Bryan Caplan  

Is the Bail-Out Based on Debt Illusion?

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My conjecture: If Paulson's bail-out were funded by a permanent tax increase sufficient to raise $700B in present value terms, it wouldn't stand a chance. The minimal public outcry, therefore, hinges on "debt illusion" - the mistaken view that debts, unlike taxes, never really have to be paid.

Am I right?

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COMMENTS (16 to date)
Gary Rogers writes:

You are absolutely right.

scott clark writes:

Minimal public outcry? I thought Congress was getting letters, calls, emails, and visits from angry constituents calling for no bailouts. I think what we have is the biggest public outcry we are going to see. It probably won't be enough to stop, but it is an outcry. No demonstrations, no marchs, but certainly there has been an outcry.

But I know what you mean, my brother thought this was all funny money anyway, and I had to tell him to think of all the awesome things that won't get to exist because we are spending resources and sending signals to keep moribund firms on life support.

David writes:

I don't think it's quite right. First, while the public outcry may be minimal, the outcry in private doesn't appear to be. Rasmussen reported Tuesday that 44% of voters opposed the plan and only 25% supported it.

Second, the reason opposition isn't higher may be because the debt might not have to be repaid, depending on the price Treasury pays for the distressed assets.

If your choices are big tax increase now and maybe lower taxes later, vs. no tax increase now and maybe lower taxes later, I can see why people favor the latter.

aaron writes:


Also think of this. We could fund the Copenhagen Consensus 14 times over.

Gabriel writes:

I disagree. The reason why a debt will work better is because much (most? all?) of those mortgages will actually work out so the government might even make some (accounting) profit on them.

Yes, but only in the way that, if you were dying from a disease that could kill you, but there was treatment for it, and you were in debt already, it would be psychologically easier to put your medical costs on a credit card than to liquidate everything you own to fund it.

Garrett Schmitt writes:

If the proposal were funded by an immediate tax evenly distributed across the population in absolute--or even income-proportional--terms, sure, it would probably never even be considered.

But what if the tax were structured as a tax on people or institutions disliked by some predetermined majority of the population (rich people, foreigners, large corporations)? Put one intermediary step introducing the possibility of obscurable unintended consequences into the funding mechanism, and public opposition becomes only a possibility.

Stephen W. Stanton writes:

Yes and no.

Yes, people would never agree to pay for the government programs that they want.

No, this program is not going to cost $700b under most scenarios.

There's a very good chance the borrows money at a low rate to buy assets that will yeild a much higher rate. Net/net, the government comes out way ahead. This is basically the simplified model of an investment bank. Unlike an i-Bank, the government's funding cost will stay pretty low.

Yes, there is an outlay of perhaps $700b. But they taxpayers might get it all back and then some.

(but worse scenarios are somewhat likely, too).

Jusitn Ross writes:

Only if voters actually paid taxes, which many do not. Also, those with anti-market bias or socialist tendencies are going to be happy about this.

I thought it was generally true that the government doesn't really have to pay anything back. They can issue more debt in the current debts place. At least that's what I've been told.

Grant writes:

Question: Can anyone guess how much of these assets the market would purchase if the feds didn't do anything? Why is it assumed that the feds' purchase of these assets will yield returns if the market does not purchase them?

David writes:

Here's more on the public outcty. It's not so minimal.


Jim Glass writes:
The minimal public outcry, therefore, hinges on "debt illusion" - the mistaken view that debts, unlike taxes, never really have to be paid. Am I right?

I think so, in fact I've seen blogs outright say this bailout will be free. For example...

What will the bailout cost the taxpayers?

As I argued in my previous post, it will not cost today’s taxpayers anything. But what will it cost future taxpayers? I suggested in my last post that perhaps the government could roll over its debt indefinitely, and no taxpayers would ever have to pay it off....

Yes, Virginia, when it comes to financing government bailouts of financial assets, there is a Santa Claus.

Of course, $700 billion present value is a triviality compared to $40 trillion present value for Medicare. Would the citizenry have voted for Medicare if it had come with a tax bill covering that cost attached?

We got the answer to that back when Congress tried to make seniors pay a teeeny little tad of a premium towards the cost of a long-term care insurance benefit provided through Medicare that they actually need -- and a mob of AARPers attacked Dan Rostenkowski in the street, litterally banging and rocking his car like he was driving though some third-world nation in the middle of a coup. Congress repealed that benefit quickly enough!

But what happens poltically when that deferred $40 trillion starts coming on budget about ten years from now?

In the big scheme of things this $700 billion, though it surely won't be free, by itself doesn't really matter to the finances of the US. The debt owed to the public today is a lot smaller than it's been in the past -- and it will remain so even if $700 billion is added straight to it.

Only five things really matter to the US's finances: Medicare, Medicare, Medicare, Social Security and Medicaid.

But given those five things being in place as they are, this $700 billion only makes matters that much worse. Icing on the cake.

Luis M writes:

If the S&L RTC Deal was such a wonder for the economy, why is the Deficit even bigger now? This ruse that we are going to profit and help pay off the deficit is fiction.

This is a shell game. The taxpayers are allowing the government another way to expand the pie of government and socialize further private assets. While the RTC worked in the 90's it was a mistake then because it sent the precedent for further intervention now. For 70 years since the new deal we continue to further expand the role of government. Our system is so far gone at this point we truly cant indentify the free markerters.

We have a created "capitalist" system that regularly requires the active intervention of government to address very problems it created in the previous intervention.

This was acceptable so long as we maintained a healthy balance sheet. But with the government balanced sheet completely wrecked at this point how exactly can inflate out this one with out completely destroying the currency and wiping out american savings..

This plan will Fail because Americans are tired of the shell game and they are broke. Smart Money is setting up giant contaiment zone around the U.S.

Tom writes:

Shoot -- let alone the bailout; I wonder how much of the *current* budget (excluding Iraq-related outlays, excluding bailouts) would pass, if it included tax adjustments (as though it's conceivable it could require cuts!) necessary to raise sufficient funds in present value terms to pay for it...

Stewdog writes:

I have found that the public through all strata of education vigorously oppose this bail out. Furthermore almost every economist reveals or at the least admits, the plan "may" make things much worse. It seems one of the safest plays maybe to go with the theory that the Great Depression was lengthened and deepened by government "solutions".
What about buckle in for a hard but cleansing ride? We may find the panic is was more lies and posturing.

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