Most people are more worried by government debt than about taxation. “But it’strillions” a friend of mine recently expostulated about the United Kingdom’s national debt. He exaggerated a bit: it is £1.7 trillion ($2.2 trillion). But one website features a clock showing the debt growing at a rate of £5,170 per second. Although the tax take is far less, the UK government still collected a hefty £750 billion in taxes in the last fiscal year. The tax base grows by the second, too, but no clock shows that.
Many people think that, however depressing heavy taxes are, it is more honest for governments to raise them to pay for their spending than it is to incur debt. Borrowing strikes them as a way of taxing by stealth. “How are they going to pay it back?” my friend asked. “Think of the burden on our children and grandchildren.”
I should say that my friend is extremely old. Horror of debt is particularly marked in the elderly, perhaps out of an ancient feeling that one should not meet one’s maker with a negative balance sheet. I should also add that my friend is extremely well educated, and had, in fact, played a prominent role in public life. But public finance is a mystery to him: he just had the gut feeling that a national debt in the trillions and growing by £5,170 a second was a very bad thing.
One should not attribute this gut feeling to financial illiteracy. It has been receiving strong support from those supposedly well-versed in public finance, particularly since the economic collapse of 2008. Britain’s national debt currently stands at 84% of GDP. This is dangerously near the threshold of 90% identified by Harvard economist Kenneth Rogoff (together with Carmen Reinhart and Vincent Reinhart), beyond which economic growth stalls.
In the face of criticism of the data underlying this threshold Rogoff has held firm, and he now gives a reason for his alarm. With US government debt running at 82% of GDP, the danger is of a “fast upward shift in interest rates.” The “potentially massive” fiscal costs of this could well require “significant tax and spending adjustments” (economist’s code for increasing taxes and reducing public spending), which would increase unemployment.
This is the financial leg of the familiar “crowding out” argument. The higher the national debt, according to this view, the greater the risk of government default – and therefore the higher the cost of fresh government borrowing. This in turn will raise the cost of new private-sector borrowing. (That is why Rogoff wants the US government to “lock in” currently low rates by issuing much longer-term debt to fund public infrastructure). Maintaining low interest rates for private bank loans has been one of the main arguments for reducing budget deficits.
But this argument – or set of arguments (there are different strands) – for fiscal austerity is invalid. A government that can issue debt in its own currency can easily keep interest rates low. The rates are bounded by concerns about inflation, over-expansion of the state sector, and the central bank’s independence; but, with our relatively low levels of debt (Japan’s debt amounts to over 230% of its GDP) and depressed output and inflation, these limits are quite distant in the UK and the US. And as the record bears out, continuous increases in both countries’ national debt since the crash have been accompanied by a fall in the cost of government borrowing to near zero.
The other leg of the argument for reducing the national debt has to do with the “burden on future generations.” US President Dwight Eisenhower expressed this thought succinctly in his State of the Union message in 1960: generating a surplus to pay back debt was a necessary “reduction on our children’s inherited mortgage.” The idea is that future generations would need to reduce their consumption in order to pay the taxes required to retire the outstanding debt: government deficits today “crowd out” the next generation’s consumption.
Although governments have endlessly repeated this argument since the 2008 crash as a justification for fiscal tightening, the economist A. P. Lerner pointed out its fallacy years ago. The burden of reduced consumption to pay for government spending is actually borne by the generation which lends the government the money in the first place. This is crystal clear if the government simply raises the money it needs for its spending through taxes rather than borrowing it.
Furthermore, the idea that additional government spending, whether financed by taxation or borrowing, is bound to reduce private consumption by the same amount assumes that no flow of additional income results from the extra government spending – in other words, that the economy is already at full capacity. This has not been true of most countries since 2008.
But in the face of such weighty, if fallacious, testimony to the contrary, who am I to persuade my elderly friend to ignore his gut when it comes to thinking about the national debt?