David R. Henderson  

Do We Just Owe it to Ourselves?

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Update below:

Ask the proverbial "man on the street" whether current government debt imposes a burden on future generations, and he will likely answer "yes." But ask the same question of sophisticated economists, especially Keynesian ones, and they will likely answer "no." Many will say "we owe it to ourselves."

I used to believe that myself. But this June Feature Article by economist Robert P. Murphy, "Government Debt and Future Generations," argues that the man on the street is right: current government debt does impose a burden on future generations.

Interestingly, this dispute is not clearly ideological. Murphy points out that he himself, as a younger economist, believed that "we owe it to ourselves" and so did the late Austrian free-market economist Ludwig von Mises. So Murphy takes on both Mises and the most prominent contemporary proponent of that viewpoint, Paul Krugman.

A key paragraph:

Finally, note the crucial ambiguity in saying that future generations "inherit" the government debt. Yes, if an older generation literally bequeaths Treasury securities to their heirs, then the analysis of Krugman et al. sounds more reasonable. But that's not what happened, for example, in War Scenario B. There, the grandchildren had to pay their elders $4350 billion for the outstanding Treasury bonds. It was rational for each individual Youngest Capitalist to do so because the government was going to start taxing and making interest payments to the holders of those Treasuries. This is exactly what happens in the real world: we have all grown up in an environment with a large government debt, and the government taxes us so that it can make interest payments. Then--if we so desire--we can enter the market and buy Treasuries. Yet none of us is free of the existing debt and the taxes levied to service it.

UPDATE

The author of the article, Robert P. Murphy, has asked me to issue the following clarification:

It's 100% true that Mises (and the younger me) thought that a deficit today couldn't shift the cost of a government expenditure onto our grandkids, because present spending is paid for out of present resources.

However, both Mises and I explicitly criticized the Abba Lerner-type argument that government debt is benign to the extent that "we owe it to ourselves." For example in Human Action, Mises explicitly rejects this view (I quote him here. And back in 2006--well before the debate flared up among Krugman, Don Boudreaux, Nick Rowe, etc.--I explicitly tackled that claim too (4th section).

So what's going on is that I never (and apparently neither did Mises) saw the really subtle point about overlapping generations and how government deficits allowed the present generation to effectively live at the expense of future generations through that one mechanism. But it's possibly misleading to say that Mises (or I) ever endorsed the "we owe it to ourselves" argument in defense of the benignity of deficit spending.


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CATEGORIES: Fiscal Policy




COMMENTS (23 to date)
JLV writes:

Am I right to conclude that the implication would be that any deficit reduction should be entirely borne by people over the age of 18? And yet every time we have reduced the deficit, retirees have generally been partially or fully exempt.

ThomasH writes:

It's an odd question. The correct one is under what circumstances is it a good idea for the government to incur a deficit. The correct answer is when the expenditures are on activities that have positive NPV when discounted at the cost of borrowing. This is why increases deficits during a recession can be income increasing; there are more such projects around.

Philo writes:

Somewhat in the vein of Robert Murphy: Take a scenario in which the government finances some momentary activity (which takes place at time t) by issuing (at t) bonds with a maturity of 2 years, promising to retire this debt with higher taxes over the two-year period. People who die shortly after t (call them "Group I"), though alive when the momentary activity took place, escape the burden of the higher taxes. People who die one year later ("Group II") pay higher taxes for only one year; thus they bear a heavier tax burden than those in Group I, but a lighter burden than those who were alive at t and who live through the full two years or longer ("Group III"). Also those who are born shortly after t ("Group IV") bear the higher tax burden for a full two years, while those born a year later ("Group V") bear it for one year. Groups IV and V are the "future people" (relative to t) onto whom the burden is shifted *compared to the scenario in which the momentary activity is fully financed by a one-time tax imposed at t*. (Those born still later, at t + 2 years or later ["Group VI"], bear no extra tax burden.)

Of course, financing an activity at t with a tax collected at t is not actually a norm, any departure from which--as by issuing bonds--would be unjustified. If the benefits from the activity are spread out over the future, it probably should be financed by bonds, perhaps of extremely long maturity, so as to be paid for by those who enjoy the benefits.

(Of course, this whole discussion assumes secure property rights and non-arbitrary taxation.)

David R. Henderson writes:

@ThomasH,
It's an odd question.
No, it’s not. If some smart people are answering the question in the affirmative and Bob Murphy shows that the right answer is in the negative, then it’s not an odd question at all, but an important one.
And, on your other point, there is virtually always more than one good question, not “the” question.

Greg G writes:

If increasing public debt imposes such a burden on future generations, that raises an obvious question. Why have our living standards increased so much over the generations despite a sharply increasing amount of public debt? There are many desperately poor countries that don't seem to have benefitted much at all from their low levels of public debt.

There have been people freaking out about the public debt ever since Hamilton convinced the Federal government to take on the debt of the states.

A writes:

Murphy's article is good and useful, but I suspect that he talks with more economically sophisticated people than the "man on the street". My anecdotal archives from the early 2010s are filled with arguments relating national debt to a household balance sheet. That incorrect framing is what Krugman probably challenged.

As an example, in 2012, Krugman wrote: "First, however, let me suggest that the phrasing in terms of “future generations” can easily become a trap. It’s quite possible that debt can raise the consumption of one generation and reduce the consumption of the next generation during the period when members of both generations are still alive." (http://krugman.blogs.nytimes.com/2012/10/12/on-the-non-burden-of-debt/)

James writes:

I've always found this topic very confusing. Suppose we have the following scenarios:

A. The government sends Father and Son each a bill for $100 and each has to pay now out of his own current assets. They cannot borrow and lend for whatever reason.

B. The government sends the same tax bills. Father and Son have the option to borrow and lend between themselves to pay, or they can pay now from their own assets as in scenario A. It's up to them. Father agrees to lend Son $100 but charges high interest because there is a risk of default.

C. Same tax bills and same lending opportunities, but the government agrees to borrow from Father and lend to Son, eliminating default risk. Father is willing to lend at a much lower rate now.

D. Same as above, but the government borrows from the lender with the lowest interest rate required, even if it means going overseas.

Each successive scenario should be an improvement on the previous scenario because everyone's options are a superset of whatever options they had in the previous scenario.

fralupo writes:

Greg G,

Living standards have also been increasing in a time of unparalleled technological change, the general elimination of trade barriers and the end of war as a reality for most people. One might suggest that since the debt has exploded while things got better then maybe the debt is the cause of that improvement. Correlation does not equal causation and all that.

I mean, if that were the case then the 1997-2000 would have seen things get worse in the US while 2007-2010 should have seen massive improvement, no?

Bob Murphy writes:

Mr. A,

Yes that is a great example of Krugman showing that he hasn't grasped the point that Nick Rowe (above all others) was going nuts about. To repeat, you quote Krugman writing:

"First, however, let me suggest that the phrasing in terms of “future generations” can easily become a trap. It’s quite possible that debt can raise the consumption of one generation and reduce the consumption of the next generation during the period when members of both generations are still alive."

^^ Although he doesn't say it in that quote, the obvious implication of his piece is that *only* if the generations are alive at the same time, can the old impoverish the young.

Krugman is still trapped with the insight that government paying interest on debt involves taxing group #1 and paying interest to group #2 at that same time, so (he thinks) there is no way people today can use government debt to live at the expense of people in 200 years. I showed in the article that that is wrong, in an important sense.

Shayne Cook writes:

Following Greg G's line of thinking, what does it matter what debt level is inherited by future generations as long as they are simultaneously inheriting the means and mechanisms for servicing that debt?

The problem I have with current (and increasing) public debt levels in the U.S. is that much of it was incurred simply to support (and enhance) current consumption. That expanded debt levels for future generations to service, without providing any additional means for servicing the debt. It was the functional equivalent of using your HELOC to finance a 30-day cowboy drunk instead of using it to enhance the value of your home.

Nick writes:

@Bob Murphy

Something seems wrong about your accounting, but it's difficult to tell because you've made it very complicated. Is it necessary for the story that there be three generations in war scenario B? Why not two generations? Can you tell this story just using two periods and a zero percent interest rate? I know you can for war scenario A.

It's difficult to follow what you're doing when there are 70 periods and a 5% interest rate compared to 5 periods with a 0% interest rate. In particular, I'm having trouble seeing where all the money is going because I don't think you've been very careful in your accounting.

Greg G writes:

fralupo,

I was not suggesting that correlation equals causation nor was I suggesting that debt is the only factor affecting future prosperity.

I was suggesting that the absence of correlation between increasing debt and an increasing "burden on future generations" is a challenge to what Krugman has called the Austerian view on debt.

Nick writes:

@Bob Murphy

I guess, reading it again, that the burden on future generations comes from the fact that

The grandchildren had to pay their elders $4350 billion for the outstanding Treasury bonds.
What did those elders do with the $4350 billion? Did they consume it all, did they bequeath any of it onto future generations, etc.? If you want to make your point more effectively, I think you should try to put it in 2-3 periods with a 0% interest rate, and include columns for assets and consumption, so it's possible to see where everything is going.

Andrew writes:
Krugman is still trapped with the insight that government paying interest on debt involves taxing group #1 and paying interest to group #2 at that same time, so (he thinks) there is no way people today can use government debt to live at the expense of people in 200 years. I showed in the article that that is wrong, in an important sense.

This is the nuance that I missed the first time the debate arose and the 5 times I read it this time.

Barry "The Economy" Soetoro writes:

Sigh...

Economists treat people like commodities. What is really going on is that the rich 1% who own the wealth to invest in treasuries lend their money to the govt, who in turn pays out the benefits to the masses, and then the next generation of the masses has to pay back the debt+interest that the first generation of the masses incurred. The average Joe on the street isn't inheriting treasuries from rich uncle Bob, so no, WE don't owe it to ourselves. The second generation of masses owes it to the second generation of the rich.

If WE owe it to ourselves, well then won't any of you just lend me $1M dollars? It doesn't matter if I pay it back because we're both Americans and it will all net out!

DMS writes:

The confusion on this issue has always baffled me.

There are two sides to a loan - the obligation to pay and the right to receipt. With government borrowing and the power of taxation, these two sides are not treated symmetrically across generations. The obligation to pay is BEQUEATHED down the generations (through the power of general taxation), while the right to receipt has been SOLD down the generations, transferring wealth from the future to the present.

It can be shown very simply. A son lends his father money. Dad spends it all drinking himself to death. Dad dies, and the son inherits Dad's balance sheet, including the obligation to pay the loan. The son now literally owes the money to himself, so according to Krugman, that means nothing has been transferred and there is no concern. But this is obviously wrong - the son is impoverished by the loan amount, just as if the money had been stolen.

Perhaps Dad actually borrowed the money not to drink, but because his father had pulled the same trick on him. Since he didn't want to be out the money, he borrowed from his son instead. And perhaps Dad's son does this to his own son, i.e. Dad's grandson, whom Dad may never even have lived to see. And so on.

The parallel to government borrowing, i.e. kicking the can down the generations, is unmistakeable. A future generation can indeed be impoverished by a prior generation's profligacy, notwithstanding "owing the money to ourselves". Of course, the prior generations might have invested the money well, allowing the later generations to also inherit assets as well as liabilities. And those assets may even exceed the liabilities. But that is not the argument made by the "we owe it to ourselves" crowd, and is in fact a separate issue.

Personally, I think this confusion is at the heart of Keynesianism. Hayek said that "Mr. Keynes' aggregates conceal the most fundamental mechanisms of change" - I think this is why Krugman et al are so blatantly in error and yet cannot grasp it.

David R. Henderson writes:

@DMS,
There are two sides to a loan - the obligation to pay and the right to receipt. With government borrowing and the power of taxation, these two sides are not treated symmetrically across generations. The obligation to pay is BEQUEATHED down the generations (through the power of general taxation), while the right to receipt has been SOLD down the generations
Nicely put. Notice that I didn’t add your last 8 words "transferring wealth from the future to the present” because other readers could mistakenly conclude that you think the selling of the right to receipt transfers wealth, when it’s really the obligation to pay being bequeathed that transfers wealth from the future to the present.

Terry writes:

Opportunity cost is an important element missing from this discussion. War likely reduces future capital stock no matter how it is financed. But what about borrowing for other government spending, including infrastructure, education, or transfer payments? Infrastructure and education are arguably investments that enrich future generations, though arguments abound as to whether government investment decisions would be as wise or profitable for future generations overall as investments mediated through the private sector. Borrowing for transfer payments would seem to involve shifting capital that otherwise would be used for investment to current consumption, and would thus unambiguously reduce the well-being of future generations.

fralupo writes:

Greg G,

The comparison you'd need to be making would be between comparable low-debt and high-debt countries. It may very well be the case that debt makes things worse for the future but other trends are improving things enough to more than compensate for the effect.

Bob Murphy writes:

DMS, that's a great analogy! I'm going to borrow it from you. (Ba DUM.)

Nick, if you want a totally specified model, complete with utility functions, to see the exact mechanics, you can dive into the huge blog wars that Nick Rowe and I were in, a few years ago. All of the links are in this summary post.

But the reason I didn't do just two generations over two or three periods is that Krugman and his fans on this issue would think I was missing the point. Krugman admits that if old people and young people are alive at time T, that the government can take from the young and give to the old. But what Krugman doesn't realize is that if you do that same trick multiple times in succession, that a whole string of earlier generations can (when all is said and done) transfer consumption from a whole string of later generations. Krugman never admitted that possibility, because he was singlemindedly focused on the fact that the government can only transfer resources at any moment during that time period, among people who are currently alive.

Nick writes:

Bob Murphy,

I'm still confused. Is your point simply that government policy can be used to transfer consumption from younger generations to older generations?

For example, everyone makes $2 a year and lives two years. There are two people alive in any year, a young person and an old person. Every year, the government taxes the young $1 and gives it to the old. So everyone consumes $1 when they're young, and $3 when they're old, except for the very first old person, who gets to consume $2 when they're young and $3.

Just like in the example you linked to, the government here managed to transfer wealth from the younger generations to the older generations. Is that the point you're making?

ColoComment writes:

Since the topic is government debt:

http://blogs.wsj.com/economics/2015/06/02/stop-obsessing-over-debt-and-watch-growth-flourish-imf-economists-argue/

If more debt is the solution to slow-growth economies, then why not finance government at 100%? It's apparently the free lunch that everyone says does not exist!

ThomasH writes:

Professor Henderson, what I meant by "odd" is that the answer does not map to a policy about taxes and expenditures. "We owe it to ourselves" does not imply that deficits are good or bad, but neither does "We do not owe it to ourselves."

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