Why Pay Down the Public Debt?

Your taxonomist and my friend, Robert McIntyre, has offered us a lesson on the merits of paying down public debt ["In Praise of Debt Reduction," September 11, 2000]. Everyone knows Bob's work on tax policy is invaluable, but his class on fiscal policy is one I'd rather cut.

Bob begins with the reasonable point that in a highemployment economy, budget surpluses could curb inflation and cool the Federal Reserve's ardor for higher interest rates. But he ducks two crucial issues: how much of a surplus to run, and for how long. His failure to take exception to the Clinton-Gore policy suggests that his preference is for as much and as long as possible, short of shutting down the "entire government for a few years."

Little inflation is in sight. Who is to say unemployment could not decline further? Extreme humility in this vein is warranted. For decades fiscal policy has labored under the delusion that unemployment could never fall beneath 6 percent without igniting inflation. The foregone benefits of lower unemployment are an unnoticed social-policy catastrophe of the 1980s and early 1990s. We now observe the blessings of tight labor markets in chronically depressed communities. It is hard to see a liberal case for such anti-inflationary zeal.

Bob asserts, without explanation, that lower public debt will help sustain long-term growth. Not necessarily. Capital formation can take place in the public sector, increasing productivity and output in the long term. Federal surpluses do not always buy new plants and equipment; they could finance housing, consumer debt, or the next Internet start-up.

A homely economic principle holds that the marginal productivity of investment diminishes as the volume of investment expands. With a high level of private investment, a bit more is not as valuable as a bit less. Increases in investment that has ebbed--like the public kind--could be more valuable than some debt reduction. Even from the narrow standpoint of measurable productivity, it is eminently possible for an incremental expansion of public investment to be more consequential than a comparable expansion of capital stock under private ownership.

Bob also suggests that debt reduction now makes possible more spending later. From an economic standpoint, this is a non sequitur. Consider which is "more": a dollar spent this year, or a dollar and two cents spent next year. If you think the latter is more, I'd like to be your banker. Borrowing and debt-repayment change the time profile of spending; in view of the time value of money, they cannot increase or reduce spending. A caveat is that those who spend now and those who spend 30 years hence are different folks. The latter, with the benefit of three decades of productivity growth, will be better off. The urge to make them richer still by sacrificing current needs for social investment is too noble for me.

From a personal standpoint, I am less concerned with the metrics of GDP growth than with the evolution of the social order. Under the most likely circumstances, my daughter will face a job market with substantially improved opportunities relative to the one I faced. More important to me than enhancement in this dimension is the kind of world she will live in. Environmental amenities, an educated populace, public safety, a fuller availability of leisure time, and an advancing sense of commonweal are higher priorities to me than whatever small accretion of material wealth is made possible by the unreasonable elevation of debt pay-down among our fiscal priorities.

Finally, we come to Bob's invocation of the Social Security problem. He notes that the trust fund begins to run a deficit in 2015 and is "exhausted" by 2037. He implies that less public debt makes future benefit payments more affordable. In this case, there is a "more" and a "less," but Bob has them backward.

In 1999 debt held by the public was about $3.6 trillion. As noted above, whether we leave it be or take it down one or two trillion in 10 or 20 years makes a big difference for when (not how much) resources are available to the federal government. And when resources are available has a lot to do with the affordability of debt repayment now versus the boost to income from interest savings later.

A trillion of public debt amounts to annual interest obligations of about $60 billion. In fiscal year 1999, $60 billion was 3.3 percent of total federal revenues. But $60 billion is much less important as time goes by, first because of inflation and second because it will be a smaller share of real national income and tax revenue. If federal revenue grows at the puny rate of 4 percent annually, in 30 years $60 billion will be 1 percent of revenue. From the standpoint of public spending, large budget surpluses (presently in the $200-billion range) are less affordable now than forgone interest payments would be in future years.

I'm afraid the taxonomist has wrongly classified his fiscal policy. His caterpillar is never going to grow wings and fly. All it can do is eat. ¤

Robert McIntyre's response

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