BOOK V, CHAPTER V
THE THEORY OF PUBLIC CREDIT AND PUBLIC DEBTS
§ 1. The peculiar position of the state economy and the great importance of public borrowing have both tended to obscure the fundamental truth that public credit is but one form of credit in general, and is, or ought to be, regulated by the same leading principles. Many of the most serious errors in this department of finance have been due to the belief that the State in its borrowing was emancipated from the restrictions that prudence imposed on the individual, and that it might safely indulge in experiments that would soon land the ordinary citizen in bankruptcy.
A reference to the nature of credit shows that a national debt is no creation of wealth; that at best it can only, in Bagehot's phrase, be 'additive' and give greater energy to production. Moreover, this position is only attained where the credit is 'productive,' i.e. used in assisting the creation of fresh wealth. Where the resource whose use is obtained by credit serves merely for some object which, however important, is not conducive to economic production, then, either for the individual or for the State, there is so far a loss of material power. Present borrowing of this latter kind implies less income in the future until the loan is repaid. In like manner the limits of individual and public capacity for borrowing are determined on the same principle. Each person can only borrow on his disposable income; a State or subordinate political body must depend on its quasi-private and tax receipts, and must deduct its necessary outlay. The fund on which a public body can call is that part of the income of individuals that the tax collector is able to appropriate, and it is on its amount that, in the last resort, borrowing power depends.
With regard to the mechanism of public credit the same fact exists. A State entering the money market for a loan stands on a precisely similar footing to the industrial corporation. It must conform to the usual course of business, and it must submit to have its solvency gauged in just the same way—by the price at which it can obtain accommodation. State credit is, then, we may fairly conclude, one branch of the modern credit system, and its general aspect is the same as that of industrial or non-industrial credit, respectively, in the case of private economics.
§ 2. But though this general conclusion is abundantly warranted, and may be usefully employed in dispelling certain fallacies on the subject, there remain for notice some special features of public economy that give a peculiar colour to its borrowing, more particularly in the case of the central government. The sources of individual wealth reside in property or personal capacity to earn; it is from them that all private income comes. But the State's revenue is mainly derivative; it can compel the taxpayers to supply it with funds. The method of borrowing is therefore naturally suggested, where heavy taxation is for the moment undesirable, and is further encouraged by the fact that public credit has the advantage of resting on a broader and more enduring basis. So far as a public domain is in existence, loans may be regarded as virtually mortgages raised on its security, as many early loans actually were in form, as well as in fact.
A second peculiarity of public economy is the difficulty of sudden retrenchment in its case. The individual, or even the industrial company, can cut down expenses, if receipts fall below their former level. Their expenditure is more elastic than that of the State. Decline in revenue receipts will not justify the disbanding of the army, or the dismissal of civic officials. Consequently, when under any given state of things a deficit is imminent, and new taxes are not for the moment available, borrowing is necessarily prescribed.
This apparent disadvantage is compensated by the greater permanence and wider field of public economy. Whatever may be the disasters of a few years,*68 the normal feature during centuries is a growth of national wealth and income that it takes more than ordinary misgovernment to dissipate. We may readily explain the special forms of state loans by reference to this circumstance. The great variety of stocks and the complicated conditions for repayment could only be adopted by a body of assured continuance and growing resources, and in this respect the greater industrial corporations, that also have the prospect of long existence, present an instructive resemblance.
More important than any of the foregoing is the peculiar legal position of a debtor State. Unlike the private citizen or corporation, it rests within its own discretion to say whether or not it will meet its obligations. The creditor who wishes to enforce his claim against a State has not at his command the usual legal machinery, the necessity of which is proved by the frequent recourse to its aid.*69 A national bankruptcy is a strictly legal proceeding, e.g. an Act of Parliament repudiating the National Debt would be quite as valid as any other measure. This privilege, which is inherent in any form of sovereignty, has been further extended to—or more accurately speaking retained by—such subordinate political bodies as the 'States' of the American Union, which at one period of their history extensively availed themselves of it.*70 But where no trace of supreme power remains, this exemption disappears, and the ordinary local governments are as amenable to legal process for recovery of debts as any other kind of corporation.*71
Though released from legal liability, the sovereign State is in practice under very powerful inducements to pay its way. In the first place, if its creditors are foreigners, a failure to fulfil its agreement lays it open to remonstrance on the part of the foreign States affected, and possibly to even more rigorous measures. The domain of international law is not yet a settled one, and it is quite conceivable that the observance of obligations to alien lenders may be one of its rules in the future.*72 With regard to native creditors there is an obvious interest on the part of the State to do nothing that will injure them, and whatever political power they possess will surely be used in their own defence. Stronger than either foreign or domestic influence is the economic sanction that protects the security of loans. The repudiating State shuts itself out from the future use of credit for the sake of a temporary gain. A national bankruptcy is a bar to any later borrowing unless on ruinous terms. The American 'States' have never recovered the shock that repudiation inflicted on their position as borrowers. The best support to the policy of paying in full is derived from the economic advantage that a reputation for honesty secures 'in the long run,' and nations, it must be remembered, have a far greater interest than individuals in paying attention to what happens 'in the long run.'
§ 3. The earlier theories on the subject of public credit were little more than the formal statement of popular prejudices. Ideas similar to those of Law on the nature of credit were somewhat widely diffused. Thus we find the public funds described as 'a mine of gold,' and state loans as 'realised alchemy.'*73 Credit was looked on as a fresh creation of wealth, and therefore public debts were naturally regarded as affording a clear addition to the national possessions. Less extreme, but just as erroneous in principle, was the assertion that the debts of the State were quite unimportant, as they were merely due by the right hand to the left.*74 This position—an evident deduction from the cruder mercantile doctrine—was strictly applicable only to the domestic debt, and was so limited by Voltaire and Condorcet. Foreign creditors, it was thought, did take money out of the country, and therefore injured it; the resident received his interest, and spent it at home. There is little difficulty in exposing this fallacy, which really rests on the same ground as certain views about expenditure and taxation already rejected.*75 The action of indebtedness on the economic system cannot be altogether without influence or effect, nor can the consumption of masses of wealth be of itself beneficial. The confusion—not altogether unknown in later writers—between wealth and evidences of ownership is the reason for the belief that public debts are an addition to the material resources of the nation. Though in some respects the existence of debt may be the cause of new wealth creation, this interpretation of its effects must be dismissed as erroneous.*76
§ 4. But the growth of debts in England and France in the eighteenth century produced a very different opinion on the subject in the case of the most prominent writers on political and social matters. Montesquieu did not hesitate to condemn public debts; he refutes the idea that they are advantageous, and approves of the English conversion and sinking fund.*77 Hume is even more pronounced. Though declining to 'waste time in declaiming against a practice which appears ruinous, beyond all controversy,' he yet states very forcibly his objections, some of which had been already given by Montesquieu. The high authority of Adam Smith is on the same side. He speaks of 'the enormous debts which at present oppress, and will in the long run probably ruin, all the great nations of Europe,' and his whole discussion of the funding system is in an extremely hostile tone.*78 Both Hume and Adam Smith prophesied that national bankruptcy would be the outcome of the continuous English borrowing. The course of events has falsified this prediction, and later writers have not hesitated to pronounce it fallacious. According to Macaulay 'the prophets of evil were under a double delusion. They erroneously imagined that there was an exact analogy between the case of an individual who is in debt to another individual and the case of a society which is in debt to a part of itself.... They were under an error no less serious touching the resources of the country.'*79 The former part of this criticism is more than questionable. In all essential points the analogy between the public and private debtor does hold good, and should never be lost sight of It is no doubt true that the material power of England was under-estimated, but then it was impossible to foresee the Industrial Revolution and its extraordinary results. The real error of Hume and Adam Smith lay in generalising from a too limited experience, and in assuming that no new forces would come into operation; just as Macaulay has probably erred in the opposite direction when he declares that 'a long experience justifies us in believing that England may, in the twentieth century, be better able to pay a debt of £1,600,000,000 than she is at the present time to bear her present load.' The true view, which regards the debt as a pressure on an elastic body, implies the necessity of measuring both the weight and the expansive power of the object on which it presses.
The French war and the accumulation of debt that it caused brought forward Sinclair as a moderate supporter, and Hamilton as a vigorous critic, of the system of borrowing. The former maintains that public loans are the necessary result of the new method of conducting warfare, and compares their advantages and disadvantages.*80 Hamilton's work expounds with remarkable clearness the general rules applicable to the management of debt, and contains among its fundamental principles the following proposition: 'If the periods of war, compared with those of peace, and the annual excess of the war expenditure, compared with the annual savings during the peace establishment, be so related, that more debt is contracted in every war than is discharged in the succeeding peace, the consequence is a perpetual increase of debt; and the ultimate consequence must be, its amount to a magnitude which the nation is unable to bear.'*81
Now, this is merely the statement in hypothetical form of the condition from which Adam Smith and Hume drew their dismal conclusions, and, as expressed, it is absolutely incontrovertible. A nation cannot, any more than an individual, keep adding continually to its liabilities without at last coming to the end of its resources.
The influence of Hamilton's teaching, which we shall have to notice again in respect to the method of repayment,*82 is plainly traceable in Ricardo's 'Essay on the Funding System,' in which he declares his preference for taxes over loans, chiefly on the grounds that (1) imprudent expenditure will be checked by the dislike felt for heavy taxation and (2) the probability that taxation will fall on revenue, while loans usually come from capital. Thus the main current of economic opinion was decidedly opposed to state borrowing.
§ 5. A comparatively novel view of the effect of public borrowing—though the germ of the idea is in Ricardo's essay—was given by Chalmers, who in his Political Economy (1832) argued that the loan system was economically disadvantageous and oppressive to the labourers. He maintained that, whatever method be adopted, the whole amount must be taken within the period, but that by taxation the charge is spread over the whole revenue of the society, while by borrowing it is placed on that part of circulating capital that goes to reward the labourers, and, as a necessary consequence, lowers their remuneration to the benefit of the capitalists. In fact, in his opinion, the system of borrowing puts double pressure on the country that adopts it; for there is the original sacrifice when the loan is contracted, and the later one involved in the payment of interest, so long as it remains outstanding, and finally in its repayment. The practical conclusion that follows from this train of reasoning is of course that no borrowing should ever take place, and that all expenditure should be met out of current revenue.*83
It is highly probable that Chalmers's argument, like many of the ingenious points made by the secondary writers on economics in the first half of this century, would soon have been completely forgotten, had not J. S. Mill seized upon and repeated it in an early chapter of his Principles. He asserts that the doctrine is substantially correct, though needing qualification, owing to the possibility of the migration of capital;*84 and in a later part of his treatise he endeavours to assign what is clearly an erroneous criterion, by which the real effect of any actual loan could be determined.
This curious doctrine is evidently based on an application of the wages-fund theory in its most rigid form, and the general abandonment, or at least qualification, of that dogma would of itself suggest serious doubts as to the soundness of any deduction from it. As we shall see in a later section, the argument is almost wholly untenable, and rests on a very partial interpretation of some economic conditions peculiar to the time at which it originated.
§ 6. The exigencies of practical finance had made the use of borrowing so general that the more practical students of the subject recognised the necessity of the loan system. In Germany especially is this view to be found. Jacob, Malchus, Rau, and Nebenius, while all dwelling on the evil effects of loans, accept them as a legitimate expedient. The arguments of Adam Smith were blended with the results of positive experience, and if the combination was not always consistent, it at least had the merit of being eminently common-sense.*85
The same judgment can hardly be passed on a later German theory, originated by C. Dietzel, which regards the loan system as the true mode of defraying extraordinary expenditure. This view, which has been already noticed in another connexion,*86 regards the State as being a part of the immaterial capital of the society, and any unusual outlay for its service as, in fact, an investment. To charge to revenue what is really due to capital is therefore a mistake in public bookkeeping, and, what is far worse, an injustice to the actual taxpayers. So contemplated, the issue of loans becomes a normal part of the working of a progressive State. Instead of regarding the process as wholly condemnable, or at best as a necessary evil, we should, it is maintained, look on it as both just and beneficial.*87 The upholders of the theory have arrived at a diametrically opposite position to that occupied by Chalmers, and one which, if generally adopted, would produce very serious practical consequences.
§ 7. A criticism of the preceding doctrines supplies the first steps towards a true theory of public debt. The idea of Chalmers that the system of borrowing presses too heavily on the labouring class can be easily shown to be fallacious. In the first place, it is not true that all loans come from capital; they may be obtained from savings made for the purpose.*88 The prospect of a new and secure investment is a stimulus to abstinence, and so far as it is operative the labourers will not suffer. But even granting this erroneous assumption, it by no means follows that loans derived altogether from capital are taken from wages. 'The loan,' says Mill, 'cannot have been taken from that portion of the capital of the country which consists of tools, machinery, and buildings. It must have been wholly drawn from the portion employed in paying labourers.'*89 He, however, offers no proof, or attempt at proof, of this proposition, which is plainly untrue. The amount taken in loans comes at first from floating capital that would otherwise have been applied to fixed capital, raw material, or the payment of workers in proportions determined by the actual circumstances. Again, the effect of the employment of the loan is altogether disregarded.*90 In so far as it is expended on hiring services it actually tends to raise wages, so that, reasoning from the wages-fund position, what is taken by the abstraction of capital is restored by the outlay of the borrower on labour. The utter unsoundness of the doctrine that all loans come from wages will appear from the absurd result to which it leads—viz. that where wages are at the minimum it would be impossible to borrow without starving some of the workers.*91
The facts that public loans are in many cases international, and that in any event capital is capable of migrating from country to country, are allowed by Mill to have weakened the theory that we are considering. If loans really come from the international market, any pressure must fall on the labourers of all the countries which contribute—e.g. South American borrowings would have injured English labourers. He is therefore led to suggest that so long as public borrowing does not raise the rate of interest, the labourers are not damnified. This qualification is again unsound; for every loan must, pro tanto, tend to raise the rate of interest or to keep it from falling. There is no line or wall of separation between capital for home and that for foreign investment.*92 The growth of international relations has rendered antiquated any argument from the hypothetical case of an isolated country.*93
Such considerations as the foregoing make it difficult to understand the acceptance of the doctrine by Mill. The explanation is to be found partly in a special case which seemed to give it support, and partly in a portion of truth that it did, in fact, contain. The great instance of state borrowing known to Chalmers and Mill was that by England in the period 1793-1815, and at that time the labourers were suffering, while the capitalists seemed to prosper. The real causes were of course different,*94 but the concomitance of the two series of facts gave a plausibility to the theory that it would not otherwise have had. The element of truth contained in it was that public borrowing is a demand for loanable capital which helps to raise its value—i.e. the rate of interest.*95 Higher interest leaves less for the other shares in distribution, and as the employer and the landlord were able to hold their own, the pressure fell on the labourers; but this could not be ascribed solely to state borrowing. Taxation that really fell on capital would have the same effect. We cannot therefore adopt, as a sweeping and absolute rule, the proposition that the State should never at any time obtain funds by borrowing.
§ 8. The opposite theory, which puts forward the loan as a normal process of meeting expenditure of the extraordinary class, is open to quite as weighty objections. The expenses of the State do, no doubt, vary from year to year, and any sudden increase which has to be met by taxation may prove inconvenient, but on the other hand we have to remember that so-called 'extraordinary' expenditure is itself recurring.*96 To treat all fresh claims as extraordinary, and to meet them from loans is an easy, but a dangerous course. There is also the further consideration, that in the long run the revenue from economic receipts and taxation must, if the State is to remain solvent, balance the outlay. So far as debt is not redeemed it is a permanent charge on the revenue, while its redemption must come from that source. If, taking a somewhat lengthened period, we find that the ordinary state revenue meets expenditure, there is no reason why—special emergencies excepted—it should not do so in each financial year. Sudden changes in taxation may be more or less inconvenient, but the system should be such as to secure some elastic sources of revenue. The English income-tax is capable of discharging this function, and the duties on commodities would also allow, in case of need, of large increases. A theory that so markedly separates ordinary from extraordinary expenditure, and assigns different funds for their immediate payment, errs by unduly emphasising a non-essential distinction.
That borrowing is justifiable to meet 'reproductive' outlay is a further part of the theory, which is at once true or false according to the meaning given to the term. Actual purchase of productive property or creation of revenue-yielding works may fairly be defrayed by loans. The property or particular work may be regarded as the primary object of the debt, and is at hand to pay the interest on it. What we have called 'economic' outlay has a claim to be met by borrowing that does not hold in respect to other forms. Taxation imposed for the purpose of adding to the domain has the disadvantage of taking the citizens' wealth for the purpose of accumulation, and should be employed sparingly, if at all. To meet the cost of the purchase of the Prussian railways, or even of the English telegraphs, by immediate taxation, even were it practicable, would not be correct.
This concession to the policy of borrowing should not be stretched to include the cost of works or other state action that yields no revenue. Non-economic expenditure is primarily to be met out of income, and unless it can be so dealt with ought not be incurred. National culture, education, the promotion of social progress are all most desirable; but their promotion is not so urgently required as to need the use of borrowing by the public powers. It is, indeed, true that much of state expenditure may be regarded as indirectly productive, and as likely to add to the national income in the future. A loan for the purpose of extending education, or for improving the housing of the workers, though it does not directly provide the interest needed, may yet so increase the income of the community as to make the tax receipts greater, without any increase either in rates or in rigour of collection. Regarded in the abstract such a proceeding seems defensible; the real objections to it arise from the difficulty of application. The results of expenditure of the kind are hard to trace or measure, and any statement respecting them must rest in a great degree on conjecture. The cost of the loan is definite and precise, and it constitutes a real burden on the resources of the society. Prudence seems accordingly to suggest that borrowing should hardly ever be adopted except for strictly economic expenditure, and then only when the extension of the state domain is clearly advisable. Political and social conditions come in to limit the purely financial action of the public powers.*97 With an individualistic organisation of society the extension of public industries has naturally to be kept within narrow bounds, and will not comprise all possibly gainful employments.
One great objection to the use of borrowing, unless there is an equivalent revenue obtained by its application, is the necessary curtailment of the future power of spending. Large immediate outlay may, as we shall see, be requisite in certain cases, but for most of the usual forms of state activity the funds obtainable by taxation are quite sufficient, and can be continually renewed. Each year meets its own expense without causing any unevenness in the employment of the fund to be devoted to the purpose. Heavy borrowing, on the other hand, if persisted in for several years, so cripples the ordinary revenue as to compel retrenchment, or further borrowing on disadvantageous terms, until the limit of solvency is touched. This appropriation of resources that will surely be needed in the future is a grave weakness in the borrowing policy.
§ 9. We have now to examine the real effects of the system of borrowing, and for this purpose it is requisite to clearly distinguish between the mere mechanism of a loan, and the actual economic phenomena that are its outcome. Reduced to its simplest form, a loan is a transfer of so much of the wealth of private holders to the State or other public body. By its aid the borrower obtains the disposal of the wealth in question, and as a consequence affects, or can affect, the production, distribution, and consumption of wealth. Thus we cannot doubt that the enormous English loans during the Revolutionary and Napoleonic wars had a powerful influence on the economic condition of the country, and we must believe that other cases of borrowing so far resembled this particular one. The application of public loans is, therefore, to be taken into account when seeking to estimate their effects. If contracted for a purely industrial purpose—say railroad construction—it is quite conceivable that their influence on the state economy may be almost imperceptible. It may even happen that the actual application will be the very one that private capitalists would have selected for their investment, in which case the public credit is only interposed as an intermediary between the real investors and the industry in which the wealth is placed. There is, of course, the additional complication of public management, but in essence the State is an unnecessary additional wheel in the mechanism.*98 The expediency of borrowing for reproductive purposes accordingly depends on the policy to be pursued in reference to public industries. Where, as in Australasia, there is a decided tendency to keep certain classes of works under the public authorities, the policy of borrowing is by that fact justified.*99
Turning to the opposite case of loans applied unproductively, the first effect is the diminution of capital and the resulting loss of wealth. The typical example is that of a loan for carrying on war. Its use is turned from the support of productive industry to the purchase of commodities and services to be employed unproductively. It is, however, important to note that this distinction is not the consequence of borrowing, but of the circumstances that have led to its destination: it results from the extra expense, not from the particular mode of meeting it.
But granting that the primary cause of the economic disturbance that accompanies extensive public borrowing is to be found in the forces that have produced the increased state expenditure, it does not follow that the system of meeting that outlay by loans, instead of by taxation, has not a serious influence on the economic conditions of the society especially as there are, beyond dispute, some pointed contrasts in the action of loans and of taxes. The first, of these has been already emphasised in Chalmers's theory. A loan, it is said, comes from the nation's capital; taxes from its annual income; the former reduces the fund that assists production; the latter curtail immediate enjoyments. By borrowing we are sacrificing the permanent interests of the country for the sake of immediate relief. That there is some truth in this position is undeniable, but it is very easy to exaggerate its importance. The sharp line thus drawn between revenue and capital does not, in fact, exist, as there is an evident reaction of each on the other. Revenue is, indeed, the spring from which capital is fed, or rather at any given time 'revenue' and 'capital' are but names for different applications of the collective wealth of the community.*100 Large public borrowing stimulates saving, and thereby checks expenditure on enjoyments, while oppressive taxation reduces the fund from which new savings are made, and so far hinders the accumulation of capital. A loan for unproductive purposes is not always a pure destruction of national capital. Though the debt charged on the national wealth is increased, there may be some compensation in the larger available assets.
A second point of contrast is in favour of borrowing. A loan is voluntary, and supplied by willing givers; taxation is levied on the willing and unwilling alike, and, if heavy, is sure to cause discontent. The former has, therefore, the advantage of putting less immediate pressure on the individual citizen, though on the other side there are the future charges, and the effect on borrowers and labourers through the increased value of loanable capital to be taken into account.
Thirdly, the equitable distribution of heavy taxation is not easily attained. Where very high imposts are laid some classes and persons are likely to suffer unduly. The division of the charge over a longer period by the use of borrowing makes the proper apportionment of the burden far easier, and more especially allows of sufficient time for its full consideration. Great and sudden changes in taxation—particularly if they are increases—are always evil. Some time is needed for the definitive incidence of a tax to become settled; a truth exaggerated in the doctrine of Canard, but still having much weight in this special connexion. It might even be said that, to avoid disturbance, taxation should always be maintained at a level sufficient to meet the average outlay over a long period. Excessive expenditure in some years would thus be compensated by savings in others, and complete equilibrium between income and outgoings would be the final result. The utter impossibility of forecasting the future course of expenditure makes this method quite impracticable. The effort to carry out such a plan would end in an accumulation of debt that would not be paid off in the prosperous periods. But though so thorough an adjustment is not to be reached, the diffusion of the burden of loans, in opposition to the immediate pressure of taxes, is a difference to be taken into account in considering their respective operations.
The contrast may also be turned the other way. Just as direct taxation is often advocated on the ground that it brings the real cost of the State more clearly before the contributors, so has the policy of paying all expenses out of taxation been regarded as 'a salutary and wholesome check' on the natural disposition to indulge in extravagant outlay. To make things smooth for the present at the cost of the future is not the duty of the wise and far-seeing statesman.
Loans for war expenditure are particularly open to this objection, and it was in reference to them that Mr. Gladstone pronounced his forcible condemnation of the policy of borrowing.*101 There can be no doubt that the immediate increase of taxation will to some extent damp the ardour of a people for war, which, however, is sometimes a doubtful advantage. From the point of view of the administration the method of borrowing is decidedly preferable; as, where taxes have to be imposed it is necessary to exercise economy and to keep expenditure within bounds, while by the use of loans a government may even secure favour with the moneyed interest, and at the same time become popular amongst other classes by profuse outlay.
Lastly, there is, or there may be, an opposition between borrowing and taxation in respect of their ultimate incidence. With proportional taxation increased to meet abnormal expenditure there is very heavy pressure on the receivers of industrial, or more generally of temporary, incomes, which may have ceased to exist when the burden is removed. In the succeeding period of low expenditure the same class of incomes escapes lightly, though the recipients have benefited by the sacrifices previously incurred. This failure in just distribution between different times may be met by the loan system, the interest on debt being paid by those who would otherwise have escaped altogether, but as we saw,*102 it can also be avoided by the use of taxes falling on property, such as succession duties, or direct imposts on realised wealth, though this course is surrounded by difficulties of its own.*103
§ 10. So far the contrast of borrowing and taxation as modes of meeting extraordinary expenditure, does not seem to lead to any very decisive result. Some broad considerations favour the use of taxation: others of no slight weight give support to, at least, a moderate use of loans. But, in truth, there is not quite free choice. After expenditure has passed a certain point, borrowing becomes, if not necessary, at all events highly expedient. The productiveness of every separate tax has its limits, and so has that of the tax-system taken as a whole. Each additional charge implies a more than proportional sacrifice by the contributors, and greater difficulty in getting in revenue on the part of the State. The existence of the condition of 'diminishing returns' in public receipts is a valid ground for the employment of loans, when, all things considered, they will be less onerous than further taxation. It appeared that 15 per cent. was probably the largest proportion of the national income that, under ordinary conditions, could be taken for the state services, and though the limits of productivity are capable of being expanded at times of trial, we can hardly doubt that an income-tax of five shillings in the pound would prove too much for even the United Kingdom.
This principle admits of more extended application. If, when taxation is exhausted, a loan has to be employed, it is evident that before that extreme point is reached, borrowing may advantageously be combined with taxation, and that the exact extent to which it should be used will depend on a complicated calculation of the different elements involved. The cost of taxation, varying as it does according to its forms and amount, must be weighed against the burden, present and future, of the loan. This is no easy matter, and it can only be approximately worked out, if, indeed, it has not to be decided at once by the insight and instinctive knowledge of the statesman, who will be guided as much by the political, as by the purely financial conditions.
The practical solution is not, however, so difficult as would appear from the preceding paragraph. A good tax-system requires as one of its qualities a considerable amount of elasticity, and, as far as possible, the first appeal should be made to taxation. The English income-tax is a valuable instrument for this purpose—as its employment in the Crimean, and, again, in the South African War shows—and its place in this respect is with difficulty filled by other taxes. Still, the customs and excise, if moderately well administered, will allow of increases for a special emergency. Tea, wine, and beer would bear much heavier duties in England, and sugar has proved to be a productive object. Some of the duties on 'acts' could also be advanced in case of need, and would soon yield a larger return.*104 Thus, even if the actual expenses are at first met by creating a floating debt, the new duties will speedily pay off what has been incurred. But when the limits of ready expansion are reached, a loan is the suitable mode of obtaining further supplies. Where there is a pre-existing debt in course of redemption, the suspension of that process will add to the available funds,*105 while if there is no debt, the light taxation previously levied can be largely increased. This last consideration suggests a disadvantage in the existence of a permanent debt, in that it brings future borrowing nearer, by imposing so much additional charge on the annual revenue, and thereby reducing the disposable balance.
The probable duration of extraordinary expenditure is an important element in determining the mode of providing for it. A sudden and large demand for a single year may well be met by borrowing (unless the movable taxes and the suspension of debt redemption suffice), as it would not be desirable to disturb the whole tax-system for such a purpose. Where there is a fair prospect of continuous outlay on the increased scale, a readjustment of taxation at the outset is the prudent course.*106 Failure in this cardinal point of sound finance was the cause of the great accumulation of debt in England at the opening of this century, and was also noticeable in the treatment of war expenditure by the United States both in 1812 and 1861, to which instances the treatment of the French expenditure for the Crimean War, and recently that of England in South Africa, may be added.*107
On the whole, then, the rules applicable to the treatment of abnormal outlay for other than economic purposes may be stated as follows:—(1) Expenditure should, as far as possible, be met out of the annual receipts, and therefore increased outlay should be balanced by heavier taxation. (2) In the case of non-recurrent expense of large amount, a loan is preferable to a serious disturbance of the normal tax-system, and may fairly be employed. (3) Where the abnormal expenditure extends over a series of years, the various forms of taxation should, speaking generally, be adjusted to meet it. (4) This general principle, however, fails where either (a) it would be impossible to secure an equitable division of the heavy taxation necessary, or (b) where the limit of productiveness with regard to the several taxes would have to be exceeded, or finally (c) where for political reasons it is inexpedient to press heavily on the taxpayers. Under any of these conditions resort to loans as a supplement to the tax revenue even for a somewhat lengthened period is defensible.
§ 11. The fact that part of the funds obtained by public borrowing is derived from abroad is of some weight in judging the loan policy. Not that a foreign loan is in its purely financial bearings so different from a home one as is sometimes supposed, but that the possibility of drawing on the capital of other countries weakens the argument in favour of taxation on the ground that, in any event, the expenditure must be met from the national resources. When taxation fails to respond to new demands, a foreign loan may supply the necessary sums, and the competition of alien with native lenders will enable the state to borrow on better terms, and with less effect on the rate of interest, and therefore to the advantage of the labouring class. But from a purely financial point of view the source of a loan is really immaterial. In any case it is an immediate relief to the taxpayers, counterbalanced by greater charge in the future. Whether the wealth to be consumed in the outlay, which is the primary cause of borrowing, be derived from the stores of home or foreign lenders may have some immediate influence, but when we bear in mind the close connexion of all the countries of the world, and the great mass of private borrowing from foreigners, it is evident that the distinction may be easily exaggerated.
The political and economic effects of the greater mobility of loan capital in recent times are highly important, and deserve careful study, but they do not belong to public finance. The possibility of political complications in consequence of a default in the payment of foreign creditors has been previously noticed.*108
§ 12. Some important questions arise respecting the absolute amount of public debts, the pressure that they impose on the borrowing States, or other bodies, and the best mode of measuring that burden. For this purpose very different methods may be used. The most obvious is that which takes the nominal capital of the debt as the basis of measurement. Thus, in 1870, France and the United States had approximately the same capital debt,*109 and therefore, it might be said, an equal liability. The defect of this method is evident from the fact that it takes no account of the interest on the borrowed capital, which latter, is moreover, not payable at the creditors' demand. 'The public debt,' as Lord Grenville put it, 'consists not in capital but in annuities,'*110 and the capital amount of debt is therefore no guide to the actual burden that it imposes. A second method might be employed by which the actual, instead of the nominal capital value, or in other words the market price of the stock, would be used as the test, but this again is open to the objection that the real value is incessantly fluctuating, and at any given time represents only the value of the small amount sold, not of the total mass of stock.*111 A third mode, by which a very different result will usually be reached, takes the interest charge as the measure; e.g. in the just-mentioned case of France and the United States, as the former had most of its stock at 3 per cent., while the latter paid 6 per cent. on much of its obligations, the comparison was altogether in favour of France.
All the foregoing methods deal with the absolute amount of the several public debts, and of themselves furnish but a slight clue to the sacrifices undergone by the people of the country. For this purpose a further combination is necessary, and the most popular plan is to divide the capital or the interest charge by the number of the population, and so get the charge 'per head.' How fallacious any test of the kind must be, has been already shown in respect to expenditure;*112 and it is equally plain here, as a comparison of the debts of England, the United States, and Victoria against those of India, Italy, and Russia, suffices to prove. The mere population of a country, any more than its area, is no measure of its wealth and financial capabilities, which must depend on so many different circumstances.
A far better test would be the relation of debt to the national revenue, or, again, to the collective wealth of the society. Such comparisons are, however, by no means easy. The annual income—and especially that part of it which is disposable—must always be more or less doubtful, and estimates of national wealth, whatever method be employed,*113 have even less chance of approaching accurately the real position. Nevertheless inquiries of the kind give a good rough result, and in relying on them we may fairly compare the annual charge of the debt with the national revenue, and in like manner its capital value with the sum of national wealth. The annual charge of £23,000,000 for the English debt should be compared with the £1,400,000,000 of national income, as the £750,000,000 of capital—subject to whatever deduction may be required for its being under par value—should be placed against the £12,000,000,000 which may be taken as the sum of British wealth.*114 In this way we get less than two per cent. as the proportion of income, and over six per cent. as that of capital assigned to the public creditors. This great discrepancy indicates the omission of some important element in the capital estimate, which can be no other than the capitalised earning power of the human beings who make up the community. Wages, and industrial and professional earnings, are a part of the revenue, but not of the ordinary capital account of the nation.*115
For practical purposes it is often convenient to take the proportion of the total state expenditure required for the payment of the annual debt charge as measuring its weight. Thus the smaller proportion of the English expenditure on debt in the later, as compared with the earlier years of the nineteenth century shows so far a reduction in the burden. The relations of public outlay to national revenue and the amount of service performed by the State are both elements to be considered before this ready test can be used with any accuracy.
Finally, in estimating the weight of public debt, it is necessary to take account of the public assets that are available for its liquidation. The property employed in the discharge of the various public functions cannot be regarded in this light. The buildings and other non-revenue-yielding possessions of any government could only be sold at the cost of abandoning the discharge of normal administrative duties. Such property is an essential condition of state activity.*116 Very different is that part of public property—the domaine privé of French administrative law—which supplies revenue. Land, forests, mines, railways, and other industrial enterprises have all a market value, and would by their sale provide funds that could be employed in paying off debt. The real value of such state property is therefore fairly to be set off as a deduction from the debt before computing its capital amount, as for precisely similar reasons its annual yield must be regarded as a mitigation of the interest charge. The importance of this consideration comes out very strongly in respect to countries in the situation of the German States, the Australasian Colonies, and the Indian Empire.*117 The greater part of the debt incurred by all these countries has been for the creation of public works, which—be their value more or less than the wealth expended in their creation—are undoubtedly worth very large sums, and if in the hands of private individuals or companies would be regarded as constituents of national wealth. The real debt burden of the countries so situated is much less than the apparent one. It may even be altogether removed.
For the purposes of this allowance it is quite immaterial whether the property has been created by means of loans, or obtained in other ways. Revenue from the rent of land is as much an aid towards the payment of debt, as receipts from railways constructed by loans. The economic revenues of the State are a compensation, more or less effective, for debt expenditure.*118 It is in connexion with the original application of loans that the distinction between property obtained by their employment, and that otherwise derived comes up for consideration.
Estimates of the real weight of public debts are, it is now plain, by no means easily formed; the considerations to be taken into account are too complex for ready and off-hand treatment. The only way of arriving at a satisfactory result is by the use of each of the different methods of calculation, and a combination of their results with the due allowances previously pointed out. Where all point in the same direction a conclusion is easily reached: where they differ the selection of the proper ones depends on the object for which the inquiry is made. If annual pressure is to be ascertained, interest is more important than capital; if the cost of redemption is wanted, capital or market value should be the primary object of investigation.
Notes for this chapter
Thus the situation of France in 1871 was an entirely unexpected one, and could be no criterion for judging the usual position of that country.
The peculiar treatment of Egypt and Greece is noticeable, as indicating the tendency towards international regulation in the case, not only of non-sovereign, but also of small independent States.
The 'repudiations' of 1840-50 are the best known examples.
It must, however, be remembered that the method of procedure may often be complex, and make recovery of the debt difficult, if not hopeless.
The case of Greece, just referred to, and the possible difficulties of European States with the South American Republics may be referred to.
The former is Berkeley's account, Querist, No. 233; the latter phrase is used by Pinto, a Dutch writer. Roscher, § 125, note 1.
'Les dettes d'un État sont des dettes de la main droite à la main gauche, dont le corps ne se trouvera point affaibli.' Melon, Essai Politique, ch. 23 in Économistes Financiers du 18me siècle, 749.
Cp. Bk. i. ch. 8, § 6, and Bk. iii. ch. 2, § 2.
Macleod's theory of credit is tainted by this fault.
Esprit de Lois, Liv. xxii. chs. 17, 18.
Hume, 'Essay on Public Credit.' Wealth of Nations, 387.
History of England, ii. 400.
Sinclair's History of Revenue, Pt. ii. ch. 2, i. 350 sq.
Bk. v. ch. 7, § 3.
Chalmers, Political Economy, ii. 71 sq.
Principles, Bk. i. ch. 5, § 8, Bk. v. ch. 7, § 1.
On these writers see Cohn, §§ 511-14; Roscher, Geschichte, §§ 152, 160, 195.
Bk. i. ch. 8, § 1.
See C. Dietzel, System der Staatsanleihen; Stein, iv. 421; Wagner, i. 144 sq., for statements of the doctrine. Cohn, §§ 515-7, supplies a pointed criticism.
This was probably true of part of the French loans of 1871-2.
Principles, Bk. i. ch. 5, § 8.
Mill briefly refers to this point in a footnote to his later editions, Bk. i. ch. 5, § 8 (6th ed.).
Mr. MacDonald (Economic Journal, xii. 24-28) misapprehends the doctrine of Chalmers which he criticises.
Mill, Principles, Bk. v. ch. 7, § 1. His error has been exposed both by Cairnes, On the Best Method of Raising the Supplies for War Expenditure, 10, 11, and by Cliffe Leslie, Notes (privately printed), 17, 18.
For a clear statement of the modern mobility of loan Capital see Cunningham, British Association Report (1891), 727.
The labourers' sufferings were really due to the continued bad harvests, the depreciated paper money, the restrictive laws against labour, the old Poor Law, the check to imports by war, and the industrial revolution. The capitalists gained by the greater use of machinery and the command that England at times obtained over the supply of foreign markets.
Cp. Sidgwick, Pol. Economy (1st ed.), 323, for the possible effect of inventions in so raising the rate of interest as to injure labourers.
Cf. Bk. i. ch. 8, § 1.
See Bk. i. ch. 1, § 2 for this peculiarity of public economy, and cp. Bk. ii. ch. 3, § 21.
The profitableness of such a method is, generally speaking, more than doubtful, but the Prussian railways may again be cited as an exceptional case.
The occasional depressions in colonial securities and the difficulty at times of procuring fresh loans illustrate the danger that attends such a system, and the need for caution in its use.
Cp. Bk. iii. ch. 2, § 5, and for a discussion of the conception of revenue see Marshall, Principles, Bk. ii. ch. 4, §§ 3, 4, (3rd ed.). Prof. Fisher and Mr. Cannan urge that the distinction between 'capital' and 'income' turns on differences in respect to time, Economic Journal, vi. 509 sq., vii. 199 sq., 278 sq.
'The expenses of a war are the moral check which it has pleased the Almighty to impose upon the ambition and the lust of conquest that are inherent in so many nations. There is pomp and circumstance, there is glory and excitement about war, which, notwithstanding the miseries it entails, invests it with charms in the eyes of the community, and tends to blind men to those evils to a fearful and dangerous degree. The necessity of meeting from year to year the expenditure which it entails is a salutary and wholesome check, making them feel what they are about, and making them measure the cost of the benefit on which they may calculate.' Hansard, March 6th, 1854. Cp. the useful criticism in Northcote, Financial Policy, 259-264.
Bk. iii. ch. 3, § 12.
On this ground the imposition of a property tax to contribute to the cost of the South African War would have been justifiable.
Professor Adams (Public Debts, 94) objects to the use of the income-tax for the purpose described in the text, but it seems on insufficient grounds. He hardly makes due allowance for the speedy yield of new taxes. 'The financier,' he thinks, 'may hope for assistance from his new taxes within eighteen months of their levy,' ib. 140. The first duties would surely come in much sooner. Speaking of the income-tax Mr. Blunden remarks, 'A further great merit in the tax is the promptitude with which its machinery can be brought into operation, the flow of funds in response to an increase of the rate beginning almost at once, and the full addition for the year being brought into account within from nine to fifteen months, according to the period of the year at which the increased rate is decided upon.' Economic Journal, ii. 642.
In England, e.g., the suspension of the terminable annuities and the new sinking fund,—which was employed in 1885, and again from 1899 to 1902—provides nearly £5,000,000 for meeting the fresh expenditure.
For the passage of 'extraordinary' into 'ordinary' expenditure see Bk. i. ch. 8, § 1.
For the weak treatment of the English debt see Bk. v. ch. 3, § 4; for the American instances, Adams, 112-133; Ross. Sinking Funds, 21-82; for the French one, Bk. v. ch. 4, § 2.
Bk. v. ch. 5, § 2.
France had £550,000,000, the United States, including the 'State debts, £532,000,000, as their respective capital liabilities. Leroy-Beaulieu, ii. 597. The French debt, so far as the central government is concerned, is probably here placed too high, but it serves as an illustration of the principle.
Essay on Sinking Fund, 29, quoted by McCulloch, note 33 to Wealth of Nations, 632.
Cp. Jevons' Theory, 119, 120, for this distinction.
Bk. i. ch. 8, § 4.
The best methods are: (1) that of Sir R. Giffen, which capitalises income, and (2) that of M. de Foville, which takes the property changing hands by succession as the base of calculation. Giffen, Growth of Capital; De Foville, La France Économique (1887), 437 sq.
If we assume that the annual increase of wealth has not changed since 1885 we can add over £2,000,000,000 to Sir R. Giffen's estimate of £10,037,000,000 for that year.
Cp. Prof. Nicholson's essay on 'The living capital of the United Kingdom' (Money, 2nd ed. 354-373), in which the highly conjectural value of £47,000,000,000 is assigned to this factor, or group of factors, of production.
Cp. Bk. ii. ch. 5, § 1 for this position.
Its application in local finance will appear in Bk. v. ch. 8, § 3. The same plea is put forward by the Russian Government in mitigation of the criticisms on its growing debt.
Thus the revenue obtained by the English Government from the Suez Canal shares is a deduction from the debt. The suggested debt of £30,000,000 to be placed on the Transvaal is of the same kind.
Book V, Chapter VI
End of Notes
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