Burden of Public Debt: Meaning, Types & Explanation

Since the Great Depression of the 1930s, the Public Debt of nations has increased manifold. It rose from 53% of GDP to 80% of GDP in advanced countries during 2007-12. The impact of public debt on an economy depends upon a variety of factors- the sources of debt, the use to which it is put, terms and conditions, maturity period and interest rate.

The concept of the burden of public debt has been a source of debate among various economists.

According to Buchanan (1958), the primary real burden of public debt falls onto future generations. Since payment of taxes is a burden in itself, debt financing postpones the levy of taxes to future generations.

Bowen Davis Kopf (1960) argued that public debt reduces the amount available for private consumption by the community at the time borrowed funds are used, and thus it affects the present consumption expenditure.

According to Modigliani’s burden thesis (1961), public debt, whether raised internally or externally, is advantageous to the generation present at the time of increase and will pose a burden on future generations through the reduction in the stock of capital. The gross burden of public debt on future generations can be measured by the interest charged on it. This burden can be reduced if the rise in debt is accompanied by an increase in government expenditure to finance productive capital formation.

Modigliani argues against public debt as it can alter the use of private resources and will displace private investment. Moreover, it can contribute to the rise in income disparities in underdeveloped and developing countries as it benefits the rentier class receiving interest on government bonds. Hence it seems that different economists perceive public debt differently, but there in no unanimity on the definition.

Public borrowings create monetary and real burdens on an economy and its public. In most cases, it leads to the redistribution of resources from more productive to less productive sectors. The public debt tends to increase the disposable income of the present generation and reduction of disposable income for future generations through an increase in taxes to generate funds for debt repayment.

Burden of Internal Debt

● Direct Monetary Burden: In the case of internal debt, there is a transfer of resources from one agent to another, i.e. from the hands of the public to the government. The aggregate position remains the same in this case, as there is no direct monetary burden on the nation as the repayment of debt and the interest involves a transfer of purchasing power within the country.

However, when we take into account the burden imposed on the general public, whenever a government has to pay off its debts, it raises taxes to generate funds. It poses an additional tax burden on the future generation. An increase in taxes can lead to the reduction of disposable income and private consumption expenditure.

● Indirect Monetary Burden: The loans raised by the government lead to the creation of additional demand for goods and services and, in case of supply shortages, can lead to higher prices.

● Direct Real Burden: It refers to the burden borne by society due to the sacrifice of economic welfare and stresses the taxpayers. The public debt is acceptable if it leads to the expansion of productive capacity and a return on it outweighs the cost of the debt. However, a debt incurred to finance unproductive activities can lead to a serious loss of social-economic welfare.

● Indirect Real Burden: Higher taxes imposed by the government reduce disposable income and discourages taxpayers to work hard for higher incomes. A fall in disposable income reduces aggregate demand and thus adversely affects the productive capacity of the economy.

⟹ Inflation: The monetized public debt raised by the government heightens inflationary expectations. The resulting increase in the money supply leads to additional demand and thus creates inflationary pressure in the economy. If the government raises indirect taxes for the purpose of raising funds for debt repayment, it may fuel inflation due to the resulting rise in prices of goods and services, adversely affecting the purchasing power of the poor.

⟹ Unjustified Transfers: The servicing of internal debt in the form of debt repayment and interest payment involves the transfer of income from present to future generations and from active to inactive organizations.

● Effect On Private Investment: Public debt crowds out private investment. Debt servicing involves huge interest payments. Therefore, there is a transfer of resources from the private sector to the government. Lesser funds are available for private capital formation and with the government for development activities such as infrastructure development. The lack of economic infrastructure further discourages private investment, which ultimately affects economic growth.

● Effect On Social Development: Debt servicing implies fewer funds available for socio-economic infrastructure development, especially for social development activities like health, education, sanitation, old age and family welfare, etc.

Burden Of External Debt

During the initial stages, External debt is beneficial for developing countries as it brings with it necessary foreign exchange reserves, helps to bridge the saving-investment gap and brings along technical know-how. Thus, it increases the resources available to the country. But its repayment and servicing create a burden on them, especially when they are already facing payment problems. The recent fall of Greece’s economy is one example in this regard.

● Direct Monetary Burden: External debt involves the transfer of resources/funds from the debtor country to the creditor country and institutions. Higher debt and associated debt servicing imply a greater burden on the debtor country.

● Direct Real Burden: External debt causes loss of economic welfare of the citizens of the debtor country. It has to reserve resources for debt repayment and servicing, which means fewer funds available for domestic consumption. For example, a country earns foreign exchange from the export of its goods and service, which can be utilized for the import of advanced goods and technology. However, in the presence of external debt, it has to create funds out of these reserves for debt repayment.

● Indirect Monetary and Real Burden: Debt servicing involves raising funds through an increase in taxes and a reduction of public expenditure. This, in turn, affects domestic production, consumption and allocation of resources.

● Debt Trap: Countries especially developing and underdeveloped ones, are heavily dependent on external borrowings for their development and nondevelopment programs. Moreover, they find it difficult to service their debt out of their own resources and, in turn, borrow more to repay their loans. This creates a vicious circle where countries get debt trapped.

● Unproductive Foreign Debt: External debt, which is incurred for unproductive purposes, will pose a greater burden and involve greater economic sacrifice on the debtor nation.

● Burden on Foreign Exchange Reserves: As mentioned earlier, servicing external debt requires foreign exchange. During an international crisis, there is often a contagion effect where a crisis in one country easily spreads to other countries. A good amount of foreign exchange reserves provides a cushion against such adverse events. Therefore a country must
maintain a good foreign exchange reserve.

● Domination by Creditor Country: Many times, a creditor country poses restrictions on the debtor country, especially if it is a small underdeveloped one. Thus, external debt might involve domination by the creditor country on the debtor country.

Read More in: Theory of Public Finance

1. Public Finance: Meaning, Nature & Scope
2. Role of Government in Economy
3. Role of Government in Mixed Economy: Public & Private Sector
4. Role of Government under Cooperation and Competition
5. Role of Government in Economic Development and Planning
6. Concept of Public Goods, Private Goods, and Merit Goods
7. Concept of Market Failure and Functions of Government
8. Market Failure and Functions of Government: Decreasing Costs
9. Market Failure and Functions of Government: Externalities
10. Market Failure and Functions of Government: Public Goods
11. Future Market: Meaning, Role & Uncertainty
12. Concept of Information Asymmetry
13. Theory of Second Best: Concept & Explanation
14. Problem of Allocation of Resources: Public & Private Mechanisms
15. Preferences: Meaning, Types & Problems of Preference Revelation
16. Preference Aggregation & Its Mechanism
17. Voting Systems, Direct Democracy, Representative Democracy, Leviathan Hypothesis & Arrow’s Impossibility Theorem
18. Economic Theory of Democracy: Concept & Explanation
19. Politico Eco Bureaucracy: Concept & Explanation
20. Rent-Seeking and Directly Unproductive Profit-Seeking Activities
21. Rationale for Public Goods: Concept & Explanation
22. Benefit Theory or Voluntary Exchange Theory
23. Lindahl Model: Concept, Equilibrium & Limitations
24. Bowen Model: Concept, Advantages & Limitations
25. Samuelson’s Model of Public Expenditure
26. Musgrave’s Model of Public Expenditures
27. Demand Revealing Schemes for Public Goods
28. Vickery-Clarke-Groves Mechanism
29. Groves-Ledyard Mechanism
30. Tiebout Model: Concept, Assumptions Equilibrium & Simple Tiebout Model
31. Theory of Club Goods
32. Keynesian Principles of Stabilization Policy
33. Difference Between Keynesian Economic Thought and Others
34. Role of Expectations and Uncertainty in Formulating Stabilization Policy
35. Intertemporal Markets Efficiency & Failure
36. Liquidity Preference Theory
37. Diamond-Dybvig Banking Model
38. Preference Shocks, Adverse Selection & Central Bank
39. Equilibrium Deposit Contract
40. Social Goods and Its Effect on Stabilization Policy
41. Effect of Infrastructural Facilities on Stabilization Policy
42. Effect of Distributional Inequality on Stabilization Policy
43. Effect of Regional Imbalances on Stabilization Policy
44. Wagner’s Law of Increasing State Activities: Explanation, Graph & Criticism
45. Peacock-Wiseman Hypothesis: Explanation, Graph & Criticism
46. Public Expenditure: Concept, Objectives, & Public vs Private Expenditure
47. Pure Theory of Public Expenditure
48. Structure & Growth of Public Expenditure in India
49. Trends, Lessons & Priorities in Public Expenditure in India
50. Social Cost-Benefit Analysis: Project Evaluation, Estimation of Costs & Discount Rate
51. Performance Based Budgeting and Zero Based Budgeting
52. Theories of Tax Incidence: Concentration Theory, Diffusion Theory & Modern Theory
53. Tax System and Its Principles
54. Equity Principle and Efficiency Principle of Taxation: Meaning, Explanation & Examples
55. Ability to Pay and Benefits Received Principle of Taxation
56. Theory of Optimal Taxation: Excess Burden & Distortions of Taxation
57. Deadweight Loss of Taxation: Causes, Measurement & Example
58. Concept of Equity & Efficiency in Economics
59. Trade-Off Between Equity and Efficiency: Meaning & Example
60. Theory of Measurement of Dead Weight Loss
61. Double Taxation: Meaning, Desirability, Forms & Solution
62. Solution to Problem of Double Taxation: Intra-Country & International
63. Double Taxation Avoidance Agreement (DTAA) and Indian Policy
64. Classical View on Public Debt
65. Compensatory Aspect of Public Debt Policy
66. Public Debt or Borrowings: Concept, Need, Sources & Types
67. Concept of Public Debt or Public Borrowings
68. Need for Public Debt or Public Borrowing
69. Sources of Public Debt
70. Classification of Public Debt
71. Burden of Public Debt: Meaning, Types & Explanation
72. Debt Through Created Money or Deficit Financing
73. Public Debt (Public Borrowings) and Inflation (Price Level)
74. Crowding Out of Private Investment and Activity
75. Principle of Public Debt Management and Debt Repayment