Burden of Public Debt and Its Measurement

Burden of Public Debt and Its Measurement!

Burden of Internal Debt:

It is said that an internal debt has no direct money burden since the interest payment on debt and the imposition of taxation to pay interest to the lenders is simply a transfer of purchasing power from one to another. This means that in case of internal debt, money is borrowed from individuals and institutions within the country.

Repayment (raised from taxation) constitutes just a transfer of resources from one group of persons to another. In other words, these are transfer payments and do not affect the total resources of the community Truly speaking, govern­ment collects money through taxation imposed on the richer people who are also the buyers of government bonds.

That is to say, government collects money from the left pocket and pays it back to the right pocket. Thus, under internal debt, since all payments cancel out each other in the community as a whole, there is no direct money burden.

Above all, money collected from internal source of borrowing is usually spent for various developmental activities. Such expenditure results in transfer of resources in the community and, as a result, aggregate resources of the country increase. Thus, there can be no direct money burden of internal debt.

But there is no denying the fact that internal debt involves direct real burden to the community according to the nature of the series of transfer of incomes from taxpayers to the creditors. If we assume that the taxpayers and bondholders are the same persons then there can be no direct real burden of debt. But we know that the taxpayers and the bondholders belong to different income groups in the community.

Usually, the bondholders are richer people compared to the taxpayers.

Certainly, it is necessary to raise taxation to pay interest on the debt and, the greater the debt, greater the amount of taxation required to provide the interest on it. Ordinarily, taxpayers are poor people. When the government pays interest with principal to the bondholders, it results in the transfer of purchasing power from the poor people to the richer people.

Thus, the payment of internal debt involves redistribution of aggregate income. This results in inequalities in the distribution of income and wealth. This is the direct real burden of debt on the community.

Again, it is argued that taxpayers are generally active people while bondholders are idle, old and inactive ones who live on accumulated wealth. In case of repayment of internal debt, wealth thus gets transferred from the active persons, i.e., taxpayers, to the inactive persons, i.e., bondholders. This certainly adds to the real burden of debt.

Some economists argue that public debt is invariably a burden on the future generation.

They argue that when the government borrows, the present generation escapes the burden. After the loan is repaid at a later date with interest, the future generation has to suffer by being forced to pay additional taxes. In other words, the future generation will suffer when the present generation reduces its savings as disposable income declines following a rise in taxation.

However, there are some people who do not agree with this view. They argue that there is no shifting of the basic burden to the future. According to modern economists, the real burden of governmental activities must be borne during the period in which expenditures are made, since, during this period, only resources are diverted from private to public sector use.

Borrowing method affects the future generations in two ways only. To the extent to which public debt reduces capital formation, the stock of capital goods and the potential level of national income in future generations will be less.

Further, the borrowing methods create some problems for the future generations in the form of adverse effects on the economy from the taxes necessary to pay interest and principal, inflationary or deflationary effects of the existence of the debt, etc. Thus, there is no shifting of the basic burden to the future.

According to J. M. Buchanan, during the period in which the governmental activities and borrowing take place, no burden is created, because burden, by nature, implies a compulsory sacrifice.

Individuals in most cases voluntarily exchange their liquid funds for government bonds. Thus, the present generation does not feel any burden on them. However, it is a burden on the future generations who pay taxes (compulsorily) for the retirement of public debt.

So, we can conclude that the question of shifting the burden of public debt to the posterity or future generation is still an unresolved phenomenon.

Burden of External Debt:

During a given period, the direct money burden of external debt is the interest payment as well as the principal repayment (i.e., debt servicing) to external creditors. The direct real burden of such external borrowing is measured by the sacrifice of goods and services which these payments involve to the members of the debtor country.

There is also indirect money burden of external debt. Loan repayment by the debtor country implies more exports of goods and services to the creditor country. Thus a debtor country experiences a fall in welfare of the community.

Indirect real burden of external borrowing is crucial. Usually, government imposes taxes to finance external debt. But taxes have disincentive effects. It discourages work- effort and saving. Lower the saving, lower is the capital formation. Thus, external borrowing eats away economic growth since growth largely depends on capital formation. This indirect real burden of external debt is quite similar to internal debt.

Knowing fully well the dangers of borrowing, governments of LDCs are compelled to public borrowing—both from internal and external sources.

Measurement of the Burden of Debt:

Usually, burden of debt refers to financial burden of the government.

But as it does not indicate true burden, we consider following ratios to estimate the burden of debt:

i. Income-Debt Ratio:

It is estimated as:

size of public debt/national income = D/Y

If Y remains at a very high level, the burden of debt, D, will be insignificant. However, if the ratio becomes high, debt then poses a great burden.

ii. Debt-Service Ratio:

This ratio is measured as:

Annual interest payments of borrowing/National income = i/Y

Increase in Y means lower debt-service ratio. However, taxes are collected for the repayment of public debt. Thus, this ratio indicates the necessity of imposing higher taxes.

iii. Debt Service-Tax Revenue Ratio:

It is worked out as:

Annual interest payments/Aggregate tax revenue = i/T

An increase of this ratio indicates the financial weaknesses of the government.