Congressional Budget Office
Congress has already appropriated about $1 trillion for these wars, and a Congressional Budget Office study projected the conflicts would eventually cost the United States about $2.4 trillion. When government purchases increase due to a war, a government can either increase taxes to pay for the war or issue government debt. Remember that when the government runs a deficit to pay for a war, it is borrowing from the general public. The government’s intertemporal budget constraint reminds us that—since government debt is ultimately paid for by taxes in the future—the choice is really between taxing households now or taxing them later. History tells us that deficits have been the method of choice: governments have chosen to tax future generations to pay for wars. There are two arguments in favor of this policy:
1. Fairness. Any gains from winning a war will be shared by future generations. Hence the
costs should be shared as well: the government should finance the war with debt so that future generations will repay some of the obligations. To take an extreme case, suppose a country is fighting for its right to exist. If it wins the war, future generations will also benefit.
2. Tax smoothing. A good fiscal policy is one where tax rates are relatively constant. In the face of a rapid increase in spending, such as a war, the best policy is one that pays for the spending increase over many periods of time, not in one year.
Taxation is expensive to the economy because it distorts economic decisions, such as saving and labor supply. The amount people want to work depends on their real wage, after taxes. So if tax rates are increased to finance government spending, this reduces the benefit from working. Put differently, increased income taxes increase the price of consumption relative to leisure. The fact that people work less when taxes increase is a distortionary effect of taxation. Instead of bunching all this distortionary taxation into a short amount of time, such as a year, it is more efficient for the government to spread the taxation over many years. This is called tax smoothing. So by running a budget deficit, the government imposes relatively small distortions over many years rather than imposing large distortions within a single year. Toolkit: Section 16.1 “The Labor Market” For more analysis of the choice underlying labor supply, you can review the labor market in the toolkit. Similar arguments apply to other cases in which governments engage in substantial spending. Imagine that the government is considering putting a large amount of resources into cancer research. The discovery of a successful cancer treatment would, of course, benefit many generations of citizens. Because households would share the gains in the future, the costs should be shared as well. By running a budget deficit, the government is able to distribute the costs across generations of citizens in parallel with the benefits. From the perspective of both fairness and efficiency, there are some gains to deficit spending. More generally, we might want to make a distinction among different types of government purchases, just as we do among private purchases. We know that the national accounts distinguish consumption purchases (broadly speaking, things from which we get short-run benefit, such as food and movies) from investment purchases (things that bring long-term benefit, such as factories and machinery). Likewise, we might want to distinguish between government consumption, such as wages of employees at the Department of Motor Vehicles, from government investment, such as spending on cancer research.
