I devoted my American Conservative column this time to everyone’s favorite question. For what it’s worth, I think this is the most succinct explanation I’ve given yet. Some key excerpts:
What Baker and Krugman want to explode is the man-on-the-street’s moralistic objection to government budget deficits as being irresponsible and a burden on future generations, who will have to deal with higher government debt. Baker and Krugman think that this is yet another example of where “micro” thinking breaks down when we try to aggregate it into the “macro” economy. They concede that it makes sense for an individual householdto worry about irresponsibly running up debts today, and thereby imposing pain in the future when those debts have to be paid off—or at least, when more of the household’s income needs to be devoted to interest payments on the higher debt.
However, so long as future Americans end up holding the Treasury bonds issued by Uncle Sam, Baker and Krugman think that our generation cannot irresponsibly run up the debt today, and pass on a burden to our kids and grandkids. The difference arises (they claim) because all of the interest payments (mostly) stay within America, to the extent that “we owe it to ourselves.” Sure, Baker and Krugman admit that some of the U.S. federal debt ends up being held by foreigners, and to that extent our grandkids will be poorer because they’ll have to make interest payments flowing out of the country. But besides this complication, Baker and Krugman argue that the mere fact of taxing and paying interest on bonds per se can’t burden our grandkids, since (some of) our grandkids will be the ones pocketing the interest payments!
Suppose the government today borrows an extra $100 billion in order to expand drug coverage for seniors. Assume that the young workers today “pay for it” in the direct sense that they reduce their consumption by $100 billion, in order to invest in the additional $100 billion in government debt that has to be issued. (Thus, we are assuming unrealistically, for the sake of argument, that the higher government debt doesn’t “crowd out” private investment, just so we can see quite clearly why Baker and Krugman are wrong on this issue.) Clearly the older folks are better off because of this deal: they get more drug coverage from government spending, and don’t have to pay higher taxes to finance it.
Now further suppose that the young workers don’t touch their bonds, which happened to be 30-year Treasury securities rolling over at (say) 3 percent. After 29 years have passed, the originally young workers are now old. The original seniors—the ones who benefited from the $100 billion in extra drug coverage—are long dead. A new group of workers—who weren’t even alive when the $100 billion was borrowed—are now on the scene.
The now-old retirees sell their 29-year-old bonds at their current market value of $236 billion (that’s the original $100 billion compounding at 3 percent annually for 29 years in a row). At this point, the middle generation—the ones who were young workers originally, and now are retiring and living off of their savings—have been made whole. Yes, they reduced their consumption by $100 billion back when the government ran a budget deficit, but at the time they voluntarily lent that $100 billion to the government, because they thought getting $236 billion in 29 years when they were retiring would make the whole deal worthwhile. They didn’t lose from the whole operation.
Finally, suppose that the young workers (who were recently born) hold on to their government bonds for one more year, when they mature with a market value of $243 billion. In order to pay off the bonds, the government imposes a one-time surtax on current workers of exactly $243 billion. It thus takes the money out of the workers’ paychecks, and then hands it right back to them to redeem the 30-year bonds that they are holding.
The way Dean Baker and Paul Krugman have been “educating” their readers since late 2011 on this issue, they would be forced to argue that in our story above, the young workers weren’t hurt by the original $100 billion borrow-and-spend scheme. After all, the government 30 years later simply took $243 billion from those workers, and then gave it right back to them. So clearly it’s a wash, right?
But we can see it obviously wasn’t a wash. The original, old generation benefited greatly, the middle generation did all right, and the young generation—not even alive at the time of the original $100 billion deficit—got skewered. Yes, they “owed the federal debt to themselves,” but that is hardly consolation to them. They acquired the bonds by reducing their consumption by $236 billion the year before the big tax bill hit. This abstinence was not rewarded with additional consumption at some future point, but instead was necessary just to break even after the government whacked them with a big tax bill to retire its exponentially rising debt.