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Adam Smith debunks that idea that when it comes to public debt “we owe it to ourselves” (1776)

In a discussion of funding a war by increasing public debt, Adam Smith (1723-1790) rejects the commonly held idea that heavy debt is not a problem for a society because “we owe it to ourselves”, or as he put it, “it is the right hand which pays the left”:

In the payment of the interest of the publick debt, it has been said, it is the right hand which pays the left. [52] The money does not go out of the country. It is only a part of the revenue of one set of the inhabitants which is transferred to another; and the nation is not a farthing the poorer. This apology is founded altogether in the sophistry of the mercantile system, and after the long examination which I have already bestowed upon that system, it may perhaps be unnecessary to say any thing further about it. It supposes, besides, that the whole publick debt is owing to the inhabitants of the country, which happens not to be true; the Dutch, as well as several other foreign nations, having a very considerable share in our publick funds. But though the whole debt were owing to the inhabitants of the country, it would not upon that account be less pernicious.

When the publick expence is defrayed by funding, it is defrayed by the annual destruction of some capital which had before existed in the country; by the perversion of some portion of the annual produce which had before been destined for the maintenance of productive labour, towards that of unproductive labour. As in this case, however, the taxes are lighter than they would have been, had a revenue sufficient for defraying the same expence been raised within the year; the private revenue of individuals is necessarily less burdened, and consequently their ability to save and accumulate some part of that revenue into capital is a good deal less impaired. If the method of funding destroys more old capital, it at the same time hinders less the accumulation or acquisition of new capital, than that of defraying the publick expence by a revenue raised within the year. Under the system of funding, the frugality and industry of private people can more easily repair the breaches which the waste and extravagance of government may occasionally make in the general capital of the society.

It is only during the continuance of war, however, that the system of funding has this advantage over the other system. Were the expence of war to be defrayed always by a revenue raised within the year, the taxes from which that extraordinary revenue was drawn would last no longer than the war. The ability of private people to accumulate, though less during the war, would have been greater during the peace than under the system of funding. War would not necessarily have occasioned the destruction of any old capitals, and peace would have occasioned the accumulation of many more new. Wars would in general be more speedily concluded, and less wantonly undertaken. The people feeling, during the continuance of the war, the complete burden of it, would soon grow weary of it, and government, in order to humour them, would not be under the necessity of carrying it on longer than it was necessary to do so. The foresight of the heavy and unavoidable burdens of war would hinder the people from wantonly calling for it when there was no real or solid interest to fight for. The seasons during which the ability of private people to accumulate was somewhat impaired, would occur more rarely, and be of shorter continuance. Those on the contrary, during which that ability was in the highest vigour, would be of much longer duration than they can well be under the system of funding.

When funding, besides, has made a certain progress, the multiplication of taxes which it brings along with it sometimes impairs as much the ability of private people to accumulate even in time of peace, as the other system would in time of war. The peace revenue of Great Britain amounts at present to more than ten millions a year. If free and unmortgaged, it might be sufficient, with proper management and without contracting a shilling of new debt, to carry on the most vigorous war. The private revenue of the inhabitants of Great Britain is at present as much encumbered in time of peace, their ability to accumulate is as much impaired as it would have been in the time of the most expensive war, had the pernicious system of funding never been adopted.

In the payment of the interest of the publick debt, it has been said, it is the right hand which pays the left. [52] The money does not go out of the country. It is only a part of the revenue of one set of the inhabitants which is transferred to another; and the nation is not a farthing the poorer. This apology is founded altogether in the sophistry of the mercantile system, and after the long examination which I have already bestowed upon that system, it may perhaps be unnecessary to say any thing further about it. It supposes, besides, that the whole publick debt is owing to the inhabitants of the country, which happens not to be true; the Dutch, as well as several other foreign nations, having a very considerable share in our publick funds. But though the whole debt were owing to the inhabitants of the country, it would not upon that account be less pernicious.

FN 52 Smith also refers to the apology for the public debt offered by some (unspecified) authors: ‘Say they, tho’ we owe at present above 100 millions, we owe it to ourselves, or at least very little of it to forreigners. It is just the right hand owing the left, and on the whole can be little or no disadvantage.’ Smith rejected this doctrine on the ground that the taxes paid by the industrious classes, such as the merchants, in effect reduced their stocks: ‘it is to be considered that the interest of this 100 millions is paid by industrious people, and given to support idle people who are employed in gathering it. Thus industry is taxed to support idleness. If the debt had not been contracted, by prudence and œconomy the nation would have been much richer than at present.’ Smith went on to point out that the contemporary clamour against the debt caused Sir Robert Walpole to try and show that ‘the public debt was no inconvenience, tho’ it is to be supposed that a man of his abilities saw the contrary himself’. In his essay ‘Of Public Credit’ Hume described the doctrine as being based on ‘loose reasonings and specious comparisons’ (Essays Moral, Political and Literary, ed. Green and Grose, i.366). Melon stated: ‘The Debts of a State are Debts due from the right hand to the left’. Essai, trans. Bindon, 329.

About this Quotation:

Adam Smith calls the Keynesian-like argument that a large public debt is not to be feared because “we owe it to ourselves” an example of “the sophistry of the mercantile system” which he had spent so much time debunking in the Wealth of the Nations (1776). He argues this is factually not true as debt may be held by foreign countries (in his case the Dutch) which means that there are international transfer payments to be made when the interest is paid. Even it were true, he believes that there are many problems which must be faced by a nation which goes into debt. He argues that it causes a “perversion” of the economy by diverting resources from peaceful and productive activities, that by moving the burden of payment into the future it deceives the people about the true cost of war and that wars therefore seem to be “cheaper” than they in fact are, that there is a crowding out effect since capital is diverted from private to public uses, and it results in increased taxation which reduces capital accumulation. But even if the public debt was entirely funded by domestic sources “we owe it to ourselves” is wrong in any case. Smith argues that within a society, public debt takes money from the “productive classes” and gives it to support “idle people who are employed in gathering it” and to the military who use it to fight, resulting in the destruction of life and property in the process. We have included the long footnote 52 where Smith makes these arguments more explicit.

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