The Great Recession led to a significant increase in the levels of unemployment, even as the individual aggregate income slumped to an all-time low. As a product, there was a steep decline in tax remittances to the government. Faced with the challenge of stabilizing the national economy, the U.S government was forced to increase its borrowing as a way of cushioning the shortfall in tax collection. Consequently, there was a corresponding swell in the already high national debt. In the United States, congressional Republicans are already opposed to the Obama administration’s desire to increase the country’s borrowing limit devoid of any concessions. Already, the country is burdened with a $16.7 trillion debt (Philips, 2013), a situation that the Republicans feel will further weigh down on the nation’s quest for job creation and economic growth.
Different theoretical views on national debt
Some economists argue that increased national debt and the resultant need for increased government borrowing means that the government is actually competing with the private sector in terms of borrowing money. The ensuing contest leads to increased interest rates. Consequently, an increasingly larger number of businesses are unwilling to invest owing to limited financing (Philips, 2013). This then leads to reduced hiring and increased unemployment.
Other economists theorise that the national debt tends to have a psychological impact on investments. Increased government borrowing is likely to result in reduced expenses and elevated saving by enterprises and consumers. This is because businesses and consumers anticipate that the government may increase taxes as it tries to offset the national debt. Businesses stop to expand and employ additional employees out of fear that the government will impose additional taxes on their profits. However, this theory has been watered down by other economists who argue that interest rates have largely remained historically low for the last six decades, in spite of the increases in national debt.
Long-run costs of high national debt
High national debt has its consequences on the economy. One of these consequences is the high interest cost that it attracts (Peter G. Peterson Foundation, 2012). A high national debt means that high interest has to be paid out. This will markedly reduce government revenue, meaning that the government has limited resources to invest in crucial areas like infrastructure, education, skills training, and research and development (R & D).
Long-term debt could also end up jeopardizing the existing government programs. For example, in case the government is faced with a fiscal crisis, it might be forced to institute huge budgetary cuts to crucial programs as a way of financing existing debts in order to remain solvent (Peter G. Peterson Foundation, 2012). This could affect important government programs like Medicare, Social Security, and Medicaid.
High national debt could also end up causing a serious economic slowdown (Furth, 2013). This will in turn lead to lowered income and a resultant reduction in the government’s revenue collection.
Costs of eliminating the national debt
To eliminate the national debt, the government has two options. First, the government can decided to increase personal tax. Secondly, the government can embrace a cost cutting measure by way of decreasing transfer payments to important government-funded programs like Medicare and Social Security or to reduce discretionary spending.
However, each of these strategies comes at a cost. To start with, increasing personal tax will likely lead to a significant decline in economic growth in that taxpayers will have fewer incentives to work, invest, and save. Specifically, increased personal taxation denies the economy the investment capital it yearns for in order to recover. Since majority of the small businesses contribute towards individual income tax, it would thus be very hard for them to invest, hire, or even remain in business (Riedl, 2010). Wealthier individuals are likely to put their wealth out of reach of the new taxes, as opposed to areas that would lead to increased economic productivity.
Transfer payments refer to the payments that the household sector receives from the federal government without any productive activity expected in return. Examples of the three main transfer payments are Social Security, Medicaid, and Medicare. A contractionary fiscal policy entails a reduction in payment schedule of several or one of the above transfer payments. For example, the federal government may decide to reduce the monthly payout to all its Social Security recipients by $ 100 as part of its cost cutting measures. Such a reduction in transfer payment undoubtedly causes a reduction in the disposable income of a household (The Heritage Foundation, 2015). Consequently, consumption expenditure also reduces, in effect resulting in less aggregate employment and production. Ultimately, this results in a reduction in inflationary pressures (Andolfatto, 2008).
Discretionary spending involves budget cuts to certain key government dockets such as the defense and education departments. Policy-makers have time and again targeted discretionary spending while reducing the national debt or cutting the federal government’s budget deficit. However, cutting back on discretionary spending has a limited impact of reducing the national debt as transfer payments, as the latter account for nearly 100 percent of the federal government’s spending growth.
Andolfatto, D. (2008). Macroeconomic Theory and Policy (2nd Edition). Retrieved
Furth, S. (2013). High Debt Is a Real Drag.
Peter G. Peterson Foundation. (2013). Why Long-Term Debt Matters.
Philips, M. (2013). Debt, Deficits, and Jobs. Where’s the Link?
Riedl, B.M. (2010). Obama Budget Raises Taxes and Doubles the National Debt.
The Heritage Foundation. (2015). Cut Spending, Fix the Debt, and Reform