Public Debt, Taxation, and Capital Intensiveness*

In his “Principles of Political Economy and Taxation” [9], Ricardo cautioned that the deficit-financing of public expenditures sets back the growth of capital. The reference was to economies with rapid adjustment to “full-employment” equilibrium. While the Keynesians denied the rapid-equilibration assumption, the postwar reevaluation of monetary policy led to a modern restatement of Ricardo’s doctrine. In several papers, of which Samuelson’s [IO] is probably the best known, it was argued that, given the level of government expenditures, a tax reduction would increase consumption and thus restrict investment if monetary policy is used compensatorily to maintain aggregate income and employment at their targeted levels. This is a statical proposition, good for each instant in time, given the currently available capital stock. But the current capital intensiveness is dependent upon the past history of taxes, so that an intertemporal model is required if we are to deduce that a permanently increased capital intensiveness will be brought about by a permanent decrease in public indebtedness per man. Analyses of this question have been few. In his parable of saving under population overlap, Samuelson [II] showed that the social “contrivance” of government-issued money (unbacked by government-owned capital or other interest-paying assets) would tend permanently to increase the rate of interest (thus tending to cure his economy from any inefficient permanent overinvestment); but whether ordinary public debt would do as well was left unexplored. Modigliani [6] in his life-cycle model of a stationary economy, argued that by permanently adding a dollar to the public debt, the government would ultimately and permanently displace exactly one dollar’s worth of capital from private portfolios. Diamond [2] synthesized these two models and showed that, under certain stability and uniqueness conditions, a permanent addition to the debt per head would produce a permanent reduction of capital per head-though not generally in an equal amount.