Obama’s debt and the future of the american people continued…

Posted on March 1, 2010 by

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What are the implications of running such a high debt?

            If we subscribe to the Ricardian equivalence,  assuming that individuals have perfect foresight, we have perfect capital markets and there are intergenerational transfers from one generation to the next, financing deficits through higher taxes later will not alter consumption. This theory built around the assumption of rational expectations suggests that taxpayers would have more money now, save it in order to offset the future higher taxes (Barro, 1974).  In other words, with intergenerational transfers and altruistic individuals, the old generation would leave enough to help the young who will be getting taxed for the old generation’s out of control government spending.  Unfortunately, because of market distortions such as an inefficient Pay-As-You-Go (PAYG) social security system, individuals not only have little or no incentive to save for old age but they also have little or nothing in terms of bequests for the next generation.  Who’s left to pay for today’s huge accumulated debt?  The next generation! 

            Furthermore, from Laffer, deemed by some to be controversial theory, to prominent economist Edward Prescott,  about the relationship between taxes and labor supply, an important result of Prescott 2004 is that marginal tax rates account for the differences in labor supply over time.  According this study, labor supply and productivity is greater in America than it is in most European nations due to our historically lower marginal tax rates.  If we follow Edward Prescott’s logic, today’s current deficits and growing debt are suggesting higher taxes for future generations, and if coupled with unemployment safety nets and welfare programs, the next generation will be faced with an even greater incentive not to work, voluntarily opting out of the labor force, to continue relying on an overstretched, indebted government which will continue to pass on the debt to future generations. Based on the search-matching theory of unemployment, when the value of staying unemployed exceeds the gains from being employed, individuals simply opt-out of participating in the labor force.

This analysis is getting scarier as we keep digging deeper.  Since some countries that we are so indebted to are not always our best of allies, it is fair to conclude that the national debt could become a major security concern.  On February 25th, 2010, democrat Hillary Clinton came to the conclusion that the US national debt was now a matter of national security.  Clinton said that the US debt has hurt “our ability to protect our security, to manage difficult problems and to show the leadership that we deserve.”  “I do not like to be in a position where the United States is a debtor nation to the extent that we are,” America’s top diplomat said.  She added: “”We have to address this deficit and the debt of the United States as a matter of national security not only as a matter of economics”.

Barro, Robert J. “Are Government Bonds Net Wealth?”. Journal of Political Economy 1974

Prescott, Edward C. “Why Do Americans Work So Much More Than Europeans?”. Federal Reserve Bank of Minneapolis Quarterly Review Vol. 28, No. 1, July 2004

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