Thursday, March 12, 2015

What Is the Burden of Federal Debt?

"We owe it to ourselves" was the common refrain that I heard from my professors as an undergraduate and graduate student about federal debt. Here are some questions that might help clear up whether growing federal debt is a serious problem.
  1. Does outstanding federal debt ever have to be repaid?
  2. If federal debt were repaid, who would do the paying, and who would receive the payment?
  3. If federal debt does not have to be repaid, the U.S. Treasury still has to pay interest to whoever holds Treasury bills and bonds.  What are the economic implications of interest on the debt?  Who bears the burden of paying the interest and who benefits from receiving those interest payments?
So far, federal debt has not been repaid.  In fact, federal debt has been growing for decades.  You and I could not continuously expand our debt, but the U.S. Treasury is different.  Because Congress can tax and because the Fed can create new money, the U.S. Treasury has a much larger capacity to repay debt (if it had to) and to pay interest on outstanding debt (which it must do to avoid default).  As long as the real economy continues to grow, federal debt does not have to be repaid, and it seems quite unlikely at present that all federal debt will ever be retired by repayment of principal.

If federal debt were repaid, repayment could come from only two possible sources: (1) taxes collected in excess of federal spending and (2) money creation.  If taxes in excess of federal spending were the case (a federal budget surplus), tax payers would be the payers and holders of maturing Treasury bonds would be the recipients.  I pay taxes, but I don’t own much in the way of Treasury bonds, so I guess I would be a payer, not a receiver.  How about you?

If federal debt does not have to be repaid, the Treasury still has to pay interest on outstanding debt.  Interest on outstanding debt can be paid from one of three sources: (1) taxes collected in excess of federal spending, (2) money creation, and (3) additional debt.  Obviously, people who own Treasury bonds are the beneficiaries of interest payments.  It isn’t obvious at all who bears the burden of making those interest payments.

Tax payers are not currently bearing a burden to pay interest on outstanding federal debt, because federal spending continues to exceed tax collections.  That fact means that interest is paid through money creation (when the Fed buys U.S. Treasuries) and by issuing additional debt, which expands outstanding debt, of course. 

The real burden of federal debt is the value forgone by using scarce resources in ways they would not have been used, aside from the government’s borrowing.  If government’s use of those scarce resources also creates value, then what we are getting is a transfer of value from Bobby to Annie, with maybe a net loss and maybe a net gain.  Transfers of value from one person to another cannot be objectively measured to see if we got a net gain.

If government’s use of scarce resources did not create value for anyone, but nonetheless caused a loss of value for someone, we end up with inefficiency and a net loss.  But most government spending benefits someone, somehow, and once again, because interpersonal comparisons of value are not really possible, we are hard pressed to say much more.

If government control of scarce resources diverts resources away from production of capital goods that would otherwise have occurred, it is possible that growth of the real economy could be retarded.  If growth of the real economy is retarded, that reduces future consumption opportunities below what they otherwise could have been.  Economists who study this phenomenon have been unable to reach what everyone takes to be conclusive, persuasive evidence about this issue.  In other words, no one has been able to persuade lots of economists one way or the other about whether government control of scarce resources has retarded growth of the economy, although any number of economists make statements about it one way or the other.

The expression “we owe it to ourselves” is pretty silly, really.  Some part of federal debt (about 40%) is debt held by private citizens of America.  Interest payments on that internal net debt amounts to a transfer of purchasing power to the owners of that debt.  Although the payers of that interest are Americans, as are the recipients of those interest payments, “we” are not “ourselves.”  In other words, growing federal debt means growing transfer of purchasing power over goods and services to people who lend to the federal government.  So, even internally held federal debt may pose some issues about which people will have normative opinions. 

For that part of federal debt that is held externally (by Japanese citizens in large measure, and by other citizens of the rest of the world), interest payments on U.S. federal debt enlarge their consumption opportunities.  But it is far from clear that those interest payments reduce the consumption opportunities of Americans.  The evidence so far is that the standard of living of nearly all Americans continues to rise.

So, should we worry about growing federal debt?  Yes, if the real rate of growth of our economy is retarded, and no, if it is not.  I am persuaded that we do not really know, but nearly everyone has a normative opinion about the wisdom or stupidity (whichever it is) about growing federal debt.