Fed debt is nothing to lose sleep over

Policy makers and voters often express concern about the level of the federal deficit, which topped $1 trillion last year, and the national debt, now more than $23 trillion. But, unlike a household that owes money to a bank, the US government has the ability to tax its creditors. This power means that the federal government can afford any level of debt that is owed to American taxpayers.
Here’s an example of what I mean.
Suppose that the government’s debt is $100 million per person — a huge amount that is many times larger than the current debt — and the interest rate is 5%. How can the government begin to pay this, a figure that amounts to $5 million per person per year? It’s actually simple.
Suppose first that all US taxpayers are exactly the same financially and so they each own the same amount of US government debt. Then, the government can tell each person: your tax bill for this year and every year thereafter is equal to $5 million. People can pay this seemingly huge tax by handing over the $5 million in interest that they receive from the government. The entire process of taxation and debt finance ends up being a complete wash.
Of course, not all US taxpayers are the same and so they don’t own the same amount of US government debt. But the government could simply announce that it is levying an annual 5% tax on all of the Treasury instruments now owned by US taxpayers. That tax would generate enough money to allow the government to pay the interest that it owes.
Neither of these tax plans is inflationary. Their effectiveness doesn’t depend on the federal debt being denominated in US dollars. And, of course, there’s nothing special about 5% or $100 million — the argument works for any level of debt and any interest rate. Indeed, if it wanted, the government could retire its entire debt in a similar fashion, rather than simply paying the interest.
The logic of the argument does depend — critically! — on the debt being owed to US taxpayers. When the US government borrows from non-taxpayers, such as the Chinese government, it becomes much more like a household that is borrowing from a bank. There is, accordingly, a limit on the level of debt or deficit that can be considered sustainable. Right now, the federal government owes about 30% of one year’s gross domestic product to foreign entities, which translates into a non-taxpayer interest obligation of less than 1% of GDP. This number seems eminently affordable to me — but unlike the overall deficit or debt, this number does
warrant watching.
Does this argument mean that the government should borrow a lot more? Not at all; it simply says that this is the wrong question. Policy makers and voters should always be talking about the appropriate scale of government resource utilisation — through infrastructure expansion, for example — given the state of the business cycle. And we should always be talking and thinking about the incentive and distributional effects of our tax and transfer-payments system. But we should never make policy on the presumption that some level of debt owed to taxpayers isn’t affordable.
—Bloomberg