War finance

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War finance is a branch of defense economics. The power of a military depends on its economic base and without this financial support, soldiers will not be paid, weapons and equipment cannot be manufactured and food cannot be bought. Hence, victory in war involves not only success on the battlefield but also the economic power and economic stability of a state. War finance covers a wide variety of financial measures including fiscal and monetary initiatives used in order to fund the costly expenditure of a war. [1]

Contents

War finance measures can be broadly classified into three main categories:

Thus these measures may include levy of specific taxation, increase and enlarging the scope of existing taxation, raising of compulsory and voluntary loans from the public, arranging loans from foreign sovereign states or financial institutions, and also the creation of money by the government or the central banking authority.

Throughout the history of human civilization, from ancient times until the modern era, conflicts and wars have always involved the raising of resources and war finance has since remained, in some form or the other, a major part of any defense economy plan. For example, economics played a key role in the Roman Empire. The brutal wars between the Roman empire and the Carthage proved to be very costly so much that Rome even ran out of money altogether at one stage. The Roman economy during this period were a pre-industrial economy which meant the majority of workers up to 80% of them were involved in the area of agriculture. Virtually all the taxes that would be collected by the government were spent on the military operations which turned out to be about also 80% of the entire budget in c. 150. Due to the huge financial burden that the maintenance of the military operations would have on the economy, techniques were thought up to help solve the burden. One such technique was the process of debasing the coinage. This was used in many countries that used coins from precious metals and they would debase the coins. This however didn't last very long as inflation started to increase. Various governments in charge attempted to curb the high cost of inflation through new reforms but some of their attempts just got steadily worse with the increasing bureaucracy that the government had to maintain as well as the huge amounts spent on welfare payments to the growing population worse. [2]

Loot and plunder - or at least the prospect of such - may play a role in war economies. [3] [4] This involves the taking of goods by force as part of a military or political victory and was used as a significant source of a revenue for the victorious state. During the first World War when the Germans occupied the Belgians, the Belgian factories were forced to produce goods for the German effort or dismantled their machinery and took it back to Germany – along with thousands and thousands of Belgian slave factory workers.

Taxation

Taxation can be one of the more politically contentious ways to finance war. Raising taxes is often domestically unpopular, as people know that higher taxes reduce their individual abilities to invest and consume. As a consequence, raising taxes on a tax-averse population in order to fund a war might result in widespread anti-war sentiment. Moreover, taxes confiscate a part of the labor and the capital of the population. [5] During World War I, the United States and Great Britain each financed one quarter of their war costs via increased taxation, while in Austria the contribution of taxation towards the expenditure was zero. [3] The British government felt that they were an exception to this general rule and they saw their wealth and financial stability as one of their strongest warfighting assets. The income tax was therefore increased from 5.8% in 1913 to just over 30% in 5 years in 1918. The threshold was reduced in order for millions more people to be liable to pay the income tax.

Borrowing

World War 1 War Bond Poster WWIHunNatlArchives.jpg
World War 1 War Bond Poster

For the government another solution to finance war is for the government to increase its debt. When the Great War began, the majority of countries assumed that the war would be short especially in the eyes of the most powerful ally countries United States, Great Britain and France. They saw no need to raise taxes as it would have been politically difficult. It turned out however that it came at an extraordinary financial expense and as such thought it was best to pay for it by borrowing money and could thus transfer the war costs to future generations. The government can issue bonds that are bought by creditors, usually the Central Banks. The sacrifices are as a result differed, the government would need in the future to pay it back with some interests. There are many examples in war history, referred to as War bond. The economic consequences of this method of finance is less direct for the population, but equally important. The interests paid can be seen as pure wealth redistribution. Moreover, an accumulation of debt, which is too important, can affect the economy of a country, through its ability of refunding its debt. It can alter the confidence of people in the country's economy. [5] The war bonds were debt securities that would be issued by the government to finance the military operations and defense mechanisms during the time of a war. In practice, war can be financed through the creation of a fresh money supply adding additional money to the financial system and the function of these bonds were to help to control the increase of inflation and to keep it stable. The United States government during World War 1 spent over $300 million which converts to over $4 billion in today's financial market. People would then buy these bonds which looked like stamps for 10 or 15 cents each from the government and the government promised to return them with an interest after a period of 10 years or more. During a war especially during World War 1, governments needed all the extra money they could get their hands on to help pay for the war equipment and supplies. The advertisement of these bonds were carried out through many media outlets and through propaganda materials on radio, cinema adverts and newspapers in order to convince the large multitude of the countries population. [6]

Inflation

The government can also use a monetary tool to finance war, it could print more money in order to pay for troops, military complex and arms. But inflation is created, which reduces the purchasing power of people and can be thus seen as a form of taxation. However, it distributes the war costs in an arbitrary manner, especially on people with fixed incomes. At some point, such inflation could even reduce the production level of a country. [5] During the great war, countries decided to turn on the printing presses with almost every country abandoning the gold standard in 1914 and started to inflate their individual currencies by printing more banknotes. E.g., in Britain money supply was multiplied by almost 1151% and 1141% in Germany. Much of the extra money supply was absorbed by the war loans fortunate for the western countries while rationing out the controlled prices.

Borrowing vs. Taxing

When a conflict leads to higher governmental expenditures, the population financing the war is either paying directly (and immediately) or indirectly (and maybe delayed). Hence, war finance is can be divided into two categories: Direct or indirect financing. The former comprises taxes through which the population bears directly the burden, the latter includes borrowing or increasing the money supply. Empirical studies have established a connection between a leader's tax policy and subsequent punitive electoral consequences as they represent a permanent transfer of purchasing power by the taxpayer to the government. [7]

From a political perspective, borrowing is a more convenient way to finance wars because it can minimize the potential electoral consequences. Levying higher tax rates has an immediate effect on the population, whereas borrowing goes along with delayed repercussions. The advantage of borrowing is that it likely transfers the financial burden to a future government and consequently does not affect the current leader's prospects of a potential re-election. Second, borrowing itself is an accepted tool for the state to carry out its duties such as exerting expansive fiscal policies. That means because borrowing affects people only indirectly and is an accepted measure in general, it makes war a more diffuse target for critics, because it will be just one of the government's numerous debt sources. Of course, borrowing contributes to the increase of debt that causes also contentious debates. But particularly in the case of the United States, it can be observed that the hazard of a government shutdown is politically an undesirable outcome, even for the opposition. Having no alternatives, the Congress invariably passes legislation to increase the debt ceiling. This certainty guarantees that borrowing minimalizes any political costs.

To conclude, wartime borrowing is politically advantageous relative to war taxation: It is just an - although often a significant one - additional source of debt, which blurs the traces of the initiator as the ultimate repayment takes place long after the leader who started the war has stepped down. These characteristics reduce the political costs for the current leader and causes borrowing to generally be more attractive and politically viable than introduction of war taxes. [8]

History of different perspectives on War finance in the US

Financing a war requires the government to seek for additional revenue sources because government expenditures increase significantly during war or when a war is about to break out. The consequences of policies that focus to secure enough income sources have tremendous impact on the economy and often go even beyond the war itself. The determinants of how to provide financial funds are therefore driven by political interests giving different parties the opportunity to conceptualize and secure certain fiscal interests of their core constituencies. In the United States, the Republicans and their predecessors - the Whigs and Federalists - favoured to impose taxes, when the taxation was introduced as an ad valorem tariff or excise tax. These tax modes favoured manufacturing and business interests, the Republican base.

The Democrats, however, traditionally tended to abstain from taxes because their support came from the South, a strong exporting region that would suffer from tariffs and excise taxes. With the constitutionality of income taxes in 1913, the Democrats advocated a progressive income tax due to the important role of labour in their political base. With the business sector being its main political base, the Republicans opposed higher income taxes, rather favouring less fiscal policy, including on war taxation. The high repercussions and redistribution effects of taxes lead to various political interests. Thus, different lobby groups formed trying to have determining influence on the tax mode, when political leaders tried to generate revenues from taxing or other alternatives. [8]

Case Study: War costs of Afghanistan and Iraq

Not surprisingly, instrumental politicians tend to avoid war taxes, especially when the reasonableness of a war is publicly challenged or when the real cost of a war a difficult to calculate. This was also confirmed in the case of the Afghanistan (2001) and Iraq (2003) war. Both wars were financed through heavy borrowing. In 2003, the Bush-Administration reckoning with a fast conquering expedition estimated the cost of the Iraq war at $50 billion to $60 billion. [9] This turned out to be a severe miscalculation, when it became clear that the conquering of Iraq was much more complicated and that stability of Iraq required a long-term engagement of the US military. Three years later, in February 2006, a working paper authored by economists Linda Bilmes and Joseph Stiglitz already believed the true cost to be more than one trillion dollars, taking a conservative approach and supposing a troop withdrawal by 2010, not even including costs borne by other countries. [10] A subsequent paper, published in March 2013, figured that the cost of the Afghanistan and Iraq conflicts will be at least $4 trillion. However, taking into consideration macroeconomic costs such as higher oil prices would be likely to raise the cost to $5 or $6 trillion. [11]

Related Research Articles

A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer by a governmental organization in order to collectively fund government spending, public expenditures, or as a way to regulate and reduce negative externalities. Tax compliance refers to policy actions and individual behaviour aimed at ensuring that taxpayers are paying the right amount of tax at the right time and securing the correct tax allowances and tax relief. The first known taxation took place in Ancient Egypt around 3000–2800 BC. Taxes consist of direct or indirect taxes and may be paid in money or as its labor equivalent.

<span class="mw-page-title-main">Fiscal policy</span> Use of government revenue collection and expenditure to influence a countrys economy

In economics and political science, fiscal policy is the use of government revenue collection and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variables developed in reaction to the Great Depression of the 1930s, when the previous laissez-faire approach to economic management became unworkable. Fiscal policy is based on the theories of the British economist John Maynard Keynes, whose Keynesian economics theorised that government changes in the levels of taxation and government spending influence aggregate demand and the level of economic activity. Fiscal and monetary policy are the key strategies used by a country's government and central bank to advance its economic objectives. The combination of these policies enables these authorities to target inflation and to increase employment. In modern economies, inflation is conventionally considered "healthy" in the range of 2%–3%. Additionally, it is designed to try to keep GDP growth at 2%–3% percent and the unemployment rate near the natural unemployment rate of 4%–5%. This implies that fiscal policy is used to stabilise the economy over the course of the business cycle.

In economics, the fiscal multiplier is the ratio of change in national income arising from a change in government spending. More generally, the exogenous spending multiplier is the ratio of change in national income arising from any autonomous change in spending. When this multiplier exceeds one, the enhanced effect on national income may be called the multiplier effect. The mechanism that can give rise to a multiplier effect is that an initial incremental amount of spending can lead to increased income and hence increased consumption spending, increasing income further and hence further increasing consumption, etc., resulting in an overall increase in national income greater than the initial incremental amount of spending. In other words, an initial change in aggregate demand may cause a change in aggregate output that is a multiple of the initial change.

<span class="mw-page-title-main">Deficit spending</span> Spending in excess of revenue

Within the budgetary process, deficit spending is the amount by which spending exceeds revenue over a particular period of time, also called simply deficit, or budget deficit; the opposite of budget surplus. The term may be applied to the budget of a government, private company, or individual. Government deficit spending was first identified as a necessary economic tool by John Maynard Keynes in the wake of the Great Depression. It is a central point of controversy in economics, as discussed below.

<span class="mw-page-title-main">Public finance</span> Study of the role of government within the economy

Public finance is the study of the role of the government in the economy. It is the branch of economics that assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achieve desirable effects and avoid undesirable ones. The purview of public finance is considered to be threefold, consisting of governmental effects on:

  1. The efficient allocation of available resources;
  2. The distribution of income among citizens; and
  3. The stability of the economy.
<span class="mw-page-title-main">Government budget balance</span> Difference between revenues and spending

The government budget balance, also referred to as the general government balance, public budget balance, or public fiscal balance, is the difference between government revenues and spending. For a government that uses accrual accounting the budget balance is calculated using only spending on current operations, with expenditure on new capital assets excluded. A positive balance is called a government budget surplus, and a negative balance is a government budget deficit. A government budget presents the government's proposed revenues and spending for a financial year.

<span class="mw-page-title-main">Personal finance</span> Budgeting and expenses

Personal finance is the financial management that an individual or a family unit performs to budget, save, and spend monetary resources over time, taking into account various financial risks and future life events.

A tax cut represents a decrease in the amount of money taken from taxpayers to go towards government revenue. Tax cuts decrease the revenue of the government and increase the disposable income of taxpayers. Tax cuts usually refer to reductions in the percentage of tax paid on income, goods and services. As they leave consumers with more disposable income, tax cuts are an example of an expansionary fiscal policy. Tax cuts also include reduction in tax in other ways, such as tax credit, deductions and loopholes.

<span class="mw-page-title-main">War economy</span> Actions taken by a state to mobilize its economy for war production

A war economy or wartime economy is the set of contingencies undertaken by a modern state to mobilize its economy for war production. Philippe Le Billon describes a war economy as a "system of producing, mobilizing and allocating resources to sustain the violence." Some measures taken include the increasing of Taylor rates as well as the introduction of resource allocation programs. Approaches to the reconfiguration of the economy differ from country to country.

<span class="mw-page-title-main">Government debt</span> Total amount of debt owed to lenders by a government/state

A country's gross government debt is the financial liabilities of the government sector. Changes in government debt over time reflect primarily borrowing due to past government deficits. A deficit occurs when a government's expenditures exceed revenues. Government debt may be owed to domestic residents, as well as to foreign residents. If owed to foreign residents, that quantity is included in the country's external debt.

Debt monetization or monetary financing is the practice of a government borrowing money from the central bank to finance public spending instead of selling bonds to private investors or raising taxes. The central banks who buy government debt, are essentially creating new money in the process to do so. This practice is often informally and pejoratively called printing money or money creation. It is prohibited in many countries, because it is considered dangerous due to the risk of creating runaway inflation.

Modern monetary theory or modern money theory (MMT) is a heterodox macroeconomic theory that describes currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restricting the supply of the financial assets needed to pay taxes and satisfy savings desires. According to MMT, governments do not need to worry about accumulating debt since they can create new money by using fiscal policy in order to pay interest. MMT argues that the primary risk once the economy reaches full employment is inflation, which acts as the only constraint on spending. MMT also argues that inflation can be addressed by increasing taxes on everyone to reduce the spending capacity of the private sector.

<span class="mw-page-title-main">Tax policy</span> Choice by a government as to what taxes to levy, in what amounts, and on whom

Tax policy refers to the guidelines and principles established by a government for the imposition and collection of taxes. It encompasses both microeconomic and macroeconomic aspects, with the former focusing on issues of fairness and efficiency in tax collection, and the latter focusing on the overall quantity of taxes to be collected and its impact on economic activity. The tax framework of a country is considered a crucial instrument for influencing the country's economy.

<span class="mw-page-title-main">Hyperinflation in the Weimar Republic</span> Occurrence of hyperinflation in early 20th century Germany

Hyperinflation affected the German Papiermark, the currency of the Weimar Republic, between 1921 and 1923, primarily in 1923. It caused considerable internal political instability in the country and led to the occupation of the Ruhr by France and Belgium after Germany defaulted on its war reparations.

<span class="mw-page-title-main">Linda Bilmes</span> American economist and academic

Linda J. Bilmes is an American public policy expert who is the Daniel Patrick Moynihan Senior Lecturer Chair in Public Policy and Public Finance at Harvard University. She is a faculty member at the Harvard Kennedy School where she teaches public policy, budgeting and public finance. She served as Assistant Secretary and Chief Financial Officer of the US Department of Commerce during the presidency of Bill Clinton.

<span class="mw-page-title-main">Fiat money</span> Currency not backed by any commodity

Fiat money is a type of currency that is not backed by a commodity, such as gold or silver. It is typically designated by the issuing government to be legal tender, and is authorized by government regulation. Since the end of the Bretton Woods system in 1971, the major currencies in the world are fiat money.

<span class="mw-page-title-main">Confederate war finance</span> Means of financing American Civil War

The Confederate States of America financed its war effort during the American Civil War of 1861–1865 through various means, fiscal and monetary. As the war lasted for nearly the entire existence of the Confederacy, military considerations dominated national finance.

The Impact of the Korean War on the Economy of the United States refers to the ways in which the American economy was affected by the Korean experience from 1950 to 1953. The Korean War boosted GDP growth through government spending, which in turn constrained investment and consumption. While taxes were raised significantly to finance the war, the Federal Reserve followed an anti-inflationary policy. Though there was a large increase in prices at the outset of the war, price and wage controls ultimately stabilized prices by the end of the war. Consumption and investment continued to grow after the war, but below the trend rate prior to the war.

This glossary of economics is a list of definitions of terms and concepts used in economics, its sub-disciplines, and related fields.

The economic history of the American Civil War concerns the financing of the Union and Confederate war efforts from 1861 to 1865, and the economic impact of the war.

References

  1. ↑ Rosella Cappella Zielinski, How states pay for wars (Cornell University Press, 2016) online.
  2. ↑ "Warfare and Financial History". projects.exeter.ac.uk. Retrieved 2018-05-01.
  3. ↑ Capella Zielinski, Rosella (2016-07-01). How States Pay for Wars. Cornell University Press (published 2016). ISBN   9781501706516 . Retrieved 2016-09-13. When belligerents do resort to plunder, it only comprises a small percent of their war finance strategy. Only two states have financed more than 25 percent of their war by plunder, Germany during the First Schleswig-Holstein War and Chile during the Pacific War.
  4. ↑ Compare: Hall, Jonathan; Swain, Ashok (2008). "7: Catapulting Conflicts or Propelling Peace: Diasporas and Civil Wars". In Swain, Ashok; Amer, Ramses; Öjendal, Joakim (eds.). Globalization and Challenges to Building Peace. Anthem Studies in Peace, Conflict and Development Series. London: Anthem Press. p. 113. ISBN   9781843312871 . Retrieved 2016-09-12. In the post-cold war conflicts, the belligerents [...] aim not to resolve conflict, but rather to sustain it, to take advantage of economic opportunities afforded by looting, rent seeking, taxing or siphoning off humanitarian aid and remittances, and by illicit trade.
  5. 1 2 3 by H.A. Scott Trask in: MisesInstitute Austrian Economics, freedom, and peace, "War Finance : Theory and History"
  6. ↑ Momoh, Osi (2003-11-18). "War Bond". Investopedia. Retrieved 2018-05-01.
  7. ↑ Gilbert, Charles (1970). American Financing of World War I. Westport, CT: Greenwood Publishing.
  8. 1 2 Flores-Macias, Gustavo A.; Kreps, Sarah E. (2013). "Political Parties at War: A Study of American War Finance, 1789–2010". American Political Science Review. 107 (November 2013): 833–835. doi:10.1017/S0003055413000476. S2CID   46949866.
  9. ↑ Herszenhorn, David M. (2008-03-19). "Estimates of Iraq War Cost Were Not Close to Ballpark". The New York Times. ISSN   0362-4331 . Retrieved 2018-05-02.
  10. ↑ Bilmes, Linda; Stiglitz, Joseph E. (February 2006). "The Economic Costs of the Iraq War: An Appraisal Three Years After the Beginning of the Conflict". NBER Working Paper No. 12054. doi: 10.3386/w12054 .
  11. ↑ Bilmes, Linda J. (March 2013). "The Financial Legacy of Iraq and Afghanistan: How Wartime Spending Decisions Will Constrain Future National Security Budgets". HARVARD Kennedy School.


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