National Deficit

Essay by shlazzUniversity, Master'sA+, January 2009

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The decrease in taxes and an increase in debt leave each taxpayer with more cash or bonds but with property diminished in net market value by a like amount, so that his net worth is unchanged. Ricardian equivalence is complete, and the stimulative effect is limited to a relatively minor liquidity effect; there may also be a saving of interest if the public debt bears a lower interest rate than private obligations. And if public debt is incurred to finance outlays on infrastructure or other features that enhance land rentals, there will be a substantial stimulative effect. These activities would then attract an added share in the burden of servicing the debt. At low debt levels, the hope may persist that other investors will come along to take up some of this burden, but at some point this bubble of hope may vanish rather suddenly, with catastrophic results.

This effect may be mitigated to some extent if the debt is incurred to finance infrastructure that enhances property values.

In most cases, however, even if investment in improvements continues unabated, if the debt is financed by taxes on improvements, the investment will fall short of what would take full economic advantage of the increased productivity generated by the public investment. Proposition 3: National deficits still stimulateAt the U.S. federal level, with heavy reliance on taxes based on earnings (or on consumption), deficit financing shifts tax burdens from present earning effort and consumption to burdens on future earnings and consumption, without capitalization in reduced asset values. Thus, current consumption and income production are encouraged, especially since, for many, the future burden, if any, will be beyond their horizon. The result is a strong stimulative effect. Proposition 4: Fallacious beliefs can be temporarily self-justifying.

Nevertheless, if a sufficiently strongly held belief prevails in...