Let’s Not Talk Past Each Other on the Burden-of-Public-Debt Issue

by Don Boudreaux on January 5, 2012

in Budget Issues, Debt and Deficits, Myths and Fallacies, Other People's Money, State of Macro

This post is the first of two long ones on the question of the burden of public debt.

In previous posts I’ve taken issue with Paul Krugman’s attempted resurrection of the argument that future taxpayers – insofar as government debt is internally held (that is, held by citizens of the same country whose government is obliged to pay off the debt) – do not bear any (significant) burden of today’s debt financing by government.  (My most relevant previous posts are here, here, here, and the last of “Some Links” here.)

Krugman’s argument on this matter is practically identical to arguments made in the mid-20th-century by a slew of economists who, following Keynes’s alleged upending of the classical-economic theory of full employment, tried to upend also the classical-economic conception of the burden of public debt.  Jim Buchanan called these new arguments about public debt “the new orthodoxy.”  He analyzed the new orthodoxy carefully and showed methodically why he believes it to be mistaken.

Perhaps Buchanan is wrong; perhaps Buchanan’s arguments are fundamentally flawed.  But nothing that Krugman says gives any hint that he (Krugman) is even aware of Buchanan’s challenge to the “new orthodoxy,” much less that he (Krugman) has thought it through and has discovered why Buchanan’s argument should be rejected.  Instead, Krugman simply repeats the new orthodoxy as if it is unquestionably correct.  (We see here the wisdom of Leland Yeager’s admonition that economists devote more time to learning the history of economic thought.)

Steve Landsburg now argues that Krugman is largely correct.  See also here.  (Indeed, Steve argues that Krugman is even more correct than Krugman himself realizes: according to Steve, public debt imposes no significant burden on future taxpayers regardless of whether or not that debt is internally held.  For reasons that I hope will become obvious below, I believe that Steve is correct that the nationalities of debt holders and taxpayers is indeed irrelevant.)

I’m hopeful, though, that I can convince Steve, at least, that Buchanan’s argument has much merit.

In fact, Buchanan explicitly concedes much of what Steve says.  At the end of the day, Steve appears to accept the “we owe it to ourselves” argument because he’s unaware of the thrust of Buchanan’s challenge to that argument.  There’s some ‘talking past’ each other here that should be cleared up.

So if you’re up for a post that’s a bit wonkier than is typical here at the Cafe, please keep reading.

…..

One (the?) key to Steve’s argument is summarized in this passage in his response to Nick Rowe’s defense of Buchanan’s position (original emphasis):

There’s no “us” that decides whether to save these tax cuts. Some of us can save them, while others spend them. That’s a failure of Ricardian equivalence, but it’s not a burden on all of the next generation. It’s only a burden on that part of the next generation that had greedy grandparents. If you’re not interested in living well at your grandchildren’s expense, then you won’t — and your grandchildren, therefore, won’t suffer.

Here, then, is the main point: Your grandchildren suffer only if you want them to. Bert wants to live well at his grandchildren’s expense; Ernie doesn’t. Therefore Bert spends his tax cut and thanks God for the public debt, while Ernie saves his tax cut and considers the public debt a matter of indifference. In this story, nobody who is alive today actually objects to the public debt. So Nick [Rowe] cannot use this story as a reason for you, me or anyone to become a deficit hawk.

Save for the last two sentences, Buchanan would (as do I, btw) fully agree.  Here’s Buchanan on page 33 of Public Principles of Public Debt (original emphasis):

[T]he effect on the national balance sheet is operationally irrelevant….  [T]he nation or community is not a sentient being, and decisions are not made in any superindividual or organic way.  Individuals and families are the entities whose balance sheets must be examined if the effects on social decisions are to be determined.  The presumed canceling out on the national balance sheet is important if, and only if, this is accompanied by a canceling out among the individual and family balance sheets.

Say what you will about Buchanan, he’s never guilty of anthropomorphizing the collective or of forgetting that all social phenomena ultimately trace back to choices and actions of individuals.  Indeed, Buchanan’s consistent practice of methodological individualism is central to his argument that the burden of government debt does not disappear if “we” owe it to “ourselves.”

As with all theories in the social sciences, they are best understood when viewed in the context of their times.  Buchanan published Public Principles of Public Debt in 1958, when Keynesian economics was at its zenith – when economists were loudly and proudly proclaiming the merits of “functional finance” and the importance (even necessity!) of government’s use of discretionary fiscal policy to stabilize the economy.  Much of the ‘classical’ analysis of fiscal policy – focused more on individual choices and less on the hulking aggregates that are the hallmark of Keynesian theory – had been either forgotten or rejected as primitive.

I suspect that it is Krugman’s vigorous Keynesianism that prompts him to resurrect the “new orthodoxy.”  What we may call the “fiscal sociology” is, for Krugman, quite the same as it was for mainstream economists in the 1950s – economists who were far more thoroughly Keynesian than economists as a group are today.

….

So what is the key to Buchanan’s argument?  It’s this: precisely because debt financing compared to financing out of current taxation better enables people today to foist the burden of paying for today’s goodies onto future taxpayers, greater reliance on deficit financing increases the risk that government today will both spend too much and spend more unwisely than otherwise.  This fact is why people today should care about the size of the debt.  (I quickly add, though, that to care is not to despair.  The former does not require the latter.)

The higher the portion of current voters who are like Steve’s “Bert” (people who are content to consume more today without worrying about who will pay for it tomorrow) – and, hence, the lower the portion of voters who are like Steve’s “Ernie” (people who, if they consume more government-supplied outputs today, reduce their consumption on other fronts and pass along those savings to their children) – the higher is the probability that today’s government spending will be too high and wasteful.

So (Buchanan concludes) because the bill for today’s debt-financed expenditures comes due tomorrow, taxpayers tomorrow must pay that bill.  Insofar as Ricardian equivalence holds – that is, insofar as citizens today are like Ernie and choose, via their own private actions, to give to their children the proceeds to pay off the principal and interest on the debt – then today’s beneficiaries of debt-financed spending can be said to be the ones who bear the burden of the debt.  Insofar as citizens are like Bert and are content to let future taxpayers pay for what is consumed today, then the burden of the debt is unambiguously pushed forward in time, onto future taxpayers.

The key issue now turns on the answer to an empirical question: how realistic is Ricardian equivalence?  I will deal with the question of the realism of Ricardian equivalence in a follow-up post.  I end this post, though, noting that Krugman’s “new orthodoxy” argument that the debt is no burden to future taxpayers insofar as future taxpayers owe the debt to fellow citizens is flat wrong.

Even with full Ricardian equivalence, whatever is consumed today because of deficit financing must be paid for.  That consumption isn’t rendered costless merely because government arranges for the bill for this consumption to come due tomorrow rather than today.  And nor is the cost of this consumption reduced or eliminated if the taxpayers who must pay the IOUs are citizens of the same country as are the holders of the IOUs.

Hypothetical: Suppose I build a chair for my son’s personal use, using only wood from a tree that I grew and only tools that I made by hand.  And my son loves my chair.  I supplied all the labor, materials, and capital; and my son, who lives with me, keeps and consumes the final product – the chair.  Would anyone conclude that this chair is costless?  Krugman, it seems, would have to do so: the payer of the costs of securing the chair (me) is a citizen of the same economic unit – the Boudreaux household – as is the recipient of the chair (my son).  Obviously, though, the cost of the chair isn’t miraculously eliminated merely because the beneficiary of the chair is a member of what might plausibly be identified as the same economic unit as the producer of the chair.

Now ask: Would the cost to my household of this chair be eliminated if I had instead bought it with money borrowed from my wife?  When the debt comes due, I – or, if I die, my son – must repay my wife.  Does this “we owe it to ourselves” scenario render the burden of paying for the chair a negligible one?  Does it make the cost of the chair to our household any lower than if I had borrowed the money to buy the chair from my credit-card issuer?  No – although Krugman would have a difficult time explaining why the answer is no if he were to continue to insist that public debt owed to ourselves is largely no burden to “us.”

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