Debt and Taxes

The price of our burgeoning national debt is this.  As our debt grows, more of our national income must be taken out of our economy and spent: at minimum, on the interest payments due; if we’re to actually pay off the loans, even more on principle payments.  But as we make the payments, if we borrow still more, still more money must be taken out of our economy for the additional payments.

In essence (to beat this horse a bit), money taken out of our economy to pay our increasing debt is money not available to our economy for use in productive things: capital investment, R&D, consumption, hiring, and so on.  Our nation’s debt, in the best of times, is a drag on our economy, but when it gets out of hand, it’s worse—it generates a negative feedback loop that actually contributes to shrinking our economy.  The more money taken out to make the payments, the less money for growth; the less growth, the less capacity for absorbing the removal of money, and the more that same removal amount hurts.

It’s true enough that the Federal Reserve Bank can manipulate interest rates, so as to keep those interest payments small and less of a drag, but only to a point.  In the end, Mr. Market overrules all of us, including our government.  As our debt grows (Greece, Italy, and Spain are graciously serving as object lessons here), our ability to repay it becomes more doubtful.  It’s certainly true that the Fed also can print all the dollars it wishes to print with which make those payments.

But there’s a rub here, too.  Our dollars are only worth what they can buy, and as we print more and more of them, they can buy less and less (that’s inflation)—including the “purchases” represented by debt payments.  There will come a time, sooner rather than later, when the interest the Fed is setting on our debt no longer accurately reflects the risks inherent in our debt, both in terms of our ability finally to repay and in terms of the value received from lending to us.  Worse, it will have become impossible to determine an accurate price either of our debt or of the risk in lending to us.  At that point, who will wish to lend to us?  Ask the Greeks, Italians, and Spanish how this is working out for them.

The price of rising taxes, another leg to our government’s efforts to right our economy, is this.  Taxing, at bottom, withdraws money from our economy.  Take everything written above about debt payments subtracting from our economy’s capacity and substitute “tax collections,” and we have the same negative feedback loop.  Increasing those taxes—a need seemingly justified by our stagnating, if not fading, economy—simply exacerbates the problem, with even more money taken out, an even more constricted economy as a result, and even less revenue going to government.  And more importantly, an even less effective economy, with lower production, less investment, fewer jobs, and reduced quality of life.

There is this one additional factor.  Some of the tax revenues do find their way back into our economy, but not all.  Roughly 75-80 cents of every dollar collected in taxes is all that makes it back.  Leaving aside the fraud, waste, and abuse that is a favorite target of our politicians’ perennial “spending cut” moves, the government acts as a middle man in the transactions, and so it keeps a fraction of every tax dollar for itself for the purpose.  Additional fractions of the tax dollar are lost simply to friction.

Further, government spending is money that is significantly misallocated, if only because it’s allocated to purposes we would not have chosen had the money been left in our hands.  It’s also misallocated, though, because so much government spending is allocated to things that inherently wasteful and destructive—overregulation from EPA regulations threaten electricity-generating power plants with closure, at the costs of jobs and of increased instability of our national power grid, for instance—and misguided—subsidies for “green” energy enterprises and for oil and gas production, for instance.  These misallocations reduce the efficiency of our markets so that our economy cannot even use the reduced production effectively.

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