First, imagine an island with two inhabitants,
Tom and Jerry. In this simplified environment money is not a necessity. Only goods and services (G&S) are voluntarily exchanged between the two as best
fit their skill sets for production and needs for consumption. Since there is
no money, all debt and GDP are in terms of G&S produced and rendered utilizing their labor and skill sets. Assume Tom and Jerry are surviving OK and enjoying a satisfactory standard of living, as they would know
nothing else.
Suddenly a critical island bridge is
washed out in a hurricane. This extraordinary rebuilding task will require one total man-year of skill-sets employed by both
Tom and Jerry, which is necessary for their long-term survival. They powwow and
agree to “tax” themselves at a 50% rate for one year by spending half of their time building the bridge and the
other half of their time producing half of the normal level of G&S for their respective consumption. The necessary consumption abstinence works perfectly as there are only 50% of the normal levels of G&S
available due to their redirected work activities. After one year the bridge
is completed, the “tax” disappears, and life goes back to the same normal level of production and consumption
that existed before the hurricane.
Introduce Federal Government Debt…
There is, however, a clever way to disguise
the real tax that Tom and Jerry imposed upon their island society. By issuing
and selling island government bonds to themselves in exchange for some island goods, then paying themselves with these same
goods as compensation for their labor in rebuilding the bridge, at the end of the year they will have a new bridge AND
the equivalent of one man-year of bonds in “wealth” to spend WITHOUT EVEN RAISING TAXES…! Since there is no money on the island, the bonds would be official contracts awarding both holders 6-man
months worth of G&S produced upon redemption.
Unfortunately, they will soon realize
when they attempt to cash-in their bonds they will find no value to them at all because the only possible way to redeem them
is by taxing each other to pay for the bonds. The exact magnitude of this aggregate
debt illusion of wealth is the total outstanding “Federal Island” debt.
Incorporate “Freddy”,
the Skilled Bridge-Builder
Let’s now add “Freddy”,
a skilled bridge-builder to the mix. First, without incorporating the Federal
Bond illusion, Tom and Jerry agree to “tax” themselves 1/3 of the goods and services they normally produce then
pay Freddy to spend the next year reconstructing the bridge, thus all three island inhabitants survive the next year on 2/3
of their normal consumption level. At the end of the year the bridge is complete,
the “tax” disappears, and all return to pre-hurricane production and consumption levels.
Now, by incorporating the Federal Bond
illusion technique, Tom and Jerry could buy the bonds with island goods, which would subsequently be utilized to pay Freddy
as he reconstructs the bridge. At the end of the year once the bridge is complete,
Tom and Jerry each have bonds representing claims on ½ man-year of goods or services.
Soon the three island inhabitants would realize there is no one signed up or committed to repay the bonds, if Tom or
Jerry decides to redeem them. Thus, the first-believed perception of wealth that
the bonds represented just vanished into an illusion.
Introduce
Uncle Sam…
Let’s
now incorporate a fourth member to the island, Uncle Sam. Sam is a charismatic
and persuasive leader who produces no goods or services; he only transfers wealth. Sam
represents government on the island.
Tom, Jerry, and Freddy normally pay
¼ of their production to Sam for his living expenses, so each on the island enjoy approximately the same standard of living,
which is ¾ of an island-producer’s output.
Without incorporating the Federal Bond
illusion, Sam would simply organize an immediate tax on all four island inhabitants of ¼ of a normal producer’s output,
and contract Freddy to reconstruct the bridge, which leaves each of them surviving on ½ of a normal producer’s output. Assuming Freddy can reconstruct the bridge in ¾ of the aforementioned times, the project
would be complete after one year, then all production and consumption returns again to pre-hurricane levels with no residual
extraordinary tax payments due.
Considering the Federal Bond illusion
technique, the island inhabitants would again similarly be left with bonds representing the PERCEPTION of wealth, when in
fact no one on the island again is committed to repay them, if later a bond owner attempts redemption. Sam’s message to all inhabitants is that on the one hand his Federal Bonds are a safe investment
representing real future wealth to the holders when redeemed, then on the other hand, the concomitant island government obligation
to pay them is a mysterious “black hole” of future limitless taxing authority that is always assumed to satisfy
these obligations without any individual committed to that fulfillment task. It
is assumed future growth will enable the debt redemption. What is not stated
is that these debt obligations will be satisfied by claims on future growth proceeds via higher taxes. Hence Sam has created the magic of a wealth increase (bond holders counting their chickens) with no announced
counter-balancing commitment to repay the bondholders (stealth future tax increases).
Could
We Tax the Unborn Child?
Let’s incorporate children or
even unborn children of the island inhabitants into the picture. Following in
the footsteps of the prior example, Sam calculates after the bridge reconstruction that we will be able to surreptitiously
increase taxes on our children when they become of working age, thus enabling a painless redemption of the bonds to those
who sacrificed earlier. Remember, the original perception on the island at the
time of bond issuance was that they represented an INCREMENTAL quantity of wealth compared to the no-bond-issuance alternative. Now, envision years later a bondholder cashing in his bond, which would increase the
tax burden immediately on the “next generation” and effectively TRANSFER real goods and services that the younger
generation would otherwise consume and enjoy. This is not an incremental community
gain; it is again only a TRANSFER of wealth. The former child now working is
likely to rebuff this real incremental tax increase as unjust.
The issuance of the bond in the first
place typically represents an incremental illusion of wealth rather than a transparent overt plan of intertemporal (intergenerational)
wealth-sacrifice transfer. One could argue a current expenditure of labor for
a government purpose (tax) will benefit those into the future, thus justifying the intertemporal wealth-sacrifice transfer. That argument is weakened, however, by the fact that any labor expenditure (tax) in
the past or current, which tends to happen continually, would benefit CURRENT as well as future inhabitants. So, why in this case should a child sacrifice for their parent’s generation, AND their grandparents
generation?
One could argue a current extraordinary
expenditure (e.g. WW-2) should be spread out over the next generation or so because the future inhabitants will enjoy the
freedoms the current generation is sacrificing economically to maintain. In this
highly unusual circumstance (WW-2) one could logically support an immediate tax increase affecting
the current taxpayers in addition to issuance of “War Bonds” designed to spread the balance
of the economic sacrifice over say the next generation as well. In reality, the
real tax (allocation of labor and natural resources) would be imposed upon the current taxpayers and they would sacrifice
significantly during the war-time period as there would be fewer consumable goods available to consume (the labor has shifted
to combat, building bombs and tanks, etc.). Later, those who sacrificed consumption
during the War by purchasing “War Bonds” would enjoy a TRANSFER of wealth from future taxpayers, NOT a new creation
of wealth, in repayment for their earlier sacrifices. The use of this spreading-the-burden
technique would be folly for anything less than a catastrophic World War or equivalent.
In any event this extraordinary application still represents an illusion of wealth (“War Bonds”) for the
same reason stated in the final paragraph of the “Introduce Sam…” section above.
Bonds
Dropping from Heaven?
Any of the Federal Bond issuances in
the examples above could be philosophically equivalent to Treasury bonds literally dropping down from the skies above because
there is no one committed to pay a higher real tax later to repay the bonds. Initially,
all gatherers of these heavenly bonds would be filled with exuberance, convinced they could retire tomorrow to a fun-filled
retirement. Clearly, once a critical mass of people quit their jobs and begin
enjoying the retirement, the perceived value of the bonds would rapidly diminish, as the market would harshly devalue them. The common theme is consistent. When
Federal bonds are issued, the perception of the entire populous is that they represent the highest grade, most secure financial
investment on earth enhancing our aggregate wealth. The financial markets, investors,
politicians, etc. all view them as incremental wealth, because in fact there is no one identified and committed to repay them,
which should rightfully neutralize the present value of the illusory bonds.
Could
We Arbitrarily Impose a Debt Obligation to be Repaid Later?
Similar to the “Bonds Dropping
from Heaven” case the answer is NO within the context of the Real Economy. If
Sam held a spear to the heads of Tom, Jerry, and Freddy, and forced each of them to sign a contract (debt? obligation) that
would supply Sam a percentage of their produce for life beginning the day each became of working age, the initial level of
“debt” would, of course, be greater than the initial output (GDP). One
could argue the noted debt obligation is in fact greater than GDP during most of their working lives.
Clarifying the definition of debt will
help develop a response. Webster defines debt as:
“…the common-law action for the recovery
of money held to be due.” The arbitrary imposition of debt is not
an act of “recovery”; it is a simple act of coercion. Therefore,
it should not be considered a debt as though one is obliged to repay
for receipt of a good or service. It should be considered as an ongoing tax as
goods and services are produced and transferred. Thus, the noted bonds represent
an illusion of wealth to the island community as there would be no difference in the aggregate future production of goods
and services whether the bonds existed or not.
Can
We Grow via Motivation or Productivity and Pay off the Debt?
NO.
Repayment of any past Federal debt via incremental output levels above the ongoing production level of goods and services
is impossible without a real tax increase! If we return to any of the examples
and assume dramatic output and/or productivity growth occurs after the bridge reconstruction, then all of the goods and services
produced in excess of the former level of production would be consumed by the island inhabitants whether the bonds existed
or not.
The Laffer Curve
philosophy applies to businesses becoming more motivated than otherwise, if they are taxed at a lower rate and are allowed
to retain a higher percentage of any marginal increase in wealth that they produce.
Again, this philosophy does not apply to producing incremental goods and services only then to be utilized in repayment
of existing Federal debt.
Could economic growth push all taxpayers
into higher income tax brackets and capital gains taxes to enable repayment of Federal debt?
Of course! This represents the same impact as the intertemporal transfer
of the tax burden discussed above. You are effectively paying a higher tax percentage,
but may not be aware of the increased real burden. HOWEVER, destructive monetary
policy practices have flooded the world with liquidity, primarily in the past 15 years, such that nearly all financial assets
have grown to become overvalued illusory perceptions of wealth. To illustrate,
if Treasury bonds dropped from the skies, gatherers would happily pay capital gains taxes when they cash them or roll them
into another financial asset, which would flood the government with windfall tax revenues that would temporarily balance the
budget. Unfortunately, once the illusory financial asset bubbles are discovered,
the opposite will happen. Massive losses will negatively affect tax collection
efforts, which may become a self-perpetuating force spiraling downward. Extraordinary
and desperate monetary intervention would likely follow attempting to re-inflate falling asset valuations via currency debasement.
Can
we Back Bonds with the Inventory of Wealth We Have?
Could we utilize the inventory of wealth
(national forests, monuments, etc.) to satisfy redemption of the Federal Debt securities issued, if necessary?
There are two fundamental problems with
this concept. First, we ALREADY OWN THE ISLAND!
Any attempt to selectively repay a bond-holder seeking redemption would be trying to recover something already claimed
by all inhabitants, which would be a redundant claim on the same asset! Second,
in our fiat currency world, you would likely be chased away, if you attempted to lay claim to an acre of national forest in
exchange for your treasury bond.
Ricardian Equivalence Defense?
David Gordon, senior fellow at
the Ludwig Von Mises Institute, writes: Robert Barro (1) (Harvard
Ph.D. economist) is most famous among economists for his defense of "Ricardian equivalence." Against claims that a budget
deficit crowds out investment, our author demurs. Faced with a budget deficit, taxpayers will realize that taxes must eventually
be raised to pay the bills.
This being so, they will, if rational, set aside money
to pay for the tax increases they anticipate. What counts is not only current taxes, but the present value of future taxes.
"[E]ach person subtracts his or her share of this present value [of taxes] from the present value of income to determine a
net wealth position, which then determines desired consumption" (p. 93). Since anticipated future taxes affect consumer spending
in the present, "taxes and budget deficits have equivalent effects on the economy" (p. 94).
Clearly, the “Ricardian equivalence” assertion that “deficits
don’t matter” has everything to do with keeping the aggregate activity levels humming in an economy, regardless
of whether the government, consumers, or businesses are doing the spending. However,
it has nothing to do with addressing the fact that the magnitude of bonds issued to fund the shortfall between government
revenues and spending is an illusion within aggregate debt valuation.
Bottom Line…
The issuance of Federal Debt Securities
is perpetuating an illusion of wealth, thus is fraudulent, and must be stopped.
Every dollar of Federal government debt
issued is purely an illusion of wealth (a bubble..!) in aggregate. Its issuance
effectively dilutes all Credit Market debt by the magnitude of the Federal debt. Any
attempt of redemption will automatically displace other debt. The reality is
that when the government spends money to activate resources for its purpose, it represents an immediate real taxation on society
at that moment in time. Whether tax money is collected to fund the expenditure,
or whether the excess spending beyond tax collection results in a bond issuance makes no difference upon the real aggregate
tax burden. In one case the funding resource is visible (tax collection and payment),
and in the other, it is an illusion (bond issuance) combined with an invisible future tax liability. Once a labor activity is performed to serve a government purpose, it becomes “spent human capital”
and can never be recovered.
Our monetary taxing system should be
aligned with reality rather than hiding an illusion of wealth in the form of bond issues.
Even in times of armed conflicts the actual spending on defense is realized the moment armaments and supplies are produced
via re-allocated labor. Taxes should rise immediately to recognize this activity
because it actually reflects reality, or spending should be reduced in other areas an equivalent amount to avoid a real tax
burden increase.
Only in extraordinary times of catastrophic
war (WW-2) or similar would logic justify a Federal Bond issuance to effectively spread the sacrifice of the real tax imposed
during the war over a long period of time. In this case real taxes should increase
immediately with reinforcing statements that they will remain at higher levels until the “War Bonds” are repaid
so those in the affected nation will not perceive the “War Bonds” as an incremental illusion of wealth, but
would see them rightfully as a method of gradual wealth transfer to bond holders which would effectively spread the extraordinary
sacrifice over time via the increased ongoing real tax level as the War Bonds are paid off.
We often hear concerns of “burdening
the next generation with Federal debt”. The reality is that they will not
be “burdened” at all with most of this debt. The actual losers will
be creditors holding debt securities that are destined to become diluted in value or worthless as governments and central
banks debase currency valuations. Largely, the Boomers retiring will be the losers.
Alternatives to Avoid the Illusion
of Federal Debt:
- Constitutionally require a balanced budget.
- When a spending increase for any reason is passed, the tax rate should increase or a new tax source should be instituted
to align with that reality immediately. Thus, for example, tax
withholding on paychecks should change immediately to accommodate the spending in the time frame it actually occurs. Congressmen voting for the spending should have a “stamp on their foreheads”
indicating they voted to further burden taxpayers and support “X”. By
recognizing the reality with this level of visibility and scrutiny we should be governed more by the principles of freedom
that shaped the formation of our Republic rather than empowering small groups to satisfy a self-serving agenda at the expense
of all others. I believe with this new paradigm broadly communicated and accepted
we would actually gain confidence in and respect for decisions taken by our elected officials.
-
A Balance Sheet Approach?
Click here then click on the link named: "Our Federal Debt is Pure "Bubble" Balance Sheet .pdf File" under the #1 Contest
Exceptions:
- Any Federal government bond issued on behalf of a Federal government owned utility company would not qualify.
- Any Federal government bond issued that will be redeemed via direct fees assessed for access or usage of property will
not qualify. E.g. grazing fees, or national park usage access.
- Generally, exceptions will exclude all Federal government bonds, which will be redeemed via Federal Tax assessments.
References:
1) Getting it Right; Markets
and Choices by Robert J. Barro, MIT Press, 1996, xv +191 pgs.
by Russ Randall; 12-15-2006
