This seems an odd statement to make since most persons view public debt as a monster to be confined and slain. However, reasonable enquiry reveals the opposite to be true. Once a community, that is a town, city, state, province or nation incurs a public debt, simple cost and benefit analysis confirms that it should never reduce or erase that debt.
One should bear in mind that I distinguish the act of reducing one’s debts from that of repaying one's lenders; For they are not the same.
Before we begin one thing must be made plain. Most people, especially economists, have a very poor understanding of public finances owing to a grand blunder made long ago and still persisting in this enlightened age. It is a glaring and mostly ignored fact that government does not furnish any of the funds or rather the resources with which to fund public expenditures or settle public debts. Government has no money or resources. Its deficit is the full amount of public expenditures regardless of whether funds are taxed by fines or penalties or borrowed by financial inducement. The important task of funding government, i.e. public expenditures, has always fallen wholly upon taxpayers or rather resident citizens, and, specifically, the collective of their assets, incomes, and property. Thus, one should always assess the transactions of public finance through this Collective to determine facts and arrive at truth. Doing so changes everything.
One should always repay lenders. This commandment is never in dispute. But repaying creditors is not the same as reducing one’s debts or liabilities. A bank in its often long history invariably repays lenders, but it rarely if ever reduces debts or liabilities. The long practice in banking is the exchange of one lender or depositor for another, transferring an outstanding obligation from an initial lender to a subsequent lender after reimbursement of all interest and principle with the bank as intermediary. Corporations and individuals operate similarly in that their liabilities generally rise through the years, meaning the sums borrowed only ever increase. Of course, an individual person, being a finite being, tends to reduce liabilities as he nears the end of his existence, but he needn't as his estate should settle all debts.
The issue is whether one should reduce one’s debts or outstanding liabilities. Simple cost and benefit analysis supplies an easy answer.
Let us say that I have an outstanding debt with an interest charge annually of 5%. I later come into some money. I may invest it at 10%. Should I reduce my debt or invest the money?
I should invest it, clearly, using half of the proceeds to pay my loan interest and the rest for some other worthy use, perhaps reducing part of my debt in absence of better returns.
If the initial lender seeks repayment, then I should seek another lender as long as he is willing to accept less than 10%. If not, I should reduce or pay off my debt.
Therefore, I should reduce my debt only if the cost of interest on my loan rises above the return to be derived from an investment.
With the public finances of a community the analysis is much the same. The community should only reduce its public debts as long as the financial benefit to the collective of assets, property, and incomes of resident citizens exceeds the cost.
Let us say the government of a certain community requires $100 funds for a public investment. It decides to borrow the funds, but only from resident lenders, that is solely from the collective of assets of that community. The Collective incurs a public debt or claim of $100. An equivalent asset of $100 is also added to the Collective as resident lenders, their assets comprising part of the Collective, hold the note. The rise of $100 in the assets of the Collective negates the $100 rise in liabilities, leaving the finances of the Collective effectively unaltered.
Let us say the government allots interest on the public debt, say $10. The interest increases the public debt of or claim against the Collective by $10 to $110. But as the public debt is held by resident citizens, specifically lenders in receipt of interest, the assets of the Collective rise by the same $10 to $110. With the interest allotment the rise in public debt claimed against the Collective matches exactly the rise in assets held by it, leaving the finances of the Collective again effectively unaltered.
If the community seeks to ease its financial burden, should it extinguish the debt or should continue to carry it?
If the community continues to carry the debt, perpetually exchanging lenders as banks do, the initial debt plus increases in allotted interest leave the finances of the Collective effectively unaltered as the years pass.
If the community decides to extinguish the debt, it must do so by taxation. The government recalls the outstanding bonds. The public debt of $110 in principle and interest claimed against the Collective is extinguished along with the matching asset of $110 held within the Collective. Funds of $110 transfer from resident taxpayers to resident lenders, moving from one part of the Collective of assets to another. With equivalent asset and liability of $110 erased and the funds transfer of $110 kept within the bounds of the Collective, its finances are unaltered in the transaction.
The result for the collective of assets of the community is the same regardless of whether the debt endures through perpetual public borrowing or is extinguished through Taxation. If carrying public debt effectively yields the same financial result as reducing or erasing the public debt, what is the benefit of erasing the public debt?
There is no benefit to a community ever reducing its public debt.
However, Taxation is a costly method of raising funds to pay for public expenditures or to settle debts, far more costly than borrowing and carrying the debt into perpetuity. Taxation bears immense costs for a nation in deterrence: taxes being fines or penalties that discourage people from doing what they normally would do were there no taxation; and in squander: government being free to take and spend as it please. Such costs disappear with full public borrowing, that an interminable begging for funds from the residents of a community. Thus, it is always best that a community have its government borrow instead of tax to fund public expenditures, and never reduce the accruing interest and principle owed to citizens as bizarre as it seems. But that is another article.
