[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Wrap-Up
GOVERNMENT DEFICITS AND SURPLUSES
Government expenditures and taxes affect the capital market.
Increases in taxes reduce disposable income, and thereby decrease private saving.
The equilibrium real interest rate is higher and private investment is lower.
When the government spends more than it receives in revenue, it must borrow
to finance its deficit. A deficit reduces public saving, leading to higher real interest
rates and lower private investment.
The lower the level of private investment, the smaller the increase in the
capital stock. With a smaller capital stock, potential GDP in the future is lower.
A surplus has the opposite effect. When the government spends less than
it receives in revenue, public saving and thus national saving rise. This increase
leads to lower real interest rates and higher private investment. Higher private
Thinking Like an Economist
DISTRIBUTION, DEFICITS, AND
INTERGENERATIONAL TRANSFERS
If you borrow money to buy a car, you can enjoy the car now
without paying for it in full. Instead, you can spread the payments
out over a relatively long time period. The same is true
of governments that borrow. Instead of raising enough in taxes
right now to pay for all its expenditures, a government can
borrow and use future taxes to repay its debt. But this approach
raises the issue of distribution. Let’s suppose the government
borrows $20 billion today, uses the money to reduce the current
level of taxes, and then plans to raise taxes in fifty years
to repay the money that it has borrowed. In fifty years, most
of the taxpayers who benefited from the tax reduction will
have died, and many of those whose higher taxes will repay
the debt are not even alive now, when the money is being borrowed.
Does this mean that government borrowing results in
a transfer of wealth between generations, from future taxpayers
to today’s?
Some economists argue that the answer is no. They point
out that those future taxpayers are the children of today’s taxpayers.
Rather than spend the tax cut, today’s taxpayers can
save it, and simply pass it on to their children in the form of a
larger inheritance. The children would then have the extra
wealth they need to pay the higher taxes they will face. They
therefore will not have to reduce their own consumption
spending to pay for the tax cut enjoyed by their parents.
Most economists, however, do not believe that private savings
increases in this way when taxes are cut. They observe
that when people find their disposable incomes higher as a
result of a tax cut, they increase their consumption spending.
They may save some of the tax cut, but private saving does not
increase enough to offset the government’s dissaving (deficit).
As a consequence, national saving falls. In the capital market,
the fall in national saving increases the full-employment equilibrium
real interest rate. Investment falls. Lower investment
means less capital (plant and equipment) is built, and future
generations inherit a smaller stock of capital. The distribution
of wealth between generations is affected: current taxpayers
have been able to consume more, while future generations will
have less capital and therefore lower incomes.
556 ∂ CHAPTER 25 GOVERNMENT FINANCE AT FULL EMPLOYMENT