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Spending other people's money

| Wednesday, Jan. 25, 2012

Politicians like promising voters goodies that allegedly are paid for by others -- preferably by others whose wealth voters feel is undeserved (such as the "1 percent"). Even better for politicians, though, is promising voters goodies that cost nothing!

Who doesn't want goodies that are free?

The problem, of course, is that almost nothing worthwhile is truly free.

So how can politicians promise free goodies• Economists influenced by John Maynard Keynes often write as if they've uncorked the secret: government borrowing from fellow citizens.

Here's their argument: If Uncle Sam borrows to pay for, say, an extra $1 trillion of stimulus spending, this spending is free to the country as a whole if the debt is owed only to Americans. True, Uncle Sam must raise taxes tomorrow to pay this debt, but the debt payments will be made to Americans. Americans will be taxed an extra $1 trillion plus interest, but every cent of these higher tax collections from Americans will be paid to Americans. The money stays here. America, as a whole, pays nothing for today's stimulus spending!

In econ-speak, internally held debt is no burden on the economy.

At first glance, this argument appears sound. But look again.

Suppose the stimulus funds are spent to build roads. We might all agree that the roads are worth every cent spent to build them. But just because something is worthwhile doesn't mean it's costless.

Real resources are used up in building the roads. The millions of hours of labor, fuel to power the construction equipment, concrete, asphalt, steel and other building materials, the land that is now paved over with highways and boulevards -- all are resources that could have been used to produce other things of value. The satisfaction that people would have gotten from those things that instead could have been produced -- but in fact aren't produced -- are the cost of building these roads.

Those foregone goods and services don't become "unforegone" simply because Uncle Sam borrows the funds used to build the roads from Americans.

My George Mason University colleague James Buchanan won the 1986 Nobel Prize in economics in part for his work explaining why it's mistaken to conclude that internally held debt imposes no (or only minuscule) burdens on the economy.

Buchanan reasoned that the burden of the debt isn't borne by the lenders: They lend voluntarily in hopes of receiving an attractive return. Had they not loaned to the government, they would have used their money in other ways, likely as loans to private investors.

Nor is the burden of the debt borne by today's taxpayers. It's precisely to avoid raising taxes today -- to avoid burdening today's taxpayers -- that government borrows.

The burden of the debt falls just where common sense tells us it falls: on the people whose taxes are raised to pay it. Those people are taxpayers in the future. And again, that the bondholders are also Americans does nothing to "unforego" the goods and services sacrificed to build the roads.

Of course, if today's taxpayers save and pass on enough money to their kids so that their kids can use these savings to pay off the debt, then today's generation would relieve tomorrow's generation of the debt's burden. But today's generation is unlikely to be so kind. Again, government debt is incurred today for the very purpose of enabling today's taxpayers to "free-ride" on future taxpayers.

And such "free-riding" means that government today will likely overspend.

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