Tuesday, April 10, 2007

Does Government Debt Matter?


For all the talk about the government "debt" and "deficits", it is questionable that most people understand these terms. Normally, the "family" analogy is used; i.e., "You wouldn't want your family to be in debt!"

That's a pretty meaningless analogy, as most people would want their families to be in debt under some circumstances, like:

- Buying a house.

- Paying for a college education.

- Borrowing money at 3% and investing it at 7%.

The relevant factor to consider is: What are the alternatives to the government going into debt? In fact, the government has two alternatives, just as any family has:

A) Make the purchase up front, without borrowing.

B) Do not make the purchase at all.

Oddly, when discussing government debt, Alternative (B) never seems to be considered. Instead, the answer is always "raise taxes instead of borrowing". But what does it matter whether taxes are raised to buy something today or to pay off a long-term loan? Neglecting the effect of interest rates, why is it better to empty your bank account to go to the casino instead of emptying your bank account to pay back a gambling loan?

The obvious solution is, "Don't go to the casino to start with." But, if you must go, then borrowing actually makes more sense if you can get a cheap loan -- like the government can with the tax-exempt bonds that it issues.

Put another way, when you are taxed, you are losing your principal and 5% interest that your money would have otherwise earned in the bank. But when the government borrows, then you get to keep your 5% interest at the bank, and pay only 3% interest to the bondholders as they slowly deplete your principal. Of course, if you are paying taxes on your 5% bank interest, then it probably doesn't matter whether the government "borrows" or "takes".

Or, maybe, the government should not be taking your money in any form to begin with.

1 comment:

Anonymous said...

Option C) Print money - cause inflation