Nick Rowe discusses public debt using apples
The government borrows 100 apples from each of cohort A, then gives each person in cohort A a transfer payment of 100 apples. It is exactly as if the government had simply given each person in cohort A an IOU for 100 apples. That IOU is a bond.
So far there is no change in cohort A’s consumption of apples.
Cohort A then sells the bonds to the younger members of cohort B. So each person in cohort A gets an extra 110 apples (assume 10% interest per generation), which he eats. Cohort A then dies.
Cohort A is better off. Each member of cohort A eats an extra 110 apples. In present value terms, those extra 110 apples are worth 100 apples at the time the transfer payment is made.
Cohort B eats 110 fewer apples when young, but 121 extra apples when old, and they sell their bonds to cohort C. Although cohort B eats 11 more apples in their lifetimes, the present value of their total consumption of apples is the same. The rate of interest must be high enough to persuade them to eat fewer apples when young and more apples when old, otherwise they wouldn’t have bought the bonds from cohort A. So cohort B is not worse off.
. . the government decides to pay off the debt by imposing a tax of 121 apples on each young person in cohort C, which it uses to buy back the bonds from cohort C.
Each member of cohort C eats 121 fewer apples.
Cohort A eats more apples, and cohort C eats fewer apples. It is exactly as if apples travelled back in time, out of the mouths of cohort C into the mouths of cohort A. (With interest subtracted as they travel back in time through the time machine.)
This is the type of example I love. However, I think his starting point obscures what is happening. In reality the government sells bonds members of cohort A. So, the bondholders in cohort A eat 100 fewer apples.
The travel through the bond markets is always a wash.
What happens is what always happens. Resources are transferred from taxpayers to the beneficiaries of government programs. Where these people exist in space and time is of no relevance to this mechanism.
The raw experience is that the affairs of members of society are rearranged under threat of death. That you do the rearranging is what it means to be the state. That you are under threat of death is what it means to be a taxpayer.
Whether you are young or old; born or unborn; purple or plaid it is always better to be the state and to not be a taxpayer. Thus if our grandchildren are taxpayers and we are not, then all else equal it is better to be us than to be them.
Yet, importantly, this is always the case. Even if the government runs a surplus it is better not to be the taxpayer.
However, an entirely different macro question arises. That is, can the state acquire liabilities in excess of its ability to pay them. Can we bankrupt our grandchildren?
In this case the answer depends solely on the state’s ability re-arrange claims on resources, which in practice is limited by Marshallian deadweight loss. In a closed economy with lump-sum transfer the state can never exhaust its ability to transfer resources and can never go bankrupt. How much debt the state acquires is utterly irrelevant.
This is because the solvency of the state depends everywhere and always on its ability to re-arrange claims on resources to suit its goals. This always happens in the current period and is limited only by the power the state can exercise in the current period relative to the power it desires to exercise.
It does not need to “come up with the money.” It needs to be able to kill you if you refuse to comply. This is always where the power of the state comes from. Again, that is what it means to be the state.
If you cannot do this, if you rely on consent and hence payment to induce action, you are not a state. You are a firm.