Government debt and deficits

Each year's deficit is a flow; it adds to the stock of government debt. And the debt brings interest payments, which add to future deficits.

Is public debt a burden? Arguments that it is:

• it must be repaid through future taxes, which fall on future generations;
• government borrowing uses up savings that private firms could have borrowed: it crowds out private investment;
• debt owed to foreigners means resources must be sent abroad to repay it.

Arguments against:

• Ricardian equivalence: forward-looking people know that borrowing today means taxes tomorrow, so they save more now. Then borrowing has the same effect as taxing.
• Deficits are not inflationary when resources are idle: output can rise instead of prices.
• Crowding out is weaker if output rises, since higher income brings more saving.
• If the borrowed money is spent on projects that earn more than the interest rate (roads returning 10% on money borrowed at 7%), the growth they bring can repay the debt.

Deficits can be reduced by raising taxes, by disinvestment, and by spending more efficiently. Note that deficits rise on their own in a recession, as tax receipts fall, so a larger deficit does not always mean a more expansionary policy.