Monday, May 08, 2006

The Progressivity of Budget Deficits

Bloggers Jane Galt and Brad DeLong have been debating my previous post on evaluating tax progressivity, focusing on the fact that deficit-financed tax cuts require lower spending or higher taxes in the future. Let me add to the discussion:

Economists are not good at judging redistributions of income. Indeed, they often claim that this issue is outside of the sphere of economics altogether. It is, therefore, somewhat surprising that economists decry budget deficits with such consensus and assurance.

One widely accepted standard for judging redistributions is the ability-to-pay principle: redistributions of income are desirable if they go from better-off to worse-off people. By this criterion, the redistributions arising from changes in factor prices are undesirable. Many people hold little wealth and consume the income from their wages, while a small part of society holds most of the economy’s wealth. When crowding out raises the returns on capital and reduces wages, the wealthy gain at the expense of the less wealthy.

Yet, from the standpoint of the ability-to-pay principle, the direct effect of budget deficits—the change in the timing of taxes—is harder to reconcile with the conventional view that deficits are undesirable. Because of technological progress, the income and consumption of a typical individual in the economy rises over time. Because budget deficits shift taxes forward in time, they benefit relatively poor current taxpayers at the expense of relatively rich future taxpayers. If reducing inequality is a goal of policy, shouldn’t budget deficits be applauded?

One way to answer this question is to go beyond neoclassical economic theory. Although standard models assume that people desire to smooth consumption evenly over time, popular discussions of economic policy presume that consumption should rise over time. Politicians often assume a moral imperative that the current generation sacrifice to ensure that future generations enjoy a substantially higher standard of living. This view suggests that it is undesirable to shift a tax burden onto our children, even though our children will be better able to shoulder that burden than we are.

Another possible answer is that levels of taxation should be based on the benefits principle, which holds that people should pay for the government benefits that they receive. For example, the use of a gasoline tax to pay for road repair is not based on the abilities to pay of drivers and non-drivers; instead, it is justified on the ground that drivers should pay for roads because they benefit from them. Similarly, one might argue that each generation should pay for the government it provides itself, regardless of its level of income.

These issues are not easily resolved. Yet one point is clear: saying whether and why deficits are undesirable requires judgments that are more philosophical than economic.

Brad may be tempted to read this post as further evidence of how low I have sunk as an economist. But he would be wrong: I have always been this bad! The above six paragraphs are an excerpt from a 1995 paper I wrote with Larry Ball.