The Politics of Debt: Not facing a debt crisis is not the same as superbly managing public debt.

• Author: Holtz-Eakin, Douglas

Why all the fuss about federal government deficits and federal debt? After all, the really important decision is to undertake federal spending in the first place. Is that spending a genuine investment or simply government-provided consumption? Does it correct a private market failure or simply crowd out equivalent private activity? These are important and difficult questions that might engender a heated debate.

Similarly, the level, composition, and design of federal taxes have important impacts on economic efficiency and the distribution of well-being. Should taxes be earmarked to pay for specific spending programs or simply constitute general revenue? Are all forms of income created economically equal, or should there be preferential rates on the return to saving and investment? Again, these are important and difficult questions that might engender a heated debate. But having had those two debates, why is the decision to replace federal tax levies with the issuance of Treasury securities such a lightning rod? With spending, current voters can commit to programs that future voters are free to eliminate. Similarly, with taxes current voters can impose a level and structure that future voters can completely restructure. But when current voters (or their representatives) choose to issue debt, there is no way for future voters to "undo" that decision. They will simply inherit this financial legacy without any choice. This excessive power raises the concern that once one leaves the realm of blackboard exercises, federal debt will enable current politicians to spend excessively and tax minimally in the present, and at the expense of future voters. In practice, this temptation has transformed into a reality in which federal debt has risen dramatically and is projected to continue to rise in an unsustainable fashion.

THE ECONOMICS OF THE FEDERAL DEBT

One cares about debt-financed federal activity because it impacts the performance of the overall economy. Here are some of the key channels by which debt affects the economy.

The starting point for understanding the impact of debt on economic performance is to think of a situation when it has no impact. Suppose that the spending programs are politically supported now and in the future. Instead of raising taxes by $100, however, the government borrows the $100. If households recognize that taxes will have to be $100 higher in the future, they will put aside $100 to cover the tax bill. Of course, the...