14 Feb 2015

Reading List for Debt Burden Stuff

Debt, Shameless Self-Promotion 5 Comments

Roger Farmer gives a good list here, though most of the papers are formal and would be hard for a non-academic to read. However, it shows the extensive history in the literature of this stuff.

Roger linked to this piece I did in the American Conservative, which I had totally forgotten. It is now going to be my go-to piece for a plain English version of my take on this controversy; if you still haven’t had it “click” for you, you might give it a try. I’m going to give a lengthy excerpt here because I think this is the best (plain English) example I had come up with. (BTW I’m working on a new article but it might not come out for a while.)

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. Theyacquired 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.

As this short tale illustrated, the man on the street’s intuition is correct: today’s budget deficits can impoverish future generations, even if future Americans hold all of the Treasury bonds. There really is a sense in which voters today can run up the credit card and stick the bill to unborn future generations.

5 Responses to “Reading List for Debt Burden Stuff”

  1. guest says:

    Taxing younger folks to pay for older folks’ retirement is not benefitting “ourselves”; It’s cronyism.

  2. EC says:

    “Finally, suppose that the young workers (who were recently born) hold on to their government bonds for one more year…”

    This was a little confusing because I thought you were talking about the new cohort of young workers.

    I’m not sure if the controversy is really over whether Krugman doesn’t care if someone bears the cost as long as they’re a US citizen because he’s just aggregating everything.

  3. E. Harding says:

    Bob, some of your post-2012 posts can be found in Bing (though I don’t think any from this year). Also, you said to remind you today on this:

  4. Rick T. says:

    I think you could have made the finale of your story a little clearer. The third generation paid $236B to buy the bonds with one year remaining until maturity. Then the next year they had to pay $243B in taxes to redeem their own bonds. That part was a wash, but the $236B was gone.

    The only way Krugman and the others’ argument makes sense is if you assume a Ponzi scheme going on forever, where no one ever has to pay back debt because there will always be new lenders. As Greece discovered five years ago, there is a point where your debt gets so high that no one will voluntarily lend you money. Then you either default, or the government taxes other people to pay your creditors.

    • Yancey Ward says:

      As Greece discovered five years ago, there is a point where your debt gets so high that no one will voluntarily lend you money.

      And Krugman will go blue in the face explaining to you that there was no reason for Greece’s credit to go bad 5 years ago- it was just Europe behaving stupidly in not backstopping all that debt going backward and forward. So, yes, he really does view it as a sustainable Ponzi.

      In the initial round of this debate, Krugman was careful to point out that the distributional effects might not be all that innocent if it was foreigners who held a country’s debt, but I noticed that in one of the essays from last week he had axed out that problem by invoking the world economy owes the debt to itself. I found that retreat fascinating.

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