Tuesday, January 8, 2008

Interest on Public Debt

Mish wrote an entry on federal debt interest payments which I thought was interesting. I want to add some thoughts.

Many libertarians believe it was no coincidence that the Federal Reserve Act and the 16th Amendment (Income Tax) came into existence in the same year, 1913. The belief is that the Federal Reserve system allows the government to take on massive debt while the Income Tax provides the revenues to pay the interest on the debt.

Fast forward to 2007:

The Interest on the Federal Debt in 2007 was $430 billion. The Individual Income Taxes paid by Americans in 2007 will be about $1.3 trillion. That means that 33% of our individual income taxes is used just to pay off the interest on the debt. Now, this is a bit misleading because much of that debt is held by the social security trust fund and that's just the government paying interest to itself (we'll ignore the future unfunded liability for now). According to Debt Outstanding, there is $9.2 trillion in debt. $4.1 trillion is intra-government debt (like the social security trust fund) and $5.1 trillion is debt owned by the public. This means that 55% of the interest payments are made to public debt holders and so 18.15% of the personal income tax goes directly to paying off interest to public debt holders.

This income tax is needed only to finance living beyond our means (having the government borrow money to pay for services) and to fund an incredibly expensive foreign policy. It wouldn't be difficult to get rid of most of the income tax simply by balancing the budget and having a humble foreign policy that does not include being the policeman of the world. By getting the debt down to a manageable level and reducing our military spending, we would be able to get rid of most, if not all, of the income tax.

In the past, the argument would be that we're paying the debt to ourselves so it doesn't matter. Wealthy Americans pay most of the taxes, but wealthy people also own most of the debt and receive the interest payments. Not true anymore. According to the Major Foreign Holders of Treasury Securities, foreign holders own $2.3 trillion, or 45% of the debt held by the public. That means that 8% of our personal income taxes is paid directly to foreign holders as interest payments on our debt.

Many libertarians believe that the federal debt is not just a bad idea, but it's fundamentally immoral. It's a bad idea because we're living beyond our means and that debt must be eventually paid off. If we're living beyond our means now, we must in the future live below our means. One can hope that economic growth and innovation means that in absolute terms, living below our means in the future will still be as good or better than living above our means now. But what if economic growth and innovation don't keep up with our debt? We will be forced in the future to live lesser lifestyles than the one we have grown accustomed to.

This is why it's a bad idea, but why is it immoral? It's immoral because we're committing future generations to pay for this generation to live above its means. We're effectively taking from the unborn to give to the living. Our children and our grandchildren will inherit an enormous debt that they will work very hard to pay off. With the debt burden moving from debt held by Americans to debt held by foreigners, we are effectively turning our descendants into debt slaves of our foreign bankers.

1 comment:

Eugene said...

Not sure why I (or anybody) should care who holds the outstanding debt? The US return on investments from abroard are much higher than the % we pay on our debt, so if I sell my T bonds to the chinese and buy thai equities in hope of higher returns - does it really matter who we as taxpayers pay the debt interest to - myself, the chinese, or even my cat?