Sinking fund
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[edit] Historical Context
A Sinking Fund was a device used in Great Britain in the 18th century to reduce national debt. While used by Robert Walpole in 1716 and effectively in the 1720s and early 1730s, it originated in the commercial tax syndicates of the Italian peninsula of the 14th century to retire redeemable public debt of those cities.
The fund received whatever surplus occurred in the national Budget each year. However, the problem was that the fund was rarely given any priority in Government strategy. The result of this was that the fund was often raided by the Treasury when they needed funds quickly.
In 1772, the nonconformist minister Richard Price published a pamphlet on methods of reducing the national debt. The pamphlet caught the interest of William Pitt the Younger, who drafted a proposal to reform the Sinking Fund in 1786. Lord North recommended "the Creation of a Fund, to be appropriated, and invariably applied, under proper Direction, in the gradual Diminution of the Debt." Pitt's way of securing "proper Direction" was to introduce legislation that prevented ministers of raiding the fund in crises. He also increased taxes to ensure a £1 million surplus could be used to reduce the national debt. The legislation also placed administration of the fund in the hands of "Commissioners for Reducing the National Debt."
The scheme worked well between 1786 and 1793 with the Commissioners receiving £8 million and reinvesting it to reduce the debt by more than £10 million. However, the advent of war with France in 1793 "destroyed the rationale of the Sinking Fund" (Evans). The fund was abandoned by Lord Liverpool's government only in the 1820s.
Sinking funds were also seen commonly in investment in the 1800's in the United States, especially with highly-invested markets like railroads. An example would be the Central Pacific Railroad Company, which challenged the constitutionality of mandatory sinking funds for companies in the case, In Re Sinking Funds Cases in 1878.
[edit] Modern context
In modern finance, a sinking fund is a method by which an organization sets aside money over time to retire its indebtedness. More specifically, it is a fund into which money can be deposited, so that over time its preferred stock, debentures or stocks can be retired. For the organisation retiring debt, it has the benefit that the principal of the debt or at least part of it, will be available when due. For the creditors, the fund reduces the risk the organization will default when the principal is due.
In some US states, Michigan for example, school districts may ask the voters to approve a taxation for the purpose of establishing a Sinking Fund. The State Treasury Department has strict guidelines for expenduture of fund dollars with the penalty for misuse being an eternal ban on ever seeking the tax levy again. See also sinking fund provision in bonds.
