The 'National Debt' Fallacy

The Government keeps telling us we are in financial crisis by alluding to our national debt.  When we are in recession the old issue of national debt seems to crop up every few days – most recently on BBC1's Question Time, and again by Obama and Romney in their Presidential debate.  All this carries over from last year when we had (from memory) a number of MPs and commentators using the national debt as a stick with which to claim their opponents do not understand the situation as well as they do (Dianne Abbott, Chris Huhne, Simon Hughes, Douglas Alexander, you know, the usual clan of economic illiterates).  The basic mess they make of the analysis is by asserting that the national debt drains the wealth of British people because of the accruing interest.  The second mistake they make is in thinking that money borrowed from Europe or China or America by the British Government makes us the taxpayer worse off than if we were borrowing it from the British Government.  It makes no difference – but I’ll come to that in a moment – let’s start with the first mistake; that the national debt drains the wealth of British people because of the accruing interest.  

The fact is that every single pound of interest British people pay on the national debt comes right back into the pockets of British taxpayers.  If a politician doesn’t understand that, he or she is not fit to commentate on the economy or obtain your vote.  Let’s make it simple; suppose the Government owes £100 and pays £3 a year in interest. The alternative to paying the specified interest is to raise current taxes by £100 and pay down the debt. If you do that, the taxpayers are going to have £100 less in assets, and will therefore, of course, earn less interest on their savings. That costs them (roughly) the same £3 a year.  That is to say, the damage was done back when the Government initially spent that £100 (point of note; if the £100 had been spent wisely, the damage might have been worth doing – but it might not have been).  Once that £100 has been spent, the taxpayers are out £3 a year forever, irrespective of whether the debt is ever paid off.

That’s why the Government’s interest payments come right back to the pockets of British taxpayers. The Government pays £3 a year as an alternative to taxing you £100 and paying down the debt. The choice to do that puts an extra £100 in your bank account, which earns you £3 a year. There’s the £3 a year coming right back in your pocket.  Another point of note for those worried about the debt accruing interest and the Government sending much of our money abroad: the money comes back to you regardless of whether the Government makes its interest payments to British people, Chinese or Indians.

Of course, you might choose not to save that £100 the national debt is saving you, which is fine, because presumably you’re spending it on something that you value more than an interest flow of £3 a year. Congratulations – you’re happy too.  Some might complain that they have no savings vehicle that will pay them the same rate as the Government’s paying on its debt. That’s where they’d be wrong – if they so wish they can save by buying Government bonds, which will acquire for them exactly the same rate the Government is paying on its debt.

I’m not saying national debt is good – it isn’t – it’s just not anything like the politicians tell you it is.  They do this to have power over the anxious taxpayer.  If the Government borrows an extra £10 billion pounds tomorrow in order to cut taxes by £10 billion pounds, it will have to make, say, an extra £300 million a year in interest payments (for which we the British taxpayer are collectively responsible) and at the same time, we’ll collectively earn an extra £300 million on our savings portfolios, so we break even.  This is economically neutral with regard to the taxpayer’s gains and losses, but the Government is dressing it up as a net loss, to convince you that this is a spectre for which the opposition party is responsible.  It’s only Government spending that leaves us worse off, not debt.

Now onto the mistake that says money borrowed from Europe or China or America by the British Government makes us the taxpayer worse off than if we were borrowing it from the British Government.  To see how absurd this is, I’ll give you an illustration.  Suppose the Government wants to buy military equipment for the armed services for £100 million.  They could pay for the equipment by raising our taxes, or they could borrow the money from, say, China.  If they tax us we pay now, if they borrow from China we pay in future taxes. It’s exactly as if George Osborne and the Treasury had collected your taxes and then lent them back to you, with a promise that they’ll be knocking on your door in a few years to collect the debt.  When the British Government borrows from the Chinese, it’s exactly as if British taxpayers had borrowed from the British Government.  Since the assets of the British Government are, ultimately, the assets of the British taxpayers, it is exactly as if the British taxpayers had borrowed from themselves.

The moment George Osborne and the Treasury borrows from the Chinese, your taxes are being lowered relative to what they would have to have been in the absence of the borrowing.  Let me make it even clearer;

Scenario 1: The British Government taxes you a one pound to pay for a pilot’s helmet, which you remove from your £100 savings account, leaving you £99. A year from now, your bank account has grown (at 10% interest for simplicity’s sake) to £108.90.  That is £99 + £9.90.

Scenario 2: Instead of taxing you, the British Government borrows that pound for a pilot’s helmet from the Chinese. This leaves £100 in your savings account, which grows to £110 a year from now. At that point, the Government taxes you £1.10 to pay off the Chinese, leaving £108.90 in your bank account.

Scenario 3: The British Government taxes you a pound for a pilot’s helmet, reducing your bank account to £99. Then it lends you the pound back at 10% interest, raising your bank balance to £100, which grows to £110 a year from now. At that point the Government demands repayment of its loan (the pound and 10% interest), so you hand over £1.10, leaving £108.90 in your bank account.

So you see, all three scenarios are exactly equivalent from the taxpayer’s point of view.  As far as the taxpayer goes, borrowing from China makes us no worse off than scenarios 1 and 3.  The Government is either lying to you when it says differently, or its ministers are representatives who don’t know what they’re talking about.  I think it is a bit of both – but the Government definitely lies about this because it wants you to think that there is a burden related to interest on past debt.  As I’ve just shown, there isn’t – because under the same principle as my 3 scenarios, it is obvious that interest payments on our past debts are not a burden to the taxpayer.  What the Government adds to your debt burden by avoiding raising taxes it also adds to your savings account.  Moreover, this is also why borrowed money is not an expenditure, it is a dividend.  When the British Government spends a pound on a pilot’s helmet that is expenditure; when it lends the money to Bob it is not the same kind of expenditure, because borrowed money doesn’t disappear in the same way that a pilot’s helmet disappears.  The money used to buy the pilot’s helmet is ready to be borrowed again so Betty can buy a fridge magnet or Jack can buy shoelaces. 

Lastly, and on a slightly different issue, to those who complain that our future generations will be worse off paying off our debt – no they won’t – the same thing I’ve said above applies to them as it does to us.  Besides, if you really feel bad about your future grandchildren, you can put some of your money in a trust fund for them and not spend it yourself.  But if you do so because you believe in charitable giving, you should consider that that’s the opposite of charity, because your grandchildren will be wealthier than you are.  Many people assume that we should try hard to pay off the national debt for the sake of our grandchildren.  The opposite is true; a national debt holds down our taxes at our grandchildren’s expense.  If you care about them – forget the national debt and add tax savings to their trust fund.