From: mccall@mksol.dseg.ti.com (fred j mccall 575-3539)
Subject: Re: The end of the Reagan Era
Organization: Texas Instruments Inc
Distribution: usa
Date: Fri, 6 Nov 1992 13:31:29 GMT

In <Wg==z6+@engin.umich.edu> jwh@citi.umich.edu (Jim Howe) writes:

>In article <1992Nov5.140902.24401@mksol.dseg.ti.com>, mccall@mksol.dseg.ti.com (fred j mccall 575-3539) writes:
>|> In <lt-=D!C@engin.umich.edu> jwh@citi.umich.edu (Jim Howe) writes:
>|> 
>|> >In article <1992Nov3.141621.22028@mksol.dseg.ti.com>, mccall@mksol.dseg.ti.com (fred j mccall 575-3539) writes:
>|> >|> In <KM-=FA#@engin.umich.edu> jwh@citi.umich.edu (Jim Howe) writes:
>|> >|> 
>|> >|> >In article <1992Oct31.223142.21346@europa.lonestar.org>, tom@europa.lonestar.org (Tom Kimball) writes:
>|> >|> 
>|> >|> >There is a theory called Ricardian Equivalence which
>|> >|> >posulates that revenue raised from debt is roughly equivalent to money
>|> >|> >raised in taxes. [...]
>|> >|> 
>|> >|> A dollar of debt is MUCH worse for the economy (assuming a reasonably
>|> >|> healthy economy with a reasonable demand for capital -- which we don't
>|> >|> have right now).
>|> >|> 
>|> 
>|> >How is it MUCH worse? [...]
>|> 
>|> But you cannot ignore the cost of money that must be paid for the
>|> borrowed funds.  Hence, not only are borrowing and taxing equally bad
>|> at the moment they occur, but in the borrowing case there must be
>|> subsequent taxation to pay the debt and the cost of the money.
>|> Overall, that looks more than twice as bad to me.  It's as if they are
>|> taxing twice, plus interest.
>|> 

>But debt is paid back with cheaper funds.  A dollar today is worth more
>than a dollar paid in 10, 20 or 30 years, even if there is no inflation.
>So while the cost of $1 of debt may be higher than the cost of $1 in
>tax, it is only the cost of the time value of money.  

But this is quite imprecise, since current interest rates for a
specific term of loan do NOT necessarily exactly meet the future cost
of that money, because that depends on things that we can't know in
advance, like the rate of inflation.  Hence, it is based instead on
EXPECTATION, which is relatively imprecise.  If the assumption when we
borrow is for 6% inflation and we only have 4% inflation, we are hurt
more by the incurred debt than we would be by a commensurate amount of
taxation.  This may operate the other way as well (and we pay less
than the money is worth).

In addition, debt is worse because it results in much worse crowding
out in the capital markets.  Consider.  For taxation and borrowing to
be equal in effect, you must assume that if you lower taxes and
increase borrowing that ALL the decrease in taxes goes into savings
(so as to become available in the capital pool).  Given our tax
structure, that is a VERY bad assumption.  I don't remember what the
tax breakdown across incomes is, but only at the upper income levels
is this even approximately true.  People at the lower income levels
tend to SPEND their extra income.  This causes demand-pull on the
economy, but no significant crowding out other than through the
mechanism of increased demand for credit by people who are producing
the goods that they buy (for expansions and such).  Of course, those
people who need credit to expand now have to compete with the Federal
government, who is also borrowing on the credit pool to finance the
tax reduction (and the credit pool did not grow by the amount that
their required borrowing because of reducing taxes grew).  The
reasoning just doesn't seem to support that taxation and borrowing are
equally bad.

>Also, as long
>as people believe the government will pay back the debt, additional
>funds can be raised.  A portion of these funds can be used to pay
>back the old debt and interest, i.e. the debt gets rolled over.  You
>may well argue that at some point taxes will be needed to cover debt
>repayment, so it would be better to not incur the debt today.  However,
>all you are doing is exchanging a probable tax increase in the future
>for a certain tax increase in the present.  Neither solution is good.
>The proper solution is to simply stop spending such a large percentage
>of GNP.  At lower levels, taxes or debt are not as economically damaging.

Neither is 'good', since the best of all possible worlds would have us
getting everything for nothing.  However, that's probably not going to
happen, so we need to make the best choices we have among the bad
ones.  And the discussion was about borrowing vs. taxing, with the
proposition put forward that they were equivalent.  I just don't find
that that proposition holds up upon examination.

-- 
"Insisting on perfect safety is for people who don't have the balls to live
 in the real world."   -- Mary Shafer, NASA Ames Dryden
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Fred.McCall@dseg.ti.com - I don't speak for others and they don't speak for me.
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