It’s Time Everyone Calmed Down About High Levels of Government Debt
Politicians and economists often frighten us with tales of the horrific burden that we are passing onto our children and grandchildren by allowing the government to run up debt.
Across the capitals of Europe, but particularly in Berlin and Athens, politicians add to the voices of influential and distinguished economists such as the American Robert Barro who argue that debt-financed government spending is bad for the economy. Their logic is that any benefit from extra government spending will be offset by anxious tax-payers saving and passing on money to future generations to help the pay off the debt. The logic rests on an analogy with household budgets: if the debt isn’t settled by the parents it will be passed on to the kids.
But while the analogy is simple it is also wrong.
Government debt bears little resemblance to household debt. Peddlers of this narrative rely on people’s personal experience of debt to shape how they think about government debt.
In reality, most Government debts get rolled over as they become due, or as interest rates fall, so that as it is repaid, more is raised to take its place. This has gone on for centuries.
Debt forgiveness or cancellation is largely unnecessary. So is the strict adherence to repayment conditions
This is of particular importance today as German Chancellor, Angela Merkel, and her Greek counterpart, Alexis Tsipras, battle over the terms for rolling over the debt of the Greek government. Debt forgiveness or cancellation is largely unnecessary. So is the strict adherence to the repayment conditions that strangle the economy today because of the fear of what might come tomorrow. These are distractions that lead to nationalist grandstanding by Greek and German politicians.
Closer examination of how debt is serviced throws light on what is really happening. Firstly, it shows that the government taxation raised to pay interest on the debt is simply a way of redistributing income. Citizens pay taxes to cover the interest due to those who lend the money to the government - the bondholders. So the tax ‘burden’ on future generations is offset by the interest paid on government debt to those generations. The ‘rational’ tax-payer would - or should, if truly rational - factor into the calculation, not only the additional taxes that will have to be paid to service government debt, but also the additional income that tax-payers will receive.
Of course not every tax-payer holds government bonds, so the resulting distribution of income from tax-payers to bond-holders is not neutral. If the tax-payers are working people, and the bond-holders are the idle rich, the resulting redistribution may be regressive and discourage work and the payment of taxes - particularly if tax-payers feel that too much of their taxes is going to the rich rather than on paying for public services.
This problem could be easily solved with a progressive tax system, in which the wealthy pay more in tax than the interest they get from lending money to the government. In theory it should even be possible, by taxing bond-holders with, say, a levy on financial portfolios, to make the rich pay for all the income that they receive from their government bonds.
THE US has the highest debt in the world YET few complain About the interest goes to foreigners
Another more serious complication arises with foreign ownership of government bonds. This redistributes income from tax-payers in the country to foreign bond-holders. This may be a pretext for resentment of foreign creditors. But this very much depends on the domestic situation in the country of the indebted government.
In Greece, much of whose government debt is foreign-owned, resentment of foreign holders of its bonds is very marked in the pronouncements of the government and people. Similar sentiments were apparent in many developing countries during the international debt crisis of the 1980s. In the case of these developing countries some of that debt was in US dollars, making a bad situation ruinous as forced currency devaluation inflated the cost of servicing the foreign debt.
government debt can be left outstanding as a system for redistributing income
By contrast, in the US, whose government has the highest debt of any in the world, the spurious ‘burden on our children’ argument holds while few complain that about half of the interest paid on that debt goes to foreigners. This may be because the US government’s foreign debt is in its own currency and perhaps also because foreign bond-holders do not fly into Washington dictating terms to American governments as they are doing in Athens or they once did in Bangkok.
A third complication arises when governments pay off debt, so that the money advanced by the original investor to the tax-payer now flows back to the current holder of the bonds. Such capital repayments give financial investors more money for investment, with the danger that this extra liquidity inflates markets for financial assets, such as stocks and shares, causing speculative bubbles. Governments should therefore manage their debt repayments to prevent such bubbles rather that just pay down the debt.
If this means that government debt is refinanced so that it is never repaid, then so much the better for the financial markets: government debt can be left outstanding as a system for redistributing income, and the only substantial issue for fiscal policy is a tax system to ensure that the eventual redistribution is fair.
If tax-payers resent paying taxes to pay interest on government debt, the answer is to reassure them that bond-holders are paying even more taxes, rather than depressing the economy with exorbitant taxes to pay off government debt.
Countries can live with high government debt as a system of redistributing income, in the same way as we live with taxes. Fears of excessive government debt, spread as much by proponents of debt cancellation as by proponents of austerity, are irrational and an obstacle to effective economic policy.
Jan Toporowski is Professor of Economics and Finance at the School of Oriental and African Studies, University of London.
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