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I. Introduction
Public debt, both internal and external, as a means of financing economic development assumes a significant role in modern times. In recent years,
Government's expenditure has been increasing faster than its ability to raise resources. It is so because now its activities are not so restricted as only to maintain law and order and protect the country against external aggression there have expanded intensively as well as extensively. Therefore, when expenditure exceeds revenue, these is a deficit in the budget of the government.
This deficit can be bridged either by raising revenue from taxation or by borrowing from the public or by depreciating the value of money in the hands of the people.
So far as taxation is concerned, both in developed and the developing countries, there are certain limits beyond which taxation cannot be raised without adverse effects on the levels of investment and production and consequently on the rate of economic growth.
Therefore, the most appropriate method, preferred by all the countries alike in mobilising their financial resources is the method of debt finance.
Meaning :-
Public debt is not fundamentally different from taxation. It may be defined as a kind of deferred tax through which public enjoys the advantages of the public expenditure much before it is met out of the current revenue. It refers to those obligations of the state as a borrower and private investor of capital where state promises to pay the lender the amount borrowed with interest after a given period of time. It excludes inter-state borrowing within the
country, unpaid salaries of public officials and pensions to be paid on retirement.
There have been different views regarding public debt. In the opinion of Hume and Adam Smith, debt was a cause in leading a nation towards disaster. A Government should normally meet all of its expenditure out of its current revenue and if really necessary, then only under certain exceptional circumstances, a government could be justified in raising some resources through loans.
Now-a-days public debt is regarded as income of the state. It is also a method through which the government may finance public services without
reducing the real wealth of individuals. It is comparatively a recent development.
The classical views on public debt:-
Public debt was favoured by the economists in the eighteenth century because they had great faith in the role of the state in the economic activities
and their favourable attitude towards public debt was a part of the Mercantilist doctrine. But in the laissez faire state of the nineteenth century and the early part of the twentieth century, public debt was condemned by the early classical economists mainly because of their lack of faith in the role of state in economic activities. Besides, Public spending was considered by them to be wasteful and unproductive. J.B. Say said, "There is this ground distinction between an individual borrower and a government borrowing that, in general, the later borrows capital for the purpose of barren consumption and expenditure." Obviously, in this
socio-political climate public finance had very little to do. Huge revenue were un-necessary for the conduct of minimum government functions-the policy of minimum spendings implied to policy of minimum taxation.
Subsequent thinkers like Malthus, Mills, Sidgwick and Cairnnes had some liberal views about the consequences of debt. But they were not whole
heartedly in favour of debt creation. The opposition to public debt was on the ground that public expenditure is wasteful and unproductive.
The classical theory of public debt came to be formulated in the last decades of the nineteenth century. H.C. Adams and C.F. Bastable who may
be taken to be the best representatives of the classical theory of public debt, refuted the idea that the burden of public debt cannot be shifted on the future generation.
Forms of Public Debt
Public debt may take various forms. Loans may be classified according to whether they are voluntary or compulsory, or according to use for which
they are intended, according to duration, or according to origin.
(1) Voluntary and Compulsory : In the case of voluntary loans, people are free to purchase government bonds if they choose to do so and there is no compulsion to lend money to the government. Normally, public debt is voluntary but during emergencies, the government compels the public to subscribe to forced loans. When emergencies such as war, famine, etc. arise,
government enforces borrowing through legal compulsion because voluntary loans fail to extract the required amount of funds for the purpose. A compulsory loan is also known as "refundable taxation" because on the one hand like a loan, government promises to repay the sum with little or no interest to the contributors and on the other hand, like taxation, it is a compulsory contribution to the government.
(2) Productive and Unproductive : Sometimes public debt is classified into productive and unproductive debt. Productive debt is that which is incurred for the purpose of constructing capital assets that yield a revenue to the government, for example expenditure on railways, irrigation, etc. The income thus yielded can be used to repay the debt and therefore, debt borrowed for such purposes is called a productive debt. On the other hand, public debt incurred to cover budgetary deficits on revenue account or for purposes which
do not yield any direct income to the government including capital expenditure that is not productive, such as construction of hospitals, school buildings or expenditure on poor relief, etc. is called unproductive debt.
But now-a-days The government never spends its revenue in a way which is unproductive from the social welfare point of view.
3) Redeemable and Irredeemable : On the basis of maturity pattern of a debt, public debt may be classified as redeemable and irredeemable. The
former is repayable at some definite future date. After the maturity period, the government pays the amount to the lenders. It is also known as a terminable loan. In the case of irredeemable debt, the principal is not repayable on any definite date, but the government may repay it at its will. However, interest on both types of debt is payable at the stipulated rate at stated intervals.
(4) Funded and Unfunded : The classification is based primarily on the duration of the debt. The public debt of the government, which is repayable
or redeemable usually after more than a year, is known as funded debt. Unfunded debt, on the other hand, is that public debt of a government which is repayable within year. The unfunded debts are commonly used for temporary purpose. They permit the government to secure funds at low rate of interest. Such securities are mostly purchased by banks and other financial institutions. They generally accelerate the rate of inflation in the economy.
(5) Internal and External : This is a classification according to the place or location of the loan. When public loan is subscribed entirely by the people of the country and the repayment is done in home currency, it is called internal debt. External debt is that debt which is borrowed by the foreign country (from individuals institutions or government). The repayment of external debt is usually done in foreign currency. Sometimes it may also be repayable in home currency.
Significance of Public Debt
The case for borrowing can be examined from two angles, the first relatesto the use of borrowing as a method of financing as compared to taxation and
the second relates to the choice of borrowing in preference to the other non-
tax sources, namely, the creation of money.
1. Taxes versus Loans
Most economists agree that, for its normal budgetary requirement a government should raise funds through taxes, because if it does not tax now, it will have to tax in the future. Meanwhile, a growing debt will shake people's confidence in its financial stability. Besides it, a public debt is usually subscribed out of savings, while a tax is likely to be met, partly or wholly, by reducing expenditure. Thus, in general, taxes reduce private expenditure while loans do not. If a government finances its entire expenditure through loans, there may be continuous under-saving and excess of expenditure by the people. This may lead to an artificial boom in which a low volume of savings available for investment will check production. Thus boom will get out of control and the State may be forced to tax to restore a balance between
savings and spendings. Therefore, it is desirable to meet expenditure of a normal recurring type through taxes.
The tax method reduces future income less than the loan method because under the tax method people generally reduce their expenditure. Taxation, relatively speaking, implies the shifting of income from the present to thefuture. On the other hand, borrowing implies the shifting of incomes from the future to the present. It may be desirable to alter the income streams to achieve stability over time. If present incomes are more because of a boom, then future incomes may fall when the boom is over. In such a case, the state
may use the tax method which will reduce present income. Thus, loans or taxes could be used as a counter-cyclical device to reduce the intensity of
economic fluctuations.
2)Choice between Borrowing and the Creation of Money
If new taxes are not supposed to be imposed, the government can raise funds through borrowing or creation of money. The latter method has two advantages; it has no contractionary effects, whatsoever and it does not give rise to interest charges or problems arising out of servicing and retirement of debt. Therefore, in periods of depression, in which non- tax methods are used
in order to lessen contradictory effect of the rising of funds, the case for creation of money is particularly strong. Borrowing is objectionable because it does exercise some contractionary effect, although such effect is much less
than in the case of taxation.
In full-employment periods, borrowing is always preferable to money creation, in depression periods, however, there is a stronger case for money creation and the use of borrowing will necessitate a large deficit to obtain a
given degree of recovery. If society accepts money creation as acceptable and there were no danger of irresponsible use of it, the case for it would be strong. Under the existing attitude, its advantages are weakened by the possibility of general loss in public confidence and subsequent misuse of the policy. Because of psychological factors, the central bank's borrowing form of money creation
is preferable to the printing of additional paper money.
Burden of Public Debt
The term burden of public debt is ambiguous. A distinction is generally made between financial or primary burden and real or secondary burden.
When a loan is obtained by the government the level of taxation in the economy has to be increased in order to meet the interest charges so long as the debt continues to exist. The income of the people is transferred to the government to the extent of the increase in the tax level. The consequent loss in the income of the people may be called the financial burden of the public debt.
The higher level of taxation caused by the rising public debt may have some repercussions on the economy in the form of adverse effects on the
capacity and willingness to save. These effects may be called the real burden or secondary burden of the public debt.
Effects of Public Debt
(i) Public Debt and Consumption: The existence of public debt has an important effect on consumption. Those who hold government bonds
representing the latters obligation to pay consider these bonds as personal wealth. This wealth would not have arisen if the government had financed its expenditure through taxation. The net result is that the possession of government bonds will induce them to speed not only their current
income but also in excess of their current income since they hold wealth.
(ii) Public debt and Liquidity: public debt is represented by bonds which are highly negotiable. Those who have bonds have highly negotiable and highly liquid form of assets.
(iii) Public Debt and Production: Public debt is generally favourable to promote production, income and employment. But the fear created by plausible higher does of taxation or even capital levy in future to repay the public debt may
discourage the investors.
(iv) Public Debt and Distribution of Income:Public debt is said to promote inequality in the distribution of income. It is held that a large amount of public debt increases inequality of income distribution in favour of the bond holders.
Since bond holders are generally rich, this leads to move inequality in distribution in income.
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