Like the mid-20th-century economists whose reasoning in terms of unwisely chosen aggregates led them to argue that public debt owed “to ourselves” is not much of a problem, Paul Krugman recognizes that one way that even such internally owed debt does pose a potential problem is if private productive activity is reduced by higher marginal tax rates made necessary for government to pay off the debt. Such a tax-induced reduction in productive output is a cost even of internally owed debt.
I ignore here the question of just how large or small this problem might be in reality. (To address this question adequately requires a discussion of the likely consequences of deficit financing on both the quantity and the quality of government projects funded with debt – and, hence, on the size of the debt burden passed on by current policymakers to future taxpayers.)
Instead, let’s be content to note that, on Krugman’s thesis, even this problem is avoidable. All that today’s government need do when faced with the need to raise marginal tax rates today in order to pay off yeterday’s debts is to default.
Insofar as we owe the debt to ourselves, default simply means that we choose not to repay ourselves. Right-hand owes left-hand; right-hand refuses to pay what it owes to left-hand – no big deal: the entity to which both hands are attached possesses the same amount of money with default as it would with payment. (Indeed, the entity possesses slightly more money with default, as the right-hand avoids dropping any money on the floor in its exercise of transferring funds to the left-hand.)
Now I doubt that Krugman (or any other adherent of the “we owe it to ourselves” school) would advise that default be generally used. The chief reason, of course, is that default today – while making all but today’s holders of mature debt better off – will greatly diminish government’s ability to borrow tomorrow. (The right-hand, alas, suffers a weird inability to understand that it’s part of the same relevant aggregate entity as the left-hand. This problem, though, is not one that we can pause to explore further.)
Why – on the “public debt is no significant burden insofar as we owe it to ourselves” hypothesis – should adherents of this hypothesis worry about any reduced ability of government to borrow in the future? Any money not loaned to government tomorrow is not loaned by us; we still have that money. It will be used by our right-hand if not by our left. But so what? We tomorrow still possess whatever money government tomorrow tried, but failed, to borrow. We refuse to lend to ourselves – no big deal.
If “we” is a relevant economic unit, how is “we” harmed by “us” refusing to lend to “us”?