The Government Debt is NOT a Burden on Future Taxpayers (slightly wonkish)

I don’t understand why trained economists find it so hard to understand the nature of government debt.

I mean trained economists like this one:

Why will the debt need to be serviced by future taxpayers?

Suppose, for simplicity, that the deficit is zero, that is, the UK government has say 1.5trn of outstanding bonds and isn’t issuing any more.

When each bond matures, the government has to find the cash to pay the bondholder, plus interest. But it can get the cash by selling another bond to somebody else. In other words, it can keep rolling over its ‘debt’ by continually transferring bonds from one bondholder to another.

‘Yes, but every time it does this, it will need to sell more bonds, to cover the principal and the interest on the last batch.’ No. This is the treadmill of debt fallacy. Interest is income for the bondholder. If she spends it, it’s income for somebody else. When that person spends it, it is income for somebody else again. Every time it gets spent, the government taxes the income (this is what Neil Wilson calls the ‘cashback bonus’ on the government’s super-platinum credit card). By ‘servicing its debt’, the government generates the income that it taxes to ‘service its debt’. No new net cost is imposed on anybody.

All the money spent on interest payments to bondholders ends up back with the government, which can use it to pay the next lot of interest. There is nowhere else for it to go, unless it gets saved, in which case the government isn’t running a zero deficit. But in the latter case there is still no net cost being imposed on anybody; the government is just increasing its issuance of bonds to supply the desire of the private sector to build up its savings. If the private sector starts spending more and running down its savings, this new spending will end up as tax revenue for the government and finance the retirement of bonds.

Some people take an even cruder view, imagining that the government will have to pay back all its ‘debt’ one day, and for this it will have to tax future generations. That is like supposing that Barclays will one day need to have all its deposits in current accounts rather than in savings accounts. It’s totally unmotivated and absurd. As one person draws out her savings deposit, another will be building up his savings deposit. The ratio might change in either direction at various times, but it’s simply silly to think that there must be some day when all the deposits are in current accounts rather than savings accounts. Now just replace ‘current accounts’ with ‘cash’ and ‘savings accounts’ with ‘government bonds’.

Moreover, the government could, in principle, pay out all its bondholders without taxing future generations. It would just instruct the central bank to ‘print the cash’ and buy all the bonds. ‘Ah, but this would cause inflation – hidden taxation!’ Again: why? People hold bonds when they want to save. The central bank can buy back the bonds by printing cash if the price is high enough to compel the bondholder to give up the guaranteed return. But this doesn’t force the bondholder to spend. She was holding the bond because she wanted to save and earn interest. Now she gets a lump sum of cash instead. But she still wants to save – her psychology hasn’t been altered by the supernatural power of the central bank.

She won’t spend any more than she was going to spend anyway. And so there won’t be any inflation: no ‘too much money chasing too few goods’. Money doesn’t chase goods unless people spend it. Remember that if the bondholders had wanted to spend when they still had the government bond, they could have done so. All they needed to do was swap the bond with a bank in exchange for a bank deposit. So printing cash to pay out bondholders doesn’t give them any liquidity options they didn’t already have. Nobody gains any actual spending power; there just isn’t any inflation channel here. Observe the effects of QE.

Flooding the banking system with reserves would, other things being equal, drive the interest rate down. Banks might speed up their lending as a result, and that could be inflationary. But bank lending is constrained by the number of creditworthy borrowers, not just by the interest rate. Moreover, in this case it isn’t the swapping of cash for bonds per se that drives inflation; it’s the interest-rate adjustment. In principle, the central bank could offset this by increasing the rate of interest it pays on reserves or draining off excess reserves using one of many instruments it has available for this purpose:

Screen Shot 2015-08-03 at 12.43.16

Finally, even if there were more spending as a result of ‘printing money’ to retire bonds, this wouldn’t have to mean inflation. Again, more spending = more income. More income = higher tax revenue (but, again, not an increased tax burden, since incomes would also be proportionately higher with higher spending). This higher tax revenue can absorb the extra spending, leaving prices where they were.

I’m not saying that a large, sustained government deficit couldn’t drive inflation. Of course it could. But it’s ridiculous to suppose that all government debt imposes a cost on future generations. The government doesn’t need to raise tax rates to service its debt; it can just keep rolling over its debt and servicing it out of current tax revenue. It doesn’t need to retire its bonds, ever. Even if it did, it could do so by printing cash. This wouldn’t need to add to net spending at all, so no inflation channel. Even if it did create inflationary pressures, higher taxes to regulate aggregate demand and control inflation would be paid out of higher incomes, the flip side of the same increased spending that was driving the inflation.

The government ‘debt’ just isn’t a burden on future taxpayers. The government spends money into the economy, then taxes it back out when it gets spent. Whatever doesn’t get spent doesn’t get taxed. That portion makes up the government’s accumulated ‘debt’. It’s our savings, not somebody’s future cost.

I don’t know why this is so hard to understand. I guess it’s political. People like whinging about the government spending ‘the taxpayer’s money’, and they don’t want their whinging to be undermined by the fact that a good portion of the government’s spending isn’t funded by the taxpayer and never will be. Sorry, but you can’t whinge the facts away.


11 thoughts on “The Government Debt is NOT a Burden on Future Taxpayers (slightly wonkish)

  1. Bob

    The thing to remember is the wealthier and thrifty members of the public contribute more to the ‘debt.’ The only way to be certain that there is no deficit is to ban financial savings – which is simply not going to happen.
    A good way to think about government ‘borrowing’ is it is like bank ‘borrowing’ when you get paid and it is deposited in your bank account. When is the debt “played off.” When people decide to spend their savings. This generates tax that “closes the deficit.” In a currency issuing government it is no problem.
    The worst that could happen is the economy goes so well that we start to hit capacity and have to raise taxes to control inflation. So government deficits may lead to higher taxes in the future (due to a booming economy) and THAT IS A GOOD THING!

    1. NeilW

      If people believe that they can’t spend more than they earn, then they should also understand that means they will not be permitted to spend less than they earn – even to the point of having £50 cash in their pocket.

  2. gastro george

    “Some people take an even cruder view, imagining that the government will have to pay back all its ‘debt’ one day”

    I remember Hugh Pym, then economics editor of the BBC, saying this when Osborne first announced the idea of a surplus. Pym is an idiot.

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  4. sasson1

    Wow! Thanks very much for finally showing people, in (relatively) easy terms what a fallacy ‘austerity’ really is; says a lot about taxing people too. Honestly, I’ve watched all sorts of financial programmes over the years but none have ever explained it so easily.

    I got the first bit – after a few readings – about the nature of bonds, but will have to save the rest until my brain wakes up later!

    I’ll reblog this – if that’s ok with you – when I’ve understood the whole thing, and I will of course post the acknowledgement here. I don’t have followers as only just restarted blogging again, but I know my daughter would pass this info on, as it needs to be.

    Shame I couldn’t sell bonds in myself, and keep rolling it over, rather than being at the mercy of the government!

    Thanks again (I may have some questions for you about other aspects of government debt.)

  5. jake

    Interest on Debt issuance is a wealth distribution issue as it subsidy for the finance sector.
    Much better to have BoE “finance” deficits at 0% interest.

    1. axdouglas Post author

      Not under current arrangements. Gilt interest pays a huge number of pensions; it isn’t just a subsidy to the finance sector.

      And it’s against the Maastricht Treaty for the BoE to finance deficits directly.

      I like the idea of phasing out Gilts in principle, since it makes policy rate setting that much easier. But there are a lot of institutional obstacles you’d have to work around to implement it in the UK – pulling out of the EU for one! It’s far from being a priority in my view.

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