DEBT AND TAXES*
| Date | 01 November 1988 |
| Published date | 01 November 1988 |
| DOI | http://doi.org/10.1111/j.1467-9485.1988.tb01058.x |
| Author | J. S. Flemming |
Sconrrh
Journnl
of
Polrrrcol
Economy,
Val
35.
No
4.
November
1988
0
1988
Scottish
Econornlc
Society
DEBT
AND
TAXES*
J.
S.
FLEMMING’
Bank
of
England
I
The question of the role of debt
in
the planning of public finance is an old
one, going back at least to Ricardo
(1977)
on
whose rejected conjecture of
irrelevance the title of “theorem” has been foisted by Robert Barro
(1974).
It may be worth rehearsing some of the amazingly strong requirements
of
the irrelevance result:
-1ntergenerational transfers are all at internal optima not at corners where
no transfer takes place
in
either direction. Thus
it
is assumed that any
measure affecting the relative position of members of different generations
will
be offset by compensating private transfers. Anything less than total
identification of parents with their children
and
vice versa
is sufficient to
ensure the failure
of
this condition.
--It
is not enough for the substitution in question to be of a poll tax for poll
tax-serviced debt; there must also be no taxes anywhere in the system with
non-constant marginal rates. The point here is that a poll subsidy on one
generation and tax on the next will require the first
to
save and bequeath
more. Progressive taxes on interest income, estates, or inheritance would
then imply changed “prices” affecting these decisions.
-There is no demographic uncertainty which can make the dynastic
incidence even of poll taxes unpredictable.
A
cut in poll taxes today might
be matched by increased taxes on
my
grandchildren-how much that
matters to me may depend on how many
I
shall have,
as
yet unknown.
How much extra should
I
save to enable them to pay the tax out
of
inherited wealth?
Although the first assumption is already strong its failure may be a matter
of degree and thus make little difference. Consider the extreme case of
perpetual debt and a population with a mean residual life expectancy of
35
years. At a 2.per cent real rate, half the debt service obligation falls on those
now alive.
A
higher real rate, inflation and partial altruism all mean that this
is a lower limit
to
the extent of “equivalence”, i.e. debt is at least
50
per cent
tax
or less than
50
per cent “net wealth”-although this last terminology has
*
Twenty-third Scottish Economic Society Annual Lecture, delivered at St Andrews
University
on
29
April
1988.
The Society acknowledges with gratitude the financial support
provided by the Scottish Provident Institutions.
Date
of
receipt
of
final
manuscript: 15-7-88
305
Associate Director and Chief Economist, Bank
of
England.
To continue reading
Request your trial