Thursday, October 18, 2012
One More Rumination on the Burden of Fiscal Deficits
You would think that everything that needs to be said about this topic has been put on the table in the past few weeks. (I will skip the links; these posts have already been linked to death.) And you might be right, but I’ll offer a different take anyway.
The debate has been cast in an aggregative framework in which the set of welfare-relevant individuals includes both those who pay taxes tomorrow to repay today’s deficits and those who hold the bonds and receive payments. Fine, but let’s consider a narrower question, one that most economists apparently think is beneath discussion: what it is the purely fiscal burden of public debt?
Well it’s obvious, isn’t it? Either you pay off the debt in the future or you roll it over and pay more interest. Either way you bear a fiscal burden, and they are the same in present value terms.
Well, try this. In thinking about the fiscal burden, it may help to imagine a country with two types of citizens. One type pays taxes but owns no financial assets; the other owns financial assets but pays no taxes. (We’re getting there....) The government runs a fiscal deficit in period 1. In subsequent periods will there have to be offsetting transfers from the taxpayers to the bondholders?
First step: I rule out the scenario in which any significant portion of the debt is paid down. This is not a deduction from theory, just an empirical observation. Fiscal surpluses are few and far between. Tomorrow’s taxpayers will no more be paying off the public debt incurred by the current generation than today’s taxpayers are paying off the debt bequeathed to us by our parents and grandparents.
So let’s get to step 2 and consider interest payments on the debt. Here the critical move is to regard the burden not as a sum of money but a fraction of income, the debt service to GDP ratio. This goes up if and only if the percentage increase in debt exceeds the corresponding percentage increase in income, given a constant interest rate. (I abstract from the issue of real versus nominal incomes and interest rates.)
Now, why would anyone think that the incremental effect of a fiscal deficit on future income growth would be positive? Two reasons. First, if the deficit finances public investment, and if this investment is more productive than the use to which the money would have otherwise been put, income will grow commensurately. Second, if the deficit reduces an otherwise stubborn income gap, hysteresis effects are likely to boost potential income in future periods. The extent to which income growth attributable to deficits offsets debt service obligations and therefore raises or lowers the future fiscal burden is uncertain.
But that’s the point. I would say it is an open question whether any particular deficit will be burdensome in the most restricted meaning of that term. The answer is likely to vary from one macroeconomic context to another, from one program of public spending to another, according to the extent of the deficit, and so on. The bottom line, however, is that, even if all the government bonds are owned by Martians so that taxpayers and bondholders are completely different species and transfers from the first to the second constitute a pure welfare loss, there is still no determinate relationship between more deficits today and more burden tomorrow.