The $919 Per Person Deficit Tax?

July 6, 2005

One of the most useful items in the economist’s tool box is the concept of opportunity cost. By forcing us to think in terms of alternatives, it focuses our attention on what we give up to get things—and what we could enjoy instead.

In the latest issue of Tax Notes (July 4, 2005) Martin Sullivan explores an opportunity cost that’s often overlooked: the opportunity cost of the federal deficit. According to his back-of-the-envelope calculation, the forgone income due to the federal debt works out to nearly $1,000 for every man, woman and child in the U.S.:

In the world’s credit markets, the U.S. Treasury Department is the biggest line cutter. Uncle Sam gets as much as he wants whenever he wants at bargain prices… As a result, the cost of credit for everybody else edges up…

So how bad is that for the economy?

Here’s a calculation that will give you an idea. Right now the U.S. Treasury has a total of $7.78 trillion of debt outstanding. Excluding Treasury debt held in government trust funds and pension funds, the total is $4.45 trillion. That is the amount the U.S. government has siphoned out of credit markets—mostly over the last 25 years at an average rate of $160 billion per year.

If the AAA-rated federal government had resisted the temptation of easy credit, that capital would have been available to private investors who, economists estimate, generate on average a 6 percent annual real return. At the current level of government indebtedness, that’s $272 billion per year of lost income… That means that each person’s annual share of lost income is $919.

This is the famous “crowding out” argument from neoclassical macroeconomics—when government spends, it competes away resources from the private sector, leaving a smaller capital stock for future generations.

Of course if every dollar borrowed by the federal government were invested in productive assets, this wouldn’t be a problem since borrowing wouldn’t shrink the overall capital stock. And the government’s ability to borrow from the rest of the world limits domestic crowding out to some extent.

But given that only about 16.3 percent of federal spending goes for capital investments, and less than 40 percent of federal borrowing comes from foreign investors, that suggests at least some cause for concern over growing debt levels, and the opportunity cost they impose on us.


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