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Should the U.S .federal government solve its current financial problems by borrowing from future U.S. Taxpayers? Some concerned Taxpayers are asking serious questions about why the U.S. national debt has not been repaid and whether it may be increasing faster than their capacity to repay it?
As of December 2009, the national debt totaled $12.28 trillion of which $4.5 trillion was owed to various U.S. government trust funds. Roughly half of the government’s trust-fund obligation is owed to the Social Security Trust Fund. Last year a spokesperson for the Social Security Administration (SSA) warned Congress that the SSA will begin paying out more than it receives by the year 2017 after which its $2.4 trillion Social Security Trust Fund surplus that is on loan to the federal government will be wiped out by 2041 unless major changes are made to the Social Security Program. This announcement is presumably based on the fact that the U.S. Tax Code does not include language preventing Congress from changing the Program and on the Supreme Court's decsion in Flemming v. Nestor (1960) that "entitlement to Social Security benefits is not a contractual right". However, this announcement ignores the possibility that Congress could exercise other options, one of which would be to revise the current U.S. Tax Code. Other options might require efforts to increase permanent domestic job growth and wage-income in the private sector. Job growth and higher taxable income could enable the Social Security Trust Fund to remain self-funded indefinitely, assuming that the federal government does not continue to borrow these funds to spend elsewhere.
Actually, the size of the national debt has not been created by borrowing exclusively from U.S. Taxpayers. It has been created by borrowing from U.S. investors, from U.S. trust funds as described above; and from foreign countries. The intergovernmental transfers from U.S. trust funds accounted for over 36.6 percent of the national debt in 2009 ($4.5 trillion divided by $12.28 trillion = 36.6 percent). The share of the national debt that was owed to foreign countries in 2009 accounted for another $2.4 trillion or 19.5 percent of the national debt. China and Japan own the largest share of this debt through their purchases of U.S. Treasury bonds. The balance was owed to U.S. citizens.
The easiest way to consider whether the national debt is increasing faster than U.S. Taxpayers’ ability to repay it is to express its size in terms of other funds that might be used to repay it. For example, as of December 2009, it would take roughly 86 percent of the value of all goods and services produced in the U.S. for an entire year to repay national debt. Or, based on the U.S Treasury Department’s anticipated $2.2 trillion in federal tax receipts from all sources in 2010, it would require about 5 years of tax receipts at this level to repay the national debt.
Since repayment of the national is virtually impossible without major revisions to the U.S. Tax Code or major cutbacks in existing federal programs, the federal government has chosen another option. It pays the interest that comes due annually on the national debt. According to the U.S. Treasury Department’s estimates as of January 2010, receipts from personal income taxes excluding social security taxes in 2010 will total $935.8 billion. This source also estimates that roughly $425 billion will be paid as interest that will be owed on the national debt in 2010. That is, $.45 of every dollar that an individual Taxpayer remits to the IRS as federal income tax in 2010 will be used to pay the interest that will be due on the national debt in 2010. Therefore, whether or not the national debt is growing faster than Taxpayers’ ability to repay it actually boils down to whether they can afford to pay the debt service. In making this decision, each Taxpayer has to decide if $.55 of each tax dollar that is paid to the IRS in 2010 will provide adequate levels of federal public services for all Americans, some of whom do not pay taxes. Moreover, if the national debt continues to increase, then every year beyond 2010 each Taxpayer must reevaluate how much more of each tax dollar should be used to pay the interest on the national debt as opposed to using this share to produce public goods and services.
Historically, the U.S. national debt has been allowed to grow because Taxpayers have been conditioned to think that it is either good for the economy which in turn implies that this debt will be good for them, or that a national emergency has forced Congress to increase the national debt. The remainder of this article addresses these opinions.
Example 1 - Productivity Gains – It’s Good for the Economy. Whether or not the national debt is a blessing for the economy and for the Taxpayers who will be able to repay the debt actually depends on more than assurances that this debt will increase productivity. It also depends on how new wealth is created from advancements in productivity, to whom this wealth is distributed; and most importantly, whether this new wealth is taxed.
For example, the U.S. national debt was not repaid during this country’s infancy because the federal government’s authorization to tax was very limited. The U.S. Constitution did not allow the federal government to impose direct income taxes on citizens until after the Constitution was amended in 1916; and this particular amendment only allowed Congress to impose tax on the rich at a rate that could not exceed 2 percent. The federal income tax base was expanded dramatically in 1942 at which time it started to absorb some of the wealth of the middle class. However, the national debt was never repaid because even as late as 2006 it was argued that the U.S. could maintain large national debt balances because the U.S. government paid higher interest rates to foreigners who would continue to support this debt because the U.S. would use the funds to create higher productivity levels in the U.S.. In order to understand why this argument is flawed, we must define ‘productivity’. The historical measure for productivity originated during the Industrial Revolution and referred to increasing each worker's output per hour, given the technology of machinery and fossil energy that was used at that time. During the 20th century, technological advancements coupled with higher levels of labor productivity expanded the nation's output and wealth. Unionized labor and minimum wage legislation helped to ensure that employees would receive higher hourly wages based on higher levels of labor productivity; and the revisions in 1942 to the U.S. Tax Code ensured that the federal government would obtain a proportional share of the wage-income that labor earned.However, the revisions to the U.S. Tax Code in 1942 did not reflect the possibility that rapid technological advancements (automation) and operational changes (outsourcing) could create wealth that would not have positive simultaneous impacts on labor's taxable wage-income.
Enhanced labor productivity, technological productivity or a combination of both can be appropriate justifications for the expansion of the U.S. national debt if it is understood that when either source is untaxed or under-taxed, the argument falls apart. Currently the U.S. Treasury Department estimates that its receipts for 2010 from all tax sources will total roughly $2.16 trillion. Individuals will contribute directly or indirectly an estimated $935.7 billion to these receipts as their federal income taxes and another $875.7 billion in the form of social security and retirement taxes. The employees' payments of social security and retirement tax are based on the assumption that employers' contributions will be passed on to their employees whose wages would be higher if these contributions were not required. In other words, individual tax filers of their 1040 tax forms will pay $1.81 trillion, or 83 percent of the federal government’s tax receipts in 2010. The official starting date of the 'jobless recovery' from the current U.S. recession refers to opinions that technological productivity,not labor-productivity, explained the growth of the U.S. economy in 2008 and 2009. This being the case, consider the fact that the U.S. Treasury Department expects that corporate income taxes will only generate $156 billion or 7.2% of total federal tax receipts in 2010. This relatively weak contribution to the federal government’s total tax receipts in 2010 does not make a strong case for the argument that taxable income attributable exclusively to technological productivity will enable the federal government to repay the national debt or pay the interest on this debt.
Example 2 - A National Economic Emergency. Deficit Spending to Recover from a Recession or a Depression- Deficit spending as a means of recovering from a national recession is based on John Maynard Keynes’ economic model for jump starting a nation’s recovery from the Depression of 1929. The simplest explanation of this model is that when machinery and workers are idle, an increase in government expenditures will not crowd out investment in the private sector or put upward pressure on interest rates and prices. If the federal government has a budget surplus, it might not have to borrow funds to increase its expenditures on public projects that employ workers. Normally, however, the federal government will borrow funds in order to create public projects and jobs until personal income (e.g., wage income) and consumption patterns are reestablished. The model is a demand side model in that as consumption patterns are reestablished, businesses' inventories begin to fall which signal businesses to increase investment and reemploy workers. As the private sector recovers, the federal programs or projects that absorbed workers temporarily are downsized or phased out.
During the Great Depression of ’29, application of Keynes’ model produced immediate improvements in domestic employment and real wage-income. However, it was a static model (i.e., it did not consider advancements in technological productivity that could replace labor); and it did not consider leakages that occur when all factors of production or contributors to growth in national output and wealth are not subject to tax. Keynes’ model did not incorporate the impacts of transfer pricing, outsourcing, foreign investment and inflation. Therefore, when Congress incurs a federal deficit that increases the national debt, the impacts will be positive; but they will be diluted by these factors ( i.e., leakages). They may also diluted by entitlement programs, irrespective of their social value, depending on how they are funded. Keynes did not address entitlements per se.
Example 3 – A National Emergency- Our Nation’s Security. It has been argued that wartime activity increases jobs and productivity; but there are flaws with this argument too because these changes may not be permanent. For example, the USA’s participation in World War II (WWII) did increase both jobs and productivity initially. However, Congress had to raise taxes, impose price controls in order to avoid rapid inflation; and it had to redirect national output from the production of consumer goods to the production of wartime equipment. Therefore, unless the U.S. planned on continuing to ration the production of consumer goods in order to concentrate on the production of wartime machinery after the WWII ended, the cost of this war was not going to be repaid by productivity gains in the national defense industry. After WWII ended, domestic workers, many whom were women, were laid off so that returning veterans could return to their former jobs in occupations that produced consumer goods. The national debt as a share of national output was 20% before the Great Depression of 1929, 40 percent during the implementation of FDR’s New Deal; and it increased to roughly 120 percent by the time WWII ended. This ratio did fall from 120 percent in 1946 to 32 percent in 1981, but whatever events made it possible to pay down the national debt were not attributable to productivity gains attributable to the production of wartime equipment. The reduction of the national debt was attributable to the major revisions in the U.S. Tax Code. AS of December 2009, the ratio of national debt to national output was 86 percent, the highest ratio since WWII.
The revisions to the U.S. Tax Code that were enacted in 1942 touched the middle class for the first time. “…The number of individual taxpayers grew from 3.9 million in 1939 to 42.6 million in 1945, and federal income tax collections over the period leaped from $2.2 billion to $35.1 billion. By the end of the war nearly 90 percent of the members of the labor force submitted income-tax returns and about 60 percent of the labor force paid income taxes. … At the same time, the federal government came to dominate the nation’s revenue system. In 1940, federal income tax had accounted for only 16 percent of the taxes collected by all levels of government; by 1950 the federal income tax produced more than 51 percent of all collections. Installation of the new regime was the most dramatic shift in the nation’s tax policies since 1916…” (Roach,B. 2007).
Summarizing, it appears that the U.S. national debt problem today is not necessarily that it is large or that it has been increasing, but that all of the sources of productivity that might have been used to justify the creation and maintenance of the U.S. national debt have not been taxed. Instead of revising the U.S. Tax Code,Taxpayers have been conditioned to think that the debt is good for the economy or that it is a necessity. The U.S. Tax Code that was revised in 1942 imposed income taxes on laborers' wages during an era when labor was considered the primary engine of economic growth, complimented by advancements in technological productivity, and because a worker's wages increased as his productivity increased. Growth in technological productivity, independent of growth in labor productivity, was not anticipated. The national debt is expected to increase from $10 trillion in September 2008 to an estimated $12.28 trillion for 2010. The U.S. Treasury Department produced this January 2010 estimate before Congress took up its March 2010 debate about extending the qualifying timelines for recipients of federally funded emergency unemployment compensation (EUC). Faced with the cost associated with the extending the EUC timelines and/or creating any new entitlement programs that could increase the national debt, Congress can explore several options. It can lower the costs and/or benefits of existing programs in order to fund other programs. It could also consider reducing some of the inequities in the current U.S. Tax Code (1) by imposing a flat tax or sales tax on consumers so that a larger share of the population will contribute to federal tax receipts, (2) by raising the federal income tax rates for non-wage income of higher income earning individuals; and (3) by revising the U.S. Tax Code to impose taxes on various forms of technological productivity that do not create complimentary gains in employment levels and wage income. The recently enacted U.S. national health care legislation included a few new tax provisions, one of which will raise taxes for higher income-earning households; but this tax policy continues to treat labor as the primary source of federal tax receipts, potentially leaving untaxed the wealth that is created from labor-reducing or labor-eliminating technological advancements.
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