Elsevier

Journal of Econometrics

Volume 231, Issue 1, November 2022, Pages 165-187
Journal of Econometrics

Beliefs about public debt and the demand for government spending

https://doi.org/10.1016/j.jeconom.2020.09.011Get rights and content

Abstract

We examine how beliefs about the debt-to-GDP ratio affect people’s attitudes towards government spending and taxation. Using representative samples of the US population, we run a series of experiments in which we provide half of our respondents with information about the debt-to-GDP ratio in the US. Based on a total of more than 4,000 respondents, we find that most people underestimate the debt-to-GDP ratio and reduce their support for government spending once they learn about the actual amount of debt, but do not substantially alter their attitudes towards taxation. The treatment effects seem to operate through changes in expectations about fiscal sustainability and persist in a four-week follow-up.

Introduction

Government debt in many of the largest economies in the world has increased over the last few decades. For example, the debt-to-GDP ratio in the United States reached a level of 104.81 percent in 2016.1 High levels of government debt can have important implications for the tax burden of future generations, the sustainability of public finances, and the possibility of a fiscal crisis. While the ultimate effects of government debt on the economy are still being debated among economists, much less attention has been devoted to people’s beliefs and preferences regarding government debt. Are individuals’ estimates of the debt-to-GDP ratio in line with underlying facts? Do voters have a preference for lowering levels of debt? And how do beliefs about the level of government debt affect attitudes towards government spending and taxation? Answering these questions has important implications for understanding voting behavior, patterns of debt accumulation and the optimal design of government policies.

In this paper, we conduct several online experiments in the United States in which we measure people’s beliefs and preferences regarding government debt. We first elicit people’s beliefs about the debt-to-GDP ratio. Then, we provide a random subset of our respondents with information about the debt-to-GDP ratio and study how this affects their attitudes towards government spending and taxation measured using both self-reports and behavioral outcomes. Overall, we recruit 3350 respondents from online panels that are representative of the US population in terms of age, income, gender and region. Moreover, we recruit 800 individuals on Amazon Mechanical Turk (MTurk), whom we re-survey four weeks after the main experiment.

We start by documenting a series of stylized facts about people’s beliefs and preferences regarding government debt: Most individuals underestimate the degree of indebtedness of the US government. The median respondent’s estimate of the debt-to-GDP ratio is 60 percent, i.e. far below the actual debt-to-GDP ratio in 2016 (104.81 percent). Moreover, the median respondent thinks that the government should aim to achieve an even lower debt-to-GDP ratio of 25 percent.

Individuals who receive information about the true debt-to-GDP ratio become more likely to consider the prevailing level of government debt as too high and become approximately 0.21 of a standard deviation more supportive of cutting the overall amount of debt. Moreover, people who receive the information also become significantly less supportive of government spending in all spending categories. Our estimated effect sizes for views on government spending are considerable and correspond to approximately 0.10 of a standard deviation or to one third of the Democrat–Republican gap, on average. In contrast, we find no strong evidence of a treatment effect on people’s views on taxation. People’s beliefs about debt also affect their political preferences as measured with a behavioral measure. Specifically, respondents provided with the information donate 0.15 of a standard deviation more to a think tank that advocates downsizing the government. This is a large effect size, corresponding to 54 percent of the gap in donations between Democrats and Republicans. However, we find no evidence that treated respondents change their willingness to sign a petition in favor of a balanced budget rule.

Do treatment effects persist over time? Using data from the four-week follow-up survey, we show that the information about government debt persistently shifts people’s views on cutting government debt and total government spending. The patterns of persistence for individual spending categories are more noisily measured but similar. The follow-up also shows that respondents in the treatment group have significantly lower biases in beliefs about the debt-to-GDP ratio. This suggests that a substantial part of the effects operate through genuine learning about the debt-to-GDP ratio rather than through short-lived emotional responses to the treatment.

We also shed light on the mechanisms through which the perceived level of government debt reduces people’s demand for government spending. We find that beliefs about public debt causally affect people’s expectations regarding the sustainability of public finances, leading to a 0.1 standard deviation difference between the treatment and the control group. There is a similar effect on people’s expectations of government spending in ten years, but it is smaller in size and more noisily measured. By contrast, we find no strong evidence of changes in expected future taxation. We interpret this as suggestive evidence that people demand immediate spending reductions as a result of a desire to smooth the consumption of public goods over time. We find no evidence that beliefs about government debt causally affect people’s trust in the government or their beliefs about rent-seeking and inefficiencies in the public sector, which could similarly lead to a reduction in desired spending levels.

We contribute to a literature on the measurement of subjective beliefs about the macroeconomic environment (Manski, 2018). Building on the measurement tools on subjective beliefs proposed by Manski (2004), a subsequent literature studies how people’s beliefs about economically relevant facts shape the demand for government spending and taxation.2 Alesina et al. (2018b) find that (left-wing) survey respondents increase their support for equality of opportunity policies when exposed to information about low intergenerational mobility. Kuziemko et al. (2015) show that people’s demand for redistribution is fairly inelastic to information about inequality. Karadja et al. (2016) and Cruces et al. (2013) provide evidence that people change their demand for redistribution in response to information about their relative position in the income distribution. Whereas all these experiments provide information that should change people’s beliefs about the societal or private benefits of government spending, ours is one of the first to provide information that should affect people’s concerns about the financing of such spending.3

In concurrent work, and most closely related to our paper, Lergetporer et al. (2018) show that informing people about current levels of education spending and teacher salaries, or various other individual spending categories, sharply reduces support for spending increases in these categories. By contrast, our study provides information that abstracts from spending flows on individual categories and focuses on the stock of government debt. The stock of government debt should be a more relevant metric for judging the sustainability of public finances than spending on individual categories. Another novel aspect of our paper is that we shed light on people’s concerns about the intertemporal allocation of funds in our analysis of mechanisms.

On a methodological level, we follow Grigorieff et al. (2019) in their use of signatures of real online petitions and donations. We introduce two novel behavioral measures to the literature on attitudes towards the size of the government, which are tailored to capture attitudes to certain policies. First, we measure people’s willingness to donate money to an NGO advocating the downsizing of the government, which captures a general desire for a smaller state. Second, we elicit people’s willingness to sign a real online petition in favor of a balanced budget rule, which measures preferences about one specific policy that is tightly linked with concerns about government debt and fiscal sustainability.

Our paper adds to the literature on the political economy of government debt, which is concerned with the question of why governments tend to accumulate (excessive) debt levels (Cukierman and Meltzer, 1989, Alesina and Tabellini, 1990, Persson and Svensson, 1989, Battaglini and Coate, 2008, Song et al., 2012, Müller et al., 2016, Alesina and Passalacqua, 2016).4 Part of this literature provides indirect evidence on voters’ concerns about government debt. On the one hand, reducing government debt could be punished by voters because of its contractionary effect on the economy (Alesina and Tabellini, 1990). On the other hand, if voters are aware of the intertemporal government budget constraint and care about future spending and taxation, this could lead to a punishment of excessive debt accumulation. Correlational studies have found at most a small positive correlation between episodes of debt reduction and the likelihood of the government to be re-elected (Alesina et al., 1998, Alesina et al., 2013, Brender and Drazen, 2008), and a zero correlation between whether spending is debt-financed or not and voting of the US population in presidential, senatorial and gubernatorial elections (Peltzman, 1992). Our paper speaks to this literature by isolating the causal effect of people’s beliefs about the level of government debt on attitudes towards government spending and taxation. Our results imply that biased beliefs about the level of government debt can make voters prefer higher levels of government spending than if they were aware of the true level of debt.

Finally, our study relates to a literature using survey methods to study people’s mental model of the economy. Existing evidence suggests that people are inattentive to macroeconomic conditions such as inflation, house prices and GDP growth, and have a rough but imperfect understanding of macroeconomic relationships (Coibion et al., 2018, Kumar et al., 2015, Armona et al., 2019, Fuster et al., 2019, Roth and Wohlfart, 2019, Andre et al., 2019). In the context of public debt, the assumption that consumers understand the intertemporal government budget constraint is at the core of many macroeconomic models and is one of the key assumptions underlying the Ricardian Equivalence Theorem (Barro, 1974). A small correlational literature testing the assumptions underlying the Ricardian Equivalence Theorem provides suggestive evidence of a limited awareness of the level of public debt (Allers et al., 1998)5 and finds little support that individuals’ consumption and savings decisions are influenced by the perceived level of debt (Allers et al., 1998, Heinemann and Hennighausen, 2012, Hayo and Neumeier, 2017). To the best of our knowledge, our paper is the first to provide systematic evidence on beliefs about the debt-to-GDP ratio using a representative sample of the US population, and on how an exogenous shift in these beliefs causally translates into people’s attitudes towards government policies. Our experimental results are consistent with the idea that voters take into account the intertemporal budget constraint of the government when forming their demand for government policies. We provide suggestive evidence on the role of expectations in mediating these effects: Individuals who learn about the high level of public debt change their expectations about fiscal sustainability, even though only respondents with higher levels of education change their expectations about the level of government spending in ten years.

The rest of this paper is structured as follows. In Section 2 we provide some background on the intertemporal budget constraint of the government and develop the hypotheses we test in the experiment. Section 3 presents the design as well as the setting and samples used in the information experiments. In Section 4 we provide evidence on our respondents’ prior beliefs about debt and changes in beliefs in response to the information. We present our main results in Section 5 and provide evidence on mechanisms and robustness in Section 6. Section 7 concludes.

Section snippets

Conceptual framework

In this section, we present a simple conceptual framework which motivates the experiment and the main hypotheses on how voters should adjust their policy demand when updating their beliefs about the amount of government debt. Voters form their expectations about future government spending and taxation and their policy demand subject to the perceived intertemporal government budget constraint: t=1pt(1+r)t=αB0+t=1Tt(1+r)twhere pt is public good provision in period t, Tt is total tax revenue

Experimental design

We conducted a total of four very similar experiments, summarized in Table A.1 in the online appendix. One of the four experiments included a follow-up survey. In this section we present our experimental design and explain the structure of the main experiment and the follow-up survey. The full experimental instructions for all four experiments are available at https://www.dropbox.com/s/9o0a5gk14x8c19m/01_instructions_v3.pdf?dl=0.7

Prior beliefs

The US debt-to-GDP substantially increased over the last decades from about 35 percent in the 1960s and 1970s to more than 100 percent today (see Fig. A.4 in the online appendix). Fig. 1 illustrates people’s beliefs about the debt-to-GDP ratio in the US, pooling Experiments 1–4. On average, people widely under-estimate the true value of around 104 percent. The median respondent in our full sample believes that the debt-to-GDP ratio is 60 percent and more than 90 percent of our respondents

The causal effect of information about government debt

In this section, we shed light on the causal effect of beliefs about the debt-to-GDP ratio on people’s views on government debt, public spending and taxation.

Why do respondents want to decrease government debt?

In what follows, we examine mechanisms through which our information intervention may increase people’s willingness to reduce government debt and to cut government spending.

Conclusion

The measurement of subjective expectations about the macroeconomic environment as proposed by Manski (2018) is becoming an important tool in political economy and public finance. In this paper, we leverage methods to measure and vary beliefs to study perceptions of government debt. Respondents who learn that the debt-to-GDP ratio in the US is higher than they thought want the government to reduce the amount of debt, become less supportive of government spending and donate significantly more to

Acknowledgments

We would like to thank the editor and two anonymous referees for helpful comments and suggestions. We would also like to thank Jan Bakker, Jon de Quidt, Alexis Grigorieff, Olga Goldfayn, Thomas Graeber, Michalis Haliassos, Johannes Haushofer, Lukas Hensel, Johannes Hermle, Chaning Jang, Yigitcan Karabulut, Hannah Paule-Paludkiewicz, Simon Quinn as well as seminar participants in Frankfurt and Mannheim. This paper was previously circulated under the title “Public Debt and the Demand for

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    The experiment is registered in the AEA RCT Registry as trial 1960 available at: https://www.socialscienceregistry.org/trials/1960. The experimental instructions are available at: https://www.dropbox.com/s/9o0a5gk14x8c19m/01_instructions_v3.pdf?dl=0. Ethics approval was obtained from the University of Oxford. The activities of CEBI are funded by the Danish National Research Foundation, Grant DNRF134. The usual disclaimer applies.

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