The financial crisis of 2008 launched a chain reaction in the global economy. The growing budget deficit and public debt became an inseparable element of everyday economic realities in the United States and the rest of the world. As national economies are struggling to reduce the burden of debt and close the existing budget gaps, questions emerge as to how classical economists could help to resolve the current macroeconomic dilemmas. In this sense, David Ricardo’s equivalence propositions could inform the development of new policies and fiscal models to reduce the pressure of public debt and increase budget revenues.
David Ricardo is fairly regarded as one of the key figures in classical economics. An ardent supporter of the classical economic thought, Ricardo promoted the ideas of economic freedom and fair competition. The contribution he managed to make in the science of macroeconomics can hardly be overstated. Unfortunately, among others, Ricardo’s works on public debt received little professional attention. This is why it is high time to review the basic propositions of Ricardian classical philosophy and apply it in the conditions of the current macroeconomic crisis.
It should be noted that budget deficit and public debt come together in a classical model described by Barro (1989). According to Barro (1989), in a closed economy, the decision to substitute budget deficits for taxation leads to an increase in aggregate consumer demand: changes in the tax cut typically exceed corresponding changes in private saving. They also lead to an increase in interest rates, which will have to restore a balance between investment demand and national saving (Barro, 1989). By contrast, in an open economy, budget deficits would have little or no effects on interest rates. Any substitution of budget deficits for taxation would inevitably increase the amount of resources borrowed from abroad (Barro, 1989). In either case, public debt and budget deficit reduce the amount of capital stock, further reinforcing their intergenerational character.
In many respects, Ricardian views on macroeconomics present an alternative to the traditional model of budget deficits articulated by Barro (1989). His theory echoes many of the most popular propositions developed by classical economists. According to Tsoulfidis (2007), Ricardo’s theory is most notable in the analysis of various forms of financing public debt. Its basic assumption is that borrowing and taxation are equivalent in their utility and potential to reduce public debt (Tsoulfidis, 2007). Even though consumers perceive debt and taxation differently, both sources of financing lead to essentially same results (Tsoulfidis, 2007). “From a purely economic point of view there is no real difference among the various ways of financing, because in the end the same sum is being paid with the same collection cost” (Tsoulfidis, 2007, p. 6). In Ricardo’s view, it is the creation rather than maintenance of public debt that creates major macroeconomic difficulties. Simultaneously, public debt redemption does not lead to any macroeconomic improvements (Wood, 1994). Moreover, Ricardian theory justifies maintenance of public debt as a strategy to redistribute resources across generations (Neck & Sturm, 2008). However, such advantages become available only, if debt is used to finance long-term economic policies that can benefit future generations (Neck & Sturm, 2008). In other situations, public debt should be redeemed to avoid a decrease in capital accumulation, capital levy being the most promising strategy to redeem the debt (Wood, 1994).
As of today, Europe experiences serious macroeconomic difficulties, which translate into persistent public debt and budget deficits. More often than not, these difficulties are viewed as a logical consequence of the global financial breakthroughs launched by the U.S. (Cayla, 2013). As of today, European countries pursue several different lines of economic recovery. In a short-term perspective, the existing debt issues are resolved by setting legal constraints on public deficits (Cayla, 2013). In a long-term period, Europe forces the most problematic countries into developing and implementing quality reforms that would restore and improve their trade balances (Cayla, 2013). Unfortunately, the existing policies offer few advantages in either short- or long-term perspectives. The outstanding debt continues to increase and is likely to reach the scope and magnitude of the American debt situation (Cayla, 2013).
If David Ricardo were alive, he would say that the current situation in Europe is particularly detrimental to the present-day generations. As the public debt and budget deficits continue to increase, they create a huge burden on the current generation. Even if the resources generated through borrowing are used to develop and implement structural reforms, all countries of Europe will inevitably face the need to redeem their debt. In this way, they will avoid a decline in capital movements that necessarily follows the decision to substitute public debt for taxation (Wood, 1994). Looking at the current situation in Europe, Ricardo would definitely vote for taxation as an alternative to borrowing. The rationale behind this decision is simple: borrowing is a form of deceiving consumers, whereas taxation motivates consumers to be more reasonable in their financial choices and anticipate future expenses (Tsoulfidis, 2007). Unlike borrowing, taxation does not affect savings that can be productively invested and generate attractive returns. In Ricardo’s opinion, Europe should implement large property taxes, since employees and entrepreneurs will hardly manage to carry a new taxation burden and make large tax payments (Tsoulfidis, 2007). Capital levy through property taxes will release European countries from the outstanding debts within two-three years (Wood, 1994). It will also motivate future generations to be more resource-savvy in their economic policies and reforms.
To summarize, David Ricardo remains one of the most distinguished scholars in the history of the classical economic thought. His theory of public debt sheds some light on the complexities facing the world after the 2008 crisis. European countries keep increasing the burden of their public debt and budget deficits. If Ricardo were alive, he would say that borrowing and taxation lead to equal financial results. Still, property taxes represent a preferred policy option, since they would allow European countries to redeem their public debt within two-three years. Public debt redemption and increased budget revenues will boost consumption and minimize the risks of declines in capital accumulation and movements.
