It’s Not a Good Idea to Pay Off the Federal Debt

“Paying off the national debt” has a nice ring to it, but it is precisely the wrong path for fiscal policy. Doing so would force current taxpayers to pay in full for federal investments mainly benefiting future taxpayers.

Federal spending can be divided into two basic categories: consumption programs that benefit current voters and investment programs--physical capital, research and development, education and training--that largely benefit future voters. As a generalization, efficiency in public budgeting requires that current voters pay current taxes for the services that benefit them and future voters pay future taxes for the programs that benefit them. After all, there is no such thing as too much or too good if someone else is paying the bill; if current voters must pay in full for investment, the political process will be driven to approve too little. And, alternatively, if future voters can be stuck with the bill for current consumption, current voters will approve too much of it. Thus it is appropriate to use debt to finance investment, so that the costs will be paid by the future voters to whom the benefits of the investment will accrue.

To the extent that this fundamental principle is honored, current voters would face the correct incentives in terms of approving federal investment yielding future benefits. This means that over time, the national debt should approximate the (depreciated) stock of federally financed capital assets.

That is why the usual gnashing of teeth over the “Reagan deficits” is misplaced. During fiscal years 1982-1989, federal budget deficits exceeded capital outlays by about $50.3 billion (in 1999 dollars) per year, a number that is trivial in the context of average annual federal outlays of $1.34 trillion and average annual gross domestic product of $5.9 trillion during that period. Moreover, well over half of the federal capital outlays during that period were for defense investment in equipment and infrastructure; President Reagan understood the long-term dangers posed by Soviet totalitarianism and the benefits to be bequeathed to future generations through resistance to it. It is clear both that the Reagan defense policy played an important role in the collapse of the Soviet empire and that the absence of the Soviet Union represents a huge asset for future generations. Therefore, notwithstanding many years of heated rhetoric about the “massive deficits” of the 1980s, the deficits of the Reagan years were roughly appropriate in that they financed assets--some measurable, some intangible--at least commensurate with their costs.

In short: Ask not whether we have stolen from our children. Ask instead whether the services that they will receive will be worth the future taxes that they will have to pay to retire the debt left to them. Perhaps counterintuitively for many--but not for Reagan--this means that a “balanced budget” is the wrong goal as long as federal investment is important. Total federal investment outlays for fiscal year 2001 are estimated at more than $246 billion; since future taxpayers will enjoy the attendant benefits, why should current taxpayers be forced to bear the entire burden? If ongoing federal investment programs are not worth their cost--an issue distinct from how such investments should be financed given that Congress has approved them--then it is even more appropriate to cut spending and return revenues to the taxpayers.

This analysis is complicated by the huge implicit debt created by federal commitments (that is, political promises) under Social Security, Medicare and other programs. Depending on assumptions about future growth in labor productivity and other parameters, that implicit debt is on the order of $9 trillion. But an explicit increase in current taxation to pay for these programs would not be feasible politically, precisely because they are not worth their costs to current voters. That is what it means to say that Social Security, for example, offers a low rate of return to young workers. A failure to return current surpluses in the form of a tax cut is the same analytically as a tax increase; the appropriate solution is to link benefits and costs for both current and future taxpayers by privatizing the Social Security system.

Government exists to serve the people, who always have first claim on their own taxpayer dollars. That view is quite contrary to the implicit belief of the permanent government class, which is that once revenues are sent to Washington, the list of rationales available to avoid returning them to the taxpayers is infinite. During the 1990s, taxes supposedly could not be cut because of the budget deficit, while now they cannot be cut because of the budget surplus. That this variant of the Brezhnev Doctrine--what’s mine is mine, and what’s yours is up for grabs--should live on in Washington is amusing, but ought not divert attention from the central principle that the burden of proof rests with those seeking to spend other people’s money.

Reagan had the insight to ask whether the taxpayers are getting their money’s worth and whether substantially higher tax payments have yielded more and better federal services. Those questions answer themselves, and that is why taxes should be cut.