The Limits of Public Debt

The Limits of Public Debt:

Often the question arises as to what extent the government should borrow without creating any adverse effect on the economy. However, in practice, it is very difficult to establish an arbitrary limit to public debt. Lerner believes that there should be no arbitrary limit to public debt and it should be permitted to rise till it reaches its natural limit at the full employment level.

Prof. Alvin H. Hansen is also of the same view. Thus, he said that “Much of the discussion about the limits of the public debt is wholly unrealistic. There are no rigid and fixed limits. The problem is a manageable one, and can best be taken care of by ensuring that taxation is adequate-

• To prevent inflation.
• To provide a reasonably equitable and workable distribution of wealth and income.

In a developing economy where the need for mobilizing the financial resources for large-scale investment is paramount, the question of how far the state may safely proceed with an expansion of the debt assumes greater importance. In the context of developing economies or under-developed economies, it is said that the limit to borrowing is determined by the rate of growth of income. The potentialities of borrowing increase when the rate of growth of income increases. The limit to public debt in a developing economy, therefore, is relative to some of the factors such as the role of the public sector, the policy with regard to the expansion of the public sector, and the rate of growth of income. These among others are the important determinants of the limits to the growth of public debt in a developing economy.

Burden of Internal Debt:

As far as the burden of internal debt is concerned, there may be no direct money burden on the community as a whole, since the payment of interest and increased taxation to meet the burden of debt involve simply a transfer of purchasing power from one group of persons to another; to the extent of the creditors (bondholders) and taxpayers are the same, there may not be any net burden at all on the community. But to the extent the creditors (bondholders) and the tax-payers belong to different income groups, changes in the distribution of income among different sections of the community may take place.

However, while estimating the burden of public debt, the purpose of the loan should be considered. If a loan is utilized for a productive purpose, it can be paid out of the profits of the investment. But, a loan to finance a war may be a dead weight and will have to be paid out by way of increased taxation. Obviously, there is no burden involved in the first case. In the second case, it is also said that the burden imposed by taxation upon the taxpayers will be cancelled by the benefits received by the taxpayers in the shape of interest on bonds. But, it should be noted that if the rich pay taxes proportionately less than the proportion of public securities held by them, then there will be a direct real burden on the community. Thus, Dalton concludes that there is almost always a direct real burden, because public securities are held mainly by the wealthier classes, and progressive taxation is not likely to be so “sharply progressive as to counterbalance, among the wealthier classes, the income derived from public securities.” Obviously, there is a net increase in the burden on the community. And we, however, agree with this view.

The burden of public debt is realized by the community in one other way, that is, the government will tax the enterprise, patriotism, activeness, and worth for the payment of the public debt, and this increased taxation is for the benefit of the wealthier, passive, old, and leisurely class, i.e., those who receive interest in lieu of their credit to the government.

Finally, the increased taxation for the payment of interest charges and the repayment of the debt may consequently affect the power as well as the willingness to work and save. Hence, it is of utmost importance, that debt repayment should be managed in such a manner that it may not adversely affect production and distribution.

Hence, it can be concluded that internal debt imposed a burden upon the community as a whole, and the belief that the internal debt does not impose any burden on the community is theoretically incorrect and practically unrealistic.

Burden of External Debt:

The nature of external debt is different from that of internal debt. However, the burden of external debt can be similar to that of internal debt in one other sense. That is, the government has to pay internal as well as external debt through additional taxation. To put it in the words of Dalton, “as a general rule, an internal debt is likely to involve an additional and indirect burden on a community, an external debt does the same”.

However, in another sense, the burden of external debt is greater to that of internal debt, because in the case of internal debt interest charges and the repayment of principal are paid within the country, and result, in a mere transference of wealth from one section of the community to another, and the tax-payer and the receiver of interest are often the same person. In the case of external debt, money is paid to those living abroad for the loan of the capital used in production. Hence, the payment of interest on foreign debt reduces the net income of the debtor country, by transferring a part of its income abroad, the payment of the internal debt has no such effect. Hence, external debt imposes a greater burden than that of internal debt.

Again, the direct money burden external debts are the money payments that have to be made for interest and the repayment of principal while the direct real burden is the net loss of the debtor country in economic welfare (in terms of consumption of goods and services sacrificed by the debtor country) due to these payments. Hence, the direct real burden will vary according to the proportions in which various sections of the community contribute towards the payment of the public debt. Since the money payment to be made to the foreign creditors is raised by way of taxation hence, if the relative burden of taxation is largely upon the rich then the real burden of the community as a whole will be less than, if the relative burden of taxation is largely upon the poor. Putting it in another way, the money payment received in lieu of loans is used by the external creditors to obtain goods and services, which would otherwise have been at the disposal of members of the debtor country. The latter are, therefore, deprived of goods and services to the amount of money payment in lieu of loans to the creditor country. Hence, the extent to which the debtor country is deprived of goods and services indicates the direct real burden on the community. If this deprivation is largely distributed among the rich, the direct real burden to the community as a whole will be less than if it is mainly among the poor.

The direct real burden of external debt also depends upon the purpose for which the debt is incurred. If the external debt is incurred to meet war expenditure, it may be called a deadweight debt, as it is unproductive in nature or it does not help in raising the production of the community. However, if the external debts are short-term, the posterity may escape from its burden, as the present generation will repay it. But, if external debts are long term the burden falls upon posterity. If, however, the external debts are incurred for productive purposes such as importing machinery, raw material, technical know-how, and other capital goods for the development of industry and agriculture and other sectors of the economy, the debtor country may be benefitted from the extent to nullify the real burden of external debt. Hence, the posterity will not only receive the burden of external debt but also the fruits of accelerated economic growth and additional income to repay the age-old debt without feeling any real burden of such debt. Alexander Hamilton, Secretary of the Treasury in Washington’s Cabinet, rightly pointed out the necessity of foreign capital for development. He described the objections to foreign capital as the fruits of unreasoned jealousy. It was essential to the encouragement of industry. There were, of course, dangers as, for example, when it led to exploitation and the strangling of competition, but this, he rightly believed, could be avoided.

The direct real burden of the external debt also depends upon the prices, it increases with the fall in prices and vice versa. Suppose, if the prices fall, then for the payment of $500 to the U.S.A., a larger amount of goods and services are exported and vice versa.

The direct burden of an external debt would arise only if the productive capacity of the community suffers, and this may be possible if the external debt is incurred for unproductive purposes and then becomes a deadweight debt to the community.

However, it should be concluded, that external debt for productive purposes is not a burden, and hence, they should not be discouraged so long as they are helpful for the development of the community as a whole and in accelerating the economic growth of the economy.