Myths vs. Realties for the United States National Debt

Myth #1: The National Debt will cause the United States to go bankrupt

Reality: The U.S. is not like you or me. The U.S. government has the power to tax the largest economy in the world, the power to print money and has an infinite life expectancy. All of these factors mean the federal government can incur large amounts of debt. Myth #2: We have to pay back all of the $5.6 trillion in debt Reality: The U.S. can simply "roll over" its debt year after year. That is, the Treasury Dept. issues new bonds to pay off the old ones. This is not a problem as long as investors are willing to hold U.S. Treasury bonds. U.S. Treasury bonds are very popular due to their liquidity (they are easily converted to cash), their low risk (they have zero default risk because they are backed by "the full faith and credit" of the U.S. government), and certain tax advantages. Myth #3: The interest payments on the national debt are a burden to future generations. Reality: U.S. citizens or even agencies of the U.S. government own most of the debt. Thus we are just paying interest to ourselves. Myth #4: Foreign ownership of the debt causes money to flow out of the U.S. Reality: Foreign interests own only about 15% of the debt, and this proportion has remained virtually unchanged since 1980. They typically reinvest their interest payments in the U.S. Myth #5: The national debt is out of control. Reality: The true measure of the debt of a nation is the ratio of that debt to the size of the economy. The debt-to-GDP ratio for the U.S. is relatively modest compared (1) to other nations and (2) historically.
There are, however two potential problems with our national debt:
  1. The interest payments on the debt redistribute income from taxpayers to bondholders. This redistribution is potentially regressive since wealthier households hold Treasury bonds. So all taxpayers pay debt interest but mostly wealthier taxpayers receive that interest. However, higher income households also bear a larger tax burden than low- and middle-income households: In 1999 the top 1% of household in terms of income paid over 30% of all income taxes.
  2. Large debts may produce the crowding out effect. Large debt levels by the U.S. government increase the demand for loanable funds, which increases interest rates and reduces the amount of private borrowing for investment spending. The size of this effect is a subject of debate among economists.