Public Principles of Public Debt: A Defense and Restatement

James M. Buchanan.
Buchanan, James M.
(1919- )
CEE
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First Pub. Date
1962
Publisher/Edition
Indianapolis, IN: Liberty Fund, Inc.
Pub. Date
1999
Comments
Foreword by Geoffrey Brennan.

1. James M. Buchanan, Public Principles of Public Debt: A Defense and Restatement (Homewood, Ill.: Richard D. Irwin, 1958), volume 2 in the series.

2. James M. Buchanan, Cost and Choice: An Inquiry in Economic Theory (Chicago: Markham Publishing Co., 1969), volume 6 in the series.

3. James M. Buchanan and Richard E. Wagner, Democracy in Deficit: The Political Legacy of Lord Keynes (New York: Academic Press, 1977), volume 8 in the series.

4. Martin S. Feldstein, "Social Security, Induced Retirement, and Aggregate Capital Accumulation," Journal of Political Economy 5 (September-October 1974): 905-26; Robert J. Barro, "Are Government Bonds Net Wealth?" Journal of Political Economy 6 (November-December 1974): 1095-117.

5. James M. Ferguson, ed., Public Debt and Future Generations (Chapel Hill: University of North Carolina Press, 1964). The Buchanan contribution written specifically for the Ferguson collection, "Public Debt, Cost Theory, and the Fiscal Illusion," 150-63, is reproduced in the Collected Works in volume 1, The Logical Foundations of Constitutional Liberty. Another Buchanan paper reprinted in the Ferguson volume, " 'La Scienza delle finanze': The Italian Tradition in Fiscal Theory," in Fiscal Theory and Political Economy: Selected Essays (Chapel Hill: University of North Carolina Press, 1960), 47-54, is reproduced in the series in volume 15, Externalities and Public Expenditure Theory, along with Buchanan's other articles on public debt.

Chapter 1

6. Seymour E. Harris, The National Debt and the New Economics (New York, 1947), p. 25. Cited by permission, McGraw-Hill Book Company.

Chapter 2

7. Abba P. Lerner, "The Burden of the National Debt," in Lloyd A. Metzler et al., Income, Employment and Public Policy (New York, 1948), pp. 255-75. Cited by permission, W. W. Norton and Company.

8. Seymour E. Harris, The National Debt and the New Economics (New York, 1947), pp. 25, 55.

9. Alvin H. Hansen, Fiscal Policy and Business Cycles (New York, 1941), p. 185.

10. Harold M. Groves, Financing Government (New York, 1954), p. 560. Cited by permission, Henry Holt and Company.

11. A. C. Pigou, A Study in Public Finance (3d ed.; London, 1949), p. 38. Citations by permission, Macmillan and Co., Ltd.

12. O. H. Brownlee and E. D. Allen, Economics of Public Finance (2d ed.; New York, 1953), p. 127. Cited by permission, Prentice-Hall, Inc.

13. Perhaps the best example is Jorgen Pedersen, whose paper in Weltwirtschaftliches Archiv (May, 1937) is cited by Hansen, who is in almost complete agreement with Pedersen. See Hansen, op. cit., p. 142.

14. David McCord Wright, "The Economic Limit and Economic Burden of an Internally Held National Debt," Quarterly Journal of Economics, LV (November, 1940), 116-29; "Moulton's 'The New Philosophy of the Public Debt,' " American Economic Review, XXXIII (September, 1943), 573-90; B. U. Ratchford, "The Burden of a Domestic Debt," American Economic Review, XXXII (September, 1942), 451-67; J. E. Meade, "Mr. Lerner on 'The Economics of Control,' " Economic Journal, LV (April, 1945), 47-70.

15. Wright, "The Economic Limit and Economic Burden of an Internally Held National Debt," op. cit., 117 and 129.

16. David McCord Wright, "Mr. Ratchford on the Burden of a Domestic Debt: Comment," American Economic Review, XXXIII (March, 1943), 115.

17. David McCord Wright, The Creation of Purchasing Power (Cambridge, Mass., 1942), p. 148.

18. Cf. Giannino Parravicini, "Debito pubblico, reddito, occupazione," Rivista di diritto finanziario e scienza delle finanze (1951).

19. Paul Leroy-Beaulieu, Traité de la Science des Finances (7th ed.; Paris, 1906), Vol. II, p. 223.

20. J. F. Melon, "Essai Politique," Chapter 23 in Economistes Financiers du 18me siecle, p. 479. Cited in C. F. Bastable, Public Finance (2d ed.; London, 1895), p. 613.

21. Leroy-Beaulieu, op. cit., p. 224.

22. Cited in E. L. Hargreaves, The National Debt (London, 1930), p. 74, where, in turn, the citation is taken from a reference in Malachy Postlethwayt, Dictionary of Trade.

23. Sir James Stuart, An Inquiry into the Principles of Political Economy (1767), p. 625 as cited in Hargreaves, loc. cit., p. 81.

24. Leroy-Beaulieu, op. cit., p. 224.

25. David Ricardo, "Principles of Political Economy and Taxation," Works and Correspondence, P. Sraffa, ed. (Cambridge: Royal Economic Society, 1951), Vol. I, pp. 244-45. This and subsequent citations by permission Cambridge University Press.

26. David Ricardo, "Funding System," Works and Correspondence, ibid., Vol. IV, p. 187.

27. Gustav Cohn, System der Finanzwissenschaft (Stuttgart, 1889), pp. 740-43.

28. Adolf Wagner, Finanzwissenschaft (Leipzig, 1877), Vol. I, p. 122.

29. Knut Wicksell, Finanztheoretische Untersuchungen (Jena, 1896), p. 131.

30. See Maffeo Pantaleoni, "Imposta e debito in riguardo alla loro pressione," Giornale degli economisti (1891), reprinted in Scritti varii di Economia, Serie Terza (Rome, 1910); Antonio de Viti de Marco, "La pressione tributaria dell' imposta e del prestito," Giornale degli economisti (1893); Benvenuto Griziotti, "La diversa pressione tributaria del prestito e dell' imposta," Giornale degli economisti (1917), reprinted in Studi de scienza delle finanze e diritto finanziario (Milan, 1956), pp. 193-261.

31. See Report of the Committee on National Debt and Taxation (London, 1927), especially p. 27.

Chapter 3

32. Milton Friedman in his outstanding paper, "The Marshallian Demand Curve," Journal of Political Economy, LVII (December, 1949), 463-95, has shown how the partial equilibrium approach can be modified to escape this inherent difficulty. In his other works, notably, "The 'Welfare' Effects of an Income Tax and an Excise Tax," Journal of Political Economy, LX (February, 1952), 25-33, he has shown how a neglect of the necessary compensating changes has produced serious analytical errors.

33. For a further and extended discussion of this and related points, see my "Ceteris Paribus: Some Notes on Methodology," Southern Economic Journal (January, 1958).

34. Cf. Gustavo Del Vecchio, Introduzione alla finanza (Padua, Italy, 1954), p. 10.

35. For a recent controversy in which the issues are clearly drawn along these lines, see my "Capitalization of Excise Taxes: Comment," American Economic Review, XLVI (December, 1956), 974-77, and the reply by J. A. Stockfisch (977-80). For a more general discussion of the issue, see my "La metodologia della teoria dell' incidenza," Studi economici (December, 1955).

36. Professor Frisch has recently made essentially this same point in reference to Hotelling's tax analysis. See Econometrica, 24 (July, 1956), 311.

37. This point is recognized by Cesare Brasca, "Intorno agli effetti economici del debito pubblico," Rivista internazionale di scienze sociale, XXV (1954), 423.

38. J. E. Meade, "Mr. Lerner on 'The Economics of Control,' " Economic Journal, LV (April, 1945), 62.

Chapter 4

39. O. H. Brownlee and E. D. Allen, Economics of Public Finance (2d ed.; New York, 1954), p. 126. Also, see Henry C. Murphy, The National Debt in War and Transition (New York, 1950), p. 60.

40. Adolf Wagner, Finanzwissenschaft (Leipzig, 1877), Vol. I, p. 122.

41. For a further discussion of this point, see my "The Pure Theory of Government Finance: A Suggested Approach," Journal of Political Economy, LVII (1949), 496-505.

42. For the best discussion of all these points, see F. H. Knight, "The Ricardian Theory of Production and Distribution," Canadian Journal of Economics and Political Science, 1935. Reprinted in F. H. Knight, On the History and Method of Economics (Chicago, 1956), pp. 37-88.

43. B. U. Ratchford, "The Burden of Domestic Debt," American Economic Review, xxxii (September, 1942), Pt. IV. Abbott, in his work on debt management, appears also to recognize implicitly that the primary real burden of debt is borne by taxpayers of "future generations." He does not, however, discuss this aspect of the problem directly. See Charles C. Abbott, Management of the Federal Debt (New York, 1946).

44. David Ricardo, "Principles of Political Economy and Taxation," Works and Correspondence, P. Sraffa, ed. (Cambridge: Royal Economic Society, 1951), Vol. I, pp. 244-45.

Chapter 5

45. Jorgen Pedersen, as cited in Alvin H. Hansen, Fiscal Policy and Business Cycles (New York, 1941), p. 142.

46. Edward Nevins, The Problem of the National Debt (Cardiff, 1954), pp. 22-23. Cited by permission, University of Wales Press.

47. At a slightly more sophisticated level of analysis, however, even this statement must be qualified. In abstract terms, its validity requires that the marginal productivities of the resources involved be equal in public and private employments, that the operation be "at the margin." This begs more questions than it answers, however, since the whole issue of evaluating resource productivity is immediately raised. By the nature of public goods, market prices are not available to assist in such comparative evaluation. The shift of resources from public to private employments or vice versa can only be adjudged to add to social wealth on the basis of individuals' revealed preferences in supporting the shift. If we assume that a debt creation-public expenditure decision is rationally made, the taxpayer group must be adjudged as having moved to a preferred position. In this sense, therefore, social wealth may be said to have been increased. But the lending as well as the borrowing group must have also benefited, at least in the ex ante subjective sense. Gains from exchange are mutual, and some advantages are expected by both parties to the contract. Lenders assume that they will receive some differential return from the government security (in terms of rate, lowered risk, or other considerations) while borrowers (taxpayers) must be credited with assuming that the public project yields a "social" rate of return in excess of the borrowing rate. The wealth of both groups, which include, of course, many of the same individuals, increases in the subjectively calculated sense. It is evident, however, that this is not the sort of increase denied in the citation quoted in the text.

48. Over and above the gain from making the exchange which is necessary for any market transaction to be rational. See the preceding footnote.

49. Abba P. Lerner, "The Burden of the National Debt," in Lloyd A. Metzler et al., Income, Employment and Public Policy (New York, 1948), p. 255.

50. There have been few dissents in the literature of the past twenty-five years. One dissent from the prevailing view should, however, be noted. Emerson P. Schmidt argued in 1943 that public debt and private debt are essentially equivalent. ("Private versus Public Debt," American Economic Review, XXXIII [March, 1943], 119-21.) The fact that his arguments apparently had little effect indicates the dominance of the "new orthodoxy."

51. I am indebted to Professor A. Morgner for a brief conversation which has caused me to add this section.

Chapter 6

52. Abba P. Lerner, "The Burden of the National Debt," in Lloyd A. Metzler et al., Income, Employment and Public Policy (New York, 1948), p. 256.

53. Philip E. Taylor, The Economics of Public Finance (Rev. ed.; New York, 1953), p. 187. Cited by permission, The Macmillan Company.

54. A. C. Pigou, A Study in Public Finance (3d ed.; London, 1949), p. 30.

55. For example, Murphy, after arguing that the real costs of war cannot be shifted in time, continues: "There are some exceptions to this generalization. The cost of a war might be financed in part from foreign loans and these loans repaid out of the proceeds of tomorrow's labor." (Henry C. Murphy, The National Debt in War and Transition [New York, 1950], p. 80.)

56. Cf. August Lösch, "A New Theory of International Trade," International Economic Papers, No. 6, pp. 50-65.

57. See Egon Sohmen, "Demand Elasticities and Foreign Exchange Rates," Journal of Political Economy, LXV (1957), 431-36.

Chapter 7

58. Harold M. Groves, Financing Government (New York, 1954), p. 561.

59. There is, of course, a fundamental indeterminacy in this model similar to that which occurs in any fully competitive model.

60. Overcompensation is possible because we are considering the repercussions in this partial sector alone. If further effects are traced, the possibility of overcompensation will, of course, disappear.

61. We may compare this conclusion with the statement made earlier that, in the classical model, inflation can best be considered as a tax. Since the effects of inflation are such as to cause individuals to be confronted with opportunities unfavorable to them which they did not expect, is this not equivalent to the case with the disappointed borrower? The equivalence is only apparent here. In inflation, which is designed to allow government purchase of real goods and services without taxation, the amount of real goods and services available for private disposition is reduced. There are, of course, individuals who gain and individuals who lose by such inflations. But, in net terms, individuals in the aggregate must give up the share of resources which the government, through inflationary finance, purchases. A second comparison may be drawn between this case and that of a partial excise tax on a particular good. This causes the price of the good to be increased. We say that consumers "bear" the incidence of the tax. Is this not equivalent to the debt case; and may we not say that borrowers forced to pay the higher rates "bear" the burden of the debt? Again the equivalence is only apparent. We say that the consumers or purchasers of the taxed commodity "bear" the tax because they are the only ones in the economy who give up real goods and services in the process of government's action. If the government operation merely increases the retail price of a good, along with the factor prices for resources going into its production, we would not call this shift in relative values a "burden." The increase in price would have harmed net consumers of the commodity, but it would have benefited net producers. The excise tax differs in that it places a "wedge" between product price and factor price. Government debt issue places no "wedge" between the private lending rate and the private borrowing rate. Its action serves merely to shift the terms of trade between borrowing and lending groups in the economy. These shifts in real income are secondary repercussions which are quite different from the primary real burden which is attributable to the debt itself. For a discussion of the distinction between the "incidence" of an excise tax and the "horizontal shifts in retail product value," see H. P. B. Jenkins, "Excise-Tax Shifting and Incidence: A Money Flows Approach," Journal of Political Economy, LXIII (April, 1955), 125-49.

62. See the Appendix for an elaboration of the points made in this paragraph.

Chapter 8

63. David Hume, "Of Public Credit," Essays Moral, Political and Literary, Vol. I (New ed.; London, 1882), p. 366. Original edition published in 1742.

64. Adam Smith, The Wealth of Nations (Modern Library Edition; New York, 1937), pp. 859-900.

65. Ibid., p. 879.

66. Ibid., p. 863.

67. David Ricardo, "Funding System," Works and Correspondence, P. Sraffa, ed. (Cambridge: Royal Economic Society, 1951), Vol. IV, p. 187.

68. J. S. Mill, Principles of Political Economy (Ashley Edition; London, 1915), p. 873.

69. H. C. Adams, Public Debts (New York, 1893), p. 24. Citations by permission Appleton-Century-Crofts.

70. Ibid., pp. 106-7.

71. C. F. Bastable, Public Finance (2d ed.; London, 1895), pp. 624-25. Citations by permission Macmillan and Co., Ltd.

72. Ibid., p. 614.

73. Ibid., p. 613.

74. Ibid., p. 609.

75. Ibid., pp. 629-30.

76. Paul Leroy-Beaulieu, Traité de la Science des Finances (7th ed.; Paris, 1906), Vol. II, pp. 224-26. Citation by permission Presses Universitaires de France.

77. Ibid., pp. 226-29.

78. O. M. W. Sprague, "Loans and Taxes in War Finance," American Economic Review, Proceedings, 1917. Reprinted in Readings in Fiscal Policy (Homewood, Ill., 1955), pp. 107-21. See especially pp. 113-14.

79. Report of the Committee on National Debt and Taxation (London, 1927).

80. Ibid., pp. 27-28.

81. Ibid., pp. 358-59.

82. These are de Viti de Marco and Griziotti. Other works which should be mentioned are Maffeo Pantaleoni, "Imposta e debito in riguardo alla loro pressione," Giornale degli economisti (1891), reprinted in Scritti varii di Economia, Serie Terza (Rome, 1910), pp. 301-22; "Fenomeni economia delle guerra," Giornale degli economisti (1916), pp. 201-3; Luigi Einaudi, Miti e paradossi della giustizia tributaria (Turin, 1938), Ch. 5; Giannino Parravicini, "Debito pubblico, reddito, occupazione," Rivista di diritto finanziario e scienza delle finanze (1951), pp. 25-38; F. Maffezzoni, "Ancora della diversa pressione tributaria del prestito e dell' imposta," Rivista di diritto finanziario e scienza delle finanze (1950), pp. 341-75; Cesare Brasca, "Intorno agli effetti economici del debito pubblico," Rivista internazionale di scienze sociale, XXV (1954), pp. 417-46.

83. The most complete statement of Ricardo's position is to be found in "Principles of Political Economy and Taxation," Works and Correspondence, P. Sraffa, ed. (Cambridge: Royal Economic Society, 1951), Vol. I, pp. 244-46. De Viti de Marco's elaboration of Ricardo's theory was first published as "La pressione tributaria dell' imposta e del prestito," Giornale degli economisti (1893), pp. 38-67, 216-31, but essentially the same analysis is contained in First Principles of Public Finance. Translated by E. Marget (New York, 1938), pp. 377-98.

84. Benvenuto Griziotti, "La diversa pressione tributaria del prestito e dell' imposta," Giornale degli economisti (1917). Reprinted in Studi de scienza delle finanze e diritto finanziario (Milan, 1956), pp. 193-261.

85. For example, see F. Maffezzoni, "Ancora della diversa pressione tributaria del prestito e dell' imposta," Rivista di diritto finanziario e scienza delle finanze (1950), pp. 341-75.

86. This argument is developed in his First Principles of Public Finance, pp. 390-93.

87. Cf. F. Maffezzoni, "Ancora della diversa pressione tributaria del prestito e dell' imposta," op. cit., p. 348.

Chapter 9

88. The oversight of this rather obvious point in the discussion of debt theory may be based on a slightly distorted meaning which is given to real cost in much careless textbook discussion. The opportunity or alternative cost of a good is often defined as those goods and services which could have been produced if the resources employed had been used in a different fashion. From this simple definition, the real cost of depression-built post offices, for example, has often been held to be zero, or nearly so, because the resources employed were not diverted from alternative employments, actually or potentially. This line of reasoning overlooks the all-important point that the absence of alternative opportunities for resource employment sets a minimum of zero to the real cost of a good or service. There is nothing to insure that this minimum is always attained. It can be attained only with fully efficient purchasing. Individual analogies are easy to draw here. If I choose deliberately to pay a price for a good in excess of that set by the market forces, the real costs to me are in excess of the goods and services which the resources could have produced in alternative employments. The alternative or opportunity cost defined in the usual manner represents the minimum real cost, not the actual real cost.

89. During periods of depression, the creation of private debt may also serve as a reasonably good substitute for money creation. Insofar as money borrowed to put resources to work comes from hoards, no real transfer of resources takes place. Cf. Emerson P. Schmidt, "Private versus Public Debt," American Economic Review, XXXIII (March, 1943), 119-21. When liquidity positions are considered, the issue of any debt, public or private, must serve as a partial substitute for money creation. That is to say, any debt, even if real, will introduce additional "moneyness" into the economy, at least to some degree. This is obvious when public debt is considered; it is less obvious for private debt. But, as McKean has shown, the illiquidity or "non-moneyness" of the debt obligation for the debtor cannot fully offset the liquidity or "moneyness" of the debt claim for the creditor. (See R. N. McKean, "Liquidity and a National Balance Sheet," Journal of Political Economy, LVII [1949], 506-22. Reprinted in Readings in Monetary Theory [New York, 1951], pp. 63-88.)

Chapter 10

90. Paul A. Samuelson, "The Effect of Interest Rate Increases on the Banking System," American Economic Review, XXXV (March, 1945), 16-27.

Chapter 11

91. Henry Simons, "On Debt Policy," Journal of Political Economy, LII (December, 1944). Reprinted in Economic Policy for a Free Society (Chicago, 1948), p. 226.

Chapter 12

92. James M. Buchanan, "The Pure Theory of Government Finance: A Suggested Approach," Journal of Political Economy, LVII (December, 1949), 496-505.

93. "But the distribution of the real cost of a war in time—between past, present, and future—cannot be affected by the extent to which it is financed by taxation or borrowing. Borrowing affects rather its distribution among persons." (Henry C. Murphy, The National Debt in War and Transition [New York, 1950], p. 61.)

94. This is not to suggest that each individual will be purely selfish in making his decision. An individual may or may not include certain social values in his own value scale which is relevant for his participating in collective decisions. For example, an individual may consider it beneficial to him individually to provide aid for the poor people of Tongatabu even though he realizes that this expenditure of public funds can in no way affect his own individual position in society.

95. Knut Wicksell, Finanztheoretische Untersuchungen (Jena, 1896), Chap. 6.

96. It is evident that much of this discussion has direct relevance for the problem of capital budgeting which has been discussed during recent years. It has been proposed, by Beardsley Ruml and others, that public expenditures for current expenses be budgeted separately from public expenditures for capital outlay. Current tax revenues should, in this argument, be sufficient to cover only current expenses including debt service and amortization. The expenditures for capital outlay are said to be appropriately covered from funds raised by the sale of government securities, that is, by government borrowing. The liability which is represented by the new issue of debt is matched by the asset embodied in the capital investment.

This variation on the balanced-budget rule in the classical model of full employment is based largely on an analogy drawn from business financing. The analysis of the individual behavior in the collective choice process indicates that there is some merit in the capital budgeting approach. It shows that debt financing for long-term projects is desirable even in the full employment model. The individual's tendency to discount too heavily future benefits would cause long-term projects to be undervalued if tax financing alone were to be relied upon. Capital budgeting as it is usually presented, however, does not include the specific earmarking of tax revenues for debt service and amortization which the analysis has indicated to be essential for reasonable rationality in the choosing process. It is necessary that the choosing individuals, whether voters, representatives, or administrators, be faced with both a future stream of benefits and a future stream of costs when decisions are to be made. And the vague knowledge that all debts must be serviced in the future is not sufficient protection here. A more fruitful approach would be that of separating from the regular budget entirely those projects to be debt financed along with the revenue sources assigned to them. In this manner, even though the projects are not self-liquidating in the ordinary or commercial sense, the earmarked revenues serve to make them self-liquidating insofar as the social choice process is affected.

97. For a further elaboration of the distinction between "pure" debt and "monetized" debt, see the Appendix.

98. Henry Simons, "On Debt Policy," Journal of Political Economy, LII (December, 1944). Reprinted in Economic Policy for a Free Society (Chicago, 1948), p. 222.

Chapter 13

99. For a current attempt to construct an economic theory of debt management see Earl Rolph, "Principles of Debt Management," American Economic Review, XLVII (June, 1957), 302-20. For a general discussion of debt management in the immediate postwar period, see Charles C. Abbott, Management of the Federal Debt (New York, 1946).

100. As indicated in Chapter 10, a large part of nominal debt issued during World War II was not "pure" debt at all, but instead was disguised currency creation. Insofar as this is true, the burden of debt per se is relatively small and the question of retirement becomes relatively unimportant.

101. Evsey D. Domar, "The 'Burden of the Debt' and the National Income," American Economic Review, XXXIV (December, 1944). Reprinted in Readings in Fiscal Policy (Homewood, Ill., 1955), pp. 479-501, especially p. 500.

102. Cf. G. Warren Nutter, "On Measuring Economic Growth," Journal of Political Economy, LXV (February, 1957), 51-63.

Chapter 14

Chapter App

103. All of the national debt of the United States is measured in this way except for Savings Bonds which are carried in the debt totals at current redemption values. For these securities the additional debt which accrues through time shows up also as expenditure, presumably in the interest item of the budget.

104. This is not the place to introduce an extended discussion of local government financing. But the above example does illustrate quite clearly how a local unit of government may (if its charter allows) finance expenditures without imposing any cost upon its own taxpayers, either present or future. Let us suppose that a local unit decides to construct a school building at a cost of $1 million. To finance this building, it issues bonds totaling $4 million at 3 per cent. It then devotes $1 million of the proceeds to the actual construction of the school. With the remaining $3 million it enters the private securities market and purchases assets which provide a pure yield of 4 per cent. These assets provide a sufficient income to enable the service charges on the local government debt to be fully offset. Local taxpayers are freed from any burden of payment when the school building is constructed, and they are not obligated to pay taxes to service the local debt. The cost of the project is shifted to federal government taxpayers in general and local citizens pay only in their capacities as federal taxpayers. In such a situation, the local government is merely taking advantage of an opportunity to make a profit through arbitrage. The differential between the rate of yield on municipals and on private bonds is, of course, exaggerated in the example. But so long as any differential at all exists, the operation outlined here is possible. Local units of government are normally prevented by charter from investing in private securities. They may be allowed, however, to invest in federal government securities. And here, too, if a differential in rate should be present, local taxpayers can be relieved of a large portion of their normal public expenditure burden through a similar operation. The implication of this appears to be that, if federal income tax rates should remain high, the stiffening of debt limit laws restricting local government borrowing or the removal of all investing opportunities may prove desirable.

105. The calculation is direct for marketable securities. The government could repurchase these below par. For nonmarketable issues, this sort of repurchase alternative is not open, but the government may, conceptually, convert this nonmarketable debt to marketable debt by selling marketable securities at current prices sufficient to offset fully the service and the amortization of the nonmarketable issues. To estimate the appropriate capital value of the marketable securities which would have to be sold in such an operation, some present market value must be applied to the nonmarketable securities. In the calculation here I have used the same market-to-maturity value ratio as that found to apply for the whole of the marketable debt. I have applied this ratio to all nonmarketable securities, including securities held by governmental trust funds, except Savings Bonds which are already carried in debt totals at current redemption values. All data employed in making this calculation were taken from Treasury Bulletin for September, 1957.

106. It is important to emphasize the conceptual nature of this repurchase operation. If the government actually attempts to repurchase its own securities, prices will be driven up and current market values will provide no measure of the actual money cost of retiring all debt. It does not seem appropriate, however, to include this adjustment in the calculations made. The aim is that of deriving some measure which will be useful in indicating the weight of carrying the debt, a measure which is in capital-value dimensions. Whether or not an actual repurchase operation would exert significant effects on bond prices will depend on the source of the funds and also upon the degree of substitution between government bonds and private bonds. See Footnote 6 for further discussion.

107. This is based on the average yield for July, 1957, on Moody's AAA Corporation Bonds.

108. These secondary effects may be easily exaggerated. The conceptual refunding operation proposed would change interest rates only insofar as the tax imposed to finance the pure debt retirement reduces consumption spending more than the retirement itself increases consumption spending. Since some effect in this direction seems probable, the whole operation will tend to reduce interest rates and to increase the capitalized value of real debt. This complication may be avoided by assuming that the capitalization rate used is some average of the initial pure rate of yield and that rate which would prevail after the conceptual refunding. The difference between these two rates would depend on the size of the debt and on the elasticity of demand for private investment funds.

109. This differential may, in part, represent other features. For example, if "patriotism" should cause individuals to accept a lower rate on public than on private loans, the capital value of this feature would be included in the $72 billion. This, and other "nonmoneyness" features, might create some difficulties if the conceptual refunding discussed were to be actually attempted since these features could not be replaced by currency. Their introduction does not, however, change the appropriateness of measuring real or pure debt by the $185 billion. In the text, we assume that the differential is represented by "moneyness" alone.

110. Henry Simons, "On Debt Policy," Journal of Political Economy, LII (December, 1944), 356-61. Reprinted in Economic Policy for a Free Society (Chicago, 1948), pp. 222-30.

111. Consols themselves, insofar as they possess some "moneyness," do not represent pure debt in the full sense of the term as here discussed. But since consols do approach pure debt instruments closely, we may, for present purposes, largely disregard the difference.

End of Notes

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