OPINION:
Alexander Hamilton became the first secretary of the Treasury shortly after the federal government was established under the Constitution in 1789.
The first Congress enacted tariffs as the major source of revenue, which made sinking funds a viable commitment option. Hamilton proposed sinking funds in two reports on funding the U.S. debt, in 1790 and again in 1795 shortly before he resigned as secretary of the Treasury. In his 1790 report, Hamilton proposed a sinking fund to retire the public debt by issuing 6% bonds to replace older bonds issued by the states and the federal government. The sinking fund would be financed from post office revenues, and Congress would be authorized to borrow funds to finance debt reduction. Congress modified Mr. Hamilton’s proposal, substituting surplus revenues from duties on imports and tonnage for post office revenues. However, very little surplus revenue was available at that time, so very little debt redemption occurred in those early years.
By 1795 the U.S. economy was prospering, and significant surplus revenue was available for debt redemption. In the plan that Hamilton submitted in 1795, he proposed redeeming the entire national debt in 30 years. Sinking fund revenues would be augmented to include interest on securities purchased and held by the sinking fund, land sale proceeds, and all surplus revenue. The funds would be placed in trust under the direction of Commissioners, and the commitment of the funds to redeem the debt would be part of the contract with creditors. The contract called for the markdown each year of the capital value of a security holder’s property by the excess of payments, equal to 2% annually, over the stipulated interest rate on the security. Hamilton’s report in 1795 became the blueprint for the sinking fund to eliminate public debt over the next three decades.
The current debt crisis poses a more formidable challenge than that inherited by the founding fathers. Today’s debt burden is much greater, with debt in excess of GDP and rising. But, it is not just the magnitude of the current public debt, even more challenging is the absence of a commitment by elected officials to reduce and eliminate public debt. That commitment was part of the “Old Time Fiscal Religion,” accepted by elected officials and citizens in the 18th and 19th centuries. The Founding Fathers may have debated how rapidly to eliminate the public debt, but there was a consensus that that was their obligation. A sinking fund as a commitment mechanism is more relevant in solving the current debt crisis than in the early national period. There are several ways that a sinking fund could effectively reduce and eliminate public debt today.
A conditional sinking fund could be an effective commitment mechanism in normalizing monetary policy, reducing and eliminating Treasury securities held in the Fed balance sheet in the near term. In addition to allowing treasury securities to mature without reinvestment, the Treasury could agree to purchase securities according to a schedule for redemption. This would require earmarking revenues to finance the redemptions. An obvious source of earmarked revenues is the interest earned by the Fed on Treasury securities, now remitted to the federal government. Redeeming all Treasury securities held by the Fed within a few decades would require earmarking other sources of revenue.
A sinking fund could be used as a commitment mechanism in redeeming debt held by the public as well. The commitment mechanism could be incorporated in the debt contract, as it was in Hamilton’s original plan. New debt could be issued paying 1% above the stated interest rate on the security, with the additional interest used to repay principal and interest over the life of the security. This contract sets an automatic timetable for the redemption of the securities. Revenues would have to be earmarked to finance this sinking fund as well. The interest rate on new debt would have to be attractive to induce citizens to replace the older debt, and the commitment mechanism built into the contract by the sinking fund could make the new debt more attractive.
Conditional sinking funds would, of course, tie Congress’ hands in issuing debt. Congress would have to close the fiscal gap and bring expenditures into balance with revenues in the near term. It would then have to earmark surplus revenue to finance the sinking funds and retire public debt to meet contractual obligations. The conditional sinking fund could be suspended in periods of war and other emergencies, with a supermajority vote of Congress.
Progressives will likely dismiss the idea of a contingent sinking fund as a relic from America’s past. However, they might be surprised at the bipartisan support for this idea even within their own ranks. At the turn of the 21st century, there was a serious discussion of reducing and eliminating public debt. After several decades of rapid economic growth, the budget was balanced and modest surplus revenues generated.
President Bill Clinton proposed a version of the sinking fund in which surplus revenues would amortize the unfunded liabilities in Social Security and Health Care plans. However, Congress rejected those plans and found ways to spend the surplus revenue.
Alan Greenspan was the last Federal Reserve chair to support reducing and eliminating public debt. In a speech to the Bond Market Association entitled “The Paydown of the Public Debt,” he argued that financial markets could function efficiently in the absence of public debt. A modern-day Treasury secretary might find bipartisan support for using a conditional sinking fund to address the current debt crisis, and who knows — one could even make a musical of the idea.
• Dr. Barry W. Poulson is a professor emeritus at University of Colorado Boulder.
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