Another Debt Installment
OK I think I’ve come up with even more obvious ways to make the point. (If you are stumbling on this as an innocent newcomer, see this post and its link to get up to speed.)
Before I do so, I want to be clear on what I’m trying to prove: Paul Krugman and others (a group that would have included me, two weeks ago) think that only the naive layperson could think “running up the government debt allows us to selfishly live at the expense of our grandchildren.” The zinger in their argument is to observe that when our grandchildren are forced to pay higher taxes to service/retire the debt (necessitated by today’s deficits), they aren’t going to be paying us, but rather they will be paying themselves. So–duh!–the layperson can’t possibly be right. Or, more specifically, if the layperson is right, it’s because of complications involving the distortions of taxes, or the distributional impacts of only some people being bondholders, etc. To drive home the fact that it’s the “they owe the debt to themselves” driving his argument, Krugman conceded that if foreigners hold the bonds, then yes, that debt truly is a burden on unborn generations.
Steve Landsburg chimed in to say he basically agreed with Krugman, except that Krugman didn’t go far enough: Landsburg said that even if the government in 100 years owes bond payments to foreigners, nothing really changes.
OK, so here’s what I’m saying: Krugman is totally, utterly wrong. (But again, I would have been equally wrong two weeks ago.) Landsburg ironically is correct, and so I was unduly harsh to him in this whimsical post. Landsburg is right to say that Krugman’s focus on the identity of the bondholders doesn’t really change things. But, what I am saying is that Krugman is WRONG whether foreigners or Americans hold the IOUs issued by Uncle Sam.
In my earlier post involving Abraham and Isaac, I focused on what I think the key issue is. However, lots of people in the comments still aren’t seeing it. So let me try to refine it even more:
There are only two time periods. In period 1, old Abraham has a tree that yields 100 apples. There is also a young Philistine who has a tree that yields 100 apples. In period 2, Abraham and his tree are both dead, but young Isaac is born. Isaac has a tree that yields 100 apples for 1 period, while the (now old) Philistine is still alive, and his tree yields 100 apples. After this period, everything is dead.
SCENARIO 1: The government comes along in period 1, and runs a budget deficit of 10 apples to finance a subsidy to Abraham. The Philistine lends the government 10 apples voluntarily, because it issues him a bond promising 11 apples in period 2.
Period 2 comes along. The government says to the newly born Isaac, “Hi! Welcome to the world. Give us 11 apples or we’ll kill you.” So Isaac complies, and the government retires the bond from the Philistine.
In summary, in period 1 Abraham consumed 110 apples while the Philistine ate 90. In period 2, Isaac ate 89 apples while the Philistine ate 111.
OK, now most people (maybe not Landsburg, because he likes to be difficult), including Krugman, would agree that in this starting scenario, the government in period 1 ran a deficit to benefit the old Abraham, by imposing a burden on the unborn future generation. Yes, the actual financing involved a loan from the Philistine, but he wasn’t really a net loser in the deal. If the layperson looks at that situation and says to Abraham, “You know, your extra 10 apples are coming at the expense of your unborn son,” there is nothing wrong with his analysis. No PhD economist can scold him for being unsophisticated. That is basically correct, and not because of fancy incentive effects or Cobb-Douglas production functions, but for the brute reason that Isaac in period 2 is going to be taxed to retire the debt that made Abraham’s extra consumption possible in period 1.
SCENARIO 2: Tweak things: Suppose in the beginning of period 2, the government defaults on its bond. Now who is harmed? The Philistine, of course. But when was he harmed? I think it’s fair to say he was harmed when the government defaulted. Up until that point–with the expectation that he was going to be repaid–the Philistine was content with arrangements.
SCENARIO 3: OK, now tweak things a different way. In this new scenario, the government doesn’t default; it pays the bond off in period 2. But, right before it does so, Isaac goes up to the Philistine and buys the bond off of him for 11 apples. The government then taxes Isaac the 11 apples, and hands them right back to Isaac to retire the bond (which he acquired from the Philistine 5 minutes earlier).
In this scenario, who “really” shoulders the burden of Abraham’s 10 extra apples in period 1? I think it is quite clearly Isaac. We are effectively back to Scenario 1, where everybody, including Krugman, thought Isaac bore the burden. That brute fact isn’t changed, if Isaac and the Philistine make a voluntary exchange 5 minutes before the government retires the debt.
So now does everybody see why it’s completely wrong to focus on “they will owe the debt to themselves”? In this particular scenario, when the government retires the bond, it is taking Isaac’s apples to give right back to him. Note that if the government defaults in this scenario (after Isaac has bought the bond from the Philistine), it doesn’t help Isaac: He benefits from not being taxed, but now his bond is worthless.
SCENARIO 4: Now we’re going to really tweak things. Throw out the Philistine, and go back to my original thought experiment. Isaac now lives both periods too. In period 1, Isaac lends the 10 apples to the government. In period 2, the government taxes Isaac 11 apples, then gives them right back to him to retire the bond.
In this final scenario, Isaac clearly suffers the burden from Abraham’s extra 10 apples of consumption in period 1. But let’s be more specific: When does Isaac suffer, and in what manner? IT IS NOT in period 1, when he lends the apples to the government. That was a voluntary decision on his part. If you don’t believe me, go back to Scenario 1 above. Quite clearly, we all agreed there that the Philistine wasn’t the one who “really” paid for Abraham’s consumption. Or, at least, whatever way you understood that the Isaac-in-period-2 was getting screwed over in Scenario 1, then that is just as true for Isaac-in-period-2 in Scenario 4. The fact that a younger Isaac lent money to the government in period 1 (in this last scenario) doesn’t alter this fact.
Last thing: In this final Scenario 4, suppose the government defaults in period 2. Well, now it doesn’t hurt Isaac-as-taxpayer, but it hurts Isaac-as-bondholder. Go back to our thoughts of the poor Philistine when the government defaulted on him in Scenario 2. We agreed that quite clearly there, the default hurt him. So, here, the default quite clearly hurts Isaac. Yes, Isaac benefits as a taxpayer, but that doesn’t restore him to equity, as if nothing ever happened.
In Scenario 4, Isaac goes into period 2 knowing he has to be harmed either as Isaac was in Scenario 1 (if the government pays off the bond) or as the Philistine was in Scenario 2 (if the governmen defaults on the bond). Either way, Isaac is getting harmed in period 2, and that’s the true harm that counterbalances the gain to Abraham in period 1. Someone who comes along and says, “No, this is pedestrian micro thinking, because any bonds in period 2 are basically owed to Isaac,” is totally confusing things. It’s not just a little off, it’s totally, utterly wrong to focus on the government taking 11 apples from Isaac in period 2, and then giving the apples right back to him, then concluding, “The burden must lie elsewhere.”
If you don’t like that, try an independent argument:
The government announces that next year, it will whip every citizen 100 times. But, if someone pays the government $1000 today, that person will be spared when the whip-master makes his rounds next year. OK, in this scenario, how is the government raising money today? Because it is threatening to impose harms next year.
New scenario. The government announces that next year, it will take $1100 from each citizen. But, if someone pays the government $1000 today, then the government will exempt that person from next year’s extortion. OK, in this scenario, how is the government raising money today? Because it is threatening to steal money next year.
Final scenario. The government announces that next year, it will take $1100 from each citizen. But, if someone lends the government $1000 today, then the government will issue him a bond that pays $1100 next year, which the person can use to satisfy the $1100 tax bill. OK, in this scenario, how is the government raising money today? Because it is threatening to steal money next year.
Does everybody see what’s going on now, and why Don Boudreaux and Nick Rowe (who were both relying on Buchanan) are right, while Krugman and Yglesias are totally wrong? The government wants to spend a bunch of money today, giving goodies to older people. If it tried to raise taxes to finance it, there would be an outcry. So instead, the government says to some wealthy investors, “OK, we are going to use our guns to extort money from some other people in 20 years. We’ll give you a cut of that loot, if you lend us some money right now to give to the older people so they vote us back into office.”
This is quite clearly a crooked scheme, and if future generations end up holding those IOUs, it doesn’t change the nature of it. There is a very definite sense in which the politically powerful citizenry who enjoy transfer payments due to government budget deficits, are living at the expense of future taxpayers. The layperson is right, and the fancy schmancy economists who doubt this are wrong.
On Landsburg – http://www.auburn.edu/~garriro/h2defmatter.htm
You just explained Krugman’s point really well, Bob.
Krugman’s argument is that it’s a distributional issue, because any debt owed by the US government is an asset owned by the US people, so collectively it’s a wash. If your objection is that there’s a transfer of wealth from the politically weak of the future to the politically powerful of the future, that makes it no less of a wash.
If, on the other hand, you conceive the “we” (domestic) as “politically weak Americans of the future” and the “them” (foreigners) as “politically powerful Americans of the future” it’s not a wash, because there’s a real transfer of wealth going on. But, again, that illustrates Krugman’s point: debt is only a transfer of wealth if the debt is held by someone outside the “we”; otherwise the issue is just how wealth is distributed among the “we.”
JM wrote:
Krugman’s argument is that it’s a distributional issue, because any debt owed by the US government is an asset owned by the US people, so collectively it’s a wash. If your objection is that there’s a transfer of wealth from the politically weak of the future to the politically powerful of the future, that makes it no less of a wash.
No no no no no no….
JM you’ve totally missed the point of this post. I don’t know how I can make it any clearer. Maybe I’m wrong, but under no circumstances should you be reading my post and then writing the above. If you still think the above, then you should be writing, “Bob your examples are wrong because of XYZ…”
Maybe somebody else can try to translate. I am out of stamina.
> debt is only a transfer of wealth if the debt is held by someone outside the “we”; otherwise the issue is just how wealth is distributed among the “we.”
I have to note: the redistribution among the “we” is no less of a transfer. Think of two wolves and a lamb agreeing on dinner.
Whoops, wrong reply.
“SCENARIO 4: Now we’re going to really tweak things. Throw out the Philistine, and go back to my original thought experiment. Isaac now lives both periods too. In period 1, Isaac lends the 10 apples to the government. In period 2, the government taxes Isaac 11 apples, then gives them right back to him to retire the bond.”
In this scenario, it looks like Isaac represents the entire country. If the government borrowed from him at T1 and (if it was a sensible government) provided him with at least 10 apples worth of services, and then later taxed him to the tune of 11 apples (whose NPV is 10 apples) it’s a wash. It’s the same if the government defaults on its obligation — it has effectively taxed him 11 apples.
The reason it’s different for the Philistine when the government defaults is because the Philistine wasn’t the beneficiary of the government services. The Philistine has in a very real sense been robbed of 10 (present value) apples.
If you don’t mean for Isaac to represent the whole country, then things get messier because Isaac might not have been the beneficiary of 10 apples worth of services. But, in practice, he also won’t get taxed the full 11 apples to retire the debt, so that would mess up the model anyway.
JM, I’m really not trying to be a jerk here, but I can’t understand why you are saying Isaac is the whole country in Scenario 4. You don’t need to guess. He is clearly not the whole country in period 1, when he lends the money that funds Abraham’s consumption. In period 2, yes, Isaac has become the whole country, and he is taxed to pay off the bond he is holding. But I showed you–in a way I thought nobody would fail to appreciate–that we can easily see cases in which Isaac is clearly hurt by the period 1 deficit spending, even if Isaac ends up holding all of the bonds that were issued at the time of the deficit.
Look, you don’t prove Krugman right by showing it’s possible Isaac would appreciate a multi-period deficit-financed government program. Krugman wasn’t saying, “We can logically imagine a situation where our children would be glad we ran deficits today.” No, Krugman made the claim that “Deficit spending today might harm our children, but not because they have to make higher tax payments to service the debt. If they owe it to themselves, it is a wash.” And that statement is wrong. All I have to do is show one case where the children hold the government bonds that they are being taxed to pay off, and where we all agree the children got screwed by their ancestors’ deficit spending. I have provided such an example in this post.
This assumes no Jacob. Can’t the government perpetuate this by borrowing from Jacob to pay Isaac? If output is growing as quickly as the rate of interest, this can go on infinituum. Your two period model is flawless, but I don’t think we’re dealing with a two period model.
Let’s be realistic here. The country doesn’t end in period 2 (Isaac has a son, Jacob), and the government borrows from Jacob to pay back Isaac. And then it borrows from Joseph to pay back Jacob, and so on and so forth.
That’s social security right there, except without the dependency ratio problems.
Why are the dependency ratio problems a problem?
JM,
I think Bob’s example makes it all clear..
If Abraham (read current old people) consumes more than he produces and finances this consuption by a government transfer he does not have to pay for (or cannot pay for because he will not be around), and future generations (the now young) can consume less than they otherwise would because they have to pay higher taxes (to retire the debt to third parties like philestine (people who are alive in both periosds, or foreigners), it is difficult to see how this is not a transfer of wealth.
There is one exeption (special case) however (which is not discussed in the model): only if the old (abraham) collectively take their transferpayments and save these to bequest their grandchildren (as can happen) and only if (big if) the
“collective” of future (marginal) taxpayers is equal to the “collective” of future heirs from these bequests..Krugman’s assumption would be true–a condition that doesn’t hold in the real world, since steve job’s kids will get a way larger share of these bequests than they will pay for in taxes…(this could be shown by some phd probably ;-))
(sorry for the confusing statement, but this reply was spontaneous)..
regards from Vienna, Austria 😉
Bob,
Again you jut proved that borrowing does not make the future generations poorer.
What happens between Isaac and Philistine is not a net minus but redistribution. So because of our borrowing now, the distribution of wealth of future generations will be affected – not their net wealth.
I am just summarizing your arguments.
And I disagree with Landsburg that this is even true for external borrowing. If the bonds aren’t held internally it changes from an redistribution matter to a net minus of wealth. I guess that means I am with Krugman on this … Schocking
Chris,
the point you are making is correct from a money perspective. But wealth as I interpret things is always reduced, if some party is forced into involuntary transactions. which is true for isaac. his wealth is impaired more from a utility perspective than the net gain to philestine, although in money terms impairment and gains cancel out. isaacs fate so to speak is path dependent, i.e. depends on a path he had no opportunity to influence…
to me this is a significant loss of wealth from a subjective utility perspective.
“Again you jut proved that borrowing does not make the future generations poorer. What happens between Isaac and Philistine is not a net minus but redistribution. So because of our borrowing now, the distribution of wealth of future generations will be affected – not their net wealth.”
Really, and is that still true if wealth is effectively distributed from more productive uses to less productive uses?
Excellent.
Is valuation cardinal?
Can we sum over the value of each apple?
If Abraham has no use for his 100th thru 110th apples, and must expend wealth to haul them away, has he benefited by this government scheme?
If Isaac has no idea what to do with more than, say, 50 apples in any period, is it any loss to him to be taxed 11 apples?
Where did we get the idea that each apple represented a fixed stock of value which was univocal across time, and independent of all context, that is, independent of changing consumption or production relations across time?
Greg wrote:
Where did we get the idea that each apple represented a fixed stock of value which was univocal across time, and independent of all context, that is, independent of changing consumption or production relations across time?
Don’t know where you got that from, Greg. Only thing I am assuming is that people value more apples, other things equal, and that there exists an interest rate that would make the lender in period 1 willing to exchange present apples for a claim on future apples.
This is what Hayek _does not assume_ in some of the most important parts of his work, e.g. monetary theory/cycle theory and in his work on collectivist planning.
“Only thing I am assuming is that people value more apples”
Indeed, as relative price relations change and production processes change, Hayek point out that some things will completely lose their “economic good” status — i.e. they will no longer be economized on at all and they will lose any place in the structure of production and consumption.
And the background for this whole debate is “stimulus” spending in order to “re-coordinate” the economy …
If you’ve lived on a farm, you’ll know that what farmers sometimes don’t value is more apples.
As a kid, I didn’t value all the overstock that fell on the ground, rotted, and had to be disposed of — just like many uncompleted houses in North Los Angeles had to be bulldozed and disposed of in the late 2000s.
Greg, you’re being absurd here. You might as well say, “What the heck Bob?! How can there be kids if there are no women in your model?”
Greg sorry I shouldn’t have said “absurd.” But what I mean is, I am trying to isolate one little thing here, because Krugman, kavram, Landsburg, and a bunch of others aren’t seeing it. When you introduce long-term government debt, there is a very real sense in which the present generation can live at the expense of the unborn. I am using a ridiculously simplistic model (with no physical investment etc etc) to show these people that they are missing something HUGE. If we made a more realistic model accounting for all the stuff you bring up, they would have no chance of seeing it because there would be too many moving parts.
I’m just saying — as Buchanan & Rothbard have said — that the logic of valuation (economic thinking) only makes sense considering individual choosers making subjective valuations at the margin.
We can make sense of more or less or constant output only via the perspectives of those choosers.
When we reason using cardinal values that “account” univocally across time and can be fixed in particular items regardless of context and subjective evaluators, we have stopped thinking economically.
This is Buchanan’s case against Lerner, and Rothbard’s case against Hayek’s Wieserian notion of a stable stream of “income” across time.
Krugman et al are saying that for a given cardinal-ish value system V, debt has property B.
Bob has presented an argument that given V, debt _does not_ have property B.
Evaluating Krugman vs. Bob does not really require figuring out whether V is empirical true, praxeologically true, subjectively true, inter-subjectively true, objectively true, conforming with Hayek’s monetary theory, etc. We just say “OK, we’ll use your framework to show that your argument is flawed.” Actually very Misesian.
Greg, your points are valid, but they are not necessary to explain what needs to be explained. They can be abstracted away, with NO loss of explanatory power.
In a way you have not fully captured the crookedness of it, because most of the treasury bonds are not in the hands of “some wealthy investors”, they are in the hands on institutional pension funds, and the actual owners of that money never got asked whether or not they wanted to buy into the loot. Thus, if it was wealthy investors who made a conscious decision and understood the deal, I’d be more tempted to just shrug and say, “they knew what they were buying into, if it defaults, they get what they get.” Unfortunately, when there are so many pension funds in the deal, and lots of people are going to be left with nothing to retire on, it makes it really hard to default (but that won’t stop them from doing it, and anyhow Social Security is much the same scam).
Anyhow, I completely accept your point of view, but even after accepting that, I still say that the crux is the instant in time when the money is spent. Let’s look at this scenario:
Government does exactly what you say and borrows money with a promise that some generation in 20 years will pay it back. Then they spend the money building a lovely stairway to heaven and along comes the new generation and the government says, “How do you like your new stairway? We built it for you. By the way, better get working so you can pay for it now.” Depending on whether the young pups do actually like the stairway, it may not be such a bad deal.
Then again, maybe it turns out that government builds a treadmill to nowhere instead, suddenly the deal looks a lot worse. That’s the whole point of course… the moment when the money gets spent is the key. It all comes back to making that decision about which investments are valuable and which are rubbish. Decision making is everything.
In scenario #4, if Abraham’s preferences are fixed, won’t he simply increase his inheritance to Isaac by 10 apples — putting us back to were we started?
Similarly, in scenario #4, if Abraham’s sense of ethics & fairness are strong, won’t he simply countervail this injustice, and increase his inheritance to Isaac by 10 apples — putting us back to were we started?
Yes, if you really go through generations, it is always a zero sum game.
The only reason that it looks a little as if one generation was paying for another is the fact that Bob tries to make us believe that Isaac and Philistine are two separate generations while they are actually one.
By the way, I am not saying that borrowing doesn’t have detrimental effects. I am just saying that internal borrowing doesn’t make society as a whole poorer in the future. However, it has very negative redistribution effects, as shown by this article, that are reason enough to object to it.
“In period 2, Abraham and his tree are both dead, but young Isaac is born. Isaac has a tree that yields 100 apples for 1 period, while the (now old) Philistine is still alive, and his tree yields 100 apples.”
I liked your first example better because it didn’t have baby labor.
This is semi off-topic so I won’t be offended if it gets deleted. I’ve been reading about the opinion polling w.r.t. Ron Paul and there seems to be a significant trend that younger voters like Ron Paul a lot more than older voters. I wonder if government debt (and by corollary government spending) is a part of that. In simple terms, old Abraham is attracted to the idea of more government spending (Obama, Romney, etc), while young Isaac is feeling nervous about getting shafted. Maybe we should just categorize this election as Baby Boomers vs everyone else? Oversimplification I know.
Even more off topic but does anyone actually believe that Rick Santorum would cut government spending if he ever got to be president?
Finally, everyone should do a refresher read of Krugman blasting George Bush over deficit spending — A Fiscal Train Wreck (March 2003), thanks to Django on William L. Anderson’s blog.
If the wealth of the society is always unchanged by the repayment of debt held within the society, why not set up a blank-check account for every household in the society funded by a debt-repayment account held in the next house over?
That way, no one will ever want for anything, and we will owe it all to ourselves!
Sorry, that is a silly objection. Your obviously can’t do that because your citizens don’t have unlimited ressources to lend to you. The point is, if you borrow money from your own citizens, this will not affect the overall future wealth because the repayment period will be a zero sum game.
But, of course, for every dollar you want to borrow, you have to find someone in your economy who is willing to lend it to the govt. The fact that the future wealth won’t change, doesn’t mean that there is a free lunch. You still have to find someone to fund it–right now!–not in the future.
Borrowing predetermines the future taxation level.
Abraham and Isaac both have Kids. Abraham and Isaac are dead in period 2 and only their kids are alive.
Situation A:
The government wants to tax Isaac by 10 apples to give them to Abraham. Isaac does not publicly resist (e.g. demonstrating or voting for another candidate that doesn’t want to tax) against the tax, so the government goes on with it. But at least Isaac could have decided to make a public outcry against taxation or vote differently.
Situation B:
The government wants to borrow 10 apples to give them to Abraham. It promises to return 11 apples in period 2. Isaac thinks: “Ok great why not “invest” in a safe asset. I can sell it for probably 10.5 apples if I need it meanwhile or if I am still alive in period 2 get 11 apples, or pass it on to my kids if I am not.” Finally he dies already in period 1 and he passes the bond on to his son.
Now what is the difference between the 2 situations? In situation A both kids are have no burden by predetermined taxation level. They can vote for or against current taxation level independent of the decisions their fathers made. In situation B this is different, the government made a commitment in the past, and if it doesn’t want to lose its credibility, it needs to tax at least 11 apples from both kids to give them to the son of Isaac. It could decide to default on the loan then the physical situation would not be different than in situation A. It would have been as if the government had taxed Isaac 10 apples directly in period 1 to give them to Abraham. But by doing this it would have deprived Isaac the possibility to resist the taxation. If it doesn’t default on the loan it deprives the kid of Abraham of the possibility to resist taxation. (For Isaac’s son there is no reason to resist the taxation since he is the beneficiary of it).
In short: Borrowing lures people into higher taxation. Government borrowing seems to me to be a kind of clan liability.
The implications are much deeper. Through this mechanism not only the government buys votes and is necessarily biased to steadily increase the debt level, and therefore deprives future generations more and more about their ability do decided themselves how high their taxation/redistribution level should be. This way they even act diametrically opposed to the original “social” reason why the redistribution of wealth was done in the first place.
Let’s tweak my example a bit. Abraham’s apple tree only yields 30 apples and is the poor guy while Isaac’s tree yields 100 apples and he is therefor the rich guy. In situation B this means that in the first period the poor Abraham got 40 apples together with the 10 of Isaac. In period 2 though when the bond comes due his Abraham’s son is even poorer than Abraham would have been in period 1 without the redistribution of wealth. Abraham’s son (if he is taxed a bit less because he is the poorer one) will have even less than 30 apples. This means to keep the wealth level of the poorer son of Abraham at the same level as his fathers they necessarily will have to issue another and this time bigger bond…. Since it will be the rich guys who will hold the higher portion of bonds the rich get richer and the poor get poorer through wealth transfer over time more and more… What irony..
Uhm can someone tell me if there is a flaw in the logic?
And the funny thing is, the only way that Abraham’s son can level the playing field would be to to use his apples to buy gold anonymously, bury it somewhere and let the government default on the bond of the rich guy… This way he can escape the clan liability.
This is quite clearly a crooked scheme, and if future generations end up holding those IOUs, it doesn’t change the nature of it. There is a very definite sense in which the politically powerful citizenry who enjoy transfer payments due to government budget deficits, are living at the expense of future taxpayers. The layperson is right, and the fancy schmancy economists who doubt this are wrong.
I think there are moral implications too with regard to how people invest. You can make a Libertarian case that holding government bonds is a de facto violation of the nonaggression principle, and a Christian case the holding government bonds is a form of theft.
In both periods in all the examples the 100 apples are all consumed in the period they are produced , right Doesn’t that mean that this has to be a distributional problem assuming you include the Philistine as part of the economy?
Distributional problems are clearly a major issue in their own right, but in as much as government borrowing and/or taxation doesn’t affect output (as seems to be the case in this example) Krugman is right.
The real issue then becomes “what affect does govt action have on output” . A fifth example could have the govt taxing Issac in period 2 and causing him to have to destroy part of his tree (to sell the wood) and reduce apple production in future periods. And of course the Philistine in period 1 may have built a new orchard in period 1 if the government had paid a higher rate of interest to fund the subsidy to Abraham.
Not sure if I’m butchering Bob’s point, but I think Bob *agrees* that it’s a distributional problem. Apples are being distributed from Isaac to the Philistine. This may be through a tax on Isaac which is used to pay the Philistine or by Isaac buying the bond, only to be later taxed so his own taxes can be used to pay back the bond he now owns.
That is not the dispute.
The key idea is that we must compare *this* distribution to the distribution that would arise if the bond had not been issued. Isaac would not lose the apples paid through taxes. He would eat them.
The only way to get the post-bond-issue distribution to line up with the no-bond-issue scenario is to either default on the bonds, or equivalently, tax the bondholders and use their money to pay them back. Even then, we run into second-order effects [odds of default affecting bond price, etc]. But the underlying point still stands.
Unless the bond is *defaulted*, apples are distributed away from future generations (Isaac) to previous generations (Philistine). This may happen in the way described, where the generation after the bond issue pays for the bond. Or it may follow a chain of transfers, where the Philistine sells the bond to Philistine Child, who sells it to Philistine Grandchild, … until Abraham Descendant gets taxed to pay off Philistine Descendant. The Philistine Descendant will not earn a huge apple interest; just the interest for holding the bond for one period. Likewise, the bond holder in his parent generation would have earned a similar interest rate. However, the compounded interest impact will be enormous, and Abraham Descendant will pay “compounded amount” more than he would pay in the no-bond-issue scenario.
Should read “if the government had NOT paid a higher rate of interest to fund the subsidy to Abraham.”
Bravo!!! Bravissimo!
I remember a long time ago, you made a similar point about a scenario 3-type situation and remarked, “Gee, [Isaac] must sure feel lucky that the government agent didn’t get hit by a bus or something! Then that bond would be *worthless!”
My only argument is that you didn’t use “DUH” even once in your article.
Sorry for my slowness here, guys. Trying to work this out.
What if Abraham doesn’t have any sons?
Say Abraham lends Skynet the 10 apples in exchange for the promise of 11 in period 2. Skynet gives the 10 to the Philistine. The Philistine dies at the end of period 1.
Then, in period 2 there are no Isaacs. Abraham collects the 11 apples he is owed, which the government taxes him in order to pay him.
We can say that in period 1, Abraham got an IOU for his 10 apples, so the deal is simply the deal.
As well. since Abraham receives the 11 apples he pays in taxes in payment on the IOU in the second period, his wealth changes from X apples to (X – 11) + 11 = X apples. Since X = X, the wealth of Abraham in period 2 is unchanged.
Is that right?
I think I’m still missing something – it doesn’t seem as though “society as a whole” is worse off in either period. In both time periods, a total of 200 apples are consumed, even though some of them are transferred around.
Any objection would have to focus more on equality and redistribution effects, but I can’t see how the citizens in period 2 have experienced any kind of “welfare loss” due to Abraham’s overconsumption in period 1
I think you need both generations alive long enough so generation 1 can sell the bond to generation 2. Please my generational response to Rob’s similar question above. [Can’t take credit, just paraphrasing Nick Rowe and Bob Murphy].
Bob,
This is probably a stupid question to be asking at this stage in the discussion but is your point that:even though output and consumption is the same in both periods.
In period 1 :there a gainer but no losers (since the bond holder voluntarily defers consumption)
In period 2: there is a loser but no gainers (since the bond holder is just getting his money back plus interest to increase his consumption)
Therefore even though they collectively produce and consume the same, some people in period 2 will consume less with no compensation for their loss ?
Yes Rob that’s it. I’m going to write up a longer example tonight so that Landsburg puts down his accounting truisms and sees the light.
If you tax directly, and only redistribute this wealth as done in your example, you have the same effect. This for my point of view is not what is special in a borrowing case. With direct taxation you can do something about it, as far as democracy gives you some tools for it. But if government borrows, democracy even works as an amplifier to increase future taxation.
Officially in period 1 there was no taxation involved in your example, that’s why it is so popular at first. But now you already have determined how much has to be taxed at least in the future in period 2 if debt cannot be rolled over. But those people who are only born in period 2 could not vote in period 1. They are forced to accept this level of taxation.
Ok, not quite the same effect. Yes you have the gainer in period 1 and the loser in period 2. I understand now what you mean. And because the pain (burden) is felt only later, it is so popular.
To simply it- Abraham’s extra consumption had to be funded by someone. If Isaac or the philistine had been taxed in period one to do so, they would have borne the burden and recognized it immediately as such (unless their name is Daniel Kuehn). The borrowing simply moved the recognition of this as a burden forward in time since the lender had a bond that promised to make him whole for the foregone consumption. The only way Krugman is correct is if said government never defaults and never taxes to buy the bond back in the future. How many governments haven’t ever defaulted in one manner or another? Someone has to pay the bill- this will always be true at some point.
Bob, this would be a lot better post if you left out the loaded “stealing” to describe taxes. It’s kind of like if you had “zombie Easter Bunny” collecting the bond payments: the nonsense distracts from the point you are trying to make.
How is the taxation in that scenario not theft? Do you believe that there is no tax that could be called theft?
I know you disagree with other people who call all taxation theft but I wouldn’t have thought you would disagree with any tax being described as theft.
This thread would have been a lot better if you had left out the loaded tacit assumption that taxes are NOT theft.
Try not paying taxes and see what happens to you. Not theft? You’re crazy.
Gene, your analogy is silly. The zombie Easter Bunny at least has the decency to not pretend it is eating my brains for my own good.
Gene is right. Whether taxes are theft or not is irrelevant to the question of whether borrowing impoverishes future generations. This is just distracting. We should be mixing economic and moral questions. And I think this is what explains the whole discussion.
If Bob just said “borrowing now is immoral because is has redistribution effects that will make parts of the future generation poorer while others will be benefiting” I would completely agree. But instead he said it would make the entire future generation poorer.
I forgot a ‘not’ again… this seems to be becoming a habit…
zombie Easter Bunny would be a welcome relief. I think we could eradicate it before it made many additional zombies. Can’t say the same for the current bond collectors.
BTW, it’s odd that no one is getting hopped up over the interest on the bond. Even in Ricardian-equivalence-land, taxpayer Isaac needs to cough up bond principle PLUS interest.
This is not a problem in the Austrian ERE, since actors never die. In the ERE, *Isaac* borrows the principle each period and enjoys it, so why shouldn’t he pay interest? If he wants to stop paying interest, he should stop borrowing so much damn money! Or restrict consumption, etc. It gets a bit sleazier when Abraham borrows the money and either bequeaths it [bad] or spends it poorly [really bad]. Maybe if we borrow money, we have some obligation to set our kids up so they can “easily” pay it off? This gets into all sorts of messy things, like inter-personal utility comparisons.
Anyway, these are all normative questions.
What if you would restate Krugmans point as:
“the level of burden today do not have any first order effects on the level of resourses available in any future time period – but it do have distributional effects”
sorrý, “level of burden” should say “level/size of debt”
excellent example that proves why krugman is right.
in time period 2, it is merely a transfer between then living generations — exactly what PK says: “hat some of our children will pay money to other children, which is a very different kettle of fish.”
after all we are all abrahams children. even the philistine =)