Tag Archives: Future taxes eaten away

Government debt, not a free lunch

9 Dec

Posted by The Ethiopia Observatory (TEO)

by Kenneth Rogoff*

With borrowing costs at multi-decade lows, governments seemingly can take on much more debt without any great concern about long-term consequences. But the real risks and costs of higher public borrowing may be hidden.

CAMBRIDGE – With interest rates on government debt at multi-decade lows, a number of leading economists have argued that almost every advanced economy can allow debt to drift up toward Japanese levels (over 150% of GDP even by the most conservative measure) without any great concern about long-term consequences. Advocates of much higher debt might be right, but they tend to downplay or ignore everything that can go wrong.

First and foremost, the new view of debt understates the risks to other claimants on public tax revenues – such as pensioners, who might be thought of as junior debt holders in the twenty-first-century welfare state. After all, most social-security systems are debt-like in the sense that the government takes money from you now, and promises to pay it back with interest when you are old. And for governments, this “junior” debt is massive relative to the “senior” market debt that sits atop it.

Indeed, governments in OECD countries are currently paying out an average of 8% of GDP in old-age pensions, and a staggering 16% in the case of Italy and Greece. Actuarially, future taxes earmarked for paying pensions swamp future taxes earmarked for paying debt by a significant multiple, although many governments have been trying to adjust pensions downward gradually, as Europe did during the financial crisis, and Mexico and Brazil have done under duress more recently. Unfortunately, slow growth and aging populations mean much remains to be done.1

Thus, even if it seems that governments can take on much more debt without having to pay significantly higher market interest, the real risks and costs may be hidden. Economists Alan Auerbach and Laurence Kotlikoff made a similar point in an influential series of papers back in the 1990s.

Second, and perhaps even more critically, the current complacency regarding much higher debt implicitly assumes that the next crisis will look just like the last one in 2008, when interest rates on government debt collapsed. But history suggests that this is a dangerous assumption. For example, the next wave of crises could easily stem from a sudden realization that climate change is accelerating much faster than previously thought, requiring governments simultaneously to stall the capitalist engine and spend vast sums on preventive measures and remediation, not to mention dealing with climate refugees. And the next global conflagration could be a cyber war, with unknown ramifications for growth and interest rates.

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