Public Sector Finances

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Government Spending (Expenditure) - National Debt

The main categories that make up government spending are national defence, social security, health programs and interest payments.

The national debt refers to the total amount the government has borrowed over time.
The budget deficit refers to how much has been borrowed in a particular year.
- E.g. In 2018, the UK national debt was £1.9 trillion.
- The amount being added to the national debt is the budget deficit (of c.£47 billion).

If the markets view the country’s national debt as unsustainable, then demand for government debt will fall. So the cost of borrowing will rise.
High repayments on the national debt (principal and interest) have a significant 'opportunity cost'. This is money which could be spent on health, education, etc.
There is also a question of intergenerational fairness: will future generations have to face increased taxes to pay off the debt being built up now?

The key measure is national debt as a % of GDP, rather than debt as a raw figure. This is over 100% in some countries.
Key factors to consider when considering whether this is a concern or not are:
- Has the money borrowed gone to current or capital spending (such as spending on infrastructure)? The latter would contribute more to future economic growth.
- What is the rate of interest on the borrowing?

The main categories that make up government spending are national defence, social security, health programs and interest payments.

When a government receives more money in taxes than it spends in a year, it runs a surplus.
When the government spends more money that it receives in a year, it runs a deficit.
If government spending and taxes are equal, it runs a balanced budget.

A cyclical budget deficit is the budget deficit that arises because of the stage of the economic cycle an economy is at, rather than underlying problems.
A key cause is the role of automatic stabilisers:
- In a recession, an economy’s budget deficit rises because unemployed people pay less income tax and consume less, reducing indirect taxes such as VAT. They also receive more welfare payments through housing benefit, income support, etc.
- So, government spending (G) automatically rises and government revenue through taxes (T) automatically falls.

A structural budget deficit is defined as the part of the budget deficit that still exists when the economy is growing at the trend rate of economic growth.
This could be because of something structurally wrong with the economy - e.g. tax collection systems could be fundamentally weak, tax evasion and avoidance could be high, or there could be an overly generous welfare system.
So a structural budget deficit would be more of a concern for the government.

If the government is spending, is it helping the private sector gain confidence to spend (this is known as crowding in).
If, on the other hand, the higher borrowing the government is having to do is creating competition for loans with the private sector, this could lead to higher interest rates for the private sector too. This may put off certain private sector investment (known as financial crowding out), which would dampen any increase in aggregate demand (AD).

Automatic stabilisers are tax and government spending measures that automatically dampen a boom and increase demand in a recession.

In a recession, more people will become unemployed and corporate profits are likely to fall.
Because of this, a government's income tax and corporation tax receipts will fall.
At the same time, unemployment benefits and welfare payments are likely to increase.
These are automatic stabilisers that increase G (government spending) and decrease T (taxation) in a time of falling demand.
Automatic stabilisers should offset some of the volatility in economic cycles.
In a time of economic growth, more taxes are paid to the government, slowing GDP growth and moderating the economic prosperity.

Discretionary fiscal policy is tax and government spending programmes that affect AD, but are not automatic stabilisers.
A government may increase the VAT rate on consumption from 10% to 30%, but this is independent of the cycle. In 2009, the Labour government cut VAT to try to stimulate demand.
A decision to increase G (government spending) on the NHS, police force or intelligence services would be examples of discretionary fiscal policy.
HS2, which is expected to be a £56bn project, improves the UK's rail infrastructure. This is an example of a discretionary fiscal policy.