Public debt is an obligation on the part of a governmental unit to pay specific monetary sums to holders of legally designated claims at particular points in time. The sums owed to creditors may be defined in standard monetary units of the debtor government or in units of an external currency. The United States national debt represents, predominantly, an obligation of the federal government to pay specific sums of United States dollars to creditors. On the other hand, national debts may, and local debts must, be defined in units of external currency. The monetary obligation may be that of paying either interest or a return of principal, or both. Specific issues of debt may or may not be characterized by definite maturity schedules. Consols, which represent obligations to pay interest in perpetuity, involve no obligation for a return of principal.
Public debt must be distinguished from currency outstanding. The obligation on the part of a money-issuing governmental authority to the holder of currency is not public debt, since the claim can also be met in currency units.
Public debt is created by the act of public borrowing, or, in other words, the act of floating public loans, the act of selling government securities. This is a process through which governmental units, in exchange for money (currency or demand deposits) give promises to pa/, this exchange being normally voluntary on the part of the lender. For governments the purpose of the exchange is that of securing current purchasing power with which they may purchase resource services, or final products. The issue of public debt is one means of financing government expenditures, alternative to taxation and to direct currency creation.
Public debt is amortized, or retired, by a reverse transfer in which government gives up money for debt instruments, either through purchase on the open market or through scheduled maturity payments.
Measurement. Public debt is normally measured in nominal maturity values. This does not represent the “size” of the public debt in such a manner as to make comparisons over time and among separate governmental units fully accurate. Varying composition of debt can affect its degree of liquidity for holders, as well as other characteristics. To the extent that debt instruments are valued for these nondebt features, the effective size of public debt, as such, is reduced. A more accurate measure of debt is produced by capitalizing the annual interest charges at some appropriate rate of discount, normally that rate which approximates the return on risk-free investment in the economy. An example will clarify this point. In terms of nominal maturity value, national debt may be of equal size, say $300,000 million, at two points in time. In the one case, however, if the debt is composed primarily of shortterm issues possessing a high degree of “moneyness,” the annual interest charges may amount to, say, only $6,000 million. In the other case, if the debt is largely funded, the interest charges may be as high as, say, $12,000 million. Clearly, the “size” of the public debt is not identical in the two cases; other dimensions than nominal maturity values must be included in any appropriate measure. For purposes of making intertemporal and international comparisons, the most appropriate measure is perhaps the ratio of annual interest charges to gross national or gross domestic product.
|Table 1 – National debt in selected countries, 1960|
|NATIONAL DEBT, 1960a (In millions of dollars)||RATIO OF DEBT TO GNPb (Per cent)|
|a. Includes intragovernmental debt. Converted to U.S. dollars at official rates.|
|b. Rounded to nearest percentage point.|
|Source: International Financial Statistics.|
Public debt may characterize both national and local fiscal systems. Data are much more readily available for national debts, and that of some selected countries may be introduced for illustrative purposes. Table 1 shows the national debts of several selected countries in 1960, defined in nominal maturity values, local currency units being converted into United States dollar equivalents at official exchange rates. The right-hand column of Table 1 indicates the ratio of national debt to gross national product of the issuing country.
The most significant fact that emerges from any comparative survey of national debts in the various countries, and one that is indicated from the data summarized in Table 1, is that no single country was, in 1960, dangerously “overburdened” with national debt. Among the major countries of the world, only for the United Kingdom was the size of the national debt larger than GNP. And for relatively few countries, developed or underdeveloped, is the ratio of national debt to GNP more than 50 per cent. There are several reasons for these results, some of which make their significance less than it might initially seem to be.
Countries that are characterized by large national debts, measured proportionately to GNP, tend to be those that have enjoyed reasonably stable government, that have been victorious in wars, and that have experienced reasonable monetary stability over a relatively long period. Great Britain and the United States, both victorious in two world wars and both characterized by political stability and relatively moderate inflation, carry relatively heavier national debts than most other countries. Causality seems to work in only one direction here, however. Political and monetary stability do not result from large national debts; instead, large national debts emerge only in conditions of reasonable political and monetary stability. In the absence of these conditions, public borrowing will rarely be important as a means of financing public spending, and, even when it is successfully carried out, the creditors of the state may be subject to confiscation through inflation or through default.
Historically, the large increases in national debts have been associated with the financing of war emergencies. This is illustrated by the growth of the United States national debt, shown for selected years in Table 2.
|Table 2 – Growth of United States national debt, selected years|
|YEAR||NOMINAL MATURITY VALUE (In millions of dollars)|
|Source: U.S. Treasury Department data.|
Composition. Public debt assumes many forms, ranging from consols at the one extreme to treasury bills of very short maturity at the other, with other characteristics not relating to maturity schedules. The form in which debt is marketed affects the interest rate that must be paid, since various features, desired in themselves, may be offered complementary to what may be called “pure debt.” Consols, which have no maturity and which obligate the issuing government only to pay a specific interest charge periodically and in perpetuity, provide a useful bench mark for comparative purposes. These come close to representing “pure debt,” and as other features are added the cost of carrying debt tends to decrease. The fixing of a definite maturity, which obligates the government to return the principal to the holder of claims, increases the liquidity of the claim, especially as maturity is approached. Hence, as maturities are shortened, liquidity is increased to the point at which short-term treasury bills take on a high degree of “moneyness.” For this reason bills can normally be sold at considerably lower rates of interest than long-term bonds.
Certain countries have been successful in floating issues of debt that obligate the government to return monetary sums of fixed purchasing power to holders of claims. These constant-value bonds, which provide holders with apparent protection against inflationary erosion in value, have been marketed at very low rates of interest. Great Britain, in the years since World War ii, has successfully introduced “premium bonds,” which incorporate certain features of a lottery.
The terms “funded debt” and “floating debt” have been used, historically, to refer to long-term and to short-term debt, respectively. Any definitions are, to an extent, arbitrary, but all issues of more than five-years maturity are generally called “long-term,” and all issues with shorter maturities are called “short-term.” The rubric “floating debt” is most explicitly used with reference to issues of less than one year maturity.
The names given to specific debt instruments reflect the maturity category. Bonds are securities issued for long term. Notes and certificates are intermediate-term, and treasury bills are short-term. The term “government securities” is used to refer to the whole range of public debt instruments.
Ownership. The pattern of ownership of public debt is an important factor in determining its impact on the national economy. In almost all countries national debt is held in significant amounts by various governmental or quasi-governmental agencies. For some purposes it is desirable to include only debt held outside the governmental sector in measuring total debt. For other purposes intragovernmental debt should be included. Insofar as the agencies holding debt are, in fact, treated as being independently accountable units, both in their investing and in their paying functions, the public debt that these agencies hold is not different in effect from that held by the nongovernmental public. However, insofar as these agencies holding debt are not independent of direct treasury control, their holding does not constitute debt at all and could as well have been canceled at the outset. For the most part, intragovernmental debt represents some combination of these two institutional situations.
It is also important to distinguish between the debt held by the nonbanking public and that held by the banking system and by certain categories within the banking system. To the extent that government securities are held by the central banks, they provide reserves for the commercial banking system, and changes in central bank holdings are indicative of important monetary movements in the economy. To the extent that commercial banks hold securities, potential reserves are available to them.
Traditionally, debt held internally and debt held externally have been sharply distinguished. In a national accounting sense, the servicing of internally held debt does not require the transfer of income resources out of the national economy, whereas, of course, such a transfer is required for the servicing of an externally held debt. This point is relevant, even though it must be kept in mind that, other things being equal, the income base from which the transfers are to be made must be larger in the case of externally held debt, precisely by the amount of the necessary interest transfer.
Management. Public debt management may be defined as that set of operations required to maintain an existing nominal debt. Again, consols provide a useful reference point; if all public debt should consist of consols, management reduces to the payment of interest charges. Significant problems of management arise because issues must be refinanced, must be “rolled over,” at periodic intervals. These problems become more difficult as the proportion of floating debt in the total becomes larger and also as economic conditions over time become less stable.
Recognition of management difficulties explains the traditional policy objective of funding the national debt to the maximum extent that is possible. This objective may conflict with other objectives that have been introduced into public policy. As national debts grow in importance, the annual interest payments assume relatively large shares of the governmental expenditure budget. This fact prompts recognition of the minimization of interest cost as an objective of debt management, one that is sharply in conflict with funding. Modern developments in the theory of macroeconomic policy have also forced the recognition that debt management exerts significant over-all effects on the economy. This produces a third possible management objective, that of supplementing macroeconomic policy in promoting stabilization-growth aims.
In a period of threatened inflation both the funding and the macroeconomic objectives would dictate a shift out of short-term into long-term issues, but this would increase interest costs. By contrast, during a period of recession both the interest-cost and the macroeconomic objectives dictate a shift into short-term issues from long-term, but this runs afoul of traditional notions about funding. The experience of the United States since World War ii suggests that the best explanatory hypothesis is that management has been directed toward maintaining substantially the same maturity structure over time.
Monetization . Interest costs on national debt could, of course, be reduced to zero through direct monetization of public debt. This is a process through which interest-bearing issues are refinanced through the issue of money, currency, or bank deposits. Because of the interest saving alone, monetization is always to be recommended insofar as it can be accomplished without inflation. Only the threat of inflation provides a barrier to monetization.
As the national economy grows, an increasing stock of money is required in order to maintain a constant level of product and service prices. One means of injecting increments to the money stock into the system is through debt monetization. Given the improbability that modern governments will retire public debts through the deliberate creation of budgetary surpluses, monetization provides the primary means through which national debts will be reduced. Monetization of debt is possible only for governmental units that possess independent money-creating powers.
National debt and fiscal policy. There is no simple connection between fiscal policy and the issue or retirement of national debt. Budgetary deficits need not be financed by the issue of debt, defined in a meaningful way. And, if such deficits are generated purposefully for the supplementing of aggregate demand, national debt should not be used as the means of financing. Instead, money should be directly created, which is always an alternative means of financing. In such a setting, the issue of debt exerts a deflationary, and undesirable, impact on total demand.
The elementary confusion about all this arises because, institutionally, national governments tend to disguise money creation through so-called “borrowing” from the central banks, and “public debt” is, nominally, created in this money-creating process. It is essential, however, that these two methods of financing deficits, which are conceptually quite different, be distinguished in the analysis.
The same analysis applies, in reverse, when budgetary surpluses are created. If the purpose of generating the surplus is that of reducing total demand, debt held outside the central banks should not be retired. Instead, the surplus should be disposed of by drawing down treasury balances or retiring debt held by central banks, which is the institutional equivalent of destroying money.
Principles of public debt. The preceding sections of this article summarize the institutional elements of “public debt,” on which there exists broad agreement among professional experts. It is the “theory,” or “principles,” of public debt that has traditionally generated controversy, and the debate shows little sign of being resolved, although essentially the same arguments have been advanced for two centuries. For those who remain skeptical about the progress of economic science, the debttheory controversy provides ample corroboration.
Nominally, the central question has been: Who bears the burden of public debt, and when? Analysis is clarified if this question is more carefully stated as follows: Who bears the real cost, or burden, of the public-expenditure projects that are financed by the issue of public loans, and when is this real cost incurred? What is sought is the incidence of debt, and the problem is comparable to that of locating the incidence of taxation, should this alternative financing device be employed.
This question is important because only if it is answered properly can a rational choice be made between debt issue and alternative financing devices. When should government borrow? This ultimate policy question cannot be answered until and unless the consequences of public borrowing can be predicted. Public spending may be financed in any of three ways: (1) taxation, (2) public borrowing, and (3) money creation. The appropriate situations for the use of the second alternative cannot be identified until the differences between this and the remaining alternatives are analyzed.
For whom is the central question relevant? Failure to clarify this point has also led to ambiguity. In any broadly democratic political structure, “government” is the institutional process through which people make “public” decisions. Therefore, “When should government borrow?” becomes merely a shorthand manner of asking, “When should individual citizens, as participants in the governmental decision process, as prospective taxpayers, borrowers, or beneficiaries, borrow?” The question of the appropriateness of public debt issue becomes analogous to the question concerning private debt issue for the individual in his private capacity.
The answer to the central question posed above seems obvious. Public borrowing should take place when it is desirable to put off or to postpone the incurring of real cost until some later period, in return for which, as in any act of borrowing, an interest charge must normally be paid. The desire to postpone the incurring of real cost or incidence of the public expenditure project may or may not be related to the characteristics of the project itself. Public or collective consumption may, in some cases, be legitimately financed from public loans, just as private consumption may be legitimately financed from private loans. A more normal or standard reason for public borrowing is found, however, in the temporal pattern of benefits that are expected to be produced by the public spending project. If the project involves a large and concentrated outlay that is anticipated to yield benefits over a whole sequence of time periods in the future, considerations of both efficiency and equity suggest resort to public loans, provided only that direct money creation is predicted to cause inflation. Traditionally, public debt has been discussed with reference to the financing of extraordinary expenditure needs, and specifically with reference to public capital formation. Historically, national debts have been created largely during periods of war emergency, when spending needs have indeed been extraordinary, even if the result has not been public capital formation of the orthodox variety.
The controversy. Little more would need to be said with respect to the “principles” of public debt were it not for the fact that the straightforward analysis has been recurrently challenged, and by economists of great eminence. Ricardo’s logic led him to enunciate the proposition that the public loan and an extraordinary tax of equivalent amount exert identical effects on the rational individual. Under conditions of perfect certainty, perfect capital markets, and under the assumption that individuals act “as if” they will live forever, the future tax liabilities that are inherent in a public debt obligation will be fully capitalized at the time of debt issue, and the effects on individual behavior patterns will be identical to those that would be produced by a tax of the same capital sum (Ricardo 1817). Within his own restricted model Ricardo’s basic proposition cannot be challenged, but its validity does not contradict the elementary notions on public debt outlined above. The individual, as prospective taxpayer-borrower-beneficiary, confronts two financing alternatives—current taxation and public debt issue. And to the extent that he interprets these two alternatives correctly, he knows that each of the two will impose upon him a real cost, a burden that in a present-value sense is substantially the same. This Ricardian equivalence does not suggest, however, that the objective pattern of cost payments remains the same over the two alternatives. Taxation and debt issue remain different, not similar, financing institutions, between which the individual may choose, for the simple reason that taxes require a transfer of resource services from the individual to the fisc during the initial period, whereas debt issue postpones such transfer until later periods. Whether or not the individual, under debt financing, correctly or incorrectly anticipates or “capitalizes” future tax liabilities as he “should” in the normative Ricardian model, is not relevant to the determination of the objective pattern of real cost payments over time.
A common fallacy. The most pervasive and recurring fallacy in the discussion of public debt has been that which summarizes the theory of internally held debt by the statement “We owe it to ourselves.” The fallacy here is not a new one; it was widely held by both scholars and publicists in the eighteenth century. It almost faded out of the literature during the nineteenth and early twentieth centuries, only to reappear and to gain predominance after the so-called Keynesian revolution of the 1930s. In the immediate post-Keynesian decades the fallacy came to be almost universally accepted by economists. Therefore, if for no other reason, the importance that this fallacy has held in the literature warrants some consideration of it here. For purposes of discussion it may be labeled the “national accounting fallacy.”
If the government borrows funds internally, so the theory goes, the public expenditure project is financed from internal resources. These cannot be brought from future time periods into the present; hence, the opportunity costs of the public project, regardless of the method of finance, must be borne during the period in which the resources are actually used. Public debt involves no postponement of cost or burden in time, and the view that it does so is based on a crudely drawn analogy with private debt. In periods after public debt issue, the required interest payments represent nothing more than transfers from taxpayers to bondholders, and, so long as both groups are members of the community, no real cost is incurred. External public debt, by contrast, because of the necessity to transfer interest payments to outsiders, is seen as wholly different from internal debt and analogous to private debt.
This conception of national debt contains a fundamental flaw in its failure to translate opportunity cost or burden from aggregative components into something that is meaningful to individual members of the community. What is the behavioral relevance of the fact that the resources actually used up in the public project are taken from current consumption or investment within the community until and unless those members of the community who must undergo the sacrifice of alternatives can be identified? Once this question is raised, however, and such identification is attempted, the fallacy is clearly revealed.
The members of the group who actually surrender purchasing power, command over current resource services, which is used by the government to carry out the public purpose, are those who purchase the public debt instruments, the government securities. No other members of the group sacrifice or “give up” anything directly during the initial period. But do the bond purchasers bear the real costs or burden of the project? That they do not becomes clear when it is recognized that their surrender of current funds is a wholly voluntary and private transaction in which they exchange current purchasing power for promises, on the part of the fisc, of income in future periods. These bond purchasers, or persons acting in this capacity, do not in any way consider themselves to be exchanging purchasing power for the benefits of the public spending, which would be the case if they should be really bearing the real cost. If, however, it is acknowledged that bond purchasers do not bear the real cost of the public spending, and if no other members of the group bear such cost during the initial period, who does pay for the project that is debt-financed? If, as the national accounting fallacy suggests, none of this cost is shifted to future periods, public debt might seem to provide for “fiscal perpetual motion,” since a means would have been located for financing beneficial public projects without cost.
The core of the fallacy lies in the equating of the community as a unit, in some aggregated national accounting sense, with the individuals-in-the-community, in some political sense as participants, direct or indirect, in collective decision making. In their capacities as prospective taxpayers-borrowers-beneficiaries, individual members of a political community can postpone the objective real costs of public spending through resort to debt finance, even though they may sell the debt instruments, bonds, to “themselves,” acting in a wholly different capacity as bond purchasers. There are two exchanges, not one, involved, and it is the neglect of this basic duality that has clouded much of the discussion and analysis. Individuals, as taxpayers-borrowers-beneficiaries, through the political decision process, “exchange” the future tax liabilities that debt issue embodies for the promise of expected benefits of the public spending, current or in future. They are enabled to do this because individuals, in their capacities as prospective bond purchasers, are willing to exchange current purchasing power for the promise of future payments. The second group makes an intertemporal exchange that is the opposite of that made by the first group. And it is grossly misleading to think of these two exchanges as canceling in effect merely because the two groups may be partially coincident in membership.
The alleged differences between internal and external debt disappear in a model that corrects for this national accounting fallacy. In either situation individuals in their roles as participants in collective fiscal choice secure command over resource services initially without the necessity of giving up purchasing power. Whether other parties to the exchange be foreigners or some subset of individuals acting in their private capacity as bond purchasers makes no essential difference, secondary transfer considerations aside.
For individuals as they participate in fiscal choice, public debt is the institutional analogue to private debt as these same individuals act privately. Basically, the same principles apply in each case, despite all the disclaimers made by economists. This is not, of course, to equate public finance with private finance in all respects. The important difference lies, however, not in the effects of borrowing but in the fact that national governments possess powers of money creation whereas private persons, and local governments, do not. The power to create money allows national governments to generate budgetary deficits without at the same time issuing debt. The principles of public borrowing, which are at base simple, have been obscured by the failure of economists to make this elemental point clear. In part, as suggested before, this has been the result of institutional complexities present in modern fiscal-financial structures. Modern governments create money through issuing what they commonly call “public debt”; they do so by “borrowing” from central banks. This disguised money creation does not, of course, have the same effects as genuine debt issue.
The analysis of public debt which was dominant in the 1940s and 1950s, as a result of the Keynesian and post-Keynesian emphasis on deficit financing combined with the confusion between debt issue and money creation, was subjected to critical attack in the late 1950s and early 1960s. Predictions as to the development of analysis or the acceptance of ideas are risky at best, but it seems reasonable to suggest that the principles of public debt are on the verge of synthesis. Undue optimism is, however, surely to be avoided, especially if the history of debt theory is to be used as a guide.
James M. Buchanan
Adams, Henry C. 1887 Public Debts: An Essay in the Science of Finance. New York: Appleton.
Bastable, Charles F. (1892) 1895 Public Finance. 2d ed. London and New York: Macmillan.
Buchanan, James M. 1958 Public Principles of Public Debt: A Defense and Restatement. Homewood, III.: Irwin.
Ferguson, James M. (editor) 1964 Public Debt and Future Generations. Chapel Hill: Univ. of North Carolina Press.
Great Britain, Committee ON National Debtand Taxation 1927 Report. London: H.M. Stationery Office. → Known as the Colwyn Committee Report.
Harris, Seymour E. 1947 The National Debt and the New Economics. New York: McGraw-Hill.
International Financial Statistics. → Published monthly since January 1948 by the International Monetary Fund.
Lerner, Abba P. 1948 The Burden of the National Debt. Pages 255–275 in Income, Employment and Public Policy: Essays in Honor of Alvin H. Hansen. New York: Norton.
Leroy-Beaulieu, Paul (1877) 1912 Traité de la science des finances. Volume 2: Le budget et le credit public. 8th ed. Paris: Alcan. → Volume 1 is entitled Des revenues publics.
Maffezzoni, Federico (1950) 1962 The Comparative Fiscal Burden of Public Debt and Taxation. International Economic Papers 11:75–101. → First published as “Ancora della diversa pressione tributaria del prestito e dell’imposta” in Volume 9 of the Rivista di diritto finanziario e scienza delle finanze.
Ricardo, David (1817) 1951 Works and Correspondence. Volume 1: On the Principles of Political Economy and Taxation. Cambridge: Royal Economic Society.
Viti de Marco, Antonio de (1934) 1950 First Principles of Public Finance. London: Cape. → First published in Italian.
DEBT, PUBLIC is an obligation of a government. Although individuals are called upon in their capacity as taxpayers to provide funds for payment of interest and principal on the public debt, their private property cannot be attached to meet the obligations if the government fails to do so. Similarly, government property normally cannot be seized to meet these obligations. With sovereign governments, the debt holders can take only such legal action to enforce payment as the governments themselves prescribe.
Public debt is one result of government financing expenditures. It is different from private debt, which consists of the obligations of individuals, businesses, and nongovernmental organizations. Public debt comes about as a result of taxing and borrowing by the federal government. The U.S. government has large capital outlays for such purposes as building or improving schools, hospitals, and highways. In order to pay for these projects, the government must finance part of their expenditures. When a government borrows money it also avoids the excessive tax burden that such payments would involve in a single tax period. Public borrowing is generally believed to have an inflationary effect on the economy and for that reason is often resorted to in recessionary periods to stimulate investment, employment, and consumption.
The debt owed by national governments is usually referred to as the national debt and is thus distinguished from the public debt of state and local governing bodies. In the United States, bonds issued by states and local governments are known as municipals. In the past, paper money was frequently regarded as a portion of the public debt, but in more recent years money has been regarded as a distinct type of obligation, in part because it is usually no longer payable in gold, silver, or other specific items of intrinsic value.
As of June 2002, the outstanding public debt in the United States stood at approximately $6,106,580,130,014. Based on that figure, it is also estimated that each citizen's share of the public debt is approximately $21,232.04. Since September 2001, the national debt has continued to increase at an average of $1.1 million per day. In the case of the federal government, the major source of debt has been borrowing to finance the costs of defense and war.
The Creation of the Public Debt
One of the first financial matters facing the new national government in 1789 was what to do about the debts that the Continental Congress and the several states had incurred. Although government officials agreed that the foreign debt, amounting to approximately $11,710,000, should be paid, they debated whether to assume the domestic debts of the Continental Congress and the states.
Alexander Hamilton, the first secretary of the Treasury, argued that the federal government had a responsibility to assume both domestic and foreign debts in order for the federal government to maintain a high credit rating at home and abroad and also to inspire public confidence. Hamilton estimated that the domestic debt (exclusive of state debts) amounted to $27,383,000, plus accrued interest of an additional $13,030,000. Despite the large sum, Hamilton's arguments eventually prevailed and Congress voted to assume the debt.
The Public Debt in the Twentieth Century
With the American entry into World War I in 1917, the public debt rose to the enormous total of $25,234,496,274. As had been the policy following previous wars, the government began to reduce the debt as soon as possible and had achieved a reduction to $15,770,000,000 by the end of 1930. But the severe contraction of the economy coupled with decreased government revenues and increased government expenditures that accompanied the onset of the Great Depression brought about another round of borrowing. As a result, by June 1933 the public debt had increased to $22,158,000,000. The economic woes that plagued the United States during the 1930s had made it impossible for federal revenues to meet federal expenses.
The huge increase of both the federal debt and the Gross National Product (GNP) during World War II demonstrated the relation between the two, prompting economists to think of all debts in terms of their relation to the GNP. Since the 1950s, therefore, all presidential administrations, whether Democratic or Republican, have tended to operate on the basis of a bookkeeping deficit, but one not large enough to prevent a relative decrease in the magnitude of the federal debt.
Between 1946 and 1970, the federal government was moving toward a lower public indebtedness. The same was not true of the debts of state and local governments. Their combined indebtedness stood at 7.5 percent of the GNP in 1945 and at about double this ratio by 1970, while interest rates were rising even faster. Although the federal debt was still over two and one-half times as large, the more rapidly growing state and local debts presumably did more to hinder private saving and consumer spending. By the early 1970s, however, the debt was less than 40 percent of the GNP, a ratio lower than in the depression years but higher than the 25 percent level of the prosperous 1920s.
Nevertheless, the deficits before 1981 paled in comparison to what followed. That year, the government cut income tax rates and greatly increased defense spending, but it did not cut nondefense programs enough to make up the difference. In addition, the recession of the early 1980s reduced federal revenues, increased federal outlays for unemployment insurance and similar programs that are closely tied to economic conditions, and forced the government to pay interest on more national debt at a time when interest rates were high. As a result, the deficit soared.
Since the early 1980s, successive presidents and congresses have tried to cut the national debt. Until recently, they met with only limited success. In the early 1980s, President Ronald Reagan and Congress agreed on a large tax cut, but could not agree about how and where to cut spending. At the same time, a recession led to increased spending to aid those in need and brought about reductions in tax revenues due to falling incomes and corporate profits. By 1985, both sides were ready to undertake drastic measures. Congress enacted the Balanced Budget and Emergency Deficit Control Act, better known as the Gramm-Rudman-Hollings Act. This legislation set annual deficit targets for five years, declining to a balanced budget in 1991. If necessary, Gramm-Rudman-Hollings required across-the-board cuts in programs to comply with the deficit targets. Faced with the prospect of huge spending cuts in 1987, the President and Congress agreed to amend the law, postponing a balanced budget until 1993.
By 1990, despite the pledge of President George Herbert Walker Bush that he would permit no new taxes, Congress enacted spending cuts and tax increases that were designed to cut the accumulated deficits by about $500 billion over five years. At the same time, Congress also enacted the Budget Enforcement Act (BEA). Rather than setting annual deficit targets, the BEA was designed to limit discretionary spending while ensuring that any new entitlement programs or tax cuts did not make the deficit worse. Yet the deficit, which many experts said would fall, actually rose, largely as the result of an economic recession.
In 1993, President Bill Clinton and Congress made another effort to cut the deficit, adopting a five-year deficit reduction package of spending cuts and higher taxes. The law was designed to cut the accumulated deficits by about $500 billion between 1994 and 1998. The deficit did fall from $290 billion in 1992 to $22 billion in 1997. In 1997, the Congress passed the historic Balanced Budget Act, which was to balance the budget by 2002.
The Bureau of Public Debt
According to the U.S. Department of the Treasury, the Bureau of the Public Debt (BPD) borrows the money needed to operate the federal government. It does so by issuing and servicing U.S. Treasury marketable savings and special securities. The BPD evolved from the Register of the Treasury, which became the Public Debt Service in 1919 and the Bureau of Public Debt in 1940. When the Government Securities Act was passed in 1986, the BPD assumed authority for the conduct of the government securities market. The functions of the BPD include borrowing the money needed to operate the federal government and accounting for the public debt this causes; receiving, storing, issuing, and redeeming government securities; servicing registered accounts and paying interest when it is due; maintaining control over accounting and auditing of public debt transactions and publishing statements; processing claims for securities that are lost, stolen, or destroyed; promoting the sale of U.S. Savings Bonds.
Although the public debt of the United States continues to rank among the lowest in the world, in the early 2000s debate has centered on such questions as how large the national debt may safely be allowed to grow, how and when public debt should be retired, what effect public borrowing has on the economy, and even whether governments should borrow at all or should finance all expenditures from current revenues. Most economists agree that financing the debt is appropriate when revenue sources are not enough to meet current needs or when the tax burden to raise money to carry out a project would be overly burdensome.
Cavanaugh, Francis X. The Truth About the National Debt: Five Myths and One Reality. Boston: Harvard Business School Press, 1996.
Gordon, John Steele. Hamilton's Blessing: The Extraordinary Life and Times of Our National Debt. New York: Walker, 1997.
Kelly, Robert E . The National Delays: From FDR (1941) to Clinton (1996). Jefferson, N.C.: McFarland, 2000.
McCulloch, J. R. An Essay on the Question of Reducing the Interest of the National Debt. Edinburgh: Printed for D. Brown, 1816.
Miles, James G. Congresses, Presidents, and the $5½ Trillion U.S. National Debt. New York: Rivercross Press, 1998.
Stabile, Donald R., and Jeffrey A. Cantor. The Public Debt of the United States: An Historical Perspective, 1775–1990. New York: Praeger, 1991.
National Debt (Issue)
NATIONAL DEBT (ISSUE)
The national debt is the amount of money owed by the U.S. government to its creditors, which may include private individuals, corporations, banks and other financial institutions, as well as foreign governments. As a result of better communications technology, improved information processing, and cheaper enforcement costs the ability of the federal government to collect taxes improved over the years. This made lenders more willing to fund the national debt and enabled the government to borrow at favorable interest rates.
The United States began its existence with a large (for the time) national debt of $75 million. This debt was the result of a deliberate policy of the first Secretary of the Treasury, Alexander Hamilton (1755–1804). Hamilton wanted to secure the confidence of wealthy
citizens in the new federal government, establish the government as a good credit risk, and provide a compelling rationale for constructing as effective federal tax system. With this in mind he convinced the U.S. Congress in 1790 to assume the debts incurred by the individual states during and after the American Revolution (1775–1783).
According to Hamilton, the funding and assumption of this debt served several purposes. One was to establish the credit of the United States among other nations. If the U.S. federal government voluntarily undertook to retire its debt the credit of the nation would be restored at home and abroad. With the repayment of the loans interest rates would be lowered. With lower interest rates investments in land, commerce, and industry would increase, and capital would multiply along with wages and jobs. Hamilton believed that, with responsible fiscal leadership, the day would not be long before economic dominance would soon pass from Great Britain to the United States—as indeed it did, but not for another one hundred and twenty years.
The South was especially hostile to Hamilton's vision of refunding and assuming the national debt. This was because many of the southern states had made substantial progress in meeting their financial obligations under the Articles of Confederation. New England states on the other hand favored funding and assumption because those states owed the largest portion of the states' collective debt.
Today we understand that the federal government has the ability to expand its own income through borrowing money, printing money, and tax increases. Since the 1930s, however, the economic theories of John Maynard Keynes (1883–1946) brought the realization that retiring the debt should not be an automatic reflex. That is because the debt can help in the fight against depression. If, during a depression, the government borrowed money and invested it in government projects that created jobs and produced a ripple effect and stimulating secondary investment and employment (such as a restaurant near a factory), the economy might regenerate itself and pay off the debt. Keynes believed that government attempts to increase revenues and decrease expenditures during a depression worsened, rather than cured, the problem of widespread unemployment and underutilized industrial capacity. Keynes argued that government spending should be counter-cyclical, that it should move in the opposite direction to private consumption and investment. Keynes believed that during an economic downturn the government should increase its expenditure to compensate for the decline in private demand for goods and services. Conversely, during an economic upturn the government should decrease its expenditure to make room for productive investment and consumption. Thus, governments should increase the national debt during economic downturns and retire the debt during business cycle upturns.
Since the founding of the republic the main source of increasing the national debt has been war. Initially, the war debt was easily retired. Within twenty years of the War of 1812 (1812–1814) the United States government paid off its war debt of $128 million. In World War I (1914–1918) the national debt underwent the first of several huge increases that would last through the end of the century. By 1990 the U.S. national debt soared to $3.2 trillion. In the late 1990s some economists believed that the anti-Keynesian tactics of President Ronald Reagan's (1981–1989) administration only made matters worse. They point to for the fact that his economic recovery program combined tax cuts with increases in government spending, thereby increasing the U.S. national debt by almost $1.9 trillion during his term. Proponents of Reagan's economics defend the administration's plan and the ensuing national debt on the grounds that a Congress controlled by the Democrats would not follow the president's wishes and dramatically cut domestic spending. They also argue that a high level of military spending was necessary to bring the Cold War to an end, and the tax cuts successfully stimulated the economy, as the stock market rose to record levels.
See also: Alexander Hamilton, John Maynard Keynes, Keynesian Economic Theory
Campagna, Anthony S. U.S. National Economic Policy, 1917–1985. New York: Praeger, 1987.
Frazer, William. The Friedman System. New York: Praeger, 1997.
Galbraith, John K. A Life in Our Times. Boston: Houghton Mifflin, 1981.
Keynes, John Maynard. The General Theory of Employment, Interest and Money. New York: Harcourt Brace, 1936.
——. Treatise on Money. New York: Harcourt Brace, 1930.
public debt, indebtedness of a central government expressed in money terms, often referred to as national debt. The debt is computed differently by nearly every nation. Some authorities exclude all government obligations other than those incurred by public borrowing from individuals.
The U.S. national debt originated with the American Revolution and as of 2009 amounted to more than $12.3 trillion. President Ronald Reagan made the debt a campaign issue in his successful presidential run (1980), but the national debt nearly tripled during his presidency. By the late 1990s, however, a federal budget surplus allowed President Bill Clinton to start paying down the debt—the first time this action had been taken since 1972. In 1998, Clinton presented the first balanced federal budget (with no annual deficit) since 1969. By 2002, however, the large tax cuts enacted under President G. W. Bush, combined with the effects of an economic slowdown and increased expenditures on national security following the Sept. 11, 2001, attacks on the United States and the U.S. invasion of Iraq, led to new deficits and an increase in the national debt. In the financial crisis that began in 2007 and the subsequent recession, the U.S. government's efforts under Presidents Bush and Barack Obama to stabilize the financial system and revive the economy led to record budget deficits.
Reasons for Government Indebtedness
Governments may borrow to meet temporary needs, as when estimated revenue falls below or is exceeded by estimated expenditures. Short-term treasury notes, payable by increased taxes or by greater economizing, may be issued, but such a debt should not become permanent. Nonetheless, many national goverments incur such debt because of an unwillingness to limit spending or increase taxes for fear of the political consequences. Borrowing to finance public works, especially when widespread unemployment exists, is another source of public debt and is justified in part by their long-term social utility. The largest public debts are incurred to meet emergencies, such as war debts that arise when it is difficult to finance the extended activities of the government by new or increased taxes, or when the government must borrow abroad to finance the war effort..
Public debt is advantageous in that part of the national funds are secured at an interest rate lower than that provided to private industry and in that the financial operations of government are funded on a permanent basis. It may also have an expansionary effect on employment and production during times of high unemployment. The disadvantages are that unjustifiable projects may be undertaken because the full burden of payment is postponed; that the government's demands may become so large that the interest rate on government bonds will rise to the point where money is diverted from private enterprise; and that too great a debt may induce governments to depreciate currency or default on obligations.
Forms of Government Indebtedness
Public loans, the characteristic form of government debts in modern times, may be in the form of short-term instruments, e.g., tax warrants, treasury certificates, treasury notes, and other notes such as those of the Federal Reserve System; of long-term government bonds; and of various notes that promise yearly payment of interest but do not specify a date for payment of principal. Although governments in times of stress have often converted bonds to issues carrying lower interest rates, have depreciated the value of currency, or have defaulted entirely on their obligations, with disastrous results for the bondholders, the number of those holding government obligations has increased in recent history. Default on obligations held by foreigners has been a reason offered for past intervention by major powers in Latin America, Africa, and elsewhere.
Payment of the Public Debt
The payment of the public debt improves the national credit by instilling public confidence in the economy, which usually leads to economic growth. Public debts may be paid by a sinking fund or by annuities, but both have the disadvantage of committing the government to fixed annual payments, whether convenient or not. Another method is to use only surplus revenue, setting a permanent appropriation to be paid against principal over and above annual interest rates. The ultimate security of the public debt lies in the willingness of the people to pay and the ability of the government to collect taxes.
See R. Heilbroner and P. Bernstein, The Debt and the Deficit (1989); D. Stabile, The Public Debt of the United States (1991); J. S. Gordon, Hamilton's Blessing: The Extraordinary Life and Times of Our National Debt (1997).