Main Propositions of Modern Theory of Public Debt

Main Propositions of Modern Theory of Public Debt:

Prof J. M. Buchanan in his book “Public Principles of Public Debt”, declares that there are three main propositions of the modern theory of public debt.

(1) The creation of public debt does not involve any transfer of the primary real burden to future generations.

It means that the burden of the government borrowing and spending activity falls during the period in which it is created and it is the real sacrifice on the initial generation.

The point of view of the modern theory of public debt is summarized by J. M. Buchanan, in the following words, “The real sacrifice of private goods and services, that is real income, allegedly occurs during this initial period, and this sacrifice stems, not from the debt per see, but rather from the decision of the government to undertake the public expenditure in question. In this particular respect, the financing of public expenditure by borrowing is little different from financing it by taxation. In either case, the real burden is borne currently. Any shifting of the primary real burden of public expenditure over time by changing the method of financing is impossible.”

It has been also observed that the public debt incurred now leaves not only an obligation to future generations but also a claim. Whatever transfer of funds takes place only between the future members of the community. The tax-payer children inherit tax liability and the bond-holder children acquire an equal asset. The loss of taxpayers is offset by the gains of bondholders and therefore, for the economy as a whole net burden will be nil. Thus, public borrowing may cause intergeneration transfers but not a loss to society. It is on this ground that it has been concluded by most economists that internal debts must not be considered debt in the ordinary meaning of the term and that they do not represent the shifting of the burden to future generations.

(2) The second proposition of the modern theory of public debt is that the analogy between public debt and private debt is fallacious.

The proponents of the, ‘no burden thesis’ are of the view that most of the misconceptions about the burden of public debt are due to the false analogy between private finance and public finance. In this context, Prof. Alvin H. Hansen observed, with respect to production, employment, and income…..the analogy between the public and private economies leads to quite erroneous conclusions. Both, indeed strive to maximize their income. But, this end can frequently not be achieved by the public economy, if it applies the financial principles appropriate for the private economy. For the individual, it is important that his expenditure be kept below, or at least within the limits of his income. For the State, an increase in expenditures may frequently increase the total national income and improve the fiscal position of the State. The individual is concerned exclusively with the effect of his action upon his business. The effect of his own economic activity upon other individuals is significant for him only in so far as this, in turn, affects his balance sheet. The balance sheet tells him all that he needs to know in order to judge the appropriateness of different lines of business policy. In the case of public finance, however, it is quite otherwise. The success or failure of public policy can be determined only by noting the effect of expenditures, taxes, and loans on the total national income and on how that national income is distributed.

Hence, it can be concluded that a public debt internally held is different in nature from a private debt. To put it in the words of Hansen, “A public debt internally held is not like a private debt. It has none of the earmarks of private debt. Public debt is an instrument of public policy. It is a means to control the national income and in conjunction with the tax structure, to regulate the distribution of income.

(3) The third proposition of the modern theory of public debt is that internal public debt and external public debt are fundamentally different in their impact.

Servicing external debt results in the transfer of resources from the domestic economy to foreigners which means a net loss to the whole economy.

To the extent of the transfer of resources, the real income of future generations is reduced.

Since taxes are imposed and tax rates are increased in the future for servicing the debt, the burden of external public debt can be shifted to future generations.

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