Cassandra and the Destruction of Savings

• • … if we were able to adjust our accounting processes to the realities of taxpayers’ obligations, the government deficit which enters into the savings of business and individuals would be offset by taxpayers’ liabilities, the fiscal (revenue and expenditure) decisions of the government would be neutralized….” (Warburton, p. 221)

Financial instruments representative of public debt are accounted for today like other securities. However, those other securities are claims on productive investments or have durable goods as collateral, while most of the existing public debt was used to fund current government expenses. Therefore, our accounting of securities’ holdings does not show that capital invested in productive endeavors or purchasing durable goods exists, while capital used to buy public bonds has already been consumed. This article aims to illustrate this situation, concluding with a proposal to perfect how public debt instruments are accounted for to better represent reality.

The theoretical framework of the analysis

One of the most intractable problems in economics is the definition of capital.

The Representational Theory of Capital was proposed to help us advance our understanding of how the economy works. It is based on the premise that capital has a dual nature. Capital is the collection of goods, services, and procedures on the “real” side of the economy that entrepreneurs find helpful in producing other things. At the same time, the instruments on the “abstract” side of the economy by which claims on those goods, services, and procedures are represented are also capital. In this sense, financial instruments are just liquid forms of property titles. Such an ontology helps explain many problems other definitions of capital cannot help.

One problem is how economic performance can be explained by qualitative differences in the stock of capital that merely quantitative differences cannot explain. It is uncontroversial that the amount of resources you save from one year’s production can be invested so that you can produce relatively more in the following year.

Savings invested and destroyed—A practical application

Let us assume that economic agents may invest their savings in financial instruments.

Could you say that all investments in financial instruments increase the stock of capital of that economy? Quantitatively, yes. What about a qualitative analysis? Some enterprises are not profitable, and some funding finances consumption.

Can we say that the money borrowed to pay for consumers’ vacations, the electric bills of public buildings, or the wages of public servants increases our productive capital? Certainly not! However, suppose you have in your portfolio a mutual fund that holds treasury bonds and securities backed by credit card receivables. In that case, that is precisely what you are doing.

It may well be the case that the civil laws about the collection of debt and the “full faith and credit of the U.S. government” are all you need to get your money back with interest. Nonetheless, no additional production results from your saved resources.

How we represent financial investments today needs to distinguish between cases in which the resources of the savers are invested in productive endeavors and those used to pay for goods and services consumed by someone else. In this case, the saver can only hope that whoever took his resources and destroyed them will have other revenue sources from which he can repay that debt.

The concept of “savings destroyed” is related to the idea of false rights proposed by the French economist Jacques Rueff. The concept is not identical because if the government can raise the taxation level, reduce its expenses, and honor its obligation without resorting to inflationary financing, the potential for false rights does not materialize. While the concept of “savings destroyed” is applied independently from the capacity of the government to service its debt by extracting a more significant share from the income generated by the existing structure of production.

The national debt of the United States as an example

Note that we are not considering the total public debt of the United States of more than 33 trillion dollars. The public debt of state and local governments is not considered. Nor are all the unfunded liabilities of the U.S. federal government or any other obligation not represented by U.S. treasuries. Since there is no end to the current annual deficits, they are also not considered. Therefore, future increases in the debt stock are left out of our example. No provision has been made in the federal budget for about thirty years to repay the debt. Therefore, new taxes will be required if expenditures are not reduced to repay the debt.

Another consideration is that against the “Golden Rule” of public finance, which states that a government should only borrow to fund investments, not spending; the American government only invests a fraction of what it borrows. The current level of investment in the national budget is about 12.4% of the total budget. Assuming that “investment” generates sufficient revenue to repay the capital invested, we deducted the same percentage from the debt to determine the amount of wealth long consumed in funding the U.S. government’s expenditures.

A final consideration is that all the debt held by agencies and departments of the federal government, the debt of the U.S. government with itself, is disregarded—for example, the treasuries held by the Social Security funds.

An exception to that rule is the amount of U.S. treasuries held by the Federal Reserve. We understand that the amount of debt monetization is conditional to the demand for money, whose variation may force the government to repay those obligations from tax revenues.

Considering all stated above, we assume that the amount of wealth “invested” in U.S. treasuries held by the public and consumed in government spending was equivalent to $21,980 billion at the end of 2023, or $22 trillion for short.

Because those resources have not been invested to generate revenue sufficient to repay that portion of the debt, the government can only repay them if it increases the existing taxes or reduces other expenditures. In both cases, inflationary finance is avoided by transferring income from taxpayers in general or some constituencies that had public transfers to them cut by the need to pay the state’s creditors with real rights.

The Purpose of this Exercise

It is worth remembering that this exercise aims to illustrate that investments in U.S. treasuries are not adequately accounted for if we want our financial statements to reflect what exists in the real world. In estimating a slice of all public sector obligations in the United States, our purpose is to find an amount of government’s liabilities that are part of someone’s assets but cannot be repaid at the current level of taxation.

Therefore, a further rubric must be added to the financial statements of some or all in the country to reflect the exact amount of existing “true rights,” that is, the precise amount of claims with identified sources of revenue to repay them.

In his Concise Encyclopedia of Economics on “Government Debt and Deficits,” John Seater offers three different classifications of government-issued debt. The first considers who issued the debt. A second considers its maturity. The third considers the source of revenue to repay it. All the federal debt of the United States is considered “General obligation bonds” and not “revenue bonds” since they are repaid from general taxes.

This third classification helps us distinguish what is and is not an investment. Furthermore, it offers a possibility for better accounting if issuances of public debt were required to indicate from which funds they would be repaid. Regardless of the merits of implementing such a rule, if public awareness about the United States’ fiscal problems is not increased first, it will likely be a dead letter.

Rational Expectations and Ricardian Equivalence

Increased awareness about the dire fiscal situation of the United States would only be worth the effort if it were problematic. Rational expectations theory assumes that economic agents already consider the future level of taxation required to pay the debt in making their decisions. That is a kind of “Ricardian equivalence.” As Seater says, “If government debt is equivalent to taxation, then most of the public discussion of the ‘deficit problem’ is misplaced.” However, Seater does not endorse “full” equivalence and states, “Under incomplete equivalence… deficits do have effects….”

Our view is also an intermediary hypothesis of “incomplete equivalence,” in which taxpayers can anticipate some, but not all, future taxation associated with present bond finance. In our view, the absence of economic consequences caused by the perceived equivalence of current deficits and future taxation, as assumed by rational expectations theory, does not hold, given two significant problems.

First, it does not consider that present savings are used to pay for present consumption instead of current investments. Secondly, it disregards the fact that the universe of all taxpayers does not perfectly overlap with the universe of bondholders.

The former qualification implies that the public debt will reduce society’s “natural” level of investments, reducing the prospect for future economic growth. The latter qualification implies that the people earning the income generated by current government borrowing are not necessarily the same as those who should save to pay for the resulting increase in future taxation. We cannot, therefore, aggregate them as if the institutional arrangement of bond finance would produce a set of contrary incentives that would cancel each other.

Non-residents of the United States own 34% of the federal debt. Everything else remaining equal, is it reasonable that that capital will remain invested in U.S. bonds if an increase in their taxation becomes likely?

Finally, it is not true that the U.S. government has never defaulted. That happened with the decisions of the legal cases of the gold clauses in the early 1930s and later, with the termination of the gold redemption by the United States in breach of the Bretton Woods Treaty. Hence, individuals are somewhat incentivized to consider the implicitly required future taxation in their present evaluations.

Historical Context and Legislative Background

Starting with the Budget and Accounting Procedures Act of 1950, the federal government uses GAAP accrual accounting, similar to private companies. Since it is at the core of the problems we identify, it is worth pointing out that it assumes that the federal government’s and private companies’ obligations have the same nature, which obviously, they have not. We are calling attention to the fact that the government has the ability to contract obligations beyond its capacity to repay them, which private companies do not possess.
Therefore, clarifications that are optional for the financial statements of private corporations to reflect their situation adequately are fundamental to a good representation of the actual state of the fisc.

The Road Not Taken

In searching for a positive proposal to address the problem of accounting for the destroyed savings, we could not propose anything that would reduce tax revenues, defeating the purpose of restoring fiscal soundness. This realization led us to limit the scope of our proposal merely to increase awareness of the problem, hoping that a well-informed populace would eventually force the hand of elected representatives.

If we propose an increase in individuals’ income tax, that could give a good idea of how much we need to increase taxes to compensate for the wealth destroyed. If we propose a new tax, say, a national VAT (Value Added Tax), that could be interpreted as a suggestion that we are not prepared to make.

If we adopt the deficit reduction proposed by the Cato Institute of reducing the deficit by about half a trillion per year, it would take 44 years to reconstitute the capital destroyed. Of course, that is better than nothing, but it does not convey the sense of urgency we think the matter requires.

An alternative to incentivizing individuals and politicians would be to create some difficulty in issuing more debt. In the end, we rejected that since absent explicit support from the citizenry to restore fiscal balance radically, those initiatives are unlikely to resist the creativity to the profligacy of the federal bureaucracy and elected politicians.

No, we decided to focus on accounting for the 22 trillion.

Since the savings destroyed are a matter of stock and not of flow, we considered comparing them to households’ net worth. The nominal net worth of all American households in 2023 was $132,218 billion dollars. A reduction of 22/132 or 16.66% must be applied to calculate the actual net worth of American families.

We realized, however, that such a calculation has many limitations. First, it does not convey the enormity of the sacrifice necessary to compensate for all savings destroyed since it assumes that such an immense portion of the existing wealth can be liquidated at current relative prices—that is, without forcing a fire sale of less liquid assets, which is obviously untrue. Secondly, and as a necessary consequence of the former, the transference of resources from the taxpayers to the creditors of the public debt should come from the flow of new resources produced, not from the stock of existing wealth, even though pairing one with the other makes an elegant comparison.

An additional reason not to develop our proposal around the idea of comparing the national debt in the hands of the public with the net worth of American families is the similitude between the calculations necessary to make such a comparison possible and the calculations required to implement the idea of “Unliquidated Tax Reserve Accounts” or ULTRAs. In “ULTRAs: The Worst Idea You’ve Never Heard Of,” Michael Munger comments on the proposal by which unrealized gains will be taxed not in money but by the imposition of a “notional equity interest.” For its proponents, it is a way to introduce a wealth tax. It is preposterous that politicians who have destroyed that proportion of the wealth of American families mentioned above are now suggesting ways to appropriate yet more of that existing wealth.

On the one hand, calling attention to the fact that a substantial portion of the wealth nominally in the hands of the public no longer exists could be an antidote to initiatives such as the ULTRAs. On the other hand, it may open the path to its implementation.

While it’s important to acknowledge that comparing savings destroyed by the national government with household net worth could be a powerful tool to raise awareness, it’s equally crucial to recognize the associated risks. While part of our proposal, this comparison should be approached cautiously and considered a secondary focus.

The Cassandra Proposal

With all these considerations in mind, we present our positive proposal.

The Federal government should publicly disclose the amount of the savings it “destroyed” as a percentage of taxpayers’ net worth every year.

For this calculation, the Federal government’s debt is considered the sum of treasuries in the public’s hands, less what was used for investments, which amounts today to $22 trillion.

For this calculation, the Federal government should commission the Bureau of Labor Statistics to create an official definition of the sum of the net worth of American citizens.

The IRS should inform annually, along with their income tax return receipts, everyone with income in the United States (even the currently exempt from paying taxes) what that percentage of their net worth it is.

It should include a warning like the one given to Social Security beneficiaries that their benefits are conditional.

Such warning would say that when required to repay the treasuries, since there is no provision under current levels of taxation and expenditure to repay the debt, the citizens may be taxed on that percentage of their net worth to repay the obligations of the federal government for it to keep its full faith and credit. Still, pairing the existing net worth of households and their proportional share of the savings destroyed by the federal government does not adequately reflect the sacrifice necessary to return those savings to the investors in the national debt.

To raise awareness about this problem, establishing a relationship between the $22 trillion in savings destroyed by the national government and household income would be better.

In 2021, taxpayers filed 153.6 million tax returns, reported earning more than $14.7 trillion in adjusted gross income (AGI), and paid nearly $2.2 trillion in individual income taxes, according to the Tax Foundation’s summary of tax data.

The average maturity of the U.S. national debt is slightly longer than six years (73 months). Despite that, for our calculation, we consider a repayment period of thirty years.

That would imply payments of about $1 trillion ($982 billion) per year for the thirty-year repayment period.

In summary, the 153.6 million taxpayers who filed tax returns in the most recent years earned a gross income of $14.7 trillion and paid $2.2 trillion, or 14.96% of their income, in income tax.

The moment when the U.S. government is asked to honor its obligations to the bondholders, for the federal government to raise the necessary resources, the income tax proceeds should increase by $1 trillion on top of the current $2.2 trillion, an additional taxation of about 45%.

In other words, all current taxpayers (including those currently exempt from taxation) would be required to pay $1 trillion, or the equivalent of 6.8% (1/14.7) of their current gross income, on top of all the taxes they currently pay, for thirty years.

Therefore, in addition to requiring that taxpayers be informed about the share of their net worth necessary to repay the portion of the national debt in the hands of the public whose resources were not invested but consumed, our proposal is, most importantly, for the taxpayers to be informed for which period and which percentage of their gross income should be allocated for that purpose.

Postscript

In the aftermath of World War II, Clark Warburton, in commenting about how bond financing of the public deficit was perceived by the Keynesian mainstream at the time as “solving” the problem of a deficient volume of savings, argued that “this solution is an illusion resulting from defective accounting procedure” (p.220).

It is worth repeating here a lengthy quote from him:

• A government deficit entails an obligation on the people of the nation, as taxpayers, to repay at some future time an identical amount to the government—even though the maturity dates and the distribution of this obligation among the various enterprises and individuals of the nation are unstated and unknown. If our accounting procedure were corrected to take account of the obligations of taxpayers, the stupendous volume of “savings” in wartime would disappear. The simple fact is that our accounting procedures, derived from the indefiniteness of taxpayers’ obligations, translates a major part of the cost of war, or of other government activities, into “savings.” This has long been recognized in economic theory but seems to have been forgotten by the advocates of “deficit spending” (p. 221).

Let us hope this proposal will remind us of this basic lesson that once again has been forgotten.

Footnotes

[1] Clark Warburton, Depression, Inflation, and Monetary Policy: Selected Papers (1945-1953). Kessinger Publishing, 2010.

[2] Leonidas Zelmanovitz, The Representational Theory of Capital: Property Rights and the Reification of Capital. Lexington Books, 2020.

[3] Ryan Bourne, “A Case for Federal Deficit Reduction: Spending Cuts to Avoid a Fiscal Crisis.” Cato Policy Analysis, April 18, 2024.

[4] Michael Munger, “ULTRAS: The Worst Idea You’ve Never Heard Of,” American Institute for Economic Research, July 1, 2024.