RETIREMENT PLANNING PROGRAMS

For many people, a cornerstone of retirement planning is participation in an employer-sponsored savings program. Ideally, this should start early in one’s career to maximize the effects of compound interest. Additional retirement programs are available to self-employed persons as well as individual retirement accounts (IRAs) for all workers with earned income.

Most employer retirement programs are qualified plans, meaning they qualify for special tax benefits. For example, a plan must be in writing and cannot discriminate among employees at different salary levels. In return, employers receive a tax deduction for their contributions and employees need not include these employer contributions in their taxable income. In certain situations (e.g., to attract highly paid executives), companies may offer nonqualified savings programs.

Types of employer retirement programs

There are four major types of qualified employer-sponsored retirement programs: pensions, profit-sharing and stock ownership plans, salary reduction, and thrift plans.

Pensions. Defined-benefit pensions provide benefits according to a formula based on income and/or years of service (e.g., two percent for each year of employment multiplied by a worker’s highest three or five year’s average pay). Benefits are unaffected by investment gains and losses and employers shoulder the risk of accumulating sufficient funds. Employer contributions are calculated according to actuarial tables.

Defined-contribution pensions provide benefits based on the performance of workers’ individual retirement savings accounts. Employers make contributions based on a fixed or variable percentage of pay, and workers receive the amount contributed plus plan earnings. Thus, employees shoulder the investment risk.

Cash-balance pensions became increasingly popular during the 1990s. Benefits accrue at an even rate throughout workers’ careers, in contrast to the higher benefits toward the end of a career offered by defined-benefit pensions. Employers contribute a percentage of workers’ salaries and credit a return that is generally tied to a market index. Cash-balance plans are controversial because workers with long service often earn less than they would have if their employer retained a defined-benefit plan. Some workers have responded with charges of age discrimination.

Profit-sharing and stock ownership plans. Profit-sharing plans allow employers to make flexible contributions contingent upon company profits. There is no requirement that contributions be made annually. Instead, they are decided by a corporation’s board of directors and can be lean or generous, depending on company earnings. Because of the uncertainty of payment, profit-sharing plans often supplement a pension. The maximum allowable contribution is $40,000 or 100 percent of compensation; if less, beginning in 2002.

Stock bonus plans are similar to profit-sharing plans, except that contributions do not depend upon profitability and are made in the form of company stock. Employee stock ownership plans (ESOPs) provide shares of company stock as an employer’s retirement fund contribution. They provide a ready market for corporate stock, a feeling of participation in company management, and an incentive for employees to work hard.

Incentive stock options are sometimes provided to nonmanagerial employees, especially in start-up companies. They allow the holder to receive cash or stock after a specified vesting period, generally three to five years. Many people use this money for retirement.

Salary reduction plans. These plans allow workers to save a portion of their income, tax-deferred. These plans are named for specific sections of the tax code.

401(k) plans allow employees of for-profit corporations to save up to $11,000 (year 2002 limit) annually for retirement. The contribution and earnings are tax-deferred until withdrawal. Many employers also match employee contributions by a certain percentage and allow participants to borrow up to half of their account balance. The deferral limit will increase to $12,000 in 2003, $13,000 in 2004, $14,000 in 2005, and $15,000 in 2006.

403(b) plans are available to employees of non-profit organizations, such as public schools, hospitals, and public and private universities. The 2002 contribution limit is also $11,000 and gradually rises to $15,000 like 401(k)s. Fewer employers match contributions because many participants are public employees. Plans include catch-up provisions for workers who did not contribute fully in the past.

457 plans are available to state and local government workers and tax-exempt organizations. The maximum 2002 contribution is $11,000 and employer matching is rarely available.

For all of the above plans, participants age 50 and older who have made the maximum deferral can contribute an additional ‘‘catch up’’ amount: $1,000 in 2002, $2,000 in 2003, $3,000 in 2004, $4,000 in 2005, and $5,000 in 2006 and later.

Thrift plans. These are after-tax, employer-sponsored savings programs. In other words, workers cannot deduct their contributions from gross income, as is possible with salary-reduction plans. Employers generally match thrift plan contributions at a certain rate. For example, with a 50 percent match, an employer would contribute fifty cents for every dollar saved by employees.

Plans for the self-employed

Simplified employee pension plans (SEPs) allow business owners to contribute to special IRAs for themselves and their employees. The contribution limits are 15 percent of earned income for employees and 13.04 percent for the owner. SEP contributions are a business tax deduction and can be forgone in low earning years. Required paperwork is minimal. Salaried workers with outside self-employment income can also use SEPs.

Keogh plans allow self-employed persons to contribute the lesser of 100 percent of net self-employment income, or $40,000, starting in 2002. Contributions must also be made for all eligible employees. Several types of Keoghs are available. A major disadvantage is an annual disclosure form that must be filed with the IRS.

The Savings Incentive Match Plan for Employees (SIMPLE) is available to businesses with no more than one hundred employees. Employees can contribute up to $7,000 annually in 2002 and employers can match up to 3 percent of workers’compensation. Like SEPs, SIMPLEs have low administrative responsibility, compared to Keoghs. Contribution limits will be increasing to $8,000 in 2003, $9,000 in 2004, and $10,000 in 2005.

Individual retirement accounts (IRAs)

An IRA is a personal tax-deferred savings plan that can be set up at a variety of financial institutions. The maximum annual contribution is $3,000 in 2002–2004, $4,000 in 2005–2007, and $5,000 in 2008 and later, and earned income from a job or self-employment is required. IRAs are not an investment, per se, but, rather, an account for which a variety of investment products (e.g., stock, CDs, mutual funds) can be selected.

Traditional deductible IRAs offer a double tax benefit: tax-deferred growth and a federal tax deduction for the contribution amount. Income limits ($44,000 of adjusted gross income for singles and $64,000 for joint filers in 2002) and availability of a qualified employer plan determine eligibility for a tax deduction.

Roth IRAs provide no up-front tax deduction. However, earnings grow tax-deferred and withdrawals are tax-free if made more than five years after a Roth IRA is established and after age 59 1/2. Unlike traditional IRAs, Roth IRAs don’t require minimum distributions after age 70 1/2, and contributions can continue after this age if a person has earned income. Roth IRAs are available to single taxpayers with up to $110,000 of adjusted gross income ($160,000 for married couples).

Traditional nondeductible IRAs offer neither an up-front tax deduction nor tax-free earnings. Still, they provide tax-deferred growth and are generally better than taxable accounts for taxpayers that don’t qualify for other IRA options.

Starting in 2002, persons aged 50 and older may make additional ‘‘catch-up’’ contributions to either a traditional or Roth IRA. An additional $500 can be saved in 2002–2005 and an extra $1,000 in 2006 and later.

To determine which IRA is best, based on personal factors such as age and household income, individuals can check one of the IRA calculator links on the website www.rothira.com. It should be noted that withdrawals before age 59 1/2 from IRAs, salary reduction plans, and plans for the self-employed are considered premature distributions. A 10 percent penalty will be levied, except in specific instances like disability, in addition to ordinary income tax at an investor’s marginal tax rate (e.g., 28 percent).

Getting help: hiring professional advisors

Some people seek professional assistance with retirement planning, often because they lack the time or expertise to do investment research, or because they are faced with an immediate decision, such as handling a lump-sum pension distribution or evaluating an early retirement buyout offer. There are many types of financial advisors, including bankers, accountants, insurance agents, employee benefit counselors, and stock brokers. In addition, over 250,000 professionals call themselves financial planners. Many have earned the certified financial planner (CFP) or chartered financial consultant (ChFC) credential or are certified public accountants with a personal financial specialist (CPA/PFS) designation. To select a financial professional, consider the ‘‘three Cs’’: credentials, competence, and cost.

Credentials. Certified financial planners are licensed by the Certified Financial Planner Board of Standards (CFP Board) to use the CFP marks upon successful completion of a ten-hour examination, three years of financial planning experience, and a biennial continuing education requirement. The names of local CFPs can be obtained at the CFP Board’s website, www.cfpboard.org.

Chartered financial consultants receive the ChFC designation from The American College, located in Bryn Mawr, Pennsylvania. ChFCs must also have three years of professional experience, pass exams, and complete continuing education courses. Information is available on the Society of Financial Service Professionals’ website, www.financialpro.org.

CPA/PFS designees are certified public accountants who have passed a financial planning exam and a rigorous tax exam, and who have met continuing education requirements. Additional information is available on the website at www.cpapfs.org.

Competence. Financial advisors with more than $25 million of assets under management are required to register with the U.S. Securities and Exchange Commission, while smaller firms must register with state securities regulators. Investors can call the North American Securities Administrators Association (NASAA) at 1-888-84-NASAA, or their state securities agency, to obtain information about specific financial professionals. These agencies can access the Central Registration Depository (CRD), which contains licensing and disciplinary information about financial advisors nationwide.

Cost. Financial planners are generally compensated in one of four ways: through salary, fees, commissions, or a combination of fees and commissions. Fee-only planners are compensated entirely by their clients. The fee can be an hourly rate, a fee per plan, or a percentage of assets under management. Commission-only planners receive commissions from the sale of products such as mutual funds. Some advisors charge both fees and commissions or use commission income to offset all or part of the fees charged for financial advice.

Those wanting to hire a financial advisor should follow this six step process:

1. Obtain referrals from other people or professional organizations
2. Call several planners for information about their services
3. Check planners’ references and CRD registration information
4. Interview several planners and ask questions such as: What services do you provide? How are you compensated? What is your investment philosophy? How often will my financial plan be reviewed? May I see a sample financial plan?
5. Assess your comfort level with each financial planner
6. Hire a financial planner upon receipt of a written agreement

Getting help: retirement planning tools

Software programs, worksheets, and online financial calculators are available to assist with retirement decisions. These tools are only as good as their underlying assumptions about key variables, however. One of the simplest retirement planning tools is the American Savings Education Council’s Ballpark Estimate (see www.asec.org). This one-page form consists of just six steps but makes certain assumptions about longevity and investment return. Another popular website is www.financialengines.com, which predicts an investor’s probability of reaching his or her retirement goal. Other sources of retirement planning tools include investment companies and county Cooperative Extension offices.

According to the 2000 Retirement Confidence Survey (RCS) conducted by the Employee Benefit Research Institute, 53 percent of American workers have calculated how much money they need to save for retirement, up from 35 percent in 1993. The 1999 RCS also found that those who have done a retirement-savings need calculation have saved considerably more than those who have not. The study found that the median amount accumulated by households that have tried to figure out how much money they will need is $66,532, compared with a median of $14,054 accumulated by those who have not done a calculation.

Getting help: formal retirement planning education

With so many retirement savings programs available at worksites, formal retirement-planning education is often provided by employers. Benefits to program sponsors include workers who more fully appreciate their employee benefits package, improved morale and productivity, and increased participation in tax-deferred retirement plans. Employers also offer educational seminars to comply with section 404(c) of ERISA (the Employee Retirement Income Security Act) and to head off future lawsuits by employees who inadequately prepare for retirement.

The U.S. Department of Labor (DOL) encourages employers to provide ‘‘sufficient information’’ so employees can make informed investment decisions. Section 404(c) permits employers to provide certain information to employees without increasing their fiduciary liability. A 1996 interpretation of section 404(c) identified four categories of financial education that do not constitute the rendering of investment advice:

• Information about an employer’s specific retirement plan
• General financial and investment information
• Information about asset allocation models (e.g., the historical performance of combinations of stocks, bonds, and cash)
• Interactive materials (e.g., worksheets and computer analyses)

Implementing a financial education program with any or all of these four categories can assure employers that they will not lose their exemption from fiduciary status as set forth in ERISA 404(c). In addition, employers must provide plan participants with at least three different investment choices and independent control over their accounts.

There are also benefits to workers who participate in formal retirement-education programs. Several studies have found that workers who attend retirement-planning seminars save more money and make wiser asset allocation decisions. Asset allocation is the placement of a certain percentage of investment capital within different asset classes (e.g., 50 percent of an investor’s portfolio in stock, 30 percent in bonds, and 20 percent in cash).

The 1998 Retirement Confidence Survey found that, among workers who received educational material or attended employer seminars about retirement planning during the previous year, 43 percent reported that the information led them to both change the amount that they contribute and reallocate the way their money was invested. In addition, 41 percent said employer-provided information led them to begin contributing to a retirement savings plan. Similar results were found from a survey of almost 700 plan sponsors by Buck Consultants, a worldwide human resources consulting firm. This study found that, of companies providing financial education programs, 60 percent reported that their employees were making larger plan contributions and 58 percent reported that employees were becoming less conservative in their investment choices.

Some employers go beyond retirement planning and provide seminars on credit and cash management. Others provide individual financial counseling. Especially difficult to reach are low-wage workers. Employers can help employees increase their take-home pay through the IRS earned income credit tax program and by providing services (e.g., child care) that would otherwise consume scarce take-home pay. Savings campaigns, such as saving one percent or more of pay, may also be effective, particularly when employer matching is provided.

Unfortunately, some employers focus their educational efforts on older workers that are within ten years of retirement. This is unfortunate because the earlier one gets started, the less one needs to save. Compound interest is not retroactive. For every decade a worker postpones saving, he or she needs to save about three times more to accumulate a specific sum. For example, a 20 year old needs to invest only $67 per month to accumulate $1 million by age 65. By waiting until ages 30, 40, and 50, the monthly savings amount needed increases to $202, $629, and $2,180, respectively, assuming an 11 percent average annual return.

Summary

A number of tax-deferred retirement plans are available to employees and self-employed persons. Thanks to the Economic Growth and Tax Relief Reconciliation Act of 2001, contribution limits have been increased and catch-up provisions established. Some retirement savings programs (e.g., 401(k)s) allow an up-front tax deduction of the amount contributed, in addition to tax-deferred growth of the principal. Additional information is available through professional financial advisors, retirement-planning software and worksheets, websites, and employer educational programs. The sooner one starts to save, the longer compound interest will work its magic. Even small dollar amounts add up. A $20 weekly deposit earning a 10 percent average return over forty years will grow to $506,300.

Barbara O’Neill

See also Annuities; Assets and Wealth; Consumer Price Index and COLAs; Estate Planning; Individual Retirement Accounts; Retirement Planning; Savings.

BIBLIOGRAPHY

American Savings Education Council. Choose to Save Forum on Retirement Security and Personal Savings: Agenda Background Materials. Washington D.C.: ASEC, 2000.

Babich, A. C. ‘‘Cash Balance Plans: The New Trend in Retirement.’’ Journal of Financial Planning, (April 2000): 92–99.

Carlson, C. B. Eight Steps to Seven Figures. New York: Doubleday, 2000.

Certified Financial Planner Board of Standards. Ten Questions to Ask When Choosing a Financial Planner. Denver, Colo.: CFPBoS, 1998.

Employee Benefit Research Institute. The 2000 Retirement Confidence Survey Summary of Findings. Washington D.C.: EBRI, 2000.

McReynolds, R. ‘‘How’s Your Pension?’’ Mutual Funds, May, 2000, p. 107–108.

O’Brian, B. ‘‘Calculating Retirement? It’s No Simple Equation.’’ The Wall Street Journal, 7 February 2000, p. R1, R5.

O’Neill, B. Investing On A Shoestring. Chicago: Dearborn Financial Publishing, 1999.

Opiela, N. ‘‘401(k) Education: Planners Responding to Plan Participants’ Calls For Help.’’ Journal of Financial Planning, June, 1999, p. 58–64.

Ostuw, P.; Pierron, B.; and Yakoboski, P. ‘‘The Evolution of Retirement: Results of the 1999 Retirement Confidence Survey.’’ In EBRI Issue Brief 216. Washington D.C.: Employee Benefit Research Institute, 1999.

Personal Tax Planning After the 2001 Tax Law. Albany, N.Y.: Newkirk Publishing, 2001.

Roha, R. ‘‘Stock Options Aren’t Just for Bigshots Anymore.’’ Kiplinger’s Personal Finance Magazine, April, 1999, p. 99–101.

Rutgers Cooperative Extension. Investing For Your Future: A Cooperative Extension System Basic Investing Home Study Course. New Brunswick, N.J.: RCE, 2000.

Storms, R. ‘‘Financial Education: Employer Trends, Benefits, and Considerations.’’ Personal Finances and Worker Productivity 3, no. 2 (1999): 25–28.

2001 Tax Law Summary. Albany, N.Y.: Newkirk Publishing, 2001.

U.S. Department of Labor. Simplified Employee Pensions: What Small Businesses Need to Know. Washington D.C.: DOL, 1997.

Whelehan, B. M. ‘‘The 123s of 401(k), 403(b), and 457 Plans.’’ Mutual Funds, July, 1998, p. 31–32.

Yakoboski, P.; Ostuw, P.; and Hicks, J. ‘‘What Is Your Savings Personality? The 1998 Retirement Confidence Survey.’’ EBRI Issue Brief 200. Washington, D.C.: Employee Benefit Research Institute, 1998.

Debt

What It Means

Debt is money owed by one person, company, or institution to another person, company, or institution. Those who borrow money are called borrowers or debtors, and those who loan money are called lenders or creditors.

In the modern world debt is very common, and it is a central part of the world economy. Borrowers can use loans to finance purchases and projects that they could not otherwise afford, and lenders can generate income by charging interest (a fee for the use of borrowed money) on loans. These activities account for a large portion of the total economic activity in most modern countries. Without debt and the purchases and income it generates, modern economies would be only a fraction of their current size.

Consumers commonly go into debt in order to purchase large items, such as automobiles and homes. Another common form of consumer borrowing is the use of credit cards, which allow individuals to make purchases (of smaller items than homes and cars) and to pay for them at a later point in time. Companies borrow money for a variety of reasons, including to build or purchase new factories and equipment, to hire new workers, to buy inventory and other materials, and to pay for unexpected expenses. Likewise people starting a new business must often borrow money to cover their initial expenses. Governments also routinely borrow money to finance schools, highways, hospitals, and other public projects, and they borrow especially large amounts of money to go to war.

When Did It Begin

The phenomenon of debt dates back to at least the earliest civilizations. As early as 3000 bc , loans were used to facilitate economic activity in ancient Mesopotamia (which now lies in Iraq, Syria, and Turkey). While creditors charged interest in these early times, this practice was widely condemned by religious figures as diverse as Buddha, Jesus, and Mohammed. Interest collecting and money lending were considered immoral by many prominent spiritual leaders, philosophers, and members of the general public from ancient times through the Middle Ages (which lasted from about 500 to about 1500).

Furthermore, prior to the twentieth century most societies dealt very harshly with debtors. In ancient Greece, Rome, and Israel, among other early civilizations, debtors who could not pay what they owed were sold into slavery, though Israeli custom required the freeing of such slaves every 50 years. The feudal system of the Middle Ages (in which aristocrats, or those belonging to a small privileged class with inherited land and wealth, ruled over all the people who lived on their land) generally treated debtors more leniently. This was true only because all men were required to serve their rulers in the military and could not be spared for the purposes of punishment. As the Middle Ages came to an end and capitalist economies (in which individuals could own property and conduct business with some amount of freedom from feudal or government control) began to develop, harsh treatment again became the norm for debtors. Until the nineteenth century people who could not pay their debts were generally sent to prison.

Even though debtors’ prisons were phased out in Europe and the United States in the mid-nineteenth century, most people continued to frown on the practice of going into debt except to purchase the most necessary items. Debt was considered irresponsible and even immoral, an attempt to acquire things one could not afford to buy by honest means. Only essential investments, such as a farmer’s purchase of seeds or a company’s construction of new factories, were seen as legitimate reasons for borrowing money.

Throughout history governments have borrowed money in order to conduct wars. Only in the aftermath of the Great Depression (the severe financial crisis that afflicted the world economy in the 1930s), however, did government debt during peacetime became routine. National governments found that they could stimulate their ailing economies by spending money (often on public projects and on aid to the unemployed, the poor, and the elderly), and this was seen as beneficial even if the money had to be borrowed. Since that time public opinion of government debt has fluctuated, but governments have continued to borrow money for peacetime needs and with the intent of managing the economy, as well as for the waging of war.

More Detailed Information

By the end of the twentieth century, debt had long since been accepted as a natural part of economic life, and borrowing and lending accounted for an enormous part of the economy in all developed countries. It had become common for the amount of debt (including the debts incurred by individuals, companies, and government at the local, state, and national levels) in a developed nation to add up to more than three times the total value of all goods and services produced by the country’s economy.

Several conditions are necessary to support an economic system in which debt plays such a big role. First, the members of such a society must be likely to repay what they owe. A credit system in which most people try to avoid payment is unsustainable. Second, there must be a sophisticated legal system that emphasizes the protection of private property. A debt is a loan of one person’s or organization’s private property to another person or organization; if debts are to be reliably collected, laws must be able to defend creditors’ property rights. Third, the society’s money must maintain its value. When a country’s currency is unstable (that is, when its money tends to lose or gain value erratically as a result of rising or falling prices), then a creditor cannot count on the value of the money he or she will eventually be repaid.

Most debt is transacted not by borrowers and lenders in direct contact with one another but by intermediaries, such as banks. Banks take in money from depositors and lend it out to borrowers. Depositors are paid interest by the bank for the use of their money, and the bank charges borrowers a somewhat higher rate of interest. The difference between these rates of interest is one of the key sources of any bank’s profits.

Debt is often based on created money: figures on paper (or in computer systems) rather than hard cash. Banks do not hand over actual coins and bills to borrowers. Instead, they give borrowers a checkbook with the amount of the loan recorded as a balance (the amount of money available) in a checking account. People can write checks or withdraw money that is subtracted from these balances, but a bank does not have actual currency on hand equal to the full value of all its bank accounts. Banks make loans, instead, in proportion to a small amount of currency that they are required by law to keep on hand. If, for example, Community Bank has $10,000 in currency, it might need to keep only $1,000 in reserve and can lend out the rest. The borrowers then take the money and place it in a bank account, which can then be lent out to other borrowers. This process continues, and the initial $10,000 in currency allows Community Bank to make loans equal to 10 times that much money. Community Bank thus literally creates 90 percent of the money in its accounts out of thin air.

This form of money, which exists only as numbers in banks’ computer systems, accounts for much of the total money supply in a country at any given time. In 2006, for instance, there was about $800 billion in physical cash in the United States. If the money supply had been calculated to include not just cash but also checking, savings, and other forms of bank accounts (all of which represent money owed by banks to account holders or by borrowers to banks), however, it would have amounted to more than $7 trillion. Debt, therefore, is one of the chief sources of the nation’s money supply. Its importance to the economy can hardly be overstated. Not only does debt fuel business ventures, make possible large purchases, and allow for the construction of highways and the fighting of wars, but it also provides much of the basic material (money) for the entire economy.

Recent Trends

The modern world relies on debt for increased prosperity, but this does not mean that debt does not at the same time threaten prosperity. At the end of the twentieth century and the beginning of the twenty-first century, one form of debt was particularly worrisome to many Americans: credit card debt. Whereas going into debt to buy a house is usually seen as a reasonable way of making a purchase that cannot be made otherwise, credit card debt often results from irresponsible spending on smaller items. In exchange for instant gratification, many Americans sentenced themselves to seemingly never-ending financial burdens and, in some cases, the threat of bankruptcy (an inability to pay debts, which can lead to the seizure of property and other valuable resources).

As of 2007 around 144 million Americans had at least one major credit card, and the average American family had eight different cards. Of the 144 million cardholders only 55 million regularly paid the full balance (the total amount owed) of their credit card bills every month. Nearly 90 million Americans, then, owed not just the amount of their balances to credit card companies but were also paying interest and fees that were often very high. People with poor credit histories (a record of late and missed payments), for instance, might be charged a yearly interest rate of around 30 percent, and the average balance for those who maintained a balance from month to month was estimated at $13,000. Thirty percent interest on a balance of $13,000 would amount to an additional charge of $3,900 a year, not counting additional fees commonly assessed by card companies. Of the 90 million people who habitually failed to pay their monthly balances, approximately 35 million made only the minimum payment of 2 percent of the total balance each month, which amplified the effect of interest and fees and extended the amount of time they would likely remain in debt.

DEBT

Individuals, businesses, and governments all incur debts, which are amounts owed to others. Household or consumer debt most commonly resulted from auto loans, home equity lines of credit, credit cards, and personal loans.

During the 1990s consumer debt climbed rapidly, rising 20 percent a year between 1993 and 1996 alone. By the end of 1996 consumers' outstanding credit card debt alone was approaching $500 billion. Given these numbers, it is not surprising that between 1996 and 1997 the number of U.S. citizens filing bankruptcy claims climbed 25 percent—100 percent higher than in 1986.

Large corporations accrued debt in the form of short-term bank loans or longer-term debt like bonds in order to invest in their own futures, use their cash efficiently, or discourage other companies from considering a takeover. U.S. tax law encouraged firms to borrow money by allowing businesses to take tax deductions on the interest payments they make on their debts. When a corporation's debt came due, rather than pay it all off debt was generally rolled over by borrowing new funds—old debt was replaced with new debt.

Like individuals and businesses, governments got into debt when their expenses exceeded their revenues. Throughout U.S. history wars and recessions have been the largest causes of federal debt. The United States began with a $75 million debt that was used to the finance the American Revolution (1775–1783). Since only one quarter of the cost of the American Civil War (1861–1865) was paid using tax revenue, government budget surpluses for several years were used to pay off the $2.7 billion Civil War debt. The next major war, World War I (1914–1918) raised the federal debt to $26 billion, and the tax revenue the government lost because of the Great Depression (1929–1939) raised U.S. debt to $43 billion by 1940. But World War II (1939–1945) expenses dwarfed any public debt in the country's history. Where U.S. debt had never exceeded one third of Gross National Product (GNP) before the war, in 1945 the government's debt exceeded the entire national GNP by 29 percent. For the most part the government remained in debt after the war. It reached crisis proportions in the 1980s, but the government now hopes to retire the debt by 2015 because of cuts in spending and a thriving economy. Although almost all discussions of government debt focused on federal debt, the debt of U.S. state and local governments was also quite large and totaled some $454 trillion by the mid-1980s.

See also: Credit, Deficit, National Debt

OIL DEPLETION ALLOWANCE

Oil depletion allowance refers to deductions allowed in petroleum industry taxation. Mineral resources, including oil and gas, are finite and may become exhausted from area to area. Although difficult to estimate the amount of the deposit left, the allowance takes into account that production of a crude oil uses up the asset. Depletion deductions provide incentives to stimulate investment in oil discovery in hazardous or financially risky areas. The deduction, a fixed percentage of sales, is subtracted from a business' gross income, thus lowering its taxable income.

The oil depletion allowance has been an integral part of the U.S. taxation system applied to oil since the end of World War I (1916–1918). First called the "discovery depletion," the allowance evolved to the "percentage depletion" in 1926 when, regardless the amount invested, corporations deducted a specific percentage of total sales. Long set at 27.5 percent, the deduction came under fire as being overly favorable to the extractive industries. Congress lowered the percentage to 22 in 1969.

In 1975 there were approximately 35 major oil producers but roughly 10,000 smaller independent producers. The oil depletion allowance again entered the political arena with opponents arguing that it constituted a special treatment gift to the oil and gas industry. Fear of losing the allowance completely lead independents to break with the majors and fight to retain it for themselves. Congress agreed that the independents indeed were America's hazardous oilfinders. Congress voted to eliminate the allowance for the majors but, although gradually reducing it to 15 percent by 1984, retain it for the independents and royalty owners. For the first time in U.S. history, a definition for an "independent producer" appeared in the basic U.S. tax code. The explicit legal definition allowed independents to be considered separately from major oil producers in legislation and saved the independents millions of dollars in the last quarter of the twentieth century. Attempts to eliminate the 15 percent tax shelter in 1985–1986 failed when sinking world oil prices alone sent the oil industry into decline.

See also: Petroleum Industry

debt / det/ • n. something that is owed or due: I paid off my debts | a way to reduce Third World debt. ∎  the state of owing money: heavily in debt. ∎  a feeling of gratitude for a service or favor: we owe them a debt of thanks.PHRASES: be in someone's debt owe gratitude to someone for a service or favor.