How to pay for the war in times of imperfect commitment: Adam Smith and David Ricardo on the sinking fund

Abstract

The paper proposes a comparative analysis of Smith's and Ricardo's views on the sinking fund. It shows that Smith and Ricardo agreed in stressing the ineffectiveness of the sinking fund as a policy instrument targeted at public debt repayment and tax-burden relief, pointing out that its actual workings had paradoxically helped to increase rather than reduce British total debt-load. Moreover, their explanation of the sinking fund paradox integrates a defective fiscal commitment technology with powerful politicians’ incentives to siphon off the money stored in the sinking fund to meet sudden increases of public expenditure whenever the occasion arose.

Keywords:

• Adam Smith
• David Ricardo
• Ricardian equivalence
• sinking fund
• imperfect commitment

JEL Classifications:

• B12
• B22

Acknowledgements

I wish to thank, without implicating, Neri Salvadori and two anonymous referees of this paper for their insightful comments on a previous version of this paper.

Notes

¹ Long before the Buchanan–O’Driscoll exchange of the mid-1970s, Roberts (1942) had stressed that Ricardo considered the debt-taxation equivalence as virtually irrelevant and “he himself … was by no means indifferent as between the alternatives on the score of burdensomeness” (Roberts 1942, p. 258).

² As noted by O’Brien (1981, p. 381), a chapter on public debt is surprisingly missing within Hollander's (1979) lengthy book on the economics of David Ricardo. Twenty-two years later, one of Hollander's students, Nancy Churchman, has filled the lacuna: see Churchman (2001).

³ To my knowledge, within the historiographical literature on the debt-taxation equivalence, only Hakes and McCormick (1996) have proposed an explicit comparison between Smith's and Ricardo's analyses of the issue. In their short note, the two authors put forward the claim that “although Ricardo may be the first to have given a numerical demonstration of debt neutrality … he is not the first to have explored the concept” (Hakes and McCormick 1996, p. 57). In their view, Smith presented the argument basically in the same way as Ricardo would later suggest, since “Smith asks whether government bonds are net wealth, or, alternatively, whether tax rebates are saved – that is, does the public save the lump-sum tax reduction occasioned by deficit finance” (Hakes and McCormick 1996, p. 57). Their conclusion is that, although inferior to Ricardo as far as mathematical rigor is concerned, “Smith deserves at least a footnote in the history of the Ricardian equivalence theorem” (Hakes and McCormick 1996, p. 60). Such a claim has been forcefully dismissed by Barro (1996) who argues that “[Smith's] analysis of fiscal policy was pretty garbled and surely inferior to Ricardo's” (Barro 1996, p. 5) and adds that “although the correct parts of Ricardo's argument cannot be found in Smith, some of the lapses seem to be there” (Barro 1996, p. 10). Be what it may, neither Hakes and McCormick nor Barro raise the issue of the sinking fund in their comparative analyses of Smith and Ricardo on fiscal policy.

⁴ In the 113 years between the War of the Spanish Succession (1702–1703) and Napoleon's final defeat at Waterloo (18 June 1815) Great Britain was at war for no less than 56 years.

⁵ One referee has called my attention to the fact that the verbatim accuracy of the Lectures on Jurisprudence, unlike that of the Wealth of Nations, cannot be taken for granted and that the institutional contexts of the Lectures on Jurisprudence and the Wealth of Nations as concerns the sinking fund issue are significantly different. I acknowledge the referee's remarks as important caveats in the assessment of the evolution of Smith's thought on the sinking fund from the Lectures on Jurisprudence to the Wealth of Nations.

⁶ Robert Hamilton was the author of An Inquiry concerning the Rise and progress, the Redemption and present State, and the Management of the National Debt of Great Britain and Ireland (1st ed. 1812; 3rd ed. 1818), a book which ignited a vast campaign against the machinery of the sinking fund (Hargreaves 1930 [1966], p. 136). Ricardo greatly appreciated and extensively quoted Hamilton's book in the Funding System. As his September 1819 correspondence reveals, Ricardo was flattered by the invitation from the editor of the Supplement to the Fourth, Fifth and Sixth Editions of the Encyclopaedia Britannica, Macvey Napier, to contribute the Funding System article. Yet he was initially hesitant to accept it since he felt he had nothing original to say on the subject, after Hamilton's book (see Ricardo to Mill, 6 and 9 September 1819, Ricardo to Place, 18 September 1819, Ricardo to Malthus, 21 September 1819, and Ricardo to Trower, 25 September 1819, Works VIII, pp. 54, 60–61, 69, 72–73 and 78).

⁷ In several Parliamentary speeches Ricardo denounced the subversion of the sinking fund as a war-fund by the government: see e.g. Excise Duties Bill, 18 June 1819, Motion for a Committee on the Agricultural Distress, 18 February 1822 and Financial Situation of the Country, 21 February 1823 (Works V, pp. 25, 130, and 251, respectively). Similarly, in a letter to Trower, dated 25 March 1822, Ricardo wrote:

I should be neglecting my duty if with my opinions of the Sinking Fund I did not do everything in my power to get rid of it. Of what use can it be to diminish the debt in time of peace, if you leave in the hands of ministers a fund which experience shews will be used only for the purpose of ultimately further increasing the debt? While ministers have this fund virtually at their disposal they will on the slightest occasion be disposed for war. To keep them peaceable you must keep them poor. (Works IX, p. 180, emphasis added):