Sunday, 22 December 2013

National debt is not deferred tax.

Debt-phobes are fond of telling us that national debt is deferred tax. While household name economists make plenty of blunders, they don’t seem to make the “deferred tax” mistake. That is, it’s second raters who make this mistake: e.g. Pete Peterson, Niall Ferguson and Alan Reynolds.

Let’s take a period over which US debt as a proportion of GDP declined substantially. In 1948 the proportion was 90% and in 1986 the proportion had halved. See this table.

Now how much tax was collected to pay back those creditors? Er…. None! In fact quite the opposite: the US debt rose in that period from $252bn to $2,125bn. Put another way, far from anyone having to pay tax of bring about that reduction in the debt relative to GDP, quite the opposite occurred. That is, taxpayers were EXCUSED paying about $2,000bn in tax in that period because the US government funded $2,000bn of its spending from extra borrowing rather than tax.

The above sort of “second raters” will be baffled. How can this be? Well the answer is that far and away the biggest way in which national debt is reduced is INFLATION!!!!!!

I.e. national debt is not deferred tax: it’s deferred robbing of a country’s creditors via inflation. And if you can rob your creditors, then why not? Go for it!!

Even in the decade or so after WWII when the debt fell faster relative to GDP than in any other decade, the debt in terms of dollars stayed more or less constant. I.e. no taxpayers were called on to bring about that substantial reduction in the debt.


Of course, the above is not to suggest that governments can stop collecting tax altogether and instead, fund their expenditure from borrowing. But the basic point I’m making is that the “deferred tax” crowd (Peterson Institute, Niall Ferguson, etc) are a bit simple: they’ve much to learn if the want to understand the tax versus borrowing question.

As a start, I suggest they get to grips with Modern Monetary Theory.


  1. Ralph, might I suggest you use the phrase "fund their expenditures by issuing T-bonds" instead of using the inapplicable neo-liberal term "borrowing". No reason for us to ever mention the words "borrowing" and "debt" when referring to the mechanisms by which a sovereign Govt creates and spends "money" or financial assets. Have a good holiday Ralph, and keep up the good work.

  2. John Redwood said pretty much the same thing recently too. lat time I looked he'd let one of my comments through but not the other.

    I'm not too keen on the idea that we should argue that National Debts can be repaid by inflation. The neo-liberals accuse Keynsians of wanting precisely that.

    As Auburn suggests "debt' isn't a good word. It suggests that countries like the USA and the UK haven't paid for goods imported from China for example. If that had happened they would want to send us any more stuff! They are happy sending it to us and we are happy to pay for in $ and £ which they are, in turn, happy to keep on account in Central Banks.

    The problem for the economies of the UK and the USA , may, one day in the future, be the accumulation of assets rather than the debt itself. That should be tackled , not by inflation, IMO , but by the imposition of taxes. The political and economic need for which need to be justified and explained.

    1. Yes, Auburn makes a good point about the word debt. Logic doesn’t count for much compared to using the right words and having the sexier sound-bites than the opposition.

      Re your last paragraph, MMTers have always recognised that the debt (aka “private sector net financial assets”) may at some point exceed private sector savings desires i.e. the amount of those assets that the private sector wants to hold. And in that case demand would tend to become excessive, which in turn would call for raising taxes and unprinting the money collected. And as you rightly say, raising taxes (or cutting public spending) can be politically tricky. I.e. REVERSABILITY is a potential problem with fiscal policy. However, the real value of the debt shrinks at the rate of inflation each year, so there’s a certain amount of “reverse” automatically built into the system, which is handy if one wants to regulate the economy via the sort of mix of fiscal and monetary policy favoured by MMTers (rather than relying just on interest rate adjustments, which is what Scott Sumner and others favour).

  3. 'They' will steal from you in one way or another...! :-) Also agreed.


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