Thursday, June 7, 2012

The Foolishness of Owing it To Ourselves

Back in March, on EconTalk, Don Boudreaux and Russ Roberts took on the notion of "owing it to ourselves" in the context of public debt. Their arguments revolve around the idea that the citizenship of the bondholder is irrelevant; this is correct, but it doesn't get at the heart of what the "we owe it to ourselves" (WOITO) crowd believes.

Following the example of Boudreaux/Roberts, let's assume there is a war between the USA and a brutal dictator (Hitler or similar) trying to enslave us. It is indisputable that government will put the money to its highest-valued use by deposing of said dictator. It sells me a war bond for $1,000 and promises to re-pay with 4% interest 10 years later. This is a free lunch for government right now, because they have traded me a piece of paper promising stuff later for money which they use to fight the dictator. I voluntarily make an investment I believe will pay off later and everyone is better off.

So far, so good. But what happens when the bond comes due? This is where Boudreaux/Roberts misunderstand the WOITO argument. The argument goes as follows: it is 10 years after the war. The bond is due. Government owes me $1,000 plus interest - wouldn't that be $1,480? - and in order to pay off the debt they raise taxes. As Boudreaux/Roberts point out, I am the taxpayer, so when they raise taxes they ultimately are raising them on me.

Here's where you need to keep your eye on the ball. For arguments' sake, let's suppose the government raises taxes on me by $1,480 in order to pay me back $1,480. Boudreaux/Roberts approach this; they talk about citizen A repaying citizen B; but they never use the example where taxes are raised ON THE SAME CITIZEN who is being repaid.

This is a crucial example because the WOITO crowd sees this as a free lunch. Here's why. From the perspective of my own personal accounting in this calendar year, I have been taxed for an amount but receive the exact same amount as payment for my bond. So my net expenses for this year are 0. FREE LUNCH!

The problem is, the WOITO thinkers took their eye off the ball. This isn't a free lunch, because the $1,480 I received in payment for the bond is the credit for the $1,000 payment I made ten years ago. If you believe the taxes taken from me and the payment to me "cancel out" and make a free lunch, then you are ignoring my original $1,000 expenditure, which is never repaid in this scenario.

The idea that "we owe it to ourselves" is a case of failing to keep your eye on the ball. It looks a little bit like two free lunches: one when government gets to fight the war on the strength of my bond, and one when it takes money from me to repay me later. The repayment isn't even painful for me, because I am receiving money from the government that exactly matches the extra taxes I owe them! However, this logic completely neglects the fact that I made an initial expenditure, and therefore I have two expenditures (one now: the bond purchase; one later: higher taxes) and only one revenue stream (later: the bond repayment).

Wish Don & Russ had more neatly made this point; I agree with their conclusions but think they misunderstand the actual error made by those who believe that it's no big deal when we owe debt to ourselves.

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Compared with the totality of knowledge which is continually utilized in the evolution of a dynamic civilization, the difference between the knowledge that the wisest and that which the most ignorant individual can deliberately employ is comparatively insignificant. ~Fredrich Hayek in The Constitution of Liberty