18 Nov 2012

Steve Landsburg Thinks the Current Debt Level Is Juuuuust Right

Debt, Economics, Steve Landsburg 37 Comments

Steve Landsburg and I can have a perfectly civil discussion on theology. He agrees not to mock me (to my face) for thinking a guy can walk on water, and I don’t make fun of him for worshipping irrational numbers. But when it comes to government debt, I think Steve and I might just have to agree never to talk about the subject. Today he writes:

How high should taxes be? High enough to cover expected outlays going forward — but no higher.

That’s because any additional revenue would be used to pay down the federal debt, which is a bad idea. It was almost surely a mistake to run up this much debt in the first place, but now that we’ve got it, the best thing to do is to keep it forever.

Here’s why:

Every $100 in outstanding debt commits the government to making payments with a present value of $100, and hence to collecting tax revenues with a present value of $100. In a world where the interest rate is 3%, the options include collecting (and paying off) $100 immediately, or $50 this year and $51.50 next year, or $11.38 a year for ten years running, or $3 a year forever. Because deadweight loss (i.e. the economic damage due to the disincentive effects of taxes) is roughly proportional to the square of the tax rate, it turns out that the latter — the policy of paying interest forever without ever making a principal payment — is (at least roughly) the policy that minimizes the present value of deadweight loss.

In other words, as far as the existing debt goes, we’re hosed no matter what we do — it’s painful to pay it off, and painful to keep paying interest forever. But at least if we pay interest forever, we’re minimizing the deadweight losses associated with raising taxes.

As usual with Steve, I think he is probably correct as far as the strict mathematics of the argument. However, I have the opposite intuition. Now the ground rules of this game (even though Steve didn’t say so) are presumably that we rule out government default on its debt as cheating, and we don’t worry about the ethics of taxation per se. In that framework, I would certainly recommend that the US government start paying down its debt, both in terms of outstanding Treasury securities but also in terms of paying people lump sums to renounce their future Social Security and Medicare claims.

Now the tricky thing is, I suspect if we spelled out our assumptions a little more, Steve and I would end up agreeing. I could even imagine after 5 emails, Steve saying, “Yeah, we’re basically saying the same thing.” And yet, it sure doesn’t seem like that, does it?

To see what I mean–that I think Steve and I are actually closer than it first appears–consider that of course I would NOT [added!--RPM] recommend raising taxes, to start paying down the debt. Rather, I would recommend slashing spending tremendously. Then the other subtlety is that you would want to allow for emergency situations where deficits occurred temporarily in the future. So by paying the debt down today (and as a general rule), you were actually just giving yourself breathing room so that the debt down the road didn’t end up higher than where you’re starting today.

In other words, Steve is saying that if the debt is 85% of GDP today, then in a century he wants it to still be 85% of GDP. (For sure that’s what he’s saying if GDP is constant; in the comments of his post it wasn’t clear if he actually wants to maintain constant dollar amount of debt, or constant debt/GDP ratio.)

Suppose I too want the debt/GDP ratio to be the same in 100 years. But, I predict that there will be periods between now and then when the deficits will be so large that the debt/GDP ratio will grow during those years. In order then to reach my target, there must be periods when debt/GDP shrinks. And unless I happen to think the present is a time that requires growing debt/GDP, why wouldn’t I start paying it down right now?

(This is a little awkward because presumably right now–coming out of the financial crisis–is an “emergency” time when tax revenues are depressed and you could expect the government to run a budget deficit. But, that’s not really important for Steve’s argument. He would have written the same post in 1984 I believe.)

Anyway, the above is just to get your wheels turning. The real problem with Steve’s analysis–by which I mean, the assumption that makes his conclusion right, but which is a bad assumption to make–is this:

Note: The above assumes that spending policies and tax policies can be set separately (subject to the constraint that tax revenues are at least high enough to cover interest payments). Things of course get more complicated if you believe that debt levels and/or tax rates constrain future spending through some political mechanism. I’ve often heard this alleged, but I’m unaware of any strong evidence for this assertion.

How about this Steve?

(The footage is from a riot in Greece earlier this month.)

37 Responses to “Steve Landsburg Thinks the Current Debt Level Is Juuuuust Right”

  1. Adrian Gabriel says:

    I don’t understand why Landsburg states in the note an assumption. He already lost the debate. Certainly you already won the debate if you were to be able to explain the ethics of taxation. Bad argument, but I understand why he makes it. In your words “He agrees not to mock me (to my face) for thinking a guy can walk on water, and I don’t make fun of him for worshipping irrational numbers.” Enough said, he’s an atheist whose religion is the state. Seems hard for him to let go of the whole keeping the state in tact, instead of arguing against taxation. Why has he not embraced Austrian Economics, oh yeah, he performs the rites of his religion by creating unrealistic models and attempts to delineate human action through them. He does this to worship the state. Interesting how someone can claim to be Libertarian, but believes in economic calculation. Quite ironic….

  2. Major_Freedom says:

    Because deadweight loss (i.e. the economic damage due to the disincentive effects of taxes) is roughly proportional to the square of the tax rate, it turns out that the latter — the policy of paying interest forever without ever making a principal payment — is (at least roughly) the policy that minimizes the present value of deadweight loss.

    Won’t the receivers of the principle payments spend the money instead of others?

    How is that a “deadweight loss”?

    • Bob Murphy says:

      No MF that’s not what “deadweight loss” means. I have street cred with you, so I hope you trust me that that’s not the way to go after Landsburg on this one.

      • Major_Freedom says:

        I was actually not challenging your definition of deadweight loss.

        I was actually asking why you are assuming additional taxes. For if there is just a shift of expenditures given the level of taxes, then where is the deadweight loss from additional disincentives due to taxes?

        When you said “Because deadweight loss (i.e. the economic damage due to the disincentive effects of taxes)”, I was thinking that if there is no additional taxes, then there is no additional “economic damage due to disincentive effects of taxes”, and because that is what you are defining as “deadweight loss”, I see no deadweight loss from paying back debt.

        You and Landsburg seem to be assuming taxes will go up when debt is paid back, but why can’t there merely be a shift in government spending away from X and towards paying back debt, with the same taxes?

        • Bob Murphy says:

          MF oh okay, well Steve would say then that if you are going to cut spending, great, then cut taxes too so that you still don’t run budget surpluses at that lower level of spending. So, you would minimize the deadweight loss by reducing taxes down to that level.

          • Major_Freedom says:

            What surplus are you talking about? I am assuming that the government is spending to pay down debt.

            If instead of the government spending $100 billion on dropping bombs on middle eastern families, they instead spent $100 billion on paying back debt, and we assume taxes are no higher, then is it not the case that no cut in taxes and no cut in spending is implied?

            What would Landsburg say if there is just a transfer of spending from one group of people (military industrial complex), to another group of people (bondholders), and taxes are unchanged?

            • Bob Murphy says:

              MF wrote:

              If instead of the government spending $100 billion on dropping bombs on middle eastern families, they instead spent $100 billion on paying back debt, and we assume taxes are no higher, then is it not the case that no cut in taxes and no cut in spending is implied?

              I’m not saying you’re wrong in the way you’re thinking about it, but in Landsburg’s framing he would say: “If it’s politically acceptable to cut military spending $100 billion, and use the freed-up tax revenue to pay off $100 billion of debt, then it makes more sense to cut military spending $100 billion, and then cut taxes $100 billion.”

              • Major_Freedom says:

                But then he would simply be question begging.

                If one of his premises for the conclusion that paying back debt is a no-win situation, is that the government shouldn’t pay back the debt, because it’s “better” that if there is any consideration of a reduction in spending on war that Major_Freedom says can be used to pay back debt instead, that Landsburg interjects and says the reduction in spending on war should be immediately accompanied by a cut in taxes and not paying back of any debt, then he hasn’t actually shown that paying back debt is a no-win situation. He just inserted his own value judgment.

                It would be like me claiming that paying back debt is a win-situation, and then when someone asks me to show it, I say “Well, I am assuming that if there is a maintaining of taxes, then it’s “better” to pay back debt than to pay for war.”

                I’d be arguing in circles.

      • Tel says:

        Hey you linked to the Wikipedia version of “deadweight loss” and they say:

        In economics, a deadweight loss (also known as excess burden or allocative inefficiency) is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto optimal.

        Now the meaning of something being “not Pareto optimal” is that opportunities exist to make some individuals better off without making anyone worse off. Stupidly though every single example given on the Wiki page shows a situation where at least one individual benefits from the supposed deadweight loss.

        I really hate it where “Pareto optimal” is cited by people who obviously haven’t sat and thought about what it means. It is extremely rare to find any market situation, nor any government intervention that is really and honestly “not Pareto optimal” simply because always these things happen to benefit somebody. We could argue about some sort of global optimality, but that’s extremely difficult to define from an Austrian perspective since it requires a global measure of goodness.

        Bob, do you have a link to a “deadweight loss” explanation that is a bit more sensible than Wikipedia?

  3. konst says:

    I don’t agree with either of you. The problem with both your arguments is that your economy consists of an authoritarian (and progressing to a totalitarian) regime even though you don’t state it in the arguments.

    There is a larger problem which neither of you seem to consider which is that most of the debt is illegitimate and therefore forcing people to pay it is like slavery.

    • Bob Murphy says:

      There is a larger problem which neither of you seem to consider which is that most of the debt is illegitimate and therefore forcing people to pay it is like slavery.

      Did you miss the part in the beginning where I explicitly said this would be a “game” in which we ignored that stuff, since those were the implicit rules Steve laid out?

      • konst says:

        No I didn’t miss that. I just think with those conditions it has no meaning . To put it another way it has no application and no basis in reality but that your concepts are taken from reality. I guess what I’m saying is that the “game” under those rules maybe breaks down or maybe has contradictions.

        • konst says:

          The last part meaning that you would probably get nonsensical answers/solutions.

  4. Nick Rowe says:

    I shall have to do a post on this. Steve is not quite right. All we need do is introduce a little uncertainty into his model (a very reasonable assumption) and you get a rationale for slowly paying down the debt. This is an immediate implication of applying Jensen’s Inequality to his convex (concave? I always get them muddled) first order condition for intertemporal optimality..

    Vivek Dehejia and I wrote a paper on this once. We called it “precautionary taxation”. Unfortunately it’s not available online. Australian Economic Papers 1995.

  5. scineram says:

    Now the ground rules of this game (even though Steve didn’t say so) are presumably that we rule out government default on its debt as cheating

    Libertarians always whine about the government violating the constitution, but you want it to ignore the 14th ammendment?

    • Ken B says:

      Read some other threads! There’s no end to the parts of the constitution Bob wants to ignore!

      • Bob Roddis says:

        SECTION 4.

        The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.

        There is that little qualifying “authorized by law” clause in there. Plus, everyone knows that a main purpose of diluting the funny money supply is to reduce the public debt of the United States without due process of law or equal protection of the law.

        Thus, we renounce the unconstitutional portion of the debt (most of it) and abolish the Fed so as to not dilute and impair the constitutional portion of the debt.

  6. Gene Callahan says:

    Greece does not issue its own currency, Bob. The situation is obviously very different that that of the US.

    • Bob Murphy says:

      Right Gene, and absolutely nothing in Steve’s argument depending on being the issuer of one’s own currency. [UPDATED: I guess it would matter if you're saying nominal spending versus real spending. But by the same token, Greece could "simply" default on its debt and "solve" its problem too. So I think in the spirit of the puzzle Steve posed, inflating your way out of the debts is similar to partial default with a stable currency.] You could’ve also pointed out that Greece is in a different continent, so clearly is a different case.

    • Silas Barta says:

      Issuing your own currency isn’t the determining factor; trust of political and financial climate is. Issuing my debt in “Barta Bux” only works if people trust Barta Bux in the first place.

      Greece would be in exactly the same trouble (probably worse) if they were working with Drachmas the whole time (because they wouldn’t have been able to get the extra credit extended to them on the basis of being in a more dependable currency zone — but then, neither could they have been so spendthrift). Sure, it gives them another means to “effectively default” (by wiping out “old Drachma” holders through hyperinflation), but that would tick off investors and hinder future financing just the same.

      Causal diagram:

      (Issues debt in its own currency?) (Handles financial crises well?)

      “Oh look Daddy, government that issue debt in their own currency handle financial crises pretty well!”

      Son, what happens when you separate governments in dependable ones and basket cases?

      “Oh … no more correlation.”

  7. rob says:

    Does Steve’s position depend upon the interest rate being low ? If the interest rate was not 3% but 20% the deadweight loss would be much higher. Would paying down the debt become the best option (keeping Steve’s other assumptions) ?

  8. Keshav Srinivasan says:

    Bob, I think you may be misinterpreting Steve’s post. At least how I interpreted it is, given a fixed set of spending policies and a given amount of existing debt, what is the best way to finance the planned spending and the debt service?

    • Bob Murphy says:

      Keshav, right, that’s what Steve’s assumptions were, and he’s right, given them. But if the question is, in the real world, should the government pay down the debt, I think the answer is yes it should, because of the types of things Nick Rowe said more clearly than I did. (And Steve said Nick was right.)

      It’s like David Friedman’s thing about houses–yes, if we assume no one ever intends to sell his house (even as a possibility) for money, then homeowners benefit if house prices go down. But that hardly proves the average person is wrong for wanting his home to go up in price.

  9. Ken B says:

    Is inflating defaulting? Hyper-inflating? Because that always seems to be political. That can be a constraint in real terms.

    • Major_Freedom says:

      Define default.

      Then you answered your question.

  10. Mike says:

    “worshipping irrational numbers”

    lol. What, you don’t “believe” in irrational numbers?

  11. ThomasL says:

    He doesn’t believe that God could walk on water?

    It is one thing not to think God does not exist; it is a far stranger thing to think that whether or not He exists, He couldn’t walk on water.

    • Ken B says:

      Guy not god. As for god, Steve certainly thinks e can walk on water.

  12. Jason B says:

    “How high should taxes be? High enough to cover expected outlays going forward — but no higher.”

    I’m certainly willing to listen why I might be wrong here, but am I the only one who read that first sentence and quivered in fear? Outlays going forward are expected to rise quite enthusiastically. If we’re currently running a trillion dollar deficit Steve wouldn’t have a problem with a trillion dollar tax increase to cover that, plus more going forward as outlays increase?

    • Bob Murphy says:

      Jason B. wrote:

      If we’re currently running a trillion dollar deficit Steve wouldn’t have a problem with a trillion dollar tax increase to cover that, plus more going forward as outlays increase?

      Steve is taking the level of spending on non-debt items as given, for the purposes of the exercise. Yes Steve would probably want the government to spend less $$ on military, welfare, education, etc. But he’s saying take that as given, and now ask yourself, should we tax enough just to cover it, to pay down the debt, or to let the debt grow? And he gave some assumptions under which the answer is to maintain the debt at its current level.

      I agree with you Jason that he is wrong, but it’s interesting to walk through his analysis to figure out exactly *what* is wrong about it.

Leave a Reply