The Validity of the Public Debt
of the United States

Fred E. Foldvary

[Reprinted from The Progress Report, 7 November, 2011]

The 14th Amendment to the U.S. Constitution states, in section 4, "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned."

The context was the debt of the Confederate States of America, and the losses of former slave owners, which the U.S. government would not compensate: "But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void."

The word "questioned" may itself be questioned, but it seems in that context that this meant not that one may not talk about the debt or its repudiation, but rather this is a restriction on the federal government. "Shall not be questioned" means that neither Congress nor the president may repudiate the debt. If a representative in Congress were to propose a law voiding the federal debt, that would put the debt service into question. Any repudiation of the federal debt is unconstitutional.

It can be argued that the U.S. government has dishonored the Constitution, so the members of Congress could ignore this section of the 14th Amendment. But the Constitution has been dishonored mostly by misinterpretation. For example, Article I, Section 8, Clause 3 empowers Congress "To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes." Congress, with the blessings of the Supreme Court, has stretched the commerce clause to include any activity at all, since ultimately every human action might affect the country. Thus the Supreme Court ruled that a person growing marijuana in his yard for his own use is involved in commerce among the states, since his crop affects the whole national supply of the plants. This is how creative legal minds think.

However, Congress is unlikely to violate a clear and explicit restriction in the Constitution. It is unreasonable to interpret the 14th Amendment to mean that a repudiation of the federal debt or interest payments on that debt is authorized. "Questioned" means "put into doubt," i.e. to intend to not honor the interest payments.

The 14th Amendment was widely discussed when Congress was debating on raising the debt ceiling. Thus this Constitutional provision is known and would come up in any proposal to avoid paying the interest on the federal debt.

Therefore the problem of the unsustainable federal debt and deficits will most likely not be resolved by an explicit repudiation by Congress. The line of least political resistance is the reduction of the real value of the debt from inflation. High price inflation would enable the federal government to pay bondholders with cheaper dollars.

It is easy for the Fed to create money to buy US debt, but not easy for the Fed to avoid bad effects on the banking system. The Fed creates money by buying bonds; in exchange for bonds, the Fed places new money in the bond seller's account, which raises the reserves or funds in the banks. The seller of the bond can spend this money. To avoid price inflation from this monetary inflation, the Fed could raise the required reserves of the banks, the amount of funds that banks are not allowed to lend. But that could then cause difficulty for the banking system, as the various banks have different amounts of required and excess reserves.

A less disruptive way to create inflation to reduce the value of the federal debt would be for Congress to authorize the U.S. Treasury to issue United States Notes. Such notes were issued as legal tender during the Civil War under the First Legal Tender Act. The U.S. Treasury Department would "print" new U.S. notes -- new money that does not pay interest -- to buy back U.S. government bonds, a transaction which today could be in electronic form. The parties who sell the bonds they'd been holding could use the notes they receive to pay federal taxes, so these new U.S. notes would have the same value as federal reserve notes.

Of course, price inflation would also reduce the value of private debt, such as corporate bonds. The loss of value from bonds would damage the portfolio of many people who have these in their retirement and other accounts. The inflation would have large economic costs.

One could also argue that if Congress deliberately authorizes price inflation to reduce the value of federal debt, this too would call into question the "validity" of the public debt. Bondholders could bring this policy to the Supreme Court, which could rule it unconstitutional.

Therefore it seems that an explicit or implicit default on the interest payments of the public debt of the United States is contrary to the U.S. Constitution. There is only one way to resolve the debt and deficit problem without a Constitutional and economic crisis. The only way to solve the problem of sovereign debt is with a radical supply-side tax shift. Eliminate all taxes that have an excess burden on the economy, and replace these with public revenue that has no economy-wide burden: land rent.

Taxes on wages, dividends, interest, profits from entrepreneurship, goods, and value added all reduce production, consumption, trade, and investment, causing less growth and more poverty. But land rent is a pure surplus, since land has a fixed supply and no cost of production. Even if all the rent is taxed, the land will not run away, nor will it shrink. Nor can land hide from the tax collector. A tax on land rent or land value cannot be passed on to tenants, as it does not change the demand to use land. After the transition, a land value tax is not even a burden on the land owner, because the price of land falls to the extent that the tax replaces what would have been paid in mortgage interest. There is no burden because the rent is a pure surplus.

Land value taxation would tax the rent of land that would be there if the site is put to its highest and best use, regardless of actual current use, and regardless of the current financial payment of the rental by a tenant, and regardless of whether the land is owner occupied or leased out. Thus in effect a land value tax is a lump sum tax independent of what the title holder does.

A complete supply-side tax shift would instantly generate high economic growth, as labor, trade, and entrepreneurship would now be tax free. Contrary to what many economists assume without investigating it, the rent would be more than sufficient to finance the provision of governmental public goods. The economies of the world could grow their way out of the debt problem, but only if they remove the obstacles they have erected. Half-measures will not do. Small and temporary reductions of tax rates will have tiny effects. The economy requires the permanent reduction of marginal tax rates to zero in order to achieve maximum growth.

If the repudiation of government debt is blocked by the Constitution, and pro-growth policies are blocked by ignorance and opposition by special interests, then another economic crisis is inevitable, not soon, but probably a dozen years into the future.