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Public debt

3 Public debt in history

States and sovereigns have long borrowed to mobilize resources to meet emergencies. Aristotle described how, in the fifth century BCE, Dionysius of Syracuse borrowed to finance military campaigns against the Carthaginians.1 The English monarch Edward III (1312–1377) borrowed to continue the Hundred Years War with France. In the 1340s, with the arrival of the Black Death, the Italian city-states of Venice and Siena borrowed to mobilize public health resources.

For more details on the tax smoothing logic, you can read ‘Federal deficit policy and the effects of public debt shocks’ by Robert J. Barro, or ‘On the determination of public debt’ by Robert J. Barro, or ‘The motives to borrow’ by Ugo Panizza, Andrea F. Presbitero, Antonio Fatás, and Atish R. Gosh.

Until the late 20th century, debt finance by governments was predominantly war finance. War is the prototypical emergency, prompting governments to mobilize all available resources, including those that can only be mobilized by borrowing. What economists refer to as ‘tax smoothing logic’ suggests that the costs associated with mobilizing those resources should be spread over time rather than paid up front, all at once. High tax rates are especially distortionary, meaning that they cause inefficient behavior. For example, taxing investment income near or at a rate of 100% weakens or eliminates all incentive to invest. Rather than raising taxes sharply in times of war and lowering them back down when peace is restored, it therefore makes more sense to raise taxes moderately both in the present and in the future, while issuing debt to finance the immediate gap between revenues and essential spending.

tax smoothing logic
A large increase in taxation to fund an unanticipated increase in government spending (such as for a war or pandemic) leads to tax avoidance and other behavioral responses that reduce the economy’s output and distort the allocation of resources. It is preferable to spread out the tax increases and borrow to fund the expenditure.

Figure 2 illustrates this for the case of the United States. It shows the evolution of debt relative to GDP (that is, relative to the size of the economy, and how that history has been punctuated by war).

In this line chart, the horizontal axis shows years, from 1790 to 2020, and the vertical axis shows the debt-to-GDP ratio in the U.S., expressed as a percentage and ranging from 0 to 140. From 1790 to 1980, the debt-to-GDP ratio rose sharply during wartime, for example, from 10% to 18% during the War of 1812, from near zero to around 35% during the U.S. Civil War in 1865, and from 10% before the First World War to nearly 120% during the Second World War. After the wars, the debt-to-GDP ratio decreased gradually over time. However, since 1980, the debt-to-GDP ratio has followed an increasing trend, from around 35% in 1980 to nearly 130% in 2020.
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https://books.core-econ.org/insights/public-debt/03-public-debt-in-history.html#figure-2

Figure 2 Evolution of the debt-to-GDP ratio in the U.S. (expressed in percentage terms), 1790–2020.

Federal Reserve Bank of St. Louis, 2022, FRED; TreasuryDirect, 2022, ‘Monthly Statement of the Public Debt (MSPD) and Downloadable Files’; TreasuryDirect, 2022, ‘Historical Debt Outstanding: Annual 1790–1849’.

Figure 2 also hints that the purposes for which governments have borrowed broadened in the 20th and 21st centuries. The U.S. federal government went deeper into debt, for example, in the Great Depression of the 1930s. The Depression, when the unemployment rate soared to 25%, was seen as a social crisis tantamount to war. It highlighted the government’s role in providing social insurance and other essential services in hard economic times. Because tax receipts fell off in the economic slump, the government had to borrow to finance their provision. The U.S. government, along with others, similarly borrowed to meet the emergencies created by the global financial crisis in 2008–2009 and the COVID-19 recession and health crisis.

Up through the Second World War, the U.S. government, having issued additional debt in response to geopolitical and economic emergencies, regularly reduced the debt-to-GDP ratio when the crisis passed. (Section 7 describes how in more detail.) Prudent governments that utilize their borrowing capacity in an emergency appreciate the need to restore that capacity subsequently, since there is no telling when it will have to be utilized again.

Since the 1980s, however, the picture looks different. U.S. federal government debt as a share of GDP has trended steadily upward, excepting only the 1990s, when strong economic growth and fiscal restraint under President Bill Clinton reduced the debt-to-GDP ratio. But taking the last four decades as a whole, the U.S. debt-to-GDP ratio has soared from 30% of GDP to more than 120%. What went up showed little tendency to come back down subsequently.

Question 2 Choose the correct answer(s)

Based on the information in this section, which of the following statements are true?

  • The logic of tax smoothing implies that raising debt can be seen as an alternative to raising taxes when the government needs to finance its expenditure.
  • Figure 2 shows that as GDP in the U.S. increased, so did the U.S. government debt-to-GDP ratio.
  • In the past, governments have only raised debt to finance war.
  • In recent decades, the trend of the debt-to-GDP ratio has changed in the U.S.
  • Tax smoothing logic presents the idea that raising debt can be seen as an alternative to raising taxes when the government needs to finance its expenditure.
  • Over time, the U.S. debt-to-GDP ratio increased, but Figure 2 does not plot U.S. GDP, so we cannot draw any conclusions about the correlation between these two variables.
  • In the past, governments have also raised debt in response to other problems, for example meeting the health emergency of pandemics.
  • Whereas in the past, governments tended to reduce the debt-to-GDP ratio once a crisis passed, this has not been the case since the 1980s.

Exercise 1 Debt-to-GDP ratio in other countries

Collect data on the debt-to-GDP ratio of a country of your choice (other than the U.S.), for the longest time span available. For example, you can use the IMF Global Debt Database. Plot the data on a graph similar to Figure 2. Compare your graph with Figure 2 and describe the similarities and differences you see. (Hint: Doing Economics offers guidance on how to plot a line chart in Excel).

  1. Eichengreen, Barry, Asmaa El-Ganainy, Rui Esteves, and Kris James Mitchener. 2021. In Defense of Public Debt. New York: Oxford University Press. ↩