Channels, Spring 2018

Page 16 Schwartz • Public Principles and Economic Legacy The final point that Buchanan critiques is the last tenet of the new orthodoxy, which argues that internal debt and external debt are fundamentally and sharply different. In this stream of thought, A.C. Pigou wrote “It is true that loans raised from foreigners entail a burden in the interest and sinking fund on future generations in the borrowing country. But interest and sinking funds on internal loans are merely transfers from one set of people in the country to another set.” 9 No matter the relevant rates of interest, then, the government should operate with internal debt as a result of this analysis. Buchanan disagrees, noting that the result of issuing internal debt is the removal of significant streams of domestic savings that would have been productively invested in the domestic economy. 10 Future private income streams are decreased under internal debt, with the magnitude of the loss depending on the rate of return for private capital investment. External debt finances public expenditure from foreign savings, allowing future income streams to be higher at first, with resulting costs of interest paid to external bondholders. Thus, the only difficulty of financial transfer from external savings, due to institutional or currency problems for instance, can differentiate internal and external debt. 11 The rate of return which the bonds will need to provide is the definitive factor in deciding between internal and external debt, unless transfer problems are severe. Finally, after rejecting the three tenets of the Keynesian orthodoxy, Buchanan moves into a brief discussion of the political and institutional realities surrounding public debt. He notes the important incentive regarding public debt in democracies: because the burden falls on future taxpayers and the benefit accrues to present citizens, almost any perceived present good will present a temptation to issue debt. 12 This presents concerns with debt issue as both a seriously and pervasively problematic instrument among Public Finance tools. Importantly, this also means that it is unlikely that citizens would be willing to allow tax increases to fund long-term expenditures. Today’s citizens would bear the cost in that case, while tomorrow’s citizens would get the benefits. Further, there is no market for an asset that will be created in the future, so the individual in this public context cannot properly evaluate the asset or program the government spending is proposed to create. 13 Similarly, there is no way to accurately calculate the cost of future debt in comparison with a current asset that is easily marketable. The collective decision-making process cannot discount correctly. 14 Thus, long-term projects should be tied to long-term debt so that costs and benefits align, with short-term projects and taxation paired as well. Still, Buchanan notes that even this precaution may not succeed in 9 A.C. Pigou, A Study in Public Finance , (3d ed. London, 1949), cited by James Buchanan in Public Principles of Public Debt, (Liberty Fund Inc., Indianapolis: IN, 1999), 59. 10 James Buchanan, Public Principles of Public Debt, (Liberty Fund, Inc., Indianapolis, IN: 1999), 61. 11 Ibid, 65. 12 Ibid, 120. 13 Ibid, 124. 14 Ibid, 123.