resulting in huge budget deficits.

Another risk of maintaining high public expenditures when the economy is doing poorly is the potential for shocks. In today's world, economies face significantly more shocks and uncertainties. Exposure to political and economic shocks during periods of high budget deficits can result in a budget problem that may take many years to reverse. Therefore, it would be more appropriate for governments to maintain a public budget balance rather than running a budget deficit. The inefficiency of public expenditures is also a critical issue. The more pertinent discussion should focus on whether the budget balance will be achieved through tax increases or savings.

Savings or taxes?

When tax increases are made to balance the public budget deficit, the ratio of public debt to GDP generally increases. In other words, raising taxes to save money produces the opposite result. This is because the increase in taxes decreases the demand in the market, and since fewer transactions are realized, the tax revenues that the public sector desires to balance the budget cannot be obtained. However, when the public saves, the ratio of public debt to national income decreases.

The second point is that while the effect of public savings is more permanent, the impact of tax increases is not. This is because tax increases are reactionary and aimed at stabilizing public expenditures. When tax increases are reactionary, they follow and attempt to catch up with public spending, which is not reduced and may even increase. Consequently, tax increases tend to be continuous. Continuous tax increases eventually lead to a slowdown in GDP growth. As national income decreases, the ratio of debt to national income increases due to the reduction in the denominator, resulting in higher costs for future borrowing.

Regarding market reaction, cutting public spending leads to a more favorable response than tax hikes. If the market anticipates that tax increases will continue once they start, confidence in the economy will be damaged. In contrast, spending cuts and savings boost market confidence. Furthermore, if public spending cuts signal that there will be no future tax hikes, the market reacts positively.

These days, when taxes and public austerity are frequently discussed, the bottom line is that balancing the budget, rather than expanding the public sector, will produce more positive results in the long run. The economy will benefit more when the public budget balance is achieved through actual savings rather than tax increases.

¹ Türkiye Devrimci İşçi Sendikaları Konfederasyonu (Disk) ve diğerleri [GK], B. No: 2016/14517, 12/10/2023). Karar metnine şuradan erişilebilir: https://kararlarbilgibankasi.anayasa.gov.tr/BB/2016/14517

² https://bianet.org/haber/1-mayis-iddianamesi-savci-42-kisi-icin-567-yila-kadar-hapis-istedi-295918

³ https://www.aa.com.tr/tr/politika/ak-partide-yeni-reform-donemi-icin-hazirliklar-basladi/3233749