Borrowing versus taxing

As we all know, I’m not an economist, but I do occasionally apply my formidable brainpower to thinking about issues outside my field. So today I’m thinking about government spending and loans versus taxes. We sometimes hear that borrowing money is “stealing from our children” or “moving consumption from the future to the present”, which puzzles me. Unless someone has been making breakthroughs in fundamental physics and/or dark-energy engineering and selfishly keeping it to themselves, we cannot literally move any loaves of bread from 2020 to now; what we can do is make notes on paper, or shuffle electrons around. Being a simple-minded physicist, I always get confused when I try to think about economics in terms of dollars; it’s a lot easier to ignore the little pieces of paper and look at the actual movement of loaves of bread. So in these terms, what is the difference between taxing and borrowing?

Let’s suppose the government wants to give a loaf of bread to a welfare recipient, in this year 2009. Clearly this loaf has to come from somewhere: Either it is extracted by taxation from the population as a whole, or it is borrowed and will be repaid later, with interest. Let’s have four economic entities: Welfare recipient, government workers, taxpayers, and me. For simplicity we’ll ignore that I and the government workers are also taxpayers.

Now then; suppose the loaf of bread is extracted by taxation. Some extra must go to feed the government workers doing this unpleasant task; let’s call this proportion ‘x’. Additionally there is some deadweight loss, where people who might, in the absence of taxation, have gone to work and made some bread decide, instead, to stay at home and do something that’s not taxed, like play with their children. Call this ‘y’. So, in real terms we have a transfer of goods like so:

Year Welfare recipient Government workers Taxpayers Me
2009 +1 +x -(1+x+y) 0

All very straightforward, but observe that this is negative-sum – nobody ends up getting that y which the taxpayers lost. That’s why it’s called “deadweight”. Now for the case of the loan. The government decides not to make itself unpopular by increasing taxes this year; instead it’ll put out some thirty-year bonds. These are in effect promises to return lots of bread in 2039 in exchange for one loaf now. I, having more bread than I need at the moment, kindly step in and take this bond. Then, in 2039, the government (I hope) pays me back, with interest – 2 loaves, let’s say. So now the transfers look like this:

Year Welfare recipient Government workers Taxpayers Me
2009 +(1-x) +x -1
2039 0 +2x -(2+2x+y’) +2

Notice that the 2039 payouts become more complicated. To find those 2 loaves I’m owed, the government has to tax (or borrow some more, but we’ll ignore that option, it doesn’t add anything to the discussion) 2 + 2x loaves out of the population, because it still needs to pay the people who check tax forms and arrest cheaters. The deadweight losses are different, y’ rather than y, because the tax rate is now higher – but on the other hand, one hopes, it’s being levied on a much larger economy. As a percentage of their actual wealth, that (2+2x+y’) may in fact be rather smaller than the 2009 (1+x+y). Perhaps not, though; it depends on the interest rate of that thirty-year bond, which is based partly on my estimate of how much the economy will grow in 30 years – if I think I can do better by lending my loaf of bread to a venture capitalist, I won’t take the government bond. Of course, predicting GDP growth 30 years in advance is not a trivial task either. At any rate, though, it’s now clear how borrowing transfers money from the future: It doesn’t, rather it transfers some money today and creates the promise of another, compensating transfer later on.

Promises, of course, can be broken; governments do sometimes default on bonds. Assuming it doesn’t, though, we can think a bit about whether the rhetoric of stealing from our children is reasonable. First, it’s clear that the borrowing option imposes a larger tax burden, in terms of loaves of bread, on the 2039 taxpayers than the taxation option imposes on the 2009 taxpayers. (Going back to dollars, it is of course possible that the debt will inflate away and when I get my payout, I’ll actually be left with two crumbs rather than two loaves. To guard against this possibility I’ve also got some of my savings in gold. But let’s assume for the moment that they are inflation-protected bonds.) However, it is not immediately clear that it is a larger tax burden as a percentage of the number of loaves they’re producing. If I am a good estimator of growth rates, it will be, though, because I want to be paid something for not having that loaf of bread for the next 30 years.

Still, this argument can be made for any form of saving. Suppose I had socked away my loaf of bread into the stock market; then the transfer would look like this:

Year Welfare recipient Government workers Taxpayers Me
2009 0 0 1 -1
2039 0 0 -2 +2

Do I end up with more goods, as a percentage of GDP, than before? Who knows? But what we don’t have is the deadweight losses and the transfer to government bureaucrats.

So: With taxes, we have to pay (1+x+y) right now. With borrowing, a slightly different set of taxpayers, presumably including some children of ours, pays (2+2x+y’) in 2039. But wait; what am I going to do with my 2039 loaves of bread? Well, at least some of it will be passed on to – my children, right. The net effect of borrowing is to redistribute the wealth of 2039; some to government bureaucrats, some to the lenders of 2009 and their children. But whoever finally ends up with those 2039 loaves of bread, we have created an obligation for the 2039 taxpayers which some fraction of them did not get to vote on.

So, I’ve actually convinced myself that the rhetoric is not without foundation: Do I want to be taxed to pay for whatever programs were being funded by borrowing in the late seventies? No. Consequently I should not put anyone else in that position. But against that: I’m ok with being taxed to pay for WWII. So in the end, it depends on how worthy you think the goal is, just like any other government spending. You could put “build a bridge” or “invade Iraq” in place of my “welfare recipient”, and the transfers remain the same.

It does seem that if you want to use 2009 resources for Worthy Cause X, it would be more honest to just do so, even if the pill can be made easier to swallow by saying “but don’t worry, in exchange for your loaf of bread now, we’ll make people work a bit extra in 2039 to give you two loaves.”

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