Krugman — So Right and So Wrong

Paul Krugman offers a nice thought experiment to illustrate why government debt, in and of itself, does not make the country as a whole any poorer:

Suppose that … President Santorum passes a constitutional amendment requiring that from now on, each American whose name begins with the letters A through K will receive $5,000 a year from the federal government, with the money to be raised through extra taxes. Does this make America as a whole poorer?

The obvious answer is not, at least not in any direct sense. We’re just making a transfer from one group (the L through Zs) to another; total income isn’t changed. Now, you could argue that there are indirect costs because raising taxes distorts incentives. But that’s a very different story.

OK, you can see what’s coming: a debt inherited from the past is, in effect, simply a rule requiring that one group of people — the people who didn’t inherit bonds from their parents — make a transfer to another group, the people who did. It has distributional effects, but it does not in any direct sense make the country poorer.

Two comments:

1) Krugman has this right, but he’s also failed to anticipate (and therefore failed to head off) the usual objection: What if some of those bonds are bought not by Americans but by Chinese? In that case, aren’t we requiring that one group of American people make a transfer to another group of non-American people? And therefore haven’t we impoverished future Americans as a whole?

The answer is no, we haven’t, because for every Chinese person who buys a $1 bond, there’s an American who’s paying $1 less in taxes, and that $1 (plus accumulated interest) is part of some future American‘s inheritance.

(Unless, of course, that American’s parents choose to consume those tax savings, but then future Americans are being impoverished not by government debt, but by their parents’ extravagance — though to be fair, it is true that government debt can facilitate that extravagance.)

Having written on this topic many times, I am sure Krugman will come to regret not mentioning this.

2) Given that Krugman (like all economists) understands this point, why does he choose to ignore it whenever it gets in the way of bashing Republicans? All of us — including Krugman — agree that to a good first approximation, the debt does not impoverish anyone. (To a second approximation, the size of the debt affects the timing of taxation and hence the timing of the distortions due to taxation, which can matter.) All of us — including Krugman — agree that spending can be costly. It follows that fiscal responsibility consists primarily of controlling spending, not raising taxes to reduce the debt. (Where have I heard this before?) Yet whenever a Republican politician proposes to cut spending without raising taxes, Krugman is first in line with accusations of misplaced priorities and fiscal irresponsibility. What’s up with that?

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53 Responses to “Krugman — So Right and So Wrong”


  1. 1 1 Bearce

    Yet whenever a Republican politician proposes to cut spending without raising taxes, Krugman is first in line with accusations of misplaced priorities and fiscal irresponsibility. What’s up with that?

    Having read Krugman’s and your blog everyday (well, mostly everday), it’s not so much that Krugman bashes Republicans when they advocate cutting spending and not raising taxes; it’s that they advocate cutting spending and cutting taxes. This has something that has always irked me about the Republican party, claiming to be fiscally responsible and trying to balance the budget but failing to see that there’s only a semantic difference between government spending and cutting taxes.

    Also, I have a question about the Chinese-American bond scenario. Chinese bond holders buy bonds because of the interest it can earn, so doesn’t the interest accrued by the Americans who save that dollar eventually transfer over to the Chinese via taxes from the US government when it comes time to pay them back once the bond approaches maturity?

  2. 2 2 Steve Landsburg

    Bearce:

    1) there’s only a semantic difference between government spending and cutting taxes.

    Of course the whole point is that there’s not only a semantic difference between govt spending and cutting taxes, and of course Krugman’s most recent post is an acknowledgement of exactly this (non-controversial) point.

    2) doesn’t the interest accrued by the Americans who save that dollar eventually transfer over to the Chinese via taxes from the US government when it comes time to pay them back once the bond approaches maturity?

    Yes, which is why borrowing from the Chinese makes Americans no richer, just as it makes Americans no poorer.

  3. 3 3 Kevin L

    What of the objection that spending is not homogeneous, and therefore government spending may be (and according to some, quite probably is) less optimal than private spending because of the lack of profit and loss signals?

  4. 4 4 Seth

    What am I missing? I thought the incentive distortions and distributional effects were precisely how such transfers ‘make the country poorer’.

    To me, it sounds like the argument is ‘if we ignore how these things make the country poorer, then they don’t make the country poorer.’

    Also, professional cyclists are obese based on how much they eat, if we ignore all the bike racing they do.

  5. 5 5 soon retired

    Kevin,

    As you say, it is not taxes, but spending that is the issue. If the government spent on exactly what we would spend, there would be no distortions – but they don’t. Real public goods are one issue (why should I pay when others will?) And govt over/under spending is a second issue.

    Seth,

    Right. There are no real transfers in the sense we use the term in our models. The distortions are probably second order, however. (That does not make then unimportant.)

    Best

  6. 6 6 Bearce

    Of course the whole point is that there’s not only a semantic difference between govt spending and cutting taxes, and of course Krugman’s most recent post is an acknowledgement of exactly this (non-controversial) point.

    So what is the difference then, I don’t see it? If a government has an annual budget and it decides to borrow an extra $500 million to spend on military artillary, it accrues $500 million worth of debt. Or if you cut taxes so that $500 million worth of revenue isn’t collected when that $500 million needs to be spent on, say, entitlements, military, federal employees, etc., that’s also debt. (You could argue lower tax rates might generate greater economic activity and then a greater amount of reciepts to an extent, but that’s a different point.)

    Yes, which is why borrowing from the Chinese makes Americans no richer, just as it makes Americans no poorer.

    That still doesn’t make sense to me. Given Krugman’s statement…

    Suppose that after the 2016 election President Santorum tries to buy senior support by giving every American over 65 a gift of newly printed government bonds; then the over-65 generation will be made richer, and everyone under 65 will be made poorer (duh).

    No wealth has left the economy. But if you substitute the 65 year old American with Chinese citizen, then that’s wealth leaving the country. All the interest acquired from saving has to be transfered over to the bond holder who earns interest on his bond.

  7. 7 7 nivedita

    @Bearce, your two situations are different because government spending is higher by $500mm in the first. To the extent that $500mm is being spent on stuff that people didn’t really want to spend on, it has real costs. But whether the $500mm is financed by raising taxes by $500mm or by raising debt by $500mm does not matter to a first approximation.

    As to your second point, we are comparing two choices for financing spending — either Americans put up a dollar now, or they borrow a dollar from the Chinese and give it back with interest in the future. Once the money is paid back to Chinese (with interest), Americans are no better or worse off compared to just putting up the dollar themselves.

  8. 8 8 Lawrence Kesteloot

    There’s a huge difference between raising taxes and incurring debt. I live in California, where there are propositions. Propositions of the form “Pay for new project XYZ by raising taxes” tend to fail, and those of the form “Pay for new project XYZ by selling bonds” tend to pass. For this psychological reason I want to force people to pay taxes immediately for all new projects. This is probably the most effective way to reduce government spending. (It’s equivalent to forcing people to pay with cash instead of an infinite credit card. They’ll spend less.)

  9. 9 9 Bearce

    your two situations are different because government spending is higher by $500mm in the first. To the extent that $500mm is being spent on stuff that people didn’t really want to spend on, it has real costs. But whether the $500mm is financed by raising taxes by $500mm or by raising debt by $500mm does not matter to a first approximation.

    You missed my point. It doesn’t matter whether that $500 million came from increased spending or decreased revenue, debt is debt. How you distinguish the two with the phrase ‘real cost’ adds nothing. You could say some debt is preferable to others, but that’s not the point being addressed; the point is if you’re going promise to balance the budget but proceed to cut spending and cut taxes, you’re got mixed priorities. You might as well put out a fire by spraying it with water and gasoline.

    As to your second point, we are comparing two choices for financing spending — either Americans put up a dollar now, or they borrow a dollar from the Chinese and give it back with interest in the future. Once the money is paid back to Chinese (with interest), Americans are no better or worse off compared to just putting up the dollar themselves.

    Okay, I now think I understand if the interest rates are the same in this case. But what if, say, interest accrued via savings is less than the interest rate on the bond.

    For example, suppose I own and save $1 with an interest rate of 10% but the US government wants to buy a candy bar from a US manufacturer for $1. It does this by borrowing from the Chinse by offering a bond with an interest rate of 30%. There is now $2.00 in the US economy, both dollars are saved and earn $0.20 interest for a total of $2.20. However, now the Chinese bondholder must be paid back principle plus $0.30. Thus $2.20-$1.30 = $0.90. Ten cents has just left the US and has gone to China and the US is now $0.10 poorer from borrowing as opposed to increasing taxes.

  10. 10 10 Bearce

    Actually, now that I think about it, if interest rates are the same then shouldn’t borrowing make both China and the US richer?

    Going back to my example, suppose interest rates are 100% for both the US saver and the Chinese bondholder. The government borrows a dollar, buys the candy bar, and both the US manufacturer and I have a dollar saved which accures to a total of $4 dollars. $2 of those dollars must then be paid to the bondholder, and then both the US and China are 1$ richer than before.

  11. 11 11 Steve Landsburg

    Bearce:

    If a government has an annual budget and it decides to borrow an extra $500 million to spend on military artillary, it accrues $500 million worth of debt. Or if you cut taxes so that $500 million worth of revenue isn’t collected when that $500 million needs to be spent on, say, entitlements, military, federal employees, etc., that’s also debt.

    In the first instance, $500 million worth of resources are devoted to producing military artillery and are therefore unavailable for other purposes. In the second instance, no resources are consumed.

    For example, suppose I own and save $1 with an interest rate of 10% but the US government wants to buy a candy bar from a US manufacturer for $1. It does this by borrowing from the Chinse by offering a bond with an interest rate of 30%. There is now $2.00 in the US economy, both dollars are saved and earn $0.20 interest for a total of $2.20. However, now the Chinese bondholder must be paid back principle plus $0.30. Thus $2.20-$1.30 = $0.90. Ten cents has just left the US and has gone to China and the US is now $0.10 poorer from borrowing as opposed to increasing taxes.

    Your example depends on the Chinese receiving 30% on US govt bonds while American citizens can earn only 10%. But when American citizens want to save, they always have the option of buying the same sort of bonds the Chinese do. So you should rework the example with both interest rates the same, and you’ll find that it doesn’t matter whether the govt finances the candy bar through taxation or through borrowing.

  12. 12 12 Roger

    You seem to be saying that borrowing money does not impoverish anyone until someone spends the money. But borrowed money is always spent. So I do not get the point of this posting.

  13. 13 13 cmprostreet

    Bearce,

    “Actually, now that I think about it, if interest rates are the same then shouldn’t borrowing make both China and the US richer?”

    In this second example it is the assumed 100% interest rate, not the borrowing, that makes the countries seem richer in year two.

    With Borrowing:
    You have $1, which at 100% interest grows to $2.
    China has $1, the US borrows it and gives it to the manufacturer. It grows to $2, both of which are returned to China. Total US starts with $1, ends with $2. China starts with $1, ends with $2.
    The world is one candy bar poorer.

    With Taxation:
    You have $1, which the government taxes and gives to the manufacturer. It grows to $2. Total US starts with $1, ends with $2.
    China does its own thing, but if we still assume 100% interest rates across the board, the $1 it started with will now also be $2.
    The world is one candy bar poorer.

    This example is too limited to show it’s the spending that matters, but it does show nicely that the financing doesn’t.* If you think the spending is irrelevant, you end up with the bizarre conclusion that nothing is relevant.

    If I choose to buy a metric ton of peaches for their aesthetic value (at the same price as one month’s rent), it doesn’t matter whether I pay cash or put them on my card- it was the purchase that impoverished my family. If my debt comes from paying my rent with my card, I still have the cash that would have gone toward the rent (if I don’t buy the peaches). If I paid cash for the rent and then used the card for the peaches, I have the same debt but also no cash. The difference isn’t in how I paid for the rent or the peaches, it’s that I bought a shitload of peaches in one case and not in the other.

    *Save for timing and other effects as briefly mentioned by others.

  14. 14 14 Bearce

    Okay, I get it now. However…

    In the second instance, no resources are consumed.

    No resources are consumed from entitlements, military, federal employees, etc.? How do you explain medicaid drug payments then, for example?

  15. 15 15 Henri Hein

    I completely agree with Lawrence (#8). Debt financing allows government to grow beyond what current tax payers are willing to support. It is true for California and it is true for the Federal government.

    I also find Krugmans reasoning morally specious. Whether “the country” is any better or worse off for all these transfers is not that interesting. This conflating of a semi-arbitrary political unit with the people in it is disturbing.

  16. 16 16 cmprostreet

    “No resources are consumed from entitlements, military, federal employees, etc.? How do you explain medicaid drug payments then, for example?”

    In the first example, the $500M was specified as extra spending, meaning it’s on top of the $500M in the second example that needs to be spent anyway. In total, $1B of resources are used in the first case compared to $500M in the second case. The assertion that no resources are consumed form the second scenario is specifically referring to the fact that no /additional/ resources are being consumed.

  17. 17 17 Bearce

    The assertion that no resources are consumed form the second scenario is specifically referring to the fact that no /additional/ resources are being consumed.

    Yes, but the purpose was to look at ‘debt’ and not so much resources. In the first case with additional military artillery, that $500 million had to be borrowed from somewhere (taxpayer, China, whatever) and the federal government owes someone $500 million plus interest. The second case the same amount is consumed but $500 in revenue was lost, so the government owes money (I.O.Us) to citizens, military, employees, etc. Either way, you have debt that must be paid off. Someonebody owe’s someone for something. Like I said, if you’re running on a platform that claims we’re going to balance the budget budget but don’t take into account tax cuts, you’re being hypocritical.

  18. 18 18 Draco

    The US Government doesn’t need to borrow money from anyone (or raise taxes on anyone)in order to spend. See Mosler et al.

    http://moslereconomics.com/category/7dif/

    It was unnecessary, and in fact counterproductive, for Romney-Ryan to pledge to make tax cuts deficit neutral. They should have pledged to cut taxes and thereby increase the deficit large enough to support full employment.

  19. 19 19 Skeptical Enlightenment

    But taking $5k from one half isn’t all that happens, is it. There is the cost of operating the transfer system, which means not all of the amount gets transferred. There is also the ongoing interest obligation that accompanies deficit spending, which can fluctuate widely. Just look at how concerned the FED is regarding deflation. Just a point something fluctuation in the wrong direction and the Federal budget is totally eaten with debt service payments.

  20. 20 20 nivedita

    Bearce, the whole point of this post is to try to explain that the budget deficit doesn’t matter so much, what matters is the amount of government spending — that is, potential resource misallocation by the government is the important thing to focus on.

    Of course if you only look at the level of government debt and ignore everything else, whether debt is created by increased spending or reduced revenues, its still debt. But from society’s viewpoint, what matters in the first instance is not so much who owes who how much, but how much overall resources are being consumed to produce how much overall benefit.

  21. 21 21 Steve Landsburg

    Bearce:

    Yes, but the purpose was to look at ‘debt’ and not so much resources.

    No, the point is that what matters is resources, not debt. (Nivedita said this nicely already, but I’ll repeat it anyway.)

  22. 22 22 Paul T

    SL: “What if some of those bonds are bought not by Americans but by Chinese? In that case, aren’t we requiring that one group of American people make a transfer to another group of non-Americans? And therefore haven’t we impoverished future Americans as a whole?

    The answer is no, we haven’t, because for every Chinese person who buys a $1 bond, there’s an American who’s paying $1 less in taxes, and that $1 (plus accumulated interest) is part of some future American‘s inheritance.”

    Another point: borrowing from China, transfers the payback risk to foreigners. As we have seen, Greenback Bernanke, Chief Counterfeiter, will run the printing presses to their mechanical limits, to finance the federal black hole. Hence, when the cliff is unavoidable, the chinese will be the ones stuck with kleenex, in $trillion notes. Or, perhaps Uncle Sam will simply default.

    Either way, Americans get years of the output of China’s factories, for free.

    Call me paranoid, but I defy you to name an empire in history that didn’t go bankrupt, with endless wars and domestic programs, running on fiat money. And I have distinguished company:
    http://tinyurl.com/WSJ-US-finances

  23. 23 23 Darin Johnson

    Professor Landsburg’s point is correct, of course. However, it always frustrates me that the distortion of incentives seems to get short shrift in these discussions.

    If all government spending meant was changing who spends, we could probably all stop talking about it. But it doesn’t mean that. When the government extracts taxes and spends resources, it distorts the incentives to work and invest. We do less of what we’d do otherwise (productive, wealth-generating things), and we do more of what we would not do otherwise (stupid, wealth-destroying things).

    I’m sure Krugman would argue that these distortions are merely corrections of market failure, but I have a hard time swallowing that.

  24. 24 24 Ken B

    @Roger: The point is we need to cut spending. Folderal, foo-foo, and hysteria over debt misses the issue. We don’t need to raise taxes to cover foolish spending in order to avert the horror of debt. We need to cut the spending.

  25. 25 25 Dilip

    Very ominous, how you correctly guessed what Krugman did not anticipate!
    http://krugman.blogs.nytimes.com/2012/10/13/foreigners-and-the-burden-of-debt/

  26. 26 26 Dilip
  27. 27 27 Matthew

    I believe there are consequences of deficits and debt though. For example, central banks around the world intentially peg their exchange rates low relative to the dollar to help their exports. In doing so, they accumulate large reserves of USD (held in the form of treasuries). At some point, they’ll abandon the peg, hurting the dollar’s value significantly. Since the US depends on financing its deficit abroad, it’ll have trouble coming up with the cash to keep spending. When this happens, it’ll turn to the Fed to print the money…and a large inflation will be off to the races.

  28. 28 28 Will A

    @ Matthew #27:

    The current interest rates for 10 year bonds is 1.66%. Given your statement are you saying that the current deficits and debts of the U.S. are at a good level since our borrowing costs are so low?

    Are you saying that the U.S. deficits and debts are bad but that state of our deficits and debts are unknown to those who buy bonds?

    Or are you saying that borrow cost could be better than 1.66% if the U.S. deficit and debt situation was in better shape?

  29. 29 29 nobody.really

    All of us — including Krugman — agree that spending can be costly. It follows that fiscal responsibility consists primarily of controlling spending, not raising taxes to reduce the debt.

    Here we go again.

    Once again Landsburg makes a well-supported argument about the misplaced emphasis on debt. Once again Landsburg makes a well-supported argument that we should focus on how resources are allocated, and whether there are better ways to allocate resources than we are currently employing. And once again Landsburg proceeds to imbed within the argument an unsupported assumption that public spending is too high.

    My point is not that public spending is or is not too high; my point is that this issue is distinct from the issue about the importance of focusing on resource allocation rather than debt. If Landsburg insists on asserting that public spending is too high, he should support the assertion. Otherwise, it appears that he is relying on his supported arguments to bolster his unsupported argument – that is, it reads like unvarnished propaganda. What’s up with that?

  30. 30 30 nobody.really

    #8 — Propositions of the form “Pay for new project XYZ by raising taxes” tend to fail, and those of the form “Pay for new project XYZ by selling bonds” tend to pass. For this psychological reason I want to force people to pay taxes immediately for all new projects. This is probably the most effective way to reduce government spending. (It’s equivalent to forcing people to pay with cash instead of an infinite credit card. They’ll spend less.)

    #15 — I completely agree with Lawrence (#8). Debt financing allows government to grow beyond what current tax payers are willing to support.

    My previous remarks notwithstanding, I’m receptive to this view. While the public’s focus on debt may be misguided, it may nonetheless be useful. Homo Economus may not attach importance to debt, but Homo Sapiens seem to – and this fact may help discipline spending decisions, including public spending decisions.

    I’ll emphasize Lawrence’s point that this dynamic is not unique to public expenditures: Behavior economics shows that people make different resource allocations based on whether they have to part with cash. (I imagine the same dynamic also influences a barter economy, but I haven’t seen research on it.) The field of accounting was created to permit people to match a firm’s income with corresponding expenditures (depreciating capital assets over useful lives, etc.). A policy that causes politicians to deliver a policy’s benefits and associated costs contemporaneously provides a similar kind of public accounting.

    Should there be exceptions to the budget-neutral policy? I suspect so.

    There may be exceptional circumstances – recessions, if you’re a Keynesian – when we want to finance governmental expenses with debt. But arguably these should be the exception, not the rule. In the height of the Reagan and W. Administrations the economy was booming, yet the US continued to run deficits. (Arguably the same was true under the Clinton Administration, if you calculate deficits appropriately.) Each of these politicians was able to claim credit for superheating the economy without having to face the electorate regarding the costs of their policies. Arguably this practice undermines the (already weak) checks and balances of the electoral system.

    And some people subscribe to the theory that the government should run a deficit that is a fixed percentage of GDP as a kind of regular stimulus. Perhaps. But the premise should be that we have some formula that operates as a budget constraint, requiring politicians to seek revenues from the electorate to match expenditures on behalf of the electorate.

  31. 31 31 Matthew

    Will A,

    I’m saying that what the Fed has done (dramatically increased the size and the duration of their balance sheet with Operation Twist and other QE) when paired with deficits is compromising the Fed’s ability to protect the value of the currency and to stop inflation when it happens.

    Matt

  32. 32 32 Steve Landsburg

    nobody.really:

    Once again Landsburg makes a well-supported argument about the misplaced emphasis on debt. Once again Landsburg makes a well-supported argument that we should focus on how resources are allocated, and whether there are better ways to allocate resources than we are currently employing. And once again Landsburg proceeds to imbed within the argument an unsupported assumption that public spending is too high.

    I did say that fiscal responsibility consists of *controlling* spending, not *cutting* spending.

  33. 33 33 nobody.really

    Hmf.

    Fair enough.

  34. 34 34 Ken Arromdee

    Case 1: The government takes money and doles it out such that each person from A-K gets an extra $5000. The people with names in that range then stick the $5000 under the mattress (we shall ignore interest and inflation). The nation is, for the reasons originally stated, not poorer off.

    Case 2: The government takes money and doles it out such that each person from A-K gets an extra $5000. The people with names in that range then use the $5000 to buy goods (evenly from the whole population) which they then consume, permanently destroying them. The end result is that half the country has $2500 extra but $2500 less in goods than in the first case, and the other half of the country has $2500 less and $2500 less in goods than in the first case. The country is poorer off.

  35. 35 35 Andrew

    Question:

    I must be reading this wrong. Krugman and Steve are making the argument that debt-financed government spending via transfer payments doesn’t make “us” poorer. The largest portions of government budgets are transfer payments both present and in the future.

    How do you get to this equaling that spending must be reduced(controlled)?

  36. 36 36 djp

    Seth (4) had it right at the start.

    Surely no one would argue that the “very different story” of distributional effects are irrelevant if we change the scale a bit — and nothing in Krugman’s “argument” has anything to do with the scale.

    So, let’s restate it as: Everyone A-K receives $500B…

    Right, that won’t have any effect at all on the economy in general, it’s just some shuffling around of numbers.

    Sad to see that such juvenile rhetorical devices get employed so often in debate.

    Also, as for any surprise at Krugman being a hypocrite, we only need to remind ourselves of his recent incorrect interpretation of the Broken Window fallacy (iPhone), coupled with his columns that 9/11 would be good for the economy because of all of the Broken Windows…

  37. 37 37 iceman

    Andrew #35 — what he’s saying is that (to a first approximation) the only thing that can make us poorer is wasteful spending, not how it’s financed. However others are suggesting here that transfer payments on a massive scale can cause the second-order effects to become significant.

    Ken A #34 — I think in saying we’re poorer you’re not valuing the utility derived from the consumption. Since the reason we work *and invest* is ultimately so we (or our heirs) can consume, I don’t think we want a model that says consumption inherently has negative value, versus good old time preference. I think a second-order effect being mentioned here is that if the govt consumes in ways we wouldn’t choose, there can be a net utility loss.

    So is it fair to say that a balanced budget at high spending levels is not necessarily more responsible than a smaller budget with a deficit? It often seems “fiscal responsibility” has been re-defined in political discourse. I might suggest a given deficit at higher levels of spending of spending and taxes seems less responsible, since lower levels leave more taxing capacity (vs. income potential) if needed to correct an accumulated imbalance. One might make a symmetric argument with regard to cutting spending from high levels, but this doesn’t seem to fit with political reality.

  38. 38 38 Paul T

    Krug: “We’re just making a transfer from one group (the L through
    Zs) to another; total income isn’t changed…
    a debt inherited from the past is, in effect, simply a rule requiring that one group of people — the people who didn’t inherit bonds from their parents — make a transfer to another group, the people who did. It has distributional effects…”

    SL: “Krugman has this right…”
    *************************************

    He does?

    You go on to clarify that it doesn’t matter if chinese buy the bonds, since americans are no poorer, because they keep, and inherit, the cash uncollected today. Hence, there are no distributional effects, from USA to China.

    Then in what sense is the Krug’s distributional effect remark, from Vic the Virginian to Fred the Floridian, in 2022, right?

    Also, there’s something underhanded going on here (Krugman? how preposterous!). Krug presents an example, where one half of the population pays the other half. Unfair, but no net wealth change. Then, “those who didn’t inherit bonds from their parents — make a transfer to those who did”. So, um, that means, debt transfers wealth from The Poor to The Rich? gee, is there an agenda here?

  39. 39 39 Andrew

    @iceman –

    So I am reading it correctly. Wealth transfers do not make “us” poorer. The majority of government spending is wealth transfers.

    This doesn’t lead to the conclusion that spending must be controlled as the majority of the spending makes no difference to “us” being poorer or richer.

    Being as the majority of spending is wealth transfer, and there is a lot more debt “we” could take on to increase wealth transfers, the conclusion should be the exact opposite of what Steve suggests. Debt-financed, wealth transfer, government spending should be increased if debt, by itself, doesn’t make us poorer.

  40. 40 40 djd

    “it is true that government debt can facilitate that extravagance.”

    Isn’t that the real point? Unless you’re using the debt for effective investment and return, the debt load will end up crushing you – and perhaps the creditor as well.

  41. 41 41 iceman

    Andrew #39 – “Wealth transfers do not make “us” poorer…[therefore] debt-financed, wealth transfer, government spending should be increased”

    The first part is neutral, the second is a policy preference on your part. SL’s claim is that all economists including PK (should) agree the focus should be on “controlling” the types of spending that “can be costly”. They (we) likely won’t all agree on which types to control, but many would surely point to other important “secondary” incentive effects on the transferors which could in fact make “us” collectively poorer. And since there’s no inherent need to borrow to make transfer payments, putting this on the credit card would seem to raise the real-world likelihood that we spend to levels where those factors kick in.

  42. 42 42 Seth

    Krugman’s closing: “…but it does not in any direct sense make the country poorer.”

    It doesn’t make the country richer either, does it? If not, why do it?

  43. 43 43 Ken Arromdee

    Ken A #34 — I think in saying we’re poorer you’re not valuing the utility derived from the consumption. Since the reason we work *and invest* is ultimately so we (or our heirs) can consume, I don’t think we want a model that says consumption inherently has negative value, versus good old time preference.

    Remember the original idea: supposedly, future generations are not made poorer by transfers because if you transfer money, there’s a group who inherits the debt but there’s also a group who inherits the asset, so the total effect on the future generation is zero.

    If you transfer wealth in the current generation and it results in excess consumption, you may consider the utility derived from the consumption to be a gain, leaving the current generation with a net zero effect. But the utility derived from consumption is not inherited by future generations–the next generation will find themselves overall poorer even if the current generation doesn’t.

  44. 44 44 Mike Rulle

    The distributional argument is literally correct (absent the “minor” detail of incentives). I will not argue that point here, but almost the whole issue is one of incentives.

    But lets ignore that for now. But this all occurs within the framework of massive deficit borrowing. What bothers me about Steve’s point is it ignores the big lie such re-distributions create. Take a look at the Fed’s household net worth table which is updated every quarter. Notice anything missing?

    What is missing on the liability side? The debt owed by our various government entities. Who are liable for those debts? Isn’t it all households and their progeny?. Do we not create false “signals” or lies to our citizens? Household net worth is less by that amount we owe.

    One might ask, what about corporate debt? Households own equity and debt of companies. That is, they own the whole company and all its future cash flows, carving it up into debt and equity does not change much (ignore tax effects for this issue).

    What about all the property the various government entities own? Well, I could buy into that as unaccounted for equity owned by citizens. Although its current usage likely creates negative cash flows, let alone massive lost opportunity cost. Also, we could also include expected payments from SS etc., but that is just a function of more future borrowing.

    So yes, on the margin, ignoring incentives, ignoring that people do not factor in future obligations they actually owe, and ignoring that these transfers are created by borrowing on the margin, it does not matter that A-K gets money from L-Z by borrowing from A-Z and giving it to A-K—-although more money is likely borrowed from L-Z, or why bother transfering in the first place?

  45. 45 45 iceman

    Ken A # 43 — As I understand it, the point of the post is that the “asset” the future generation (conceptually) inherits need not be some physical investment or involve the funds being put in a fiscal lockbox; it’s simply the value of the taxing capacity (i.e. dollars left in people’s current pockets / accounts) that is not taken via taxes now. If so, this should be true even if a debt-financed transfer is entirely consumed today. Of course everyone might agree that a productive investment like a useful bridge etc. can make us collectively better off. The converse is that wasteful spending can make us collectively worse off – but in that case it’s the *spending* that’s the source of the loss, not the way it’s financed. Clearly many here also feel the ‘secondary’ effects e.g. on incentives +/or borrowing facilitating greater unproductive spending are pretty important.

    I’m not sure why you say there’s a “net zero effect” on the current generation, unless fhey fully value the offsetting liability they are accruing (i.e. use the preserved taxing capacity to fully reserve against it); but in that case it’s not a net loss for the future generation. Otherwise it’s a gain for us (collectively) and an offsetting loss for them. I don’t see how it can be a net loss for both generations combined. This gets to the point made somewhere here that debt allows us to *choose* how much to impoverish the future generation.

  46. 46 46 Ken Arromdee

    Otherwise it’s a gain for us (collectively) and an offsetting loss for them

    Yes, it’s a gain for us and a loss for the future generation.

    But you’re losing track of the original argument. The original argument is that it’s not a loss for future generations.

    The way the original argument goes is that if government borrowing leaves our descendants with a debt, in fact our descendants have no overall debt, because one group of descendants has a debt, but another group of descendants has the debt owed to them.

    This argument is false because such debts are accompanied by spending. If the government spends money on something that gets used up, and leaves current people with a debt, various groups of descendants have a combination of debt, creditor-ness, and loss of the consumed goods. As you recognize, it’s a gain for us (for those of us who consume the goods the government went into debt to distribute), and a loss for future generations–contrary to the original argument.

  47. 47 47 iceman

    Mmm, that might be the way PK argued it, but not this post. Note it begins with “debt in and of itself” doesn’t make us poorer, which leads to ‘focus on the spending’. PK talks about it in terms of Americans buying the bonds (I see now that’s what you meant by “asset”), but SL allows the Chinese to buy them which shifts the “asset” to the increased inheritances from the tax deferral. From there SL clearly acknowledges that the current generation can choose to consume those tax savings and thereby impoverish future Americans. So it seems like we’re all saying the same thing.

    [Except I still don't get your case 2 (#34) which seems to basically say the $5000 transfer is a wash but if the $ is used for consumption the current generation itself (?) is collectively poorer because resources are "permanently destroyed" (both groups have fewer goods). Wouldn't that be the case if each group just consumed $2500 worth - or $1 worth - with no transfers occurring? Were the two groups really supposed to represent current & future?]

  48. 48 48 Ken Arromdee

    Wouldn’t that be the case if each group just consumed $2500 worth – or $1 worth – with no transfers occurring?

    Sure, but that would contradict the assumptions built into the original argument.

    The argument is that when the government goes into debt to spend, it doesn’t make future generations worse off compared to a situation where there wasn’t any debt. If there wasn’t any debt, there wasn’t any spending of money received by going into debt, and there wasn’t any consumption of goods bought with the money that wasn’t spent.

    If you’re going to compare government spending to individual spending instead, you’re no longer making the same comparison that Paul tried to make (and Steve supported most of the way).

  49. 49 49 iceman

    “The argument is that when the government goes into debt to spend, it doesn’t make future generations worse off compared to a situation where there wasn’t any debt”…

    …and so the same amount of spending / consumption is financed through current taxation, yes. (Or of course we can look at it as debt vs. no debt with no spending in either case.) My take was that consumption by individuals just entered the picture along with the Chinese, i.e. the “asset” for us is no longer the bonds but the tax deferral. So we’re not comparing govt spending to individual spending, the latter simply provides the option of taking what is still a zero burden in the aggregate (so the basic point stands) and distributing some or all of it to the next generation.

    I appreciate the exchange and again it seems like we agree on the core. My side comment was just trying to understand why your example seems to suggest consumption (by individuals) makes us poorer, irrespective of debt or transfers, since to me that seems to contradict a lot of things. We’ve established that “wasteful” spending by the govt can make us poorer (again debt or no debt), but it’s less clear how as individuals we can consume in “ways we would not choose.” (I suppose some room for externalities here but that seems off-topic.) In short I’m still not seeing how your example can produce a loss for the future generation but only a “net zero” for the current generation.

  50. 50 50 Ken Arromdee

    it’s less clear how as individuals we can consume in “ways we would not choose.”

    The government can transfer money from person A to person B and then person B can use the money in ways that person A would not choose.

    In short I’m still not seeing how your example can produce a loss for the future generation but only a “net zero” for the current generation.

    In the current generation, everything is just transference except for the consumption, and thus causes no net loss when summed over society. For the consumption the loss by not having the consumed goods is balanced by the utility gained from consuming them.

    However, that utility isn’t inherited. All the next generation gets is the loss.

  51. 51 51 Ken B

    This debate, with reference to this post, is raging all over Free Advice (on the blog roll above). In particular here http://consultingbyrpm.com/blog/2012/10/my-final-word-this-generation-the-debt-really-is-fundamental.html

  52. 52 52 iceman

    “The government can transfer money from person A to person B and then person B can use the money in ways that person A would not choose.”

    But this says nothing about the effect on total utility, absent some assumption about whose preferences are stronger. By contrast only the govt can, say, force everyone to fund a bridge to nowhere.

    “In the current generation…the loss by not having the consumed goods is balanced by the utility gained from consuming them…All the next generation gets is the loss.”

    It seems you’re counting a loss twice. The source seems to be assigning some inherent ‘asset value’ to the consumable goods other than their potential utility in consumption, with the implication that consumption does not make people better off. Otherwise, it’s only a ‘loss’ in the sense that once we consume goods (and derive the utility) we don’t get to consume them again.

  53. 53 53 Ken Arromdee

    I’m not counting a loss twice, but I am arguing something narrower than what you seem to think I am. I’m disputing the original argument–which is that if the government goes into debt by spending money, this does not leave future generations worse off because while some of the future generation has a debt, others in the future generation have the same debt owed to them.

    If the government spends money, making people go into debt, and the money is spent to buy something that is consumed, future generations are in fact worse off.

    The fact that present generations find utility in consumption doesn’t change this. Future generations inherit the debt, and inherit being owed a debt, but they don’t inherit the utility gained from consumption.

    If you want to argue about someone other than future generations, then fine, but that’s not what I was addressing.

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