Ins & Outs of Government Borrowing

The following is an excerpt from our short course entitled “What Could Governments Do for Us?” In this post, we discuss issues related to government deficits and borrowing.

Some national governments seek balanced budgets, but most run deficits. A fiscal deficit arises when total spending exceeds revenues. That deficit must be financed by money creation or by borrowing.

Money creation is inflationary, so most governments rely on borrowing, often from domestic lenders but also from foreign lenders.

The accumulation of debt from borrowing, however, brings its own problems. Governments must pay interest to lenders.

Interest payment obligations can sometimes crowd out other spending when governments borrow too much without repaying their old debts fast enough.

• In the case of the U.S. government in 2024, the debt stock was nearly 121% of GDP. Net interest obligations were roughly 13.5 % of total spending. They could rise to as much as 16% of total spending by 2034, depending on Congressional policy choices between now and then. See Figure 1 below.

Figure 1: U.S. Federal Deficit as a Percent of Gross Domestic Product

Source: Congressional Budget Office, May 2, 2019   Congressional Budget Office, Feb. 2024: The Budget and Economic Outlook: 2024 To 2034.

• Click here to see central government debt stocks as shares of GDP in various countries, as reported by the International Monetary Fund.

Government deficits and borrowing can be harmful or helpful in much the same way that private debts and borrowing can be harmful or helpful.

Most people borrow sometime in their lives, perhaps for a car, a house, a new business, or when they can’t pay their credit card back in full. Such borrowing is helpful when borrowing for an investment that gains you more income faster than the associated interest obligations. For example, a business might borrow to invest in new equipment if the owners are confident that doing so would allow them to earn enough to cover interest and repayments and still increase their profits.

Similarly, governments can gain revenue faster than interest obligations grow when the economy’s growth rate is higher than the average interest rate, with both adjusted for inflation. This condition is sometimes called “the golden rule of investment,” which requires that spending never exceed revenues except when borrowing for investments with a sufficiently high rate of return.

Wars and natural disasters are often accompanied by higher borrowing. For example, the U.S. debt stock reached 106% of GDP in 1946, just after the end of World War Two.

More recently, of 203 countries reviewed, 139 national governments borrowed heavily in 2020-2022 in response to the COVID epidemic (IMF Fiscal Data).

The United States increased its stock of total gross debt in 2020 to 132 percent of GDP from 108 percent in 2019. By 2024, the debt had come down to 121 percent of GDP.

Government policies can help reduce deficits, borrowing, and the stock of debt. The main options are to increase revenues, reduce spending, and increase the pace of economic growth.

Higher revenues can be obtained without hurting growth through more government legitimacy and better tax administration rather than increasing tax or tariff rates.

Expenditures can be reduced without hurting growth through efficiency gains (see internal capacity below), by protecting investments in productivity and output, and – if politically feasible – by eliminating low-priority programs.

The next post in this series will cover issues related to the internal capacity of governments to get things done.

To see the full short course, click on the blue link “What Can Governments Do for Us?“

We offer several other short courses on the U.S. system of government. You can find them here: https://cffad.org/topics/