Economists Don Boudreaux and Randall Holcombe collaborated on a newly published book titled, The Essential James Buchanan, which covers the work of this eminent economist. Buchanan received a Nobel Prize for his work on Public Choice. My interest and the subject of this article is restricted to a secondary work of Buchanan’s, The Public Principles of Public Debt, which Boudreaux and Holcombe discuss in Chapter 6.
I congratulate Boudreaux and Holcombe (B&H going forward) for discarding aged conventions and focusing on the true nature of public finance. I have long argued that examining the finances of government, an entity devoid of the means of funding itself, can yield only erroneous and bewildering conclusions. B&H, like David Ricardo 200 years before, wisely shift the focus to what actually funds government, to the combined assets of the residents of a community, the true source of the government’s spending power. Unfortunately, poor analysis badly mars this theoretical leap forward, but old conventions are beginning to fracture nicely.
B&H set about explaining Buchanan’s argument on public debt via the example of the construction of a $25 billion dam, funded by issuing a bond to a wealthy investor in 2021 for a period of 30 years. In 2051, at the end of the term, the wealthy investor is rewarded with $108 billion of principle and interest. I think ‘lender’ a better term than ‘investor’ given the function of each. B&H speak of both foreign and local lenders, but I choose to limit the discussion to local lenders for brevity and clarity.
Following Buchanan’s argument, B & H make a perplexing claim that public goods acquired by taxed funds are paid for in the immediacy of the purchase, but public goods acquired through the issuance of public debt shall not be considered as paid until the financing term ends. Thus, in the case of the dam, resources consumed in its construction would not be paid for until 2051 when taxpayers must settle up.
That is an odd thing to say! I may have misinterpreted the point, which is an easy thing considering the unusual and abstruse argument, but the dam was certainly constructed with labour, material and equipment garnered and paid for in 2021, and the people of the community will theoretically enjoy the benefits derived from the dam as long as it operates.
The financial liability of principle and accruing interest incurred in 2021 certainly imposes on the assets of present and future generations of resident citizens, much in the way that a debt incurred for a worthy venture imposes on the assets of a firm, bank or person. But the existence of a financial liability pertaining to the dam has little to do with the dam or community asset erected in 2021.
It would be strange to describe the labour, material and equipment contracted for and disbursed through the US Civil War, WW1 and WW2 as being in arrears because the debt then incurred has been incorporated into many subsequent issuances of debt.
The only reason Buchanan and B&H and so many other economists advance such an odd proposition for public debt is that they believe that all public debts eventually must be repaid or reduced by taxes imposed on resident citizens; That there is no alternative. A $25 billion public debt incurred in 2021 and having risen to $108 billion 30 years later must be settled with taxed funds imposed on the residents of a jurisdiction.
This lack of options consists in the presumed unwillingness of many knowledgeable economists and thinkers to make a distinction between repaying a lender and repaying a debt. Every responsible borrower knows that a lender must be repaid on agreed terms. Violation of that solid principle of conduct entails much grief for all involved parties. But does repaying a lender require repaying or reducing a debt?
The answer is no as the financial records of any individual, firm, bank or government of the past and present confirm. The debts of all generally rise through time. A person, being a finite being, does attempt to settle accounts before death. But as the estate would do so, it isn’t an imperative.
Repaying a lender may be achieved through asset exchanges, the initial lender exchanging his bond for a sum of money comprising principle and accrued interest supplied by a second lender. The $108 billion due in 2051 to the wealthy lender could be settled by having another eager lender exchange funds in that amount for the bond, thence re-issued by the Dam’s Borrowing Authority for another 30 year term.
The big question becomes, “Should the Borrowing Authority reissue the bond or should it repay the debt by taxing resident citizens?” I have repeatedly analyzed the costs and benefits of repaying a public debt for the aggregate assets, property, and incomes of resident citizens. Buchanan, Boudreaux and Holcombe and many others perhaps haven’t. In that case, let’s erase this delinquency, perform the calculations, and work on solving the riddle.
In 2021 a bond is issued in the amount of $25 billion for the construction of a dam. Only resident lenders may hold the note. The aggregate of assets of resident citizens incurs a public debt or claim of $25 billion. However, an equivalent asset of $25 billion is also added to the aggregate of assets as resident lenders, their assets comprising part of the aggregate, hold the note. The rise of $25 billion in aggregate assets negates the $25 billion rise in liabilities, leaving the finances of the aggregate effectively unaltered.
In 2051 the public debt of or claim against the aggregate of assets has risen to $108 billion with accruing interest. But as the public debt is held by resident citizens, specifically lenders in receipt of interest, the aggregate of assets has risen by the same to $108 billion. The interest allotment of $83 billion both elevates the public debt claimed against and the assets held in the aggregate by an equivalent amount, leaving the finances of the aggregate again effectively unaltered.
If the community seeks to ease its financial burden, should it extinguish the debt or should it continue to carry it? If the community decides to extinguish the debt, it must do so by taxation. The government recalls the outstanding bonds. The public debt of $108 billion claimed against the aggregate is extinguished along with the matching asset of $108 billion held within the aggregate. Funds of $108 billion transfer from resident taxpayers to resident lenders, moving from one part of the aggregate to another. With equivalent asset and liability of $108 billion erased and the funds transfer of $108 billion kept within the bounds of the aggregate, its finances are unaltered in the transaction.
What is the benefit of erasing $108 billion in public debt for the aggregate of assets that fund government when it leaves the finances of the aggregate effectively unaltered? There is none! On this point Buchanan’s argument falters badly. Let the debt rollover, repaying lenders indefinitely with new lenders until the benefit of repaying or reducing the debt exceeds the cost. But that shall never happen.
