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Dialogues concerning fiscal religion
Journal of Monetary Economics 4 (1978) 627-636. © North-Holland Publishing Company
DIALOGUES CONCERNING FISCAL RELIGION James M. BUCHANAN and Richard E. WAGNER Virginia Pol"
~nic Institute and State University, Blacksburg, VA 24061, U.S.A.
1. Introduction
In writing and in publishing Democracy hz Deficit, we were aware that we would arouse antagonism from many camps. We attacked ~he Keynesian orthodoxy in macroeconomic policy, yet for expository purposes we accepted the central features of the Keynesian model. We did this because we wanted to focus on the manner in which the Keynesian precepts would be applied within democratic political institutions. The Keynesian theory of policy proceeds as if policy is enacted by benevolent and omniscient despots. Our primary inquiry concerned the probable conduct of policy once we allowed for the obvious reality that results emerge through democratic processes. Our main emphasis was not with macroeconomic analysis as such, though aspects of our presumptions about macroeconomics appear in several places in Democracy in Deficit. As we acknowledged in the book, we do not deny that major unsettled issues remain in macroeconomic analysis, treated independently of the implementation of policy. And, of course, these issues deserve the efforts and attention of economists. But does not the 'political economy' of policy also merit notice ? Our macroeconomic position cannot be simply described by Keynesian, Monetarist, or Marxist. It is not, therefore, surprising that we have attracted the attention of a disparate set of critics. Before responding to the critics specifically, we should express our gratitude to Professor Karl Brunner for organizing this symposium, as well as to the critics who have made contributions. When all is said, the worst treatment authors can receive is neglect. Intelligent criticism carries its own mark of mutual respect. We hope that this brief response lives up to the standards of our critics.
2. Who were the Keynesians?
Professor Tobin reacts personally to our criticism of American Keynesians and in so doing he serio~ ' misinterprets our argument. If we can be allowed the occasional rhetorical nourish that may well have been misleading, we did nt~t intend to suggest that Keynesianism arrived full-blown in Washington in 1961.
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Keynesian economics was not really brought in denim carpetbags from Cambridge, Minneapolis, and New Haven, The policy advice of the 1962 Economic Report did not sweep out the long stagnant swamps in one blow. Had this interpretation described our reading of the historical record, we should have named more names, given credit where due, and we should have tried to cite line and verse. But surely such an interpretation gives far too much influence to the particular policy advisors of the early 1960s or of any other time. Keynesian economics came to Washington and to the consciousness of our politicians in fits and starts from the 1940s, through the 1950s, and into the 1960s. It came via the textbooks read by budding politicians of the whole postwar era; it came in the academic and intellectual discourse of the 1950s; it came in the financial and economic journalism of this period. We do not suggest that the Camelot economists pulled off a monumental coup and took control over the implementation of economic policy, as Tobin seems to think we do. Camelot economics merely represented the culmination of a protess in which the understanding of economic reality that informs public policy changed essentially from the Classical vision to the Keynesian. The dominant belief about our economic order came to be Keynesian. Our critique, therefore, was aimed at a generation of economists rather than at a handful of readily identifiable persons who, perchance, may have been in the vanguard when the politicians finally began to act out the repeated messages they had been receiving.
3. The theory of public debt At least three of our critics question the theory of public debt that our book embodies. Tobin charges that our argument is 'factually false' in attributing the 'no future burden' position to the Keynesian economists. This charge is again related in part to Tobin's misinterpretation of our targets. We challenge anyone to read the elementary textbooks of the 1945-65 period and to find more than the occasional passing reference to the future burden of public debt. The overwhelming preponderance of the discussion is on the other side, discussion that suggests the fallacy of the classical position rather than its elemental truth. ln!erestingly, in this respect, we could scarcely do better than to cite Tobin himsel~ who, in 1965, asked, and answered: 'Does debt-financing...place a "burden" on future generations? The answer has long been..."no" among academic economists. '~ Exegesis aside, however, do the Keynesians, even today, accept the theory of debt burden that we have tried to present, in Democrao' in Deficit and elsewhere ? I! Tobin correctly summarizes the Keynesian view it seems clear that they do not. He acknowledges the presence of 'future burden' only to the extent that 1James Tobin, 'The Burden of Public Debt: A Review Article, Journal t f Finance, 20 (December 1965), p. 679.
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capital accumulation is affected adversely by debt issue. But this possible effect of debt finance is only a by-product of its primary influence. By comparison with taxation, debt issue reduces the charges on current-period taxpayers, on voters, on legislators who are sensitive to voters' wishes, and increases charges on persons who will live and vote in future periods. This fact is too elementary to warrant repetition save for the continuing refusal of highly sophisticated economists to accept its logical consequences. Robert Barro fully appreciates the central issue in debt theory, and we welcome his constructive criticism of our thesis. We are encouraged that the longforgotten Ricardian equivalence theorem has found an elegant modern defender. Barro's suggestion that our own model of public debt is closer to the Keynesian than to the Ricardian is only partially correct, however, for the relations among the Ricardian, the Keynesian, and our theories of debt entails consideration of two separate dimensions. The Ricardian as well as our own says that public debt will shift the temporal location of the tax burden from taxpayers in the present to taxpayers in the future. In this respect, we stand with the Ricardians in opposition to the Keynesians. Taxpayers in the future will, of course, be either the same people as taxpayers in the present, only older, or children of taxpayers in the present. Barro suggests that present taxpayers will take full account of the future tax liability entailed by debt finance, in which event debt finance will be indistinguishable from tax finance in its impact. This identity results because present taxpayers will increase their saving in response to debt finance, and will do so in an amount sufficient to amortize the debt when it comes due. We differ from the Ricardians because we do not think that future taxes are fully discounted. We think that public debt is different from taxation precisely because we, unlike Barro, do not think that people act with an infinite-lived perspective. While the debate between us and the Ricardians should be open to empirical examination, let us be careful to avoid adding to existing confusion here. We are not concerned with the differential impact of these alternative financing instruments on the private economy. Our main concern is with how the issue of debt differs from taxation in its impact on the public economy. Niskanen is correct in noting that our proposition that debt finance will increase public spending because of its effect in reducing the perceived price of government entails the proposition that debt finance will increase aggregate spending. Nonetheless, our book is about the public sector import of debt finance. Our thesis suggests that an expanded use of debt finance will lower the perceived price of government, thereby producing a larger public budget. Niskanen presents evidence to support this thesis. Within a model of federal spending, Niskanen finds that a relative decrease in the importance of tax finance (a relative expansion in the use of debt finance) lends to an increase in federal spending, and with an elasticity of about 0.6, meaning that a $100 replacement of taxation by debt would increase public spending by about $60. Where does Niskanen's evidence leave Barro's proposition in support of the
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Ricardian Equivalence Theorem ? If debt is viewed as less costly than taxation, ,why would tax finance be used at all ? Perhaps we should distinguish between average and marginal perceptions here. If public expenditure is viewed as less costly when financed by debt than when financed by taxation, there would seem to be strong tendencies for borrowing to take place. Suppose we postulate the reasonable proposition that the perceived cost of any source of revenue rises ,with the use made of that source. An equilibrium distribution between debt and 1Laxation would result when the marginal perceived costs were equal. At this margin, the Ricardian Theorem would come into effect. Yet in total terms debt finance will have increased public spending. In closing this section we may discuss briefly the empirical indications that are used to signify a proclivity toward debt finance. Both Barro and Gordon suggest that we have interpreted the post-World War II period incorrectly because the ratio of debt to GNP has been declining over this period. Barro further suggests that the identical pattern of or declining debt/GNP ratio holds for all postwar periods, and uses this observat;on to suggest there been has no change in the historical pattern of debt finance. We contend that debt/GNP ratios are inappropriate for the analytical task at hand, and that actual amounts of debt are the appropriate magnitudes. What we are concerned with is action by individuals in a political context. The patterns ofa debt/GNP ratio is irrelevant to such rational political action. What is relevant is that the ability to borrow reduces the price of government below what it would have been had only tax finance been used: This, and only this, is what is relevant to our thesis. That the ratio ofdebt to GNP is declining is of no behavioral relevance. The observed behavior of politicians and the observed patterns of policy discussion also support our central hypothesis. We do not find politicians generally indifferent between tax finance and debt finance. This absence of indifference would seem to suggest that the Ricardian Equivalence Theorem is not fully descriptive of economic reality. Historically, the discussion of public debt in the pre-Keynesian era was accompanied by discussion of sinking funds to provide for debt amortization. A sinking fund is, in fact, an institutional arrangement that has the effect of approximating the results described by the Ricardian Theorem. Moreover, we still observe debt limits at all levels of government. These considerations suggest that, in all ages, political action has been on our side of the issue in question, recognizing the need for constitutionalinstitutional arrangements to constrain the tendencies toward debt finance.
4. Rational expectations and public choice: A cautionary criticism Barro's reconstruction of the Ricardian Theorem on public debt is derivative from the rational expectations hypothesis in the theory of macroeconomic policy, a development to which Barro himself has made major contributions. As
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we noted in our book, we do not accept the thesis that the implications of rationality are the same for both private choice and public choice. We submit that the particular manifestations of rational economic conduct depen~l on the institutional setting within which choice takes place. People may be basically rational in all conduct, but the outcomes of choice will still vary as between market choice and public choice. We shall limit our remarks here to Barro's extension of rational expectations to public-debt theory. In the theory of market exchange, so long as a sufficient number of participants possess the knowledge to act efficiently, the results are equivalent to those that would emerge if all participants should possess this knowledge. So long as a sufficient number of tra~ers possess information and act in response to it, the marginal adjustments will insure movements toward equilibrium positions that are indistinguishable from those produced under vniversal omniscience over all traders. When, however, we extend the usage of economic tools to the explanation of behavior in nonmarket situations, the generalization of the rationality postulate must be made with considerably more prudence. Not that people are necessarily less rational, but that the informational foundations for economic conduct are weaker. Relatedly, the absence of a profit motive in government weakens the incentive to act on the knowledge that is possessed. These differences mean that there may not exist opportunities which enable those participants who possess the appropriate infermation to act so as to generate equilibrium results equivalent to those produced by universal omniscience. Consider a simple example. In a competitive labor market for carpenters and plumbers, there may b~ no more than five percent of the workers in the total community who may detect a difference in returns to the two occupations, and be willing to change occupations in consequence. But the willingness to shift to this small number may be enough to insure that wage rates of carpenters and plumbers will be equalized, a result that would, of course, also be produced if all workers in the community should know about the wage difference and be willing to shift employments in response. Consider now, how'ever, a setting in which individuals must 'vote' on a pair of alternatives, say, betw,-en the debt-financing and the tax-financing of a specific governmental outlay. Assume, as in our market example, that five percent of the voters are fully informed in that they, and only they, realize that the tv,'o alternati~,es are equivalent in present-value terms. The remaining ninety-five percent of the voters do not sense the equivalence, but instead view the debt alternative as being less costly than tax finance. Do there exist opportunities through ~hich those whose actions correspond with the predictions of economic theory can bring the results into equivalence with those that might be forthcoming in a market setting? It scems to us that such opportunities are indeed limited, and that the median voter ,~vill likely be among the uninformed in the public choice that must be made as between taxation and debt creation.
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We should never lose sight of the fact that traditional economic theory works so well, in spite of the questionable status of the usual presumptions about knowledge, because values are set at the margins. In public choice theory, by contrast, there is little scope for arbitrage through the actions of a few people at the margin, at least in the simple models of democratic process. A recognition of this basic difference between market and political institutions suggests that propositions derived from a model of market choice cannot be applied automatically to public choice. Consequently, much more attention should be given to the way in which information flows, learning motivations, and institutional constraints may make political or public-choice outcomes different from those that would be predicted to e~a~ergeunder market choice.
5. The two hypotheses William Ni~kanen empirically examines two hypotheses that are suggested in our book. While his evidence supports the thesis that deficits increase public outlays, it rejects the thesis that deficits produce inflation via the stimulus given to money expansion. Barro similarly finds no support for the proposition that deficits influence the supply of money. Ultimately, of course, we need a theory of the money supply process if we are to understand the relation between deficits and monetary expansion. Our examination of the relation between Federal Reserve actions and the desires of the legislature is not, of course, a theory of the money supply process. Rather, our observations on this topic simply express the importance of recognizing that the Federal Rcgerve is not truly independent of the legislature. Hence, legislative desires to spend in excess of the revenues will, when combined with a desire not to let the increased demand for loanable funds that results from the government's borrowing ~equirements drive up interest rates and crowd out private investment, not general!y be neutralized by the Federal Rese, ve. In our framework, the rate of expansion in the supply of money will be elastic with respect to public deficits. Other s ariables would also go into a full model of the money supply process. Questions of the interpretation of empirical evidence depends, of course, on the acceptability of the model used for testing. While we have some questions about the models of the money supply process advanced by Barro and Niskanen, this symposium is not the place to initiate an examination of the theory of money supi:~iy. It suffices to say here that we find Barro's and Niskanen's results and formZations suggestive, though not definitive. Barro finds a positive relation between deficits and the supply of money until he introduces a '~ariable to account for the impact of the difference between actual and 'normal' expenditures upon the supply of money. While Barro interprets this variable as accounting for wartime increases and recessionary falls in spending, it also picks up a period of rising expenditure because of the adaptive lag structure he uses. This gets us ri~,Jat back to the question of the relation among deficits, money, and government
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spending. Niskanen similarly found a positive relation between deficits and the supply of money. By bringing in a dummy variable for the period since 1966, Niskanen also found the relation between deficits and the supply of money to disappear. But what accounts for the shift in the money supply process that occurred in the mid-1960s ? Perhaps the three of us are not in that much disagreement after all. We will need more work on the theory of the supply of money before we can tell. There are s~,me other questions that can be raised about the causal relationship between budget deficits and the growth of government. In his paper, Donald Gordon identifies a vulnerable aspect of our argument, an aspect that had also been emphasized by Victor Goldberg in his comments on a prepublication draft of the manuscript. Our hypothesis does not 'explain' the observed explosion in state-local spending in postwar decades, even after we have made adjustments for central government grants, matching requirements, administrative and judicial mandates, and other Federal pressures. Niskanen's evidence supports our reasoning that debt finance will lead to expanded government spending because debt reduces the perceived price of government. This proportion would seem as true foc local government as for the federal government. But the money creating power of the federal government would also seem to give an added impetus to expansions in federal spending. Yet the growth in state-local spending remains a puzzle. Once again, of course, we must not mistake a particular coefficient for an entire model. Spending increases for many reasons, with debt finance being only one reason. It is always possible that these other factors required to describe a complete model wo'ald operate to increase state-local spending more rapidly than federal. In the absence of such a model, the implications of different rates of spending growth for our theory about debt finance must remain open-ended. Perhaps Gordon is correct: perhaps even with strict budget balance and without the Keynesian theory of economic policy, we should have had roughly the spending explosion we have observed. Perhaps history cannot be 'explained,' even in part, by the influence of the ideas of academic scribblers. If this is the case, we had as well join those of our colleagues who engage in the escapist worlds of puzzles, theorems, and proofs. But in some final sense, we simply refuse to believe that people, and their ideas, cannot exert some control over events.
6. The model of political process Craig Roberts accuses us of political naivet6. He offers an alternative explanation of the factual record by postulating a model of a monolithic government bent on furthering its own interest, which translates cirectly into maximization of the size of the public sector. Keynesian economics, in Roberts' view, was used merely as the apologetics for the massive power grab that we have witnessed
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since the close of World War II. His explanation requi~es no resort to error, illusion, or institutio::al influence. The actors in his model are coldly rational, and they know quite well what they want and how to get it. The last part of Donald Gordon's paper finds common ground with Craig Roberts' critique. Gordon suggests the possible contradiction between the position taken in Budgets and Bureaucrats, 2 and that represented in Democracy ht Deficit. In the former, the behavior of a partially independent and uncontrollable bureaucracy in generating the observed acceleration in the growth of government was the focus of attention. The existence of this force need not, however, preclude the complementary element discussed in our book. We make no claim that the Keynesian bias is the only significant explanatory factor. Our purpose was to isolate this ilacter and to examine its influence c~itically. There seems to us to be no inconsistency in examining other factors, at other times and places, that may either offset or complement the one that was treated in our book. We do not deny the apparent correspondence of many aspects of the monopolygovernment model and the reality that we observe. But we share with Tobin the view that such a fully-closed model leaves no room at all for normatively inspired policy discussion. If all that we can do is describe the behavior of selfseeking agents who act on behalf of the government, what is the point of our activity as economists ? Surely, there must be improvement that is possible, and surely there is some role for economists in achieving this. At this level of discussion, our position is somewhere between Tobin on the one hand and Roberts on the other. We do not despair of offering normative policy advice, as Roberts" model implies we should. But we do not expect ordinary politicians to have the wisdom of saints, as Tobin's position implies we should. We are neither elitist nor z,athoritarian, unless these labels should be a',tached to anyone who honestly tries to evaluate the limits of representative democracy in economic policy management. When these limits are acknowledged (and we suggest tha~ they must be), we take a stand quite explicitly for the introduction of constraining rules, for an explicit fiscal constitution, that will keep the political excesses within bounds. It is toward the development and implementation of such rules that our own normative channels for improvement lie. Roberts would, if put to it, have to call the existing situation hopeless; Tobin would have to look for wiser men in politics: we hope for constraining rules based on reasoned consideration of political reality. We do not suggest that the constraining rules advanced in our book are optimal in any orthodox sense of this term. (We do not quite know what "optimal' means in such contexts, and we are simply at a loss when Gordon starts talking about the 'optimal' size of public debt.) We agree with Tobin that much analysis and dialogae is required, but we do insist that normative policy discussion shift 2See, Bt,.dg~ts and Bureaucrats: Sot, rces of Government Growth, edited by T. E. Borcherding (Durham: Duke University Press, 1977).
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to the level of alternative rules as opposed to alternative policy expedients within the existing political process. We do not think that an effective fiscal-monetary constitution would resolve all of the difficulties of our time, nor do we think that its absence caused the Viet Nam war. Our claims are much more modest; an effective fiscal-monetary constitution can exert directionally-desired influences on political decision-makers, and through a recognition of such influences, can introduce stabilizing elements in the economy. 7. The question of macroeconomic perspective Barro and Tobin suggested that we should have made more of a direct contribution to macroeconomics. To do this would have been to adopt a quite different purpose for our analysis than the one we chose to adopt. Our main interest was simply in treating seriously the straightforward observation that politicians, not economists, make economic policy. The economic impact of the economic policy that emerges from the political process does, of course, depend on the character of the economic order. In considering this impact, we do possess a macroeconomic perspective, and this perspective was revealed at several places in our book. Indeed, it is recognition of the political implementation of economic policy as filtered through our macroeconomic perspective that allows us to portray the economic consequence of Keynesian policy to be harmful. In our view the economic order is essentially stable, and monetary disturbance operates in nonneutral fashion in ~he short run. 3 An institutional framework that promoted monetary and fiscal stability would facilitate the coordinative properties of the market economy. The implementation of economic policy within the existing institutional framework, however, acts to generate economic instability. The price signals in the market economy are distorted by policy, so economic discoordination zesults. When the observed state of economic circumstances is filtered through the Ke) nesian vision of the economic order, however, economic management to correct the economic discoordination seems to be called far. An economy that is distinctly non-Keynesian in nature can appear to be Keyncsian through the implementation of economic policy. Our vie,~vs on n~acroeconomi,:s, in other words, enable us to describe the political biases of Keynesian economic policy as something distinctly harmful and responsible for economic malaise.
8. Conclusion Democracy hi Deficit ~vas completed in the summer of 1976. Since that time, we have had two additional years of budgetary history. These years ha;'c q~". 3See, for instance, Richard E. Wagner, 'Economic Manipulation for Political Profit: Macroeconomic Consequences and Constitutional Implications,' Kyklos, 30, no. 3 (1977), pp. 395-410.
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refuted the book's centr~,l Lypothesis that the United States has embarked on a regime of permanent de:fici~ financing of significant, and possibly accelerating, scope. We acknowledge in the book, and we reaffirm here, that our purpose was, and is, in part that of constr active dialogue. Only by predicting the consequences of observed processes in advance can these consequences be avoided if they are deemed to be undesirable. We do not need to fall off the cliff in order to convince ourselves that, empirically, the cliff is there. Is it not far better to find out in advance that the cliff is ahead and that we still might prevent disaster if we can reverse direction ? We do not accept the charge that we presented no analysis, as such, in the book. We attempt to analyze the workings of political institutions through which macroeconomic policy has been made in the post-Keynesian era. We invite other economists to do the same thing. Our analysis may be incorrect, in the large or in the small. We may not be cynical enough in modelling the behavior of public choosers, as Craig Roberts suggests. Or we may not attribute a sufficient degree of rationality (and political control) to the ultimate taxpayer-voter, as Barro urges. Or perhaps the quantitatively measurable record does not bear our analysis empirically, in some respects, as both Niskanen and Gordon suggest. We are institutionalists in the sense that we think that arrangements or rules do affect outcomes. Ultimately the test of our analysis of politics, and our interpretation of the histc.rical record will stand or fall on empirical grounds. But our concern is that the ,:vidence required to convince recalcitrant professional colleagues may arrive too late to allow the necessary constitutional reforms to be introduced in time to be effective. Quite frankly, we are more interested in opening a dialogue that may generate preventive steps than we are in achieving simon pure empirical credentials or as being labeled as belong!ng to this or that camp or school. There is, indeed, a deal of ruin in a nation, as Adam Smith assured us. But defensive dialogue is essential to preserve that which remain~ vulnerable to those forces that would do the dealing.
DIALOGUES CONCERNING FISCAL RELIGION James M. BUCHANAN and Richard E. WAGNER Virginia Pol"
~nic Institute and State University, Blacksburg, VA 24061, U.S.A.
1. Introduction
In writing and in publishing Democracy hz Deficit, we were aware that we would arouse antagonism from many camps. We attacked ~he Keynesian orthodoxy in macroeconomic policy, yet for expository purposes we accepted the central features of the Keynesian model. We did this because we wanted to focus on the manner in which the Keynesian precepts would be applied within democratic political institutions. The Keynesian theory of policy proceeds as if policy is enacted by benevolent and omniscient despots. Our primary inquiry concerned the probable conduct of policy once we allowed for the obvious reality that results emerge through democratic processes. Our main emphasis was not with macroeconomic analysis as such, though aspects of our presumptions about macroeconomics appear in several places in Democracy in Deficit. As we acknowledged in the book, we do not deny that major unsettled issues remain in macroeconomic analysis, treated independently of the implementation of policy. And, of course, these issues deserve the efforts and attention of economists. But does not the 'political economy' of policy also merit notice ? Our macroeconomic position cannot be simply described by Keynesian, Monetarist, or Marxist. It is not, therefore, surprising that we have attracted the attention of a disparate set of critics. Before responding to the critics specifically, we should express our gratitude to Professor Karl Brunner for organizing this symposium, as well as to the critics who have made contributions. When all is said, the worst treatment authors can receive is neglect. Intelligent criticism carries its own mark of mutual respect. We hope that this brief response lives up to the standards of our critics.
2. Who were the Keynesians?
Professor Tobin reacts personally to our criticism of American Keynesians and in so doing he serio~ ' misinterprets our argument. If we can be allowed the occasional rhetorical nourish that may well have been misleading, we did nt~t intend to suggest that Keynesianism arrived full-blown in Washington in 1961.
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Keynesian economics was not really brought in denim carpetbags from Cambridge, Minneapolis, and New Haven, The policy advice of the 1962 Economic Report did not sweep out the long stagnant swamps in one blow. Had this interpretation described our reading of the historical record, we should have named more names, given credit where due, and we should have tried to cite line and verse. But surely such an interpretation gives far too much influence to the particular policy advisors of the early 1960s or of any other time. Keynesian economics came to Washington and to the consciousness of our politicians in fits and starts from the 1940s, through the 1950s, and into the 1960s. It came via the textbooks read by budding politicians of the whole postwar era; it came in the academic and intellectual discourse of the 1950s; it came in the financial and economic journalism of this period. We do not suggest that the Camelot economists pulled off a monumental coup and took control over the implementation of economic policy, as Tobin seems to think we do. Camelot economics merely represented the culmination of a protess in which the understanding of economic reality that informs public policy changed essentially from the Classical vision to the Keynesian. The dominant belief about our economic order came to be Keynesian. Our critique, therefore, was aimed at a generation of economists rather than at a handful of readily identifiable persons who, perchance, may have been in the vanguard when the politicians finally began to act out the repeated messages they had been receiving.
3. The theory of public debt At least three of our critics question the theory of public debt that our book embodies. Tobin charges that our argument is 'factually false' in attributing the 'no future burden' position to the Keynesian economists. This charge is again related in part to Tobin's misinterpretation of our targets. We challenge anyone to read the elementary textbooks of the 1945-65 period and to find more than the occasional passing reference to the future burden of public debt. The overwhelming preponderance of the discussion is on the other side, discussion that suggests the fallacy of the classical position rather than its elemental truth. ln!erestingly, in this respect, we could scarcely do better than to cite Tobin himsel~ who, in 1965, asked, and answered: 'Does debt-financing...place a "burden" on future generations? The answer has long been..."no" among academic economists. '~ Exegesis aside, however, do the Keynesians, even today, accept the theory of debt burden that we have tried to present, in Democrao' in Deficit and elsewhere ? I! Tobin correctly summarizes the Keynesian view it seems clear that they do not. He acknowledges the presence of 'future burden' only to the extent that 1James Tobin, 'The Burden of Public Debt: A Review Article, Journal t f Finance, 20 (December 1965), p. 679.
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capital accumulation is affected adversely by debt issue. But this possible effect of debt finance is only a by-product of its primary influence. By comparison with taxation, debt issue reduces the charges on current-period taxpayers, on voters, on legislators who are sensitive to voters' wishes, and increases charges on persons who will live and vote in future periods. This fact is too elementary to warrant repetition save for the continuing refusal of highly sophisticated economists to accept its logical consequences. Robert Barro fully appreciates the central issue in debt theory, and we welcome his constructive criticism of our thesis. We are encouraged that the longforgotten Ricardian equivalence theorem has found an elegant modern defender. Barro's suggestion that our own model of public debt is closer to the Keynesian than to the Ricardian is only partially correct, however, for the relations among the Ricardian, the Keynesian, and our theories of debt entails consideration of two separate dimensions. The Ricardian as well as our own says that public debt will shift the temporal location of the tax burden from taxpayers in the present to taxpayers in the future. In this respect, we stand with the Ricardians in opposition to the Keynesians. Taxpayers in the future will, of course, be either the same people as taxpayers in the present, only older, or children of taxpayers in the present. Barro suggests that present taxpayers will take full account of the future tax liability entailed by debt finance, in which event debt finance will be indistinguishable from tax finance in its impact. This identity results because present taxpayers will increase their saving in response to debt finance, and will do so in an amount sufficient to amortize the debt when it comes due. We differ from the Ricardians because we do not think that future taxes are fully discounted. We think that public debt is different from taxation precisely because we, unlike Barro, do not think that people act with an infinite-lived perspective. While the debate between us and the Ricardians should be open to empirical examination, let us be careful to avoid adding to existing confusion here. We are not concerned with the differential impact of these alternative financing instruments on the private economy. Our main concern is with how the issue of debt differs from taxation in its impact on the public economy. Niskanen is correct in noting that our proposition that debt finance will increase public spending because of its effect in reducing the perceived price of government entails the proposition that debt finance will increase aggregate spending. Nonetheless, our book is about the public sector import of debt finance. Our thesis suggests that an expanded use of debt finance will lower the perceived price of government, thereby producing a larger public budget. Niskanen presents evidence to support this thesis. Within a model of federal spending, Niskanen finds that a relative decrease in the importance of tax finance (a relative expansion in the use of debt finance) lends to an increase in federal spending, and with an elasticity of about 0.6, meaning that a $100 replacement of taxation by debt would increase public spending by about $60. Where does Niskanen's evidence leave Barro's proposition in support of the
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Ricardian Equivalence Theorem ? If debt is viewed as less costly than taxation, ,why would tax finance be used at all ? Perhaps we should distinguish between average and marginal perceptions here. If public expenditure is viewed as less costly when financed by debt than when financed by taxation, there would seem to be strong tendencies for borrowing to take place. Suppose we postulate the reasonable proposition that the perceived cost of any source of revenue rises ,with the use made of that source. An equilibrium distribution between debt and 1Laxation would result when the marginal perceived costs were equal. At this margin, the Ricardian Theorem would come into effect. Yet in total terms debt finance will have increased public spending. In closing this section we may discuss briefly the empirical indications that are used to signify a proclivity toward debt finance. Both Barro and Gordon suggest that we have interpreted the post-World War II period incorrectly because the ratio of debt to GNP has been declining over this period. Barro further suggests that the identical pattern of or declining debt/GNP ratio holds for all postwar periods, and uses this observat;on to suggest there been has no change in the historical pattern of debt finance. We contend that debt/GNP ratios are inappropriate for the analytical task at hand, and that actual amounts of debt are the appropriate magnitudes. What we are concerned with is action by individuals in a political context. The patterns ofa debt/GNP ratio is irrelevant to such rational political action. What is relevant is that the ability to borrow reduces the price of government below what it would have been had only tax finance been used: This, and only this, is what is relevant to our thesis. That the ratio ofdebt to GNP is declining is of no behavioral relevance. The observed behavior of politicians and the observed patterns of policy discussion also support our central hypothesis. We do not find politicians generally indifferent between tax finance and debt finance. This absence of indifference would seem to suggest that the Ricardian Equivalence Theorem is not fully descriptive of economic reality. Historically, the discussion of public debt in the pre-Keynesian era was accompanied by discussion of sinking funds to provide for debt amortization. A sinking fund is, in fact, an institutional arrangement that has the effect of approximating the results described by the Ricardian Theorem. Moreover, we still observe debt limits at all levels of government. These considerations suggest that, in all ages, political action has been on our side of the issue in question, recognizing the need for constitutionalinstitutional arrangements to constrain the tendencies toward debt finance.
4. Rational expectations and public choice: A cautionary criticism Barro's reconstruction of the Ricardian Theorem on public debt is derivative from the rational expectations hypothesis in the theory of macroeconomic policy, a development to which Barro himself has made major contributions. As
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we noted in our book, we do not accept the thesis that the implications of rationality are the same for both private choice and public choice. We submit that the particular manifestations of rational economic conduct depen~l on the institutional setting within which choice takes place. People may be basically rational in all conduct, but the outcomes of choice will still vary as between market choice and public choice. We shall limit our remarks here to Barro's extension of rational expectations to public-debt theory. In the theory of market exchange, so long as a sufficient number of participants possess the knowledge to act efficiently, the results are equivalent to those that would emerge if all participants should possess this knowledge. So long as a sufficient number of tra~ers possess information and act in response to it, the marginal adjustments will insure movements toward equilibrium positions that are indistinguishable from those produced under vniversal omniscience over all traders. When, however, we extend the usage of economic tools to the explanation of behavior in nonmarket situations, the generalization of the rationality postulate must be made with considerably more prudence. Not that people are necessarily less rational, but that the informational foundations for economic conduct are weaker. Relatedly, the absence of a profit motive in government weakens the incentive to act on the knowledge that is possessed. These differences mean that there may not exist opportunities which enable those participants who possess the appropriate infermation to act so as to generate equilibrium results equivalent to those produced by universal omniscience. Consider a simple example. In a competitive labor market for carpenters and plumbers, there may b~ no more than five percent of the workers in the total community who may detect a difference in returns to the two occupations, and be willing to change occupations in consequence. But the willingness to shift to this small number may be enough to insure that wage rates of carpenters and plumbers will be equalized, a result that would, of course, also be produced if all workers in the community should know about the wage difference and be willing to shift employments in response. Consider now, how'ever, a setting in which individuals must 'vote' on a pair of alternatives, say, betw,-en the debt-financing and the tax-financing of a specific governmental outlay. Assume, as in our market example, that five percent of the voters are fully informed in that they, and only they, realize that the tv,'o alternati~,es are equivalent in present-value terms. The remaining ninety-five percent of the voters do not sense the equivalence, but instead view the debt alternative as being less costly than tax finance. Do there exist opportunities through ~hich those whose actions correspond with the predictions of economic theory can bring the results into equivalence with those that might be forthcoming in a market setting? It scems to us that such opportunities are indeed limited, and that the median voter ,~vill likely be among the uninformed in the public choice that must be made as between taxation and debt creation.
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We should never lose sight of the fact that traditional economic theory works so well, in spite of the questionable status of the usual presumptions about knowledge, because values are set at the margins. In public choice theory, by contrast, there is little scope for arbitrage through the actions of a few people at the margin, at least in the simple models of democratic process. A recognition of this basic difference between market and political institutions suggests that propositions derived from a model of market choice cannot be applied automatically to public choice. Consequently, much more attention should be given to the way in which information flows, learning motivations, and institutional constraints may make political or public-choice outcomes different from those that would be predicted to e~a~ergeunder market choice.
5. The two hypotheses William Ni~kanen empirically examines two hypotheses that are suggested in our book. While his evidence supports the thesis that deficits increase public outlays, it rejects the thesis that deficits produce inflation via the stimulus given to money expansion. Barro similarly finds no support for the proposition that deficits influence the supply of money. Ultimately, of course, we need a theory of the money supply process if we are to understand the relation between deficits and monetary expansion. Our examination of the relation between Federal Reserve actions and the desires of the legislature is not, of course, a theory of the money supply process. Rather, our observations on this topic simply express the importance of recognizing that the Federal Rcgerve is not truly independent of the legislature. Hence, legislative desires to spend in excess of the revenues will, when combined with a desire not to let the increased demand for loanable funds that results from the government's borrowing ~equirements drive up interest rates and crowd out private investment, not general!y be neutralized by the Federal Rese, ve. In our framework, the rate of expansion in the supply of money will be elastic with respect to public deficits. Other s ariables would also go into a full model of the money supply process. Questions of the interpretation of empirical evidence depends, of course, on the acceptability of the model used for testing. While we have some questions about the models of the money supply process advanced by Barro and Niskanen, this symposium is not the place to initiate an examination of the theory of money supi:~iy. It suffices to say here that we find Barro's and Niskanen's results and formZations suggestive, though not definitive. Barro finds a positive relation between deficits and the supply of money until he introduces a '~ariable to account for the impact of the difference between actual and 'normal' expenditures upon the supply of money. While Barro interprets this variable as accounting for wartime increases and recessionary falls in spending, it also picks up a period of rising expenditure because of the adaptive lag structure he uses. This gets us ri~,Jat back to the question of the relation among deficits, money, and government
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spending. Niskanen similarly found a positive relation between deficits and the supply of money. By bringing in a dummy variable for the period since 1966, Niskanen also found the relation between deficits and the supply of money to disappear. But what accounts for the shift in the money supply process that occurred in the mid-1960s ? Perhaps the three of us are not in that much disagreement after all. We will need more work on the theory of the supply of money before we can tell. There are s~,me other questions that can be raised about the causal relationship between budget deficits and the growth of government. In his paper, Donald Gordon identifies a vulnerable aspect of our argument, an aspect that had also been emphasized by Victor Goldberg in his comments on a prepublication draft of the manuscript. Our hypothesis does not 'explain' the observed explosion in state-local spending in postwar decades, even after we have made adjustments for central government grants, matching requirements, administrative and judicial mandates, and other Federal pressures. Niskanen's evidence supports our reasoning that debt finance will lead to expanded government spending because debt reduces the perceived price of government. This proportion would seem as true foc local government as for the federal government. But the money creating power of the federal government would also seem to give an added impetus to expansions in federal spending. Yet the growth in state-local spending remains a puzzle. Once again, of course, we must not mistake a particular coefficient for an entire model. Spending increases for many reasons, with debt finance being only one reason. It is always possible that these other factors required to describe a complete model wo'ald operate to increase state-local spending more rapidly than federal. In the absence of such a model, the implications of different rates of spending growth for our theory about debt finance must remain open-ended. Perhaps Gordon is correct: perhaps even with strict budget balance and without the Keynesian theory of economic policy, we should have had roughly the spending explosion we have observed. Perhaps history cannot be 'explained,' even in part, by the influence of the ideas of academic scribblers. If this is the case, we had as well join those of our colleagues who engage in the escapist worlds of puzzles, theorems, and proofs. But in some final sense, we simply refuse to believe that people, and their ideas, cannot exert some control over events.
6. The model of political process Craig Roberts accuses us of political naivet6. He offers an alternative explanation of the factual record by postulating a model of a monolithic government bent on furthering its own interest, which translates cirectly into maximization of the size of the public sector. Keynesian economics, in Roberts' view, was used merely as the apologetics for the massive power grab that we have witnessed
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since the close of World War II. His explanation requi~es no resort to error, illusion, or institutio::al influence. The actors in his model are coldly rational, and they know quite well what they want and how to get it. The last part of Donald Gordon's paper finds common ground with Craig Roberts' critique. Gordon suggests the possible contradiction between the position taken in Budgets and Bureaucrats, 2 and that represented in Democracy ht Deficit. In the former, the behavior of a partially independent and uncontrollable bureaucracy in generating the observed acceleration in the growth of government was the focus of attention. The existence of this force need not, however, preclude the complementary element discussed in our book. We make no claim that the Keynesian bias is the only significant explanatory factor. Our purpose was to isolate this ilacter and to examine its influence c~itically. There seems to us to be no inconsistency in examining other factors, at other times and places, that may either offset or complement the one that was treated in our book. We do not deny the apparent correspondence of many aspects of the monopolygovernment model and the reality that we observe. But we share with Tobin the view that such a fully-closed model leaves no room at all for normatively inspired policy discussion. If all that we can do is describe the behavior of selfseeking agents who act on behalf of the government, what is the point of our activity as economists ? Surely, there must be improvement that is possible, and surely there is some role for economists in achieving this. At this level of discussion, our position is somewhere between Tobin on the one hand and Roberts on the other. We do not despair of offering normative policy advice, as Roberts" model implies we should. But we do not expect ordinary politicians to have the wisdom of saints, as Tobin's position implies we should. We are neither elitist nor z,athoritarian, unless these labels should be a',tached to anyone who honestly tries to evaluate the limits of representative democracy in economic policy management. When these limits are acknowledged (and we suggest tha~ they must be), we take a stand quite explicitly for the introduction of constraining rules, for an explicit fiscal constitution, that will keep the political excesses within bounds. It is toward the development and implementation of such rules that our own normative channels for improvement lie. Roberts would, if put to it, have to call the existing situation hopeless; Tobin would have to look for wiser men in politics: we hope for constraining rules based on reasoned consideration of political reality. We do not suggest that the constraining rules advanced in our book are optimal in any orthodox sense of this term. (We do not quite know what "optimal' means in such contexts, and we are simply at a loss when Gordon starts talking about the 'optimal' size of public debt.) We agree with Tobin that much analysis and dialogae is required, but we do insist that normative policy discussion shift 2See, Bt,.dg~ts and Bureaucrats: Sot, rces of Government Growth, edited by T. E. Borcherding (Durham: Duke University Press, 1977).
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to the level of alternative rules as opposed to alternative policy expedients within the existing political process. We do not think that an effective fiscal-monetary constitution would resolve all of the difficulties of our time, nor do we think that its absence caused the Viet Nam war. Our claims are much more modest; an effective fiscal-monetary constitution can exert directionally-desired influences on political decision-makers, and through a recognition of such influences, can introduce stabilizing elements in the economy. 7. The question of macroeconomic perspective Barro and Tobin suggested that we should have made more of a direct contribution to macroeconomics. To do this would have been to adopt a quite different purpose for our analysis than the one we chose to adopt. Our main interest was simply in treating seriously the straightforward observation that politicians, not economists, make economic policy. The economic impact of the economic policy that emerges from the political process does, of course, depend on the character of the economic order. In considering this impact, we do possess a macroeconomic perspective, and this perspective was revealed at several places in our book. Indeed, it is recognition of the political implementation of economic policy as filtered through our macroeconomic perspective that allows us to portray the economic consequence of Keynesian policy to be harmful. In our view the economic order is essentially stable, and monetary disturbance operates in nonneutral fashion in ~he short run. 3 An institutional framework that promoted monetary and fiscal stability would facilitate the coordinative properties of the market economy. The implementation of economic policy within the existing institutional framework, however, acts to generate economic instability. The price signals in the market economy are distorted by policy, so economic discoordination zesults. When the observed state of economic circumstances is filtered through the Ke) nesian vision of the economic order, however, economic management to correct the economic discoordination seems to be called far. An economy that is distinctly non-Keynesian in nature can appear to be Keyncsian through the implementation of economic policy. Our vie,~vs on n~acroeconomi,:s, in other words, enable us to describe the political biases of Keynesian economic policy as something distinctly harmful and responsible for economic malaise.
8. Conclusion Democracy hi Deficit ~vas completed in the summer of 1976. Since that time, we have had two additional years of budgetary history. These years ha;'c q~". 3See, for instance, Richard E. Wagner, 'Economic Manipulation for Political Profit: Macroeconomic Consequences and Constitutional Implications,' Kyklos, 30, no. 3 (1977), pp. 395-410.
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refuted the book's centr~,l Lypothesis that the United States has embarked on a regime of permanent de:fici~ financing of significant, and possibly accelerating, scope. We acknowledge in the book, and we reaffirm here, that our purpose was, and is, in part that of constr active dialogue. Only by predicting the consequences of observed processes in advance can these consequences be avoided if they are deemed to be undesirable. We do not need to fall off the cliff in order to convince ourselves that, empirically, the cliff is there. Is it not far better to find out in advance that the cliff is ahead and that we still might prevent disaster if we can reverse direction ? We do not accept the charge that we presented no analysis, as such, in the book. We attempt to analyze the workings of political institutions through which macroeconomic policy has been made in the post-Keynesian era. We invite other economists to do the same thing. Our analysis may be incorrect, in the large or in the small. We may not be cynical enough in modelling the behavior of public choosers, as Craig Roberts suggests. Or we may not attribute a sufficient degree of rationality (and political control) to the ultimate taxpayer-voter, as Barro urges. Or perhaps the quantitatively measurable record does not bear our analysis empirically, in some respects, as both Niskanen and Gordon suggest. We are institutionalists in the sense that we think that arrangements or rules do affect outcomes. Ultimately the test of our analysis of politics, and our interpretation of the histc.rical record will stand or fall on empirical grounds. But our concern is that the ,:vidence required to convince recalcitrant professional colleagues may arrive too late to allow the necessary constitutional reforms to be introduced in time to be effective. Quite frankly, we are more interested in opening a dialogue that may generate preventive steps than we are in achieving simon pure empirical credentials or as being labeled as belong!ng to this or that camp or school. There is, indeed, a deal of ruin in a nation, as Adam Smith assured us. But defensive dialogue is essential to preserve that which remain~ vulnerable to those forces that would do the dealing.