Consumption-Linked Perpetuities: A Path to Fiscal Sustainability in the United States

Introduction

The United States stands at a critical fiscal juncture, grappling with immense challenges largely due to escalating entitlement obligations such as Social Security and Medicare. As the net national debt soars past $27 trillion (almost 100% of GDP), innovative solutions are imperative to secure the country’s financial future. One promising approach is the issuance of Consumption-Linked Perpetuities (CLPs) — a financial instrument that could transform how the government manages its debt while promoting fiscal responsibility and economic stability.

What Are Consumption-Linked Perpetuities?

Consumption-Linked Perpetuities are government bonds with no maturity date, meaning they make payments indefinitely and have no principal. The unique feature of CLPs is that their payments to bondholders are directly proportional to revenues raised by a specified Value-Added Tax (VAT) rate. In other words, the payments are not fixed in advance but fluctuate based on actual VAT collections. For instance, a CLP could be tied to the revenues generated by a 0.01% VAT on national consumption. As consumption grows or contracts, so do the payments to CLP holders, aligning government obligations with the nation’s economic activity.

Addressing Immense Fiscal Challenges

The United States faces significant fiscal pressures from entitlement programs, which are projected to expand considerably as the population ages. These obligations risk placing an unsustainable burden on federal finances, potentially crowding out other essential government functions and increasing the debt load on future generations.

By issuing CLPs, the government can establish a sustainable mechanism for debt servicing that grows in tandem with the economy. Since CLP payments are funded through a VAT tied to consumption, the ability to meet these obligations naturally scales with economic activity, helping to mitigate the strain caused by entitlement spending.

Enhancing Fiscal Responsibility Through Transparency

A critical advantage of CLPs is the increased transparency they bring to government borrowing. Because CLP payments are funded through a dedicated VAT, any new debt issuance directly impacts consumers through changes in VAT payments. This immediate connection makes the cost of debt more observable to everyone, encouraging voters to hold policymakers accountable for fiscal decisions. With the cost of borrowing visible in everyday transactions, there is a stronger incentive for the government to exercise fiscal restraint.

A Modest VAT Suffices

Concerns may arise about the potential burden of a new VAT on consumers. The U.S., famously, is one of very few countries without a national consumption tax. However, the required VAT rate to service CLPs would be relatively small. Consider a back-of-the-envelope calculation, using the Gordon growth model:

Asset Price = (Next Payment)/(Interest Rate — Payment Growth Rate)

and the following assumptions:

- Total national debt: $27 trillion
- Total annual consumption: $19 trillion
- Difference between the interest and payment growth rate: 1%

This means that servicing the entire existing debt through CLPs would require a VAT rate of approximately 1.4%. If applied only to additional debt, the required VAT rate would be even smaller. Thus, the tax increase would be modest, unlikely to significantly burden consumers or hinder economic growth.

Preventing the Crowding Out of Investment

Under the current system, increased government borrowing can lead to higher interest rates, crowding out private investment. By relying on CLPs financed through VAT revenues, the government reduces its dependence on capital markets. This approach fosters a more favorable investment climate, promoting economic growth and innovation.

While the Ricardian equivalence theory suggests that consumers might offset government borrowing by consuming less and saving more, in reality, this theory may not fully hold due to imperfect capital markets and behavioral biases. By making the cost of debt immediate and transparent, CLPs address these limitations, ensuring that consumers adjust their behavior in response to actual fiscal policies.

Attractive Inflation Protection

CLPs are inherently inflation-protected because payments to bondholders are tied to VAT revenues, which generally rise with inflation. As prices increase, so do VAT collections, ensuring that CLP payouts maintain their real value over time. This feature makes CLPs appealing to investors seeking to preserve their purchasing power, potentially broadening the investor base and reducing borrowing costs for the government.

Automatic Adjustment During Recessions

During economic downturns, consumption typically decreases, leading to lower VAT revenues and, consequently, reduced payments to CLP holders. This automatic adjustment means that government liabilities decrease in a recession, providing fiscal relief when it’s most needed. By aligning debt obligations with economic performance, CLPs make it easier for the government to keep its finances in order during challenging times without the need for disruptive policy interventions.

Making VAT More Palatable by Earmarking for Debt Service

Implementing a new tax can be politically challenging, but dedicating the VAT exclusively to servicing CLPs can make it more acceptable to the public. This earmarking ensures transparency and builds trust, as taxpayers can see that their contributions are directly funding debt obligations rather than being diverted to unrelated expenditures. A dedicated VAT for debt service enhances the policy’s political and social acceptability.

Preserving Space for Social Spending

While a VAT is a flat tax, the government would retain ample room for tax progressivity (for instance through the income tax), which can be used to fund social spending programs.

Conclusion

Issuing Consumption-Linked Perpetuities presents a compelling strategy for the United States to proactively address its fiscal challenges. By tying debt servicing to a modest, dedicated VAT:

• Fiscal responsibility is enhanced through immediate and transparent debt costs.
• The required VAT rate remains relatively small, minimizing consumer impact.
• Private investment is supported by reducing reliance on capital markets.
• Inflation protection and automatic liability adjustments enhance financial stability.
• Essential social spending is preserved through other taxes, maintaining social safety nets.

Implementing CLPs requires thoughtful planning and clear communication to the public. However, the potential benefits to the nation’s fiscal health and economic resilience are substantial. By embracing this innovative approach, the United States can secure a stabler and more prosperous future.