Question: Who benefits from government debt?

Readers Question: I would like to know more on the issue of who exactly benefits from the UK national debt that my great grandchildren are going to be paying.

It is helpful to think of the three aspects of the government debt

  • Structural deficit – related to above inflationary increases on health and education and / or reluctance to tax.
  • Cyclical deficit – the deficit created by recession and the modest attempts at fiscal expansion e.g. VAT cut.
  • Financial sector innovation – to bailout banks.

We are borrowing to spend more on health care and education. Arguably, we spent more than prudent. We should have limited spending on health care or increased taxes to pay for it. But, without borrowing or higher taxes we would currently have less funds for health care and longer waiting lists e.t.c.

The alternative to borrowing is raising taxes to pay for the spending increases. We could reduce borrowing by raising taxes. You could say that borrowing represents a transfer burden from current taxpayers to future taxpayers. But, it’s not quite as simple as that. If taxes were raised now, it could reduce economic growth and mean future tax receipts are less.

The cyclical deficit is arguably a necessity. If we tried to balance the budget in this recession (like at the onset of the Great Depression) the recession would be undoubtedly much worse. If the recession was worse, there would be an even bigger fall in tax receipts. Therefore, the decision to borrow now, is helping future taxpayers in the sense that it is necessary to help the economy recover.

Bailouts for Banks have caused borrowing to increase. But, arguably the alternative of allowing banks to fail would have been much worse for the economy and future taxpayers.

A significant portion of the current debt is a necessity. Future taxpayers are benefitting from attempts to save the economy from plunging into a depression.

Not all the debt is desirable. Ignoring the cyclical deficit there is an underlying structural deficit caused by spending commitments being greater than willingness to tax. In particular, the next generation, will be paying for very generous periods of retirement for the baby boomers.

To summarise a simple way of thinking about the benefit of national debt is to consider the alternative – which is much lower spending or higher taxes.

However, the ‘burden’ on future taxpayers may be less than many fear. If we have economic growth / modest inflation, the debt burden will diminish over time. The cost of servicing the debt, does not have to become too onerous.

The post war generation were hardly held back by the, much larger, debt arising from the Second World War.

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