Economics, 3rd Edition

Argument 2: The Government Should Not Balance its Budget 

The problem of government debt is 

often  exaggerated. Although government debt does represent a tax burden on younger generations, it 

is often not large compared with the average person’s lifetime income. Often, the case for balancing the 

government budget is made by confusing the economics of a single person or household with that of a 

whole economy. Most of us would want to leave some kind of bequest to friends or relatives or a favourite 

charity when we die – or at least not leave behind large debts. But economies, unlike people, do not have 

finite lives – in some sense, they live forever, so there is never any reason to clear the debt completely.

Critics of budget deficits sometimes assert that the government debt cannot continue to rise forever, 

but in fact it can. Just as a bank evaluating a loan application would compare a person’s debts to his 

income, we should judge the burden of the government debt relative to the size of the nation’s income. 

Population growth and technological progress cause the total income of the economy to grow over time. 

As a result, the nation’s ability to pay the interest on the government debt grows over time as well. Really, 

we should not be looking at the total amount of debt but at the ratio of debt to income. As long as this is 

not increasing, then the level of debt is sustainable. In other words, as long as the level of government 

debt grows more slowly than the nation’s income, there is nothing to prevent government debt from grow-

ing forever. Some numbers can put this into perspective. Suppose the output of the economy grows on 

average about 3 per cent per year. If the inflation rate averages around 2 per cent per year, then nominal 

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800  PART 15  INTERNATIONAL MACROECONOMICS

income grows at a rate of 5 per cent per year. Government debt, therefore, can rise by 5 per cent per year 

without increasing the ratio of debt to income.

Moreover, it is misleading to view the effects of budget deficits in isolation. The budget deficit is just 

one piece of a large picture of how the government chooses to raise and spend money. In making these 

decisions over fiscal policy, policymakers affect different generations of taxpayers in many ways. The  gov-

ernment’s budget deficit or surplus should be considered together with these other policies. For example, 

suppose the government reduces the budget deficit by cutting spending on public investments, such 

as education. Does this policy make young generations better off? The government debt will be smaller 

when they enter the labour force, which means a smaller tax burden. Yet if they are less well educated 

than they could be, their productivity and incomes will be lower. Many estimates of the return to schooling 

(the increase in a worker’s wage that results from an additional year in school) find that it is quite large. 

Reducing the budget deficit rather than funding more education spending could, all things considered, 

make future generations worse off. A distinction has to be made between borrowing to finance invest-

ment, which helps boost the future productive capacity of the economy and borrowing to finance current 

government expenditure (on things such as wages for public sector workers).

The qualification that the government budget on current expenditure will be balanced on average over 

the business cycle allows for the effect of automatic stabilizers, such as the increase in welfare expendit-

ure and reduction in tax revenue that automatically occur in a recession (the opposite in a boom) and so 

helps flatten out economic fluctuations. Allowing a budget deficit on investment expenditure is sensible 

because, although it leads to rising public debt, it also leads to further growth opportunities through 

spending on education, roads and so on. Just asserting that the government should balance its budget, 

irrespective of the economic cycle and irrespective of what kind of expenditures it is making, is overly 

simplistic.