Since the publication of our Explainer, “Understanding Public Debt,” we received some great feedback and questions for clarification from readers. We greatly appreciate our readers and hope this follow-up brings additional clarity about public debt.
If the federal government has a budget surplus, shouldn’t that money go back to taxpayers?
Shouldn’t any accumulation of wealth be put back into the system instead of being hoarded by the government? If the government runs a budget deficit, then at least it is not hoarding hard-earned taxpayer money?
Yes, ideally, a surplus of tax revenue should be returned to taxpayers because that money is put to its best use when in the hands of taxpayers. This is generally how TABOR functions, which we discuss in Part 3 of the paper. When the state of Colorado collects any tax revenues above the TABOR limit (the sum of population plus inflation growth), that surplus must be paid back to the taxpayers.
The government operating on a budget deficit, however, is a dangerous idea. This goes back to the myth we discuss in Part 2: “Debt is money we owe to ourselves.” When governments operate on a budget deficit, if policymakers do not want to raise taxes or cut spending, they’ll take on debt to cover the budget gap. That debt must ultimately be paid by future taxpayers (the future versions of ourselves as well as future generations). Rather than putting wealth “back into the system,” operating on a budget deficit inevitably means robbing the future of wealth to finance spending now.
Why do we measure intergovernmental debt? Shouldn’t it all be on the same balance sheet?
There’s a kernel of truth here. At the end of the day, all debt is paid for by the American people, either through direct taxation or through the erosion of purchasing power through money printing. Intergovernmental debt is generally used to track transfers from one part of the government to another. These debts are held in what the government refers to as “trust funds.” As we discuss in Part 1, these “trust funds” are nothing like a private sector trust fund. Government “trust funds” are used to track money designated for a special purpose or program (such as Social Security, federal employee retirement benefits, and highway funding), essentially an IOU for these programs. There are no assets set aside or invested.
While there is no “net effect” on government finances, growing intergovernmental has a crowding out effect. When one program redeems intergovernmental debt, it draws from federal tax revenues that could have otherwise gone to different programs or back to the taxpayer. The more these programs rely on intergovernmental debt for funding, the less revenue is available for other programs.
What is the impact of federal spending on US Territories in the budget?
Federal spending on US Territories is typically listed under the broader category of intergovernmental transfers, which include state, local, and tribal governments as well (although the averages we use only include the 50 states). In FY 2023, the federal government transferred $1.08 trillion to state and local governments (17.4 percent of the $6.2 trillion total the federal government spent that year). This includes federal mandatory spending for entitlement programs as well as discretionary spending programs for disaster relief and defense. Beyond this, the Government Accountability Office (GAO) admits that “data gaps” exist when examining these territories such as “gaps in coverage, disparities and lags in reporting, and different mechanisms for measuring data quality.”
From the little information that is available, transfers to these territories make up a relatively small proportion of total federal spending. However, if the federal government were to cut intergovernmental transfers due to fiscal stress, these territories (much like state and local governments) would be required to fill budget gaps with their own revenue and/or cut spending. If these territories are unprepared for a reduction in intergovernmental transfers, it could result in a fiscal crisis.
Why does China own so much of US debt? What are the consequences of it holding so much debt?
The Chinese government (like any other investor in Treasury notes) sees it as a relatively low-risk investment with a reliable return on investment. It is interesting to note, however, that foreign-held debt has generally declined, including debt held by China. Figure 1 shows Federal Debt Held by Foreign and International Investors as a percentage of total public debt from 2000-2024.
Foreign-owned debt hit its 24-year peak in 2012 at 35.71 percent of total public debt, but it has declined since. From 2020-2021, foreign-owned debt decreased by almost 3 full percentage points from 30.45 percent to 27.51 percent followed by a near 4 percentage point decline from 27.51 percent to 23.68 percent and has yet to return to pre-pandemic highs. While this reflects the Federal Reserve’s willingness to purchase “as much government-backed debt as necessary” during the pandemic, it may also signal wavering confidence in the federal government’s ability to pay back its debt.
A possible implication of any foreign government increasing its holdings of US debt could be potential leverage that comes with the willingness to purchase debt. As the federal government desperately hopes to continue financing massive spending with government debt, foreign governments could use that desperation to their advantage. They may only be willing to purchase additional debt in exchange for aid, favorable lending rates, or preferential treatment in trade and diplomatic negotiations.
