Firstly, the truth of modern capitalist economies is that large amounts of the process of production go towards creating demand that wouldn’t formerly be there – advertising, marketing and so forth. Standard rebuttals to this point tend to rest on the idea that people behave like perfectly logical robots, but the fact is that people are influenced by advertising to buy things they didn’t previously know they wanted – if they weren’t, it wouldn’t exist. So a decent proportion of private spending is ‘artificially’ created, and hence people wouldn’t miss it if it were gone.
Secondly, consumption tends not to increase happiness past a certain point, as humans fall victim to two cognitive biases that, as Jonathan Aldred says, put them on the ‘happiness treadmill':
- Adaptation. This is when people become accustomed to new things they have, and their happiness level adjusts back to where it was previously. This is pretty extensively documented – there are many examples of lottery winners who do not feel any happier than previously, and there is the well known phenomenon of ‘buyer’s remorse‘.
- Rivalry. This is the fact that a large part of our desires for consumption rest on what we see around us and what our neighbours have – ‘keeping up with the Joneses‘.
So people buy things because others have them, and quickly adapt, resulting in no net gain of happiness or utility. This continues, fuelled by advertising, and growing consumption fails to deliver the goods, so to speak. Hence, reducing people’s private purchasing power does not necessarily make them less happy, though of course it depends on the stage of development and on the type of good.
Even if you accept this, you might ask ‘well how can the government improve on this once it has the money?’ The answer is actually very simple, neoclassical (!) economic theory: the government provides public or quasi public goods, which would be under provided or not provided at all in the private sector. Private individuals do not have the incentive to provide these goods, so the government is required to step in. After all, it’s better than spending money on things for which demand has been artificially created, and which do not appear to increase people’s happiness.
The idea that governments can spend money better than the private sector has been suggested as as a reason for high tax rates appearing to be a net positive for economic growth, though there are numerous other possible explanations. It also may help to explain the relative success of the Scandinavian economies, where consumption (and other) taxes are high and advertising is strictly regulated. As a result, consumerism is lower and public services are, broadly speaking, the best and most well-funded in the world.