New research by Professor Michael Ben-Gad explores the political economy of deficit bias and immigration.
Published (Updated )
In societies where the share of immigrants and their descendants is growing rapidly, governments will increasingly rely on debt rather than current taxation to shift some portion of the tax burden to the future.
That is the conclusion of new research by Professor Michael Ben-Gad of City, University of London.
His study, published in the Economic Journal, shows how demographic changes motivated the rise in US federal government debt since the early 1980s – and how they are likely to motivate even more debt in the future.
In 1946, a year after the end of the Second World War, publicly held US federal debt reached 106.1 per cent of GDP. For three decades, the debt burden steadily declined, reaching 24.9 per cent in 1979. Since then, net debt has more than tripled, reaching 77 per cent at the end of 2016.
Prior to President Trump signing in to law the Tax Cuts and Jobs Act in December 2017, the extended baseline forecasts published by the US Congressional Budget Office (CBO) already predicted that due to rising spending on social security and Medicare, publicly held debt would reach 91.2 per cent of GDP in 2027 and 150 per cent by 2047. According to the CBO’s more pessimistic Alternative Fiscal Scenario (no longer published after 2015), net public debt was forecast to reach 200 per cent of GDP in 2047.
In much of Western Europe too, both public debt and unfunded public liabilities have climbed, at rates unprecedented in peacetime, as elected officials opt to raise government expenditures, particularly on transfer payments, but resist raising taxes to pay for them.
The new study postulates that there is a strong connection between rapid demographic change and the willingness of the native population to tolerate, and indeed support policies that shift the tax burden to future generations. These are policies that in the absence of demographic change would only create economic distortions and in the past garnered little support.
Skewed in favour of the present
During the 1970s, the rate of net migration to the United States averaged 1.9 per thousand. It rose to 2.8 during the 1980s, to 4.3 during the 1990s, before receding to 3.2 per thousand. Yet the impact of immigration on the future composition of the population is also a function of the fertility rates among native women in the United States, which dropped below replacement by the early 1970s.
The foreign-born share of the population rose from 4.7 per cent in 1970 to 13.9 per cent in 2015, and it is predicted to reach 17.7 per cent by 2065. By then, the US population is projected to grow from 324 million to 441 million, with nearly the entire increase comprised of future immigrants or their descendants.
Rapid demographic changes created a strong incentive for natives to support significant reductions in the tax rate on unearned income in the early 1980s, causing the debt burden to begin rising. This policy of accumulating high debt to be financed by high and highly distortionary taxes in the future deviates from the standard prescriptions of optimal public finance.
According to Professor Ben-Gad, policy-makers representing the interests of current voters tolerate higher deficit spending not because they are intergenerationally selfish, but because they understand that their own children will not inherit the burden of the accumulating debt alone. Rather, the burden will be shared with future immigrants.
Governments weigh the cost of distortions that such policies generate, which will affect the descendants of natives and future immigrants alike, against the benefit that accrue to native households from shifting the tax burden from the present to the future.
Professor Ben-Gad, of the Department of Economics, argues it seems likely that, as immigration and falling birth rates transform societies in the developed world, decisions about taxation as well as public investment will become increasingly skewed in favour of the present.