In this post I showed a chart of UK government debt to GDP since 1900. It starts off at below 50%, then rises sharply to 200% during WWI. It rose to 250% during WWII, but then fell steadily during the post war golden age, going below 50% by the mid-1970s. The next sharp rise is after the Global Financial Crisis, followed by a smaller rise during the pandemic, getting to current levels of around 100% of GDP.
This brief chronology suggests that debt to GDP (and more recently also central bank issued reserves to GDP) rise sharply in extreme crises. But climate change is an extreme crisis facing every country, so why are most governments (maybe US excluded) resisting the idea that they should be running large deficits to pay for measures to reduce the extent of climate change? Is there a clear way of deciding when it is OK to allow large and persistent government deficits and when it is not?
In this post I set out why there is. To make things simple, I will assume the case for higher spending is overwhelming, so the issue is only how it should be paid for. The obvious alternative to allowing this additional spending to generate persistently large deficits is to substantially increase taxes. There is a standard economic proposition called ‘tax smoothing’, which states that it is better to smooth taxes over time than have erratic increases or decreases. In economic terms most taxes have distortionary costs, where the costs associated with a unit increase in taxes are likely to increase with the level of taxes, so it is less costly to smooth taxes over time. It is also intuitive: if a government offered people the chance of paying no tax for 5
