National Debt

Converting into Lower Interest.

A further feature of national, as distinct from individual debts, is to be found in the manner in which a State is frequently able by means of a rise in its general credit to make terms with its creditors in a way which is not very commonly practised by business enterprises or the indi vidual. A State, for example, may in times of stress or emergency, have borrowed a large amount in a 5% form, the loans running for anything from 25 years upwards. Long before the time of redemption arrives, however, the State may have become so prosperous that its credit is really on a 4% or 33.% basis. It is, therefore, in a position to raise fresh money on, say a 31% basis, repaying the old loan and making a big saving in the annual interest charge. Moreover, the State when it issued its, say, 5o year loan, would have been careful to protect itself by retaining the option to repay at some earlier date, if desired. Therefore, when such conditions arise, the State is in a position to issue a kind of ultimatum to its lenders offering to convert the old loan into perhaps a 31% issue, failing the acceptance of which repay ment takes place. Simultaneously with such offer of conversion, new subscribers to the 31% loan are usually approached, with the result that under skilful guidance, the 5% debt, long before the final date of repayment, becomes changed into a security carrying a lower rate of interest.

In the years immediately subsequent to 1933, the United States Government issued its bonds at extremely low rates and refunded its earlier obligations with great savings in interest. The com puted interest rate on the Federal debt in the United States dropped from 4.3% as of June 3o, 1921, to 3.9% in 1929 and then fell to below 2.6% in 1936.

Debt or Taxation.

There has been and continues to be a sharp cleavage of opinion as to the preference between financing extraordinary government outlays by taxation or by borrowing. No doubt, there is a general agreement that regular and recurring expenditures of the nation should be met by taxation and, further, that a large and continuous rise in the national debt is undesir able and unhealthy for an extended period of time. There the agreement ends. Some economists are even in favour of meeting all fiscal requirements by resorting to taxation under any circum stances, no matter how large the required revenues nor for what purpose the expenditures are made. To place this problem in its proper setting it is necessary to consider the basic nature of debt and taxation. For the moment it will be assumed that the entire debt is internal, i.e., the borrowing is exclusively from domestic sources. Taxes represent an exaction by the government of funds from individuals or business enterprises. For these funds the government renders a variety of services to taxpayers. The relationship between the value of such services and the size of the tax bill is not relevant to the subject under consideration.

Tax revenues are used primarily by the government to buy goods and services and to pay its personnel. When the government bor

rows it uses the funds for similar purposes. Whether the sources of funds paid as taxes or loaned to the government are identical or different, depends largely upon the incidence of national taxes, i.e., who pays the taxes. The funds borrowed are principally de rived from the higher income classes, since government bonds are held in large measure by banks, insurance companies, other savings institutions and higher income recipients. If the tax program is progressive and based on ability to pay, the funds loaned and the taxes paid might come from the same source, in which case there would appear to be little choice between taxing and borrowing. Political feasibility, psychological effect on the business community, and the matter of interest charges are factors to be considered. Even the interest charges would be un important if the tax from which this charge was met fell on the bondholding group. On the other hand, if the tax program were such that the incidence of taxes fell to a considerable extent upon the lower income classes, then the choice between taxing and borrowing would appear to be important, since taxation would be equivalent to reducing the purchasing power of all taxpayers, whether receiving low or high incomes, and borrowing would mean taking funds only from those with savings. Thus, the na ture of the tax program is an important consideration in this matter. Also important is the general business situation in terms of the existence of idle investment resources and of effective con sumer purchasing power. Some would argue in favour of gov ernment borrowing when private investment channels are not active, in that the government would be both activating idle in vestment funds and, at the same time, not reducing the purchas ing power of the lower income classes through taxation, assum ing, of course, that the tax program made them subject to taxa tion. Others contend the increase of national debts further dis courages private investment and thus creates a vicious spiral. During the depression of the 1930's there were instances of in creased Government spending largely designed to add to the purchasing power of the lower income groups, financed by large borrowings from the higher income classes. Such policies were defended as making use of idle funds by Government investment, i.e., by creating publicly owned assets, or by the government shifting idle funds to persons who would immediately return the money to the income stream. It was contended that taking the funds from those with large resources was more desirable eco nomically than if the funds had been raised by taxation, and thereby increased the tax payments of business enterprises and the lower income classes. The program was claimed to have increased the purchasing power of consumers, kept taxes on business at low levels, and made effective use of otherwise idle funds. There fore both the incidence of taxes and the status of business condi tions are significant elements to be considered in determining fiscal policy.