200 plus years ago a bright fellow by the name of David Ricardo posed a very unusual idea. He claimed an equivalence existed between Taxation and Borrowing; that it made no difference if a community had its government tax or borrow from resident citizens to fund public expenditures. Though he may have lacked the tools to fully explain why, Mr. Ricardo was indeed correct.
Ricardo’s idea remained an obscurity until the 60’s and 70’s when several researchers, notably Robert Barro, rediscovered and examined the idea. These efforts resulted in a notoriously bad conclusion. Barro concluded that it would be reckless to suspend Taxation, let public debts rise to outrageous limits, then re-institute Taxation, perhaps generations later, and extract taxes from persons far removed from initial expenditures. Barro’s analysis by disregarding critical facts took a strange path to a stranger conclusion. However, a proper examination of Ricardo’s work should squelch this errant effort permanently and confirm Ricardo’s irrefutable conclusion.
As I have said previously, government possesses no hoard of money, no assets, no financial instruments with which to meet its daily needs. Government cannot fund government. It never has and it never will. The Taxpayer, or more fittingly the resident citizen, and further still the collective of his property, assets, and income through assorted charges applied to wages, profits, consumption, savings, investments, property, inheritance supply funds for all government outlays. Therefore, the deficit comprises the whole of government expenditures, which Pre-Covid amounted to ~$4 trillion in the US Federally and not just the misconstrued and borrowed $1 trillion.
With this in mind is it better that a community have its government tax or borrow solely from the Collective of assets, property, incomes of resident citizens?
The answer to this question would seem reflexively obvious to any person. For those confident that Taxation is the correct answer a great surprise is to be unveiled.
Let us say that government shall fund public expenditures in 2 scenarios -- Taxation and Borrowing -- with effects wrought upon the Collective of Assets, CA, of the community’s residents through changes in aggregate Income, Y, net of government expenditure, G. Two time periods, T1 and T2, are used to reflect these changes. Government expenditure has a value of G in T1 and 0 in T2, and only resident citizens may lend to the government.
In Taxation, the gain to the Collective of Assets, CA, is straightforward. CA rises in Period 1 by Aggregate Income, Y1, less government expenditure, G, or Y1 – G, and in Period 2 by solely Aggregate Income, Y2, since government expenditure, G, is nil. In Taxation the total gain for CA from both Time periods is Y1 – G + Y2.
In Borrowing, the gain to the Collective of Assets, CA, is the same as with Taxation, but with more paperwork.
In Period 1, the gain to CA is Aggregate Income, Y1, less Government expenditure, G, or Y1 – G. But added in the mix are an IOU or public debt in the amount of G issued against CA and an equivalent IOU or public bond in the amount of G held by CA (by its lenders). As the bond held equals the debt issued, they sum to zero, leaving the gain to CA as Y1 – G.
In Period 2, the gain to CA is Aggregate Income is simply Y2 as G equals 0, the same for Taxation. But again added in is the IOU or public debt plus accruing interest issued against CA as well as the IOU or public bond and accruing interest held by CA. Fortunately, the bond and accruing interest held equals the debt and accruing interest claimed, which sum to zero, leaving the gain to CA as Aggregate Income or Y2. Adding the gain from both Time periods yields the same result as under Taxation or Y1 – G + Y2.
A numerical example may help. Suppose Income in Period 1 is 100 units and 110 units in Period 2. Government expenditures are 30 units. Interest is 10%.
Under Taxation, gain in assets by CA works out to 100 – 30 in Period 1, and 110 in Period 2 with G being 0, for a total gain of 70 + 110 or 180 units.
Under Borrowing, gain in assets by CA in Period 1 works out to 100 – 30 – IOU claimed + IOU held or 100 – 30 – 30 + 30, which equals 100 – 30 + 0 = 70 units. In Period 2, G being 0, gain in assets by CA is 110 – (30 + .1(30)) + (30 + .1(30)), which equals 110 – 33 + 33 = 110 units. Total gain is 70 + 110 or 180 units, just as with Taxation.
If the community has its government borrow strictly from resident citizens, every public debt with accruing interest claimed against the Collective of Assets of resident citizens exactly matches a public bond with accruing interest held by the Collective of Assets of resident citizens, an equivalence that remains into perpetuity for all debts issued plus accruing interest.
Thus, Pure or True Ricardian Equivalence as advocated by David Ricardo in the early 19th century does exist theoretically and appears irrefutable. However, there is only a superficial equivalence between Taxation and Borrowing. Taxation bears massive costs in deterrence and government squander that disappear with Borrowing. Thus, it is always best that a community has its government borrow from rather than tax resident citizens. The next article shall explain this seeming absurdity as well as the unprecedented enrichment of communities that would follow the abolition of Taxation and the institution of full public borrowing.
