Dec
12
2011

What's the difference between government debt and a government's deficit?

Debt spiral (image by Patrick Hoesly - CC-BY)

The terms deficit and debt are sometimes used loosely by politicians. It may even be politically expedient to use the terms sloppily.

If a government spends less than its income, the government is said to operating at (or “running”) a surplus. If a government spends more than it receives, it is running a deficit. If its income and expenditure are equal, the government has a balanced budget.

If a government balances its budget, and it wishes to dispense more goodies to one sector of its voters, it must either increase taxes or reduce the amount it spends on some other sector of its voters. Neither higher taxes nor reduced handouts are electorally popular, so governments have a disincentive to balance their budgets or run a surplus. Most western governments run a deficit in most years.

If, in a year, a government spends a hundred billion dollars more than it takes in, it is said to run a deficit for that year of a hundred billion dollars. This can be expressed as a percentage of the country's total monetary income (its GNP, or Gross National Product). So, if the country's GNP for that year was one trillion dollars, a deficit of a hundred billion dollars would be 10%.

The government can fund its deficit by borrowing from people or businesses. It's fashionable to refer to this as selling debt rather than borrowing money, but both terms mean the same. Or, the government can borrow money from (sell debt to) its central bank, which can create new money to lend to the government (to purchase the debt with). Creating new money is essentially a tax on those with savings, because by increasing the total amount of money in circulation it debases the value of each unit of that money. This is the process of inflation.

Suppose a government runs a deficit of 10% for five years in a row. The government is now in debt to the tune of 50% of the nation's GNP. This means that if the government were to spend no money, and if it taxed all the income of all the people, the government could pay back its debt in half a year. Of course, debt repayment can never happen at that speed because people still need a certain amount of money for basics such as food, clothing, housing and energy.

A government can borrow essentially unlimited sums from its central bank, so there is little motivation for the government to pay back the debt. Many countries routinely “roll over” their government debt as it becomes due for repayment. However, interest must continue to be paid on that debt. As the debt mounts up, the interest payments can become a big drain on the nation's wealth.

For example, if a country has debts equal to 100% of its GNP (as many countries do), and the average interest rate on that debt is 6%, then the government must pay 6% of the nation's income each year just to service the debt. If the government taxes, say, half of the income generated by its people, then the interest payments will represent 12% of the government's budget. This forces a choice between government austerity, higher taxes, profligate further borrowing, or a default on some or all of the debt.

None of these options is appealing, yet governments have been forced to do them many times in the past, and many governments are deep enough in debt that they are today faced with these choices.

There is an additional source of debt which is usually not included in the headline debt figure: debt due to unfunded future liabilities. If the government makes a promise of future pensions, or a promise that it will pay for future medical care for its citizens, those costs must be met in the future (or else the government must default on its promises). If money has not been put aside for future liabilities, these are said to be unfunded, and the amount of those liabilities must be added to the government debt to arrive at a true figure representing the government's liabilities.

Government debt is an obligation that will fall onto future generations. It is essentially a tax on those who are not yet old enough to vote, and on unborn children, and probably on the children of those as-yet-unborn children. The ability of any government to meet its future obligations depends on the willingness of future generations to be taxed enough that the debt which has been passed on to them can be repaid.

When a politician says “we have reduced the deficit”, it doesn't mean that the debt is being reduced. It means there is still a deficit, and that the debt is still growing. It's just that the deficit is a bit smaller than it was last year, and that the debt is growing a little more slowly.

For government debt to be reduced, the government must be “in surplus”. When a politician says “the budget will be in balance within five years”,

this means that the national debt will continue to increase over those five years. And after waiting patiently for those five years, don't be surprised to hear a politician saying “the budget will be in balance within five years”.

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