Front Page Titles (by Subject) Why Democracies Choose Deficits - Literature of Liberty, July/September 1979, vol. 2, No. 3
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Why Democracies Choose Deficits - Leonard P. Liggio, Literature of Liberty, July/September 1979, vol. 2, No. 3 
Literature of Liberty: A Review of Contemporary Liberal Thought was published first by the Cato Institute (1978-1979) and later by the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio.
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Why Democracies Choose Deficits
“Deficits and Democracy.” Southern Economic Journal 44 (April 1978): 813–827.
Democracies have tended to resort to budget deficits to finance expenditures. We can use a model of political competition which explains deficit financing in democracies by recognizing that institutional arrangements and corresponding assignments of property rights significantly influence individual choice.
We can view politicians as political suppliers of deficits in a monopoly situation: politicians compete for the right to supply a monopoly product (governing) for a limited time which is renewable through reelection. This view implies that political parties will strive to give the voters what they want in order to get elected; hence voters seem in some sense to “want” deficits rather than taxes to finance expenditures. The “rational expectations” literature predicts that (since deficits imply future tax liabilities) rational voters will treat deficits and taxes as equivalent claims and exhibit no preference between the two forms of finance. However, even perfectly rational and foresightful voters will prefer deficits.
One reason politicians can get away with deficit financing without voter preference is the incentive structure. Voters may be conceived of as owners of public goods and politicians as “managers.” Then the politician-managers would have no personal liability for financial mismanagement, and would thus reduce the capital value of the public stock beyond their own pro rata share of future tax liabilities. Deficits are then seen as the least costly means of financing expenditures. Voters, on the other hand, would demand expenditure because they see the increased cost to any one voter as negligible while the potential benefit can be great.
Two factors explain why voters will prefer deficit financing in a democracy. The first is that individuals have positive discount rates (positive time preference), and the second is that they can shift some of the costs to the future. That is, voters desire deficits because they do not rate the utility of next generation's consumption as equal to their own. They can, in fact, shift the burden of the debt to the future by taxing human capital rather than non-human capital. If non-human capital alone were taxed, a budget deficit would place a liability on future income streams of capital goods. This would reduce the present value of the good sufficiently to offset increased future taxes. The present owner would bear the burden of the debt. If human capital is taxed, one cannot capitalize his own present value indefinitely into the future, so part of the future tax will be paid out of the human capital of the next generation. One test of this hypothesis would be if states which rely more on income taxes than property taxes have greater deficits. Testing has shown this to be the case. Governments which routinely tax human capital to finance at least part of their budgets are more likely to run deficits.