More On The Burden Of Debt (by: Paul Krugman)

I suspect that I may have been too cryptic in my post on the real burden of debt. So let me give you a thought experiment that may help clarify matters.

Suppose that for some reason the nation temporarily ends up being ruled by a guy who is driven mad by power, and decrees that everyone will have to wear their underwear on the outside (sorry, Woody Allen reference) everyone will receive a large allotment of newly printed government bonds, adding up to 500 percent of GDP.

The government is now deeply in debt — but the nation has not directly gotten any poorer: the public, in its role as taxpayers, now owes 500 percent of GDP, but the public, in its role as investors, now owns new assets equal to 500 percent of GDP. It’s a wash.

So where’s the problem? Well, to pay interest on that debt, the government will have to raise a lot more revenue. Again, this is a wash — the extra revenue is matched by the extra income people receive as bondholders. But tax rates will have to go way up; and because lump-sum taxes don’t exist in the real world, this means that marginal tax rates will have to go way up.

And you don’t have to be a right-winger to acknowledge that yes, very high marginal tax rates act as a disincentive to productive activity. So real GDP may well fall significantly.

This is what I mean when I say that the burden of debt is about incentives, not about having to deliver resources to other people.

Private debt, by the way, creates a different kind of problem: again, it doesn’t directly make us poorer, but it increases our macroeconomic vulnerability.

The general point is that the analogy with a family that owes too much is all wrong. Unfortunately, this dumb analogy dominates our national discourse.