Dealing with the debt stock

The US debt ceiling dialogue between President Joe Biden and House Speaker Kevin McCarthy remained inconclusive, and an agreement looked elusive at the time of writing of this column. Treasury Secretary Janet Yellen has warned that the US government will be unable to pay its bills from June 1. Although the debt ceiling is a self-imposed restriction on how much the US government can borrow — the ceiling currently is about $31.4 trillion — the possibility of missing the deadline to increase the limit could inflict serious economic costs, not only for the US but also the world. The US economy is anyway slowing and uncertainty over the government’s ability to spend, or a significant reduction in spending over the medium term as a compromise to lift the ceiling, will affect output.

Although chances are low, the possibility of an outright debt default by the US government can lead to unimaginable consequences. The US government bonds are viewed as the safest in the world. A default would thus result in panic selling in financial markets, with longer-term consequences. In fact, given the kind of needless risk the whole debt ceiling spectacle has created, large investors, including central banks, may be forced to rethink their investment assumptions. A potential rating downgrade, though its chances are again slim, could take a lot of funds off the table. Where this money will potentially go is another discussion.

However, for the moment, it is also worth noting that the debt ceiling is not the only problem on the fiscal front for the US. The level of the Budget deficit has increased structurally, which will have wide consequences, both for the US and the global economy. According to the Congressional Budget Office (CBO), the US federal Budget deficit will average 6.1 per cent of gross domestic product (GDP) over the coming decade, compared to an average of about 3.6 per cent in recent decades. What this essentially means is that the US government would corner a significantly large amount of savings and leave so much less for others. Further, sustained higher borrowing by the US government is likely to result in higher interest rates. Both the availability and cost of money in the US could thus affect capital flows to emerging market economies, with implications for growth and financial stability.

According to the International Monetary Fund’s (IMF’s) projections, the general government debt in the US is likely to increase from 122.2 per cent of GDP in 2023 to 136.2 per cent by 2028. For comparison, the level was at 107.4 per cent of GDP in 2018. This sharp elevation in public debt would significantly increase interest payments, particularly when interest rates may remain comparatively high even if the rate of inflation moderates. However, the US is not alone in this context. The global public debt is projected to increase to about 100 per cent of GDP by 2028, compared to about 83 per cent in 2018. Debt levels were pushed up sharply by the pandemic in most countries. Global public debt as a proportion of GDP increased by over 15 percentage points in 2020. What this means is that while the output may have recovered from the shock, the pandemic will continue to cost in terms of higher interest payments and lower growth.

India has also witnessed a significant increase in public debt. The general government debt is expected to remain above 83 per cent of GDP till at least 2028. However, the impact could be deeper than in advanced economies, primarily because of the difference in government revenue. According to numbers compiled by the IMF, government revenue as a percentage of GDP in India was 20.16 per cent in 2021. The comparable number for the US was 31.46 per cent. Lower revenue, sustained higher general government deficit, along with an elevated level of debt stock, would make managing public finances more difficult. It is also worth underscoring here that competitive populism will only make things worse.

The government thus will need to work on both rationalising expenditure and raising revenue. There is, in fact, considerable scope for improvement in both indirect and direct tax collections. On the indirect tax side, the much-needed rationalisation of rates and slabs in goods and service tax is still pending. Although the collections have improved, GST has largely underperformed because of complexities that must be addressed as soon as possible. On the direct tax side, the government introduced changes in capital gains tax this year, which should help. It is also nudging taxpayers to go for the exemption-less option to make the system more efficient. But more efforts will need to be made to check evasion. It appears that far too many people are escaping the tax net. Economist Ravindra H Dholakia showed in a recent Economic & Political Weekly article that about 40 per cent of personal income is evading tax. Thus, there is significant scope for bringing more people and income into the tax net through better tracking and the use of technology. Without increasing the tax base, it would not only be difficult to bring down debt and deficit, but the government’s ability to invest in capacity building will also remain severely constrained.