Days before the US government could start to run out of money and default on its debt, Congress has approved a deal to lift the country’s borrowing limit.US President Joe Biden and Republican House Speaker Kevin McCarthy hammered out the agreement after weeks of high-stakes budget negotiations to prevent global financial crisis. This ended the month long drama in world financial domain. But it raises several question in the mind of a common man. Few example are, why government take debts? Why not they simply print money and spend? What is the impact of government borrowing on a common man? Why there is a limit being imposed on government borrowing? And so on… We will try to answer few question here in this article.
Why government borrow?
Government borrow when the expenditure of a government is more than the revenue generated by the government in a given fiscal year. And this is known as fiscal deficit. So the fiscal deficit is the difference between the total revenue and total expenditure of a government in a financial year. Fiscal deficit happens due to events like a major rise in capital expenditure or deficit arising from revenue. It serves as an indicator of how well the government is managing its finances.A situation of fiscal deficit prompts governments to indulge in welfare activities for the nation without any need to raise taxes.This concept is about the fiscal deficit that plays an important role in the economy of a nation. It can occur due to a major rise in the capital expenditure required for creating long term assets or providing financial assistance to poor farmers, labourers and other vulnerable sections of the society. The government finances these deficits by borrowing money from the capital markets. They can do this by issuing bonds or from the central bank.A high fiscal deficit every year hints that the government has been spending beyond its means. Economists need to keep an eye on the fiscal deficits to determine how much the government is exceeding its income.
How is Fiscal Deficit Calculated?
Fiscal deficit is calculated by subtracting the total revenue obtained by the government in a fiscal year from the total expenditures that it incurred during the same period.
Mathematically, it can be represented as follows:
Fiscal deficit = Total Expenditure – Total revenue (Excluding the borrowings)
Fiscal deficit is seen in all the economies, while the surplus is considered a rare occurrence. A high fiscal deficit is not always considered bad for the economy. It is good if the amount is used in constructing roads, railways, airports, etc. These help in generating revenue for the government after a certain period.
For example, if the GDP of a country is ₹100 lakh crore and the difference between total income and expenditure is ₹10 lakh crore then the fiscal deficit is 10%.
What are the Components of Fiscal Deficit?
The fiscal deficit is composed of two components, namely income and expenditure. The components are discussed in brief in the following lines:
Components of total income of the government
These consist of two variables, which are revenue generated from various taxes such as GST, taxes from union territories, custom duties, corporation tax, etc. They are collected by the centre and the non-tax revenues that consist of dividends and profits, interest receipts, and other non-tax revenues.
Components of expenditure:
The government expenditure consists of capital expenditure and revenue expenditure such as salary and pension payments, grants for creation of capital assets, infrastructure, healthcare, and interest payments.
Fiscal deficit is calculated as a percentage of the GDP (gross domestic product).
How does the government balance the fiscal deficit?
Governments take borrowings in the form of issuing bonds and selling them through the banks. Banks buy those deposits and then sell them to the investors. Government bonds are considered a safe form of investment. Hence, they are free from risks.
What are the impacts of fiscal deficit on economy?
A high fiscal deficit can lead to inflation, devaluation of the currency and an increase in the debt burden.While a lower fiscal deficit is seen as a positive sign of fiscal discipline and a healthy economy. Fiscal deficit is having both positive and negative aspects.
Positive Aspects of Fiscal Deficit:
Increased Government Spending: Fiscal deficit enables the government to increase spending on public services, infrastructure, and other important areas that can stimulate economic growth.
Finances Public Investments: The government can finance long-term investments, such as infrastructure projects, through fiscal deficit.
Job Creation: Increased government spending can lead to job creation, which can help reduce unemployment and increase the standard of living.
Negative Aspects of Fiscal Deficit:
Increased Debt Burden: A persistent high fiscal deficit leads to an increase in government debt, which puts pressure on future generations to repay the debt.
Inflationary Pressure: Large fiscal deficits can lead to an increase in money supply and higher inflation, which reduces the purchasing power of the general public.
Crowding out of Private Investment: The government may have to borrow heavily to finance the fiscal deficit, which can lead to a rise in interest rates, and make it difficult for the private sector to access credit, thus crowding out private investment.
Balance of Payments Problems: If a country is running large fiscal deficits, it may have to borrow from foreign sources, which can lead to a decrease in foreign exchange reserves and put pressure on the balance of payments.
What is Difference between the Deficit and the Debt?
The terms deficit and debt are frequently used when discussing the nation’s finances and are often confused with one another.
To pay for a deficit, the government borrows money by selling Treasury bonds, bills, and other securities. The national debt is the accumulation of this borrowing along with associated interest owed to the investors who purchased these securities. As the government experiences reoccurring deficits, which are common, the national debt grows.
Deficits from previous years are added to the current year’s deficit to equal total debt. In reality, the government must pay interest on the national debt. This interest expense increases spending each year, increasing spending (and thus, deficits) as the debt grows.
Now let’s talk about US debt ceiling and the most talked crisis.
What is US Debt ceiling and why it has been imposed?
The U.S. has carried debt since its inception. Debts incurred during the American Revolutionary War amounted to over $75 million by January 1, 1791. Over the next 45 years, the debt continued to grow until 1835 when it notably shrank due to the sale of federally-owned lands and cuts to the federal budget. Shortly thereafter, an economic depression caused the debt to again grow into the millions. The debt grew over 4,000% through the course of the American Civil War, increasing from $65 million in 1860 to $1 billion in 1863 and around $2.7 billion shortly after the conclusion of the war in 1865. The debt grew steadily into the 20th century and was roughly $22 billion after the country financed its involvement in World War I.
Notable recent events triggering large spikes in the debt include the Afghanistan and Iraq Wars, the 2008 Great Recession, and the COVID-19 pandemic. From FY 2019 to FY 2021, spending increased by about 50%, largely due to the COVID-19 pandemic. Tax cuts, stimulus programs, increased government spending, and decreased tax revenue caused by widespread unemployment generally account for sharp rises in the national debt.To pay for government programs while operating under a deficit, the federal government borrows money by selling U.S. Treasury bonds, bills, and other securities. The national debt is the accumulation of this borrowing along with associated interest owed to investors who purchased these securities.
Fiscal Surplus/deficit of United State (in trillion U.S. dollars)
In the last 50 years, the federal government budget has run a surplus five times only, most recently in 2001.
The above fiscal deficit has created a huge debt burden on the United State.
Comparing a country’s debt to its gross domestic product (GDP) reveals the country’s ability to pay down its debt. This ratio is considered a better indicator of a country’s fiscal situation than just the national debt number because it shows the burden of debt relative to the country’s total economic output and therefore its ability to repay it. The U.S. debt to GDP ratio surpassed 100% in 2013 when both debt and GDP were approximately 16.7 trillion.
When adjusted for inflation, the U.S. federal debt has steadily increased since 2001. Without adjusting for inflation, the U.S. federal debt has steadily increased since 1957. Another way to view the federal debt over time is to look at the ratio of federal debt related to GDP. This ratio has generally increased since 1981.
Considering the pros and cons of fiscal deficit the debt ceiling, or debt limit, is a restriction imposed by the U.S. Congress in 1917 on the amount of outstanding national debt that the federal government can have. The debt ceiling is the amount that the Treasury can borrow to pay the bills that have become due and pay for future investments. Once the debt ceiling is reached, the federal government cannot increase the amount of outstanding debt, losing the ability to pay bills and fund programs and services. However, the Treasury can use extraordinary measures authorized by Congress to temporarily suspend certain intra governmental debt allowing it to borrow to fund programs or services for a limited amount of time after it has reached the ceiling.
The debt ceiling is different from a government shutdown. Government shutdowns occur when annual funding for ongoing federal government operations expires, and Congress does not renew it in time.
The U.S. government has created the Bureau of the Fiscal Service in 2012 (to be operated under the Department of the Treasury) to manages all federal payments and collections and provides government-wide accounting and reporting services. A primary function of the Fiscal Service is to account for and report the national debt, as dictated by the U.S. Constitution, which states that “regular Statement and Account of the Receipts and Expenditures of all public money shall be published from time to time.
Raising or suspending the debt ceiling becomes necessary when the government needs to borrow money to pay its debts. For much of the past century, raising the ceiling has been a relatively routine procedure for Congress. Whenever the Treasury Department could no longer pay the government’s bills, Congress has acted quickly and sometimes unanimously to increase the limit on what it could borrow. Since 1960, Congress has increased the ceiling seventy-eight times, most recently on June 2023
In January 2023, the total national debt and the debt ceiling both stood at $31.4 trillion. The U.S. government has run a deficit averaging nearly $1 trillion every year since 2001, meaning it spends that much more money than it receives in taxes and other revenue. To make up the difference, it has to borrow to continue to finance payments that Congress has already authorized.Even short of default, hitting the debt ceiling would hamstring the government’s ability to finance its operations, including providing for the national defence or funding entitlements such as Medicare or Social Security.Potential consequences of reaching the ceiling include a downgrade by credit rating agencies, increased borrowing costs and a drop off in consumer confidence that could shock the United States’ financial market and tip its economy and the world’s into immediate recession.Since the United States has never defaulted on its obligations, the scope of the negative repercussions related to a default are unknown but would likely have catastrophic consequences in the United States and in markets across the globe.
On 3rd June 2023 the debt ceiling has been elevated. Thank God! They have not defaulted.