No, the National Debt Does Not Need To Be Paid Off

And balanced budgets are not beneficial when it comes to the federal government

I know, I know, I said no more debunking, but this is a BIG one. In fact, it may be the biggest and most destructive myth of all.

Previously, we looked at the overwhelming, unambiguous, incontrovertible, and indisputable evidence that Democrats are better at managing the capitalist economy than Republicans. Republican administrations have presided over lower growth, higher unemployment, and four of the last five recessions, and we are headed for yet another one even as we speak.

Democratic administrations, by contrast, have often presided over economic growth and expansion, including expansions that have increased wages and employment for the middle and lower classes. They’ve not increased as much as they should, of course, but it’s still far better than under Republicans. Even wealthy Americans make out better under the Democrats.

No, Republicans Are Not Better for the Economy

Nevertheless, despite these data, people who call themselves economic (or fiscal) conservatives typically support Republicans. They will tell you this themselves. Why is that?

And what, exactly, does it mean to be an “economic (or fiscal) conservative?” That’s a good question! People who describe themselves with that label rarely define what the term means. Perhaps they think it’s self-evident.

So I’m going to go out on a limb here and speculate.

What They Believe

Fiscal conservatives believe in “sound finance,” which means that they want a “balanced” budget. That is, the federal government must take in enough money via taxation to match exactly what it spends—to the penny (except there are no more pennies). “I can’t spend money I don’t have, so the government shouldn’t, either,” goes the thinking. In other words, they believe that there is a limited supply of money in the world, and the federal government’s budget operates exactly the same way as a domestic household budget.

Spending money “you don’t have” is therefore “irresponsible” because you will run up “debt” (you’ll see why I’m putting these in scare quotes later). Thus, if the government runs up a lot of debt, it places an “intolerable burden” on future generations who will be “on the hook” to pay off our debts, with interest! Economic conservatives are usually obsessed with debt, particularly the size of the national debt. They like to use phrases like “running up the nation’s credit card” to emphasize this point. They think that governments can go “bankrupt” just like private businesses if they spend too much.

Fiscal conservatives believe that the government doesn’t have any money of its own, so it can only get money by taking it away (some would say, “stealing” it) from the private sector. Thus, all the revenue the government collects in taxes is simply a dead weight loss to the “real” economy in a zero-sum situation. Because the money government spends ultimately comes from the private sector (i.e. “taxpayer money”), they think that government spending cannot add anything to the economy by definition—it can only subtract. Therefore they advocate for “small government,” and push for budget cuts.

Thus, the government must always be “responsible” and never spend a cent more than it “earns” via taxes, or it should even be “profitable” (that is, run a surplus). In short, the government ought to be run “like a business.” Since most business people tend to vote Republican, that may be why people associate Republicans with fiscal rectitude and “sound finance,” despite all the evidence to the contrary.

In a nutshell:

Government spending = bad

National debt = bad

Balanced budget = good

Small government = good

These, then, are the basic, fundamental principles of what it means to be a “fiscal conservative” as I understand them, and hopefully it is an accurate summary of their beliefs. This view was summed up by Margaret Thatcher:

“Let us never forget this fundamental truth: the State has no source of money other than money which people earn themselves. If the State wishes to spend more it can do so only by borrowing your savings or by taxing you more. It is no good thinking that someone else will pay—that “someone else” is you. There is no such thing as public money; there is only taxpayers' money.”

However, these beliefs are based on a number of misconceptions.

Why this view is wrong

First, the federal government is nothing like a private business or household.

Economic conservatives have it precisely backwards. In reality, it is the private sector which has no money, and the public sector which is the source of all money. Therefore, the private sector needs to get its hands on the government’s money, not the other way around.

If you think about it for a second, this is obvious. The private sector cannot create new money—that is called counterfeiting, and it’s illegal. Therefore, since it cannot create new money, businesses can only be paid by customers and suppliers using legal tender or bank deposits which ultimately have to come from somewhere.

The only entities that can legally create money are the federal government itself via spending (state and local governments cannot do this), or by private intermediaries known as banks to whom the government has delegated that authority¹. A bank is a very special type of business which is granted a license by the government, has an account at the Federal Reserve, is a member of FDIC, and so forth, which allows it to create new monetary reserves through the extension of bank credit, subject to certain restrictions and regulations.

So, unless the entity in question is a private bank, it is the private sector which does not have any money, and the government which has all the money, either directly or through its designated private intermediaries, the banks.

This means that spending must logically come before taxation and borrowing, not after, otherwise there wouldn’t be sufficient money to tax or borrow. This chicken-and-egg cycle began so long ago that the original sequence was forgotten and eventually reversed. Sometimes this is expressed as S(TaB)—as opposed to (TaB)S—with ‘S’ representing the primacy of spending in this sequence and taxing and borrowing (TaB) necessarily following after.

Why does this matter? Because it necessarily leads to the conclusion that federal spending is ultimately not funded by taxes paid to the government. When the government authorizes spending, it is money spent into the system de novo which the government then reclaims a portion of via taxation, deliberately removing spending power from the public. It does this by transferring funds from your account to the government’s via keystrokes (and spends by reversing this operation).

Why does it do this? Well, there are several reasons.

A big one is to prevent too much money from being injected to the system which could cause inflation. Taxes provide the “fiscal space” for government spending. Another is to induce demand for the government’s currency. Another is to redistribute a portion of wealth which is necessary for any society to function. Another is to account for externalities not priced into markets by taxing “bads” and subsidizing “goods.” Yet another is to reassure international investors and holders of the sovereign’s currency that the government can regulate the amount of the currency in the system to keep it under control.

It also means that we are not dependent on billionaires to fund our federal spending like children begging for an allowance from their parents. We do not have to go to the billionaires, hat in hand, to politely ask for enough money to accomplish the things that we want our elected representatives to do for us (“please sir…”), despite what even people on the political left seem to believe. Money doesn’t grow on rich people.

It follows, then, that government spending is not a subtraction, but rather an addition to the domestic economy. This is why throttling back government spending never causes the economy to grow faster. In fact, it usually does the opposite—it induces a recession, lowers investment and economic growth, and increases unemployment.

Government spending accounts for nearly 40 percent of GDP (federal expenditures alone are about 23 percent). That’s not a bad thing—these are things that we’ve told our elected representatives we want them to do for us like keep us safe, build roads and other infrastructure projects, prevent people from becoming destitute, educate the public, provide health care, predict the weather, undertake basic scientific research, make sure our food supply is safe to eat, keep the lights on, make sure planes don’t crash, and a host of other things.

In fact, federal government deficits turn out to be private sector surpluses. This is not a theory—it is an empirical observation based on the rules of accounting (which is based on double-entry bookkeeping). Every liability is someone else’s asset—in other words, “the government’s red ink is our black ink.”

If, by contrast, the federal government is withdrawing more money via taxation than it spends back into the economy (i.e. it makes a “profit”), it really is withdrawing money from the system. The accounting identity described above still holds, meaning that the federal government’s surpluses are the private sector’s deficits. Its gain really is a net loss to the private sector.

When the federal government’s budget is “balanced,” it is not adding or subtracting any money to the domestic economy at all. That means that if the money supply is to grow, it is dependent on bank lending to do so, with all the problems that entails².

When the federal government spends more than it taxes in any given year, then it “borrows” the difference. Fiscal conservatives assume that this “borrowing” is exactly the same as you or I going down to the bank or Payday Loan Store and taking out a loan. But that analogy is misleading.

Unlike you or I, the federal government issues its own currency so it does not need to “borrow” in order to spend. Instead, it issues Treasury Bills (T-Bills) in the equivalent amount for people to invest in. People voluntarily buy Treasuries because they want a safe asset to store their money, and the federal government will pay you interest for holding onto them. It’s a way of absorbing excess money in the system. The money to buy these Treasuries is ultimately dependent on government spending in a semi-closed loop within the financial system.

(This so-called “borrowing” is a holdover from the days when there was an artificial constraint on new money creation under the old currency conversion rules. Buying and selling bonds was also used by governments to manage interest rates.)

What this means is that the nation’s “debt” is merely assets held by the private sector (as well as government entities like central banks, both foreign and domestic).

Recall that every liability is someone else’s asset. This is an iron law of accounting. These assets are on the positive side of the ledger, meaning that they contribute to private sector wealth, not subtract from it. In fact, if you cut the national debt in half, you would cut national savings in half as well. Not only that, the interest paid on the national debt is paid to the private sector, increasing their net wealth, not taking away from it. It is “welfare” for the investor class. Thus, whatever they tell you, the “national debt” is nothing at all like your and my credit card debt³.

This was succinctly expressed by Abba Lerner back in the 1940s:

“One of the most effective ways of clearing up this most serious of all semantic confusions is to point out that private debt differs from national debt in being external … A variant of the false analogy is the declaration that national debt puts an unfair burden on our children, who are thereby made to pay for our extravagances. Very few economists need to be reminded that if our children or grandchildren repay some of the national debt these payments will be made to our children or grandchildren and to nobody else. Taking them altogether they will no more be impoverished by making the repayments than they will be enriched by receiving them.”

Abba Lerner, The Burden of the National Debt (1948)

And while the government could take in more than it spends, this would inevitably lead to private sector deficits, and private entities—unlike national governments—cannot run deficits indefinitely. Unlike the federal government, they actually do need to make a profit. The “private sector” is not a single household or business—it is the sum total of all households and businesses in the country. And while a household has a limited lifespan, governments are permanent institutions that extend across generations. Confusing these is a basic category error.

The national debt could be paid off tomorrow if we wanted to—all it would take is moving money from one account to another— but it would extinguish a big portion of national savings in the process, probably also inducing a recession. In fact, every time the national debt has been paid off too quickly, a recession has immediately followed rather than an economic boom according to research by Frederick Thayer, a professor of public and international affairs at the University of Pittsburgh. The most recent example was the downturn at the end of Clinton’s second term.

So what I take “fiscally conservative” to mean is not spending more than you earn.

And while that may indeed be good advice for your private life, it’s not a good idea to run the federal government this way because the federal government is totally different. The government issues the currency and sets the rules of the game—it is the house in a casino, or the banker in Monopoly. And it definitely should not be run “like a business.” Private businesses are dedicated to profitable enterprises alone, and not everything that needs to be done is profitable. The things the government does—including spending and deficits—are what enable the private sector to make profits.

Thus we see that the public and private sectors are complimentary, not antagonistic, which is why the notion of “small government” makes no sense. The largest and most successful economies in the world with the highest living standards are all run by the world’s biggest and richest governments. The poorest economies in the world tend to have smaller, poorer, and weaker governments, but they are not more prosperous as a result.

Libertarian thought would have it that when the government shrinks, the private sector must grow by the same amount since it is no longer taking away “taxpayer money” from the public. But that is not what happens. In reality, when government shrinks, the private sector shrinks also. This has been known for a long time—we’ve seen it again and again. No national government has ever “shrunk” its way to prosperity⁴. This is called austerity, and it has a very poor track record of spurring economic growth.

At the end of the day, the only thing that matters are the conditions of the real economy—jobs, growth, inflation, unemployment, poverty, and so on. Everything else is just an accounting identity with no further significance. Think about it: in your lifetime, as well as mine, I’m willing to bet that the national debt has gone up, and gone down, several times. Has it affected your life in any way? Paying down the debt while allowing the actual economy to fall apart and workers to suffer makes no sense whatsoever. Obsessing over these accounting identities is counterproductive and pointless.

To both [John Maynard] Keynes and [Abba] Lerner it was evident that the state had the ability to promote full employment and a stable price level – and that it should use its powers to do so. If that meant that it had to take on a debt and (more or less temporarily) underbalance its budget – so let it be!

Public debt is neither good nor bad. It is a means to achieving two over-arching macroeconomic goals – full employment and price stability. What is sacred is not to have a balanced budget or running down public debt per se, regardless of the effects on the macroeconomic goals. If “sound finance”, austerity and a balanced budgets means increased unemployment and destabilizing prices, they have to be abandoned.

An MMT perspective on the public debt problem (Real World Economic Review)

Fiscal “Responsibility”

If you go online, you will inevitably see economic conservatives complaining that Republican politicians have abandoned “fiscal responsibility.” You will also see the opposite—people praising the Democrats for being “fiscally responsible” by paying down the debt, or balancing the federal budget.

The idea is that spending money is always bad, and paying down debt is always good, regardless of macroeconomic conditions.

But how “responsible” is it to NOT spend money, anyway?

If you’re suffering from cancer, is it “fiscally responsible” to not spend money “you don’t have” on medical treatments to regain your health? Is it better to save money at the cost of your life?

People take out loans much higher than their current income to go to school because they know that they will be better off because of it. Is it “fiscally responsible” to not get an education? In many instances, the answer is, “no.” Clearly it makes sense to invest in your “human capital” as an individual, just as it makes sense for a nation to invest in its own people. Doing otherwise in the name of “fiscal responsibility” is like eating your seed corn.

It is “fiscally responsible” to not spend any money on house maintenance, even as your house falls apart around you? Is it “fiscally responsible” not to spend money on exercise or preventative care, even as your health deteriorates? Is it “fiscally responsible” to not spend money on insurance so that you risk losing everything in case of misfortune? Is it “fiscally responsible” not to hire a lawyer if you’ve been wronged? There are a lot times where not spending money is hardly the responsible thing to do.

All of these are analogies for people who monomaniacally prioritize paying down “the debt” (which isn’t really a debt, as we’ve seen), or “balancing the budget” over everything else. As we’ve seen, balanced budgets take money out of the economy.

Why, then, is there so much hysteria surrounding the national debt and deficits? Simple—because it allows politicians to claim that the government is “broke,” and therefore it can’t do things for its citizens that polls routinely show most people want it to do. Instead, people have to resort to GoFundMe to beg for help from strangers on the internet when they get sick or injured and hope for the best (and where does that money come from?). They have to sink themselves into debt for education, health care, and child care. It doesn’t have to be that way.

The political importance of this was driven home to me by a recent article in The Guardian. It describes the terrible impact of the current government’s draconian and discretionary fiscal cutbacks on the lives and communities of people in rural California. Yet they still support President Trump, despite these devastating cuts, because they think that anything else would be “unsustainable.”

Bruce Ross, a Shasta county Republican, acknowledged the difficulties of seeing layoffs, but said he had been pleased with the direction of the administration.

“Everybody who lives up in north-eastern California knows folks who work for the Forest Service, or for federal agencies, and it’s tough for them. I think on a human level, that’s real,” Ross said. But, he added, he had seen a willingness on the part of the administration to listen when local officials have pushed back against proposed cuts, and the practical changes had ultimately, so far, been less severe than they initially seemed…Ross, who is also the secretary for the Shasta county Republican central committee, admitted there would probaly [sic] be pain as Trump enacts his agenda, but argued that was necessary to tackle the federal deficit.

“There’s a $2tn annual deficit with the federal government in Washington in a time of peace and a fairly strong economy,” he said. “How do you ever go about trying to balance that without being somewhat aggressive about actually cutting spending? It’s never going to be easy to do.”

(My emphasis) And:

Steve Barkley, a 74-year-old who lives in northern California’s Sierra foothills, said he felt confident in the president’s agenda, and wasn’t worried about any cuts to Medicare or social security.

“He’s the first candidate that was really saying the things that I wanted to hear, and promised to do the things that I want done, and he’s keeping his promises,” Barkley said, adding that he believed Trump’s recent actions ensure the longevity of those programs and boost the economy.

“I’m happy. I don’t expect anything to get done right away. It’s going to take time.”

Ross is hopeful that even with some short-term pain, Trump’s policies will ultimately improve the region…“I think that’s going to be good for northern California. It’s not just about money – it’s about what is their direction, and what are their goals? And just bluntly, they’re on our side,” he said.

“And again, look at the federal deficits and explain how that’s sustainable, and explain how that’s going to change in a way that doesn’t cause some dissension. It’s hard on any level. But I think long-term, it’s what the country needs.”

In California’s deep-red north, voters startled by pace of cuts – but they’re still backing Trump (The Guardian)

So now you can see the true agenda behind economic conservatism—it can get people to enthusiastically support the destruction and impoverishment of their own communities in order to “pay off the debt” and “balance the budget” (even as trillions in tax cuts are proposed for the wealthiest Americans). For them, it’s “short term pain for long-term gain,” just like Dave Ramsey told them to do with their own household budgets. As Stephanie Kelton notes:

By persuading voters that something must be done about these big scary numbers, politicians can push for cuts to popular programs, like Social Security and Medicare. Winning support for an agenda that calls for painful cuts requires sustaining public outrage over our national finances. These are programs that benefit enormous constituencies. People will fight tooth and nail to protect them. Unless, of course, they can be convinced that there is no alternative. That we must act to “fix the debt” before it’s too late.

Stephanie Kelton, The Deficit Myth p. 80

Look around you. Look at our decrepit infrastructure. Look at our airports, our roads, our libraries, our schools, our train stations, and our public spaces. Look at our rural hospitals and overflowing emergency rooms. Look at the streets filled with homeless people. Look at our dilapidated small towns and blighted inner cities. Look at our child poverty and falling life expectancy. Does this look like a country that’s been spending too much money? People who regularly travel to Western Europe and Asia know the truth.

Slashing the government’s budget and paying off the national debt, then, is not a pathway to prosperity, nor is the debt an existential crisis, despite what everyone on the internet and in the media is telling you⁵. Neither is the budget deficit of particular concern. The deficit is merely the difference between what the federal government has spent into the economy and what it has chosen to withdraw via taxes. The national debt is the sum total of all past deficits, and corresponds to interest-bearing assets held by the private sector. In fact, the national debt need never be repaid, since it represents a major portion of our nation’s money supply.

So, for me, being truly “economically conservative” means paying attention to real, actual economic conditions and the health of our fellow citizens and communities rather than trying to run government “like a business,” or prioritizing paying off a debt which we mostly owe to ourselves. Economic conservatism is based on a fundamental category error and not understanding how macroeconomic sectors interact. It seems like self-described “economic conservatives” are either making this category error, or else basing their economic reasoning on emotions rather than the facts of how the modern economy actually operates.

1. Technically, anyone can create money, but there is a "hierarchy" of money, with the government's own currency at the apex because it can be used to settle all debts, public and private by legal statute, and therefore has the most utility.

2. There are also import/export impacts that I'm omitting for clarity.

3. Remarkably, in her book, The Deficit Myth, Kelton lists several examples of Democratic politicians using this kind of rhetoric. She notes that candidate Obama repeatedly complained that we're borrowing money from China and that, “we're going to have to pay it back.” (p. 81)

4. See, for example Governor Sam Brownback’s experiment in Kansas.

5. And who is funding all those “national debt clocks” everywhere, like the one you see at the top of this post? And for what purpose? Where does that money come from?