On the proper use of public debt
By Jason Gay
If the argument of the previous papers is understood simply as “government debt is bad”, then it has been misunderstood.
There are circumstances in which public borrowing is not merely defensible, but prudent. Governments must be able to respond to events that cannot reasonably be funded from the revenue of a single year. War, severe recession, natural disaster and other national emergencies can produce costs far beyond the ordinary capacity of a Budget. A government that refused to borrow under such circumstances might preserve the appearance of fiscal discipline while allowing far greater damage to the country it was meant to protect.
The difficulty is therefore not the existence of debt. It is the gradual loss of any meaningful distinction between exceptional borrowing and ordinary borrowing.
A useful fiscal system must begin by recognising that debt has a legitimate place, while also refusing to treat it as another ordinary source of revenue.
During a severe economic downturn, for example, government revenue tends to fall at precisely the moment that demands upon government increase. Unemployment may rise, business activity may contract and households may require additional support. Attempting to balance the Budget immediately by cutting spending or raising taxes can deepen the downturn. In such circumstances, borrowing allows government to spread the financial cost of the crisis across a longer period rather than concentrating it at the moment the economy is least capable of carrying it.
The same argument applies more strongly to war or major national disaster. There are moments when the immediate preservation of life, security and economic stability must take priority over normal financial rules. Any fiscal constitution that failed to recognise this would risk becoming not disciplined, but foolish.
Yet the existence of legitimate exceptions creates an obvious danger. If the definition of emergency is loose enough, the exception soon becomes the rule. Every government faces political pressures that can be described as urgent. Every Budget contains worthy causes. Every election produces promises that somebody considers essential. A system that permits borrowing whenever a government sincerely believes additional spending is important would differ very little from the system we already have.
The purpose of an independent fiscal framework would therefore not be to prevent borrowing, but to restore a presumption against ordinary borrowing.
Government should be required to explain why debt is necessary rather than merely why the expenditure itself is desirable.
That distinction is more important than it first appears. Many government programs are worthwhile. Many would improve somebody’s life. Many would produce benefits greater than their direct financial cost. None of those facts necessarily establishes that the program should be funded with debt.
The question is not simply whether something is good. The question is whether future taxpayers should be required to help pay for it.
This becomes more complicated when borrowing finances an asset that will itself serve future taxpayers. A railway, dam, port or other major piece of infrastructure may remain in use for generations. There is an intuitive fairness in allowing some of its cost to be spread across the people who will benefit from it. Borrowing for such an asset is different in character from borrowing to finance the ordinary administration of government.
But even here, caution is required. Governments are capable of building expensive assets that deliver poor returns. The fact that an expenditure produces concrete, steel or kilometres of rail does not automatically make the borrowing responsible. Long life does not guarantee high value.
The proper case for infrastructure borrowing therefore rests on more than the existence of an asset. It rests on the quality of that asset, the expected duration of its benefit, the government’s ability to service the debt and the opportunity cost of committing future revenue to interest and repayment.
There is another principle that deserves greater attention: debt should have an intended end.
When governments borrow during extraordinary periods, the return to ordinary conditions should also begin a return to ordinary fiscal rules. This need not mean rapid austerity or arbitrary repayment targets. A large emergency debt may properly take a decade or more to reduce. But there should be some recognised obligation to rebuild the national balance sheet once the emergency has passed.
Without that obligation, extraordinary debt simply becomes part of the permanent financial landscape. The circumstances that justified it disappear, but the liability remains.
This is one reason I am reluctant to treat the size of public debt only as a percentage of GDP. That measure is important because a growing economy may be capable of carrying a larger nominal debt. But the fact that a country can carry more debt does not establish that it should continually choose to do so.
Debt servicing still claims future revenue. Interest still competes with hospitals, defence, education, tax relief and every other future priority. A nation may be perfectly capable of servicing a debt while still being less free because of it.
The discipline proposed in these papers is therefore not a prohibition on borrowing. It is a return to purpose.
Borrow when the circumstances genuinely justify it. Borrow where intergenerational fairness supports it. Borrow when failing to act would impose a greater cost than the debt itself.
But do not borrow simply because choosing between competing priorities is politically difficult.
A mature fiscal system should be able to distinguish between borrowing because we must and borrowing because we would rather not say no.
That distinction is where responsibility begins.
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