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In Debt to Jim Buchanan

Here’s a letter to a correspondent whom I met, via e-mail, only today.  I use his name with his kind permission.

Dear Mr. Edward Palmer:

In response to my Wall Street Journal essay on the late Jim Buchanan you ask: “How can you say repayment of domestic debt is a net burden on a nation?  Bond redeemers get what taxpayers give up.  There is no NET cost.”  (By “domestic debt” I take you to mean government debt held by citizens of the same country as the taxpayers who pay to redeem the debt.)

Suppose that Sam taxes Smith today and then pays these tax proceeds to Jones who uses them to build a bridge.  Sam, Smith, and Jones are Americans.  Would you agree that, regardless of how worthwhile the bridge might be, the bridge is not free; it is built at a cost.  Would you agree also that the cost of building this bridge is paid by Smith?  I assume your answers to both questions are ‘yes.’

Now change the scenario slightly.  Suppose that Sam borrows money today from Williams, who lends his money voluntarily to Sam, expecting to be repaid with interest.  Sam then pays these borrowed funds to Jones who uses them to build a bridge.  Tomorrow Sam taxes Smith and uses the tax proceeds to repay principal and interest, in full, to Williams.  Sam, Smith, Jones, and Williams are all Americans.

Do you agree that, in this second scenario as in the first, the bridge is built at a cost?  (I assume so.)  Who pays this cost?  Clearly, neither Sam nor Jones pays it.  That leaves only Williams (the lender) and Smith (the taxpayer).  Williams advanced the funds for the bridge, but was repaid in full (plus interest) for his advance.  Williams no more paid to build this bridge than does your bank pay for the car that you buy with funds borrowed from your bank.  We’re left only with Smith, whose taxes are raised to pay for the bridge.

So now the crucial questions: How does merely introducing an American creditor (Williams) change the fact that the American whose taxes are raised to pay for the bridge (Smith) still pays for the bridge?  And how does the fact that Williams is an American who is repaid with Smith’s taxes cancel out Smith’s cost in such a way as to make it legitimate to say that the bridge costs Americans as a group nothing to build?

Unless and until you identify a means by which the act of deficit financing (as in scenario two) cancels out costs that clearly exist in the absence of such financing (as in scenario one) your case that internally held government debt represents no net cost to society seems to me to be very weak.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030