Burdens of national debt Fact, fiction, uncertainty

April 26, 2010
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The public has become alarmed about the burdens of the additional national debt that will result from passage of the Affordable Health Care Act. Unfortunately, discussions about the national debt and its associated burdens usually generate more heat than light.

The national debt consists of two components, public debt and intergovernmental debt.  Public debt consists of the outstanding, accumulated bonds and other debt instruments issued by the Treasury to cover deficit spending by Congress. Intergovernmental debt consists of loans of accumulating trust fund balances from off-budget programs like Social Security and Medicare. At the end of 2009 these amounts were $7.8 and $4.5 trillion respectively for a total debt of $12.3 trillion. 

Historically, the largest jumps in the national debt occurred when budget deficits happened in World Wars I and II and, on a smaller scale, during recessionary periods when economic activity and its associated tax revenue contracted while spending in programs to support the unemployed rose. These jumps would raise the public debt. Note that even in periods of full employment the national debt continues to rise not only because Congress rarely manages to balance the budget (an exception was fiscal years 1999 and 2000) but because the accumulating trust fund surpluses are transferred to cover Congressional spending thus raising intergovernmental debt.   

Total federal spending in any given year overstates the federal government’s use of the country’s scarce economic resources. That’s because a large percent of federal spending represents transfer payments from one set of households to another. For example, of the                   $3,522 billion government spending in fiscal year 2009, only around two-thirds represented government acquisition of scarce resources to build highways, provide national defense, etc. while the remaining one-third represented transfers of purchasing power to select groups of households in the form of unemployment compensation, Social Security benefits, etc. Note that deficit spending for either purpose, real use of scarce resources or income transfers, creates national debt. 

Foreign holdings of the public debt rose from 36 percent in 2000 to 52 percent in 2009.  As a percent of the national debt this is a rise from 18 percent to 29 percent.  In descending order of importance China, Japan, United Kingdom and oil exporting countries in the Persian Gulf are the largest foreign holders.   

The popular conception of a burden associated with accumulation of national debt is that going forward we and our children will need to pay more taxes to pay the interest and eventually the principal of the bonds when they mature. But reality is more complex than this.

A first fiction is that public debt is always like private debt. When we incur private debt to enjoy a more luxurious lifestyle than our current income can provide, we borrow from lending institutions. In the years following creation of this private debt annual interest and principal payments must be made to the lender. Unless our earning power has significantly risen, this will entail a burden, namely a contraction in spending as the loans are repaid.    

Most of our national debt is not analogous to private debt because the vast majority of it is owned by our own citizens and institutions. When we pay back this internally owned national debt we are paying it to ourselves, unlike when a household must repay a loan to a lender.  But, as foreigners own an ever growing share, currently 29 percent, the analogy with private debt will be accurate and future generations will bear a burden for repaying this foreign owned debt. 

Apart from foreign ownership of the national debt, there are additional considerations that will determine if burdens are created for the current or for future generations. When Congress deficit spends to put unemployed resources to work the national debt created does not create any burden for the current generation. This is so because the current generation does not need to sacrifice any private production or consumption. As for future generations, there is uncertainty. If government uses the resources it acquires in a productive way to expand the economy’s productive capacity then future incomes will be larger and, with an unchanged tax structure, the additional interest and principal payments required by the additional national debt can be raised without creating a burden on future generations. If government does not use those resources in a productive way future generations will bear a burden.

If government deficit spending is only to transfer or redistribute consumer spending power from one group of citizens to another such that overall consumer spending is constant, there would not be a burden for the current generation. But, there will likely be a burden for future generations. This is because clearly the additional debt will require future interest and principal payments and to sell the debt instruments interest rates are likely to rise incrementally causing business to at least marginally reduce its capital spending therefore slightly reducing the economy’s future potential productive capacity.

Alternatively, if government deficit spending is used to acquire scarce resources, there will clearly be a burden for the current generation because fewer resources will be available for the private sector. The existence and magnitude of a burden for future generations will depend on how productively the government uses those resources compared to how productively the private sector would have used them. If government uses the resources in a more productive way to expand the economy’s productive capacity then the private sector would have used them future incomes will be larger. In this case, even with an unchanged tax structure, the additional interest and principal payments required by the additional national debt can be raised without creating a burden for future generations. Alternatively, if the government does not use the resources as productively as the private sector would have used them, then future generations will bear a burden from the debt created. 

Ominous and urgent are the revenues that will need to be generated to pay off intergovernmental debt as various Trust Funds are liquidated because annual program tax contributions fall short of mandated benefits. During the years when employer and employee tax contributions to these programs exceeded needed payouts the annual surpluses were used to cover Congressional deficit spending and thus reduce the need for creating more public debt. The intergovernmental debt is not accumulated, unspent dollars but rather IOUs that will need to be covered as the Trust Funds need to be liquidated. Covering these IOUs will require use of general tax revenues or creation of more public debt and will surely constitute a huge burden on future generations. The major Trust Funds are Social Security and Medicare.

Of course, Congress and the president could together solve the Trust Fund deficit problem by raising the contribution rates, lowering benefit levels, or some combination and, additionally, in the case of Social Security, raise the minimum retirement age to receive benefits. Unfortunately, as time passes and the Baby Boom generation ages, it will be even more difficult to generate the political will to address this problem.

Prudence would have dictated that before enacting any new program that would further raise the national debt, Congress and the President first enact changes to Social Security and Medicare that would address their short and long run actuarial imbalances.

Since the economy is currently operating at far below full employment, the health care reform legislation may have no burden for the current generation. The act will lead to a bit healthier and more productive work force but it is burdened with economically unproductive spending such as having the IRS hire enough additional personnel so as to be able to verify monthly that each of us has purchased health insurance.

On balance, the act will make even larger future tax increases unavoidable and future generations will surely be further burdened.

John Reifel is associate dean for the Seidman College of Business, Grand Valley State University.

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