In controlled laboratory experiments with and without overlapping generations, we study the role of intergenerational altruism in public debt accumulation. Public debt is chosen by popular vote, pays for public goods, and is repaid with general taxes. We use an optimal control model to derive a theoretical benchmark. With a single generation, public debt is accumulated prudently. With multiple and over-lapping generations, the burden of debt and the risk of over-indebtedness are shifted to future generations. We find a weak but significant sign of intergenerational altruism, observing that the revealed debt preferences increase as the number of following generations decreases. However, we find considerably fewer intergenerational fairness concerns than one would expect on the basis of the behavioral and experimental literature. Instead, political debt cycles that vary with voters’ age emerge. Debt ceiling mechanisms fail to encourage intergenerational altruism and do not mitigate the problem of burden shifting.

Introduction

Public debt, its accruement, its impact on the economic performance of states, and the question of how over-indebtedness can be successfully avoided are problems that have seized top places on the agenda of economic research for decades. Consequently, the number of theories and approaches that try to deal with these problems is quite high. Pure normative theory tends to look at public debt in a relatively relaxed way. Starting with [1] and [2], the indebtedness of states is modeled as an interplay between a benevolent rational planner, who tries to maximize the welfare of a representative individual with an infinite time horizon, and strictly rational citizens, who adapt their inheritance behavior in order to ensure that their children are able to pay the higher future tax that follows an increase of the public debt.

This rather optimistic normative theory does not, however, fit very well with the empirical observations. The normative model can explain neither the large number of national bankruptcies, nor the huge differences in the indebtedness of different nations. Furthermore, during the last three decades we have observed a sharp increase in the public debt of a couple of important industrial countries that also cannot be easily explained by the normative models of intergenerational altruism and long-term planning. Very recently, this development has caused a dramatic situation in the southern states of the European Union. In the USA, increased public debt has from time to time triggered brief illiquidity episodes for the central government.

Given the high economic impact of public indebtedness, it is essential to understand what the driving forces for the observed phenomena are. This explains the large number of theoretical papers studying the emergence of public debt (see section 2). However, on a behavioral level, little is known about the driving forces and the behavioral motives of an increasing public debt. A better knowledge of the individual motives and preferences would enable democracies to devise measures to deal with worsening public debt.

If we look at public debt from the perspective of individual citizens who vote on taxes and indebtedness, choosing the level of public debt accumulation offers an instrument to adjust the burden of public good provision between current and future generations. The question on the behavioral level is whether people are willing to use this instrument to their own advantage, or whether their intergenerational altruism is strong enough to prevent them from exploiting future generations. This is the central research question we deal with in this paper.

The problem is that intergenerational preferences are difficult to observe. The only data we have concern the inheritances people leave for their descendants. But the discussion in the above-mentioned literature has shown that observed inheritance is not closely related to the development of public debt. In our view, controlled laboratory experiments are the most promising way to collect data on the relationship between intergenerational altruism and the willingness to accumulate public debt.

The disadvantage of experiments that mimic a sequence of generations is that their external validity is not guaranteed. We cannot be sure that subjects in an artificial laboratory environment really look at the next experimental “generation” in the same way they look at “real” next generations. Nevertheless, an experimental investigation could be an important first step towards a deeper understanding of intergenerational preferences for the following reason. There is a large body of experimental and theoretical literature on other-regarding preferences (see [3] for a recent overview) that demonstrates that, within one generation, preferences of this kind do play a very important role. If experiments with an intergenerational design show other-regarding preferences are not at work in this context, this could be an important hint that the reason for the strong increase of public debt can at least partly be found in the individual preferences concerning one’s own income and the income of future generations. In this paper, we report the results of an experiment with an intergenerational design and find only very little evidence for other-regarding preferences across generations.

To this end, we introduce a novel experimental design with future generations, public good provision, an income tax system, the risk of over-indebtedness, and debt ceiling mechanisms that enable us to scrutinize many aspects of the issue. An important feature of our design is that it allows us to observe the voting decision on public debt of the whole generation and the revealed debt preference of each single subject at the same time. Thus, we observe not only the aggregated debt on a “macro-level”, but also the “micro-level” public debt decisions. Our design can serve as the nucleus of a new experimental paradigm for research on intergenerational issues in public economics. In section 2, we will discuss our design choice and methodological aspects in more detail. In order to detect altruistic behavior, it is necessary to have a rational, payoff maximizing solution of the decision problem that serves as a benchmark. We use an optimal control model of the debt dynamics to calculate the rational choice solution for rational, payoff maximizing individuals. The optimal control model provides the most straightforward symmetric solution to our dynamic, intergenerational game with a stochastic number of periods and players (in the overlapping-generations setting). Other more involved theoretical approaches that allow for asymmetric solutions may also be of some interest, but they would clearly go far beyond the scope of this study.

We find that the main driving force behind the public debt is the intergenerational transmission of the tax burden. Even in small groups that entertain strong social ties across generations we find a strong tendency to consume beyond the intergenerationally sustainable levels. Within a single generation, without future generations, we observe a prudent public debt policy that avoids excessive indebtedness by all means. The behavior in these groups is more prudent than risk-neutral optimal public debt policy, but qualitatively the observed and theoretical dynamics almost perfectly match. With non-overlapping future generations, we observe a similar behavior within the lifetime of each generation. New debt is substantially increased only towards the end of the lifetime, leaving high levels of intergenerational debt for the next generations. With overlapping future generations and a stochastic lifespan, individuals are neither willing to keep the public debt on a low level, nor willing to reduce public debt voluntarily when the debt level is relatively high. As a consequence, our overlapping generations (OLG) economies often run heavily into public debt early on, leaving the current and the next generations at a high risk of over-indebtedness, public bankruptcy, and penalty taxation.

We implement an absolute debt ceiling mechanism to reduce excessive public borrowing in the intergenerational setting, but find that the negative situation is not improved by this measure. The debt ceiling fails to help because it is simply removed by majority vote whenever it sets a binding constraint on new debt. Finally, with overlapping generations we find clear evidence for political cycles that are driven by the age structure of the electorate. Older individuals typically vote for higher levels of new debt than younger individuals. They also tend to vote for the elimination of debt ceilings more often than the younger ones do.

In our experiment, we observe a weak but significant sign of intergenerational altruism. In particular, we find evidence that revealed debt preferences increase as the number of following generations decreases. However, the financial consequences of intergenerational concerns are rather small and cannot prevent economies from burdening future generations heavily. Although we find that individuals behave prudently and fairly within one generation, intergenerational fairness has only little influence on the emergence of public debt. We observe intergenerational fairness concerns and altruism to a much smaller degree than one would expect on the basis of the behavioral and experimental literature. Neither the introduction of a debt ceiling measure, which could serve as a signal against an excessive accumulation of debt, nor the introduction of strong social ties across generations manage to encourage intergenerational fairness concerns.

Although we are cautious not to naively claim full external validity for our experiment, our results are in remarkable accordance with phenomena we observe in reality. Both the sustained increase of public debt that we observe in many developed countries as well as the repeated failure of debt ceilings are reproduced in the laboratory. This encourages us to believe that the experimental approach—in our study and beyond—can help to understand the behavioral foundations of public debt emergence.

The remainder of the paper is organized as follows. In section 2, we provide a brief review of the related literature and discuss some methodological aspects of the experimental design we use. This is necessary because we could not build up on an existing experimental standard design for the investigation of public debt problems, but had to create a new one. In section 2 we explain in detail why we chose this particular design. Section 3 presents the treatments, the theoretical benchmarks, and the experimental protocol. The results of our study and two robustness tests are presented in section 4. In our last section, Section 5, we summarize and discuss our results.