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• Foreword
• Preface
• Acknowlegments
• Cost and Choice
• 1.: Cost In Economic Theory
• Classical Economics
• Marginal-utility Economics
• The Marshallian Synthesis
• Frank Knight and American Neoclassical Paradigms
• 2.: The Origins and Development of a London Tradition
• Wicksteed and the Calculus of Choice
• H. J. Davenport
• Knight On Cost As Valuation
• Robbins, 1934
• Mises, Robbins, and Hayek On Calculation In a Socialist Economy
• Hayek, Mises, and Subjectivist Economics
• The Practical Relevance of Opportunity Cost: Coase, 1938
• G. F. Thirlby and “the Ruler”
• Mises’ Human Action
• The Death of a Tradition?
• Appendix to Chapter 2: Shackle On Decision
• 3.: Cost and Choice
• The Predictive Science of Economics
• Cost In the Predictive Theory
• Cost In a Theory of Choice
• Choice-influencing and Choice-influenced Cost
• Opportunity Cost and Real Cost
• The Subjectivity of Sunk Costs
• Cost and Equilibrium
• 4.: The Cost of Public Goods
• The Theory of Tax Incidence
• Costs and Fiscal Decision-making: the Democratic Model
• Costs and Decision-making: the Authoritarian Model
• Costs and Decision-making: Mixed Models
• The Choice Among Projects
• The Costs of Debt-financed Public Goods
• Ricardo’s Equivalence Theorem
• Tax Capitalization
• 5.: Private and Social Cost
• Summary Analysis
• A Closer Look
• Internal Costs, Equilibrium, and Quasi-rents
• An Illustrative Example
• Pigovian Economics and Christian Ethics
• Narrow Self-interest and Alternative-opportunity Quasi-rents
• Conclusion
• 6.: Cost Without Markets
• Prices, Costs, and Market Equilibrium
• Resource-service Prices As Final-product Costs
• Market Equilibrium, Costs, and Quasi-rents
• The Cost of Military Manpower: an Example
• The Cost of Crime: Another Example
• Artificial Choice-making
• Socialist Calculation and Socialist Choice
• Costs In Bureaucratic Choice

The Costs of Debt-Financed Public Goods

Nowhere has the elemental confusion in cost theory been more in evidence than in the sometimes acrimonious discussion of public-debt incidence. Indeed, it was precisely through my own involvement in the modern debt-burden controversy and my subsequent attempt to reconcile my notions with those of respected fellow economists that my attention was directed to cost theory.5 The debt-burden problem illustrates the necessity of distinguishing between choice-influencing and choice-influenced cost on the one hand, and the necessity of relating cost directly to choice on the other.

Consider, first, the view that was very widely held by sophisticated economists prior to 1958. It was alleged that the “real burden” of debt-financed public goods, the genuine opportunity costs, must be experienced during the time period when the real resources were actually used. In the case of the debts of World War II, the steel was used to make guns in 1943 and not in some later period. It seemed manifest nonsense, a violation of the most elementary opportunity-cost reasoning, to claim that public-debt burden was “shifted to future generations.”

As difficult as it may seem in 1969 to hold such a view (despite its continued espousal in nonsophisticated textbook discussion), orthodox opportunity-cost reasoning, which measures real costs in terms of real resources objectively quantified and which concentrates on costs independently of the particulars of decision, leads quite logically to this conception. Who gives up command over the real resources that are secured for public use under debt financing? The obvious answer is those who purchase the debt instruments from the treasury. These bond purchasers are not at all concerned about the decision to issue debt; their choice is simply whether to purchase debt or to purchase privately available investment or consumption goods. These bond purchasers surely do not participate in the fiscal choice as such. They cannot be said to bear the “cost” of the public goods that the debt issue finances. To locate the genuine cost of public goods, a cost which influences fiscal choice, we must look at the fiscal alternatives. What is avoided if debt is not issued and the public goods not provided?

If public debt is not created, if bonds are not marketed, the decision-maker, along with others in the collectivity, avoids the necessity of servicing and amortizing the debt in future periods. The costs of debt issue, in the way that they may influence a decision among fiscal alternatives, must be reflected in the decision-maker’s subjective evaluation of these subsequent outlays. In the choice-influencing sense, these costs are concentrated in the moment of choice and not in the later periods during which the actual outlays must be made. But the choice-influencing, subjective costs exist only because of the decision-maker’s recognition that it will be necessary to make future-period outlays. The concentration of choice-influencing cost in the moment of decision arises from the simple fact that a decision is made; this cost has no relationship whatsoever to and is not influenced by the fact that resources are used up in the initial period.

The choice-influenced costs of debt-financed projects, the losses in utility as a result of choice, are borne exclusively in periods subsequent to decision. These actual payments, which may also be measured in money, may reduce the utilities of others than those who participate in the decision. In one sense, this burden of debt is always deadweight, and its location in time has no relationship whatever to the time period during which the public projects yield their benefits.

Some of the contributors to the modern discussion of public-debt theory have acknowledged that, by comparison with tax-financing, debt issue does impose a relative “burden on future generations.” They reach this conclusion, however, because debt-financing is alleged to reduce private capital formation to a relatively greater degree than tax-financing. Hence, “future generations” inherit a somewhat smaller capital stock under current public-debt financing than they would under current tax-financing for similar public outlays. This line of argument, which can be associated with Vickrey and Modigliani,6 is also based on the failure to relate cost to choice. Whether or not private capital formation is or is not relatively reduced by debt-financing is irrelevant to the location of debt burden in periods subsequent to choice. Even should all funds for the purchase of bonds be drawn from current consumption, the subjective costs of debt issue still consist in the decision-maker’s evaluation of the enjoyments that must be foregone, by himself and by others, in future periods when the outlays for servicing and amortization must be made. The decision of a prospective bond purchaser is, of course, relevant to the rate of private capital formation, but this is not the same decision as that of the prospective bond seller. If the bond purchaser draws down private investment, he does impose a “burden” on his heirs in future periods, and the recognition of this will be the obstacle to his choice. If he draws down current consumption, no such burden is imposed. But the point to be emphasized here is that his choice is quite a separate and different one from that made by the debt issuer. The emphasis on the capital-formation aspects of public debt seems to arise from a confusion of the results of not one, but two decisions, and the calculus of not one, but two sets of decision-makers.

[5. ]In my early book, my ideas on cost were confused. See my Public Principles of Public Debt (Homewood, Ill.: Richard D. Irwin, 1958). Somewhat later, in response to critics, I traced the differences in debt theory to cost-theory confusions. My contribution, along with other papers, is contained in James M. Ferguson (ed.), Public Debt and Future Generations (Chapel Hill: University of North Carolina Press, 1964).

[6. ]See their contributions in Ferguson, op. cit. A similar error is made by Feldstein and endorsed by Prest and Turvey in their review of cost-benefit analysis. In Feldstein’s view, the cost of a project depends, in part, on whether or not the funds are withdrawn from current consumption or from investment. However, to the extent that cost-benefit measurements are helpful at all, the persons from whom funds are secured, presumably in this case through taxes, must be assumed to be in equilibrium between consumption and investment outlays. In this case, the utilities per dollar’s worth have been equalized at the margin. As suggested earlier, unless such full equilibrium is assumed, the whole approach, which is limited at best, becomes worthless. See M. S. Feldstein, “Opportunity Cost Calculations in Cost-Benefit Analysis,” Public Finance, XIX (1964), 126, as cited in A. R. Prest and R. Turvey, “Cost-Benefit Analysis: A Survey,” Economic Journal, LXXV (December 1965), 686-87.

Interestingly enough, Davenport seems to have indirectly warned against this error a half-century ago. He stressed that the cost to a borrower (that which he must give up in order to secure funds) has no direct relationship to the cost to the lender (that which he must give up when he makes a consumption-saving decision). Two distinct choices are involved and hence two costs. See H. J. Davenport, Value and Distribution (Chicago: University of Chicago Press, 1908), p. 260.