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National Debt
Topic Thirty

Government Debt

Government debt which is also known as public debt or national debt is the debt owed by a central government. A government is said to have a deficit when it expenditures exceed its receipts in a particular year. Government debt is when the government borrows to funds its expenditures. Government debt is one method of financing government operations. The government can also create money to monetize their debts, thereby removing the need to pay interest. This can be achieved by printing money. Governments usually borrow by issuing securities, government bonds and bills. Less creditworthy countries sometimes borrow directly from an international agency such as the World Bank and the International Monetary Fund.

Types of taxes

The government’s main source of revenues is that of taxes. The following are the different types of taxes:

Proportional tax – is a tax where the rate of taxation is fixed, as 15 percent or 25 percent and stays a fixed percent of one's income, irrespective of how high or low the income is. A proportional tax applies the same tax rate across low-, middle- and high-income taxpayers.

Progressive tax – is a tax in which the tax rate increases as the tax base increases. A progressive tax takes a larger percentage of income in taxes from the high-income group than it does from the low-income group.

Regressive tax – is a tax imposed in such a manner that the tax rate decreases as the amount of taxable income increases. In this case, the higher income group pays less in taxes than the lower income group.

Indirect tax – an indirect tax is one that increases the price of a good so that consumers are actually paying the tax by paying more for the products. An indirect tax is most often a percentage of the price of the product and is thought of as a tax that is shifted from one taxpayer to another, by way of an increase in the price of the good.

Why Does Government Borrow

There are several reasons why the government may want to borrow. The following are some of these reasons.

  • Automatic fiscal stabilizers – in a recession, government tax revenues fall. Also the government may have to spend more on unemployment benefits. Therefore, in an economic downturn, borrowing rises. Without borrowing in a recession, this would make the recession worse and increase inequality and the government will be unable to pay unemployment benefits which are automatic stabilizers.
  • Investment – the government may invest in public sector investment. For example, building schools, hospitals, better roads. This investment can give a return on the investment which helps to boost productive capacity and increase economic growth. In this case, the government is acting like a firm who takes out a loan to finance investment.
  • When tax revenues are less than expected – borrowing means the government can meet a temporary shortfall by borrowing when tax revenues are less than expected, rather than having to immediately cut back on spending.