True or False?
The answer is True. The taxes raised to service the public debt are equal in the aggregate to the interest payments on that debt, so cancelling the debt would not affect the sum total of everyone's wealth. But there is a problem. The people who have to pay the taxes are typically not the same people who own the government debt. So cancelling the debt would bring about a major redistribution of wealth within the community from bond holders to taxpayers.
The fact that the government debt is owed by some people in the community to others means that there is a limit to how large that debt can be. If the debt expands sufficiently, there will be a point at which taxpayers responsible for the interest on it, who represent a majority of the community, will exert political pressure to obtain relief from the future tax burden represented by that interest.
One way in which the government could give taxpayers relief would be to increase the money supply and create inflation. This would reduce the real value of the debt and the taxes necessary to pay the interest on it. As the debt grows larger and larger, therefore, the question will arise in the minds of investors as to whether that debt is a good investment.
As investors become less confident that the government will honour its obligations to redeem and service its debt, the interest rate that it must pay to borrow increases. If things get bad enough, interest rates on government bonds will becomes so high that the government will be unable to refinance the debt as it comes due.