Costs and Benefits of the Federal Debt

WM Oversight: Hidden Cost: The True Price of Federal Debt to American Taxpayers, December 6, 2023

Less than full faith and credit

While my comments are usually frank, these will be on the brutal side. I will not be pulling punches, will share the raw politics of this situation and will be sharing my comments with the rating agencies.

Any downgrades we have had - and there have been two - did not come because the Democrats are spending out of control. It is because Republicans refuse to compromise until the last minute, with a significant portion of leadership not wanting to compromise at all. This unwillingness cost Mr. McCarthy his Speakership and likely drove John Boehner out of Congress. 

Downgrades came for the same reason - brinkmanship on the debt limit in an attempt to force temporary tax cuts to be made permanent. The irresponsible strategy and the end goal alarm the bond markets because they indicate that one major party has no commitment to fiscal responsibility - play politics instead in fear of Grover Norquist - who no longer has skin in the game. Donald Trump took all of the radical oxygen away from the Republican fringe.

I am going to assume that leadership, especially among members of the Freedom Caucus, as well as their staffs are truly ignorant of how the national debt actually works. In short, it is the reason capitalism can exist at all. This is why, when the debt was paid off and the national bank was closed by Andrew Jackson, the economy collapsed. 

Historic perspectives

In the 1960s, the debt from World War II was quickly being paid down. By the end of the decade, there was no federal debt to leverage other liquid investments. This eventually led to tax cuts, but President Reagan overshot the mark and then codified it in the 1986 tax reform. Presidents Bush and Clinton found the growing deficits unsustainable and adjusted tax reform at the margins. Doing so reduced the debt while fueling economic growth. 

The Clinton cuts to capital gains taxes put too much money into the hands of speculators, which led to the tech boom and bust. It had nothing to do with technology and everything to do with IPOs. Even then, as budget balance was a real possibility, Alan Greenspan sounded the alarm about abolishing the debt. Many thought that this was to preserve the ability to maintain a fractional reserve currency, but the real motivation was to continue to provide the leverage on which capitalism depends.

The title of this hearing indicates that this history is new to the majority and staff. Either that or it is pandering to public ignorance. Regardless, please consider the current circumstances further.

Federal Debt Ownership

According to the Treasury Bulletin, the national debt is owned by the Federal Reserve System and its member banks (about a third), long term investment, insurance and retirement funds - both public and private - as well as Savings Bonds (another third). Using figures from the 2019 Federal Reserve Survey of Consumer Finance, I estimate that the top 10% of households own around 54% of these funds, with the bottom 90% owning the remainder (although the bottom three quintiles own essentially nothing - nor do they owe it - as will be described below.

The last third is owned by mutual and bond funds, as well as offshore investors. The top 10% of households own 77% of these funds. If the majority continues to dance on the edge of default, these are the investments that are at risk. The top 1% own the same percentages as of what the top 10% hold. This means that from the second to the tenth percentages own 25% of deposits retirement and mutual funds backed by Treasuries. 

The top 1% hold one quarter of debt assets held through deposits and long-term investment funds and half of what is held by mutual and bond funds. There are better ways to increase interest rates for these borrowers than messing with the Full Faith and Credit of the United States, which is essentially what the Freedom Caucus led assault on the status quo is doing.

Let us add that of the debt held overseas, roughly two thirds are held by foreign governments who, by doing so, facilitate international capitalism - especially the import of consumer goods from Japan and China. Messing with these funds put WalMart shopping at risk, as well as the entire chain. Much of the remainder of foreign bond holdings are in the Caymans, Ireland, Switzerland and Luxembourg. In other words, they are held in tax shelters for very wealthy Republican donors.

These investors know exactly where their debt assets are being held. It seems as if members of the Freedom Caucus do not. Unless there is a plot to destroy capitalism that I have not yet heard about, we suggest that the debt limit be abolished and the 2018 tax cuts allowed to expire on schedule. This will restore the confidence of both rating agencies and investors at home and abroad.

Continuing on the current path, where a major portion of the Republican Party acts against the interests of investors and the nation at large and sustains unsustainable tax cuts could have drastic consequences. The entire economy could collapse again, but this time for real. If the Federal Reserve loses its international leverage because the debt has become worthless, there will be no bailouts for questionable investments in mortgage backed securities - investments that have shifted from owner-occupied housing to single-family rentals. The bill to ban hedge fund ownership of these properties will reduce risk overall, but will not save the nation from the risk of losing its good credit.

Who Owes the Debt?

Debt obligation is a function of income tax paid (FICA tax paid to create assets held in trust by the government, not debt obligation). The current factor is 19 dollars of debt owed for every dollar paid in tax. 

Ownership of Social Security assets is realized when households are in the bottom quintiles who, at that time (because only 20% have income beside Social Security), own almost all FICA trust fund assets. The bottom quintiles hold more than their obligation.

The next three quintiles owe more than they own until we get to the top 0.1%. Because half of their income is earned through asset ownership taxed at preferred rates and their high share of ownership of debt, they break even. They own what they owe. In other words, when interest rates go up due to downgrades, their wealth expands in terms of debt owned compared to debt owed. This should guide how the debt should be reduced responsibly.

Please see the first attachment for more information on how debt is owned and owed. See the second attachment for our tax reform proposals that will responsibly bring down the federal debt.

Possible scenarios

It is now time to speculate on what may happen next. Let us assume rational actors who are capable of changing their behavior. Again, we will be pulling no punches.

Business as usual would be for an agreement between leadership, neo-liberal Republicans and neo-liberal Democrats to enact a reasonable set of spending bills, with the usual dissenters in the Freedom Caucus never coming around to do their duty as members of Congress in the majority party to keep government open.

A variation of that option is for those who have been voting with Democrats to simply switch parties, or at least enough of them to end the drama for the rest of this Congress.

Another change in leadership may, and probably will, occur when Roger Stone and his associates in the Willard Hotel War Room, including members of Congress who were part of the planning process, are indicted by Jack Smith. At this point, from the time these members resign or are expelled and until they are replaced by special elections, Minority Leader Hakim Jefferies becomes the Speaker and enacts a menu of tax, spending and budget process reforms. 

The same variation is possible as above, which is for some number of current Republican members to permanently change parties - especially if they wish to remove the taint of having been in a party which had a majority of its members vote as if they had helped plan the Insurrection on January 7, 2021, because they realize that an elector bloodbath rivaling 1974 is likely.

The worst case scenario is Republican solidarity, allowing the debt to go into default and leading to permanent damage to the economy, including that portion of trade that occurs between China and the United States which is more akin to the internal operations of Wal-Mart. This would include the collapse of the Federal Reserve. If this occurs, it will be before the election, so that no Trumpian tyranny will result.

The least likely option is the challenge made in these comments - a return to bipartisanship without the kind of rhetoric used in naming this hearing - which has infected what was the status quo of this Committee. Under that option, Congress returns to business as usual and quietly passes the required legislation to keep the government running through the middle of 2025.

The fantasy option is for Jack Smith to do nothing related to Congress, with Trump returning to power with strong Republican majorities - strong enough so that he can turn aside any 14th Amendment challenges to taking office again. Anyone who thinks this is at all likely needs both psychiatric and legal advice.

The ideal option, which is also unlikely, is for bipartisanship to result in the reforms detailed in the second attachment. This would actually settle most controversy over taxes for the long-term, which is what makes it unlikely. A lot of money is spent on going back and forth on tax policy, sadly putting our nation at continued risk of financial collapse.

Attachment: Settling (and Squaring) Accounts: Who Owns the National Debt? Who Owes It? 

Attachment: Tax Reform Videos included