Does the Debt Matter? – We Owe It to Ourselves

President Franklin Roosevelt is supposed to have said that the size of the Federal debt didn’t matter because “we owe it to ourselves”.

Of course, he was right in a certain sense because at the time, individual Americans were buying and holding a wide variety of United States Treasury debt. Common citizens bought “War Bonds” and “Liberty Bonds” out of patriotism and a shared need to win World War II.

The debt, however, was owed by the corporate Federal government to each and every individual holder of US bonds. So, it wasn’t really “owed to ourselves”. The government was obligated to pay others and those others expected and depended on the government to honor the obligation.

Once, some years ago, I really did owe a debt to myself. I borrowed a sum from my 401k account so, in true FDR fashion, the size of the debt didn’t matter since I truly owed it to myself. Or did it?

My 401k loan didn’t have to be paid back. But, an unpaid 401k loan is treated by the IRS as a distribution. And, if you’re not yet 59 ½ years old, an early 401k distribution is levied a 10% surcharge on top of your normal income tax. So, if I failed to pay back my loan I would owe income tax on the unpaid balance with a 10% surcharge.

Beyond these costs, failure to repay the loan would mean the value of the loan would not be available to compound and grow my 401k account.

In the event, I partially repaid the loan. When I changed jobs the unpaid balance was due immediately but I didn’t have the money to pay it off. So, I allowed the balance of the loan - about $3,500 – to become an early distribution. I paid the income tax and the 10% penalty - a combined total of about $1,000.

The debt I owed myself turned out to matter quite a lot. It cost me $1,000 out of pocket and my retirement account will be lighter by about $61,000 ($3,500 compounded annually for 30 years at 10%). Worse, I don’t even remember why I took the loan in the first place.

Our current Federal government debt can’t be described as one that we “owe to ourselves”. A great deal of it is owed to foreign governments. And, unlike during World War II, few individual Americans hold government debt except thru pension funds and mutual funds.

Winning World War II was an overarching and clear justification for Federal borrowing. But, “We owe it to ourselves” was never a very good rationalization for increasing Federal debt. Today it makes no sense at all.

Quote of the Day
“We can evade reality, but we cannot evade the consequences of evading reality.”
Ayn Rand (1905-1982)

Link to Other Topics in the Special Report: Does the Debt Matter?