James M. Buchanan on public-debt finance.

• Author: Tempelman Jerry H.
• Position: PREDECESSORS

When James M. Buchanan was awarded the 1986 Alfred Nobel Memorial Prize in Economic Sciences for his seminal contributions to public-choice theory, the Royal Swedish Academy of Sciences mentioned his work on public-debt finance in only a single sentence of its press release. Buchanan himself, however, considers his work on public-debt finance to represent not merely a "side alley" or "digression" to his work on public-choice theory, but rather an "extension" or "application" thereof (Buchanan [1986] 1999a, 17-18): "The most elementary prediction from public choice theory is that in the absence of moral or constitutional constraints democracies will finance some share of current public consumption from debt issue rather than from taxation and that, in consequence, spending rates will be higher than would accrue under budget balance" ([1987] 2000c, 471, emphasis added).

The recently published twenty-volume series The Collected Works of James M. Buchanan contains ten monographs, two of which deal specifically with public-debt finance: Public Principles of Public Debt, originally published in 1958 (1999f), and Democracy in Deficit, cowritten with Richard E. Wagner and published in 1977 (2000a), volumes 2 and 8 in the series, respectively. In addition, there are nineteen papers, comments, book chapters, and encyclopedia articles on public debt, spread out over the remaining volumes but most contained in volume 14, Debt and Taxes. Taken as a whole, the writings span nearly four decades. (1)

Although Buchanan considers himself strictly an academic, not a political advocate, he has made an exception with regard to the issue of public-debt finance. During the 1980s and 1990s, he was an active participant in the political debate over enactment of a constitutional balanced-budget amendment. He explained in an interview: "Personally, I'm not the type of economist who does much testifying before Congress or for political parties. I'm very, very much ivory tower. The only policy issue at all that I've been on board with is the balanced budget: the constitutional change" (1995).

The political debate over government debt and deficits abated with the emergence of federal budget surpluses at the end of the Clinton administration, but the surpluses turned out to be a temporary phenomenon. Buchanan's work on public-debt finance clearly is as relevant today as it was when first published.

In this article, I provide a brief overview of Buchanan's work on public-debt finance. The presentation is organized in accordance with seven propositions distilled from Buchanan's writings. These propositions relate to the incidence of public debt, its economic consequences, Ricardian equivalence, Keynesian macroeconomics, the permanence of public debt, its moral consequences, and Buchanan's call for a constitutional balanced-budget amendment. Although many of Buchanan's views on public-debt finance are now widely accepted, they were not accepted when he originally advanced them. Even today, Buchanan's contributions remain greatly underappreciated.

The Incidence of Public Debt

Buchanan began his work on public-debt finance during the 1955-56 academic year, when he held a Fulbright research scholarship in Italy. "At the very end of the Italian year, I suddenly 'saw the light.' I realized that the whole conventional wisdom on public debt was simply wrong, and that the time had come for a restoration of the classical theory, which was correct in all its essentials ....Immediately on my return to America in 1956, I commenced my first singly-authored book, Public Principles of Public Debt" ([1986] 1999a, 18).

Buchanan's starting point in his investigation of public-debt finance is a consideration of its incidence. As he frames the question, Who pays for public debt, and when do they pay? His answer is that public debt constitutes a burden on future taxpayers: "The essence of public debt, as a financing institution, is that it allows the objective cost of currently financed expenditure projects to be postponed in time. For the taxpayer, public debt delays the necessity of transferring command over resource services to the treasury" ([1964] 2000d, 358).

Buchanan points out that bondholders lend voluntarily by choosing from among multiple investment opportunities, and in the future they receive back their invested principal plus interest. The voluntary nature of their lending shows that it makes them better off instead of worse off, so bondholders are clearly not the ones bearing the burden of government debt.

If an individual freely chooses to purchase a government bond, he is, presumably, moving to a preferred position on his utility surface by so doing. He has improved, not worsened, his lot by the transaction.... The economy, considered as the sum of the individual economic units within it, undergoes no sacrifice or burden when debt is created.... The fact that economic resources are given up when the public expenditure is made does not, in any way, demonstrate the existence of a sacrifice or burden on individual members of the social group.... It is not the bond purchaser who sacrifices any real economic resources anywhere in the process. He makes a presumably favorable exchange by shifting the time shape of his income stream." ([1958] 1999f, 28-32, emphasis in original) Thus, bondholders do not bear a burden by financing today's public expenditures. Because bondholders will eventually be repaid from the proceeds of future taxes, future taxpayers pay for today's debt-financed public expenditures and bear its real burden.

Buchanan interprets burden as a utility loss rather than a financial loss. He draws a distinction between subjective and objective costs ([1964] 1999d, 153-54), arguing that the voter-taxpayer's conception of the cost of debt is based on his subjective evaluation of forgone alternatives at the moment of choice, rather than on the objective effect of future cash flows of interest and principal: "'[C]ost' or 'burden' remains meaningless until and unless it can be translated into effects on some persons in the group at some time" ([1964] 2000d, 357). The objective cost is the actual "burden" of debt--namely, the value of resources sacrificed by future taxpayers ([1964] 1999d, 155). The decision to incur debt, however, is made by present taxpayers, based on an evaluation of the subjective cost to them, which is negligible in the case of public debt. (2)

As Buchanan himself points out, he was not the first to advance this view. He credits classical economists such as Henry C. Adams, Charles F. Bastable, and especially Paul Leroy-Beaulieu ([1958] 1999f, 82-86). At the time that he wrote Public Principles of Public Debt, however, these writers' ideas had been abandoned and replaced by the idea that the burden of public debt is born by present rather than future generations because "we owe it to ourselves" (Lerner 1948, 256). (3) Buchanan counters that in this statement "we" should be disaggregated into present-day people in their capacities as taxpayers and bondholders. The two do not offset because neither bears a burden. The aggregation expressed in the word we obscures the analysis. Indeed, the Lerner view is now widely discredited. Still, as an illustration of the underappreciation of Buchanan's views on public-debt finance, standard public-finance textbooks do not mention Buchanan's ([1958] 1999f) contribution, even as they continue to discuss the "we owe it to ourselves" argument (see, for example, Stiglitz 2000, 784, and Rosen 2002, 429-30). (4)

Public Debt and Capital Formation

In addition to the burden of principal repayment that falls on future generations, there is an economic cost of borrowing. Just as a lender receives interest in return for postponing consumption from the present to the future, so a borrower must pay interest for the ability to increase consumption in the present without paying for it until some time in the future. The interest payment has a negative effect on net wealth because using debt to finance increased consumption in the present permanently reduces the borrower's standard of living in the future. As Buchanan phrases it, "By financing current public outlay by debt, we are, in effect, chopping up the apple trees for firewood, thereby reducing the yield of the orchard forever" ([1986] 2000e, 447).

That borrowing has a cost does not mean that it is undesirable. Borrowing allows economic actors to align their actual consumption pattern more closely to their inter-temporal consumption preferences. So long as no one is forced to borrow, borrowing merely allows the borrower to reach a higher utility curve, as depicted by the standard...