Assume an economy with no government debt and a balanced
budget of $2,000 billion. Suppose the government plans a one-year program
to refurbish the highway system at a cost of $100 billion. The funds
could be acquired from the public either through additional taxes or borrowed
at interest from the public. Which of the two financing options is more
equitable, and why?
The Taxing Option
Assuming an effective income tax rate of 20%, $20 billion of
the funds will be acquired from the workers themselves by the tax on the income
they receive on the program. The simplest way for the government to
obtain the remaining $80 billion would be a one-time tax surcharge of 4% on
everyone’s income. We will ignore the
second order effects.
At the end of the
year the budget will be balanced with no government debt. A total of $100
billion of the public’s money will have been redistributed to those who did the
work. Because of the tax bite, their net income will be only $80 billion.
However the total monetary assets of the public remain unchanged since
tax revenues are balanced by government spending.
The Borrowing Option
In the borrowing option, again $20 billion will be obtained
from the income tax on those who did the work. The remaining $80 billion
must be acquired through the sale of government bonds, which we will assume pay
interest of 5% per year.
At the end of the year the government will have a debt of
$80 billion on which it must pay interest of $4 billion per year. To
maintain a balanced budget going forward, the government could roll over the
debt continuously and cover the interest payments with additional taxes.
The required increase would be 0.2% of the $2,000 billion per year paid
before the program was launched.
In both options the public as a whole, including the bond
buyers and those who do the work, ultimately pay for the work through increased
taxes. In the taxing option, the government extracts the
funds in proportion to each tax payer’s normal tax liabilities. In the
borrowing option the government obtains the funds on a voluntary basis,
according to the investment preferences of the public. Those who buy the
bonds gain no advantage since the others can use their funds to purchase other
investments of the same value.
In both options the government program causes a circulation
of the public’s money supply, which results in additional employment and
income. Neither option changes the monetary wealth of the public as a
whole. In effect the public acquires a refurbished highway system in
exchange for the work of a few, and remunerates those who do the work.
economically from the program in varying degrees depending on their use
of the highways and the taxes they pay. The program causes a
redistriibution of financial wealth, but that is true for any
government spending. While both options are equivalent in terms of
aggregate financial impact, the borrowing option has one potential
advantage. The benefits of the refurbished highway system will last
well beyond the current generation. To the extent that there are any
financial inequities across generations, it is fair that they should be
shared. For that reason, the borrowing option is likely to be more
equitable in this case.