What Is the Money Illusion?

The illusion of public debt is a special case of fiscal illusion, which mainly refers to the inability of taxpayers or members of society to accurately estimate the present value of future tax burdens that may be caused by government borrowing ^[1] .

Public debt illusion

Right!

The illusion of public debt is a special case of fiscal illusion, which mainly refers to the inability of taxpayers or members of society to accurately estimate the present value of future tax burdens that may result from government borrowing ^[1]

In the formula, Kt is the initial public debt illusion of t period; At is the present value of the expected tax burden generated by the issuance of public debt; At 'is the present value of the expected tax burden that the individual recognizes. ^[1]

In real fiscal systems, imbalanced budgets are always possible. Once a strict budget balance constraint is absent or abandoned, the potential fiscal deficit will become a real fiscal deficit. As Buchanan said, if the democratic political system clearly divides fiscal choices into two separate choices, namely, public revenue and public expenditure, which are less relevant, it is easier to generate more fiscal deficits and the illusion of public debt. Under the illusion of public debt, taxpayers often cannot make appropriate savings decisions to fulfill their fiscal debt obligations due in the future. ^[1]

In fiscal practice, because public debt creditors (citizens or residents) often do not constitute hard constraints on debt financing entities (governments), and governments at all levels have a certain degree of illusion or illusion of "free capital" when obtaining debt funds, thereby The use of debt funds inevitably appears to be over-standard and inefficient, resulting in the government's obvious preference for financing methods that use public debt instead of taxation, which makes it easier to create a debt finance situation. According to Buchanan, "As a member of a local government unit, the financial awareness that an individual may have will become weaker and weaker as the number of citizens in the group increases. At the central government level, individual citizens are basically Private fiscal responsibility is not felt. "If Buchanan is right, local governments, especially the central government, are more likely to cause debt fiscal problems when they make fiscal decisions. ^[1]

In fact, debt finance does not change its economic and political consequences because of the illusion of public debt. Here, we use a highly simplified political-public debt model to illustrate the adverse consequences of debt finance. If the government introduces public debt issuance for various theories or reasons (such as stabilizing the macro economy, establishing a welfare state, etc.) to finance the continued expansion of fiscal expenditure pressures-the resulting debt creation can be seen as a government finance agency Facing the outward shift of the "possible boundary". As a result, the budget equilibrium was replaced by the fiscal budget issued by public debt. In this analysis, assuming that the government's fiscal deficit accounts for less than 5% of the gross domestic product (GDP), an individual's response to the issuance of public debt in the corresponding political choice environment may be more than a tax or currency creation The resistance response is weak. But above the limit of 5% of GDP, the citizens' resistance to public debt is more negative than the resistance to taxation and currency creation (that is, the pressure rebound effect).

In the first stage of the political response, after introducing the possibility of debt finance, the nature of the new fiscal equilibrium will be determined by the following three factors: (1) the ratio of public fiscal expenditures will rise; (2) a certain amount of public debt creation will occur; (3) There are lower tax rates and lower tax revenue. It should be noted that part of the fiscal revenue raised by the government through the issuance of public debt will be used for the expanded public expenditure ratio, and part will be used to fill the fiscal gap caused by the decline in tax revenue.

We assume that the government bond issued in the first stage is D. The money was withdrawn from the private sector of the economy. If there is no public debt, the funds will either be transformed into current consumption or current capital investments. In other words, government borrowing is really borrowing (that is, borrowing money from current consumption or investment). Under market economic conditions, the government has entered into a debt and debt contract with each bond purchaser, and individuals purchase government bonds in completely voluntary transactions. They gave up their current (first stage) dominance over resources in exchange for dominance over interest income on bonds. It will repay the entire principal plus the required interest. In this way, in the short term, "everyone is happy": the government has used debt creation to achieve its fiscal goal of increasing public expenditure, while also satisfying voters who want to increase government public goods and services and reduce Self-pay tax requirements. As a result, the government's budget equilibrium has begun to enter the initial stage of debt finance.

Let us consider again the possible situation in the second stage. In order to maintain the full level of labor achieved in the first stage, in addition to the public revenue provided by taxation, the amount of public debt D must be supplemented. The government will once again resort to public debt to raise money. In this case, the public debt incurred in the first stage still exists, and this initial debt must be paid at least interest in the second stage. The government must find a certain financial source to pay the holders of public debt to promised interest income. If the government bonds issued in the first phase have reached the indicated political turning point (such as 5% of GDP), then in the second phase, it is impossible for the government to increase its borrowings without breaking the established political equilibrium. Ratio. In order to raise the combined expenditure requirements (G + D + rD) faced by the government in the second stage, the government will either raise the tax rate or cut down on expenditures. However, no matter which of the above methods is adopted, it will destroy the first stage China has achieved fiscal balance.

Since equilibrium is bound to be replaced, adjustments will occur along possible margins. The nature of the second-stage equilibrium will depend on three factors: (1) a lower ratio of public expenditure than in the first stage; (2) a higher tax burden than in the first stage; and (3) issuance in the second stage Of new debt equal to the debt issued in the first phase. If in the first stage due to various reasons, the government-issued public debt has not reached the limit of the political constraint point, then it is expected that the government will expand the bond issuance in the second stage. This process will be carried out phase by phase until the political constraint is finally reached.

The above analysis shows that there is a link between preliminary results at any stage. Since the interest on public debt that must be paid will increase from stage to stage, the equilibrium ratio of government expenditure will decrease from stage to stage, and the equilibrium tax rate will increase from stage to stage. In theory, the government may default on short-term debt. As long as the political equilibrium is maintained in one phase after another, the debt will never be paid off. In this way, the total government debt will inevitably increase until it reaches a turning point at a certain stage, which means that the interest payment on the outstanding public debt will also increase accordingly. The above results will continue to be interpreted even when government spending on various public services has ceased. Correspondingly, in order to pay interest on debt, taxes will continue to increase, and this payment itself will continue to grow with the issuance of new public debt, which has to be issued in order to pay the interest on bonds issued at previous stages. In extreme cases, the entire national output will be used to pay interest on debt.

Of course, the above model is an extreme case. It potentially assumes that neither the government nor the taxpayer who lent money to the government will adjust their economic behavior based on financial results (ie there is a complete illusion of public debt). However, we can expect that as the balance of public debt continues to accumulate, citizens or taxpayers will react more and more negatively to debt creation. This is partly because taxpayers will worry that the government will adopt a default attitude on public debt held by creditors, and this default attitude will make future borrowing at higher public debt rates. After this result reaches a certain level, there will be no political equilibrium on the issue of bonds. However, if society is to avoid government default or default on public debt, taxpayers must accept higher tax rates and lower levels of public service provision. If this society has always followed the "classical saying" (that is, the classical economist): abandoning any form of debt finance, the tax rate in our environment will be much lower, and the level of supply of public services will be higher Much more. Obviously, in the eyes of classical economists and the public choice school, increasing public consumption by debt finance means destroying or "depleting" capital, so that the real "national wealth" will be cut.