Check sibling questions

Government Debt is a Burden because of following reasons

When a govt borrows, it issues bonds to Public

On these bonds, Govt will have to pay interest in future

To Pay these interest, Govt will have to increase taxes in future

When govt will increases taxes in future, disposable income of people in future will reduce

Because disposable income will fall, consumption will also fall (as less amt will be available to be spent in future)

Less consumption will means less production in future and hence less GDP

Because GDP will fall, Savings of people will fall

So there will be less capital formation and less growth

hence, we can say Debt is a Burden on future generation

Why Govt Debt is Burden - Teachoo.JPG

Counterview - Govt Debt is not a Burden

Debt does not matter because we own it to ourselves

If Govt borrows from Public, it will have to pay interest to Public

This Interest will be Income of Public

Hence, disposable income of public will increase

Because income of people increases, they will save more for their future generations

Hence Increase in Public Saving will offset Increase in Govt disaving

hence, National savings will not change

This counter view is called Ricardian Equivalence

Counterview-Why Govt Debt Is not a Burden - Teachoo.JPG

What is Ricardian Equivalence?

It is an economic theory given by famous economist David Ricardo

As per this theory

Taxation and Borrowing are equivalent means of financing budget deficit

In case of budget deficit,

Govt can either increase borrowing which will be repaid by future generation by paying more taxes

or

Govt can increase taxes today and use the money to make more govt expenditure

 

If Govt increases borrowing today

It will lead to interest liability on govt

To Pay this int, Govt will increase taxes in future

People will expect that govt will raise taxes in future, so they will save more today by cutting their spending

 

If Govt Increases taxes today

Person's disposable income will reduce

Hence, they will be able to save less

However, Govt will be able to save more

 

In both cases, overall savings remain the same

What is Ricardian equivalence - Teachoo.JPG

Ricardian Equivalence Option-1 - Teachoo.JPG

Ricardian Equivalence Option-2 - Teachoo.JPG

Debt Does not Matter as we Own to ourselves.

Explain

If Govt takes debt from within the country (from public)

It does not matter

As Increase in Debt will lead to More Income and Savings for public

 

If Govt takes debt from outside country,

It matters as we have to pay interest to outside country

(it will be an expense for our economy and income for foreign country)

Debt Does not Matter as we Own to ourselves - Teachoo.JPG

Debt is a Burden if taken from Outside Country - Teachoo.JPG

NCERT Questions

Question 12

Does public debt impose a burden?

Explain.

View Answer

Other Books

Question 1

In the following questions, select the correct answers:

What is the theory of Ricardian Theory?

  1. It states that government debt creates a burden
  2. This states that government can either do borrowing or taxation and both have equal effect.
  3. According to this government debt leads to reduction in GDP.
  4. None of the above
View Answer

Are ads bothering you?


Transcript

Why Govt Debt is Burden Govt borrows today Pays interest in future Increase taxes to pay int in future Disposable income of people decrease Less consumption by people Less production Less income and less savings Less capital formation and less growth Burden on future generation Counterview- Why Govt Debt Is not a Burden Govt borrows from public Pays interest in future It will be income of public in future More savings of public National income remains same, So it is not a burden Note Increase in saving of public= Dissaving of govt This is called Ricardian Equivalence What is Ricardian equivalence? It is an Economic theory by David Ricardo As per this theory In case of budget deficit Govt can do either Taxation or Borrowing Both have equal effect Hence there are 2 Options With Govt in case of Budgetary Deficit Option 1 Increase Taxation Option 2 Borrowings Ricardian Equivalence Option 1 If Govt increases borrowing today More borrowing by Govt More interest to be paid by Govt To Pay interest Govt will Increase Tax People know about increased taxes People cut their spending People’s Income increases More tax to be paid Summary Govt can either increase borrowing which will be repaid by future generation by paying more taxes Ricardian Equivalence Option 2 If Govt Increases taxes today More taxes by Govt Less income left by People to spend People disposable income Reduced Less Saving by People But more saving for Govt due to increased taxes More Govt Expenditure Summary Govt can increase taxes today and use the money to make more govt expenditure Debt Does not Matter as we Own to ourselves. If Govt Takes Debt Within Country Indian Govt Borrowings Interest Indian Public Indian Govt Pays Interest Indian Public Receives Interest Money Remains within country No Effect on Economy Counterview- Debt is a Burden if taken from Outside Country Indian Go Borrowings Interest Foreign Country Indian Govt Pays Interest Exp Foreign Country Receives Interest Money flows outside country (Loss to Economy)

CA Maninder Singh's photo - Expert in Practical Accounts, Taxation and Efiling

Made by

CA Maninder Singh

CA Maninder Singh is a Chartered Accountant for the past 12 years. He also provides Accounts Tax GST Training in Delhi, Kerala and online.